Category Archives: MMP

By L. Randall Wray

Last week we discussed denomination of government and private liabilities in the state money of account—the Dollar in the US, the Yen in Japan, and so on. We also introduced the concept of leverage, for example, the practice of holding a small amount of government currency in reserve against IOUs denominated in the state’s unit of account while promising to convert those IOUs to currency. This also led to a discussion of a “run” on private IOUs, demanding conversion. Since the reserves held are not nearly sufficient to meet the demand for conversion, the central bank must enter as lender of last resort to stop the run by lending its own IOUs to allow the conversions to take place. This week we examine bank clearing and the notion of a “pyramid” of liabilities with the government’s own IOUs at the top of that pyramid.

Clearing accounts extinguishes IOUs. Banks clear accounts using government IOUs, and for that reason either keep some currency on hand in their vaults, or more importantly maintain reserve deposits at the central bank. Further, they have access to more reserves should they ever need them, both through borrowing from other banks (called the interbank overnight market; this is the fed funds market in the US), or through borrowing them from the central bank.

All modern financial systems have developed procedures that ensure banks can get currency and reserves as necessary to clear accounts among themselves and with their depositors. When First National Bank receives a check drawn on Second National Bank, it asks the central bank to debit the reserves of Second National and to credit its own reserves. This is now handled electronically. Note that while Second National’s assets will be reduced (by the amount of reserves debited), its liabilities (checking deposit) will be reduced by the same amount. Similarly, when a depositor uses the ATM machine to withdraw currency, the bank’s assets (cash reserves) are reduced, and its IOUs to the depositor (the liabilities in the deposit account) are reduced by the same amount.

Other business firms use bank liabilities for clearing their own accounts. For example, the retail firm typically receives products from wholesalers on the basis of a promise to pay after a specified time period (usually 30 days). Wholesalers hold these IOUs until the end of the period, at which time the retailers pay by a check drawn on their bank account (or, increasingly, by an electronic transfer from their account to the account of the wholesaler). At this point, the retailer’s IOUs held by the wholesalers are destroyed.

Alternatively, the wholesaler might not be willing to wait until the end of the period for payment. In this case, the wholesaler can sell the retailer’s IOUs at a discount (for less than the amount that the retailer promises to pay at the end of the period). The discount is effectively interest that the wholesaler is willing to pay to get the funds earlier than promised.

Usually, it will be a financial institution that buys the IOU at a discount—called “discounting” the IOU (this is where the term “discount window” at the central bank comes from—the US Fed would buy commercial paper—IOUs of commercial firms–at a discount). In this case, the retailer will finally pay the holder of these IOUs (perhaps a financial institution) at the end of the period, who effectively earns interest (the difference between the amount paid for the IOUs and the amount paid by the retailer to extinguish the IOUs). Again, the retailer’s IOU is cancelled by delivering a bank liability (the holder of the retailer’s IOU receives a credit to her own bank account).

Pyramiding currency. Private financial liabilities are not only denominated in the government’s money of account, but they also are, ultimately, convertible into the government’s currency.

As we have discussed previously, banks explicitly promise to convert their liabilities to currency (either immediately in the case of demand deposits, or with some delay in the case of time deposits). Other private firms mostly use bank liabilities to clear their own accounts. Essentially, this means they are promising to convert their liabilities to bank liabilities, “paying by check” on a specified date (or, according to other conditions specified in the contract). For this reason, they must have deposits, or have access to deposits, with banks to make the payments.

Things can get even more complex than this, because there is a wide range of financial institutions (and, even, nonfinancial institutions that offer financial services) that can provide payment services. These can make payments for other firms, with net clearing among these “nonbank financial institutions” (also called “shadow banks”) occurring using the liabilities of banks. Banks, in turn, clear accounts using government liabilities.

There could, thus, be “six degrees of separation” (many layers of financial leveraging) between a creditor and debtor involved in clearing accounts.

We can think of a pyramid of liabilities, with different layers according to the degree of separation from the central bank. Perhaps the bottom layer consists of the IOUs of households held by other households, by firms engaged in production, by banks, and by other financial institutions. The important point is that households usually clear accounts by using liabilities issued by those higher in the debt pyramid—usually financial institutions.

The next layer up from the bottom consists of the IOUs of firms engaged in production, with their liabilities held mostly by financial institutions higher in the debt pyramid (although some are directly held by households and by other production firms), and who mostly clear accounts using liabilities issued by the financial institutions.

At the next layer we have nonbank financial institutions, which in turn clear accounts using the banks whose liabilities are higher in the pyramid. Just below the apex of the pyramid, banks use government liabilities for net clearing.

Finally, the government is highest in the pyramid—with no liabilities higher than its inconvertible IOUs.

The shape of the pyramid is instructive for two reasons. First, there is a hierarchical arrangement whereby liabilities issued by those higher in the pyramid are generally more acceptable. In some respects, this is due to higher credit worthiness (the government’s liabilities are free from credit risk; as we move down the pyramid through bank liabilities, toward nonfinancial business liabilities and finally to the IOUs of households, risk tends to rise—although this is not a firm and fast rule).

Second, the liabilities at each level typically leverage the liabilities at the higher levels. In this sense, the whole pyramid is based on leveraging of (a relatively smaller number of) government IOUs. There are typically far more liabilities lower in the pyramid than there are high in the pyramid—at least in the case of a financially developed economy.

Note however that in the case of a convertible currency, the government’s currency is not at the apex of the pyramid. Since it promises to convert its currency on demand and at a fixed exchange rate into something else (gold or foreign currency), that “something else” is at the top. The consequences have been addressed in previous blogs: government must hold or at least have access to the thing into which it will convert its currency. As we will see in coming weeks, that can constrain its ability to use policy to achieve some policy goals such as full employment and robust economic growth.

Next week we will take a bit of a diversion to look at the strange case of Euroland. This is the biggest experiment the world has ever seen that attempts to subvert what Charles Goodhart has called the “one nation, one currency” rule. The members of the European Monetary Union each gave up their own sovereign, state, currencies to adopt the euro. While there have been other such experiments, they were small, usually temporary, and often an emergency measure. In the case of Euroland, however, we had strong, developed, rich, and reasonably healthy nations that voluntarily abandoned their sovereign currencies in favour of the euro. The experiment has not gone well. To say the least.

By L. Randall Wray 

This week we addressed denomination of “money things” in the state money of account—for example, the Dollar in the US. We began a discussion of “leveraging”—making one’s IOUs convertible (on demand or on some contingency) into another’s IOUs. Next week we will turn to the notion of a “debt pyramid” with the state’s own IOUs at the apex. For now, on to the questions and comments. As usual I will group them into themes; some commentators actually answered several of the questions (Thanks!) but I’ll briefly repeat some of what they said.

Q1: (Jeff) Can’t the Fed just control inflation by raising required reserve ratios? At the limit, to 100% reserves? And would that affect interest rates?

A: As discussed in a bit more detail below, and in this blog later, required reserve ratios do not control bank lending. To hit its interest rate target, the central bank must accommodate the demand for reserves—whether the ratio is 1% (about where it is now) or 10% (the ratio usually used in textbooks to simplify math). (Note: the required reserve ratio in Canada is a big zip, zero! That is actually the most advanced way to run the system. Hats off to our neighbors to the north.) Since it would not control lending there is little reason to believe raising ratios would affect inflation. Also note that raising the ratio does not affect the overnight rate (fed funds rate in the US)—since that is the policy variable.

Higher ratios do act like a tax on banks—they must hold a very low earning asset. If the ratio is 1% they hold 1% of their assets (more or less—close enough for this analysis) in an asset that earns a very low interest rate (the support rate paid by the central bank on reserves). They need to cover their costs and make profits by earning more than that on the rest of their assets (99%). Raising the ratio to 10% means they only have 90% of their assets potentially earning higher returns. And so on. Will that affect lending rates earned (what they charge borrowers) and deposit rates paid (what they pay depositors)? Well banks live on the spread between those two—that is how they cover costs and make profits. So, yes, raising ratios might cause them to raise loan rates and lower deposit rates—not a good thing for borrowers or depositors. 

Finally, what about 100% reserves? There is a good book by Ronnie Phillips (Google it) on the Fisher-Simons-Friedman proposal to do just that. However, this is usually presented as a way to make banks “safe”—they’d hold only reserves or treasuries against their demand deposits, on the idea that with safe assets, the deposits are always safe (so you do not need deposit insurance, FDIC). Sounds OK so far as it goes. Someone else has to do the lending since the banks are not allowed to do it. A big topic.

Q2: (Jeff) How can China operate domestic policy with a fixed exchange rate?

A: Trillions of dollars of foreign exchange reserves! No George Soros is going to bet against China’s ability to peg its exchange rate. So, yes, there are exceptions to the rule that pegged exchange rates reduce policy space.

Q3: (Neil) What about IMF conversion clause? What makes banks special? (others also asked that)

A: Come on, you are sounding like Ramanan. I answered that already—yes you can tie your shoes together and try to run a marathon. First, this discussion was general. Second, as I showed, in practice the clause has no impact. What makes banks special? We’ll save that for coming blogs. But two characteristics that are very important are: access to central bank, and access to deposit insurance.

Q4: (Godefroy) What does the central bank lend against? How does a bank get cash?

A: Central bank lends against qualifying assets. It’s the boss and can decide. Yes, it lends against treasuries (IOUs of the Treasury); it can lend against “real bills” (short term commercial loans made by banks to good customers); it can lend against toxic waste MBSs (maybe a bad idea?). It can use collateral requirements as a way to supervise/regulate banks: encourage them to make only safe loans by narrowing what it accepts as collateral.

When you go to the ATM to withdraw cash, your bank has a bit on hand—that counts as part of its reserve base. If everyone goes tomorrow, obviously the bank runs out quickly. It orders more from the Fed—shipped in armored trucks—and the Fed debits the bank’s reserves, and when that is insufficient it lends the cash (a loan of reserves) against collateral. The Fed holds the bank’s IOU as an asset; it is of course a liability of the bank.

Q5: Do money center banks influence the FOMC?

A: Is Goldman Sachs a bloodsucking vampire squid that bought and paid for Timmy Geithner’s NY Fed as well as Treasury?

Q6: (Glenn; Jeff) Why does government need to borrow its own IOUs and pay interest? And why pay interest on “fiat money”?

A: Good question! Government cannot borrow its own IOUs. Neither can you! If you give an IOU to your neighbor for a cup of borrowed sugar, you do not go back and ask if you can borrow it. It is a senseless operation.

Instead, government offers Treasuries as a higher interest paying IOU, exchanged for reserves. When you go down to your bank, you can exchange your demand deposit for a saving deposit on which you earn higher interest. That is really all that a government bond sale is—a substitution of a demand deposit at the central bank for a time deposit.

Note that cash (“fiat money”) does not pay interest. A Chicago Mafioso loan shark might lend you cash at 140% interest. Why? You are desperate. He gets compensated for the risk that you will run with the money. Of course, there is a substantial penalty for nonpayment. But why would the Treasury pay interest on bonds, and why would the Fed pay interest on reserves? There is no necessity of doing that. We’d accept cash and banks would accept reserves without interest—there is no default risk (on sovereign government IOUs on a floating exchange rate), and we need them to pay taxes. But it is nice to get interest, isn’t it? Think of it as a government transfer payment, a form of charity. It might be a bad idea—a topic for later.

Q7: Does a lack of sufficient reserves constrain loans?

A: No. Don’t take my word for it. Here’s a comment from the Fed’s Senior Vice President, Federal Reserve Bank of New York, Alan Holmes. Holmes explained why the then faddish Monetarist policy of controlling inflation by controlling the growth of Base Money had failed, saying that it suffered from “a naive assumption” that the banking system only expands loans after the [Federal Reserve] System (or market factors) have put reserves in the banking system. In the real world, banks extend credit, creating deposits in the process, and look for the reserves later. The question then becomes one of whether and how the Federal Reserve will accommodate the demand for reserves. In the very short run, the Federal Reserve has little or no choice about accommodating that demand…

Q8: (unknown) How do banks work? What happens if a borrower goes bankrupt?

A: We’ll look in more detail at how banks “work”. They’ve got assets on one side of their balance sheet and liabilities plus capital on the other. When the assets go bad, the capital is reduced (shareholders lose); once the capital is wiped out, the losses come out of the other liabilities, so creditors lose. Since the FDIC insures depositors, if losses are big enough to hit deposits, Uncle Sam covers those.

Q9: (HadNuff) Don’t you pay taxes with demand deposits? Banks can be illiquid but not insolvent?

A: You write a check to the IRS but your bank pays the taxes for you using reserves, since the IRS sends the check on to the Fed, which debits the bank’s reserves (and increases the Treasury’s deposit). The central bank lends reserves to solve liquidity problems, lending against collateral. Banks do become insolvent, as discussed above. They then must be “resolved”—there are a variety of methods but it comes down to selling the assets, covering insured depositors first, and then other creditors and the shareholders take the loss.

By L. Randall Wray

In the past two weeks we took a bit of a diversion the case of so-called commodity money consisting of precious metal coins. We also briefly discussed the gold standard. I argued that even on a gold standard, the currency is really the government’s IOU backed by taxes. And that remains true even if the sovereign stamps the IOU on a gold coin. So those precious metal coins were really what is often derided as a “fiat money”. The typical dichotomy posed between “fiat money” that has “nothing” backing it versus a “hard money” or “commodity money” with gold or silver behind it is actually false. All “modern money” systems (which apply to those of the “past 4000 years at least” as Keynes put it) are state money systems in which the sovereign chooses a money of account and then imposes tax liabilities in that unit. It can then issue currency used to pay taxes.

In the introduction to this Primer I had promised not to delve too much into history—first because our main purpose is to explain how money works today; and second because the past is admittedly cloudy (“mists of time” as Keynes said). However, I felt it was necessary to explain how things worked on the gold standard and with metal coins (as best as we can determine) in order to argue that those who think that “fiat money” systems are something strange, unnatural, and of recent vintage, are confused. Governments of the past and present can choose to tie their hands, so to speak, by standing ready to convert their currencies to precious metal or foreign currencies. Fixed exchange rate systems stand at one extreme of the modern money continuum. They are a policy choice. There is nothing “natural” about them. They do, however greatly reduce fiscal policy space—in ways to be discussed more later in the primer. The US and other sovereign countries could choose to tie policy in that manner. But they would not thereby return to some mythical utopian past with a natural self-regulating commodity money. In truth, domestic fixed exchange rate systems usually bring on more problems than they resolve, and they are typically short-lived. And international fixed exchange rate systems—such as the sterling system or the Bretton Woods system fared no better.

This week we return to our analysis of the operation of today’s monetary system, examining the denomination of IOUs in the state money of account.

IOUs denominated in national currency: government. In earlier blogs we have noted that assets and liabilities are denominated in a money of account, which is chosen by a national government and given force through the mechanism of taxation. On a floating exchange rate, the government’s own IOUs—currency—are nonconvertible in the sense that the government makes no promise to convert them to precious metal, to foreign currency, or to anything else. Instead, it promises only to accept its own IOUs in payments made to itself (mostly, tax payments, but also payments of fees and fines). This is the necessary and fundamental promise made: the issuer of an IOU must accept that IOU in payment. So long as government agrees to accept its own IOUs in tax payments, the government’s IOUs will be in demand (at least for tax payments, and probably for other uses as well).

On the other hand, when government promises to convert on demand (to foreign currency or precious metal), holders of the government’s liabilities have the option of demanding conversion. This might in some cases actually increase the acceptability of the government’s currency. At the same time, it commits government to conversion on demand—which as discussed earlier requires that it have accumulated reserves of the foreign currency or precious metal to which it promises to convert. Ironically, while it might be able to find more willingness to accept its currency since it is convertible, it also knows that increasing currency issue raises the possibility it will not be able to meet demand for conversion. For this reason, it knows it should limit its issue of a convertible currency. Should holders begin to doubt government will be able to convert on demand, the game is over unless government has sufficient access to foreign currency or precious metal reserves (either its hoards, or to loans of reserves). It can be forced to default on its promise to convert if it does not. Any hint that default is imminent will ensure a run on the currency. In that case, only 100% reserve backing (or access to lenders) will allow government to avoid default.

We repeat that convertibility is not necessary to ensure (at least some, perhaps limited) demand for the domestic currency. As discussed above so long as government can impose and collect taxes it can ensure at least some demand for a nonconvertible currency. All it needs to do is to insist that taxes be paid in its own currency. This “promise to accept in tax payment” is sufficient to create a demand for the currency: taxes drive money.

Private IOUs denominated in the domestic currency. Similarly, private issuers of IOUs also promise to accept their own liabilities. For example, if a household has a loan with its bank, it can always pay principle and interest on the loan by writing a check on its deposit account at the bank. Indeed, all modern banking systems operate a check clearing facility so that each bank accepts checks drawn on all other banks in the country. This allows anyone with a debt due to any bank in the country to present a check drawn on any other bank in the country for payment of the debt. The check clearing facility then operates to settle accounts among the banks. The important point is that banks accept their own liabilities (checks drawn on deposits) in payments on debts due to banks (the loans banks have made), just as governments accept their own liabilities (currency) in payments on debts due to government (tax liabilities).

Leveraging. There is one big difference between government and banks, however. Banks often do promise to convert their liabilities to something. You can present a check to your bank for payment in currency, what is normally called “cashing a check”, or you can simply withdraw cash at the Automatic Teller Machine (ATM) from one of your bank accounts. In either case, the bank IOU is converted to a government IOU. Banks normally promise to make these conversions either “on demand” (in the case of “demand deposits”, which are normal checking accounts) or after a specified time period (in the case of “time deposits”, including savings accounts and certificates of deposits, known as CDs—perhaps with a penalty for early withdrawal).

Banks hold a relatively small amount of currency in their vaults to handle these conversions; if they need more, they ask the central bank to send an armoured truck. Banks don’t want to keep a lot of cash on hand, nor do they need to so in normal circumstances. Lots of cash could increase the attractiveness to bank robbers, but the main reason for minimizing holdings is because it is costly to hold currency. The most obvious cost is the vault and the security guards, however, more important to banks is that holding reserves of currency does not earn profits. Banks would rather hold loans as assets, because debtors pay interest on these loans. For this reason, banks leverage their currency reserves, holding a very tiny fraction of their assets in the form of reserves against their deposit liabilities.

So long as only a small percentage of their depositors try to convert deposits to cash on any given day, this is not a problem. However, in the case of a bank run in which a large number of depositors tries to convert on the same day, the bank will have to obtain currency from the central bank. This can even lead to a lender of last resort action by the central bank that lends currency reserves to a bank facing a run. In such an intervention, the central bank lends its own IOUs to the banks in exchange for their IOU—the bank gets a reserve credit from the central bank (an asset for the bank) and the central bank holds the bank’s IOU as an asset. When cash is withdrawn from the bank, its reserves at the central bank are debited, and the bank debit’s the depositor’s account at the bank. The cash held by the depositor is the central bank’s liability, offset by the bank’s liability to the central bank.

Next week: we will begin with an analysis of how banks clear accounts among themselves, by using central bank reserves. This also leads to a discussion of “pyramiding”: in modern economies that leverage liabilities, it is common to make one’s own IOUs convertible to those higher in the debt pyramid. Ultimately, all roads lead back to the central bank.

Thanks for the comments, which were very tightly focused on gold and gold coins. I want to reiterate my summary: gold coins are not an example of a “commodity money” such as the sea shells supposedly chosen by Friday and Crusoe. Rather, they were a “fiat money”, government IOU that happened to be stamped on precious metal. These coins almost always circulated far above the value of the embodied metal; however, that value set a minimum below which the coin’s value could never fall.

That proved handy when a crown was overthrown; or when the coins circulated beyond the crown’s reach. I argued it is not a coincidence that the gold standard, precious metal coins, Mercantilism, wars for foreign conquest, and internecine European wars evolved together. The rise of the modern state, with its ability to conscript warriors and enforce taxes made all of that oh-so-Medieval. Precious metal coins were banished to the dustbins of history.

Yet, today’s goldbugs want to bring it all back. Presumably they love the outfits—anyone for the Society for Creative Anachronism? You too can wear tights and pursue damsels in distress with all the accouterments.

OK more seriously, on to the questions and comments.

Q1: It appears that markets do behave as if gold is money. Is this irrational? Does it reflect rational concern with the stability of fiat money? What is gold if it is not money? Is all this speculation just a “greater fool” theory? And what determines the price of gold, anyway?

Answer: All good questions. First, let me remind you that gold is only one of 25 commodities going through a tulip-bulb type speculative hysteria. Indeed, since 2004 we have lived through the greatest commodities bubble in human history—bar none. Please see my Levy Institute piece http://www.levyinstitute.org/publications/?docid=1094.

Now you will notice the date—2008—and you might think it is all outdated. From 2004 to 2008 we had the previous all-time biggest bubble. Then Lieberman and Stupak initiated an investigation into Goldman Sachs (oh, you know it had to involve Goldman) and pension funds (say what?). Yours truly played a walk-on part (I worked behind the scenes with their staffs). I was the only economist they could find willing to say “it is not supply and demand” (it never is—and butlers never commit the murder, either). I wrote the piece you can read at their invitation. Pension funds got scared sh*tless. Their members would blame them for the $4 gas at the pumps. They pulled one third of their funds out. Commodities’ prices collapsed (remember oil fell from approx. $150 to $49 a barrel). Then the financial crisis and the government deficit hysteria and Frank Dodd and all manner of other diversions diverted Congress’s eye away from the ball. Given that real estate was no longer a good speculative cake walk, Goldman induced pensions and other managed money back into commodities. And there you go. $4 gas. They boomed. They bubbled. They exploded. The mother of all tulip bulb hysterias.

And gold is dragged out (again) as the hedge against Chairman Bernanke’s helicopters that will surely induce hyperinflation. (If there was ever a sure bet, the bet against USA inflation has got to be it. But that is a topic for another day.)

The gold shoe will drop. Remember, inflation adjusted gold is still below 1980 levels. Gold has never been a good “investment” against inflation. It is a purely speculative bet because gold has no inherent return. Sure, it is somewhat limited in supply and industrial demand (as well as the demand for bright shiny stuff to attach to bodies) grows. But, still, like all other commodities it suffers from a dangerous predicament: mining technologies improve. OK, maybe not enough to halt rising (nominal) prices over time. But enough to make gold a sucker bet.

Besides, governments have locked a huge portion of the world’s gold supply behind bars. They can let gold out anytime they damned well please–for “good behavior” or just to screw the gold bugs. Whether they will is all political. Betting on politics is a fool’s bet, too. Our gold bug in chief (Greenspan) has been put out to pasture. Don’t count on the Bernanke-Geithner team to continue to boost gold prices. (I won’t go into the rumors that Greenspan helped to stabilize gold prices—using the President’s stabilization fund, yes the same one apparently used to bail out Euro banks so that the money market mutual funds wouldn’t “bust the buck”—as that is a bit too close to UFOs and alien abduction. But I can report that reputable commodities markets experts believe it.) The point is that gold is a tiny market and governments are big players. Remember silver? A bigger market that the Hunt brothers managed to almost corner. Those were two Bush W-like cowboy offspring of a Texas oilman. Do you really want to bet that the world’s central bankers have the interests of gold bugs at heart as they make decisions about the proper price of gold? The US government crushed the Hunt brothers as if they were ants. End of silver boom.

So, no, gold is not money and never has been money. It is a commodity, like Tulip bulbs. Remember what happened with tulip bulbs? Think USB drive sticks. They multiplied. Production costs fell. Prices collapsed. Everyone sold, sold, sold. Yes, central banks will end up with egg on their faces. For most of them, it will be no worse than the Fed’s purchases of toxic waste MBSs. Paper losses, covered by Treasury.

If you’ve got some unused gold, sell it now. You will never regret the decision. (Disclaimer: I do not provide investment advice. If you want investment advice, go to Goldman. They can professionally advise you how to lose your life’s earnings. To them.)

Q2: Didn’t use of gold coins reduce forgery?

Answer: Undoubtedly. But it then led to clipping, weighing, Gresham’s Law dynamics, and so on as discussed last week.

Q3: Can you pay taxes in gold?

Answer: Seriously doubt it. Give it a try. But I’ll give you $32 an ounce and you can use the dollars to pay your taxes. Ship it to me, c/o UMKC (better insure it). And, yes, a dollar is always worth a dollar in tax payment. Much better than gold—you never know what that will be worth when it comes time to pay. So ship gold today!

Q4: Was crying down coins inflationary or did it lead to hoarding and thus was deflationary?
Answer: As discussed, there would be some Gresham’s Law dynamics: you hoard heavy coins and push the light ones in payment. Any coins cried down would be pushed (not hoarded). At the public pay offices (where you paid fees, fines, and taxes) you would experience inflation (deliver more coins to pay your tax debt). From what I understand, the impact on prices in “markets” would not be quite one-to-one. In other words, prices would not necessarily rise fully to take account of the lower value at the public pay offices. But I would say that these historical reports are not conclusive. Still we can surmise that the coins that were cried down probably would fall in value so we’d see some market price inflation in terms of these coins. And “velocity” of them would probably increase as everyone tried to offload them. Coins that were not cried down would get hoarded. But that effect was probably not huge—the historical reports are that crying down was well-understood and even more-or-less accepted as a legitimate means of increasing the tax burden. The story is that the population accepted it so long as it was not done too often. Finally recall that coins had no nominal value printed on them—so the crown had to announce the value at which they’d be accepted. And recall that entire coinages would frequently be called-in for recoinage. It is highly misleading to focus on coins. They were rarely important. Most taxes were paid in tallies (which could not be cried down since the nominal value was cut into stock and stub) and most private transactions took place in bills of exchange or as credits and debits (bar tallies, for example)—again all nominal.

Thanks, again, for comments. Next week: IOUs denominated in the domestic currency: government and private.

By L. Randall Wray

Last week we examined the origins of coins, arguing that coinage is a relatively recent development. From the beginning, coins did have precious metal content. We examined a hypothesis for that, because from the MMT view, the “money thing” is simply a “token” or record of debt. If that is true, why “stamp” the record on precious metal? For thousands of years, debts were recorded on clay or wood or paper. Why the switch? We argued that the origins of coins in ancient Greece must be placed in the specific historical context of that society. Use of precious metal was not a coincidence, but also was not consistent with the commodity money view. While it is true that use of precious metal was important and perhaps even critical, this was for social reasons and was tied to the rise of the democratic polis. This week, we examine coinage from Roman times to the present in Western society.

Roman coins also contained precious metal. But there is very little doubt that Roman law adopted what is called “nominalism”—the nominal value of the coin is determined by the authorities, not by the value of embodied metal in the coin (termed “metalism”). The coin system was well-regulated and although precious metal content changed across coinages, there was no significant problem with debasement or inflation. In Roman law, one could deposit a sack of particular coins (in sacculo) and when repaid demand the same coins to be returned (vindication). However, if one were owed a sum of money (rather than specific coins), one had to accept in payment any combination of coins tendered that were “money of the realm”—officially sanctioned coins with payment enforced in court (condictio).

This practice continued through the early modern period, in which one deposited for safe keeping either sealed sacks of coins (and could demand exactly the same coins back in the still-sealed bag) or loose coins (in which case, any legal coins had to be accepted). Hence, “nominalism” prevailed in the general, although what appears to be a form of “metalism” applied to specific coins in sacculo.*

In reality, it had more to do with the view that coins were a “moveable chattel”, something the owner had a property interest in. However, once the owner’s loose coins were mixed with other coins, there was “no earmark”—no way of determining specific ownership and hence the claimant only had a claim to be repaid in legal money—the legalis moneta Angliae, for example in England, which was stipulated to be a sum of “sterlings”. There was no sterling coin (indeed, England did not even coin the Pound, its money of account), rather, the debt was paid up by providing the appropriate sum of coins declared lawful money by the Crown—and could include foreign coins—at the nominal value dictated by the King.

The authorities that issued coins were free to change the metal content at each coinage; penalties for refusing to accept a sovereign’s coin in payment at the value stated by the sovereign were severe (often, death). Still, there is the historical paradox that when the King was paid in coin (in fees, fines and taxes), he would have them weighed—and reject or accept at lower value the coins that were low weight. If coins were really valued nominally, why bother weighing them? Why did the issuer—the King—appear to have a double standard, one nominalist, one metalist?

In private circulation, sellers also favored “heavy” coins—those that weighed more, or that were of higher fineness (more precious metal content). They certainly did not want to find themselves in the situation of trying to make payments to the Crown with low weight coins. Hence, a “Gresham’s Law” would operate: everyone wanted to pay in “light” coins, but to be paid in “heavy coins”. There was thus obvious concern with the metal content of coins, and fairly accurate (and quite tiny) scales were manufactured and sold to weigh coins individually. This makes it appear to modern historians (and economists) that “metalism” reigned: the value of coins was determined by metal content.

And yet we see in the courts rulings indications that the law favored a nominalist interpretation: any legal coin had to be accepted. And we see Kings who imposed long prison terms (the sentence was usually to serve “at the King’s pleasure”—a nice way of putting it! One can just imagine the King’s pleasure at holding indefinitely those who refused his coins.), or death, for refusing any coin deemed legal. It all appears so confusing! Was it nominal or was it metal?

The final piece of the puzzle appears to be this: until modern minting techniques were invented (including milling and stamping), it was relatively easy to “clip” coins—cut some of the metal off the edge. They could also be rubbed to collect grains of the metal. (Even normal wear and tear rapidly reduced metal content; gold coins in particular were soft. For that reason they were particularly ill-suited as an “efficient medium of exchange”—yet another reason to doubt the metalist story.)

This is why the King had them weighed to test for clipping. (As you can imagine the penalty for clipping was severe, including death.) If he did not, he would be the victim of Gresham’s Law; each time he recoined he would have less precious metal to work with. But because he weighed the coins, everyone else also had to avoid being on the wrong side of Gresham’s Law. Again, far from being an “efficient medium of exchange”, we find that use of precious metals set up a destructive dynamic that would only finally resolved with the move to paper money! (Actually, even paper is less than ideal; perhaps some readers have experienced problems getting older paper money accepted—as I did even in Italy before it adopted the euro—due to Gresham Law dynamics. Thank goodness for computers and keystrokes and LEDs.)

Kings sometimes made those dynamics worse—by recanting his promise to accept his old coined IOUs at previously agreed upon values. This was the practice of “crying down” the coins. Until recent times, coins did not have the nominal value stamped on them—they were worth what the King said they were worth at his “pay houses”. To effectively double the tax burden, he could announce that all the outstanding coins were worth only half as much as their previous value. Since this was the prerogative of the sovereign, holders could face some uncertainty over the nominal value. This was another reason to accept only heavy coins—no matter how much the King cried down the coins, the floor value would be equal to the value of the metallic content. Normally, however, the coins would circulate at the higher nominal value set by the sovereign, and enforced by the court and the threat of severe penalties for refusing to accept the coins at that value.

There is also one more aspect to the story. With the rise of the Regal predecessors to our modern state, there were the twin and related phenomena of Mercantilism and foreign wars. Within an empire or state, the sovereign’s IOUs are sufficient “money things”: so long as the sovereign takes them in payment, its subjects or citizens will also accept them. Any “token” will do—it can be metal, paper, or electronic entries. But outside the boundaries of the authority, mere tokens might not be accepted at all. In some respects, international trade and international payments are more akin to barter unless there is some universally accepted “token” (like the US Dollar today).

Put it this way: why would anyone in France want the IOU of France’s sworn enemy, the King of England? Outside England, the King’s coins might circulate only at the value of precious metal contained in them. Metalism as a theory might well apply as a sort of floor to the value of a King’s IOU: at worst, it cannot fall in value much below gold content as it can be melted for bullion.

And that leads us to the policy of Mercantilism, and also to the conquest of the New World. Why would a nation want to export its output, only to have silver and gold return to fill the King’s coffers? And why the rush to the New World to get gold and silver? Because the gold and silver were needed to conduct the foreign wars, which required the hiring of mercenary armies and the purchase of all the supplies needed to support those armies in foreign lands. (England did not have huge aircraft to parachute the troops and supplies into France—instead they hired mainland troops and bought the supplies from the local outfitters.) There was a nice vicious circle in all this: the wars were fought both by and for gold and silver!

And it made for a monetary mess in the home country. The sovereign was always short of gold and silver, hence had a strong incentive to debase the currency (to preserve metal to fund the wars), while preferring payment in the heaviest coins. The population had a strong incentive to refuse the light coins in payment, while hoarding the heavy coins. Or, sellers could try to maintain two sets of prices—a lower one for heavy coins and a high one for light coins. But that meant toying with the gallows.

The mess was resolved only very gradually with the rise of the modern nation state, a clear adoption of nominalism in coinage, and—finally—with abandonment of the long practiced phenomenon of including precious metal in coins.

And with that we finally got our “efficient media of exchange”: pure IOUs recorded electronically. Precious metal coins were always records of IOUs, but they were imperfect. And boy have they misled historians and economists!

Admittedly, I have not yet made a thorough case that money must be an IOU, not a commodity. We need some more building blocks first.
References

* I thank Chris Desan, David Fox, and other participants of a recent seminar at Cambridge University for the discussion I draw upon here.

By L. Randall Wray

Thanks for all the responses—this might have been a record number for the MMP. Coins are fascinating. I have to admit that even though my approach downplays the role of coins in monetary systems, I always head right to the coin displays in the museums. Indeed, when in Cambridge recently I was treated to a quick tour of the collection of the late Phillip Grierson, who not only was among the greatest numismatists who ever lived but also one of those who recognized that the origins of money are not to be found in markets. Rather, it was his hypothesis that money came out of the penal system (debts again!)—a view that I believe must be correct. But that is a topic for another day.

Today I will address the first set of comments on the MMT approach to “commodity money coins”. In Blog 12 I began to explain why the MMT view is that gold or silver coins are not examples of commodity money. Rather, they are simply IOUs of the issuer that happen to be stamped on precious metal.
On to the comments and questions.

Q1: What is MMT’s view of the reserve currency?

Answer: Well, today it is the Dollar; a century ago it was the Pound. MMT principles apply—it is a sovereign currency issued through keystrokes. The issuer of the reserve currency can either float (in which case the issuer does not promise to convert at a fixed exchange rate) or it can fix. As I have argued, fixing reduces domestic policy space. Reserve status probably increases external demand for the nation’s currency—which is used for international clearing. To satisfy that demand, the reserve currency issuer (the US today) either supplies the currency through the capital account (lending) or the current account (trade deficit, for example).

Many believe this allows the nation that issues the reserve currency to “get something for nothing”, often called “seigniorage”. This is largely false—did American consumers get free goods and services over the past decade as the US ran current account deficits? No, of course not. They are left with a mountain of debt. Did the US government get “something for nothing”? Well, perhaps—but all sovereign governments can be said to get something for nothing, since they purchase by keystrokes.

But that is not seigniorage—it results from the fact that sovereign government imposes liabilities on its population–taxes, fees, and fines. The US does it; but so does Turkey. Sovereign government first puts its population in debt, then it uses keystrokes to move resources to the public sector and its keystrokes create its IOUs that provide the means through which taxpayers can retire their tax debt. The sovereign’s currency can circulate outside the country to varying degrees, but that is ultimately because the sovereign’s citizens need it to pay taxes domestically—since foreigners are not normally subject to the tax.

So in principle the issuer of the reserve currency is not unique—although the external demand for the reserve currency is greater. We’ll study this more later; think of this brief response as an appetizer that is no doubt going to spur some “hegemonic” objections!

Q2: The CPI has increased by a factor of 7 since 1966. Is the currency still a store of value?

Answer: Well, sure it is–but as the commentator noted, it is not a good store of value in terms of purchasing power of a basket of consumer goods and services over a period as long as a half century. We can quibble about the use of the CPI as a measure of inflation—it has well known problems we will not pursue in detail here.

As Keynes argued, you need some “stickiness” of wages and prices in the money of account—or you might abandon money. That is what can happen in a hyperinflation. You try to find something else. But clearly except for a few gold bugs, US inflation since 1966 has been sufficiently low that the Dollar remained a useful money of account, and currency has been voluntarily held.

In truth, economists are hard-pressed to find negative economic effects from inflation at rates under, say, 40% per year. But clearly people do not like inflation when it gets to double digits.

Returning to Keynes, he said that no one would hold money as a store of value in the absence of uncertainty. Holding wealth in a highly liquid form like money makes sense only if you are uncertain, and even scared, about the future. In a financial crisis, everyone runs to cash. It gives a very low return, but that is better than a huge loss!

If you wanted a good store of wealth, and you were making a decision back in 1966 as to the portfolio you would hold until 2011, it is unlikely that you would have held much cash. There would have been many assets that would be better stores of value. However, if we are talking about a desirable portfolio to be held over the next few months, you probably would hold some cash. There is a trade-off between liquidity and return.

I know the gold bugs like gold; but those who bought it in 1980 were kicking themselves for the next 30 years, and still have not recouped their losses. In general, commodity prices fall over time in real terms—they are terrible inflation hedges—plus they have storage costs.

Let me just say I have no knowledge of Dungeons and Dragons—I suppose it is a board game like Monopoly–so I cannot answer Neil’s question about gold, silver, and copper pieces. But I think Monopoly still uses the same paper currency and same prices and rents? Not sure what the question is. Games don’t have to have inflation? OK—games have rules. I suppose inflation is not built into the rules of those games.

On Karl’s statement that past labor is not equivalent to today’s labor, hence, it is not surprising that wages and prices are higher today, I do believe he is onto a point.

We must adjust the CPI or other measures of price for quality improvements. How much would a modern laptop have cost in 1966? Millions of dollars? Billions? As Warren Mosler always jokes, your IPhone has more electronic wizardry than NASA was able to muster for the trips to the moon. The CPI is more of an art than a science—since we have to put prices on things that did not exist, and make imaginary quality adjustments.

Further there is something called the Baumol disease. A symphony orchestra back in Mozart’s time was as large as one today—give or take a few. And it took about the same time to perform a piece—depending on the conductor. There has been no productivity improvement. Yet, workers in other fields are infinitely more productive than they were in Mozart’s day. There is a similar problem in many other areas, mostly services where you really cannot improve productivity much (think barbers, teachers, doctors). The relative price of these things should have become insanely expensive over the past 200 years relative to, say, manufacturing output with tremendous productivity gains. And if we rewarded workers only for productivity gains, our musicians would still be working for Mozart era wages. It still takes one barber to keep one hundred heads of hair looking good. By contrast, a single farmer feeds as many hungry consumers as 100 farmers used to feed. But the farmer and barber still earn about the same living (give or take). Rather than vastly underpaying the farmer we choose to overpay the barber. At the same time, the Baumol disease thesis is that an ever growing portion of our nation’s output is in those sectors that suffer the disease. So we overpay ever more workers in those sectors. The trend for wages (and, thus, prices) is up.

(Wages grow faster than productivity because we have those low productivity sectors that get the same wage increases. And to carry the analysis a bit further, the thesis is that over time government tends to take over more of these “diseased” sectors—so government tends to grow as a percent of GDP. This is not meant to be a criticism, and of course there are countervailing tendencies. But think of healthcare and projected tens of trillions of dollars of government budget deficits and you’ve got the picture.)

Blame the concert violinist for erosion of the value of the dollar.

In a sense, a part of inflation is to even these things out—otherwise, all our musicians and artists would live like paupers relative to our factory workers. Think of it this way, inflation is the cost of preserving culture. Occasionally we like fine art, too. And we like our Kindergarten teachers to maintain class size of 15 kids. To keep pace with productivity growth in manufacturing, each Kindergarten teacher today would have to have hundreds of 5 years olds crowded into every classroom. It didn’t happen. (Well, with state and local government budget cuts, it might.)

To preserve “inefficiency” in the Kindergarten classroom we need inflation.

Sorry, that was rather long-winded, but the comment by Karl was on the right track.

Finally, as Neil hints, some inflation is probably good. Keynes argued it helps to encourage investment, by increasing nominal returns and making it easier to service debt. When I graduated from college with mountains of student loan debt, I really appreciated the Carter years’ inflation! The alternative would be rapidly declining prices in every sector that does not suffer from the Baumol disease—but deflation itself is a dangerous disease. This would be like fighting the common cold with a good dose of terminal cancer.


Q3: What about Chinese holding of Dollars—what is the impact on the US?

Answer: I want to hold off on this a bit, but clearly the Chinese do not really lend Dollars to the US and especially not to the US government. Every dollar they got came from us. Our problem is that we allow imports to displace US workers—we could put them to work in other jobs. But instead we leave a lot of them unemployed. We do not fully enjoy the advantages of running a trade deficit—consuming more than we produce—because we operate our economy below capacity and keep millions unemployed. But clearly the answer is not to go begging to the Chinese to keep those dollars flowing to the US (as VP Biden is doing right now)! Rather it is to put the unemployed to work doing useful things to improve our living standards.

Q4: Could use of gold be linked to anti-counterfeiting measures?

Answer: That sounds right to me! Yes, government could attempt to control gold supply making it harder to counterfeit coins.

Q5: What about the state of Utah accepting gold coins?

Answer: Heck, I’ll accept them, too. Send me yours! Worst case scenario is that gold prices will collapse and I’ll have to use the coins at nominal value. More likely, they will remain collector’s items.

I also like platinum: I’d like Treasury to coin ten $1 trillion dollar coins, and give me one. The other nine could buy back Treasuries so that our debt hysterians could worry about something else for a while.

Q6: Today, are there two “commodities” serving as medium of exchange, currency and demand deposits?

Answer: Neither are commodities. Sorry, we are using the word commodities in two senses. One is the Wall Street terminology: “natural resource” inputs to production: oil, soybeans, corn, copper, silver…and, yes, gold. These are now the subject of a speculative boom driven by pension funds buying futures contracts. The other is in the sense of “products of labor, produced for sale in markets”. But on neither definition is currency nor demand deposits an example of a “commodity”. Both are IOUs, either stamped on base metal or paper, or recorded electronically through keystrokes.

Q 7: In what sense does the state go into debt to the public when it issues money?

Answer: It must accept back its own IOUs. What it “owes” you is the right to redeem its IOU for the tax debt it imposed on you. Government “redeems” by accepting its own IOU. All debtors must accept back in payment their own IOUs. Even government. Refusal to accept is a default.

Q8: Were clipped coins accepted at original value?

Answer: Yes. And No. More on Gresham’s Law next week. Roman Law was nominalist as I discussed. Deviations from nominalism, however, were common in early modern society. But that does not make metalism correct. Read next week.

To finish up, a few more comments and responses:

Thanks much to Ramanan for providing citations to the St Augustine statement on Christ’s coins. I will update the blog. : St. Augustin on Sermon on the Mount, Harmony of the Gospels and Homilies on the Gospels: Nicene and Post-Nicene Fathers of the Christian Church, Part 6″ (Sermon XL) ; Just above Sermon XLI here.

Alternatively; toward the end of the page: Christ’s coin is man. In him is Christ’s image, in him Christ’s Name, Christ’s gifts, Christ’s rules of duty

A commentator noted: “People as coins” just might be a rabbinic allusion: “When Caesar puts his image on a thousand coins, they all look alike. But when God puts His image on a thousand people, they all come out different.”

LRW: Thanks, I will look into this.

Dave said: People might find this of interest:

LRW: I agree! His view of money is similar to mine, I believe. In a word, debt.

Lewis, you appear to be channeling A. Mitchell Innes. Good job.

Darwin: yes, if you play by the rules on a gold standard, the quantity of gold constrains coin issue. You can call in gold, you can raise the price for gold paid at the mint, you can put less gold in your coins, and you can use hazelwood tally sticks and bar tabs. All of the above.

Anon Marx: I agree with you. Some Marxists do want to find commodity money in Marx. I do not. Marx’s whole analysis requires nominalism. I interpret his statements on gold as contingent—special cases having to do with operation of the gold standard.

Oil Drum Anon: “I think this particular installment of the MMP is weak…. Where is there an axiomatic development of MMT, uncluttered by asides about ancient history?

Answer: Well, Anonymous you’ve found the right site but you started in on #12. Begin at the Beginning. (Hint: they are numbered consecutively, so the beginning would be #1.) Further, many or even most people have this belief about commodity coins of the past, and believe that all would be right with the world if we only went back to coining gold. But that is an imaginary past. That is what I am trying to correct, since stories color our understanding. Indeed, our understanding really boils down to stories—it is how we sort things out. Humans are born story tellers. All of them are false, of course.

OK: done for today. Thanks for comments and questions. Part two next week. That will get more into the nitty and the gritty.

By L. Randall Wray

Last week I asserted that coins have never been a form of commodity money; rather they have always been the IOUs of the issuer. Essentially, a gold coin is just the state’s IOU that happens to have been stamped on gold. It is just a “token” of the state’s indebtedness—nothing but a record of that debt. The state must take back its IOU in payments made to itself. “Taxes drive money”—these “money things” are accepted because there are taxes “backing them up”, not because they have embodied gold. As promised, this week I will begin try to dispel the view that coins used to be commodity monies. Next week, we will finish up the discussion.

In this Primer I do not want to go deeply into economic history—we are more interested here with how money “works” today. However, that does not mean that history does not matter, nor should we ignore how our stories about the past affect how we view money today. For example, a common belief (accepted by most economists) is that money first took a commodity form. Our ancient ancestors had markets, but they relied on inconvenient barter until someone had the bright idea of choosing one commodity to act as a medium of exchange. At first it might have been pretty sea shells, but through some sort of evolutionary process, precious metals were chosen as a more efficient money commodity.

Obviously, metal had an intrinsic value—it was desired for other uses. (And if we take a Marxian labor theory of value, we can say metal had a labor value as it had to be mined and refined.) Whatever the case, that intrinsic value imparted value to coined metal. This helped to prevent inflation—that is, decline in the purchasing power of the metal coin in terms of other commodities—since the coin could always be melted and sold as bullion. There are then all sorts of stories about how government debased the value of the coins (by reducing precious metal content), causing inflation.

Later, government issued paper money (or base metal coins of very little intrinsic value) but promised to redeem this for the metal. Again, there are many stories about government defaulting on that. And then finally we end with today’s “fiat money”, with nothing “real” standing behind it. And that is how we get the Weimar Republics and the Zimbabwes—with nothing really backing the money it now is prone to causing hyperinflation as government prints up too much of it. Which leads us to the gold bug’s lament: if only we could go back to a “real” money standard: gold.

In this discussion, we cannot provide a detailed historical account to debunk the traditional stories about money’s history. Let us instead provide an overview of an alternative.

First we need to note that the money of account is many thousands of years old—at least four millennia old and probably much older. (The “modern” in “modern money theory” comes from Keynes’s claim that money has been state money for the past 4000 years “at least”.) We know this because we have, for example, the clay tablets of Mesopotamia that record values in money terms, along with price lists in that money of account.

We also know that money’s earliest origins are closely linked to debts and record-keeping, and that many of the words associated with money and debt have religious significance: debt, sin, repayment, redemption, “wiping the slate clean”, and Year of Jubilee. In the Aramaic language spoken by Christ, the word for “debt” is the same as the word for “sin”. The “Lord’s Prayer” that is normally interpreted to read “forgive us our trespasses” could be just as well translated as “our debts” or “our sins”—or as Margaret Atwood says, “our sinful debts”.*

Records of credits and debits were more akin to modern electronic entries—etched in clay rather than on computer tapes. And all early money units had names derived from measures of the principal grain foodstuff—how many bushels of barley equivalent were owed, owned, and paid. All of this is more consistent with the view of money as a unit of account, a representation of social value, and an IOU rather than as a commodity.

Or, as we MMTers say, money is a “token”, like the cloakroom “ticket” that can be redeemed for one’s coat at the end of the operatic performance.

Indeed, the “pawn” in pawnshop comes from the word for “pledge”, as in the collateral left, with a token IOU provided by the shop that is later “redeemed” for the item left. St. Nick is the patron saint of pawnshops (and, appropriately, for thieves), while “Old Nick” refers to the devil (hence, the red suit and chimney soot) to whom we pawn our souls. The Tenth Commandment’s prohibition on coveting thy neighbor’s wife (which goes on to include male or female slave, or ox, or donkey, or anything that belongs to your neighbor) has nothing to do with sex and adultery but rather with receiving them as pawns for debt. By contrast, Christ is known as “the Redeemer”—the “Sin Eater” who steps forward to pay the debts we cannot redeem, a much older tradition that lay behind the practice of human sacrifice to repay the gods.*

We all know Shakespeare’s admonition “neither a borrower nor a lender be”, as religion typically views both the “devil” creditor and the debtor who “sells his soul” by pawning his wife and kids into debt bondage as sinful—if not equally then at least simultaneously tainted, united in the awful bondage. Only “redemption” can free us from humanity’s debts owing to Eve’s original sin.

Of course, for most of humanity today, it is the original sin/debt to the tax collector, rather than to Old Nick, that we cannot escape. The Devil kept the first account book, carefully noting the purchased souls and only death could “wipe the slate clean” as “death pays all debts”. Now we’ve got our tax collector, who like death is the only certain thing in life. In between the two, we had the clay tablets of Mesopotamia recording debits and credits in the Temple’s and then the Palace’s money of account for the first few millennia after money was invented as a universal measure of our multiple and heterogeneous sins.

The first coins were created thousands of years later, in the greater Greek region (so far as we know, in Lydia in the 7th century BC). And in spite of all that has been written about coins, they have rarely been more than a very small proportion of the “money things” involved in finance and debt payment. For most of European history, for example, tally sticks, bills of exchange, and “bar tabs” (again, the reference to “wiping the slate clean” is revealing—something that might not be done for a year or two at the pub, where the alewife kept the accounts) did most of that work.

Indeed, until very recent times, most payments made to the Crown in England were in the form of tally sticks (the King’s own IOU, recorded in the form of notches in hazelwood)—whose use was only discontinued well into the 19th century (with a catastrophic result: the Exchequer had them thrown into the stoves with such zest that Parliament was burnt to the ground by those devilish tax collectors!) In most realms, the quantity of coin was so small that it could be (and was) frequently called in to be melted for re-coinage.

(If you think about it, calling in all the coins to melt them for re-coinage would be a very strange and pointless activity if coins were already valued by embodied metal!)

So what were coins and why did they contain precious metal? To be sure, we do not know. Money’s history is “lost in the mists of time when the ice was melting…when the weather was delightful and the mind free to be fertile of new ideas—in the islands of the Hesperides or Atlantis or some Eden of Central Asia” as Keynes put it. We have to speculate.

One hypothesis about early Greece (the mother of both democracy and coinage—almost certainly the two are linked in some manner) is that the elites had nearly monopolized precious metal, which was important in their social circles tied together by “hierarchical gift exchange”. They were above the agora (market place) and hostile to the rising polis (democratic city-state government). According to Classical scholar Leslie Kurke, the polis first minted coin to be used in the agora to “represent the state’s assertion of its ultimate authority to constitute and regulate value in all the spheres in which general-purpose money operated… Thus state-issued coinage as a universal equivalent, like the civic agora in which it circulated, symbolized the merger in a single token or site of many different domains of value, all under the final authority of the city.”** The use of precious metals was a conscious thumbing-of-the-nose against the elite who placed great ceremonial value on precious metal. By coining their precious metal, for use in the agora’s houses of prostitution by mere common citizens, the polis sullied the elite’s hierarchical gift exchange—appropriating precious metal, and with its stamp asserting its ultimate authority.

As the polis used coins for its own payments and insisted on payment in coin, it inserted its sovereignty into retail trade in the agora. At the same time, the agora and its use of coined money subverted hierarchies of gift exchange, just as a shift to taxes and regular payments to city officials (as well as severe penalties levied on officials who accepted gifts) challenged the “natural” order that relied on gifts and favors. As Kurke argues, since coins are nothing more than tokens of the city’s authority, they could have been produced from any material. However, because the aristocrats measured a man’s worth by the quantity and quality of the precious metal he had accumulated, the polis was required to mint high quality coins, unvarying in fineness. (Note that gold is called the noble metal because it remains the same through time, like the king; coined metal needed to be similarly unvarying.) The citizens of the polis by their association with high quality, uniform, coin (and in the literary texts of the time, the citizen’s “mettle” was tested by the quality of the coin issued by his city) gained equal status; by providing a standard measure of value, coinage rendered labor comparable and in this sense coinage was an egalitarian innovation.

From that time forward, coins commonly contained precious metal. Rome carried on the tradition, and Kurke’s thesis is consistent with the statement of St. Augustine, who declared that just as people are Christ’s coins, the precious metal coins of Rome represent a visualization of imperial power—inexorably doing the emperor’s bidding just as the reverent do Christ’s.*** Note, again, the link between money and religion.

OK, that gets us to Roman times. Next week we examine coinage from Rome through to modern times.

References:
*Payback: debt and the shadow side of wealth, by Margaret Atwood, Anansi 2008.
**Coins, Bodies, Games, and Gold, by Leslie Kurke, Princeton University Press, Princeton, New Jersey, 1999; xxi, 385; paper $29.95 (ISBN 0-691-00736-5), cloth $65.00 (ISBN 0-691-01731-X).
***If anyone knows the source for St. Augustine’s comparison of people to coins, please provide it. I thank Chris Desan, David Fox, and other participants of a recent seminar at Cambridge University for the discussion I draw upon here.

Thanks for comments. Let me stick to the topic: MMT and alternative exchange rate regimes. At one end we have fixed exchange rates—with the currency pegged to gold or to a foreign currency. At the other we have floating rates. No one seemed to question my (obvious) claim that floating rates provide more domestic policy space, in general. Other than that, what are the advantages and disadvantages?