Flexible Exchange Rates, MMT, and the Ruble Crises of MMT

Ramanan continues on his MMT critique focusing on Forex. sovereignty, and flexible exchange rates. The standard MMT position around "currency sovereignty" is simply that a state has the ability to issue its own currency and thus is "sovereign" in it's matter. State obligations, in its own currency, are easily extinguished by it issuing more, and moreover, were initially funded by it issueng currency.

A simple thought experiment: if I was to establish winterspeak-land tomorrow, no one could pay a tax denominated in winterspeak-bucks because none would exist, nor could anyone buy a winterspeak-bond because they would have no winterspeak-bucks to do so with. The original winterspeak-buck would need to come from somewhere, and that somewhere would be me (else it would be counterfeit).

This is in some ways the most intuitive part of MMT, and yet it seems to cause problems when you have higher level discussions on more technical points. Regardless, let's turn to the real world and see just what the limits are to currency sovereignity, what the real world policy space is re: floating exchange rates, and what a countries' Forex obligations actually are.

First, let's establish that any goods and services that a state can generate and provider for itself can be entirely managed in its own currency. However, most states need some imports, and those imports may or may not be available in the state's own currency. In those cases, the state will need to either export real goods and services to get the required currency, or will need to be able to swap it's currency for the target currency on a forex market.

In the currency swap scenario, the state can either let the currency float freely, or it can attach it to some sort of peg. If the currency floats freely, then currency sovereignty it maintained. If there's a peg, then sovereignty is compromised as the state will be obligated to maintain that peg, or default.

In practice, most countries operate on what I called a "mixed currency regime" where the citizens use a mix of local and foreign currencies. This is certainly true in third world countries, and this mixed regime reflects how sovereignty in those countries is also weak -- there is usually limited law enforcement, corruption, weak property rights, etc. As the sovereignty of the state increases, you find mixed currency regimes becoming less mixed, and if the state is hyper-sovereign, ie. has the ability to dictate, or at least strongly influence the affairs of other states, then you find its currency beginning to dominate in those other countries as well. The US$ is exhibit A.

Ramanan writes:

Now, it is clear from the above quote that Mitchell admits that nations with government have a constraint on fiscal policy. But the more troublesome fact is that he presents it as if the government doing this had some full volition to not have been indebted in foreign currency.

It depends on how much the country wants to import. Free trade has costs instead of benefits, and a country can easily develop internal auto industries, for exmaple, if it wants to. The cars won't be as good as if they came from Japan, but it could do it. Aside from certain commodities, countries do have the option to trade less, and this become less indebted in a foreign currency, although that also has costs.

He continues:

So the Neochartalist story that somehow the government shouldn’t borrow in foreign currencies is vacuous. Only a few nations have the ability to attract investors to purchase their debt in domestic currency and typically these nations are successful in international trade. But this by no means guarantees continued success – if net indebtedness to foreigners keeps rising relative to output because trade in international markets for goods and services turns weak, then output gives in. And a shift in investors’ portfolio preferences also can lead to the original sin, even if one starts with zero government debt in foreign currency.

I don't agree that the MMT story is vacuous, I think it highlights another real cost and risk to free trade. He ends on what I consider another non-sequitor:

Now the backfire effect: in the “modern monetary theory” blogs, examples such as those of Pakistan are presented as if it was Pakistan’s policy makers huge error to have borrowed in foreign currency and to their fans this appears to strengthen the view that in the supposed world which the Neochartalists fantasize, there is no balance-of-payments constraint. And the error is the failure to recognize that “money” has an international aspect in addition to what it has to do with the government and banks.

At present, the solution is for the world leaders to provide a coordinated fiscal expansion and induce the creditor nations to increase domestic demand and hence increase latter’s level of imports. But the long term solution is to move away from a system of free trade. And that is far from the “MMT” overkill description of the world and overly simplified solutions.

I'm very familiar with Pakistan, and borrowing in dollars with a peg certainly constrains Pakistan's ability to use fiscal policy to boost domestic demand if that's what necessary. Honestly though, Pakistan's bigger problem is it's inability to generate savings demand for rupees from it's domestic population because it has very weak tax collection. Stronger tax collection would mean a bigger sink for rupees, reducing inflationary pressure, and letting it run higher deficits. Pakistan's need to borrow in foreign currency stems directly from it being unable to tax in it's own, although I do not want to imply that if it could tax in rupees that would fund it's ability to spend in rupees. The mechanism isn't a causal funding mechanism. The Pakistani government is a limited sovereign.

The ruble example of 98 is interesting because there, Russia defaulted on ruble denominated debt, which it could theoretically have honored. The contagion mechanism there was actually first world hedge funds, who were forced to sell other positions because their foreign debt portfolios were being squeezed.


One of the more interesting MMT insights, as stated by Mosler, is "exports are a cost, imports are a benefit", which is the opposite of the usual narrative where export driven economies, like Japan, are hailed while import driven economies, like the US, are said to be more vulnerable. When you look at straight goods and consumption, it's obvious that a country wants goods (which are hard to produce) more than it wants it's own currency (which is trivial, the trick is in getting it accepted). There are other reasons why an import heavy economy generates it's own costs, but if you had to choose between beads or the island of Manhattan, I hope the choice is clear even if you aren't conversant in MMT.