The Nature of Money

1

Money as a Commodity and ‘Neutral’ Symbol of Commodities

There can be no unerring measure of either length, of weight, of time or of value unless there be some object in nature to which the standard itself can be referred.

David Ricardo in Sraffa 1951: 401, emphasis added

Monetary facts... have no direct significance for economic welfare. In this sense money clearly is a veil. It does not comprise any of the essentials of economic life.

Pigou 1949: 14

[E]ven in the most advanced industrial economies, if we strip exchange down to its barest essentials and peel off the obscuring layer of money, we find that trade between individuals or nations largely boils down to barter.

Samuelson 1973: 55

The late nineteenth-century theorists who established the methodology of modern economics held to one version or another of the commodity theory of money. ‘Money proper’ referred to either precious metal or its convertible paper symbol. Money was essentially material and tangible; it could be stored and passed from hand to hand – it circulated. The accepted theory of money was the theory of the gold standard. Money in this sense was distinguished from credit, regardless of whether the latter was understood as the practice of the book clearance of debits and credits in the banking system or the issue of circulating credit instruments – such as bills of exchange and promissory notes.

But the theory at the heart of the new economic science was in fact very old. Many of the most influential seventeenth- and eighteenth-century political economists – Locke, Petty, Hume, Cantillon – subscribed to the essentials of Aristotle’s explanation of the evolution and functions of money. A little later, ‘Adam Smith substantially ratified it’ (Schumpeter 1994 [1954]: 290). Late nineteenth-century economists simply incorporated the well-established theory of precious metal coinage into their theories of marginal utility and supply and demand.

Moreover, despite the subsequent disappearance of all forms of precious metal money (either as actual currency or as a non-circulating standard of value), the fundamental assumptions of modern orthodox economic thinking remain grounded in this earliest known theory of the origins and functions of money. I shall argue that this intellectual provenance is the root cause of the significant deficiencies in mainstream economic thinking on the nature of money. Aristotle had produced an ethical critique of the pursuit of ‘value’ as an end in itself in the form of money, as opposed to the satisfaction of wants and the gaining of utility by the production and exchange of commodities.1 This critique was derived from his conception of an idealized ‘natural’ economy that was neither capitalist nor market-based. He was concerned with how money ought to be used in a society whose ‘moral ethos was unfavourable to the values of commerce’ (Meikle 2000: 167). It is therefore not surprising that theories implicitly based on his analysis have proved to be a very poor guide to the money of the modern capitalist world.

The Meta-theoretical Foundations of Orthodox Monetary Analysis

The theorems of modern economic micro-economics that deductively model the decision making of rational utility-maximizing individuals and the exchanges between them are derived from a stylized conception of a simple trading economy in which exchange ratios of commodities express their ‘real’ values. The model comprises object–object relations (exchange ratios between commodities, or the ‘production function’) and individual agent-object relations (individual acts of utility calculation, or the ‘utility function’). (For similar distinctions, see Ganssmann 1988; Weber 1978: 66–9.) Together, object–object and agent–object relations constitute what Schumpeter described as the ‘real’ economy.

Real analysis proceeds from the principle that all the essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them. Money enters the picture only in the modest role of a technical device that has been adopted in order to facilitate transactions... so long as it functions normally, it does not affect the economic process, which behaves in the same way as it would in a barter economy: this is essentially what the concept of Neutral Money implies. Thus, money has been called a ‘garb’ or ‘veil’ of the things that really matter... Not only can it be discarded whenever we are analyzing the fundamental features of the economic process but it must be discarded just as a veil must be drawn aside if we are to see the face behind it. Accordingly, money prices must give way to the exchange ratios between the commodities that are the really important thing ‘behind’ money prices. (Schumpeter 1994 [1954]: 277)2

Other than the ‘higgling’ to arrive at a mutually agreed exchange, agent–agent, or social, relations form no part of the model (Ganssmann 1988). It is assumed that a continuous process of ‘higgling’ is able to transform the myriad bilateral exchange ratios between all the different commodities, based on individual preferences, into a single price for any uniform good. Money, in the form of a highly liquid commodity, may be introduced into the model to ‘lubricate’ the process of exchange. As a commodity, the medium of exchange can have an exchange ratio with other commodities. Or, as a symbol, it can directly represent real commodities. It is in this sense that money is a ‘neutral veil’ that has no efficacy other than to overcome the ‘inconveniences of barter’ which, in the late nineteenth-century formulation, result from the absence of a ‘double coincidence of wants’. In his influential Money and the Mechanism of Exchange (1875), Jevons illustrated these deficiencies with two examples. The first tells how a French opera singer, Mile Zelie, on tour in the South Pacific, had a contract to receive payment of one third of receipts. After one concert, her share comprised quantities of pigs, turkeys, chickens, coconuts and other tropical fruits. She could not consume them and, instead, provided a feast for the local population. In the second illustration, Jevons recounts how Wallace, the naturalist and protagonist of evolutionary theory, had to go hungry in the Malay Archipelago during the 1850s. Despite a general abundance of available food, Wallace’s party, on occasion, did not have anything that was acceptable in barter for it.

As we have noted, two slightly different versions of the basic orthodox conception of the medium of exchange may be distinguished. The medium of exchange may be either an actual commodity that maintains an exchange rate with other commodities or, as in Walrasian general equilibrium theory, a symbol of a ‘representative’ commodity or ‘basket’ of commodities. The Walrasian device of an arbitrarily assigned numeraire (symbolic representation of existing commodity values) enables the modelling of an exchange economy in which the market ‘clears’ (Allington 1987) – that is to say, an equilibrium where prices are reached at which no goods remain unsold. Further analytical assumptions of instantaneous – that is, ‘timeless’ – multilateral trades under conditions of certainty and perfect information are made in order render this ‘general equilibrium’ amenable to a precise mathematical expression. But these conditions also render money redundant – particularly as a store of value and means of final payment, or settlement. As a leading exponent of such theorizing explains:

The most serious challenge that the existence of money poses to the theorist is this: the best model of the economy cannot find room for it. The best-developed model is, of course, the Arrow–Debreu version of a Walrasian general equilibrium. A world in which all conceivable contingent future contracts are known neither needs nor wants intrinsically worthless money. (Hahn 1982: 1)

In Walras’s equation, the numeraire is not explained; rather, it is simply introduced along with the ‘auctioneer’ in order to render the model operational – that is to say, to get the bidding started.3 But money does no more than lubricate the transaction process. It is not an autonomous force – it does not make a difference to the level of economic activity and welfare; it merely enables us, according to Mill, to do more easily that which we could do without it.

This conception of money runs as a continuous thread through the development of orthodox economic analysis. Hume’s essay Of Money (1752) more or less paraphrases Aristotle: ‘Money is not, properly speaking, one of the objects of commerce, but only an instrument... It is none of the wheels of trade: It is the oil which renders the motion of the wheels smooth and easy’ (quoted in Jackson 1995: 3). In the late nineteenth century, Alfred Marshall affirmed the orthodoxy that money is no more than a device by which the ‘gigantic system of barter’ is carried out. As the third epigraph to this chapter tells us, one of the most influential economists of all time...