Why focusing on the foreign exchange rate won’t get us anywhere

This is a slightly edited repost of something I wrote in a discussion at Crommunist’s blog. I don’t want it to get lost in the comments.

There’s a commenter who calls himself Raging Bee who focuses on the relative external value of a currency to the exclusion to everything else.

These blinders prevent him from reading the “fiat” definition, which is not just the one I am using but also the one the Merriam-Webster, Keynes – as the author of the post I commented on pointed out, and the MMTlers use, properly.

“fiat” is a command or act that creates something, not a command or act that gives it value. Furthermore, without effort or with negligible effort – which means precisely that a currency that is backed by a commodity cannot be fiat, contrary to his claim, because acquiring this commodity will take an effort.

Instead he focuses on the foreign exchange rate and assumes that a currency is guaranteed “most by a sound economy”. As I describe in an earlier comment, when an economy produces something that is desired by other entities, they will attempt to get hold of that economy’s currency, causing its exchange rate to appreciate, but what it can’t do is guarantee that this currency is accepted in the first case.

As an abstract example, assume an economy in which every producer produces the same product – one highly desired by entities outside this economy. No producer in this economy would have a motivation to accept the national currency – the only thing they could buy would be what they produce themselves and if they desire products from other economies, they need to acquire those currencies. So they’re better off getting paid in those currencies directly, or bartering.

Enter taxes and a government that enforces their collection: since every citizen needs to pay taxes, they have an interest in acquiring the currency. This in turn means that entities from outside the economy have an interest in acquiring the currency etc. This is the MMT understanding of the necessity of taxes. There’s also quite a bit about taxes as tools of achieving certain social goals and motivating certain behaviors.

Furthermore, as Raging Bee himself pointed out, is it impossible to control the exchange rate of one’s currency. Even if one is on a commodity standard, one only has some control if everyone else is also on that standard. Otherwise, there might be low demand for your currency compared to a fiat currency and your exchange rate drops. Just setting an arbitrary value, as the Warsaw Bloc tried doesn’t work either. Which is also precisely why I had at no time (and neither have the people on whose writing I base this) claimed that a floating exchange rate makes a fiat currency. Raging Bee made this claim, ascribed it to me and then proceeded to use it to try and shoot down the claim that current government issue fiat currencies.
What one can do is force others who might devalue into a peg – which is what Germany did to the members of the EMU.

What a focus on the exchange rate does, on the other hand, is severely limit one’s options. If one is locked into trying to achieve a certain exchange rate then this dictates one’s political options, which in turn allows forces from outside one’s state to dictate them. Exchange rate in that case influences policies.

Which is nicely illustrated by one of Raging Bee’s post as well: according to him “sensible fiscal policy” is necessary for a “sound” economy which in turn influences the exchange rate. The question now is what one would consider “sensible fiscal policies”. From a progressive left-wing POV, sensible fiscal policies are ones that improve the populations’ life – a decent minimum standard of living, full employment, general healthcare, free high-quality education, a non-polluted environment, good infrastructure etc. Since the foreign exchange rate has no effect on what the government can purchase domestically, a fiat currency issuing government can spend according to these social goals, and worry about the foreign exchange rate later.
For someone focused on the foreign exchange rate, however, “sensible fiscal policy” keeps the foreign exchange rate at the desired level, no matter the effect on the population. Which is why it is so important that people, especially left-wingers and progressives, stop thinking in pre-fiat terms.


Now, I am going to take several of Raging Bee’s statements at face value here and assume that he actually believes everything he wrote here and doesn’t just use it because he disagrees with the social goals that could be achieved by a fiat-currency issuing government. I’ll furthermore assume that he didn’t reconstruct his memories from pre-internet times and that people he talked to actually misinterpreted fiat currencies as he does. Fiat currencies are powerful tools in making societies more equal, in lifting people out of poverty, in subverting power structures since an educated voter is less likely to vote for neo-liberal policies. Which also means that there is a lot of opposition and there is a large body of mainstream macroeconomic work that does its best to make people believe that we live in pre-fiat times, that government debt matters, that there are funding choices to be made between different social services – hell, someone like Crommunist thinks in those terms and he’s clearly progressive. So it’s absolutely possible that those people were misguided too or actively engaged in undermining the idea of fiat currencies because those would be a challenge to those who opposed FDR and everything he implemented, and who have worked so hard since the mid-70s to roll it all back.

Update: As if I’d ordered it! Devin Smith lays out things more extensively and clearer at New Economic Perspectives.

This entry was posted in economic policy, macroeconomics, MMT, standards of living, wealth distribution. Bookmark the permalink.

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