The Orthodox Origin Story: Metallism and the Barter Myth

What kind of an economy do we live in?  Or, what kind of economy do we want to live in? These are not trivial questions. The Enlightenment thinkers took these questions quite seriously. Rejecting the constraints of a feudal society, philosophers such as John Locke, Thomas Hobbes, and Jean-Jacques Rousseau formulated methods for imagining a different world. Their approach was really quite simple: they asked their audience to imagine a place called the state of nature, a blank slate, or a time-equals-zero starting point. Using this state of nature, they considered possible social outcomes when they populated these blank slates with individuals possessing free will. Their method of rational deduction represented a radical departure from the determinist nature of the feudal world, where one was born into their societal role. Use of a fresh state of nature allowed these Enlightenment philosophers to ask fundamental questions about society and human nature. Setting their fictional populations of free individuals loose from the constraints of the feudal order, they deduced possible outcomes. Outcomes such as chaos, barbarism, or a harmonious stable society were imagined to emerge from the summation of individualized acts of free will.

In Locke’s version, individuals needed to follow two simple constraints or rules in order for a harmonious society to emerge and to avoid chaotic barbarism. The first rule is the spoilage constraint.  In the state of nature, no individual should collect more food, nuts, and berries than they can consume before they spoil. Second, the prejudice constraint could not be violated. This constraint is “predicated on the right to subsistence: the privatization of land could not disadvantage non-property holders, violating their right to subsistence goods”.^[1]  As long as all those in the state of nature follow these two simple moral constraints, then a harmonious and stable society is argued to emerge. Through the evolution of similar stories, political economy would add its own plot twists and establish the script for orthodox economics.

What these imaginary stories have in common is the collective illusion that capitalism or free market economics grows out of a state of nature. The basic plot and stage for this story remain the same in orthodox economics today. How often do you get dressed and ready for your day and prepared for class in the Cartesian plane? The Cartesian plane is a two-dimensional mathematical universe and the orthodoxy’s state of nature. In this mathematical space, rational agents maximize by making optimal decisions, like Locke’s imagined individuals facing fruit and nut constraints, the summation or aggregation of rational choices leads to a harmonious and stable solution. This solution is known as equilibrium. While the technical names and the math provide the orthodox story with a scientific veneer, the underlying plot remains generally the same as those told over the previous four hundred-plus years. This is similar to the Spiderman films. While CGI and other technologies allow the films to have more realistic effects, the underlying stories remain very similar. One must respect the staying power of these stories, both orthodox economics and Spiderman, but a significant cost of this longevity is a lack of analysis regarding the actual economy in which we live and conduct business.

Another central feature of the harmonious happy endings found in the state of nature narratives is barter exchange. The economies described by Jean Baptiste Say^[2] and other classical political economists of his era, as well as by modern orthodox economists, is a barter economy. In a barter economy, goods trade for other goods. If we were to open a barter market in class, and students could trade their hats, backpacks, books, shoes, and whatever else they have in their possession with other students, would many trades take place? Generally, the answer is no. This is because it would be rare that the double coincidence of wants would be solved.

The double coincidence of wants means that for trade to occur I must have what you want and you must have what I want. If and only if this is the case will trade occur. Further, trade must make us both better off than we were before the trade took place. Given these criteria, arriving at a situation in which trades take place is difficult. The double coincidence of wants represents a significant barrier to trade and a problem. To solve this problem and reduce the amount of time individuals need to spend seeking out solutions to the double coincidence of wants, society spontaneously agrees to use a commodity as the facilitator of exchange—or at least this is how the story is told from the state of nature and Cartesian plane origins.

Before moving on with this story, let us take a moment to consider the proposition of spontaneous agreement. We have a society practicing barter, that tires of solving the double coincidence of wants, and spontaneously agrees that one item, one special commodity can be used as a facilitator of all exchanges. That seems like a major economic decision. When was the last time that you were in a group, and the group spontaneously and unanimously came to a decision? For instance, how often, when you and your roommates or family members are discussing dinner or other household decisions does spontaneous and unanimous acceptance occur? This unexplained or clarified gap in the narrative should raise flags about this narrative’s plot.

But let’s humor our narrator and set aside the challenges of making collective decisions. What was this magical commodity that solved the double coincidence of wants problem and set the economy free? Money, or more specifically, commodity money in the form of gold or silver is the traditional telling of the story. These metals are often described as the commodity in this narrative, because, it is argued, they have what is called intrinsic value. Intrinsic value is a key concept and can be defined as the value the object has in and of itself. This intrinsic value is why precious metals are able to fulfill the critical task of facilitating exchange. Because everyone knows this intrinsic value, they can establish a measure or price in relative terms to all goods being traded. Thus, through this spontaneous and collective agreement to use gold, silver, or some other commodity, the transaction costs for all the producers and consumers in this economy are reduced, and they are all therefore better off.

Because of the use of precious metals to denote the value of money, we refer to those who claim this origin story of money as Metallist.  We can model money as the facilitator of a barter transaction using the following notation of C for commodity and M for money.

This barter economy story is likely the one you have heard before, and it is definitely the one that was told to your parents in their introductory economics courses. As mentioned above, it is an old story. The roots of its origins go as far back as Plato and Aristotle, but the more modern versions are linked to the 16th and 17th-century Enlightenment philosophers discussed above.

The staying power of this story is partially attributable to the idea that gold or silver is where money’s value comes from and that gold is valuable in and of itself. It has intrinsic value that can be measured by the metal’s weight and quality. These features help orthodox economists explain why it is a convenient object or commodity for facilitating trades with other commodities. Moreover, as a commodity, money preserves the barter system. In a barter framework, economists are able to practice real analysis, which is the standard methodological approach in orthodox economics.

Real analysis is described by the 20th-century economist Joseph Schumpeter as:

[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. This device can no doubt get out of order, and if it does it will indeed produce phenomena that are specifically attributable to its modus operandi.  But 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.^[3]

By unpacking this quote and placing it within the context of modern economic events, it will become clear that the commitment made by orthodox economics to the Metallist’s story is not intended to provide an accurate understanding of history, but is rather an effort to preserve their method of economic analysis.

While the barter story is intuitively appealing, especially when described as an economy in a time and place far, far away, difficult questions about value and the role of the state complicate this simple story. For instance, when gold or silver was spontaneously accepted as commodity money, did people just trade nuggets or pieces of metal? Where did coins come from? Who made the coins, and how was their value determined? Does gold really have value in and of itself, or is its value the result of costumes and culture? Furthermore, as economies incorporate paper money, how is the value of the currency maintained if it cannot be directly converted into gold or silver? These questions are examples of critical analysis. Rather than accepting the story as given, critical thinking and investigation help our understanding of money advance.

To address these critical inquiries, let us return to Schumpeter’s description. Money’s value is derived from its use as a technical device in the facilitation of exchanges. Its value is intrinsically grounded by precious metals. In this scenario, it is a commodity like all other commodities. Difficulty only emerges if it gets out of order. If money’s modus operandi extends beyond the facilitator role, then the economy is no longer functioning as part of a barter system. It is in this capacity, as something more than a technical device, that the Chartalist school of thought is introduced and a second origin story takes shape.

Similar to the complications created by the overlapping narratives in the Marvel Cinematic Universe, money’s commodity story is disrupted by changes in technology, laws, and global politics. Combining all three of these disruptions is the creation of fiat currencies. Merriam-Webster defines fiat money as “money (such as paper currency) not convertible into coin or specie of equivalent value.” Specie is coins created from precious metal such as gold or silver. Thus, fiat money is simply money that is created without any equivalent or intrinsic value connected to it.

In other words, money’s value is not connected to some other commodity. Examples of fiat money are the dollar in the United States, British pounds in England, and the Japanese yen. These monetary notes are issued by fiat because the issuer will not give us anything other than other notes they issue if you want a replacement. In other words, the dollar is inconvertible paper money. The gold standard allowed the commodity money story to survive the complications associated with the expansions of both credit money lending and paper money. As long as money remained convertible into gold, the argument could be sustained that its value was intrinsic. However, the elimination of the gold standard has ended the convertibility-intrinsic value chapter and requires further explanation that goes beyond the capacities of real analysis. If money cannot be converted into gold, and value is not intrinsically determined, then where does its value come from?

Origins in History and Accounting: Smith, Marx, and Keynes

To introduce our inquiries into fiat money’s value, let’s examine the following two quotes, from arguably the two most significant characters in the history of political economy.  The first comes from Adam Smith’s Wealth of Nations:

A prince, who should enact a certain proportion of his taxes be paid in a paper money of a certain kind, might thereby give a certain value to this paper money.^[4]

The second quote, similar in theme, comes from Karl Marx and reads:

The only part of the so-called national wealth that actually enters into the collective possessions of modern peoples is—their national debt. Hence as a necessary consequence, the modern doctrine that a nation becomes the richer the more deeply it is in debt.  Public credit becomes the credo of capital.  And with the rise of national debt-making, want of faith in the national debt takes the place of the blasphemy against the Holy Ghost, which may not be forgiven.^[5]

From these two quotes, the primary difference between the Metallist’s and Chartalist’s approaches to understanding money is revealed.  Money is not a commodity.  Money is, in the words of the legal scholar Friedrich Knapp, a creature of the state.

What may seem to be a subtle difference is in reality substantial. The reorientation of money as a state phenomenon, rather than a market solution to the double coincidence of wants, requires a completely different framework for analyzing the economy. The economy can no longer be modeled as a barter system. Real analysis fails to capture the complexity and social character of money, and thus even the existence of general equilibrium itself is called into question. Returning to Schumpeter, if the modus operandi of money is not simply a facilitator role, then we must conduct monetary analysis.  Simply put, this requires the abandonment “of the idea that all essential features of economic life can be represented by a barter-economy model” (Schumpeter 1954).

We can begin to appreciate the difference between the analysis of a barter system and a monetary economy by applying Marx’s notation and modeling of the circuit of money capital. This notation is simple and straightforward (see also Chapter “The Megacorp”).

The first stage M – C, where M is money and C represents commodities, is termed purchase and is followed by the production process P culminating with C’ – M’ sale, where C’ denotes new commodities and M’ more money.  This analysis of the economy is a form of monetary analysis.  Returning to the barter notation, from above, the transaction is modeled as follows.

Note, there is no C’ in this exchange.  This is because the value is generated, not by production or labor, but through the act of exchange.  Remember, in the barter economy of the orthodox school, trade does not occur unless both parties benefit.  Value is created through the exchange process and relative prices become the measure of those values (this is also described in Chapters “Philosophy of Science” and “Challenging the Role of Utilitarianism“). In contrast, using Marx’s model, value is created through the production process and value is created by labor.

As you can see, the interpretation of how the economy operates is very different. The predictions of outcomes from market activity are also at odds with this monetary perspective. In the real analysis of orthodox economics, markets trend towards equilibrium. Real analysis predicts a stable solution where the quantity demanded is equal to the quantity supplied. However, if the economy is investigated from the monetary analysis perspective, simple solutions do not immediately present themselves, as conflict, business cycles, and crisis are all consistently observed in capitalist economies and represent important factors in heterodox theoretical frameworks.

This is one of the reasons why John Maynard Keynes considered his approach to understanding the economy as The General Theory of Employment, Interest, and Money.  Similar to Marx, although Keynes denies any Marxian influence, Keynes moves his analysis of the economy beyond the barter system and real analysis and attempts to understand the dynamics of a monetary production economy. In a series of lectures at Cambridge University, Keynes argued to move beyond the simple barter model of neoclassical economics: “the next task is to work out in some detail a monetary theory of production.” Primary to that task is to understand “the problem of selling real output for money in order to ‘realize’ its value.” Similar to Marx, this “realization” occurs when output is sold for a profit or what Marx defined as surplus value.

The problem of realization includes understanding money not as a simple commodity, but as something very different. In his discussion of money Keynes identifies two special properties and describes how those special properties influence the dynamics of our macroeconomy. For example, Keynes presents the case that in a monetary production economy, there is no reason to assume the economy will trend toward full employment equilibrium in the labor market. In fact, given the special properties of money, the economy is more than capable of coming to rest, for long periods of time, at a level of output far below what is necessary to achieve full employment (see also chapter “A Heterodox Macroeconomic Perspective“). This contribution was particularly relevant during the writing and development of the General Theory, as the world was plummeting into the Great Depression.

The two special properties that make money different from all other commodities are a near zero elasticity of production and a near zero elasticity of substitution. The first means that, while it might be reasonable to argue that a problem in our local economy is that there is a shortage of money, we cannot go into the business of selling money.  So unlike wheat, milk, cars, computers, or any other good or service, as entrepreneurs, we cannot address the unmet demand for money by producing and bringing it to market ourselves.

The second of these properties, a near-zero elasticity of substitution, relates to the use of money as a means of payment. The state and most private vendors will only accept dollars (in the United States) as means of payment to satisfy debt obligations. Wow, that is a mouthful, but it simply means that there are very few substitutes for money as a method of payment. The IRS will not take your laptop as payment for your taxes. The gas company is not interested in your tee shirts to satisfy your bill; they will only accept one thing: cash. As the Wu-Tang Clan so succinctly puts it, C.R.E.A.M. “cash rules everything around me…. dollar dollar bill y’all.”

So, both of these special characteristics or properties of money influence a monetary production economy by incorporating two missing pieces from the real analysis approach of orthodox economics—uncertainty and the state. By differentiating money from all other commodities, we may still be able to “barter” in a monetary production economy, but the addition of money, as something special, identifies a new and more complex economic system that must be analyzed using new and different approaches. Hence, it is a more “general theory.”

To demonstrate how Keynes’s understanding of money complicates matters, let’s introduce the role of the state in monetary affairs and then provide a brief discussion of uncertainty. Why can’t we produce dollars? Well, one very good reason is that it is against the law. The U.S. Constitution authorizes Congress and only Congress to issue and create money through legislation and appropriation. We will elaborate on this in detail in the next section. Spending and the creation of new money starts with Congress (a near zero elasticity of production).

The second property, a near zero elasticity of substitution, is also a function of law. Why won’t the IRS take my laptop in payment of my tax liability? For this let’s take a moment to look at the dollar (Figure 1 above). Up in the upper left corner, it says “THIS NOTE IS LEGAL TENDER FOR ALL DEBTS, PUBLIC AND PRIVATE”. This means that there is no reason for the government to accept anything else. If you believe that your laptop is of sufficient value to cover your tax obligation, then you must first convert it into cash to pay your tax bill. The need to convert assets into dollars in order to satisfy one’s debt obligation introduces Keynes’s conceptual framework for understanding liquidity as well as uncertainty to his monetary production economy.

Liquidity is a measure of the costs associated with converting an asset into cash. This, in a sense, reverses the commodity money story’s understanding of convertibility. Remember, in the orthodox story, money is convertible into gold, a commodity; here, you must convert your commodity into money to satisfy your obligations. For instance, a savings account is an asset. It has a high degree of liquidity, because all you need to do to convert it into cash is to go to the bank and withdraw the funds. Your time and effort are a cost, but these costs are relatively low. An example of an asset that is not generally described as being liquid is a home. The sale and conversion of a home into cash is a time-consuming and often expensive process. An asset’s liquidity is of great importance for understanding uncertainty and economic volatility.

To describe the value of assets in a monetary production economy, Keynes developed a very simple model known as the own rate, given by the equation below.  The own rate is a measure of an asset’s economic value and is composed of three parts, the expected return on the asset (q), its carrying costs (c), and the liquidity premium (l).  The own rate is modeled mathematically as,

[latex]\text{own rate} = q - c + l[/latex]

Returning to the example of a home, the housing market in the United States was rather consistent up until the housing crisis of 2008. Before this market crash, the conventional wisdom was that if you purchase a home, you can expect that it will increase in value over time. This trend has recovered to some extent in the U.S., but variability in prices remains more of a concern since the Great Recession. So q is generally considered to be positive when determining the own rate. Next, a home’s carrying costs are not cheap and must be considered.  Maintenance, mortgage payments, property taxes, etc. all push up the carrying costs, but one big benefit is that you get to live there. The final component of the own rate is the liquidity premium. A house in a sellers’ market in a good neighborhood might sell quickly, whereas a home next to a newly constructed slaughterhouse might not be so easy to unload. Therefore, the former is more liquid, easier to convert into cash, than the later.

Thus, people’s view toward the future plays a critical role in determining an asset’s own rate.  If the housing market is strong, people believe prices are trending up, then it is easy to sell because the expected return is positive and the future seller does not think selling in the future has many risks either. On the other hand, if the economy is doing poorly, the expected return is going down, carrying costs might be increasing, pickier buyers are demanding more and more repairs, and the liquidity premium is disappearing, as a buyer cannot be found.

The own rate equation can be applied to all sorts of commodities. Give it a try.  Think about a car, financial assets, or a record collection. These assets all experience changes to their own rate based on expectations of the future and how quickly they can be converted into cash.  Because it is more difficult to convert assets into cash when markets are unstable and uncertain, people tend to hold onto the one item that is not negatively impacted during these periods of uncertainty. You guessed it: their cash money.

If we return to Adam Smith’s comments above, we can add the contributions of Marx and Keynes to complete the basic framework for understanding money, not as a commodity in a barter system, but as a social relation in a modern monetary production economy.  Remember, the value of money in the Metallist’s story is derived intrinsically from precious metal, but Adam Smith suggests that value can be generated by the actions of the Prince. Smith is making a prescient observation, because modern fiat currencies maintain value by generating demand through the implementation of a tax or other obligation to the money-issuing authority. From this historical and institutional approach to investigating money, we can see that the heterodox development of monetary analysis reveals fundamentally different dynamics and explanations of the operations of the modern economy. This interdisciplinary perspective argues that economic activity is observed to begin and end with money. Money plays this central role because it has special properties, and an institution, such as the state, is responsible for maintaining the currency’s value.

In sum, a monetary production economy is one in which money mobilizes productive resources and that mobilization is contingent upon the prevailing economic expectations of individuals and institutions. Breaking free from the methodological constraints of real analysis and building from the works of Smith, Marx and Keynes, Modern Monetary Theory, neo-chartalism, and constitutional money represent a collection of alternative schools of thought that provide insights into economic activity where money serves as more than the modus operandi in a barter economic system. As such, each of these schools of thought contribute to the development of monetary analysis and more general theories of economics.

In the next section, monetary analysis is conducted to understand money as a social relation. One critical insight developed is that money, as a social relation, is identified as a two-sided balance sheet operation. The relation between credits and debits and the power to construct these balance sheet operations is organized in the modern economy by hierarchical structures. From this perspective, the coordinating function of money in the economy becomes evident and allows us to further inquire if the firm or money is the mobilizer of resources.

Glossary

barter economy

a system in which goods trade for other goods, that is, without money as an intermediary

chartalism

the belief that the value of money derives, not from the intrinsic value of the commodity, but from its general acceptability for payments and the ability of the state to create demand for it through taxation

double coincidence of wants

the fundamental problem of barter in which, for trade to occur, I must have what you want and you must have what I want

intrinsic value (of commodity money)

the value the object has in and of itself

metallism

the belief that the value of money derives from the intrinsic value of the commodity (for instance, gold) the physical money is made from

prejudice constraint

One of John Locke’s two constraints on property rights, holding that private property cannot prevent the ability of non-property holders to survive.

real analysis

the study of real changes to output, employment, distribution, and growth without addressing money as anything other than a facilitator of exchange

specie

coins created from precious metal such as gold or silver

spoilage constraint

One of John Locke’s two constraints on property rights, holding that no person should collect more resources than they can use before they spoil.