Saturday, March 24, 2012

Alfred Mitchell Innes on the Credit Theory of Money

Alfred Mitchell Innes (1864–1950) wrote the following article on the nature of money:
Mitchell Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2: 151–168.
This is one of two important articles he wrote (the other is Mitchell Innes 1913). Mitchell Innes was a British diplomat, expert on finance, and served in the British Embassy in Washington D.C. from 1908 to 1913. (As an aside, there seems to be some confusion about whether his surname was merely “Innes,” or whether he bore the hyphenated or non-hyphenated double-barrelled surname “Mitchell Innes.” In what follows, I assume the latter and call him “Mitchell Innes,” but I might be wrong on this.)

There is a useful set of essays in L. R. Wray (ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes (Cheltenham, UK, 2004) examining the legacy of Mitchell Innes’s work on monetary theory. The modern Post Keynesian or advocate of Modern Monetary Theory (MMT) does not have to agree with everything in Mitchell Innes’s papers or his, at times, strident presentation of his credit theory, in order to recognise that he made important contributions to the theory of money.

In this post, I will summarise Mitchell Innes’s original article, as follows:
(1) Mitchell Innes (1914: 159) attributed the origin of the credit theory of money to the Scottish economist Henry Dunning Macleod (1821–1902), a writer whose work on banking and credit is much underrated (see MacLeod 1902). Mitchell Innes saw his own work as a “more consistent and logical development of … [sc. Macleod’s] teaching.”

(2) Mitchell Innes noted that, in his day, people thought that gold and silver were “the only real money and that all other forms of money are mere substitutes” (Mitchell Innes 1914: 151), an erroneous view in his opinion.

Money is explained by the credit theory of money, which is that money is, in essence, credit:
“the Credit Theory is this: that a sale and purchase is the exchange of a commodity for a 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.” (Mitchell Innes 1914: 152).
The credit nature of money can be seen, above all, in bank money (or fractional reserve demand deposits), a form of negotiable, transferable credit.

It is a credit that redeems a debt. Mitchell Innes (1914: 155) argued that payment is, in the end, the promise to “cancel our debt by an equivalent credit expressed in terms of our abstract, intangible [sc. monetary] standard.”

Even government money is a “‘promise to pay,’ just like a private bill or note” (Mitchell Innes 1914: 155). Mitchell Innes states:
“ …. the dollar is a measure of the value of all commodities, but is not itself a commodity, nor can it be embodied in any commodity. It is intangible, immaterial, abstract. It is a measure in terms of credit and debt. Under normal circumstances, it appears to have the power of maintaining its accuracy as a measure over long periods. Under other circumstances it loses this power with great rapidity. It is easily depreciated by excessive indebtedness, and once this depreciation has become confirmed, it seems exceedingly difficult and perhaps impossible for it to regain its previous position.” (Mitchell Innes 1914: 159).
Thus the monetary unit is an intangible and abstract thing (Mitchell Innes 1914: 155).

(3) I would contend that Mitchell Innes showed an awareness of the endogenous nature of the money supply in a developed capitalist nation:
“Every merchant who pays for a purchase with his bill, and every banker who issues his notes or authorises drafts to be drawn on him, issues money just as surely as does a government which issues drafts on the Treasury, or which puts its stamp on a piece of metal or a sheet of paper, and of all the false ideas current on the subject of money none is more harmful than- that which attributes to the government the special function of monopolising the issues 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 accustom itself to other and perhaps less convenient forms.” (Mitchell Innes 1914: 152).
A related point here is how absurd the Austrian obsession with private sector, fractional reserve banking or public sector money creation is: capitalism has always, in its real world form, had endogenous money, with promissory notes or bills of exchange, as well as bank money, creating an elastic money stock.

(4) It is the confidence that the community has in government credit and the necessity of obtaining government money for payment of taxation that makes it of greater relative value than private bank money, promissory notes and bills of exchange:
“The dollar of government money in America is equal to that of bank money, because of the confidence which we have come to have in government credit, and it usually ranks in any given city slightly higher than does the money of a banker outside the city, not at all because it represents gold, but merely because the financial operations of the government are so extensive that government money is required everywhere for the discharge of taxes or other obligations to the government. Everybody who incurs a debt issues his own dollar, which may or may not be identical with the dollar of any one else’s money. It is a little difficult to realize this curious fact, because in practice the only dollars which circulate are government dollars and bank-dollars and, as both represent the highest and most convenient form of credit, their relative value is much the same, though not always identical” (Mitchell Innes 1914: 154).
Even government money is a credit in the sense that it can be used to cancel debt owed to the government.

(5) Mitchell Innes (1914: 161) in fact had the following insight that has made its way into Modern Monetary Theory (MMT):
“most … government money finds its way to the banks, and we pay our tax by a cheque on our banker, who hands over to the treasury the coins or notes or certificates in exchange for the cheque and debits our account. This, then – the redemption of government debt by taxation – is the basic law of coinage and of any issue of government ‘money’ in whatever form. It has lain forgotten for centuries, and instead of it we have developed the notion that somehow the metallic character of the coin is the really important thing whereas in fact it has no direct importance.”
(6) On pages 156–158, Mitchell Innes digresses and discusses the monetary reforms in Britain in the 1690s and how this was erroneously interpreted by Metallists.

(7) Mitchell Innes argues that
“… while the monetary unit may depreciate, it never seems to appreciate. A general rise of prices at times rapid and at times slow is the common feature of all financial history; and while a rapid rise may be followed by a fall, the fall seems to be nothing more than a return to a state of equilibrium. I doubt whether there are any instances a fall to a price lower than that which prevailed before the rise, and anything approaching a persistent fall in prices, denoting a continuous rise of the value of money, appears to be unknown. (Mitchell Innes 1914: 159).
He means by this that throughout history price inflation has generally been the rule. Perhaps that it is a somewhat exaggerated view: there have been aberrant periods like 1873–1896 where almost continuous price deflation occurred.

(8) Mitchell Innes engages in a lengthy (p. 165ff.) discussion of how price inflation is explained by his theory, but his ideas here seem of little merit to me, and I will not summarise them.

MacLeod, H. D. 1902. Theory and Practice of Banking (6th edn), Longmans, Green, Reader, & Dyer, London.

Mitchell Innes, A. 1913. “What is Money?,” Banking Law Journal 30.5: 377–408. (reprinted in L. R. Wray (ed.). 2004. Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 14–49).

Mitchell Innes, A. 1914. “The Credit Theory of Money,” Banking Law Journal 31.2: 151–168 (reprinted in L. R. Wray (ed.). 2004. Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham. 50–78).

Wray, L. R. (ed.), Credit and State Theories of Money: The Contributions of A. Mitchell Innes, Edward Elgar, Cheltenham, UK. 79–98.

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