Consequences of Modern Monetary Theory for cryptocurrencies and taxation

At the 2022 All-Actuaries Summit, Anthony Asher presented on the consequence of Modern Monetary Theory (MMT) for cryptocurrencies and taxation. His concurrent presentation was centred around three key areas: The background of MMT, how it applies to current topics, and how to manage the impacts.

What is Modern Monetary Theory?

As a refresher on economics, MMT looks at the Government’s inability to go bankrupt by printing money or deficit spending. This does not necessarily mean that the currency has value and is not the same as the Government funding itself by issuing bonds. In effect, the Government can create money simply by printing it.

However, it is not just the Government that creates money, but also the banks through the demand of customers for loans. Money is created by banks issuing loans (rather than by taking deposits), that is, at the point a loan is created (for example $100), they give a customer a loan of the value ($100) and a deposit of equal amount ($100) which is the money created. The customer can then transfer that deposit to someone else, and so on as it moves around the economy. The amount of bank created money is about four times greater than Government created money at any one time. Governments can also control the amount of money that banks create using various ‘macro-prudential’ tools.

Anthony Asher speaks during his presentation at the 2022 All-Actuaries Summit.

Because the Government can print money at any given time, if there are underutilised resources in the economy, they can buy them up. This means that if there is unemployment, the Government can create jobs. MMT argues this as a leading expenditure item by the Government – that they should be spending money on things that otherwise wouldn’t happen. Further, they argue that too much Government spending causes inflation, puts pressure on the exchange rate, and may crowd out the private sector, leaving too few resources in private hands.

Inflation, however, is not just caused by the printing of money by Governments but can also come from various other sources including supply shortages and competition between different sectors, such as companies raising prices to increase profit, or unions or managements pushing up their own wages. When managing inflation, each source should be individually targeted, rather than the collective impact.

Another way the government can reduce the supply of money in the economy is through taxation. According to Beardsley Ruml (1946 Chair of the New York Federal Reserve Bank), the four purposes of taxation are:

  1. To stabilise purchasing power and take money out of the economy when there is too much demand.

  2. To express public policy in the distribution of wealth and income.

  3. Subsidising or penalising industries and economic groups, such as tobacco and carbon tax.

  4. User charges, for example on toll roads and social security.

Cryptocurrencies and inflation

Cryptocurrencies can be split into two categories – those which are asset-backed which are akin to mutual funds or banks, and those that are limited issue fiat ‘currencies’. The presentation focused on the latter.

These ‘currencies’ are not backed by an asset, not legal tender, and are not particularly liquid – which is why a large portion of the money made in the crypto space is from those who are transacting it and earning ‘gas’ fees (fees for transactions). They are also not required to pay taxes, and thus, don’t have the four important elements of normal currency.

However, as they have value, they can contribute to demand push inflation (such as house price inflation with overnight crypto millionaires buying mansions). The value of the currency is generated by the ‘belief’ in the cryptocurrency:

  • They grow in value while the ‘crypto’ community grows and invests more.

  • They decline in value as the community shrinks and disinvests.

  • They will collapse if there is uncontrolled fraud.

The value of cryptocurrencies depends on whether the belief exists, if the arguments of MMT are correct.

Quantitative easing and inflation

Priming is the process where the Government spends more than it collects in taxes and quantitative easing occurs when it issues bonds of varying durations which the Central Bank buys. The Central Bank increases their price and increases private deposits. The hope is that the higher asset prices and lower interest rates will stimulate spending.

Because the government currently has a deficit, the private sector has more money (surplus) which is used to buy other assets – as demand for these assets increase, so does the price. This process of quantitative easing has been successful in driving up asset prices, which can be seen through globally higher housing prices and cryptocurrency bubbles.

However, the Central Bank mismatches make it difficult to change the interest rates without going bankrupt (for example in the US where 25% of the Federal Reserve’s assets are 30-year agency mortgages). MMT says this approach to stimulating the economy is too general – pumping money into it and hoping for second and third order effects that cause people to invest in the economy. MMT’s preferred approach is targeted spending to provide full employment and meet needs that can be met within real resource constraints.

Managing inflation

To reduce inflation, MMT suggests avoiding excessive demand by aiming for balanced budgets over the cycle. In addition, one can introduce a competition policy to avoid price gouging, set wage restraints to reduce pressure, and increase reserve requirements to limit banks from offering excess borrowing.

Will higher interest rates reduce inflation?

A common idea on managing inflation is to increase interest rates. However, interest rate increases won’t necessarily reduce inflation.

If it arises from higher commodity prices due to supply constraints No

If it transfers money from spenders to savers:

Potentially

 – If the Government is a major borrower

No

 – If Australians are net overseas borrowers

Yes

 – If most borrowers are liquidity constrained younger people

Yes

 – To the extent that most savers are pensioners who spend their interest income

No

 – If higher interest rates discourage investment

Yes

If the main effect is to push borrowers into insolvency and disrupt the economy (along with their lives!)

Yes

Using taxation to manage inflation

So, how can taxation be used to reduce inflation? The short answer is that it is difficult, and it depends on the type of tax that is increased. Taxes may reduce demand but often have negative consequences. An example of this is personal income taxes, which means that while inflation is managed by reducing peoples’ ‘net’ income, it means that people are overall worse off. Likewise, increasing GST will increase prices and only indirectly manages inflation. Land Tax, however, can reduce inflation, as it cannot be escaped (not subject to capital flight).

Another way that taxation can be used to manage inflation is by taxing capital gains on properties. As a starting point, if realised capital gains taxes are increased, then tax revenue should also be higher. However, this doesn’t seem to be the case, as the tax only applies at point of sale, which people are not doing. The suggestion is therefore to introduce a small tax (say 3%) on unrealised capital gains.

The introduction of this unrealised capital gains tax has the potential to have very positive impacts. For example, over the last 20 to 30 years landlords in Australia (including those with investment properties) have about $2 trillion of capital gains unrealised. Introducing a tax on unrealised capital gains brings forward the tax that people would pay eventually and will help to balance the Government deficit (which is currently around $70 billion). In addition, this tax would help control excess house price growth – some people won’t be able to afford the tax and so they will have to sell their assets, resulting in housing prices coming down. This would need to be carefully managed, including the introduction of a robust and fair method of valuing unlisted assets.

There are problems presented with inflated asset prices, including the risk of speculative and Ponzi borrowing. In addition, while it can increase consumption and investment, higher house prices are disruptive and reduce the standard of living of young families and renters. In particular, renters need to pay more rent, and buyers need to save more money and are faced with large mortgages. For families, this has a stress impact which is measurable, seen in the correlation between higher house prices and lower fertility rates.

Policy suggestions

Suggestions to manage the problem of inflation include considering Government policy. Rather than sacrificing inflation for lower unemployment, the Government can directly address long term unemployment through job guarantees. Another suggestion is to penalise companies whose operations are detrimental to the environment. This can be done through taxes on environmental harms, such as carbon emissions and waste by-products. Currently, no party in Australia has this as an agenda item, compared to the half of OECD countries successful in reducing carbon emissions through taxing it. Finally, macro-prudential oversight such as APRA and the RBA should make controlling house prices apart of their agenda to avoid further price increases for the foreseeable future. Similarly, there should be oversight of new credit technologies to ensure they are regulated (such as cryptocurrencies).

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