Credit theory of money
Credit theories of money, also called debt theories of money, are monetary economic theories concerning the relationship between credit and money. Proponents of these theories, such as Alfred Mitchell-Innes, sometimes emphasize that money and credit/debt are the same thing, seen from different points of view. Proponents assert that the essential nature of money is credit (debt), at least in eras where money is not backed by a commodity such as gold. Two common strands of thought within these theories are the idea that money originated as a unit of account for debt, and the position that money creation involves the simultaneous creation of debt. Some proponents of credit theories of money argue that money is best understood as debt even in systems often understood as using commodity money. Others hold that money equates to credit only in a system based on fiat money, where they argue that all forms of money including cash can be considered as forms of credit money.
The first formal credit theory of money arose in the 19th century. Anthropologist David Graeber has argued that for most of human history, money has been widely understood to represent debt, though he concedes that even prior to the modern era, there have been several periods where rival theories like metallism have held sway.
According to Joseph Schumpeter, the first known advocate of a credit theory of money was Plato. Schumpeter describes metallism as the other of "two fundamental theories of money", saying the first known advocate of metallism was Aristotle. The earliest modern thinker to formulate a credit theory of money was Henry Dunning Macleod (1821-1902), with his work in the 19th century, most especially with his The Theory of Credit (1889). Macleod's work was expanded on by Alfred Mitchell-Innes in his papers What is Money? (1913) and The Credit Theory of Money (1914), where he argued against the then conventional view of money arising as a means to improve the practice of barter. In this alternative view, commerce and taxation created obligations between parties which were forms of credit and debt. Devices such as tally sticks were used to record these obligations and these then became negotiable instruments which could function as money. As Innes puts it in his 1914 article:
The Credit Theory is this: 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 or metals, but on the right which the creditor acquires to "payment," that is to say, to satisfaction for the credit, and on the obligation of the debtor to "pay" his debt and conversely 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.
Innes goes on to note that a major problem in getting the public to understand the extent to which monetary systems are debt based is the challenge in persuading them that "things are not the way they seem".
A Quantity Theory of Credit was proposed in 1992 by Richard Werner, whereby credit creation is disaggregated into credit for GDP and non-GDP (financial circulation). The approach is tested empirically in a general-to-specific econometric time series model and found to be superior to alternative and traditional theories. According to Werner bank credit creation for GDP transactions Granger-causes nominal GDP growth, while credit creation for financial transactions explains asset prices and banking crises. Based on this, Werner (2005) developed a new approach to macroeconomics, which integrates the nature of banks as money creators in macroeconomics - usually ignored in conventional macroeconomics. Werner's approach is based on the scientific research methodology (the inductive method), not the axiomatic-hypothetical deductive approach commonly used in macroeconomics, which assumes away the existence of banks or market rationing. Hence in his approach markets are not expected to be in equilibrium, but the short side principle applies, which emphasises the power of banks in making decisions about the amount and allocation of credit created and distributed in the economy. Werner used the Quantity Theory of Credit (also known as the Quantity Theory of Disaggregated Credit) to develop a new monetary policy for post-crisis banking systems, which he called 'Quantitative Easing' (Werner, 1995, published in the Japanese financial newspaper, the Nikkei), a name later adopted by the Bank of Japan and Bank of England for related policies . The role of banks as creators of both the credit and the money supply has since been empirically demonstrated by Werner in widely-noted finance journal publications.
Since the late 20th century, Innes' credit theory of money has been integrated into Modern Monetary Theory. The theory also combines elements of chartalism, noting that high powered money is functionally an IOU from the state, and therefore, "all 'state money' is also 'credit money'". The state ensures there is demand for its IOUs by accepting them as payment for taxes, fees, fines, tithes, and tribute.
In his 2011 book Debt: The First 5000 Years, the anthropologist David Graeber asserted that the best available evidence suggests the original monetary systems were debt based, and that most subsequent systems have been too. Exceptions where the relationship between money and debt was less clear occurred during periods where money has been backed by bullion, as happens with a gold standard. Graeber echoes earlier theorists such as Innes by saying that during these eras population perception was that money derived its value from the precious metals of which the coins were made, but that even in these periods money is more accurately understood as debt. Graeber states that the three main functions of money are to act as: a medium of exchange; a unit of account; and a store of value. Graeber writes that since Adam Smith's time, economists have tended to emphasise money as a medium of exchange. For Graeber, when money first appeared its primary purpose was to act as a unit of account, to denominate debt. He writes that coins were originally created as tokens which represented a unit of account rather than being an amount of precious metal which could be bartered.
Economics commentator Philip Coggan holds that the world's current monetary system became debt-based after the Nixon Shock, in which President Nixon suspended the link between money and gold in 1971. He writes that "Modern money is debt and debt is money". Since the 1971 Nixon Shock, debt creation and the creation of money increasingly took place at once. This simultaneous creation of money and debt occurs as a feature of fractional reserve banking. After a commercial bank approves a loan, it is able to create the corresponding amount of money, which is then acquired by the borrower along with a similar amount of debt. Coggan goes on to say that debtors often prefer debt-based monetary systems such as fiat money over commodity-based systems like the gold standard, because the former tend to allow much higher volumes of money to circulate in the economy, and tend to be more expansive. This makes their debts easier to repay. Coggan refers to William Jennings Bryan's 19th century Cross of Gold speech as one of the first great attempts to weaken the link between gold and money; he says the former US presidential candidate was trying to expand the monetary base in the interests of indebted farmers, who at the time were often being forced into bankruptcy. However Coggan also says that the excessive debt which can be built up under a debt-based monetary system can end up hurting all sections of society, including debtors.
In a 2012 paper, economic theorist Perry Mehrling notes that what is commonly regarded as money can often be viewed as debt. He posits a hierarchy of assets with gold at the top, then currency, then deposits and then securities. The lower down the hierarchy, the easier it is to view the asset as reflecting someone else's debt. A later 2012 paper from Claudio Borio of the BIS made the contrary case that it is loans that give rise to deposits, rather than the other way round.
In a book published in June 2013, the writer Felix Martin, influenced by Werner (2003, 2005), argued that credit based theories of money are correct, citing many of Werner's sources, such as Macleod: "currency ... represents transferable debt, and nothing else". Martin writes that it is difficult for people to grasp the nature of money, because money is such a central part of society, and alludes to the Chinese proverb that "If you want to know what water is like, don't ask the fish."
The conception that money is essentially equivalent to credit or debt has long been used by those advocating particular reforms of the monetary system, and by commentators calling for various monetary policy responses to events such as the financial crisis of 2007–2008. A view held in common by most recent advocates, from all shades of political opinion, is that money can be equated with debt in the context of the contemporary monetary system. The view that money is equivalent to debt even in systems based on commodity money tends to be held only by those to the left of the political spectrum. Regardless of any commonality in their understanding of credit theories of money, the actual reforms proposed by advocates of different political orientations are sometimes diametrically opposed.
Advocacy for a return to a gold standard or similar commodity based system.
Advocates from an Austrian School, right-libertarian perspective often hold that money is equivalent to debt in our current monetary system, but that it need not be in one where money has inherent value, such as a gold standard. They have frequently used this view point to support arguments that it would be best to return to a gold standard, to other forms of commodity money, or at least to a monetary system where money has positive value. Similar views are also occasionally expressed by conservatives. As an example of the latter, former British minister of state The Earl of Caithness made a 1997 speech in The House of Lords where he stated that since the 1971 Nixon Shock, the British money supply had grown by 2145% and personal debt had risen by almost 3000%. He argued that Britain ought to move from its current "debt-based monetary system" to one based on equity:
It is also a good time to stand back, to reassess whether our economy is soundly based. I would contest that it is not ... as it is debt-based ... a system which by its very actions causes the value of money to decrease is dishonest and has within it its own seeds of destruction. We did not vote for it. It grew upon us gradually but markedly since 1971 when the commodity-based system was abandoned...We all want our businesses to succeed, but under the existing system the irony is that the better our banks, building societies and lending institutions do, the more debt is created ... There is a different way: it is an equity-based system and one in which those businesses can play a responsible role. The next government must grasp the nettle, accept their responsibility for controlling the money supply and change from our debt-based monetary system. My Lords, will they? If they do not, our monetary system will break us and the sorry legacy we are already leaving our children will be a disaster.
In the early to mid-1970s, a return to a gold-anchored system was advocated by gold-rich creditor countries including France and Germany. A return has repeatedly been advocated by libertarians, as they tend to see commodity money as far preferable to fiat money. Since the 2008 crisis and the rapid rise in the price of gold that soon followed it, a return to a gold standard has frequently been advocated by goldbugs.
Advocacy against the gold standard
From centrist and left-wing perspectives, credit theories of money have been used to oppose the gold standard while it was still in effect, and to reject arguments for its reinstatement. Innes's 1914 paper is an early example of this.
Advocacy for expansionary monetary policy
From a moderate mainstream perspective, Martin Wolf has argued that since most money in our contemporary system is already being dual-created with debt by private banks, there is no reason to oppose monetary creation by central banks in order to support monetary policy such as quantitative easing. In Wolf's view, the argument against Q.E. on the grounds that it creates debt is offset by potential benefits to economic growth and employment, and because the increase in debt would be temporary and easy to reverse.
Advocacy for debt cancellation
Arguments for debt forgiveness have long been made from people of all political orientations; as an example, in 2010 hedge fund manager Hugh Hendry, a strong believer in free markets, argued for a partial cancellation of Greece's debt as part of the solution to the Euro crisis. But generally advocates of debt forgiveness simply point out that debts are too high in relation to the debtors’ ability to repay; they don't make reference to a debt-based theory of money. Exceptions include David Graeber, who from a radical perspective, has used credit theories of money to argue against recent trends to strengthen the enforcement of debt collection, such as greater use of custodial sentences against debtors in the US. He also argued against the over-zealous application of the view that paying one’s debts is central to morality, and has proposed the enactment of a biblical style Jubilee where debts will be cancelled for all.
Advocacy for full-reserve banking
The 2008 financial crisis has led to renewed interest in full reserve banking and sovereign money issued by a central bank. Monetary reformers argue that fractional reserve banking and debt-based money lead to unpayable debt, growing inequality, inevitable bankruptcies, and an imperative for perpetual and unsustainable economic growth.
Advocacy for the ongoing establishment of new community banks
Werner argues that the knowledge and understanding of banks as creators and allocators of the money supply should be harnessed to benefit humanity in general and ordinary people in particular - instead of abolishing this power, as the 'monetary reform' movement demands. According to Werner this can be done by establishing hundreds of not-for-profit community banks, modelled on Germany's local co-operative banks, Raiffeisenbanks and Sparkasse savings banks. These banks have been one of the drivers of the striking success for German small firms over the past two centuries in delivering job creation, strong exports and constantly upgraded technology. Werner says that instead of further centralising the power of money creation in the hands of ever fewer people, as monetary reformers and central planners demand, this public privilege should be returned "to the people to whom it belongs", and this can only be done in a meaningful way with sufficient accountability by copying the traditional German community banks. 
Relationship with other theories of money
Historically, debt theories of money have overlapped with chartalism and were opposed to metallism. This largely remains the case today, especially in the forms commonly held by those to the left of the political spectrum. Conversely, in the forms held by late 20th-century and 21st-century advocates with a conservative libertarian perspective, debt theories of money are often compatible with the quantity theory of money and with metallism, at least when the latter is broadly understood.
Notes and references
- As Innes mentions in What is money? (1913), whenever he uses the word credit or debt, "the thing spoken of is precisely the same in both cases, the one or the other word being used according as the situation is being looked at from the point of view of the creditor or of the debtor."
- Chpt 1 Graeco-Roman Economics , 'History of Economic Analysis, Joseph Schumpeter , (1954)
- Anitra Nelson. "Marx's objections to credit theories of money (extract from Nelson's 1999 book: Marx's concept of Money )" (PDF). Mount Holyoke College. Retrieved 2013-07-08.
- Originally published in The Banking Law Journal, since reprinted in books such as Wray (2004) and made available online by the CES
- Randy Wray, ed. (2004). "See esp Chpt 1 7". Credit & State Theories of Money. Edward Elgar. ISBN 1843765136.
- Richard A. Werner, 1993, Towards a Quantity Theorem of Disaggregated Credit and International Capital Flows, with Evidence from Japan, paper presented at the Royal Economic Society Annual Conference in York in April 1993, and the 5th Annual PACAP Conference on Pacific-Asian Capital Markets in Kuala Lumpur, June 1993 and published later as Richard A. Werner, 1997, Towards a New Monetary Paradigm: A Quantity Theorem of Disaggregated Credit, with Evidence from Japan, Kredit und Kapital, 30, 2, pp. 276-309. Available at http://eprints.soton.ac.uk/36569/. See also http://www.kredit-und-kapital.de/archiv/1997-2.html#r1 and Werner, Richard A. (2012). Towards a New Research Programme on ‘Banking and the Economy’ – Implications of the Quantity Theory of Credit for the Prevention and Resolution of Banking and Debt Crises, International Review of Financial Analysis, 25, 94-105, 
- Richard A. Werner, 2005, New Paradigm in Macroeconomics, Palgrave Macmillan.
- Richard A. Werner (1995), Keiki kaifuku, ryōteki kinyū kanwa kara, (How to Create a Recovery through ‘Quantitative Monetary Easing’), The Nihon Keizai Shinbun (Nikkei), ‘Keizai Kyōshitsu’ (‘Economics Classroom’), 2 September 1995 (morning edition), p. 26; English translation by T. John Cooke (November 2011)
- Werner, Richard A. (2016), A lost century in Economics: Three theories of banking and the conclusive evidence, International Review of Financial Analysis, 46, July, 361–379, online:  and Werner, Richard A. (2014). Can Banks Individually Create Money Out of Nothing? – The Theories and the Empirical Evidence, International Review of Financial Analysis, 36, 1-19, 
- Fullwiler, Scott; Kelton, Stephanie; Wray, L. Randall (January 2012), "Modern Money Theory : A Response to Critics", Working Paper Series: Modern Monetary Theory - A Debate (PDF), Amherst, MA: Political Economy Research Institute, pp. 17–26, retrieved May 26, 2019
- Éric Tymoigne and L. Randall Wray, "Modern Money Theory 101: A Reply to Critics," Levy Economics Institute of Bard College, Working Paper No. 778 (November 2013).
- This is the classic Metallist view.
- Polanyi goes as far as to say Ricardo "indoctrinated" economists into viewing money just as a medium of exchange - see chapter 16 of The Great Transformation.
- David Graeber (2011), "passim, see especially chapter 2: The Myth of Barter", Debt: The First 5000 Years, ISBN 978-1-61219-181-2
- The new debt will generally soon exceed the newly created money due to added interest.
- Philip Coggan (2011). "passim, see esp Introduction". Paper Promises: Money, Debt and the New World Order. Allen Lane. ISBN 978-1846145100.
- In the Financial sector, gold is often said to be the only financial asset that does not represent someone else's liability to pay.
- Perry Mehrling (2012-01-25). "The Inherent Hierarchy of Money" (PDF). Columbia University. Archived from the original (PDF) on 2012-12-21. Retrieved 2012-07-10.
- "The financial cycle and macroeconomics: What have we learnt?", by Claudio Borio, Bank for International Settlements December 2012
- Richard A. Werner (2003), Princes of the Yen, 2nd edition by Quantum Publishers [www.quantumpublishers.com]
- Felix Martin (4 March 2014). Money: The Unauthorized Biography. Knopf Doubleday Publishing Group. ISBN 978-0-307-96244-7. Chapter 1
- Ian Birrell (2013-06-09). "Money: The Unauthorised Biography by Felix Martin – review". The Guardian. Retrieved 2013-07-08.
- Ron Paul (12 Sep 2003). "Fiat Paper Money". LewRockwell.com. Retrieved 16 July 2012.
- Malcolm Sinclair, 20th Earl of Caithness (1997-03-05). "Our Debt-Based Money System Will Break Us". Prosperity UK. Retrieved 2012-07-12.
- Helleiner, Eric (1995). States and the Reemergence of Global Finance: From Bretton Woods to the 1990s. Cornell University Press. ISBN 0-8014-8333-6.
- Izabella Kaminska (31 May 2012). "Debunking goldbugs". The Financial Times. Retrieved 16 July 2012.
- During the two centuries leading up to WWII, it was mostly only those who leaned towards the left who opposed the Gold Standard, but this has since became a centrist position.
- Martin Wolf (9 Nov 2010). "The Fed is right to turn on the tap". The Financial Times. Retrieved 16 July 2012.
- Courtney Comstock (2010-02-10). "Watch Hedge Funder Hugh Hendry Fight WIth Joe Stiglitz". Business Insider. Retrieved 2012-07-18.
- Jackson, Andrew; Dyson, Ben (2012). Modernizing Money. Why our Monetary System is Broken and how it can be Fixed. Positive Money. ISBN 978-0-9574448-0-5.
- Richard A. Werner (2018), Shifting from central planning to a decentralised economy, www.professorwerner.org  see also Local First Community Interest Company and their movement to establish community banks 
- Simply put, this contrasts with exogenous creation where money is created by events such as new finds of gold occurring outside of a narrowly conceived economy.
- In the 19th century, and to an extent the early 20th century, metallism enjoyed an almost "unchallenged" position as the dominant theory of money – see for example Chapter 1 of Schumpeter's History of Economic Analysis
- Chartalists will sometimes say money derives it value by virtue of being the legal way to pay ones debt to the State as taxes. Debt theories can be broader in scope – Graeber, Innes and others have argued that organic debt based monetary systems that did not involve the state continued to operate well into the 19th century.
- Stephanie A. Bell and Edward J. Nell, ed. (2003). "Passim". The State, the Market, and the Euro: Chartalism Versus Metallism in the theory of money. Edward Elgar. ISBN 1843761564.