by Reynold F. Nesiba, New Economic Perspectives
This past May, marked the one hundredth anniversary of A. Mitchell Innes’s (1913) publication of a paper titled, “What is Money?” in The Banking Law Journal. In it, this British diplomat, then living in the US, reviewed the history and usage of money and its forms in credit and coinage. On both historical and logical grounds, he asserts that the “modern science of political economy” rests on a series of assumptions regarding money and credit that are “false.”
One of the most important of these assumptions is the belief that “under primitive conditions men lived and live by barter.” Who should we blame for this false assumption? According to Innes, it is Adam Smith (1776), the father of economics, who in turn rests his arguments on the words of Homer, Aristotle, and those writing about their travels to the New World.
Perhaps one reason Innes’s work has been so widely ignored is because his critique cuts too deeply. For economists to incorporate his insights would require a wholesale rethinking of where money and credit comes from, how it works, and how it influences the economic processes of production and distribution. That said, his work on money received attention and was cited immediately after his first publication in 1913 and a second in 1914. Even John Maynard Keynes had favorable things to say about it. But then his work was ignored for almost 75 years until the 1990s when some Post-Keynesian monetary theorists brought it back to light (Wray and Bell 2004, p.12). Recent academic work in economics (Bell 2000, Wray 1998, Ingham 2004, see Nesiba 2013 for a review) and anthropology (Graeber 2010), demonstrate that the process of rethinking is underway. Regardless of this recent research, economists and principles of economics texts continue to tell the Smithian or traditional story of money and credit and ignore the insights of Innes.
Over most of my 18 years of teaching at Augustana College in Sioux Falls, South Dakota, I too have perpetuated this error by repeating the traditional story of money. It goes something like this. In a barter economy, as in the (chronologically vague) days of old, goods were traded (in a geographically ambiguous location) for other goods without the use of money. Without money trade is only possible if there is a double coincidence of wants. If one person raises and sells potatoes and the other makes shoes, they will only engage in exchange if the one selling shoes wants potatoes and the one selling potatoes wants a new pair of shoes. Even if they each have a surplus of the good they wish to sell, no trade will occur since the potential buyer lacks anything needed by the seller. They are at an impasse.
Adam Smith (1776, 25-36) explains how money arose to resolve this economic conundrum with these words.
In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.
So for Smith over time (and in every place and time) eventually a specific commodity—perhaps gold or silver—arises to serve as a money-thing that can be used to purchase other goods and services. Economists refer to this monetary function as a medium of exchange.
Over time, economists have come to define money as anything that fulfills the four functions of money. In addition to serving as a medium of exchange, money can also serve as a way to postpone purchases by serving as a store of value. As long as a currency is not experiencing rapid inflation, holding wealth in money form allows us to delay purchases for a sunny or rainy day. Money can also be used to pay debts as a means of payment to fulfill our contractual obligations to other individuals, firms, lenders, or governmental entities. And perhaps most importantly, money serves as a way of keeping score as a unit of account. It is in this last function that money is not a “thing,” like a coin, but instead serves instead as a point system or standard of measurement by which sales, debts, and payments can be accounted. Just as an inch or a centimeter can be used to measure length, a dollar or euro as a unit of account can be used to measure value without actually being a money-thing.
Now for Smith, the most important function of money is to serve as a medium of exchange. Because once this is established his apocryphal story expands. As a medium of exchange money facilitates trade, encourages greater specialization and productivity, reduces transactions costs, and allows for the further flowering of capitalism. It also serves as the beginning of the banking system. As metals become the preferred medium of exchange, banks are created to store and manage these wealth holdings. The coining of metal by state governments facilitates this process by standardizing weights and degrees of alloyed purity. The bankers than issue receipts describing the amount of gold stored or deposited on its premises. Over time, bankers realize that these gold receipts are circulating as money. They also realize that only a fraction of their holdings are called for on any given day. Thus they can make loans at interest and issue gold receipts far in excess of their actual holdings. This emergence of credit further greases the wheels of capitalist exchange, savings, and investment. However, in the overall economy, money only affects prices and not the process of actual physical production.
This standard story has been repeated in uncountable numbers of articles and textbooks. And it is this story that Innes challenged 100 years ago. Innes asserts that the barter story that emerged from Smith contradicts both the logic and the historical record. In terms of logic, Smith’s story is simply not convincing. For example, if you grew up in a small town in the western US in the 1970s, you might remember that you could go to the grocery store, pick up groceries, and simply sign a slip a paper acknowledging your receipt of the groceries. The same could be done in Smith’s hypothetical example. If the shoe seller or potato seller were trustworthy, the shoe seller could simply create a record of the shoes purchased on credit by the potato seller/shoe buyer and their value in some agreed upon unit of account. This is not barter and it is not a purchase using a medium of exchange. Instead it is (p. 391) “the exchange of a commodity for a credit.” And it is far easier that the use of a medium of exchange.
Is there no anthropological evidence of a society based on barter trade? In his recent book David Graeber (2010) asserts that there is not. Graeber claims that Stanley Jevons’s book in 1871 “took his examples straight from Smith, with Indians swapping venison for elk and beaver hides, and made no use of actual descriptions of Indian life…” (p. 29) Similarly “around that same time, missionaries, adventures, and colonial administrators were fanning out across the world, many bringing copies of Smith’s book with them, expecting to find the land of barter. No one ever did.” To make his point as clear as possible, Graeber (p. 29) quotes from Caroline Humphrey’s Cambridge University dissertation as the definitive anthropological work on barter. Her statement is as clear as it is emphatic. “No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests there has never been such a thing.” Innes knew this 100 years ago, yet the myth persists.
So if there has never been a land of barter, where did we get money and credit? Innes (p. 397) argues that systems of credit pre-date coins by over a thousand years. “The earliest known coins of the western world are those of ancient Greece, the oldest of which, belonging to the settlements on the coast of Asia Minor, date from the sixth or seventh centuries B.C.” In contrast, the law of debt goes back to at least the Code of Hammurabi in Babylonia 2000 years B.C. Innes saw that the foundation of society and thereby of credit was that promises or obligations were and are viewed as sacred. In all societies (p. 391) the breaking of the pledged word, or the refusal to carry out an obligation is held equally disgraceful.” He goes on to explain how wooden tally sticks and clay shubati tablets were used to track credits/purchases and debits/sales long before the existence of coins. And that one could repay a debt by returning a credit of the same amount to the lender. In fact, village fairs were convened so that those holding the debts of others could match credits and debits together and thereby clear their accounts. Over time others showed up to buy and sell other goods and services or to cater to those in this most basic business of banking.
There are a variety of reasons why this matters for monetary theory and macroeconomic policy. But let me leave you with just one. From the Smithian story, it was gold and silver that backed the issuance of a paper currency. However, if Innes is right, the banking system never worked in that way. In Innes’s world, money is and always has been a token representing a socially constructed debit-credit relationship. A stamped coin, $20 bill, or tax refund check is an asset—a credit— to those who hold it and a liability—a debit—for the government who issues it. When the federal government spends, perhaps by directly depositing a Social Security recipient’s check into her account, a special kind of credit is created. This credit—a new “debt” of the federal government—satisfies all four functions that are used to define money. It serves as a medium of exchange, store of value, means of payment, and a unit of account. But what gives this money value? The money is valuable because it is the only token acceptable for the payment of taxes. And when those taxes are paid, the money that had been spent into existence is extinguished. Thus, it is through federal government spending that money enters the economy and through taxation that it is destroyed. This is where Innes’s 100- year-old insights lead. If these ideas are hold up under academic scrutiny, are further disseminated, and become the basis of how we understand money and credit, an entirely new paradigm will need to emerge in the study of monetary economics.
Bell, S. (2000): Do taxes and bonds finance government spending?, in: Journal of Economic Issues, 34(3), 603-620.
Graeber, D. (2010): Debt: The First 5000 Years, Brooklyn, NY: Melville House Publishing.
Ingham, G. (2004): The Nature of Money, Cambridge: Polity Press.
Innes, A.M. (1913, May): What is money?, in: Banking Law Journal, 377-408.
Nesiba, R.F. (2013, May): “Do Institutionalists and Post-Keynesians Share a Common Approach to Modern Monetary Theory (MMT)? European Journal of Economics and Economic Policies: Intervention, Vol. 10 No. 1, 2013, pp. 44–60.
Smith, A. (1776): An Inquiry into the Wealth of Nations. The Cannan Edition, New York: Modern Library, 1937.
Wray, L.R. (1998): Understanding Modern Money: The Key to Full Employment and Price Stability, Northampton, MA: Edward Elgar.
Wray, L.R. and S. Bell (2004): In Credit and State Theories of Money: the contributions of A. Mitchell Innes, Cheltenham, Edward Elgar, L.R. Wray editor.