The Origins of Money and Some Philosophy of History

In the last post I told a little story about the origins of money. It was what Gregory Mankiw might call ‘an extreme and stylized presentation’ (i.e., I completely made it up). But I don’t think it’s actually that far off the reality. See this article.

There is a different story about the origins of money, in which the state doesn’t play a central role. This is the story told in most economics textbooks (and, of course, in Adam Smith’s Wealth of Nations). On this story, money arose naturally out of the barter societies that predated the development of money. People started off swapping actual goods (for mutual gain). But for various reasons they found it inconvenient to always swap actual goods. So they started using tokens – money – to stand for certain quantities of goods, to be later provided in exchange for the tokens.

Archaeologists and historians have long argued that the myth of barter is nonsense. There never was any pre-monetary barter society, and so we need a different account of the origins of money. See here. David Graeber skewers the myth of barter in a chapter of his book Debt: The First 5000 Years. But the Austrian economist Robert Murphy (on the basis of an interview; Murphy didn’t read Graeber’s book) takes issue with Graeber’s inference from the complete lack of evidence that barter societies ever existed to the conclusion that they did not, in fact, exist. He argues as follows:

At least in the [Von] Misesian exposition, the original state of pure, direct exchange — where people just exchanged in order to obtain goods that they directly valued — would last very briefly. The advantages of indirect exchange, where people acquired some goods intending to trade them away again in the future, were so obvious and great that the practice would have begun almost immediately. . . . I don’t recall Menger or Mises ever giving a guess as to how long this transition would take, but it’s not fatal to their theory if anthropologists only have evidence of markets based on money (as opposed to markets based on direct exchange, or what the layperson means by “barter”).

If you’re going to assert a historical fact that you have no intention of supporting on evidence, it had better be one that by definition will not, or at least might not, leave any visible trace of itself. Still, we should be fair to Murphy. The philosopher of history William Dray made a famous distinction between ‘how-possibly’ explanations and ‘why-necessary’ explanations. Where historical records don’t tell us much – as, for instance, when evolutionary biologists attempt to discover how a particular trait was ‘selected’ – ‘how-possibly’ explanations will often be the best we can provide. For example, one possible way in which an animal might come to have luminous skin is that this attracts potential mates, so that the creatures with less luminous skin are less successful breeders and are gradually eliminated from the gene pool. This isn’t a ‘why-necessary’ explanation, since it’s also possible that the luminous skin is favourably preserved on account of some other advantage that it provides, or perhaps is just genetically linked to some other advantageous trait. But it seems decent scientific practice to provisionally accept what is clearly the best available ‘how-possibly’ explanation until a better one comes along.

Murphy’s claim seems to be that Menger and Von Mises provide the best ‘how-possibly’ explanation for the origins of money. Obviously I disagree. I think chartalism – the idea that the state turns intrinsically worthless things into media of exchange by forcing people to acquire them for coerced tax-payments – is better. But I think it is common among economists to place an extra restriction on the explanandum of the origins of money: the challenge is to explain how money evolved through voluntary interactions among free individuals. This last restriction is generally respected in economics as a non-negotiable condition of economic explanation. Economic explanations, many economists still think, are models in which familiar macro-level outcomes are generated from micro-level voluntary transactions among individual agents. Bringing in institutional features such as facts about power imbalances is cheating in an economic explanation: do that and you’re no longer doing economics.

There is some merit to this approach. If you’re asked in an economics exam why, ceteris paribus, the price of a commodity goes up when supply is restricted, you’re not allowed to answer: ‘Because a secret cartel of suppliers collude to control prices in such a way as to fool economists into believing in the law of supply and demand’, even though the case, as described, could possibly be explained that way. Out of Murphy’s spiritual ancestors, Carl Menger in particular made some complicated noises about economic phenomena calling for specifically economic explanations. But he didn’t say enough to make it clear why the origin of money should be taken as an economic phenomenon.

I suspect one reason he would want to take it as such is that if the origin of money isn’t an economic phenomenon then almost nothing else is either. After all, as I’ve tried so hard to argue, if money – the basis of almost all exchange in modern society – has its value underwritten by the state’s monopoly on power, then almost no exchanges can be understood merely as the outcome of individual voluntary choice. Whether it wants to or not, the state, in partnership with the banks, controls the quantity, the price, and the distribution of money: and all of this obviously constrains the exchange possibilities open to the individual. Free markets cannot exist, for the simple reason that nobody is free when the state and the banks control the price, quantity, and distribution of the medium of exchange.

It is obvious, then, why Menger and Mises should want it to be the case that money doesn’t, at least doesn’t always, originate through the imposition of state power. They would love it if there were some kind of naturally evolving, organic money. For then all the things they like to talk about – all the economic phenomena calling for economic explanations – free markets, voluntary exchange, and all the rest of it – could exist in the real world.

But can this be the case? Can their story about the origins of money compete with the chartalist story? Really, I think it can’t. First, as I said, the problem is not simply, as Murphy alleges, that there is no archeological evidence for the myth of barter. It’s much worse: there is archeological evidence in favour of the chartalist alternative. Michael Hudson’s work (his paper is the first link in this post) has established at least that much.

Secondly I don’t think the myth of barter even works as a how-possibly explanation. Think about the transition from a barter society to a monetary one. Why would the very first seller, offered a mere token instead of real goods, accept it as payment? We might reply, because the buyer would assure her that she could later exchange it for his goods, once he has them ready. But then the token is just an IOU: the buyer may as well destroy it once he’s held up his side of the exchange bargain. How does money become a permanent, circulating medium of exchange? If we stick with voluntary exchanges, this can only happen, I think, if everybody comes to expect that money will be accepted as payment by somebody else. But somebody else will only accept it as payment if he has the same expectation. This expectation is reasonable enough if there is already a convention in place, to the effect that money is to be the medium of exchange. What David Hume said of promises, his friend Adam Smith ought to have said of money: it is ‘not intelligible naturally, nor antecedent to human conventions’ (Treatise of Human Nature, 3.2.5). Thus in explaining the origin of money, we are trying to explain how a convention came to be established. Our explanation is no good if it requires the supposition that the convention already exists. The myth of barter doesn’t even work as a how-possibly explanation.

One way of putting the problem is to say that the myth of barter can’t explain where the demand for money comes from. It is meant to come from the expectation that money can be accepted as payment for real goods. And yet the only thing that could ground that expectation would be the demand for money itself. The myth of barter provides no way out of the circle. But chartalism does. On the chartalist story, the demand for money does not organically evolve. It is imposed upon the people by the state, which compels payment in money on pain of coercive sanctions. Mosler likes to tell a story of a British colony in Africa, where the native population refused to accept or use British money until the colonists imposed a ‘hut tax’ upon them, payable only in British pounds.

If the chartalist story is right – and I think it is – then the spectre of state coercion haunts every transaction in the economy. There is no such thing as a truly free market and no such thing as a purely voluntary exchange. If this means that there is nothing left for economics to explain, then so much the worse for economics.

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9 thoughts on “The Origins of Money and Some Philosophy of History

  1. Pingback: I Do More Bash Of Libertarians and Peter Schiff | Origin of Specious

  2. man-et-arms

    I would like to understand how you explain the use of cigarettes as currency in prisons.

    ” Why would the very first seller, offered a mere token instead of real goods, accept it as payment?”
    maybe because it wasn’t just a token, but because it had *actual* value. Rice, salt, gold, silver actually have real value to people, aside from it’s value as a media of exchange.

    Reply
    1. axdouglas Post author

      There are no ATMs in prison. The only way to draw money out of your bank account is to buy cigarettes by direct debit. Other prisoners accept the cigarettes as payment because they know they’re worth money; if you give me a pack of cigarettes that I otherwise would have spent £7 on, you’ve effectively given me £7. But only because a monetary system is already in place.

      All commodities have real value to people. Real value therefore doesn’t help to explain why any *one* commodity should become the medium of exchange. And even if it did, this would fail to explain why the decision of governments to stop redeeming currency for gold, or something else perceived to have ‘real value’, doesn’t break the whole monetary system. When Britain came off gold in 1931, the pound fell by about a quarter of its value, but that was all.

      Reply
      1. man-et-arms

        “Other prisoners accept the cigarettes as payment because they know they’re worth money; if you give me a pack of cigarettes that I otherwise would have spent £7 on, you’ve effectively given me £7.” -> and how have inmates converged to cigarettes as a medium of exchange, without a central authority to impose it?

        “All commodities have real value to people. Real value therefore doesn’t help to explain why any *one* commodity should become the medium of exchange.” -> yes, but some commodities are valuable to virtually all people. a piece of gold or silver, a sack of rice or salt, all are valuable to most people most of the time because of the own utility. they become the medium of exchange precisely because they are so useful.

        “And even if it did, this would fail to explain why the decision of governments to stop redeeming currency for gold, or something else perceived to have ‘real value’, doesn’t break the whole monetary system.” -> because the government forces the acceptance of the currency it issues within its territory. as you have said, this makes those valueless paper sheets valuable because everyone will accept them as a means of exchange. but it’s not the only way a currency may come into existence. and surely it doesn’t seem the best, given there are non-coercive ways of doing the same thing.

      2. axdouglas Post author

        It depends on the prison. Most prisoners aren’t cut off from the existing monetary system. They can buy things by debiting their bank accounts; they can earn (small amounts) of money by doing jobs. They don’t have access to cash, so they use something with a readily denominated money price. They haven’t invented a new currency; they’re just using something accessible as a proxy for existing currency. It’s no more mysterious than casinos using chips to stand for specific amounts of money.

        You’re assuming that money emerged out of a barter system. I see no grounds for the assumption. There’s no historical evidence that barter systems predating money ever existed. Moreover, if I go to somebody in a barter society with a sack of rice, wanting to exchange it for something she has, there’s no guarantee she’ll want my rice. If she’s already stocked up with more rice than she needs, she won’t accept the trade. She’ll ask me to offer something else. Of course if her intention is to keep the rice in order to use it to purchase what she *does* want from somebody else, then the rice is already money. But we’re trying to explain how something becomes money; it’s circular to do so by assuming that it already is. And it’s no use to say that the thing in question is pretty generally desirable. That doesn’t tell us why, out of all the roughly equally desirable things, that one became the single universally accepted means of settling payments – something that people will accept even if they have no use for it, because they’re confident that it will be accepted by others as payment for what they do need.

        Anyway some of the things on your list aren’t especially useful at all. Gold is too soft for any useful purpose. It looks nice around your neck, but so do lots of things.

  3. man-et-arms

    “It depends on the prison. Most prisoners aren’t cut off from the existing monetary system. They can buy things by debiting their bank accounts; they can earn (small amounts) of money by doing jobs. They don’t have access to cash, so they use something with a readily denominated money price. They haven’t invented a new currency; they’re just using something accessible as a proxy for existing currency. It’s no more mysterious than casinos using chips to stand for specific amounts of money.”

    my question is simply: how have they coordinated in order to use cigarettes, and *not* anything else, without a centralized institution to impose it? if people can coordinate thus in such setting, why couldn’t they do it in any other setting – including when there was no other currencies?

    “Moreover, if I go to somebody in a barter society with a sack of rice, wanting to exchange it for something she has, there’s no guarantee she’ll want my rice. If she’s already stocked up with more rice than she needs, she won’t accept the trade. She’ll ask me to offer something else.”

    not necessarily, she may want to store even more than what she needs, to save for future use.

    “Of course if her intention is to keep the rice in order to use it to purchase what she *does* want from somebody else, then the rice is already money. But we’re trying to explain how something becomes money; it’s circular to do so by assuming that it already is.”

    but it’s in this precise moment – when people realize their stock of rice can be traded further – that rice becomes money. the origin of money is related to the concept of time preference and saving vs consumption.

    “And it’s no use to say that the thing in question is pretty generally desirable. That doesn’t tell us why, out of all the roughly equally desirable things, that one became the single universally accepted means of settling payments – something that people will accept even if they have no use for it, because they’re confident that it will be accepted by others as payment for what they do need.”

    being generally desirable is only one of the necessary conditions. other characteristics will make for an incentive for those commodities to become money: ease of transport, easy divisibility, being uniform across large areas, etc.

    “Anyway some of the things on your list aren’t especially useful at all. Gold is too soft for any useful purpose. It looks nice around your neck, but so do lots of things.”

    shining under the sun is pretty attractive XD. but you’re right, probably gold wasn’t the first money, and came in to replace other exchange media, since it doesn’t corrode, is easily malleable and very rare, making for a very good currency commodity.

    Reply
    1. axdouglas Post author

      ‘probably gold wasn’t the first money, and came in to replace other exchange media, since it doesn’t corrode, is easily malleable and very rare, making for a very good currency commodity.’

      Why bother with these speculative narratives when the historical record tells a totally different story? I know those are the kinds of purely speculative exercises you get in economics textbooks. But read David Graeber or Michael Hudson – people who actually look at the historical record. There never was any barter society from which money emerged. We began with elaborate credit systems. Money evolved as a universally acceptable means of settling debts. This occurred, in almost every case, when a central authority incapable of producing anything of its own sought to provision itself, paying with its own credit notices. The only way its liabilities could be accepted as final settlements would be if it imposed liabilities upon others by force. These others would then want its credit notices as means of canceling out their own (imposed) liabilities, since one debt cancels another running in the opposite direction. This is per the story I told in the previous blog. Mine was a joke version, obviously, but the point is that this isn’t a ‘how-it-might-have-happened’ story; it’s a ‘how-it-did-happen’ story, at least as the evidence so far suggests.

      ‘the origin of money is related to the concept of time preference and saving vs consumption.’

      I think it’s related, rather, to the concepts of debt and settlement. If what you want is rice for the future, why bother accepting it as payment now and then paying the cost of storing it until you’re ready for it? Why not, instead, accept payment in the form of a credit notice promising the rice at a future date? Debt is, among other things, an instrument for trading over time preferences while avoiding storage costs. Money begins where credit notices of one debt are accepted as a means of settling other debts. This can happen without a central issuer. But the accounting value of the credit notice will be contingent on the solvency of the debtor – not always readily measurable. The only way to have credit notices with fixed accounting values is to have a perfectly solvent debtor, and only the issuer of the currency can be that.

      Reply
    2. axdouglas Post author

      As for your question: ‘If people can coordinate thus in such setting, why couldn’t they do it in any other setting. . .?’ As Hyman Minsky said, anyone can create money; the trick is to get it accepted. You’re welcome to pick some token and then try to convince everyone in your nation to accept it as currency. You might, in the process, learn why what works for a handful of prisoners doesn’t work on a bigger scale. Most likely scenario: people will just ignore your ‘currency’. Best-case scenario: people will buy it as an appreciating asset; its price will skyrocket and then crash, just like Bitcoin. Still not a real currency, unless it’s ok for a currency to work so that this year I have the equivalent of £100 in my bank account, next year it turns into £30,000, and the year after it’s down to £500. Not ideal when it comes to, say, planning my retirement.

      Reply
  4. Pingback: What My Students Taught Me About Capitalism | Origin of Specious

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