What exactly is money?

Money shapes our lives, yet we rarely reflect on where it came from

Author: David Orrell
February 23, 2015

According to the authors Lipsey and Ragan of Canadian textbook Economics, money emerged as a replacement for barter: “If there were no money, goods would have to be exchanged by barter… The major difficulty with barter is that each transaction requires a double coincidence of wants… The use of money as a medium of exchange solves
this problem.”

Fortunately the book was free, so in this case neither barter nor money were required. The authors went on: “All sorts of commodities have been used as money at one time or another, but gold and silver proved to have great advantages… The invention of coinage eliminated the need to weigh the metal at each transaction, but it created an important role for an authority, usually a monarch, who made the coins and affixed his or her seal, guaranteeing the amount of precious metal that the coin contained.”

Money is not just a facilitator for barter, but an active medium with powerful properties of
its own

Marked money
This seemed clear enough. Commodity money emerged from barter. The best commodities, for various reasons, were gold and silver. The only role of government was to come along at the end and put its stamp on the coins. I had seen the same argument made before, with minor variations, by 19th-century economists such as William Stanley Jevons and Carl Menger, and by Adam Smith in the 18th century. But to check it out, I decided to go right to the source, the origin of origin stories: the philosopher himself.

In Politics, Aristotle said: “More complex form of exchange [money] grew, as might have been inferred, out of the simpler [barter]… the various necessaries of life are not easily carried about, and hence men agreed to employ in their dealings with each other something which was intrinsically useful and easily applicable to the purposes of life, for example, iron, silver, and the like. Of this the value was at first measured simply by size and weight, but in process of time they put a stamp upon it, to save the trouble of weighing and to mark the value.”

So the official textbook story about the origins of money has remained essentially unchanged since antiquity. Which is strange, for two reasons. First, most textbooks have been updated since Aristotle’s time – we don’t still think the planets are set in crystalline spheres that rotate around the earth. Second, the theory – as a little more research showed – turns out to be wrong.

One thing that struck me about these accounts was the lack of dates, references, or supporting details. The British economist Alfred Mitchell-Innes had a similar suspicion: “So universal is the belief in these theories among economists that they have grown to be considered almost as axioms which hardly require proof, and nothing is more noticeable in economic works than the scant historical evidence on which they rest, and the absence of critical examination of their worth.” But Mitchell-Innes had more: “Modern research in the domain of commercial history and numismatics, and especially recent discoveries in Babylonia, have brought to light a mass of evidence which was not available to the earlier economists, and in the light of which it may be positively stated that none of these theories rest on a solid basis of historical proof – that in fact they are false.”

So how has this ‘modern research’ impacted the field of economics? Not much, apparently. Because Mitchell-Innes wrote that over a century ago, in 1913. According to anthropologists, economies based purely on barter don’t appear to ever have existed. Instead, money has its roots in a virtual credit system created 5,000 years ago in ancient Mesopotamia.

Coin money came later, and ever since, money has alternated between spells where it is based primarily on credit (the Middle Ages, modern fiat currencies), and on precious metals (ancient Greece and Rome, the gold standard). It is perhaps understandable that Aristotle got it wrong, since he didn’t have extensive research by anthropologists to draw on, but why are economics textbooks still repeating the same story thousands of years later?

Founding myth
One reason is that if money has emerged naturally from commerce rather than been imposed by government, then economics can be seen as a kind of natural science, divorced from its social and political context.

The economics version also reflects an inbuilt assumption that there is essentially no trust between parties, so exchange has to be immediate, in the form of goods or some form of money. Economics can therefore ignore the complex web of human relationships in which the economy is embedded.

Above all, though, the idea that money replaced barter by making it more efficient allows one to see the economy as something in which money is nothing more than an inert, passive intermediary – which means it can be ignored as a driving factor in the economy. Former Bank of England Governor Mervyn King noted: “Most economists hold conversations in which the word ‘money’ hardly appears at all”, which is particularly strange given the way the financial community hangs on every word of central bank governors.

The general equilibrium models relied on by policy makers treat the economy as a giant barter system. One reason the Bank of England failed to predict the banking crisis of 2007 was that the general equilibrium models it used to forecast the economy didn’t include banks.

The central, founding myth about the origins of money is one of the reasons why mainstream economists still, despite the countless number of books written on the subject, seem to be in denial about its true nature. Money is not just a facilitator for barter, but an active medium with powerful properties of its own. We need to start taking it more seriously – and a first step would be to update our Aristotelian textbooks.