Academic journal article The American Journal of Economics and Sociology

Debt as the Basis of Currency: The Monetary Economics of Trust

Academic journal article The American Journal of Economics and Sociology

Debt as the Basis of Currency: The Monetary Economics of Trust

Article excerpt


The Nineteenth Century Ideology

S. Herbert Frankel's excellent little book Money: Two Philosophies contains a chapter entitled "The Nineteenth Century Ideology," in which he argues that nineteenth-century thinkers understood that "borrowable money" (Walter Bagehot's phrase) emanated from an organic credit system. Rather than being constructed on some rational plan, such a system grew from individual relationships between and among many different lenders, borrowers, and guarantors. The success of such a system (Walter Bagehot argued) lay in the willingness of those possessing financial wealth to hold assets other than coin. That is, the system was successful because individuals possessing financial wealth were willing to entrust their money to those in need of liquid funds in exchange for promises to repay the loan principal plus interest in the future. For Bagehot (as for Frankel), trust lay at the center of England's financial system.

Bagehot wasn't alone in his view of the situation. As Frankel notes, continental writers also struck the theme. Prominent among them were Georg Simmel and Carl Menger. Simmel recognized the element of trust inherent not just in private lending but in a nation's money itself; he compared "money to a bill of exchange drawn on society on which the name of the drawee has not been filled in" (Frankel, 1977, p. 32). Menger, of course, is famous for his argument that money arose as "the unintended result, as the unplanned outcome of specifically individual efforts of members of a society" (1963, p. 155; quoted in Frankel, 1977, p. 32). In addition to these well-known contributors to monetary thought, Frankel also saw fit to comment on the ideas of a little-known Victorian writer, Henry Dunning Macleod, who went beyond the belief that a sophisticated monetary system must be based on trust to argue that money is credit, although of a more perfect sort than individual credit. It is with Macleod's theory of credit money, and a particular application of that theory, that we are concerned in this paper.

I have examined Macleod's credit theory of money elsewhere (Skaggs, 1997). Here I demonstrate the usefulness of Macleod's notion by examining his dictum that money must be based on debt, and hence on trust. When money is grounded in debt, and the institutional structure of the system generating and trading debt claims is sound, the monetary system should provide the greatest support for economic activity while generating the fewest problems. The following three sections briefly review Macleod's theory of money, examine Macleod's application of it to a particular errant species of monetary theory, and draw conclusions from Macleod's analysis for our own day and age.


Macleod's Theory of Credit Money

According to the standard mythology, money arose in the midst of prehistory when traders, seeking to reduce the transaction costs of exchange, began to accept certain commodities with the intent of exchanging them in the future, rather than from the desire to use or consume the commodities themselves. As more traders became willing to accept these "tradable" commodities, they became increasingly demanded for exchange purposes. Over time, commodities enjoying a narrower sphere of acceptance gave way as media of exchange to commodities generally accepted over wider spheres. By an evolutionary process, a particular commodity eventually came to dominate the trading process. Because the primary function of this generally accepted commodity was to act as a medium of exchange, the physical qualities of the commodity were important. Durability, divisibility, and portability, among other desirable attributes, made one of the precious metals especially suited to serve as the medium of exchange. Thus, over times, barter societies were transformed into monetary societies by the self-interested behavior of individual traders. Later, in recorded history, credit systems grew around money, as market participants sought to economize the use of commodity money to extend their ability to trade and to reduce transaction costs. …

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