This is the second post in my mini-series on “soft money” Modern Monetary Theory (MMT) to the left, “hard money” Goldbugs to the right, and mainstream economists between. Mainstream economists worry that soft money economists lead their countries on the path to hyperinflation and sovereign bond default. MMT scholars argue that many of the examples used by mainstream economists are inapplicable because the governments cited were not sovereign money issuers. This post explores what MMT scholars mean by sovereign money – with a fun detour to the supposedly sovereign money of colonial subjects.
The MMT concept of sovereign money can be quite subtle. Today, we will see how some MMT scholars argue that British North American colonies in the 18th century were sovereign money issuers despite British mercantilism and colonial lack of what most people would consider sovereignty. Yet, those same states are no longer sovereign money issuers despite achieving independence and amending the new Constitution with the 11th amendment’s guarantee of state sovereign immunity against its creditors. Sorting it out will require revisiting an old debate in economic history, was there a money shortage in the English North American colonies?
Under English Mercantilism, the colonies had to return English coins to the mother country (England). As a result, other forms of payment circulated as the medium of exchange in colonial North America, including the Spanish dollar. Graphic 1 shows some North American money used during the colonial era. The colonies experimented with a number of paper alternatives. Many of these items were not designated money through a legal tender law compelling private sellers to accept them as payment; rather, they often circulated organically like the giant stones of Yap. (I apologize for the blurriness of the attached pic of colonial money from the Museum of American History.)
Reminder – The first post in this series used the giant stone money of the island of Yap to illustrate the standard “greater fool” theory of the origins of commodity money. The stone rai used on Yap demonstrated how an evolved commodity money can rely on a ledger to track money balances, not the commodity itself, even if the commodity sinks to the bottom of the ocean. Mutual ascent of the value of ledger balances replaces any intrinsic value of the commodity, if it ever had any. A working financial system can evolve money without real backing, but that doesn’t mean it did.
Randall Wray and other MMT scholars reject the commodity money framework as historical fact and as a framework to evaluate public policy. They believe that government power to spend and compel tax payments for redemption is the true origin of money. People willingly accept a government spending receipt as a medium of exchange because somebody will have to pay taxes, not just because it has been designated legal tender. Importantly, while MMT scholars say government spending receipts are money, they distinguish fully “sovereign money” from other government issued money. Therefore, some MMT scholarship is an objective assessment of the options available to a government that issues “sovereign money,” and the consequences of those options. Other MMT scholarship is a normative case for adopting the institutions of “sovereign money.” So, what do MMT scholars mean by “sovereign money” and what are some examples?
Sovereign Money Institutional Requirements
- Government chooses the money of account in which money balances are denominated
- Government imposes tax obligations denominated in its chosen money of account
- Government issues currency denominated in its chosen money of account
- Government accepts the currency it issues to satisfy its tax obligations.
- Government obligations against itself (bonds) are denominated and payable in its currency.
- The rate of exchange between this government’s sovereign money and other government’s sovereign money is allowed to float.
Some examples may help. The United States government is a sovereign money issuer. It chooses the accounting for money (the US dollar), imposes taxes in US dollars, issues currency denominated in US dollars, issues bonds denominated in US dollars, US taxes and US bonds are payable in US dollars, and the rate of exchange between US dollars and other currencies is allowed to float. The US government also has the power to determine the interest rate on its dollar denominated obligations.
The state of Illinois is not a sovereign money issuer. Illinois does not control the issuance or accounting standard for the currency used to satisfy its tax obligations or to redeem its bonds. The rate of value between an “Illinois dollar” does not float against the value of a “Nebraska dollar.” The state of Illinois cannot determine the interest rate on Illinois-dollar denominated assets.
Greece is not a sovereign money issuer. Greece is part of the European Union and relies on the EU currency, the Euro. Greece is more sovereign than Illinois in many ways, but Greece does not determine the value of the Euro just as Illinois does not determine the value of the US Dollar. Greece does not control the issuance of Euros. Greece’s bonds and tax obligations are denominated in Euros, not a currency it controls. Whatever its sovereignty in other dimensions, Greece is not a sovereign money issuer in an MMT perspective.
The case of Denmark is more nuanced. Denmark is part of the EU, but issues its own currency, the Danish Krone (DKK). At first blush, Denmark appears to be a sovereign currency issuer. It controls the accounting for DKK, issues currency and bonds denominated in DKK, and payment of DKK satisfies tax obligations and bond redemption. In theory, Denmark could regulate the interest rate of its obligation or let its currency float against other sovereign currencies. However, Denmark typically pegs the value of the DKK to the Euro rather then let its exchange rate float. Proposals for the EU to issue bonds always require addressing the rate at which Denmark and other EU members who do not use the Euro will be required to contribute to common bond obligations. Commitments by Denmark to maintain its peg to the Euro or to contribute to common bonds at a fixed conversion rate are not the hallmarks of a sovereign currency issuer.
Caution – it is a mistake to conclude that the general hierarchical relationship determines sovereign money from the MMT perspective. The United States participates in many multinational organizations, some of which it has ceded full or partial sovereignty over narrow policy areas. A treaty binding US acceptance of a UN or WTO decisions does not negate the US status as a sovereign money issuer unless it affects the six criteria listed above.
MMT scholars argue that many mainstream economic policy concepts do not apply to governments which issue sovereign money. First, acceptance for tax payment, not declaration of legal tender for private debts, creates money status. Private markets willingly accept the sovereign money because they can rely on someone having to pay tax obligations to accept them in return. Taxpayers create demand for money that satisfies the tax payments even for exchanges between two non-taxpayers for the same logic as the “greater fool” theory of commodity money. Issuers of sovereign money always have the ability to redeem and retire their bonds because the bonds are denominated in their own sovereign currency. Should government obligations be transferred to foreign hands, the floating exchange rate ensures the ability to redeem any amount of obligations.
Sovereign Money Consequences in MMT View
- Sovereign Money Issuing (SMI) Government cannot run out of money
- SMI Government interest rate policy, not bond markets, determines the terms of government finance
- SMI Government does not face a budget constraint as conventionally defined
- SMI Government can always ensure employment of its entire population
- SMI Inflation is caused by demand for real resources, not the supply of money
Some critics of MMT issue dire warnings of financial collapse. Critics accuse the MMT scholars of believing that governments should (a) spend without limit, (b) act as if deficits don’t matter, and (c) operate government with unconstrained budgets. Critics argue pursuing the above three policies, which critics believe would require central banks to print money, would lead to hyper-inflation.
But MMT scholars deny the advocate for profligate spending. MMT scholars accuse the critics of conflating positive theoretical assessment with normative advocacy. For example, MMT scholars believe that mainstream scholars overemphasize a link between money creation and inflation. MMT is not unusual in believing that increased government spending during a period of high unemployment or otherwise slack economy does not necessarily cause inflation. More controversially, the MMT scholars deny that central banks need be the primary tool of money creation – remember that to an MMT scholar the receipts of government spending can circulate as money until they are redeemed as taxes.
Something about MMT seems wrong to people familiar with history. There seem to be too many examples of monetary basket cases and budget constrained countries to believe governments can’t run out of money – whether winners or losers in war, whether a developed economy or part of the developing world, whether in the modern era or long past history. Both victorious post-revolution America and defeated post WWI Germany experienced hyper-inflations. From Argentina to Zimbabwe, a variety of countries struggle with exchange rate collapse, inflations, and sovereign bond defaults.
MMT scholars are not blind to these historical events. In each case, MMT scholars attempt to identify an institutional feature that they say disqualifies the example as a sovereign money issuer, or find a catastrophic event in the real economy that they hold responsible for the government’s financial straits. Some MMT scholars may even suggest that developing nations are not yet ready for, or have not yet achieved, the ability to be a stable sovereign money issuer. This leads to the question of whether there are foundational conditions necessary for sovereign money.
It is easy to be misled into thinking that some level of economic development is the pre-requisite for issuing sovereign money. This is not the case. A sovereign money issuer need not have a powerful military, or issue the internationally recognized reserve currency, or closely regulate its banking system, or act as the central hub of a trade network. In fact, the government need not be the only monetary authority. Advocacy for issuing a parallel currency is not an uncommon application of MMT. Randall Wray believes that the American colonies illustrate the possibilities of a parallel currency and sovereign money even in the context of a dependent colony.
Monetary Experiments in the American Colonies, 1607-1787
Randall Wray relies on the work of economic historian Farley Grubb to describe the colonial monetary regime. https://www.nber.org/people/farley_grubb?page=1&perPage=50 Grubb’s work casts doubt on a relationship between money printing and inflation.
The quantity theory of money is applied to the paper money regimes of seven of the nine British North American colonies south of New England. Individual colonies, and regional groupings of contiguous colonies treated as one monetary unit, are tested. Little to no statistical relationship, and little to no magnitude of influence, between the quantities of paper money in circulation and prices are found. The failure of the quantity theory of money to explain the value and performance of colonial paper money is a general and widespread result, and not an isolated and anomalous phenomenon. https://www.nber.org/papers/w22192
Wray interprets Grubb’s work on colonial American monetary institutions as an illustration of MMT principles. The general policy of the British mercantilist policy in the colonial period was to accumulate currency in the mother country. Pursuant to that policy, British metal coinage was shipped back to England. When British interests favored colonial assistance against rival powers, the colonies were permitted to issue paper bills of credit to pay soldiers and acquire supplies. Colonies issuing and redeeming their own bills of credit became common, with outstanding paper bills forming part of the circulating money supply. An example from the 1690 Prince William’s War was printed with the following.
“This indented Bill of Five Shillings due from the Massachusetts Colony to the Possessor
shall be in value equal to money and shall be accordingly accepted by the Treasurer and
Receiver Subordinates to him in all Public payments and for any stock at any time in the
Treasury – New England, February the third, 1690. By order of the General Court.” file:///C:/Users/Owner/Downloads/historyo.pdf
Wray argues that colonial paper satisfies sovereign money. A Virginia Bill or North Carolina Bill was spent in units of Virginia or North Carolina pounds, and satisfied a corresponding tax obligation. Colonies could not rely on their bank regulatory authority to create money because of British review by the Board of Trade. Instead, the fact that a colony accepted its own bills for tax obligations encouraged circulation. The value of colonial bills floated against each other and circulated simultaneously.
MMT scholars place importance on the fact that these circulating bills of credit were government spending prior to being money or taxes. It was not unusual for these bills of credit to be destroyed upon redemption by the colonial government. In the MMT view, the colonial spending created money during the period of circulation. Redemption of the bills through taxation was effectively an inflation fighting move in their view. In colonial America, MMT scholars do not see the primacy of a commodity money magnified by banking balances.
Implications and Further Questions
The MMT scholars have invited us to revisit the origin, history, and nature of money. The seemingly obscure example of colonial North America has many implications for modern governments. For example, to what extent could countries in the Eurozone avoid a future crisis similar to Greece by allowing modern equivalents of circulating bills of credit? On the other hand, to what extent were colonial bills of credit effective because of an implicit relationship to the British crown, if any?
A system of multiple sovereign moneys creates exchange rate risk for international traders, financiers, and travelers. Even if MMT’s controversial theories of taxation, money, and inflation are true, would multiplication of currencies be stable in an increasingly globalized world? Consider the following quote from 1741 colonial America. ““There certainly can’t be a greater Grievance to a Traveller, from one Colony to another, than the different values their Paper Money bears.” An English visitor, circa 1742 (Kimber, 1998, p. 52). https://eh.net/encyclopedia/money-in-the-american-colonies/
These first two posts have been focused on convincing readers that Modern Monetary Theory’s conception of money is different from mainstream economists in a fundamental way. Unlike mainstream economists, MMT scholars do not start with commodity-based payment system and then build a money multiplier through the banking system. MMT scholars start with the receipts of government spending, redeemed through taxes, as the foundation for the payment system. Using the mainstream framework to evaluate the policy suggestions of MMT scholars assumes the MMT scholars are wrong from the beginning. In order to assess MMT, it is better to approach their theories about government spending, taxes, and payment systems with the same critical mind of any other theory. Future posts will discuss how an MMT approach to macroeconomic policies would differ from current approaches and discuss legal obstacles and options to implementing MMT.
Independent Perception 