Just as the dusk settles on the day and the moon begins to peek through the clouds, Sumita returns home. It has been a successful day for her at the market where she traded her family’s rice for vegetables and clothes so that they may survive the winter.
She utters a silent prayer as she returns home to her family, carrying the supplies they so desperately needed. She got lucky today, considering no one has needed her rice over the past week and the future offers no comfort as she enters her house.
Sumita’s story is one among millions who lived during the age of Barter. Barter refers to the system where two or more people mutually exchange goods or services without the use of a monetary medium.
An essential element to Barter is the lack of a monetary medium as people simply trade goods for goods. All those times where as children we traded lunches? That's barter!
However, in the modern economic world, the concept of barter has been overruled by the concept of Money. Before looking at the pros and cons of both Barter and Money, it is important to understand what the word money means.
Colloquially, the word money is used to denote either how much someone has in physical tender (cash or coins) or bank balance. Economists define the word Money as any commonly accepted medium of exchange with the features of divisibility, relatively stable values and some form of centralization. Each of these words represents an essential feature in understanding what money is.
(Speaking of money, take a look at our blog on Digital Money)
Features of Barter
Looking at the features of barter, we see a certain set of criteria for a system to be considered as barter. Based on whether both parties exchange goods, values of the goods exchanged as well as a rudimentary form of personal credit all play essential roles in understanding what barter is.
Exchange of goods or services: A Barter trade requires two or more parties to come together to exchange goods and services. For example, if a farmer offers his produce to a blacksmith in exchange for a few tools, it qualifies as a barter trade.
Barter trades can even occur between more than two people. If a farmer exchanges his rice with a poultry farmer for chicken and uses that chicken to get the tools he needs from the blacksmith, still barter!.
Absence of monetary medium: During a barter exchange, there is no form of money present or prevalent. If participants exchange goods without the use of any standardised currency, only then is it barter.
Personal Credit: Historically, Barter would require both parties to have the goods or services that the other wants. Many times this wouldn't be possible. Thus came about the system of personal credit.
Personal Credit in this context refers to the interest free credit given to long time buyers or sellers. It involves an element of trust and was the hallmark of the delayed payment system in a barter economy
(Speaking of Credit, check out our blog on Credit Risk)
While the above are often essential to a barter trade, modern barter trade encompasses a lot more with legal and institutional protections for companies and individuals alike. Gone are the days where two parties haggle over the values of their own products.
The modern barter system is most commonly prevalent in a B2B model. In the modern world with consumers and producers increasingly disconnecting from each other to the extent that many consumers don’t even know who they’re buying from, it remains viable only for the barter system to remain among businesses.
Common situations of barter include Online product swaps and deals between businesses. It is common for businesses to offer their services to each other in exchange for a service of their own.
For example, an accounting firm may offer to conduct an audit for a legal firm in return for legal advice. In this manner, both can save the cost of hiring the other and instead mutually benefit from the transaction.
Barter also gains relevance during times of economic distress or hyperinflation where money cannot do its job. In countries such as Zimbabwe where extreme inflation took place, the common people chose barter as goods were exchanged for other goods.
Features of Money
Money, on the other hand, is any medium of exchange that is centralised (usually by a central bank) and relatively retains its value. Money has certain essential features for it to be termed as money:
Common Medium of exchange: Money can only be money if people recognise it as such. When the physical nature of money is examined, it remains to be seen that it is but a piece of paper.
However, when people recognise it as value and accept it in return for goods and services, it becomes a piece of paper worth the blood, sweat and tears behind each of the products produced. This point ties into the fact that money requires centralization.
Centralization: In the Federalist Papers, Alexander Hamilton wrote about the importance of centralization of money supply. For money to be commonly recognised by all and to prevent the problem of refusal to accept payments, a central bank or the government has to play a role.
Historically, all forms of money have been sanctioned by the government and in many cases, the central bank. Only with a legal backing to money can it be used.
Without centralization, money becomes just another good subject to the laws of supply and demand rendering its value highly unstable. Although money is traded on foreign exchange markets, its stability is backed by a government who’s strength rests on the money they house.
Along with centralisation, money also requires legal backing from the government. Money cannot become money unless the law says so and thus arises the concept of legal tender.
(You might want to sneak a peek at our blog on Fiat Money)
Stability: Money must remain relatively stable and not fluctuate in value. This feature becomes important as money aims to solve the problem of goods over time.When a good is traded, its value at that particular time is taken.
Due to the good’s nature, it changes over time. For example, a batch of fresh produce versus a batch of relatively older produce will be valued differently. With this factor combined with the concepts of deferred payments, goods do not retain their values over time.
Money aims to solve this problem as it retains its value over time. The fact that money is often pegged to some other commodity (like gold), gives it a certain degree of stability and in countries where the currency isn’t a free floating tender, the value remains pegged as the government has jurisdiction over the values of their currency.
The above features of money are essential in defining it and consists of a broad spectrum of factors that economists have agreed on to define money. Without these factors, money either loses its value or its importance. Most countries use the above characteristics in defining their central currency.
(Now that we mentioned currency, check out Cryptocurrency)
Money vs Barter System
Despite the barter system's obvious flaws in the 21st century and its lack of universal applicability, it continues to be in use where money cannot be. In a way, barter and money are two sides of the same coin, and when one fails, you flip to the other.
In situations of economic distress, where money no longer holds value and hyperinflation becomes rampant in a nation, the barter system takes precedence and allows people to lead relatively more stable lives.
However, in the normal functioning of the economy, especially in this modern era of globalization and liberalisation, money plays the more dominant role among the two. It is through money that million dollar deals are conducted, employment is generated, and international trade is conducted.
Despite each nation using different systems of money, their relative stability and the fact that their value can be pegged against either gold or the US dollar allows for accurate comparisons and enables easy trade.
However, in rural economies and backwood areas, barter still remains of high importance. Where concepts of money and centralisation remain alien to those in the lower rungs of society, the barter system continues to prevail. To this day, some of the poorest in India continue to trade or ‘barter’ with their belongings for sustenance.
Moreover, in situations where money itself holds no intrinsic value, such as in remote or hilly areas, the barter system tends to prevail. In said areas, it is expensive to use money to buy goods and services, when the cheaper alternative of bartering is available.
The concept of ‘hitchhikers’ proves this: stories of travellers who have worked their way to a meal or shelter proves that the barter system holds its own in some areas. Ultimately, money and barter both hold importance in the modern world. The fundamental difference being money is a lot more universally adopted.
They can be thought of as backups to each other for when money fails, barter steps up. It is interesting to note that both depend on whether or not the people accept it. For governments, banks and economists only hold as much power as the people give them.