TWoN Book 2 Chapter 2 Part 3

On page 239 we find: “As the same guinea which pays the weekly pension of one man to-day, may pay that of another to-morrow, and that of a third the day thereafter, the amount of the metal pieces which annually circulate in any country, must alwys be of much less value than the whole money pensions annually paid with them.”  The point appears at first glance to be reasonable: we cannot count the metal coins because we are already counting the, if I may, virtual coins as part of each person’s income.  The trouble is, we also have the actual metal coins which are, at any given time, somewhere.  These coins have value (for the metal they contain, if no other way).  It seems to me that there is something unresolved here.  In spite of several excellent remarks in previous posts, I do not believe that a mere agreement among a set of people that a certain commodity will be used to trade for any other commodity, to mediate among them, removes all value from that commodity.  Among societies (mentioned, I believe, by Smith in Book 1) where pigs are a medium of exchange, pigs could still be, and were, eaten.

Well, let’s move on.  Page 240: “The whole capital of the undertaker of every work is necessarily divided between his fixed and his circulating capital.  While his whole capital remains the same, the smaller the one part, the greater must necessarily be the other.  It is the circulating capital which furnishes the materials and wages of labor, and puts industry into motion.  Every saving, therefore, in the expence of maintaining the fixed capital, which does not diminish the productive powers of labor, must increase the fund which puts industry into motion, and consequently the annual produce of land and labor, the real revenue of every society.”

Okay, there are a couple of problems here.  First, yes, it is certainly the case that, by cutting the costs of machinery, more capital is available for production.  But any reduction in wages and material that doesn’t reduce production (ie, cutting wages, or finding cheaper material), also provides more capital for putting into production: If you are paying 10 workers $100 a day, and cut their wages to $90 a day, you can hire another worker, and even have $10 to invest in material.  The more significant problem, however, is that, in point of fact, that is not how capitalism works: the tendency is for more and more capital to be invested in machinery.  As technology improves, the capitalist is forced, by competition and the need to maintain market share, to upgrade his machinery, in many cases, before the old machinery has been paid for.  Of course, this was probably not as true in the 1760s, and I can’t think that Smith is culpable for not knowing it.

On page 241, he talks about the importance of confidence in a banker issuing notes.  Today, this is the pervue of a government, but his point is no less valid.  Notes have value insofar as it is believed that there is a commodity with actual value backing them.  Further down, he speaks of a banker with one hundred thousand pounds worth of notes in circulation, but requiring only twenty thousand pounds of actual metal to have available for demands of payment.  He says, “Eighty thousand pounds of gold and silver, therefore, can, in this manner, be spared from the circulation of the country; and if different operations of the same kind should, at the same time, be carried on by many different banks and bankers,, the whole circulation may thus be conducted with a fifth part only of the gold and silver which would otherwise have been requisite.”  Okay, am I missing something, or is this not a recipe for inflation?

**Edited later, because I was muddled the first time**

He goes on to speak of notes circulating within a country leaving the actual metal for circulation out of the country.  While I can see where this would bring additional profit to the banker, it also points out yet another reason for imperialism–that is, for capitalism to necessarily expand.  Markets, not only for products, but for metals must always be available.  He speaks of a “channel” within a nation being full, and therefore money being sent outside of the nation.  In other words, a given nation can only, because of the amount of available labor and material, make use of a given amount of currency.  However, he says, bank notes may be circulated within the country sufficient to fill the channel, leaving the actual coinage available to send (ie, invest) in other channels–that is, in other countries.  This is only one, but a very important reason why capitalism becomes international.  The trouble is, it seems to me,   that nation to which we send the coins has it’s own “channel.”  This was probably not a problem in his time (there were colonies galore, after all), but looking forward a hundred years or so, we start to see where conflicts over who gets to use what channel might eventually need to be backed up by armed might.

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0 thoughts on “TWoN Book 2 Chapter 2 Part 3”

  1. Re Smith’s p. 239 and your comment about circulating metal pieces versus annual revenue. Smith isn’t talking about virtual versus physical (see his sentence directly before the one you’ve quoted). He’s saying that the metal pieces are doing double or triple duty–or more–moving around from person to person in the course of a year, so a single coin might literally be used to pay part of the wages of several people before the year is out. Each laborer has gotten full use out of that coin, yet if we add up all the wages earned and then compare that to the physical number of coins used to pay those wages, we come up well short on the coins. My last “Eureka” note on Part 2 didn’t make the sidebar list for some reason, but if you read down through comment #15, you’ll see where I finally figured out that it isn’t a matter of coins not having value–it’s just that they aren’t direct sources of revenue.

  2. Re Smith’s p. 240 and whole capital broken down into its fixed and circulating components. His point here is, even if we can’t find any way to increase our overall stock of capital, we can still improve our net revenue by shifting resources from the fixed to the circulating side of the equation, because–at least from an 18th century perspective–it’s the latter category that really drives production.

  3. The more significant problem, however, is that, in point of fact, that is not how capitalism works: the tendency is for more and more capital to be invested in machinery.

    I have found that is often not the case anymore. Why spend money that could otherwise be considered as profit? That was something I noticed in my last venture into the world of industry. The focus is (or was) on short term profits, rather than long term growth or sustainability.

  4. On p.239 he is talking about what will later be called the velocity theory of money, where velocity is a multiplier. As Knob_e says, each coin goes through several transactions in the course of a year, so the actual supply of money is larger than the count of monetary units would indicate. In fact, it’s much larger (you multiply m*v to get the money supply).

    This is also a good piece of argument against the old view of money (i.e., that the value of money is limited to the value of gold in the coins*). The gold standard people would say that the only way to get more money out of the same amount of gold is to debase the value of the gold. Smith says no, since the pieces of money have a velocity (or money multiplier)>1, you have more money in supply than units of currency in existence.

    p.240, I think he’s talking here about the connection between saving (non-consumption) and investment. That which is not consumed is saved, and that which is saved can be invested elsewhere (“the fund which puts industry into motion”).

    p.241 This is not a recipe for inflation, although inflation may result. Inflation=falling price of money=rising cost of goods=change in price level. One simplified explanation for this=”too much money” following “too few goods”, or monetary oversupply. This doesn’t always happen just because there’s a velocity of money >1, as mentioned here. You can have very high velocities of money (money changes hands quickly) without having high inflation; it’s the change in the money supply vs. demand that impacts the price level.

    The question of the international channel was actually more intense in Smith’s (and then Ricardo’s day). Now, we don’t have to use gold and silver to manage foreign exchange, and mercantilism is (mostly) dead. We’ve got open markets for goods and currencies, and a diversified trade model that works well for peer countries (still a bit rocky on the developing side).

    *or pigs, or bolts of cloth, assuming you used these alternative substances as “money”. Feel free to email me if you’re still unclear after reading this…

  5. Scott: re p. 240. I think you may be overlooking the broader context. In the paragraphs directly above,Smith is talking about how money shares several attributes with fixed capital. In the paragraph below, he moves on to discussing the introduction of paper money as a means of reducing capital costs. The reference paragraph, about shifting costs from fixed to circulating capital, is Smith’s way of playing on money’s fixed-capital similiarity.

    skzb: re p. 241. Smith is, in fact, concerned about the risks of inflation. It just takes him a few more pages to get around to that part of his discussion. And he never does use the word itself. Also, he takes the same view as Scott, above, that inflation is a problem only under certain sets of conditions. But, still.

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