The Origin of Money – 1

“The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.”
–J.M Keynes

Last time we saw that the “conventional” definition of money does not hold in an anthropological context. We saw that different “money-things” functioned in different and often distinct spheres of exchange. We also saw that “money” was used primarily to discharge social obligations, rather than being used in closed-ended spot transactions. Often times, money used in market exchanges was kept distinct and separate from what was used in reciprocal social obligations, often to protect social relationships from monetization, as Karl Polanyi pointed out.

These facts are important to keep in mind when discussing the history of money.

1. The conventional theory is wrong

The conventional view is that money evolved to reduce transaction costs in an imaginary barter society. An intermediate commodity that would serve as a “medium of exchange” would be chosen by all members of the community through a process of trial-and-error. Not just any item would do, however. It had to be durable. It had to portable. It had to be divisible. And it couldn’t be too common, otherwise money would lost its value.

Gold (and silver), being all of these things, gradually emerged as the most logical choice. It does not oxidize or decay. It is malleable into different shapes. It is portable. It is reasonably rare:

Karl Menger, an Austrian economist, set out one school of thought as long ago as 1892. In his version of events, the monetisation of an economy starts when agricultural communities move away from subsistence farming and start to specialise. This brings efficiency gains but means that trade with others becomes necessary. The problem is that operating markets on the basis of barter is a pain: you have to scout around looking for the rare person who wants what you have and has what you want.

Money evolves to reduce barter costs, with some things working better than others. The commodity used as money should not lose value when it is bought and sold. So clothing is a bad money, since no one places the same value on second-hand clothes as new ones. Instead, something that is portable, durable (fruit and vegetables are out) and divisible into smaller pieces is needed. Menger called this property “saleableness”. Spices and shells are highly saleable, explaining their use as money. Government plays no role here. The origin of money is a market-led response to barter costs, in which the best money is that which minimises the costs of trade. Menger’s is a good description of how informal monies, such as those used by prisoners, originate.

On the origin of specie (The Economist)

Alfred Mitchell-Innes, the author of a groundbreaking paper on the true origins of money, laid out the conventional theory this way:

…under primitive conditions men lived and live by barter…as life becomes more complex barter no longer suffices as a method of exchanging commodities, and by common consent one particular commodity is fixed on which is generally acceptable; and which therefore, everyone will take in exchange for the things he produces or the services he renders and which each in turn can equally pass on to others in exchange for whatever he may want…this commodity thus becomes a “medium of exchange and measure of value.”

…a sale is the exchange of a commodity for this intermediate commodity which is called “money;”…many different commodities have at various times and places served as this medium, of exchange, – cattle, iron, salt, shells, dried cod, tobacco, sugar, nails, etc.;

…gradually the metals, gold, silver, copper, and more especially the first two, came to be regarded as being by their inherent qualities more suitable for this purpose than any other commodities and these metals early became by common consent the only medium of exchange…

What the Classical and Austrian economists did, in essence, was to try and imagine the origin of money by envisioning a society much like their own–Western European market societies, complete with dense populations of strangers, centralized governments and banks, and occupational specialization–and then take money away. How would people cope? They would have to barter for things, of course! And then they constructed the rest of the narrative from there.

However, this is bad anthropology, and bad science. Ancient societies were very different from their own market-oriented societies. Market societies are a historical contingency based on a great variety of factors, many which were not known to classical economists. You cannot simply imagine one’s own society, complete with all its various complex political and socioeconomic arrangements, and then take away one variable to construct the history of that variable.

Rather than using empirical reasoning to arrive at their conclusions, they used deductivist reasoning not rooted in actual data. Their conclusions were also predicated on the aggregate actions of isolated individuals who had no pre-existing social relationships with each other, something also not found in actual societies.

Several problems emerged almost immediately with this narrative. One is the extreme unlikelihood of a single standard emerging without recourse to some sort of established central authority, as Randy Wray notes:

Orthodoxy has never been able to explain how individual utility maximizers settled on a single numeraire. While the use of a single unit of account results in efficiencies, it is not clear what evolutionary process would have generated the single unit. Further, the higgling and haggling of the market is supposed to produce the equilibrium vector of relative prices, all of which can be denominated in the single numeraire. However, this presupposes a fairly high degree of specialization of labor and/or resource ownership–but this pre-market specialization, itself, is hard to explain.

Once markets are reasonably well-developed, specialization increases welfare; however, without well-developed markets, specialization is exceedingly risky, while diversification of skills and resources would be prudent. It seems exceedingly unlikely that either markets or a money of account could have evolved out of individual utility maximizing behavior.

Geoffrey Ingham argues that the typical sequence has it backwards: money had to be established first, before markets could form. Otherwise, how could anonymous market exchanges take place? In other words, money is historically anterior to markets, and therefore could not have emerged out of innumerable market transactions:

‘In the first place, without making a number of implausible assumptions, it is difficult to envisage that an agreed money of account could emerge from myriad bilateral barter exchange ratios, as the Mengerian commodity theory implies. How could discrete barter exchange of, say, 3 chickens to 1 duck or 6 ducks to 1 chicken, and so on, produce a universally recognised unit of account? The conventional answer that a ‘duck standard’ would emerge ‘spontaneously’ involves a circular argument. A single ‘duck standard’ cannot be the equilibrium price of ducks established by supply and demand because, in the absence of a money of account, ducks would continue to have a range of unstable exchange ratios.

As opposed to discrete truck and barter, which produces myriad bilateral exchange ratios, a true market, which produces a single price for ducks requires first and foremost a stable unit of account’.

As we have seen, most specialization took place within the context of a redistributive economy, whereby specialized products would be collected and redistributed by some sort of central authority such a tribal chief, religious authority, or palace, rather than a market-oriented one. Other economies functioned on a household basis where craft specialists were members of the same household and produced items for internal use of the group rather than external market exchange. Although some specialists might sell their surplus goods outside of the household context, and households exchanged surplus commodities with each other, this likely was not done through barter exchanges. Instead, merchant intermediaries would likely acquire surplus commodities from various households and store them for later use. These merchants would then match up goods with buyers over time in their shops. In other words, the producer was usually not also a seller. This was just as likely conducted through credit/debit relationships rather than though barter. This is how many small village markets operate even today in developing countries.

Another flaw in this theory is that very often specialist producers would have nothing to barter with until they first procured the the land or raw materials they needed in order to create their item. This means exchanges are often spaced out in time as well as space, requiring not spot transactions but, once again, credit.

For example, a farmer needs to acquire land and seeds long before she has any crop to sell. A herdsman needs to first procure the cattle for breeding before he can sell the calves. A smith needs to first procure metal before he can forge a tool. All of these exchanges require not spot trades, but rather credit. This means that barter was an unlikely basis for an economy even in more complex, specialized Neolithic economies:

The idea that barter, that is the direct free exchange of goods and services, was a viable basis for an economy is unrealistic for two reasons. First, due to the seasonal nature of many products, the things which people need to exchange may not be produced at the same time of the year.

Second, and even more important, is the fact that most productive activities involve a sequence of stages from the production of the primary raw material to the sale of the finished product. The perfecter of the finished article has nothing to exchange with the producer of the raw material: the latter has to supply on credit terms, that is on trust that at some future time he will be reimbursed in some way.

Wray, Credit and State Theory of Money pp. 118-119

There are other problems as well. The historical evidence indicates that in ancient times, precious metals were far too valuable to be used in everyday transactions:

it should not be accepted on faith that using monetary metal was simpler than barter. To begin with, the high value of silver and gold implied that they would be used only for large transactions. In the Old Babylonian period (2000-1600 BC), notes Marvin Powell, a shekel ‘represented a month’s pay’, thereby limiting the ability of most people to pay on the spot for consumer transactions. Measuring smaller quantities of monetary metal became more error-prone, with deviations rising to about 3 per cent for small weights.

Wray, Credit and State Theories of Money p. 101

This “stable unit of account” is what allowed markets to form and market trading to take place. It was a schedule of price equivalencies evaluated against a common standard which allowed market trading to take place. All historical and anthropological evidence indicates that this stable unit of account was established through the actions some sort of central governing authority, whether political or religious, in every society. In other words, money was first and foremost a social technology which facilitated cooperation and trade; it was not generated spontaneously through the gain-seeking actions of numerous “rugged individualists” by osmosis. It was a way of recording debts and credits, and was never an intrinsically valuable “thing.” The fact that precious metals were used to keep track of these is a historical contingency which masks the true nature of money.

In addition, coins are what have survived. The systems of credit clearing which underlay these items do not preserve in the archaeological record. This gives the mistaken impression that the precious metals contained in coins were what was being traded for, and credit was just a substitute–a promise to pay gold and silver later because the former were just to hard to carry around.

The flaws of the conventional theory are summed up by Tim Johnson:

The narrative that money emerges out of barter has become part of received wisdom and as with most ‘common sense’, it has no basis in fact. Just as astrophysicists use telescopes to look back in time, anthropologists visit isolated communities to see how society evolved, and the evidence of this research is summarised by Caroline Humphrey (a.k.a. Lady Rees of Ludlow):

“Barter is at once a cornerstone of modern economic theory and an ancient subject of debate about political justice, from Plato and Aristotle onwards. In both discourses, which are distinct though related, barter provides the imagined preconditions for the emergence of money …[however] No example of a barter economy, pure and simple, has ever been described, let alone the emergence from it of money; all available ethnography suggests that there never has been such a thing.” [Humphrey, 1985, p 48]

What actually happens in practice is that when individuals knew each other, exchange was based on reciprocity; a gift would be given in the anticipation of it being reciprocated in the future (when they don’t know each other there is barter, but in such situations money cannot emerge because cowrie shells might be important in one society, and gold in another).

One of the most famous stories illustrating the role of reciprocal exchange has concerns an anthropologist who after spending some time with bushmen, gave one of them his knife. When visiting the group some years later, anthropologists discovered that the knife had been owned, at some point in time, by every member of the community. The knife had not been communally owned, its ownership had passed from one person to the next and its passage was evidence of a social network in the community, just as the motion of planets is evidence of an, otherwise invisible, gravitational field.

Lady Credit (Magic, Maths and Money)

So how did money really come about? That’s what we’ll start to look at next time.

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