It has been well said by others that so-called “Modern Monetary Theory (MMT)”—similar to the Holy Roman Empire—is not modern, not monetary, and not a theory. Interestingly, Mises made this argument in The Theory of Money and Credit (1912) and actually used the terminology “modern monetary theory.” Mises cogently argues that the state theory of money—especially represented by his contemporary, G.F. Knapp—essentially abandons the economic problems involved in monetary theory.
The Methodenstreit Context: Causal-Realism versus the German Historical School
To appreciate Mises’s critique, we also have to know something about the intellectual context in which Mises and Knapp argued. This has been called the Methodenstreit—the struggle over proper social scientific methodology. On one side was the German Historical School, which according to Mises’s description, “works with induction only, makes the erroneous assumption that this is the road that usually leads the natural sciences to their findings.” On the other hand, the causal-realist philosophy regarding the science of economics, represented by Menger, argued, “History and the statistics of economy are historical sciences... economics is a theoretical science.” In other words, given the nature of studying acting, choosing humans in a changing world, the methods of the natural sciences are inappropriate and a sound and realistic theory is required for economics.
German Historicism sought to develop social scientific theory through generalizations derived from empirical observations of specific, non-repeatable historical phenomena. There were also similar sister philosophies—sharing similar presuppositions—that either already existed or would continue to grow during this era. These were empiricism and logical positivism. Unlike the German Historical School, the empiricists, and the later logical positivists, Menger perceptively recognized the self-defeating and absurd nature of claims to determine economic theory by empirical observations. In his own words, “Testing the exact theory of economy by the full empirical method is simply a methodological absurdity, a failure to recognize the bases and presuppositions of exact research.” Further, “To want to test the pure theory of economy by experience in its full reality is a process analogous to that of the mathematician who wants to correct the principles of geometry by measuring real objects....”
Menger highlighted the key distinctions between the natural sciences (e.g., physics, biology, chemistry, etc.) and the social sciences. Interestingly, Menger also identified that even empirical sciences necessarily have core non-empirical presuppositions. In other words, the notion that one can purely develop an empirical theory without presuppositions, only from historical empirical evidence, already presupposes the validity of a non-empirical theory. (The validity of the theory of empiricism rests on the non-empirical assumption that empiricism is valid). This means that such methods are self-defeating.
Relevant to the subject at hand, Mises argues that the state theory of money naturally emerged from the German Historical School’s commitments to historical empiricism as an economic theory,
An acatallactic monetary theory is a logical necessity for the empirico-realistic trend in Economics. Since this school, unfavourable to all ‘theory’, refrains from propounding any system of catallactics, it is bound to oppose any monetary doctrine that leads to such a system. So at first it avoided any treatment of the problem of money whatever; so far as it did touch upon this problem (and in its often admirable work on the history of coinage and in its attitude towards political questions), it retained the traditional Classical theory of value…. To a school that has inscribed the device of etatism [statism] on its banner, and to which all economic problems appear as questions of administration. Knapp completed this connexion. Hence the success of his book in Germany.
Mises further described why the “etatist” (statist) school led to the state theory of money,
But the etatist school is responsible for the facility and rapidity with which the State Theory of money succeeded in becoming the accepted doctrine in Germany, Austria, and Russia. This school had struck out catallactics, the theory of exchange and prices, as superfluous from the series of problems with which Economics was concerned; it undertook the attempt to represent all the phenomena of social life merely as emanations of the exercise of power by princes and others in authority. It is only a logical extension of its doctrine to endeavour eventually to represent money also being created merely by force. The younger generation of etatists had so little notion even of what economics really was concerned with, that it was able to accept Knapp’s paltry discussion as a theory of money.
Catallactics: A Theory of Value, Exchange, and Prices
Mises criticized the state theory of money, represented by Knapp, as acatallactic. In an early footnote in Human Action, Mises wrote, “The term Catallactics or the Science of Exchanges was first used by Whately. Cf. his book Introductory Lectures on Political Economy (London, 1831), p. 6.” Catallactics is the science of market exchanges, prices, and voluntary interactions, and the economic question is how money can be integrated into that theory. In fact, a key goal of The Theory of Money and Credit was to integrate money—with its unique difficulties and challenges—into a theory of human action and exchange.
With that established, we can now more fully appreciate Mises’s critique of the state theory of money as acatallactic. Mises wrote,
Another acatallactic doctrine seeks to explain the value of money by the command of the State. According to this theory, the value of money rests on the authority of the highest civil power, not on the estimation of commerce. The law commands, the subject obeys. This doctrine can in no way be fitted into a theory of exchange; for apparently it would have a meaning only if the State fixed the actual level of the money prices of all economic goods and services as by means of general price-regulation. Since this cannot be asserted to be the case, the State Theory of money is obliged to limit itself to the thesis that the state command established only the Geltung [validity, worth] or validity of the money in nominal units in commerce. But this limitation amounts to the abandonment of the attempt to explain the problem of money.
What point is Mises making here? Mises’s point is that the state theory of money either claims too much (that the state determines all market prices in terms of the money it originates) or retreats to claiming too little (that it merely names money), and, in doing so, fails to explain money’s actual value at all. The state theory of money is acatallactic because it does not explain the value of money through integrating it into a theory of exchange and prices.
The state theory attempts to circumvent this by arguing that money received its value by the decree of the state. But, for that fiat-token to have value as money in voluntary market exchanges, that would mean that the state would have had to also coercively determine all price ratios for non-money goods and services. Without this, there would be no way to determine all the exchange rates between money and goods, and thus no meaningful economic calculation, and no way to guarantee acceptance of that fiat-token in market exchanges.
Since no one can claim that—alongside issuance of a fiat-token by the state as the origin of money—the state did not simultaneously declare price ratios between the token and other goods and services, then the state theory of money must retreat to the claim that the money is imposed and valued because of tax acceptance and legal tender laws. Taxes may drive demand for a token, but they do not explain its purchasing power. Mises, therefore, sees this as an “abandonment of the attempt to explain the problem of money.”
MMT, chartalism, or the state theory of money claim to explain money by pointing to the state’s power to tax, the state’s designation of a unit of account, the state’s acceptance of fiat-tokens, and the state’s spending operations. However, there is no explanation of relative prices, no explanation of initial valuation, no explanation of why this purchasing power emerges, and no explanation of exchange ratios. According to Mises, this means that the state theory of money—whether chartalism or neo-chartalism—fundamentally abandons the economic issues involved, that is, how money gets its value and why it is exchanged. In this sense, it therefore cannot be called a monetary theory. Mises provides a fair but brutal treatment of Knapp’s chartalism and the state theory of money in the following quotes,
The fact that Knapp has nothing to say about the catallactic monetary problem, the problem of purchasing power, cannot be regarded as an objection from the point of view of a doctrine which repudiates catallactics and has abandoned in advance any attempt at a causal explanation of the determination of prices….
So long as a theory is not thought out and worked up in an absolutely inadequate manner, then it is not a matter of supreme difficulty to expound it so as to explain the ‘facts’ – even if only superficially and in a way that can by no means satisfy truly intelligent criticism. It is not true, as the naive scientific doctrine of the empirico-realistic school has it, that one can save oneself the trouble of thinking if one will allow the facts to speak. Facts do not speak; they need to be spoken about by a theory….
What could they, who deliberately reject the problem of the value of money, have to say about those problems of value and price which alone constitute all that is important in the monetary system?... But if the State Theory does not help to elucidate the questions that seem important to us, what is its use? The State Theory is not a bad monetary theory; it is not a monetary theory at all….
Nevertheless, a doctrine that does not mention the quantity of money at all, that does not speak of the connexion between money and prices, and that asserts that the only thing that is essential in money is the authentication of the State, directly encourages fiscal exploitation of the ‘right’ of creating money….
Knapp makes no attempt at all to determine what economics says about money.
Chartalism and Neo-Chartalism
Within the state theory of money, MMT proponent Randall Wray helpfully distinguishes between chartalism or “C-form theory” and neo-chartalism (nC). In the former,
The central idea of the alternative view [chartalism] is that the value of money is based on the power of the issuing authority, and not by any embodied or backing precious metal. Hence, Chartalists give a central role to the state in the evolution and use of money.
In this form of chartalism, money’s value is said to rest on the power of the issuing authority of the state rather than on prior market valuation, with the evolution of money linked to the state’s ability to command resources through its taxing and spending power. Regarding this “theory,” and against theories of barter leading to a generally-accepted medium of exchange, chartalists and MMTers speak with great boldness and confidence. For example, Kelton refers to “the ahistorical barter narrative,” Wray refers to “a fantasized story about barter” and the “Peter Pan and Lost Boys, Never-Never (Laissez-Faire) Land” that “simply never, ever, existed.” Wray again, “There is no evidence of a barter-based markets (outside trivial prisoner-of-war cases), and all the evidence about the origins of money points to state involvement.” Note that such authors are not specifically dealing with Menger’s argumentation, but usually attacking a straw-man—a neoclassical, non-existent homo economicus.
We cannot fail to detect the tonal disdain held against other monetary theories by MMT (which encapsulates chartalism and the state theory of money). Their assessment is obvious: chartalism is smart, and historically grounded; money emerging from barter on the market is stupid and unhistorical. Now, whether the claim of historicity weighs against all monetary theories equally is debatable, but the MMT position is clear. However, this is where current MMT—with its acatallactic theory of money—often takes another step to neo-chartalism.
After such bold assertions, neo-chartalism now abandons, not only the economic, but the historical field of battle (after firing shots), declaring it irrelevant! Neo-chartalism is presented as a modern, post-Keynesian approach, drawing on Knapp, Innes, and Lerner, and said to generate “very different conclusions regarding the origins and functions of money,” monetary sovereignty, and prices. Wray argues,
The nC approach begins with the recognition that no matter what might have been the case in the long distant past, the nearly universal situation today is one in which the nation state establishes the unit of account to be used within its boundaries. (emphasis added)
Bold historical criticisms are used to superficially reject market-based accounts on the origins of money, only to be declared irrelevant when discussing modern money. Wray elsewhere states,
I will be brief on the historical account of the origins of money, not because this is uninteresting, but rather because it is tangential to the main concern—modern money. Even if the Samuelsonian story about the origins of money were true (which it is not), all modern states operate with a fiat money…
Similarly, Lance Taylor describes that, according to chartalism, “money is legally a creature of the state, incorporating a modern central bank. Money becomes the means of exchange because the state rules that it must be used to pay taxes.” But he admits, “MMT as fiat money theory could certainly stand alone without using Chartalism as a crutch” (emphasis added), and, “With regard to foundation myths for MMT, Chartalism adds little to the observation that a modern macro economy operates on the basis of fiat money supported by state power which transcends enforcing the mere payment of taxes” (emphasis added).
This equivocation mirrors precisely the difficulty identified by Mises in his critique of the state theory of money. Ironically, an acatallactic pseudo-theory of money that emerged from a school of thought that rejected theory in favor of an empirico-realistic, historical theory of money now finds it intellectually acceptable, not only to reject catallactic economic theory, but also empirical history.
Conclusion
Mises criticized Knapp’s chartalism not merely as incorrect, but as a retreat from the economic problem of money. By substituting legal definitions and fiscal arrangements for an explanation of exchange and purchasing power, chartalism abandons catallactics in favor of juridical description. Neo-chartalist and MMT formulations do not resolve this difficulty. To the extent that they emphasize taxation, state spending, and monetary sovereignty while remaining silent on the emergence of exchange ratios and price formation, they likewise replace economic explanation with institutional narrative. As such, neo-chartalism can function as a descriptive account of modern fiscal systems, but not as a theory of money in the catallactic sense.
Neo-chartalism does not answer the catallactic question: What is money in exchange? Rather, it answers a different question: What does the state accept in settlement of obligations? From this institutional fact it then infers, without sufficient justification, that money circulates as a medium of exchange because it is accepted in tax settlement. This inference conflates legal acceptability with market exchangeability and substitutes a description of fiscal authority for an explanation of monetary valuation. That a token can discharge a tax obligation does not explain why it trades at particular exchange ratios, why it is accepted in non-tax transactions, and why it maintains purchasing power over time. Tax acceptance explains where a token can be used, not why it is valued.
