Comments on: TWoN Book 2 Chapter 2 Part 4

By: knob_e

knob_e — Mon, 29 Jun 2009 06:22:33 +0000

Re Smith’s p. 245 and money as a limiting factor in production. More money has the power to leverage more–and more motivated–labor, even to the extent of bringing it in from ever-greater distances. And did you notice that Smith is agreeing with you here about gold and silver coins having value as a commodity? He alluded to it earlier, when he talked about the paper-replaced coinage going to foreign trade, but that took a lot of extra thinking about exactly how coinage was valued between different countries (which he spells out a little more fully later on). Now he’s flat-out saying “the whole value of gold and silver which used to be employed in purchasing” materials, tools, and maintenance can be “added to the goods which are circulated and distributed” by means of the rebuilt-with-paper great wheel.

Re bills of exchange. Scott’s right, of course; my sources say much the same thing. With an added note about how the ability to define a specific rate of exchange for foreign transactions (or even not-so-foreign, as between Smith’s oft-invoked London and Edinburgh) gave merchants a stay-out-of-hell-free card to play against the party-pooping hardline stance the Catholic church had taken on usury.

Unfortunately, this entirely correct description will only get you in trouble when you try to sort out the check-kiting–uhh, bill-of-exchange-discounting scam that Smith describes up ahead. Whether he didn’t know BoE mechanics all that well himself or was just trying to keep the discussion simple (as if), he doesn’t assign the various parties to their correct roles.

By: skzb

skzb — Mon, 29 Jun 2009 03:20:32 +0000

Thank you, Scott!

By: Scott

Scott — Mon, 29 Jun 2009 02:43:05 +0000

I should add that there’s a lengthy subplot in Neil Stephenson’s _The Confusion_ involving the movement of large quantities of cash using Bills of Exchange.

By: Scott

Scott — Mon, 29 Jun 2009 02:38:50 +0000

A “Bill of Exchange” is a negotiable instrument, where one party, the “drawer”, instructs the “drawee” to pay money to the “payee”. The most common example of this is a check, where the drawee is a bank, the drawer is the person with the checking account and the payee is whoever’s name is on the “pay to the order of” line. The payee is also able to transfer the right to receive the money to a fourth party by signing the Bill over.

There are more complicated ways of using Bills of Exchange. For example, they were (and are) often written with a specific payment date (payable January 1, 1700) and place (payable at the City of London). They could also be written in foreign currency. With those two additional provisions, they come to resemble a currency forward contract, and can be used for international trade transactions, among other things.

It is also possible to embed a discount (or interest rate) into the Bill, in which case it takes on aspects of a short term loan. Example: commercial paper.

In the rest of the sections, he’s talking about liquidity constraints: the gold standard is one (which we no longer have, thankfully), inability to have trade credit (accounts payable/ accounts receivable) is another, and reserve requirements are a third.

The banker’s two problems are, in fact, distinct but connected. One is that you’ve got to have a certain percentage of cash on hand for any of your demand depositors who come in the door, and two is that you’ve either got to have extra cash (so that you never fall below a minimum level) or you have to be able to either borrow more quickly or call in some loans (to make up the difference). In the 21st century US, we have both a reserve requirement and a system of interbank lending (the federal funds system) that allows banks to cover their reserve requirements on a daily basis, and further backed by the “discount facility” at the Fed itself.

By: skzb

skzb — Mon, 29 Jun 2009 01:40:42 +0000

Lenny: I’m pretty sure that when Smith speaks of “produce” he is referring to anything that is produced (ie, any commodity), not merely agricultural produce.

By: Lenny Bailes

Lenny Bailes — Mon, 29 Jun 2009 01:32:31 +0000

“The whole paper money of every kind which can easily circulate in any country never can exceed the value of the gold and silver, of which it supplies the place, or which (the commerce being supposed the same) would circulate there, if there was no paper money.”

I have no academic training in economics, but it seems to me that this sentence shows dated (and no longer valid) logic in attempting to analyze the meaning and value of currency.

Money now represents the services and labor that are owed the bearer; it no longer represents the amount of precious metal that can be redeemed for the numerical value on the currency. We don’t really measure the wealth of a nation by the amount of agricultural produce it yields, either. The value of the produce is a function of the amount of labor that went into growing it and the demand for it on the market. I think fertile land counts for something, but only in terms of the labor that must be invested in it to produce a marketable good and the demand for the good.