In the previous post Everything You Need to Know about Money, we learnt about the origin of money. Now once the money has been invented and is being used as a medium of buying products and services there’s another concept that arises – Currency Exchange. In this post also, I will try to explain the concept through a simple narrative.
Let us assume there are two tribes – A and B. In tribe A, all the people were initially vegetarian. They were expert in growing crops, vegetables and fruits. But over the period of time their eating habits changed and some of them started to eat meat as well. But they were not skilled enough to cook it well, and they were not good hunters either. Tribe B on the other hand, rarely grew vegetables. They were largely dependent on the meat for their food. Tribe B people were skilled in hunting the animals and also cooking the meat. Both the tribes have their own currencies – Aollar and Bollar respectively. If you had Aollars in tribe A, then you could buy various things and also get services from the tribe people. And the same was for Bollars in tribe B.
Seeing the growing food requirements in both the tribes, the respective heads decided to conduct a meeting. In this meeting it was decided that Tribe B will provide well cooked meat to Tribe A every day. And in return, Tribe A people will cook vegetables and give them to Tribe B. Initially they agreed upon five pots of vegetables to five pots of meat. The life became convenient for both sides. Tribe A people slowly started focusing only on farming and stopped hunting the animals. And the Tribe B people did the opposite. That way both sides developed more expertise, and did more production.
One day the head of Tribe B called that of Tribe A urgently. He told him that since the animals were getting scarce, they would not be able to provide five pots of meat every day. He mentioned that hunting and preparing meat required more effort and therefore it was not justified to exchange the same amount of meat with vegetables. Tribe A head didn’t have any choice. His tribe needed meat. So he made a deal. He said that they would give ten pots of vegetables in exchange of five pots of meat. The agreement was made. And the life continued.
Tribe B people had to do a lot more effort than Tribe A people as hunting was really difficult. Tribe A people decided not to work very hard as they were sure that they would grow enough vegetables with little effort. Tribe B kept working hard and discovered more and more ways of hunting and cooking meat. They also started growing vegetables as they were still not satisfied with the exchange. Due to their persistence in work they had developed a number of things. Tribe A didn’t care much about its growth.
In the mean time an important financial deal was made between the two tribes. Earlier if a tribe A person came to Tribe B he could not buy anything from here as he didn’t have Bollars, and similarly tribe B people couldn’t buy anything in tribe A as they didn’t have Aollars. The deal suggested that both tribes’ people could buy things from each other’s markets. But they had to exchange the Aollars with Bollars or vice versa, at the border itself. Once they had exchanged their currency they could buy things with the local currency.
Once again initially the exchange rate was set 1:1 which meant that one Aollar could be exchanged with one Bollar. But later it was found out that tribe A people visited tribe B more often and therefore bought more things than the tribe B people bought in tribe A. This was due to the fact that tribe B had made more progress and had more things to offer than tribe A.
But there was a catch in the process that soon caused a big problem to tribe B. Earlier one pot of meat could be exchanged with two pots of vegetables. But with the use of currency, tribe A people could buy meat at same cost as that of the vegetables. This was due to the fact that each pot of vegetable would cost 100 Aollars in tribe A, and each pot of meat was priced at 100 Bollars in tribe B. But since 1 Aollar = 1 Bollar, tribe A people were actually exchanging one pot of vegetable with one pot of meat. The intellectuals in tribe B recognized this problem and called a meeting. In this meeting it was decided that the exchanges would be according to the real value of currency. And therefore 1 Bollar was converted to 2 Aollars. Clearly the strong economy of tribe B was because of their hard work and ability to provide more exports.
Thus began the era of currency exchange.