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Goods as Money

Under a system of mutual barter, literally anything may be used as money. Our modern system of electronic transfer, checking accounts and paper money in place of the mutual trading of actual goods and services would occupy a short paragraph in the book of human history. Millennia before legal tender laws and central reserve banks, there were many different kinds of generally accepted money. Some were easier to acquire and use than others. When the European settlers first arrived in North America, they discovered a form of money the natives produced by the arrangement of wampum (seashells) into long strings. Native American debts were settled in lengths of wampum. In order to conduct trade with the Indians, the settlers were obliged to trade their excess goods for lengths of these seashells, using this as the medium of exchange when trading with the various tribes. This must have felt quite strange to a people accustomed to paying their debts in denominations of gold and silver coin. In South America, the Spanish settlers found the native Incas trading in birds’ feathers!

In this chapter, we will examine a hypothetical scenario whereby the origins of commodity money (barter) may be logically deduced.

Before Bartering

There is no way of knowing for certain where the barter system evolved first, how or even when, since it existed long before the written word (or possibly the spoken word). We do know that it still exists as the economic basis in some primitive societies today and to a much lesser extent in the developed world (A few minutes spent observing Kindergarteners at lunchtime spontaneously trading items of food can be educational). This being the case, all we can do is try to reverse engineer this system and come to some logical conclusions about its origins based on what we do know. It makes sense to begin with the smallest economic unit - a single person. Let's say that a modern human being was stranded on a deserted island, alone, with no tools or resources to aid him except what exists in the state of nature all around him. What would he have to do to survive? Obviously, his immediate needs are water, food and shelter, and possibly in that order. Finding a handy stream of clean, fresh water, he then looks around the immediate area for a source of food. Let's say that he finds a berry bush nearby and is able to pick his fill from the lower hanging branches in a few hours. Now that he has food and water, he looks for shelter and finds a suitable cave not too far away. Not bad for his first day.

Over the next few days he eats, drinks and explores his immediate surroundings, mapping the area and looking for useful features such as obvious rock and mineral deposits, alternate sources of food and water, possible signs of other inhabitants, maybe even a way off the island. After picking most of the lower hanging berries on his bush, it becomes more time consuming to get his daily food and he realizes that he needs some tool to help him reach the higher branches of the berry bush. He estimates that it will take about a day to make a stick suitable for the task and decides to spend extra time every day picking berries until he has enough to feed himself for the time it takes to fashion his new tool. After a week of saving, he takes a day off from berry picking and makes his picker-stick, using up the berries he has saved. Now he is able to reach the higher branches for more berries and it takes less time to feed himself each day, leaving him free for other activities, such as finding flint to start a fire with.

Less obviously, we assumed that our subject was not impeded in his endeavor by outside influences. He was able to estimate the cost of the stick in berries, in this case a day’s supply, then save and invest that cost to successfully produce his capital equipment. Let's say that a storm or other calamity occurred on the day he was to make his stick and he was forced to use up his supply of berries without producing his stick. Clearly the saving would not have been wasted, as he was able to weather the storm without starvation, but his capital investment would not have been made as planned and he would be back where he started. Had he estimated too few berries, his stick would not have been finished before the berries were gone and further saving would be needed. Had he made the stick, but overestimated its benefits, the saved berries may have been mal invested as the benefit of the stick would not justify the savings it took to make it. To be successful, the benefit obtained from his investment must meet or exceed his expectations, or the effort will have been at least a partial failure. This condition is generally referred to as a mal investment. Of course, had he overestimated the required savings, he would still have "capital" for further investment, a happy situation to find oneself in. That our unfortunate subject has engaged in a sort of 'personal barter' is significant.

What he has done is to trade a portion of his time that he may have spent at other useful activities, or indeed at leisure, for an extra day's supply of berries so that he could make a piece of capital equipment (the picker-stick), thus easing his burden of gathering food and freeing his time for less pressing activities. By saving the berries, he was able to invest in the stick. There are some valuable lessons to be gained from this hypothetical exercise:

His preference for the stick caused him to voluntarily sacrifice something else, in this case, his time and labor. We can say that he traded his time for more berries: In all transactions, the perceived benefit must outweigh the perceived cost.

Only by sacrificing his time and saving his berries was he was able to invest in his ability to produce the stick: There can be no investment without prior saving.

By making this investment, he was able to somewhat mechanize his food production process by producing capital equipment (the stick): There can be no capital equipment (lengthening of the production process) without prior investment.

He was not the subject of outside interference and was able to complete his project: Saving and investment must proceed unaffected by outside influences.

Only by obeying these natural rules can the entrepreneur operate efficiently and avoid mal investments of savings gained by sacrifice.

Bartering Amongst Groups

We have seen how one person left alone must provide for all of his basic needs and find that the rules of the marketplace operate even though that market consists of its most basic unit - a single individual. How would these simple rules operate if there were more than one person participating in this system?

Let us now say that our deserted island dweller (let's call him Fred) is able to explore the entire island over time and happens upon a small tribe of friendly natives living not too far away. He looks around the village and sees many things they make for themselves that would improve his own quality of living beyond his currently meager standard. Naturally he does not want to simply try and take these things by force, there are too many natives and he would prefer to remain friendly. Also, he watches these things being made and realizes that he does not possess the high skill level needed to make his own. What to do?

Whilst wandering the village, he gets a little hungry and reaches into the pouch at his side for some of the berries he brought with him. A native sees him eating berries and gets very excited, running up to Fred and gesticulating wildly, pointing to the berry pouch. After a second, Fred sees that the native wants some berries and gives him a few to sample. The native likes the berries very much and it turns out that the berry bushes do not grow on the natives' side of the island. The native then looks around for something to give Fred for more berries and sees that he is very interested in the meat roasting over the villager's fire. Fred gives the native some  berries for some meat and they shake hands and part ways, both happy with their new acquisitions.

The trade was able to take place because both parties (Fred and the native) preferred the others' goods to their own. Fred wanted the meat because, although the berries are very sweet and juicy, he wanted to supplement his diet with some protein; he could always use his stick to get more berries. The native preferred the berries because they taste very good and he already had plenty of meat. Both parties were able to gain something more desirable (in their individual eyes) from the other by giving up some portion of their own possession. Each person's quality of living was enhanced from his own point of view by interacting with the other. This principle of mutual benefit is the basis for barter.

Now let us suppose that a few days go by and Fred wants to get some more meat from the friendly native, but the native decides that he has enough berries for now and refuses the trade. Although Fred prefers to trade some berries for some meat; in the native's eyes, for the moment, the meat is a more desirable commodity than the berries. How then could Fred use his berries to gain some meat? He would have to find some other thing to trade for his berries that the native would prefer to the meat. This may be something that he already possesses or something else that he can trade for.

As it turns out, a neighbor of Fred's friend has some fish that he finds very desirable. The neighbor does not desire the meat, but finds Fred's berries very appetizing. Making use of this knowledge, Fred trades some berries for some fish, then trades the fish (that he did not particularly desire) with his friend for some meat. In this way, all three parties gain something more desirable, in their eyes, for something they already possess. Unfortunately for Fred, he was forced to transact two trades to gain his desired meat, thus working twice as hard.

Thus we find the Achilles’ heel of the barter system. In order for a trade to be agreed upon, each party must receive something he desires more than the good(s) or service(s) he provides. In the absence of a commonly desirable commodity that can be used ‘in lieu’ of the commodity his native friend desired, Fred was forced to convert his goods (the berries) into a more desirable medium of exchange (the fish). We could say that Fred used the fish as money to buy the meat. Of course, Fred’s friend could have traded the meat for the berries and then the berries for the fish, had he known that his neighbor desired berries, thus using the berries as money in the same way that Fred used the fish.

There are several hypothetical questions we can pose about this story which may expand our knowledge of the barter system, for instance:

What if the villagers already had plenty of berries and did not desire Fred's? How would Fred have been able to improve his living standard by gaining the meat if he did not have something his native friends valued more? Certainly there could be no trade if both parties do not receive something they value more than the object(s) they provide. Fred was lucky in that he found the fish his friend valued more. The concept of perceived value is very important to the barter system. In a free market, all trade is conducted voluntarily.

What if Fred's berries were so precious to the villagers that they were willing to trade large portions of their possessions for a relatively small amount of the berries (or vice-versa)? This would give Fred (or the villagers) a huge trading advantage as his desire for the villagers' goods would not be as strong as the villagers' desire for his (or vice-versa). This may occur where the berries are very rare in quantity compared to the villagers' produce or where the villagers have copious quantities of everything they need and assign little value to the excess. In a free market, the perceived value of any good is relative to the perceived values of all other goods in the same market. These relative values are set by each individual's willingness to voluntarily trade his possessions for those of others. If for some reason, Fred's native friend should lose part of his stock of meat, he would place a greater relative value on the remainder and would be more resistant to trade.

What if, for some reason, all the villagers refused to trade with Fred? Say, for instance, they believed his berries to be poisonous? How, then, would Fred convince the villagers that his goods are safe to eat and as such desirable in the marketplace? What effect would this have on the relative value of his berries even if he were able to prove them safe to eat? To answer these questions, we must refer back to when Fred was a lone person providing for himself. Assuming that Fred had no idea whether the berries were poisonous before he tried them, we can say that he assumed a huge risk by eating an unknown substance in the first place. Having tried them and found them wholesome, it would be a simple demonstration to eat some in front of his prospective trading partners and allow them to observe his lack of adverse reaction. If they were still not willing to trade for the berries as food, he would be forced to find some other use for them that the villagers would find desirable and increase their willingness to trade, perhaps to use as a dye or some other purpose.

Suppose using the berries as a dye is found to be equally or even more desirable than using them as food; Fred's berries would then have multiple uses and their perceived value would rise as more villagers learned of his wonder-berries! Fred would then be in the happy position of having many prospective customers bidding up the value of his berries as each offered more than the last.

We have seen that through bartering, our primitive society is able to significantly improve the living standards of those who participate in the market. The native gains berries that he otherwise would not have enjoyed and Fred gets the meat he so desired. By dividing their labor into specific tasks, or groups of related tasks, both parties are able to improve their own standards and that of their trading partners. Their motives may well be completely selfish; but by helping themselves, they also (as a consequence) help others. By specializing in their chosen fields, each is able to make more efficient use of his labor and thus produce excess goods to trade for other goods that he or she may otherwise not have the opportunity of benefiting from.

In many ways, the basic rules surrounding the barter system can be said to be instinctive. Firstly the question of ownership is solved by the instinctive understanding that anyone who freely chooses to apply his labor through intelligent manipulation of some other bounty of nature automatically assumes ownership of the resultant good, regardless of its perceived value in the marketplace. Ownership of private property is considered an extension of the person’s right of self-possession. Without self-possession, there can be no private property ownership and therefore no voluntary transfer of ownership through barter or any other system.

The question of equity in worth is solved through a process whereby both market participants weigh the perceived benefit of the good(s) received against  the similarly perceived benefit of the good(s) relinquished, freely choosing to make the transaction. Thus a peaceful transfer of ownership is achieved whereby both participants benefit from the efforts (thought, time, labor, capital investment, etc.) of the other.

The main difference between a primitive barter system and a commodity monetary market system is the popular acceptance of the medium of exchange. In a primitive barter system, all goods may be described as money, regardless of relative worth or ease of acceptance in the marketplace, whereas a commodity monetary market system has only one, two or a few commodities widely accepted as money that is (are) used to trade for other more desirable commodities. Owning a quantity of monetary commodities enables the trader to bid for and buy desired goods or commodities without the disadvantage of owning an undesirable medium of exchange. What could be more desirable than money? Ask yourself the same question when grocery shopping or out at the theme park. In essence, everything you buy is, in your estimation, more desirable than the money you used to buy it with, or the voluntary transfer of ownership would never take place.

In essence, any commodity based market system can be described as a barter system. Our modern (essentially worldwide) financial system of fiat paper money issued from a central bank and loaned at interest on the financial market is not a traditional barter system. The medium of exchange (paper currency) is not in itself a commodity and has no intrinsic value. Had our desert island dweller offered his native friends paper dollars (or Euros, Yen, Pounds, etc.) instead of something that they perceived as having intrinsic value, such as the sweet, juicy berries, he would probably not have been enjoying the roasted meat anytime soon.

We have seen that a prerequisite of a free market is the right of personal ownership and its natural extension, the right of private property ownership. We know that in order to trade freely, each participant must perceive a greater value in the goods received than in the goods relinquished. We have learned that there can be no capital investment without the prior acts of sacrifice and saving and that these activities, to be successful, must proceed without outside interference.