What Is Monetary Sovereignty?
Part 3 of a Series
In this series of articles our objective is to anticipate the hue and cry about raising the U.S. federal debt limit which is likely to dominate Washington politics and the news media in the coming months.
The hue and cry began to grow in volume this past week as House Speaker Kevin McCarthy tried to sell Wall Street on the Republican party's plans. In a rare display of tactical political cleverness, the Biden administration has rendered it toxic for Republicans to call for cuts to Social Security or Medicare -- a maneuver that has left deficit hawks seething. We want to see past (or through) the hue and cry and understand the issues more deeply.
Where We've Been
Last week, we began by asking, "Suppose we were looking at Earth from outer space and could observe all the different nation states. What would all those states have in common with respect to their purpose?" The answer we came up with was, "The state mobilizes resources in pursuit of the public purpose." We then described money as a tool created by the state to persuade people to exchange goods and services with the state in return for things which people can satisfy tax burdens imposed by the state. In short, taxation drives demand for the currency created by the state. We called this the state theory of money.
We also hinted that we would discuss the degree to which different nation states can use money effectively in pursuit of the public purpose. We call this concept monetary sovereignty (or currency sovereignty). That's
the main subject of today's post.
What is monetary sovereignty?
Monetary sovereignty1 refers to a collection of powers exercised by a sovereign state, including:
The power to name a money of account such as the U.S. dollar or the British pound.
The power to issue currency in that money of account.
The power to impose taxes in that money of account.
The power to determine how monetary contracts will be legally enforced.
The power to decide how the state will make its own payments.
In principle, every nation state enjoys the powers listed above, even if a given state chooses not to exercise a particular power. For example, the countries of the Eurozone have chosen to forego their own moneys of account and currencies (the German mark, the French franc, the Italian lira, and so forth) in favor of a common money of account and currency, the Euro. No Eurozone country could be described as monetarily sovereign, even though countries like Germany and France are quite economically powerful.
Once a state exercises these powers, it confronts a number of important policy questions, such as:
Should our state undertake debt obligations only in our own currency, or should we incur debt in foreign currencies as well?
Should we attempt to guarantee that our currency exchanges with other countries' currencies at fixed rates, or should we allow exchange rates to vary (float)?
Should we attempt to guarantee that our currency exchanges with precious metals at fixed prices?
The policy choices a particular state makes vary over time. At times in the late nineteenth century and again in the 1920s, both Great Britain and the United States pledged to buy and sell gold at a fixed price expressed in their domestic currencies. After World War II, many countries tied their currencies to the U.S. dollar, while the U.S., to a limited degree, tied the value of the dollar to that of gold. However, the Nixon administration took the U.S. completely off the so-called gold standard in the early 1970s, so the U.S. dollar no longer trades at fixed exchange rates with other currencies.
All countries are not created equal. Consider Sanspetrolia.
We said above that "in principle," every nation state can make choices about its money of account and currency. In practice, however, things are quite different. A sovereign state could issue its own currency and collect taxes in that currency, yet still face limited policy options due to natural resource constraints or internal or external political constraints.
Let's imagine that there exists a poor country that we'll call "Sanspetrolia." Sanspetrolia issues its own currency and imposes taxes in that currency. It has a large underemployed population but does not produce crude oil. Sanspetrolia must import oil at world market prices and pay for that oil in whatever currency oil producers specify. The oil producers demand payment in U.S. dollars, so so Sanspetrolia must somehow earn U.S. dollars. For Sanspetrolia's government, "mobilizing resources in pursuit of the public purpose" must include policies that support sales of goods and services priced in U.S. dollars. That could, for example, mean that Sanspetrolian agriculture has to emphasize production of crops for exports, such as cotton, rather than crops for domestic food consumption.
What do we mean by a "spectrum of monetary sovereignty?"
Monetary sovereignty is therefore not something which a country either has or does not have. It makes more sense to speak of a spectrum of monetary sovereignty and ask where a given country finds itself on that spectrum. (For convenience, however, we will describe a country which sits high on the spectrum of monetary sovereign as being a "monetarily sovereign country.")
Where does the United States sit on the spectrum of monetary sovereignty?
Since the U.S. disposed of the last vestiges of the gold standard in the 1970s, the U.S. has been the epitome of a monetarily sovereign country. The U.S. government issues its currency in the process of spending it and imposes taxes in that currency. It does not incur debt obligations in foreign currency. It can therefore meet all its debt obligations as they come due with payments of its own currency. It cannot be forced into involuntary default on its debt. It can purchase any goods and services that are produced in the U.S. and which are offered for sale in its currency. The U.S. makes no promises to redeem its currency for any particular amount of precious metal, nor does it promise to exchange its currency for that of any other country at any specified rate.
What is the benefit a nation or its state derives from a high degree of monetary sovereignty?
We actually hinted at the benefits of monetary sovereignty in the response to the previous question. Let's cite two benefits.
First, a monetarily sovereign country can always fund the purchase of any goods or services that are domestically produced and offered for sale in its own currency. Such a country may be constrained with respect to its real resources but it is not financially constrained.
Consider the experience of the United States at the outset of the COVID-19 pandemic in 2020. The U.S. faced a health emergency in which hundreds of thousands of people ultimately perished. Because of outsourcing of production of things like face masks, we were resource-constrained in our initial response to the pandemic. Large parts of the economy had to be shut down, which led to a very sharp rise in unemployment and a loss of income for purchases. But we were not financially constrained. Congress approved the creation of vast amounts of money for income support. Personal consumption rebounded as did employment; as a consequence the COVID recession of 2020 was very short-lived.
Second, a highly monetarily sovereign country can generally avoid undertaking debt obligations ("borrowing") in foreign currencies. If a country's government only issues debt instruments in its own currency, it can meet all obligations for principal and interest as they come due. Hence it can never involuntarily default on its debt obligations.
Suppose that the government of Sanspetrolia borrows in U.S. dollars from Citibank or from the International Monetary Fund. It has to repay those loans in U.S. dollars, which in turn means that it has to engage in economic activity which will bring in the dollars needed to pay off those loans. Once again, Sanspetrolia may be forced to orient its economy toward production of goods for exports which can be sold for dollars. If the country fails to pay off its dollar loans, it can be forced into default and its assets can be seized.
So why is the concept of monetary sovereignty relevant to the current U.S. debt limit "crisis"?
This is where we'll pick up next time. I encourage you to pose questions in the Comments.
This section draws heavily upon Chapter 2, "Spending by Issuer of Domestic Currency," in L. Randall Wray, Modern Money Theory: A Primer on Macroeconomics for Sovereign Monetary Systems, Second Edition, Palgrave Macmillan, 2015.