Money: The Unauthorized Biography
John Lunn is Professor of Economics at Hope College. The Extended Review is a new book review feature that on occasion will appear in future CSR issues. It will provide an extended review from a Christian perspective of a scholarly book intended for a wide audience.
The thesis of Felix Martin’s book is that money matters. But, it is more than that—what matters is the proper idea of money. Money has been misunderstood by most people throughout history, and this misunderstanding causes problems such as the financial crisis and recession that began in 2007. A proper understanding of money could lead to institutional changes in economies that could help generate, “…a just and prosperous society” (265). It is an interesting book and is worth reading. It is often entertaining, with a writing style that is not “academic,” but also not overly dramatic as some of the books about the recent financial crisis have been. Historical examples are used in an entertaining yet informative way, and there is sense of humor in much of the book, with chapters having titles such as “The Natural History of the Vampire Squid,” and “Money Through the Looking-Glass.”
The starting point in Martin’s thought is that money is not a “thing.” It is not currency, or precious metals, or anything else, and it never has been. Instead, money is credit (27). Or, more completely, money is, “a social technology composed of three fundamental elements” (27). The three elements are an abstract unit of account, a system of accounts that keep track of credit and debt balances as people engage in exchange, and that the debt obligations can be transferred to someone else to settle an unrelated debt. He adds, “The third element is vital. Whilst all money is credit, not all credit is money; and it is the possibility of transfer that makes the difference” (27).
Martin draws on interesting historical events that help to show that money is not a thing. In doing so, he uses the same approach as David Graeber in a recent book on debt.1 Both relate how economists often begin with a barter economy, show the inefficiencies of barter when the numbers get large, and say that people began using money as a medium of exchange. Graeber, an anthropologist, claims that there is no evidence that money began in any society in any time in history as an outgrowth of a barter economy. Both Martin and Graeber argue that debt preceded money. Martin used the example of the island of Yap, where money is represented by fei—large, stone wheels of various sizes. People would engage in transactions, keeping track of debits and credits, and transfer ownership of a fei only rarely when settling accounts.
Martin uses other historical examples to illustrate that money is not a thing. These include a period in Ireland when the banks were closed for an extended period and people used private transferable debt as money, the English use of wooden sticks to record tax payments and to settle debts with others, and a conclusion among Chinese philosophers in the fourth century BCE that money was a tool of the sovereign. Martin often stresses that money should be a tool of the sovereign.
Another theme involves the idea of money as a universal measure of economic value. Martin claims that the Ancient Greeks, when coinage initially developed, were the first to develop the idea of money as a universal measure of economic value. He notes that some Greek philosophers were troubled by this development, and worried that money would impact social life negatively. This concern periodically shows up in the history of money.
A sizeable portion of the book traces out the development of ideas concerning money from Ancient Greece to recent times, as well as relevant changes in European society and governance. Sovereigns in Europe usually took responsibility for minting coins used as money and made from precious metals such as gold and silver. But sovereigns also realized that this gave them the opportunity to control more resources for activities such as war by debasing the currency through either minting coins with less gold or silver than claimed, or by altering the coins through clipping or scrapings, subsequently minting new coins from these scrapings. The practice was unpopular with the public. Some intellectuals also took up the topic. Nicolas Oresme, for example, wrote a tract in which he argued that the sovereign should be responsible for minting coins, but should do so for the benefit of the subjects and not for his personal benefit. However, sovereigns tended to look for ways to obtain funds, and it was hard to stop them.
Meanwhile, large merchants gradually realized that they could avoid reliance on the possibly debased coins by relying on their own IOUs rather than the coin of the realm. The result was privately produced money over most of the European continent. Sovereigns were not pleased with this development. What Martin refers to as “The Great Monetary Settlement” involved turning the Bank of England, which was a private bank, into a bank that would reorganize the king’s debts. It would also provide loans to the king but was given the right to issue banknotes which would circulate as money. It was a deal between the sovereign and the “money interests,” as Martin calls the bankers and merchants. But many people, including some in Parliament, were suspicious of an arrangement that seemed designed to benefit the “money interests.” When John Locke argued against it, saying that money was gold or silver and had a certain value that should not be altered, “The Great Monetary Settlement” fell apart. Further, the classical economists, such as Adam Smith, accepted Locke’s arguments, thereby causing them to defend the wrong definition of money.
Other names that entered the fray include Walter Bagehot, who worked in the financial district of London, and whose book, Lombard Street, established the procedures that a central bank should follow in a financial crisis. In opposition to the classical economists, he knew money was not a thing. John Maynard Keynes accepted Bagehot’s approach and urged changes in monetary policy even before the Great Depression. Martin argues that economists still want to treat money as a thing with a fixed value, which leads to an emphasis on low and stable inflation as the proper policy goal. That emphasis proved to be too narrow in the years leading up to the financial crisis in 2007 and is partially to blame for the crisis and the recession that followed.
What is to be done? How would an alternate view of money generate a more secure system? Martin’s solution is not spelled out in detail, but a key to his thinking is that economic value cannot be seen as irrevocably fixed. That is, the sovereign may need to recalibrate the value of money to change the financial risks in society. In particular, he advocates that governments should inflate more in order to help people in debt. He offers three changes that need to take place: (1) a closer match between the costs and benefits that bankers, firms, and taxpayers bear when it comes to financial risk; (2) that the political powers should be able to alter the monetary standard; and (3) the reform of banks to simplify the regulatory process.
Before discussing his arguments, I want to point out that the biography of money leaves out some important events. Inflation is hardly mentioned. The hyperinflation of Germany after World War I and the relatively high inflation rates of the U.S. in the 1970s are not discussed. The latter caused a breakdown of the banking and financial system that had lasted for decades. Relatively stable prices enhance the exchange process. Inflation retards the effectiveness of market exchange and imposes real costs on people. In a market system, prices and price changes are signals to market participants and encourage both buyers and sellers to change their behavior. But, when the inflation rate is increasing, people do not know how to interpret a price change for a particular good. Is the change due to inflation or because either demand or supply of the good has changed? People begin spending time and resources on protecting themselves against unexpected price changes. Martin focuses so much on the unit-of-account function of money that he pays scant attention to the medium-of-exchange function of money. Even if Martin and Graeber are correct and money did not appear in response to the high transaction costs of barter exchange, a modern economy is characterized by market exchange. Money’s role as a medium of exchange is crucial in modern market economies.
There are several steps in Martin’s argument. He claims that people, including many economists, misunderstood the nature of money. This misunderstanding affected how central banks, governments, banks, and other institutions operate, making the financial system unstable. He believes that the change in perspective would allow a different outcome.
Martin argues that the change in perception he advocates can lead to a more just society. He begins with sovereign money—money issued by the government. “So long as citizens permit the sovereign a discretionary power to recalibrate the financial distribution of risks by adjusting the monetary standard when it becomes unfair, sovereign money can work” (249). In his view, the physical concept of money cannot be allowed to force the government to maintain a constant standard of monetary value. Instead, the government must be responsive to the demands of democratic politics. As part of this, central banks should not be independent. Further, their goal should be to promote a just and prosperous society.
Next the banking system needs to be reformed. Here he mentions some form of “limited purpose banking,” as suggested by Larry Kotlikoff,2 or a suggestion of Irving Fisher during the Great Depression of requiring 100 percent reserves protecting deposits in banks. In either case, a goal would be to create a system in which risks taken on by financial institutions are not backstopped by taxpayers.
In the end, Martin’s analysis and policy recommendations are not adequate. First, monetary policy is a very blunt instrument to use to try to achieve a more just society. Martin writes, “Spending public money to protect bank bondholders has become an issue of rich versus poor” (232-233). I agree. But, spending public money to protect bank bondholders has to do with the financial system, not monetary policy. Inflation helps net monetary debtors and harms net monetary creditors. Not all creditors are wealthy financiers. Many retirees count on interest from bonds or CDs to help them. Further, for inflation to have the effect of helping net monetary debtors, it must be unanticipated by people, or else the interest rates would have adjusted to account for the expected increase in prices. That is, the policy Martin is advocating requires the money creator to fool people intentionally on a regular basis.
As far as the rest of Martin’s story goes, I think he has overstated his case. First, modern economists do not have the “conventional view of money” that Martin says they have. While there are some politicians who advocate going back to a gold standard, I know of very few economists who make that argument. Exchange today is marked by computer entries of debits and credits more than by handing currency over to a sales clerk. We have a fiat money system. It was not the idea of money held by economists that caused the recent financial crisis and recession; instead, it was a number of factors that involved the government in many ways, as recounted in some recent books.
Martin’s account of the financial crisis is short and not very illuminating. There have been recent books that offer a much better analysis. In particular, Charles Calomiris and Stephen Haber offer an illuminating analysis in Fragile by Design.3 They note that the United States has experienced fourteen banking crises over the last 180 years while Canada experienced two—in 1837 and 1839. Why is the Canadian system so stable and the American system so unstable? Calomiris and Haber argue that the institutional development of the two banking systems differed for historical reasons. In their analysis, they examine the history of banking systems in six nations, including the U.S. and Canada.
Calomiris and Haber claim that the nation-state and chartered banks arose at the same time in Europe, and that this was no coincidence. The emerging nation-states created chartered banks to aid in the government’s financing. As noted before, sovereigns historically have sought for ways to improve their finances. The banks received some privileges from the state, often including the ability to create monetary claims. The nature of a country’s banking system comes out of the arrangements made between the government and the banks. The historical development of the banking system in the United States responded to a different set of interest groups than was true in Canada when their banking system arose.
Reform of the American banking and financial systems is a good idea. The key questions have to do with the nature of the reforms and how they will be brought into fruition. Martin wants the political process to control the monetary system more directly. But, as Calomiris and Haber have shown, the system we have came out of political processes. The arguments they offer and the suggestions they make for reform make more sense and are more clearly articulated than those of Martin. Another excellent source for information on subprime mortgages, the shadow banking system, and how there was a run on the shadow banking system is Gary Gorton.4 Calomiris, Haber and Gorton are knowledgeable about banking history and the history of regulation.5
The issue is the banking system and not the definition of money. Martin’s call for a more political response ignores the point made by Calomiris and Haber—the banking system we have is the result of the political process. Since the rise of the nation-state and the state-chartered banks, the banking system has been inevitably the outcome of political coalitions influencing government policy. Historically, sovereigns have manipulated money for their own purposes. Democratic processes are an improvement over the divine right of kings, but the people in the Senate and the House of Representatives want to be re-elected, and would likely be willing to manipulate the money system to achieve their goals. As I noted earlier, monetary policy is too blunt of an instrument to be used by the government to create a more just society. Inflation may help net monetary debtors but harms many people who are on relatively fixed incomes. Keeping central banks independent is needed to reduce the likelihood the government will use inflation as a “hidden” tax.
Martin’s book can lead to some interesting discussions concerning monetary policy, the banking and financial system, and ways we can make our system more stable. However, the focus of such discussions should be on improving the stability and transparency of the banking and financial systems. The details are in the institutional arrangements that develop and evolve out of our political processes. Several of the books I referenced above have more to offer in reforming the financial system than Martin’s focus on money as debt. The devil is in the institutional details rather than the idea of money.
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Footnotes
- David Graeber, Debt: The First 5,000 Years (Brooklyn, NY: Melville House Publishing, 2011).
- Laurence J. Kotlikoff, Jimmy Stewart is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking (Hoboken, NJ: Wiley, 2010).
- Charles W. Calomiris and Stephen H. Haber, Fragile by Design: The Political Origins of Banking Crises & Scarce Credit (Princeton, NJ: Princeton University Press, 2014).
- Gary B. Gorton, Slapped by the Invisible Hand: The Panic of 2007 (Oxford: Oxford University Press, 2010); and Gary B. Gorton, Misunderstanding Financial Crises: Why We Don’t See Them Coming (Oxford: Oxford University Press, 2012).
- Two other recent books offer possible ways to reform the banking system. See James R. Barth, Gerard Caprio Jr., and Ross Levine, Guardians of Finance: Making Regulators Work for Us (Cambridge, MA: The MIT Press, 2012); and Anat Admati and Martin Hellwig, The Bankers’ New Clothes: What’s Wrong with Banking and What to Do about It (Princeton, NJ: Princeton University Press, 2013).
