For the most part, economists continue to believe a story of money told to generations of students by a series of textbooks over the past 150 years.
This story asks us to imagine a pre-monetary barter economy, where people bought goods and services by trading them for other goods and services.
Eventually a suitable commodity – perhaps gold or silver – emerged as both an acceptable means of exchange for conducting trade and a convenient unit of account for expressing value.
Later, coins were issued – eventually to be monopolised by governments – and later still paper money, credit, and banking systems.
So where did money come from exactly? One difficulty we face is that writing about money – what gives it value, and how monetary systems work – is not something young economists are generally encouraged to do.
As a consequence, among the best articles ever written about money are two now more than 100 years old by British economist Alfred Mitchell-Innes, entitled “What is Money?” and “The Credit Theory of Money”.
These papers, until recently almost completely ignored by the economics profession, tell a different story, rejecting the idea that money evolved naturally from barter.
We can now be confident this version is closer to the truth. And it has big implications for how we think about the role of governments within monetary systems, and what gives money value. Acknowledging the true story of money would force a paradigm shift among economists – no wonder a lot of them don’t want to think about it.
Actually, early governments invented money
The truth is that money predates markets. Governments invented money – it did not emerge independently from pre-existing barter systems.
Market economies simply could not develop until money existed. For much of history, the currency tokens people regarded as money had little or no intrinsic value, taking the form of clay tablets, hazelwood tally sticks, base metals, shells or paper.
The earliest forms of what Keynes called “modern money” – to distinguish it from gift tokens used for ceremonial purposes in communal groups – go back to the origins of taxation, accounting, and even literacy and numeracy. These early currencies were units of account used to assess the tributes that had to be paid to early governmental institutions in the Middle East.
The word shekel is still used as a currency unit, but dates to ancient Babylon and the emergence of money itself, over 5,000 years ago.
The idea that the need to pay taxes is what creates a demand for a currency was well understood by colonial governments. They knew how to introduce their currencies into countries they had invaded. To force locals to supply labour or goods to the government, they imposed a tax liability – often, a hut tax. This tax could only be paid using the currency of the colony.
Locals had to either work for the colonial government or supply goods to others who did, else they wouldn’t have the specific currency needed to pay taxes. This created a demand for the colonial power’s currency, which the government could then spend.
If such a government spent more overall than it withdrew in taxation – running a budget deficit – the community could add the remaining currency to its savings. Taxation and the legal system created a demand for the government’s money and provided the impetus for the development of a monetary economy.
Even today, it’s the tax system that drives the monetary system. Demand for a government’s money is guaranteed because people need it to pay federal taxes.
