Although some countries, notably the US and UK, have separated control of their currencies from the day-to-day business of running a government, there remains in all countries a very close connection between the value of a currency and the fiscal behaviour of government. Further, there is no longer any sense in which a country can operate monetary policy in disregard of global trends.
Clearly, the IMF and the Bank for International Settlements (BIS) take part in creating and controlling the global financial environment in which currencies exist. They were described in Chapter 1 and are more fully analyzed in Appendix One. Rating agencies also form part of the global financial landscape in which nation states must maintain their currencies. Organizations such as Standard and Poors and Moody's have great power over the fiscal behaviour of nation states, and they certainly don't have just a reactive role, being very ready to voice criticisms and make suggestions with the goal of strengthening a currency or a nation's credit-worthiness.
Says Fitch Ratings Sovereigns Group: 'The sovereigns rating methodology draws on modern instances of default and near-default to identify a range of key indicators of debt payment capacity and willingness – quantitative and qualitative – to assess and monitor sovereign creditworthiness in a consistent fashion across countries and over time. A comprehensive analysis of public and external accounts, structural strengths and weaknesses of the economy and the political and social constraints faced by the national authorities are central to the Fitch sovereign rating approach, underpinned by rigorous and data rich research available to clients.'
Perhaps it is a bit strong to say that there is a modern science of sovereign debt-worthiness; but still there is clearly a received idea of how nation states can and must behave if they wish to tap global debt markets on the best possible terms – and they all do! Taken together with the IMF's policy prescriptions, there is not much fiscal freedom of action left to individual countries.
The enormous foreign exchange and derivatives markets – which in their size absolutely dwarf the economies of even the largest states – also maintain a close watch over governments' fiscal behaviour and are quick to punish any departure from fiscal orthodoxy.
Then there are the central banks, which are increasingly supra-national in nature, not just because of the work of the BIS, but because they are tending to form regional power-bases. This is particularly true of the central banks of smaller countries, which are largely powerless to swim against global tides. The EU is the most obvious example, with currency issuance and management having been abandoned by most member states in favour of the ECB (European Central Bank) and its euro. The 9 East Caribbean states (OECS) have also created a common Central Bank. It would be quite surprising not to see equivalent organizations arising among Asian and African countries during the next ten years.
Other small – and not so small – countries have given up the unequal battle to remain fiscally sovereign simply by adopting a dollar peg. Examples are Hong Kong, Panama and Costa Rica, Thailand and Saudi Arabia. The Fed is therefore not just the central bank of the USA, but to all intents and purposes the Central Bank of a large slice of the world's economy. In the past, Canada, Russia and China have all pegged to the dollar, but for differing reasons have abandoned it. In the cases of Canada and China, it was growing economic strength that allowed them to drop the peg; in the case of Russia, it switched to the euro.
It is extremely hard to say whether the loss of fiscal freedom that goes along with the loss of a national currency is balanced by the gains in terms of stability and discipline. The United States is an instructive example, showing that regional economic flexibility is an economically satisfactory replacement for currency flexibility – but the consequences are unacceptable to many social democrats. This scenario has yet to play itself out in Europe. If and when it does, all eyes will be on the euro. Which nation will be the first to ditch it? Or will 'ever closer union' prove to be stronger than political convenience?
One thing is clear: while there are more and more countries in the world, there are fewer and fewer currencies. Logically, it should end with very many more countries and just one currency (the latter is another assumption made by most science fiction writers).
Monetary globalization has arguably progressed fast because of the internationalization of securities markets; fiscal affairs have not been impacted to the same extent. But as economic and cultural globalization progresses along the lines of Chapters One and Two, pressure will mount on existing largely national fiscal models. Governments may retain control of local and personal taxation and spending, but they will certainly lose control of international and business taxation. These developments were explored in Chapter Three – Fiscal Globalization, which concludes that while business taxation will probably disappear, personal and value-added taxation will be retained at national level, albeit according to internationally-agreed rules.