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Money is a concept that most people have a solid intuitive grasp of. For example, the majority of people understand that they use money to exchange for goods and services, and that the utility they gain from money is derived from its use in trade.

This common sense no longer seems to apply when people think about monetary systems. People assume that without government-controlled and provided money, trade could never happen. They think that, despite free and open competition in other industries leading to better products at lower prices, this doesn’t hold true for money.

My intention in this post is not to make a complete argument for free banking and a free-market in money production. Far more modestly, I would like to show by way of example that money evolves out of a desire for indirect exchange on the market, not solely through government fiat.

Anything can take on the role of money in a group of people, but there are qualities of commodities that make some more suitable as money than others. A potential money will fare better if it is easily divisible, has a long shelf-life without losing value, is of limited supply, etc. Competition determines what becomes money in a given society. Historically, gold and silver have been the most widespread monies, but things like salt, cocoa, beads, shells, and many others have taken on a monetary role; that is, fostering indirect exchange of goods and services.

Since money evolves out of a desire for trade, people will tend to stock commodities that are generally valued or generally accepted in their society. A valuable microcosm of a society would be inside the walls of a prison or POW camp, where cigarettes have outcompeted monetary alternatives such as candy bars, toilettes, and food.

The Economic Organization of a POW Camp

In a paper written by R.A. Radford in 1945, just months after being liberated from a Nazi POW camp, the spontaneous adoption of cigarettes as currency is explored.

A camp like this provides us with an interesting case study in the evolution of money and indirect exchange. While hardly a natural, free-market environment, it does show us how people economically adjust to certain conditions. So, what are the economic conditions/assumptions of this environment?

First off, it is an isolated, closed economy. People in this POW camp aren’t engaging in trade with the outside world. While this is obviously a significant condition with regards to the lives of these prisoners, it doesn’t have much of a bearing on our economic analysis. If you zoom out far enough, any economic system is “closed”. For example, the Earth’s economy is closed, at least until we begin trading with other planets.

In addition, dollars and other official currencies aren’t allowed. Prisoners aren’t trading in dollars or francs. This condition actually makes the model more realistic, not less. There are no artificial fiat currencies, so the inmate economy grows organically without a preexisting bias towards currencies that already exist.

Finally, this is an economy without production, where initial resources are equal and provided by a central authority:

“Everyone receives a roughly equal share of essentials; it is by trade that individual preferences are given expression and comfort increased. All at some time, and most people regularly, make exchanges of one sort or another.”

This constraint does limit what we can glean from this case study. We can’t learn much about the very important subject of production. However, we are most interested right now in studying exchange, and the POW camp provides a perfect example of how humans will engage in trade in order to fulfill their various wants.

Price System

Very quickly, a price system formed in this camp. The assorted goods that came in peoples’ rations each found a price on the market. Early on, these prices were imperfect; the market required some time for peoples’ preferences to become adequately incorporated into prices.

“Stories circulated of a padre who started off round the camp with a tin of cheese and five cigarettes and returned to his bed with a complete parcel in addition to his original cheese and cigarettes; the market was not yet perfect. Within a week or two, as the volume of trade grew, rough scales of exchange values came into existence. Sikhs, who had at first exchanged tinned beef for practically any other foodstuff, began to insist on jam and margarine. It was realized that a tin of jam was worth l/2 lb. of margarine plus something else; that a cigarette issue was worth several chocolate issues, and a tin of diced carrots was worth practically nothing.”

Note how at this stage, trade was primarily done directly; that is, through bartering. While this is certainly better than having no trade at all, exchange still required a “double coincidence of wants”. In other words, you want what I have and I want what you have. Barter, of course, is quite inefficient, because it is not particularly common to experience this double coincidence of wants.

This is one area where the lack of production in the economy does impact the analysis. Bartering rations that were provided for you in advance is far easier than having a division of labor where everyone produces something different and then needs to trade with someone who wants what you’ve produced. As we will see later, this weakness in the example does not take any force away from our conclusions.

In any case, it only took a short while before the prisoner economy evolved past bartering and developed indirect exchange.

“By the end of a month, when we reached our permanent camp, there was a lively trade in all commodities and their relative values were well known, and expressed not in terms of one another – one didn’t quote bully in terms of sugar – but in terms of cigarettes.”

If I had extra butter and wanted some chocolate, I no longer needed to find someone who had chocolate and wanted butter. I could “sell” my butter to someone in exchange for cigarettes, and then “buy” the chocolate from a third party with those cigarettes. In other words, cigarettes became money.

“The public and semi permanent records of transactions led to cigarette prices being well known and thus tending to equality throughout the camp, although there were always opportunities for an astute trader to make a profit from arbitrage. With this development everyone, including non-smokers, was willing to sell for cigarettes, using them to buy at another time and place. Cigarettes became the normal currency, though, of course, barter was never extinguished.”

This cigarette-based economy became fairly well-developed. It was generally known throughout the camp how many cigarettes it would take to buy any given item. At this point, cigarettes were in high demand, because they could be used to purchase anything the prisoner wanted (well…anything that was provided in their given rations). Therefore, if you didn’t want your applesauce, you could just exchange it for cigarettes with someone else who did.

Money Helped Foster Entrepreneurship

The existence of indirect exchange fostered the creation of a real labor economy and some entrepreneurship.

Without money, you would need to trade your labor directly for whatever it is that you want to consume. Of course, this is highly inefficient, since we tend to enjoy consuming a variety of different goods. Some people might work for popcorn (as Bart Simpson was made to do), but certainly not everyone.

If you can sell your labor in exchange for money, however, you can now use that money to procure anything else that you want.

“Even when cigarettes were not scarce, there was usually some unlucky person willing to perform services for them. Laundrymen advertised at two cigarettes a garment. Battle-dress was scrubbed and pressed and a pair of trousers lent for the interim period for twelve. A good pastel portrait cost thirty or a tin of “Kam.” Odd tailoring and other jobs similarly had their prices. There were also entrepreneurial services. There was a coffee stall owner who sold tea, coffee or cocoa at two cigarettes a cup, buying his raw materials at market prices and hiring labor to gather fuel and to stoke; he actually enjoyed the services of a chartered accountant at one stage.”

With cigarettes as money, prisoners found ways to increase the social good by performing services or starting small businesses. It’s highly unlikely that a prisoner would do someone else’s laundry for a specific item (rather than money) on more than rare occasions. But with money, someone could regularly offer a laundry service.

Prisoners who didn’t want to do this chore could give up two cigarettes (and therefore whatever else they could exchange those cigarettes for) to avoid it, while prisoners who wanted extra consumption goods had a means of getting money to exchange for them. Everybody wins!

Time Preference

Money is also used to coordinate consumption decisions over time. If you wanted to save some of your fruit now in order to eat more in a month, it would go bad in the process. Money doesn’t “go bad” (unless you count inflation), so it can be saved in order to buy fresh fruit later on.

There are many lessons we can learn about economics with regards to time and money. Naturally, a POW camp has a very simple economy, so we can’t explore all the implications of this relationship through this example. Despite its simplicity, however, the POW camp still developed a fairly advanced futures market.

“Bread was issued on Thursday and Monday, four and three days’ rations respectively, and by Wednesday and Sunday night it had risen at least one cigarette per ration, from seven to eight, by supper time. One man always saved a ration to sell then at the peak price: his offer of “bread now” stood out on the board among a number of “bread Monday’s” fetching one or two less, or not selling at all – and he always smoked on Sunday night.”

People prefer goods now to goods in the future, so there was a premium for “bread now”. Through planning and the use of these futures markets, an individual could smooth out his consumption over time to optimally match his preferences.

Markets like this that trade across time make it important that money retain its value over that time period. This is why apples are very unlikely to become a currency. After a week, they have lost most of their value. Cigarettes tend to stay good for a bit longer. And before they go stale, they are likely to have been smoked and replaced by fresher ones.

A currency also benefits from uniformity. The amount of tobacco in a cigarette was the primary variable that people wanted to be uniform. Therefore, hand rolled cigarettes were not as “good” of a money as normal cigarettes. Because they were not of a consistent size, prices could not be quoted in terms of cigarettes as easily. Never the less, people could verify how much tobacco was in a handroll, and adjust the price accordingly.

“Certain brands were more popular than others as smokes, but for currency purposes a cigarette was a cigarette. Consequently buyers used the poorer qualities and the Shop rarely saw the more popular brands: cigarettes such as Churchman’s No. I were rarely used for trading. At one time cigarettes hand-rolled from pipe tobacco began to circulate. Pipe tobacco was issued in lieu of cigarettes by the Red Cross at a rate of 25 cigarettes to the ounce and this rate was standard in exchanges, but an ounce would produce 30 home-made cigarettes. Naturally people with machine-made cigarettes broke them down and re-rolled the tobacco, and the real cigarette virtually disappeared from the market. Hand-rolled cigarettes were not homogeneous and prices could no longer be quoted in them with safety: each cigarette was examined before it was accepted and thin ones were rejected, or extra demanded as a make-weight. For a time we suffered all the inconveniences of a debased currency.”

While Radford rightly considers this an instance of currency debasement, the consequences in the POW camp are far more modest than they are in a more complex, free economy. It is far easier to judge how much tobacco is in a cigarette and make a rough comparison than it is to determine what percentage of gold or silver is in a coin, or how rapidly a paper currency loses value as more and more is printed.

Price Fixing

When people believe they can secure some advantage through cheating or manipulation, they often will try. That is one reason why it is critically important to have institutions that minimize the ability to do so.

Luckily, the “invisible hand” of the market process is a very effective means for curbing this tendency. Despite attempts at price fixing as well as fairly widespread sentiment in favor of “just prices”, the market price inevitably won out.

“Curious arguments were advanced to justify price fixing. The recommended prices were in some way related to the calorific values of the foods offered: hence some were overvalued and never sold at these prices. One argument ran as follows: not everyone has private cigarette parcels: thus, when prices were high and trade good in the summer of 1944, only the lucky rich could buy. This was unfair to the man with few cigarettes. When prices fell in the following winter, prices should be pegged high so that the rich, who had enjoyed life in the summer, should put many cigarettes into circulation. The fact that those who sold to the rich in the summer had also enjoyed life then, and the fact that in the winter there was always someone willing to sell at low prices were ignored. Such arguments were hotly debated each night after the approach of Allied Aircraft extinguished all lights at 8 p.m. But prices moved with the supply of cigarettes, and refused to stay fixed in accordance with a theory of ethics.”

This is all the more impressive given the relatively small size of a POW camp. With at most a couple thousand people, the conditions for forming a cartel are about as good as they get (on a free market, at least. Given the power of government coercion, forming cartels is far easier).

And people still engaged in mutually beneficial trading despite whatever ethical theories or Marxist sentiments people had. In fact, the spontaneous formation of the market was in direct contradiction to some of these theories.

“It is thus to be seen that a market came into existence without labor or production. The B.R.C.S. may be considered as “Nature” of the text-book, and the articles of trade – food, clothing and cigarettes – as free gifts – land or manna. Despite this, and despite a roughly equal distribution of resources, a market came into spontaneous operation, and prices were fixed by the operation of supply and demand. It is difficult to reconcile this fact with the labor theory of value.”

Is A POW Camp A Realistic Model?

Some would argue that I have mischaracterized this instance of the development of commodity money as what would happen on a free market, despite the fact that POW camps are hardly a paragon of freedom of economic association.

In fact, it’s hard to think of a more centralized and coercive environment. Consider this argument from Matthew Berg:

“Far from being a stateless society or a paradise of market individualism, Radford’s POW camp was in fact… a POW camp. And that is not something we should allow ourselves to easily forget. There was a “state,” and for that matter the “state” (the German guards) was all-powerful. It was possible for the “market economy” to emerge because and only because the guards and the Red Cross established and preserved the conditions to enable it to emerge. Cigarettes and other commodities were – because of decisions by the Red Cross and the Germans which lay entirely outside of the control of the prisoners – delivered from a distant and utterly disconnected external world.”

There is much truth to this statement. A POW camp is not a free market, and the nature of the market that evolved in that camp was surely a product of the so-called “state”. Chances are, things would have turned out wildly differently were it not for the artificialities of the camp.

Berg uses this to claim that commodity money would not naturally emerge like this, but that it only exists because of “the state”. Were it not for the guards and administration of the POW camp and the fact that prisoners were provided rations automatically, cigarettes would not have become currency.

Berg is probably right; were it not for these state-like circumstances, cigarettes likely would not have become currency. In a free market, a different currency would have likely emerged (say, gold or silver). There are disadvantages of cigarettes as money, and surely preferable alternatives would have been discovered if given the opportunity. And thousands of years of monetary history have shown that, typically, gold and silver are the best currencies. Many have been tried, including salt, chocolate, shells, and beaver pelts.

What Berg ignores is that we aren’t so much concerned with the specifics of what happened in Radford’s camp (cigarettes becoming money) as we are with the process in general (something becoming money). The interventions that make a POW camp less of a free market may change the result of the market process, but they have not qualitatively changed the market process in a way that would make the example any less instructive.

If anything, the limits imposed on the POW camp economy makes the emergence of money even more impressive. The problems with the use of cigarettes as currency came from the lack of free market ability to import or bring in additional cigarettes to meet the monetary demand.

“While the Red Cross issue of 50 or 25 cigarettes per man per week came in regularly and while there were fair stocks held, the cigarette currency suited its purpose admirably. But when the issue was interrupted, stocks soon ran out, prices fell, trading declined in volume and became increasingly a matter of barter. This deflationary tendency was periodically offset by the sudden injection of new currency. Private cigarette parcels arrived in a trickle throughout the year, but the big numbers came in quarterly when the Red Cross received its allocation of transport. Several hundred thousand cigarettes might arrive in the space of a fortnight. Prices soared, and then began to fall, slowly at first but with increasing rapidity as stocks ran out, until the next big delivery. Most of our economic troubles could be attributed to this fundamental instability.”

Due to consumption of cigarettes (through smoking) and an inconsistency in supply (no free market in production/distribution of cigarettes), there was significant currency instability. None the less, it is clearly documented that they did use cigarettes as currency despite these problems. In other words, commodity money emerged in spite of the interventions in the market, not because of them.

There are many instances of the emergence of commodity money throughout history, and this is just one of them. Criticizing the theory of how money evolves based on (incorrect) views on a single one of those examples is a weak point to be arguing from. It is made especially weak given how cigarettes became money in post-World War II Germany, in a circumstance without the limitations of a POW camp.

Cigarettes as Money in Post-World War II Germany (1945-48)

German monetary history during the 20th century is fascinating. The time period that is talked about the most, and rightly so, is the hyperinflation in the Weimar Republic between 1921 and 1924. Much of the characteristically German suspicion of fiat paper money can be at least partially explained by sentiments dating back to this hyperinflation.

The period immediately following World War II in Germany is an obscure yet illuminating example of this. Bignon (2004) provides a description of how cigarettes came to be used as money throughout Germany between 1945 and 1948. As we explore this historical episode a bit more, we’ll see that the alleged weaknesses of the prior analysis of the emergence of commodity money vanish.

After the war, the Reichsmark lost its trust as a currency among the German population, and was only accepted in transactions about half the time. Despite not being a hyperinflationary environment, the lack of value of the Reichsmark led to a breakdown of the price system. As such, Germany devolved into what was largely a barter economy, with black market trades being responsible for the other half of German trade.

The end of the war resulted in a massive breakdown in production in Germany. Since war rationing was over, there were considerable changes in food production specifically, which motivated a change to direct exchange or bartering. Food was diverted from normal market channels as people went and traded for food directly from farms.

Workers began to be paid, at least in part, by their factory’s product, which they would then take to the farmers to exchange for food. Once this change in firm behavior began to take place, it drastically increased the need for a useful medium of exchange.

Very quickly, a handful of commodities emerged as widely accepted goods far barter: cigarettes, chocolate, and alcohol were accepted and traded more frequently than most other goods.

While chocolate and alcohol had fairly high trading volumes, cigarettes became the de facto currency in Germany. The existence of a population of smokers provided some immediate demand for cigarettes in the barter economy. The existence of smokers led to non-smokers accepting cigarettes as middlemen with a bid-ask spread for trading purposes.

The utility gain of smoking helps explain the acceptance of cigarettes as money by the whole population. Because cigarettes are not necessary for survival, the utility gain that smoking provides is often less than that of their use in trade. This led to smokers deliberately abstaining from smoking to gain an even greater utility by acquiring other goods in exchange.

This historical episode is clear proof that commodity monies can and do emerge organically. Even without the influence of the “authorities” that are present in a POW camp, cigarettes became widely used to facilitate indirect exchange in post-war Germany.

Cigarette Policies in US Prisons

For a long time, cigarettes were used as currency among inmates of prisons in the US. However, since the mid-1980s, cigarette smoking policies have become significantly more restrictive in prisons across the US. This allows us to observe a social experiment where we can compare how different cigarette policies in prisons affect their use as currency. If you are interested in a great ethnography of prison economies under varying cigarette policy regimes, you’ll find that previous link fascinating.

Because US currency is prohibited in prisons, a new kind of currency must evolve to facilitate indirect exchange and the various “hustles” going on in the prison economy. Cigarettes are a decent option for several reasons, including some discussed above.

Cigarettes are smoked, and thus are often replaced by new packs before old cigarettes have a chance to get worn out from too much trade. This is truer of the prison economy than the POW camp, because access to cigarettes is far less controlled (that is, in prisons where cigarettes were not banned). An inmate could always get more from the commissary, assuming they could afford it.

In addition, cigarettes have convenient denominations. In other words, they can be traded as individual cigarettes, whole packs, or entire cartons. This makes it easy to trade cigarettes in exchange for both cheaper and more expensive goods.

However, the benefits of inmates using cigarettes as currency are wiped out when they are banned from the inside of prisons. Of course, this intervention causes far more harm than just making indirect exchange more challenging – all the negatives of black market industries begin to emerge as well.

As long as there is a demand for cigarettes, people will come up with clever ways to sneak tobacco into prisons. Usually, this leads to serious institutional corruption. For example, “mules” will often pay officers $20 “gate fees” to avoid getting a patdown on their way into the prison. In fact, prison officials in these prisons play a crucial role in the black market for cigarettes.

As the supply of cigarettes is drastically curtailed when they are banned, their price skyrockets. As with most goods that are made illegal, they become a huge money maker for gangs, and the prison officials who work with them.

In fact, prison guards charge between $20-50 for a single pack of cigarettes, and can often make more than an entire week’s wages in a single transaction. The profits on tobacco, even when bought at these outrageous prices, are so high that some inmates request that family members do send-ins of tobacco (pay money to officers who then deliver tobacco to the inmate) instead of directly depositing money into their account. After all, a single carton could fetch a street value of $200-500 dollars with little effort.

Despite a ban on cigarettes, the desire to exchange doesn’t go away. Inmates will find a new way to transact – for example, books of stamps have become a replacement currency in some of these prisons.

The point of this all isn’t that outlawing certain goods is a bad thing (although that is certainly the case). Rather, the point is that people will find a way to get what they want through trade. People adapt, and they will come up with creative solutions that allow them to engage in mutually beneficial exchange.

Conclusion

So, what was the point of this whole discussion?

Many people just assume that money is something that government creates, and it cannot be done any other way. But this is simply not the case.

There is a human impulse to exchange; we act to satisfy our desires, and this involves engaging in trade with others. Direct exchange (trade without money, or barter) is highly inefficient, because two people would need to have the specific item that the other person desires (a double coincidence of wants). This creates a demand for some type of special good, aka money, to facilitate indirect exchange.

As the most efficient way of satisfying our desires is to trade for things that we want, it makes sense to trade for things that other people want as well. If I have things that other people want, I can more easily get what I want. These uncoordinated actions of all the individuals within an economy lead to certain goods becoming more widely accepted, because people know that other people will take them in exchange. Hence, money is born.

In this post, we’ve explored the use of cigarettes as money in various circumstances. In our day to day lives, we think of “dollars” as money, and cigarettes as a thing that some people smoke. But it isn’t quite that simple and categorical. If, say, the monetary system in the US were to break down completely (as it has in Zimbabwe recently, the Weimar Republic, and nearly all fiat money regimes throughout history), it’s quite possible that cigarettes will be facilitating trade, and dollars will be getting burned.