How the law enabled traders to change “Bills of exchange” into money

“All goods must therefore be measured by some one thing … now this unit is in truth, demand, which holds all things together…but money has become by convention a sort of representative of demand; and this is why it has the name nomisma – because it exists not by nature, but by law (which in Greek was nomos) and it is in our power to change it and make it useless”

Aristotle

Tom Hickey is surprised about Simon Wren-Lewis, who, at his Mainly Macro blog, discovers the social nature of money.

Wren-Lewis states, when writing about “Money, the unauthorised biography‘ from Felix Martin:

“Some of this will be familiar, although what was new for me (but perhaps not to followers of Minsky or MMT) – and quite challenging – was the idea that this could all be traced back historically to a misconceived view of money itself. (According to Martin, the 17th century philosopher John Locke has a lot to answer for.) The threads developed from the historical account of the origins of money are numerous. For example money as credit is inevitably social, and so its value is bound to be politically determined. In a financial crisis, when the size of debts begin to encumber the economy, it is therefore quite logical and natural to adjust the value of money to redistribute between creditors and debtors”

Which makes Hickey rightly remark: 

“This is really quite fascinating. According to his CV, Professor Wren-Lewis “began his career as an economist in H.M.Treasury…. His current research focuses on the analysis of monetary and fiscal policy in small calibrated macromodels, and on equilibrium exchange rates…. In 2002 he wrote one of the background papers for the Treasury’s 2003 assessment of its five economic tests for joining EMU. He was also the principal external advisor to the Bank of England on the development of its current and previous core macroeconomic models. A long time advocate of Fiscal Councils, his 2007 proposal was influential in the formation of the UK‘s Office of Budget Responsibility.”

And he did not really understand the basics of money and credit? I don’t fault him for this. This entire institutional system, from education to government to finance and economics is blindsided.”

This might well be the occasion to put a  little more emphasis on ‘money as a creation of the law’ and the spontaneous development of money following changes of the law which redefined the social order. Fortunately, this can be outsourced to Veronica Aoki Santarosa, who shows that a legal change enabled Pieter to use a promise of Peter to pay Paul to pay Pjotr or Pedro as well: a debt was changed into money. Emphasis added

“The term Bill of Exchange (BofE) refers to a financial instrument whereby a merchant (the issuer) ordered his agent abroad (the payer) to make a payment in a different currency on his behalf to another merchant (the beneficiary), often in a third location, at a set date in the future. The beneficiary could further transfer his claim to another party, an endorser, in exchange for currency, debt or merchandise. My research shows that a seventeenth century legal innovation, the Joint Liability Rule (JLR), enabled the medieval BofE to develop into the dominant means of payment and credit in the early modern period. The JLR specieed that in case of default, all endorsers, in addition to the issuer and payer, could be held legally liable for reimbursement. Through the endorsement on the back of the bill, each successive endorser not only surrendered his financial claim to the bill but also acknowledged his full liability for reimbursement in the event of default. This paper shows that the powerful mechanism of Joint Liability permitted merchants to conduct a larger volume of trade through BofE than would have been possible otherwise. My findings uncovered an European-wide and anonymous market for bills of exchange that provided liquidity and credit to a local merchant house. Bills originated and were settled in a geographic area that extended all over Europe, north of Africa, Ottoman Empire up to Syria, and the Caribbean Islands. Despite evidence of ongoing problems of adverse selection and moral hazard, I showed that bills worked to broaden trade in the sense that agents used them across business networks. I identified groups of merchants who were in regular business relationships with Maison Roux. In many instances the issuer, the payer, and most of the endorsers of the bills did not belong to Maison Roux’s business network… This paper has broad implications for our understanding of the process of growth in which economies mature. By examining the virtues and limitations of the joint liability rule, this paper casts new focus on the role of law in shaping the development of financial markets and highlights an important step in the transition from reputation, personal-based exchanges to formal, law-based institutions.