Friday, July 13, 2012

The real world does not like barter

Economics from a place short of cash.

I was re-reading recently the brilliant analysis of money by A. Mitchell Innes ( and whilst agreeing with him in all he said, I thought that I could advance his critique of Adam Smith even further

To set the scene, here is a quote from the above mentioned 1913 paper:
` If we assume that in pre-historic ages, man lived by barter, what is the development that would naturally have taken place, whereby he grew to his present knowledge of the methods of commerce? The situation is thus explained by Adam Smith:
But when the division of labor first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than, he himself has occasion for, while another has less. The former consequently would be glad to dispose of, and the latter to purchase, a part of this superfluity. But if this latter should chance to have nothing that for former stands in need of, no exchange can be made between them. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No change can in this case be made between them. He cannot offer to be their merchant nor they his customers; and they are all of them thus mutually less serviceable to one another. In order to avoid the inconveniency of such situations, every prudent man in every period of society, after the first establishment of the division of labor, must naturally have endeavored to manage his affairs in such a manner, as to have at all times by him, besides the peculiar produce of his own industry, a certain quantity of some one commodity or other, such as, he imagined that few people would be likely to refuse in exchange for the produce of their industry.Many different commodites, it is probable, were successively both thought of and employed for this purpose. . . . . . . . . . In all countries, however, men seem at last to have been determined by irresistible reasons to give the preference, for this employment, to metals above every other commodity.
Adam Smith’s position depends on the truth of the proposition that, if the baker or the brewer wants meat from the butcher, but has (the latter being sufficiently provided with bread and beer) nothing to offer in exchange, no exchange can be made between them. If this were true, the doctrine of a medium of exchange would, perhaps, be correct. But is it true?Assuming the baker and the brewer to be honest men, and honesty is no modern virtue, the butcher could take from them an acknowledgment that they had bought from him so much meat, and all we have to assume is that the community would recognize the obligation of the baker and the brewer to redeem these acknowledgments in bread or beer at the relative values current in the village market, whenever they might be presented to them, and we at once have a good and sufficient currency. A sale, according to this theory, is not the exchange of a commodity for some intermediate commodity called the “medium of exchange,” but the exchange of a commodity for a credit.` 
To support this, here is a short summary of what I have learnt about barter in the last two years, the hard way - from first-hand experience.

I own a 400 acre farm (165 hectare) in the North-East of Brasil, close to the equator, which I am running with the help of my brother. Being here after living in London for most of my adult life is like travelling back in time, and I am not talking about technology. We have mobile phones, internet and cars – it is more the economics relations between people that seem to come from a time long ago. In Brazil interest rates are high and banks require solid collateral before lending, so bank credit and money are scarce. Does the exchange between people slow down or stop?  Well, no – for to give Adam Smith credit where credit is due: ´The propensity to truck, barter and exchange one thing for another is common to all men, and to be found in no other race of animals.`

Let us analyze transaction number one:
Recently I have traded two trucks of wood for a truck of bricks. Ah, barter, you say! Well, from a distance, so it seems. However, let us study the detail:
1. The bricks do not yet exist. They need to be fired with, you guessed what, the wood I have just given to my trading counterparty. 
2. Even if the bricks existed, there is only one truck available to do the transport, and as the trucker has other transports to make, the bricks might be delayed for a week or two.
So – now he owes me a truck of bricks, and he has the wood on credit.

Another recent transaction:
I swapped a chainsaw for fence posts. Again, the detail:
1. The posts are still in the forest, waiting to be cut.
2. Also, I need two thousand posts, and the chainsaw will only pay for 1500.
3. The posts take time to be cut.
4. My counterparty has other customers to service
5. I do not need all the posts at once
6. A truck can only transport 500 posts, so it will take around 2-3 weeks for the posts to arrive in my yard.
This one is a bit more involved. Initially I extend him credit, and he takes the chainsaw. After he delivers the 2000 fence posts, I owe him for 500, which I will settle in cash, but maybe not straight away.

Transaction number three: A friend arrives at the farm; he likes my second hand car parked in a barn. We start the negotiations:
1. He offers me 5000,
2. but he has no cash,
3. he can pay me in gravel.
4. In the future I need gravel for internal roads,
5. but not right now, because I am doing other things.
Does the transaction fail, as Adam Smith predicts? Well, no, for there is always credit:
6. We agree a price of 5600, and over the next 3 or 4 months he delivers me the truckloads of gravel, about 25 of them, at a rate of one or two a week. Done.

To finish with, let us look at a simpler transaction:

Transaction number four:  My friend wants a goat to barbecue for his birthday party, and he offers me a truckload of gravel. Perfect barter, you say! Not so fast, I am afraid. For my friend´s birthday is in a few weeks’ time, but he brings the gravel straight away, because he has a free slot in his deliveries. This time it is me who gets credit, but it is credit again, even in the seemingly most perfect of barter swaps.

Are four transactions statistically significant? Well, maybe no – they are just detailed examples. At the same time I know of tens or maybe over a hundred of similar transactions, involving either me or my friends, for we talk of little else during our occasional evening farmer beers. For the beers, of course, we paid with real cash.