In modern states, demand for currency comes from the ongoing self-imposed liability for the currency. There is no need to pay savers in order for them to desire to hold the currency (interest on sovereign bonds issued for “deficit spending”). Any justification for doing so must rest on some other perceived benefit of paying savers....ClintBallinger.com
How About a Nice Game of Chess?
Clint Ballinger
"Internationally, besides forex speculation, the fundamental reason there is demand for a currency is because entities from outside of that currency area desire to purchase something from within it."
ReplyDeleteThat misses the main case.
The main reason to hold 'hard currency' is to disguise the fact that the nation is creating money at the central bank by discounting the government's power to tax.
Same with anything on the asset side of the central bank balance sheet that isn't just a straight overdraft with the Treasury.
The secondary reason is 'neomercantilism'. If you hold foreign currency and issue your own currency against it then your currency becomes weaker relative to the target and that makes your exports cheaper in that target. The lack of domestic circulation in your target then damages their investment growth potential which increases the consumption demand for your exports.
That's how 'export led growth' nations extract growth - because countering 'neomercantilism' requires policies that are completely counterintuitive (the target nation needs to accommodate the foreign currency holdings by issuing more currency or by confiscating foreign holdings that are not spent).
Neil. I find your comments very interesting. Any references on export oriented economies?
ReplyDeleteThe "hard currency" comment isn't at all clear.
ReplyDeleteCountries besides the key currency- the fundamental reason anyone would ever want their currency is bc they desire to purchase something for sale in that currency.
This of course can be obscured by the key currency system, interest rates etc.
But this fundamental reason always underlies the true, long-run dynamics.
"The "hard currency" comment isn't at all clear"
ReplyDeleteLook at Russia or China.
The central bank takes 'hard currency' onto its balance sheet, and issues the local currency - Rouble or Yuan - against it.
The central bank now can't get rid of the 'hard currency' to buy anything with it because it is the asset against which the liabilities are issued. To free it up would require revealing the truth - that the central bank discounts the state's power to tax when it issues money. That would occur when the central bank takes on to its balance sheet assets that are the liabilities of the state Treasury, ie some sort of overdraft arrangement.
You get the same in Norway with its 'pension fund', or in Denmark with the main pension schemes.
All the 'sovereign wealth' concepts are just chimeras to hide the fact that the central bank is issuing local currency to people in that area to offset the amount the people have saved - and thus maintain the domestic circulation.
It is very much a mistake - and very mainstream - to believe that nations hoard foreign currency solely to buy things from the nation whose currency they are hoarding.
There are two reasons:
(i) to allow local currency issue to occur without exposing the 'noble lie'.
(ii) to lock the foreign currency away and thereby reduce the circulation in the foreign nation, which will impact the levels of investment and employment there. That helps prevents substitution from arising and protects your exports.
Since the currency is locked they can only swap it for other investment products. The key then is to make your financial investment products unattractive or unavailable, so that the cost of holding your currency as FX is as high as possible. Which is where ZIRP comes in.
ReplyDeleteYou are talking about key currency dynamics. Those are very real of course, but not what I am discussing. The reality of the key currency system adds a layer of complexity on top of the dynamic I discuss (the latter in the context of developing countries especially). Both dynamics have to be understood - the fundamental driver I discuss gets less clear attention than key currency dynamics; neither has enough clear exposition. Ultimately they have to be discussed together, but first each has to be overtly understood, which is seldom the case now.
ReplyDelete