June 11, 2023

by Stephen Stofka

This week’s post is about money and Adam Smith (2009), the author of the Wealth of Nations, a book that authors sometimes refer to by its acronym – WON. In 2026, it will be the 250 year anniversary of the publication of that work and Smith remains the most cited author in economics literature, according to Avner Offer and Gabriel Söderberg (2019), authors of The Nobel Factor. Smith lived in an age of a metallic or hard currency standard, but one with an active trade in paper or “bank” money. In Part 1, Chapter 4 of WON he attributed the debasement of hard currencies to the “avarice and injustice of princes and sovereign states.” We will see why he thought so.

Smith noted the chief flaw of hard currencies, particularly in an era of increasing industry. The supply of those metals depends on the success of mining operations and the fortunes of ships carrying the metals across the seas. There is either not enough hard currency to support the number of transactions in a country of increasing industry, or there is too much of the metal currency during economic downturns. Paper or bank money acted as a substitute for hard currency. In Part 2, Chapter 2, Smith notes that the exchange of bank money was mostly between wholesalers, not between dealers and consumers. In an age when the revenue of a country depended largely on excise taxes on particular goods and property taxes on landowners, the flow of taxes was mostly between the wealthy and the state.

Like most substitute goods the value of bank money rose when there was a shortage of hard currency, falling again when there was an adequate supply of gold or silver coin. A prince or state stabilized the value of paper money by allowing or stipulating the payment of taxes in paper money. Smith admired the resilience of the working class, a sentiment not shared by others in the higher social classes. When the American colonies drafted their Constitution, only those of means were allowed to vote because they were the primary source of direct government funding. The founders paid little recognition to those on the lower rungs of the socioeconomic ladder who paid few taxes directly to a government.

The working class paid taxes in three indirect forms: 1) higher prices on goods, 2) lower compensation for their labor, and 3) inflation. In an open letter written about 1780, American founder Benjamin Franklin remarked (https://founders.archives.gov/documents/Franklin/01-34-02-0156) that the printing of vast quantities of paper money to fund the American war against Great Britain had caused an explosive hyperinflation. In less than five years, 60 dollars of American paper currency had become equivalent to one dollar in gold. As Smith noted, a country abandons a hard currency standard as soon as it goes to war so that it can fund the war without increasing taxes.   

The developed countries of the world have realized Smith’s vision. Diverse economies with a lot of specialization promote growth. Less developed countries share a common characteristic – the economy is very reliant on agriculture. The growth of the retail trade in developed countries necessitates the increasing use of bank money. Hard currency is neither reliable nor convenient. Smith might attribute the persistent inflation of bank money not to an oversupply of paper money but to a shortage of hard currency. In growing economies, that shortage promotes deflation, benefitting those who have at the expense of those who have not. That is the injustice of hard money.

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Photo by Zlaťáky.cz on Unsplash

Keywords: Adam Smith ,gold coin, silver coin, hard currency, bank money

Malthus, T. R. (1989). An essay on the principle of population. Cambridge: Cambridge Univ. Pr.

Offer, A., & Söderberg, G. (2019). The nobel factor: The prize in economics, social democracy, and the market turn. Princeton University Press.

Smith, A. (2009). Wealth of Nations. New York: Classic House Books.