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Credit theories of money, also called debt theories of money, are
monetary economic theories concerning the relationship between credit and
money. Proponents of these theories, such as Alfred Mitchell-Innes, sometimes
emphasize that money and credit/debt are the same thing, seen from different
points of view.[1] Proponents assert that the essential nature of money is
credit (debt), at least in eras where money is not backed by a commodity such
as gold. Two common strands of thought within these theories are the idea that
money originated as a unit of account for debt, and the position that money
creation involves the simultaneous creation of debt. Some proponents of credit
theories of money argue that money is best understood as debt even in systems
often understood as using commodity money. Others hold that money equates to
credit only in a system based on fiat money, where they argue that all forms of
money including cash can be considered as forms of credit money. The first
formal credit theory of money arose in the 19th century. Anthropologist David Graeber has argued that for most of human history,
money has been widely understood to represent debt, though he concedes that
even prior to the modern era, there have been several periods where rival
theories like metallism have held sway.
Scholarship:
According to Joseph Schumpeter, the first known advocate of a credit theory of
money was Plato. Schumpeter describes metallism as the other of "two
fundamental theories of money", saying the first known advocate of
metallism was Aristotle.[2][3] The earliest modern thinker to formulate a
credit theory of money was Henry Dunning Macleod (1821-1902), 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),[4] 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".[5]
Since the late 20th century, Innes' credit theory of money has been integrated
into Modern Monetary Theory. The theory also combines elements of chartalism,
noting that high powered money is functionally an IOU from the state,[6] and
therefore, "all 'state money' is also 'credit money'". The state
ensures there is demand for its IOUs by accepting them as payment for taxes,
fees, fines, tithes, and tribute.[7]
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,[8] 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.[9] 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.[10]
Economics commentator Philip Coggan  holds that the world's current monetary system became debt-based
after the Nixon Shock, in which 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 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.[11]
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 William Jennings 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.[12]
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[13] 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.[14] A later 2012 paper from Claudio Borio of the BIS made
the contrary case that it is loans that give rise to deposits, rather than the
other way round.[15] In a book published in June 2013, the writer Felix Martin,
influenced by Werner (2003, 2005), argued that credit based
theories of money are correct, citing many of Werner's sources, such as
Macleod: "currency ... represents transferable debt, and nothing
else". Martin writes that it is difficult for people to grasp the nature
of money, because money is such a central part of society, and alludes to the
Chinese proverb that "If you want to know what water is like, don't ask
the fish."[16][17][18]
Advocacy:
The conception that money is essentially equivalent to credit or debt has long
been used by those advocating particular reforms of the monetary system, and by
commentators calling for various monetary policy responses to events such as
the financial crisis of 2007–2008. A view held in common by most recent
advocates, from all shades of political opinion, is that money can be equated
with debt in the context of the contemporary monetary system. The view that
money is equivalent to debt even in systems based on commodity money tends to
be held only by those to the left of the political spectrum. Regardless of any
commonality in their understanding of credit theories of money, the actual
reforms proposed by advocates of different political orientations are sometimes
diametrically opposed.[12]
Advocacy for a return to a gold standard or similar commodity based system.
Former US presidential candidate Ron Paul has spoken out against fiat money,
partly on the grounds that it encourages the buildup of debt.[19]
Advocates from an Austrian School, right-libertarian perspective often hold
that money is equivalent to debt in our current monetary system, but that it
need not be in one where money has inherent value, such as a gold standard.
They have frequently used this view point to support arguments that it would be
best to return to a gold standard, to other forms of commodity money, or at
least to a monetary system where money has positive value. Similar views are
also occasionally expressed by conservatives. As an example of the latter,
former British minister of state The Earl of Caithness made a 1997 speech in
The House of Lords where he stated that since the 1971 Nixon Shock, the British
money supply had grown by 2145% and personal debt had risen by almost 3000%. He
argued that Britain ought to move from its current "debt-based monetary
system" to one based on equity:[20] It is also a good time to stand back,
to reassess whether our economy is soundly based. I would contest that it is
not ... as it is debt-based ... a system which by its very actions causes the
value of money to decrease is dishonest and has within it its own seeds of
destruction. We did not vote for it. It grew upon us gradually but markedly
since 1971 when the commodity-based system was abandoned...We all want our
businesses to succeed, but under the existing system the irony is that the
better our banks, building societies and lending institutions do, the more debt
is created ... There is a different way: it is an equity-based system and one
in which those businesses can play a responsible role. The next government must
grasp the nettle, accept their responsibility for controlling the money supply
and change from our debt-based monetary system. My Lords, will they? If they do
not, our monetary system will break us and the sorry legacy we are already
leaving our children will be a disaster.
In the early to mid-1970s, a return to a gold-anchored system was advocated by
gold-rich creditor countries including France and Germany.[21] A return has
repeatedly been advocated by libertarians, as they tend to see commodity money
as far preferable to fiat money. Since the 2008 crisis and the rapid rise in
the price of gold that soon followed it, a return to a gold standard has
frequently been advocated by goldbugs.[12][22] Advocacy against the gold
standard From centrist[23] and left-wing perspectives, credit theories of money
have been used to oppose the gold standard while it was still in effect, and to
reject arguments for its reinstatement.
Innes's 1914 paper is an early example of this.[5][12][22] Advocacy for
expansionary monetary policy From a moderate mainstream perspective, Martin
Wolf has argued that since most money in our contemporary system is already
being dual-created with debt by private banks, there is no reason to oppose
monetary creation by central banks in order to support monetary policy such as
quantitative easing. In Wolf's view, the argument against Q.E. on the grounds
that it creates debt is offset by potential benefits to economic growth and
employment, and because the increase in debt would be temporary and easy to
reverse.[24]
Advocacy for debt cancellation Arguments for debt forgiveness have long been
made from people of all political orientations; as an example, in 2010 hedge
fund manager Hugh Hendry, a strong believer in free markets, argued for a
partial cancellation of Greece's debt as part of the solution to the Euro
crisis.[25] But generally advocates of debt forgiveness simply point out that
debts are too high in relation to the debtors’ ability to repay; they
don't make reference to a debt-based theory of money. Exceptions include David
Graeber who has used credit theories of money to argue against recent trends to
strengthen the enforcement of debt collection, such as greater use of custodial
sentences against debtors in the US. He also argued against the over-zealous
application of the view that paying one's debts is central to morality, and has
proposed the enactment of a biblical style Jubilee where debts will be
cancelled for all.[10]
Advocacy for full-reserve banking:
Main article:
Full-reserve banking:
The 2008 financial crisis has led to renewed interest in full reserve banking
and sovereign money issued by a central bank. Monetary reformers argue that
fractional reserve banking and debt-based money lead to unpayable debt, growing
inequality, inevitable bankruptcies, and an imperative for perpetual and
unsustainable economic growth.[26] Advocacy for the ongoing establishment of
new community banks Werner argues that the knowledge and understanding of banks
as creators and allocators of the money supply should be harnessed to benefit
humanity in general and ordinary people in particular - instead of abolishing
this power, as the 'monetary reform' movement demands. According to Werner this
can be done by establishing hundreds of not-for-profit community banks,
modelled on Germany's local co-operative banks, Raiffeisenbanks and Sparkasse
savings banks. These banks have been one of the drivers of the striking success
for German small firms over the past two centuries in delivering job creation,
strong exports and constantly upgraded technology. Werner says that instead of
further centralising the power of money creation in the hands of ever fewer
people, as monetary reformers and central planners demand, this public
privilege should be returned "to the people to whom it belongs", and
this can only be done in a meaningful way with sufficient accountability by
copying the traditional German community banks.[27]
Relationship with other theories of money:
Debt theories of money fall into a broader category of work which postulates
that monetary creation is endogenous.[5][28] Historically, debt theories of
money have overlapped with chartalism and were opposed to metallism.[29] This
largely remains the case today, especially in the forms commonly held by those
to the left of the political spectrum.[30] Conversely, in the forms held by
late 20th-century and 21st-century advocates with a conservative libertarian
perspective, debt theories of money are often compatible with the quantity
theory of money and with metallism, at least when the latter is broadly
understood.[5][10][12][31]
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Notes and references:
As Innes mentions in What is money? (1913), whenever he uses the word credit or
debt, "the thing spoken of is precisely the same in both cases, the one or
the other word being used according as the situation is being looked at from
the point of view of the creditor or of the debtor."
Chpt 1 Graeco-Roman Economics , 'History of Economic Analysis, Joseph
Schumpeter , (1954)
Anitra Nelson. "Marx's objections to credit theories of money (extract
from Nelson's 1999 book: Marx's concept of Money )" (PDF). Mount Holyoke
College. Retrieved 2013-07-08. Originally published in The Banking Law Journal,
since reprinted in books such as Wray (2004) and made available online by the
CES Randy Wray, ed. (2004). "See esp Chpt 1 7".
Credit & State Theories of Money. Edward Elgar. ISBN 1843765136. Fullwiler,
Scott; Kelton, Stephanie; Wray, L. Randall (January 2012), "Modern Money
Theory : A Response to Critics", Working Paper Series: Modern Monetary
Theory - A Debate (PDF), Amherst, MA: Political Economy Research Institute, pp.
17–26, retrieved May 26, 2019 Éric Tymoigne and L. Randall Wray,
"Modern Money Theory 101: A Reply to Critics," Levy Economics
Institute of Bard College, Working Paper No. 778 (November 2013).
This is the classic Metallist view. Polanyi goes as far as to say Ricardo
"indoctrinated" economists into viewing money just as a medium of
exchange - see chapter 16 of The Great Transformation.
David Graeber (2011), "passim, see especially chapter 2: The Myth of
Barter", Debt: The First 5000 Years, ISBN 978-1-61219-181-2 The new debt
will generally soon exceed the newly created money due to added interest.
Philip Coggan (2011). "passim, see esp Introduction". Paper Promises:
Money, Debt and the New World Order. Allen Lane. ISBN 978-1846145100.
In the Financial sector, gold is often said to be the only financial asset that
does not represent someone else's liability to pay.
Perry Mehrling (2012-01-25). "The Inherent Hierarchy of Money" (PDF).
Columbia University. Archived from the original (PDF) on 2012-12-21. Retrieved
2012-07-10.
"The financial cycle and macroeconomics: What have we learnt?", by
Claudio Borio, Bank for International Settlements December 2012 Richard A.
Werner (2003), Princes of the Yen, 2nd edition by Quantum Publishers
[www.quantumpublishers.com]
Felix Martin (4 March 2014). Money: The Unauthorized Biography. Knopf Doubleday
Publishing Group. ISBN 978-0-307-96244-7. Chapter 1 Ian Birrell (2013-06-09).
"Money: The Unauthorised Biography by Felix Martin – review".
The Guardian. Retrieved 2013-07-08.
Ron Paul (12 Sep 2003). "Fiat Paper Money". LewRockwell.com.
Retrieved 16 July 2012.
Malcolm Sinclair, 20th Earl of Caithness (1997-03-05). "Our Debt-Based
Money System Will Break Us". Prosperity UK. Retrieved 2012-07-12.
Helleiner, Eric (1995). States and the Reemergence of Global Finance: From
Bretton Woods to the 1990s. Cornell University Press. ISBN 0-8014-8333-6.
Izabella Kaminska (31 May 2012). "Debunking goldbugs". The Financial
Times. Retrieved 16 July 2012.
During the two centuries leading up to WWII, it was mostly only those who
leaned towards the left who opposed the Gold Standard, but this has since
become a centrist position.
Martin Wolf (9 Nov 2010). "The Fed is right to turn on the tap". The
Financial Times. Retrieved 16 July 2012.
Courtney Comstock (2010-02-10). "Watch Hedge Funder Hugh Hendry Fight WIth
Joe Stiglitz". Business Insider. Retrieved 2012-07-18.
Jackson, Andrew; Dyson, Ben (2012). Modernizing Money. Why our Monetary System
is Broken and how it can be Fixed. Positive Money. ISBN 978-0-9574448-0-5.
Richard A. Werner (2018), Shifting from central planning to a decentralised
economy, www.professorwerner.org
[1] see also Local First Community Interest Company and their movement to
establish community banks
[2] Simply put, this contrasts with exogenous creation where money is created
by events such as new finds of gold occurring outside of a narrowly conceived
economy. In the 19th century, and to an extent the early 20th century,
metallism enjoyed an almost "unchallenged" position as the dominant
theory of money – see for example Chapter 1 of Schumpeter's History of
Economic Analysis Chartalists will sometimes say money derives it value by
virtue of being the legal way to pay ones debt to the State as taxes. Debt
theories can be broader in scope – Graeber, Innes and others have argued
that organic debt based monetary systems that did not involve the state
continued to operate well into the 19th century. Stephanie A. Bell and Edward
J. Nell, ed. (2003). "Passim". The State, the Market, and the Euro:
Chartalism Versus Metallism in the theory of money. Edward Elgar. ISBN
1843761564.
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