Yes, sovereign currency issuers can always be ‘solvent’ – but don’t be so damned blasé about it

This video on New Economic Perspectives explains the view of modern monetary theorists (MMTers) that a ‘monetary sovereign’ – i.e. one with its own domestically-controlled currency, like the UK or US, rather than a country in the euro area – does not face financial constraints and therefore cannot be forced to default on domestic-currency debts.

I’ve heard this view expressed a number of times to explain why either: (a) the ratings agencies are stupid to downgrade the debts of countries like the US;  (b) governments of sovereign currency issuers are stupid to pursue fiscal consolidation in countries like the UK; or (c) euro members are stupid to have foregone monetary sovereignty by joining the single currency.

The argument behind this is incredibly simple. It goes like this.

(1) Monetary sovereign governments in advanced economies spend, tax and borrow primarily in their own domestic currency.

(2) Their domestic currency can be created at will by their central bank, which these governments can control through legislation.

(3) These central banks have made no legal commitment to maintain the value of their currencies against any other currency or physical commodity – i.e. these are floating, fiat currencies.

(4) Therefore, if a government is ever unable to sell its bonds privately, it can always change the law and force the central bank to create new domestic currency to fund a deficit.

So sovereign currency issuers are always ‘solvent’, in terms of being able to make any debt and interest payments to bondholders in nominal terms, simply by forcing the central bank to buy up the new issuance required to fund these payments.

There is nothing profound about this. It just says that, if all else fails, you can monetise your deficit.

I cannot believe that this is put forward as a serious or practical policy argument.

I am all in favour of the ECB doing what’s needed to prevent continent-wide contagion from a Greek exit, including temporarily backstopping sovereigns. But governments should still do whatever it takes to avoid getting to the awful point of commandeering the central bank to avoid a certain default. And once there, they should do whatever it takes to get off monetary financing, as quickly as humanly possible.

Deflation can be brutal. Today’s Americans learn this from their country’s inter-war history.

Hyperinflation can be so much worse. Today’s Europeans learn this from Europe’s own inter-war history and its bloody, savage, senseless aftermath.

Yes, a sovereign currency can always turn to the printing press to prevent a default. And in extremis, once you’ve reached the point of ‘monetise or default’, monetisation may be the best of a bad set of options.

But don’t ever forget the horrors wrought on their citizens by governments that became addicted to the printing press.  And don’t be so damned blasé about it.


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