MONEY AND THE FINANCIAL SYSTEM

The barter system of exchange Origins and evolution of money Today’s class… The barter system of exchange Origins and evolution of money

The barter system of exchange Before money came into being, there was a system of exchange – Barter System. Barter involved the direct exchange of one good for some quantities of another good. However, for the barter system to be possible, there was the need for a double coincidence of wants.

Goods could also exchanged for services. Thus the barter economy was more of a moneyless economy.

Difficulties of the Barter System

1. Lack of Double Coincidence of Wants. Double coincidence of wants is a requirement for an efficient barter system. It was necessary for a person who wanted to trade his/her good or service to find some another person who was not only willing to buy his good or service, but also possessed that good which the former wanted. Exchange becomes a laborious and time- consuming process.

Consequently, if the double coincidence of wants is not matched exactly, no trade is possible under barter.

2. Lack of a Common Measure of Value That is, the lack of a common unit in which the value of goods and services should be measured. Even if the two persons who wanted each other’s goods meet by coincidence, a problem arises as to which proportion of the two goods should be exchanged. So the rate of exchange was arbitrarily fixed according to the intensity of demand for each other’s goods

3. Indivisibility of Certain Goods Difficulty in fixing exchange rates for certain goods which were indivisible. Indivisibility of certain goods made the barter system broke down.

4. Difficulty in Storing Value The commodity may become obsolete or deteriorate in value during the period of storage. As people trade in cattle, grains, and other such perishable commodities, it was very expensive and often difficult to store such commodities and to prevent them from deteriorating and losing their values over the long period of storage.  

5. Difficulty in Making Deferred Payments. As payments were made in goods and services, debt contracts were not possible due to disagreements on the part of the two parties on the following grounds: 1. It would often invite controversy as to the quality of the goods or services to be repaid.

2. The two parties would often be unable to agree on the specific commodity to be used for the repayment.

6. Lack of Specialization The barter system was associated with a production system where each person was a jack-of-all –trades. Specialization and interdependence in production was only possible in an expanded market system based on the money economy.

The Evolution of Money

The word “money” is derived from the Latin word “Moneta” which was the surname of the Roman Goddess of Juno in whose temple at Rome, money was coined. The origin of money is seen in ancient times.

Even the primitive man had some sort of money. The type of money in every age depended on the nature of its livelihood. In a hunting society, the skins of wild animals were used as money. The pastoral society used livestock, whereas the agricultural society used grains and foodstuffs as money.

The Greeks used coins as money. Let’s now look at the stages in the evolution of money.

Stages in the Evolution of Money The evolution of money has passed through the following five stages depending upon the progress of human civilization at different times and places.

Commodity Money Various types of commodities have been used as money form the beginning of human civilization. Stones, spears, skins, bows and arrows and axes were used as money in the hunting society. The pastorals society used cattle as money.

The agricultural society used grains as money. The Romans used cattle and salt as money at different times. Precious stones, tobacco, tea, shells, fishhooks, and many other commodities served as money depending upon time, place and economic standard of the society.

With the spread of civilization and trade by land and sea, metallic money took the place of commodity money. Many nations started using silver, gold, copper, tin, etc as money. However, metal was an inconvenient thing to accept, weigh, divide and assess in quality. For that reason, metal was made into coins of predetermined weight.

Thus coins came to be accepted as a convenient method of exchange. As the price of gold began to rise, gold coins were melted in order to earn more by selling them as metal. This led governments to mix copper or silver in gold coins so that their face value might be more than their intrinsic value.

Paper Money The development of paper money started with goldsmiths who kept strong safes to store their gold. As goldsmiths were thought to be honest merchants, people started keeping their gold with them for safe custody. In return, the goldsmiths gave the depositors a receipt promising to return the gold on demand.

These receipts of the goldsmiths were given to the sellers of commodities by the buyers. Thus receipts of the goldsmiths were a substitute for money. Such paper money was backed by gold and was convertible on demand into gold. This ultimately led to the development of bank notes.

The bank notes are issued by the central bank of the country. With time, there was a gradual decrease in bank notes backed by gold to fiat money (which is inconvertible and it is accepted as money because it is backed by law)

Credit Money Another stage in the evolution of money in the modern world is the use of the cheque as money. It is simply a written order to transfer money. The cheque is like a bank note, in that it performs the same function. However, checks expires with a single transaction. large transactions are made through cheques these days and bank notes are used only for small transactions.

Near Money The next stage in the evolution of money has been the use of bills of exchange, treasury bills, bonds, debentures, savings certificates, etc. They are known as “near money.” They are close substitutes for money and are liquid assets. So money has somewhat become intangible and its ownership is now transferable simply by book entry.

E-Money The final stage in the evolution of money is e-money. E-money is the form of money that exists in electronic form. The introduction of electric payments technology as a means of transacting business has not only substituted for cheques but also for cash as well in the form of electronic money (e-money).

Examples of such e-monies include credit cards, debit cards and smart cards. Debit cards (which are almost similar to credit cards) are used by consumers to make payments by electronically transferring funds from an individual’s account to trader’s account.

The smart card (for example, the e-zwich) is a type of store- value card that contains a computer chip at allows it to be loaded with digital cash from the owner’s bank account whenever needed.

Trial Questions Money has moved from commodity to near money. Explain the stages of this evolution What are some of the commodities used as commodity money? What is the difference between cheque and money? What is the barter system? Explain how the barter system operated. Mention and explain some of the difficulties of the barter system.