How credit money came about according to Credit Theory

How could credit money come about? Let us return to the economics professors’ imaginary town.

Say, for example, that Joshua were to give his shoes to Henry, and, rather than Henry owing him a favor, Henry promises him something of equivalent value. Henry gives Joshua an IOU. Joshua could wait for Henry to have something useful and then redeem it. In that case Henry would rip up the IOU and the story would be over. But say Joshua were to pass the IOU on to a third party—Sheila—to whom he owes something else. He could tick it off against his debt to a fourth party, Lola—now Henry will owe that amount to her. Hence, money is born, because there’s no logical end to it. Say Sheila now wishes to acquire a pair of shoes from Edith; she can just hand Edith the IOU and assure her that Henry is good for it.

In principle, there’s no reason that the IOU could not continue circulating around town for years—provided people continue to have faith in Henry. In fact, if it goes on long enough, people might forget about the issuer entirely.

What credit theorists like Mitchell-Innes were arguing is that even if Henry gave Joshua a gold coin instead of a piece of paper, the situation would be essentially the same. A gold coin is a promise to pay something else of equivalent value to a gold coin. After all, a gold coin is not actually useful in itself.

One only accepts it because one assumes other people will. In this sense, the value of a unit of currency is not the measure of the value of an object, but the measure of one’s trust in other human beings.