I will explain, but first for the sake of context let me yield the floor to Uncle Joe, speaking to us remotely from 1954:
Even today, textbooks on Money, Currency, and Banking are more likely than not to begin with an analysis of a state of things in which legal-tender 'money' is the only means of paying and lending. The huge system of credits and debits, of claims and debts, by which capitalist society carries on its daily business of production and consumption is then built up step by step by introducing claims to money or credit instruments that act as substitutes for legal tender and are allowed indeed to affect its functioning in many ways but not to oust it from its fundamental role in the theoretical picture of the financial structure. Even when there is very little left of its fundamental role in practice, everything that happens in the sphere of currency, credit, and banking is construed from it, just as the case of money itself is construed from barter.Bitcoin begins with the error of, as Schumpeter puts it, starting with the coin. If you start this way and then ask a question like 'how is money created?', the answer you get is something like 'somebody makes it, either by mining gold out of the ground or by printing bills'. The concept of 'mining' bitcoin by performing expensive calculations is merely an ingenious conceptual twist on metallism, and makes perfect sense only within that framework. Outside of that framework, it is simply bonkers.
Historically, this method of building up the analysis of money, currency, and banking is readily understandable: from the fourteenth and fifteenth century on (and even in the Graeco-Roman world) the gold or silver or copper coin was the familiar thing. The credit structure -- which moreover was incessantly developing -- was the thing to be explored and to be analyzed. The legal constructions, too -- remember that most economists who were not businessmen were jurists -- were geared to a sharp distinction between money as the only genuine and ultimate means of payment and the credit instrument that embodied a claim to money. But logically, it is by no means clear that the most useful method is to start from the coin -- even if, making a concession to realism, we add inconvertible government paper -- in order to proceed to the credit transactions of reality. It may be more useful to start from these in the first place, to look upon capitalist finance as a clearing system that cancels claims and debts and carries forward the differences -- so that 'money' payments come in only as a special case without any particularly fundamental importance. In other words: practically and analytically, a credit theory of money is possibly preferable to a monetary theory of credit.
(J.A. Schumpeter, A History of Economic Analysis, p. 717)
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When smart people try to think carefully about the function of money, three phrases usually come to their minds: 'medium of exchange', 'store of value', and 'unit of account'. None of these descriptions are wrong per se, but if you examine each function carefully you'll notice that they form a chain of dependencies: money couldn't be a good medium of exchange if it weren't an effective store of value, and it couldn't be an effective store of value if it weren't a universal unit of account.
But then, how does it get to be a universal unit of account? Account of what?
Strangely enough, most 20th century economics texts never ask this question, leaving the whole theory of money hanging in mid-air. To even get the merest hint that this was ever an open question, we have to travel all the way back in time to 1919, and take a look at Ralph Hawtrey's Currency and Credit, which was widely read up until WWII or so. In its first chapter we find a sketchy example of just what Schumpeter suggests: an illuminating analysis of an imaginary non-monetary market, conducted entirely on the basis of debit-and-credit book-keeping amongst producers and bankers. The first chapter is only sixteen pages long, it is available for free, and is remarkably lucid (though dense), so you really have no excuse not to read it. Go on, I'll wait.
What Hawtrey shows is that the one essential function of money is to act as a standard of deferred payment -- in other words, as a reliable means for the legal discharge of debt. In fact, most economic activity could go on virutally unaltered in the absence of money, using only credit issued by banks. However, says Hawtrey, there is a complication:
. . . in the absence of money there is a certain difficulty in closing transactions. The value of a debt depends upon the solvency of the debtor. The credit of the ordinary debtor is not good enough, or at any rate not well enough known, for his debt, unsupported by security or guarantee, to be a suitable means of payment. The use of bank credits would be necessary for this reason alone. But even banks are not always of unquestionable solvency, and in the exchange of a credit on one bank for a credit on another there is no finality. The need for a medium of payment which cannot be legally disputed is obvious. (R.G. Hawtrey, Currency and Credit, p. 15)
This is a neat way of glossing over what, historically, has actually happened over and over: the introduction of the rule of law administered by a sovereign legal entity has coincided with the imposition of money by fiat -- if the sovereign has to deal with disputes over debts anyway, it can save itself considerable hassle (and indeed, profit quite considerably) by imposing a standard, legally unambiguous way of terminating debts. The king's head on the coin means: 'The buck stops here.'
Nowhere, to my knowledge, do you see any of this explicitly pointed out in any economics text written after 1919. Even Hawtrey, having climbed this ladder, proceeds to discard it once he arrives at the higher abstraction layer of monetary analysis that fills the rest of the book -- a bit like how modern computer science students are required to take one course where they write a compiler in assembly code, and then expected to promptly forget all that nasty stuff for the remainder of their careers. Economics has sufficiently advanced in its senility, apparently, than even understanding the miracle the great financial 'compiler' performs is regarded as nolonger necessary.
Perhaps there is a reason for this. After all, two obvious implications of this point of view are:
1) That chartalism is after all a perfectly accurate theory of fiat money, so far as it goes, its main fault being that it's properly speaking a historical and legal theory rather than an economic theory, which has little to say about the really interesting aspects of economies. Admitting this would of course draw attention to the fact that money and power go together like carriage and horse, and help us to untangle economy and polity from the hopeless conceptual muddle they've been in since the 15th century, and of course make it obvious to everyone that economists are the handmaidens of state power. Er, whoops, did I say that out loud?
2) That if we had some alternative way to reliably and efficiently 'close transactions', i.e. a trustworthy mechanism to resolve debts frictionlessly, we would have no need whatsoever of money -- and hence no need of monetary theory. Hmm. The silence on this point is suddenly less surprising.
So, it seems that if we really want an honest opinion from an expert without vested interests, we're going to have to go back a little further in time.
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If we set our DeLorean for just a few years earlier, back to 1913, we get a real treat: in an essay which innocently asks 'What is Money?', the scholarly (and independent) diplomat Alfred Mitchell-Innes, something of an amateur time-traveller himself, begins at the same place as Hawtrey and then goes backward instead of foreward.
He points out that so far as the bulk of historical evidence is concerned there has never been any evidence for the 'metallic' theory of money -- that, for example, there has apparently never existed any stable relationship between monetary units of account and the material nature of the coinage. Quoth Mitchell-Innes: 'There can be no doubt that all the coins were tokens and that the weight or composition was not regarded as a matter of importance. What was important was the name or distinguishing mark of the issuer, which is never absent.'
The value of the coin lay entirely in the mark of the issuer, you say? Why, that sounds less like money and more like credit! Interesting! But this might motivate a person to think heretical thoughts, like: perhaps money merely represents the debt of the sovereign, which we the subjects hold as credit? Indeed, perhaps that money is itself just credit? And indeed this is precisely where Mitchell-Innes takes us: 'Credit is the purchasing power so often mentioned in economic works as being one of the principal attributes of money, and, as I shall try to show, credit and credit alone is money.'
Less concisely:
. . . while a debtor must be in a position to satisfy his creditor, the really important characteristic of a credit is not the right which it gives to "payment" of a debt, but the right that it confers on the holder to liberate himself from debt by its means -- a right recognized by all societies. By buying we become debtors and by selling we become creditors, and being all both buyers and sellers we are all debtors and creditors. As debtor we can compel our creditor to cancel our obligation to him by handing to him his own acknowledgment of a debt to an equivalent amount which he, in his turn, has incurred. For example, A having bought goods from B to the value of $100, is B's debtor for that amount. A can rid himself of his obligation to B by selling to C goods of an equivalent value and taking from him in payment an acknowledgment of debt which he (C, that is to say) has received from B. By presenting this acknowledgment to B, A can compel him to cancel the debt due to him. A has used the credit which he has procured to release himself from his debt. It is his privilege.
This is the primitive law of commerce. The constant creation of credits and debts, and their extinction by being cancelled against one another, forms the whole mechanism of commerce and it is so simple that there is no one who cannot understand it. Credit and debt have nothing and never have had anything to do with gold and silver. . . .
The value of a credit depends not on the existence of any gold or silver or other property behind it, but solely on the "solvency" of the debtor, and that depends solely on whether, when the debt becomes due, he in his turn has sufficient credits on others to set off against his debts. If the debtor neither possesses nor can acquire credits which can be offset against his debts, then the possession of those debts is of no value to the creditors who own them. It is by selling, I repeat, and by selling alone -- whether it be by the sale of property or the sale of the use of our talents or of our land -- that we acquire the credits by which we liberate ourselves from debt . . .
(A. Mitchell-Innes, 'What is Money?')
Ka-pow! He also amply backs up Hawtrey's logical analysis with historical evidence that not only can a lot of economic activity go on in the absence of money proper, but in fact that it apparently did in many places and many times, by debit-credit accounting devices of varying degrees of sophistication. All of it based, more or less explicitly, on the sanctity of an obligation. Anyone familiar with the instances of delayed reciprocity among various animals should not be terribly surprised at the idea that modern human commerce is merely an elaboration on this.
Mitchell-Innes then followed this straight left with a hard right, in another essay published the following year with the more confident title of 'The Credit Theory of Money' (emphasis mine):
A government dollar is a promise to "pay," a promise to "satisfy," a promise to "redeem," just as all other money is. All forms of money are identical in their nature. It is hard to get the public to realize this functional principle, without a true understanding of which it is impossible to grasp any of the phenomena of money. Hard, too, is it to realize that in America to-day, there are in any given place many different dollars in use . . . . Everybody who incurs a debt issues his own dollar, which may or may not be identical with the dollar of any one else's money. It is a little difficult to realize this curious fact, because in practice the only dollars which circulate are government dollars and bank dollars and, as both represent the highest and most convenient form of credit, their relative value is much the same, though not always identical. (A. Mitchell-Innes, 'The Credit Theory of Money')Alfie, dude, you're blowing my mind here! It is, of course, important to recognize a terminological difference between Mitchell-Innes and Hawtrey, and in the span of time between them (a span not without sigificance) we can actually watch the worm turn: for Mitchell-Innes, money is credit in the widest sense; for Hawtrey, money is fiat money in the narrow sense. The semantic drift the former bemoans in 1913 is virtually complete by the time the latter is writing in 1919. (This in itself would make a good dissertation topic, if anyone in the humanities is looking for one.)
Which use of the term is right? In one sense it doesn't matter since they're in full formal agreement about what's actually going on; in another sense, though, this kind of lexical instability is bad for the brains since it makes straight thinking harder and provides all manner of opportunities for bad ideas to slip past us by trading on the ambiguity of the embattled term. Money, credit, currency -- are these synonymous or different, and if they are different what is the difference? Sadly, no 20th century economist can help us here. Back into the DeLorean, kids!
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To see an early example of the kind of confusion this ambiguity induces even in the most incisive intellect, we can make a pit-stop back in 1876, and summon William Stanley Jevons to the bench. In his Money and the Mechanism of Exchange we can see the first clear-eyed, explicit acknowledgement of money as a standard of deferred payment:
Every person making a contract by which he will receive something at a future day, will prefer to secure the receipt of a commodity likely to be as valuable then as now. This commodity will usually be the current money, and it will thus come to perform the function of a standard of value. (W. S. Jevons, Money and the Mechanism of Exchange, p.14)As well as an acknowledgement that all of the aforementioned functions of money must be kept conceptually distinct even if in practice they travel together:
It is in the highest degree important that the reader should discriminate carefully and constantly between the four functions which money fulfils, at least in modern societies. We are so accustomed to use the one same substance in all the four different ways, that they tend to become fused together in thought. We come to regard as almost necessary that union of functions which is, at the most, a matter of convenience and may not always be desirable. (ibid., p. 16)He goes on to point out that in fact a number of different commodities have in the past been used as currency for the sake of fulfilling each of these distinct functions -- which, having the benefit of our Mitchell-Innes, we might regard as evidence that perhaps our insistence on identifying currency with commodity is in fact a source of faulty thinking.
And yet, on the very next page he deftly resists the temptation to think such thoughts: 'There is evident convenience in selecting, if possible, one single substance which can serve all the functions of money.' This happens depressingly often in the history of science: an intrepid thinker catches tiny glimpses of the cold light, before promptly returning to the warm dark.
If that is not enough for you, prepare for an irony overload as we flash forward to 1976, the centennial of Jevons' little book on money. We find Friedrich Hayek, who had certainly read his Jevons very closely, digressing on Jevons' 'four functions' in the midst of his Denationalisation of Money. After having repeated the Austrian credo that 'medium of exchange' is the essential function of money and that the other three functions will naturally gravitate toward whatever becomes current in this sense, he admits quite honestly in the next breath:
. . . although at first different attributes of money may seem desirable for its different uses, money renders one service, namely that of a unit of account, which makes stability of value the most desirable of all. Although at first convenience in daily purchases [i.e. as currency] might be thought decisive in the selection, I believe it would prove suitability as a unit of account that would rule the roost. (F.A. Hayek, The Denationalisation of Money, p. 67)Wait, what? Function as liquid currency is most essential, but function as a stable standard of calculation is most causally efficacious in determining what gets used as money? There is something . . . not . . . quite . . . right . . . about this thinking. And again, on the next page: 'The chief demand for holding would probably be in the currency in which people expected to have to pay debts.' You see, when we consider the celestial phenomena in detail it is almost as if the earth revolves around the sun, but we know this cannot be true because Aristotle said otherwise.
What's going on here is that Hayek's decades of thinking deeply about capital and business cycles have forced certain uncomfortable realities about the role of credit upon him, which are in direct conflict with the hypothesis of the origin of money that he cut his teeth on. A little earlier in the book, again the heavens part and again the scholar averts his gaze:
Occasionally we shall also speak of 'money substitutes' when we have to consider borderline cases in the scale of liquidity -- such as traveller's cheques, credit cards and overdrafts -- where it would be quite arbitrary to assert that they either are or are not part of the circulation of currency. (ibid., p. 58)If liquidity -- that is, ease of circulation -- is the measure of moneyness, and liquidity is a continuous variable, then it is evident that everything is money to varying degrees. Again, this should set off alarm bells: this does not sound like a stable conceptual foundation upon which to build a theoretical edifice, so perhaps we should reconsider our starting-point. This is a textbook case of an abstraction leaking out all over and flooding your basement. But no, you see, these 'borderline cases' can be handled adequately by the expedient of a few epicycles -- and possibly a lot of caulk and duct tape.
I single out Hayek here because his case is particularly poignant after having just had your world rocked by Michell-Innes: the latter, uninhibited by any commodity theory of money, simply goes in one giant leap all the way in the direction the former wants to go but must struggle for every inch of ground as though against a giant ball and chain. It costs Hayek great intellectual pains to make a tentative case for free banking, while Mitchell-Innes can boldly state that all of this is irrelevant once we understand credit and that any legal person that can issue credit is already, in principle, issuing currency -- the only question is whether they're doing it intelligently or not, and what ways the law affords them to do so.
The hypothesis that the earth rotates on its axis had been floating around since ancient Greek antiquity, and was well known to the learned Schoolmen of the Middle Ages -- as thoroughly discredited. Likewise, erudite 20th century economists were not unaware of the hypothesis that debt was the motive force behind the creation of money, and considered it at best a perverse curiosity of bad thinking. And yet, it moves . . .
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But we were supposed to be going backward, not forward. Our last stop takes us to 1859, where the Scottish legal scholar Henry Dunning Macleod has just published his magnum opus, The Theory of Credit. Having aged over a century and a half, this will no doubt strike you as a deeply goofy book in a number of ways, but the clarity it exhibits is irreplaceable.
He spends the entire first part of the book setting the record straight on what words mean so far as jurisprudence is concerned -- and his authority is unimpeachable here, since, roughly, economics is to jurisprudence as chemistry is to physics.
Jurisprudence determines rights, and economics determines the exchange of rights. When I trade you an apple for an orange, what is being exchanged is the right to one fruit for the right to another; if I merely shove the apple into your hands and grab the orange, that's not an exchange -- it's a combination of a theft and a donation. Market exchanges are never about the thing, always about the right, and the rights determine the market equilibria. If this sounds obvious to you, great -- because there is an entire profession called 'law and economics' that sprung up in the last 60 years whose entire claim to fame lay in re-discovering this a hundred years after Macleod pointed it out.
I belabor it because it's the key to Macleod's entire way of thinking, and indeed all clear thinking about credit and money: among the many things he will set you straight on is that credit is a right to demand payment where debt is the corresponding duty to pay (both completely distinct from the thing to be paid), that money is anything a creditor is legally obliged to accept as payment from a debtor, and that currency consists of all credit and money in circulation.
So when we see everyone from Jevons to Hayek muddling over the 'function' of currency, they're falling all over themselves because they've failed to analyze a compound concept. Mitchell-Innes is guilty of the same conflation: credit is currency, but credit is not necessarily money -- it only becomes money when backed by state compulsion, just as Georg Friedrich Knapp tells us at length in The State Theory of Money. (This is extra-credit reading only.) Money is legal standard of debt payment and thereby becomes unit of account; credit is a store of value and thereby becomes a medium of exchange, i.e. currency. Sometimes these things coincide but their functions are distinct and separable. Can we have currency without money? Yes, we can!
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Now, let us take a look at Bitcoin, through Macleod's eyes: what is this thing? Is it money? Clearly not, since it's not endorsed by the sovereign and almost nobody would accept it as payment of a debt. Is it credit? Also clearly not, since there is no debtor who will treat it as a legitimate claim on their wealth. What's lacking here is legal obligation.
But is bitcoin currency? Hmm. If credit and money are the only two types of currency, then obviously it can't be currency. And yet people are trading it around for things, so there are two possibilities: 1) Bitcoin is a ponzi scheme or perhaps a really expensive and pointless game, and 2) Bitcoin is a revolutionary new form of currency which is neither money nor credit. In any case, whatever it is Macleod's lexicon does not quite cover it.
What bitcoins definitely are is a pure commodity. That is to say, they are useless for anything but trading. Another thing bitcoins definitely are is volatile in value. Thus far they've made a terrible standard of defferred payment, which makes them a lousy unit of account, which makes them a poor store of value, which makes them a questionable medium of exchange.
These two facts are related: a pure commodity is by definition volatile in value precisely because it is the ideal vehicle for speculative trading. That is to say, there is absolutely nothing keeping it grounded in fundamental economic relationships like credits and debts, nor can it be used to pay your taxes -- it floats completely free and untethered, its value held up 100% by magic.
Of course, if the US government suddenly switched to bitcoin rather than the dollar -- then bitcoin would be money, and bitcoin would oust the dollar rapidly. If, on the other hand, the US government crushed bitcoin (as it still is quite capable of doing) or if Satoshi suddenly dumped all his bitcoin onto the market (as he is also still quite capable of doing), its value would drop to nothing and never recover. As long as neither of these things happens, the waveform will not collapse. Is it a viable currency? Maybe!
In any case, what bitcoin certainly is, is the logical endpoint of the idea that all a currency needs to be is perfectly exchangeable and all the rest will follow. Maybe it's just that Macleod has gone to my head, but I'm betting that come 2021 Bitcoin will be of mainly historical interest. Can we do better? I think so.
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POSTSCRIPT: Immediately after publishing this, I discovered that in fact the IRS has just killed bitcoin's hopes of being currency, dead as a doornail, by the elegant expedient of taxing it as a commodity rather than as money. This is both legally impeccable and utterly destroys the fungibility of bitcoins, thereby ensuring that while Uncle Sam may profit from their trade, bitcoins will never replace dollars so long as the Fed shall live. Ave, Cæsar!
