Money & trade

Money is whatever does three jobs, and each job has a name.

First, everyone accepts it in payment, so a baker can buy shoes without finding a shoemaker who wants bread. Here money is a medium of exchange, the go-between in every sale.

Second, it keeps. Fish rot and grain is eaten by mice, but money earned this month can be spent next year. Here money is a store of value. It does this job imperfectly, since rising prices wear its worth away.

Third, it gives every good a price in the same units, so that a goat, a day’s work and a roll of cloth can be compared at a glance. Here money is a unit of account. It measures worth as a metre measures length. Anything that does all three jobs is money, whether it is a gold coin, a banknote or a number in a bank’s computer.

Early money was something useful or wanted in itself: cattle, salt, cloth and, above all, metal. This is commodity money. Its worth as money rests on its worth as a thing. A gold coin melted down is still gold.

Metal had the right properties. It does not rot, it can be cut into small pieces and joined again, and a little of it is worth a lot, so it is easy to carry. Its drawback was that every payment meant weighing the metal and testing its purity. Coins solved that. In the seventh century BC, in the kingdom of Lydia in what is now western Turkey, lumps of a gold and silver alloy began to be stamped with a seal that vouched for their weight. A coin is a piece of metal that someone trusted has already weighed for you.

In the late seventh century the lands under Muslim rule still used coins of the old empires’ design: Byzantine gold in the west and Persian silver in the east, stamped with emperors and fire altars. About 696 the caliph ʿAbd al-Malik replaced them with a coinage of his own. His coins carried no image at all. Both faces were filled with Arabic writing: the declaration of faith and verses of the Qur’an.

The gold coin was the dinar, set at about 4.25 grams. The silver coin, issued soon afterwards for everyday sums, was the dirham, set at just under 3 grams. The weights were fixed so that seven dinars weighed the same as ten dirhams. For centuries these two coins were accepted from Spain to Central Asia, and hoards of dirhams have been dug up as far away as Sweden, carried there by trade.

Gold is heavy and tempting to thieves, and merchants of the Abbasid lands had a way to avoid moving it. A merchant who kept his money with a banker could pay with a ṣakk, a written order to pay. The seller took the paper to the banker and was given the coins. In the tenth century the geographer Ibn Ḥawqal recorded a ṣakk for 42,000 dinars, written for a debt between two merchants on opposite sides of the Sahara.

A ṣakk was only as good as the merchant who wrote it. The next step was paper that anyone would take. In the Chinese province of Sichuan, where coins were made of heavy iron, merchants began issuing notes that passed from hand to hand. In 1024 the Song government took the business over and printed notes of its own. They were the first paper money issued by a state.

For centuries a banknote was a receipt, which the bank that issued it would exchange for a fixed weight of gold or silver. That promise was why people accepted it. The last link to gold was cut in 1971, when the United States stopped giving it for the dollars that other governments held. Since then the world’s money has been fiat money, from a Latin word meaning “let it be done”. It is money because a government declares it to be.

A note costs pennies to print and is worth what is printed on it for one reason. I accept it because I am sure the next person will accept it from me. Its worth rests on trust, the trust that others will accept it. Where that trust fails, as it has in countries whose governments printed too much, the notes turn back into paper.

It is tempting to think of a sale as a contest, in which whatever one side wins the other must lose. It is not. A baker has more bread than her family can eat and no shoes. A cobbler has shoes on every shelf and no bread. When they trade, each gives up something valued less for something valued more, and each expects to end up better off. Otherwise one of them would simply refuse.

That is the test of a voluntary exchange, one that nobody is forced into: it happens only when both sides expect to gain. Nothing new has been made, yet both are richer in the things they care about, because goods have moved to the people who value them most. The gain disappears if either side is forced or deceived.

A market is any arrangement that brings buyers and sellers together, whether a town square, a livestock auction or a website. What it produces, besides sales, is a price for each good.

A price begins with scarcity: there is less of a good than people would take if it were free. Air has no price. Water in a desert does. But a price is more than a tag. It is a signal. When frost kills half the orange crop, oranges grow scarcer and their price rises. Nobody needs to explain why. The higher price tells shoppers to buy fewer and switch to apples, and tells growers elsewhere to send more oranges this way. Millions of strangers adjust to one number, and no one is in charge. In this way a price steers a shortfall towards its own cure.

Two words sum up the two sides of a market. Demand is how much of a good buyers are willing and able to buy. It depends on the price: the lower the price, the more they buy. Supply is how much of the good sellers are willing to bring to market, and it runs the other way: the higher the price, the more they bring.

Take bread. At a high price few loaves are bought, but every baker wants to bake. At a low price everyone wants bread and few bakers think it worth lighting the oven. Drawn on a graph with the price up the side and the quantity along the bottom, demand is a line sloping down and supply a line sloping up. The two cross at one point, and the market is drawn towards that point.

What happens when the price is wrong? Say that bread sells out exactly at 5 coins a loaf, the price where the two lines cross. Suppose the bakers ask 8. At that price they bake more loaves than people will buy, and bread is left on the shelves. The unsold excess is a surplus. To clear it the bakers must cut the price.

Now suppose they ask only 2. Everyone wants bread, the bakers bake little, and the shelves are empty by noon. This is a shortage. Buyers who went without will pay a little more tomorrow, and the price is bid up.

Either way the price is pushed back towards the point where the amount offered equals the amount wanted. Economists call that point equilibrium, a balance. No one sets it. Sellers and buyers find it by trial and error, every day.

Trade lets people stop doing everything for themselves. A weaver who weaves all day makes more and better cloth than a farmer weaving in spare hours, and she can trade the cloth for grain. Concentrating on one kind of work is called specialization, and a whole community sharing out its tasks this way is a division of labour.

In 1776 Adam Smith described a workshop where ten men shared out the eighteen steps of making a pin and turned out 48,000 pins a day. Working separately, he reckoned, none of them could have made twenty.

Four centuries earlier, Ibn Khaldūn had drawn the wider lesson. No one, he wrote, can make even his bread alone: the tools for it need a smith, a carpenter and a potter. People suppose that a country is rich because it holds gold and silver. Its wealth, he argued, is the labour of its people.

Specialization works between countries as it does between neighbours. China had silk and porcelain, India had pepper and cotton, Arabia had incense, and West Africa had gold. Goods moved between them along settled trade routes, by camel caravan and by ship.

The most famous is the Silk Road, a web of overland tracks some 6,400 kilometres long that joined China to the Mediterranean through Central Asia and Persia. Few merchants travelled all of it. Goods passed from hand to hand, and from the eighth century much of the carrying was done by Muslim traders, who also sailed the sea route from the Gulf to India and China.

Trade carried more than goods. Paper-making came west from China along these roads. Words travelled too. Italian merchants took from Arabic the word taʿrīf, a notification, for a list of the duties to be paid on goods, and English still uses it: tariff.

A market runs on trust, and a cheat can ruin it for everyone. The Qur’an warns those who demand full measure when they buy and give short measure when they sell. In a well-known hadith the Prophet, peace be upon him, pushed his hand into a heap of grain on sale and found it wet underneath. Rain had fallen on it, the seller said. Then why, the Prophet asked, was the wet grain not on top, where buyers could see? “Whoever cheats is not one of us.”

Muslim cities made that concern an office. The duty of keeping the market honest was called hisba, and its officer was the muḥtasib. His work was inspecting the market for fraud. He tested scales and weights against the official standard, looked for flour mixed with cheaper barley, and could punish on the spot. Handbooks written for him list the tricks of each trade.

Islamic law draws one line through the middle of finance. The Qur’an says that God has permitted trade and forbidden ribā, the interest charged on a loan. A man who lends a hundred dinars and demands a hundred and ten back is owed his ten whatever happens. The borrower must pay them whether his venture succeeds or fails.

Trade is different, because the trader’s money is at risk. He buys goods that may spoil, sink or fail to sell, and if he sells them for more than he paid, the difference is his profit, a lawful reward. On the same reasoning Muslim merchants financed voyages by partnership. One partner supplied the money, the other the work, and they shared whatever profit there was in agreed portions. If the venture lost money, that loss fell on the partner who had supplied it, and the other had worked for nothing.