Thursday, 17 August 2017

Articles & Op-Eds

The Institutional Character of Money

May 31, 2017

On the one hand, money is the language of commerce; money prices are the very medium of economic experience. On the other hand, there seems to be a deeper reality behind the monetary economy. In this scenario, real resource constraints, as described by Walrasian general equilibrium or Misesian evenly rotating economy, ultimately place bounds on what is economically feasible. How can we reconcile this paradox?

My answer is to look to the institutional character of money. Money is an institution: a rule or method that makes human behavior more predictable. This means that the qualities of particular monies, and the ultimate laws governing its provision and use, cannot be fully understood without recourse to the institutions that govern money in specific contexts.

Carl Menger’s famous theory of the origins of money is often misinterpreted as history. That is, his detractors assume he is making a specific claim about how money, in fact, emerged. The truth is more subtle. Menger sought to provide a spontaneous order theory of money, to show the economic forces at work that could result in an economy dovetailing to a common medium of exchange without any central direction or foresight. In this sense, Menger’s theory is also institutional. It is a theory of money within the nexus of institutions, whatever they are in any given society, that protect private property rights, enforce contracts, and uphold a nondiscriminatory rule of law.

The most popular alternative to Menger’s theory, sometimes called the chartalist theory, is also institutional. Its adherents often insist they are making concrete historical claims: money arises not due to spontaneous cooperation, but due to political conflict. In particular, when strong groups conquer or otherwise rule weak groups, the strong groups frequently impose taxes or tributes. Whatever good they demand to be paid in acquires additional value because it can discharge obligations to the sovereign. These claims are often used to support the theory that money is, in essence, a debt relation. Money must ultimately be understood with reference to political power, monopoly privilege, and sovereign fiat. While much of chartalist history is valuable, what really matters is their claims as an institutional context for money.

But we do not need to dig into the particular historical claims to see chartalism’s institutional character. It is a theory of money that arises from regularized, and hence predictable, coercively enforced transfer payments. This is the institution we call taxation. Furthermore, a debt approach to money does bear some resemblance to current economic realities. For example, when most people think of money, they think of Federal Reserve notes. This is fiat money which is nothing more than a deb claim (albeit an unredeemable one) on the central bank. (For more on the link between current fiat money and historical commodity money, see my co-blogger Will Luther’s excellent posts on the regression theorem.) Importantly, money in a society ultimately governed by the norms of Misesian liberalism is not the same thing as money in a society where a central bank, backed by the force of the sovereign, claims a monopoly on the provision of the economy’s most liquid asset.

Ultimately, what money does, and how it constructs economic reality, will depend on the particular institutions governing the provision of money. My claim is that an economy that ‘really does’ look like Walrasian general equilibrium or Misesian evenly rotating economy, at least in tendency, is due to money governed by liberal institutions. Alternatively, an economy that is less tightly bound —and hence more difficult to navigate by economic actors— in terms of real resource constraints, is due to money governed by illiberal institutions. I will develop each of these claims in future posts.