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The classical Ricardian notion of neutral money, in terms of its impact on the real economy, has arguably exerted the strongest strategic influence on policy for 200 years, even though not all of the classical economists adhered to this (Harris 1981: 91). Since capitalist economies are monetary ones, and a complete theory of money’s function is inseparable from capitalist theory, the focus has been on real economy factors. Ricardo, in conjunction with Smith, Say and Mill et al., provided a clear conception of capitalism that consisted of private ownership of productive resources, capital accumulation, free markets and competition between firms for the pursuit of profit. Neutral money is added in order to make the markets work, and monetary authorities are expected to monitor its quantity to avoid inflation. These Ricardian monetary ideas are identified in the later work of thinkers such as Walras, Patinkin, Marshall, Wicksell, Fisher, Pigou and monetarists such as Friedman (Harris 1981, Chap. 6). In the twenty-first century, their influence remains, reflected in the prolific use of New Keynesian DSGE models in central banking that still assume that money is neutral in the long term but recognise frictions or hindrances to the establishment of the equilibrium in the short term (Tovar 2009).

The classical economists presented a capitalist economic system that possessed a harmonious equilibrium, which could only be achieved if the authorities avoid misguided intervention and market rigidities were removed. They claimed that the unfettered operation of markets would lead to the efficient allocation of scarce resources and economic development. It was assumed that the ‘trickle-down’ benefits would ensure that the spoils would later reach the marginalised. The Fable of the Bees story in the 1700s, by Bernard Mandeville, was often used as a capitalist apologetic suggesting that as bees (analogous to profit-seeking firms)

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pursued their own interest, they subsequently maximised the efficiency of the whole beehive (Mandeville 1997). The Classicals concluded that universal capitalism per se was the natural historic economic/social order that could not be improved upon.

In this context, money is seen as secondary, imperative for the functioning of capitalism but neutral, serving merely as a means of exchange and not able to instigate or radically alter the operation of economic activity or any real economic variables.53 Money is also defined by its function and is perceived as created by the authorities, either directly by state issue or indirectly through the legal sanction of privately produced currency. The thesis argues that this concept of neutrality serves the interests of capital, which prefers to view money resources as secondary to real production, where wealth is produced, since it diverts attention away from the accumulation and concentration of money resources that are a claim to the same wealth.54 These political considerations become even more important if monetary factors are instead seen as variables that determine outcomes, as a result of their instigative and fungible qualities. In this case, the entities that determine the money issue and purchasing power are then endowed with substantial social power that needs to be explored and understood. A consideration of such matters has been routinely ignored by mainstream economists, from the early classical thinkers to the more contemporary ones, who preferred to focus on the productive economy served by neutral money.

The foundation of these ideas of neutrality is the quantity theory of money (QTM), derived from Cantillon and Hume et al., which posits that when the money supply is increased ceteris paribus, the price level rises but relative price ratios are unaltered (Blaug 1995: 29). The Fisher or Cambridge equation of exchange identities used for the QTM both assume that money is issued exogenously i.e. determined by forces outside the model. They assume a stable velocity of circulation (that is not influenced by endogenous factors), that the volume of transactions is determined independently of the model, that causality runs from money supply to price (rather than the reverse) and that the problems of adjustment to equilibrium

53 _{Blaug notes that there is the notion of ‘super neutrality’, adhered to by some of the monetarist school, which}

claims the neutrality of money even under specific conditions of an increasing rate of growth of money supply. This was something that Hume (and Friedman in the 1960s) had not agreed with (Blaug 1995: 30).

54 _{In contrast, heterodox approaches to the role of money (see Chapter Four) illustrate that money is non-neutral}

(see 1.4) and affects a range of economic outcomes. This is consistent with the modern financialisation (see 1.1) literature ideas e.g. Palley (Palley 2007).

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are small i.e. the frictions/imperfections that hinder equilibrating forces (Blaug 1995).55 _The early QTM, in Hume’s conception, had involved ‘fictitious-value’ money, in the sense that money merely represented labour and commodities in the sphere of exchange. In the aggregate, Hume posited that the value of money would be equal to the inverse of the price level. His assumption here, contrary to Locke, is that money is only utilised for the circulation of commodities as a means of exchange and does not represent a claim to accumulated wealth or be subject to hoarding. Hume had discussed the ‘international level’ of specie money whereby money seeks the ‘same level’, like water, between countries (Itoh 1999: 8). If the source of specie for one state increases then monetary metal flows out of the country, since domestic commodity prices have risen, and a balance of payments deficit ensues until the ‘level’ is found again. Hume had a transmission mechanism to illustrate how this worked in the short term. Extra money puts more people in work and boosts production but, in time, the temporary boost is reversed as output returns to its previous level with higher prices. So, for Hume, and later for Ricardo, money is a veil on real economic activity representing neutrality in the longer term. In terms of the creation of money (he did not distinguish between different money forms) it is implicit in Hume’s work that the state should monitor the quantity of money in order to avoid inflation but that the fresh money- issue derives from the mining of precious metals (Itoh 1999). In this sense Hume, like many mainstream thinkers since, had assumed that the control of the money issuance per se was of secondary (political) importance and that the regulatory role of the state should be focussed on the standardisation of the money form, and its overall supply, in order to facilitate a smooth running of the productive economy and the mitigation of inflation.

The emerging classical political economy of the late eighteenth century was in direct contrast to the mercantilists, who had considered that the primary economic aim of the state was to intervene in order to facilitate an international trading surplus. Mercantilists hoped to ensure an influx of specie, which was considered commensurate with wealth. Ironically, since the current account surplus of one nation is matched by a corresponding deficit elsewhere the mercantilist policies could not be successful for all. The classical school, in contrast, held that minimal state intervention in the form of free trade relations allowed international markets to operate more effectively, leading to efficiencies and increased output for all trading partners.

55 _{Irving Fisher’s identity was MV=PT (where M = money supply, V = velocity of circulation, P = price level}

and T = number of transactions) whereas the Cambridge version Ms_{=Kpy, where K is the inverse of the velocity}

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The two opposing views have clear policy consequences for the state monetary authorities. The mercantilists envisaged a proactive state that sought to galvanise its ‘monopoly of force’ (see 1.2 and 7.5) by trade protectionism in order to safeguard (and increase) specie reserves, whilst classicals advocated removing the state regulation of international trade on the premise that private capital and market forces would deliver greater output for all trading nations.56 Given that more influence over specie flows (see 2.4) implied greater control of the levels of specie reserves in the private banks (and state coffers), this gave the state greater control over credit, the means of circulation and the purchasing power of money i.e. more financial power. The classicals had established the principle that national wealth, comprised mainly of commodities, did not reside in trade surpluses but in the labourcontent of produce (the labour theory of value) since labour was the real cost of production. This was in contrast to the mercantilists, who had held that value (in the form of price), was determined by demand and supply in the sphere of exchange. The neoclassical/neoliberal schools, whilst upholding the belief in free markets, have rejected labour value theory in favour of utility theory. Hence value is established in the market, which is closer to the ideas of the mercantilists.57 The utility theory of value is predicated on the subjective notion of perceived satisfaction derived from goods, usually called use-value. These subjective values determine demand that, in conjunction with supply, form the prices. To appreciate the role of money per se in the productive economy, and the importance of financial power (as defined), it is important to define the concept of value clearly, since money is the claim to (and the practical depository of) value in the capitalist economies and is the representation of value. In 3.6 and 3.7, the research outlines how this utility theory forms part of the orthodox notion of general equilibrium. In 5.4, how Marx developed the classical notion of the labour theory of value is outlined whilst still recognising the role of market prices driven by the vagaries of supply/demand. It is this latter concept of value, defined by Marx, which forms the theoretical basis for the thesis: value represents labour.

In the real economy, the classicals had maintained that free markets would be beneficial and stable and this was extended to the operation of money and credit, although two separate classical traditions emerged. The currency school, supported by Ricardo (also Torrens and Overstone), was based on the idea that stability would exist between real output and total

56 _{These ideas were best formulated by Ricardo’s theory of comparative advantage (Ricardo [1821] 1962).} 57 _{In terms of price theory, modern Marxian analysis is the closest to the classical school today.}

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(commodity or convertible) money, providing that there was no state (or other) interference with the operation of commodity markets. The currency school maintained that an over-issue of credit (in relation to its metal base) would always result in inflation, even if full convertibility existed. An excess of paper would lead to depreciating value, in relation to specie, leading to falling exchange rates and an outflow of gold.58 This led to their support for the English Bank Act 1844 that sought inter alia to restrict credit. This quantity theory of money policy had contemporary monetarist adherents, most notably in the Reagan/Thatcher administrations, and has influenced the mainstream view. The currency school implied that there needed to be a proactive role for the state in controlling the overall quantity of money created and the maintainenance of its purchasing power i.e. the existence and exercise of financial power, but with minimal interference in the general economy. The first quantity theories had been based on commodity money (e.g. Hume) that tends to be endogenously created (from specie sources), and it is perhaps irrelevant to consider policies of quantity control in these circumstances since this implies the state capacity to control the money-issue (Blaug 1995: 31).59 Prior to the 1844 Act, banknotes could be advanced as credit endogenously, since banks practised fractional reserve banking, making it more difficult for the monetary authorities. After the 1844 Act, the BOE became sole issuer of banknotes, with the aim to create a 100% backing to the currency. This proved to be difficult in practice since bank deposits could be created by private bank advances and used as payment via cheque clearing systems.60

The banking school (or anti-quantity theorists) e.g. Fullarton and Thomas Tooke, in contrast, had maintained that stability exists between real output and credit money, provided that the credit was extended for productive investment and not speculation, and thus they were not particularly concerned with over-issue.61 In order to sustain this position the banking school had to emphasise specie hoarding and the paying functions of commodity money, that

58 _{To the currency school, these exchange rate movements were clear evidence of the ‘over-issue’. This led to}

the so-called currency ‘criterion principle’ of Robert Torrens who stated that the only acceptable quantity of banknotes was the amount that facilitated current account (trade) balance. The so-called ‘Palmer’ rule was adopted where the Bank of England had to maintain gold reserves of a third of all banknotes (Itoh 1999: 26).

59 _{It is recognised (see 2.4), that the state has (at times) exercised significant influence over the quantity of}

precious metals in circulation.

60 _{Cheques and clearing (as noted in 2.4) were now established in the capitalist banking systems.}

61 _{Tooke had famously identified that low interest rates do not necessarily lead to more speculative activity and}

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implied that money was non-neutral and functioned as an effective store of value.62 _They asserted that productive capitalists in possession of commodity monies would be more inclined to hoard surpluses rather than spend, and that the necessity of payment for commodities and investment goods promotes (perhaps permanent) economic activity that would otherwise not occur rather than necessarily fuelling inflation. Monies could be extended or withdrawn from hoards, thus responding to the needs of circulation. Rather than the quantity of money determining the price level they claimed that the causality worked the other way. Raised prices led to more money in circulation, drawn from hoards or form an increased velocity of circulation. The school had distinguished between fiat money and credit money, positing that fiat money could be issued to excess, and remains in circulation, whereas credit monies would be subject to the law of reflux whereby credit contracts are cancelled through repayment. The banking school thus identified the properties of different money forms and functions and these ideas have tended to influence the more heterodox views of money as a consequence. The currency school and the QTM serve, in contrast, as antecedents of the mainstream monetary view that has pervaded much of the policy space since the industrial capitalist age.