WHAT ADAM SMITH’S “THE WEALTH OF NATIONS” SAYS ABOUT THE ORIGIN AND USE OF MONEY

Even when Adam Smith first published The Wealth of Nations in 1776, money already had an ancient history. Therefore, it is worthwhile to consider some extracts from his book.

Smith explains the origin and use of money in chapter 4 of Book 1 of The Wealth of Nations. He begins by explaining that the need for money is a result of the division of labor. 

But when the division of labour first began to take place, this power of exchanging must frequently have been very much clogged and embarrassed in its operations. One man, we shall suppose, has more of a certain commodity than he himself has occasion for, while another has less. The former consequently would be glad to dispose of, and the latter to purchase, a part of this superfluity. But if this latter should chance to have nothing that the former stands in need of, no exchange can be made between them. The butcher has more meat in his shop than he himself can consume, and the brewer and the baker would each of them be willing to purchase a part of it. But they have nothing to offer in exchange, except the different productions of their respective trades, and the butcher is already provided with all the bread and beer which he has immediate occasion for. No exchange can, in this case, be made between them. He cannot be their merchant, nor they his customers; and they are all of them thus mutually less serviceable to one another.

Thus, the division of labor created a problem. What could be used as a medium of exchange? What would everyone accept in return for what they produced?

Many different commodities, it is probable, were successively both thought of and employed for this purpose. In the rude ages of society, cattle are said to have been the common instrument of commerce; and, though they must have been a most inconvenient one, yet in old times we find things were frequently valued according to the number of cattle which had been given in exchange for them. The armour of Diomede, says Homer, cost only nine oxen; but that of Glaucus cost an hundred oxen. Salt is said to be the common instrument of commerce and exchanges in Abyssinia; a species of shells in some parts of the coast of India; dried cod at Newfoundland; tobacco in Virginia; sugar in some of our West India colonies; hides or dressed leather in some other countries; and there is at this day a village in Scotland where it is not uncommon, I am told, for a workman to carry nails instead of money to the baker’s shop or the ale-house.

Metals were found to work best.

Metals can not only be kept with as little loss as any other commodity, scarce any thing being less perishable than they are, but they can likewise, without any loss, be divided into any number of parts, as by fusion those parts can easily be reunited again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation. The man who wanted to buy salt, for example, and had nothing but cattle to give in exchange for it, must have been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could seldom buy less than this, because what he was to give for it could seldom be divided without loss; and if he had a mind to buy more, he must, for the same reasons, have been obliged to buy double or triple the quantity, the value, to wit, of two or three oxen, or of two or three sheep. If, on the contrary, instead of sheep or oxen, he had metals to give in exchange for it, he could easily proportion the quantity of the metal to the precise quantity of the commodity which he had immediate occasion for.

Different metals have been made use of by different nations for this purpose. Iron was the common instrument of commerce among the antient Spartans; copper among the antient Romans; and gold and silver among all rich and commercial nations.

However, even metals were not without problems.

The use of metals in this rude state was attended with two very considerable inconveniencies; first with the trouble of weighing; and, secondly, with that of assaying them. In the precious metals, where a small difference in the quantity makes a great difference in the value, even the business of weighing, with proper exactness, requires at least very accurate weights and scales. The weighing of gold in particular is an operation of some nicety. In the coarser metals, indeed, where a small error would be of little consequence, less accuracy would, no doubt, be necessary. Yet we should find it excessively troublesome, if every time a poor man had occasion either to buy or sell a farthing’s worth of goods, he was obliged to weigh the farthing. The operation of assaying is still more difficult, still more tedious, and, unless a part of the metal is fairly melted in the crucible, with proper dissolvents, any conclusion that can be drawn from it, is extremely uncertain. Before the institution of coined money, however, unless they went through this tedious and difficult operation, people must always have been liable to the grossest frauds and impositions, and instead of a pound weight of pure silver, or pure copper, might receive in exchange for their goods, an adulterated composition of the coarsest and cheapest materials, which had, however, in their outward appearance, been made to resemble those metals. To prevent such abuses, to facilitate exchanges, and thereby to encourage all sorts of industry and commerce, it has been found necessary, in all countries that have made any considerable advances towards improvement, to affix a public stamp upon certain quantities of such particular metals, as were in those countries commonly made use of to purchase goods. Hence the origin of coined money, and of those public offices called mints; institutions exactly of the same nature with those of the aulnagers and stampmasters of woollen and linen cloth. All of them are equally meant to ascertain, by means of a public stamp, the quantity and uniform goodness of those different commodities when brought to market.

Thus, the inconvenience of perpetually assaying the value of metals led to coining money.

The inconveniency and difficulty of weighing those metals with exactness gave occasion to the institution of coins, of which the stamp, covering entirely both sides of the piece and sometimes the edges too, was supposed to ascertain not only the fineness, but the weight of the metal. Such coins, therefore, were received by tale as at present, without the trouble of weighing.

Smith uses the term “tale” here as we today use the term “tally” for count. 

Of course, different denominations were required.

The denominations of those coins seem originally to have expressed the weight or quantity of metal contained in them. In the time of Servius Tullius, who first coined money at Rome, the Roman As or Pondo contained a Roman pound of good copper. It was divided in the same manner as our Troyes pound, into twelve ounces, each of which contained a real ounce of good copper. The English pound sterling in the time of Edward I., contained a pound, Tower weight, of silver of a known fineness. The Tower pound seems to have been something more than the Roman pound, and something less than the Troyes pound. This last was not introduced into the mint of England till the 18th of Henry VIII. The French livre contained in the time of Charlemagne a pound, Troyes weight, of silver of a known fineness.

Unfortunately, not even stamped metal coins could be trusted.

For in every country of the world, I believe, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins. The Roman As, in the latter ages of the Republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, came to weigh only half an ounce. The English pound and penny contain at present about a third only; the Scots pound and penny about a thirty-sixth; and the French pound and penny about a sixty-sixth part of their original value. By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfil their engagements with a smaller quantity of silver than would otherwise have been requisite. It was indeed in appearance only; for their creditors were really defrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.

Thus, what we call inflation today is at least as old as the invention of coins. What is different is only the fact we use a paper currency, and we depend upon our government to regulate the money supply. Ideally, we want the ratio between the money supply and goods and services to remain constant, but that does not happen. Why?

Not so many years ago, the United States printed silver certificates.

Silver Certificates are a type of representative money printed from 1878 to 1964 in the United States as part of its circulation of paper currency. They were produced in response to silver agitation by citizens who were angered by the Fourth Coinage Act, which had effectively placed the United States on a gold standard. The certificates were initially redeemable in the same face value of silver dollar coins, and later in raw silver bullion. Since 1968 they have been redeemable only in Federal Reserve Notes and are thus obsolete, but are still valid legal tender. (from here)

Now the United States no longer backs its currency with either gold or silver. So why is our money worth anything? We have to have money to pay our taxes.

So how do we get inflation today? The government prints money and spends it, increasing the money supply.

Why is inflation harmful? Inflation reduces the value of our savings, effectively taking away the incentive to either save or lend money. However, politicians benefit. When they print and spend money, they spend it at its present value. The problem comes latter, when people realize the money supply has increased, thereby reducing the demand for our currency and making the money we still have in our pockets worth less.

6 thoughts on “WHAT ADAM SMITH’S “THE WEALTH OF NATIONS” SAYS ABOUT THE ORIGIN AND USE OF MONEY

  1. Tony, your comments are incredibly arrogant and ignorant. Tom, you are being too modest in your response to Tony’s attempt to justify the existence of the Fed. It’s hysterical and ridiculous to think The Federal reserve as actually being a “regulatory agency” whose job it is to protect average Americans from inflation, boom/bust cycle, or any other form of economic hardship. The Fed is inflationary at its core! That’s the point! Why else would we have a secretive, unaccountable, central private bank issuing our currency!!! The Fed doesn’t protect against business cycles, it guarantees and perpetuates them. That’s the same rhetoric that was spewed all over the American people in 1907 to rally support for another central bank – claiming economic depressions would be virtually impossible. So, the Federal Reserve act was passed in 1913 and, the money machine went to work. During the roaring twenties, no one was complaining about the benefits of inflating the currency like the housing boom. We all know what happened later. The market had to correct the distortion. Read “the road to serfdom” written by Friedrich Von Hayek, Nobel peace prize winner for his theories on economics. I find it funny when you mention Marx in a dissociative context while at the same time promoting similar ideas of central economic planning. You cannot have personal liberty without economic liberty, they are one in the same — I’m sorry, I know it’s difficult to find the connection between an elite group of unelected private bankers, who tricked the American people (AGAIN) in handing over the power to create and issue our currency, and how that unconstitutional fiat monetary system always lead to financial collapse and loss of freedom – it’s “complicated” you may have to do some more research…

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  2. Tony, thank you for the comment.

    Wallstreet vampires? 😆

    It should be fun to check out the people with “business experience” in government these days. I suppose that is worth a post. It would also be interesting to review how much of the financial sector our government dominates. So much to do, so little time.

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  3. I’m not questioning the scarcity of your economic knowledge, just the conclusions that you draw from that small amount of knowledge.

    Of course, the complexity and size of macro economic systems have changed drastically since the time of Adam Smith. During Smith’s time, we had a mainly agrarian economy. The Industrial Revolution was just beginning. Economies and money supplies were tiny fractions of what they would come to be under the full fledged capitalist economies that erupted in the 20th Century and which have more rapidly become global economies. (Did you know that of the 50 largest economies in the world right now, half of them are not countries, but mutli-national corporations).

    During Smith’s time, banking was just recently invented in Holland in order to finance the numerous European wars where the new professional armies and weapons technology were becoming increasingly expensive. It would be another century before banks began to have their dramatic impact on money supply and today, they “are” the money supply.

    As you allude, only a tiny fraction of our “money supply” is actually in paper currency and coins. Almost all of it is in financial instruments that are managed by banks and other financial institutions. Money is just the intangible ones and zeros in computers all around the world. How does the government literally “print” this electronic money? Well, sorry, but it is complex.

    To some extent it has to do with how much money the government borrows, in other words, how many treasury bills and other government bonds it sells. But more importantly, it has to do with the interest rates that the Fed charges as a lender of last resort to banks. It also has to do with how much money the Fed requires that the banks keep in reserve for every dollar that they lend.

    Banks actually “print” most of the money in this way by how they lend it out, the risks that they take with this increase in the money supply. If the economy is too hot and inflation begins to rise, the Fed uses these mechanisms to get the banks to shrink the money supply. If the economy cools to much, growth is shrinking, and inflation is low, the Fed expands the money supply to spark investment and circulation.

    That’s essentially how it has worked since Volker. And it has worked. Until recently, we have had fairly consistent growth, shallow recessions and nominal inflation for the past 30 years. Compare this to wild cycles of the late 19th and early 20th century. The Great Depression was not the first depression since the Industrial Revolution. Economic monetarists have essentially solved the problem of inflation and steep economic cycles, but what they have not solved is the problem regulation of financial risk taking.

    The reason why our economy almost collapsed is not because monetary “regulation” is too complex or doesn’t work, just the opposite. Our economy almost collapsed because banking regulation and monetary policy has not kept up with the complex economic innovation and complex inventive chicanery of modern financial institutions.

    Furthermore, the only reason why our economy did not collapse, as it did under the similar bubbles and the institutional risk taking spree prior to the Great Depression, is because we have those post Depression institutions and mechanisms in place that kept another Great Depression from happening, for now anyway. The Fed has essentially been getting banks to print money like it is going out of style – they are charging zero interest rates to banks in order to get them to lend and increase the money supply. And the Federal Government is giving borrowed money away in the form of stimulus packages and tax cuts for everybody. Yet, the bond traders are still giving cheap interest rates for federal notes and inflation is more than modest, its even approaching deflation in many sectors of the economy. Deflation, not inflation, is the really scary enemy of a vibrant economy.

    What scares me is not that the monetarists are wrong, all this once again proves them right. What scares me is that we have forgotten what the Great Depression taught us about banking regulation, specifically limiting excessive risk taking by financial institutions that are “too big too fail” without their collapsing our entire financial system and the economy along with them. By bailing them out without any strings attached, then letting them grow wildly bigger while at the same time not regulating their risk taking (for example, look at the recent Facebook purchase by Goldman), we are simply encouraging them to go further cause they know that if they are right then they make millions, and if they are wrong, we will have to bail them out again, and they still again make millions.

    Did you know that in the late 19th and early 20th century, one of the biggest demands of industrial workers in this country was “cash money”. Actual money was so scarce that workers were not paid with it. They were provided dismal company housing and paid with company script that could only be used at the overpriced, understocked company store. The company essentially controlled the money supply and its value and therefore the companies kept their money cheap and prices inflated, thus artificially decreasing their labor costs. The workers wanted an increase in the cash money supply so that they could force the company to pay them in cash currency. Nowadays cash money is hardly even necessary. It could easily become obsolete eventually.

    Money is essentially the mechanism for exchanging the value of labor and resources between numerous parties. You could call it credits, or dollars, or zeros and ones in a bank. It is basically just the economic current between buyers and sellers You work. Your employer pays you for labor by electronically transferring the value of your work to your bank. You in turn electronically transfer part of that value to pay for the labor, resources, value added, etc. that you purchase in the form of goods and services.

    The amount of money produced and needed are interrelated just as the size of the money supply and the value of a given good or service is related. Money supply effects the supply and demand curves of every product. Increased money for investment can spark demand and heat up the economy. As the demand curve shifts upward on given products it also effects employment supply and demand curves. We hit full, or better than full, employment and good/services prices rise as labor prices rise. The Fed then shrinks the money supply to cool off the economy and keep inflation in check and all the curves shift again. It is all interrelated and it is incredibly complex. Economists link together dozens of such graphs just to chart the most basic economic analysis.

    Sorry it is so complex, but if you want to demand a return to simplicity in a complex economic world, then we can always return to the Dark Ages. It was real simple then. And if we are going to give banks, not governments, the necessary ability to essentially “print money”, the liquid economic blood flowing through our economy body, then not to regulate that is simply economic suicide. We may as well open up a vein. And that we seem to be trying to set ourselves up for, especially if we let politicians dumb us down with deregulatory platitudes to the point that we don’t even realize that we let these Wallstreet vampires suck us dry.

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  4. Of course, we can increase the money supply by “printing” it electronically. Nonetheless, I will readily agree I don’t entirely understand economics. Does that make me unusual? Of course not, and therein lies a great many problems. When we create a complex government entity like the Federal Reserve, how are us voters suppose to control it? If we don’t even know what it does, how do we decide which politicians to elect? Do the politicians we elect understand what the Federal Reserve does? How would we know?

    Nevertheless, I think you vastly underestimate what Adam Smith understood and overestimate our “progress.” Although our technology has advanced considerably, people have not changed all that much. I also doubt that economic cycles have changed that much.

    Your example is a case in point. Just as Marx used too little data, you risk doing the same. When we look around us and try to predict the future based just upon our own experience, we usually get it wrong. Why? I suspect that the boom/bust cycles we see occur within larger cycles that exceed our lifetimes.

    In any event, commerce remains essentially the same, and so does banking. We still have fractional reserve banking, and that banking model still poses much the same problems as in Smith’s time.

    What is the Federal Reserve Bank about? Essentially, it represents an aspect of our need for control. Because fractional reserve banking is inherently unstable, we look for ways to prop up the banking system up, hence the Federal Reserve.

    Does the Federal Reserve improve financial stability? When most of us don’t even know what the Federal Reserve is or what does, I suspect that that institution just provides yet another example of giving politicians more trust than is wise.

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  5. I am no economist, but I know enough to know that you don’t understand exactly how the monetary policy works, how the government essentially “prints money” to increase or decrease the money supply.

    In a macro economic sense, the actions of the Fed can have as much or more to do with size of the money supply, particularly in the short term, than does the spending of Congress, and the “borrowing” of Congress is essentially more important than the spending.

    Adam’s Smith’s economic and social incite in Wealth of Nations is genius, but keep in mind that, during Smith’s time, banking was in it’s mere infancy and there was no regulatory agency such as the Fed. As such, cyclical expansions and contractions could lead to boom/busts in the economy of a nation, in other words times of tremendous economic growth followed by deep economic depressions. In fact, the rational assumption that this boom/bust cycle would inevitably continue for the worst was the false premise that weakened the foundation of Karl Marx’s determinist prediction that the workers would eventually revolt.

    In order to understand why we did not continue (arguably until almost again recently) to have these huge cycles, you need to understand the changes to the Fed and banking regulations that took place following the Great Depression, and you also have to understand the tremendous innovations in monetary policy that were put in place by Paul Volker during the Carter/Reagan administrations. Prior to that time, we often had runaway inflation (remember double digit inflation and the price controls under Nixon). Yet despite an every burgeoning federal budget and debt, we have nominal inflation today. If fact, deflation, not inflation, is right now the greater fear. But that is a longer story.

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