From Barter to Banking, the Evolution of "Honey into Money".

By Chris Lind www.ChristopherLind.com

Part I: The emergence of money, the evolution of a commodity into money

It is difficult to conceive of, yet it is a fact, that money itself is a technology.
Like all technologies, there was a time when money did not exist. What did exist was barter.
Say Bob has fish and Jones has apples. If Bob wants apples, he can do one of several things. One possibility is for Bob to grow his own apples. Another possibility is for Bob to trade Jones fish for apples. Trade itself is a form of technology. For Bob, it is a technology that transforms fish into apples.

If Jones does not like fish, Bob must find out what Jones does like. Say Jones likes spam. Bob must find a third person who has spam and also happens to want fish. When he does, Bob will trade fish for spam, and then trade Jones spam for apples.

The problem that Bob had with Jones is that Jones did not want Bob's fish. This sort of problem is prevalent in any society that relies on barter. In economics, this problem has a name. It is called the problem of a "double coincidence of wants". This phrase describes a situation where 2 people each happen to want what the other person has. Bob solved this problem by indirect exchange. Bob had to trade with a 3rd party for an item he did not want, and then trade that item for the product he did want.

As you might imagine, this process of indirect exchange can be very inconvenient. In the course of his day to day bartering, Bob may notice that people tend to prefer honey in trade over other items. He begins trading his own goods and services for honey. Bob does this, not because he likes honey, but because he knows that honey can be more readily traded for what he does want, than what he could obtain by directly bartering with his own goods and services.

This sets up what is known as a positive feedback loop. Increased use of honey in barter, causes Bob and others to begin trading their goods and services for honey, not because they like honey, but because they know that the honey can be readily traded for what they do want. This causes even more people still to begin trading and bartering for honey, until finally Bob's whole community is bartering and trading, not for what they do want, but for honey. They then take the honey and trade for what they do want.

I have just described to you, the evolution of honey into money.

Any economics textbook will tell you that money is anything that:

1) Serves as a medium of exchange
2) Provides a standard measure of value of goods and services
3) Provides a method of storing value

Honey started out in Bob's community as merely a food that some people enjoyed eating. Gradually over time, with no one person or group of people sitting down to invent the concept of money or engineer / design money, honey is now being used in this community to provide all 3 of these functions.

Honey is being used as a medium of exchange. Bob happens to be allergic to honey. Yet he now accepts honey as payment for his fish. Why? Because he, along with the rest of his community, has learned that honey is readily accepted as payment for any good or service you would want to buy.

Honey acts as a standard measure of value. In a pure barter economy, answering the question, "how much is that doggie in the window?" is not very easy to do. Should the pet store accept as payment 500 pairs of socks for 1 dog? 30 cans of spam? Has the business made a profit or loss by choosing to accept socks as payment for the dog? It is difficult to say. The problem is that in a barter economy, a good or service such as a dog does not have one price, but a potentially unlimited number of prices, each in terms of what the good or service could be traded for. With everyone buying and selling using honey, however, each and every price is in terms of ONE thing, mass (or weight) of honey.

Honey provides a method of storing value. Bob's fish aren't going to last forever. In short order, they will spoil and become worthless. Trading fish for honey allows Bob to actually store the value of his fish, and therefore, the value of his labor. 5 hours of fish farming on Wednesday can be stored for months in 80 pounds of honey.

In short, Honey has BECOME money. What is particularly noteworthy about the evolution of honey into money, is that the entire "evolutionary process" was driven by intelligence. Intelligent decision makers such as Bob, acting as "Judges" in a sort of survival of the fittest competition among competing methods of payment, simply preferred honey in trade to other goods. They preferred honey because they had learned from experience that honey was easier for them to trade for goods and services they did want. This is a process of natural selection, with Bob and every other buyer and seller in the community acting as the "selectors". What makes this process evolutionary is that although the selectors are intelligent, not one of them realizes they are taking part in the creation of money. The whole process is without design. No money engineers, money architects, or money inventors are required. Nor was it necessary for Bob or anyone else to know about concepts such as medium of exchange, measure of value, or store of value.

What is even more amazing, is that REAL LIFE examples of "honey evolving into money" occurred more than once in the 20th century!

It happened in POW labor camps in WWII and it happened again in the late 1980's in Moscow as the Soviet Union was breaking up. In both instances, a community of people were forced into a situation where the only method of buying and selling goods was barter. In POW camps, the prisoners were stripped of their money. As food, cigarettes, clothing, and anything else was bartered for among prisoners, cigarettes gradually emerged as money through a process of natural selection.

In Moscow in the late 1980's rampant inflation made the national currency, the Ruble, virtually worthless. People simply stopped accepting the Ruble as payment for goods and services, and much of Moscow's economy reverted to a system of barter. Employees of bicycle shops, for example, were paid in Bicycles. Ditto for employees of other industries. The 5 day work week was quickly reduced to the 3 day work week, as days 4 and 5 were spent by employees attempting to overcome the problem of a double coincidence of wants. Cigarettes quickly evolved into money by a process of natural selection. There were no government sponsored ads encouraging people to prefer cigarettes over rubles, nor was it necessary for a person to understand concepts such as medium of exchange. All that was necessary was for people to feel the very real pressure of trying to buy food, clothing, and rent with a bicycle. I first learned of the POW cigarette money in the text book "What has government done with our money" by Murray N. Rothbard.

Rothbard's textbooks can be downloaded for free at http://www.mises.org/studyguide.aspx?action=author&Id=299

I later rediscovered this example, as well as the example of cigarettes being used as money in Moscow, in the economics textbook "Brief Principles of Macroeconomics" 3rd Edition. By N. Gregory Mankiw. Page 222.

Mankiw's websites are: www.whitehouse.gov/cea/mankiwbio.html
and http://post.economics.harvard.edu/faculty/mankiw/bio.html

Cigarettes and honey are both commodities.
The process of evolution of a commodity into a money is general and universal. It occurs anytime a large group of people trade goods and services under the conditions of barter.This process can be broken down into 5 simpler parts:

1) The "selection pressure", the force driving the natural selection process, is the problem of a double coincidence of wants.

2) The selectors are the intelligent decision makers trading goods and services via a process of indirect exchange.

3) These selectors, guided only by experience from past transactions, will select from among competing methods of payment, those commodities that can be most easilly traded for other commodities and services.

4) An understanding of the fundamental concepts of money i.e. medium of exchange, measure of value, and store of value are NEVER required at any stage for this process of selection to occur. The selectors are driven only by their desire to make life easier on themselves.

5) Increased selection of one commodity as a method of payment will only increase its "preferrability" as a method of payment in the eyes of the selectors. This causes a positive feedback loop to occur, causing even more selectors to select this commodity as a method of payment. The end result of this process is that over time, an entire population of people are now buying and selling their goods and services in exchange for that single commodity only. By definition, this commodity IS money, whether the selectors are aware of it or not. When a commodity is used as money, the money is called "commodity money". Among primitive tribes, everything from shells, to cattle, to cocoa beans have been used as commodity money. Gold and silver were used as commodity money in America right up to the beginning of the 20th century.

I will now trace the evolution of commodity money into paper money.

Part II: The origin of banks and the evolution of commodity money into paper money

Let's say you're a successful business owner living in a community where honey has emerged as a commodity money. Through hard work and shrewd business deals, you have amassed a small fortune in money...50 pounds of honey!

You don't want to worry about thieves breaking into your house and stealing your honey, so you take your honey to a warehouse for safekeeping. The warehouse charges you a small annual fee for their services.

The warehouse gives you a receipt for the honey you have deposited with them. This receipt has the words, "Will pay to the bearer on demand 50 pounds of honey".

At this point, your 50 pounds of honey have been completely removed from circulation, under lock and key in a warehouse. In place of the honey, you now have a paper receipt, which you can present to the warehouse at any time for your honey.

The warehoue has been in business for quite some time. People know from experience that the items they deposit at the warehouse will still be there months or years down the road when they need them again. The warehouse has a reputation of trustworthiness in the community.

The next day, you happen to see a television set worth 50 pounds of honey that you'd like to buy. You start to head down to the warehouse to redeem your honey, but then stop, struck with a sudden thought.

Perhaps the television owner would be willing to accept the warehouse receipt as payment for the television. The television owner could then take the receipt to the warehouse at their leisure and redeem the receipt for the 50 pounds of honey.

The television owner agrees! You pay the former owner of the television your 50 pounds of honey paper receipt, and they give you the television.

Paper money has just been born.

This type of paper money is called Receipt money, because it is literally a receipt, or certificate, for a tangible physical good that exists. There are 2 factors which will cause the entire community to soon accept paper receipt money in their day to day business deals.

These factors are:

1) Convenience. It is much easier to carry around a piece of paper than 50 pounds of honey or some other commodity.

2) Trustworthiness. The community trusts that the paper reciept or certificate actually represents the tangible good printed on the paper. In the previous example, if the television owner suspected that the reciept would not be able to be redeemed for the 50 pounds of honey, no trade would have taken place.

The use of paper money which meets these 2 criteria will cause a positive feedback loop to occur. Increased use of paper money will cause even more people still to accept and use paper money in trade, until eventually the entire community is buying and selling goods and services not with a commodity, but with pieces of paper representing that commodity.

In order for paper money to emerge in a community, both convenience and trustworthiness are of equal importance. In order for people to begin accepting peper as money, the paper MUST represent an actual tangible commodity already in use as money. Think about it. If I went up to you and offered to you with 15,000 pieces of monopoly money, and offered to buy your car with the money used in the board game, would you accept the offer? You would not, and neither did the people who first accepted paper money as payment for goods and services throughout history, first in China, then in Europe, and finally in the American colonies of the 17th and 18th centuries.

The evolution of commodity money into paper in China
Paper money first arose in China around 800 AD during the T'ang Dynasty. Prior to the existence of paper money, a merchant selling his goods in the city of Szechuan, risked loss by theft as he transported his commodity money and unsold goods back to his home city. As a way of earning revenue, the Chinese government, in posession of fortified strongholds in each city to store tax revenues, offered the following service. For a fee, a merchant could deposit their gold and silver coin with the government in city A. In exchange the merchant received a paper receipt for the gold deposited. When the merchant arrived back home at city B, he could go to the treasury of that city to redeem his paper reciept for the commodity money in use. Over time, as people learned that the commodity represented by the paper would actually be there, merchants began buying and selling with the paper receipts themselves.

This set up a positive feedback loop, driven by the convenience of using paper representing say 50 or 100 pounds of silver, rather than the actual silver itself. The result of this feedback loop is that eventually entire communities of people were buying and selling using paper money.

The chinese called this paper money Fei Ch'ien or "Flying Money".

The evolution of commodity money into paper in America
Paper money first appeared in America in in the late 17th century. In 1690, the government of the Massachusetts Bay Colony, in an effort to increase government spending while avoiding the unpopular act of raising taxes, began printing paper money to pay for its expenses. To convince the Massachusetts Bay colonists to accept the paper as payment, the government promised to redeem the paper in gold and silver coin collected in taxes at a later date. It also promised to never print paper money again. While both promises were quickly broken by the government, is is interesting to see that, again, what caused people to begin accepting paper money as payment for goods and services, is the understanding that the money could ultimately be redeemed for tangible wealth in the form of the commodity money in use at the time.

Below is a picture of Massachusetts Bay Colony, issued in 1776. Notice the promise to pay to the "bearer of the paper, One Shilling out of the Treasury of the State by October 18, 1781".


During the American Revolution, in order to finance the war, an american government once again resorted to printing paper money to pay for its' expenses. In 1777, the Second Continental Congress printed $13 million dollars worth of paper bills called Continental Currency. Once again, in order to convince the people to accept the paper money, a promise was made to redeem the notes in gold or silver, the commodity monies in use at the time.



Receipt money continued in use in the United States right up until the middle of the 20th century! Below are two Federal Reserve notes, both depicting the words, "Pay to the bearer on demand". The first is picture is a picture of a $10 dollar bill from 1941. The second is a picture of a $5.00 bill from 1950, only 55 years ago!


Federal Reserve Note. 1941.


Federal Reserve Note. 1950.

Take a Federal Reserve Note out of your wallet and look at it. What words do you find missing from the note? The reason that the words "Pay to the bearer on demand" have been removed represents the next stage in the evolution of money. This is the evolution of reciept money into both fractional and fiat money.