Why we need to change our view on money for emerging economies

Conventional economics confines central banks’ role to setting interest rates in order to control inflation and economic activity. But are monetary authorities missing a vital tool – which emerges from a fundamental rethink of money supply - to use money issuance as a source of funding for new investment opportunities? What if nations could use fiat money as companies use equity?

Fiat money as equity capital

Money is a financial asset as well as a store of value, a means of exchange, and a unit of account. In our new book Money Capital – New Monetary Principles for a More Prosperous Society along with fellow economist Haizhou Huang, I suggest that we could treat fiat money the same way as a share in a company. Money, in effect, is a share in the output of a nation. Just as companies issue shares, countries could issue fiat money when they need to fund investments, and growth, or capitalise on demand. Well executed investments increase the value of a company, and this is reflected in the share price. Seen through this lens of corporate finance, investments at a national level improve the value of the stock or, in this case, the currency.

Many nations have chosen central bank independence over recent years, and with this comes the idea of monetary policies dictated by inflation targets of around two per cent. To achieve this goal, today central banks use mostly interest rates. By and large, a money supply policy doesn’t feature in their armoury, except when interest rates hit the zero lower bound. Mainstream monetary thinking has shut down the idea that money supply could change in response to external pressures, evolving circumstances, and different contexts. And when authorities face decisions about how to govern money supply, they lack any guiding principles or analytical framework.

This lack of a conceptual framework is astonishing. After the global financial crisis of 2008, inflation in developed economies dropped close to zero (or even went negative) and interest rates fell accordingly, reaching zero or even negative values in Japan and elsewhere. Central banks were flummoxed – they had little leeway on rates and scant guidance on how to respond, prompting a certain level of trial and error. Nobody had answers to vital questions such as how much money supply was enough, or when banks should grow or shrink supply.

How and when could countries issue more money? In our book we suggest that printing money should be approached in similar ways to equity issuance.

Central banks raise money supply by buying assets such as government bonds and other forms of debt. They can also channel money through the banking system. But the question of when is more complex. There are two striking examples that reveal our thinking.

Companies issue more stock for two main reasons – because they see investment opportunities or because the stock price is high and they want to take advantage of demand. 

Nations leveraging money supply for investment

China offers a fine example. Had Beijing followed conventional economic wisdom, the nation would never have experienced the growth that it has enjoyed over the past two and a half decades - because printing money to fund investment in infrastructure would have been ruled out as beyond the central bank’s remit. But the People’s Bank of China chose to increase money supply by 10 to 20 per cent each year, and yet China did not experience inflationary pressures as a result. In fact, inflation remained close to zero. Funds were used to finance productive investments which contributed to economic growth.

Switzerland’s foreign reserves strategy during the global financial crisis is another striking example of adept use of money supply. During the eurozone crisis which followed the global financial crisis, investors flocked to the Swiss franc as a safe asset amid the turmoil. Subsequently the Swiss franc soared in value – leading the Swiss National Bank to print more Swiss francs and buy up dollars, euros, yen and more. Within four years Switzerland had acquired foreign currency assets worth 100 per cent of GDP. We see the soaring currency here as the equivalent of rising stock prices, which can prompt companies to issue shares to capitalise on higher prices. In Switzerland’s case, some 20 per cent of foreign currency assets have since been invested in stock markets, generating income that is ultimately redistributed back to the Swiss people through spending and tax breaks. The benefits of using money supply can be substantial indeed. But if the Swiss authorities had followed traditional economic wisdom – that money supply should remain constant – the nation would have missed a huge opportunity.

Compare this with the position of the US Treasury, which has no policy governing foreign exchange reserves. The Federal Reserve has no authority to take advantage of a strong dollar by buying foreign currencies – and this is a huge policy gap.

Unlocking opportunities for growth

While advanced economies might already benefit from many different sources of funding and investment thanks to sophisticated capital markets, emerging economies have a huge capacity for growth but suffer financial constraints. These are the economies that stand to benefit if they could print more money to invest in infrastructure and other growth opportunities.

Of course, there must always be good ‘corporate’ governance and a disciplined approach. Here the financial analogies are useful. Respected companies don’t issue shares randomly or use the proceeds recklessly. They raise funding when investment opportunities arise. New share issues don’t dilute the value of existing holdings because proceeds are used to add value to the company.

The analogy with corporate finance is not perfect, but recasting money as a nation’s equity capital does add a new dimension for policy makers. Central banks could play an important role in boosting the finance for investment, in stabilising financial markets, and taking advantage of a strong sovereign currency – can they afford not to?