If you’re a student of economics, you probably know what money is and why it’s useful. Money is a medium of exchange – it’s the good we use to buy all other goods. And it’s useful because it’s fungible – it can easily be used for multiple purposes, which helps us evaluate tradeoffs between various lines of production and consumption.

But where does money come from? Why does it exist? There are two main schools of thought here.

The first school of thought, held by most economists and derived from Carl Menger’s classic article “The Origins of Money”, is that money is an emergent outcome of a series of exchanges. In any community where goods are exchanged, we would expect some individuals to specialize in producing goods that are relatively more saleable than others, i.e., those that are easier to exchange for what they finally want to consume.

Saleability can be understood by looking at goods that are not very saleable. Consider a cattle rancher. The rancher knows a cow is costly to raise and keep, hard to transport, and almost impossible to divide into smaller units without destroying the value of the cow.

This makes a cow hard to exchange. It’s not very saleable. So the rancher who wants to consume, say, cucumbers will probably not trade his cow directly for cucumbers; he instead will trade his cow for any good he feels will enable him more easily to exchange for cucumbers. In other words, he engages in indirect exchange for a more saleable good, to better acquire cucumbers.

As everyone in an economy thinks this way, some goods come to be in greater demand because they are more readily exchanged for other goods. The end result of this snowballing effect is money — one or a few goods that everyone accepts in exchange for other goods.

Most economists hold that money is an emergent outcome of a series of exchanges.

The other school, sometimes called the chartalist school, holds that the state (or rather, political power) is the essential feature that gives rise to money. Here’s how it works: a band of warlords conquers a territory. They impose tribute on the population, which has to be paid in some specific good.

That good, whatever it is, becomes more valuable to the native population; where before it only had the value it could confer in consumption or exchange, now it has additional value because it can discharge obligations to the warlords. The act of imposing tribute in a specific good can cause that good to rise in exchange value, and this is how a good can become generally accepted in exchange.

The chartalist school holds that the state is the essential feature that gives rise to money.

In defense of their argument, the chartalists point to the historical record of ancient societies, where we do see their proposed mechanism at work. Strong groups frequently conquered weak groups and forced them to pay tribute or some other form of tax. That good in many cases had use as a rudimentary medium of exchange. So it seems the coercive process of debt imposition, rather than the voluntary process of market cooperation, explains the origins of money.

Not so fast. The chartalists, while often doing very good history, drop the ball when they try to generalize from their observations to social scientific explanations. At the end of the day, while we must recognize the validity of much chartalist history, we can still safely embrace Mengerian theory.

Check out part 2 of this series on money to see why!

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