Book 1 of The Wealth of Nations is an analysis of the means by which we pursue self-interest and a critique of that pursuit. It is also a warning against pursuing what is worse. Adam Smith did not want us to be like 'the common people of England,' whom he saw as 'so jealous of their liberty, but … never rightly understanding wherein it consists'.38
CHAPTER 5
The Wealth of Nations, Book 2 'Of the Nature, Accumulation, and Employment of Stock' Let Adam Smith Be Your Market Guru
Investment guides and business motivational books sell in shocking numbers. The New York Times Book Review sends them to Coventry in the 'Advice, How-To and Miscellaneous' appendix to the best-seller list. But there in Coventry they stay, often for years on end, waxing fat and providing their authors with profits worthy of the fastest among 'countries going fastest to ruin'. These profits cause the authors of other sorts of books, such as this one, to seethe with envy and declare that the country is going to ruin indeed if investment guides and business motivational books are what sells.
The investing tips are always jejune. The motivating tomes usually are based on one more or less shrewd observation about business that is then plumped and padded, reiterated and restated until a marketable number of pages can be typeset. For instance, 'Keep in mind that your competitor is a man of layers. Don't judge him merely by surface appearances. Try to see "inside the suit," and understand both the things that make him comfortable and the things that rub him wrong.' Hence What Color Is My Underwear?, Cooksome Books, 230 pp., hardback, $29.95.
But here is The Wealth of Nations with its truly sagacious notice of every aspect of economics and its brainy commentary on all manner of financial concerns. Take an example from book 2. Hundreds of years before yuppies began installing pseudo-Palladian windows in the profusion of gables that block my view, Adam Smith warned against betting too much 'accumulation and employment of stock' on a red-hot housing market:
A dwelling house, as such, contributes nothing to the revenue of its inhabitant … If it is to be let to a tenant for rent, as the house itself can produce nothing, the tenant must always pay the rent out of some other revenue … Though a house, therefore, may yield a revenue to its proprietor … it cannot yield any to the public, nor serve in the function of a capital, and the revenue of the whole body of the people can never be in the smallest degree increased by it.1
What with Smith's work being in the public domain and all, there's an understandable temptation to wonder if something in the investment guide or business motivational line can't be culled from The Wealth of Nations. At the very least there should be material enough for one of those vade mecums for the self-admitted mental deficient, which people seem so unembarrassed to buy – The Idiot's Guide to the Betterment of Life, perhaps.
And it just so happens that book 2 of Wealth lends itself perfectly to such projects. Smith's subject is capital, where it is gotten, and how it may be employed to gain whopping returns. This is the stuff of best-sellers on a par with secret sexual techniques of the House of Windsor.
Unfortunately there's a problem. Adam Smith's advice, his how-tos, and, for that matter, his miscellanies are all addressed to the powerful figures who work as secretaries of the treasury, chancellors of the exchequer, chairmen of the Federal Reserve, and governors of the International Monetary Fund and the World Bank. This is not a mass market. On the other hand, the mighty do have sycophants, and maybe they'll all buy my book and give it to Paul Wolfowitz for Christmas.
Central Banking for Dummies
A central bank is the institution that controls the supply of a country's money. This would be a straightforward matter if it weren't for three facts: Money is imaginary. Banking doesn't involve money. And a central bank isn't a bank.
What the Heck Is Money Anyway?
'Money,' Smith wrote, 'is neither a material to work upon, nor a tool to work with.'2 Money, like the Impartial Spectator, is make believe. It's a conjectural idea we have that vaguely approximates value. Using the guesswork of money lets us transfer goods and services in a way that is less cumbersome than barter and less repellent to our Impartial Spectator than theft.
Money is the offspring of division of labor and free trade. It is a contentious child. Notions of value cause arguments. This Smith pointed out in a Glasgow University lecture: 'The offering of a shilling, which to us appears to have so plain and simple a meaning, is in reality offering an argument to persuade one to do so and so as it is for his interest.'3
Smith wrote that 'money, by means of which the whole revenue of the society is regularly distributed among all its different members, makes itself no part of that revenue.' Being imaginary, it can't. 'The great wheel of circulation,' he continued, 'is altogether different from the goods which are circulated by means of it.'4
We probably shouldn't try to think too hard about the nature of money. In book 1 of Wealth, Smith made an opaque statement that showed the effect of such thinking: 'I am always willing to run some hazard of being tedious in order to be sure that I am perspicuous; and after taking the utmost pains that I can to be perspicuous, some obscurity may still appear to remain upon a subject in its own nature extremely abstracted.'5
And What Is a Bank?
A bank is an institution that doesn't deal in money. If we accept Smith's definition of value as 'toil and trouble', banks deal in toil and trouble. Banking is a clever device for storing your toil and trouble. And instead of being charged storage fees, you're compensated for engaging in excess toil and going to extra trouble.
For example say that, per book 1 of Wealth, you are killing a lot of deer. You're only getting one beaver for every two deer you kill but, nonetheless, you're getting more beavers than you know what to do with. Absent some system of banking, you have to pile the beavers under your bed where they're of no use to anyone. And they stink. Banking allows you to rent the beavers to me with 'some tolerable security' of receiving the agreed upon beaver lease revenue and getting your beavers back when I'm finished with my high-profit, beaver-intensive business deal. Money doesn't come into it except insofar as the transaction is more convenient and pleasant if it's conducted in money instead of used beavers.
'It is not by augmenting the capital of the country,' Smith declared, 'but by rendering a greater part of that capital active and productive … that the most judicious operations of banking can increase the industry of the country.'6 What the judicious operations of banking can't do is increase the industriousness of the country – for instance by lending money to any fool, such as me, who comes along with a lunatic idea for alternative energy technology based on methane production from rotting beavers. Political advocates of 'economic stimulus' often claim that banks ought to do this. And bankers often claim that they've done it. But they shouldn't, and they can't.
There was a banking crisis in Scotland in 1772. Only three of Edinburgh's thirty private banks survived. Every time and place has its equivalent to dot.com-boom, Silicon Valley startups. Adam Smith described the attitude of investors in 1999 as well as in 1772: 'The banks, they seem to have thought, were in honour bound to supply … them with all the capital which they wanted to trade with.'7
So What Are Banks Really Good For?
They're good for make-believe. Banks are as imaginary as the dollars they lend. Their pillared porticos, their impressive vaults, and their handy time and temperature signs, are just symbols. The symbols represent something else we've made up called 'contract'.
It's fortunate that Adam Smith was free to be a psychologist as well as an economist. Any examination of economics quickly turns into a session on the couch, with dreams to analyze, narcissisms to probe, and family conflicts to be resolved. Money is the child of division of labor and freedom of trade, an active little bastard conceived while we were enjoying some subconscious cooperation. The wedding of property rights to equality before the law also produces an offspring, more widely recognized as legitimate than money, known as valid and binding contract. Bad banking is a ba
d marriage where contract is being spoiled by the selfishness of private property and the failure of equal rights to assert herself. 'When the law,' wrote Smith, 'does not enforce the performance of contracts, it puts all borrowers nearly upon the same footing with bankrupts or people of doubtful credit.'8 Counseling should be sought. Otherwise poor little contract may start associating with the wrong element, get corrupted by money, and grow up with low self-esteem and self-destructive tendencies. This is what happened to America's Social Security trust fund.
So We Need to, Like, Regulate Banks
Freedom cannot exist without limitation. Adam Smith was not a man to flinch at this conundrum. In his consideration of banking Smith stated his most fundamental free market principle: 'If any branch of trade, or any division of labour, be advantageous to the public, the freer and more general the competition, it will always be the more so.'9 However, in his consideration of banking, Smith also stated his most fundamental caveat to that principle: 'But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments.'10
So much is sensible, although you'd never know it to hear the senseless arguments between lawmakers who believe one of these ideas and lawmakers who believe the other. Unlike most politicians Smith was usually able to make his way past the sirens of authoritarianism and the sirens of license without having a head full of wax or needing to be tied to the mast. Smith had a clearer idea of the purpose of law than legislators do. He didn't see writing laws as a contest or a compromise between battling interest groups. He saw writing laws as a way of furthering 'that natural liberty which it is the proper business of law, not to infringe, but to support'.11 Sometimes we get that kind of law. And when we do, a lot of bankers go to jail.
What Is a 'Central' Bank?
You can't get a debit card that draws on the Federal Reserve Bank, nice as that would be, and never mind that the Bush administration apparently can. A central bank is not really a bank at all but a government agency. Smith called it 'a great engine of state'.12 It regulates the amount of money in circulation by, basically, regulating real banks. A nation's currency supply is supposed to be matched to that nation's supply of economic value. If a nation has less circulating money than it has labor and goods, you get a credit collapse and a Great Depression. If a nation has more money than it has labor and goods, you get the 1970s. Which is worse depends upon whether you are more annoyed by double knit, disco, and Henry Kissinger or by claptrap about the Greatest Generation, enormous Medicare expenditures, and your parents.
The purpose of central banking is to prevent the return of disco and to get your parents to shut up. The technical mechanisms by which a central bank does that are beyond the scope of this book, not to mention the understanding of this writer. You actually are a dummy if you think you're going to plumb the mysteries of central banking here. The importance of what Adam Smith wrote about central banks was that Smith, as usual, understood the practical principles behind the mystery. He realized that money was not a government asset, but a government liability. He called it 'that great but expensive instrument of commerce'.13 And noted that 'the stock of money which circulates in any country must require a certain expence, first to collect it, and afterwards to support it.'14
The Adam Smith Plan for Increased Wealth (of Nations): How Central Banks Can Use Paper Money to Make the Great Instrument of Commerce Work Cheap
The 'certain expence' of having a handy medium of exchange made Smith an early advocate of paper money. Not only are precious metals costly to mine, transport, and mint; precious metals also have a real – not just a monetary – value in manufacturing and industry.
Smith went almost literary on the subject. He wrote that 'gold and silver money' could be 'compared to a highway, which, while it circulates and carries to market all the grass and corn of the country, produces itself not a single pile of either'.15 Paper money would, 'by providing, if I may be allowed so violent a metaphor, a sort of waggon-way through the air, enable the country to convert, as it were, a great part of its highways into good pastures and cornfields'.16 (Although now that we really do have a 'waggon-way through the air', not many of our interstates have been turned into pastures and cornfields.)
Money is information. In his advocacy of paper money Smith was foreseeing the virtual aspect of the modern economy and all the efficiency that comes from it. Why buy a pricey slab of granite and have information chiseled into it by skilled workmen when information can be encoded almost effortlessly in the ether?
Smith was aware of the danger in what he called 'the Dædalian wings of paper money'.17 He was an honest and sane early advocate of paper money, which was not usual. Many eighteenth-century paper money promoters favored paper not because they thought it made money more efficient but because they thought it made money free. The most famous of these was a fellow Scot, John Law. Law proposed a national bank of Scotland which, as Smith put it, 'he seems to have imagined might issue paper to the amount of the whole value of all the lands in the country'.18 The Scottish parliament demurred. Law went to Paris and in 1717 concocted the Mississippi Scheme along the same lines. Smith gave a detailed account of Law's operations in a Glasgow University lecture. 'The greatest part of the people,' he said, 'had their whole fortunes in notes and were reduced to a state of beggary.'19 And in Wealth of Nations, Smith declared that 'the paper currencies of North America' were 'a scheme of fraudulent debtors to cheat their creditors'.20
Many paper currencies issued by many central banks are no better nowadays. Would you like your change in Argentinian pesos? All modern money is paper money but with nothing ensuring its relative value except the promises of a government or, in the case of the euro, the even more nebulous promises of a bunch of governments. We have our paper, or 'fiat', money because it's easier for our governments to print more of it in the name of 'greater monetary policy flexibility'. The quality of money, like the quality of the human body after the age of eighteen, is not often improved by increases in quantity. Smith wrote that 'paper money does not necessarily increase the quantity of the whole currency.'21 Italics added, alas. In February 2006, Zimbabwe's reserve bank introduced a new fifty-thousand-dollar bank note, and it was not worth enough to buy a beer.
Smith proposed various intelligent limitations on central banking's paper currencies. None of them are of interest to us today because fiat money was beyond even Adam Smith's powers of conception. He thought that money would always be on a gold standard or a silver standard or a standard of some kind. (When, as mentioned before, Smith wrote about the price of food grains determining 'the real value of all other commodities',22 he was in effect suggesting a 'market basket' of consumer goods as a currency standard.)
The worth of fiat money is linked to political whims far less substantive than John Law's 'value of all the lands in the country'. Modern governments have taken the Mississippi Scheme and made it work. Except, of course, when it doesn't.
So There Are Limitations to What Private Banks and Central Banks Can Do to Improve the Economy, but Can't Institutions Like the World Bank Provide the Economic Stimulus We Need to Eliminate Poverty and Aid Developing Nations?
No. Smith put this forcefully in book 4 of Wealth: 'I have never known much good done by those who affected to trade for the public good.'23 The explanation for that grouchy outburst is in book 2 where Smith described the Ayr Bank, the collapse of which led to the 1772 Edinburgh banking crisis. 'It was the avowed principle of this bank to advance … capital which was to be employed in those improvements of which the returns are the most slow and distant.'24 This being what the World Bank tries to do. 'The operations of this bank,' Smith continued, 'seem to have produced effects quite opposite to those which were intended.'25 That being how things turn out for the World Bank. Smith wrote that the wonderfully named Ayr Bank 'no doubt, gave some temporary relief … But it thereby only enabled [its borrowers] to get so much deeper
into debt, so that when ruin came, it fell so much the heavier.'26 And there was no Bono in those days to put everything right.
Owing money to beneficent organizations is not beneficial. It's better to owe money to your scowling uncle or the skinflint down the street. Borrowers are debtors, after all. 'The sober and frugal debtors of private persons,' Smith observed, 'would be more likely to employ the money borrowed in sober undertakings … which, though they might have less of the grand and the marvellous, would have more of the solid and the profitable.'27 This maxim applies to everything from programs of foreign aid in the developing world to local city council debates. One new hot dog vendor is better for a town than any number of municipally financed sports stadiums. Smith declared that if the Ayr Bank had succeeded it still would have been a failure, that 'this operation, therefore, without increasing in the smallest degree the capital of the country, would only have transferred a great part of it from prudent and profitable, to imprudent and unprofitable undertakings.'28
A recurring lesson in The Wealth of Nations is that we shouldn't get greedy. And no people are as rapacious and grabby as those who work for the public good. They don't want mere millions or billions of dollars to satisfy personal avarice. They seek the trillions of dollars necessary to make life on earth better for everyone. The World Bank should content itself with private good, from which all good things flow.
CHAPTER 6
The Wealth of Nations, Book 2, Continued: Adam Smith, Un-Motivational Speaker
Besides being a discourse on currency and banking, book 2 of Wealth is also an examination of economic planning – and the crying need for less of it. Adam Smith was one of the first and best campaigners in the endless war against governmental attempts to control business and industry. Smith's strategy was to convince the people who guide the world's economies to get lost.