Editors’ Note: One of the first major book reviews undertaken at the Prickly Pear, was a critical assessment of Modern Monetary Theory, which we found not really modern and hardly a theory. It is just a clever academic excuse for the old principle of the government paying for its expenses by printing excessive quantities of money, and depreciating the value thereof. It has happened many times in history, and why academics insist we repeat the mistake over and over again remains a mystery. However, inflationary policies should be more than just an academic debate. The destruction of the savings of millions of people is not only quite harmful to the people directly but very harmful to society and the political structure. It almost always results in significant social revolution, often ending in rebellion and violence. If the government is to be allowed the monopoly power to issue money, then government must issue honest money, that is money that holds its value over long periods of time and that is neutral in its social effects. It should not favor debtors over creditors, spenders over savers, and the rich over the poor. It should be as much as possible, a stable and neutral factor, allowing long-term contracts and long-term productive endeavors to be financed, without the incessant bursts of wild speculation that are a fundamental hallmark of inflationary policies. One of the glaring failures of both the Republican Party and the MAGA movement is that has not emphasized the critical role of honest money and sound government finance. The critical function of the government’s control of money needs to be elevated in our political priorities, or much of what we seek to change will simply disappear in an upheaval caused by destructive monetary management.

While many factors contributed to the crisis in Sri Lanka, a key one has been conveniently overlooked by many economists: the monetization of its debt.

Developments over the past few months in the small island nation of Sri Lanka have captured the attention, and concern, of many around the globe. Footage has gone viral on social media of protestors storming the President’s House and occupying the streets of the capital city of Colombo, prompting the nation’s government to declare a state of emergency.

The upheaval in Sri Lanka is largely the product of an economic crisis that’s seen a chronic shortage of key goods such as food, fuel, and medicine, leaving in its wake an inflation rate upwards of 70 percent. Mainstream economists’ fingers have pointed to a variety of explanations for these numbers, ranging from declining tourism industry to the country’s ban of chemical fertilizer to the Russia-Ukraine conflict.

While these factors have each undoubtedly contributed to the economic crisis, there remains a key component almost conveniently overlooked by many economists: the monetization of Sri Lanka’s debt, an economic policy heavily favored by advocates of Modern Monetary Theory (MMT).

MMT argues that the federal government can spend as much money as necessary to achieve full employment without being constrained by tax revenue or debt issuance. Rather, the government can finance such spending by borrowing money from the central bank, essentially printing new money into existence in the process known as debt monetization.

Advocates of MMT argue that as long as the economy is below full employment, this tactic of debt monetization will not trigger inflation. Sri Lanka, however, serves to disprove this rather empty belief. Despite its economic crisis being defined by a critical deficiency of basic needs, such a catastrophe can be traced back to years of inflation under MMT-guided policies.

Particularly, the adoption of MMT in Sri Lanka triggered rampant inflation which, in turn, triggered a currency crisis that prevented the developing economy from importing its most crucial necessities. It’s important, however, to see this process play out over time.

Sri Lanka and the Attempt at MMT

On the eve of December 2019, Sri Lankan President Gotabaya Rajapaksa introduced an unprecedented series of tax cuts that saw a 33.5 percent decline in registered taxpayers, not only vastly reducing government revenue but downgrading the country’s credit rating in its ability to pay off outstanding debt.

As a result, the central bank under Governor W.D. Lakshman embarked on a campaign to increase the proportion of domestic debt through the central bank’s takeover of much of the debt’s financing, arguing that, “domestic currency debt… in a country with sovereign powers of money printing, as the modern monetary theorists would argue, is not a huge problem.” Economist Mihir Sharma in writing for Bloomberg identifies that with this statement, “Sri Lanka is the first country in the world to reference MMT officially as a justification for money printing.”

With MMT as official policy, Sharma finds a 42 percent increase in Sri Lanka’s money supply between December 2019 and August 2021. This reflects the findings of Prof. Sirimevan Colombage of the Open University of Sri Lanka, who observed a 156 percent increase in Bond Currency Derivatives (the Sri Lankan equivalent of Treasury Securities) bought by the central bank in 2021 alone, equivalent to $6.5 billion.

Contrary to MMT advocates’ predictions, however, high money supply growth brought with it a high rate of inflation. Whereas 2019 saw a rate of 3.5 percent, inflation immediately jumped to 5.7 percent in January 2020 then to an unprecedented 17.5 percent in February 2022.

It’s important to recall that this rise in inflation was not in itself the defining issue of Sri Lanka’s economic crisis, but rather a catalyst of it. Nonetheless, the fivefold increase in inflation over a roughly three-year span meant a spiraling cost of living while economic growth stagnated from the erosion of price signals.

Inflation and the Currency Crisis

MMT and its corollary of inflation still spell out a much worse scenario for developing countries that rely on imports for much of their economic activity, like Sri Lanka. The small island nation, like many other developing economies, runs a sizable trade deficit, heavily relying on the importation of everything from food and medicine to oil and machinery.

This matters because most countries finance their imports with a global reserve currency such as the US Dollar, meaning that in order to sustain its imports Sri Lanka has to first swap its own currency, the Rupee, for other currencies like the dollar. Yet as the rupee has encountered serious inflation through years of MMT policy, it’s steadily depreciated relative to the dollar before crashing in March.

Since December 2019, the cost of a US Dollar, in terms of Sri Lankan Rupees, has nearly doubled. And since imports to Sri Lanka have to be financed with a global reserve currency like the dollar, this means that imports have essentially become almost twice as expensive. Meanwhile, the collapsing rupee has made it far more expensive to buy or borrow dollars on the foreign exchange market, while the country’s trade deficit means that Sri Lanka can’t generate enough funds through exports.

The result is a dire situation of economic and social collapse in the nation. Drivers have had to wait in line for days for rationed gas. The supply of life-saving medicine has become incredibly scarce, and for some drugs, completely depleted. At the same time, chronic shortages have left millions in a state of food insecurity.

A Lesson to be Learned

Although a somber tale that will continue to take a toll on the country for months to come, the economic crisis in Sri Lanka should serve as a lesson for all other countries contemplating the lure of Modern Monetary Theory. Not only does debt monetization and seemingly limitless spending bring with it drastic inflation, but potentially economic collapse when a country can no longer afford to import the goods it’s reliant upon.

Rather, it goes back to the old adage that if something seems too good to be true, it probably is. MMT, with its promise of reaching full employment through merely printing money, has proved itself to be nothing short of a failure in its first application in Sri Lanka. Whether other countries can understand this in light of the ideology’s seductive appeal remains to be seen.

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This article was published by FEE, Foundation for Economic Education, and is reproduced with permission.

“Conservatives need to get over their allergy to government action.”

That was the headline on an opinion column by Henry Olsen last week in The Washington Post. Olsen is not alone among conservatives in thinking so.

Across much of the right today, there’s more openness to having the government do more in the economy. Olsen observes that there are significant constituencies in America, especially blue-collar America, who appear supportive of a conservative agenda that would involve more state intervention, whether in the form of industrial policy, tariffs, or more expansive entitlement programs.

The right, Olsen wrote, cannot ignore those trends if it wants to stay electorally relevant. That necessitates moving away from what he labels “market fundamentalism.”

Winning elections is very important. But to embrace a bigger economic role for government amounts to conservatives endorsing policies that would push the United States even further in social democratic directions that would undermine America’s long-term economic and political well-being.

Here’s the fact often omitted by contemporary conservatives friendly to more government economic intervention: The American economy is already awash with interventionist policies—so much so that, according to The Heritage Foundation’s 2022 Index of Economic Freedom, overall economic liberty in America has been in decline since 2008. (The Daily Signal is the news outlet of The Heritage Foundation.)

The index ranked America as the world’s 25^th-freest economy. Many of the countries listed ahead of it are European nations with strong social democratic traditions. Moreover, the index adds:

Government spending [in America] has amounted to 38.9 percent of total output (GDP) over the past three years, and budget deficits have averaged 9.0 percent of GDP. Public debt is equivalent to 127.1 percent of GDP.

That doesn’t sound like small government to me.

In fact, even with[out] the extra state spending induced by the COVID-19 pandemic, the federal government has been spending like a drunken sailor for quite some time—and using debt to do so.

Leaving aside the ruinous expenditure levels and notorious inefficiencies associated with interventionist policies, there are serious political problems associated with conservatives adopting more economically interventionist stances.

“There’s a middle ground,” Olsen asserts, “between government directing everything or nothing.” Alas, if there’s anything that 20th-century economic history shows, it is that once the state’s economic role moves beyond securing certain public goods—the rule of law, property rights, national security, public works, etc. (none of which are small endeavors)—the genie is hard to put back in the bottle.

The middle ground thus ends up not being an essentially market economy operating within a framework of the rule of law and intertwined in a robust civil society. Instead, it becomes a type of social democracy in which excessive state power is omnipresent throughout the economy.

That doesn’t mean that you eventually get a Soviet-style command economy. But you do find yourself encumbered with the rampant cronyism that infects so much of D.C. politics, and, more insidiously, what the great political philosopher Alexis de Tocqueville described in his classic “Democracy in America” as “soft despotism.”

Soft despotism is a Faustian bargain between the political class and the public. It involves “an immense protective power,” Tocqueville wrote, in assuming the prime responsibility for everyone’s happiness—provided that power remains “sole agent and judge of it.”

That power would, Tocqueville added, “resemble parental authority” and attempt to keep people “in perpetual childhood” by relieving them “from all the trouble of thinking and all the cares of living.”

That’s the deal that progressives have proposed to Americans for more than a century. And it has saddled America with social and economic disasters like President Lyndon Johnson’s Great Society, which, as the economic historian Amity Shlaes illustrates in her book “Great Society,” wreaked havoc upon black America and the white working class.

In that light, there’s no reason to think that conservatives can devise an interventionist agenda that somehow avoids all of the problems—the one-size-fits-all mentality approach, the unintended consequences, the inability to address the non-material causes often central to social dysfunctionality, et al.— inseparable from such policies.

Faith in state intervention to effect positive economic and political change has also encumbered America with a vast administrative state. It’s no secret that these federal government departments, administrative bodies, and regulatory agencies are dominated by people ranging from indifferent to hostile to conservative ideas. Why would American conservatives want to affirm (let alone augment) the administrative state’s power by adopting economically interventionist programs?

Americans deserve better than having to choose between soft and hard versions of social democracy at election time. Nor should they have to put up with economic debates being reduced to who is willing to spend more.

If anything, American conservatives need to be more allergic to government economic intervention—not less.

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This article was published by Daily Signal and is reproduced with permission.