Chartalism

Abstract

This chapter addresses the legal and institutional foundations of the monetary system. The topic of state theory versus market theory of money is revisited. Particular emphasis is placed on the historical controversy between the Currency School which stood for re-implementing state control over the stock of money, and the Banking School which was in favour of unregulated private bankmoney. Today, we have a state-backed private bankmoney regime that has captured the sovereign monetary prerogatives of money creation and seigniorage.

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3.1 State Theory Versus Market Theory of Money

Most people still relate the origin and nature of money to a narrative of classical economics, as for example in Adam Smith, and the neoclassical extension of that narrative by Carl Menger in 1871 (neoclassical Austrian School). According to this view, money is imagined to have emerged as a spontaneous creation in archaic barter and market processes for facilitating the exchange of goods. Money is seen in this context as a commodity like any other, and thus a private affair. This point of view is most often called the commodity theory of money.¹

If a legal aspect is involved, it is private or civil law. From this angle, the classical narrative is a private-compact theory of money. It may be preferable here to speak of the market theory of money. The reason is that the classical narrative entwines at least three aspects that ought to be kept apart analytically: in addition to the question of whether money is state- or market-borne, there is the question of whether money is a commodity or a symbolic token (answered above in support of the token), and the question of whether money is credit and debt in a credit-and-debt relationship, or whether money is a debt-free token for the settlement of debts.

At this point, the focus is on whether money is state- or market-borne. In face of the empirical evidence which economic historians were able to produce—notably, and of relevance to the Occidental world, from early antiquity, Greece, Rome, Byzantium, the Arabo-Islamic world, the Christian middle ages and early modernity—the Smith–Menger narrative appears to be largely fictitious.² The findings back up the concept of money as a public affair and a prerogative of rulers, in short, the state theory of money, to adopt this term here.

The evolutionary pattern starts in ancient Mesopotamia and Egypt with the extended households of temple and palace complexes and their entourage, in the beginnings within local city-states some of which developed into ever larger kingdoms. The related economies were centrally managed by a specialized administration, including the labor-divisionary organization of chains of provision and public works such as irrigation systems or town walls, the redistribution of harvests and of other means of providing for craftspeople and workmen, the administration itself, later on standing armies. All this required the development of contracting, legal structures, scripture and documentation.³

Money is described as having emerged within those early state structures from tribal traditions of making gifts and contributions, such as dowry or bride price, paying wergeld in compensation for physical injury or sacrificial oblations, and later also including regular duties and tributes, the latter mostly imposed on conquered tribes, if they were not bound to forced labor or outright slavery. Equally, there is evidence from Mesopotamia of the practice of lending goods, the amount of which had to be returned with interest—that is, the amount of goods to be returned was higher than the amount lent.

In an extended household of hundreds and thousands of people, gifts and duties as well as current provisions of goods have to be measured and registered. All transactions were made in kind, and it is thought that some staple goods of the time, or highly valued goods, developed into general units of account, such as a weight unit of grain or silver, serving as a common denominator which made different goods comparable in relative quantity or value. Those units of account were fixed by a ruler’s administration.

This does not exclude the eventual development of trade and finally markets where the quasi-monetary units of account could be used for transacting goods. Apparently, local and long-distance trade developed in ancient economies early on. The important thing is that the emergence of trade and markets was tied to the ‘state’ households of kings, high priests or warlords, and largely tied to the centrally managed operations and supply chains they maintained. This also applies to the sovereign coins that rulers finally began to issue from around the seventh century bc.

If there are messages to be drawn from this historical survey, the most fundamental is that markets do not emerge and develop in a constitutional vacuum free of state powers. Markets build and rest upon a state’s institutional and legal structure, of which the money system is an integral part. There is no evidence that trade, markets, prices and means of payment would have developed ‘spontaneously’ from primitive barter.⁴ As Graeber put it:

States created markets. Markets require states. Neither could continue without the other. ... We are told that they are opposites ... But it’s a false dichotomy.⁵

Closer to our own times, this can again be studied in the evolution of nation-states and markets within the modern world system that began to emerge about 500 years ago. In building up this system, adventurers, colonizers, soldiers, missionaries, merchants and bankers did not create legal structures and monies of their own, but they always were, and needed to be, envoys of the states from which they originated, or contractual partners of the states across which they expanded their business and trade networks.

Rather than postulating money as a market-borne commodity, markets are more easily understood as being money-borne, or at least money-based and money-facilitated, or money-catalyzed, as is correctly stated in the neoclassical narrative in a functional sense, whereby, however, the money was not market-borne, but state- and law-borne as an instrument of sovereign rule.⁶ With monetarization came a money-based financialization of the economy. Money has served the purposes of the real economy and the financial economy ever since.

Even though the commodity theory of money may historically be wrong and does not hold as a founding tenet in classical economics, there is no problem acknowledging that the Smith–Menger narrative grasps the basic functions of money in contributing to the development of markets. Money is a marvelous market catalyzer, catalyzing transactions, an intertemporal device for facilitating transactions that would otherwise be unimaginable, thereby enabling a match of supply and demand without necessitating a coincidence of wants (a coincidence of supply and demand at a given time in a given place). Payment in money helps avoid immemorial creditor–debtor relationships, rather than being a result of the latter. Equally, money facilitates the funding of investment, which otherwise would be quite complicated. Money itself is thus traded as a financial commodity. But trading money presupposes money to exist, and in this respect it has to be acknowledged that money was not market-borne ‘bottom up’, but was introduced ‘top down’ by a respective state authority.

To summarize what is relevant regarding the question of commodity theory versus state theory of money: in ancient times, money was developed as an official unit of account for documenting and clearing claims and obligations (debt, tributes). This took place in the extended household economies of the secular and religious rulers of the time and their related supply chains. When coins were introduced much later, 2700 years ago, coining remained under the control of rulers.⁷

The economy, including long-distance trade, developed around the extended households of the courts and temples of the rulers of a realm, under their control, including control of the monetary and financing practices at subsequent stages of development. To put it succintly, the market economy is a creature of money rather than the reverse; and money is a creature of the state as much as the markets are framed by state powers and law rather than existing in an extraterritorial private nowhereland.

The classical and neoclassical approaches to economics tend to model the economy as a Robinson Crusoe island beyond the state, based on private law with no role for public or state law. The appearance of the commodity theory of money in the eighteenth century, as a component of that extraterritorial approach to economics, can be seen in the context of growing rebelliousness of the then middle classes against the repressive state of the ruling aristocracy.

However, amid all the justified criticism of absolutism and statist mercantilism of the seventeenth to the nineteenth centuries, the fundamental and indispensable role of the state in modern society, including the monetary system and creating a legal framework for the economy and finance, was improperly dismissed. The baby was thrown out with the bathwater. Even Marx and Engels in their earlier years took an anti-statist attitude when they imagined the dwindling of the state in communism. In hindsight this was a gross misunderstanding, but in the first half of the nineteenth century it was an element of social romanticism which fed into both anarchism and socialism. Classical liberalism, by contrast, was rationalistic rather than romanticist. But all the then ‘enlightened’ political philosophies were united in their resentment against the state.

3.2 The Sovereign Monetary Prerogative and Its Two Historical Challenges

Money tokens, as they have been created and issued under state control from antiquity to the present day, are a legal instrument by state fiat, that is, money acknowledged by administrative fiat or law. Today, there are two basic kinds of fiat money, the first representing sovereign money issued by a respective authority, including coins issued by the treasuries and notes issued by a state’s central bank; the second representing bankmoney, on account and as e-cash in mobile sub-accounts.

As money by sovereign fiat, coins and notes are legal tender. This means money which, by force of law, has to be accepted in settlement of debts. Bankmoney, by contrast, is not legal tender, although it represents official money because it is recognized by administrative fiat as a general means of payment. There is no law that puts bankmoney on an equal footing with treasury coins and central bank notes, yet bankmoney is regularly accepted and used by everybody, including public bodies (except the central bank). Various regulations presuppose the existence of bankmoney. As a common practice, the money surrogates of the banking sector have become so deeply entrenched that they might even claim to be a legitimate matter of customary law.⁸

Sovereign money gives a nation-state, or community of nation-states, monetary sovereignty. This includes three monetary prerogatives:

• 1. Determining the currency of the realm, the monetary unit of account;

• 2. Creating and issuing money, the means of payment denominated in that currency;

• 3. Benefitting from the seigniorage, the gain that accrues from the creation of money.

Today only the currency prerogative is still intact. What the state has almost entirely lost are the sovereign prerogatives of money creation and seigniorage as these have devolved to the banking industry for the most part (Chap. 4). Prior to industrial capitalism, money was sovereign money as a matter of course. It was understood that the monetary prerogatives of a state were of the utmost importance, in fact of constitutional importance, as was formally recognized in the Constitution of the United States from 1789. The founding fathers of the USA understood that the monetary prerogatives were essential for the new nation’s sovereignty.

The monetary prerogatives of the state became questioned in the course of the eighteenth and nineteenth centuries, first by private paper money, then with the advent of demand deposits, bankmoney on account, as a general means of payment. The private issuance of banknotes required a licence issued by parliament or the treasury. The issuance of bankmoney today still requires a banking licence from the central bank. Such licensing, however, in no way controls the monetary dynamics of privately issued money. Private banknotes, even if state-licensed, thus became the first historical challenge to the sovereign prerogatives of money and seigniorage. This was eventually reflected in the controversy between the Currency and Banking Schools, resulting in the state’s recapturing of the prerogatives of paper money and related seigniorage through the British Bank Charter Acts of 1833 and 1844.

The second big challenge was already present in the first, but was not yet given due consideration. That challenge was, and still is, bankmoney on account through private primary credit creation. In the decades before Black Friday in 1929, demand deposits had started their take-off towards becoming the major means of payment. This led to the bank credit theory of money.⁹ At the same time, theories of the monetarized and financialized nature of modern economies and banking capitalism arose, as did proposals to reform the money and banking system.

Among the latter there were new business models of banking as developed in the mutualist and co-operative movements of the time. In regard to monetary reform, two approaches gained particular attention, one by Silvio Gesell (the stamp scrip movement), the other by C.H. Douglas (the social credit movement).¹⁰ Both Gesell and Douglas aimed for the full nationalization of money. They were followed by a number of approaches to 100 % reserve banking; these are detailed in Sect. 6.14.

All these approaches had their shortcomings. In Gesell and Douglas there were a number of problematic theorems, such as the supposed structural advantage of money holders over commodity suppliers in Gesell, and the corresponding proposal of a demurrage rate on money holdings. Both Gesell and Douglas stood for a reductionist criticism of the role of interest in the vein of anarcho-syndicalism, and both lacked a detailed understanding of money in the fractional reserve system. The shortcomings of the approaches to a 100 % reserve on deposits are rooted in keeping the reserve system as such.

Politicians did not care too much about monetary reform, even though a number of renowned economists were in favor of 100 % banking and two members of Congress, Senator Cutting and Representative Patman, introduced legislative bills in the Senate and the House of Representatives in 1934.¹¹ Close to monetary reform, the most successful measure of monetary policy was the Canadian experience of a benign period of sovereign central bank credit to the government, de facto non interest-bearing, from 1936 to 1973.¹²

At the time, the practice provided impressive results against the background of very low levels of public debt as well as underused capacities and the country’s huge untapped resources and growth potentials. Thanks to monetary financing under such conditions, Canada appears to be the only country that emerged from World War II without burdensome levels of sovereign debt. W.L. Mackenzie King, Canadian prime minister from 1935 to 1948, is reported to have said in 1935 that

once a nation parts with control of its currency and credit, it matters not who makes that nation’s laws. … Until the control of the issue of currency and credit is restored to government and recognized as its most conspicuous and sacred responsibility, all talk of the sovereignty of Parliament and of democracy is idle and futile. ¹³

The reform finally implemented by the US government, as an alternative to monetary reform and as the lesser of two evils viewed from a banking point of view, was separate banking in the form of the Glass-Steagall Act of 1932–1933. This was watered down in the following decades, and then repealed by President Bill Clinton in 1999. The act set investment banking apart from commercial banking. This was somewhat mistaken, because separate banking cannot have a meaningful effect as long as, first, commercial banks are allowed to lend limitlessly to investment banks, governments, real-estate investors and so forth, and second, as long as the management of money on account and cashless payments is not set apart from both commercial and investment banking.

Whether due to conceptual shortcomings or banking-conservative politics, a lasting answer to the second challenge of the monetary prerogative was postponed to the contemporary wave of crises which set in with global financialization as it took off around 1980. That take-off resulted in a credit-and-debt binge unequaled by former such maldevelopments. The second challenge to the prerogatives of money and seigniorage is still waiting for a meaningful response. Following the logic of monetary modernization, that response is a transition from bankmoney to sovereign money on account and sovereign digital cash.

3.3 The Currency Versus Banking Controversy

The first challenge to the monetary prerogative—the growing use of private banknotes in the eighteenth and beginning of the nineteenth centuries—came with the experience of inflation and deflation, re- and devaluation of currencies, and cyclical crises. The recurrent experience sparked the monetary controversy between the British Currency and Banking Schools in the 1820–1840s.¹⁴

Today, remarkably little attention is given to that controversy, even though it conveys a frame of reference for monetary policies of lasting relevance to modern money systems. The central question was whether money creation should be left to the banks (Banking School), or whether the state ought to re-establish its control over the money through an adequate institutional arrangement (Currency School).

The Currency School emanated from earlier doctrines of mercantile bullionism, namely the idea that a nation’s wealth depends on its stock of money, which in fact meant the national stock of silver and gold that should be prevented from draining away abroad. At the time, the Currency School supported the implementation of a national gold standard. Now that the metal age of money is over, the Currency School is generally considered to be irrelevant. This is an error, because gold was not the crucial element in Currency School doctrine that it appeared to be. Two hundred years ago everybody was a ‘metallist’ in the sense of considering precious metals to be the base of banknotes and bankmoney. The Currency School, however, as represented by Ricardo, Torrens and Thornton, had no interest in gold as such. Torrens considered himself to be an anti-bullionist. Currency scholars wanted a modern paper currency and credit system, albeit a sound and stable one, avoiding monetary scarcity as well as oversupply.

Currency scholars and leading politicians of the time saw out-of-control issuance of private banknotes as the main cause of recurrent banking and economic crises. The analogy to banks’ out-of-control credit and deposit creation today is obvious. In the absence of proper regulation, the free creation of banknotes and bankmoney tends to procyclically overshoot, temporarily shrink, and in consequence to be without restraint. It thus results in an unstable and ultimately inflationary and asset-inflationary money supply which prompts bank failures and bank runs, as well as wider financial and economic crises. The Currency School assumed causality to run from the quantity of money to the level of prices and interest. The Banking School, conversely, assumed the money supply to result from interest rates and prices.¹⁵

As a consequence, from a Currency School point of view, it needs to be determined by law what shall be money in the sense of currency in general circulation, and under whose control and responsibility fiat money shall be created. The Currency School wanted to establish a mechanism that would ensure control over the quantity of banknotes.

The opposing Banking School, with Tooke and Fullarton as its main representatives, contradicted the Currency Schol by invoking the law of large numbers, the law of money reflux, and what was known then as the real bills doctrine (real bills meant debt bills from creditworthy originators).¹⁶

The doctrine says that as long as bankers write out credit and banknotes against real bills at short notice, the money will surely be put to good use. Upon maturity of credits, the money will be taken out of circulation (reflux), making sure there is no more money than there is ‘real’ demand for it. The quality of available real bills will regulate the quantity of credit and banknotes created thereupon. They considered bankers to be honorable merchants of impeccable judgement.

As to the fractional reserve of coin and bullion in relation to banknotes issued, the Banking scholars maintained that, on the grounds of the law of large numbers, fractional reserve banking involves no more risk than lending on a full reserve base. Bankers know from experience how large a reserve they actually need. As long as banks observe the real bills principle, the banknotes will be trusted, not normally converted into coin, and no problem will arise.

The Banking scholars questioned inflation and deflation, and re- and devaluation of the currency as general phenomena. Official statistics were not yet available. Should these phenomena exist, there must be broader economic reasons beyond bank credit and banknotes. According to Fullarton’s law of reflux, it can be excluded that inflation and boom-and-bust cycles would occur for monetary reasons. If something like an overhang of banknotes were looming, the holders would notice early on, and immediately exchange notes for coin, so that any overhang would be choked off. Sure enough, given the fractional coverage of banknotes, such a reflux of notes is not documented ever to have happened—although it has often been attempted in bank runs, when long queues of people wait in vain in front of closed banks to take their money out.

Even if the term ‘real bills’ is not used anymore, the real bills doctrine is a mainstay of any Banking theory from the early nineteenth century to the present day. It is also a core principle of central banking (prime quality assets eligible for monetary policy operations). The Banking doctrine today is hardly different from what it was 200 years ago. It says, let banks freely create money, then banknotes, and today digital money on account. The money supply takes care of itself. Money and capital markets continually readjust and thus establish equilibrium, so that under conditions of symmetric endowments, information and competition, banks cannot fail to create the optimum amount of credit (money) and financial markets cannot derail. No one ever asked how something like a self-limiting market equilibrium would ensue as long as the banking industry has a strong self-interest in expanding the money supply, as well as the power to create the money on which it operates, which cyclically results in a self-propelling growth of the money supply and financial assets, of credit and debt, disproportionate to economic output, as if defying the gravity of an economy’s productive potential.

A prominent figure in Banking School teachings of the recent past was Friedrich von Hayek, who called for the radical denationalization of money.¹⁷ The community of Neo-Austrian economists, many of them Americans, continues to spread the word. Fama’s efficient market hypothesis can also be seen as a typical Banking School approach of the recent past.¹⁸ The neoclassical Washington Consensus from the 1980s to the beginning of the 2000s held a generalized belief in the efficient self-regulation of markets, including banking and finance as well as politically deregulated global markets. Financial markets were seen as near-perfect information processing machines which relentlessly absorb and price in any relevant information. This is similar to the all-superior swarm intelligence which Hayek ascribed to markets, contrasting this to unknowing central planners, while ignoring the swarm madness in which markets can also become caught.

The Banking School rationale is based on the axiomatic classical belief in the ‘invisible hand’ of markets, which is a modernized variant of the medieval Scholastic theology of God’s wise manus gubernatoris unfailingly creating a harmonia mundi unless distorted by devilish machinations.¹⁹ In neoclassical economics, the latter are normally identified with government interference.

The Currency School’s response to the real bills doctrine was the thesis of the real bills fallacy. It argues that the belief in ‘good bills’, ‘good uses’, ‘good bankers’, ‘perfect markets’ and other features of ideal worlds does not apply to real-world banking. Torrens, as leader of the Currency School, had himself been a supporter of the real bills doctrine. He became disappointed, however, with the realities of ‘real’ bills and with bankers’ actual practices. According to Thornton, a respected banker of the time, it is impossible to reliably know in advance which bills will be ‘real’ and which will turn out to be fictitious. Equally, banks discounted long-term bills almost as willingly as short-term bills. Unforeseen events can throw over any calculation. The banking business itself, Thornton observed, including the Bank of England, had a tendency towards over-issuing credit and banknotes for pure self-interest, thereby becoming over-exposed to various risks, eventually bringing banks and financial markets into trouble, the more so because banknotes, to be accepted, had to be redeemable in silver coin.²⁰

For the Currency School, the quantity theory of money was an essential foundation. Equally, they were aware of the pivotal role of bank credit for the entire economy. They did not expressly criticize ‘the power of banks’, but as far as the issue of banknotes was involved they in fact wanted to see that power tamed.

By contrast, the Banking School type of thinking tends to deny or belittle the power and importance of money. To bankers, the power of banks has always been a non-issue. This is in line with the neoclassical view of money as an ephemeral veil over the economy, simply mediating business and trade, but not being constitutive of them, also known as the doctrine of neutrality of money, according to which changes in the money supply may change price levels but do not generally result in structural changes of investment, employment, production and consumption.

The Banking School did not reject quantity theory, and bankers up to the present day routinely speak out in favor of stable prices, stable currencies and so forth. In practice, bankers tend to be hypocritical in this respect and contribute to the volatility of currencies by unrestrained foreign exchange trading, as they contribute to fueling inflation and asset inflation by creating as much credit leverage as possible. It is in the interest of banks to expand their business and thus their balance sheets. This increases the nominal value of various bank assets, it decreases bank liabilities just like those of any other debtor, and it may temporarily even include a higher interest margin. If inflation and asset inflation are not extremely runaway, banks are happy to live with inflation and asset inflation; in fact they live on it to a degree in that they are the first users of the money.

By comparison, Currency scholars were classical market economists. They recognized, however, that money is not simply a commodity like any other. What is more, the creation and first use of money has a legal and political side. Modern money tokens can be created at discretion. Without anchorage in a value base—formerly gold, today the potential and actual output of an economy—money and capital markets will not reach a stage of equilibrium and self-limitation.

In consequence, there must be some mechanism to keep the money supply in a commensurate relation to real economic growth. The key to achieving this was, as Whale put it, the Currency School principle ‘that banking ought to be separated from the control of the currency’.²¹ The proposal of creating an institutional arrangement that would separate the control over the stock of money from the banking business of extending credit and funding investment was put forth in Ricardo’s Plan for the Establishment of a National Bank from 1824. This plan provided for the national money supply to be re-established as the sovereign prerogative it used to be until the spread of private banknotes. Similar ideas were widespread in the USA. Among the American founding fathers, Jefferson was ascribed a number of statements on money and banking, some verified, others unverified. One such statement puts in a nutshell the politics based on Currency teaching: ‘Bank-paper must be suppressed, and the circulating medium must be restored to the nation to whom it belongs.’²²

Separating money and credit appears to threaten the position of the bankers, in that it denies them as creators of money, and confines them to be money changers and money lenders and investors, as they have always been. To Banking scholars, moreover, as to most neoclassical, Keynesian and post-Keynesian economists today, the Currency School principle of keeping money and credit apart appears to be an impossibility, for they firmly believe in money and credit as being one and the same (Sect. 4.15).

The Currency vs Banking controversy was settled with the Bank Charter Acts of 1833 and 1844. The first Act made banknotes issued by the Bank of England legal tender, while, however, still permitting the issuance of banknotes by the country banks of the time. The Act of 1844 nevertheless triggered the process of phasing out private banknotes and establishing the central-bank monopoly of banknotes that exists to the present day.²³ The Act of 1844 also introduced a renewed gold standard. The permissible number of banknotes was tied to a specific money-to-gold ratio, the gold existing as a national hoard, backing up the central bank notes. Both Acts served as a model for similar measures in the nineteenth century across the then industrializing world.

With the control over banknotes, the national central banks—some of them only set up on this occasion—also took over the benefit of interest-borne seigniorage from the issuance of notes. Central banks do not need to refinance the notes they are loaning to the banks. Monetarily, they create the notes ‘out of nothing’. The related interest-borne seigniorage is thus almost identical to a central bank’s lending interest—almost, because there are the costs, comparatively low, of producing and managing the notes.

The Bank Charter Acts are most often seen as a victory for the Currency School. In practice it increasingly looked as if the banks were victorious. The gold standard was repeatedly suspended on the request of the Bank of England, under pressure from the banks to print additional money in order to further fuel the railway boom of the time—which promptly resulted in the banking panics and financial crises of 1847 and 1857. Moreover, neither Act took into account the role of credit and deposit creation by the banks, in spite of discussion from Currency and Banking scholars on the subject.²⁴ Periods of overshooting boom and devastating bust thus continued to occur.

To conclude, the decisive difference between Currency and Banking teachings is not about a gold standard. It is about the question of how to control the overall quantity of money, and the question of who ought to be entitled to the prerogative of issuing and controlling the money, and benefitting from the seigniorage: either the banking industry on the basis of private contracts (Banking position) or a state authority or state-controlled institutional arrangement based upon public law (Currency position).

The historical Currency School created awareness of the necessity of tying modern fiat money, since it can freely be created at any amount, to an anchor of value, or relative scarcity respectively. On the basis of the quantity theory of money this was the right response to the problem of inflation, asset inflation, bubble building and recurrent crises. However, they supported the introduction of the gold standard, which they saw as the natural anchor of scarcity. They did not recognize the problem of stagnant or sub-optimal growth due to the restrictive effects of a fixed amount of gold-related money, or even deflation and destabilizing degrees of unemployment in times of crisis. In retrospect, the gold standard appears as a flawed concept right from the beginning. It was backward-looking and half-hearted, in fact a halfway house between traditional and modern money. It came to a stepwise end with World War I, the Great Depression of the 1930s and the Bretton Woods system from 1944 until 1971 when US President Richard Nixon had to take the unrestrained dollar expansion off the gold standard once and for all.

The gold standard related only to banknotes and failed to include bankmoney on account. The relation between banknotes and the required amount of gold coverage was loosened or even suspended time and again, which also contributed to defeating the intended purpose of the gold standard. Where the standard was maintained, it induced deflation, stagnation and misery for the many poor, rather than achieving growing productivity and transmitting the wealth thereof by way of stable earned incomes and lower prices. In real-world economies, voluntary smooth downward elasticity does not exist; instead we have price and wage ‘stickiness’ from unemployment and stagnant productivity and purchasing power.

The major reason why the Bank Charter Acts failed to exert a lasting effect was growing adoption of bankmoney on account as the preferred means of payment. The Bank Charter Acts had left the banking sector’s credit and deposit creation unregulated, the ‘check system’, as it was later called. In the course of the nineteenth century—in parallel with and in a sense in the shadow of banknotes—demand deposits came to be used as a regular means of cashless payment in the bank-managed clearing procedures among companies, government bodies, rich families and banks themselves.

The Currency School found its way into various subsequent theories, among them chartalism as well as neoclassical, Keynesian, and monetarist approaches to inflation and exchange-rate theory. Of course, any present-day Currency theory needs updating to contemporary conditions.²⁵ A number of differences would have to be worked out in detail. For example, rather than upholding an obsolete gold standard, a modernized Currency perspective aims for a pure system of sovereign fiat money, closely tied to economic productivity, capacity utilization and potential output.

3.4 Full Chartalism Versus State-Backed Commercial Bankmoney

The terms chartalism and state theory of money were coined by G.F. Knapp in 1905.²⁶ Both terms refer to the same subject. Knapp was a representative of the historical and institutional school of national economics from around 1870 to the 1920s. ‘Charta’ is derived from the Greek and Latin for paper, document or legal code. According to Knapp, ‘money is a creature of the legal order’.²⁷ The teaching dates back via late medieval Thomism to Aristotle: ‘Money exists not by nature but by law.’²⁸

According to Knapp, the most important legal and political premise for establishing a currency is public law, in combination with the credible power to enforce it. A state’s authentication of a token as legal tender in payment of all debts stands a much better chance of serving as the currency of the realm than do private monies not officially recognized. According to Knapp, the strength of a national currency ultimately depends on the political and economic stability and strength of the respective nation-state.²⁹ Keynes approved of Knapp’s chartalism, and Lerner, a fervent promoter of Keynesianism in the 1940–1950s, took a stand for money as a ‘creature of the state’.³⁰ Thereafter, chartalism has been present in much of post-Keynesianism.³¹

In one passage, Keynes’s opinion of chartalism sounds rather absolute: ‘all civilized money is, beyond the possibility of dispute, chartalist’.³² This may be true, were it not for a specific ambiguity which actually blurs the difference between chartal money and privately issued money. That ambiguity was already present in Knapp. Most people will associate a ‘state theory of money’ with a stock of money consisting of state money (sovereign money) issued by an authority such as the national central bank. This, however, is not the only meaning in Knapp and not necessarily what economists—neoclassical and Keynesian alike—have come to understand by the currency and money of a nation-state.

In Knapp’s view it is not that important whether a nation’s money is issued by the state. This can be the case, but is not a necessity. In Knapp, the state’s basic role is to define the national currency unit. The decisive factor for the establishment of a specific token as a general means of payment then is what a state’s treasury accepts in payment of taxes, or the courts in payment of penalty charges:³³

All means by which a payment can be made to the state form part of the monetary system. On this basis, it is not the issue, but the acceptation ... which is decisive.³⁴—A state’s money will not be identified by compulsory acceptance, but by acceptance at public cash desks.³⁵

This teaching was carried forward by Abba Lerner:

The modern state can make anything it chooses generally acceptable as money and thus establish its value quite apart from any connection ... with gold or with backing of any kind. It is true that a simple declaration that such and such is money will not do. ... But if the state is willing to accept the proposed money in payment of taxes and other obligations to itself the trick is done. ... Money is a creature of the state. Its general acceptability, which is its all-important attribute, stands or falls by its acceptability by the state.³⁶

Scholars had long been aware of the role of taxes in establishing a currency. One recalls tally sticks as a kind of tax credit; or the adventurous life of John Law, who after the death of Louis XIV was engaged in 1719 to introduce paper money to France in order to reduce the crown’s debt. Part of the plan was to have the new paper money generally acknowledged by accepting it at the treasury in payment of taxes, and then to use part of the increased tax revenue to redeem sovereign debt, in a context of economic growth which was expected to result from the increased money supply.

The tax issue is certainly crucial for establishing a means of payment, but it is not the only important element. In addition, Lerner referred to a state’s borrowing of money. Either way, the money a government takes in by way of taxes or borrowing is the means used for government expenditure. Furthermore, there were times when sovereign currency existed but taxes did not. Ancient forms of oblation, tribute, toll or similar cannot be identified with taxation in a modern sense, any more than can the decrying of coin (recall for reprocessing) in the high middle ages.³⁷ Moreover, taxes are absent today in a number of oil-rich states with a currency of their own.

According to the now predominant understanding of chartalism—implicit for the most part—the monetary prerogatives have been reduced to defining the currency, the national unit of account, while the creation of money denominated in that currency and the related monetary benefit (seigniorage) have increasingly been left to the private banking sector. Bankmoney now counts for almost everything, sovereign money for little. No wonder this reduced notion of chartalism creates misunderstanding. It represents an incomplete, only partial notion of chartalism, if it can still be referred to as chartalism at all. The monetary prerogatives as introduced above in Sect. 3.2 are comprehensive and unimpaired sovereign rights, in no way to be shared with banks and other financial institutions. The present-day state theory of money, by contrast, has mutated into a theory of state-backed commercial bankmoney. It thus now represents Banking teaching rather than Currency theory.³⁸

The background to and reason for the mutation of comprehensive chartalism into a state-backed regime of private bankmoney was the rise of bankmoney as the preferred general means of cashless payment, in a first surge in the decades leading to Black Friday 1929, followed by a slight decline during the ensuing Great Depression and World War II and post-war periods, and a second surge from around the 1960–1970s which resumed the path toward a money supply exclusively consisting of bankmoney.

Cashless payment goes hand in hand with the development of the related two-tier banking system based on bankmoney and central bank reserves. The situation of having nationalized banknotes since the first half of the nineteenth century, while continuing with commercial bankmoney on account, developed into a new kind of parallel money system in the following decades; that is, sovereign money (coins, banknotes, central bank reserves) and private bankmoney in parallel. Toward and after 1900 this resulted in a split money circuit, consisting of interbank circulation on the basis of reserves (non-cash central bank money) and public circulation on the basis of bankmoney (demand deposits). The remaining notes and coins have become a merely technical sub-amount that is no longer of constitutive relevance to either of the two circuits.

What is more, bankmoney on account (deposits) as well as central bank reserves have been credit-issued money from the outset, just like former banknotes. Today, banknotes are issued in exchange for reserves, or bankmoney on account respectively, and the reserves and the bankmoney are not spent, but loaned into circulation. After all, we should remember that central banks began their existence as privileged commercial banks.

The monetary importance of the take-off of cashless payment practices by transfer of demand deposits was fully recognized only between 1890 and 1920, when the bank-credit theory of money was developed. Important contributions were made by Macleod, Withers, Hawtrey and Hahn, also by Schumpeter and von Mises.³⁹

Hahn, a Frankfurt banker, stressed the growing independence of credit expansion from previous savings. He knew from experience that with the rise of bankmoney and the corresponding decrease in the share of central bank notes, the deposit business was no longer a prerequisite for extending credit. On the contrary, the deposit business had become a mere reflex of the crediting business on the asset side.⁴⁰ In present-day post-Keynesianism this is wrapped in the formula ‘credit creates deposits’. In the same vein, Macleod had concluded that a bank, rather than lending deposited cash, is an institute for creating bankmoney by crediting current accounts.⁴¹

With the advent of private banknotes and bankmoney on a large scale, banks increasingly became monetary institutions, capturing the sovereign monetary prerogatives to a growing extent. That seizure was recaptured by the state through the central bank monopoly on banknotes as introduced in the course of the nineteenth century. However, with the rise of cashless payment by transfer of demand deposits, the banking industry has recaptured the prerogatives of money and seigniorage to a larger extent than ever before.

The chartal concept of national currencies and state control of the money, be this in the form of state-issued money or at least state-controlled issuance of money, has never really been called into question by classical, Marxist or neoclassical economics, or even by historical and institutional economics, and certainly not by Keynesianism.

Most often, however, scholars of neoclassical standard economics are not sensitive to the subject; Neo-Austrians are, but tend to misinterpret the situation as misguided state and central-bank entanglement rather than perceiving the actual development of state-backed bankmoney as a path possibly leading to their goal of ‘free banking’ beyond the state and central banks. Supporters of private crypto currencies may presently also contribute to a belief in ‘free money creation’, but may end up providing proof that ‘free money’ beyond state power is doomed to fail.

Unfortunately, most of those who consider themselves chartalists have not objected to the development of the regime of state-backed private bankmoney. Rather than perceiving it as a serious challenge to the monetary sovereignty of a state, they tend to affirm and defend the state-backed regime of bankmoney, from Keynes up to present-day post-Keynesianism, circuitism and ‘modern money’ theorists.

This is partly due to an erroneous but still prevailing belief in central banks exerting control over the banks by way of reserve positions or interest-rate policy, or a partially misconceived understanding of ‘endogenous’ bankmoney which insinuates that the creation of bankmoney according to demand and the banks’ proprietary intentions will result in an optimum money supply, thereby in fact reproducing the Banking School’s real bills doctrine.