3.5  Monetary sovereignty and sovereign currency. Defining the monetary prerogative

/62/ MMT depicts present-day monetary systems in nation-states as sovereign monetary systems built upon a sovereign currency. In the light of the foregoing, one has profound reason to question that exposition. According to Wray, a sovereign currency exists when

'a nation adopts its own money of account, and … the government issues a currency denominated in that unit of account', … the currency 'usually consisting of metal coins and paper notes. … The sovereign government retains for itself a variety of powers that are not given to private individuals or institutions. Here we are only concerned with those powers associated with money. The sovereign government alone has the power to determine which money of account it will recognise for official accounts. … Further, modern sovereign governments alone are invested with the power to issue the currency denominated in its money of account’.[1]

/63/ This definition sounds right, but on closer inspection it is not. The understanding of sovereign currency and monetary sovereignty expressed here is only partial, and partly distorted. Three aspects in this definition need to be clarified.
First, the notion of currency misses the inclusion of bank money on account (demand deposits), as explained in 2.1.
Second, MMT's usage of 'government' remains equivocal about who is actually concerned – whether treasury and cabinet, or parliament, or the central bank. We will come back to this in 3.8 and 4.1.
Third, the assumption that treasury, cabinet or parliament have control over issuance of the currency cannot be maintained. Most governments actually do not issue the currency, but have left this to the banks. Cash is not spent into circulation by the government but bought and lent into circulation by the banks. The central bank too no longer exerts effective control, if it ever has to a decisive extent. Today it is the banks who proactively decide on how much money is issued. Government's role is to be debtor, not creditor, as MMT has it (3.8). The central bank willingly reacts to the banks' initiative by fractionally refinancing what banks predetermine (2.2–6).

From an NCT point of view, one agrees of course that a sovereign nation-state ought to have monetary sovereignty, in addition and in analogy to comparable prerogatives of constitutional importance such as the exclusive powers of legislation, executive government and administration, jurisdiction, or the monopoly of force, and the monopoly of taxation. A state's complete and unimpaired monetary prerogative includes three components:
1. Determining a country's standard currency unit, i.e. the monetary units of account.
2. Issuing the currency, i.e. the entire money supply, the stock of lawful means of payment, denominated in that standard unit.
3. Taking in to the benefit of the public purse the seigniorage which accrues from creating additions to the stock of money; be this genuine seigniorage resulting from spending new money into circulation, or interest-borne seigniorage resulting from loaning money into circulation.

/64/ Wray's definition neglects 3 and includes just 1 and 2, with 2 being partly wrong on governments' issuance of coin and notes and on not including bank money (customer demand deposits as well as interbank demand deposits). MMT does not recognise that the entire money supply today depends on the banks' individual discretion. If, however, the entire money supply originates from primary commercial bank credit, and this is summarised under 'sovereign currency', then this turns any sensible meaning of the term upside down.

In this regard, MMT is in line with the state theory of money according to Knapp and Mitchell-Innes. In spite of their conviction that money is a creature of the legal system, their understanding of a state's monetary prerogative, beyond defining the national currency, was largely incomplete. They replaced state money with the acceptance of bank money, and missed to include the question of seigniorage. So Knapp's and Mitchell-Innes' state theory of money actually comes out as a theory of mixed money (20 per cent state cash and 80 per cent bank money) in a state-backed banking regime―an economic view fully in tune with the self-righteous impetus of the national-liberal bourgeoisie in the 19th century.

The only point in which Mitchell-Innes and Knapp clearly differed was Mitchell-Innes' insisting on money to be credit and debt, whereas to Knapp money was a quasi preconditionless means of payment by state fiat for making out loans or paying down debts. In this respect, NCT sides with Knapp. As a general theory Mitchell-Innes' view cannot be upheld, but with specific regard to modern fractional reserve banking he is right too. This is actually what is behind the idea of 'an integration of the creditary and state money approaches.'[2]

Furthermore, both Knapp and Mitchell-Innes did not reflect on questions of quantities of freely created fiat money. Quantity theory of money, probably the oldest and most proven economic theory, is not part of their considerations. MMT too, similar to Lerner, tends to neglect questions on the optimum amount of money, in spite of Keynes' unequivocal position on the quantity theory: 'This theory is fundamental. Its correspondence with facts is not open to question.'[3]      

/65/ As to 3 (seigniorage), the lion's share of seigniorage today is foregone to the public purse. It is the banking sector that enjoys the privileges related to the prerogative of extending primary credit and deposits. The banks' privilege of having their debt to customers declared official money is actually an amazing achievement.[4] State coffers have to make do with a remaining relatively small interest-borne seigniorage accruing from making out fractionally needed central-bank credit to banks and managing the nation's foreign reserves.

Today's money supply is a mixed blessing of residual state money and predominant bank money, far from being the sovereign currency depicted by MMT. Most people, experts and laypersons alike, will understand 'sovereign currency' as money created and controlled by a state authority. In reality, the entire creation of money is done or determined by credit creation on the part of commercial banks – with the central bank not acting as proactive issuer of first instance (this is left to the banks), but having become nothing more than a reactive lender of least reserves – and also a lender of last resort for banks when these run short of liquidity or get in another type of trouble, acting in this exclusively as the bank of the banks, i.e. for the benefit of the banking industry, hardly as the bank of the state and for the benefit of the public purse. The latter has formally even been prohibited – prompting what is for once an alert comment by Wray, that this 'is a strange prohibition to put on a sovereign issuer of the currency.'[5]

Other than that, MMT's notion of currency is fully in line with the predominant banking-theoretical confinement of this term to just coin and notes in a mixed-money two-tier banking system. MMT thus avoids having to face up to the question of whether or not bank money is currency, and if yes, how it can be that commercial banks exercise the sovereign prerogative of issuing currency. Demand deposits are in fact the most important part of today's money supply, thus currency. /66/ It is telling that most state agencies demand to be paid in demand deposits, which is bank money, while refusing to accept cash, which is state money (3.1).

Having said this, what then remains of monetary sovereignty today? Among the three components of the monetary prerogative – determining the currency unit, issuance of the currency, benefiting from the seigniorage – only the first one is an unimpaired 'creature of the state'. But banks will not care too much about the currency unit as long as the central bank promptly fulfils the banks' fractional demand for cash and reserves.

Banking theory avoids reflecting on 'currency', for this comes with the meaning of sovereign money or state money. Vested interests would not want to see bank money merged with and integrated into the currency supply. Instead, banking has managed to incorporate what once was the currency into its credit-created and debt-based bank money system. The term of choice then, surprisingly, is 'cash'. Common usage often says 'cash' when actually talking about demand deposits. This has even been enshrined in the Generally Accepted Accounting Principles (GAAP), which refer to demand deposits as 'cash in bank', equal to 'cash in vault'. GAAP however do not consider banks' quasi-currency to be lawful money (legal tender) in strictly legal terms.

The GAAP term 'cash in bank', or 'cash on account', actually reflects what has become a reality today – and yet it comes close to obscuring realities.[6] It confers upon banks' money surrogate the appearance of being sovereign currency. This amounts to elevating banks to the rank of sovereign authority, conferring upon banks the sovereign prerogative of creating the money supply as well as benefiting from the seigniorage thereof, both in its genuine and its interest-bearing form (even if the latter cannot be identified in a bank's books as a separate money flow, but represents financing costs avoided). This authenticates bank money as the official de facto currency, i.e. a nation's general and regular means of payment.

MMT does not systematically reflect the fact that bank liabilities from typing credits into customer current accounts practically never fall due to 100%, but on average just to 2.5–10% depending on country, and also depending /67/ on the size of a bank. As a consequence, MMT does not recognise the truly princely money-creating privilege this gives to the banking industry, alien to any modern state and society based upon democratic control of constitutional prerogatives and based upon achievement rather than privilege.

Things have evolved this way throughout the past century because of the ever more widespread use of current accounts and cashless payment practices. The process was furthered by academia's and politics' thoughtless authentication of bank money as the predominant means of payment. The state's authentication, however, is a de facto placet. There are a number of paragraphs and ordinances which build on the existence of bank money as a matter of fact, but there is no explicit law on who has the right to issue currency on account or on mobile storage media. Legislation throughout the past 100–150 years has missed extending the treasuries' monopoly on coin and central banks' monopoly on banknotes to money on current account. One important reason for this is orthodox economics' obsolete understanding of the role of banknotes, as well as its erroneous belief in central banks' control of banks' credit and deposit creation through reserve requirements and base rate policies.

MMT does not mind whether fiat money is issued by a government body or by banks. The reason is that in MMT's understanding bank money is not non-sovereign, but is deemed a legitimate and authorised part of the existing system which they think to be a government and central-bank controlled 'sovereign' currency system. Banks are seen to positively fulfil a para-governmental role; formally not part of the state, but nevertheless representing and serving government's monetary interests. As Lerner has put it: 'In effect the banks are acting as agents for the government in issuing credit or bank money'.[7] This rather unusual reinterpretation – in fact misrepresentation – of the role of banks and government debt will be discussed further in 3.8.


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[1] Wray 2012 42.

[2] Wray (ed) 2004 259.

[3] Keynes 1923 74.

[4] Häring 2013 14.

[5] Wray 2012 204.

[6] Cf. Schemmann 2011 pp.16.

[7] Lerner 1942 300.