Have the bond vigilantes killed off modern monetary theory? MMT proponent Stephanie Kelton says that’s nonsense.

One conclusion surely is that a nation's financial flexibility is limited by the willingness of world markets to finance it, as investors assess the remarkable change in fiscal policy from one of the world's number six economies, the U.K.

"Ending MMT is the international lesson of the U.K. debacle, any populist selling fiscal pipedreams will be confronted by the precedent of the U.K.," said Paul Donovan, chief economist at UBS Global Wealth Management.

The leading proponent of modern monetary theory and author of The Deficit Myth replies "rubbish"

elton participates in the best new ideas in m oney

She told MarketWatch that the market reaction to the mini budget was not unreasonable. Kelton said that the Bank of England would move even more aggressively given the expectation that the energy subsidies and tax cuts would make inflation worse.

There was a lack of coordination with the Bank of England. She said that you needed to communicate with the Bank of England ahead of time and have a better idea of the market's reaction. There is a way to get the budget that she wanted.

The market bullied her into submission. Kelton said, "Who would have had it if she hadn't blinked?" Financial market stability is what it is about. Kelton said it wasn't about fiscal dominance or anything like that.

The pound GBPUSD, -0.06% on Wednesday was trading above $1.12, well above the lows of $1.03 in the ensuing reaction to the initial budget plans that have now been almost entirely reversed. The yield on the 30-year gilt TMBMKGB-30Y, 3.936% fell below 4%, after recently reaching as high as 5.17%.

The US did yield curve control during World War II. Any country can do it. She said that it was not a reserve currency.

If you aren't the world's reserve currency, the bond vigilantes can show up at any time and strip you of your ability to run the government programs that you want to run. It's possible to give a tax cut. You can increase the amount of money you spend. There are possible consequences of inflation and possible exchange rate implications. MMT didn't say anything else.

The Bank of England is determined to sell gilts in order to fight inflation. My running joke is "Japan says hi" Kelton said that the common narrative in financial markets is wrong. Japan can't get inflation up after three decades of deficit spending, the largest debt-to-GDP ratio in the world and decades of quantitative easing. Japan would have inflated itself after a long time.

Gov. Lael Brainard spoke about rising profit margins as a source of inflation. It's pretty clear to me that a lot of the inflation that we're experiencing is due to companies with pricing power, using the chance to raise prices by more than the increase in wages, in energy costs and materials and other things.

Kelton wanted to know why the U.K. and other countries were issuing debt in the first place. She said it's an important question. When the gold standard was in place, there was only a finite amount of gold reserves. The Federal Reserve used to rely on Treasurys. The Fed pays interest to banks on reserves in order to reach its interest rate target.

These bonds only have one purpose, and that is to be used as security. She said that it was strange to match the issuance of these securities to the budget box at the end of the year. She said that plumbing froze up because of requirements, insufficient quantities at single points in time, that required central bank intervention.

Italy has a new government but no central bank or currency. Kelton said she almost had a heart attack when Christine Lagarde said her job wasn't to close spreads.

Kelton recalls that at the time of the Lagarde comment, the yield on the 10-year Italian bond TMBMKIT-10Y, 4.768% was lower than that of the U.S. TMUBMUSD10Y, 4.145% On the surface, that made no sense, but in reality it did, because the ECB had negative interest rates and was buying massively to support governments through the pandemic. “I did countless interviews through those two years. And every time a European journalist asks what worries me, well what worries me is when they stop, when they withdraw the support, and let yields go where markets take them. And I’ve been saying that for more than two years.”