The Origin of Money — Part II


This is part 2 of a series on the history of the origin of money. For part 1, which covers credit theories of money (needed for this article), click here. For my article on what money is, where I define money, click here.

There’s another theory of money related to the credit theory called the ‘state theory of money’ or ‘chartalism’. The theory says that money (the common medium of exchange) was created by governments so that they could demand it as payment for taxes. By doing this, they could use the tax revenue and their money-creating powers to allocate resources wherever they wanted, and incentivise the production of whatever they wanted. I’ll let one of the proponents of the chartalist theory explain on my behalf. Quote: “money was created to give government command over socially created resources.”

The idea is basically that if you’re the ruler of a state and want to pay for things like a military, that if you create a common medium of exchange, circulate it amongst your soldiers, and then make it so that ordinary people have to pay their taxes in it — then (the theory goes) you will have incentivised the population to provide food, armour and weapons for the soldiers so that they can get money to pay their taxes. And people will prefer to be paid with the thing that they need to pay taxes in, so will start only accepting that thing in trade. Or, putting it another way, governments created money because as the sole issuer of money they could redirect resources to wherever they liked. Supporters of the view believe that that in this way, governments invented money to create markets for certain goods and services.

Another variant of chartalism (state-credit theories of money) builds on the credit theory of money. First, it says that the gift-debt, tokenised debt theory of money is true. THEN, it says, governments came in and standardised the medium of exchange to a universal tally stick (rather than just ones with individual people’s names on them), and mandated that the standardised IOU (tally stick or otherwise) was needed to pay taxes. They did this, this account says, to create a more efficient and scalable monetary system — and because standardisation is normally a role of governments. Note that governments need not be the issuers of money for this theory to be valid. Governments merely decide what becomes money by demanding a specific medium of exchange in taxes. The actual creation of the money can occur in the banking system, between two parties, or through any other conceivable means.

The government explaining to the society that they need to start paying taxes, and start paying them in a common medium.

While the state-credit theory is interesting — it is not actually relevant to the origin of money, as we have defined it. Instead, it is a claim about the state’s role in the evolution of money after it had originated from something like a gift-debt, tally stick system. Why? Because the theory already accepts something like tally sticks as the first common medium of exchange, meaning that money existed before the government got to it — and that government was just a tool to help standardise and the money so that it would scale with a growing society.

Chartalism turns a lot of fundamental economic interpretations on their head, creating a lot of questions from those trying to figure out how it conceives the rest of economics. A common critique goes something like this: “Chartalism gets things backwards. Humans don’t work to pay taxes to the government. They produce and exchange with each other to survive. Then the government comes in to redirect resources to provide public goods and services. But people already had money to be taxed. Furthermore, if there was no common medium of exchange before governments created it by asking people to pay taxes in it, 1) how could the government convince everybody to pay taxes when most societies didn’t actually pay taxes? And 2) why would everybody else be willing to suddenly accept paying taxes in this new medium which they previously didn’t need or use for exchange in the first place?”

How can these differences in perspective be reconciled?

Duck Rabbit — (Image: from the 23 October 1892 issue of Fliegende Blätter)

Answers to the first question of “why and how did the government convince everybody to pay taxes to begin with” are varied, and include:

  • The greedy government theory: The government or rulers of society wanted to exert influence over society, so had to create taxes so that people paid them in a common medium of exchange that they could spend however they liked (to shape society or benefit themselves). Under this view, tax collection was initially justified to the people on the basis of paying for the military.
  • The primordial debt theory: Individuals feel a natural debt to the society they live in for helping raise them, and helping them live in safety and certainty. The feeling of ‘primordial debt’ also has a religious grounding. The king or ruler of the society who often aligns themselves with god is therefore naturally seen to have the right to make people pay taxes as the protector of primordial debts (e.g. the king held all the gold in aztec societies), and people would consent to being taxed on that basis.
  • ‘Social Communism’ theory: Human societies and relations are at core, communistic (that is, they all emerge out of and depend on the morality “to each according to his needs, from each according to his abilities”). In such a society, taxation would be something that people would voluntarily agree to on the basis of moral redistribution and altruistic sacrifice.
  • ‘Force theory’: I made this one up, but will include it because it seems plausible. In the formation of states, the person who becomes ruler will end up with a disproportionate amount of power. With the military on their side, they could very easily use fear and the threat of violence to force people to pay taxes to them in a specified medium. People would rapidly start demanding to be paid in this new medium so that they could pay their taxes.

I will leave it to you to evaluate and dig deeper into these perspectives on your own if you want to learn more about them.

King Rabbit, recipient of taxes.

The mainstream economic interpretation (Let’s call it the ‘social contract theory’) is a non-Chartalist theory, meaning it says that governments had nothing to do with the initial invention (or emergence) of money. This perspective deems Chartalist money theories incorrect and hence deems the question of “why and how did the government get us to pay taxes” as not relevant to the question of money. This school of thought says that taxation arose out of a societal consensus to serve common interests of the people — and that governments tax people because they provide them with services such as defence through a military, roads and public infrastructure.

In this picture of things, governments are taxing money which already existed before the government collected taxes, and people agreed to pay taxes because they generally benefited from government expenditure. State-money theorists reject this theory — and from what I have found the reason is something to do with their belief that money (and markets!) can’t exist without governments. In my opinion, this mainstream view is similar to the ‘communism’ theory, with the key differences being 1) instead of using ‘communist morality’ to justify taxation, it uses common individual benefit as the justification, and 2) it maintains that money did not originate with the state, and arose by other means.

The origin(s) of taxation and money is a matter for historians. It has no bearing on economics, which is concerned with formulating logical, causal descriptions of economic phenomena — for the ultimate purpose of determining how to optimally utilise resources to achieve desired ends. That is, how to economise.

Let’s summarise: the chartalist theory of money says that money only comes into existence when the government creates it. Now, obviously if a state through law decrees that one specific medium of exchange should be accepted by all and used to pay taxes, then it will push that medium of exchange to be used by the majority of the society — and it will likely become a common medium of exchange: money. Governments in this way, through law, and through leveraging their powers of taxation (on whatever basis they were granted these powers), have the power to create money. But the ability for governments to create a money through law is not a disputed fact in economics. The real historico-economic question around chartalism is: was the government compelling the use of a certain medium of exchange necessary for money to come into existence — or could (and did) common media of exchange emerge in the absence of government? Was the first instance of money government money?

Once more, this is purely a historical debate and completely irrelevant to the definition of money. We need to already have a definition of money to be able to determine the historical circumstances it emerged out of. Okay. So, what does the historical evidence say? Is it even possible for a common medium of exchange to come into existence without the government?

Well, black markets adopt their own common medium of exchange emerge spontaneously without state intervention often — whether it’s cigarettes in prison, or privacy preserving cryptocurrencies like Monero online. In these cases, governments didn’t create cigarettes OR cryptocurrencies OR compel them to be used as money. They became money due to being preferred by the participants of the economy in question.

Similarly, anybody who has played enough multiplayer video games will also realise that common media of exchange can emerge naturally out of players acting freely in the game (for example, diamonds are often used as money in no-mod minecraft servers). In games, it is often a scarce and generally desirable status-raising item which gets used as a common medium to buy things from other people.

A very old meme, but illustrative of the point.

Even as a child between the ages of 5–12 in school, I had similar experiences where myself and my friends would go crazy over some new collectible — whether it was handballs or soccer balls or playing cards for a game like Pokemon or YuGioh — even just a certain type of shiny rock that we thought was cool that was rare around the schoolyard. This collectible would be universally desired by the group, so could be used to get things from other people — like toys or pencils or the good bits of other people’s lunch. Here we have several generalisable instances of common media of exchange (and even markets) emerging not by government decree.

One time, a rumour on the schoolyard started that one rock was from the moon, and for a while anyone would happily surrender their lunches for possession of the rock. Maybe if there was a king that wanted it, they would have mandated paying taxes in moonrock fragments.

So, there seems to be a fair few number of cases where under our definition of money, money emerges without the state. Under other definitions of money (like the ‘unit of account’ definitions of money), this might not be the case. Remember, the linguistic ‘truth’ about money might change depending on the definition we take, but the underlying situations we are describing and interpreting with our words are the same. Definitions are purely for helping us understand things, and different people use different definitions to make sense of things.

Now, even though money can come into existence by non-governmental means, this does not actually falsify the chartalist theory. Whether the first instances of money emerged through government or otherwise is ultimately unknowable. All we can do is apply the highest level of historical scrutiny and logic to better estimate the probability that each money-origin theory is true. It will always be an open question whether there is a higher probability that the first instances of money originated out of government decree, or out of non-government means like people hoarding a scarce and generally desirable object, or people co-ordinating trade in non-government markets (which Chartalists don’t believe exist).

See: ‘The Problem of Induction’, ‘The Scientific Method’, ‘Falsifiability

Regardless, it should be noted that however money arose does not say anything about how money should be. If something is invented with the initial intention of serving a specific purpose, this does not mean it must always be used in that way and can only subsequently exist under those same conditions. In this case, if the government was necessary for the money to be brought into existence — it would not mean that money always needs a government to exist, just that it initially did. Wheels were certainly not invented for roulette tables, yet this does not prohibit them being used as such!

There’s another perspective I feel it is important to emphasise, which is that ultimately it is not the government, king or ruler that makes something money — but the people adopting the thing as the common medium of exchange. The state’s legislation means nothing if it is not respected by the people, and it cannot be assumed that people will invariably obey the government. If the government said that people had to use bubbles as money and accept bubbles as the medium of exchange and pay taxes in bubbles, this doesn’t mean people would do it. They would reject the decree as absurd and simply not do it. So bubbles would not be money. In this way, even if government decree is deemed to be NECESSARY for money to emerge (meaning, it has always been historically needed for money to emerge), what actually makes something money is mass adoption by the participants in a society — and this alone is the essential factor in whether something is money or not.

It is not the decree which makes something money, but compliance with the decree.

Ok. That’s the basics of the Chartalist theory of money. Next up: the barter theory.