HOW MONEY BEGINS - The Mystery of Banking

Before examining what money is, we must deal with the importance of money, and, before we can do that, we have to understand how money arose. As Ludwig von Mises conclusively demonstrated in 1912, money does not and cannot originate by order of the State or by some sort of social contract agreed upon by all citizens; it must always originate in the processes of the free market.

Before coinage, there was barter. Goods were produced by those who were good at it, and their surpluses were exchanged for the products of others. Every product had its barter price in terms of all other products, and every person gained by exchanging something he needed less for a product he needed more. The voluntary market economy became a lattice work of mutually beneficial exchanges.

In barter, there were severe limitations on the scope of exchange and therefore on production. In the first place, in order to buy something he wanted, each person had to find a seller who wanted precisely what he had available in exchange. In short, if an egg dealer wanted to buy a pair of shoes, he had to find a shoe maker who wanted, at that very moment, to buy eggs. Yet suppose that the shoe maker was sated with eggs. How was the egg dealer going to buy a pair of shoes? How could he be sure that he could find a shoe maker who liked eggs?

Or, to put the question in its starkest terms, I make a living as a professor of economics. If I wanted to buy a news paper in a world of barter, I would have to wander around and find a news dealer who wanted to hear, say, a 10-minute economics lecture from me in exchange. Knowing economists, how likely would I be to find an interested news dealer? This crucial element in barter is what is called the double coincidence of wants. A second problem is one of indivisibilities. We can see clearly how exchangers could adjust their supplies and sales of butter, or eggs, or fish, fairly precisely. But suppose that Jones owns a house, and would like to sell it and instead, purchase a car, a washing machine, or some horses? How could he do so? He could not chop his house into 20 different segments and exchange each one for other products. Clearly, since houses are indivisible and lose all of their value if they get chopped up, we face an insoluble problem. The same would be true of tractors, machines, and other large-sized products. If houses could not easily be bartered, not many would be produced in the first place.

Another problem with the barter system is what would happen to business calculation. Business firms must be able to calculate whether they are making or losing income or wealth in each of their transactions. Yet, in the barter system, profit or loss calculation would be a hopeless task.

Barter, therefore, could not possibly manage an advanced or modern industrial economy. Barter could not succeed beyond the needs of a primitive village.

But man is in genious. He managed to find a way to overcome these obstacles and transcend the limiting system of barter. Trying to overcome the limitations of barter, he arrived, step by step, a tone of man’s most in genious, important and productive inventions: money.

Take, for example, the egg dealer who is trying desperately to buy a pair of shoes. He thinks to himself: if the shoe maker is allergic to eggs and doesn’t want to buy them, what does he want to buy? Necessity is the mother of invention, and so the egg man is impelled to try to find out what the shoe maker would like to obtain. Suppose he finds out that it’s fish. And so the egg dealer goes out and buys fish, not because he wants to eat the fish himself (he might be allergic to fish), but because he wants it in order to resell it to the shoe maker. In the world of barter, everyone’s purchases were purely for himself or for his family’s direct use. But now, for the first time, a new element of demand has entered:

The egg man is buying fish not for its own sake, but instead to use it as an indispensable way of obtaining shoes. Fish is now being used as a medium of exchange, as an instrument of indirect exchange, as well as being purchased directly for its own sake.

Once a commodity begins to be used as a medium of exchange, when the word gets out it generates even further use of the commodity as a medium. In short, when the word gets around that commodity X is being used as a medium in a certain village, more people living in or trading with that village will purchase that commodity, since they know that it is being used there as a medium of exchange. In this way, a commodity used as a medium feeds upon itself, and its use spirals upward, until before long the commodity is in general use throughout the society or country as a medium of exchange. But when a commodity is used as a medium for most or all exchanges, that commodity is defined as being a money.

In this way money enters the free market, as market participants begin to select suitable commodities for use as the medium of exchange, with that use rapidly escalating until a general medium of exchange, or money, becomes established in the market.

Money was a leap forward in the history of civilization and in man’s economic progress. Money—as an element in every exchange—permits man to overcome all the immense difficulties of barter. The egg dealer doesn’t have to seek a shoe maker who enjoys eggs; and I don’t have to find a news dealer or a grocer who wants to hear some economics lectures. All we need do is exchange our goods or services for money, for the money commodity. We can do so in the confidence that we can take this universally desired commodity and exchange it for any goods that we need. Similarly, indivisibilities are overcome; a home owner can sell his house for money, and then exchange that money for the various goods and services that he wishes to buy.

Similarly, business firms can now calculate, can figure out when they are making, or losing, money. Their income and their expenditures for all transactions can be expressed in terms of money. The firm took in, say, $10,000 last month, and spent $9,000; clearly, there was a net profit of $1,000 for the month. No longer does a firm have to try to add or subtract in commensurable objects. A steel manufacturing firm does not have to pay its workers in steel bars useless to them or in myriad other physical commodities; it can pay them in money, and the workers can then use money to buy other desired products.

Further more, to know a good’s “price,” one no longer has to look at a virtually infinite array of relative quantities: the fish price of eggs, the beef price of string, the shoe price of flour, and so forth. Every commodity is priced in only one commodity: money, and so it becomes easy to compare these single money prices of eggs, shoes, beef, or whatever.


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