16 The Functions of Money: From Cigarettes to Community Currency

Let’s start by discussing what money is and how we define it. In simple terms, anything can be considered money as long as it fulfills the functions of money. For instance, if you write a number on a piece of paper and that piece of paper performs the essential functions of money, then it can be considered money. Even if it doesn’t fulfill all the functions perfectly, it might still serve as money in certain situations.

So, what are these key functions of money? Money typically has three main functions: it serves as a medium of exchange, a store of value, and a unit of account. The most important function of money is its role as a medium of exchange. If a piece of paper is accepted by others in exchange for goods and services, it can be considered money. In other words, if people in your community recognize and agree to use that piece of paper to trade, it functions as money.

For example, imagine you live in a small village where you are a farmer. One day, a plumber comes to your house to fix something, and instead of paying him in official currency, you hand him a piece of paper with “100 FM” (FM standing for “Farmer’s Money”) written on it. The plumber accepts it, trusting that other villagers will also accept this note because you have a reputation for being reliable. He believes that when he uses the note, others will accept it in exchange for goods or services.

This creates an obligation on your part. By signing that piece of paper, you are essentially promising that if anyone (including the plumber) in the village presents it to you, you will provide them with goods or services worth 100FM, produced by you on your farm. In this scenario, the piece of paper has become money, as it is recognized and used by others for trading, and you are committed to honoring its value.

It seems that people in the village have accepted your piece of paper as a medium of exchange, but there’s a small issue we need to address. What does the “100 FM” written on that paper actually represent? This brings us to the second key function of money: the unit of account.

For money to be useful, it must provide a standard measure of value. This means that everyone in the village should be able to use the same unit – FM, in this case – to set prices for goods and services. For example, imagine you visit a small grocery store, and you see that the price of a box of six eggs is listed as 2 FM. The barber, too, starts pricing his services, stating that a haircut costs 10 FM.

Now, your FM currency is functioning not just as a medium of exchange, but also as a unit of account. It allows people to price their goods and services consistently, making trade more straightforward. Without this function, it would be much harder to price anything, leading to confusion and inefficiency when people try to exchange goods and services. In other words, the unit of account function of money brings clarity and consistency to economic transactions.

This situation unfolded during World War II in prisoner-of-war (POW) camps. Inmates in these camps regularly received help parcels from the Red Cross, which contained essential items such as food (like powdered milk, tea, or coffee), tobacco, personal hygiene products (such as soap, shaving items, and toothpaste), and sometimes clothing, like socks.

However, not everyone valued these items equally. For example, some prisoners might not have liked tea and would have preferred to trade it with others who didn’t want their canned fish. As a result, an informal market emerged in the camp, where prisoners began trading the items they didn’t want for things they did.

The problem was that it became difficult to determine the relative value of these items. How many bags of tea would equal a pair of socks? How many cans of fish would you need to trade for some powdered milk, biscuits, or toothpaste? Pricing every item against every other item was complicated and confusing.

To solve this, they decided to use cigarettes as a common currency. This made transactions much simpler. For example, a pair of socks might be priced at 20 cigarettes, a tea bag at 1 cigarette, and a tube of toothpaste at 15 cigarettes. With everything priced in cigarettes, trade became much easier and more efficient within the camp. This system worked because cigarettes provided a standard value everyone could understand, making the exchange of goods far more straightforward.