The Credit Theory of Money

From: William F Hummel (wfhummel_at_comcast.net)
Date: 11/14/04 

Date: Sun, 14 Nov 2004 18:43:19 GMT

An article appearing in the "Banking Law Journal" in 1914 by A.
Mitchell Innes presented an exposition of the Credit Theory of money,
as opposed to the Metallic Theory. It should be noted that the
article was written in the era when precious metal coins were viewed
as the only "true money." Even today in the era of fiat money, there
are still many who hold to that belief. Following is a brief digest
of the article.

Up to the time of Adam Smith, not only was money identified with the
precious metals, but it was popularly held that they formed the only
real wealth. To Adam Smith belongs the credit of having finally and
for all time established the principle that wealth does not reside in
precious metals. But when it came to the question of the nature of
money, Adam Smith’s vision failed him. Having convinced himself that
wealth was not gold and silver, he was faced with two alternatives.
Either money was not gold and silver, or it was not wealth, and he
inevitably chose the latter alternative.

If money is not wealth in the common meaning as representing
“purchasing power” that alone constitutes real riches, then the whole
of human commerce is based on a fallacy. Smith’s definition of money
as being not wealth, but rather the “wheel that circulates wealth,”
does not explain the facts that we see around us -- the striving to
accumulate money. If money were but a wheel, why should we try to
accumulate wheels. The analogy is false.

Much has been written since the days of Adam Smith on the subject of
money, but we still hold to the idea that gold and silver are the only
real money and that all other forms of money are mere substitutes.
The necessary result of this fundamental error is that utmost
confusion prevails in political economy.

How complete the divorce is between the experience of daily life and
the teaching of the economists can best be seen by reading Marshall’s
chapter on capital, with its complicated divisions into national
capital, social capital, personal capital, etc. Every banker and
every commercial man knows that there is only one kind of capital, and
that is money. Every commercial and financial transaction is based on
the truth of this proposition; every balance *** is made out in this
well-established fact. And yet every economist bases his teaching on
the hypothesis that capital is not money. It is only when we
understand the credit theory that we see how well it harmonizes with
the known facts of everyday life.

The Credit Theory asserts in short that a sale and purchase is the
exchange of a commodity for credit. From this main theory springs the
sub-theory that the value of credit or money does not depend on the
value of any metal. Rather it depends on the right which the creditor
acquires to “payment.” That is it depends on the right to
satisfaction for the credit, and on the obligation of the debtor to
“pay” his debt. Likewise it depends on the right of the debtor to
release himself from his debt by the tender of an equivalent debt owed
by the creditor, and the obligation of the creditor to accept this
tender in satisfaction of his credit.

Such is the fundamental theory, but in practice it is not necessary
for a debtor to acquire credits on the same persons to whom he is
debtor. We are all both buyers and sellers, so that we are all at the
same time both debtors and creditors of each other. And by the
wonderfully efficient machinery of banks to which we sell our credits,
and which thus become the clearing houses of commerce, the debts and
credits of the whole community are centralized and set of against each
other. In practice, therefore, any good credit will pay any debt.

In theory we create a debt every time we buy, and acquire a credit
every time we sell. In practice this theory is also modified, at
least in advanced commercial communities. When we are successful in
business, we accumulate credits on a banker and we can then buy
without creating new debts, by merely transferring to our sellers a
part of our accumulated credits.

If we have no accumulated credits at the moment we wish to make a
purchase, instead of becoming the debtors of the person from whom we
buy, we can arrange with our banker to “borrow” a credit on his books
and transfer this borrowed credit to our seller. In doing so, we hand
over to the banker the same amount of credit (and something over)
which we expect to acquire when we in turn become sellers.

As the greatest buyer of commodities and services in the land, the
government issues in payment of its purchases vast quantities of small
tokens which are called coins or notes, and which are redeemable by
the mechanism of taxation. We can use these credits on the government
to pay for small purchases in preference to giving credits on
ourselves or transferring those on our bankers.

So numerous have these government tokens become in the last few
centuries and so universal their use everyday life - far exceeding
that of any other species of money - that we have come to associate
them more especially with the word “money.” But they have no more
claim to the title of money than any other tokens or acknowledgements
of debt.

Of all the false ideas current on the subject of money, none is more
harmful than the notion that the government has a monopoly on the
issue of money. If banks could not issue money, they could not carry
on their business. And when the government puts obstacles in the way
of the issue of certain forms of money, one of the results is to force
the public to use perhaps less convenient forms.

As can be clearly proven by careful study of history, a dollar or a
pound or any other monetary unit is not a fixed thing of known size
and weight, and of ascertained value, nor did government money always
hold the preeminent position which it today enjoys in most countries.

The notion that the government coin is the one and only dollar, and
that all other forms of money are promises to pay that dollar, is no
longer tenable in the face of the clear historical evidence to the
contrary. A government dollar is a "promise to pay,” a "promise to
redeem,” just as all other money is. All forms of money are identical
in nature, namely a credit for the holder and a debt of the issuer.

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