INNES AND THE STATE THEORY OF MONEY

INNES AND THE STATE THEORY OF MONEY

As discussed, Schumpeter distinguished between the monetary theory of credit and the credit theory of money - a useful distinction that can also be found in Innes. Neither of them went so far as to adopt a pure credit approach; both provide a role for 'real' or 'lawful' money. In his second article, The Credit Theory of Money, Innes (1914) devoted much of the analysis to this role (ironically, his first article What is Money? spent proportionately more space on the credit theory, while the second article really delved into the nature of money while spending far less time on credit). While there is no evidence that Innes was familiar with the work of Knapp (Knapp's book was not translated to English until 1924, although it had been published in German in 1905), the similarities are remarkable. Along this line, another useful distinction is that made by Goodhart (1998), between the metallist approach and the chartalist approach. Both Innes and Schumpeter rejected the metallist approach. Schumpeter wrote about the chartalist approach, but unfortunately he defined it too narrowly. (He identified it as a legal tender approach, much as that adopted by the Greenbackers. However, neither Knapp nor Innes adopted a legal tender approach, in which government money is supposedly accepted because of legal tender laws. Knapp called legal tender laws nothing more than an expression of a 'pious wish'; Innes called for abolition of legal tender laws, arguing that they are not the source of 'the real support of the currency' but rather encourage bank runs.) Innes did not mention the chartalist approach, but much of his analysis is consistent with it. In this section, I will present the chartalist and state money approaches (I do not believe there is a real difference between them) and relate them to the analysis provided by Innes.

Above we have briefly examined an alternative approach to the origins of money, suggested by the great numismatist, Grierson, and elaborated in Goodhart (1998) and Wray (1998a). According to this alternative, money originated not from a pre-money market system but rather from the penal system (Grierson 1977, 1979; Goodhart 1998). Hence, we emphasise the important role played by 'government' in the origins and evolution of money. More specifically, it is believed that the state (or any other authority able to impose an obligation - what we will describe as 'sovereign power') imposes an obligation in the form of a generalised, social unit of account - a money - used for measuring the obligation. The next important step consists of movement from a specific obligation - say, an hour of labour or a spring lamb that must be delivered - to a generalised, money, obligation. This does not require the pre-existence of markets, and, indeed, almost certainly predates them. Once the
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authorities can levy such an obligation, they can then name exactly what can be delivered to fulfil this obligation. They do this by denominating those things that can be delivered, in other words, by pricing them. To do this, they must first 'define' or 'name' the unit of account. This resolves the conundrum faced by methodological individualists and emphasises the social nature of money and markets - which did not spring from the minds of individual utility maximisers, but rather were socially created.

Note that the state can choose anything it likes to function as the 'money thing' denominated in the money of account, and, as Knapp emphasised, can change 'the thing' any time it likes: 'Validity by proclamation is not bound to any material' and the material can be changed to any other so long as the state announces a conversion rate (say, so many grains of gold for so many ounces of silver). (Knapp 1973 [1924/1905] p. 30). What Knapp called the state money stage begins when the state chooses the unit of account and names the thing that it accepts in payment of obligations to itself- at the nominal value it assigns to the thing. The final step occurs when the state actually issues the money thing it accepts. In (almost) all modern developed nations, the state accepts the currency issued by the treasury (in the US, coins), plus notes issued by the central bank (Federal Reserve notes in the US), plus bank reserves (again, liabilities of the central bank) - that is, the monetary base or high-powered money (HPM). The material from which the money thing issued by the state is produced is not important (whether it is a gold coin, a base metal coin, paper notes or even numbers on a computer tape at the central bank). No matter what it is made of, the state must announce the nominal value of the money thing it has issued (that is to say, the value at which the money thing is accepted in meeting obligations to the state).

Innes insisted that even government (or state) money is credit. Note, however, that he recognised it is a special kind of credit, 'redeemed by taxation' (Innes 1914, p. 168). This credit takes the form of'small tokens which are called coins or notes', issued 'in payment of its purchases', which its subjects then 'use in the payment of small purchases in preference to giving credits on ourselves or transferring those on our bankers' {pp. cit., p. 152). In other words, we can use credits on government ('currency') to purchase without going into debt (but we can also do that with bank money, if we first obtain the bank money through sale of goods or services). Still, for the government, a 'dollar is a promise to "pay", a promise to "satisfy", a promise to "redeem", just as all other money is. All forms of money are identical in their nature' (op. cit.,p. 154). But what is it that the government 'promises to pay'? Innes argues that even on a gold standard it is not gold that government promises to pay. If

government paper money is submitted in exchange for gold, government promises to pay have not been reduced:

By contrast, orthodox economists are 'metallists' (as Goodhart 1998 calls them), who argue that until the twentieth century, the value of money was determined by the gold used in producing coins or by the gold that backed up paper notes. However, in spite of the amount of ink spilled about the gold standard, it was actually in place for only a relatively brief instant. Typically, the money thing issued by the authorities was not gold

money nor was there any promise to convert the money thing to gold (or any other valuable commodity). Indeed, as Innes insisted, throughout most of Europe's history, the money thing issued by the state was the hazelwood tally stick: 'This is well seen in mediaeval England, where the regular method used by the government for paying a creditor was by "raising a tally" on the Customs or on some other revenue getting department, that is to say by giving to the creditor as an acknowledgement of indebtedness a wooden tally' (Innes 1913, p. 398). Other money things included clay tablets, leather and base metal coins, and paper certificates. Why would the population accept otherwise 'worthless' sticks, clay, base metal, leather or paper? Because the state agreed to accept the same 'worthless' items in payment of obligations to the state.

Once the state has created the unit of account and named that which can be delivered to fulfil obligations to the state, it has generated the necessary preconditions for development of markets. All the evidence suggests that in the earliest stages the authorities provided a full price list, setting prices for each of the most important products and services. Once prices in money were established, it was a short technical leap to the

creation of markets. This stands orthodoxy on its head, by reversing the order: first money and prices, then markets and money things (rather than barter-based markets and relative prices, and then numeraire money and nominal prices). The next step was the recognition by government that it did not have to rely on the mix of goods and services provided by taxpayers, but could issue the money thing to purchase the mix it desired, then receive the same money thing in the tax payments by subjects/citizens. This would further the development of markets because those with tax liabilities but without the goods and services government wished to buy would have to produce for market to obtain the means of paying obligations to the state. As Heinsohn and Steiger (1983) say, the market is the place to which one turns for earning the means of debt settlement, including the means of tax settlement. This is quite different from the orthodox view that markets develop so that individuals may maximise utility by trading consumables.