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Wealth of Nations

January 7th, 2004 (02:35 pm)

current mood: curious

So I asked for Adam Smith's Wealth of Nations for Christmas. I wanted to see how economics started out, I think. On that front, I'm not seeing much in the way of surprises; it turns out that Adam Smith knew about the same things taught in the introductory macroeconomics course I took in college. Of course, as you'd expect, he was a lot less rigorous than modern economists. For one thing, he didn't have any statistics; instead he relies on anecdotal evidence and navel-gazing.

What I'm finding more interesting is the view it gives me of 18th-century England. It's obviously somewhat skewed (Smith clearly had a romanticized view of the life of the poor), but he does talk about all kinds of economic activities--i.e., most of people's lives--which I'd never thought about before. For example, he discusses the old style of raising cattle (already mostly displaced by the enclosure movement), under which they were permitted to wander through the woods, looking for forage. To a modern mind, this is something of a shock: haven't cattle always been kept in pastures?

One thing I spotted last night: when Smith wrote, in 1776, there were already banknotes (literally: issued by banks, rather than by the government), and he clearly explains how this separation of money and gold enables society to carry on more economic activity with less gold tied up as coinage. But he didn't make the conceptual step of pointing out that the gold in the banks then becomes superfluous; he clearly considers the banknotes to be a proxy for gold, rather than something usable as currency in themselves. It wasn't until 1971 that Britain (and the US) went off the gold standard. I'd love to read a history of how the world got from point A to point B. Why did it take so long? Would we have been better off, or worse, if we'd gone off the gold standard earlier? Of course, the world might have been cautioned by the example of 1930s Germany. To pay their debts from World War I, Germany started printing money they didn't have, and suffered hyperinflation as a result. It was so bad that people would get paid twice a day, and take a wheelbarrow full of money to the grocery store, because the money they got paid at noon would be worthless by evening.

Actually, inflation is another of Smith's blind spots: he knew that it happened (e.g., he explained how the real purchasing power of silver in 1776 was about half what it had been two hundred years earlier), but he apparently had no idea how fast it could happen (probably because it hadn't, yet). He points out that, if you print £800,000 of banknotes in a country that has £1,000,000 of gold and silver in circulation, you've created £800,000 of money, but not of actual goods. So, reading that, I expected him to discuss the fact that each £1 would then be worth less; but, instead, he predicts that the £800,000 of gold and silver will then be used for foreign trade (where the banknotes are worthless), increasing the wealth of the nation. It apparently never occurred to him that one effect would be to let people offer more money for goods, and thereby drive up the prices. It's not a difficult idea to grasp, either; I once managed to explain it to my 10-year-old cousin while we were floating down a river in inner tubes. It must have been hard to realize in the first place, though.


Posted by: Alexx Kay (alexx_kay)
Posted at: January 9th, 2004 08:17 pm (UTC)

Actually, inflation is another of Smith's blind spots: he knew that it happened (e.g., he explained how the real purchasing power of silver in 1776 was about half what it had been two hundred years earlier), but he apparently had no idea how fast it could happen (probably because it hadn't, yet).

I'm not up on the specifics, but I'm pretty sure that the first really *big* inflationary period (in economics) happened when New World exploitation started massively increasing the available supply of gold and silver. It certainly wasn't 30's Germany level, but I gather that it was similar in scale to what we now consider to be "normal inflation".

Posted by: Who, me? (metageek)
Posted at: January 9th, 2004 08:38 pm (UTC)

Right, that was what Smith was referring to. But inflation of 100% over two hundred years is only about 0.3% per year, barely perceptible in the short term. He apparently didn't extend that lesson to realize that creating money via banknotes could have the same effect as creating money via mining.

I should dig back into the earlier part of the book to make sure it was only 100% in 200 years; I might be misremembering.

Posted by: Who, me? (metageek)
Posted at: January 9th, 2004 09:04 pm (UTC)

OK, I'm wrong: it was more like a factor of 4 than a factor of 2. So more like 0.7%--still low by today's standards, but, as you say, similar in scale to what we see today.

Posted by: Jehan du Lac (jdulac)
Posted at: April 1st, 2004 06:24 am (UTC)
the Great Wave...

One of my favorite relatively recent books is The Great Wave: Price Revolutions and the Rhythm of History by David Hackett Fischer. He posits long cycles of inflation and "correction", beginning with the 12th century. It's a compelling thesis. The 16th c. inflation was just one of these cycles. Silver from the new world played a role (mostly in fuelling the Spanish war machine in the Low Countries), but the price rise had begun well before the silver started flowing in great quantities. Around 1500 the European peasant probably lived better than at any time in history, up until the 19th c. To grossly simplify, the cycle is one of economic expansion followed by contraction -- people are optimistic, there are good wages for labor, people have more children at younger ages, the population increases, puts pressure on the basics of housing, food, and fuel, the prices of these things rise, the "middle" class is squeezed, wages go down, more people sink into poverty, eventually there is a major meltdown and population/price correction (Black Death, Thirty Years War, etc.), wages go up and the cycle starts all over again. Somehow, the elites usually manage their way through, and the crashes usually serve to make them even more elite, creating bigger gaps between rich and poor. These waves are on the order of centuries, tho'. With the development of nation states, it has become possible to put in ameliorating policies that make the crashes less drastic than in the past (poor relief, welfare, social security, etc), but the wave is still there...

worth reading after you're done with Smith :) (whom I've been meaning to read for a long time now...)

Posted by: Who, me? (metageek)
Posted at: April 1st, 2004 06:30 am (UTC)
Re: the Great Wave...

Yeah, I think I did read that, actually--it's sitting on my bookshelf, at least. ;-)

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