Countries do not control their own currencies

In 1956, Carlo Cipolla, an Italian medievalist, published five short lectures under the title Money, Prices and Civilization in the Mediterranean World.

They’re interesting even if you don’t happen to be into medieval money. Cipolla, for example, dedicates a chapter to what he calls the dollars of the middle ages, the high-value gold florins and ducats of the Italian city states, accepted and copied from Constantinople to the Rhineland.

Kingdoms and cities, Cipolla points out, did not have what we now think of as monetary sovereignty — a monopoly on the issue and control of currency within their own borders. Coins, particularly the most valuable ones, moved promiscuously from private mints to any market they pleased, and the best a king or a doge could hope for was a way to regulate the mints and manage the flow of coins. Money, Prices and Civilization is accidentally the single-best explanation of how money works now, today, in our current economy.

As the dollar approaches record highs against the pound and the euro, we should reissue Cipolla’s book and hand it to every policymaker, fiscal and monetary, in the G20. And we should attach to it, with a binder clip, a printout of a paper published in August by two political economists — Rethinking Monetary Sovereignty: The Global Credit Money System and the State. Just as was true for Cipolla’s medieval Europe, the paper argues that it is unhelpful for states to believe that they issue and control their own money.

The paper’s authors, Steffen Murau of Boston University and Jens Van ‘t Klooster from the University of Amsterdam, believe that the dominant definition of monetary sovereignty is Westphalian — nation states create and control their own money. But like Carlo Cipolla’s medieval rulers, governments now actually issue very little currency on their own. They have some influence over the rest of the system. But it is limited, even in a more closed financial system like China.

The paper divides currency into three categories. Public money sits on the balance sheet of central banks, as paper notes or reserves. Public-private money consists of deposits at commercial banks, created every time a bank makes a loan. A deposit is a private decision by a private actor, but the state can regulate the bank, or discourage new loans by raising interest rates. Traditional theories of money present central banks as the creators of currency, but they’re really more like currency shepherds, nudging banks back and forth. And the last category — true private money — sits either on the balance sheets of lightly regulated shadow banks or completely offshore, beyond the control of the state.

Murau and Van ‘t Klooster use these categories to present a more useful way to think about sovereignty: What is a country attempting to do with currency policy? And does it work? If we apply this rubric to the dollar, we first have to nail down exactly which dollars we’re talking about — as the authors point out, there is no such thing as a dollar, just dollar-denominated credit assets. Then we ask what the US wants to accomplish with those dollars, and whether it’s working.

Start with true private money and we find eurodollars — dollar-denominated deposits at offshore banks, outside of US regulatory control. But as the political economist Eric Helleiner has pointed out, the de facto US policy in a financial crisis is to offer currency swaps to foreign central banks, lending them dollars that they can in turn lend to their own commercial banks. If the goal is to support offshore private dollar creation by acting as a global dollar lender of last resort, then it’s working.

With public-private money, the dollars held as deposits at regulated, US-based commercial banks, the policy goal is clear: full employment and low inflation. But the Federal Reserve and the Treasury do not together have a working theory of what kinds of bank loans create jobs, or how to effectively encourage them. And they can’t reach every American with bank money even when they hand it out — access to bank accounts is not treated as an important policy goal.

This leaves public money, the notes and reserves on the Fed’s balance sheet. Here, the US has, under the traditional definition, unquestionable sovereignty. The Fed’s cash office runs a system of warehouses that can swap federal reserve notes for deposits, anywhere in the country, on demand. Cash works. With reserve creation, however, what’s the goal? The Fed can trade Treasuries for reserves, and quantitatively ease or tighten. But it argues, even internally, over whether and how this works.

If we define monetary sovereignty as effectiveness, then even mighty America does not seem to be completely sovereign over its almighty dollar. We are no better off than kings and doges, nudging the mints with laws and incentives, trying imperfectly to make money work.