Continuing the topic of the previous post and adding the work of Fadhel Kaboub (which you may listen to an interview on Bloomberg here), I want to develop the notion of monetary sovereignty and its importance for the political decisions within a country.
Doctor Kaboub explains the concept of monetary sovereignty as a spectrum, where a country achieves it totally if:
- Has its national currency;
- On which it levies a tax on its citizens;
- Has a flexible exchange rate;
- Doesn’t have debt in foreign currencies.
Most developed countries achieve a perfect 4/4 (except Eurozone countries ..), but emerging and mostly, developing countries fail the pre-conditions. That will, in some cases, undermine their convergence with developed countries and sustainable development.
I would like to develop a little bit further the concept of monetary sovereignty (which is maybe one of the most important concepts in macro theory).
- A government in an autarkic country is “always” perfectly sovereign, but as it deprives itself from the gains of “global specialization”, it will probably face low levels of development or even poverty.. (cough North cough Korea). So, let’s discard this one.
- A government that fails 3 and 4 can still be “sovereign”. But it must be “Rich”, which means, it must have A LOT of foreign currency. Just like a household must have a lot of money to be able to buy something outside its “family”. Saudi Arabia fits this category. However,…oil doesn’t last forever.
- In this category the government doesn’t have to spend foreign currency per se, but if it wants to expand expenditures in national currency it must be able to defend the foreign exchange rate if the receivers of national currency rather have foreign currency.
- Finally, a country that is a 4/4 is totally sovereign.
Or is it?
I would like to add another condition to have full monetary sovereignty. This one probably invalidates the notion that several countries are sovereign.
5. Lack of foreign debt.
Why is this any different from original point 4?
Let’s take the United States. Its government has been able to buy everything inside the US as it’s payable in USD and it also has been able to sustain constant external deficits (without massive USD depreciation). Why?
Well, because as someone wrote recently (but I can’t remember whom) the USDollar and US securities are probably the best export product that America has. It’s really an “exorbitant privilege” to have the currency that is:
- The medium of exchange internationally
- The unit of account internationally
- And most important, the reserve of value internationally.
But…imagine in the future, Donald Trump does something REALLY stupid and suddenly all the foreign owners of USDollars figure out they are sick and tired of holding USDollars (and US securities).
What happens next? Two (?) options:
- Either they sell USD (buying other currencies), which leads to a depreciation of USD that “impoverishes” USDollar holders internationally (but increases exports…)
- Or Exports increase (selling USD and buying US goods).
What? Only this? We made it! Exports are great! We made America great again! We have a HUGE surplus! No more trade deficits!
Sure about that? When exports increase massively (in a floating exchange rate regime, and with previously accumulated exports) there is not enough goods and services for the American citizens and foreign citizens. That will lead to scarcity and eventually inflation!!
INFLATION I TELL YOU!!! (start to shout Venezuela and Zimbabwe at the same time)
In conclusion, are we all doomed?
No. Of course not. This is a pretty unrealistic scenario.
The main lesson I want to draw from this post is (excluding being autarkic/poor or being in a monetary union):
- If a country wants to maintain a fixed exchange rate, the country must accumulate a lot of foreign reserves to be sovereign (or maybe some capital controls?)
- If a country wants to have floating exchange rates, it must convince its trading partners (or its trading partners’ trading partners) to hold its national currency as foreign reserves.
But at the end of the day, unless the country is a military superpower (and therefore force its currency on other countries, just like a sovereign country does to its citizens), the notion of monetary sovereignty is a utopia. It is a worthwhile battle to try to converge to it, but still a utopia.