an individual point of view, every
trading transaction has two parts. In the first part I sell
something, which I no longer want, in exchange for money. However, I really
don’t want money. I want something else that I can use. I use the
money to buy the thing that I really want. The full transaction is not complete, until I
have bought it. Buying is the second part of the
consists of two parts: selling and buying. After the
transaction is complete, I am better off
because I have replaced something that I did not want with something
that I wanted more. Both
buyer and the seller are better off, because they end up with
something they value more than what they gave up.
A link with the
first part of the transaction that allows the second
part of the transaction is essential. In the example above,
money provides the link between the two parts. When I sell my goods, I accept money in return,
because I expect that I can use the money to get what I want
to complete the transaction.
I only hold the
money for a short time. I start with something I did not
want. I end up with something that I wanted more. The money is
my security for the short time between the first part of the transaction
and the second part. Money allows exchanges to to
Holding money is
quite risky. Once I have handed over my thing to the buyer, I
cannot get it back, but I cannot be certain that I will be able to
buy the thing that I want with the money. If no one will
accept the money in exchange for what I want, I will be left with nothing useful (I did
not want money). Once I have made my purchase, the risk is
gone, because I have the thing I wanted. The risk has passed
to the person who takes the money from me.
The possession of money is a sign to other people in the society that
a seller has completed half of his transaction, by giving up something. It
allows him to buy something from someone else to complete his
transaction. Money is a record of a half-completed transaction.
The main risk during trade that my money will not be accepted. I don't want to get
into a situation where I cannot complete the second part of my transaction. If I
am unable to complete a transaction, I bear the cost.
Therefore, I will only get involved in trading, if there a record of half-completed transactions, that is
honoured by other members of society. Money is a
widely recognised record of a half-completed
To understand how this can work, imagine eight people on an
island. They have no money system, so they do all their trading by
barter. They live a long way from each other, so barter is only
practical with the person who lives on either side. For example, B
can only have regular contact with A and C, so the opportunities
for barter are very limited.
Each person has gone out and done what they do best, so each one
has a surplus they can trade for other things. B wants what A has. C wants what B
has, D has what C has, and so on round the circle. The problem
faced by this small society is to come up with a way of trading with
each other, so that each person ends up with what they want.
blue arrows represent the direction that the surpluses need to move
for each person to get what they want. This could be achieved by each person
giving his surplus to the
person on his right. However, there is no easy way for this to
happen, as no one would be willing to give up their surplus, because
they would have nothing left to barter with. They would have no way
of getting back the things that they want. Something
different will need to happen, or trade will not start. There are several possibilities.
A may simply give his surplus to B. This might inspire B to give
what he has to C. C might also give what he has to D. If this
generosity went right round the circle, they might all end up with
what they wanted. However, this level of generosity would be very
unlikely. Even if A was generous, the chain of generosity would most
likely break down somewhere. Then anybody further round the chain
would still be left with the surplus they did not need.
The yellow blobs represent goods received. A would be worst off,
having lost his surplus and receiving nothing back. The risk of this
happening would be a strong incentive against generosity. Even if A
tried it once, he would be unlikely try it again.
There might be some commodity that all eight people used
regularly, eg bread or potatoes. If they all used this commodity, it
would be of value to them all.
A might also have some surplus bread. He could trade this bread
with H for some of the goods that he wanted. H might take the bread,
because he would know that he could find someone who would trade their
surplus for the bread. H could then trade with G to get what he
wanted in exchange for the bread. This could proceed right round the
circle. The blue arrow shows the movement of the surplus
goods. The green arrow shows the movement of the bread. Each person would give up their surplus in return for the
bread, knowing that they could trade it with someone else.
Eventually, B would give the bread to back to A, in exchange for A’s
surplus that he really wanted.
Everybody, would end up with what
they wanted. A would end up with some well handled bread and would
be lucky is someone had not taken a few bites on the way round. At
least he would be able to get the goods that he wanted from H.
A might work extra hard and find a small nugget of gold, which
would be of value to everyone on the island.
He could trade this
gold with H, for some of the goods that he wanted. H would take the
gold, because he would know that he could find someone who would
trade their surplus for the gold. H could then trade with G to get
what he wanted in exchange for the gold. This could proceed right
round the circle. The orange arrows show the movement of the
gold. Each person would give up their surplus in return
for the gold, knowing that they could trade it with someone else.
The yellow blobs represent goods received. Eventually, B would give the gold to back to A, in exchange for A’s
The goods would flow found the circle in one direction. The gold
would move around the circle in the other direction. It would
eventually get back to A, who found it.
Everybody would end up with what they wanted. A would have get the goods that
he wanted from H and would also get
his gold back. Being a metal it would not be damaged, but there
would be a risk that someone would file some gold off the
There would be four problems with this situation
- Trade would only start if A wanted to trade. If A did not
want to trade nobody else would be able to trade. This would
give too much power to A.
- Trade could break down at any point on the circle. If D
decided the gold was worth more to him than what he wanted
from C. He might keep the gold, and not trade with C. This
would give him the power that A previously had. However, C and
B would be left in a position where they could not trade.
- The trade round the circle might be too slow. It might take
too long for the gold to move round the circle. B and C would
get very frustrated, because they could not trade when they
wanted to. (The velocity of the gold might be too slow.)
- If A found sufficient gold, he might go to each of the other
people and buy their surplus. This would leave A in
better position. The other people would not get
the goods they wanted, but they would have some gold.
Everyone has some Gold
When the other people see that owning some gold gives some
advantages, they might all want some gold. They might go and find
some gold for themselves. If A was the only one who knew where to
find the gold, the others might have to barter with A to get some
gold. Once half of the people had some gold, the trading situation
A C E and G could go and exchange their gold for the surplus
goods with B D F and H, respectively. B D F and H would then hold
They could then exchange their gold for surplus goods with
C E G and A.
Everyone would then have the goods that they wanted. A
C E and G would have received back their gold.
The benefit of this
solution is that trading is sped up, so that people will be able to
do more than one exchange in a day. This increase in trade, will
make the society more efficient.
There are some problems with this solution.
- People will put a lot of effort into searching for gold.
While they are looking for gold, they will stop producing the
surpluses that other people want. Time wasted searching for
gold may reduce the overall welfare of the society, because
less goods will be produced.
- Unless people are willing to give up their ability to buy
goods, the gold always ends up with the person who had it at
the beginning of the round of trading. Like the bread it ends
up where it started. Apart from enabling them to trade, the
gold does not add to their welfare. The society would be better off, if they
could find a way of trading without gold.
- The system would be vulnerable to theft. People might debase
the gold by mixing it with other minerals. Society would need
a legal process for punishing people who committed theft in
this way. (The most common method has been to give the king a
monopoly on issuing coins. This has not worked well, because
throughout history kings have been the worst offenders at
- People would have to put security systems in place for
protecting their gold from theft. They would be particularly
at risk when moving away from their home base to do trade.
This risk could be reduced by people placing all their gold
into a security store and exchanging gold receipts when they
are trading. (This is the origin of the modern banking
- Some days only one or two people may want to trade goods. On
those days most of the gold will be sitting idle. On some days
people may want to do a lot of trading. On those days their may
not be enough gold to facilitate all the required trade. In
general the optimum amount of gold will not be available.
The amount of gold in circulation in society (the supply of
money) will become a
significant issue. If there is not enough gold, trade
may be slowed down. Apart from the slowing of trade, a
shortage of gold will not be a serious problem. If there
is too much gold, several people may want to buy the same surplus
goods. A situation could develop, where all eight men
want to buy the entire surplus of the other seven. If there is
two much gold the price of the surplus goods will increase.
Prices will generally rise until the value of the goods available
matches the amount of gold.
An independent clerk might arrive on the island and set up system
for recording trading balances, like that described in the parable (Beeble).
The pattern of trade would work like this.
All previous exchange had been by barter, so each person would
start with a balance of zero. A C E and G could go and buy surplus goods from B D
F and H, respectively. The clerk would record positive balances for
B D F and H.
B D F and H could then go and purchase some surplus goods from
C E G and A. Their positive balances would be the proof that would
entitle them to purchase from C E G and A.
The clerk would subtract
from the positive balances of B D F and H. He would add to the
negative balances of C E G and A. All balances would return
to zero. Everyone would then have the goods that they wanted.
The clerk may make a charge for this service. However, an
efficient computerised recording system would reduce the cost of any
transaction to almost zero. The price for the service would be very
low. It would likely be cheaper than searching for gold.
This approach achieves the same result as using gold.
- Exchanges would be very efficient. There would be no
restraints on busy days due to shortage of gold. The only
constraint would be ability of the recording system to record
- The wasted effort that went into searching for gold would no
longer be required. People will be able to concentrate on
producing goods and services that other people on the island
- Any person can initiate a round of trade. So no one is given
the power, that went to the person mining or own gold.
This system has just three limitations, but they are easily
- A dishonest person might allow their balance to go negative by
buying some goods and then refuse to sell anything to anyone
else. They have effectively stolen from someone. This crime is easy to
deal with, because their theft has been recorded. There would be
a strong incentive preventing people from doing this. They would
not be able to trade again, as the clerk would refuse to deal
with them until they sold something that would return their
balance to zero or positive (plus any penalty for theft). They would be outlawing themselves
from society. Very few people would risk doing this.
- A dishonest clerk would be a serious problem. He could change
some of the records in his favour, or accept a bribe to change
another person's record. A legal process for punishing
a clerk stealing in this way would be essential. However, the
best protection would be competition amongst clerks. This would
make stealing a risky business. A clerk, who was dishonest,
would destroy his business, once he was exposed. People could be switch to another
clerk, with a better reputation. Each clerk would need to guard
his reputation carefully. One way to build a reputation would be
to keep the books open to scrutiny by other clerical experts.
This scrutiny and the risk of being caught being dishonest would
tend to keep the clerk honest. This competition among clerks
with respect to honesty would be very important. If the king
gave one clerk monopoly rights, this protection would break
- Trade could only occur in places that were connected to the
clerk’s recording system. With modern communications networks
linking computers, this is not a serious limitation.
With this system there is no concern about the supply of money.
Every transaction involves two people. One person's account
has the price added to it. The other person's account will
have been debited by the same amount. The total balances
will at all times sum to zero.
I have just shown the transactions that occur on one day.
At the end of round of trade, every person has a balance of
zero. (The money supply would be zero). The same pattern could be repeated on
subsequent days. In reality, a full round of the transactions may not be completed
in a day. At the end of the day some people might be positive
and others would be negative.
Some times, if a lot of people have not completed all their
trading, the value of positive accounts will be quite
high. This does not matter, as they will be balanced by other
negative accounts. At other times they may go down close to zero, if
most people have completed both their selling and
buying. However, at all times total balances would still sum to
zero. (The so-called money supply does not matter).
I have assumed in each option above that all exchanges are equal
value. In practice, this would not be the case. People would want to
make exchanges of different value. In a gold system, the gold would need to be in coins of different
denominations to allow exchanges of different value to take place.
With the transaction recording system, the clerk would just
record the appropriate value for each sale. The only limitation
would be on the number of decimal places the clerk’s system could
(For simplicity I have ignored saving, but this can also be dealt
with be adding a timestamp to the clerk's records. This is
explained in my article on money).
The clerk will allow all eight people who live on the island to
go negative when buying goods provided they have a reputation for
honesty. However, they will have to get
back to zero or positive within a few days. Every one who is
honest will have this privilege. The value
by which they can go negative will be determined by a formula
based on their trading history and record of payments. If they
do not get back to zero as required, they are effectively stealing
from someone. They would have to go positive before they could
trade again or they would have lose the privilege of going
negative. Foreigners would not have this privilege as their
reputation would not be known.
The privilege of going negative is a form of credit. The
clerk is not giving or creating credit, as credit is something that an
honest person already has. The clerk just acknowledges their
honesty and reliability (credit). The person allowed to go
negative must have a reputation for honest dealing in trade.
are creditable so they have credit. The clerk just recognises their
reputation (credit). If they do not go back to positive, they will
quickly lose their reputation. Their credit will disappear. They will
become a discredited person and will lose the privilege of being
able to trade by going negative first.
The clerk would have to be careful about allowing people who are
not creditable to go negative, as it would destroy his business.
The business is dependent on honesty being maintained. The clerk will have a role in assessing the credit of
people who are trading, as if he allows people to be dishonest the
consequence will be worse for him than for he fraud. To protect their business they would
have to be very cautious in recognising credit.
Credit card companies already carry out this function. They give
new clients a small credit limit. They allow these clients to go
negative. As clients prove to be creditworthy, they increase their
credit limit. This allows them to go negative further.
We often say that the bank has given us credit. This is
incorrect. Banks do not give us credit, they recognise the credit
that we already have established for ourselves through honest and
Each honest person on the island will have credit that will be evident
to the clerk. They will all be wanting to increase their
credit as much as possible by practicing honest and reliable behaviour.
They will not be interested in living in debt, but will only go
negative to facilitate trade. Their reputation for honesty
will always far outweigh the value of their temporary negative
The total value of
the credit available will not matter, because most people will never
use all the credit. The volume of trade will not be determined
by the total credit of the people, but by there ability to
pay for their purchases. People will have to limit their total purchases to
what they can sell, so that they do not lose their credit. A
person who loses their credit, will be limited to selling before
they can buy. Those who have credit will have the option of
buying before they sell. This will enable them to get better
bargains, so their credit will be something they value highly.
People who have the great credit will guard it more carefully,
because they have the most to lose.
This system will benefit those who have proved they are honest,
because they will have greater choice and opportunity to make the
This system does not need everyone to have credit. In the
example above, on half of the population went negative.
An even smaller proportion of honest people will be sufficient to
get trade started.
Those who are dishonest will be able to survive. They can
still buy and sell, but they will always have to go positive before
they can make any purchases. Dishonest people will still be able to
participate in trade, but they will be forced to sell (or work)
before they can buy. They will forced to trust others.
If a modern banking system was transformed to work on these
principles, most people would start with positive balances in their
accounts. Therefore, allowing people to go negative
would not be such an important issue. It might be
required as trade expanded and the population grew, but generally it
would be taken care care of by declining prices.