What is Money?

John Smithin

• Publisher: Routledge
• Year: 2002
• ISBN:
  9781134623662
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This volume provocatively rethinks the economics, politics and sociology of money and examines the classic question of what is money. Starting from the two dominant views of money, as neutral instrument and as social relation, What is Money? presents a thematic, interdisciplinary approach which points to a definitive statement on money.
Bringing together a variety of neclassical and heterodox perspectives, this work collects the latest thinking of some of the best-known economics scholars on the question of money. The contributors are Victoria Chick, Kevin Dowd, Gilles Dostaler, Steve Fleetwood, Gunnar Heinsohn, Geoff Ingham, Peter Kennedy, Peter G. Klein, Bernard Maris, Scott Meikle, Alain Parguez, Colin Rodgers, T.K.Rymes, Mario Seccarreccia, George Selgin, Otto Steiger, John Smithin and L. Randall Wray.

1 What is money?
Introduction

John Smithin

From a commonsense point of view, economic activity in the capitalist or market economy is all about money: making money, earning money, spending money, saving money, and so forth. It is true that recent changes in computer technology have led to discussions of a ‘cashless society’ or ‘virtual money’. However, it is fairly obvious (except perhaps to writers of ‘op-ed’ articles in the popular and financial press) that this is a change of form rather than substance. All that is implied by a cashless society is that it is possible to envisage a payments technology which makes no use of bits of paper and small metal discs. However, the cashless society is hardly ‘moneyless’, far from it. The purpose of ebusiness or e-commerce is also to ‘make money’, exactly as before. Indeed, under capitalism new technology would not be introduced at all if it could not be made ‘to pay’ in the traditional sense.

A much more serious issue, intellectually, in terms of arriving at a scientific understanding of the economic system, is that orthodox economic theory, the theory on which we were all ‘brought up’ in the words of Keynes (1936:1), has had a persistent tendency to deny the importance of money and monetary factors in determining economic outcomes, despite the apparent evidence of our senses. This goes back to a time long before anybody had thought of computers. The essence of the economic thought of the classical economists, such as Smith (1981 [1776]), Ricardo (1973 [1817]), and Mill (1987 [1848]) was their indignation at what they perceived to be the errors of their mercantilist predecessors, including the idea ‘that wealth consists in..gold and silver’ (Smith 1981 [1776]:429), or in other words, the money of the day. And this attitude has persisted to the present day. As is stated by Dostaler and Maris (Chapter 12 of this volume) ‘orthodox economics wanted to create a science that ignored money’, and every economist is familiar with the catchphrases and slogans which express this point of view, such as ‘money is neutral’ or ‘money is a veil’. Underlying this perspective is the view that economics deals fundamentally with the so-called ‘real’ exchange of goods and services, as opposed to the accumulation of financial resources. As Yeager has recently expressed it, in a volume which nonetheless stresses the importance of monetary disequilibrium, ‘(f)undamentally, behind the veil of money, people specialize in producing particular goods and services to exchange them for the specialized outputs of other people’ (Yeager (1997 [1986]: 217). This is a proposition which is virtually unchallenged in the textbooks and journal articles of contemporary neoclassical economic analysis, and which naturally leads on to a viewpoint which de-emphasizes the importance of money in the evolution of actual economic outcomes, except precisely in disequilibrium situations. The latter, however, no matter how serious the consequences may be in the short-run, are held not to permanently affect the underlying real economic equilibrium.

At a more formal level, and as discussed by Rogers (1989), Schumpeter, in his classic History of Economic Analysis (1994 [1954]) made the important distinction between ‘real analysis’ and ‘monetary analysis’ in the history of economic thought. Real analysis operates on the assumption that all the important features of the economic process can be understood in terms of the barter exchange of real goods and services, and their cooperation in production. In monetary analysis, however, the fact that employment and production decisions depend on expectations of monetary receipts relative to money costs, and, in general, that the reward structure of the whole society depends ultimately on monetary receipts and monetary disbursements, is taken seriously. In other words, money, and in particular the cost of acquiring financial resources (the rate of interest), is an integral part of the economic process. For our purposes, the significance of Schumpeter’s distinctions is that almost all mainstream economic analysis since the time of Adam Smith has been orientated to real, rather than monetary, analysis. One exception would obviously be Keynesian monetary production, but the so-called ‘Keynesian Revolution’ ultimately failed to have a lasting impact on the majority of academic economists and policy-makers. This was due to both theoretical flaws in the General Theory itself (see Rogers and Rymes, (Chapter 13 of this volume), and a variety of historical, political, and sociological factors, which I have discussed elsewhere (Smithin 1990, 1994, 1996).

However, in spite of the eclipse of Keynes’s thought, and stepping back from the ubiquitous influence of contemporary textbook orthodoxy, there are a number of fairly obvious reasons for questioning the validity of the underlying neutral money assumption. The first is the frequency with which problems in the real economy have been accompanied by, or coincided with, disruptions and crises in monetary conditions, and the twists and turns of monetary policy. Monetary matters have been at the very centre of the debate about real world economic and political problems from the original ‘Great Depression’ of the 1890s (the very existence of which is, significantly, denied by some contemporary scholars on the basis of revised statistical evidence), through its much more serious successor in the 1930s, then through the stagflationary era of the 1970s and the recrudescence of the business cycle in the 1980s, and up to and including the recurrent currency crises of the 1990s. Moreover, it is presumably this general impression which has instinctively led many of the most important names in economics to devote such a large part of their energies to money and monetary matters, including Keynes, Hicks, Hayek and Friedman in the twentieth century. This point remains valid, even if a number of those devoting themselves to money (Friedman, for example) eventually arrived at a real rather than a monetary analysis, in the sense defined above (Smithin 1994). An even more compelling argument, however, is that if money really does not matter it would be impossible to explain why the social control and production of money and credit continues to be the subject of such ferocious political debate. Why is it important to the financial interests, for example, that central banks should be independent (i.e., not subject to democratic control)? Why do participants in the financial markets in Wall Street hang on every word uttered by the Chair of the Board of Governors of the Federal Reserve System in congressional testimony? And what is the significance of the contentious social experiment of the ‘single currency’, the Euro, currently underway in Europe? (See Smithin and Smithin 1998 and Parguez 1999.)

In a recent paper (Smithin 1999), I argued that two fundamental issues in monetary theory were the exogeneity or endogeneity of the money supply in the system under consideration, and whether the Wicksellian notion of a (non-monetary) ‘natural rate’ of interest (Wicksell 1962 [1898]) is a meaningful concept. Orthodox or mainstream monetary theory with its insistence on monetary exogeneity and a basically non-monetary theory of interest was taken to be at one extreme. Conversely, it was argued that a more viable or realistic theory for the monetary production economy would reject both exogenous money and the existence of a mythical natural rate. In other words, the jettisoning of these assumptions is necessary for the correct analysis of what Ingham (Chapter 2 of this volume) calls ‘capitalist credit money’. There is, however, clearly a prior question to both of these analytical problems, which is how the social constructs of money and credit come into existence in the first place.

It is the premise of this volume that the answers given to the analytical questions in dispute will be closely related to the views taken on the prior issue of the role which money plays in the economy. This is coupled with the historical/logical question of how capitalist institutions, in particular the basic concept of production for the market, specifically for monetary reward, came to exert such a dominating influence in our social life.

Although it will be seen that not all of the contributors whose work is represented here would agree with this point of view, the starting point of the original call for papers was that two main approaches to the issues could be identified. The first was one version or another of the mainstream view which focuses on money’s role as a medium of exchange, and asserts that money arises as an optimizing response to the technical inefficiencies of barter. The classic account which is usually cited is that by Menger (1892), and the tradition has persisted to the present day in such contributions as Jones (1976), Kiyotaki and Wright (1989, 1993) and almost every textbook. In this view, the development of money must presumably make some difference to the economic system at the time it is first introduced, in terms of improving the efficiency of exchange and reducing transactions costs. However, it is held (somewhat inconsistently?) that once the concept is firmly established, subsequent changes in the monetary variables do not impinge on the underlying barter exchange ratios. The whole approach is therefore consonant with, and leads to, concepts of neutral money, money as a veil, natural rates of interest, fixed quantities of money, and so on. In short, it leads directly up to an essentially real analysis of economic phenomena in Schumpeter’s sense.

The other main line of approach begins with what Ingham (1996) has called the ‘social relation’ of money. Starting with the basic concept or idea of money, and the development of specific social rules, mechanisms, and institutions regarding money creation, the suggestion is, in effect, that markets, exchange, even capitalist production itself, are the consequence, rather than the cause, of the development of the notions of money, price lists, and credit. From this point of view, the textbook story about money emerging spontaneously from some pre-existing natural economy based on barter exchange is rejected as being both historically and logically inaccurate. Rather than money emerging from the market, the suggestion is that if anything the converse is true. Some writers have focused on what Hoover argues has been ‘traditionally regarded as the weak sister of the famous triad’, that is, ‘[the] unit of account’ (Hoover 1996:212). Interestingly Keynes for one explicitly stated that, ‘[m]oney of account, namely that in which debts and prices are expressed, is the primary concept of a theory of money’ (Keynes 1930:3, original emphasis). However, on a wider view presumably a money of account would be just the starting point for a more complete description of the development of the social structure of monetary practice, which would also include the development of standardized means of (final) payment denominated in the unit of account and the development of secure credit relations (see Ingham, Chapter 2 of this volume).

The main point is that these alternative views on the logical and historical development of monetary concepts ultimately lead to the view that money, or at least the price of money (the rate of interest), ‘enters as a real determinant in the economic scheme’ (Keynes 1936:191), and away from neutral money, exogenous money, and ‘natural rates’ of all kinds. In other words it leads to a more genuinely monetary analysis, of which Keynesian monetary production is itself one prototype.

In addition to, and frequently overlapping with, the two broad streams of thought identified here, there are ongoing debates on the nature of money within the confines of particular analytical traditions, such as the Austrian, Marxian, and Post Keynesian traditions (Dow 1985). Whatever view is ultimately taken on the merits of the various positions in detail, the basic point that different opinions on the key analytical and policy questions will depend on the underlying views taken on the role of money in the economy and the social structure must surely survive. This is inescapable, as soon as it is accepted that there is more than one way of looking at these issues.

Mention of the textbook functions of money highlights another difficulty which seems endemic in most discussions of monetary theory. The textbook triad (medium of exchange, store of value, unit of account) has in itself tended to structure and limit the discussion in a variety of ways. Among these are attempts to define money as simply that which fulfils each of the three functions in any given society at any point in time, an approach which inevitably comes to grief as financial innovation proceeds. In the early twentieth century the academic journals were filled with discussions on whether the checkable demand deposits of commercial banks should count as money. That issue having been decided, during the debates over monetarism in the 1960s and 1970s, the issue shifted to precisely which deposits in which financial institutions should be allowed to count, M1 versus M2 versus M3, and so on. Financial innovation and deregulation have obviously proceeded even more rapidly in the past twenty-five years, making the search for a unique monetary aggregate which fulfills textbook requirements even more futile.

An opposite temptation suggested by the textbook triad is to question whether the different functions logically need to be bundled together in the same asset or set of assets, and whether it is possible to design a coherent system in which the monetary functions are separated. This viewpoint also questions whether such a system would function more efficiently than the current one, and which of these alternatives would have evolved in the imagined ideal natural economy. Comprehensive discussions of these issues are to be found, for example, in Cowen and Kroszner (1994), Greenfield and Yeager (1983, 1989), and Selgin and White (1994).

Finally, there are the debates on which is the most important or significant of the different functions of money, and (perhaps even more importantly to contemporary economic theorists) which is the most capable of being modelled with the requisite degree of formalism. For example, both the search models discussed earlier, and cash-in-advance models based on the original suggestion of Clower (1967), try to model formally the medium of exchange function, while overlapping generations of models following Samuelson (1958) focus on money as a store of value, as do portfolio choice models in the tradition of Tobin (1958). For an overview of the neoclassical literature see Walsh (1999); or, in a more accessible treatment Laidler (1993); and for a reasoned critique see Hoover (1996). Frequently however the debates over the usefulness or otherwise of the formal models boil down to the assertion that they each emphasize one of the monetary functions at the expense of the other (s), and, as mentioned, the unit of account aspect invariably seems to be on the back burner.

As is demonstrated in a number of the contributions in this volume, a major weakness of the textbook triad approach is that it draws attention away from the hierarchical nature of monetary systems in practice. Even if there is a multiplicity of media of exchange in any given monetary system, there invariably seems to be a unique asset which constitutes the medium of (final) settlement or medium of redemption in the given social setting. This corresponds to what is described as base money in the mainstream literature, or valuata money in the chartalist or state money approach discussed by Wray Chapter 3 of this volume). Dow and Smithin (1999) have argued that a hierarchical system is in some sense fundamental, and that a logical prerequisite for a functioning system of monetary production is that the medium of (final) settlement and the unit of account are unambiguously united in the same asset, even in the presence of a multiplicity of actual exchange media. Only in these circumstances does taking a long position in the production of goods for sale in the market become a feasible or viable proposition.

It is clear from both current practice and historical example that various exchange media other than the final medium of settlement can arise, but by definition they attract less confidence, and must be related to the ultimate means of payment in some way, such as by redemption pledges. This results in the notorious fragility of credit-based systems in periods of crisis, when the reliability of the substitute media has been called into question for some reason. In the typical banking system the substitute media, after all, consist simply of the balance-sheet counterparts on the liabilities side to the credits which have been granted on the prospect of future income, sales, or profit.

Another key issue is whether the ultimate reserve asset is in relatively fixed supply (e.g.if it is a commodity such as gold). It is clear that monetary systems in which the reserve asset is not in fixed supply will operate in a different fashion from those in which it is. In the former, supplies of the reserve assert can be readily increased whenever the issuing institution itself is willing to make loans of some kind. Hence the emergence of the ‘pure credit economy’ (Wicksell 1962 [1898], Hicks 1989), in which the money supply becomes ‘fully endogeno...

Table of contents

• Cover Page
• Title Page
• Copyright Page
• Figures
• Tables
• Contributors
• Acknowledgements
• 1: What is money? Introduction
• 2: ‘Babylonian madness’: on the historical and sociological origins of money
• 3: Modern money
• 4: The property theory of interest and money
• 5: The credit theory of money: the monetary circuit approach
• 6: Money and effective demand
• 7: The invisible hand and the evolution of the monetary system
• 8: Aristotle on money
• 9: A Marxist theory of commodity money revisited
• 10: A Marxist account of the relationship between commodity money and symbolic money in the context of contemporary capitalist development
• 11: Menger’s theory of money: some experimental evidence
• 12: Dr Freud and Mr Keynes on money and capitalism
• 13: The disappearance of Keynes’s nascent theory of banking between the Treatise and the General Theory