The Decline of Sovereignty
The United Nations counts 193 full members. But when financial crisis strikes, how many countries truly control their own fate? Very, very few, says Katharina Pistor, the Michael I. Sovern Professor of Law and Director of the Center on Global Legal Transformation at Columbia Law School.
In her paper “From Territorial to Monetary Sovereignty,” published in the Journal on Theoretical Inquiries in Law, Pistor argues that the rise of a global money system has quietly changed what it means for a nation to be independent. In the old days, sovereignty was defined by the control of land, and land is immobile. But in today’s world of free-flowing private capital, sovereignty is primarily defined by the control of money, says Pistor, whose research spans comparative law and finance. “This matters hugely,” she writes, because “it challenges the very notion of state sovereignty.”
Only the handful of lucky states that control their own money supply and borrow in their own currency were obviously the masters of their own destiny in 2007-2008, according to Pistor. The world’s seven issuers of reserve currency are the United States, the United Kingdom, Canada, Japan, Switzerland, China, and the European Union. By hoarding their monetary powers, these entities clearly kept the crucial ability to respond to a financial crisis and rescue
But other states– most notably Germany and France—fared well in the great financial crisis despite dropping their currency and ceding their monetary powers to the European Union. The reason: they are home to major private banks and other market actors who fuel the export of capital. The European Central Bank forced Greece to painfully repay German and French banks in full, because it saw their stability as crucial to the world money system. Evidently, not every state that drops its currency loses its global standing. “Control over capital flows is a key source of power,” she notes, “and perhaps ultimately the most important.”
Whether a state is a monetary power, or has interests aligned with one, sets its place in the sovereign hierarchy. This pecking order predetermines the winners and losers in a crisis, says Pistor--and each crisis reinforces the hierarchy. At the pinnacle, the U.S. Federal Reserve Bank blithely doubled its balance sheet during the great financial crisis, and the U.S. emerged relatively unscathed. Then the world’s core central banks strengthened their own positions by creating permanent currency swap lines with one another.
Embracing the free flow of capital–without creating a mechanism for sharing the costs of financial crises–has created a structural problem for the losers in this international game. A global regime to manage the insolvency of private banks and public treasuries might be ideal, but it is politically unfeasible. The loser nations are left to experiment with piecemeal solutions, inevitably subject to legal erosion and regulatory arbitrage. “There's no silver bullet,’ says Pistor. “If you want to live in the world and get the benefits of capital inflows then you have to continually manage the risk.”
For the unlucky state far from the apex of the global system, the best way to preserve autonomy is to take steps to avoid a financial crisis. Nations like Brazil have sought to limit capital inflows by regulating with high specificity what may be converted into local currency. States like Uruguay have returned to issuing debt in local currency. Countries like Chile (among many others) have built up sizable foreign exchange reserves in a stab at self-insurance.
In the absence of a global bank resolution regime, the Eurozone is experimenting with a regional banking union that gives the European Central Bank the authority to supervise larger banks and creates a Single Resolution Mechanisms to wind up troubled banks. Meanwhile, across the channel, London is maneuvering desperately to maintain its status as a private global banking center in the wake of Brexit.
Even at the pinnacle of the global system, there is cause for anxiety. The economist Hyman Minsky, who did seminal work on financial crises, posited that a responsible government, after resorting to a bailout, would address the causes of failure. But Pistor fears the U.S. is complacent about structural reform. As an example she cites the plan to gut the preemptive care provisions of Dodd Frank Wall Street Reform Act as it pertains to banks with less than $100 bln in assets. Worse yet, she fears that the U.S. takes for granted the full faith and confidence that undergirds any regime of fiat money. When Congress threatens to let the U.S. default on its bonds rather than raise the debt ceiling, it is putting its place in the global financial hierarchy at risk.
“Even the country at the apex of the system is dependent on maintaining its own credibility,” warns Pistor. “The U.S. position as global monetary sovereign is not cast in stone.”
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Published on April 17, 2018