Busting money's creation myths

In a previous article, I discussed the IMF's analysis of the existing monetary system in its working paper "The Chicago Plan Revisited”, authored by Jaromir Benes and Michael Kumhof. Today I’m going way back to their discussion of the origins of money, debt, and Jubilees.

Here again Kumhof breaks new ground for a neoclassical economist. Since the vast majority of neoclassical economists ignore banks, debt and money completely when they model the macroeconomy, they also completely ignore the historical question "where did money come from?”

This is in sharp contrast to the blogosphere, where the origin of money is as hot a topic as the origin of species was in biology two centuries ago. The reaction to US financial program Keiser Report, hosted by broadcaster Maxwell Keiser, illustrates this. My answer to Max’s "Is gold money?” question in last week’s Keiser Report was indicative here, evoking over 500 comments in just two days. Keiser was adamant that gold is money; I was equally adamant that it’s not.

As in all such debates, I prefer to resolve them by the empirical record. In a marked departure from neoclassical norms – where armchair theorising is almost compulsory – so does Kumhof. Here’s his opening sortie in the paper on the conventional belief about the origin of money:

"The monetary historian Alexander Del Mar (1895) writes: 'As a rule political economists do not take the trouble to study the history of money; it is much easier to imagine it and to deduce the principles of this imaginary knowledge.' Del Mar wrote more than a century ago, but this statement still applies today.

"An excellent example is the textbook explanation for the origins of money, which holds that money arose in private trading transactions, to overcome the 'double coincidence of wants' problem of barter. As shown by Graeber (2011), on the basis of extensive anthropological and historical evidence that goes back millennia, there is not a shred of evidence to support this story.

"Barter was virtually non-existent in primitive and ancient societies, and instead the first commercial transactions took place on the basis of elaborate credit systems whose denomination was typically in agricultural commodities, including cattle, grain by weight, and tools.

From that record (developed by anthropologists examining late Cro-Magnon and early Sumerian society, where the first writing originated) it’s clear that the statement 'money developed out of barter' is one of the two great Creation Myths of economics – the other being that 'gold is money'.

The barter myth was a core concept in Adam Smith’s Wealth of Nations, in which he argued that barter was an innate characteristic of the human species. It’s worth citing Smith (who is often referred to as the father of economics) at length here because it turns out – as Benes and Kumhof assert in their paper – that despite its persuasive feel, Smith’s 'armchair theorising' about reality is almost the opposite of what the historical record reveals:

"This division of labour… is the necessary, though very slow and gradual consequence of a certain propensity in human nature which has in view no such extensive utility; the propensity to truck, barter, and exchange one thing for another… It is common to all men, and to be found in no other race of animals…," he says.

"Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog… When an animal wants to obtain something … it has no other means of persuasion but to gain the favour of those whose service it requires. A puppy fawns upon its dam…

"Man sometimes uses the same arts with his brethren… But man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only. He will be more likely to prevail if he can interest their self-love in his favour, and show them that it is for their own advantage to do for him what he requires of them…

"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. Nobody but a beggar chooses to depend chiefly upon the benevolence of his fellow-citizens…

"In fact, it appears that human society began as what we would today call a gift-exchange system. Humans did not 'make a fair and deliberate exchange' in the early tribal groups, but bonded with each other via reciprocal gifts. In the small (generally less than 150) hunter-gatherer groups that preceded the agricultural revolution, everyone knew everyone else and was aware of what they had given to others, and what they had received in return. Debts were interpersonal obligations that bound those early societies together." (Jean Auel’s historical novel Clan of the Cave Bear gives a well-researched rendition of this personal basis of exchange.)

The sheer scale of agricultural society made this informal system of credit impossible. The act of keeping record of who was obligated to whom in these newly sedentary societies spurred the development of writing, and the keeping of those records was undertaken by the most trusted members of society – the religious leaders. This first record-keeping (one couldn’t yet call it writing) involved clay pots that contained symbolic representations of grain, animals and so on. By 3300 BC, these had evolved into the clay tablets of the Sumerian civilization: the origin of writing (Jane Gleeson-White’s book Double Entry covers this history nicely).

Therefore neither gold nor barter featured in the actual origins of money: instead, credit did. It transformed over time from personal obligations to recorded and socially enforced ones, and ultimately led to fiat money: debts and credits recorded and enforced by the state, and coins whose values were state-determined.

Figure 1: A cunieform tablet recording debts in commodities


This message comes through strongly in University of London anthropologist David Graeber’s book Debt: the first 5000 years: barter as a defining feature of human existence is a myth.

"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 that there never has been such a thing,” he says.

The same is true, it transpires, of the view that gold or silver was money. As Kumhof puts it, most of the times when gold played a major role in currency, it was because it had been nominated as the form of money by the sovereign. In an irony for critics of fiat money, gold became money because of fiat:

"There is another issue that tends to get confused with the much more fundamental debate concerning the control over the issuance of money, namely the debate over "real” precious-metals-backed money versus fiat money. As documented in Zarlenga (2002), this debate is mostly a diversion, because even during historical regimes based on precious metals the main reason for the high relative value of precious metals was precisely their role as money, which derives from government fiat and not from the intrinsic qualities of the metals.

"These matters are especially confused in Smith (1776), who takes a primitive commodity view of money despite the fact that at his time the then private Bank of England had long since started to issue a fiat currency whose value was essentially unrelated to the production cost of precious metals. Furthermore, as Smith certainly knew, both the Bank of England and private banks were creating checkable book credits in accounts for borrowing customers who had not made any deposits of coin (or even of bank notes)."

There were periods when gold was used in customary exchange, but these coincided not with commercial societies but ones based on plunder, where the rule of law – even the law of a local despot – had broken down. One can of course draw parallels with today, and argue that we are witnessing one of those periods where the established order is collapsing, and gold and silver will rule in those circumstances. But when this period is resolved, historical precedent suggests that a system of credit will supplant it.

Firstly, one hopes that future society – and ours today for that matter – will be characterised by peaceful relations rather than conflict and plunder. If so, we are likely to evolve a system based on credit rather than gold:

"While credit systems tend to dominate in periods of relative social peace, or across networks of trust (whether created by states or, in most periods, transnational institutions like merchant guilds or communities of faith), in periods characterised by widespread war and plunder, they tend to be replaced by precious metal. What’s more, while predatory lending goes on in every period of human history, the resulting debt crises appear to have the most damaging effects at times when money is most easily convertible into cash."

Secondly, the weight of history is on the side of credit and fiat money systems, rather than a "commodity money” like gold. As Graeber points out, in a broad sweep view of money, credit money systems have dominated human history:

"The cycle begins with the Age of the First Agrarian Empires (3500–800 BC), dominated by virtual credit money. This is followed by the Axial Age (800 BC to 600 AD) … which saw the rise of coinage and a general shift to metal bullion. The Middle Ages (600–1450 AD), … saw a return to virtual credit money… [T]he next turn of the cycle, the Age of Capitalist Empires, … began around 1450 with a massive planetary switch back to gold and silver bullion, and … could only really be said to have ended in 1971, when Richard Nixon announced that the US dollar would no longer be redeemable in gold."

Figure 2: A debt denominated in silver, with independent witnesses


Thus far, this IMF working paper gets big ticks from me on two fronts where I normally castigate neoclassical economists: the analysis explicitly includes money and is based on a realistic model of how money creation works today; and the historical knowledge of money and credit is accurate. In a future article I’ll consider the next issue: their analysis of the Chicago Plan to replace credit-based money with something rather different.

Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.

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Horse puckey, Steve. Having lived among 'primitive' people, and dealt with some of the most untouched by modern civilization (the San), the issue is simply that barter is unrecorded, debt is recorded (Busting money's creation myths, December 3).
Gold, or silver or copper or bronze or sheaves of wheat have value relating to the effort and skill required to produce them, they have both utility (be it for ornamentation, or conductivity of electricity, or bottoms of pots) and rarity (unlike mechanically produced copies of a picture on a piece of paper, or electronic imagination of the same).
Debt based promissary notes are only really long term viable if they promise goods or services which maintain their value. If a dollar buys a dollar's worth tomorrow and the next day, Fiat can work. In natural systems it bounced between upper and lower values balanced through deflation and inflation. Inflation on its own is a pipe dream.
I don't think Steve argues very convincingly against "gold is money". The Basel Committee on Banking Supervision, part of the Bank of International Settlements [BIS], is considering in its implementation of
Basel III's new capital rules commencing January 1st 2013, making gold equal to cash and sovereign bonds in its proposed liquidity component (Busting money's creation myths, December 3).
However, probably the greatest advocate for "gold is money" is Alan Greenspan's 'Gold and Economic Freedom'. Written in 1966, it can be found at: constitution.org/mon/greenspan.gold.htm
I would like to add a quotation from Alan Greenspan testifying before Congress when he was head of the Federal Reserve on May 20th 1999 (Busting money's creation myths, December 3):
"Gold is always accepted and is the ultimate means of payment and is perceived to be an element of stability in the currency and in the ultimate value of the currency
and that historically has always been the reason that governments hold gold".
I would also like to remind people that 95% of central banks hoard gold in their reserves,including our own
Reserve Bank.The US, Germany, France and Italy each have more than 70% of their reserves in gold.
Anything can be money as long as all parties accept it (Busting money's creation myths, December 3).
Barter is quite obviously at the core of every economic system. I'll trade the fruits of my labour for the fruits of yours.
If that's not barter than I don't know what is.
I was really hoping Steve was going to explore the history around the creation of the private central banks such as the Bank of England and the Federal Reserve, the role of fraction reserve lending and the fact that private banks directly control the amount of money in circulation via their expansive or restrictive lending policies.
For a truly eye opening documentary about money supply I can highly recommend "The Money Masters" which is available via Youtube and Google Video.
It's a conspiracy theorists wet dream, but when it comes to creating money, conspiracy is the name of the game. It's worth a look purely as a history lesson.
For a moneyless economy in recent history eg. Cambodia's 1975-1978 the monetarists' famed quantity identity MV = PT (where M: money supply, V: velocity of maney; P: price level; T: number of transactions) failed pitifully because although V=0, people still have transactions of goods and services (Busting money's creation myths, December 3). Cambodian experiences at the time shows the modified quantity identity should be MV + Gv = pT where G is the sum of all gold in the economy; v is the velocity of gold circulation in the economy;and p is the price level measured in ounce of gold of each transaction.
I think money is created when individuals in society agree that an unperishable subject or material be it man-made or natural should be used in their exchanging of goods and services conveniently, easily kept and changed hands.Silver, gold are examples of money in the past. Paper money and credits are more convenient and speed up transactions but run the risk of bankers' abuses.
I haven't bothered to read all the article. I merely go back to what I was taught in year 9 Commerce. money is a "recognised denomination as a median of exchange". Its value is defined by its denomination by those who use it as a median of exchange (Busting money's creation myths, December 3).
Gold is a form of asset, where gold is more liquid then money, but is not money, being gold can be more easily exchanged in any country in the world. Gold's value is dependent on what a person is willing to pay and what the owner is willing to sell. Essentially, as we know, gold is a commodity.
Why try to over complicate things?!
I think this is a pointless debate. Let's focus on devising a monetary system which produces the best allocation of resources in an economy (Busting money's creation myths, December 3). Whilst I do not believe gold is the answer, a system whereby money can be debased very easily through printing and discourages savings is doomed for failure.
Thanks Steve, you have a laid an important foundation (Busting money's creation myths, December 3).
I might add that the Egyptians, who valued gold highly, also valued ostrich feathers equally.
The Spartans used iron for their coinage. Iron can be melted down and made into swords. That implies resource(s) backed money.
Early cuneiform, developed as a form of quantifying available resources, used by the scribes (accountants).
In pure science, what is a ledger? A ledger is a balance between positive and negative. This is Einstein's explanation of relativity, that is - that energy and mass are interchangeable. The entire universe runs on this dynamic.
However, accountants (scribes), never understood this principal, until the number zero was invented. Positive plus negative equals zero, therefor a balance is achieved.
The universe according to Einstein, is based on the principle that negative and positive, interchange to achieve balance.
Steven Hawking goes to the next phase and states that the big bang was created from nothing and wavelengths create all mass until gravity causes the mass to collapse, compress then explodes (like a supernova).
So, getting back to bonds (the origins of modern banking). Bonds allowed trade for difference. Just like FOREX trading.
It was the Yuan Dynasty (Kublai Khan), that produced the first paper money (promissory note).
It was the Kublais son, Ghenkis Khan, that produced the greatest trading empire, that the world has ever seen and it was all based on promissory notes (credit).
China are now reclaiming, their trading patent.
Isn't one of the criteria of money that it be a "store of value" (Busting money's creation myths, December 3). Fiat money fails this test due to inflation eroding its purchasing power while an ounce of gold remains an ounce of gold (for what its worth).
Barter systems are feared by governments because avoiding fiat money makes collecting taxes far too difficult.
Milton Friedman notes several examples of different commodities being used as money (Busting money's creation myths, December 3).
Also, it's probably quite true that government helped gold become money at different times. Even if so, the value in a gold standard is to stop money expansion or unproductive/destructive counterfeiting of the monetary unit.
Also, it is correct to say that most of gold's value can come from the monetary value and not the industrial value. In the same sense, fiat money is not "inherently worthless" if it has monetary value. It's just easier to expand for short-term political reasons.
These are separate matters, whether money arose out of barter, and whether money facilitates barter. The historical evidence is for “no” (Graeber, Hudson, etc) and “yes” (witness today). Though Graeber thoroughly establishes that interpersonal debts preceded money, he fails to explain why (he merely *describes* these more primitive societies) (Busting money's creation myths, December 3).
A natural explanation is simply that, in these primitive societies, there was not much to barter (no variety of goods and services), except the same good from one time to another (“You give me some wheat today, that I am short, and I owe you wheat in the future”), which is precisely the meaning of interpersonal debts denominated in the few commodities extant.
Only once a society has more specialized skills and production processes, to generate a variety of goods and services, does there arise a need for a facilitator of barter – i.e. a need of money (whatever its material). That's why money postceded interpersonal debt contracts, because societies usually add, rather than forget, specialized skills and production processes. Simple enough, Mr. Graeber!
These seems to me to be some blurring in the distinction between three quite separate areas: the means of exchange (currency); 'tariffs, tax or tribute'; and credit (Busting money's creation myths, December 3). 'Money' seems to have originated as a form of tribute or taxation and a means of forcing individuals into an economic system or exchange that they probably would otherwise not have chosen to enter by forcing them to acquire some form of scarce and controlled currency ... there are plenty of examples of this throughout history, Jesus in the temple highlighting one and the English 'poll tax' colonial scam being another of the more obvious examples. One form or another of 'currency' - the supply of which is pretty much always controlled by exploitative forces - is used to force indivuduals into an interaction or system for the purpose of extracting tribute or 'tax'. As this is usually a government or monarch - or international bankers today - this currency is seen as secure and therefore safe to horde or hold wealth. But it is still only 'money', not credit. Exchange doesn't need to involve money nor credit and credit need not be money, or any other medium of exchange. And tariffs, or tribute, are neither. The controlling power may well demand a large chunk of your crop, or your first born instead. The current system of exploitative, predatory financial interaction uses credit and fiat currency, but neither credit nor fiat currency is the cause of the exploitation, only the means. It is the greed and desire for control at the core of the system that creates our modern predicament of scarcity and hording. 'Money' was created for the purpose of exploitation and, as a byproduct, its relative security resulted in its use as a medium of exchange. Credit also has been hijacked via currency to become an exploitative system, but it certainly does not need be. This is just my reading of history and I hope it doesn't come across as being too naive.