The Theory of Money and Credit

The simple statement, that money is a commodity whose economic function is to facilitate the interchange of goods and services, does not satisfy those writers who are interested rather in the accumulation of material than in the increase of knowledge. Many investigators imagine that insufficient attention is devoted to the remarkable part played by money in economic life if it is merely credited with the function of being a medium of exchange; they do not think that due regard has been paid to the significance of money until they have enumerated half a dozen further “functions”—as if, in an economic order founded on the exchange of goods, there could be a more important function than that of the common medium of exchange.

After Menger’s review of the question, further discussion of the connection between the secondary functions of money and its basic function should be unnecessary.4  Nevertheless, certain tendencies in recent literature on money make it appear advisable to examine briefly these secondary functions—some of them are coordinated with the basic function by many writers—and to show once more that all of them can be deduced from the function of money as a common medium of exchange.

This applies in the first place to the function fulfilled by money in facilitating credit transactions. It is simplest to regard this as part of its function as medium of exchange. Credit transactions are in fact nothing but the exchange of present goods against future goods. Frequent reference is made in English and American writings to a function of money as a standard of deferred payments.5  But the original purpose of this expression was not to contrast a particular function of money with its ordinary economic function, but merely to simplify discussions about the influence of changes in the value of money upon the real amount of money debts. It serves this purpose admirably. But it should be pointed out that its use has led many writers to deal with the problems connected with the general economic consequences of changes in the value of money merely from the point of view of modifications in existing debt relations and to overlook their significance in all other connections.

The functions of money as a transmitter of value through time and space may also be directly traced back to its function as medium of exchange. Menger has pointed out that the special suitability of goods for hoarding, and their consequent widespread employment for this purpose, has been one of the most important causes of their increased marketability and therefore of their qualification as media of exchange.6  As soon as the practice of employing a certain economic good as a medium of exchange becomes general, people begin to store up this good in preference to others. In fact, hoarding as a form of investment plays no great part in our present stage of economic development, its place having been taken by the purchase of interest-bearing property.7  On the other hand, money still functions today as a means for transporting value through space.8  This function again is nothing but a matter of facilitating the exchange of goods. The European farmer who emigrates to America and wishes to exchange his property in Europe for a property in America, sells the former, goes to America with the money (or a bill payable in money), and there purchases his new homestead. Here we have an absolute textbook example of an exchange facilitated by money.

Particular attention has been devoted, especially in recent times, to the function of money as a general medium of payment. Indirect exchange divides a single transaction into two separate parts which are connected merely by the ultimate intention of the exchangers to acquire consumption goods. Sale and purchase thus apparently become independent of each other Furthermore, if the two parties to a sale-and-purchase transaction perform their respective parts of the bargain at different times, that of the seller preceding that of the buyer (purchase on credit), then the settlement of the bargain, or the fulfillment of the seller’s part of it (which need not be the same thing), has no obvious connection with the fulfillment of the buyer’s part. The same is true of all other credit transactions, especially of the most important sort of credit transaction—lending. The apparent lack of a connection between the two parts of the single transaction has been taken as a reason for regarding them as independent proceedings, for speaking of the payment as an independent legal act, and consequently for attributing to money the function of being a common medium of payment. This is obviously incorrect. “If the function of money as an object which facilitates dealings in commodities and capital is kept in mind, a function that includes the payment of money prices and repayment of loans...there remains neither necessity nor justification for further discussion of a special employment, or even function of money, as a medium of payment.”9

The root of this error (as of many other errors in economics) must be sought in the uncritical acceptance of juristical conceptions and habits of thought. From the point of view of the law, outstanding debt is a subject which can and must be considered in isolation and entirely (or at least to some extent) without reference to the origin of the obligation to pay. Of course, in law as well as in economics, money is only the common medium of exchange. But the principal, although not exclusive, motive of the law for concerning itself with money is the problem of payment. When it seeks to answer the question, What is money? it is in order to determine how monetary liabilities can be discharged. For the jurist, money is a medium of payment. The economist, to whom the problem of money presents a different aspect, may not adopt this point of view if he does not wish at the very outset to prejudice his prospects of contributing to the advancement of economic theory.

• 4See Menger, Grundsätze, pp. 278 ff.
• 5See Nicholson, A Treatise on Money and Essays on Present Monetary Problems (Edinburgh, 1888), pp. 22 ff.; Laughlin, The Principles of Money (London, 1903), pp. 22 f.
• 6Cf. Menger, Grundsätze, pp. 284 ff.
• 7That is, apart from the exceptional propensity to hoard gold, silver, and foreign bills, encouraged by inflation and the laws enacted to further it.
• 8Knies in particular (Geld und Kredit, 2d ed. [Berlin, 1885], vol. 1, pp. 233 ff.) has laid stress upon the function of money as interlocal transmitter of value.
• 9Cf. Menger, Grundsätze, pp. 282 f.