They say that money makes the world go around. But bestselling macroeconomist Felix Martin thinks we would not be in such a financial mess if we actually understood more about what money actually is and what its history is.

The problem, he said during an exclus-ive interview with Times of Malta Business, is that if we do not understand what money is all about, when things go wrong we blame it on the wrong things – concluding, for example, that the financial crisis was due to all bankers being wicked and greedy and economists being corrupt because they worked on the side for investment banks (as was revealed in the Oscar-winning documentary Inside Job by Charles Ferguson).

“Banking is no less susceptible to corruption than any other discipline. But I don’t think that is the root of the problem. I think it comes from a very basic mis-understanding of how the system works.

“Even worse than that is a lack of understanding not only among academics, politicians and policy-makers but also among the public,” he said.

The conventional theory or history of money starts off with the barter of produce.

“This relied on whether I wanted your corn and you wanted my fish and we both wanted them at the same time. If so, we would make a transaction – what economists called a double coincidence of wants,” he said.

In the conventional history, the next phase was to create one thing to serve as a medium of exchange, something accepted as payment – not because you want the fish but because you know you can use it to pay for other things. Different things were accepted as the medium of exchange over time but in practice, precious metals like gold and silver were more often used.

The next phase, according to the theory, was the invention of credit – borrowing and lending this medium of exchange – which led to institutions, usually goldsmiths, which was basically the invention of banks.

So far, so good. But Mr Martin believes that this story, which forms the basis for money and banking and in turn monetary policy and the regulation of banks, is seriously flawed.

“Money is not about the token or medium of exchange. Money is the system of credit and clearing of that credit that these tokens represent. It is the invention of the ideas which you need in order to operate a monetary economy,” he said.

There are basically three ideas behind his approach. The most important is the idea of universal economic value – or monetary value – which you can apply to virtually anything.

“Most ideas of value or worth are confined to a particular sphere, such as aesthetic value, religious value, spiritual value etc. The whole point of economic value is that you can apply it absolutely everywhere: the value of the good that you are buying and selling in the market; the value of time when you look at interest; the value of a human life when you are doing a cost/benefit analysis.

“When societies acquired this idea it was an important moment in human history. The medium of exchange on its own is not money. For that you need two other things: a system of accounting which uses this idea of value in order to structure what people do in order to accumulate money, credits and debts; and the transferability of the credits,” he said.

To prove his point, he explained that while transfers were historically based on coinage, this was now virtually unimportant, with most transactions being done electronically.

Mr Martin referred to the virtual currency, Bitcoin, pointing out that it was not the first viable private currency as is being claimed (based on the argument that it was not controlled by any government).

“It is certainly true that most money today is issued by states or at least indirectly issued by states. But there are numerous examples of private money throughout history and all over the world. These range from things like local currencies ­– there is one in Brixton in London – which are usually quite constrained as they only work within a small group of people who have the same ideas and commitment.

We would not be in such a mess if we understood more about money

“Another example is the WIR network in Switzerland, a private monetary community used by 60,000 businesses.

“These are usually created because people are not satisfied with liquidity available – essentially the monetary policy of a national money. They think, for example, that they would like to do more trade but they are not able to get enough loans from banks and so they decide to set these things up.

“They have national limits and don’t usually compete very well with national currencies.

“But there is one example which had extraordinary success, and that is the private money issued by banks. Indirectly, practically all money is sovereign money, but in truth almost all the money we use today is the liability of private, commercial banks. The only money that we use which is actually a liability of the sovereign is the paper money or coins. But that is just two to three per cent of the money supply,” he said.

Mr Martin explained that this development dates back to the creation of the Bank of England in 1694. The merchant bankers demanded that the sovereign endorse their private money – which meant it could be used to pay taxes and to circulate nationally – and in return, they allowed the private currency to be regulated.

“In whose interest they were regulated is really the key question, the one that has been thrust to the forefront of our minds during the crisis.

“Back when the BOE was founded, the king was not particularly interested in regulating the banks: he wanted funding for his wars on the continent. We would not accept that today, obviously. We live in a democractic society and the idea of a monetary policy is that it should be made in the interests of the people whose currency it is.

“Before the crisis, we ended up with a framework for monetary policy which concentrated rather narrowly on consumer inflation, the big problem in the 1970s and the 1980s to the exclusion of almost everything else.

“In fact, monetary policy has many other aspects and effects. For example, there is prudential regulation of banks to make sure that they do not blow up and leave a huge hole in their balance sheets and need a bailout.

“There are the distributional effects of monetary policy which are becoming more obvious now when we have had interest rates at very low levels for a very long time, of course. But these things did not appear anywhere in the framework for monetary policy before the crisis.

“That has been revealed to be a failing of the framework we had. That is the cash value of everything I have been saying. It is not just a bit of history or interesting philosophy. It has real and practical effects and implications for the way in which we do monetary policy,” he warned.

In his book Money: The Unauthorised Biography, which he discussed during a public talk organised in Malta by Curmi and Partners last year, he also argued that money was a powerful force for freedom.

He explained this by referring to the transition from feudalism and social organisations based on power and violence.

“Once feudal obligations were dissolved, the social structure was transformed to a monetary relationship; feudal rents became monetary rents. People were able to earn money which in turn produced social mobility and entrepreunerial activity. Without money, one would not have had any of this...

“Even more obvious is the example of banking. Sovereigns in the mediaeval ages issued money for their own ends. They would think nothing of creating a huge inflation in order to transfer wealth from their subjects to themselves, in order to go and fight a war or to buy the most luxurious things they could find.

“The merchant classes did not want to put up with this and therefore they formed their own monetary network. It was not just a commercial act. It was a very polit-ical act. This is how they expressed their power and how they forced sovereigns to come to that sort of arrangement which I finally describe. So in that sense it has been one of the most important tools for democratisation and the spread of political power in history.”

Mr Martin clearly has an opinion on whether a single currency can be imposed on so many countries. And, as you can imagine, it is not terribly optimistic.

“A currency is not just a commercial or an economic thing. And although we like to partition in our minds between politics and economics, this is never the case. It reinforces what we are all learning by bitter experience at the moment. You cannot create a single currency without a great deal more political and administrative unity, practically speaking fiscal unity...

“Had I said this six years ago, it would have sounded like foresight. Now it just sounds like ‘stating the bleedin’ obvious...’

“The single currency is based on the idea that money is somehow separate from banks; that you can have a central bank and lots of banks and lots of prudential regulatory regimes and that it can work. But if you understand that money is really an operating system and that one part is operated by the central bank but that mostly it is operated by commercial private banks, then that does not make any sense,” he said.

Could it be salvaged? He said that the European project was a noble one which was born at a moment which was truly revolutionary.

“I tend to think it would need another moment like that to put things on the right course. Financiers and economists have dug their own graves on this one. They have kept the understanding of it so far from the public that it would now be very difficult to generate the momentum behind that kind of moment. It might take a bigger crisis than the last one to produce it... I hope I am wrong...”