Turning to the “nature” and “origins” of money, institutionalists reject the orthodox notion that money is essentially a commodity that functions primarily as a medium of exchange, invented to reduce transactions costs. Institutionalists and other heterodox economists insist that money is “social” in its nature. As Ingham puts it “money necessarily consists in social relations between economic agents and between them and a monetary ‘authority’….” (Ingham 2000, p. 19) Or, as Neale argues: “all monies are parts of larger systems of economic and social relationships.” (Neale 1976, p. 4). Further, Neale warns that “Despite the fact that many a text on money says that money originated in the inconvencies of barter, that money was invented as a medium of exchange….neither historical evidence nor argument by analogy from contemporary nonliterate societies lends support to this speculative history.” (Neale 1976, pp. 8-9) Admittedly, any story of the origins of money is necessarily speculative for two reasons. First, we must decide what “social relation” from the past qualifies as something we are willing to label “money”. Neale argues that it is best to think of “monies” rather than “money” because those social relations vary widely by society. He emphasizes that in most precapitalist societies the range of social relations associated with use of a "special purpose money". For example, we would now likely include medium of exchange, unit of account, means of debt settlement, and store of value as functions that are served today by general purpose money. However, in previous societies (and in nonliterate societies today) there have been "special purpose monies" that served only one or two of these functions but not the others. The second problem is that it is possible and even likely that the origins of money lie in a very distant past for which we have no easily interpretable records; indeed, many believe that money predates writing. (It has long been believed that writing was invented to keep track of nominal debts, although the history of writing is probably as complex as the history of money. See Schmandt-Besserat 1989.) hence we will probably never have a completely satisfying story of the origins of money.
Still, it is tempting to speculate on money's origins. There are three plausible alternatives to the orthodox story. Heinsohn and Steiger (1983) argue that money developed not out of a barter economy but when private property and loans developed. Following Keynes, they emphasize that early monetary units were based on a specific number of grains of what or barley. (Keynes 1982, pp. 233-36) Later, metals (such as iron, copper, silver, or gold) were used as money, with the value denominated in those grain units of measurement. According to their argument, the first money was created when private property (so many units of grain) was loaned with the expectation of payment of a great sum of grain in the future. Eventually, grains of wheat or barley would be used as a universal equivalent to measure value of all types of alienable private property to reduce transactions costs, acting as a unit of account in all creditor-debtor relations. Gradually, representative money, in the form of metal but still denominated in these grain weight units, could be loaned, used as a medium of exchange, and used to settle debts. Hence, Heinsohn and Steiger focus on money as a unit of account developed in these early loan agreements, and the "thing" used as money is important primarily because it represents the loan agreement that is denominated in the unit of account.
A second approach has been advanced by Hudson (2001), who has developed an alternative thesis for the origins of money of account in Babylonia. He argues that money originated within the temple and palace communities for internal accounting purposes. Like Heinsohn and Steiger, his story also emphasizes the importance of loans, however, he argues that early loans were made by the temple and palace communities to the "external" sector. Thus, rather than focusing on private property and loans between individuals that gradually become standardized in a grain unit of account, Hudson believes the unit of account was created within the early bureaucracies. Clearly, his argument focuses more on the social nature of the origins of money and hence is probably more appealing to institutionalists.
A third approach has been developed by the great numismatist, Grierson, and elaborated in Goodhart (1989, 1998) and Wray (1998). According to this view, money evolved out of the pre-civilized practice of wergeld; or to put it more simply, money originated not from a pre-money market system but rather from the penal system. (Grierson 1977, 1979; Goodhart 1998) An elaborate system of fines for transgressions was developed in tribal society. Over time, authorities transformed this system of pines paid to victims for crimes to a system that generated a variety of payments to the state. (Innes 1932) Until recently, fines made up a large part of the revenues of all states. (Maddox 1769) Gradually, fees and taxes as well as rents and interest were added to the list of payments that had to be made to authority. To be clear, this authority should be seen as a gradually evolving institution - from early temples to palace communities to feudal kings and finally to democratically elected representative governments - with varying degrees of sovereign power. All that was required was some sort of authority able to levy obligations on a population - anything from fines or tithes to fees and taxes. While wergeld payments did not require a unit of account (the fines were assessed in the form of particular items or services to be delivered to victims), payments to the authority were gradually standardized, measured in a money of account.
This approach has been called the "Chartalist" or "taxes-drive-money" approach. It is also closely related to Knapp's "state money" approach. Briefly, this view emphasizes the important role played by "government" in the origins and evolution of money. More specifically, it is believed that the state (or any other authority able to impose an obligation - whether that authority is autocratic, democratic, or divine) imposes an obligation in the form of a generalized, social unit of account - a money - used for measuring the obligation. The next important step consists of movement from a specific obligation - say, an hour of labor or a spring lamb that must be delivered - to a generalized, money, obligation. This does not require the pre-existence of markets, and, indeed, almost certainly predates them. Once the authorities can levy such an obligation, they can then name exactly what can be delivered to fulfill this obligation. They do this by denominating those things that can be delivered, in other words, by pricing them. To do this, they must first "define" or "name" the unit of account. This resolves the conundrum faced by methodological individualists and emphasizes the social nature of money and markets.
Note that the state can choose anything it likes to function as the "money thing" denominated in the money of account, and, as Knapp emphasized, can change "the thing" any time it likes: "Validity by proclamation is not bound to any material" and the material can be changed to any other so long as the state announces a convertion rate (say, so many grains of gold for so many ounces of silver). (Knapp 1924, p. 30) What Knapp called the State money stage begins when the state chooses the unit of account and names the thing that it accepts in payment of obligations to itself - at the nominal value it assigns to the thing. The final step occurs when the state actually issues the money-thing it accepts. In (almost) all modern developed nations, the state accepts the currency issued by the treasury (in the US, coins), plus notes issued by the central bank (Federal Reserves notes - green paper - in the US), plus bank reserves (again, liabilities of the central bank) - that is, the monetary base or high powered money (HPM). The material from which the money thing issued by the state is produced is not important (whether it is a gold coin, a bse metal coin, paper notes, or even numbers on a computer tape at the central bank). No matter what it is made of, the state must announce the nominal value of the money thing it has issued (that is to say, the value at which the money-thing is accepted in meeting obligations to the state).
Manually copied by myself letter with letter from this paper by Randall Wray: