Chapter Nine, The Evolution of Money-From Commodity Money to Credit Money and Beyond

The entirety of money, banking, and finance is comprised of claims and obligations.
— Thomas H. Greco, Jr.

It was in a dusty old bookshop close to the British Museum in London that I discovered a slim volume that was to complete for me the picture of how money has evolved over time. I had been traveling in Europe and the United Kingdom in the summer of 2001 with my then partner, Donna, attending conferences, meeting with friends and cohorts, and enjoying the sights, sounds, and cultures of the Old World. It was actually Donna who discovered the book in the basement stacks and brought it to me, saying, “What about this one?” The book was The Meaning of Money by Hartley Withers.[1] Although I had already been engaged in intensive research into the subjects of money and banking for more than twenty years and had written three books of my own on the subject, I had not previously heard of Withers, but it was evident that he must have been, in his day, a recognized authority on the subject, and that his book must have served for a long time as a leading text; I surmised that from the fact that the volume I held in my hands was the seventh edition, published in 1947, of a work first published in 1909, and that Withers had been the editor of The Economist magazine from 1916 to 1921. Reading Withers crystallized my understanding of the double transformation that money had undergone during the previous three hundred years, an understanding that afforded a clearer comprehension of the nature and significance of the changes that have taken place, an understanding that prepares the ground from which to launch the next great improvement in the exchange process.

What We Don’t Know Is Hurting Us

Money has long been clouded in mystery, and there are few who really understand it, but it is merely made to seem that way by financial journalists, bankers, and monetary economists who speak an obscure language and behave as if the wizards of Wall Street were possessed of some superior form of intelligence. This discourages most people from even trying to understand money. But what we don’t know can hurt us, and it is this general ignorance that is at the root of much of the present misery in the world. As John Adams, the second president of the United States expressed it in a letter to Thomas Jefferson, “All the perplexities, confusions and distresses in America arise not from defects in the Constitution or Confederation, not from want of honor or virtue, as much as from downright ignorance of the nature of coin, credit and circulation.”[2] That is even more true in the present day than it was in the late eighteenth century.

The fundamental fact about money is that it is a human contrivance created to facilitate the exchange of goods and services. In this chapter, we will dispel the mystery by telling the story of money in a way that clearly distinguishes the various kinds of money that have historically been used and reveals their essential nature. We will explain the transformational stages through which money (or more accurately, the exchange process) has passed, and in the following chapter, how it is once again being transformed. Subsequent chapters will describe the more efficient and equitable exchange mechanisms that are now emerging and will suggest how they might be further optimized and scaled. For this, we need not speculate about the distant past, nor seek to uncover the obscure origins of money in ancient societies. It will suffice to examine how money and banking have evolved together over the past three hundred fifty years.

Economic Exchange and Interpersonal Distance

Before we consider the evolution of money and the precise role that money is intended to play, let’s consider the more fundamental question of how economic value changes hands in various situations and social settings. In our physical nature, we humans have material needs that must be satisfied. Economics is that area of human activity which involves all aspects of providing for our physical creature needs — production, storage, transportation, distribution, exchange, and ultimate use and consumption.

It is the exchange and distribution aspects of economics which comprise our focus here. The institutions of money and markets have become so dominant in our modern industrial culture that we have generally lost sight of the other mechanisms by which material goods and services have been, and are being, apportioned and allocated. Economic anthropologist Karl Polanyi reminds us that, “No society could, naturally, live for any length of time unless it possessed an economy of some sort; but previously to our time no economy has ever existed that, even in principle, was controlled by markets.”[3] In our materialistic society we are just now beginning to recognize once again that the non-material exchanges and interactions that take place between people are often of greater importance to our quality of life and long-range welfare.

A fundamental characteristic of a developed economy is the specialization of labor according to which the work of the community is divided among its individual members. The degree to which we are interdependent upon one another is a fundamental reality. As Adam Smith so eloquently put it, “Every man is rich or poor according to the degree in which he can afford to enjoy the necessities, conveniences, and amusements of human life. But after the division of labor has once thoroughly taken place, it is but a very small part of these which a man’s own labor can supply him.”[4]

From the standpoint of efficiency, productivity, and competence, the specialization of labor is undeniably beneficial. Both the quantity and the quality of the goods and services we enjoy are enhanced by it, and ideally, specialization should allow each member to do those things which she finds most meaningful and pleasant, and for which she is best suited by aptitude and skill.

But can a good thing be carried too far? Is there ever any good reason to do-it-yourself? Why are the rich getting richer, while the poor keep getting poorer and the middle-class continues to shrink? Consideration of questions such as these begins to open us up to the “dark side” of our modern industrial culture. In the extreme, work can become so menial, and the workers so detached from the end product, that work loses most of its meaning and satisfaction. Charlie Chaplin’s elegant and amusing portrayal of man-as-machine in the movie Modern Times drives home that point in a charming way. Further, over-specialization robs us of our wholeness as multi-faceted humans and makes us vulnerable to exploitative efforts of organized groups and institutions. What price have we paid for our material abundance and present way of life?

Kinds of Economic Interaction
How does economic value change hands? I can think of only three ways:

• Gifts
• Involuntary transfers
• Reciprocal exchange

In the case of a gift, if it is truly a gift, something of value is transferred without any particular expectation of the giver receiving anything in return; there is no quid pro quo. In the case of involuntary transfers (such as theft, robbery, extortion, or taxes), some form of force or threat is applied to coerce the transfer of value from one person or entity to another. In reciprocal exchange, two parties voluntarily agree to exchange one kind of value for another, in which case, each party subjectively values the thing received more than the thing surrendered, so both are enriched by the bargain. Typically, we exchange something we have in abundance for some other thing that we cannot provide for ourselves. It is within the realm of reciprocal exchange that money plays its fundamental role. Any feature of a monetary system that subverts reciprocity is dishonest and destructive to the intended outcome of mutual benefit among those who use that money system. We have already described in previous chapters many of the ways in which the present interest-based, political fiat money system subverts reciprocity and exploits those who use it.

As I contemplate our predicament, it occurs to me that a major factor in determining the nature of an economic relationship is that of interpersonal distance. I will not try to give a precise definition of what I mean by that term, but I think it will become clear enough as we proceed. I will say at the outset that it relates to how we conceive of the “self,” and our attitude toward the “other.” It has to do with how separate we feel, the degree to which we are able to empathize with others, and our understanding that our individual welfare is entirely dependent upon the welfare of everyone.

This way of looking at things causes us to understand how we might better relate to one another economically, and how we might promote more peaceful and equitable relationships overall. It is a way of examining how the spiritual dimension of values, attitudes, and beliefs determines what happens on the level of action-how we behave toward one another. In other words, ethics and morality are the behavioral patterns which come out of our spirituality, which to my mind is the motivating force of our values, attitudes, and beliefs. The idea of interpersonal distance highlights some important questions, like:

• Where are market mechanisms appropriately employed, and where are they corrosive to the social fabric?
• Where is strict reciprocity in exchange important, and where can it be relaxed?
• Can business be conducted in a way that is fair and compassionate rather than exploitative and dominating?
• Is it possible for everyone on earth to live a decent and dignified life?

I have divided the map of the interpersonal distance scale into four realms, which are distinguished from one another as interpersonal distance increases from slight to great. These are shown in the chart below and will be discussed in order.

Figure 9.1 Economic interaction and interpersonal distance

The first realm is characterized by interpersonal closeness. I call it the Realm of Independence, Self-reliance, and Familial Nurturance. It is the realm of the individual both as a monad and as a member of a fundamental social unit. This is a social unit within which there is little distinction made between the self and the other, or perhaps more precisely, where the perception of the self includes the others. I am talking primarily about the family, but not necessarily the blood-related nuclear family. It might include others, like lovers and close personal friends, who are thought of as family. It could also be a spiritual family, in which the bonds are empathetic rather than genetic, or a religious order in which the members are bound by a common faith and practice, which makes them “brothers” and “sisters” in spirit. Independence is part of the description because the individual is the smallest possible social unit, in contrast to which the other is defined, and because it defines the primary alternative to exchange, which is reliance upon oneself to produce what is used. It includes familial nurturance because the members of the family, seeing each other as extensions of themselves, are more or less ready and willing to do whatever is required to satisfy each other’s needs. Material exchanges here are done without any attempt to keep formal accounts or to achieve reciprocity. If such a thing as altruism exists, this is its defining situation.

The economic mechanisms which operate in this realm are make and use, give and receive, sharing, and free borrowing and lending. Make and use refers to the process of providing for one’s own needs (and those of the family) through self-effort, not just as individuals but as part of the family enterprise. The relative self-reliance of the fundamental social unit presumes, of course, adequate access to land and natural resources, which provide the material basis for subsistence, either through hunting and gathering, husbandry, or subsistence farming. Even in urban environments it is possible to practice these in some degree since urban environments are usually resource-rich and provide great opportunities for gardening, foraging, and scavenging. As an “urban forager” friend once put it, “It is unbelievable what Americans throw away.” Nonetheless, it becomes increasingly evident that as time goes on, the avenues for independent subsistence are becoming fewer and narrower as ownership of resources becomes more concentrated, and our societies become ever more regimented. The forces and interests that promote the modern global economy seem determined to herd everyone through a variety of “tollgates” which they control, making it possible for them to further enhance their relative power and wealth.

As interpersonal distance increases, we move into what I call the Realm of Mutual Support and Communal Interdependence. This realm involves the next level of social relationships-typically, the extended family, the clan, the circle of close friends, and perhaps one’s close neighbors or fellow villagers. This realm is characterized by exchange relationships which, while still less formal than monetary and market mechanisms, are more intent on reciprocity than those in the first realm previously described. The sharing is here slightly more constrained, and borrowing and lending, while still free, are more limited by expectations of prompt repayment or return of the thing borrowed. Reciprocity begins to take on some importance, and the use of money is sometimes employed. Barter is common within this realm, and even free market buying, selling, and renting transactions occur. There is usually no attempt to “drive a hard bargain,” unless, as it is in many cultures, for sport-a kind of social sparring. Rather, fairness to both parties is a major concern. At times, the buyer may even try to persuade the seller to accept a higher price than asked to avoid any sense of “taking advantage.”

The third realm can be characterized as impersonal. It is the area in which the other stands out clearly as an object in whom there is little interest except as the provider of satisfaction for a particular need or desire. The seller tries to get the highest price possible, and the buyer seeks to get what she wants at the lowest possible price. It is in this realm where the other is seen as an object to be used, or even exploited, and the use of money begins to be perverted. This realm is called the Realm of Exploitation and Dependence because I believe that one cannot be exploited unless she is in some way dependent. The dependent party may be either the seller or the buyer, depending on the situation. Economic relationships within this realm are shaped by unequal power and motivated by self-enrichment above all else. This is particularly true in transactions between an individual and a corporation which by its nature is impersonal and, despite the rhetoric about supporting the “free market,” corporations typically seek to dominate the markets within which they buy and sell. Large corporations attempt not only to persuade the other to make the “proper” choices when buying, but also to limit the other’s options when they are selling (their labor, for example). This may be accomplished by driving out competition, by fostering addictions, by creating psychological needs, or by limiting access to important information necessary for making informed choices. Typical mechanisms in this realm are usurious lending and borrowing, and monopolistic pricing, as well as deception, fraud and legal coercion. On the buying side, other behaviors which are commonly observed are colonialism, union busting, and the exercise of political influence to dominate suppliers of labor and raw materials.

The question ultimately arises, “Must these types of behaviors always occur within this realm?” The answer depends on how we decide to define interpersonal distance. In relations between individuals, it is a matter of defining who is my neighbor? The parable of the Good Samaritan seems to adequately answer that question. In relations between an individual and a large corporate entity, such behaviors are predetermined by the nature and goals of the corporation, as enabled by a government-granted corporate charter and the demands of the shareholders. Corporate behavior is driven by the goals of ever-increasing sales, profits and share price, which are usually achieved through a process of externalizing such costs as waste disposal and forcing others to bear the burden dealing with the effects of pollution. A corporate executive may behave in one way in his dealings as a private person, and quite another in his capacity as an officer of the corporation.

We seem to have forgotten not only that the welfare of each depends upon the welfare of all, but that we are all dependent upon the entire web of life and the free gifts that the Earth provides. To think that I can enhance my well-being at someone else’s expense or by degrading the natural living systems is a delusion of the highest order.

The final realm, where interpersonal distance is great in the extreme, is what I call the Realm of Coercion and Crime. This is the realm of criminals and victims, which is characterized by the objectification of the other and extreme lack of empathy. It involves transfers which are involuntary in the usual sense of the word. Although we always have a choice, the alternatives posed here are onerous, as in the demand, “Your money or your life.” Extortion and robbery involve threats of harm, physical or otherwise. Theft relies upon stealth and exploitation of the victim’s vulnerability. I will leave it to psychologists and criminologists, who are better equipped, to describe the interpersonal dynamics which operate here, but surely there must be some measure of fear, alienation, or hatred underlying these types of criminal behaviors.

In sum, I believe that the creation of a happier, more peaceful world depends upon our ability to redefine ourselves in ways that allow us to embrace one another and, indeed, the whole web of life. Reducing interpersonal distance means driving out fear, hatred, and alienation, and choosing trust, love, and compassion. I can imagine a world in which the fourth realm has been largely eliminated and even the third has all but disappeared, where everyone is treated as family, and we acknowledge that we are each in fact “our brother’s keeper.”

What is Money?

In order to dispel the mystery of money, we first need to define precisely what money is. There is certainly no shortage of definitions, but the matter is complicated by the fact that money has evolved over time; money today is not what it used to be, and what money is becoming is different still.

Let’s begin with these:
Hartley Withers maintains that “money is what it has always been, a means of payment.”[5]
Bilgram and Levy say, “We should… define money as any medium of exchange adapted or designed to meet the inadequacy of the method of exchanging things by simple barter.”[6]

Money, then, is a medium we use to facilitate the exchange of value in reciprocal trade.

“The Ladder of Economic Civilization”

A further key to understanding money lies in being able to distinguish between its mere forms on the one hand, and its true essence on the other. Withers, in describing the various forms that money has historically taken refers to “the ladder of economic civilization,” which is the progression of the means we use for enabling reciprocal exchange. The steps of that ladder are as follows:

• Barter trade
• Commodity money
• Symbolic money
• Credit money
• Credit clearing

Each of these will be discussed in turn.

The First Evolutionary Step-Barter to Commodity Money

The first evolutionary step in the process of reciprocal exchange was from simple barter to commodity money. Barter is the most primitive form of reciprocal exchange; it involves only two people, each of whom has something the other wants. However, if Jones wants something from Smith but has nothing that Smith wants, there can be no barter trade. So, barter depends upon the “double coincidence” of wants and needs. Money, in its most fundamental role, enables traders to transcend this barter limitation. Money bridges the gap in both space and time, acting as a “placeholder” that enables the need of a buyer to be met wherever and whenever the needed good or service may be found. This requires the agreement of the seller to defer satisfaction and to find his needed goods or services elsewhere. Thus, the first evolutionary step in reciprocal exchange came when traders began to use as an exchange medium some useful commodity that was in general demand and could be easily passed along in payment to other sellers.

Commodity Money

The most primitive type of money, then, is commodity money. Commodity money carries value in itself and can fulfill all of the classical functions attributed to money. It can be at once a payment medium, a measure of value, and a store of value. Throughout history, a wide variety of commodities has served as money, including cattle, tobacco, grains, nails, shells, hides, and of course metals-especially those so-called precious metals, gold and silver. I may personally have no use for tobacco, but if there are many others who want it, I will accept it in payment for the things I sell because I know that I can use it later to pay for something I want. So, some commodities acquired “exchange value” as well as “use value.” But by using commodities as money, the transaction essentially remained a barter trade of one thing for another.

Because they are durable, portable, and easy to divide into smaller amounts (fungible), certain metals (most notably silver and gold) became commodities of choice for mediating the exchange of all other goods and services. Eventually, these metals were struck (minted) into pieces (coins) of certified weight and purity (fineness) as a way of obviating the need for sellers to weigh and assay in the marketplace the metal that was offered as payment. The certification may have been made by some trusted person or entity. There are many examples of private coinage, but more often coinage was claimed as a prerogative of the local political authority, a prince, or a king, because there were good profits to be made from it. Official certification, if it could be relied upon, increased the convenience of using metallic money and reduced the cost of evaluating it, but over time, it became common for the certifying authority-the prince, the king, or the government-to abuse its authority by forcing people to accept inferior coinage containing lesser amounts of precious metal.

The first coins to be minted date from antiquity. In modern times, every civilized country has minted and circulated a variety of gold or silver coins. When the constitution for the United States was written, it simply recognized the monetary standard that had already been established by popular usage. That happened to be the Spanish milled “dollar.” Spanish dollars were silver coins that circulated widely throughout the American colonies. This fact was acknowledged by Thomas Jefferson in his treatise Notes on the Establishment of a Money Unit, and of a Coinage for the United States. Jefferson stated that “The unit or dollar is a known coin and the most familiar of all to the mind of the people. It is already adopted from south to north.”[7]

These Spanish dollar coins, however, were not uniform in weight or fineness. Dollar coins issued at different times varied slightly from one another. To complete the task of defining the monetary unit for the United States in a way that would not disturb commerce, a committee was commissioned to survey the money stock and assay a representative sampling of Spanish dollar coins so that the American dollar would closely approximate those coins already in circulation. This was easily accomplished, and it was quickly settled that the United States dollar should be defined as a silver coin containing 371.25 grains of fine silver.[8] Coins were subsequently minted according to that specification along with gold coins valued in dollars. As the country developed, various expedients were implemented to make money more abundant. While increasing the supply of money was necessary to facilitate exchange in a growing economy, many of the measures used were, unfortunately, designed to concentrate economic and political power into fewer hands, as we have already described.

Symbolic Money

As we’ve argued in previous chapters, the need for a flexible money supply requires that money, or currency, ought to be symbolic of valuable goods and services that are in the market waiting to be sold. The simplest form of symbolic money is the “warehouse receipt” or “claim check” for goods on deposit somewhere. A prime example is the grain bank receipts which have been issued at various times and places. In ancient Egypt, as in some African countries today, a farmer might bring his grain crop to a central warehouse and receive receipts for his grain. These receipts might then be exchanged in payment for other goods and services-and when issued in conveniently small denominations, might serve as a general medium of exchange within the region. The holder of the paper notes then has the option of presenting the notes at the warehouse and obtaining the grain they represent.

Paper notes that are redeemable for gold or silver coins are another example of a symbolic currency or warehouse receipts. The general acceptability of symbolic money derives from the fact that it can be redeemed by the holder on demand for the amount of the commodity that it represents. The shift from direct exchange of commodities to the exchange of notes or tokens representing claims to commodities was a sort of half-step that prepared the way for the next evolutionary step. Figure 9.1 depicts the process of creating symbolic money on the basis of deposits of gold held initially by goldsmiths, then eventually by bankers.

Figure 9.1 Bank notes issued as symbolic of gold on deposit.

The Second Evolutionary Step-From Commodity Money to Credit Money

The second evolutionary step, which I call the great monetary transformation, was the shift from metallic money (commodity money) and “claim check” money (symbolic money) to credit money. This transformational development provided a major leap forward in the potential efficacy of exchange media — but unfortunately, it also opened the door for greater abuse. The failure to distinguish between the different kinds of paper money that came into circulation caused much confusion and enabled subtle forms of cheating to proliferate, as we will explain. For now, let us just say that the important question to be answered with regard to any piece of paper currency is, “What does the paper represent?” Not all paper is created equal.

Credit money initially took the form of paper banknotes issued independently by the various banks, then later took the form of bank “demand deposits,” or in Europe, “sight deposits” against which checks could be drawn. In either case, whether it takes the form of paper notes or demand deposits, credit money is essentially a promise to pay-what Americans call an IOU. By Withers’s account, the introduction of the banknote was the first step in the development of the machinery for “manufacturing credit.” As he describes it, “Some ingenious goldsmith conceived the epoch-making notion of giving notes not only to those who had deposited metal, but to those who came to borrow it, and so founded modern banking.”[9] Withers’s view of credit money is one of “mutual indebtedness” between the banker and his customer. The customer would give the banker his promissory note or mortgage (the customer’s debt, which was an asset to the banker) in return for the banker’s notes (the banker’s debt to the customer, which was a liability to the banker) redeemable in gold. This process is depicted in Figure 9.2.

Figure 9.2 Bank Creation of Both Symbolic Money and Credit Money

But did that “ingenious goldsmith” intend to revolutionize money, or was he perpetrating a fraud? The prevalent mindset, at that time, considered money to be gold or silver, and banknotes to be merely claim checks (symbolic money) for gold or silver held on deposit. When the banker issued notes in amounts greater than the amount of metal in his vault and made all notes redeemable on demand for metal, the stage was set for trouble.

Two Distinct Kinds of Money-Fractional Reserve Banking

This situation became problematic because now there were two different kinds of paper money being issued into circulation, the one a “claim check” for gold on deposit and the other a credit instrument issued on the basis of a promise to pay and backed by some other form of collateral assets such as merchandise inventories or real property, yet both were redeemable for gold. This “fractional reserve system,” as it came to be known, was problematic from the start. Whenever people, for any reason, lost confidence in a bank or began to have doubts about the bank’s ability to redeem their notes, there would be a “bank run.” Those who got there first got the gold. When a bank’s stores of gold were exhausted, it would have to close its doors, sometimes never to reopen. At times, when there was sagging confidence in the banking system as a whole, bank panics became generalized and widespread. Many perfectly sound banks were put out of business because their supply of gold was inadequate to redeem any substantial portion of their issue of banknotes. In the classic film It’s a Wonderful Life,[10] actor Jimmy Stewart dramatically explains to the people how their money resides not in the bank’s vault but in the homes and businesses of their neighbors, perfectly sound collateral the value of which would eventually become liquid again as people repaid their loans.

Those who have decried the issuance of paper money have had good reason to do so, but they have also failed to recognize that it is not the paper that is problematic, but what the paper represents. Paper money that is properly issued on the basis of sound collateral can be a perfectly sound and legitimate medium of exchange. It cannot be too greatly stressed that, as we have already shown, one of the most fundamental problems with paper money historically was the fact that both symbolic paper and credit paper were made redeemable for gold. But that problem was compounded by another, more fundamental error-the frequent issuance of paper money on an improper basis, as we described at length in Chapter 7.

It is important to realize that those who would have us revert to commodity money like gold and silver do so because they see no other way of imposing discipline upon the powers that have gained control over the process of money creation and allocation, namely bankers and politicians. But by understanding the fundamental nature of modern money as credit, it becomes possible to liberate and perfect it, and to avoid throwing out the more evolved credit money “baby” with the “bath water” of perverse centralized issuance of pseudo-money.

Another aspect of the money problem was, and remains, the manipulation of interest rates and the supply of credit money. In the bubble stage, they lower interest rates and make credit “easy,” then they begin to raise interest rates and make credit “tight,” forcing businesses into bankruptcy and taking possession of their collateral assets by foreclosure. The “subprime” mortgage crisis that developed during 2007 and 2008 is a conspicuous example of this. That crisis developed out of the prior inordinate expansion of credit by the banking system on the basis of inflated real estate values. The banks created the real estate “bubble” by lending on (initially) easy terms and low interest rates to unqualified borrowers. Later on, as many of those borrowers were unable to make their mortgage payments and defaults mounted, the financial system was taken to the brink of global meltdown.

Redeemability Abandoned

Eventually, the redeemability feature of money was abandoned. In stages, silver and gold were officially demonetized. Now virtually all of the money in circulation is credit money, created by banks when they make loans, as we described in Chapter 4. This money exists not as banknotes, but in the form of “deposits” or “balances” in bank accounts. We see then that the problem of the scarcity of conventional money, which at first consisted of gold and silver, was alleviated by the introduction of a new kind of payment medium based on credit. This credit is manifested on one side of the bank’s ledger as an asset, which is the borrower’s promissory note, and on the other side as a liability, which is paper currency notes or deposits, which are the banker’s IOU, as depicted earlier in Chapter 4 and again in Figure 9.3 below. Giving those early bankers the benefit of the doubt, one can argue that it was first necessary for the community to develop sufficient confidence in credit money to be willing to accept it as a form of payment, and that making the credit money redeemable for the old (gold) money was necessary to build that sort of confidence. Others will argue that making both kinds of money redeemable caused more harm than good to the credibility of paper money generally.

Figure 9.3 The creation of bank “debt-money” as deposits.

Be that as it may, the evolutionary step from metallic (commodity) money to credit money was accompanied by much confusion, abuse, and discomfort. The problem stemmed, as we’ve said, from the concurrent circulation of two different kinds of money and the general failure to distinguish between them. Was a paper banknote merely a claim check for gold held on deposit in the bank’s vault, or was it money in itself, a credit instrument backed by some other form of value such as a lien against physical inventories of goods, a mortgage on a farm or factory, or some other asset?

The problems that arose from the concurrent circulation of both symbolic money and credit money might have been avoided if a clear distinction between them had been made from the beginning, and the redeemability feature had been explicitly limited. This, in fact, was proven by the operation of Scottish banks during the early part of the nineteenth century. During that period, notes issued by the Scottish banks gave the banks the option of delaying gold redemption for a certain period of time according to the availability of gold. These banks became known for their strength and stability, and their notes were readily accepted at face value despite this “gold option clause.” Banknotes issued on the basis of valuable assets (proper collateral) have proven to be just as sound and acceptable an exchange medium as precious metal coins, without their physical quantity limitations and the inconvenience of their transfer. History has shown that redeemability could be readily dispensed with, and credit money, despite widespread abuse by central authority, has become universally acceptable in its own right. And, as the Scottish banks proved, retaining gold as the measure of value and unit of account does not require that credit money be immediately redeemable for gold.

This point is worth reiterating. Credit money is a legitimate form of money that represents a great improvement over symbolic money that is redeemable for gold or silver, because the supply of credit money is limited only by the amount of real value that is produced and available to be exchanged in the market. However, under the current centralized monetary regime, the control of credit has become an instrument of power which causes great economic and social harm. But that needn’t be the end of the story. The advantages of credit money can be more fully realized as we develop ways for producers of real value to take direct control of their credit and use it not only for their own benefit but also for advancing the common good.

Checks and Checkable Deposits Displace the Use of Banknotes

Beginning around the mid-nineteenth century, bank deposits and the use of checks to make payments came to predominate over the hand-to-hand transfer of banknotes. Hartley Withers describes how this practice arose in response to attempts by the British government to restrict the issuance of banknotes representing credit money and to maintain the note-issuing monopoly in the hands of the Bank of England. In an attempt to address the frequent abuses by issuing banks, which caused recurrent bank failures, the British Parliament passed the Bank Act of 1844, which prohibited all banks except the Bank of England from issuing banknotes and required that any subsequent issuance of notes by the Bank of England must be based only on metal, not on securities. It was an attempt to make the bank note “a mere bullion certificate,”[11] i.e., a warehouse receipt for gold held on deposit. While the intention of this law may have been good, the effects could have been extremely problematic for trade and industry because it restricted the supply of exchange media. Withers points out that:

“If the apparent intentions of the Act of 1844 had been carried out, the subsequent enormous development of English trade, if it had been possible at all, must have been accompanied by the heaping up of a vast amount of gold in the Bank’s vaults. But its intentions were evaded by the commercial community, which had already accepted the advantages of a currency based on mutual indebtedness between itself and the banks [credit money]. The commercial community ceased to circulate bank notes under the new restrictions, developing the use for daily cash transactions of a credit instrument which had already acquired some popularity, namely, a draft or bill on its bankers payable on demand and now commonly called a cheque. The drawing of cheques was not in any way limited by the Act of 1844, and the cheque was in many ways a more convenient form of currency than the bank note. The use of the cheque, however, involves the element of belief to a much greater extent than that of the bank note.[12]

Thus, we see another instance in which “necessity is the mother of invention.” Since a check is not money but merely an order to pay money, anyone who accepts a check must first ascertain the credibility of both the drawer of the check and the bank upon which it is drawn. Does the drawer of the check actually have an account with the stated bank, and does that account have a sufficient balance for the check to be honored? Does the bank on which the check is drawn actually exist, and is it solvent? Despite these risks, and despite the fact that checks were not legal tender, their use became ever more popular. In Withers’ words, “the cheque has had to fight its way to its present supremacy without this advantage [of legal tender status], and to drive gold and notes out of circulation in spite of the fact that they were legal tender, and it was not. This it was enabled to do by its safety and convenience and the power of the drawer to hedge it about with restrictions.”[13]

The convenience of the check is obvious to those of us who grew up using it, but considering the risks described above, what makes it safe, and what are the restrictions that Withers speaks of? First, it can be legally negotiated (cashed or deposited) only by the payee. Unlike banknotes (which anyone can spend), a check, if it is lost or stolen, cannot easily be cashed or spent by the finder or thief. In addition, it can be made out for the exact amount due and after it is cancelled it is returned to the drawer to serve as a record and receipt for payment. These days, of course, instead of using checks, we more often transfer funds electronically to make payments and rely on our financial institutions to keep accurate accounts, although it is still wise to reconcile our account statements on a regular basis.

Gold Versus Credit Money-A Comparison

Many monetary reformers today still believe that money, to be sound, must be fully backed by gold or silver and be redeemable on demand. But this would be a step backward to a more primitive medium of exchange and would unnecessarily throttle the exchange process. The limited supply of whatever commodities might serve as money would limit the amount of trading that could take place with disastrous consequences for the economy. The reasons for this will become clear as we proceed. The answer to the abusive issuance and circulation of credit money lies not in turning back the clock and reverting to more primitive forms, but in perfecting the superior form, credit money, within the arena of free competition and decentralized control. The biggest challenge then is to find ways of transcending the political money system which has gained a virtual monopoly on credit worldwide.

The general lack of understanding of the real nature of money and the proper basis for credit money has often caused the political debate to run askew, leading many well-intended reformers to inadvertently restrict the supply of exchange media in an attempt to remedy abusive banking practices. Such was the case during the Jackson era (roughly, the second third of the nineteenth century). In the “Bank War” that we described in Chapter 4, President Andrew Jackson rightly put an end to the extreme privilege and power of the Second Bank of the United States, but at the same time he also adopted a restrictive “hard money” policy. Fortunately, the proliferation of banks and the easy availability of credit during this “free banking” period, while sometimes flawed, enabled a great expansion of industry and commerce in America.

The real argument is not between gold and paper, but between commodity money and credit money. To posit the argument as between specie and paper misses the point by confusing the physical manifestation or form of money with the essential substance of money. It is the basis upon which money is issued that is all important. Paper money can represent a “claim check” or “warehouse receipt” for gold on deposit (symbolic money), but it can instead represent the value inherent in particular collateral assets against which credit is monetized (credit money). Under the original fractional reserve banking system, these two were confused and intermingled, making trouble inevitable. As long as both claim check money and credit money were redeemable for specie, one could expect periodic bank runs and panics. The supply of commodities like gold and silver is limited by natural factors, and the cost of increasing such supply (by the process of mining, refining, and coining-or even by taking it as plunder) is very great, and furthermore, it is destructive to the environment. How does it make sense to dig gold out of one hole (a mine) only to bury it again in another (a vault)? Gold has very little use value aside from ornamentation-its desirability derives primarily from its historical “exchange value.” In times of financial uncertainty, gold may serve as an effective savings medium by hedging against the effects of inflation of legal tender currency. It can also provide portability of wealth for refugees, as well as some measure of financial privacy. Gold might serve to define a measure of value or unit of account, but it will not return as a primary payment medium unless there is a major breakdown of civilization. The expansion of credit, on the other hand, can be achieved at very low cost, and its quantity is limited only by the collective capacity of the people to produce and the aggregate value of the goods and services that people wish to exchange. By enabling every producer to create-within proper and reasonable limits-the credit money needed to satisfy their needs for goods and services, it is possible to have an honest, flexible, and sound means of facilitating exchange.

How Credit Money Malfunctions

In summary, a multitude of problems derive from abuse of the credit creation function. The great leap forward that credit money represented was, and still is, perverted by a financial regime that designed it to centralize power and concentrate wealth in a few hands. The monopolistic control over credit, exercised through a banking cartel armed with government-granted privileges, allows wealth to be extracted from producer clients and, despite the trappings of democracy, the control of governments to be maintained in the hands of an elite ruling class. Credit is allocated on a biased basis to favored clients, including central governments, which distorts both the system of economic rewards and the exercise of political power. Under this regime, the people’s own credit is privatized and “loaned” back to them at interest. The enormous benefits that credit money makes possible can be realized only when credit is allocated on a proper value basis and its circulation is controlled by we the people ourselves, within our communities. How that can be achieved will be fully explained in the following chapters.

[1] Hartley Withers, The Meaning of Money, 7th ed., 1947.

[2] To Thomas Jefferson from John Adams, 25 August 1787.

https://founders.archives.gov/documents/Jefferson/01-12-02-0064. Accessed April 21, 2024.

[3] Karl Polanyi, The Great Transformation. Boston: Beacon Press, 1944, 1957, p. 43.

[4] Adam Smith, Wealth of Nations. New York: Collier, 1909.

[5] op. cit., Withers, p. xi.

[6] Hugo Bilgram (with L. E. Levy), The Cause of Business Depressions. Philadelphia: J. B. Lippincott Company. 1914. p. 95.

[7] Jack Weatherford, The History of Money, p. 118.

[8] Edwin Vieira, What-Is-A-Dollar-An-Historical-Analysis-of-the-Fundamental-Question-in-Monetary-Policy-pdf. Accessed May 18, 2024.

[9] op. cit., Withers, p.18.

[10] RKO Pictures, 1946.

[11] op. cit., Withers, p. 21.

Originally published at http://beyondmoney.net on July 10, 2024.