In his 1871 book Principles of Economics, the economist Carl Menger described the circumstances in which money is likely to have come about for the very first time “without the need for a special agreement or even government compulsion”.1 That is, the origin of money was, according to Menger, a market phenomenon that spontaneously emerged by “economizing individuals” rather than something that came about by decree of a king or some other political leader.
Even in a barter economy, individuals would still be able to benefit from interpersonal exchange. If Bob has five apples that he is willing to trade for a hammer, and if Alice has a hammer but prefers to have five apples instead, then both individuals can reach mutual benefit by trading one for the other. In this example, we observe direct exchange because both individuals plan to use the item they receive personally. Bob will use the hammer for production, and Alice will use the apples for consumption.
But what if either Bob or Alice do not want something that the other individual is willing to offer in exchange? Imagine, for example, that Alice still has a hammer that she is willing to trade but does not want apples. If Bob has nothing that Alice is willing to accept for the hammer that she owns and that he wants, then we find ourselves observing what is called the problem of double coincidence of wants. In the first scenario, both individuals want something that the other person has, but in this scenario, it is no longer the case.
Once either Bob realizes that he can trade something that he has to someone else in exchange for something that Alice wants, we have moved from direct exchange to indirect exchange. So, for example, if Sam has two coconuts that he is willing to accept in exchange for the five apples that Bob has, and if Bob believes that Alice wants two coconuts, then Bob can trade the apples with Sam for the two coconuts so that he can engage in yet another trade with Alice: the two coconuts that he earned from Sam in exchange for the hammer that Alice has, which she prefers less to the two coconuts. In this indirect exchange, the coconuts are the medium of exchange because Bob happily received them neither for his own consumption nor production use. He accepted the coconuts only because he believed that Alice would accept them for what he actually wanted: a hammer.
Yet despite the two coconuts being a medium of exchange, they are not money. All money is a medium of exchange, but not all mediums of exchange are money.2 Further, what we have observed so far is still a barter economy in which money does not yet exist.
Once we have moved from direct exchange to indirect exchange with coconuts as a medium of exchange but still with no existence of money, Bob may notice that certain other goods work better than coconuts as a medium of exchange. That is, Bob notices that other people more readily accept some goods than others. So if Alice, Sam and others in the community are willing to accept shiny stones and seashells in indirect exchanges, then shiny stones and seashells are both mediums of exchange, but neither of them have achieved the status of money unless one of them becomes commonly accepted.
In this barter economy, each “economizing individual” quickly notices that some goods are more marketable to others as mediums of exchange based on their respective properties. Some goods are not easily divisible or would become worthless if they were divided (such as a spear or an axe). Others are not fungible (seashells). Others are not durable (bread). Some are far from scarce (sand – especially near beaches or in the desert). Others still are less portable (houses).
Menger explains that different goods would compete with one another to become money in such a barter economy based on their marketability in a step-by-step evolutionary process as each person seeks to improve his own situation. Obviously, the relative desirability of one good or another for indirect exchange (how marketable they are) depends on time and place. For example, bitcoin is useless as money on an island with no internet connectivity. But historically, gold and silver have stood the test of time as being incredibly well-suited candidates (highly marketable) for money.
Note that Menger does concede that “the sanctity of the state” for a particular good can indeed help it achieve universal acceptance (and thus help it rise to the status of “money”), but we have no particular reason to believe that the origin of money is due to such state sanctity. In Menger’s words3:
"Money is not an invention of the state. It is not the product of a legislative act. Even the sanction of political authority is not necessary for its existence. Certain commodities came to be money quite naturally, as the result of economic relationships that were independent of the power of the state."
Richard A. Radford was an economist who served in the British military during WWII and was captured and held in a Nazi-controlled Prisoner of War (POW) camp. Radford tells of his experience in observing what he referred to as “a lively trade in all commodities” between prisoners of various Allied powers within the camp. Rather than use sovereign (state-issued) currencies as a medium of exchange, they used the goods they had around them: toilet requisites, clothing, as well as Red Cross food parcel items: tinned milk, jam, butter, biscuits, bully, chocolate, sugar. But cigarettes – especially industrially-rolled cigarettes – spontaneously emerged as a winning money.
Radford writes that despite the “lively trade in all commodities”, prices were quoted not in one commodity for another but in cigarettes. In Radford’s own words: “...one didn’t quote bully in terms of sugar–but in terms of cigarettes. The cigarette became the standard of value”.4 Thus, it was cigarettes that spontaneously emerged due to its relative “marketability” between the available candidates for commodity money within this POW camp.
Although we cannot go back in time to observe the origin of money – the first instance in which a commodity became a commonly accepted medium of exchange – Radford’s paper provides an informative observation supporting Menger’s thesis. Although taking place under the jurisdiction of the (Nazi-controlled) nation state, the spontaneous emergence of cigarettes as money did not come about by decree of any political leader.
1 Menger (2011), pp. 258-259.
2 We shall define money as a commonly accepted medium of exchange.
3 Menger (2011), pp. 261-262.
4 Radford (1945), p. 191.
MENGER, C. (2011): Principles of Economics, Auburn, Ludwig von Mises Institute
RADFORD, R.A. (1945): “The Economic Organisation of a P.O.W. Camp”, Economica, New
Series, Vol. 12, No. 48, pp. 189-201.
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