Gary Rabbior is the president of the Canadian Foundation for Economic Education. This is the fifth of a six-part series on understanding how the economy works and why it matters to investors.
The following account of a World War II prisoner-of-war camp economy, helps to illustrate the impact on an economy of changes in the supply of money.
For the prisoners of the Second World War, comforts of material goods came largely through the issue of Red Cross parcels. These contained primarily food items such as biscuits, chocolate, sugar, jam, butter, etc. They also included cigarettes.
Each prisoner received the same parcel. Only through exchange could a prisoner alter, and possibly improve, his level of material comfort. There was some provision of services in the camp such as laundry and tailoring. In addition, some parcels did arrive from home, providing items such as clothing. However, overall, there was very little production activity within the camp so this left the process of exchange as the primary route to improved welfare.
The early economic activity in the camp began as direct barter—one good or service directly traded for one or more of another. Over time, the level and rate of trading increased significantly. Some prisoners became particularly adept at it. There was the story of one prisoner who set out with a tin of cheese and 5 cigarettes. He returned later with another complete parcel, as well as his original cheese and cigarettes.
Rough scales of trade evolved. A tin of jam was worth a half a pound of margarine plus something else. A cigarette was worth several chocolate issues. A tin of diced carrots was worth almost nothing. With the camp being split into different areas, prices in one part of the prison area could be different than in another. This meant that some prisoners could earn a profit from arbitrage—acquiring a good in a market where its price is relatively low and selling it in another market where its price is relatively high.
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However, over time, as the camp economy became more developed and complex, bartering became very complicated. A simplifying system was needed, and a simplifying system arose. Eventually, a unit of account and medium of exchange evolved. The value of everything in the camp came to be expressed in terms of cigarettes. The cigarette became the unit of account and the medium of exchange, in effect, a form of commodity money for the camp.
At first this system had some rough edges. In the hours after an issue from the Red Cross was received, the camp would be bedlam as prisoners walked through the camp calling out their offers such as “cheese for seven”—cheese in exchange for seven cigarettes.
This chaotic form of trading, however, eventually changed and the verbal exchange market was replaced by an “Exchange and Mart” notice board. On the board, in each area of the camp, a prisoner’s name would be listed along with his room number, what was wanted, and what he was offering in return. Through this type of public trading, prices became generally well-known. Prices, then, were largely influenced by the forces of supply and demand.
In the camp, certain entrepreneurial efforts were established. One prisoner set up a coffee stall selling coffee, tea, and cocoa at two cigarettes a cup. A restaurant was eventually set up in the camp as well.
Credit (being able to use something today and pay for it at a later date) also evolved in the camp as did spot and futures markets. Spot and future prices meant that a good could have a certain price if bought today and another price if you wanted to establish an agreement today to buy it in the future. For example, a treacle ration sold for 4 cigarettes today or 5 cigarettes if you agreed today to buy it next week. To be prepared to make an agreement for a higher future price, the buyer obviously had to believe that the price would rise. The higher price offered today would be worth it in the future, for example, if the buyer thought the price for treacle might be 6 or 7 cigarettes next week when the available supply was less.
