Rethinking Monetary Sovereignty: the Global Credit Money System And

Rethinking Monetary Sovereignty: The Global Credit

Money System and the State

Steffen Murau, Boston University ([email protected])

Jens van ’t Klooster, KU Leuven/University of Amsterdam,

Abstract: This article proposes a conception of monetary sovereignty that recognizes the reality of today’s global credit money system. Monetary sovereignty is typically used in a Westphalian sense to denote the ability of states to issue and regulate their own currency. This article rejects the Westphalian conception.

Instead, it proposes a conception of effective monetary sovereignty that focuses attention on what states are actually able to do in the era of financial globalization.

The conception fits the hybridity of the modern credit money system by acknowledging the crucial role not only of central bank money but also of money issued by regulated banks and unregulated shadow banks. These institutions often operate ‘offshore’, outside of a state’s legal jurisdiction, which makes monetary governance more difficult. Monetary sovereignty consists in the ability of states to effectively govern these different segments of the monetary system and thereby achieve their economic policy objectives.

Keywords: Financial ethics; political theory; international finance; money; offshore; shadow banking

1. Introduction1

Even though monetary sovereignty has repeatedly been declared dead, the concept remains an important reference point in both academic discourse and international politics.2 Its rumoured demise, we contend, is due to a poor understanding of what it means to be sovereign in relation to money. Monetary sovereignty is typically used in a Westphalian sense to denote the mere ability of states to issue and regulate their own currency. This, indeed, is the default understanding of the term in fields ranging from orthodox economics3 to heterodox monetary theory4, and from International

Political Economy (IPE)5 to international monetary law6. However, the Westphalian conception has two weaknesses, which make it unsuited for the realities of financial

1 Acknowledgments: We would like to thank Benjamin Braun, Nik de Boer, Armin Haas, Elizaveta Kuznetsova, Perry Mehrling, Marco Meyer, John Morris, Fabian Pape, Eniola Soyemi, Anahí Wiedenbrüg and participants in the January 2020 Prospects of Money workshop at the Hamburger Institut für Sozialforschung for detailed comments on earlier drafts of this paper. Steffen Murau acknowledges funding from the German Academic Exchange Service (DAAD) and Deutsche Forschungsgemeinschaft (DFG). 2 Susan Strange, The Retreat of the State: The Diffusion of Power in the World Economy (Cambridge University Press, 1996); Benjamin J. Cohen, The Geography of Money (Ithaca and London: Cornell University Press, 1998). 3 Paul De Grauwe, Economics of Monetary Union, 9th ed. (Oxford: Oxford University Press, 2012); Giancarlo Corsetti and Luca Dedola, “The ‘Mystery of the Printing Press’ Monetary Policy and Self- Fulfilling Debt Crises,” Discussion Papers (Centre for Macroeconomics (CFM), August 2014), https://ideas.repec.org/p/cfm/wpaper/1424.html; Mervyn King, The End of Alchemy: Banking, the Global Economy and the Future of Money (Little, Brown Book Group Limited, 2016). 4 William Mitchell, L. Randall Wray, and Martin Watts, Macroeconomics (Macmillan Education UK, 2019). 5 Deborah Mabbett and Waltraud Schelkle, “What Difference Does Euro Membership Make to Stabilization? The Political Economy of International Monetary Systems Revised,” Review of International Political Economy 22, no. 3 (2015): 508–34. 6 Rosa Maria Lastra, “International Financial and Monetary Law” (Oxford: Oxford University Press, 2015), https://econpapers.repec.org/bookchap/oxpobooks/9780199269341.htm; Charles Proctor, Mann on the Legal Aspect of Money, 7th ed. (Oxford: Oxford University Press, 2012); Claus D. Zimmermann, A Contemporary Concept of Monetary Sovereignty (Oxford: Oxford University Press, 2013).

2 globalization: its formal understanding of sovereignty and its simplistic understanding of money.

Our first objection to the Westphalian conception concerns its implicit understanding of state sovereignty. This conception is formal in the sense that it focuses on the legal competences of the state, which sovereign states are meant to exercise without interference from other states. So why should issuing and regulating a currency without interference matter so much? Although a national currency can indeed be an immense source of geopolitical power, the mere ability to issue a currency is by no means a guarantee for such power.7 Indeed, the existing literature on state sovereignty increasingly recognizes the conceptual limitations of conceptions of state sovereignty that focus on absence of interference.8 For this reason, political theorists have sought to rethink the concept to highlight its effective dimensions. Effective conceptions understand sovereignty as the ability of states to

7 Strange, The Retreat of the State; Cohen, The Geography of Money; Benjamin J. Cohen, Currency Power: Understanding Monetary Rivalry (Princeton University Press, 2015); John Agnew, “Sovereignty Regimes: Territoriality and State Authority in Contemporary World Politics,” Annals of the Association of American Geographers 95, no. 2 (June 2005): 437–61, https://doi.org/10.1111/j.1467-8306.2005.00468.x. 8 Robert H Jackson, Quasi-States: Sovereignty, International Relations and the Third World. (Cambridge: Cambridge University Press, 1992); Miriam Ronzoni, “The Global Order: A Case of Background Injustice? A Practice-Dependent Account,” Philosophy & Public Affairs 37, no. 3 (2009): 229–56, https://doi.org/10.1111/j.1088-4963.2009.01159.x; Elisa Orrù and Miriam Ronzoni, “Which Supranation Sovereignty? Criminal and Socioeconomic Justice Compared,” Review of International Studies 37, no. 5 (2011): 2089–2106; Miriam Ronzoni, “Two Conceptions of State Sovereignty and Their Implications for Global Institutional Design,” Critical Review of International Social and Political Philosophy 15, no. 5 (December 1, 2012): 573–91, https://doi.org/10.1080/13698230.2012.727306; Peter Dietsch, “Rethinking Sovereignty in International Fiscal Policy,” Review of International Studies 37, no. 5 (December 2011): 2107–20; Peter Dietsch, Catching Capital: The Ethics of Tax Competition (Oxford University Press, 2015); Juri Viehoff, “Eurozone Justice,” Journal of Political Philosophy 26, no. 3 (2018): 388–414.

3 make meaningful choices and achieve their ends.9 Building on these approaches, we turn to the monetary realm to develop an account of effective monetary sovereignty.

Our second objection to the Westphalian conception of monetary sovereignty concerns its simplistic understanding of money. Recent work on the monetary system highlights the crucial role of private money forms, thereby casting doubt on the state-centric focus of the Westphalian conception.10 In fact, public money forms, whose issuance is under the direct control of states, are only a small part of the global money supply. The larger share is made up of private credit money forms such as bank deposits and various forms of unregulated deposit substitutes, often termed ‘shadow money’. The recent literature also casts doubts on the

Westphalian idea of states as constitutive building blocks of the international monetary system.11 Instead, the existing global financial system leaves money

9 Ronzoni, “Two Conceptions of State Sovereignty and Their Implications for Global Institutional Design,” 574. 10 Daniela Gabor, “The (Impossible) Repo Trinity. The Political Economy of Repo Markets,” Review of International Political Economy 23, no. 6 (2016): 967–1000; Daniela Gabor and Cornel Ban, “Banking on Bonds. The New Links Between States and Markets,” Journal of Common Market Studies 54, no. 3 (2016): 617–35; Daniela Gabor and Jakob Vestergaard, “Towards a Theory of Shadow Money,” INET Working Paper (Institute for New Economic Thinking, 2016); Perry Mehrling, The New Lombard Street. How the Fed Became the Dealer of Last Resort (Princeton and Oxford: Princeton University Press, 2011); Perry Mehrling, “Elasticity and Discipline in the Global Swap Network,” International Journal of Political Economy 44, no. 4 (2015): 311–24; Perry Mehrling, “Beyond Bancor,” Challenge 59, no. 1 (2016): 22–34; Steffen Murau, “Shadow Money and the Public Money Supply. The Impact of the 2007-2009 Financial Crisis on the Monetary System,” Review of International Political Economy 24, no. 5 (2017): 802–38; Zoltan Pozsar, “Shadow Banking. The Money View,” Working Paper (Office of Financial Research, 2014); Adam Tooze, Crashed. How a Decade of Financial Crises Changed the World (New York: Viking, 2018); Benjamin Braun, Arie Krampf, and Steffen Murau, “’Financial Globalization as Positive Integration. Monetary Technocrats and the Eurodollar Market in the 1970s,” Review of International Political Economy, 2020, https://doi.org/doi.org/10.1080/09692290.2020.1740291. 11 Stefan Avdjiev, Robert McCauley, and Hyun Song Shin, “Breaking Free of the Triple Coincidence in International Finance,” BIS Working Papers (Bank for International Settlements, 2015); Iñaki Aldasoro and Torsten Ehlers, “The Geography of Dollar Funding of Non-US Banks,” BIS Quarterly Review (Bank for International Settlements, 2018); Dong He and Robert McCauley, “Eurodollar Banking and Currency Internationalisation,” BIS Quarterly Review (Bank for International

4 creation largely to private financial institutions which issue money ‘offshore’, using a unit of account (e.g. the US-Dollar) outside of the jurisdiction to which this unit of account is legally connected (e.g. the US).

Rather than giving up on the concept of monetary sovereignty altogether, the aim of this article is to propose a new conception of monetary sovereignty. The concept of monetary sovereignty is the general idea as it is widely used in economic and political discourse, while the conception is a particular way of defining the concept that distinguishes it from other conceptions.12 We propose an effective conception of monetary sovereignty that is distinct from the Westphalian conception and focuses on what states are able to do within the constraints set by the global credit money system.

In developing our conception, we understand the modern credit money system as composed of a public, a private-public and a private money segment. The agency of the state—what we describe as monetary governance—takes different shapes in relation to these three segments. States can control public money through central bank design but can only exercise more arms-length influence over private money creation. The private-public segment of the credit money system consists in the regulated banking sector, which is subject to public guarantees and has access to monetary policy operations. The pure private segment consists in money creation that takes place outside the states’ regulatory reach without public guarantees. It

Settlements, 2012); Hiro Ito and Robert McCauley, “A Key Currency View of Global Imbalances,” BIS Working Papers (Bank for International Settlements, 2018). 12 John Rawls, A Theory of Justice, Revised Edition (1971; repr., Cambridge, MA: Belknap Press, 1999).

5 confronts states with a challenge of management, rather than regulation. In managing pure private money, states can seek to accommodate private money into the regulated banking system, issue an outright ban, or opt for a laissez-faire approach.

Building on these observations, we understand monetary sovereignty in terms of monetary governance, which encompasses not only the issuance of public money forms, but also governance of regulated banks and unregulated money forms, onshore and offshore. All three dimensions of monetary governance are constitutive of monetary sovereignty. Thus, we define monetary sovereignty as the ability of states to control public money, regulate private-public money and manage private money so as to achieve their economic policy objectives (see Figure 1). In putting forward this new conception of monetary sovereignty, the article contributes to the currently modest literature on the state in relation to the global monetary system.13 Normative research currently lags vast improvements in IPE scholarship of the past decade. The article stakes out a new field of empirical and normative enquiry into the real constraints that states face in achieving their aims in the face of the hybrid global credit money system.

13 Sanjay G. Reddy, “Developing Just Monetary Arrangements,” Ethics & International Affairs 17, no. 1 (March 1, 2003): 81–93; Aaron James, Fairness in Practice: A Social Contract for a Global Economy (New York: Oxford University Press, 2012); Boudewijn de Bruin et al., “Philosophy of Money and Finance,” in The Stanford Encyclopedia of Philosophy, ed. Edward N. Zalta, Winter 2018 (Stanford University, 2018); Viehoff, “Eurozone Justice”; Lisa Herzog, “Global Reserve Currencies from the Perspective of Structural Global Justice: Distribution and Domination,” Critical Review of International Social and Political Philosophy 0, no. 0 (May 11, 2019): 1–23, https://doi.org/10.1080/13698230.2019.1616441.

Controlling Regulating Managing Public Money Private-Public Private Money

Economic Policy Objectives

Figure 1—Monetary Sovereignty and the three dimensions of monetary governance

The remainder of the article is organised as follows. Section Two highlights the weaknesses of the Westphalian conception and argues for an effective conception. Section Three discusses the global credit money system and its relation to the state. This allows us to distinguish a public, a private-public and a private segment. Section Four analyses how states can control issuance in the public money segment, regulate the private-public money segment and manage the private money segment. Section Five concludes by reflecting on how to study monetary sovereignty empirically.

2. Beyond Westphalian monetary sovereignty

The concept of sovereignty has historically been used in a wide range of divergent senses14 but has often been taken to involve issuing a national currency.15 The 16th century thinker Jean Bodin who introduced the concept names explicitly the ability to coin money as one of the defining aspects of sovereignty. The Westphalian conception of monetary sovereignty focuses on this specific ability. In contrast to the narrow Westphalian conception, our conception of effective monetary sovereignty focuses on what states are able to achieve within the confines of the global credit money system. We argue for the relevance of such a conception by comparing what four countries—the United States, Bangladesh, Denmark, and the

Netherlands—can effectively do by governing money.

The Westphalian conception of state sovereignty focuses on the right of states to make certain key domestic decisions without interference from other states. The issuance and regulation of a national currency is one such key decision.

A corresponding legal principle of monetary sovereignty originates in a 1929 ruling of the Permanent Court of International Justice. In the so-called Serbian Loans Case, the court stated that “it is indeed a generally accepted principle that a state is entitled to regulate its own currency”. Theorists of sovereignty have explored this principle by distinguishing an internal and an external dimension.16 Internally,

14 Daniel Philpott, “Sovereignty,” in The Oxford Handbook of the History of Political Philosophy, ed. George Klosko, vol. 1 (Oxford University Press, 2011), https://doi.org/10.1093/oxfordhb/9780199238804.003.0032. 15 Proctor, Mann on the Legal Aspect of Money. 16 Proctor, para. 19.02-8; Zimmermann, A Contemporary Concept of Monetary Sovereignty.

8 monetary sovereignty refers to the right of a state to issue a national currency, regulate its use within the territory and use monetary policy to achieve domestic policy objectives; externally, it refers to the ability to set the exchange rates.

Political theorists have challenged legal conceptions of state sovereignty as a normative benchmark for international relations. The legal approach is both not demanding enough and too demanding. It is not demanding enough since it requires little more from other states than the absence of interference.17 Indeed, states can retain the legal competences to issue and enforce regulation while lacking the capacities and resources to achieve their domestic policy objectives. At the same time, it is too demanding in that it sees treaties in which states give up selected legal competences as reducing sovereignty, even where these treaties improve the capacities and resources available to states to achieve their domestic policy objectives.18

Moving beyond legal conceptions of sovereignty, these authors have argued for a renewed focus on the policy options that are available to states and the outcomes that they can achieve.19 Invoking the classic distinction of Isaiah Berlin between negative and positive liberty20, they reject the legal conception’s focus on non-interference. Instead, they highlight the importance of normatively valuable outcomes that states can achieve. Understood in a “positive” or “effective” sense,

17 Jackson, Quasi-States, 40–47. 18 Ronzoni, “Two Conceptions of State Sovereignty and Their Implications for Global Institutional Design.” 19 Jackson, Quasi-States; Ronzoni, “The Global Order”; Ronzoni, “Two Conceptions of State Sovereignty and Their Implications for Global Institutional Design”; Dietsch, “Rethinking Sovereignty in International Fiscal Policy”; Dietsch, Catching Capital. 20 Isaiah Berlin, Four Essays on Liberty (Oxford University Press, 1969); Jackson, Quasi-States.

9 sovereignty refers to “the substantive problem-solving capacity of states and to their ability to make meaningful and genuinely discretionary choices on a range of issues”.21 A similar turn, however, has not taken place with regard to the concept of monetary sovereignty, which reflects the modest size of the existing normative literature on the state in relation to the global monetary system.22

Why do we need a conception of effective monetary sovereignty? In today’s monetary system, the ability of states to achieve their ends is not distributed equally.

There is indeed considerable variation in the extent to which states are able to achieve their economic policy objectives. Today’s global monetary system is one of market-driven monetary competition.23 States struggle to foster widespread usage of their national unit of account. Those states that succeed acquire a powerful tool of economic policy. For those states that fail, the money within their territory becomes subject to foreign rules.

The constraints that financial globalization and monetary competition impose on states is often analyzed in terms of the macroeconomic trilemma.

According to the trilemma, a state cannot at the same time maintain three things all widely considered desirable: free movement of capital, stable exchange rates and an independent monetary policy. Free movement of capital can put pressure on exchange rates, which states can offset through monetary policy. States can also use

21 Ronzoni, “Two Conceptions of State Sovereignty and Their Implications for Global Institutional Design,” 574. 22 Reddy, “Developing Just Monetary Arrangements”; James, Fairness in Practice; Bruin et al., “Philosophy of Money and Finance”; Viehoff, “Eurozone Justice”; Herzog, “Global Reserve Currencies from the Perspective of Structural Global Justice.” 23 Strange, The Retreat of the State; Cohen, The Geography of Money; Cohen, Currency Power; Agnew, “Sovereignty Regimes.”

10 monetary policy for other purposes, but then they lose control over the exchange rate. The Mundell-Fleming model that informs the theory, however, deals only with public money forms, which states are assumed to control.24 As a consequence, the agency of the state is portrayed as limited to deciding which horn of the trilemma to take, while obscuring the state’s agency in relation to the private-public and private segments of the global credit money system.

To illustrate the complex interrelations between money and sovereignty, we discuss four states and their highly divergent ability to govern money: the US,

Bangladesh, Denmark, and the Netherlands.

Consider first the immense variation in effective monetary sovereignty of states that issue a national currency. Within the global credit money system, the US is well-placed at the top of the international hierarchy of money.25 In setting its monetary policy, the Federal Reserve focuses almost exclusively on its domestic objective of price stability. To focus on US-Dollar denominated money issued by the

Federal Reserve would limit our understanding of the US’s hegemonic position within the global credit money system. The majority of US-Dollars are created by private financial institutions, banks and shadow banks, often domiciled offshore— beyond the purview of US authorities.26 Nonetheless, the existing monetary system

24 J. Marcus Fleming, “Domestic Financial Policies under Fixed and Floating Exchange Rates,” IMF Staff Paper 9, no. 3 (1962): 369–80; Robert A. Mundell, “Capital Mobility and Stabilization Policy under Fixed and Flexible Exchange Rates,” Canadian Journal of Economic and Political Science 29, no. 4 (1963): 475–85. 25 Thomas A. Bernes et al., “China’s Engagement with an Evolving International Monetary System. A Payments Perspective,” Special Report (Centre for International Governance Innovation (CIGI) and Institute for New Economic Thinking (INET), 2014). 26 Steffen Murau, “Offshore Dollar Creation and the Emergence of the Post-2008 International Monetary System” (Institute for Advanced Sustainability Studies (IASS), Potsdam, 2018).

11 leaves the US in a very privileged position, with ample policy space to achieve a range of economic policy objectives. Consider, in contrast, an emerging market economy such as Bangladesh. Like the US, Bangladesh issues a national currency, the Taka. Since it is highly reliant on the US-Dollar, Bangladesh seeks to stabilize market fluctuations of its exchange rate (a so-called “managed float”). Its monetary policy is constrained by this objective, but again, monetary policy is only part of the story. As its domestic firms borrow in US-Dollars, its economy is structurally dependent on foreign lenders. The key role of the US-Dollar in the global credit money system gives the US banking system a key edge over competitors and the Fed a powerful voice in shaping global banking regulation at Basel’s Bank for

International Settlements and other global banking fora. Bangladesh finds crucial parts of its banking system outside of its jurisdiction and is unrepresented in deliberation on global banking regulation. To stabilize its currency, Bangladesh holds a record $32 billion in low-yielding currency reserves, while paying over 8% interest on its sovereign bonds.27 The currency reserves are largely held in US-

Dollar denominated bonds. The functional role of US government debt as currency reserves and private sector collateral allows the US to fund historically unprecedented debt levels at much lower rates. Westphalian conceptions of monetary sovereignty obscure the very different positions of Bangladesh and the US within the global credit money system. Where the existing monetary system allows

27 Bangladesh Bank, “Foreign Exchange Reserve (Monthly),” April 2019, https://www.bb.org.bd/econdata/intreserve.php; Bangladesh Bank, “Treasury Bills & BGTB Auction,” April 2019, https://www.bb.org.bd/monetaryactivity/treasury.php.

12 the US to achieve a range of economic policy objectives, the same is not true for

Bangladesh.

The Westphalian conception of monetary sovereignty also overstates the importance of the ability to issue a national currency. This becomes clear when we compare a Eurozone country like the Netherlands with a Euro opt-out country such as Denmark. As a member of the Eurozone, the Netherlands has given up its former currency, the Gulden, and no longer conducts its own monetary policy. Instead, monetary policy is made by the governing council of the European Central Bank

(ECB), where Dutch interests are represented by its central bank governor. Euro- membership clearly affects the ability of states to achieve their domestic economic policy objectives, but they are not for that reason more constrained than countries whose currency is pegged to the Euro. The Danish Krone is pegged to the Euro at a fixed exchange rate, which precludes its use for pursuing an independent monetary policy 28. The Dutch banking system benefits from Eurozone membership and Dutch banks continue to be an important player in the global credit money system. Where the Danish banking system is subject to global banking regulation, drafted without much in the way of Danish political involvement, the Euro provides the Netherlands with a limited voice in banking regulation. To say that Denmark has monetary sovereignty while the Netherlands has not, betrays a narrow focus on the ability to issue a national currency. Despite lacking Westphalian monetary sovereignty, it is

28 James D. G. Wood, “Mortgage Credit: Denmark’s Financial Capacity Building Regime,” New Political Economy, November 14, 2018.

13 far from clear that the Netherlands is placed less-favourably in the global monetary system than Denmark.29

These examples show that there is great variation in what states can do within the constraints of the global credit money system. Whether they issue a national currency is only one factor. Although they retained their national currency,

Bangladesh and Denmark face pervasive constraints in using money as a tool of economic policy. The Netherlands no longer issues a national currency but is not clearly more constrained in governing money within its domestic economy. The dominant position of the US, finally, is not only a function of US-Dollars issued by the Federal Reserve, but also depends on the widespread private US-Dollar creation outside the US. The way other states are constrained, similarly, is not adequately captured by the macroeconomic trilemma. Effective monetary sovereignty is thus not just a matter of issuing a national currency. Instead, it depends crucially on the position of states within the global credit money system. This is the topic to which we now turn.

29 Nicolas Jabko, “The Hidden Face of the Euro,” Journal of European Public Policy 17, no. 3 (April 1, 2010): 318–34, https://doi.org/10.1080/13501761003662081; Amy Verdun, “Small States and the Global Economic Crisis: An Assessment,” European Political Science 12, no. 3 (September 1, 2013): 276–93, https://doi.org/10.1057/eps.2012.34.

3. The state and the global credit money system

According to the Westphalian conception, monetary sovereignty involves little more than allowing each state to issue its own national currency. To the extent that states cooperate internationally, primarily by organizing the conversion of their national moneys, they form the ‘international monetary system’. In the Westphalian logic, this goes bottom up, which makes the state the smallest unit of international finance, its natural building block.30 We challenge the Westphalian conception on how it conceptualizes monetary sovereignty both within states and between states.

In its internal dimension, the Westphalian conception focuses on the legal competences of states in issuing and regulating the money that circulates within its territory. It portrays our era as one of ‘fiat money’, issued by the central bank as a direct agent of the state. The state’s ability to issue money, indeed, may appear unconstrained since, in contrast to the previous Gold Standard and Bretton Woods era, issuing money no longer requires a scarce precious metal. In its narrow focus on public money creation, however, the Westphalian perspective omits the crucial role of private money forms in existing capitalist economies. Banks and other private financial institutions issue new money in the act of handing out loans. As a consequence, capitalist states not only have limited control over the use of money outside of their territory. States are similarly constrained in their control over domestic money creation.

30 David Lake, “Open Economy Politics. A Critical Review,” Review of International Organization 4, no. 3 (2009): 219–44.

Recent work in IPE has done a lot to challenge the Westphalian conception’s narrow focus on public money.31 This literature conceptualizes the domestic monetary system as a payments system in which all money is credit money, whether physically printed or not. We can only hold money as an asset that is someone else’s liability. In this understanding, money creation takes place denominated in a nominal unit of account—the US-Dollar, the British Pound, or the Euro—that is connected to state structures but can be used by non-state institutions.32 New money is issued by institutions that participate in the payment system, such as the central bank, commercial banks, and non-bank financial institutions, often called

‘shadow banks’.

Building on this work, we distinguish three segments of the money supply, in relation to each of which the state has a different role. First, public money is money issued directly by a public institution. The main instruments that correspond to the category of public money are central bank notes (or currency) and central bank deposits (or reserves). Today, public money is typically issued by an independent central bank, which uses the issuance of new money to pursue macroeconomic objectives outlined in a legal mandate.

31 Gabor, “The (Impossible) Repo Trinity. The Political Economy of Repo Markets”; Gabor and Ban, “Banking on Bonds. The New Links Between States and Markets”; Gabor and Vestergaard, “Towards a Theory of Shadow Money”; Mehrling, The New Lombard Street. How the Fed Became the Dealer of Last Resort; Mehrling, “Elasticity and Discipline in the Global Swap Network”; Mehrling, “Beyond Bancor”; Murau, “Shadow Money and the Public Money Supply. The Impact of the 2007-2009 Financial Crisis on the Monetary System”; Pozsar, “Shadow Banking. The Money View”; Tooze, Crashed. How a Decade of Financial Crises Changed the World; Braun, Krampf, and Murau, “’Financial Globalization as Positive Integration. Monetary Technocrats and the Eurodollar Market in the 1970s.” 32 Alfred Mitchell-Innes, “The Credit Theory of Money,” The Banking Law Journal 31 (1914): 151– 68; John Maynard Keynes, A Treatise on Money. Volume I—The Pure Theory of Money (London: Macmillan, 1930).

Second, private-public money is created by private institutions and backstopped via explicit or implicit guarantees by public institutions such as the central bank and the treasury. Despite direct control of money creation being in private hands, issuance of private-public money forms takes place in the context of a strict public regulatory framework. Issuers will often need a banking license, but also receive access to last resort credit from the central bank and benefit from deposit insurance to protect the customers of the issuer against default. Together, the guarantees serve to make private-public moneys for most economic purposes identical to public money forms. Straightforward examples of private-public money are insured bank deposits but the category also includes instruments such as overnight repos and shares of government money market funds if they are subject to public guarantees.33

Third, private money forms are issued by private institutions but do not have any public guarantees. These money forms need not be used as a means of payment themselves but are often merely convertible into means of payment at par.

Monetary history has witnessed multiple shadow money instruments come and go, for example country bank notes in the 18th and 19th century, trust deposits in the

19th and 20th century, as well as money market fund (MMF) shares, repurchase agreements (repos) and asset-backed commercial papers (ABCPs) in the 20th and

21st century.34 Definitions of what counts as private money or shadow money vary,

33 Pozsar, “Shadow Banking. The Money View.” 34 Charles Poor Kindleberger and Robert Z. Aliber, Manias, Panics, and Crashes: A History of Financial Crises, 5. ed (Basingstoke: Palgrave Macmillan, 2005).

17 which is hardly surprising as the opacity of those instruments is often part of their issuers’ business strategy.35

Figure 2 represent the hybridity of the monetary system as a hierarchical three-layered pyramid structure.

Figure 2—Public, private-public and private money segments

All credit instruments that count as money are denominated in a unit of account, for example the US-Dollar, the Euro or the British pound. The defining feature that makes these instruments money is that they maintain a one-to-one exchange rate with each other (i.e. they trade at par). You can easily transfer one US-

Dollar note (public money) into a bank deposit (private-public money) by paying it

35 Pozsar, “Shadow Banking. The Money View”; Gabor and Vestergaard, “Towards a Theory of Shadow Money”; Morgan Ricks, The Money Problem. Rethinking Financial Regulation (Chicago and London: The University of Chicago Press, 2016).

18 into your bank account and then shifting it into an uninsured money market fund

(private money), or vice versa. This often conceals inherent differences between these categories of instruments, which matter crucially for what it means for a state to have monetary sovereignty.

Figure 3—Mobility of money forms between segments

The ability of states to decide the structural setup of the money supply is limited by the fact that a money form is not firmly tied to one segment. Instead, new money forms can emerge upon private initiative and be shifted around between the segments. This stands in stark contrast with Westphalian visions of states issuing national currencies. The instruments that today are public or private-public money typically originated as private money, became systemically relevant over time, were subject to a bank run in a systemic financial crisis, and had to be turned into private-

19 public money to prevent the monetary system from collapsing—a recurring process that may be called ‘private credit money accommodation’ (see Figure 3).36

Today’s central bank notes, or currency, originated as private credit money in the 17th and 18th century, were ‘accommodated’ in 1797 when the English Bank

Restriction Act stopped gold convertibility and introduced a public guarantee for par clearance, before they were made public money with the 1844 Bank Charter Act.

Bank deposits were even older instruments, turned into private credit money after the 1844 Act. In the US, bank deposits were accommodated in 1933 when Franklin

D. Roosevelt, to end the Great Depression, announced a 100% guarantee. Money market fund shares and overnight repos developed as ‘shadow money’ in the 1970s and were accommodated in the 2007-9 Financial Crisis through the emergency interventions of the Federal Reserve and the US treasury.

The ability of states to govern money is further limited by the global nature of the contemporary credit money system. The traditional perspective of external

Westphalian monetary sovereignty is that individual nation states co-exist next to each other, with states issuing a national currency and regulating banks that issue money denominated in that currency within their territory.

The vision that informs the Westphalian conception of monetary sovereignty is one where three things coincide: territorial borders, political authority and the use of money.37 In such a world, the national currency is indeed a decisive lever for

36 “The Political Economy of Private Credit Money Accommodation. A Study of Bank Notes, Bank Deposits and Shadow Money” (PhD thesis, London, City, University of London, 2017). 37 Avdjiev, McCauley, and Shin, “Breaking Free of the Triple Coincidence in International Finance.”

20 making domestic economic policy, while other states could have little legitimate purpose to interfere. This coincidence, however, has historically been the exception rather than the rule.38 Indeed, although this model may have been more or less close to reality in the state-centric and financially repressed post-World War II situation, little of this ideal type is left in the real world of financial globalization.39

Instead, the globalized monetary system crucially relies on money creation

‘offshore’. In contrast to money creation ‘onshore’, banks create money offshore when they use the unit of account specific to a state in order to create money denominated in that unit of account while being legally based in another monetary jurisdiction. The monetary jurisdiction is the part of the global monetary system over which the state has legal authority. It is the part that it can effectively govern and which it can seek to shape to achieve its domestic economic policy objectives.

The monetary area, in contrast, is the space in which a unit of account is used.

Offshore money is denominated in a state’s unit of account but located outside a state’s monetary jurisdiction. For example, a French bank in London can make a US-

Dollar loan to a Chinese borrower and in the course of this create US-Dollar deposits outside of the United States. ‘Offshore’ here not only refers to tax havens but to the monetary area outside the state’s monetary jurisdiction. Offshore money creation

38 Karl Polanyi, The Great Transformation. The Political and Economic Origins of Our Time (New York: Farrar & Rinehart, 1944); Cohen, The Geography of Money; Eric Helleiner, The Making of National Money. Territorial Currencies in Historical Perspective (Ithaca and London: Cornell University Press, 2003). 39 Katharina Pistor, “From Territorial to Monetary Sovereignty,” Theoretical Inquiries in Law 18, no. 2 (June 29, 2017).

21 began in the 1950s on the Euro-currency markets.40 With the end of the state-centric

Bretton Woods system, the private Euro-currency markets attained an increasingly important role. From 1974, the Eurodollar market—the Euro-currency markets’ core component—went global and became the backbone of the privatized international monetary system, centered around offshore US-Dollar creation.41

Today, 12.8 trillion US-Dollar creation takes place offshore.42

As Figure 4 demonstrates, offshore money creation is not limited to private money forms. Through so-called swap lines, central banks facilitate each other in issuing new public money in foreign units of account. The Federal Reserve and the

ECB have allowed other central banks to provide US-Dollar and Euro-denominated credit money to their domestic banking sectors. In this way, both central banks have effectively put other central banks in the position to create public money in a foreign unit of account. This allows them to provide liquidity backstops to banks creating offshore bank deposits in their respective monetary jurisdictions, which then makes these deposits part of the private-public money segment. Other sources for backstopping banks are central banks’ foreign exchange reserves, regional financing arrangements, and IMF credit lines. Through these different arrangements, states are able to provide support to offshore money creation in units of account for which they do not issue public money .43

40 Eric Helleiner, States and the Reemergence of Global Finance. From Bretton Woods to the 1990s (Ithaca and London: Cornell University Press, 1994). 41 Helleiner. 42 Aldasoro and Ehlers, “The Geography of Dollar Funding of Non-US Banks.” 43 Ed Denbee, Carsten Jung, and Francesco Paternò, “Stitching Together the Global Financial Safety Net,” Financial Stability Paper (Bank of England, 2016); Mehrling, “Elasticity and Discipline in the

Figure 4—Three segments and the onshore-offshore antagonism

What does all of this imply for our understanding of effective monetary sovereignty? First, a conception of monetary sovereignty must give up on the triple coincidence of the scope of state decision making, the usage of the state’s unit of account, and the state’s domestic economy. Unlike the Westphalian conception’s territorial focus, effective monetary sovereignty depends on what a state is able to do under the conditions of financial globalization. However, the ability of states to issue and regulate money in their unit of account is limited to its onshore ‘monetary jurisdiction’, the dark blue segment in Figure 4. Dealing with the offshore segment of its own the monetary area— the blue-grey segment in Figure 4—is only possible to a limited extent and generally requires the collaboration of other states.

Global Swap Network”; Murau, “Offshore Dollar Creation and the Emergence of the Post-2008 International Monetary System.”

Second, a conception of monetary sovereignty must acknowledge that the state is not a unitary actor. Rather, different actors act on behalf of the state in relation to the monetary system. They may be individual politicians, government agencies, legislative bodies, courts and public administration. Within the confines set by the domestic constitutional and political structures of individual states, these actors seek to influence the balance sheets of the various institutions that issue money. The way the state governs money is the sum of those actions.

Finally, we need a conception of monetary sovereignty that covers all three segments. State agency manifests itself in relation to these segments in three ways.

First, state actors can exercise direct control over the issuance of public money.

Today, public money is generally in the hands of central banks and other regulatory agencies. Second, state actors can regulate the private-public money segment. They have announced explicit, or put in place implicit, liquidity or solvency guarantees and exercise regulation and supervision. The main institutions subject to banking regulation are deposit-issuing commercial banks. For internationally active banks, the Basel Committee and other transnational regulatory bodies seek to establish harmonized regulation. The domestic regulatory framework is shaped in part by the central bank, the treasury, and other government agencies. Third, state actors have only a limited influence on the ‘private money segment’ outside of the public-private partnership. Shadow banks are subject to modest regulation, but not to the strict regulatory framework that applies to banks and do not have recourse to liquidity backstops. Rather than regulate, we will describe state actions towards shadow banks as managing. Shadow banks are the key institutions issuing historically

24 changing shadow money forms. State actors involved in managing shadow money are, for example, financial authorities such as the Securities and Exchange

Commission in the US or courts that enforce contracts and solve disputes.

Taking into account the onshore-offshore distinction, a state can exercise monetary governance over only a part of the monetary area for its unit of account.

Within its monetary jurisdiction, a state can govern onshore money, denominated in that state’s unit of account, and offshore money, denominated in another state’s unit of account. This means that money denominated in one unit of account can be part of multiple monetary jurisdictions and hence, as Figure 5 shows, is subject to monetary governance by a multitude of states. In particular, offshore money denominated in the unit of account of one monetary jurisdiction can only be governed through the institutions of other monetary jurisdictions. The pervasive disconnect between money and territory raises entirely new challenges for what it means to be sovereign in relation to money.

Figure 5—Monetary governance and the three segments of the monetary area

4. Effective monetary sovereignty

We define effective monetary sovereignty as a state’s ability to effectively make use of its tools for monetary governance—controlling, regulating and managing the three segments of the global credit money system—in order to achieve its economic policy objectives.

This conception meets two desiderata that any normative conception of monetary sovereignty must fulfill. First, it singles out something that is normatively significant. Monetary sovereignty, if the term has any meaning today, is something that states rather have more of than less. Effective monetary sovereignty is normatively attractive in the sense that it is almost always better for states to be able to achieve their economic policy objectives. It is also normatively significant in the sense that it can ground duties of other states. For example, we can ask what sorts of duties states have towards each other to secure the conditions under which each can effectively govern money within their territory.

Second, an adequate conception of monetary sovereignty should be compatible with a range of further empirical and normative beliefs. Like concepts such as “freedom” and “well-being”, the question what constitutes sovereignty is itself a legitimate topic of political disagreement. Although our proposal may be faulted for being too thin, we think many extant accounts obfuscate the difference between monetary sovereignty and particular policies that contribute to it.

Proponents of Modern Monetary Theory, for example, have claimed that states only have monetary sovereignty if they meet all of three conditions: First, they issue a

27 national currency in which they collect taxes, whose exchange rate is, second, floating and non-convertible, and, third, they have no foreign-currency denominated debt.44 To define it in this way reduces monetary sovereignty to a set of policy prescriptions, but it is not at all obvious that these conditions are individually conducive to achieving economic objectives.45 Making its three conditions part of the definition of monetary sovereignty resolves genuine political disagreement on a conceptual level. Our conception, in contrast, invites more sustained debate over what actually improves the position of states in relation to money.

Since we only propose a conception of monetary sovereignty and no empirical benchmark or policy prescription, our account is also indeterminate with regard to how to govern the different segments of the monetary system as well as the relative importance of the individual segments. In the existing hybrid monetary system, central banks issue public money as a low-risk instrument for the financial system, while more risky lending is left to private firms. A hybrid monetary system, if it functions well, can combine the advantages of various public and private arrangements.46 Full reserve banking and sovereign money proposals reject hybridity in favor of a purely public monetary system 47, while free bankers favor an

44 Mitchell, Wray, and Watts, Macroeconomics. 45 Bruno Bonizzi, Jo Michell, and Annina Kaltenbrunner, “Monetary Sovereignty Is a Spectrum: Modern Monetary Theory and Developing Countries,” Real-World Economics Review, no. 89 (October 4, 2019): 46–61. 46 Robert Hockett and Saule Omarova, “The Finance Franchise,” Cornell Law Review 102, no. 5 (July 1, 2017): 1143. 47 Andrew Jackson and Ben Dyson, Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed (London: Positive Money, 2012).

28 entirely privatized system.48 Among those who support a hybrid system, there remains a broad range of options from financial systems subject to strict credit controls49 to the laissez-faire approaches associated with pre-crisis Basel II regulation.50 Our conception of monetary sovereignty is compatible with these different positions.

Although there is no a priori connection between our conception and any particular segment, monetary sovereignty manifests itself in very distinct ways in the individual segments of the credit money system. To flesh out what it means for states to make their own economic policy within the constraints set by the global credit money system, we will now analyze the different ways in which states govern money. They can control the issuance of pure public money through central bank design (4.1), regulate private-public money through banking regulation and monetary policy (4.2), and manage private money through laissez-faire, bans or accommodation (4.3).

48 Friedrich August von Hayek, Denationalisation of Money - The Argument Refined. An Analysis of the Theory and Practice of Concurrent Currencies (London: The Institute of Economic Affairs, 1976). 49 Dirk Bezemer et al., “Credit Where It’s Due: A Historical, Theoretical and Empirical Review of Credit Guidance Policies in the 20th Century,” UCL Institute for Innovation and Public Purpose Working Paper Series, 2018, https://www.ucl.ac.uk/bartlett/public- purpose/publications/2018/nov/credit-where-its-due; Eric Monnet, Controlling Credit: Central Banking and the Planned Economy in Postwar France, 1948-1973 (Cambridge University Press, 2018). 50 Daniel K. Tarullo, Banking on Basel: The Future of International Financial Regulation (Peterson Institute, 2008).

4.1 Controlling issuance of pure public money

In today’s monetary system, a state’s key discretionary choices for issuing pure public money concern the status and the design of its central bank—its institutional organization, mandate and permissible operations.51 The design of the central bank determines who decides what regarding pure public money creation on the central bank balance sheet and hence determines the size and accessibility of the pure public money segment within a monetary jurisdiction. This, in turn, influences the volume of central bank money creation, who gets access to central bank money, and how much of it. The central bank also has a crucial role in regulating public-private money, which we turn to below.

From the standpoint of effective monetary sovereignty, there is no obviously correct way to design the political structures for public money creation. Even though the prevalence of a central bank in a monetary jurisdiction has become the norm in the late 19th and early 20th century, the mandate, institutional organization and actual operations differ quite substantially between different central banks, and have been subject to profound historical change.52 First, concerning formal organization, states make choices with regard to its role as state bank and bankers’ bank 53, its level of democratic accountability and independence from government

51 Ricardo Reis, “Central Bank Design,” Journal of Economic Perspectives 27, no. 4 (November 2013): 17–44, https://doi.org/10.1257/jep.27.4.17. 52 Charles E. Goodhart, The Evolution of Central Banks (Cambridge and London: The MIT Press, 1988). 53 Peter Conti-Brown, The Power and Independence of the Federal Reserve (Princeton: Princeton University Press, 2016).

30 interference54, as well as the scope of international monetary cooperation55. Second, concerning the mandate, central banks have historically been closely connected to government expenditures, in particular war finance, converting notes and managing international trade for foreign exchange conversion. Under Keynesian regimes, they were attributed with numerous tasks, such as achieving growth and full employment. According to new consensus models, their primary responsibility is to maintain price stability, while monetary policy also retains an important role in stabilizing exchange rates.56 Third, concerning actual instruments, the way in which central banks create money has evolved considerably over time57 as has the degree of coordination with fiscal authorities.58

In light of the constraints that states face individually, effective monetary sovereignty can be increased by sharing governance structures for controlling public money.59 From a perspective of Westphalian monetary sovereignty, membership in a currency union such as the Euro is often seen as involving a dramatic loss of control over public money issuance.60 However, it is a contested

54 Paul Tucker, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State (Cambridge (MA): Harvard University Press, 2018); Jens Van ’t Klooster, “The Ethics of Delegating Monetary Policy,” Journal of Politics, 2020, https://doi.org/10.1086/706765. 55 Harold James, Making the European Monetary Union (Harvard University Press, 2012). 56 Charles Goodhart, Forrest Capie, and Norbert Schnadt, “The Development of Central Banking,” in The Future of Central Banking. The Tercentenary Symposium of the Bank of England, ed. Forrest Capie et al. (Cambridge and New York: Cambridge University Press, 1994), 1–112. 57 Ulrich Bindseil, Monetary Policy Implementation: Theory--Past--Present (Oxford; New York: Oxford University Press, 2004); Jens Van ’t Klooster and Clément Fontan, “The Myth of Market Neutrality: A Comparative Study of the European Central Bank’s and the Swiss National Bank’s Corporate Security Purchases,” New Political Economy, August 23, 2019, https://doi.org/10.1080/13563467.2019.1657077. 58 Bezemer et al., “Credit Where It’s Due: A Historical, Theoretical and Empirical Review of Credit Guidance Policies in the 20th Century.” 59 Cohen, The Geography of Money, chap. 4. 60 Proctor, Mann on the Legal Aspect of Money.

31 question how membership in a currency union impacts the state’s ability to achieve its economic policy objectives.61 A more modest loss of unilateral control over money occurs when central banks provide swap lines to each other. The Federal

Reserve and the ECB have allowed other states to issue public money offshore, which allows them to backstop offshore money within their monetary jurisdiction.

This has been seen to erode Westphalian monetary sovereignty because it challenges these central bank’s role as monopoly issuer of the currency.62 Yet, from a perspective of effective sovereignty, swap lines have contributed to achieving economic policy objectives in stabilizing the global credit money system during the crisis. The conception of monetary sovereignty that we propose does not answer these questions. Instead, it is a conception of sovereignty that can elucidate disagreement over the objectives of economic policy and how to achieve them.

4.2 Regulating private-public money

The Westphalian conception of monetary sovereignty focuses on decisions that a state can make without interference from other states. Due to this focus, it says very little about how states should relate to money creation by private financial institutions. States are thought of as sovereign as long as they can regulate financial institutions domiciled within their territory. In this regard, the Westphalian

61 Viehoff, “Eurozone Justice”; Ndongo Samba Sylla, “It’s Time to End the CFA Franc,” 2018, https://africasacountry.com/2018/06/its-time-to-end-the-cfa-franc. 62 Christophe Destais, “Central Bank Currency Swaps and the International Monetary System,” Emerging Markets Finance and Trade 52, no. 10 (October 2, 2016): 2253–66, https://doi.org/10.1080/1540496X.2016.1185710.

32 conception has a narrow territorial focus that abstracts from what economic policy objectives states can achieve by regulating private money.

For private-public money, effective monetary sovereignty consists in the ability of states to design the public-private segment in their monetary jurisdiction.

In principle, this applies to both onshore money denominated in that state’s unit of account and offshore money denominated in other units of account. We distinguish two means for states to do this: first, regulating the regulated banking sector; and second, designing their monetary policy framework.

Banking regulation determines under what conditions banks and other financial institutions are allowed to issue new credit money. One crucial objective of banking regulation has traditionally been financial stability: preventing the default of individual banks as well as banking crises.63 To this end, states seek to regulate the financial risks that banks are allowed to take. In the post-war era of

“embedded liberalism”, states regulated bank deposit creation through detailed prescriptions.64 Since the 1970s, the practice of banking regulation has become more hands-off and left money creation to be guided primarily by the profit motive.

Effective monetary sovereignty depends on what states can actually achieve but is compatible with each of these objectives.

Within the global monetary system, where a state’s monetary jurisdiction and the monetary area no longer overlap, the ability of states to regulate banks is

63 Tarullo, Banking on Basel; Ricks, The Money Problem. Rethinking Financial Regulation. 64 Bezemer et al., “Credit Where It’s Due: A Historical, Theoretical and Empirical Review of Credit Guidance Policies in the 20th Century”; Monnet, Controlling Credit.

33 constrained by competitive dynamics and the prominence of cross-border transactions.65 Offshore money constitutes a powerful challenge to the ability of states to achieve their economic policy objectives. The offshore space outside of a state’s monetary jurisdiction has become a venue not only to escape financial regulation but also to avoid taxes and launder money. For states whose citizens and firms use such services, offshore finance undermines their monetary sovereignty.

To deal with these challenges, states coordinate their regulatory activities in global fora such as the G20, the Basel Committee on Banking Supervision, and the

Financial Stability Board.66 While the coordination of banking regulation may involve giving up Westphalian sovereignty over banking regulation, it can improve the ability of the state to achieve the objectives of regulation. The same is true for giving up control over the regulation of cross-border financial flows.67 States that are not part of the exclusive fora of banking regulators are largely rule-takers. States whose economy relies on finance provided outside its monetary jurisdiction lack the ability to apply its rules to begin with. Being integrated in such international regulatory bodies and having a tangible influence on their policies increases a state’s effective monetary sovereignty.

The second way in which states exercise control over their banking system is through monetary policy. Today, the issuance of public money is primarily used to steer private-public money creation. By changing the conditions under which banks

65 Ronen Palan, Richard Murphy, and Christian Chavagneux, Tax Havens: How Globalization Really Works (Cornell University Press, 2013); Gabriel Zucman, The Hidden Wealth of Nations: The Scourge of Tax Havens (University of Chicago Press, 2015). 66 Chris Brummer, Soft Law and the Global Financial System (Cambridge University Press, 2015). 67 Dietsch, Catching Capital.

34 have access to central bank credit, states have considerable sway over what banks do. The ways in which states have sought to steer the creation of private-public money within their monetary jurisdiction have varied considerably over time. In the

1990s, central banks have converged on the use of short-term interest rates as the most important monetary policy tool.68 As one of the determinants of funding costs, it is thought to indirectly affect the creation of credit money by private financial institutions. Banks’ reliance on central bank refinancing operations makes this tool particularly effective for the regulated banking system, even if its effects reverberate through the entire financial system. More recently, central banks have turned to a host of unconventional monetary policy tools, which involve large scale financial asset purchases (so-called Quantitative Easing). The tools that states use for steering private-public money creation are historically contingent, have changed over time and may well do so in the future.

Effective monetary sovereignty in this field means having the ability to flexibly adapt the monetary policy strategy to a changing macro-financial environment. States that cannot use their monetary policy for these purposes, or whose banking system relies on a unit of account for which they do not control monetary policy to begin with, are limited in their monetary sovereignty. Central bank swap lines are a starting point for more international coordination of

68 Claudio Borio, “A Hundred Ways to Skin a Cat: Comparing Monetary Policy Operating Procedures in the United States, Japan and the Euro Area,” BIS Working Papers (Basel: Bank for International Settlements, 2001).

35 monetary policy, which may help states regain effective monetary sovereignty vis-

à-vis the global credit money system.

4.3 Managing private money

Private money forms are money forms whose issuers do not have direct access to public backstops and hence are not subject to monetary policy operations. While their issuers tend to be subject to modest regulation, they remain outside the strict regulatory framework applied to banks. Nonetheless, states retain the ability to manage private money. The ability of states to do so is a crucial part of their ability to achieve their economic policy objectives.

The normative assessment of the private money segment differs profoundly.

From the perspective of critics, the emergence of new private money forms is an important driver of financial instability.69 During an extended economic upturn, the financial system will tend to issue new money forms, which fund increasingly speculative investments.70 In a panic, financial markets lose confidence in these instruments, which often forces governments to integrate them into the private- public segment (Murau 2017b). This means that the most aggressive private issuers acquire new on-balance-sheet credit money balances, which public authorities are forced to guarantee. In this way, unregulated private money creation can undermine monetary sovereignty by forcing onto states unwanted private money creation.

69 Ricks, The Money Problem. Rethinking Financial Regulation; Pistor, “From Territorial to Monetary Sovereignty.” 70 Hyman P. Minsky, Stabilizing an Unstable Economy, New ed. (1986; repr., New York, [NY]: McGraw-Hill, 2008); Kindleberger and Aliber, Manias, Panics and Crashes.

A more optimistic perspective understands the private money segment as a legitimate source of funding for risky, potentially path-breaking investments and financial innovation. Historical experience shows that the prevalence of shadow money instruments in one form or another is a recurring byproduct of capitalist development.71 It is here where the largest fluctuations over the financial cycle take place, and where transformational changes of the financial and the real economy often materialize. As private money is often backed by sovereign debt it also facilitates states in funding their expenditures.

It is hard to determine ex ante which instruments are likely to develop into private money and what their connection to economic policy objectives will be. This poses a specific challenge to states for dealing with them. In the run up to the 2007-

9 financial crisis, various instruments of the shadow banking system—often termed

‘shadow money’ (Pozsar 2014)—have become part of the private money supply.

While the regulatory community initially perceived them as beneficial, they turned out to be an important driver of the crisis. The past years have seen a rampant proliferation of assets based on the blockchain technology, some of which promise to maintain par with public money forms (so-called stable coins). So far, however, these instruments have failed to stabilize their value sufficiently to serve as money for a state-issued unit of account.

States can take three entirely distinct approaches to managing private money. A first option is accommodation whereby new instruments are integrated

71 Joseph Alois Schumpeter, The Theory of Economic Development. An Inquiry into Profits, Capital, Credit, Interest, and the Business Cycle (Cambridge, MA: Harvard University Press, 1912).

37 into the public or private-public money segment. Depending on the nature of the instrument, this may involve liquidity backstops on the central bank’s balance sheet or measures for solvency insurance. What is crucial from a perspective of sovereignty is that such decisions are made in accordance with the state’s political procedures, rather than forced onto it as happened in the 1930s and in the 2007-9 crisis (Murau 2017a).

A second option is for states to pursue a ban of some or all private money forms, forcing non-bank financial institutions to give up par clearance or prohibit their operations entirely. Such a policy aims to stop private credit money forms from taking on systemic relevance and hence the potential for forced accommodation in a crisis. It also precludes benefiting from a more diversified set of monetary instruments.

Finally, states can also choose to acknowledge the existence of a pure private segment within their domestic monetary jurisdiction. Acknowledging is not the same as ignoring and involves monitoring risks and vulnerabilities emerging out of an expanding private money supply. Monetary sovereignty then manifests itself in a laissez-faire approach that leaves shadow money creation to itself, while making sure that the public cannot be made liable for it when something goes wrong. To remain sovereign in relation to private money requires preventing unregulated private money forms from taking on systemic relevance, which forces accommodation onto states.

5. Conclusion

Since money is the pivotal institution of a capitalist economy, any conception of sovereignty should be able to acknowledge its significance. We have proposed a new way of thinking about monetary sovereignty that fits the reality of today’s global credit money system. This allows us to overcome not only the Westphalian conception’s inadequate understanding of money but also its uncompelling account of sovereignty.

Analyzing effective monetary sovereignty is a complex undertaking and it is obvious that this article has only scratched the surface of the relevant empirical questions. We think that the study of effective monetary sovereignty is worthwhile because it is something that matters. Through detailed study of effective monetary sovereignty, we get a better understanding of how states are doing and what they might owe to each other as a matter of justice.72 We hope that a reconsideration of monetary sovereignty inspires more detailed quantitative and qualitative enquiry into what states can effectively do in the face of the existing global credit money system.

Compared to the Westphalian conception, the study of effective monetary sovereignty is difficult and raises three key challenges. First, the real constraints that states face in governing money cannot be read off of legal statutes but rather deserve detailed institutional analysis. The Westphalian conception suggests that

72 Ronzoni, “The Global Order”; Viehoff, “Eurozone Justice”; Herzog, “Global Reserve Currencies from the Perspective of Structural Global Justice.”

39 we can discover how sovereign a state is in relation to money simply by looking at the legal competences of the state and the way these are constrained by international treaties. However, if monetary sovereignty is understood in terms of national currencies, then all states that issue and regulate one are equally sovereign.

Conversely, if monetary sovereignty means having control over money creation within a territory, no state—not even the US—has any monetary sovereignty to speak of. Our conception broadens the focus of how money shapes what states can do. Moving the focus to effective sovereignty helps us to make sense of the crucial differences between Bangladesh, Denmark and the US, which are all monetary sovereigns in a Westphalian sense. It also raises new comparative questions concerning currency unions and whether a loss of a national currency can potentially be offset by more control over regulated and unregulated private money forms (we refrain from taking a position on whether the Euro or the CFA Franc today do this). In making such comparisons, our conception precludes any binary opposition of sovereigns and non-sovereigns or simple rankings of states.

Second, rather than focusing on a status that states may or may not have, effective monetary sovereignty requires us to think about the ways in which monetary governance allows states to achieve their objectives. This depends on the structure of a state’s domestic monetary arrangements. Hence, an adequate comparison of individual states requires considering all three segments of the global credit money system. Moreover, an individual state’s arrangement cannot be chosen unilaterally. No state faces an easy choice between giving up fixed exchange rates or retaining an independent monetary policy. Global banking competition constrains

40 the ability of states to effectively regulate their banking system. States in the periphery of the global credit money system often face pervasive domestic savings, credit provision and prices in a foreign unit of account. In the global credit money system, some states are better off than others but each state faces its own challenges.

No state, not even the US, has complete monetary sovereignty. To study monetary sovereignty empirically, research should not just consider legal and constraint that result from other states and international treaties, but also those resulting from domestic cultures and market forces.

Finally, the study of effective monetary sovereignty raises difficult normative questions, which should be pursued through an interdisciplinary agenda that spans political theory and international political economy. Since states face trade-offs, determining what constitutes an increase in monetary sovereignty is in part a function of weighing policy priorities. In this regard, the study of monetary sovereignty unavoidably confronts researchers with the question of what policies states should be able to pursue. This is not a call to politicize social science since the brunt of the empirical work will remain that of institutional analysis and the study of instruments available to states. Still, judgment unavoidably comes in when drawing on that evidence to say that one state is better placed within the global credit money system than another.