Currency Theory (CT) and Modern Money Theory (MMT) – in the same boat?

The sovereign money concept and the monetary system analysis on which it is based can be referred to as currency theory, intentionally remindful of the historical Currency School versus Banking School debate. Quite a few people presume currency theory (hereafter CT) and modern money theory (MMT) to be in the same boat. This is a fallacy.

On the face of it, both teachings might be seen as varieties of chartalism, a term coined in Knapp's State theory of money (1905). According to this view, money is a creature of state law rather than being based on private arrangement. A nation-state defines its national currency (as unit of account), while the general acceptance of a means of payment denominated in that unit depends on that state's treasury and courts accepting a respective means in payment of taxes and fines. Knapp's book, it should be noted, was not about a Theory of state money, but just about a hypothesis on the dependence of the validity of any money – state-issued, bank-issued or otherwise private – on the de-facto approval by the authorities. Even the near-complete rule of bankmoney, such as it stands today, fits into such an understanding of chartalism – and that in fact is the view held by MMT.

CT's understanding of chartalism, by contrast, builds on the monetary prerogatives of a sovereign state (or community of sovereign states, partially ceding their sovereign rights to the community). These monetary prerogatives include determining the currency (unit of account), issuing the money (means of payment) denominated in that currency, and benefitting from the related gain of money creation (seigniorage). The sovereign monetary prerogatives are of constitutional importance, much like the monopolies of lawmaking, jurisdiction, state administration, taxation and use of force. The monetary prerogatives do not exclude private monies, provided they are not denominated in the national currency unit, not backed by the monetary authority, not warranted by the government, and not accepted in payment of taxes.

Obviously, MMT's and CT's concepts of chartalism (or sovereign currency) are fundamentally diverging from each other, and this also applies in quite a number of other respects. Consider, for example, the question of who is in control of the present money system. In earlier writings MMT shared the post-Keynesian view that it is the banking sector (rather than a nation's central bank or treasury) that has the pro-active lead in monetary matters, determining how much money is created for what or for whom, thereby also pre-determining the banks' anytime fractional re-financing by the central bank, including, if need be, Quantitative Easing for the banking sector and finance.

CT's monetary system analysis clearly includes that view, stating that what we have is a bankmoney regime backed by the central banks and warranted by government. The base of central-bank reserves which the banks still need is now down to about 1–2.5% of bankmoney, while cash is dwindling away, leaving the field to bankmoney alone. As a result, conventional instruments of monetary policy, particularly base rate policy, have become largely ineffective and central banks have to a large extent lost the monetary control they are supposed to exercise.

MMT, by contrast, does not see problems of that kind. Rather than striving for a sovereign currency system as CT does, MMT declares the present money system in actual fact to be a sovereign currency system, sort of public-private monetary partnership under alleged government control. Much like many a central bank today, MMT recognises the banks' pro-active creditary money creation, but refuses to recognise the actual consequence of central banks having given up on monetary control.

Instead, MMT maintains the illusion of control, while sideling the role of the banking system for many years now and focusing instead on what MMT sees as money creation by 'the government' in the form of a tandem-like cooperation between the U.S. Treasury (issuing bonds) and the Federal Reserve (buying them up on the open market, thus monetising the debt in sovereign currency). No doubt such cooperation exists to some extent, apparently more so in the U.S. than elsewhere. But MMT's stance on this clearly means taking a smaller part of the money system (Washington's national debt) for the entire picture (which is dominated and determined by Wall Street).

Even after 2007/08, MMT has turned a blind eye to the fact that since the 1970/80s the biggest share of newly created money, rather than contributing to real output, went into the non GDP-contributing branches of finance, replacing inflation with asset inflation and bubble building, and resulting in increased financial instability and an increased distributional bias in favour of financial income at the expense of the share of earned income. Why has non-GDP finance not been an issue for MMT (the more so in view of their self-branding as left-wing)?

When the 2007/08 crisis hit, MMT retracted to Minsky's financial instability hypothesis. Nothing to be said against, as little as against Shiller's system dynamics approach to 'irrational exuberance'. Similarly, the Basel Bank for International Settlements has shown evidence for the existence of financial cycles, partly detached from real-economic cycles. In these approaches, disproportionate credit and debt growth is generally identified as a crisis indicator. That's fair enough, but something is missing. They fail to identify the out-of-control money and banking system as the root cause of overshooting credit and debt. Leaving the money system out reduces market dynamics, cycles and crises to human behaviour alone: crowds may basically be intelligent but can also go mad. Minsky has now even been embraced by quite a few people in central banking and finance who read the Minsky hypothesis as an ineluctable law of nature - it's the way it is, not much can be done about it. Not exactly reassuring, but eliminating reason and responsibility.

As to its idea of sovereign money creation, MMT uses an over-simplified model of sector balances – the public and the private sector, and, occasionally, the foreign rest of the world. This is sufficiently coarse to make central bank, treasury, governing Cabinet, or President's office, and parliament disappear in a black hole called the 'public sector' or 'government'. To a degree this corresponds to a comparable usage of 'the state' in Europe. In MMT, it serves as a basis for what Wray calls the 'creditary-fiscal synthesis'. The question of who exactly creates or ought to create money according to what criteria thus recedes into the background as if it were irrelevant. Overall, however, MMT includes a de facto priority for fiscal interests over monetary criteria (MMT routinely and calmingly mentions inflation). Some MMTers have openly derided the idea of 'sound finances', particularly 'sound public finances'.

In CT, by contrast, it is unequivocally clear that in monetary matters it must be the monetary authority (usually the central bank) that is in charge and has the last say, not the treasury or the parliament, and definitely not the banks as is the case today. CT rests on the separation of powers between the monetary responsibilities of a state's monetary authority and the fiscal responsibilities of the parliament and the governing Cabinet, including the treasury. Moreover, according to CT the monetary authority must not only be independent from Cabinet directives, but, in a sovereign money system, also be independent from particular banking interests. Contrary to this, in today's bankmoney regime (based on highly fractional reserves) there are tight functional interdependencies between the central bank and the banks – consented by MMT that positions itself much closer to Banking School doctrine than to Currency School thinking.

To MMTers, monetary financing of government expenditure is self-evident; to supporters of CT it isn't, even though in a sovereign money system there are much bigger amounts of seigniorage to be expected, that is, newly created central-bank money to the benefit of the public purse or, alternatively, a citizens dividend. Beyond the seigniorage from regular money creation, most supporters of CT would agree with monetary financing subject to extraordinary conditions such as a deflationary lack of effective demand in a severe crisis, or a national state of emergency.

Regarding the monetary crisis policies in the past decade, supporters of both CT and MMT, as many others, have criticised the imposition of austerity schemes as counter-productive. They have been advocating monetary financing of additional government expenditure targeted at real-economic recovery, such as helicopter money and Quantitative Easing for the people (i.e. the real economy) rather than Quantitative Easing just for finance. Here again, however, when it comes to the spending preferences both camps part company. MMT prefers to subsidise employment through a government job guarantee. CT prefers funding income independently of work, thus reducing the old-industrial labour bias of social security.    

Another core element in MMT's idiosyncratic sort of chartalism is to dispute that taxes fund government expenditure, asserting just the opposite, that is, government expenditure funding taxes. Having to pay taxes could basically be forgone were it not for undesirably high inflation rates which are prevented by collecting the taxes. (Never mind that this means recycling the tax money into general circulation and thus actually much restricting a government's scope for money creation, be it self-created or created upon government demand). Sounds a bit upside down which in fact it is, the more so as government demand for money, even though big, is way less than the amounts of money creation triggered by demand for money by the financial industry, real-economy firms and private households.

In this regard, CT sees no reason at all to dispute financing of public budgets by taxes, administrative fees and by borrowing, i.e. becoming indebted to creditors. That could be different – although just to the rather limited extent set by criteria of monetary, financial and economic stability – in a true sovereign currency system in which the bigger part of newly created money, as debt-free genuine seigniorage, can be issued into general circulation by government expenditure. That would include, however, to readapt a central bank's structure and accountancy rules in one respect, namely, segregation of sovereign money creation from conventional central banking practices (cf.

In contrast to this, monetary financing according to MMT will create a claim of the central bank on the treasury and a debt of the treasury to the central bank (apart from this, non-cash 'credit and debt money' always remains a liability of the issuing central bank or bank). In MMT's over-simplified sector balances, both the central bank and the treasury are part of the same sector, thus quasi 'the same'. Therefrom, public debt seems not really to be a problem and should be re-interpreted, say, as a 'special' debt that never needs fall due. Keynes called that unworldly construction a zero-coupon perpetual consol.

One generalising step further, MMT postulates that public debt denominated in the domestic currency (unlike private debt) is basically no problem because a sovereign state can always create additional money denominated in the domestic currency and thus needs not default. At a first glance, such a thesis on, say, a government's 'non-defaultability' on sovereign debt denominated in the domestic currency seems to have a point. In the real world, though, it means to reckon without the host.

Governments can certainly exceed the money, credit and debt limits of sound finances for quite some time. By and by, however, this will come with counter-productive repercussions such as inflation, asset inflation and proneness to financial crises, currency devaluation, comparatively high capital-market interest rates, stagnant productivity and declining international competitiveness. Central banks and governments might then implement measures of so-called financial repression, trying to keep interest rates and prices/wages as low as possible. It may work for a while, but will not prevent a final day of reckoning, triggered by some unforeseen development or event.

If this can be taken as a historically proven rule, the United States today seems to represent the exception to the rule. Since forty years the U.S. runs a twin deficit (budgetary and foreign trade) and has turned from creditor to debtor nation, and yet its innovative technology industries and financial corporations are the world champions. As to be expected, the dollar follows a secular path of declining exchange value and purchasing power (MMT, too, supports 'soft currency' politics), but the dollar is still seen as a 'safe haven' in crises and continues to be the uncontested dominant world currency. Accordingly, MMT has no problem with foreign deficits either. Most of American foreign debt is denominated in domestic dollars after all, and most of international trade and cross-border product chains depend on payment in dollars. Truly an 'exorbitant privilege'. Seen from this America-specific angle, MMT has a point to tell Washington and Wall Street not to worry about sector imbalances, deficits and debt. Life can be that easy. Just look at it through the right glasses. It works until it doesn't.

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