by Felix Martin
In his Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith formulated the first systematic theory linking individual behaviour with the organisation of the economy, and presented the first cogent synthesis of earlier thinkers’ ideas of how the financial revolution had transformed traditional society. The growth of commerce and money, he argued, had “generally introduced order and good government, and with them, the liberty and security of individuals.”30 It was Smith who recognised the historical irony in the accumulation and paying-out of this political dividend. The feudal lords who had been the prime beneficiaries of traditional society had been bewitched by the magic of money. Their love of luxury had made them encourage the monetisation of their feudal rents: “thus, for the gratification of the most childish, the meanest and the most sordid of all vanities, they gradually bartered their whole power and authority.”31
Smith’s metaphor for Mandeville’s paradoxical process—the “invisible hand” which ensures that “by pursuing his own interest [the individual] frequently promotes that of the society more effectually than when he really intends to promote it”—is so famous that it has long ago taken on a life of its own.32 Smith also emphasised that this pleasing outcome is a feature not so much of the individual’s decisions, as of the system itself: the individual “generally, indeed, neither intends to promote the publick interest, nor knows how much he is promoting it.”33 Smith articulated a vision of society in which economic value had become the measure of all things, and static traditional social relations were being replaced by dynamic monetary ones. It was a vision of monetary society as an objective system which would tend towards an equilibrium that was both economic and political. For once traditional society had been thrown over, once “the tenants in this manner [were] independent, and the retainers dismissed … a regular government was established in the country as well as the city, nobody having sufficient power to disturb its operations in the one any more than in the other.”34 Smith had achieved something unprecedented in the history of monetary thought: a thoroughgoing justification of monetary society in both economic and political terms.
It was an historic accommodation on the intellectual and moral planes to match the Great Monetary Settlement on the practical level. The founders of the Bank of England believed that their marriage of private banking and sovereign money had unleashed the greatest force for economic and social progress in history. The economists had now proved that they were right. And the father of political Liberalism himself had decreed that—so long as one kept to the correct understanding of money, and did not stray from the immutable, natural standard of economic value that it entailed—it was all perfectly consistent with the new gospel of constitutional government. Money had achieved its apotheosis.
There was, however, a problem.
9 Money Through the Looking-Glass
THE ACHILLES’ HEEL OF MONETARY SOCIETY
That problem was debt—and specifically, its tendency to accumulate to unsustainable levels. Today, we are only too aware of the vulnerability of monetary society to what is euphemistically known as “financial instability.” But the global financial crisis that began in 2007 is just the last of a long list within recent memory—from international sovereign debt crises like the Argentinian default of 2002 and the Russian default of 1998, to domestic financial crises such as the collapse of the boom in U.S. technology stocks in March 2000, the U.S. Savings and Loans crisis of the early 1990s, or the October 1987 stock-market crash in the U.K. But the unusual persistence of the current crisis has provoked a deeper interest amongst economists in the longer-term incidence of debt crises. Readers rushed to consult the great financial historian, Charles Kindleberger.1 To learn of his discovery that “financial crises have tended to appear at roughly ten-year intervals for the last 400 years or so” was either disturbing or comforting, depending on one’s perspective.2 Within a couple of years, however, the economists Carmen Reinhart and Kenneth Rogoff had published an even more comprehensive investigation into the history of financial crises. Its ominous subtitle warned the reader to expect not just four but “Eight Centuries of Financial Folly.”3 And as Tactitus’ account of the credit crunch under the Emperor Tiberius shows, monetary society has been prone to the problem of growing indebtedness ending in a crisis of solvency for much longer even than that.
The reason is that this instability is intrinsic to money’s miraculous promise to combine security and freedom. The distinctive claim of money was that it could combine social stability and social mobility in a way that traditional society, with its immutable social structure, never could. It was this promise that made it so revolutionary and so irresistible an invention. And to be sure, the spread of money proved again and again to be extraordinarily effective at licensing ambition and innovation where previously society and the economy had been hidebound by tradition. Money had indeed been the agent of vigorous and pervasive social change on an undreamt-of scale—to say nothing of the political revolution that its chief accomplice, banking, had fomented. Not without reason did two well-known sceptics of its benefits, Karl Marx and Friedrich Engels, complain of the highly developed monetary society of the mid-nineteenth century that “[a]ll fixed, fast-frozen relations, with their train of ancient and venerable prejudices and opinions, are swept away, all new-formed ones become antiquated before they can ossify. All that is solid melts into air, all that is holy is profaned.”4
The trouble was that it had never been quite as simple as the sceptics claimed. Social fluidity was only one half of the bargain. The other half was the paradoxical promise of continued stability. Monetary society did not promise anarchy—that would never have caught on. Instead it promised a rule for anarchy: both mobility and stability, both freedom and certainty. And the feature of money that delivered this second part of its promise was the fundamental axiom of the fixed nominal value of credit and debt. Wherever social obligations were destroyed, financial obligations—debts—were heaped up in their place. And the whole point of debts was that unlike the obsolete social obligations they had just replaced they were not going to be “swept away.” Smith and his school had constructed a theory that purported to show how both parts of money’s promise could hold—how objective laws governing monetary society would so choreograph things that the fixed financial obligations would not themselves fall foul of money’s indefatigable promotion of social change. But the reality of monetary society is—and has always been—strikingly at odds with this idea.
This failure of the economists’ new framework to engage with the central problem of monetary society was not just a cosmetic shortcoming. As we have rediscovered in the aftermath of the global financial crisis, the unsustainable accumulation of debt can present not just incidental, but existential, challenges to monetary society. Money’s intrinsic tendency to generate instability, in other words, is a danger not only to the victims of crashes and recessions—but ultimately to money itself. When a financial crisis results in half the youth population being out of work, or in civil servants facing the sack to free up funds to pay foreign bondholders, then conventional remedies available within the current economic system can begin to look unappealing. Central bankers and finance ministers work on the assumption that monetary society itself works fine. Its rules must be respected, they counsel, and any injustices that result should be remedied by more progressive taxation or transfusions from wealthy benefactors abroad. But the mood of those at the sharp end of the debt crisis is less business-as-usual. Why respect the rules of the system, ask the Occupy protestors in New York and the indignados in Madrid, if the system consistently generates crises?
The idea that, left unchecked, monetary society’s tendency to generate unsustainable debt burdens is its own worst enemy is not new. In June 1919, John Maynard Keynes resigned from the British delegation to the Versailles peace negotiations. The Allied powers, hell-bent on extracting massive recompense from the defeated Germans, had imposed grievous reparations payments on them. Only
thus, they had argued, would the lessons of aggression be learned and future peace assured. Keynes realised that Germany’s new financial obligations were unrealistic, however—and that attempting to enforce them would end in disaster. In The Economic Consequences of the Peace—the sensational exposé of the negotiations that he published in December 1919—he implored the Allies to find a way to reduce the debts they had rashly imposed. His plea was refused as dangerous nonsense: an immature attempt to play fast and loose with the rules of international finance that were the most basic guarantors of stability and peace. But his prognosis proved sound. Unable to revive its crippled economy or to extract sufficient revenues as a result, and racked by civil strife, Germany drifted towards total economic collapse—including the most extreme hyperinflation ever recorded. In 1923, the default that Keynes had publicly predicted arrived, and the Allies were forced to rewrite the reparations settlement.
By then, Keynes was ready with a piercing analysis of the more general lessons of this policy error. The spectre of Versailles haunted his Tract on Monetary Reform, published that year. It is not just craven politicians at peace negotiations who create unsustainable debts, he wrote—the problem is intrinsic to monetary society: “The powers of uninterrupted usury are great. If the accretions of vested interest were to grow without mitigation for many generations, half the population would be no better than slaves to the other half.”5 So those who set up respect for contract as an idol while forgetting the higher law that all financial contracts must be fair to be sustainable—the victors at Versailles, the followers of Locke—will ultimately be the authors of their own frustration. “[S]uch persons,” wrote Keynes, “by overlooking one of the greatest of all social principles, namely the fundamental distinction between the right of the individual to repudiate contract and the right of the State to control vested interest, are the worst enemies of what they seek to preserve. For nothing can preserve the integrity of contract between individuals except a discretionary authority in the State to revise what has become intolerable.”6 Locke’s monetary doctrines lead, in other words, to a profound irony. Not only is respect for contract alone insufficient for the survival and prosperity of monetary society, but “[t]he absolutists of contract … are the real parents of revolution.”7
Keynes was right. The true nature both of debt crises and of the ways that they can be resolved reveals a fundamental flaw in the reasoning of Smith and his school. Money promises to organise society in a manner that combines freedom and stability. This it will achieve first by transforming social obligations—traditional rights and duties that are fundamentally incommensurable with one another—into financial obligations—assets and liabilities all measured in the same units of abstract economic value; and then by making these financial obligations liquid—allowing them to be transferred from one person to another. The trouble is that the world is an uncertain place. Liquidity evaporates, solvency is reassessed: the network of indebtedness that a moment ago was sustainable is suddenly not. The network must adapt—but there’s the rub. Money has created interests vested in the network as it stands. What happens next is the key question; one to which Smith and his school offered no answer.
How was it that the new discipline of economics managed to miss the problem of debt and the financial instability it causes? Why did it not notify the grateful new inhabitants of the ideal city of these flaws in its foundations? Given subsequent financial history, it was a rather dramatic oversight. One obvious answer has enjoyed much popularity through the ages: that monetary thought, and indeed economics more broadly, is simply a corrupt discipline. On this view, Nicolas Oresme set the tone: orthodox economists are in the pay of vested interests, and their allegedly objective theories are little more than special pleading for the moneyed classes. The title of U.S. director Charles Ferguson’s Oscar-winning documentary on the role of economics in the global financial crisis sums it up. Modern finance theorists, Ferguson’s film argues, were not the impartial scientists they made themselves out to be. They were just cheerleaders for the banking lobby, handsomely remunerated to produce an elaborate intellectual justification for an immoral commercial enterprise. The debt crisis was an Inside Job.
But there is another possibility—one which is, in the end, even more alarming. What if the real reason for the chronic failure of economics to engage with the reality of monetary society is not due to vested interests? What if it is the consequence of a mistake on the level of ideas? What if, in other words, no warning of the structural failings of monetary society was ever issued because the theorists honestly believed that there were no problems to report? The real culprit for the gargantuan blind spot in the theory of Smith and his school is not a set of vested interests, but an idea—none other than the conventional understanding of money promulgated by John Locke.
MONEY THROUGH THE LOOKING-GLASS
The problem was that John Locke’s well-intentioned effort to make money safe for constitutional government came with a significant hidden cost. As the great recoinage debate had revealed, Locke’s understanding of money represented a complete reversal of perspective from the vantage point occupied by Lowndes and his practitioner friends. It was obvious to them that the pound was just an arbitrary standard of economic value. It had lost value against silver—there had been inflation, and the price of silver had risen. The coinage had lost its silver content because the pound had lost value. Locke, by contrast, thought this was getting it completely the wrong way round. A pound was nothing but a definite weight of silver bullion. The pound had lost value because the coinage had lost its silver. The old understanding had been that money is credit, and coinage is just a physical representation of that credit. The new understanding was that money is coinage, and that credit is just a representation of that coinage. Lowndes and his ilk had believed that the Earth went round the Sun. Locke had explained that the Sun in fact revolves around the Earth.
The consequences of looking at the universe from standing on the Sun turned out to be dramatic. It was as if money had gone, with Alice, Through the Looking-Glass, to a world in which what had for centuries been the central dilemmas of money were now nowhere to be seen. To begin with, there was the question of what was the appropriate scope of monetary society, and how extensive a role its central concept of economic value should play in co-ordinating social life. This was a dilemma, as we saw, that had troubled philosophers since the time of money’s invention by the Greeks. In the Looking-Glass world of the conventional understanding of money, however, things are different. Economic value is just a property of the natural world, like length, or weight, or volume. One might just as well complain that it is unethical to measure the distance between Pyongyang and Seoul as start asking whether it’s right to put a price on human life.
Through the Looking-Glass: where the conventional view of money leads …
(illustration credit 9.1)
Then there was the question of the monetary standard. For centuries, this had been the subject of the most heated political contention. It was the fulcrum on which the scales weighing the competing claims of the sovereign and his subjects were balanced, and where that fulcrum should sit was one of the quintessential questions of political justice. In the Looking-Glass world of Locke, however, money was a thing, value was a natural property, and the monetary standard was therefore an objective fact. The fulcrum of the scales had to be fixed—otherwise, how could it generate consistent measurements? In the old world, respect for contract and for the monetary standard had been understood to be operational principles; but the morality of breaching contract or the monetary standard by debt restructuring, devaluation, or inflation was understood to be a quintessentially political question. In the Looking-Glass world of Locke’s understanding of money, however, respect for contract and for the monetary standard became a matter not of fairness, but of accuracy.
The truth, of course, is that this Looking-Glass world—like the one that Alice visited—is just a dream. Far from being a natural
property of the physical world, there was a time, as we have seen, when the concept of economic value simply didn’t exist—because money had not yet been invented. And far from there being any objectively true standard against which economic value must necessarily be measured, the choice of monetary standard is always a political one—because the standard itself represents nothing but a decision as to what is a fair distribution of wealth, income, and the risks of economic uncertainty. As a result, the triumph of Locke’s understanding of money led not to a new age of objectivity in economic affairs but, perversely, to just the opposite. It opened the way to the dominance of particular, quite arbitrary, prejudices—and even worse, it covered their tracks with a veil of apparent scientific objectivity.
For the new understanding did not mean that there was no ethical debate to be had about money; not a bit of it. It was just that the ethics of money now meant something completely different. The old dilemmas disappeared from view. If money was a thing and value a physical property, to discuss either in ethical terms no longer even made sense: to call the monetary standard unjust made about as much sense as calling the weather unfair. But in their place, the Liberal shibboleths of the free pursuit of self-interest and respect for contract became the overriding focus of moralising attention. Morality in monetary society now meant whether or not you submitted unquestioningly to the philosophy of laissez-faire, and whether or not you paid your debts. Money’s commandments, like those of the law, had to be obeyed: it was disobedience that constituted unethical behaviour. Perhaps Through the Looking-Glass is too light-hearted a literary analogy. Perhaps it would be fairer to say that money had been transported to the Prague of Franz Kafka’s The Trial, or the Paris of Anatole France’s The Red Lily, in which the cynic Choulette applauds “[t]he majestic equality of the laws, which forbid the rich and the poor alike to sleep under the bridges, to beg in the streets, and to steal their bread.”8