The Origin of Money — Part III, Barter and the Evolution of Money

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Indexes
  1. Money from the barter system
  2. The history of barter
  3. The barter theory explained
  4. Abstracting the selection process of money out of the barter theory

Welcome to part three in our Origin of Money series! In the first two parts, we covered credit theories of money and state theories of money. The credit theory makes mention here, so I’d recommend familiarising yourself with it first before you continue reading. In this article, we’re going to be exploring the barter theory of money and an associated monetary selection process by which money evolves.

Early Morning, The Market, Hoi An, Vietnam by Peter Brown

Money from the barter system

For most of modern economics the view has prevailed that money emerged as an outgrowth of the ‘barter system’. Supporters of the theory believe that money emerged through certain media of exchange being increasingly selected for trade due to their superior monetary properties and increased usage (marketability, societal adoption), until one or two dominant media of exchange prevailed over all others in common use (such as gold and silver, which came to be used as money repeatedly throughout history).

The argument goes something like this: Ancient societies used to operate by people trading goods with one another without a common medium of exchange. Some goods were more desirable and efficient to use for exchange than others, and so they were used more often in trade by more people. The greater number of people using and accepting these goods in trade made the goods even more desirable to hold onto and trade with — which made even more people trade with them — until eventually the most universally desirable good for trade (sometimes it was two goods) came to be used widely and predominantly for the purpose of exchanging — meaning, they became common media of exchange. Money.

Now, when you look up what barter is, you’ll find something like this:

This is, of course, under the standard definition of money as “the general medium of exchange in an economy.”

In a barter system, individuals exchange goods and services for goods and services. Every good is a medium of exchange, but there is no common medium of exchange in the economy. *This is the definition of barter I will be using — an economic system where there is no common medium of exchange. This means that to barter is to exchange without using a medium of exchange that is not generally accepted in the economy. Under a barter system, if you wanted bread, you’d have to give someone eggs or flour or clean their house. All exchange is trading things for other things — but there is no universal thing used for trade. If money is defined as the common medium of exchange, then barter can be defined as a system of exchange without money.

Many see the barter system as the logically necessary implication of an economy without a dominant medium of exchange. Obviously humans moved from a state of no common medium of exchange, to one with a common medium. And in the state where there was no common medium of exchange, the only ways to perform exchanges would have been without using a common medium (by definition) — which means, through barter. Even in a gift-debt system. In the gift-debt systems, people were still exchanging goods and services for goods and services without a common medium — which is bartering, under our definition — just over time (credit exchange) and governed by different rules (sociocultural norms). Under the definition of barter we have outlined, if a common medium of exchange was not used in a gift-debt economy, then it was by definition, a barter economy.

If you’ve come across barter before and are a little confused that a gift-debt economy can be an instance of barter, that’s because what people normally think of when they say ‘barter system’ is a specific type of barter: non-credit barter. That is, a situation where there is no common medium of exchange AND all transactions occur without credit — as instantaneous trades of one thing for another. In non-credit barter economies, individuals traded goods for goods at the same time, without either party finishing one half of the exchange sometime in the future. Eggs for milk. Milk for bread. Cattle for a house. Wood for Cattle. On the spot, with no credit. This is normally the type of society that barter theorists envision we used to have. *Note: no economy complex enough to have bakers, cleaners and bicycles would use the barter system. Long before then, they would have adopted a form of money to facilitate their exchange. But for simplicity, I will use these things in examples when describing barter exchanges.

Day and Night, by M.C. Escher

The history of barter

Interestingly, there is little historical record of non-credit barter economies other than their emergence after periods of massive monetary crisis (hyperinflationary or deflationary collapses).

Based on the historical record we do have, barter seems mainly to have been used between strangers in history — whether on the individual, tribe, group or state level. This is why the credit-based theory of the origin of money is taken more seriously now than it used to be — because it points out that more ancient and ‘primitive’ human societies did not to function by individuals exchanging things between one another, as our societies today do. Instead, they were more communal and ‘shared’ what they had with each other in a gift-debt fashion, while trade was something done with strangers who did not trust one another. So for credit money theorists, viewing a no-money economy through the lens of “society ran on non-credit barter exchange, but was just more inconvenient” is not historically up to scratch. Societies were gift-debt societies, they argue, not commodity exchange societies as the barter theory envisions them. I’ll quickly note that an accommodating modification could easily be made to the barter theory which would have money arising out of inter-community trade rather than intra-community trade.

I would also like to add here that — as already discussed in my piece on the credit theory of money — gift-debt exchange is still exchange. It is distinct from donations or theft. In this way, gift-debt societies were credit exchange societies. So the credit theorists can be right that society wasn’t the way it is typically portrayed in barter theories of money (this is a purely historical matter), but it cannot be denied that gift-debt economies were also barter systems — just credit-based barter systems, until they adopted a common medium of exchange. We’ll get back to the implications of this a bit later.

The Savage State, by Thomas Cole

Proponents of the non-credit barter theory of money (typically just called the barter theory of money) argue that the lack of historical record for non-credit barter communities is because their existence would have been extremely brief and quickly supplanted by money-based systems (for reasons that will be explained shortly). They also argue that exchange is a fundamental, natural and inevitable part of human action — and that wherever humans have existed, exchange has existed, and out of exchange money would have inevitably come to exist due to the monetary selection process the barter theory outlines. Interestingly, small barter community economies have emerged naturally in modern times, especially during times of economic hardship where individuals don’t have money, but do have skills or goods to offer to others. See here, here, here or here for some examples if you’re interested. *In my opinion, if non-credit barter was used within communities, it would have been used alongside credit barter (and vice versa). It seems impossible to imagine a society without either trade or debt.

History aside, one thing the barter theory does very well is provide an explanation for how a common medium of exchange evolves once it exists. It provides a strong account for a selection process of money based off of monetary properties, which can be applied to the idea of money more generally, no matter what conditions you think money first arose out of. This selection process is how the barter theory gets us from non-credit barter, to money.

So, what actually is the barter theory of money?

The barter theory explained

A lot of people say that “money is just a concept” and is purely the result of the human ability to believe in abstractions. They say that the value of money is totally determined only by collective belief. While this may be more true for the form of money we have today, under the barter theory of money this way of thinking would not be considered universally true. In the barter theory, money was not a concept that was just suddenly invented in the form we know today and accepted by all spontaneously. Rather, it was a natural outgrowth of exchange. This is why barter theorists often think of money as no different to any other commodity — other than that it is the most ‘salable’ (sellable) commodity — in an economy.

I’m going to use a thought experiment to teach you basic premises of the barter theory.

1. Some goods are used more than others in exchange

Imagine a community where people exchange things with one another without a common medium of exchange. In a credit or non-credit fashion. Everybody trades things for other things. So if I want milk from someone, I have to give them something that they want in return — maybe bread. And if I want wood from someone, I have to find the person who has wood and give them whatever it is that they want (which might be a different thing to what the first person wanted) — maybe this person wants eggs, rather than bread. In this little community, there is no universal thing which everybody wants that I can confidently bring to an exchange and be sure the other person will accept — that is, there is no common medium of exchange.

Now, which good somebody wants to receive in order to complete an exchange depends entirely on their subjective valuations. Since not all goods are equally desired by all people (because people are in different situations and have different wants, tastes and needs), some goods will be preferred to be received in trade by a greater number of people than others. For example, let’s say that in our little economy there is generally a more widespread and persistent demand for eggs than there is for beans. This means that across all the many exchanges occurring in the community, more people ask to be paid with eggs than with beans. Eggs are a relatively popular medium of exchange.

Similarly, some things will be preferred to be used as payment than others, for any number of reasons. For example, maybe live chickens are a less popular medium of exchange because it’s too laborious to carry chickens around when you want to go buy something.

Ok — so we know that some goods are used more often in exchange than others. Let’s continue with the example where eggs are a relatively popular medium of exchange. Meaning: you will have a better chance of being able to buy what you want if you offered to pay with eggs than if you tried to use some other less popular medium of exchange like beans.

Fruits, 1995, Yayoi Kusama

2. People save and accept payments in goods which are more sellable

Now, if you know that eggs are more commonly desired as a form of payment than other goods in the economy, then you will save up some eggs so that you can use them to buy things in the future. And this savings is not just for convenience — you might do it because you’re afraid of finding yourself without anything that people will accept in trade. What if you needed something urgently, say ingredients for cooking, but didn’t have anything to exchange for the ingredients that people were willing to accept. So you stockpile some eggs — not to consume yourself — but so that you can use them as a medium of exchange. And you might even start accepting eggs as payment in exchange yourself, because you know that out of all the goods in the economy, you’ll have the highest chance of being able to get something you want with eggs. Since eggs are a relatively popular medium of exchange, other people will do the same too — they’ll start saving up eggs and accepting them in payment as well.

Because of this, eggs will be used more in trade than before — their adoption as a medium of exchange has increased.

Chicken Cup

3. More sellable goods are used more in trade

What just happened? Because eggs were a decently popular medium of exchange, they were driven to be used even more in exchange. This self-reinforcing cycle of adoption (where a greater adoption of a medium of exchange increases its adoption further) drives out many of the lesser used media of exchange — which become even less desirable to use and accept in trade, until only a few major media of exchange remain in the economy.

Let’s say that in our little community economy, this process plays out and we are left with three prevailing media of exchange: eggs, gold and copper. Whether this is because these were the most widely needed things, the most widely wanted things, the most practical things to trade with — or some combination of the three (these are, in my estimation, the main reasons for something to become a popular medium of exchange to begin with) — let’s just say it is eggs, gold and copper that became the primary media of exchange used by people in the economy.

At this point, with three relatively common media of exchange, trading in the economy is much easier than it used to be. Before, if you wanted to buy something from someone — you needed to find the EXACT good that they wanted — and this was extremely inconvenient. For example, let’s say you wanted bread from the baker, and the baker was only accepting milk as payment — but you didn’t have any milk. In this situation, you’d first need to go and find somebody with milk who wanted something you had, trade with them for milk, and THEN give the milk you acquired to the baker for bread. This cumbersome process (called ‘roundabout exchange’) doesn’t really happen as much in a situation where there are only three major media of exchange in the economy. In our little community, now if you bring either eggs, gold or copper to an exchange — you’ll be quite likely to trade it for what you want from pretty much anyone.

Having three media of exchange which, between the three of them, will be able to buy what you want, is pretty good. You could call these ‘money’ if you liked. The exact point at which something is generally accepted enough to be money is blurry, and arbitrarily defined. But this tri-money system is not quite money as we know it. How does an economy go from several major media of exchange to just a single dominant one in the barter theory? The answer is: it all comes down to ‘monetary properties’.

Drawing Hands, by M.C. Escher

4. The goods with the best monetary properties win out over time

Monetary just means ‘to do with money’, and properties are just certain qualities that something has. So monetary properties are just properties which make something a better (more desirable) medium of exchange — that is, a better form of money. This is my definition for this explanatory framework, but you can define words however you like. There’s a whole list of monetary properties (Portability, Durability, Divisibility, Fungibility, Scarcity, Digital, Verifiable etc…).

Let’s quickly go through the most important ones, and why they make something a better money:

  • Portability. People prefer to both pay and get paid with something that they can easily carry around.
  • Divisibility. People prefer to pay with something that’s divisible, because then they can buy things for the exact amount they value it at rather than having to overpay with something indivisible.
  • Durability. Savers don’t want to save up something that is going to wither away or get destroyed over time. And nobody wants to be paid in perishable goods that need to be spent or consumed quickly either.
  • Scarcity. If something is easy to make more of, then you don’t want to accept it as payment or save it for future trades because its value will constantly be declining.

*Note: A good which is scarce, durable, and demanded over time leads it to become a ‘store of value’. This combination of properties is highly desirable for a money to have, because it is ideal for savers wanting to preserve their wealth into the future.

  • Fungibility. A fungible good is something that is self-interchangeable. Not all bicycles are equal in kind and perfectly interchangeable amongst one another, but one ounce of the same quality gold is always equivalent to any other ounce — so gold of the same grade is fungible. This makes it easier to trade with, because standardisation simplifies exchange.

Now, here’s the key insight of the barter theory: goods with stronger monetary properties are, by definition, more optimal for exchange. They are better media of exchange, and so when individuals trade freely, they become increasingly used as medium of exchange because they are preferable to use than goods with weaker monetary properties.

So how does this play out in our little community economy, which uses eggs, gold and copper as the three prevalent media of exchange? Well, we know that eggs, gold and copper can each be used to buy many things. But it’s a whole lot easier to get more eggs from chickens than more gold or copper from mining — eggs are the least scarce of the three commodities. Eggs also break more easily and are not as easy to store as gold and copper over long periods of time (they are the least durable of the three), and they are a lot more difficult to transport the needed quantity of than coins of gold and copper (they are the least portable of the three).

Eggs clearly have the weakest monetary properties out of the popular media of exchange in this economy. Which means that in exchange, if you could pay someone with either eggs, gold or copper — you’d choose eggs. Since the goods with the strongest monetary properties give you a greater guarantee that you’ll be able to trade them for something you want, you’ll want to save them, and only spend them when you absolutely need to. In as many instances as possible, you will give people the least desirable medium of exchange that they are willing to accept. You save the good money, and spend the bad money.

However, in the absence of legal tender laws that force people to accept eggs (the inferior monetary asset) as payment in trade, people will prefer to accept gold and copper (the superior monetary assets) in trade, and will be less reluctant to accept eggs because they know that eggs are less durable, portable and scarce than gold and copper. If you know that your stockpile of eggs is easily breakable, and that the value of eggs is constantly declining because everybody is farming as many as they possibly can to use in trade, then you won’t want to be paid in eggs — you’ll want to be paid in gold and copper instead! So you’ll stop accepting eggs, and start only accepting gold and copper. After enough people think the same way and start doing the same, eggs will become a less and less popular medium of exchange — making accepting them as payment even less desirable for people, because eggs no longer buy them as wide a range of things. So eggs, due to their weaker monetary properties, eventually get driven out of circulation as a medium of exchange.

But this only happens in the absence of legal tender laws. If you were forced to accept eggs as payment, then people would never swap to other money, and the inferior money would remain in use (Gresham’s law) until it became worthless, at which point people would stop respecting the legal tender laws and swap to better money.

Old Woman Selling Eggs, by Hendrick Bloemaert

So. Our little community is now left with gold and copper as the two dominant media of exchange. What happens next? This process continues to play out, but this time with gold and copper. Let’s compare the monetary properties of gold and copper.

Key monetary properties of gold and copper — a comparison

Interestingly, gold is also a status object because of its scarcity and aesthetic value (shiny rock give dopamine), which further increases its desirability to people. Regardless, gold has stronger monetary properties than copper (we can let people argue about whether or not ‘desirability’ or ‘use value’ are monetary properties). And this means that more people will want to be paid in gold than in copper. In this instance, it is because copper’s inferior scarcity makes it a worse means of savings than gold — because any one person’s percentage of the total copper supply will diminish over time as other people easily and frequently mine new copper. So as less and less people become willing to both save and accept copper in trade, copper becomes an increasingly worse medium of exchange than gold — and gradually gets replaced until gold becomes THE common medium of exchange in the economy. And this is how you get money, a common medium of exchange, from the non-credit barter system.

Although barter theorists don’t normally refer to it by name, this process of ‘good money’ driving out ‘bad money’ under free trade conditions is called ‘Thier’s Law’ (side note: Thier’s law is the complement of Gresham’s law. Thier’s law holds in the absence of legal tender laws, whereas Gresham’s law holds when legal tender laws are present). In fact, this process that I just described with eggs and copper (Thier’s law) is the only piece of the barter theory that is really essential. It is all that is needed to explain the origin of money out of exchange within a community, because it can be applied to a society with any number of media of exchange of any distribution of popularity for exchange. The only other thing is accepting the premise that in history people traded with other people in the same community. But again, this exact same process could have played out in gift-debt societies, with certain goods being preferred to be used for paying debts with — and individuals saving and accepting goods which they knew other people preferred to accept as gifts (which would be the goods with the strongest monetary properties) so that they would have them on hand.

Analogously to natural selection, where animals optimally adapted for survival win out in the long run — the money which optimally serves the strongest needs of the population (mainly: exchanging efficiently and preserving wealth) will come to be selected as money.

So, under the barter theory of money, money evolves naturally out of human exchange — without any government intervention or collective leap of abstraction on behalf of the members of society. Goods with superior monetary properties came to be accepted and used as payment in exchange more generally because they were more optimal for exchange. And people accumulated these goods purely because they knew that many others accepted them as media of exchange. Further societal adoption of the superior medium of exchange made it even more desirable to use in trade, because at least you’d know you that if you used it, you were more likely to be able to buy whatever you wanted. And eventually, barter with inferior monetary assets, which included anything that was not a decently popular medium of exchange — dwindled away, and we found ourselves in a situation time and time again where a general medium of exchange — money — had risen to prominence. Barter theorists also like to point out that this explanation is consistent with the adoption of gold and silver as money around the world in very many disconnected societies throughout history, and eventually by the world.

Although there are different variations — this is the essence of the barter theory of money.

Abstracting the selection process of money out of the barter theory

Regardless of what is used as money — when left to the people, money evolves predictably

At its core, what the barter theory outlines is a selection process for how money evolves over time. It uses this selection process to account for the origin of money, but this selection process can be abstracted out of the theory and be understood independently of the barter theory. The simple piece of logic is that over time and in the absence of laws which compel certain media of exchange to be accepted, people will prefer to use and receive goods with superior monetary properties.

Now, irrespective of how money actually came into existence — whether it was through the non-credit barter system or through the gift-debt system or both or otherwise — this monetary selection process is still valid and can be applied to money in an economy. It can be used to explain the evolution of any money over time — such as the tendency of societies to move towards using gold and silver as money throughout history, even if it wasn’t the money they started with — and how the world ended up on the gold standard. The process plays out on the inter-national level as well as on the intra-national level.

So, however money came to exist, we observe that in the absence of legal tender laws, the thing with the strongest monetary properties will eventually come to be used as money because A) the most commonly used media of exchange will go through a self-reinforcing cycle of adoption, and B) in the absence of legal tender laws, strong money drives out weak money because people will prefer to accept superior monetary items as payment. This same selection process can play out in credit-based economic systems — like a gift-debt society using tally sticks as money. What the historical debate about the origin of money really relates to is whether this process first played out in systems based on credit or not. So let’s remember: the logical process by which money evolves still holds true regardless of what the origin of money is. Process of evolution does not need equal theory of origin.

If you want a quick historical example of this selection process instead of hypothetical situations, there are many. Here’s one: when the colonists first came to America, they found that the native American Indians used wampum — clamshells strung onto pendants — as money in a gift-debt system. While the supply of Wampum was always fairly stable among the native peoples, when the colonialists applied their modern manufacturing techniques, they were able to more efficiently produce wampum until they produced so much of it that it became effectively worthless.

Accepting wampum as payment would be giving up your hard earned goods for something that was now extremely cheap to produce. This situation, where the money supply increased, diluting the wealth of everybody else holding it and reducing its exchange value — is called debasement. And it happens time and time again throughout history. We’ll be covering it in more depth in future articles. When you hear the word ‘hard money’, what people are referring to is money that is hard to produce more of. It refers to the monetary property of ‘scarcity’. Money which is not ‘hard money’, which is easy to produce more of, will inevitably be debased over time by whoever has the ability to make more of it. And as we have described, in the absence of legal tender laws, people will stop using weaker money and instead swap to money with stronger monetary properties.

Wampum shells and the associated jewellery-money

Wampum was eventually abandoned and replaced as money by gold. And for the same reasons, weapons, sea-shells, beads, bones, furs, tobacco, cattle and myriad other things were driven out as money time and time again in history. The general trend from the historical evidence is: in the long run, the money with the strongest monetary properties survives.

Thanks for sticking around to learn about the barter theory of money! If you learned something, then please follow for more — in the next and final article of the ‘origin of money’ portion of this series on money, we’ll be covering the framing issue of histories of money, the implication of which theory is true, and a summary on the benefits of money. Afterwards, we’ll cover the mechanics of money before the series starts focusing on the evolution of the monetary system over time.