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By Maria K
MONEY AND BANKING
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MONEY & BARTER EXCHANGE

 Money refers to anything generally accepted/acceptable as a medium of exchange used to

effect transactions or to discharge/settle debts. Before any form of money came into
being, the system of exchange was barter were there was a direct exchange of goods for
goods, goods for services or services for services. This system however was associated
with different problems.

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Problems of Barter Trade

 Lack of double coincidence of wants. It was very difficult to get one who has got what
you want and at the same time willing to exchange it for what you have.
 Indivisibility of some commodities. Some commodities could not be divided up into
small units to effect small transactions for example if one had a cow for exchange but
another had a tin of beans, a needed 2kg of beef then it became difficult to get them from
a cow.
 Difficulty in determining the exchange rates for example how many cocks for a cow.
 Some commodities were perishables which made future trade impossible.

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 Limited storage facilities that some goods are bulky and others are perishable.
 Difficulty in transportation given the bulkiness of some products and existence of poor
roads.
 Barter trade system encourages dependence on economy by other economy and in case of
conflicts a country may suffer.
 It leads to loss of value of utility when one gives up more goods and gets less in terms of
value.

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Advantages of Barter Trade

 It expands friendly relationships between countries and their citizens.

 It shortens the trade process because it’s more direct.
 It is not inflationary because there is no use of money.
 It facilitates trade among small countries and increases their share in international trade.

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 Barter trade system saves foreign exchange that is scare especially LDCs hence devoted
to other uses.
 It reduces Balance of Payment problems in LDCs by reducing their foreign exchange
expenditure abroad.
 It promotes specialization because countries are assured of exchanging the others.
 It expands the range of markets no problems of shortages in foreign exchange by the
importers of a county’s products.

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THE ORIGIN OF MONEY

 Before any form of money came into existence, the system of exchange used was Barter
Trade later on commodities with greater value and ability to satisfy human wants were
used as money (Commodity Money). These included Salt, Ivory, Corn, Tobacco etc.
However, some of these commodities were found to be perishable and could not therefore
act as good medium of exchange. So, later on durable commodities such as Iron, Cowry
shells, Beads and many others were adopted but many of these commodities were
plentiful in supply and could therefore not serve as good money.

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 Therefore, rear and precious metals such as Gold, Silver and Diamond were used as
money. Eventually these metals were converted into coins. Coins minted at first, were
fully bodied (intrinsic value = to face value). The use of such coins was however a bit
problematic in that whenever the value of metal in which the coin was made rose to a
higher level than that indicated on the coin, people could melt the coin to sell them as
metals. So the solution was to carry out debasement of coins in which new coins were
made with the face value greater than their inner value (token money).

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 Paper money came into existence from the time when people where depositing their gold
with the goldsmiths for safe custody and the goldsmith issued them with receipts. These
receipts were accepted as a medium of exchange because they were backed by gold. As
time went by, banks took over the work of the goldsmith and the receipts were
transformed into paper notes. Initially the paper notes issued were fully backed by gold
and the supply of money in the economy depended upon the amount of gold available in
the treasury. This system was known as the gold standard. Latter on fiat money came
into being and this is the money issued by the central bank but not backed by gold or
hard currencies. In many countries fiat money is used in circulation and

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In summary the principle stages in the
development of money are as follows:

 Use of commodities with a high value.

 Use of durable commodities i.e. Copper, Ivory
 Use of precious metal i.e. Gold, Silver and Diamond
 Use of coins i.e. Coins’ Face Value = intrinsic value and then after Token money whose
Face Value > intrinsic Value.
 Receipts issued goldsmiths.
 Banknotes
 Bank deposits operated by use of cheques
 Credit cards and debit cards

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 LEGAL TENDER: This refers to money which by law must be accepted as a medium of
exchange of goods and services or settlement of debts in a given country. A country’s
currency is its legal tender in other wards a legal tender is anything that people are
compelled by law to accept as a medium of exchange while exchanging goods and
services or settling debts.

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 CURRENCY: This is money in form of paper notes and coins commissioned by a

particular country to facilitate the exchange of goods and services and settlement of debts
within the country. E.g. Uganda’s currency is a shilling, Japan-Yen, British- Pound, South
Africa- Rand.

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Essential elements/parts of the Financial
System

1. Money: Anything used as a means of payment for exchanging goods and services and
settlement of debts. In Uganda paper money, also known as fiat money is used as a means of
payment. This has not always been the case; we once used gold and silver coins as a means of
payment. In ancient days, people used things like beads as a means of payment.
2. Financial Instruments: These are written legal obligations of one party to transfer
something of value to another party at some future date under certain conditions. These
obligations usually transfer resources from savers to investors. Examples include Stocks,
treasury bills, bonds, insurance-policies, shares etc.

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3. Financial Markets: These are markets where financial instruments are traded. For
example the Kampala Stock Exchange Market.
4. Financial Institutions: These are entities that provide services and allow agents access to
financial instruments and markets. Examples: Banks, Insurance companies.
5. Central Bank: This is a government entity which monitors the state of the economy and
conducts monetary policy. For the case of Uganda the Bank of Uganda manages the country’s
monetary system.

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Functions of money

1. Mean of payment
The primary characteristic of money is that it is used as a means of payment. In most of the
transactions, money is taken as a form of payment. This is because other forms of payment typically
will not work.

2. Unit of Account
 Money is also a unit of Account. A unit of account is simply how we measure prices and debts.
In Uganda prices are measured in terms of shillings. This unit of measurement allows for a
quick comparison of prices across goods and service. Remember, what is important is the
relative prices of goods. So, the unit of account allows us to measure the price of each good
relative to a shilling bill.

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3. Store of Value/Wealth
Money is also an asset which can serve as a store of wealth/value. If money is to be valuable
for transactions, it needs to be able to retain value over time. A shilling today needs to have
the power to purchase goods in the future. Many other assets also serve as a store of value:
Bonds, and Savings Account. What makes money unique is its high liquidity. Liquidity is
simply a measure of how easy it is to turn assets into consumption..

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4.Standard for Deferred Payment

 The function of money as a standard of deferred payment is closely related to its use as a
store of value. It would be awkward for someone obliged to make a payment to another
person at a future date to state the obligation in terms of pigs or tomatoes or shoes or
hours of work. It would also often be difficult for the one to whom the payment is owed to
predict the combination of goods and services that would be desired in payment of the
debt at some future time. The dilemma is easily resolved by stating the obligation in terms
of a payment in monetary units at a future date. Other word, money is used as a measure
of settling debts in future for the goods and services taken on credit. It helps to effect
transactions without immediate payment of cash.

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Characteristics / Qualities of Good Money

 Acceptability i.e. money must be generally accepted as a medium of exchange by all

people in the country concerned.
 Should be Divisible / Divisibility. Money should be capable of being divided into suitable
units or denominations to enable purchase of both large and small goods without getting
problem of change.
 It should be Homogenous (Homogeneity) notes and coins of the same denomination
should be typically the same for good money e.g. all 10,000 notes should be similar.
 Should be Scarce/Scarcity. Good money should be limited in supply so as to moderate its
value and it’s because of that, people will work hard for it.

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 Should be Portable/ Portability: Good money should be relatively light and easy to carry
from one place to another i.e. should not be bulky.
 Should be fairly Stable in Value: Good money should not loose its value so easily but
should be fairly stable in value to maintain its worth.
 The Cognoscibility: Good money should be easily recognized as good money by
everyone in the country such that it’s freely used.
 It should be difficult to Forge: Good money should not be easy to forge it should
maintain its worth. Marketability: Good money should be easy / cheap and convenient to
print by the minting authority. Durable/Durability: Good money should last for fairly
long time to reduce the cost of frequent printing of money.

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Types of Money

 Coins: These are metallic monies. They are less than full-bodied because their intrinsic
(metallic) value is less than their face value.
 Currency notes: these are merely pieces of paper that have no intrinsic value of their
own.
 Deposit money: These are not like coins or currency notice. Deposit money is treated as
demand deposits of commercial banks on which cheques can be drawn as money.

By Maria K