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The
Credit Theory
of Money
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An article appearing
in the "Banking Law Journal" in 1914 by A. Mitchell Innes presented an
exposition of the Credit Theory of money, as opposed to the Metallic
Theory.
It should be noted that the article was written in the era when
precious
metal coins were viewed as the only "true money."
Up
to the time
of Adam Smith, not only was money identified with the precious metals,
but it was popularly held that they formed the only real wealth.
To Adam Smith belongs the credit of having finally and for all time
established
the principle that wealth does not reside in precious metals. But
when it came to the question of the nature of money, Adam Smith’s
vision
failed him. Having convinced himself that wealth was not gold and
silver, he was faced with two alternatives. Either money was not
gold and silver, or it was not wealth, and he inevitably chose the
latter
alternative.
If
money is not
wealth in the common meaning as representing “purchasing power” that
alone
constitutes real riches, then the whole of human commerce is based on a
fallacy. Smith’s definition of money as being not wealth, but
rather
the “wheel that circulates wealth,” does not explain the facts that we
see around us -- the striving to accumulate money. If money were
but a wheel, why should we try to accumulate wheels. The analogy
is false.
Much
has been
written since the days of Adam Smith on the subject of money, but we
still
hold to the idea that gold and silver are the only real money and that
all other forms of money are mere substitutes. The necessary
result
of this fundamental error is that utmost confusion prevails in
political
economy.
How
complete
the divorce is between the experience of daily life and the teaching of
the economists can best be seen by reading Marshall’s chapter on
capital,
with its complicated divisions into national capital, social capital,
personal
capital, etc. Every banker and every commercial man knows that
there
is only one kind of capital, and that is money. Every commercial
and financial transaction is based on the truth of this proposition;
every
balance sheet is made out in this well-established fact. And yet
every economist bases his teaching on the hypothesis that capital is
not
money. It is only when we understand the credit theory that we
see
how well it harmonizes with the known facts of everyday life.
The
Credit Theory
asserts in short that a sale and purchase is the exchange of a
commodity
for credit. From this main theory springs the sub-theory that the
value of credit or money does not depend on the value of any
metal.
Rather it depends on the right which the creditor acquires to
“payment.”
That is it depends on the right to satisfaction for the credit, and on
the obligation of the debtor to “pay” his debt. Likewise it
depends
on the right of the debtor to release himself from his debt by the
tender
of an equivalent debt owed by the creditor, and the obligation of the
creditor
to accept this tender in satisfaction of his credit.
Such
is the fundamental
theory, but in practice it is not necessary for a debtor to acquire
credits
on the same persons to whom he is debtor. We are all both buyers
and sellers, so that we are all at the same time both debtors and
creditors
of each other. And by the wonderfully efficient machinery of
banks
to which we sell our credits, and which thus become the clearing houses
of commerce, the debts and credits of the whole community are
centralized
and set against each other. In practice, therefore, any good
credit
will pay any debt.
In
theory we
create a debt every time we buy, and acquire a credit every time we
sell.
In practice this theory is also modified, at least in advanced
commercial
communities. When we are successful in business, we accumulate
credits
on a banker and we can then buy without creating new debts, by merely
transferring
to our sellers a part of our accumulated credits.
If
we have no
accumulated credits at the moment we wish to make a purchase, instead
of
becoming the debtors of the person from whom we buy, we can arrange
with
our banker to “borrow” a credit on his books and transfer this borrowed
credit to our seller. In doing so, we hand over to the banker the
same amount of credit (and something over) which we expect to acquire
when
we in turn become sellers.
As
the greatest
buyer of commodities and services in the land, the government issues in
payment of its purchases vast quantities of small tokens which are
called
coins or notes, and which are redeemable by the mechanism of
taxation.
We can use these credits on the government to pay for small purchases
in
preference to giving credits on ourselves or transferring those on our
bankers.
So
numerous have
these government tokens become and so universal their use in everyday
life
-- far exceeding that of any other species of money -- that we have
come
to associate them alone with the word “money.” But they have no
more
claim to the title of money than any other tokens or acknowledgements
of
debt.
Of
all the false
ideas current on the subject of money, none is more harmful than the
notion
that the government has a monopoly on the issue of money. If
banks
could not issue money, they could not carry on their business.
And
when the government puts obstacles in the way of the issue of certain
forms
of money, one of the results is to force the public to use perhaps less
convenient forms.
As
can be clearly
proven by careful study of history, a dollar or a pound or any other
monetary
unit is not a fixed thing of known size and weight, and of ascertained
value, nor did government money always hold the preeminent position
which
it today enjoys in most countries.
The
notion that
the government coin is the one and only dollar, and that all other
forms
of money are promises to pay that dollar, is no longer tenable in the
face
of the clear historical evidence to the contrary. A government
dollar
is a "promise to pay,” a "promise to redeem,” just as all other money
is.
All forms of money are identical in nature, namely a credit for the
holder
and a debt of the issuer.
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