2
The ‘Incompatibles’: Commodity and Credit Theories

As we noted in the previous chapter, the earliest known coined form of money was minted in Lydia (now western Turkey) around 700 BCE. This was minted from a naturally occurring alloy of silver and gold (electrum) and spread quickly to Classical Greece. Here we find the first accounts of the dispute about the nature of money in the observations of Plato (428–348 BCE) and Aristotle (384–322 BCE). (See Peacock, 2013, for the most accessible, comprehensive account of early coinage and money.) In a critique of coined money’s social and political impact, Aristotle contended that the pursuit of money as a means of power was unethical. Barter, which he believed had previously been the routine way of making transactions, was based on a mutually agreed exchange of commodities; but money could now be accumulated and used as a means for disruptive and corrupt political domination. Money, Aristotle argued, should be no more than a ‘neutral’ instrument: that is, a commodity used as a medium of exchange for transactions that increase the welfare of those involved. Plato’s later criticism of the wasteful unnecessary use of precious metal as coins strongly implies that he believed that the value of money was not ‘intrinsic’. In this regard, he appears an early advocate of the nominalist and social constructionist tradition in which money is a matter of law and convention; it does what we agree it should do (Schumpeter, 1994 [1954], 56). However, over the centuries, the Aristotelian version has had a greater – if indirect – influence via eighteenth- and nineteenth-century ‘classical economics’, in which the concepts of ‘neutral’ money, commodity money, and ‘real’ value were established.

Commodity Theory and ‘Metallism’

Adam Smith’s The Wealth of Nations (1776) followed Aristotle’s derivation of money’s origins and functions from assumptions about the nature of society and human motivation. Smith explained that the advantages of the division of labour increased production but removed self-sufficiency. Henceforth, specialized producers could only satisfy their wants by the barter exchange of their respective produce. Eventually, it was found that they could maximize their exchange opportunities by holding stocks of the most tradable commodities as media of exchange – iron nails and dried cod in Smith’s account. In other words, money as a medium of exchange is the commodity that ‘buys’ all other commodities.

Although Smith’s sternest critic, Karl Marx, saw the importance of the new forms of capitalist bank-credit paper money, which we shall discuss shortly, he also focused on commodity money. Marx’s ‘labour theory of value’ – in which the value of commodities is determined by the labour time necessary for their production – led him to present a version of the commodity theory of money. The value of the labour involved in mining and minting gold is embodied in the coin. Therefore, the commodity gold can become the instrument for the measurement and exchange of other values in relation to ‘the quantity of any other commodity in which the same amount of labour time is congealed’ (Marx, 1976 [1867], 186; for a comprehensive orthodox Marxist analysis of money, see Lapavitsas, 2016). Nevertheless, Marx dismissed the ‘classical economics’ of Adam Smith and his early nineteenth-century followers for its inability to see that ‘capital’ was not simply the material means of production: technology and other physical resources. Rather, capital entailed a social relation between those who owned the material means of production – capitalist entrepreneurs – and those who operated them – the workers. However, Marx failed to apply the same analysis to money and fully to grasp that all money is credit in the sense that its value is given by the existence of debts that it can cancel (Ingham, 2004; 63–6; Smithin, 2018).

For ‘classical economics’, money is a spontaneous unintended consequence of what Smith called rational individuals’ ‘propensity to truck, barter, and exchange’ in seeking to maximize self-interest. Their individual strategies culminate in the ‘wisdom’ of the market – the ‘invisible hand’– which ‘chooses’ the most tradable commodity. Commodities are held in the first instance for their ‘intrinsic’ value and/or usefulness – Smith’s nails and cod, or gold. However, as trade in some commodities increases, their potential is recognized, setting in train a momentum that culminates in the transition from barter to money as the most exchangeable commodity. This ‘creation myth’ was firmly established by the Cambridge economist William Stanley Jevons in his Money and the Mechanism of Exchange (1875): money emerges spontaneously to avoid the ‘inconvenience’ of the ‘absence of a double coincidence of wants’ in barter. This was illustrated with the example of how the naturalist Alfred Russel Wallace went hungry on an expedition to the Malay Peninsula in the 1850s because, although food was abundantly available, his party did not have any commodities that were acceptable at the time for which it could be bartered.

The development of coinage was easily explained by commodity-exchange theory with the further conjecture that precious metal commodities have the additional advantages of portability, divisibility, and durability, which enable the minting of commodity money into convenient uniform pieces of equal weight and fineness. Consequently, this theory of money is also known as ‘metallism’. Endorsed by the leading constitutional scholar and philosopher John Locke during a dispute in the late seventeenth century, ‘metallism’ became the accepted basis for monetary practice and policy (see Martin, 2013, chap. 8). At that time, the price of silver on the European markets was greater than the London price offered by the mint for coinage. Consequently, silver was held as a non-monetary store of value and not taken to the mint for coinage. The London financier William Lowndes proposed a 20 per cent reduction of the silver content of English crowns (5 shillings) to increase the nominal value of coins above the price of silver and so discourage the export of silver with a higher market price than its face value as coin. Locke dismissed the proposal for being based on a false theory of money. Silver, he argued in 1695, is the ‘instrument and measure of commerce by its quantity, which is the measure also of its intrinsick value’ (quoted in Martin, 2013, 126). He argued that measures of economic and physical phenomena should be constructed on the same principle: both values being measured were given in ‘nature’. For Lowndes to claim that a coin would retain its value despite losing 20 per cent of its silver was as mistaken as lengthening a foot by dividing it into fifteen parts instead of twelve and calling them both inches (Martin, 2013, 127).

‘Metallism’ became closely related to economics’ ‘quantity theory’ of money, in which price levels are determined by the exchange ratio of quantities of commodities: precious metal and goods. Using mathematics, the theory was formalized by Irving Fisher at the height of the gold standard era (Fisher 1911). In its simplest form, his equation holds that the price level (P) is a direct function of the quantity (M) and velocity (V) of circulation of money in relation to the number of transactions (T): that is, MV = PT. Although the equation is a logical identity in which each side equals the other, it was generally assumed that MV determines PT: that is, the quantity of money is the causal factor in price inflation. In chapter 4, we will see that ‘quantity theory’ lay behind the ‘monetarist’ attempts in the 1970s and 1980s to control inflation.

The Essentials of ‘Classical’ Theory: ‘Neutral’ Money and ‘Real’ Value

By the late nineteenth century, commodity-exchange theory – money’s neutrality and the concept of the ‘real’ economy – was the accepted orthodoxy. As John Stuart Mill put it in his Principles of Political Economy (1871), money’s existence ‘does not interfere with the operation of any laws of value’ (quoted in Ingham, 2004, 19); it enables us to do more efficiently what had been done before without it. As we outlined in chapter 1, value in this theory derives from the utility or functional contribution of factors of production, which is determined independently of the use of money. Money merely measures the value of the pre-existing ‘real’ values which exchange at ratios which express the relative contributions/utility of ‘real’ factors of production. ‘Capital’ was seen in terms of the contribution of machinery, land and buildings, and other physical assets to production. Modern mainstream economics has continued to view capital in essentially the same way as ‘stocks’ of factors that can be expected to generate profits over time. As we have noted, this conception of capital was at odds with business usage. From Italy from the thirteenth century to Britain in the eighteenth, the word...