Credit Theory of Money

From Debt, The First 5000 Years, David Graeber

Mitchell-Innes was an exponent of what came to be known as the Credit Theory of money [..] Credit Theorists insisted that money is not a commodity but an accounting tool . In other words, it is not a “thing” at all. You can no more touch a dollar or a deutschmark than you can touch an hour or a cubic centimeter [..]. The obvious next question is: If money is a just a yardstick, what then does it measure? The answer was simple: debt. A coin is, effec­tively, an IOU [short for I-Owe-You, meaning debt..].

Say, for example, that [an imaginery person] Joshua were to give his shoes to Henry, and, rather than Henry owing him a fa­vor, Henry promises him something of equivalent value. Henry gives Joshua an IOU. Joshua could wait for Henry to have something use­ful, and then redeem it. In that case Henry would rip up the IOU and the story would be over. But say Joshua were to pass the IOU on to a third party-Sheila-to whom he owes something else. He could tick it off against his debt to a fourth party, Lola-now Henry will owe that amount to her. Hence is money born [..].

What credit theorists like Mitchell-Innes were arguing is that even if Henry gave Joshua a gold coin instead of a piece of paper, the situ­ation would be essentially the same. A gold coin is a promise to pay something else of equivalent value to a gold coin. After all, a gold coin is not actually useful in itself. One only accepts it because one assumes other people will. In this sense, the value of a unit of currency is not the measure of the value of an object, but the measure of one’s trust in other human beings [..]

But systems like these cannot create a full-blown currency system, and there’s no evidence that they ever have. Providing a sufficient number of IOUs to allow everyone even in a medium-sized city to be able to carry out a significant portion of their daily transactions in such cur­rency would require millions of tokens. To be able to guarantee all of them, Henry would have to be al most unimaginably rich. All this would be much less of a problem, however, if Henry were, say, Henry II, King of England, Duke of Normandy, Lord of Ireland, and Count of Anjou.

According to Knapp, whether or not the actual, physical money stuff in circulation corresponds to this “imaginary money” is not par­ticularly important. It makes no real difference whether it’s pure sil­ver, debased silver, leather tokens, or dried cod-provided the state is willing to accept it in payment of taxes. Because whatever the state was willing to accept, for that reason, became currency [..].

Modern banknotes actually work on a similar principle, except in reverse. Recall here the little parable about Henry’s IOU. The reader might have noticed one puzzling aspect of the equation: the IOU can operate as money only as long as Henry never pays his debt. In fact this is precisely the logic on which the Bank of England-the first successful modern central bank-was originally founded.

In 1694, a consortium of English bankers made a loan of £1,2oo,ooo to the king. In return they received a royal monopoly on the issuance of banknotes. What this meant in practice was they had the right to advance IOUs for a portion of the money the king now owed them to any inhabitant of the kingdom willing to borrow from them, or willing to deposit their own money in the bank-in effect, to circulate or “monetize” the newly created royal debt. This was a great deal for the bankers (they got to charge the king 8 percent annual interest for the original loan and simultaneously charge interest on the same money to the clients who borrowed it), but it only worked as long as the original loan remained outstanding. To this day, this loan has never been paid back. It cannot be. If it ever were, the entire monetary system of Great Britain would cease to exist.

[On taxes]

Why did they make subjects pay taxes at all? This is not a question we’re used to asking [..].

Say a king wishes to support a stand­ing army of fifty thousand men. Under ancient or medieval conditions, feeding such a force was an enormous problem-unless they were on the march, one would need to employ almost as many men and ani­mals just to locate, acquire, and transport the necessary provisions . On the other hand, if one simply hands out coins to the soldiers and then demands that every family in the kingdom was obliged to pay one of those coins back to you, one would, in one blow, turn one’s entire national economy into a vast machine for the provisioning of soldiers, since now every family, in order to get their hands on the coins, must find some way to contribute to the general effort to provide soldiers with things they want. Markets are brought into existence as a side effect.