Don’t Start from the Coin


Even today, textbooks on Money, Currency, and Banking are more likely than not to begin with an analysis of a state of things in which legal-tender ‘money’ is the only means of paying and lending. The huge system of credits and debits, of claims and debts, by which capitalist society carries on its daily business of production and consumption is then built up step by step by introducing claims to money or credit instruments that act as substitutes for legal tender… Even when there is very little left of [money’s] fundamental role in practice, everything that happens in the sphere of currency, credit, and banking is construed from it, just as the case of money itself is construed from barter. 

Historically, this method of building up the analysis of money, currency, and banking is readily understandable… Legal constructions, too, … were geared to a sharp distinction between money as the only genuine and ultimate means of payment and the credit instrument that embodied a claim to money. But logically, it is by no means clear that the most useful method is to start from the coin—even if, making a concession to realism, we add inconvertible government paper—in order to proceed to the credit transactions of reality. It may be more useful to start from these in the first place, to look upon capitalist finance as a clearing system that cancels claims and debts and carries forward the differences—so that ‘money’ payments come in only as a special case without any particularly fundamental importance. In other words: practically and analytically, a credit theory of money is possibly preferable to a monetary theory of credit.

Perry Mehrling quotes this passage at the start of his essay Modern Money: Credit or Fiat. If you’re someone who worries about the vexed question of what is money anyway, you will benefit from the sustained intelligence Perry brings to bear on it.

Readers of this blog may not be familiar with Perry’s work, so let me suggest a few things. The Credit or Fiat essay is a review of one of Randy Wray’s books, but it makes important positive arguments along with the negative criticism of MMT. [1] A good recent statement of Mehrling’s own views on the monetary system is The Inherent Hierarchy of Money. Two superb essays on monetary thought in the postwar neoclassical synthesis are The Money Muddle and MIT and Money. [2] The former of these coins the term “monetary Walrasianism.” This refers to  the idea that the way to think of a monetary economy is a barter system where, for whatever reason, the nth good serves as unit of account and must be on one side of all trades.  This way of thinking about money is so ingrained that I suspect that many economists would be puzzled by the suggestion that there is any other way of thinking about money. But as Perry shows, this is a specific idea with its own history, to which we can and should imagine alternatives. Finally, The Vision of Hyman Minsky is one of the two best essays I know giving a systematic account of Minsky’s, well, vision. (The other is Minsky as Hedgehog by Dymski and Pollin.) Anyone interested in what money is, what “money” means, and what’s wrong with economists’ answers, could save themselves a lot of trouble and wrong turns by reading those essays. [3]

But let’s talk about the Schumpeter quote.  I think it is right. To understand the monetary nature of modern economies, you need to begin with the credit system, that is, the network of money obligations. Where we want to start from is a world of IOUs. Suppose the only means of payment is a promise to pay. Suppose it’s not only possible for me to tell the bartender at the end of the night, I’ll pay you later, suppose there’s nothing else I can tell him — there’s no cash register at the bar, just a box where my tab goes. Money still exists in this system, but it is only a money of account — concretely we can imagine either an arbitrary unit of value, or some notional commodity that does not circulate, or even exist. (Historical example: non-circulating gold in medieval Europe.) If you give something to me, or do something for me, the only thing I can pay you with now is a promise to pay you later.

This might seem paradoxical — jam tomorrow but never jam today — but it’s not. Debts in this system are eventually settled. As Schumpeter says, they’re settled by netting my IOUs to you from your IOUs to me. An important question then becomes, how big is the universe across which we can cancel out debts? If A owes B, B owes C, and C owes A, it’s not hard to settle everyone up. But suppose A owes B who owes C who owes …. who owes M who owes … who owes Z, who owes A. It’s not so easy now for the dbets to be transferred back along the chain for settlement. In any case, though, my willingness to accept your IOUs depends on my belief that I will want to make some payment to you in the future, or that I’ll want to make some payment to someone who will want to make a payment to someone …. who will eventually want to make a payment to you. The longer the chain, the more important it is for their to be some setting where all the various debts are toted up and canceled out.

The great fairs of medieval Europe were exactly this. During their normal dealings, merchants paid each other with bills of exchange, essentially IOUs that could be transferred to third parties. Merchants would pay suppliers by transferring (with their own endorsement) bills from their customers. Then periodically, merchant houses would send representatives to Champagne or wherever, where the various bills could be presented for payment. Almost all the obligations would end up being offsetting. From Braudel, Capitalism and Civilization Vol. 2:

… the real business of the fairs, economically speaking, was the activity of the great merchant houses. … No fair failed to end with a ‘payment session’ as at Linz, the great fair in Austria; at Leipzig, from its early days of prosperity, the last week was for settling up, the Zahlwoche. Even at Lanciano, a little town in the Papal States which was regularly submerged by its fair (though the latter was only of modest dimensions), handfuls of bills of exchange converged on the fair. The same was true of Pezenas or Montagnac, whose fairs relayed those of Beaucaire and were of similar quality: a whole series of bills of exchange on Paris or Lyons travelled to them. 

The fairs were effectively a settling of accounts, in which debts met and cancelled each other out, melting like snow in the sun: such were the miracles of scontro, compensation. A hundred thousand or so “ecus d’or en or” – that is real coins – might at the clearing-house of Lyons settle business worth millions; all the more so as a good part of the remaining debts would be settled either by a promise of payment on another exchange (a bill of exchange) or by carrying over payment until the next fair: this was the deposito which was usually paid for at 10% a year (2.5% for three months). 

This was not a pure credit-money system, since coin could be used to settle obligations for which there was no offsetting bill. But note that a “good part” of the net obligations remaining at the end of the fair were simply carried over to the next fair.

I think it would be helpful if we replaced truck-and-barter with something like these medieval fairs, when we imagine the original economic situation. [4] Starting from a credit view of money modifies our intuitions in several, as I see it, helpful ways.

1. Your budget constraint is always a matter of how much people will lend you, or how safe you feel borrowing. Conversely, the consequences of failing to pay your debts is a fundamental parameter. We can’t push bankruptcy onto the back burner as a tricky but secondary question to be dealt with later.

2. The extension of credit goes with an extension of the realm of the market. The more things you might be willing to do to settle your debts, the more willing I am to lend to you. And conversely, the further what you owe runs beyond your normal income, the more the question of what you won’t do for money comes up for negotiation.

3. Liquidity, money, demand, depend ultimately on people’s willingness to trust each other, to accept promises, to have confidence in things working out according to plan. Liquidity exists on the liability side of balance sheets as much as on the asset side.

4. When we speak of more or less liquidity, we don’t mean a greater or lesser quantity of some commodity designated “money,” but a greater or lesser degree of willingness to extend credit. So at bottom, conventional monetary policy, quantitative easing, lender of last resort operations, bank regulations — they’re all the same thing.

When Minsky says that the fundamental function of banks is “acceptance,” this is what he means. The fundamental question faced by the financial system is, whose promises are good?

[1] I don’t want to get into Perry criticisms of MMT here. Anyone interested should read the article, it’s not long.

[2] MIT and Money also makes it clear that I was wrong to pick Samuelson’s famous consumption-loan essay as an illustration of the neoclassical position on interest rates. The point of that essay, he explains, was not to offer a theory of interest rate determination, but rather to challenge economic conservatives by demonstrating that even in a simple, rigorous model of rational optimization, a public pension system could could be an unambiguous welfare improvement over private retirement saving. My argument wasn’t wrong, but I should have picked a better example of what I was arguing against.

[3] Perry has also written three books. The only one I’ve read is The New Lombard Street. I can’t recommend it as a starting point for someone new to his work: It’s too focused on the specific circumstances of the financial crisis of 2008, and assumes too much familiarity with his larger perspective.

EDIT: I removed some overly belligerent language from the first footnote.

19 thoughts on “Don’t Start from the Coin”

  1. If I understand correctly your point, the problem with an idea of money based on "coins" is that we start assuming a certain quantity of stuff that is used as money (coins), and thus we have an exogenous quantity of money.
    If, on the other hand, we start with debt/credit, we have an endogenous quantity of money, plus "trust" as a fundamental asset in economics.
    I like the idea of endogenous money, I like less the focus on trust because I believe that this trust is not an independent variable, but rather an assesment of the financial capabilities of the debtor (for example, people with more assets can borrow more easily), and thus a dependent (endogenous) variable.

    But, I have a more fundamental problem with collapsing debt with money, that while is not really relevant to your post, is still very important from my point of view:

    Most economic models that I know start with an implicit assumption that the final purpose of economic activity is consumption. For example people like to have an high wage, because so they can consume more.
    However, if you take this assumption to its extreme consequence, you have to assume that people should try to consume everything they have.
    For example, a guy builds or buys a car factory. This means that much wealth is freezed in the factory. If the guy was really a consumption maximiser, then the only reason he has to tie down his wealth in the factory is that he wants to consume much more later (a time preference).
    However people who buy capital assets do not usually plan to sell all their assets at a specific point in the future, instead it is quite likely that they use the cash flow from the assets to buy more assets, in a continuous cycle (okay, this is stupidized Marx and I don't need to tell this to you, but this is very important because it is this process that causes increases in inequality).
    Thus there is a very important difference between consumption goods and capital assets, and between people who act as consumers and people who act as "wealth accumulators".
    When we speak of debt, it is important to note that debt is a financial assets to the creditor, and, while it is a financial liability to dthe debtor, it is often used to buy other capital assets whose cashflow is supposed to be higher than the interest on debt (or that are supposed to appreciate by more than the debt principal + cumulated interest).
    On the other hand, "coins" carry no interest, so are not capital goods in themselves, and are most often used to buy consumption goods.

    I believe that a good theory of money should not skip this difference (consumption vs capital, stuff that doesn't generate profits vs. stuff that generates profits).

    Ok, now I'll read the links so if this is addressed I'll feel stupid.

    1. That it is. The best thing I've read on that point is an unpublished paper by Mike Beggs which, unfortunately, is not available on the web. Is there anything you like on it?

    1. Very much so. I made a choice not to cite it because Graeber is kind of polarizing and I wanted to show that these ideas are widely shared. But I'll add an update mentioning him.

  2. RL-

    I'm not surprised you don't like the idea of trust as a basic economic parameter. I would have been disappointed if you did like it, since this is a basic cleavage between Schumpeter and Keynes on the one hand, and Marx and the classicals and neoclassicals on the other.

    For Schumpeter and Keynes, what ultimately sets the pace of investment/accumulation/growth is the rate at which new purchasing power is created by the credit system. For Keynes, newly created purchasing power creates real resources for investment by mobilizing previously idle productive capacity, while for Schumpeter creation of purchasing power by banks reallocates resources to investment from other uses via forced saving. But both agree that it is ultimately financial conditions that call the tune for accumulation. I.e. investment determines saving, not vice versa.

    Marx and the (neo)classicals, on the other hand, the availability of real resources is the prior condition for investment. For Marx (and for Smith, Malthus and Ricardo), real resources are made available by being redistributed to capitalists, i.e. "saving" happens automatically as a consequence of profits increasing at the expense of some other form of income. While for the neoclassicals savings represents a choice by a representative household to defer consumption. These are quite different stories, but both agree that the pace of accumulation is ultimately limited by the availability of real resources, not by the availability of finance.

    Since you are — from what I can tell – a serious Marxist, you are right to be uncomfortable with the idea that credit decisions operate independently of the fundamental income-generating capacity of borrowers.

    On the second point, you are right that the idea that consumption is the only end of economic activity — which is an axiom of mainstream economics going back at least to Jevons and Bohm-Bawerk — does not describe real economies. Businesses and wealth-owners are maximizing wealth, subject to some safety margin and (for the latter) conventional level of consumption. And ordinary people consume at a conventional level without maximizing anything. You are also right that almost all debt finances purchases of productive assets, not consumption. (I mentioned this in one of my recent interest rate posts.) On this point, keynesians and Marxists are on the same side. As I've mentioned before, Keynes himself said that Marx had a better understanding of modern economies than most economists because he understood that business activity is organized as M-C-M', not C-M-C'.

    As for the suggestion you make at the end. I interpret it as: A quantity theory of money is more relevant to households/workers, because they don't accumulate assets and therefore don't issue debt, so we can ignore the liability side of their balance sheets. I think there may be some truth to this, but I also think how much depends strongly on the time and place. I'll have to think about this more.

  3. Netting-out debts across the EU would be a good first step to getting things under control. It's such a simple concept that there's no chance it will ever be utilized. Here's a study that modeled the exercise :

    Results :

    The countries can reduce their total debt by 64% through cross cancellation of interlinked debt, taking total debt from 40.47% of GDP to 14.58%

    Six countries – Ireland, Italy, Spain, Britain, France and Germany – can write off more than 50% of their outstanding debt

    Three countries – Ireland, Italy, and Germany – can reduce their obligations such that they owe more than €1bn to only 2 other countries

    Ireland can reduce its debt from almost 130% of GDP to under 20% of GDP

    France can virtually eliminate its debt – reducing it to just 0.06% of GDP

    Doing the same with the debt of individuals wouldn't yield much , since the rich hold all the paper and the non-rich owe the debt.


    1. Doing the same with the debt of individuals wouldn't yield much , since the rich hold all the paper and the non-rich owe the debt.

      Don't be so sure. The non-rich do have assets. Houses, to begin with. As I've noted here before, essentially all of the deleveraging that has occurred since 2008 has been due to defaults. And insofar as those defaults have been on mortgage debt, they are a form of netting-out.

    2. Oh , yes , that's certainly true , but that's a little different from what I had in mind. The article I cited above suggests that by setting up some kind of "debt clearing house" , many EU countries could greatly clean up their books , simply by swapping paper contracts. I'd see this sort of process as having some value , even though net liabilities don't change , simply because makes the system more transparent and tractable for investors , regulators , politicians , etc.

      That study is a couple of years old , so I'm sure the numbers have shifted around quite a bit by now.


    3. The clearing house idea could probably be put to good use for derivatives and financial sector debt in general. I'd feel a lot better knowing there were only $100 trillion in loose financial nukes laying around instead of the current quadrillion or so.


    1. JW,
      Braudel, whom you quote, says the whole credit system falls apart if there are not enough "real coins". I take him to mean the important thing is to maintain the debt-per-dollar ratio in a workable range. Start from the coin or begin with the credit system, as you will; what matters is the workable range.

  4. Art,

    The point is not that the Champagne fairs are an example of a pure credit system. There never has been such a thing, nor has there ever been a pure token-money system with no private credit.

    In a pure credit system, every real expenditure involves the creation of a new liability. In a pure token-money system (or monetary Walrasian system in Mehrling's language), expenditure never involves the creation of a new liability. Both of these are abstractions, both represent extreme cases that don't occur in reality. But a good way to understand a complex phenomenon is often to start with a simplified extreme case, and then make it more realistic. So the question here is which extreme should we start from — the pure money system that economics normally starts from, or the pure credit system that Schumpeter is suggesting we start from instead? I brought up the Champagne fairs as a concrete example of a system further toward the pure credit pole, not to suggest that money played no role in them. You're right, it did, a necessary role.

    And — drinks are not on the house at the bar I'm describing. They only reason they take my IOU is because they think it will eventually be netted out against some debt they owe to me. If they don't think they're ever going to owe me anything, they won't serve me.

    A good way to think about it is in terms of balance sheets. In the pure money world, just like in the barter world, no transaction changes the liabilities of either party. In effect, there are no liabilities. In a pure credit system, every transaction changes the liabilities of at least one of parties. Schumpeter's suggestion is that the pure credit system can be a more useful analytic starting point for certain questions, not that it really existed historically.

  5. Thanks JW. When I finally understood your sentence "Money still exists in this system, but it is only a money of account" I understood that they would eventually open the box and expect something in return for my tab tally. Thing is, I didn't understand your sentence till I had made good use of the incorrect meaning that I came up with.

    I should have rewritten my response, cut off the offending member, and gone with something shorter, but I didn't.

    As for the rest… None of us (me, you, Schumpeter, Braudel) is thinking of a "pure" credit or a "pure" money system. I understood, in your post you were looking for a better way to understand the money-and-credit system. I was using your post and your source (Braudel) to respond to something you said some time ago:

    "Arjun and I had quite a few discussions about the best way of measuring leverage, and I'm certainly open to the idea that we ended up with the wrong answer. But it's not at all clear to me why debt/M1 would be a better measure."

    Braudel's "American silver reaching Genoa" is particularly relevant here.

    Lately (since reading your post) I have been thinking in terms of "settlement money" which is money that can be used to reduce debt. This excludes credit, because borrowing money to pay down debt doesn't reduce debt. It excludes money in savings, because the money would have to come out of savings before it could be used in a transaction. To my mind, that leaves M1 as settlement money.

    People who look at "debt relative to income" seem to forget that a lot of "income" comes from newly created debt. That throws off the calculation. Conclusion: The significant ratio is debt relative to settlement money.

  6. Money is the credit and flow from sovereign authority.

    The age of credit produced awesome investment gains for those invested in fiat money and fiat wealth such as stocks and real estate, and produce some global economic growth, via central bank investment inflationism, more specifically through the three dynamos of creditism, globalism and corporatism, which saw the Federal Reserve’s balance sheet inflate from $900bn to $4.5 TN in just six years.

    The age of debt servitude is one of investment loss and economic deflation, which comes via destructionism, and where the singular dynamo of regionalism prevails to establish regional security stability and sustainability, via regional fascism.

    The age of credit presented the opportunity to grow wealth by investing in fiat assets such as stocks, bonds, and real estate. In the age of the failure of credit, a new form of money will develop, that being diktat money. Wealth can only be preserved by purchasing and taking possession of and safely storing gold bullion.

    Those who own gold are economically sovereign and together with emerging regional fascist leaders possess seigniorage; the new money will have its value from the word, will and way of regional sovereign bodies, and regional sovereign leaders, whose authority comes from regional framework agreements. Public private partnerships will coin money as their edicts replace the leveraged speculative investment community’s schemes of credit and currency trade investing.

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