Myths & Reality: Money is Loaned into Existence!

The Economic Textbooks talk of anecdotal incidents or imaginary stories that recount insurmountable difficulties faced in trading of goods (Barter) until someone imagined money. Then they tell how money facilitated commerce, which in turn facilitated more efficient organization of communities, previously impeded by difficulties of barter, by making social division of labour or trade specializations possible on large scale. Money’s triad of qualities is then unfolded with masterly flourish.
Medium of Exchange.
Unit of Measurement.
Store of value.
How neat? The Textbooks have been most effective in perpetuating this “classy myth” about money, but they are hardly blameworthy. Adam Smith, professor of moral philosophy at the University of Glasgow, is credited with giving birth in the year 1776 to the discipline of economics. His tome, The Wealth of Nations, singlehandedly formalized the myth of money creation.
        Special Skills cause Division of Labour.
*]In a tribe of hunters or shepherds, a particular person makes bows and arrows, for example, with more readiness and dexterity than any other. He frequently exchanges them for cattle or for venison, with his companions; and he finds at last that he can, in this manner, get more cattle and venison, than if he himself went to the field to catch them. From a regard to his own interest, therefore, the making of bows and arrows grows to be his chief business, and he becomes a sort of armourer. Another excels in making the frames and covers of their little huts or moveable houses. He is accustomed to be of use in this way to his neighbours, who reward him in the same manner with cattle and with venison, till at last he finds it his interest to dedicate himself entirely to this employment, and to become a sort of house-carpenter. In the same manner a third becomes a smith or a brazier; a fourth, a tanner or dresser of hides or skins, the principal part of the clothing of savages. And thus the certainty of being able to exchange all that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labour as he may have occasion for, encourages every man to apply himself to a particular occupation, and to cultivate and bring to perfection whatever talent of genius he may possess for that particular species of business. –Wealth of Nations, Chapter II, Of the principle which gives occasion to the division of labour.
Barriers to Barter.
*]But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another. –Wealth of Nations, Chapter IV, Of the Origin and Use of Money.
Need for Medium of Exchange.
*]In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labour, must naturally have endeavoured to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of someone commodity or other, such as he imagined few people would be likely to refuse in exchange for the produce of their industry. –Wealth of Nations, Chapter IV, Of the Origin and Use of Money.
Hearsay Storytelling about what was used as Money.
*]Salt is said to be the common instrument of commerce and exchanges in Abyssinia; a species of shells in some parts of the coast of India; dried cod at Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is at this day a village In Scotland, where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the ale-house. –Wealth of Nations, Chapter IV, Of the Origin and Use of Money.
Birth of Money.
*] In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, scarce anything being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be re-united again; a quality which no other equally durable commodities possess, and which, more than any other quality, renders them fit to be the instruments of commerce and circulation. –Wealth of Nations, Chapter IV, Of the Origin and Use of Money.
This lengthy detour with Adam Smith was necessary to learn from the master “how speculative the basis of mythmaking about Money” has been since the foundation of the discipline. The myth is so powerful it is taken as self-evident truth. Not only is it inflicted upon students of economics, but has magnetic hold on most mainstream economists as well and is the foundational belief of their economic modelling, including that of Nobel Prize winner and popular New York Times columnist, Paul Krugman, as pointed out by Minsky-ian economist Steve Keen. Keen is among the handful of economists who saw the Tsunami of Financial Crisis coming and is credited with predicting its timeframe. Readers, whose appetite is whetted, are urged to explore Keen’s Blog.
For others, suffice it is to note that Banks/Loans/Money are considered irrelevant by the likes of Paul Krugman to develop “Realistic Models” that study how demand-supply, leveraging-deleveraging, asset bubbles-deflation, etc. in “real economy” behave. Their argument is based upon “Loanable Funds” model, in which Banks merely act as intermediaries, who accept deposits from those who don’t need money or have less propensity to spend and give loans to those who need money but don’t have or have high propensity to spend. This results “merely” in transfer of *Spending Power* from one economic agent to another with little effect on aggregate demand save its timing- Borrower wants to spend now than later. Keen and some other economists (Michael Hudson, Dirk Bezemer) have for long argued that for modern banking this simply is not true. Banks can and routinely create money and destroy it. Banks don’t have to have deposits to make out loans. By giving out loans, they, in fact, create matching deposits or create money. The repayment of loans destroys matching deposits or destroys money. Does it sound “Counter-Intuitive”? (Remember the powerful myth!). Therefore, by leveraging in “good times” and by “deleveraging” in “bad times” banks actually fuel and quench aggregate demand in the economy. This is called “Endogenous Money” Model. Luckily, Keen alerted his readers to an excellent paper prepared by Bank of England. It explains through examples, diagrams, and short videos (shot in its vault) how the modern banking system operates and how central bank can limit the power of commercial banks to make loans through its monetary policy. I wonder if the U.K. movement Positive Money has had anything to do to stimulate this path-breaking paper from Bank of England. Strongly recommended to anyone concerned about financialization of world economy.
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One Response to “Myths & Reality: Money is Loaned into Existence!”

  1. Sadanand Patwardhan Says:

    I forgot to mention an important point in above narrative. If the popular myth making about how Money came into existence is pure hogwash, then How and why did money come into existence? A clue is to be found on every currency note issued in a modern state. The currency note is a promissory note (solemn pledge and contract), issued by the State and signed by some factotum of the state, that says, “I PROMISE TO PAY THE BEARER THE SUM OF ……….” What does it show? It simply shows that money is DEBT owed by someone and further shows that the holder of the money has claims over that someone's labour or goods. When A provides a debt to B, B is bound by the norms of laws (legal, moral, religious) of every society at all times, to pay back the debt as per agreed terms. However, B has this obligation only towards A, or if A is dead then towards her legal heirs. Suppose, A dies without leaving any legal heirs. Then, it would be considered a lottery won by B, because he is legally at least released from his debt. Now suppose such “DEBT” is monetized and is backed by the coercive power of the State, then A could pass on the beneficial ownership of such DEBT at any time by passing on the “MONEY” that represents such a debt to someone else, who now becomes its rightful owner. That is what Money is, it symbolizes DEBT and thereby, claim over labour and goods produced in any society. Money, thus makes Debt impersonal and the relationship of 'who owes whom what' diffused. Money makes debt look benign. The history of Money has been explored by many economic anthropologists among other disciplines; and one among them, David Graeber has explored the anthropological evidence as available through various sources in his seminal work: DEBT: THE FIRST FIVE THOUSAND YEARS. Thus, not only in modern banking, as Bank of England paper seems to suggest, the economic myth promoted by Adam Smith and popularized by others wrong; but it was wrong all along the the first five thousand years of human civilization.

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