How to Rethink Monetary Sovereignty in an Era of Financial Globalization

By Steffen Murau and Jens van ‘t Klooster

As financial markets are again putting Italy under pressure, the new political party, Italexit per l’ Italia, promises an easy answer: leave the European Union (EU) to regain sovereignty. Economists, lawyers and political scientists regularly assert that joining the euro means giving up all monetary sovereignty. However, in a new journal article in Perspectives on Politics, we argue that to understand contemporary geopolitics, the relationship between the state and money must be fundamentally rethought.

Today, commentators, pundits and academics typically use the concept of monetary sovereignty in a way that we refer to as “Westphalian.” According to the Westphalian conception, monetary sovereignty consists in the ability of states to issue their own money, as well as regulate its use within their borders. Given this definition, a country with its own currency has monetary sovereignty while all others do not, and to join a monetary union is to give up all sovereignty over money.

Despite its widespread use, the Westphalian conception is not a useful way of thinking about money in the age of financial globalization. Instead, we propose a new conception of “effective monetary sovereignty” that focuses on what states can actually do within the constraints of the global credit money system. We explain our conception with reference to both European monetary integration and the Offshore US Dollar System.

One can see that the Westphalian conception of monetary sovereignty is too simplistic when comparing a euro area country, such as Italy, with an EU country that opted out of the monetary union, such as Denmark. In joining the euro, Italy gave up its national currency, the Italian lira, and the Banca d’ Italia no longer sets its own interest rate policy. Instead, monetary policy is made by the European Central Bank (ECB), where Italy is represented by Italian central bankers—powerful officials such as Tommaso Padoa-Schioppa and Mario Draghi. This is an improvement over the 1970s and 1980s, when the most important monetary decisions for Italy were made by foreign central banks: the Bance d’Italia often followed interest rates set by the German Bundesbank and the US Fed.

Euro membership clearly affects the economic policy of a member states, but it is not, per se, more constrained than countries who are pegged to the euro. The Danish krone is pegged to the euro at a fixed exchange rate, which precludes its use for pursuing an independent monetary policy. It has monetary sovereignty in a Westphalian sense, but to say that Denmark has monetary sovereignty while Italy does not betrays a narrow focus on the ability to issue a national currency.

Does that mean Italy is better off than Denmark? This comparison is not easy to make, as these countries are very different in many regards. Would Italy be better off outside the euro? Again, there is no simple answer. There is a longstanding debate over whether joining the euro was actually the right choice for any given state—membership in a monetary union is not uncontroversial. However, we take this to be a viable topic of debate, which should not be settled by saying one state has sovereignty while the other does not.

Reflecting on what states can actually do highlights that the specific design of a monetary union is crucial. In 2005, the European Central Bank (ECB) decided to allow the use of government debt in its monetary policy operations conditional on US based credit rating agencies like Standard & Poor’s (S&P) and Moody’s. Already in the 1990s, central bankers had warned internally against such a move. As a German central banker stated at the time: “[a]n extensive use of ratings by market agencies would risk partly transferring ECB sovereignty to a few, profit-oriented agencies.” The 2005 decision made member states like Italy vulnerable to financial market speculators during the 2010-12 Eurozone crisis, but in the years that followed, the ECB learned important lessons. With the 2012 Outright Monetary Transactions, the Pandemic Emergency Purchase Programme and the 2022 Transmission Protection Instrument, the ECB came to protect the sovereignty of the member states in the face of unreliable financial markets.

Our ambition in reconceptualizing the meaning of monetary sovereignty goes beyond the specific case of the euro. As we argue, the Westphalian concept of monetary sovereignty also obscures important differences within the global monetary system. We use the US and Bangladesh as examples. Both are equally sovereign in the Westphalian sense because they issue a national currency for use within their territory. Arguably, Bangladesh is even closer to the ideal of Westphalian monetary sovereignty as it can easily regulate the use of its currency, the taka, which is barely used outside of its territory. The US dollar (USD), as the international key currency used around the globe, largely escapes the US’s legal order. However, to say that Bangladesh is more monetarily sovereign than the US seems hopelessly misleading.

By contrast, the idea of effective monetary sovereignty helps make sense of the differences between the US and Bangladesh. These states take up very different positions in the global credit money system. Since Bangladesh is highly reliant on the USD for trade and finance, it seeks to stabilize market fluctuations of its exchange rate, a so-called “managed float.” Its monetary policy is constrained by this objective, but monetary policy is only part of the story. As its domestic firms borrow in USD, its economy is structurally dependent on foreign lenders.

The outstanding international importance of the USD gives the US government enormous leverage to achieve its political and economic objectives. The key role of the USD in the global credit money system gives US banks a major edge over competitors and makes the US Federal Reserve the most powerful central bank in the world. The US government has been able to develop a policy strategy of financial sanctions that is unmatched, with the recent measures against Russia being just one example. Bangladesh, meanwhile, finds crucial parts of its banking system outside of its jurisdiction and is not represented in deliberation on global banking regulation. The functional role of US government debt as collateral in shadow banking systems allows the US to fund historically unprecedented debt levels at much lower rates. Where the existing monetary system allows the US to achieve a range of economic policy objectives, the same is not true for Bangladesh.

Many reject the Brexiteers’ rhetoric of regaining sovereignty but continue to use the term “monetary sovereignty” in a similarly simplistic way. In the article, we set out a research agenda focused on what states can really do in terms of effective monetary sovereignty. To this end, we describe the modern credit money system as composed of a public and private segments. The agency of the state—what we describe as monetary governance—takes different forms in relation to these different segments. States can control public money through central bank design but can only exercise more arms-length influence over private money creation. A part of the private system consists in money creation that takes place outside the states’ regulatory reach without public guarantees, such as cryptocurrencies and stable coins. Scrutiny of these different segments is crucial to study monetary sovereignty understood as the ability of states to use the tools of monetary governance to achieve their objectives. Reflecting on the extent to which states can do this, we claim, is crucial to understanding today’s geopolitics.

Jens van ‘t Klooster is Assistant Professor at the Department of Political Science of the University of Amsterdam and a Research Foundation – Flanders Fellow at the KU Leuven Institute of Philosophy.

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