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An introduction to heterodox views of money and MMT (Part 1)

Phil Armstrong

For neo-classical economists a ‘conjectural history’ (Dowd 2000) where money develops from barter serves a very useful purpose; it supports their ethics. It is most helpful to specify a system where money develops as a ‘natural’ response to changing circumstances by individuals behaving so as to maximise expected utility. However, careful examination of the available evidence contradicts this view.

Historical analysis tends to support heterodox views, and in particular the state and credit theories of money.

Conjectural histories have been around for a long time and although there is some variation in the story they tend to follow a similar pattern. Wray (1998, p.

39) considers, justifiably, that a succinct analysis of early conjectural histories can be found in Mitchell-Innes (1913). Before providing a thorough critique of the story, Mitchell-Innes provides an excellent summary. According to Innes, the story goes as follows; in ‘primitive’ economies exchange was based on barter but as societies developed, efficiency was improved by the introduction of one commodity as a means of exchange. This commodity also served as a unit of value. A wide range of different commodities have been used in different societies at different times but eventually all roads tended to lead to precious metals as the most efficient variant. A fixed quantity of a metal (typically gold or silver) of known purity became a standard of value and this standard should have been guaranteed by rulers. However, when the ‘authorities’ took control of the system they exploited it to their own ends by debasing the currency. Eventually credit was introduced as a substitute for gold, requiring less direct use of metal and improving efficiency.

In contrast to the neo-classical theory which finds its roots in the optimising behaviour of individuals, the state theory contends that the origins of money are rooted in the development of power and inequality.

Traditional tribal societies were essentially egalitarian and had no need for money. According to Polanyi, they were based upon reciprocity, redistribution and householding (Polanyi, 1944, ch. 4). However, with the development of inequality, a raison d’être for money emerged. Henry finds the essential origins of money lie in power and inequality rather than exchange. ‘Those who see money as a social relationship stress the significance of money as a unit of account in which obligations are both created and extinguished. Money, then, represents a relation between those who claim these obligations and those who must service those claims’ (Henry, 2004, p.79). He goes on to suggest that the role of exchange in the genesis of money is of minor significance, especially since the existence of markets is in no way a necessary condition for the evolution of money. Money’s role as a medium exchange is downplayed while its role as a unit of account is stressed.

In order to find alternative theories which may provide better explanations of money’s origins and greater empirical support we may look towards state and credit theories. In terms of the state theory of money, the significance of Georg Friedrich Knapp’s seminal work The State Theory of Money (1905, translated into English in 1924) needs to be stressed. Knapp’s exposition is difficult to follow as he creates his own highly complex vocabulary and uses it extensively during his explanations. However, it is certainly a book worthy of a great deal of attention.

For Knapp, it is the state that decides on the unit of account and the ‘money things’ that are to be used in settlement of debts denominated in this unit.

Initially, the unit of account may be a weight of precious metal of given fineness. However, the state may choose to change the unit to a different metal by decree. The choice of unit is in the hands of the state rather than springing from a process involving individuals searching for the most efficient way of reducing the costs of barter. If the state decided that a different metal was to be used as a standard of value, it held the power to change the unit of account.

Knapp analyses, in considerable detail, the process of monetary development from the starting point of a monetary unit expressed as a weight of metal of given fineness. The use of stamped coins whose weight determines value is seen as a later development. A further stage was reached when the coins were given a nominal value by the authorities not based upon weight or precious metal content.

Ancient authorities would use their power to move resources from the private sector to themselves. Control of the monetary system provided a highly effective means for this aim to be achieved. From this perspective, taxation serves, not to fund spending as is mistakenly believed by most economists and nearly all the population, but to create a demand for the currency and to reduce the spending capacity of the private sector. This will allow the state ‘room to spend’ without inflation.

A stylised story employing the use of stamped metal might go as follows; a ruler might decide what she/he desired, for example, palaces, amphitheatres and an army of conquest. She or he could utilise their monopoly power over the monetary system to obtain what they desired. They would first define the unit of account and then decide upon the money things acceptable in payment of debts denominated in this unit, say, stamped metal discs clearly marked with her or his head. The disc may contain precious metal. This precious metal content (if any) would be decided upon by the state (the mint standard). The use of precious metal may help prevent counterfeiting and raise the prestige of the issuer but the intrinsic value of the coins provided only a floor value for the currency. The nominal value would be higher and determined by decree.

She or he then imposed a tax on her or his subjects denominated in its chosen standard, payable by the surrender of the stamped discs. The ruler decided the nominal value of the coins and how many each person must pay to satisfy their tax bill. This process gave the coins value. They were tokens showing the holder had a credit on the state.

They were really ‘tax credits’. The ruler could now spend these tokens on whatever she or he wished as long as it was available in her or his own domain – or ‘monetary space.’ The private sector suppliers of goods accepted the tokens, not because they were made of precious metal but rather because the population needed them to pay taxes. The rulers then paid their soldiers with the stamped metal discs and the soldiers, in turn, were able to go to the villages and buy whatever they wished, provided of course it was available! The populace sold the soldiers real goods to obtain the discs needed to meet their tax liabilities. Clearly, the empress or emperor had to spend before she or he could collect. A private agent minting discs with the ruler’s head on without her or his permission would soon be put to the sword. It may appear that the ruler needed to tax before spending but this is an illusion!

So the state’s ability to impose and collect taxes enables it to act as a currency issuer within its sovereign monetary space and transfer resources from the private sector to itself. The ultimate ‘value’ of a tax-driven currency is determined by the amount of effort required by the issuer in order to obtain it. Viewed from another perspective the state, as the monopoly issuer of ‘that which is required to pay taxes’, has the power to determine its value. In other words, the price level is necessarily a function of the prices paid by the state; a key insight provided by Modern Monetary Theory (MMT).

It is also worth considering the credit theory of money. Together with the state theory it provides some powerful insights which are absent from the neo-classical story. Once the state has named a unit of account, private sector agents may issue their own money denominated in that unit of account.

We can focus our attention on the work of Alfred Mitchell Innes and his famous articles in the The Banking Law Journal, ‘What is Money?’ (1913) and also ‘The Credit Theory of Money’ (1914). For Innes, the nature of money is founded upon the credit and debt relationship and not as a development of barter. He states, ’A first class credit is the most valuable kind of property. Having no corporeal existence, it has no weight and takes no room. It can easily be transferred, often without any formality whatever’ (Innes, 1913, p.10). Innes follows up with a powerful statement, ‘Credit is the purchasing power so often mentioned in economic works as being one of the principal attributes of money, and, as I try to show, credit and credit alone is money’ (Innes, 1913, p.9).

Innes had already clarified the meaning of credit, ‘It is here necessary to explain the primitive and the only true commercial or economic meaning of the word “credit.” It is simply the correlative of debt. What A owes to B is A’s debt to B and B’s credit on A. A is B’s debtor and B is A’s creditor. The words “credit” and “debt” express a legal relationship between two parties, and they express the same legal relationship seen from two opposite sides. A will speak of this relationship as a debt, while B will speak of it as a credit’ (Innes, 1913, p.9). He then explained the relationship between credit and debt, ‘Whether…the word credit or debt is used, the thing spoken of is precisely the same in both cases, the one or the other word being used according as the situation is being looked at from the point of view of the creditor or of the debtor’ (Innes, 1913, p.10). ‘Money, then, is credit and nothing but credit. A’s money is B’s debt to him, and when B pays his debt, A’s money disappears. This is the whole theory of money’ (Innes, 1913, p.16).

We are now in a position to consider the core propositions of MMT and the extent to which they are consistent with the state and credit theories of money. MMT is founded on the insights provided by the state theory of money, which asserts that money in the form of currency is chartal – a creation of the state. The credit theory of money also considers money as a social institution, where ‘credit and credit alone is money’ (Innes, 1914). We might note the clear links between the work of J. M. Keynes and chartalism, ‘The State, therefore, comes in first of all as the authority of law which enforces the payment of the thing which corresponds to the name or description in the contract. But it comes in doubly when, in addition, it claims the right to determine and declare what thing corresponds to the name, and to vary its declaration from time to time – when, that is to say, it claims the right to re-edit the dictionary. This right is claimed by all modern States and has been so-claimed for some 4000 years at least’ (Keynes, 1930, p. 4).

An excellent summary of the distinctive nature of MMT is provided by Warren Mosler in his ‘statement of purpose’ (Mosler, 2012, p.13-16). In recent correspondence he noted succinctly, ‘MMT recognizes that the currency is a public monopoly, taxes function to create unemployment and the funds used to make payments to the government come from the government. The price level is a function of prices paid by government and loans create both deposits and required reserves. The national debt is nothing more than the dollars spent by the government that haven’t yet been used to pay taxes and remain outstanding as ‘net savings’ in the economy until used to pay taxes.

They ‘rest’ in the form of cash, reserve balances at the Fed and balances in securities accounts at the Fed’ (Mosler, 14 March, 2015).

MMT provides a compelling picture of the core or operational reality which is present in monetary systems. Thus MMT clearly distinguishes between the operational reality present when a government issues its own fiat currency under floating exchange rates and the different core reality that exists under a regime where currency is convertible into a commodity at a fixed rate or in fixed exchange rate regimes.

In a world free of political blockages in the monetary plumbing, where the state issues its own non-convertible currency under floating exchange rates, the government never faces ‘affordability’ questions in a monetary sense. It never ‘has’ or ‘doesn’t have’ money. It issues money ex-nihilo and can purchase anything available within its own sovereign monetary space. In such a situation the limits of production and consumption of goods and services are real not monetary. The quantity and quality of factors of production determine what can be produced and consumed domestically. The state must ensure the economy performs so as to ensure that the nation lives up to its means. It must use its position as a monopoly issuer of the currency to ensure full employment.

Each operational monetary reality has an accompanying socio-political layer. Elements of this layer may be essential responses required to maintain the operational integrity of the monetary system or they may be unnecessary additional constraints imposed for primarily ideological reasons.

We might initially consider an analysis of an earlier core reality. The development and eventual hegemony of this earlier monetary reality was intimately linked to a much wider change in society and the relationship between economics and society itself; specific- ally, the introduction of the self-regulating market and what it required, in particular in relation to the actual operation of the monetary system. For the following analysis I will rely heavily upon the work of Karl Polanyi, especially his seminal text of 1944, The Great Transformation.

Polanyi denies the universal nature of markets. He charts the growth of the importance of markets and considers the hegemony of the market system to be a recent phenomenon. For Polanyi, man’s supposed innate desire to truck and barter is much exaggerated, early societies were not based on market forces, but on reciprocity and redistribution. Markets, up until comparatively recently, have always been embedded in society, their influence had been controlled to protect the structure of society. The ‘disembedding’ of markets – where society is ordered so as to serve the self-regulating market is considered by Polanyi as essentially a nineteenth century experiment; one that, if continued without hindrance would destroy the nature of society itself. It involved the marketization of land, labour and money. It required reducing their essential nature to that of commodities. However, they can only be ‘fictitious commodities’.

‘The crucial point is this; labour, land and money are essential elements of industry; they must also be organised in markets; in fact, these markets form an absolutely vital part of the economic system. But labour, land and money are obviously not commodities; the postulate that anything that is bought and sold must have been produced for sale is emphatically untrue in regard to them.

In other words, according to the empirical definition of a commodity they are not commodities. Labour is only another name for a human activity which goes with life itself, which in turn is not produced for sale but for entirely different reasons, nor can that activity be detached from the rest of life, be stored or mobilized; land is another name for nature, which is not produced by man; actual money, finally, is merely a token of purchasing power which, as a rule, is not produced at all, but comes into being through the mechanism of banking or state finance. None of them is produced for sale. The commodity description of labour, land and money is entirely fictitious’ (Polanyi, 1944, p75-6).

Polanyi introduced the idea of the double ‘movement’ ; the attempt to treat land, labour and money as commodities, in order to create a unified market society, was a utopian project which was bound to create, in turn, a counter- movement required to prevent the destruction of society. For Polanyi, there was nothing natural about a market economy; it had to be planned from the outset.

‘The road to the free market was opened and kept open by an enormous increase in continuous, centrally- organized and controlled intervention- ism. To make Adam Smith’s “simple and natural liberty” compatible with the needs of human society was a most complicated affair’ (Polanyi, 1944, p 146).

Although the development of a market society was planned, the responses to its introduction were spontaneous, essentially defensive, and necessary as a means to protect the structure of society from the action of the self- regulating market.

‘While laissez-faire economy was the product of deliberate state action, subsequent restrictions on laissez-faire started in a spontaneous way. Laissez faire was planned; planning was not’ (Polanyi, 1944, p147).

‘The legislative spirit of the counter-movement against a self-regulating market as it developed in the half- century after 1860 turned out to be spontaneous, undirected by opinion, and actuated by a purely pragmatic spirit’ (Polanyi, 1944, p147).

References This article summarises a longer paper by the author (Armstrong, 2015).

Armstrong, P. (2015), ‘Heterodox Views of Money and Modern Monetary Theory’

Dowd, K. (2000), ‘The invisible hand and the evolution of the monetary system’ in What is Money?

(Smithin ed.) Abingdon: Routledge p139-141.

Henry, J. (2004), ‘The Social Origins of Money’ in Credit and State Theories of Money.

Cheltenham: Edward Elgar.

Innes, A. M. (1913), ‘What is money?’ Banking Law Journal, May, 377-408

Innes, A. M. (1914), ‘The credit theory of money’, Banking Law Journal, January, 151-168 Keynes, J. M. (1930), A Treatise on Money. New York York: Harcourt and Brace.

Knapp, G. F. (1924), The State Theory of Money. New York: Augustus M. Kelley (1973). Mosler, W (2012) Soft Currency Economics II. US Virgin Islands: Valance

Mosler, W (2014)‘Reader’s [Armstrong, Phil’s] note to Palley’, Available from Feb. 14.

Mosler, W (14, March 2015) personal correspondence by email as response to first draft of the paper, ‘Heterodox Views of Money and Modern Monetary Theory’.

Polanyi, K. (1944/1957) The Great Transformation. Boston MA: The Beacon Press. Wray, L. R. (1998), Understanding Modern Money. Cheltenham: Edward Elgar.

Wray, L. R. (2004), Credit and State Theories of Money. Cheltenham: Edward Elgar. Wray, L. R. (2012), Modern Monetary Theory. Basingstoke: Palgrave Macmillan

Phil Armstrong has a BSc from the University of Hull and an MA in economics from the University of Leeds. He has taught economics and business for more than 30 years, and currently teaches at York College, UK. He has a strong interest in post- Keynesian economics, particularly MMT, is a committee member of the Association for Heterodox Economics, and believes in the critical importance of economic pluralism

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