CASHLESS SOCIETY? New research on the origins of money suggests that it was introduced to raise taxes, not replace barter

07 Apr 2017

Money was not created to replace barter, as most historians suggest, but to boost trade that rulers could tax. This new theory of the origins of money will be presented by central bank economist Vincent Bignon at the Royal Economic Society''s annual conference at the University of Bristol in April 2017.

The standard explanation for the invention of money is that it was created by rulers as a trade-off, as they gave up the opportunity to keep records of transactions (and allow some traders to avoid tax) because of the inconveniences of barter, which limited trade.

Instead, the new study argues, historical records show that money was introduced in many societies where there were sophisticated credit arrangements in place that had already replaced barter. In these cases, money was both more encompassing than credit – and cheaper. Also, by introducing money, rulers forced traders to do business that could be taxed. Money was often introduced in a society when a ruler needed to raise taxes, for example, because of war.

The authors comment: ''Today''s debate about the cashless society revolves around the benefits of discouraging the use of an anonymous payment technology with the hope of replacing it with one that keeps track of the names of transactors. We argue that this opposition was the initial trade-off faced by rulers in antiquity when they contemplated introducing the first coins or banknotes.''

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There is a current debate in the media and among policy-makers about the desirability and possibility of a cashless society; see Rogoff and McAndrews for opposing views on the matter. Some argue that society might be better off by reducing cash-intensive activities. Others outline that new payment technologies allow a reduction of the need for cash in payment.

In ''On the origin of money'', we propose a theory comparing the use of money with the use of credit and show that suppressing the use of money may not always be optimal.

Recently, the media has featured policy-makers and academics advocating the suppression of cash. In a recent book, Harvard economist Kenneth Rogoff proposes to limit the use of large denomination notes to complicate criminal activity. India''s Prime Minister Narendra Modi''s decision to ban 86% of banknotes in India from circulation on 8 November 2016 was motivated by the desire to limit tax evasion.

The debate revolves around the benefits of discouraging the use of an anonymous payment technology with the hope of replacing it with one that keeps track of the names of transactors.

In ''On the origin of money'', we argue that this opposition was the initial trade-off faced by rulers when they contemplated introducing the first coins or banknotes. They had to weigh the benefit of allowing the use of a means of payment that does not reveal the identity of the payer – cash or coins – with the benefits of recording the transactions of all traders to enforce debt repayment.

In a nutshell, the opposition is between an anonymous payment technology and a credit or record-keeping technology. A record-keeping technology encompasses very diverse technological devices, from the use of wax tablets in Babylon to the use of digital money today. The minimal function of a record-keeping technology is to record transactions, names of debtors and creditors as well as defaulters on debt repayment.

Our theory discusses possible reasons for why the use of money can be better than the use of credit. A drawback of using money to mediate trade is that agents have to hold a stock of it prior to trade. To the extent that agents may not have sufficient cash with them when a trading opportunity arises, this may lead to missed opportunities for trade.

A credit system does not suffer from this drawback. But in order for a credit system to work, it must be both encompassing and cheap. There may be missed trade opportunities with a credit system if traders have to exchange with many people that cannot use the system, either because they are foreigners or because credit is expensive to implement in some transactions.

Our theory stands in contrast to the usual explanation of the origin of money. The standard economic explanation for the origin of money is that money grew out of the inconveniences of barter.

Many economists have proposed their own explanation for why money is more convenient than barter, from Adam Smith in 1776 to Stanley Jevons in 1875, Carl Menger in 1892 and more recently Kiyotaki and Wright in 1989. However appealing, this explanation for the use of money does not square well with existing historical and anthropological evidence.

History and anthropology alike emphasise that money usually replaced fairly sophisticated credit arrangements. In those societies, once people have agreed on a common standard to measure the indebtedness (a unit of account), there was no need for a medium of exchange.

Future contracts were commonly used to buy or sell grains in Babylon starting in the 18th century BCE, twelve centuries before the first coins were ever struck by the King of Lydia. Even after coins were invented, they did not spread quickly to neighbouring kingdoms, as would have been predicted if money had grown out of barter.

Moreover, in the few documented instances of barter economies, barter grew out of the demise of money. This was for example the case with cigarette money episode of post-war Germany.

If credit was more efficient than coins, how could have rulers been successful in having coins circulated? We argue that a self-interested ruler who maximises his own welfare would have been able to tax more with cash than with credit if he could have suppressed the credit technology.

By suppressing credit he was effectively forcing the use of cash. But by implementing a higher taxation rate on people holding no cash, he was effectively giving traders incentives to trade constantly in order to acquire cash and hence reduce the chance to pay the higher tax rate associated with having no cash.

We argue that this mechanism can go a long way towards explaining why money was introduced in antiquity when a ruler was in need of more taxes, for example because of war.

Toward a cashless society? On the origin of money and its desirability - Luis Araujo, Vincent Bignon, Regis Breton and Braz Camargo