From Barter to Money


Most people understand barter. The premise is simple. I work and produce something and then I exchange my production, the fruit of my labour, for someone else's production. The risk for both parties is extinguished at the point of trade - ie. we both get something back in the transaction that we value more than the thing we gave up for it.

There are a number of problems with barter:

The first is what is known as the "double coincidence of wants". If I raise chickens and want to exchange them for turnips - I need to find someone who has turnips and wants chicken in exchange. If that isn't possible I have to find what the turnip seller desires through a series of similar exchanges. And, the turnip seller needs to have a similar time-preference to me, I want my goods immediately and so must they.

The second problem is that of change. If I have a cow to exchange and a cow is deemed to be worth 50 chickens, I have to find someone willing to exchange 50 chickens for a cow. I can't cut the cow in half without killing it so change is a problem.

The third problem is that different goods have different expiry dates so-to-speak. An vegetable farmer has a limited time to exchange his produce before it rots.

It didn't take long for people to find a solution - money. Money evolved from the most marketable commodity. If I know the butcher, baker and the candlestick-maker will all accept tobacco in exchange for their goods, I will seek out tobacco in exchange for mine regardless of whether I wish to consume it myself. Money evolved as a medium of exchange. The trade was still relatively riskless because money did actually represent payment in full - you got something of intrinsic value - ie. someone had to produce it. It's of paramount importance to note that this situation could not have been imposed arbitrarily by a king or government simply declaring that a certain item was now to be considered money. It had to evolve that way.

Many things have been currency and money but they all have a single characteristic: they are universally accepted. All monies evolved in the marketplace of human beings swapping their production for someone else's. (See Carl Menger and Ludwig von Mises).

To be money, a good must have the three characteristics...

  1. Be a unit of account
  2. Be a medium of exchange
  3. Be a store of value

Number 3 is the most important and is the nature of the fraud we will come to later.

Now some things are better money than others. The most perfect money would also have the following characteristics...

  1. Limited/fixed in supply so as to be a stable numéraire (a basic standard by which values are measured).
  2. Fungibility - one unit is equal to other units - (for example - diamonds are all different to each other making economic calculation difficult).
  3. Durability - money shouldn't wear out or rot away.
  4. Divisibility - we need to be easily able to divide money, to provide small amounts for the purposes of change and small transactions.
  5. High value/weight ratio - iron isn't a good money because it is so abundant it would be very difficult to transport.

Precious metals have been used for 6000 years because they fulfil all the required characteristics. They were universally desirable, they were of a limited supply that was relatively inelastic (difficult to increase). Now, I'm not saying they were perfect money - that's not true. There have been times when gold and silver discoveries caused a huge increase in supply, which distorted their values but over longer periods of times they have proven to be very stable.

This is often where a common confusion occurs. Discussions often use the term "money" when really they mean "credit" and/or "currency".

Currency is what circulates as a medium of exchange. It can be money or it can be a claim on money. Money can be currency, but currency can't necessarily be money, unless it is payment in full and not a claim on payment in full. It's an important distinction to make.

Money allowed people to forego consumption to save for a later day. If I fish, and choose to eat less over a few days (ie. save) I then have a store of wealth that I can consume at a later date (perhaps when I'm ill and can't work). And that should be the nature of money. True money represents freedom because it actually represents my labour. People should be able to earn a days wage - save that money and then receive essentially the same value a year, 5 years, 10 years in the future. All they are doing is altering their time preference of consumption, choosing to spend later rather than consuming today. There is no fraud, no deception, no taking advantage of other people. In fact, true money can protect your freedom because it makes you much less dependent on government. It empowers the individual to take responsibility for themselves, because that's all you can do.

Coins made perfect sense and solved the problems of the barter system.

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