What came first – money or credit?

One standard narrative on evolution of money is this. Earlier people would just barter to exchange their surplus with something they needed. Over a period of time, they realised this was complicated and through this evolved money which allowed people to quote all goods in the money. This eased lives considerably as one could now just buy and sell anything without any barter. This is called as Mengerian account of money based on Carl Menger’s work.

However, this thinking has been disputed by scholars recently. They say Barter was non-existent in most societies. Infact the credit instruments came much before money. These credit instruments circulated as IOUs enabling people to buy and sell. This is called as Innesian view based on A. Mitchell Innes.

Needless to say, there was a war of words between the two camps. Much of these war of words is fascinating as they get to core of so called monetary economics.

Michael V. Szpindor Watson of Mises Institute says there is no need to fight. One could merge the two views by looking at intertemporal barter:

Barter is ordinarily understood as spot transactions, where two people trade two different goods at some instant and not over time. The same occurs in an economy with a common medium of exchange, except that one of the goods (money) is usually used for transactions and purchases. Credit in an economy without a common medium of exchange is simply inter-temporal barter. It is no different than credit where a common medium of exchange exists, except the prevalence of what the credit is redeemable in.

Even when there is no common medium of exchange it is reasonable to expect that people will still want to transact over time and not always in the given moment. Within communities of trust or where there is a method of enforcing contracts we can expect that Casimir promises Anastasia a part of his future grain harvest for milk that her cow just produced. Anastasia has credited milk to Casimir for a claim on his future grain harvest — a credit market has been created where Anastasia and Casimir have engaged in inter-temporal barter.

Inter-temporal barter doesn’t have claims on a common medium, but to one of a variety of goods (and maybe even services). As Innes et al. suggest, tallies or other means of recording debts and credits could have been invented as primitive economies and populations grew. Such means of recording credits and debts would bring down the transaction costs of inter-temporal barter. Conceivably such instruments of recording credits and debts could have been negotiable and exchanged for other goods.

Imagine that Anastasia has a promissory note (IOU) for a portion of Casimir’s grain harvest, but prefers apples now to a future claim on Casimir’s grain. Thaddeus prefers a future claim on grain than the apples hanging on his trees. So Anastasia offers Thaddeus the promissory note in exchange for apples. If not for the promissory note Anastasia, Casimir, and Thaddeus would have all had to meet to agree to such a transaction. Without inter-temporal barter in the form of a promissory note, Anastasia and Casimir would have never made the transaction and Anastasia wouldn’t have had the promissory note to use to barter for other goods.

The rejection of Menger based on the fact that credit existed before money is invalid. However, what Innes and Graeber argue is not entirely irrelevant. The story we tell to students and ourselves is oversimplified. We should rewrite our textbook accounts to include the possibility of credit preceding a common medium of exchange and call it inter-temporal barter.

 All this is just so fascinating. These intertemporal IOUs in turn are nothing but forwards. Then one has to think how were these financial instruments priced and so on.

It is a pity that none of this is taught even at a PhD level. Monetary economics has just been reduced to thinking about targets and rules/discretion which are just around a few equations.  One hardly gets a sense of how all these things have evolved. Atleast students should be made aware of these issues/discussions.

If one uses these ideas to figure monetary history of India, one does read about both barter and IOUs existing. What came first is a big puzzle to figure as well.

It is interesting to see how monetary wisdom is being challenged. One another debate was what comes first deposits or credit? So far, we were taught that deposits lead to creation of credit and then the whole thing multiplies to become money supply. Now they say all this is rubbish, Banks always create credit first and then comes deposits.   This changes the entire thinking on money multiplier and so on.

Plenty to think and ponder upon than the usual question of how much the inflation target should be…

2 Responses to “What came first – money or credit?”

  1. Roy Says:

    Check out this book Debt: The first 5000 years. Its pretty good, I’m sure you’ll enjoy it.

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