The History of Money and Monetary Arrangements

Insights from the Baltic and North Seas Region

Thomas Marmefelt

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781136728259
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

Today, most money is credit money, created by commercial banks. While credit can finance innovation, excessive credit can lead to boom/bust cycles, such as the recent financial crisis. This highlights how the organization of our monetary system is crucial to stability. One way to achieve this is by separating the unit of account from the medium of exchange and in pre-modern Europe, such a separation existed. This new volume examines this idea of monetary separation and this history of monetary arrangements in the North and Baltic Seas region, from the Hanseatic League onwards.

This book provides a theoretical analysis of four historical cases in the Baltic and North Seas region, with a view to examining evolution of monetary arrangements from a new monetary economics perspective. Since the objective exhange value of money (its purchasing power), reflects subjective individual valuations of commodities, the author assesses these historical cases by means of exchange rates. Using theories from new monetary economics, the book explores how the units of account and their media of exchange evolved as social conventions, and offers new insight into the separation between the two. Through this exploration, it puts forward that money is a social institution, a clearing device for the settlement of accounts, and so the value of money, or a separate unit of account, ultimately results from the size of its network of users.

The History of Money and Monetary Arrangements offers a highly original new insight into monetary arrangments as an evolutionary process. It will be of great interest to an international audience of scholars and students, including those with an interest in economic history, evolutionary economics and new monetary economics.

1 Evolution of monetary arrangements

1.1 Introduction

This book is about the historical evolution of monetary arrangements, considering specific historical contexts. However, the problem considered is the current emergence of intangible money, which warrants attention to the functional separation of unit of account from medium of exchange. Hence, rather than considering the evolution of money, like Orrell and Chlupatý (2016), this book considers the co-evolution of units of account and media of exchange in different historical trading contexts, focusing on four historical cases in the Baltic and North Seas region, from the Hanseatic League to seventeenth century exchange banks, the gold standard and monetary unions, and interwar monetary fragmentation. Finally, some lessons are drawn about the interaction of cognition and institution for money as a social institution.

Money as a social institution – a clearing device for the settlement of accounts – rather than a commodity is essential, since the book is about credit money and monetary arrangements that give appropriate liquidity to the real economy, since most money today is credit money, which is created by banks when they give credit. This approach differs from the conception of money as a commodity that would entirely focus on the silver, copper, and gold content of coins. When using the conception of money as a clearing device, the value of money is not based on the metal content, but on some shared agreement of what purchasing power money gives. Here, the interaction between abstract units of account and media of exchange being commodity money or fiat money is of interest. The credit money approach brings in the bills of exchange as private money, which has liberated money from the constraints of precious metal.

The aim of this book is to study the evolution of money and credit as social institutions, considering the interaction between the cognitive and behavioral aspects of these institutions. In human societies, money and markets are interdependent. As Clower (1999) argues, monetary exchange arises from the same forces of self-interest that induce individuals to make markets; some transactors becoming marketors, eventually specializing, but what constitutes money depends on what country we are in, when we are there, and where we are. Orrell and Chlupatý (2016) argue that money created its own markets and institutions as well as its own demand, and the credit systems of ancient Mesopotamia predated the use of coins. Hence, credit money, not commodity money is the origin of money, and the money on which this book focuses.

1.2 Monetary arrangements as historically specific social institutions

We should view monetary arrangements as historically specific social institutions, depending on the patterns of exchange rather than a uniform social institution. Symbolic communication by means of money prices requires some shared understanding of the value of money. In an evolutionary context, economic agents develop heuristics to address uncertainty. There is an adaptive toolbox, which provides the building blocks for fast and frugal heuristics; fast because they can solve problems in little time, and frugal because they can solve it with little information (Gigerenzer 2008). Monetary heuristcs are shaped by the history of monetary exchange within an epistemic community.

The concept of epistemic community refers to shared frames of reference and cognitive orientation systems, in which people master the cognitive frames of reference, the symbolic means of communication, and the physical artifacts used (Holzner 1968; Håkanson 2010). Concerning monetary arrangements, market agents would have common knowledge of the worth that the unit of account used represents, the prices expressed in that unit of account, and the accepted media of exchange, be it coins, or bank money. Rather than relying on biological foundations, brain-based epistemology (Edelman 2006) characterizes these epistemic communities. This means evolution, in which brain, and body are embedded in the environment, the brain being epigenetic in origin, formed by inputs from body and environment, and action. The human brain is highly plastic and epigenetic rules are selected and accumulated during the course of human history (Changeux 2002). Rather than being innate, the symbolizing function of language has induced the brain’s evolved capacity to sustain language in an interactive evolutionary process, thus implying co-evolution of language and the human brain (Deacon 1997).

As Searle (1999) argues, all institutions but language require language or language-like symbolism. Searle’s description of the symbolizing role of language as the foundation of the social universe is quite analogous to the symbolizing role played by money prices in the economic universe, and money prices communicate contextual and tacit knowledge, which is beyond the capacity of language (Horwitz 2007). Market prices possess a language-like symbolizing function, but language is required to establish a shared meaning of money, property, exchange, and price, to give market prices that function (Marmefelt 2009). The human capacity to communicate through money prices evolves through social interaction in the market.

The evolution of money and credit will be analyzed by means of theoretical conjectures to interpret monetary history, making this book a study in historical economics rather than economic history. History is seen from a theoretical lens, looking for plausible rather than actual explanations. The key objective is to understand the mechanisms of interaction bertween cognition and institutions. Menger’s explanation of money as medium of exchange provides a plausible explanation, using theoretical conjectures, rather than a historical explanation, thus being abstract (Aydinonat 2008). As social institution, money has a cognitive dimension, which represents the way traders think about money as unit of account and medium of exchange, respectively, in the form of monetary heuristics; but money also has a behavioral dimension, which is expressed in the purchasing power of money. The cognitive-behavioral spiral involves monetary strategies, giving rise to a set of market prices, along the behavioral dimension, which leads to a shared meaning of money prices, in turn shaping individual monetary beliefs about the value of monies and commodities, along the cognitive dimension, in turn shaping the monetary strategies. Money is a social institution and Aoki (2011) argues that institutions have both a cognitive as well as a behavioral dimension; in the former, behavioral beliefs are inferred from a public representation of the state of play and in the latter, strategic choices motivated by behavioral beliefs generate a state of play.

The behavioral dimension is assessed through monetary history, while the cognitive dimension is assessed through history of monetary thought. Studying a credit economy, attention will be given to the use of letter obligatory and the bill of exchange, considering various accounting systems of exchange.

In monetary exchange, economic agents share attention on alternative monies and the price of a commodity in various monies, thus opening up communication by means of money prices. Boulding (1962) describes a learning system ‘as a social process by which the image of the world possessed by individuals of the society comes to change.’ Boulding stresses that there is constant interaction between images and society, so institutions interact continually with cognition in the form of images, stressing how social learning made possible through symbolic communication shapes expectations, decisions, and actions of individual agents, and how the role of cognition and communication is crucial to understand the evolution of social institutions (Marmefelt 2013). There is interaction between the cognitive and behavioral patterns. According to Endres and Harper (2013), the orientative behavior of entrepreneurs operates at three levels:

(i) the socio-cultural and cognitive dimension of the institutional system, where decisions are mediated by a general orientation structure;

(ii) capabilities of individuals manipulating elements of the structure above;

(iii) concrete acts as observable manifestations of active minds.

The exchange rate reflects the relative purchasing power of two currencies, along the behavioral dimension, from which we infer the cognitive dimension, the shared monetary understanding of the relative purchasing power of the two currencies which, through the monetary map, shapes individual monetary belief.

1.3 Plan and summary of the book

The underlying idea of this book is that there is a co-evolution of monetary arrangements and market exchange. Money shapes the market, which shapes money. However, monetary arrangements mean various forms by which units of account and media of exchange are structured, either united in a single asset, money, or functionally separated.

Chapter 2 considers the Black-Fama-Hall system, also called the BFH system, developed by Greenfield and Yeager (1983), in which the unit of account is physically defined by the state as a non-convertible nearly comprehensive commodity bundle, while the media of exchange are privately issued, subject to competition, using the ideas of Fischer Black, Eugene Fama, and Robert Hall. It is a market-based approach to monetary stability, by letting the state define the unit of account and then let competing firms provide media of exchange. As the unit of account is set by definition, inflation is defined away. However, the stability of the unit of account as measure of value is problematic, because it is defined as a commodity bundle, in which the commodities have fixed weights set by the state. As the economy evolves, the relative importance of commodities changes, and new commodities enter, while other commodities become obsolete and exit. For this reason, Marmefelt (2012a) thinks of the commodity bundle as a population subject to population dynamics, where the share of each commodity in the bundle varies discretely over time, along the lines of Fisher’s (1913) compensated dollar, but for a comprehensive commodity bundle rather than gold. Fisher’s scheme has been extended to indexed units of account, where a commodity bundle is used instead of gold, such as the Unidad de Fomento in Chile since 1967, which is driven by monthly data from the cost-of-living index (Shiller 1998, 1999; Hall 2005). However, acknowledging the pre-modern functional separation of units of account from the media of exchange in Europe, we need to consider historical cases of the emergence of units of account in the light of foreign trade and economic integration.

Chapter 3 develops the ideas of the so-called ‘New Monetary Economics’, to which the BFH system belongs, since a functional separation of unit of account from medium of exchange is a crucial component, by considering ideas in the monetary thought of Knut Wicksell, Ludwig von Mises, and Joseph Schumpeter, to make the unit of account a measure of value independent of commodities. Schumpeter’s view on credit as crucial to finance innovation is contrasted with the view of Austrian business cycle theory, where credit is a harmful injection of liquidity giving an artificial boom that leads to bust. Taking an evolutionary perspective, a monetary regime remains viable to the extent that it provides sufficient credit to finance investment, while avoiding excess credit creation that yields boom-bust cycles. Wicksell, Mises, and Schumpeter stress the importance of credit and that money is a clearing device – a social institution rather than a commodity – where the value of money is given by its purchasing power. It involves Wicksell’s pure credit economy, Mises’s subjective valuation of commodities, and Schumpeter’s pure settlement of account system. The unit of account then reflects subjective valuations of indirect utility obtained from the commodity bundle. This warrants an abstract unit of account, like Meulen’s (1934) banknote pound, which is perfectly consistent with Fisher’s compensated dollar. Meulen stresses the importance of credit and that the unit of account represents a stable worth of some commodity bundle, not the bundle itself, whose value may vary over time.

Chapter 4 considers the links between cognition and institutions, or more specifically the interdependence between the cognitive and behavioral aspects of social institutions, here between monetary heuristics, and exchange rates. By doing so, it develops a method of how to assess the monetary heuristics of traders in historical times, expressed in the form of units of account and the media of exchange they used, and their success in their contemporary trading environments. The medium of account provides a script that translates the unit of account into a particular worth. When the value of the underlying commodity bundle changes from the original worth, market agents observe a script deviation of that bundle, attributing that to changes in the commodity space, and adjust the bundle accordingly. Money is an emergent order and the monetary regime is required in order to keep credit creation consistent with the financing requirements of innovation (Marmefelt 2012a), while liquidity constitutes a crucial link to the financial system (Marmefelt 2012b). Liquidity of enterprises in the real economy is provided through credit creation by the financial system ex ante and must be absorbed by innovation desired by consumers ex post, so sustainable growth requires that the financial system, through a trial-and-error process, finds the correct liquidity (Marmefelt 2012b). Monetary arrangements are seen as emergent orders, in which monetary heuristics play a crucial role, based on the co-evolution of biology and culture rather than the biological determinism assumed in evolutionary psychology. Humans continually develop monetary heuristics giving some medium of account, providing an adequate stability for making calculations in the economic environment and associated media of exchange for conducting the exchange. The commodity bundle defining the unit of account adjusts over time, thus changing the social script, the shared mental map for the social routine by which a unit of account is used to evaluate commodities obtainable using the media of exchange associated with that unit of account. The emergence of the social institution of money is essentially a social learning process, where acceptability is established by means of assignment of a Searlean status function (Marmefelt 2012a). Language and the language-like symbolism of money give humans an image-creating and image-communication faculty (Marmefelt 2009). Exchange rates between currencies were established according to relative perceived purchasing power, some kind of classifier system, along the lines of Mises’s subjective valuations of purchasing power.

Chapters 5–8 consider the co-evolution of units of account and media of exchange in the Baltic and North Sea region, studying the processes of establishing the value of money as a unit of account. The monetary arrangements are seen as complex, evolving systems, with an increasing level of complexity over time, reflecting the stages of financial development. Financial evolution means that monetary arrangements obtain a higher level of complexity, including more sophisticated monetary heuristics. Hence, the complexity refers to the structure of the monetary arrangements in contrast to unstructured disorder. These chapters emphasize the co-evolution of units of account and media of exchange, in which cognition, and institutions interact within the trading context of the Baltic and North Seas region.

Chapter 5 analyzes the Hanseatic monetary arrangements, given the importance of the Hanseatic League for the Northern European trading zone of the Baltic and North Seas region, but stretching down to the Bay of Biscay, in which Bruges was the focal point. Medieval German monetary unions developed as an adaptive response to a prevailing monetary anarchy. The Wendish Monetary Union, Wendische Münzverein, is analyzed as a social institution, involving both a cognitive and behavioral component, in the light of the development of long-distance trade. A Misesian approach to money as social institution is developed. It implies we should look at the exchange rates to understand how agents valuate currencies by means of their heuristic...