Despite monetary authorities’ many obvious practical and technical problems in conducting ‘monetary policy’ – essentially, attempting to control inflation – the long-run neutrality of money remains a core assumption of most mainstream economics. To believe otherwise – that money can be used as an independent creative force – is to suffer from the ‘money illusion’. As we shall see, the ‘illusion’ is to think that money has powers beyond its function as a simple instrument that only measures existing value and enables economic exchange. However, the centuries-old persistence and intensity of the unresolved disputes tells us that money is not merely this technical device to be managed by economic experts. Rather, it is also a source of social power to get things done (‘infrastructural power’) and to control people (‘despotic power’) (Ingham, 2004, 4). The ‘money question’ lies at the centre of all political struggles about the kind of society we want and how it might be achieved.
In the late nineteenth and early twentieth centuries, the longstanding intellectual, ideological, and political debates on money became embroiled in an acrimonious academic dispute about the most appropriate methods for the study of society, which ultimately led to the formation of the distinct disciplines of economics and sociology (Ingham, 2004). In 1878, exasperated by the endless wrangling, American economist Francis Amasa Walker decided on a deceptively simple solution (see Schumpeter, 1994 [1954], 1086): ‘money is what money does’, which he described in terms of four functions:
1 money of account/measure of value: a numerical measure of value and for economic calculation; pricing offers of goods and debt contracts; recording income and wealth;
2 a means of payment: for settling all debts that are denominated in the same money of account;
3 a medium of exchange: something that can be exchanged for all other commodities;
4 a store of value: a repository of purchasing and debt settling power, enabling deferment of consumption and investment or simply saving ‘for a rainy day’.
This list is still found almost without exception in today’s textbooks. Its longevity gives the impression that the money question has been settled, but this is far from the case. Although it is obvious that money does these things, matters are not quite as simple as Walker had hoped. His solution masked the difficulties and confusions that had caused his and many others’ exasperation. Schumpeter correctly saw that the main reason for the unresolved disagreements was that the commodity and claim (credit) theories of money, including their respective ‘real’ and ‘monetary’ analyses, were by their very nature ‘incompatible’ (Schumpeter, 1917, 649). We should add that he also saw that the two theories were often inconsistent and contradictory, obscuring their differences and making ‘views on money as difficult to describe as shifting clouds’ (Schumpeter, 1994 [1954], 289). These theories are examined in the following chapter; here we need only note the basic differences.
In the simplest terms, the main points of contention reflect two longstanding general intellectual positions: materialism and naturalism versus nominalism and social constructionism. On the one hand, did money, as a medium of exchange, originate in barter as the intrinsically valuable material commodity that could be exchanged for all others? For example, during the debate on the reform of the monetary system in the late nineteenth century, the US Monetary Commission in 1877 concluded that value ‘inheres in the quality of the material thing, and not in mental estimation’ (quoted in Carruthers and Babb, 1996, 550). The Commission favoured following the British ‘gold standard’, in which currency comprised the issue of gold coins, such as the £1 sovereign, and the promise that all paper notes with a face value of £1 were ‘convertible’: that is, exchangeable in an officially declared weight of gold. (Present-day British paper currency carries the anachronistic pledge ‘I promise to pay the bearer on demand the sum of [x] pounds’: that is, the sum in gold at a rate declared by the Bank of England; see chapter 4.) By the end of the nineteenth century, an increasing number of countries adopted the gold standard, which linked their currency’s exchange rates to the common standard and facilitated participation in the international trading system based in London.
On the other hand, a minority rejected the view of the US Commission and held that money was precisely a ‘mental estimation’: that is, a socially and politically constructed abstract value (Del Mar, 1901). Soon after, in a critique of the dominant materialist conception of commodity money at the zenith of the gold standard era, Alfred Mitchell Innes concurred, declaring that “[t]he eye has never seen, nor the hand touched a dollar. All that we can touch or see is a promise to pay or satisfy a debt due for an amount called a dollar [which is] intangible, immaterial, abstract” (Mitchell Innes, 1914, 358). The dollar debt was settled by a token credit: that is, a means of payment which constituted a claim on goods offered for sale in a dollar monetary system. The existence of a debt gives money its value. As Georg Simmel explained, around the same time, in his sociological classic The Philosophy of Money, ‘[M]oney is only a claim upon society … the owner of money possesses such a claim and by transferring it to whoever performs the service, he directs him to an anonymous producer who, on the basis of his membership of the community, offers the required service in exchange for the money’ (Simmel, 1978 [1907], 177–8).
Furthermore, ‘claim’ (or ‘credit’) theory and ‘commodity-exchange’ offered diametrically opposed analyses of banking. ‘Commodity-exchange’ theorists saw bankers as intermediaries collecting small pools of money from savers and lending it from the accumulated reservoirs to borrowers. Nothing was added to the supply of money; banks enabled it to be used more efficiently (see Schumpeter, 1994 [1954], 1110–17). However, it was obvious that something more mysterious was at work in banking. How could savers and borrowers still have use of the same fixed and finite quantity of money? As we will see in chapters 3 and 4, claim (or credit) theory was more closely associated with the view that ‘the banker is not so much primarily a middleman in the commodity “purchasing power” as a producer of this commodity’ (Schumpeter, 1934, 74, emphasis added). We shall see in chapter 4 that capitalist banking originated in early modern Europe and other commercially developed regions from use of ‘bills of exchange’ and other acknowledgements of debt (IOUs) issued by merchants as means of payment within their trading networks. Gradually, these evolved into interdependent banking giros: that is, networks in which the banks borrowed from each other and extended loans to clients – especially to the emerging states. Unlike money-lending, where loans depleted the stock of coined money, the bankers’ loans comprised newly created credit money based on trust and confidence in their business. A deposit would be created in the borrower’s account by a stroke of the banker’s pen from which the borrower could draw banknotes (IOUs) in payment to third parties. Their acceptance was based on the issuing bank’s promise to accept them in payment of any debt owed. In their double-entry bookkeeping, the loan (deposit in the borrower’s account) was the bank’s asset (debt owed by the borrower) balanced by the borrower’s liability (debt owed to the bank). Banks also borrowed from each other in the giro to balance their books. In this way, money could be produced by the expansion of debt and the promise of repayment as represented in double-entry bookkeeping, which, in turn, represents the social relation of credit and debt. In modern economics, this is referred to as ‘endogenous’ money creation as opposed to the ‘exogenous’ production of currency outside the market by governments and central banks.
Walker merely sidestepped the ‘incompatibility’ by smuggling