This is “Better to Have Had Money and Lost It Than to Have Never Had Money at All”, section 3.2 from the book Finance, Banking, and Money (v. 1.0). For details on it (including licensing), click here.

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3.2 Better to Have Had Money and Lost It Than to Have Never Had Money at All

Learning Objective

  1. What usually happens when money is absent in an economy?

To further appreciate money’s importance, consider what happens when it is absent—universal distress, followed quickly by money’s reintroduction or reinvention! After World War I, for example, the German government created too much money too quickly. Hyperinflation, a very rapid rise in the prices of all goods, ensued. Prices increased so fast that workers insisted on being paid twice daily so they could run, not walk, to the nearest store to buy food before their hard-earned wages became worthless. Before the hyperinflation, it was said that you could buy a wheelbarrow full of food with a purse full of cash. During the hyperinflation, you needed a wheelbarrow full of cash to purchase a purse full of food. At the end of the debacle, you kept the wheelbarrow at home lest your most valuable asset, the wheelbarrow, be stolen! At the end of the crisis, the German economy was on a barter basis, but only briefly before currency reforms stopped the inflation and restored a money economy.

Stop and Think Box

During its most recent financial crisis, in 2001–2002, Argentina faced a severe shortage of its money, called pesos. Private firms responded by setting up giant flea markets where goods were priced and paid for using the firm’s notes, which in most instances were called creditós. The creditós could be used in subsequent flea markets run by the issuing firm but not in markets run by other firms. Creditós had very limited circulation outside the flea markets. As soon as the peso crisis passed, the firms stopped running flea markets and no longer honored the creditós they had issued. What happened in Argentina?

A new form of private credit money spontaneously arose to fill the vacuum created by the dearth of pesos. Although not as liquid or safe as pesos, creditós were far superior to barter. The end-game default can be interpreted as seigniorage, the profit the issuers of creditós exacted for providing money to local Argentine communities.

In prisons, prisoner-of-war camps, and other settings where money is unavailable, inmates quickly learn the inadequacies of barter firsthand and adopt the best available commodity as money—a medium of exchange; unit of account; a store of value; and even, to the limited extent that credit is available in such circumstances, a standard of deferred payment. Packs of cigarettes often emerge as the commodity moneyForms of money that have intrinsic value as a commodity. of choice. (Talk about one’s fortune going up in smoke!) There are good economic reasons for this preference. Although not perfect, cigarettes are a serviceable medium of exchange. First and foremost, sealed packs of cigarettes are easily authenticated because it would be extremely difficult to counterfeit or adulterate them, especially under prison conditions. Although they differ somewhat from brand to brand, they are also relatively uniform in quality. If you gave up a bar of soap for two packs, you could rest relatively well assured that you were not being cheated. Second, cigarette packs are divisible, into twenty individual cigarettes, or “loosies,” without giving up much of their ease of authentication. (A loosie is easier to adulterate than a sealed pack, say, by replacing the tobacco with sawdust, but is still not easy.) Divisibility is important because supply and demand might well dictate an equilibrium price that includes a fraction of a pack, just as it often leads to prices that are a fraction of a dollar ($), yen (¥), euro (€), or pound (£). Individual cigarettes are also somewhat divisible but only when filterless or when consumed. One might, for instance, sell a good blanket for four packs, two loosies, and five drags or puffs.

Cigarettes also have relatively high value-to-weight and value-to-bulk ratios. In other words, they are relatively valuable given their size and weight. That portability is, of course, important to their function as a medium of exchange. Although they eventually go stale and can be ruined if smashed or drenched in water, sealed cigarettes packs are durable enough to also serve as an intermediate term store of value. The elasticity of the supply of cigarette packs is volatile, however, because smokers find it difficult to quit smoking, no matter the price and the fact that the quantity of packs in circulation depends on shipments from the outside world. In modern prisons, this is less of a problem, but in prisoner-of-war (POW) camps, sudden gluts caused the prices of goods (noncigarettes) to soar (that is, the value of cigarettes plummeted), only to be followed by long periods of deflation (lower prices for noncigarettes) as the supply of cigarettes dried up and each cigarette gained in purchasing power.

Key Takeaways

  • Where money is absent, an available commodity with the best combination of ease of authentication, uniformity, divisibility, durability, portability, and elasticity of supply may emerge as money.
  • In other instances, as in Argentina, private credit money may emerge.