Sovereign Money Theory and Modern Money Theory – in the same boat?
Quite a few people assume that sovereign money theory and its underlying monetary system analysis are in the same boat as modern monetary theory (MMT). On a closer look, this proves to be a fallacy.
On the face of it, both theories claim to be on modern money, or monetary modernisation respectively, and 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 civil law and private contracts. A nation-state defines its national currency (as unit of account), and the general acceptance of a means of payment denominated in that currency unit depends on the 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 any money's validity – state-issued, bank-issued or otherwise private – as being dependent on its 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.
Sovereign money theory's understanding of chartalism, by contrast, builds on the monetary prerogatives of a sovereign state; or community of states, such as the European Monetary Union to which the member states freely cede part of their sovereign rights to a certain extent. The monetary prerogatives include determining the currency (the national unit of account), issuing the money, i.e. the official means of payment, denominated in that currency, and benefitting from the related seigniorage, i.e. the gain from money creation. 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 necessarily rule out private monies. But there is an apparent collision of interests and functionalities when privately issued money is denominated in the national currency unit, used in state payment transactions, backed by the monetary authority (usually the central bank), and warranted by the government.
In these respects, MMT's and sovereign money theory's concepts of chartalism diverge 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 money creations, determining how much money is created for what or for whom.
Sovereign money theory 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 liquid central-bank reserves the banks still need is now down to about 2–4% of bankmoney, while cash is dwindling away, leaving the field to bankmoney alone. As a result, regular monetary quantity policy is now next to impossible, while transmission of conventional base-rate policy has lost much of its effectiveness. As a result, central banks have to a large extent lost the monetary control they are supposed to exercise. Central banks and government have become auxiliary bodies of the private banking sector; central banks as anytime refinancers of the banks (lender of last resort), the government as bankmoney guarantor of last instance and, if need be, as recapitaliser of systemically relevant banks. One has become so accustomed to that kind of government servitude to the private interests of banking and finance that one no longer even sees in it the constitutional problem it represents.
MMT, too, does not see any constitutional or systemic problem of that kind. Rather than striving for a sovereign money system, or at least a mixed money supply determined by sovereign money, MMT declares the present bankmoney regime 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' lead in money creation by way of extending monetary bank credit, but refuses to recognise the actual consequence of central banks having given up on monetary control.
MMT maintains the illusion of control, while sidelining the role of the banking system and focusing instead on what MMT misperceives as money creation by the government in the form of a paso-doble-like cooperation between the U.S. Treasury issuing bonds, and the Federal Reserve buying them up on the open market. This refinances the previous bondholders, mostly banks and non-bank institutional investors, while the government's deficits are funded by selling sovereign bonds to those private banks and institutional investors in the first place. No doubt such monetary-fiscal cooperation exists, especially since the monetary policies of Quantitative Easing of the 2010s. However, this is not about sovereign money creation, but for the most part private money creation, fractionally refinanced by the central bank, and triggered by the government incurring debt from private lenders.
Moreover, MMT is so one-sidedly fixated on money creation in the context of government spending that other areas go largely unnoticed, such as bankmoney creation triggered by demand from non-monetary financial institutions, real-economic companies and businesses, private households, municipalities and various other kinds of public bodies. 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 in general or public spending in particular, went into the non GDP-contributing branches of finance. Thereby, inflation was eclipsed by asset inflation and bubble building, 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?
When the 2008 crisis hit, MMT made recourse 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, nowadays especially credit and debt in non-GDP finance. That's fair enough, but something important is missing: identifying 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; which is not exactly reassuring, while eliminating reason and responsibility.
Sovereign money reform is in the tradition of the British Currency School, including the separation of money and credit, that is, money creation by a monetary authority separate from the credit and investment business of banks and non-bank financial institutions. MMT, in full contrast, has explicitly committed to the alleged identity of money and credit, shared by orthodox economics as well as many post-Keynesians. The false identity of money and credit exposes money to the inevitable risks of finance, making both the stock and value of money as unstable and insecure as is the banking business and finance in general, instead of building the financial economy on a safe and stable stock of sovereign money.
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 rough 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 clearly stands for fiscal dominance over monetary criteria. Some MMTers have openly derided the idea of 'sound finances', particularly 'sound public finances'.
Sovereign money theory, by contrast, holds that it must be the monetary authority (usually the central bank) that is in control of the money and able to pursue effectual monetary policy, not the treasury or the parliament, and definitely not the banks as is primarily the case today as a matter of fact. Sovereign money theory 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 sovereign money theory the monetary authority must not only be independent from Cabinet directives, but, in a sovereign money system, also be independent from particular banking interests. Such independence is absolutely illusionary in today's bankmoney regime of credit and debt money based on highly fractional reserves, which results in 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.
Regarding the monetary crisis policies of the 2010s, supporters of both sovereign money theory and MMT, as many others, have criticised the imposition of austerity regimes as counter-productive. They have been advocating monetary financing of additional government spending 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. However, when it comes to the spending preferences, both camps part company. MMT prefers to subsidise employment through a government job guarantee. Sovereign money theory prefers funding income independently of work, thus reducing the old-industrial labour bias of welfare politics.
To MMTers, monetary financing of government spending is self-evident. Sovereign money reform also supports monetary financing of government spending, even though not exclusively, and only within the limits set by criteria of monetary and financial stability, in particular an economy's capacity to absorb money without causing CPI, asset inflation and foreign-exchange devaluation, and without exceeding the economy's financial carrying capacity. Furthermore, both sovereign money theory and MMT think of leaving newly created money to the public purse free of debt.
In MMT, however, this comes down to the central bank and/or the treasury itself extending credit to the treasury account, credit without interest and maturity, zero-interest perpetual credit as it were. With regard to interest, this actually makes sense as far as interest payments from the treasury to the central bank flow back to the treasury with the central bank's annual profit. With regard to the principal, however, things are different. Monetary credit paid back extinguishes the related amount of money and thus reduces the existing stock of money. Independently, in MMT's over-simplified sector balances, both the central bank and the treasury are part of the same sector, thus quasi 'the same', owing money or debt to itself. Therefrom, according to MMT, public debt seems not really to be a problem and should be re-interpreted, say, as a 'special' debt that never needs fall due, thus not really being debt. Provided all sides agree on such interpretive sophistry, it can be done pragmatically that way, even if it distorts realities and is highly inconsistent in terms of financial accountancy.
By contrast, in sovereign money theory, because of the separation of money creation and credit, new money can both be loaned into circulation on regular creditary terms, and also be spent into circulation truly debt-free, for example as genuine seigniorage to the public purse, or as helicopter money to the people and firms if need be. That would include, however, to readapt a central bank's structure and accountancy rules in one respect, namely, segregation of sovereign money creation from the operational balance sheet of conventional central banking. (Cf. sovereignmoney.site/how-to-account-for-sovereign-money). So far, MMT has failed to develop a consistent idea of how to issue money debt-free, something that is not even conceivable within the framework of the false identity of money and credit.
Another core element in MMT's idiosyncratic sort of chartalism is the utterly strange view that government spending means money creation, while tax payments to the state would delete that money. That view is not about money creation triggered by government borrowing, but about claiming that government spending is tantamount to money creation. To sovereign money theory this is devoid of any real-world sense, whereas MMT steadfastly disputes that taxes fund government spending, asserting just the opposite, that is, government expenditure funding taxes.
In the MMT mindset, having to pay taxes could basically be forgone were it not for undesirably high inflation rates which are prevented by collecting the taxes. In view of the money flows and their accounting in the real world, however, it is unmistakably clear that tax money is not deleted, but recycled into general circulation. This alone significantly restricts a government's scope for money creation, be it self-created or created upon government demand.
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 first glance, the thesis of a government's 'non-defaultability' on sovereign debt denominated in the domestic currency has a point. In the real world, though, there are those limits of an economy's monetary absorptive capacity and financial carrying capacity. MMT certainly doesn't deny, for example, that inflationary potentials can be a problem. But MMT has never shown the slightest interest in addressing this issue more closely. For sure, governments can exceed the limits of sound finances for quite some time. By and by, however, this will come with counter-productive repercussions such as CPI, asset inflation, bubble building, proneness to financial crises, coming with social and political crises, currency devaluation, high capital-market interest rates, stagnant productivity and declining international competitiveness.
If this can be taken as a historically proven rule, the United States today seems to represent the exception to the rule. Since decades the U.S. runs a twin deficit (budgetary and foreign trade). It 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's praise of 'soft currency' politics goes well with this. The dollar is still in demand as a safe haven in crises, and continues to be the uncontested dominant world currency. Unsurprisingly, MMT has no problem with foreign deficits either, casually regarding this as a 'beggar-my-neighbor' thing. Most of U.S. foreign debt is denominated in U.S. 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.