The Shoemaker and the Hatmaker

Medium of Exchange

By Robert Ringer

Early men bartered with one another for goods and services - i.e., one man would give another his "product" in exchange for a product or service he desired as payment. As you can imagine, this was a rather cumbersome way to do business. Everyone had his own medium of exchange.

The advent of money simplified this bartering process. The purpose of money was, and is, to facilitate exchange. Men could now exchange their goods and services for money, then use that money at a later date in exchange for other goods and services.

Since the beginning of civilization, almost anything one can think of has been used as money at one time or another. In earlier times, this included such items as ornaments, weapons, horses, hunting knives, and even wives. As civilization advanced, mining brought metals to the fore, with gold and silver (especially gold) eventually emerging as the most desirable forms of money.

Gold and silver were durable, easily transportable, subject to precise division by weight, and scarce enough that they could not be obtained in great quantities without considerable effort. In other words, gold and silver were not arbitrarily chosen. They survived the test of supply and demand over the centuries.

Money, then, is not wealth. It is nothing more than a commodity. But it has one great distinguishing feature: It is highly acceptable to most people as a medium of exchange. And in order for people to accept a commodity in exchange for goods and services, they must have confidence that others will, in turn, accept it from them in exchange for things they subsequently will want to acquire.

There are basically three kinds of money:

One is "commodity money," which I have just described: a commodity (such as gold) that is in demand because of its durability, transportability, and so forth, and which usually also has a utilitarian use (e.g., for manufacturing or ornamentation).

A second kind of money is "credit money." Essentially, this is an IOU in exchange for something of value - the promise to pay for the item at a later date.

Finally, there is "fiat money" - anything that a government, unilaterally and arbitrarily, decrees to be money. The normal way that fiat money comes into use is for a government simply to print pieces of paper and proclaim them to be "legal tender," with complete disregard to the factors that have historically made money acceptable to people as a means of exchange.

So, what does all this mean in actual practice?

Let's say a shoemaker has made one pair of shoes and a hatmaker has made one hat. The shoemaker needs a hat, but the hatmaker does not need a pair of shoes. Assuming there is no government fiat money involved, there are two ways these men can trade with one another.

The shoemaker can give the hatmaker an amount of gold or silver (or some other commodity acceptable to the hatmaker) that the hatmaker feels is adequate compensation for his investment of time, labor, and materials. He must, however, feel confident that he will be able to use the commodity he receives to buy something which he believes to be of equal value.

The other possibility is for the shoemaker to give the hatmaker an IOU, promising to repay him with a specified product, service, or commodity at some specified later date. The hatmaker's willingness to accept the shoemaker's IOU will depend on his faith in the shoemaker's ability to make good on his obligation. That is the only way his IOU could be considered a real medium of exchange.

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