The uselessness of monetary sovereignty.

• Author: Schwartz, Pedro
• Position: European economy

The very politicians and economists who repudiate Keynesian policy at home become fervent Keynesians when they contemplate the horrors of British membership of the single currency.

--Robert Skidelsky

Before addressing the question of whether Britain should keep sterling, we should examine what little we know about the nature of money and about the functions and capacities of the nation state. Though it may be true that changing one's monetary standard has deep implications for national sovereignty, one should first give some thought to the reduced role of money and to the limits of state power in a modern open economy. There could be a need for recasting the arguments both for and against adopting the euro.

Thus, as regards the ability to influence the real economy with monetary instruments, the friends of the euro predict that economic convergence brought about by the single currency will help the European Central Bank govern the European economy with a continentwide monetary policy; and the friends of sterling hold it that it will be much easier to control economic fluctuations by means of the Bank of England interest rate. Thus also, as regards the consequences of globalization on national states, the defenders of the European Monetary Union hold it that the nation state is obsolete and impotent, while the defenders of national sovereignty, especially in Denmark and Sweden, fear the discipline of the euro for its effect on the welfare state. But views may change in more ways than one after seeing the limited effects of all monetary policy on real economies in a globalized world, be it applied by the ECB or the Bank of England. And the same may happen to one's political hopes for Europe or Britain after realizing that the nation state is enfeebled, not so much by its small size, as by the excessive span of its functions.

It is my contention that the notion of sovereignty is stretched and misapplied as regards the economic and political consequences, both favorable and unfavorable, of adopting the new European currency. It is as if both camps started from an unspoken Keynesian assumption that monetary and political authorities can exercise discretionary influence on society if their territories are of the requisite size.

For Keynes, the capitalist system could not function properly without continuous intervention by politicians and civil servants; and what is more, elected and unelected officials could be trusted to work for the public good. The defenders of the euro, pointing at the fact that national currencies are too small for an independent macroeconomic policy and ruing the time when national central bankers enjoyed monopoly powers, extol the advantages of a single European central bank, able to pursue monetary stability while governments can carry out active macroeconomic and welfare policies. Many critics of the euro also want an active monetary and social policy but think it possible only within a sovereign national state.

Now, what if

* a successful anti-cyclical policy is not within the reach of a central bank;

* central banks cannot directly and permanently contribute to full employment by expanding the money supply or reducing interest rates in the money market;

* central banks turn out to be unable to change the real interest rate on long-term credit;

* the real rate of exchange cannot be managed discretionally;

* the welfare state should turn out to be unsustainable whatever the size, national or continental, of the area over which it obtains?

Then a whole family of economic and political arguments for and against the euro lose relevance.

One may ask those in favor of the euro why they want to impose a new currency if people will increasingly be able to choose whatever money suits them best. Equally one may say to those wishing to retain monetary sovereignty that there is little point in wanting to control monetary policy, or wield the instrument of the bank interest rate, or intervene in foreign exchange markets, as economies become increasingly globalized. The discussion should turn on whether the various economies are flexible and open enough to ride over monetary disturbances and what political institutions will contribute to making them so.

Assume for a moment that in trying to exercise sovereignty both national and European authorities cause more harm than good. In that case there is room for a different type of monetary and political arrangement, allowing Europeans to reap the benefits of currency competition thus thwarting central banker attempts to manage the economy; and to profit from the capabilities of a minimal state, thus escaping attempts to regulate everything under the sun.

The battle must be fought on another field than euro pro and con. The choices would be those of centralization versus individual choice, and of government discretion versus competition among institutions and jurisdictions. To join or not to join, is not a question of sovereignty.

Does the Currency Matter?

Economists, believe it or not, have always had great difficulty in integrating money in their models or representations of the economy. If, on the one hand, the analytical framework is that of a perfectly competitive economy, tending toward a state of general equilibrium, what is the point of perfectly informed transactors keeping liquid money in their pockets? From that point of view money is but a veil that should be pulled aside to get at the real phenomena. If, on the other hand, the starting assumption is that cash balances are needed because transactors are immersed in a world of uncertainty, is not the belief that authorities can manipulate money to counter fluctuations and make the economy grow a return to the belief in Plato's philosopher kings?

Money Is Two-Edged

Explanations of the need for money go back at least to Aristotle. Everyone is familiar with the three functions of money: measure of value, means of exchange, and store of value. All three are of great importance in helping supersede the primitive barter economy and moving to one in which people can sell without buying (and vice versa) and not have to take what they do not want. The store of value function is especially useful in allowing individuals to deal with uncertainty: receipts may unexpectedly not tally with payments, so that a store of cash comes in handy. Notice that the value stored in coins or notes is simply one way of dealing with the uncertainties of the future: credit is the supply of a store of value by a saver to a borrower. Hence, this third function summarizes all the financial services of a community that help multiply productivity. Adam Smith saw this very clearly when he defined money as capital, that is to say, as a factor of production (Smith [1776] 1976: Book II, chap. 2).

However, this useful instrument of trade and credit is not the coins, notes, book entries, or electronic digits that we perceive with our senses, but the permanent value symbolized by the monetary instrument. Smith saw this too:

When, by any particular sum of money, we mean not only to express the amount of metal pieces of which it is composed, but to include in its signification some obscure reference to the goods which it can be had in exchange for them, the wealth or revenue which it in this case denotes, is equal ... to the money's worth more properly than to the money [Book II, chap. 2: 17]. So that individuals, if they can help it, will not be taken in by the appearance of money, but will use the real value behind its nominal worth. That is to say, people will continuously discount the nominal money they receive by its purchasing power in the market.

The first way in which money matters is the positive one of allowing people to transact, because they...