In the past year, Modern Monetary Theory (MMT) has shifted the policy debate in a way that few heterodox schools of economic thought have in recent memory. MMT’s central notion—that nations with their own strong currencies face no inherent financial constraints—has made its way into politics and, notably, the world of finance. The last few months have brought MMT explainers from financial media outlets including Reuters, CNBC, Bloomberg, Barron’s, and Business Insider, as well as from investment analysts at Wall Street firms including Goldman Sachs, Bank of America, Fitch, Standard Chartered and Citigroup.
Popularizing the shorthand notion that “deficits don’t matter” has been an achievement for those promulgating MMT. Yet one largely unappreciated change brought about by the MMT debates involves a somewhat subtler point: a shift in the implicit story we tell about money.
The rise of MMT poses a challenge to the mainstream commodity money story. That parable, familiar to anyone who has taken high school economics or read Adam Smith, involves an inefficient barter system that gives way to the more convenient use of some token that represents value, typically a precious metal. If government plays a role in this story, it is only to regulate money after the marketplace births it.
The MMT parable—known in the literature as chartalism—reverses the commodity money view. For chartalists, money arises through an act of law, namely the levying of a tax which requires citizens to go out and get that which pays taxes; the state comes first and markets are subsequent. As Abba Lerner puts it, money is “a creature of the state.”
It is tempting to present the conventional commodity money and charlatist views as two poles in a monetary binary, but there is also a third line of thought, related to yet distinct from the chartalist school. This is the credit money tradition, which sees money’s origins in reciprocal obligations between producers. Unlike chartalism, the credit theory presupposes markets of some sort. Unlike the commodity view, credit theory does not require money to initially take some physical form of value. Government typically plays a role in the story that the credit money school tells, but not the foundational one that it does in chartalism.
Market societies use narratives to justify the social technology called money. How do the essentially worthless slips of paper in my wallet or the digital entries in my bank account give me command over real resources? Answering this question requires, consciously or not, a story that rationalizes money—even if it’s not exactly accurate. Like the Copernican theory of epicycles, a story can function effectively even if it’s not strictly true. But this sort of story can also lead us astray. As debates around money, debt, and the state continue, it is worthwhile to review these three theories of money, each of which has distinct implications for the role of government in the economy and the limits of monetary policy.
The commodity money story begins with Aristotle, who located the birth of money in large-scale foreign trade. Because “the various necessaries of life are not easily carried about,” traders came to conduct exchange in something “intrinsically useful and easily applicable to the purposes of life” such as iron or silver. Later, some authority stamped the metal discs to save the time of weighing them.
Two millennia later, Adam Smith wrote his own commodity money parable. Here, money arose from the domestic division of labor between the butcher, the brewer, and the baker. The brewer and baker need meat while the butcher has too much of it. Yet because the butcher has enough bread and beer, no exchange takes place. In a society with a division of labor, then, “every prudent man” would set aside “a certain quantity of one commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry.” This commodity became money.
Commodity money got its most rigorous treatment from Austrian economist Carl Menger, who in 1892 devised the notion of saleability to explain money’s origins. In Menger’s theory, trial and error teaches producers to exchange their goods for those commodities that are easiest to sell: at any time, they can be exchanged at the smallest possible discount. Compare, for instance, the ease of selling 10 shares of Apple stock in the next 24 hours versus trying to offload some of the examples Menger gives as not-so-saleable goods: “astronomical instruments, anatomical preparations, sanskrit writings, and such hardly marketable articles.”
For Menger, money emerges as the “most saleable” commodity. It might be grain or iron, given the circumstances: the point is that it is always accepted because others will take it as well. Money emerges “without convention, without legal compulsion, nay, even without any regard to the common interest,” a product of decentralized exchange that serves only to lubricate the wheels of commerce. Incidentally, Marx’s account of money shares certain similarities with Menger’s story, and some contemporary Marxist interpretations follow in this tradition, such as the recent work of Costas Lapavitsas, who cites Menger favorably.
Chartalism, or State Money
The chartalist parable preferred by MMT proponents turns the commodity money story on its head. Instead of money arising in exchange and later getting state approval, chartalist money begins with a central authority. The name chartalism originates with the early 20th century German economist Georg Friedrich Knapp. Knapp chose the word “chartal,” rooted in the Latin word for “ticket,” to describe money as merely a token devised by the state. Knapp imagined a hierarchy of money with state-defined money at the top.
Knapp’s impenetrable system, which required scores of specialized terms, did not take off. Yet Knapp had his admirers—among them John Maynard Keynes, from whose 1930 Treatise on Money MMT gets its name. Keynes saw the state’s role not only in enforcing money contracts, but, crucially, in the right to define what counts as money. “This right is claimed by all modern States and has been so claimed for some four thousand years at least,” Keynes wrote. Once states exercised this right, “Knapp's chartalism—the doctrine that money is peculiarly a creation of the State—is fully realised.” “Modern” money thus began with the Babylonians.
Chartalism advanced with the progressive New Deal-era economist Abba Lerner, father of “functional finance.” In the 1990s the so-called neo-chartalists emerged, among them economists L. Randall Wray and Stephanie Kelton. Each has provided something of a parable for the state money viewpoint.
In his 1998 book Understanding Modern Money, Wray imagines a hypothetical colonial governor who wants her subjects to build her a mansion. After futile efforts at getting the natives to work by offering wages and threatening violence—because they are ignorant of “money, prices, and markets”—she finds that taxation will do the trick. She levies a tax and offers paper money (adorned with her face) in exchange for labor done in her service. The state pays people who work for money so that they will pay taxes back to the state. Eventually the governor gets her house. (Such a process has indeed occurred throughout history, especially as part of the process of European colonialism.)
Kelton has offered a more politically palatable narrative. To illustrate the notion that the state must spend money before it is taxed back—that money is not something external to the state that it needs to acquire—Kelton offers the analogy of the game of Monopoly. For a game to begin, the “banker” gives everyone money. It would make no sense if the game began with the banker (i.e., the state) demanding payment of taxes so that the state could then spend. The lesson, says Kelton is that “somebody has to spend the currency into the game or the game can't begin.” This is the role of the state.
Neither Wray’s parable nor Kelton’s explains the origins of money in a literal sense. In the colonial governor story, the governor must be already familiar with money before it is thought to emerge. Commodity money stories suffer from a similar chicken-egg problem: Smith and Menger each take as given the existence of well-developed domestic markets. But would these markets exist before money was around to enable them? Notably, Aristotle (as well as Marx) saw money’s origins not in a stylized domestic sphere, but in foreign trade. In fact, Aristotle held that it was the introduction of coin that actually spurred retail trade. Smith’s account reverses this causation.
The credit money tradition takes as its starting point debts between producers. Though various thinkers in the 18th century prefigured credit theory, it was finally stated in full by the idiosyncratic Scottish economist Henry Macleod in 1889, for whom money is “merely a Right or Title to acquire some satisfaction from some one else, i.e., a Credit.”
The credit money parable draws its characters directly from Smith’s barter parable. Advancing Macleod’s thesis in the 1910s, economist A. Mitchell Innes imagined a baker and brewer bartering for meat from a butcher who, again, needs neither bread nor beer. Instead of fixing upon some physical item to serve as an exchange token when direct barter fails, the merchants just exchange IOUs. As long as “the community would recognize the obligation of the baker and the brewer to redeem these acknowledgments in bread or beer at the relative values current in the village market,” we have “a good and sufficient currency.” The community’s recognition of the mutual debts may take the form of a state decree that x is the money of account, that is, x is how debts are measured and extinguished.
The idea that money is best thought of as credit would prove influential. Schumpeter lent substantial support to the credit-first view of money. Post-Keynesian economists from Nicholas Kaldor and Paul Davidson onward operated from a credit-money viewpoint. There is also some overlap between the credit and neo-chartalist approaches. MMT emerged largely from post-Keynesian circles, and neo-chartalists endorse some credit-money notions (Wray is largely responsible for resurrecting Innes).
The fuzzy boundary between chartalism and credit money is not a recent phenomenon. In the same chapter that Keynes describes “modern” money as state money, he notes that in reality, “the use of bank money is now so dominant that much less confusion will be caused by treating this as typical and the use of other kinds of currency as secondary, than by treating State money as typical and bringing in bank money as a subsequent complication.” That is, credit money—money borne ab initio from the lending of banks—logically precedes state money.
Why money parables matter
When we judge monetary parables, exact correspondence to history is not the primary criterion. As Keynes wrote, money’s true origins “are lost in the mists when the ice was melting, and may well stretch back into the paradisaic intervals in human history of the interglacial periods, when the weather was delightful and the mind free to be fertile of new ideas.”
Money parables serve a purpose beyond historical specificity. They highlight aspects of money that theorists believe are paramount to economic life as we know it. For commodity money theorists, the essential economic fact is that of depersonalized market exchange between strangers. For chartalists, the point is the state’s power of monetary coordination; money does more than grease the gears that power the market. In the third view, credit money, uncertainty and mutual obligation take precedence.
Any theorist can pull from the depths of economic history some event that proves their narrative is the “right” one. But having the “right” origin story is not the main purpose of a money parable. Money parables identify the key aspects of money as it currently operates and rationalize its social purpose.
A nice contrast between two money parables can be seen in recent publications by two of the world’s foremost central banks: the U.S. Federal Reserve system and the Bank of England. The New York Fed publishes educational comics explaining the monetary system. One issue, titled “Once Upon A Dime,” is essentially Adam Smith’s parable but with cartoon aliens. By contrast, the BoE’s 2014 publication “Money Creation in the Modern Economy” takes a more modern view: “Whenever a bank makes a loan, it simultaneously creates a matching deposit in the borrower’s bank account, thereby creating new money,” the authors write. Money, the BoE says, is credit.
As the sociologist of money Geoffrey Ingham writes, monetary systems require “naturalizing” narratives—stories that convince us that money is not just some flimsy social construct, but something solid and necessary. The commodity view has obvious intuitive appeal: paper money has value because it stands in for something weighty and real. It may be less intuitive to see the monetary system as a set of interlocking promises or a government construct.
In some ways it doesn’t matter which parable holds sway, as long as it “works.” Copernican astronomers could predict the motions of the planets quite accurately using the artificial notion of epicycles; analogously, the modern entrepreneur might build a billion-dollar company under the illusion that each dollar must have some physical thing backing its value.
But eventually the wrong story can lead to error. Such was the case in the post-crisis years, when the Fed began its quantitative easing program, trading its own newly “printed” dollars for privately held financial assets in order to drive down interest rates on outstanding bonds. Those with a doctrinaire commodity-money view warned that such money creation could only lead to inflation. But as MMT proponents and credit-money theorists predicted—along with conventional economists less rigidly tied to the commodity-money view—quantitative easing did not spark runaway inflation. The recent predictive record of non-mainstream economists is in large part why Wall Street and financial media have given hearing to heterodox monetary ideas.
Much of the debate over MMT has to do with specific policy proposals, like the jobs guarantee or the suggestion that government not issue bonds. But underlying those specifics is an often unstated dispute over the nature of money and the stories we tell to comprehend it. Wherever one comes down on the validity of MMT’s claims, it would be beneficial if the current fervor around government debt and monetary policy leads to a wider recognition of the various narratives one can tell about money.
Experience and history show that the commodity view is insufficient to explain all the attributes of the institution of money. The dimensions of money that are downplayed in the textbook Smith-Menger barter narrative—credit and the state—are of central importance in understanding both how modern money likely arose and how it operates now. Economics education at every level ought to include and even privilege those narratives that foreground the role of debt and the state in money’s origins and operation.