MMT Basics: The Hierarchy of Money
Anyone Can Create Money; The Problem Is Getting People To Accept It. The Modern Monetary Theory (MMT) perspective and the hierarchy of money
What you will learn
Why anyone can create something that functions as money; how money is an idea built on trust rather than a physical commodity; what the hierarchy of money is and why state currency sits at the top; how state-issued money derives its power from taxes and legal authority.
Technical Terms/Jargon Used in This Article
You will find definitions of all of the technical terms/jargon used in this article in my series of Modern Monetary Theory (MMT) Economic Jargon Buster articles. Paid subscribers can also download my MMT Dictionary.
Not All Money Is Created Equal – Why Some Forms Are More Powerful Than Others
“The state, or the central bank acting on its behalf, claims a monopoly on the issue of certain forms of money... but in principle, anyone can create money; the problem is to get it accepted.” – Hyman P. Minsky
In this post I seek to explain something called ‘the hierarchy of money’. That is, the idea that some forms of money are more widely accepted and trusted than others. The more trusted the form of money you offer, the higher up the hierarchy it is and the more likely it is to be accepted as a form of payment.
Different forms of money are ranked by how widely they are trusted and accepted:
State / government currencies: Pounds, dollars, euros, yen, yuan, won, rupee and Canadian and Australian dollars. These are issued by the government, backed by law, and accepted for taxes and other legal obligations. They sit at the top of the hierarchy because their acceptance is guaranteed across the economy.
Bank deposits / commercial bank money: Savings accounts, digital balances. Created by commercial banks when they make loans, these deposits are widely accepted for most transactions (though not all, some people want ‘hard cash’). People trust it because it can always be exchanged for government money, which sits at the top of the hierarchy.
Community-issued money: local currencies (for example, the Chiemgauer in Germany and the Torekes in Belgium). These are only accepted within specific communities or networks, limiting their usefulness.
Private digital currencies / crypto-assets: Bitcoin, Ethereum, and other cryptocurrencies. Accepted by niche groups, their value can fluctuate widely and they are not universally recognised as payment.
Private IOUs, gift cards, loyalty points, coupon books and vouchers: Promises between individuals, promises between shoppers and businesses. These are only valid if the recipient agrees to accept them, and so they sit at the bottom of the hierarchy.
“What counts as money and what counts as credit depends on your point of view, which is to say that it depends on where in the hierarchy you are standing” Perry Mehrling - The Inherent Hierarchy of Money (2012)
The hierarchy of money is a useful concept for MMT as it shows the power of a government’s currency - which sits at the top of the hierarchy - and it gives MMT advocates an opportunity to explain where that power comes from. That is, it comes from the government’s power to levy taxes on its citizens: taxes that must be paid in its government’s currency. This is a power backed by law. If you don’t pay your taxes you can end up in jail.
As L. Randall Wray explains:
“We can conclude that taxes drive money. The government first creates a money of account (the Dollar in Australia, the Tenge in Kazakhstan, and the Peso in the Philippines), and then imposes tax obligations in that national money of account. In all modern nations this is sufficient to ensure that many (indeed, most) debts, assets, and prices will also be denominated in the national money of account” L. Randall Wray 2024.
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Anyone can create money
The hierarchy of money implies that anyone can create money. Why? Well, because it tells us that money is anything that can be used to settle a debt or make a payment that others will accept. If someone is willing to recognise your promise, whatever you use to represent that promise functions as money.
However, it’s not the object itself that is money: it’s not the inherent value of the coin, the tally stick, the cowry shell, the grain, or the banknote that makes it money. Its value comes from the trust in the promise. The object is just a token, a way of recording or symbolising that promise. Even when gold coins were used as currency, it was the king’s backing that gave them their value, not the inherent worth of the gold itself. The value of the coin surpassed that of the gold it was made from. That’s not to say that, when far from the king’s jurisdiction, the value of the gold wasn’t a handy fallback.
A coin is only money because people agree it is; a cowry shell only works as money when a community accepts it as having value. Paper notes or digital balances are just promises that someone will honour them.
“Money represents a debt-relation or a promise to pay that exists between human beings. It cannot be identified independently of its institutional usages, for money expresses a social relation”, Stephanie Bell – Working Paper No. 231 The Jerome Levy Economics Institute
“Money is credit and nothing but credit. It is a promise to pay.” - Alfred Mitchell-Innes, “What is Money?” (1913), Banking Law Journal, p. 377
Why is government currency at the top of the hierarchy of money?
The stronger that trust and the wider the acceptance, the higher up the hierarchy the money sits. Government currency is at the top because its promise is backed by law – it must be accepted for taxes and other obligations – while coins, community currencies, or IOUs derive their acceptance from personal or local trust or agreements.
An essential aspect of money is the social relationships it represents: what one person is prepared to accept from another. All UK residents accept the state’s money as payment, whereas someone you do not know is unlikely to accept the promise encapsulated in your personal IOU.
In short, anyone can create money, but whether it is widely accepted depends entirely on the strength of the promise and the trust behind it.
“Money is a creature of the legal order. It is not a commodity that has value, but a token of trust.” - Georg Friedrich Knapp, “The State Theory of Money” (1905)
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What are the implications of money as an idea (or if you prefer, a concept) rather a physical commodity?
When money ‘is but an idea’, representing trust between individuals rather than a physical commodity, we can begin to understand why it only takes the imagination of a politician, backed by the power of the state, to bring it into existence.
When a politician, given permission by parliament, decides to spend on a new nuclear plant or a fighter jet, that idea literally becomes money at the point when it appears in the account of the construction firm or defence company chosen to manifest that idea.
And, whatever your opinions of politicians are, I suspect that you would agree that there’s no limit to the number of ideas that they can have, which is why the finances of currency-issuing governments like the UK or the US are unlimited. That’s not to say there are no restrictions on spending that money: the restrictions are the existence of real resources that can be purchased with that currency.
All modern state currencies are fiat money
What do we call this type of money? We call it a fiat currency: money that is not backed by gold, silver, or any other physical commodity, but by the promise that the government will accept it for taxes and legal obligations. In other words, money doesn’t need to be mined, printed, or dug out of the ground first; it exists because we agree to treat it as a medium of exchange.
In conclusion: the hierarchy of money shows that anything can be money, but not all forms of money are created equal
Anyone can create something that functions as money. How widely accepted it is depends on the degree of trust people have in it, and the willingness of others to accept it in exchange for goods, services, or to settle obligations.
With some exceptions the state currency sits at the top of that hierarchy of money, for example, states where the national currency is not widely accepted even within its own borders or countries with a fixed exchange rate. Outwith such exceptions, state currency is accepted everywhere, can be used to pay taxes and settle debts, and is backed by the law, which gives it a unique authority. Other forms, like private IOUs or gift cards, can function locally, but they will never match the reach or authority of a state currency.
A postscript from Warren Mosler
Warren Mosler got in touch to add the following: in relation to a fixed exchange rate, it’s about the ‘distance’ from convertibility. For example, on a gold standard gold is on top. Then gov gold certificates, then gov securities that delay access to gold Etc. It’s a pyramid of conversion risk Etc. Thanks Warren.
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If you have any questions or if you disagree with anything I write in this article, I want to hear from you. I may have missed something simple, particularly in relation to a topic like this one, so please add your comments in the discussion area. Contrary views are welcome.
Resources
Mehrling’s summary of Minsky’s work (INET, 2012 video lecture, The Hierarchy of Money)
The Inherent Hierarchy of Money - Perry Mehrling (2012)
The Hierarchy of Money (1998) by Stephanie Bell
The State Theory of Money (1905) - Georg Friedrich Knapp
What is money? (1913) Alfred Mitchell-Innes
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MMT Factsheet 3: If Taxes Are Not For Spending What Are They For?
That's a very useful summary, Jim. One nit-pick: you list reward points under "Corporate or community-issued money", but loyalty points along with Private IOUs etc. I would have thought they're the same thing?
Regarding Mosler's addition, in relation to, "on a gold standard gold is on top. Then gov gold certificates, then gov securities that delay access to gold Etc."
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Just to zoom in on how this works. Here is just the image I get when I read that:
So, from 1913 onwards, the Treasury is spending into the Fed check clearinghouse, as checks come in slowly by mail from the banks.
Alongside taxes, currency issuance, coin and gold certificates alike were issued as a reserve drain.
Then, in the Mosler model, treasuries are not issued as a drain, as they would be now, but such that all the [paper portion of the] formerly reserve drained payments don't pop right back and ask for the real money instead, piles and piles of ten and twenty dollar coin faster than the Treasury can mint it!
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Fast forward to post 1933 and on into Bretton Woods.
What was this "gold" that government securities was delaying access to. Or, I mean, what was this store of liabilities being, pending to be, turned in for gold. Just these paper dollars, right?
Again, the Treasury spends into the check clearinghouse, assuming the FedACH hadn't come out yet, and these payments are drained as gold certificates, bringing back up the overnight rate from approaching too close to zero. But variability in some factor--causes A REVERSE reserve drain BACK into, now it's Bretton Woods-style, bullion. Except thank God, we have Treasuries!
Did I get that right?