The Barter System Was Flawed

“Nobody ever saw a dog make a fair and deliberate exchange of one bone for another with another dog. Nobody ever saw one animal by its gestures and natural cries signify to another, this is mine, that yours; I am willing to give this for that….” – Adam Smith

I’ve been reading Adam Smith’s epic The Wealth of Nations. It’s considered the bible of modern capitalism, and Smith has been coined the “father of economics.” I’ll write a full review of the book at a later date, because it’s worthy of a deeper look. However, for now I want to touch on a point that Smith makes in the book, as well as the reasons behind it.

The currency of a nation should always be tied to a gold/silver standard.

This is a concept that has confused me for years. Why should a country be tied to something that is intrinsically worthless? Food, clothing, shelter…those things have value. But what is gold? A shiny metal – nothing more. So why should the fortunes of an entire nation be linked to it? That discrepancy always clouded my mind.

But Smith helped me understand the concept. Societies began with barter systems. Then, they moved on coin money – the gold standard represents the reserve of this coined money. Paper money then came to represent the reserve of gold/silver. And printing more paper money than you have in reserve is a lie, since you’re stating you have something that you don’t.

Historical Overview

The United States is no longer on the gold standard. Many people cite this as a principal cause for the financial problems of the nation, such as inflation.

On June 5, 1933, the United States went off the gold standard, a monetary system in which currency is backed by gold, when Congress enacted a joint resolution nullifying the right of creditors to demand payment in gold.

Roosevelt took the United States off the gold standard to remedy the economic fallout from of Great Depression. Since then, inflation has rose considerably – note the 1933 prices of a home, for example, as opposed to the prices today.

Roosevelt took the United States off the gold standard. Adam Smith would have condemned him for that.

But why was the US on the gold standard to start with? Smith reviews this in The Wealth of Nations, citing many reasons. To understand the concept fully, we have to go back to ancient times…

The Barter System is Flawed

Older civilizations worked on a barter (trade) system. You went to the central market and traded other people for the things you needed. This was efficient for a small town. However, as towns grew into cities, this system became inefficient.

This system works well in small villages, but it breaks down in big cities.

Case in point: Imagine that you need a pair of shoes. But all you have to trade is a chicken. So you wander the streets, looking for person willing to trade you a pair of shoes for a chicken. You spend three hours trying to make the deal. Then, you finally find someone who likes the deal. But instead of one chicken, he wants two chickens. Frustration ensues. You can see the problem with the barter system.

In short, coined money is an improvement on the older system of “trade economy.” 

Now you can save your coins. Then when you want a pair of shoes, you merely go to the shoe store and buy it. You save time, the society becomes better organized, and everybody is happier.

Smith believed that the coining of money was the marking of a superior culture. In short, countries that were able to coin money became more advanced that those who couldn’t. He uses the Spanish conquering of the Americas as an example:

The Peruvians, though most advanced of all these peoples, had no coined money and operated on a barter system (p. 162).

These Pre-Colombian cultures worked in the trade systems that had died thousands of years earlier in Europe. Smith believed that this was one of the reasons that marked Europeans as “superior” to these indigenous cultures, in the organizational sense. They were able to save people time, which the people could then allot to other pursuits.

Money Must Be “Made” of Something

So what can replace the barter system? Smith points out that precious metals work well because they do not break down (such as meat, vegetables, etc.) and they can be divided and multiplied. In this way, the coining of money is a brilliant thing. It allows for a symbol of wealth to be distributed. And it allows people to earn, save, and then distribute their wealth.

Seen through this lens, the coining of money is one of the most amazing developments in the history of human development. It allowed civilization to place their wealth in non-disposable objects, which could then be saved and used at later dates.

There are many critics of money – see the “money is the root of all evil” quote. However, if looked at comparatively against an inferior system (such as the barter system) we quickly see how valuable it is. And linking this coined money to a reserve supply, such as a gold standard, becomes a solid bedrock for the building of a great civilization.

Conclusion

Every action causes a subsequent action – the evolution of money is a good example of this. The inadequacy of the barter system led people to search for a solution, which they found in the coining of money. This coining then gave value to precious metals: gold, silver, etc.

For those interested in reading the full novel, see the following link: The Wealth of Nations