FM on Money (5) Origins

Felix Martin gets into a debate about the origins of money. The original idea that is expounded by economists is that money was originally a commodity. God or silver were the most common, because they were portable and divisible into coins. The first banknotes were receipts from bullion warehouses for gold and silver in storage. It was often easier to exchange the paper receipt than to exchange the gold or silver. According to this theory, proper money got under way when governments took over this role by holding gold and silver and issuing bank notes.

The other theory is that money began as debt issued by kings. When the king borrowed from his citizens, the person making the loan would get a written IOU from the King. These began to circulate as paper money.

Felix Martin prefers the latter explanation. He argues that the commodity money theory held back the development of monetary policy. He blames John Locke for this development.

I don’t think it matters too much which explanation is correct. I suspect that both occurred, and it is not clear which came first. It probably does not matter.

The debt theory is interesting because it shows that money is a social phenomenon.

At the centre of this alternative view of money- its primary concept, if you like – is credit. Money is not a commodity medium of exchange, but a social technology composed of three fundamental elements. The fist is an abstract unit of value in which money is denominated. The second is a system of accounts, which keeps track of individuals’, or the institutions’ credit or debt balances as they engage in trade with one another. The third is the possibility that the original creditor in a relationship can transfer their debtor’s obligation to a third party in settlement of some unrelated debt.

The third element is vital. Whiles all money is credit, not all credit is money and it is the possibility of transfer that makes the difference. An IOU which remains for ever a contract between two parties is nothing more than a loan. It is credit, but it is not money. It is when that IOU can be passed on to a third parry, when it is able to be “negotiated” or “endorsed”, in the financial jargon – that credit comes to life and starts to serve as money. Money, in other words is not just credit – but transferable credit.

This is good stuff. I have described a system of money that can meet these elements that does not need gold and silver or the intervention of the sovereign in Bank Deposits and Loans.