Modern monetary theory (MMT) argues that all governments that issue their own currency have the same fiscal and monetary policy space. This paper argues against this position. For MMT’s assumptions to be valid, MMT must abstract from the gravitational force of the US dollar that stems from it being backed by a mass of securities – an influence transmitted through international investment flows. Once the dollar’s gravitational force is recognised, it becomes clear that the huge size disparity separating the US financial market from those of other markets, and most notably those of the emerging market economies (EMEs), translates into an equally huge disparity regarding fiscal and monetary policy capacities. The strategic implications of recognising this disparity are that EME governments should, where possible, join their financial markets into regional blocs of sufficient size to give their regional currencies enough backing mass to allow them to resist the gravitational pull of the dollar. Only by pooling their currency sovereignty can EME governments retain some scope for pursuing macroeconomic policies independently of those pursued by the US government. Without doing so, if EME governments in countries with small financial markets follow MMT’s advice to retain their local currencies, this will condemn these currencies to entrapment in the dollar’s gravitational field and possibly outright dollar colonisation.

Drawing on untapped, open-source commentaries from elite Chinese commentators, we show that since 2018, China has become fixated on preparations for a potential “financial war” with the United States. China appears to have adjusted its renminbi (RMB) internationalization strategy – and broader approach to financial regulation – accordingly. China's perceived vulnerability to dollar sanctions increases the urgency of RMB internationalization but also makes it unacceptably risky to liberalize the capital account. The sources suggest that China's solution is to pursue partial RMB internationalization by keeping the capital account tightly regulated while encouraging trade partners to sign up for RMB settlement platforms. As more foreign banks sign up for RMB payment systems, China is gaining confidence that its financial system could weather the sudden imposition of dollar sanctions. However, China remains vulnerable in principle to a “monetary sniping” attack on the offshore RMB market.

The rise of China has sparked a debate about the economic and political consequences for the global economy of the internationalisation of the renminbi. We argue that the dominant focus of this literature – primarily the external conditions and requirements for a national currency to become an international currency – misspecifies the connections between the international and domestic requirements for currency internationalisation, as well as the potential to become the dominant international reserve currency. We correct this oversight by developing an integrated theoretical framework that highlights the domestic adjustment costs which a state must accommodate before its currency can carry the weight of internationalisation. These costs constitute a critical element of an international currency’s ‘political economy’, and they force states to negotiate contentious social trade-offs among competing domestic claims on finite public resources in a sustainable manner. Our analysis suggests that the likelihood of China being able to successfully negotiate the social costs associated with running a fully internationalised currency is currently very low, precisely because this will place unacceptable pressure on groups benefiting from the economic and political status quo. This further suggests that the American dollar will remain unchallenged as the global economy’s pre-eminent international currency for the foreseeable future.