Sunday, 30 June 2013

Money as Credit

The relationship between money and macroeconomics is very strange. At one time money was thought to be central to the discipline - advanced courses in macroeconomics were often called monetary economics. We had monetarism. Then gradually money slowly faded away. We had real business cycle models that were just real, and if we wanted to make them nominal you just added money as a ‘medium of exchange’. Then even Keynesian models with sticky prices began to dispense with money altogether, becoming cashless. Money seemed both essential - for example to the concept of inflation and to why Says Law did not hold - but also dispensable.

These thoughts followed from reading a book called ‘Money: The Unauthorised Biography’ by Felix Martin. 

The first thing to say is that this book is a great read, and one that I think non-economists will find completely accessible. Much of the book, as you would expect from the title, involves a historical discussion of how money evolved, was developed and was understood in particular societies at different times. Some of this I was familiar with - like the stones of Yap - but a great deal was new to me. But this is a biography with a message. Money is not fundamentally a commodity medium of exchange that made exchange more efficient compared to barter, but a particular form of credit, a system of clearing accounts (transferable credit). Yet, Martin argues, the dominant view since Adam Smith has been of money as a commodity medium of exchange, and this has enabled macroeconomics to largely ignore financial crises, until they actually happen. Here is a passage:

“From the moneyless economics of the classical school there evolved modern, orthodox macroeconomics: the science of monetary society taught in universities and deployed in central banks. From the practitioners’ economics of Bagehot, meanwhile, there evolved the academic discipline of finance - the tools of the trade taught in business schools, used by bankers and bond traders. One was an intellectual framework for understanding the economy without money, banks and finance. The other was a framework for understanding money, banks, and finance, without the rest of the economy. The result of this intellectual apartheid was that when in 2008 a crisis in the financial sector caused the biggest macroeconomic crash in history, and when the economy failed to recover afterwards because the banking sector was broken, neither modern macroeconomics nor modern finance could make head or tail of it.”

Some of this will be familiar, although what was new for me (but perhaps not to followers of Minsky or MMT- and quite challenging - was the idea that this could all be traced back historically to a misconceived view of money itself. (According to Martin, the 17th century philosopher John Locke has a lot to answer for.) The threads developed from the historical account of the origins of money are numerous. For example money as credit is inevitably social, and so its value is bound to be politically determined. In a financial crisis, when the size of debts begin to encumber the economy, it is therefore quite logical and natural to adjust the value of money to redistribute between creditors and debtors.

So this is a big ideas, big picture kind of book. Inevitably, therefore, some of the brushstrokes may be a little too broad or bold for some. The story of macroeconomics as essentially classical and real with only a brief incursion by Keynes is I think too simple and easy, and I would have liked to know his take on the explosion of macro work on financial frictions since the crisis. But the historical detail is fascinating, and the ideas they are used to illustrate are clear and thought provoking, so I’m very glad I read it.


  1. I think this is mostly nonsense,

    "Yet, Martin argues, the dominant view since Adam Smith has been of money as a commodity medium of exchange, and this has enabled macroeconomics to largely ignore financial crises, until they actually happen."

    Economists have developed various monetary theories of the business cycle, even those who believe that the main function of money is as a common medium of exchange -- just see the interwar business cycle literature, where these theories flourished.

    How does this book compare to Graeber's Debt?

    1. if it develops around the theme

      "... credit is inevitably social, and so its value is bound to be politically determined." and "... it is therefore quite logical and natural to adjust the value of money to redistribute between creditors and debtors"

      it must be pretty close to "Debt..."

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    1. Michael,

      Some of us have been saying this for quite a while, though until recently it was falling on deaf ears.

      If you look at the UK's banks, all five of our biggest lenders were badly damaged in the financial crisis and its aftermath. RBS and LLoyds were partly nationalised, and both embarked on major balance sheet clean-up and business restructuring which has taken years and cost a shocking amount of money. But it is less widely known that HSBC is now in the third year of a major restructuring programme in which it is shedding thousands of jobs, and Barclays is also undergoing major restructuring following the Libor scandal that cost Diamond his job. The building society sector was also badly damaged in the financial crisis: Nationwide swallowed three failing building societies early in 2009 and suffered a massive case of indigestion, and we now know the Co-Op's acquisition of Britannia nearly killed it.

      All five of the big lenders plus the Co-Op have divided their balance sheets into "core" and "non-core" sections, with "non-core" containing large amounts of non-performing and impaired loans that are gradually being wound down. All of the big lenders except Nationwide are shrinking their balance sheets, selling off some of their business lines, withdrawing from overseas activities and reducing their investment banking activity. All of them INCLUDING Nationwide (even though it is a mutual) are desperately trying to increase their capital levels and improve their loan to deposit ratios. How can a banking sector as badly damaged as this possibly support the economy?

      The extraordinary thing to me is that people apparently believed that these banks could and should lend normally despite the mess they were in, so economic policy thus far has largely relied on them to reflate the economy. They aren't capable of doing that - hence the slump. We should bypass them as Delong suggested.

      The US is not quite so badly affected because its banking system is disintermediated, so Fed policy can influence corporations and households directly rather than relying on banks for transmission. However, the collapse of private-label MBS issuance and shortage of collateral in the shadow banking system have slowed the US recovery, I would say. And of course the damage to the US's small banks was horrible - hundreds were still failing three years after the crisis. Among other things, that will have slowed recovery of the US's housing market. I think one of the main drivers of the present housing market recovery is probably the Fed's purchases of agency MBS.

  3. Excellent run down on money and debt as a short series of animated videos here

  4. It good to see the endogenous approach to money getting some leverage in the academic community - however this community has some reposnsibility to teach it. This approach has not appeared in any as far as I know widely used undergraduate textbook since WWII. This dichotomy between theories of the real economy and finance is poisoness to economics. Woodford for example deals in a pure moneyless economy in a scenario that could have been written by Wicksell. The classical dichotomy even effects DGSE leaving it unable to explain the causes of credit crises see here

  5. "moneyless economics of the classical school"

    Surely one glaring omission? I seem to remember one weighty volume from a classical economist which opens with an exhaustive discussion of money and then proceeds to relate this the 'real economy'.

    It's called Capital.

  6. I assume he made no mention of Robert Shiller picking the housing bubbles in 2003, and writing in Irrational Exuberance (2nd edition, May 2005) that the 1997 US housing bubble, which he called 'the rocket' - what comes up must come down - started in London in 1996?

    Certainly the overwhelmingly number of economists' dogs did not bark, but Shiller, Krugman, and Stiglitz were there by 2005.

    And Woodford's model is understanding money in an environment where you cannot define money.

    Not that this stops the BBC saying weekly that the UK has "run out of money"!

  7. Did he suggest how much of this 'misconceived view of money' on Locke's part was intentional?

    It seems likely (ok, essentially certain to me) that today the 'misunderstanding' is less a misunderstanding and more an intentional exploitation of the fact that money is political.

    Innes has good essays on the Credit Theory of money circa 1913:

  8. "Money is not fundamentally a commodity medium of exchange that made exchange more efficient compared to barter, but a particular form of credit, a system of clearing accounts (transferable credit). Yet, Martin argues, the dominant view since Adam Smith has been of money as a commodity medium of exchange..."

    I suppose that this statement only makes sense if the word credit is redefined. A gold coin, once issued, is not the liability of its original issuer --- so how can it function as credit? A credit is by definition always matched with a debit, a counterpoint that neither gold coins, cigarette money, nor wampum possess.

    1. The idea is that gold coins, cigarettes, dollars, etc are all just numerically quantifyable tokens for accounting of credit-debt relations.

      But once the token circulates, it gains a value of its own due to its acceptance as a medium of exchange.

      But the credit-debt relations come first. Even chimps display this kind of 'you owe me' relationship in their social behaviour.

  9. (1) @JP Wampums did originally not function as money, they were ritual items, something like our wedding rings or the english crown jewels or olympic medals, i.e. bound to situations and persons. Only when the white settlers ran out of cash and wampums were accepted as a means to pay taxes they started to be used as money (oops - a means to settle tax debts...).

    (2) The way central banks actually measure money is of course entirely consistent with the 'credit money' approach, you might want to read the ECB manual about this (not the most exiting read - but economists really have to spend more time on how stuff is actually measured...): Let me state this somewhat stronger: anybody who calls himself a monetary economists should be aquintanced with the way central banks measure money. Scientists know how the stuff they talk about is measured.

    Again: the approach sketched above is 100% consistent with monetary statistics, the 'laughable funds' theory of money isn't. The ECB manual is by the way consistent with the balances and income and spending statements of the national accounts - we do already have a stock flow consistent monetary model of the real economy (and the ECb manual indeed contains a 'formula of everything' which connects the financial accounts (money, debts) with the national accounts (via the current account).

    (3) Paper money is of course a liability of the issuer - the ECB is bound to exchange paper money for bank money at a 1:1 rate! These are really two different kinds of money, though both are nominated in Euro.

    (4) About gold/silver coins and debts (do these still exist as functioning money...?) - it might be interesting to read a little bit about the history of the Amsterdam exchange bank: Gold and silver served to quite some extent as collateral for virtual money, not as means of exchange. Anyway - google 'bills of exchange' and the meaning of 'debt as money'becomes abundantly clear: John accepted Mary's written promise to pay Peter as a payment from Peter and John used this promise to pay Elisabeth:‎

    Merijn Knibbe

  10. JP, first money can be both credit and a commodity. However, you raise an interesting example with the gold coin. I suspect if the coin is issued as a national currency it likely would remain the liability of the issuing Central Bank as well as retain its commodity value as gold. So a gold coin issued as one US Dollar would be a liability of the Fed.

    We are accustomed to think about debt from the perspective of the debtor, as an IOU. However, money is a credit from the perspective of the creditor. Having a dollar is a U Owe Me.

    If I go to the corner store without money and walk out with milk having only left an obligation to pay next time I come to the store, I have just created money, I have an IOU, and the store has a U Owe Me. It's hard to imagine that this type of transaction didn't precede the use of gold coins (historically) it's hard to imagine money as anything but credit once you read some of the treatises on money as credit.

    In fact gold almost certainly solves quite a different problem than the one proposed by the barter theory. Gold is mostly useful when the enforcement mechanism for credit breaks down. Force/enforcement is required to make sure credit owed is paid. What happens when there is not an easy enforcement mechanism? Use gold, as a record of the credit. If the debt is NOT paid, at least the creditor has the gold which is highly likely to be accepted by another party for similar reasons. This is particularly useful in international transactions and during periods of unstable governments.

  11. Geoffrey Ingham's "The Nature of Money" (2004} is a good source for the theory and its history, and a strong argument for the historical primacy of state-created "fiat" money.

    “Money is uniquely specified as a measure of abstract value [e.g., Keynes' "money of account"]… All money is constituted by credit-debt relations--that is, social relations. The holder of money is owed goods; money is a claim on the social product.”

    “Money cannot be created without the simultaneous creation of debt.”

    A central point in Ingham's argument is that money and the tokens representing it (i.e., currencies) are different things, and conflating them is a category error.

    Also, Robert Kuttner's review of Graeber's "Debt: The First 5000 Years" in the NY Rev. of Books (Ma7 9, 2013) is really good. Here's a quote:

    "Despite extensive scholarly efforts to find an example, Graeber reports, there is no historical evidence of an actual primitive economy that ran on barter. Why is he making this point? In fact, two thousand years before kings began minting coins, there was credit. Before paper, accounts were kept on clay tablets. Landowners gave peasants provisions on promise of repayment. And where there is credit, there is of course debt. What appears to be a random excursion sets up a central discussion about debt and reciprocal obligation."

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  13. Professor Simon Wren-Lewis, I read some of Felix Martin's recent book, and I couldn't help but get the vibe that he may have unwittingly revived the Real Bills Doctrine. While the term itself doesn't appear in the book's index, I couldn't help but get that feeling. For those who are unaware of what the Real Bills Doctrine is, please see this link to a collection of papers by Michael N. Sproul.

    Also, people may wish to read this 1993 History of Economics Review article by Gillian Hewitson, which explores the intellectual history of what Post-Keynesian economists call "Endogenous Money" and implicity alludes to the RBD. Thomas Tooke is one figure cited by the Post-Keynesian economists as a forerunner of "Endogenous Money", and is historically connected to the RBD, and Hewitson refers to Tooke and the RBD in the article. (I thank J.P. Koning for pointing this article out to people on the blogosphere.)

  14. Hello sir,
    I liked your article about economics. Great post and informative for us.

  15. hi
    i think it helps a lot in relationship between money and macroeconomics.

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  17. A central point in Ingram's argument is that money and the tokens representing it (i.e., currencies) are different things, and conflating them is a category error.


  18. Money is the credit and flow coming from sovereigns. Money is coined by the policies of those sovereigns and is experienced and used in the schemes provided by the prevailing economic leaders.

    Under the final phase of liberalism, defined as freedom from the state, the democracies of the world and the speculative leveraged investment community set persons free to be investors, according to their use of credit and their risk profile to invest in fiat investments, that is in real estate, equities and credit. All had identity and experience in the Milton Friedman Free to Choose architecture of floating currencies; fiat money ruled in liberalism.

    The price of money is determined by trust in the ability of the sovereigns to provide economic gain.

    Now with the failure of Major Currencies, DBA, such as the Australian Dollar, FXA, and the British Pound Sterling, FXB, and the Emerging Market Currencies, CEW, such as the Indian Rupee, ICN, sinking in value, a new trust must, and will emerge.

    New trust is already emerging; it is trust in the ability of regional sovereigns to provide economic security, stability, and sustainability; the diktat of the Troika in Greece is an example. The new money is diktat money.

    Leaders will meet in summits to renounce national sovereignty, and to announce regional pooled sovereignty and regional framework agreements, which will be the constitution of economic experience. Diktat money rules in authoritarianism.

    New sovereigns, that is regional leaders, will provide fascist mandates for people’s trust and thus regional fascism will rise to replace crony capitalism, European Socialism, Greek Socialism, and Chinese Communism.

    All will have identity and experience in the required to comply architecture of diktat money.

    The chart of the Bear Market ETF, HDGE, shows that it entered an Elliott Wave 3 Up on April 23,204; the bear market of a lifetime is underway on the failure of credit in the Eurozone and in China.

    A portfolio of Inverse Market ETFs could serve as collateral; this might include STPP, XVZ, JGBS, GLD, PPLT, PALL, EUO, YCS, SAGG, DTYS, DNO, as well as HDGE, SBB, SBM, DDG, EFZ, YXI, SZK, SDP, KRS, REK.

    One could sell a number of stocks short, such as the consumer staple stock Revlon, REV, which manifested an evening star candlestick in its chart pattern.

    The problem with short selling is that all it produces is fiat money, which will forever be trading lower in value, and which will be increasingly worthless as confidence grows in diktat money.

    Gold is both a commodity and a currency; it is the safe haven which bound higher and higher as investors derisk out of fiat investments.

    One should not be invested in paper gold, such as the Gold ETF, GLD. One should take possession of the genuine article, that is gold bullion, as it will be trading awesomely higher, as in the age of the failure of credit, it and diktat of regional sovereigns, are the only two forms of sustainable economic activity.

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