Credit Theory of Money - Scholarship

Scholarship

The earliest modern thinker to formulate a credit theory of money was Henry Dunning Macleod, with his work in the 19th century, most especially with his The Theory of Credit (1889). Macleod's work was expanded on by Alfred Mitchell-Innes in his papers What is Money? (1913) and The Credit Theory of Money (1914), where he argued against the then conventional view of money arising as a means to improve the practice of barter. In this alternative view, commerce and taxation created obligations between parties which were forms of credit and debt. Devices such as tally sticks were used to record these obligations and these then became negotiable instruments which could function as money. As Innes puts it in his 1914 article :

The Credit Theory is this: that a sale and purchase is the exchange of a commodity for credit. From this main theory springs the sub-theory that the value of credit or money does not depend on the value of any metal or metals, but on the right which the creditor acquires to "payment," that is to say, to satisfaction for the credit, and on the obligation of the debtor to "pay" his debt and conversely on the right of the debtor to release himself from his debt by the tender of an equivalent debt owed by the creditor, and the obligation of the creditor to accept this tender in satisfaction of his credit.

Innes goes on to note that a major problem in getting the public to understand the extent to which monetary systems are debt based is the challenge in persuading them that "things are not the way they seem"

In his 2011 book Debt: The First 5000 Years, the anthropologist David Graeber asserted that the best available evidence suggests the original monetary systems were debt based, and that most subsequent systems have been too. Exceptions where the relationship between money and debt was less clear occurred during periods where money has been backed by bullion, as happens with a gold standard. Graeber echoes earlier theorists such as Innes by saying that during these eras population perception was that money derived its value from the precious metals of which the coins were made, but that even in these periods money is more accurately understood as debt. Graeber states that the three main functions of money are to act as: a medium of exchange; a unit of account; and a store of value. Graeber writes that since Adam Smith's time, economists have tended to emphasise money as a medium of exchange. For Graeber, when money first appeared its primary purpose was to act as a unit of account, to denominate debt. He writes that coins were originally created as tokens which represented a unit of account rather than being an amount of precious metal which could be bartered.

Economics commentator Philip Coggan holds that the world's current monetary system became debt based after President Nixon suspended the link between money and gold in 1971. He writes that "Modern money is debt and debt is money". Since the 1971 Nixon Shock, debt creation and the creation of money has increasingly took place at once. This simultaneous creation of money and debt occurs as a feature of Fractional reserve banking. After a commercial bank approves a loan, it is able to create the corresponding amount of money, which is then acquired by the borrower along with a similar amount of debt. Coggan goes on to say that debtors often prefer debt based monetary systems such as Fiat money over commodity based systems like the gold standard, because the former tend to allow much higher volumes of money to circulate in the economy, and tend to be more expansive. This makes their debts easier to repay. Coggan refers to Bryan's 19th century Cross of Gold speech as one of the first great attempts to weaken the link between gold and money; he says the former US presidential candidate was trying to expand the monetary base in the interests of indebted farmers, who at the time were often being forced into bankruptcy. However Coggan also says that the excessive debt which can be built up under a debt based monetary system can end up hurting all sections of society, including debtors.

In a 2012 paper, economic theorist Perry Mehrling notes that what is commonly regarded as money can often be viewed as debt. He posits a hierarchy of assets with gold at the top, then currency, then deposits and then securities. The lower down the hierarchy, the easier it is to view the asset as reflecting someone else's debt.