RIP Money from Barter

David Fields
Economist, State of Utah
Fellow, The Monetary Policy Institute

and

Louis-Philippe Rochon
Full Professor, Laurentian University
Editor-in-Chief, Review of Political Economy

Monetary Policy Institute Blog #136

“Moreover, the lack of evidence in defense of barter has not prevented mainstream economists from placing it at the very heart of their analysis of macroeconomics and money.”

One of the most sacred assumptions of mainstream monetary theory, taught in practically every macroeconomic or monetary class in colleges and universities, has attained the status of irrefutable proof — like many other neoclassical assumptions. It is repeated ad nauseum, and used to justify certain policies. But it is too ‘misleading and disastrous’ — to paraphrase Keynes — to leave it unchallenged. As such, in this blog, we take it upon ourselves to explore yet another myth — the creation of money — and hopefully convince you that the mainstream explanation of how money was created belongs in the dustbin of economic theory.

According to mainstream economists, money was created to facilitate the exchange of goods and services between individuals. Never mind the fact that there is not a slither of sociological, historical, or anthropological evidence to support this claim, and forget the fact that French economist, Jean-Michel Servet, said it was nothing but a ‘fable’, nothing has seemingly stopped mainstream economists from telling a tall tale.

Of course, we are all very familiar with the concept of barter, where one would exchange a good or a service for someone else’s goods or services. The story is simple: I want to trade my goods and obtain some other goods. But I must find someone whose wares I want who in turn wants mine. It may not be that easy, and I might have to trade with several people until I can finally have some sort of good that someone wants in exchange for my goods. Moreover, every good would have had multiple prices: the price of a shirt in terms of wool, or in terms of shoes, or in terms of coats, or in terms of every other good, each very difficult to calculate. All this, according to this version of history, would have been timely and costly.

Wouldn’t life be easier if we simply had money? Give me food and in exchange I give you money: money is an asset that everyone wants. As such, it is argued that money spontaneously arose to reduce transaction costs, and allowed for a more efficient working of the market economy — this is the essence of the mainstream assumption known as Say’s Law.

This is essentially how mainstream macroeconomics is taught: we explain to students that the concepts of labour markets and unemployment, production, wages, (relative) prices, investment, savings, aggregate demand, international trade and exchange rates, and growth all take place well before we discuss money: money is decoupled from discussions over production and investment. The discussion over money only arises much later in the classes and in textbooks. Money is discussed as a simple afterthought. As Davidson and Weintraub wrote some 5 decades ago, this is a “Walrasian world, where money is superimposed only after all the real elements are resolved.” This is precisely what Schumpeter called a ‘real analysis’ (Joan Robinson called it ‘imaginary’). For Schumpeter,

Real analysis proceeds from the principle that all the essential phenomena of economic life are capable of being described in terms of goods and services, of decisions about them, and of relations between them. Money enters the picture only in the modest role of a technical device that has been adopted in order to facilitate transactions. . . So long as it functions normally, it does not affect the economic process, which behaves in the same way as it would in a barter economy; this is essentially what the concept of neutral money implies.

In other words, money is a veil. It does not interfere with the functioning of the economy; in the long run, we can effectively dispense from it to explain how the economy works. Money simplifies the story; it does not alter it. Well, the mainstream story that is. For post-Keynesians, it is another story altogether.

Moreover, the lack of evidence in defense of barter has not prevented mainstream economists from placing it at the very heart of their analysis of macroeconomics and money.

Yet, anthropologists have insisted that barter was not an important component of economic life. For instance, Carolyn Humphrey, from the University of Cambridge, writes: “we know from the accumulated evidence of ethnography that barter was indeed very rare as a system dominating primitive economies”. Referring to barter as an ‘imagined state’, she then adds that “[n]o example of a barter economy, pure and simple, has ever ”.

Heinsohn and Steiger reached a similar conclusion and wrote that “the concept of a pure barter economy from which the monetary economy devolves is no more than a historical speculation and does not correspond to the true course of history.”

It should now become clear that the story of barter is fallacious. As such, we can infer that policies that emanate from such a story can only be deemed equally fallacious — indeed ‘misleading and disastrous’. As Joan Robinson said, it is “misleading to apply conclusions drawn from such an imaginary world”.

While coins have circulated throughout history, the principal way people kept track of transactions was through the acknowledgement or recording of debt. I buy a hat from you and in return, I owe you something. As David Graeber noted, “A history of [money] is […] a history of [credit]. Some of the very first written documents that have come down to us are Mesopotamian tablets recording credits and [thus] debits, rations issued by temples, money owed for rent of temple lands, the value of each precisely specified in grain and silver. Some of the earliest works of moral philosophy, in turn, are reflections on what it means to imagine morality as debt. [Money as barter] is a fantasy world”.

In this sense, money is first and foremost a social institution of credit. Real economic activity is presupposed by the degree to which banks make loans to firms to spur capitalist investment: credit, money, debt, production and investment are linked together. There cannot be a discussion of economics without first having a discussion of money — this is a far cry from the mainstream story (with consequences for the IS-LM model, in particular, which is the subject of another blog). This is what Schumpeter called ‘monetary analysis’: money must be introduced “on the very ground floor of our analytic structure and abandons the idea that all essential features of our economic life can be represented by a barter-economy model’. Rochon had argued that money is “part and parcel of the production process”.

The capacity for firms to purchase necessary amounts of labor and material inputs necessary for satisfying expectations of profit extraction and, hence, for workers to receive wages, is assigned by the scope of debt commitments. Capitalism depends on a struggle for economic existence shaped and fashioned by the deontic power of credit granting. This power is determined and shaped by the social and political conditions as defined by the evolution of the State. This means that the power of credit granting, rather than the confidence of the markets, is essential for the development of ‘moneyness’ of a particular asset. In other words, money results from specific historically determined social relations. The cumulative process of what sets the parameters of power secure financial instrument constitutes how money is christened. Money does not emerge in the form of a valuable commodity, but as a unit of account in the form of tokens to account for debt payments. Capitalism is a credit driven social structure.

This social process is what heterodox economists call the monetary circuit, which can be elucidated using the following schema:

M* — M — C´ — M´ — M*´

where M* represents bank loans to firms to facilitate the production process (M — C’ — M’), which eventually is converted into M*´ (which is a distinct source of some debate), that is, the payment of interest to the banker out of realized profits M´. Profit is quantitatively distributed between ‘financial’ capitalists and ‘industrial’ capitalists, which give rise to a qualitative distinction between interest and profit of enterprise.

Money as a social institution of credit is a dynamic force. It cannot be considered just a saleable commodity, because its very essence as a tool of prospective yield is what sets in motion the very act of investment and consumption upon which capitalist growth and development is based. Capitalism could not exist without money defined in such fashion. Anything that upsets this social process of finance inhibits capital accumulation, fosters uncertainty, and ensues recession. The barter story of money radically differs from this accurate description of how money is preordained. The failure to take into account the institutional dynamics of the credit-based economic system that underpins capitalism is more than sufficient reason to reject the conventional body of theory. And for this reason, we affirm yet another sleight of hand of the mainstream to be vanquished.