Currencies
Now let's throw in the fact that societies developed separately. It would have been great if the world had a universal measure of value from the start, but unfortunately this is not how things happened, and money developed differently in different cultures and countries, and societies developed pride in their currencies and saw them as symbols of their identity. They were still transacting with one another though, so the valuation table needed entries to translate between different currencies now.
Suppose we take two currencies, cA and cB, and consider their valuation tables' entries for cows.
1 cow = 5 cA
1 cow = 10 cB
Well, great! We conclude that 1 cA = 2 cB.
Oh but wait, let's look at the entries for bathroom tiles.
1 tile = 1 cA
1 tile = 1.5 cB
Oops.
This is hardly unexpected - it is a reflection of how different societies have different valuation tables because of their different priorities, wants and needs, and access to resources. But it makes finding the combined valuation table's entries complicated.
So instead of trying to "solve for" the cross-currency ratios, we do something different. We make the currencies themselves things-to-be-transacted, and let individuals and societies create entries for external currencies. So the society with currency cA would have an entry in their valuation tables which looks like
1 cB = <some number> cA
Trade
Now who even needs these valuations? Why would a member of society A require the currency of society B? The only reason would be that they need to transact with members of society B i.e. engage in import and export.
So the trader in bathroom tiles would use one ratio, and the trader in cows would use another. But if they're smart, they will trade in both tiles and cows! Let's look at the perspective for a trader from society A, the case for B is just the opposite. We will use the numbers from above.
Trader A takes 15 cA and buys 3 cows. He sells these cows in society B for 30 cB. With those 30 cB he buys 20 bathroom tiles, which he brings back home and sells for 20 cA. His profit from the transaction is 5 cA.
Why couldn't he just keep doing this? Well, sometimes he can, and some people do. But usually what happens is that the other people in these transactions realize what is happening and start adjusting their prices - the cow seller in society A starts charging more for her cows and the cow buyer in society B starts paying less. Or a similar price adjustment happens with the bathroom tiles - in both cases the valuations of societies A and B start to converge.
The problem with prices converging, is that people who are not engaging in these clever cross-border trades start getting screwed. Cows become more expensive for everyone in society A, not just to our trader. And bathroom tiles become more expensive in society B, leading to great unhappiness on that side.
On the one hand one could say to the people in society A - "Look, they are willing to pay more for cows, why don't you just send your cows over instead of milking them or eating them yourselves?". But people want their cows, dammit, and they'll be damned if they're going to be forced to send them over to society B.
Duties / Tarrifs
So they band together collectively and raise the price of transporting cows across the border. The price of the cows stays the same, so they continue living happily, but the cost of doing the clever (nefarious!) cow-tile trade goes up. Now the cow-tile trader is not making so much money, and after society B enacts a similar rule on bathroom tiles, societies A and B continue to see their old prices for cows and tiles.
If the cost of doing business (the duty, or tariff) is too high, the cow-tile trader won't engage in the transactions. But the people of societies A and B are quite smart, and they don't make those costs that high. Instead, they raise them to where the trader makes only 2 cA per transaction instead of 5 cA. Now 2 cA is better than nothing, thereby giving him incentive to trade, and the remaining 3 cA gets taken in duties and is used for the beautification of the public parks. (That 3 cA will actually consist of some cA and some cB... you can figure out the details).
The last example showed the trader as being the "good guy" trying to do business despite the obstacles put in place by the duty-regimes in both nations he wants to trade in. Here's another narrative, which has also occurred several times in history. Let's use the same valuations for cows and bathroom tiles as before:
1 cow = 5 cA
1 cow = 10 cB
1 tile = 1 cA
1 tile = 1.5 cB
Again, the trader will buy tiles from nation B and sell them cows. The differences in this scenario are:
Now let's throw in the fact that societies developed separately. It would have been great if the world had a universal measure of value from the start, but unfortunately this is not how things happened, and money developed differently in different cultures and countries, and societies developed pride in their currencies and saw them as symbols of their identity. They were still transacting with one another though, so the valuation table needed entries to translate between different currencies now.
Suppose we take two currencies, cA and cB, and consider their valuation tables' entries for cows.
1 cow = 5 cA
1 cow = 10 cB
Well, great! We conclude that 1 cA = 2 cB.
Oh but wait, let's look at the entries for bathroom tiles.
1 tile = 1 cA
1 tile = 1.5 cB
Oops.
This is hardly unexpected - it is a reflection of how different societies have different valuation tables because of their different priorities, wants and needs, and access to resources. But it makes finding the combined valuation table's entries complicated.
So instead of trying to "solve for" the cross-currency ratios, we do something different. We make the currencies themselves things-to-be-transacted, and let individuals and societies create entries for external currencies. So the society with currency cA would have an entry in their valuation tables which looks like
1 cB = <some number> cA
Trade
Now who even needs these valuations? Why would a member of society A require the currency of society B? The only reason would be that they need to transact with members of society B i.e. engage in import and export.
So the trader in bathroom tiles would use one ratio, and the trader in cows would use another. But if they're smart, they will trade in both tiles and cows! Let's look at the perspective for a trader from society A, the case for B is just the opposite. We will use the numbers from above.
Trader A takes 15 cA and buys 3 cows. He sells these cows in society B for 30 cB. With those 30 cB he buys 20 bathroom tiles, which he brings back home and sells for 20 cA. His profit from the transaction is 5 cA.
Why couldn't he just keep doing this? Well, sometimes he can, and some people do. But usually what happens is that the other people in these transactions realize what is happening and start adjusting their prices - the cow seller in society A starts charging more for her cows and the cow buyer in society B starts paying less. Or a similar price adjustment happens with the bathroom tiles - in both cases the valuations of societies A and B start to converge.
On the one hand one could say to the people in society A - "Look, they are willing to pay more for cows, why don't you just send your cows over instead of milking them or eating them yourselves?". But people want their cows, dammit, and they'll be damned if they're going to be forced to send them over to society B.
Duties / Tarrifs
So they band together collectively and raise the price of transporting cows across the border. The price of the cows stays the same, so they continue living happily, but the cost of doing the clever (nefarious!) cow-tile trade goes up. Now the cow-tile trader is not making so much money, and after society B enacts a similar rule on bathroom tiles, societies A and B continue to see their old prices for cows and tiles.
If the cost of doing business (the duty, or tariff) is too high, the cow-tile trader won't engage in the transactions. But the people of societies A and B are quite smart, and they don't make those costs that high. Instead, they raise them to where the trader makes only 2 cA per transaction instead of 5 cA. Now 2 cA is better than nothing, thereby giving him incentive to trade, and the remaining 3 cA gets taken in duties and is used for the beautification of the public parks. (That 3 cA will actually consist of some cA and some cB... you can figure out the details).
The last example showed the trader as being the "good guy" trying to do business despite the obstacles put in place by the duty-regimes in both nations he wants to trade in. Here's another narrative, which has also occurred several times in history. Let's use the same valuations for cows and bathroom tiles as before:
1 cow = 5 cA
1 cow = 10 cB
1 tile = 1 cA
1 tile = 1.5 cB
Again, the trader will buy tiles from nation B and sell them cows. The differences in this scenario are:
- The trader has an abundance of cows to sell, so domestic prices are unaffected
- The trader deploys soldiers in nation B and tells them not to raise their tile prices. Oh, and they better buy all these cows which are being sent over the border.
(Sometimes the soldiers weren't even necessary - say if the "cows" were opium and "nation B" were China...)
In fact coupling soldiers with traders is basically how European colonialism worked, certainly in Africa and Asia. I don't know enough about other types of colonialism to comment here.
Today nations don't need to deploy soldiers (although that still happens). There are other ways to coerce other nations in matters of trade.