How modern monetary theory affects your portfolio

US Federal Reserve chairman Jerome Powell (left) and Treasury Secretary Stephen Mnuchin bump elbows at the conclusion of the House Committee on Financial Services hearing this week in Washington. Picture: AFP

The pandemic recession has rapidly thrust a previously arcane economic theory squarely into the spotlight: Modern Monetary Theory.

MMT is an item of hot debate and, whether you agree or disagree with it, in terms of investment outcomes, it hardly matters. The important thing is to understand what it might mean for your portfolio.

Running the risk of brutal simplification, you might say MMT holds that governments can print money, and this “debt” need not be repaid. It also suggests that inflation does not come from printing money and it also implies the government can — and should — provide full employment. At any time, such theories might remain within the circles of academic debate. But just now as governments have little choice but to lift deficits, print money and find answers for high unemployment, it is getting a serious hearing.

As an investor, if you don’t incorporate the dominant economic theory of any period into your assumptions you will quite literally be on the “wrong side of the trade”. Imagine if in the 1990s you thought privatisation was a passing fad or in the 2000s you underestimated globalisation or, more recently, you dismissed technology stocks because you “didn’t understand them”.

The influence of MMT is already on the agenda, especially among AA- rated economies such as Australia, where we fully control our own currency.

The RBA’s historic move towards printing money and the government’s JobKeeper program are both real life manifestations of MMT-related thinking.

One way to look at it is that MMT is the opposite of austerity economics, where governments facing a crisis raise taxes and cut spending.

Inflation outlook

For investors, the outstanding dimension of MMT is the outlook for inflation. It challenges the assumption that all this money printing will bring about inflation. It refers to Japan as the example of a wealthy nation where a long-held program of money printing has not caused inflation. Inflation will only happen when a country reaches “resource capacity”, the theory goes, and if that actually comes to pass then a government may be forced to raise taxes.

As investors, we have to look forward and make decisions inside a framework: if we assume this MMT thinking may dominate, then we will not have inflation and we will have low rates for a lot longer than we may have previously considered.

As Will Hamilton of Hamilton Wealth Management put it in this section in November: “As they say on Wall Street, don’t fight the Fed, even if this time around the Fed and its peers such as the RBA might be hard to take seriously”.

So what might an MMT influenced era mean for investors?

Property

Borrowing can be carried out with confidence in terms of the future direction of interest rates — they are going nowhere anytime soon. For property then, we might reasonably assume that mortgage rates will be in the 2-3 per cent range for some years.

But clearing borrowings through the traditional means of “inflating your way out” is not going to be feasible — the underlying asset is going to have to pay for itself. You cannot assume the price of the asset will simply float higher as the years go by.

Shares

Sharemarket prices will continue to have the wind behind them. The framework in which we buy shares is set to reward profit and dividend growth to the maximum. The MMT influence already explains why the strength in the market over the past four months appears to have disconnected with GDP growth. It also explains the astonishing premiums offered to the companies that suit these times — those that promise unlimited growth.

On the ASX this would be Afterpay, now a top 20 stock. On Wall Street it would mean Tesla, now the biggest car manufacturer by market value. Neither of these two stocks are making a profit and their share prices defy logic.

Bonds

An MMT regime in global markets will offer stability in the bond markets. We might reasonably expect interest rates and bond rates to remain low and considerably less volatile than shares. The unprecedented intervention of central banks in markets — to the point where the US Fed will buy individual corporate securities — means “price discovery” difficulty is common to all assets, but particularly relevant in the bond market.

Cash

The outlook for cash remains miserable. On the local market the RBA has set 0.25 per cent for cash and a 0.25 per cent target for the three-year government note and those levels would appear to be on ice. These rates will continue to force investors into the sharemarket looking for returns.

Gold

Perhaps the only asset class where the impact of MMT is unclear, gold is an inflationary hedge and if it is ordained by the MMT brigade that inflation will not arrive in conjunction with money printing, then a major positive for gold is removed. But gold is also a safe haven, especially when confidence in fiat currencies declines. It is hard to see how any adherence to any dimension of MMT would increase confidence in conventional currencies. In turn, this is a growing positive for gold.

There are many other aspects to MMT, not least the impact a massive surge in government-created jobs might have on the economy.

But for investors the essential point to grasp is that this theory is taking off, and you need to be in front of the curve whatever you might think of the theory.