2. What are the advantages of a fiat currency and what are the limits?
Of course, fiat money cannot work wonders. It does not mean that a state, being able to produce infinite money, can afford and realize everything. A state can only employ its own currency to buy and utilize the resources that its country effectively owns. For example, if there is insufficient national construction industry and a lack of trained local teachers, the state will soon exceed its capacity when it comes to building schools. This means that the resources positively available within the country are the limit, not the national currency. If the state produces more money than there are resources available, it will create inflation. On the other hand, if there are still resources available, including labour, the state could still create the fiat money to deploy these for the public good.
When it comes to buying products from foreign countries, things become more complicated, as a state can only guarantee the internal value of its fiat currency through taxation. The external value of a currency, in contrast, depends on different factors, the most important of which is export. A country with sufficient exports can use the earned currency to buy products that it cannot produce itself. On the contrary a poor country with little exports will find itself in difficulty when needing to import. It cannot earn the foreign currency through export and its own national currency will have a low exchange rate and little international buying power. Therefore, it might feel constrained to borrow currencies such as Dollars or Euros from foreign lenders to import necessary products. In this case the state will have external debt in a foreign currency. And now what is said in this article about fiat currencies and sovereign debt no longer applies.
A state with debt in foreign currency becomes an ordinary debtor that is dependent on its creditors, for now it owes a currency that its central bank cannot generate. It is therefore crucial to always distinguish between debt in a country’s own currency and debt in foreign currency, as these are fundamentally different types of debt. When analysing the debt crisis of the last decades, you will almost always find debt in foreign currency being involved. Or as in the case of Greece, the key factor was the new construction of the Eurozone, a currency area that had not yet decided how to treat its own member-countries; as foreign countries or as a part of a common currency area for whom the central bank will use their unlimited privilege to generate fiat money.
Fiat money will not resolve existing global disequilibrium, power structures and the dependencies of poorer countries. To resolve global injustice in the long run, a different international trade order is necessary; one that allows the global south to protect and develop its own economies and that discourages export surpluses, recognising this as the other corresponding explanation of the global debt-crisis. Because when it comes to accounting on a macro-level, inevitably and by definition, one country’s surpluses are another country’s deficits, one raising net-savings and the other raising net-debt. MMT analysis can help to understand this, as well as the dangerous nature of debt in foreign currency. And it can highlight the chance for all states to strengthen the cycle of fiat money, government spending and taxation to harness most effectively the resources that a country effectively owns, including unemployed labour.
To keep the pattern simple, in the following passage we will leave out the third sector of foreign countries, and instead we will concentrate on the relationship between government and the private sector. We will begin by exploring the case of a national currency, which will lay the foundation for understanding the more complex, supranational currency that is the Euro. But first of all, we will deepen our understanding of what it means to live in a two-stage monetary system.
- On the topic of strategies against global injustice, see also the article “Sovereign Debt, Europe and the Global South” on this website.
