Category: The Wealth of Nations

One of the reasons the study of capitalism is so difficult (and, in some ways, so much fun) is that so many of the processes are hidden.  In, for example, a feudal economy, things are pretty straightforward: peasant grows crops, gives some to landlord, eats the rest and makes most of his goods at home and uses them himself.  Exchanges at the market are subsidiary to the basic flow of the economy, and not all that hard to understand (need iron to make a plow?   Give me ten bushels of corn.  Thanks.  Cheers).

A market economy by it’s nature hides a lot of its activity.  For example, the exchange value of a commodity is not realized until it reaches the market; therefore, it looks as if the value is created at the market, which leads to no end of confusion.  Lord Kyenes, for example, never was able to shake the notion that the market created value, and the economists who followed him are still stuck there.  The explosive power of TNT is created when the compound is formed, but not realized until it is detonated; to say that value is created at the market would be like saying that the explosive power of TNT is created by the explosion.

Smith’s ability to lay bare many of the processes of a market economy (the creation of value by labor, the effect of infrastructure on the realization of profit, money as a circulating commodity that eases production) may not have resulted in a full understanding of these processes, but showed that they could be understood, and pointed the way to understanding them.

The role of money–a commodity used for universal exchange–in a market economy is inherently difficult to understand.  I don’t blame myself terribly for having so much trouble with it in spite of lots of smart people trying to explain it to me; I think it is just the nature of the beast.  I started this project in order to understand rent, because I need to for a book I’m working on.  I may never understand rent, and I may never understand money; but the struggle to do so is amazingly gripping, and I want to thank all of you who have been helping me with it for your patience.

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.

I have found places in this book where I respectfully differ with Mr. Smith.  They fall into two categories: 1. Those things which he couldn’t have understood simply because the information wasn’t available at the time he wrote (one cannot expect advanced metallurgy from a culture which just that morning discovered iron, or or full understanding of a market economy just as it’s gearing up), and 2. Occasional objections to his method, where it seems to me made complex, contradictory processes seem linear and mechanical (as for example when he speaks of acquiring stock coming first, then division of labor).

One trouble I’m having in this chapter is that I’m seeing what appear to be a different sort of error–false deductions and cases of ignoring significant data.  It seems to me that if I’m seeing those kinds of errors, I’m missing something; I am more likely to be mistaken about that kind of thing than he is.  All I can think of to do is try to grasp what he means, point to the mistakes I’m seeing, and hope some Smart Person can, using small words, help me figure out what I’m missing.

That said, let’s look at Page 236: “Money, therefore, is the only part of the circulating capital of society, of which the maintenance can occasion any diminution of their neat revenue.”  Doesn’t this ignore the cost of transport, payment of storage of finished commodities, and the cost of various middlemen, who, by definition, concern themselves with circulating capital?

Page 237: ” A certain quantity of very valuable materials, gold and silver, and of very curious labor, instead of augmenting the stock reserved for immediate consumption…is employed in supporting that great but expensive instrument of commerce, by means of which every individual in society has his subsistence, conveniencies, and amusements, regularly distributed to him in their proper proportion.”  Is this the answer to my point above?  That is, is he here referring to the market itself, as well as the infrastructure that supports it?

“…as the machines and instruments of trade, &c, which compose the fixed capital either of an individual or of a society, make no part either of the gross or of the neat revenue of either,; so money, by means of whichthe whole revenue of the society is regularly distributed among all its different members, makes itself no part of that revenue.  The great wheel of circulation is altogether different from the goods which are circulated by means of it.  The revenue of the society consists altogether in those goods, and not in the wheel which circulates them.

He becomes more specific about this point later.  His point is that money is the means whereby commodities circulate, and, in calculating the revenue of an individual or nation, one can count the money, OR the commodities one can purchase with the money, but not both.  As far as that goes, it makes sense.  The trouble is, money is a commodity.  Whether paper (which he discuses later) or heavy metals makes no difference.  Money in any case, has a use-value, an exchange-value, is interchangable, and was created for exchange.  That is the definition of a commodity.  What makes money unique is that it is the only commodity whose use-value is quantifiable–or, put another way, whose use-value is its exchange-value.  This permits us to exchange commodities using money as a medium, and thus it appears to be a separate thing, but it isn’t.  In actual practice, when determining the “net worth” of an individual, one takes into account the market value of that person’s possessions, AND that person’s money–no one suggests counting the possessions, the money, and what a person could buy with the money.

Smith is obviously making a point here, and it is a point I’m missing.

This chapter deals with money, and it makes my head hurt.

He begins by restating that the price of the “greater part” of commodities resolves itself into: wages of labor, profit, and rent.  His use of “greater part” here makes me wonder about the rest; unless I missed something, those are the only parts of price he has told us of; but that isn’t the point here, so we’ll let that go.

He then goes on to speak of the produce of an entire country: Page 223: “The whole price or exchangeable value of that annual produce, must resolve itself into the same three parts, and be parcelled out among the different inhabitants of the country, either as the wages of their labor, the profits of their stock, or the rent of their land.”  So far, so good.  If the value of each commodity thus resolves itself, so must the the total produce of a country.

He then speaks of dividing this produce of the country, as of an individual, into gross and net.  (Which he writes as gross and “neat” giving us the etymology of “net” which, in itself, is neat;  In quoting him, I’ll update the spelling, as I’ve done with a few other words here and there, which I do just to keep things net).

His use of gross and net is pretty straightforward, I think: Gross refers to whatever comes in, net to whatever value is left over after expenses.

Page 234: “The whole expense of maintaining the fixed capital, must evidently be excluded from the net revenue of the society.  Neither the materials necessary for supporting their useful machines and instruments of trade, their profitable buildings &c. nor the product of the labor necessary for fashioning those materials into the proper form, can ever make any part of it.  The price of that labor may indeed make a part of it; as the workmen so employed may place the whole value of their wages in their stock reserved for immediate consumption.  But in other sorts of labor, both the price and the produce go to this stock, the price to that of the workmen, the produce to that of other people…”

If I understand this correctly, he is saying that maintainance of fixed capital cannot be included in the net profit of a society.  If I am understanding correctly, this makes sense, in that maintainance of fixed capital, while in the long run producing profit, does not immediately provide income, but rather is an expense; and he is asserting that this is also true for the total profit of a society.

“The intention of the fixed capital is to increase the productive powers of labor, or to enable the same number of laborers to perform a much greater quantity of work.”  Yes, exactly.   By fixed capital here, we mean the means of production, and Smith correctly draws no distinction here between those means that take the form of machines, and those that take the form of land which is or has been made suitable for agriculture.

Page 235: “A certain quantity of materials, and the labor of a certain number of workmen, both of which might have been immediately employed to augment the food, clothing and lodging, the subsistence and conveniencies of the society, are thus diverted to another employment, highly advantageous indeed, but still different from this one.”  Right.  Makes sense.  Properly laid out investment in improving machinery does return a profit, but is nevertheless an expense and does not directly add to an individual’s or a country’s net.

Page 236: “But, thought the whole expense of maintaining the fixed capital is thus necessarily excluded from the net revenue of the society, it is not the same case with that of maintaining the circulating capital.  Of the four parts of which this latter capital is composed, money, provisions, materials, and finished work, the three last, it has already been observed, are regularly withdrawn from it, and placed either in the fixed capital of the society, or in their stock reserved for immediate consumption.  Whatever portion of those consumable goods is not employed in maintaining the former goes all to the latter, and makes part of the net revenue of the society.”

Any provisions, materials, and finished work that isn’t immediately consumed by those who produce it can be sold.  Okay.  He then continues, “The maintainance of those three parts of the circulating capital, therefore, withdraws no portion of the annual produce from the net revenue of the society, besides what is necessary for maintaining the fixed capital.”  I’m still fine.  Other than expenses for maintainance and that tiny portion which might be immediately consumed (the farmer eating some of his corn, the owner of textile factory keeping a few bolts of cloth), produce is available for sale (by circulating) and thus adds to a society’s net.

“The circulating capital of a society is in this respect different from that an individual.  That of an individual is totally excluded from making any part of his net revue, which must consist altogether in his profits.  But though the circulating capital of every individual makes a part of that of the society to which he belongs, it is not upon that account totally excluded from making a part likewise of their net revenue.”

Where I get lost is, why is the circulating capital of an individual excluded from making any part of his net revenue.  I’ve just reread chapter 1 of Book 2, which is where I should have figured that out, and I don’t get it.  I’m missing something important here.  The circulating capital of an individual consists of that portion of his stock that he exchanges.  Is Smith here making a distinction between *realizing* a profit, which happens in the marketplace, and *creating* a profit, which happens at the point of labor?  That would, indeed, make a great deal of sense, but I don’t think that’s what he’s saying.  Does anyone?  I’m lost.

I’ll hold off on continuing this chapter until I think I have some sort of understanding of this part, because after this it gets really tangled.