Tension between radical new ideas threatens to break social contract
Modern monetary theory, universal basic income and cryptocurrencies a ‘trilemma’ that could derail system
The social contract that holds the SA democratic nation state together is under threat. This social contract is premised, in its most simple terms, on a trade: citizens pay protection money, in the form of taxation, and submit to the rule of the democratically elected state, which provides physical and fiscal protection in the form of maintaining and enforcing law and order and, increasingly, providing welfare entitlements and social safety nets.
Citizens thus give up some freedoms and contribute some costs, in exchange for increased security. However, the Covid-19 crisis has shown just how fragile that social contract is. Increasingly, citizens are being asked to give up more freedoms (and more funds) for diminishing marginal returns in the form of real security improvements. Despite growing government monetary and fiscal policy interventions, inequality is rising, unemployment has increased to record levels, economic growth expectations are negative, and in real and relative terms the middle class is in decline.
According to a study by the University of Cape Town’s Liberty Institute of Strategic Marketing, the SA middle class has shrunk to 2.7-million individuals, down from 6.1-million in 2017, and over the same period the number of ultra-poor individuals has increased by 6.6-million. These economic woes are occurring against a backdrop of political and policy instability and a protracted global pandemic.
Rising inequality, declining living standards, increasing welfare demands and shrinking future growth expectations (and a shrinking tax base) are antithetical to social stability. When populations do not feel they have a say or a stake in their own economic future, they are likely to take matters into their own hands.
Radical ideas are now required to repair the social contract. In times of turmoil, new big ideas tend to get the oxygen required to grow. Three of these radical new ideas — modern monetary theory, universal basic income and cryptocurrencies (led by bitcoin) — have taken root with remarkable speed, moving from the fringes into mainstream economy policy.
Underlying, potentially irreconcilable tensions between these three big macroeconomic ideas threaten to break the very social contract they are attempting to fix. This new “trilemma” can be explained as follows.
Proponents of universal basic income advocate for guaranteed living wages, without means tests, for all, as a way for societies to cope with the threat of technological unemployment, jobless growth and stagnating wages. The ultimate goal of this version of utopia is to achieve “fully automated luxury communism ”— a society in which technology does all the work, a basic income allows every individual to share in the proceeds, and people are free to pursue selfactualising activities. The challenge for proponents of universal basic income is how to fund it. In SA, for example, the shrinking tax base and low growth prospects make such plans impractical, if not impossible, without heterodox funding schemes.
MONEY SUPPLY
One such heterodox funding scheme is modern monetary theory, which explains that since fiscally sovereign states have a monopoly on their own fiat currencies and can increase money supply at will, the only real limits to state spending are political will — and the threat of inflation. Unlike with universal basic income proposals, however, modern monetary theory advocates propose using the state’s de facto monopoly on fiat currency to “spend money into existence” to fund investments in infrastructure and other initiatives, to close the productivity gap and bring the economy up to full employment, most commonly in the form of a jobs guarantee of some sort.
For this to work, public sector investments are required to reduce the productivity gap, or run the risk of destabilising inflation. However, proponents of universal basic income believe incomes should not come with strings attached for recipients and the goal should be a post-work, rather than a forced-work, economy.
This stalemate is likely to lead to tensions between the two schools of thought. Furthermore, if modern monetary theory-type money expansions are used to fund universal basic income-type entitlements rather than focusing on increasing productivity, the risk of inflation does increase. It remains unclear whether society can have their basic income and their magic money tree too.
The second tension relates to cryptocurrencies which, as opposed to national sovereign fiat money, are in effect private, borderless, international money. The very existence of private money as a viable alternative to state monopoly money threatens the viability of modern monetary theory policy, which is premised on governments having full control over their own sovereign monetary policy. But cryptocurrencies are in effect a leak in the fiscal bucket. If citizens have the option to opt out of fiat systems and use private money instead, governments lose some important levers of control over their economies.
If citizens choose to invest in crypto assets rather than spend their share of the increased money supply, there is a risk that money expansion will not lead to an increase in productivity after all. This leads to a vicious cycle, whereby governments will be forced to accelerate monetary expansion and contend with a diminishing money multiplier effect, potentially leading to destabilising inflation as “bad” inflationary fiat money changes ever more “good” deflationary crypto money out of circulation.
There is also a perverse incentive for holders of private crypto money to cheer on the breakdown of the social contract, in that the faster fiat money is devalued, the faster cryptocurrencies prices appreciate in value. This “disaster looting” arbitrage opportunity is unlikely to increase social cohesion or economic stability.
Looking ahead, governments and central banks will need to decide if the power of manipulating money supply is worth the risk of chasing more wealth outside the control of central planners; or if they are able to resist the temptation to save the democratic nation state social contract.
DEMOCRATIC SOCIALISM
Cryptocurrencies also present a perverse incentive regarding welfare funding and entitlements. Cryptocurrencies are effective tax havens, safe from explicit taxation and hidden backdoor seigniorage taxation. If individuals are able to opt out of paying taxes by not just saving in cryptocurrencies but increasingly earning and spending within these sorts of financial walled gardens, without the need to use fiat on-ramps and off-ramps at all and while still enjoying the real-world benefits of law, order and other social safety nets, how then can governments enforce the funding or legitimacy of the social contract?
Resolving the cryptocurrency question in line with the social contract of the nation state democracy is essential to the sustainability of the growing welfare state and its entitlement expectations, particularly in these post-Covid times when more vulnerable people than before (there will be 18.7-million grant recipients in SA in 2021/2022, according to the Treasury) are living at the mercy of the state.
Woe betide any government that overpromises and underdelivers in these fragile times.