Chartalism

There are two main theories about the origin, and nature, of money. The first, main- stream, view proposes that money developed by a process whereby the private sector sought to minimize the costs of making exchanges whilst trading. This group of theorists tends to argue that the value of currency depended primarily, or solely, on the intrinsic value of the metallic backing of the currency. The second group of theorists (chartalists) argues instead that the use of currency was based primarily on the power of the issuing authority; that money was used initially for social, and legal, interactions, rather than as a substitute for barter in the course of trade; and that currency becomes money primarily because the coins (or monetary instruments more widely) are struck with the insignia of sovereignty, and not so much because they happen to be made of gold, silver or copper (or later of paper). Chartalists note both the difficulty of assaying the purely metallic value of a lump of (precious) metal, and the widespread monetary use of items, such as cattle, from which the word pecuniary is derived, whose characteristics are hardly condu- cive to facilitating day-to-day trade.

The mainstream team has assembled the more illustrious collection of economists (plus the endorsement of Aristotle, circa BC 340; and Locke, 1960), and has expressed its analysis in more formal and elegant terms, from the earlier economists such as Jevons (1875), and Menger (1892), von Mises (1934), Brunner and Meltzer (1971) and Alchian (1977), on more recently to Kiyotaki and Wright (1989, 1993), plus a host of other eminent economists. Against them, the chartalist team has arrayed a more motley fringe group of economists, such as Knapp (1924) in Germany, Mireaux (1930) in France, and (most of) the post-Keynesians in the United Kingdom and United States. Nevertheless, as Mélitz (1974) and Redish (1992) have noted, the chartalist team approach has also received the support of a large number, probably a sizeable majority, of those in other disciplines - for instance, anthropologists, numismatists and historians concerned with the origin of money. A leading contributor in this group is Grierson (1977); also see Einzig (1949 [1966]) and Polanyi (1957). Whereas the mainstream group has been strong on formal theory, it has been constitutionally weak on institutional detail and historical empiricism.

The mainstream theorists would accept that there are costs of assessing the value of raw metal, but would argue that a combination of the innate characteristics of the pre- cious metals, plus the identification cost reduction allowed by minting, enabled the private sector to evolve towards a monetary system. Again, however, that analysis is historically flawed. Although, once the idea and technical process is discovered, minting would seem to be as capable of being carried out within the private sector as any other metal-working process, in practice minting has, in the vast majority of cases, been a government, public sector, operation. Amongst the experts on the historical evolution of minting coins are MacDonald (1916), Grierson (1977, 1979) and Craig (1953). These authorities, in turn, refer to hosts of other earlier writers. In those cases where the mint has been run by the private sector, the government has in most cases both set the standards of fineness and extracted a rent, or seigniorage tax, that collected most of the available profits. This concentration of minting under the government's aegis is not accidental. There are two associated reasons why this is so.

First, a mint requires an inventory of precious metals. It will, therefore, act as a magnet for opportunistic theft and violence. It will require protection, and the protector (who wields the force necessary to maintain law and order in the economic system) will there- fore be able to extract most of the rent from the system.

Second, the costs of identifying the true value (quality) of the metals included in the minted coin lead to time inconsistency. The mint operator is bound to claim that the quality will be maintained forever, but in practice will always be tempted to debase the currency in pursuit of a quick and immediately larger return. Olson (1996) has described how the development of a secure, dynastic regime reduces time inconsistency in the ruler (see also McGuire and Olson, 1996).

Few inventions are made by government bodies. This has also been so in the monetary field. The metallurgical developments and the invention of banknotes, in China and the West, came initially from the private sector, but money's initial role as a means of payment, for wergeld, bride price, religious occasions, and so on (which probably pre- dated money's role as a medium of exchange), and its role in facilitating the fiscal basis of government, meant that government made the monetary process - for instance, the guarantee through minting of the fineness and at the outset of the weight of the coins - into a pillar of the sovereign state.

There is, as set out by Grierson, a further argument leading to the same conclusion. Society cannot work if violent behaviour is too prevalent. Some people will always be violent. An initial act of violence provokes revenge and a possibly endless feud.

Feuds destroy society. One early crucial function of money, wergeld, was to set a tariff, whereby (the relatives of) the initial offender could recompense the damaged party. This practice spread to other interpersonal relationships (bride price, slaves), in some cases before formal markets and the use of money in trade arose. Kleiman (1987, pp. 261-87) describes such compensations.

The governance structure of a society and the monetary institutions within it are, therefore, closely interconnected, as argued by chartalists. This has widespread implica- tions, not least for the adoption of the eurozone single currency, as argued in Goodhart (1998). A key feature of the eurozone is that the link between the political authorities and the European Central Bank (ECB) has been weakened to a degree rarely, if ever, known before. A primary constitutional feature of the ECB is its absolute independence from government (at any level). Meanwhile, the political and fiscal powers of the various European institutions (Parliament, Commission, and so on) at the matching federal level are far weaker (than has been the case in other previous federal states). That, in itself, raises constitutional and political issues.

The thrust of the mainstream's theoretical analysis is that this divorce is all to the good; indeed, it is largely the purpose of the exercise. The blame for recent inflation has been placed on political myopia, via the time inconsistency analysis, and the ability of the political (fiscal) authorities to bend and misuse monetary powers for their own short-term objectives. While there is much truth and realism in this analysis, chartalists continue to worry about whether the divorce may not have some unforeseen side effects.

See also:

Central bank independence; Central bank money; European Central Bank; Fiat money; Metallism; Money supply; State money; Time inconsistency.