Where Does Money Come From?

Free exchange, the economics column in the Economist, has a really interesting piece in this week’s issue on two theories of the origin of money. The first theory is the evolutionary market theory propounded by Carl Menger, one of the three independent and simultaneous co-discoverers of the marginal utility theory of value in the early 1870s, (the two co-discoverers being William Stanley Jevons and Leon Walras) in a classic 1892 paper “On the Origins of Money,” and the other being the Cartalist theory, famously advanced by G. F. Knapp in his State Theory of Money, but also by other more orthodox theorists like P. H. Wicksteed (see my earlier posts here and here), and more recently in a paper by Charles Goodhart, discover of Goodhart’s Law, an only slightly less general statement of what came to be known some years later as the Lucas Critique.

Menger’s theory is a brilliant conjectural history of how money might have evolved as the result of individual choices by individuals seeking to reduce their transactions costs in an economic environment that is changing from subsistence farming into a market economy characterized by specialization. Some individuals, realizing that certain commodities were easier to trade than others, would begin holding inventories of those goods beyond their immediate demands, thereby enhancing their ability to find trading partners. But by holding inventories of those commodities, these alert individuals would do two things, first they would make it even easier to trade in those commodities, and second they would induce other people to follow their example. As others followed their example, the costs of trading in those commodities originally identified as low cost commodities to trade would be reduced still more. This was an early description of what have recently come to be known as network effects or network externalities. A good characterized by a network effect is a good for which the demand increases as more people demand it. Menger beautifully described the process by which a commodity would emerge as money owing to the network effects inherent in being used as a medium of exchange.

While theoretically brilliant and supported by some historical evidence, Menger’s conjectural history hardly provides a complete or unerring account of the development of money. One important part of the story that Menger left out is the pervasive, though not necessarily exclusive, role of the state in the development of money.  Here is Free exchange:

Take the widespread use of precious metals as money. A Mengerian would say that this happens because metals are durable, divisible and portable: that makes them an ideal medium of exchange. But it is incredibly hard to value raw metals, Mr Goodhart argued, so the cost of using them in trade is high. It is much easier to assess the value of a bag of salt or a cow than a lump of metal. Raw metals fail Menger’s own saleableness test.

This is complicated. Traders traveling long distances would want to use a medium of exchange that had a high value relative to the cost of transportation. So precious metals probably became more important as media of exchange not in the earliest stages of the historical development of money, when salt and cattle were widely used, but at a later stage, when professional traders began buying in one location and selling in other, distant locations, precious metals served their purposes better than bulkier commodities, much more costly to transport than precious metals.  Free exchange continues:

This problem explains why metal money has circulated not in lumps but as coins, with a regulated amount of metal in each coin. But history shows that minting developed not as a private-sector attempt to minimise the costs of trading, but as a government operation. It was state intervention, not the private market, that made metal specie work as money.

Again, my reading of the historical evidence – and I don’t claim more than a superficial knowledge of the historical evidence – is that there is evidence of early private minting operations. However, the early private mints were quickly displaced by mints operated by the state (or whatever you care to call the organizations headed by early monarchs). In my book Free Banking and Monetary Reform, I argued that having a monopoly over the mint was beneficial to the survival chances of any “state” competing for survival against other nearby states. To be able to survive, a state needed to be able to hire soldiers and pay for weapons. How could a monarch do that if he didn’t have an efficient system of collecting taxes? One very good way was to own a mint, and have at least a local monopoly over the minting of coins, which gave the monarch the ability to raise funds in an emergency by debasing the coinage. A prudent state would not debase the coinage except under dire circumstances, but in order to be able to engage in currency debasement, the state needed a monopoly over the coinage, and the ability to force its subjects to accept those coins at face value to discharge previously contracted obligations.  Monarchs that were also monopolists over mints had an important advantage in competition with monarchs without a mint.  So mints became part of the essential equipment of any self-respecting monarch.  Back to Free exchange:

Mr Goodhart used monetary history to test these competing theories. He examined the overthrow of Rome and a period in the tenth century when the Japanese government stopped minting coins. If the origin of money were purely private, these shocks should have had no monetary effects. But after Rome’s collapse, traders resorted to barter; in Japan they started to use rice instead of coins. There is a clear link between fiscal power and money.

My interpretation of Roman history (I am afraid that I must plead ignorance about Japanese history) is a bit different. The overthrow of Rome was largely the work of the Arab conquests of the seventh and eighth centuries. Henri Pirenne in his wonderful book Mohammed and Charlemagne argued that the Arab conquests of most of the Mediterranean sea ports essentially cut off the long-distance Mediterranean trade of the remnants of Western Roman empire. The closing off of export markets and the corresponding loss of imported goods caused a regression from specialization and trade back to autarchy. As foreign trade collapsed, local economies became increasingly self-sufficient and the demand for money dropped correspondingly. Reversion to barter was not occasioned by the absence of a state that provided coinage, but by the collapse of an exchange economy that created the demand for coinage.

So I don’t see the conflict between the Mengerian theory and Cartalist theory as being as sharp as Goodhart and Free exchange seem to suggest. On the other hand, the 1998 paper by Goodhart was remarkably prescient in describing the kinds of problems that have beset the euro, problems closely associated with “unprecedented divorce between the main monetary and fiscal authorities” in charge of conducting policy for the Eurozone.

The topic is far from exhausted, but I am.  Perhaps I will have more to say on subject in a future post.


35 Responses to “Where Does Money Come From?”

  1. 1 andrew lainton August 19, 2012 at 9:26 pm

    The peice is woefully lacking in not including the innes/macloud credit theory of money – which is largely compatable with the chartlsits view. Puzzling as of course Hawtry, together with scheumpeter, was its most able modern exponent. Also the ‘reversion to Barter’ is a victorian myth disproved by half a century of scholarship, see chapter 2 of 5000 years of debt for a list of references


  2. 2 Daryl Montgomery writing for the New York Investing Meetup August 19, 2012 at 9:53 pm

    The early state took over the issuing of coins because it was the only entity that had the power to create what we in modern times would call a “brand”. The state branded metal coins and this gave them credibility. No merchant or proto-bank had the ability to do this. Unfortunately, it didn’t take long for governments to realize they could cut corners. The Greeks were kept relatively honest because if one city-state debased their coinage traders could turn to coins from another state. The Romans however had central control and this allowed them to create the first widespread inflation in history. When companies debase their brands the public loses confidence in them. The same is true for countries that debase their currencies.


  3. 3 Blue Aurora August 19, 2012 at 11:06 pm

    Speaking of the origins of money David Glasner, have you read David Graeber’s Debt: The First 5000 Years? It deals with mainly debt, but it does address the origins of money.



  4. 4 Lorenzo from Oz August 20, 2012 at 4:19 am

    Pirenne was a great medievalist, but his thesis has been fairly comprehensively disproved on archaeological and other evidence.


  5. 5 stickman August 20, 2012 at 5:07 am

    RE Graeber’s book, as mentioned up by Blue Aurora and Andrew Laiton…

    I recall that he was involved in a spat with the Mises.org community, who took umbrage to his attempts at undermining the Mengerian theory. Bob Murphy actually wrote an article in response to Graeber’s challenge, to which Graeber then replied in rather devastating fashion. Still, the response of (some) Austrian acolytes was fairly telling in that they broke no time for evidence that disagreed with their inviolable theories: http://bit.ly/OFGY9a


  6. 6 PeterP August 20, 2012 at 6:40 am

    I also recommend Graeber. He shows that the origin of money was non-instantaneous barter which is… credit. No state necessary. I give you chicken you give me… promise to repay with wheat. If you are known to be credible, i can use the note to buy from person C, and only that person (or someone even further down the chain) will redeem the note with you. Clearing houses appeared to assess credibility and guarantee the notes. The modern clearing house which stamps redeemability promise on bank liabilities is .. the Fed. The debt records from Babylonia are way older than the oldest commodity money and the historical record of barter is very thin.



  7. 7 Mike Sproul August 20, 2012 at 6:45 am

    1. The state’s ability to debase the money is a questionable advantage, since people who know the state has that ability will not trust the state in the first place.
    2. Token moneys, like wooden tallies, Babylonian clay tablets, etc., probably pre-date coins, and they were certainly used more than coins.
    3. The early paper moneys that I know of (e.g., Massachusetts paper shillings, 1690) were usually a form of borrowing, and only incidentally became used as money.


  8. 8 John August 20, 2012 at 6:48 am

    Money was created the first time someone made an enforceable future promise that could be assigned, for the test of whether any tangible or intangible is “money” is whether the promise it carries, either express or implicit, can be enforced in the future by a third party.

    Barter is not money. Swapping wheat for gold is not money, even if the gold is a private coin, for the bearer of the gold coin has no right to enforce its future promise. All that private coinage does is, in effect, assure the quantity and quality of the coin.

    Swapping wheat for a gold coin that can be used to pay taxes or to pay next month’s rent, as the choice of the bearer is money.

    The distinction is that the enforceability of future promises creates an entirely new and different economic system: finance

    And, obviously, future promises can only be enforced by “government,” so the answer is that as soon as governments got in the business of enforcing assignable future contracts, money was created.

    Since at least when man built the Great Pyramids, the only question about any proposed or future human activity has been, How do we finance such?

    Consequently, the label economics, or at least macro economics, should be replaced by the word: finance

    Doing such would clarify our problems. I.e., what is our society not financing the employment of all our people who want to work?


  9. 9 W. Peden August 20, 2012 at 7:54 am


    What’s an example of instantaneous barter?


  10. 10 Wonks Anonymous August 20, 2012 at 9:44 am

    Crooked Timber’s book event on Graeber’s book is here:
    They started off saying some rather positive things, but it ended on a sour note, in part the result of Graeber interpreting some posts as attempts to deligitimize his book.
    I personally agree with Nick Rowe that part of the point of Menger’s argument that money reduces the transaction costs of barter is that you should NOT EXPECT to see much barter, folks will switch to money instead (using cigarettes as money in prison, for example).


  11. 11 Becky Hargrove August 20, 2012 at 10:12 am

    Lots of food for thought here. Cartalism seems to come into play when production reaches a critical point, to be sure. Perhaps the mistake governments make is not realizing how much money-for-product already needs to be circulating before people can then turn around and use some of that coin for human skill. What’s more – up to a point – money freed for skills adds significantly to the entire GDP total, so who is really paying attention when one day, that is no longer true?

    And Cartalism especially falters in the belief that skills can always be measured by money, in that for profit and not for profit institutions over time begin to ‘outsource’ skills and knowledge time use ‘for free’ to the individual, in order that the institution remain economically viable. What that means in practical terms: even though individuals have often not been free to exchange skills directly with one another, they are not reinbursed for the skills/time/labor they provide to institutions for the ‘purchase’ of the institution’s product. But the skills they purchase from the institution do not have the same economies of scale as the separate product (which money and product barter represent so well). Hence skills time tends to be available either for free in the present or at a price far higher than the monetized product which can be separated from human time. (You’re already exhausted, I hope this didn’t make your head hurt!)


  12. 12 zoniedude August 20, 2012 at 4:19 pm

    As long as the coin can be used to pay taxes to the government it has value. There is really no other factor needed. If the government will accept a wooden nickel, then a wooden nickel has value equal to the amount the government will credit that toward taxes.


  13. 13 Steve August 20, 2012 at 4:19 pm

    No mention of cigs or alcohol as a high value/weight alternative to grain or cows?
    My sense is that both have been used as money at least temporarily at points in time. Of course these goods are also prone to “debasement” which poses counterparty risk in high value transactions.

    I don’t really have a point, other than it’s fun to talk about 🙂


  14. 14 Mark Stamatakos August 20, 2012 at 5:57 pm

    Enter Rockhead

    This highfalutin debate about the origin of money is way over my head. Could someone please help me understand the current state of the U.S. dollar within the framework of the following questions:

    Is the U.S. forced to lower the value of the dollar in order to mitigate the practice of running budget deficits?

    Is the only reason that our U.S. dollar is not almost completely worthless due in large part to the extreme weakness of the Euro?

    Most of the actual, physical currency that makes up the “dollar” is overseas in foreign countries. What happens when the world loses faith in the dollar as the reserve currency?

    Moody’s, Fitch, and S & P seem to have had it with the U.S. dollar going forward. At what point are we looking at junk status? Is that far-fetched?

    Why should I or anyone else with a brain in this country believe the figures we are given for our unpaid obligations. Haven’t we reached the point of “no return” to ever pay all the unfunded obligations down? How big a foot do you need now to kick the 5,000 pound can down the road a little longer?

    Do we do ourselves a favor to simply default on our debt and start over? Is this precisely what the politicians eventually intend to do?

    Any responses to any of these questions from those with more informed perspectives would be welcomed. Thanks.


  15. 15 John August 20, 2012 at 9:17 pm


    I have noted your “theory” and that you never define money. You write, sometimes, that it has certain characteristics, but you never define money.

    Second, your “theory” that one can have many currencies are money is, frankly, circular. The gov’t could enforce many currencies, but to be money the “currency” has to be enforceable.

    Accordingly, I have to ask, What’s your point? I sure cannot find one


  16. 16 Kaleberg August 21, 2012 at 9:38 am

    It might make some sense to discuss the origin of property and ownership to get some insight into the origin of money. Enforcing property rights involves some form of coercion, usually in the form of “you and what army”. Sure, you can have an anarchic state where each individual has to enforce his or her own property rights, but this rarely lasts as a society gets wealthier. Socieities tend to develop a dynamic with a ruler and inner circle and various circles of enforcers with declining powers of ownership as they move from the center. (Women, children and many men, that is, most people, wind up in the category of property, not owners.)

    Once you have the enforcement and coercion structures, implementing money is simple. Just as there is recourse in the event someone steals something or doesn’t repay a debt, there is enforcement when someone passes bad coinage or weights. Money is just one other thing in the framework that also adjudicates boundary disputes and keeps one in line as a slave. (Remember, most people were property of some sort or another.)

    Private property and money are just something government is expected to do, like filling potholes or defending the border. In societies with little surplus, trade is handled on an ad hoc basis, often involving ties of kinship. Societies with a surplus of durable property wind up developing some sort of money to suit the needs of trade and ownership, just as they develop a history and religion to justify their decisions. After all, money can be anything. Look at the big rocks used for money on Yap, the dried mackerel packets in prisons or the magnetic transition states in our own society.


  17. 17 Hedlund August 21, 2012 at 1:42 pm

    Maybe that 1998 Goodhart paper was prescient, though I suppose that makes this 1971 Kaldor article downright prophetic.


  18. 18 Bernard Leikind August 22, 2012 at 8:20 am

    Yap Island stone money, see http://en.wikipedia.org/wiki/Rai_stones , shows that money doesn’t have to be convenient to carry around. It is worth a look at these “coins” while theorizing about the meaning of money.


  19. 19 PeterP August 22, 2012 at 7:51 pm

    @Mark Stamatakos

    “Is the U.S. forced to lower the value of the dollar in order to mitigate the practice of running budget deficits?”

    No. The US can run any deficits it wants. The state money is just a data entry in a Fed spreadsheet. If the state issues more numbers than it erases by “taxing: it makes no difference for its future spending ability. Moreover the money it net issues gets accumulated by the private sector. Government deficit = private sector surplus, to the penny.

    Please read this: http://mosler2012.com/wp-content/uploads/2009/03/7deadly.pdf

    “Is the only reason that our U.S. dollar is not almost completely worthless due in large part to the extreme weakness of the Euro?”

    No. Dollar would have worth if Europe sunk into the ocean. The reason dollar is not completely worthless is because the state demands it as a payment of taxes. The state shreds the money we send over as taxes, because it doesn’t need it (it produces it costlessly by typing it into a spread sheet: http://tinyurl.com/3pmseq8 but for it to be not as worthless as numbers in *your* spread sheet it requires us to obtain it to pay taxes or face penalties).

    “Most of the actual, physical currency that makes up the “dollar” is overseas in foreign countries.”

    No. All US dollars (except tiny fraction that is physical paper currency and coins) is in Washington DC as numbers in a Fed spread sheet. Banks create dollar look-alikes, IOUs that promise to repay dollars, but actual dollars are rarely involved. Deposit and credit card money are also numbers on spreadsheets but this time at private banks.

    “What happens when the world loses faith in the dollar as the reserve currency?”

    Is stops trying to acquire it by forgoing consumption and sending iPads and oil here to obtain an electronic entry at the Fed saying that is has “dollars”. The trade deficits decreases, jobs return here, dollar weakens, and the federal deficit decreases by as much the trade deficit decreases. No problem whatsoever apart that Americans stop enjoying free consumption for which they pay in electronic entries.

    “Moody’s, Fitch, and S & P seem to have had it with the U.S. dollar going forward. At what point are we looking at junk status? Is that far-fetched?”

    S&P ratings are irrelevant for states using their own currency. They made fools of themselves by downgrading the sole ISSUER of dollars in the Universe. The US does not fund itself like a corporation funds itself by by borrowing (or like Greece that uses money emitted by ECB in Frankfurt). “Borrowing” is smoke and mirrors: first reserves are issued out of thin air (watch Bernanke above), those reserves get stuck in the banking system and the US gracefully allows the public to swap them for interest-paying bonds. The public cannot get enough of bonds, this fiscal year alone 54T worth of them were sold (yep, that is right, 54 Trillion with a T). http://mikenormaneconomics.blogspot.com/2012/07/54-trillion-paid-back-and-counting.html

    “Why should I or anyone else with a brain in this country believe the figures we are given for our unpaid obligations.”

    The govt cannot have “paid” obligations. It can pay whatever sum without having any “income”, it is the issuer of money. In fact it cannot start borrowing or taxing before it issues the money *first*, otherwhise nobody in the whole world has a single dollar.

    “Haven’t we reached the point of “no return” to ever pay all the unfunded obligations down?”

    Paying federal debt down is destroying money. We will do it when the economy and the population shrink. Then it will be at no economic cost because the dollars outstanding will not have a match in real production anyway so it will be best to retire them. Now it would kill the economy like every time it was tried: https://rodgermmitchell.wordpress.com/2009/09/07/introduction/

    “How big a foot do you need now to kick the 5,000 pound can down the road a little longer?”

    No can needs to be kicked. We are not Greece that USES foreign currency like US corporations use dollars emitted by someone else (the govt.)

    “Do we do ourselves a favor to simply default on our debt and start over?”

    it would make zero sense. The government only promises to repay dollars and bonds with… identical dollars and bonds it produces with a data entry. And by accepting them in payment of taxes, it can always fullfil that obligation.

    “Is this precisely what the politicians eventually intend to do?”

    Looks like it, because they are morons.

    Best regards.


  20. 20 W. Peden August 23, 2012 at 6:15 am


    “Government deficit = private sector surplus, to the penny.”

    Only in a closed economy.


  21. 21 Wonks Anonymous August 23, 2012 at 8:50 am

    Selgin has a post responding to “The Economist” on Chartalism & Goodhart:


  22. 22 PeterP August 23, 2012 at 11:16 am


    “Government deficit = private sector surplus, to the penny.

    Only in a closed economy.”

    No. I take the private sector is: internal + foreign. What matters is that the net assets that the US private sector and all foreigners accumulate match exactly what the government net issued in any given period.

    If you want to break down sectors:

    “Government deficit = internal private sector surplus + trade deficit (foreign sector surplus)”, to the penny.


  23. 23 W. Peden August 23, 2012 at 1:28 pm


    (This is laughably fiddly.)

    Public sector deficit = private sector surplus is true at a global level i.e. the world is never in debt or credit. At the national level, it’s simply false, except by changing the definition of “private sector”. Since “private sector” already has a standard meaning, I think that the latter equation (public sector deficit = private sector surplus + the balance of payments) is more useful. It allows us to see very clearly that it is possible for an economy to have either public sector net savings and private sector net savings OR public sector net debt and private sector net debt. It’s also analytically misleading to regard foreign public sector surpluses/deficits as private sector surpluses/deficits.

    Still: if you define the foreign public sector as “the private sector”, then what you are saying is a (boring and misleading) tautology. If you had said “public sector deficit = non-public sector surplus”, this would be very quick and also a tautology, but also very boring.

    The New Cambridge School of Wynne Godley, Nicholas Kaldor et al used the “public sector deficit = private sector surplus + the balance of payments” tautology in a non-boring way: since the private sector surplus is roughly a constant, the balance of payments can be controlled by controlling the public sector deficit and import controls (the latter to allow for the use of fiscal policy in controlling unemployment). As usual, Kaldor’s great virtue was in developing theories that were empirical, testable, and wrong- the private sector’s saving/borrowing behaviour cannot be regarded as a constant and therefore public borrowing/saving is not a usable mechanism for controlling the balance of payments e.g. Britain had balance of payment problems in the late 1980s despite running privatisation-financed surpluses.

    “Public sector deficit = the balance of payments” is not a tautology, but imagine someone who redefined “balance of payments” to mean “balance of payments + private sector surplus”. Potentially, very misleading.

    There’s nothing necessarily wrong with redefinitions, but it’s worth spelling them out especially when without them it could look like you are making a hypothesis when actually you’re stating a tautology.


  24. 24 PeterP August 23, 2012 at 5:21 pm

    W Peden,

    If tautologies are boring for you, who am I to argue. They are never misleading though, unless you only mean yourself, then again, whatever you say.

    Some people are indeed misled (like Scott Sumner who predicted no impact from Britain’s austerity), because they fail to understand them, but it doesn’t mean the identity is misleading, other people did just fine and rightly predicted a recurrence of a recession in Britain.

    I don’t know about Kaldor but eg. MMT doesn’t ascribe too much importance to balance of payments, it’s not something that has to be “controlled”. It will be less variable than the private sector’s desire to save, because it comprises many more people so it “evens out”.

    And lo and behold:

    You see the saving of the private sector jumping all over the place, the public deficit has to be flexible enough to accommodate this variable saving’s desire at all times.

    Identities or tautologies are powerful because they exclude from the get go impossible scenarios, this enabled Godley to call a huge recession looming in 2006, this also allowed MMT people to predict that the Clinton surpluses will kill the economy and won’t possibly last while most economists lauded the surpluses, and again, Bush’s skyrocketing deficits proved MMT folks right. Too bad those deficits weren’t big enough to stop the private debt from soaring. The rest is history.


  25. 25 W. Peden August 23, 2012 at 6:22 pm


    Tautologies are not misleading, but redefinitions within tautologies can be.

    “I don’t know about Kaldor but eg. MMT doesn’t ascribe too much importance to balance of payments, it’s not something that has to be “controlled”. It will be less variable than the private sector’s desire to save, because it comprises many more people so it “evens out”.”

    Consider: if (1) public sector deficits were “skyrocketing” under Bush and (2) private debt was soaring, then who was doing the saving? Someone had to be buying a lot of both US public sector debt and private sector debt.

    I think a lot of Americans wish they could have a “dead” economy as they did under Clinton. As for lasting, that’s as much a political science as an economics question,

    If you’re trying to trumpet the credentials of MMT, I wouldn’t focus on Godley’s predictive record- Godley’s name appears on the infamous letter of the 364 economists to the Times in 1981, which constituted the final discrediting of traditional Keynesianism in Britain.


  26. 26 John August 25, 2012 at 4:01 am

    cigarettes in prison are not money; they are just 3 way barters.

    if joe owes $10 to his cellmate, I can assure you the cellmate doesn’t have to accept cigarettes in payment


  27. 27 Tas von Gleichen September 9, 2012 at 3:03 am

    I love this post. Money really does interest me a lot. Carl Menger was a great economist. I would love to read a lot more about him.


  28. 28 ezra abrams September 17, 2012 at 7:04 pm

    maybe I’m just be ing cranky and exhibing evilwebmanners, but why do discussions like this emphasize theory over data ?

    If economics was a science, by now a blog post like this should begin with something like “empirical data (ref) now largely supports the ideas of cartalism (ref) over the theories of menger (ref)

    or something like that

    but no, we emphasize theory. I don’t get it


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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey’s unduly neglected contributions to the attention of a wider audience.

My new book Studies in the History of Monetary Theory: Controversies and Clarifications has been published by Palgrave Macmillan

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