Did money emerge as a result of a government ruling?

By Dr Frank Shostak

By some theories such as the Modern Monetary Theory (MMT), money originated on account of the government decree. Money according to the MMT is what the State decides it is going to be1.

Following the ideas of the German economist, Georg Knapp, the Modern Monetary Theory (MMT) regards money as a token. For instance, when an individual places a coat in the cloakroom of a theatre, he receives a tin disc or a paper receipt. This receipt or a disc is a proof that the individual is entitled to demand the return of his coat.

According to the MMT, the material used to manufacture the tokens is irrelevant – it can be gold, silver, or any other metal or it can even be paper.

By this theory, money is established because the State forces people to pay taxes with the money that the State has decided upon.

The State taxes have to be paid with the money tokens issued by the State. Note that the State exchanges empty tokens for goods and services produced by individuals. It then requires individuals to pay taxes with part of the tokens.

The State it is held also has the ability to control the value of money through its declaration of how much it is willing to pay for a certain commodity produced by the private sector.

In the MMT framework, the token money is seen as a receipt on the economy’s resources. A token money held by an individual is regarded as his claim on a portion of resources. Individuals have exchanged goods and services for a receipt given to them by the government.

Individuals who have generated goods and services are acknowledged for this by the tokens issued to them by the government. Given that individuals are the owners of goods and services they can exercise their claim over these goods and services whenever they deem it is required.

In his writings, Carl Menger raised doubts about the soundness of the view that the origin of money is government proclamation. According to Menger,

An event of such high and universal significance and of notoriety so inevitable, as the establishment by law or convention of a universal medium of exchange, would certainly have been retained in the memory of man, the more certainly inasmuch as it would have had to be performed in a great number of places. Yet no historical monument gives us trustworthy tidings of any transactions either conferring distinct recognition on media of exchange already in use, or referring to their adoption by peoples of comparatively recent culture, much less testifying to an initiation of the earliest ages of economic civilization in the use of money2.

Does it make sense that the government can force individuals to use tokens in the transactions among themselves? Why would anyone accept a token as a payment because government accepts these tokens as tax payments? Let us try another approach.

The origin of money

To establish the origin of money we have to ascertain how a money-using economy evolved. Money emerged because of the fact that barter could not support the market economy. The distinguishing characteristic of money is its function as the general medium of exchange. It has evolved from the most marketable commodity. On this Mises wrote,

There would be an inevitable tendency for the less marketable of the series of goods used as media of exchange to be one by one rejected until at last only a single commodity remained, which was universally employed as a medium of exchange; in a word, money3.

Similarly Rothbard wrote that,

Just as in nature there is a great variety of skills and resources, so there is a variety in the marketability of goods. Some goods are more widely demanded than others, some are more divisible into smaller units without loss of value, some more durable over long periods of time, some more transportable over large distances. All of these advantages make for greater marketability. It is clear that in every society, the most marketable goods will be gradually selected as the media for exchange. As they are more and more selected as media, the demand for them increases because of this use, and so they become even more marketable. The result is a reinforcing spiral: more marketability causes wider use as a medium, which causes more marketability, etc. Eventually, one or two commodities are used as general media-in almost all exchanges-and these are called money4.

Hence, money is the thing that all other goods and services are traded for. This fundamental characteristic of money must be contrasted with other goods. For instance, food’s characteristic is that it supplies the necessary sustenance to human beings.

Capital goods’ characteristic is that it permits the expansion of the infrastructure that in turn enables the production of a larger quantity of goods and services.

Contrary to the MMT then, the essence of money has nothing to do with tax payments to the government. In addition, according to Rothbard,

Money is not an abstract unit of account, divorceable from a concrete good; it is not a useless token only good for exchanging; it is not a “claim on society ; it is not a guarantee of a fixed price level. It is simply a commodity. It differs from other commodities in being demanded mainly as a medium of exchange. 5

In addition, money does not and cannot originate by the order of the State or by some sort of social contract agreed upon by all citizens; it must always originate in the processes of the free market6.

Note money is demanded because it has an exchange value; it is exchangeable in terms of other goods and services. The benefit it offers is its purchasing power i.e. its price. Therefore, for something to be accepted as money, it must have a pre-existing purchasing power, a price.

Now, we know that the law of supply and demand can explain the price of a good. Likewise, it would appear that the same law should explain the price of money. However, there is a problem with this way of thinking; since the demand for money arises because money has purchasing power. Yet if the demand for money depends on its purchasing power, how can the purchasing power of money be explained by demand?

We are seemingly caught here in a circular trap, for the purchasing power of money is explained by the demand for money while the demand for money is explained by its purchasing power. The circularity seems to cast doubt on the historical selection process of money, as described by Mises and Rothbard and it seems to provide trustworthiness to the view that the acceptance of money is the result of a government decree.

Mises’s regression theorem solves the circularity problem

In his writings, Mises solved the circularity problem and showed how money become accepted.7 He began his analysis by noting that today’s demand for money is determined by yesterday’s purchasing power of money.

Consequently, for a given supply of money, today’s purchasing power is established in turn. Yesterday’s demand for money in turn was fixed by the prior day’s purchasing power of money. Therefore, for a given supply of money, yesterday’s price of money was set. The same procedure applies to past periods.

By regressing through time, we will eventually arrive at a point in time when money was just an ordinary commodity where demand and supply set its price.

The commodity had an exchange value in terms of other commodities i.e. its exchange value was established in a barter. On the day a commodity becomes money it already has an established purchasing power or price in terms of other goods.

This purchasing power enables us to set the demand for this commodity as money. This in turn, for a given supply, sets its purchasing power on the day this commodity starts to function as money.

Once the price of money is established, it serves as input for the setting up of tomorrow’s price of money. It follows then, that without yesterday’s information about the price of money, today’s purchasing power of money cannot be established.

With regard to other goods and services, history is not required to ascertain present prices. As demand for these goods arises because of the perceived benefits from consuming them.

The benefit that money provides is that it can be exchanged for goods and services. Consequently, one needs to know the past purchasing power of money in order to establish today’s demand for it. Furthermore, the regression theorem shows that money must emerge as a commodity and not as an empty token.

Moreover, following the regression theorem we can also infer that if the government were to enforce its own money this runs the risk of destroying the present monetary system. (Note that the present monetary system survives on account of the historical link to the market chosen money which is gold).

This in turn is going to undermine the division of labour and in turn the market economy. This in turn runs the risk of plunging the world into a primitive existence with a drastic collapse of individuals’ living standard.

The MMT Framework and Wealth Creation

In the MMT world, given that money is created by the government and given that the government is able to print freely as much money as it requires, the government by implication has command over unlimited amounts of real wealth.

If the government determines what should be regarded as money and what is going to be its value, this also means that the government dictates the rate of exchanges between money and goods and services. This means that prices are set by the government and bypasses market forces. Economic theory shows that such conduct leads to the inefficient use of resources and in turn leads to economic impoverishment. An example in this regard is the collapse of the former Soviet Union and the inability of planned economies such as Cuba and the North Korea to feed its people.

Conclusion

Using the Mises’s regression theorem, we can infer that it is not possible that money could have emerged because of a government decree as suggested by the modern monetary theory (MMT).

For the decree cannot bestow purchasing power upon a thing that the government proclaims will become the medium of the exchange. The regression theorem shows that money must emerge as a commodity.

1 L. Randall Wray – From The State Theory of Money to Modern Money Theory: An alternative to Economic Orthodoxy, Levy Economics Institute of Brad College, March 2014.

2 Carl Menger, “On the Origins of Money” Economic Journal, volume 2 (1892) p.239-55

3 Ludwig von Mises, Theory of Money and Credit, pp.32-33.

4 Murray N. Rothbard, “What Has Government Done to Our Money? Mises Institute

5 Murray N. Rothbard, “What Has Government Done to Our Money? Mises Institute.

6 Murray N. Rothbard, The Mystery of Banking. Mises Institute 2nd edition.

7 Ludwig von Mises, Human Action Scholars edition chapter 17