Understanding Modern Monetary Theory is a bit like trying to beat a street hustler at Three-card Monte, there may only be three cards moving at any one point in time, but you only have two eyes, which means you’ll always end up a dollar short.

Mario Petronio was no stranger to games of chance. Before moving to New York City in the late 1980s, Petronio had grown up in the small town of Sutera, Sicily, where he had observed the village men gamble using dominoes, cards and dice.

Petronio would while away hours during the long Sicilian summers, watching as sun-baked middle-aged men gathered in the town square near the main church, to play Scopa, an Italian card game which combined a mix of skill and luck, but significantly, tested a player’s powers of observation and ability to read body language.

Watching the players deal out the cards, noting their idiosyncrasies as well as their “tells,” Petronio was soon able to figure out which players were bluffing and which ones had good hands.

So when his parents took him across the Atlantic to settle in New York’s meatpacking district, he was curious to see men at street corners, calling out to passers-by to bet money on finding the Jack of Spades among three cards that were shuffled randomly — the infamous Thee-card Monte.

Curious, a 12-year old Petronio watched one day as grown men, some in suits, tried their luck at what was (to him at least) obviously a con job.

Try how they might, the card that they selected would never be the Jack of Spades (the money card) — yet over time, Petronio also noticed a pattern.

In a typical Three-card Monte, the con artist would draw the victim’s attention to the position of the Jack of Spades and while distracted, would reposition the other cards so that the victim or “mark” would almost always pick out the wrong card.

But Petronio had learned from watching thousands of games with the old sun-baked men in his home town of Sutera, that you never pay attention to what someone wants you to look at — you observe the entire situation.

And after watching probably hundreds of Three-card Montes being dealt, Petronio finally figured out the tricks that the con artists usually employed.

Plucking up the courage one day, he approached a Three-card Monte and played using his allowance.

He won.

Then he played again and won.

And pretty soon, the con artist who had thought a 12-year-old kid would make an easy mark, was starting to attract a crowd as he lost money to this Italian kid who could barely speak any English.

But it wasn’t that Petronio was a gifted gambler or had some special skills — he was just observant, and more importantly, he didn’t pay attention to the thing that the Three-card Monte con wanted him to focus on — the Jack of Spades.

It’s Not the Money

Which is why talk of printing money and fears of inflation against a backdrop of unprecedented monetary and fiscal measures from central banks across the globe in response to the coronavirus pandemic, are not what we should be paying attention to — it’s the entire system that we should be focusing on.

Focusing on the so-called “money printing” aspect of the U.S. Federal Reserve’s policy response is a bit like watching the Jack of Spades in a Three-card Monte — that’s what the dealer wants us to focus on, when really, if we paid closer attention, the whole system itself is rigged.

And it doesn’t help when spectators standing by the way side keep pointing at the Jack of Spades to distract from what we should be watching.

In a recent commentary, Willem Buiter of Columbia University suggested,

“Much of the U.S. response will come in the form of “helicopter money,” an application of Modern Monetary Theory (MMT) in which the central bank finances fiscal stimulus by purchasing government debt issued to finance tax cuts or public spending increases.”

In other words, many commentators, including Buiter view Modern Monetary Theory as a green light for turning on the printing press, whether to send cash directly to Americans or to provide liquidity to financial markets through the Fed’s actions.

And while the visual imagery of U.S. Federal Reserve Chairman Jerome Powell sitting in a helicopter, using a shovel to rain down money in Times Square is striking, that’s not what Modern Monetary Theory is.

At its core, Modern Monetary Theory is simply a description of how a government that issues its own currency actually spends, taxes and sells bonds as a matter of course.

What Modern Monetary Theory suggests is that a government like that of the United States, is not in fact limited by financial constraints.

The idea is hardly new.

Somewhere Between The Casino & The Stock Market

As far back as the 18th century, a convicted murderer and gambler, John Law, who had studied finance somewhere between the casino and the stock market in Holland wrote,

“I maintain that an an absolute prince who knows how to govern can extend his credit further and find needed funds at a lower interest rate than a prince who is limited in his authority.”

Law’s absolutist theory of finance, was based on the assertion that,

“In credit as in military and legislative authorities, supreme power must reside in only one person.”

And Law found the perfect stomping ground for his new financial theories in 18th century France.

Saddled with huge amounts of public debt from the fiscally ruinous wars of Louis the XIV, France was on its way towards its third bankruptcy in less than a century.

According to Law, the key for France to get out of its financial quagmire was to make royal credit work more productively than in the past, when the crown had borrowed money hand-to-mouth to finance its wars.

Under Law’s scheme, the monarch would effectively delegate his credit,

“To a trading company, into which all the materials of trade in the kingdom fall successively, and are amassed into one.”

The whole French nation, as Law put it, would eventually,

“Become a body of traders, who have for cash the royal bank, in which by consequence all the commerce, money and merchandise re-unite.”

Law’s experiment with France’s national finances, as any student of financial history will tell you, did not end well.

After creating stock in the Mississippi Company (that was supposedly set up to develop Louisiana in America) that the French people could invest in, Law unwittingly created the world’s first stock market bubble.

Anytime Law needed more money to be pumped back into the system, he merely walked down the hallway in the Place Vendôme to have more money printed, chasing the price of shares in the Mississippi Company higher, until finally, they were found to be worthless.

The ensuing crash in shares of the Mississippi Company eventually led to the French Revolution.

If that sounds familiar (apart from the ending), that’s because it’s what Modern Monetary Theory is based on.

Vive La France

In the normal course of operations, the U.S. Treasury Department (the spending arm of the government) and the U.S. Federal Reserve (the government’s bank) co-ordinate so that Treasury can spend and tax authorized amounts.

While Congress appropriates spending, the Fed (the government’s bank) ensures that the checks the Treasury writes clears, and that bond auctions to sell U.S. government debt, go off without a hitch.

Under normal (it’s been awhile since things have even vaguely resembled normal) conditions, the U.S. Treasury issues bonds and sells them at auctions.

The Fed, through lending (to commercial banks to buy those bonds) or its own purchases of the same, ensures that there is sufficient supply of reserves in the system to pay for these newly issued bonds.

Now then this begs the question — how does the Fed pay for these bonds?

Here’s where things get a little bit hairy.

It’s true that the Department of the Treasury isn’t the one printing money — only the Fed can do that.

But when the Fed commits to buy bonds even before Congress passes a spending bill, which happened recently with regards to the coronavirus stimulus package — the line between who’s printing what and at whose discretion, becomes less clear.

To make matters even murkier, the Fed has been crediting bank accounts on behalf of the Treasury without the Treasury issuing new bonds — in other words, without draining reserves from the system.

Which begs the question again? Where is the money coming from?

Because the Fed claims that when it funds bond purchases, it does so as an interest-rate maintenance mechanism and not as a matter of course to print money.

Fair enough.

But that still doesn’t answer the question, where does the money the Fed uses to buy these bonds to maintain interest rates, come from?

One part of course is out of the reserves that the central bank requires commercial banks to keep with the Fed.

But then where do commercial banks get their monies to deposit with the Fed?

Several places, most of which don’t have material impact on the point at hand, including deposits, investments, loans, fees, but most importantly, from the central bank itself, which makes funds available to commercial banks through the Fed’s discount window.

Wait, so the Fed makes money available to commercial banks so that some of those monies can be redeposited to the Fed as reserves?

Yes.

Isn’t that just making money out of thin air?

Sort of.

Remember our trip through history and John Law’s financial experiment in 18th century France?

Modern Monetary Theory is simply the modern incarnation of John Law’s financial theories in that it assumes the Fed faces no financial constraints on its ability to buy assets or lend.

And because the Fed credited bank accounts on behalf of the Treasury without new bond issuances, the difference between money and government debt becomes increasingly less clear.

Confused yet?

That’s the whole idea.

Proponents of Modern Monetary Theory suggest that Congress must stop attaching strings such as increased taxes or spending cuts in order to fund spending, because regardless of the budgetary outcome, the spending will always take the form of payments made by the Fed, on behalf of the Treasury.

And no the Treasury is not printing more money, because the Fed does it for them.

Q.E.D.

Quite Easily Done.

So should we be worried?

Yes and no.

Monetary dominance has historically tended to wane long after empires have collapsed.

Whether it was the Roman Empire’s denarius or Great Britain’s pound, monetary inertia has ensured that their currencies persisted long after the sun had set on their empires.

In other words, the dollar isn’t going to go away anytime soon.

The currency of commerce is not an easy thing to unseat, regardless of how digital the prospective usurper portends to be.

But there are several ideologies that come with Modern Monetary Theory that do pose risks to the value of the dollar.

Betting Big On Bitcoin

As the Spanish conquistadors who plundered Aztec silver and gold and brought it back to Europe learned the hard way — more money doesn’t make one rich.

All the treasure in the world is worthless except what goods and services someone else will give you in exchange for it.

And because vocal proponents of Modern Monetary Theory are finding their voice, supporting the idea of a universal, federally-funded job guarantee program, which would act as a macroeconomic stabilizer during times of crisis — there is a risk that Americans will learn the same lessons as the Spanish conquistadors — that inflation is never too far away.

Supporters of Modern Monetary Theory maintain that U.S. government spending is only limited by available economic capacity.

It is not.

There are countless examples of countries with vast economic capacity who have overextended themselves, debased their currencies and sparked runaway inflation.

Ancient Rome, Venezuela, Argentina, Zimbabwe (formerly Rhodesia) and Germany’s Weimar Republic are just a few examples.

And history is replete with examples of empires who had stretched the largess of their creditors to bursting point.

That’s not to say that America is coming close to that point.

But that’s also not to say that point is an impossibility.

Because ever since 1971, when the Nixon administration abandoned the gold standard, where a dollar could be exchanged for its equivalent in gold, America entered uncharted waters in terms of currency expansion.

The decade and a bit since 2008 has seen concerns over “moral hazard” become nothing more than an academic curiosity.

Add to that mix the Trump administration’s insularity, isolationism and undermining of global institutions which are underpinned by the dollar, and it’s hard to estimate the immeasurable damage on the global world order for decades to come and America’s role in its leadership.

And therein lies the greatest Three-card Monte con of all.

Because with Congress spending, the Treasury borrowing and the Fed paying, it’s hard to keep both eyes on three moving parts all at once.

And while we’re busy trying to find the Jack of Spades, we’re not noticing that we’re the ones getting played.

Which is why more than one hedge fund manager has recommended an outside (and perhaps outsize) bet on Bitcoin.

Because we don’t know when the dealer will stop shuffling.

We don’t know when the music will end.

We don’t know when someone will call the bluff on the entire financial system.

We don’t know.

But with Bitcoin we do know.

We do know that there will only ever be 21 million Bitcoin ever.

Period.

We do know that as manipulated as Bitcoin is, the blockchain makes it obvious whenever anyone tries to move the goal post.

We do know that the more people who participate in, trade, talk about and deal with Bitcoin, the more it develops a character that (for now) avoids politics, policy and pandemic.

The greatest trick behind the Three-card Monte isn’t a trick of confidence, it’s a trick of observation and the question we should all be asking ourselves is, what are we focusing on?