The Myth of the Currency Hierarchy

(response to Coppola’s “The Myth of Monetary Sovereignty” and related discussions)


A) Properly understanding the macroeconomy allows countries to operate at their full real-resource potential, whatever that might be.

B) Understanding the macroeconomy does not change the real resource potential of countries. That is a more fundamental question concerning the improvement of the institutions and productive capacity of a nation.

Understanding monetary sovereignty helps with (A). Frankly, no one has achieved any clear solutions for (B).

(A) and (B) can be pursued simultaneously. They are in no way mutually exclusive.

Not working to achieve (A) in developed and semi-developed countries in no way follows from the lack of progress on (B) in the least-developed countries.


Frances Coppola supports her view based on three points:

1) balance of payments crises have happened to countries with floating currencies; this is because they borrowed; but they had to borrow because they are resource poor

2) weak/thinly-traded currencies are volatile

3) countries with weak institutions/capital markets have “hot money” flows

Regarding (1):  Balance of payments crises, of course, are only possible with a floating currency if there is foreign-denominated debt. Thus Coppola’s argument must immediately retreat to an argument that foreign-denominated debt is “inevitable” for developing countries, so they are in practice not monetarily sovereign.

At the international level (unlike the domestic level), the household analogy is true: If a country is unproductive and/or resource-poor, it can only sustainably take on foreign-currency-denominated debt that increases production, not debt for consumption. If it wants to import for consumption, the only sustainable way is with a current account surplus/reserves from export.** The constraint for developing countries is exports, not lack of monetary sovereignty. The proper economic focus on real resources, not finance, applies as always.

Leading scholars on financialization in developing countries, after much consideration, still manage to come to the exact same inescapable conclusion and policy prescription:

“Lending in hard currency should be available only to domestic borrowers with earnings in that currency, that is, exporters. Importers would have to find a way to obtain currencies, unless specific imports are deemed necessary for developing policy objectives.” (Bortz & Kaltenbrunner, 2018, p. 13) (and even these should be “for capacity-expansion objectives, ideally oriented to boost exports.”)

In other words, only import for consumption what you can pay for in the moment without becoming a foreign currency user (borrower).

The limit on these least-developed countries has nothing to do with monetary sovereignty and everything to do with the unresolved problem that the poorest countries are the ones that need more real resources yet have nothing to trade for them.

This is a real-resource issue. It is just plain silly to call it a monetary sovereignty issue.

Regarding 2) Weak currencies are volatile. True. (but…)

Regarding (3): Here we have a fundamental misunderstanding of monetary sovereignty from many sides.

Coppola rests her point on an Asian Development Bank paper that states “Emerging markets with naturally higher interest rates are swamped with hot money inflows.” (McKinnon and Liu 2013, abstract).

The dilemma Coppola and others highlight is that “hot flows,” due to higher interest rates, cause destabilizing inflows; yet developing countries can’t then respond by altering rates without causing further destabilizing swings. Relatedly, interest rates must be set high to “maintain demand” for their currencies but these higher interest rates cause private borrowers in the developing country to borrow in foreign currencies:

“the international currency hierarchy forces DEEs [developing and emerging economies] to adopt higher interest rates to maintain demand for their currencies. It is this policy, however, which encourages national agents to borrow in international markets, thereby increasing their foreign exchange exposure and adding to debt servicing outflows.” (Bortz & Kaltenbrunner, 2018, p. 14)

Coppola’s argument and the “hierarchy of currencies” and “hot money” literature is based to a large degree on the premise that developing countries must prop up their interest rates.

This is precisely what an understanding of monetary sovereignty shows to be false.

Monetary sovereigns run their economy by emitting domestic tax-credits, which are valued due to their sovereign (monopoly on force) ability to tax. The tax-credit unit in turn forms the unit-of-account for their private banking sector. These are the two fundamental traits of a monetary sovereign.

The idea that a currency-issuer must sell bonds at interest demonstrates a basic lack of understanding of how modern money works. If a currency-issuer “sells” bonds in exchange for their own tax-credit, then accounting-wise they have done nothing (swapping one government token for another government token temporarily, and voluntarily paying eager savers interest. This does not “stop inflation from spending” since the holders were eager savers anyway and sovereign bonds are highly liquid. Indeed, rates on bonds can contribute to inflation, not reduce it because 1) businesses price higher rates into prices and 2) the relentless injection of interest rate payments in high powered money into the economy has potentially large effects in the medium- to long-term).

Artificially propping up interest rates, in the belief that this must be done to sell bonds, is to not understand the capability of a modern monetary sovereign, regardless of their development level. (Vestigial bonds and their once-needed interest offering have in turn been encrusted by layers of epiphytic pro-interest arguments: saving against inflation, as a policy tool etc; all of these things are achieved more directly with no government interest-rate manipulation).

If rates are propped up in order to borrow, then the same real-resource constraints apply we have already discussed in (1). In other words, interest rate manipulation is no financial fix to any real-world constraint. There is no useful purpose served by artificially propped up interest rates above zero, nor does a monetary sovereign in any way need to pay interest on its tax-credits (via bonds) to “sell” them to manage its domestic economy.

The “hierarchy of currencies” concern for hot money issues is largely based on propped-up interest rates. Yet it is precisely a distinguishing feature of monetary sovereigns that they can run at zero interest. Forever.

This aspect of monetary sovereignty is still not widely understood. But that is an issue for another day.


Note: That it is interest rates driving the hierarchy is evident in the proposed solution: “Reform efforts should focus much more on international monetary harmonization that limits interest differentials” (McKinnon and Liu 2013,p. 11). Harmonizing at zero is the obvious natural choice.

**Countries indeed must roughly match imports with exports over time or inevitably suffer. Even if, like the US, you can export dollars like a commodity, doing so harms the long-term employment situation & manufacturing capacity of the country. Any useful discussion of international trade must deeply incorporate the role of trading in increasing vs decreasing returns industries to meaningfully discuss the full costs:benefits of exporting/importing.


Bortz, Pablo and Annina Kaltenbrunner (2018). “The International Dimension of Financialization in Developing and Emerging Economies.” Development and Change, 49: 375-393.

McKinnon, Ronald and Zhao Liu, (2013). “Hot Money Flows, Commodity Price Cycles, and Financial Repression in the US and the People’s Republic of China: The Consequences of Near Zero US Interest Rates.” Asian Development Bank, Working Paper Series on Regional Economic Integration.

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