Outgrowing Adam Smith

Adam Smith’s view of money

Money is the topic of Chapter 4 Book 1 of The Wealth of Nations.  It is a key element in Smith’s economic system.  In Chapters 1 -3, he describes the importance of specialisation and the need for trade to enable workers to specialise in producing particular items. In Chapter 4 he goes on to explain that money is essential as a universal means of exchange so that one good (such as salt) can be exchanged with another good (such as sheep) by valuing them both in terms of money ¹ .

In general terms, the definition of money is a potentially complex discussion (see here) but Smith is quite specific.  For him, money means either gold coins or gold bullion.  He considers governments that value their coins above the gold value of the metal as defrauding the public ².

This is not an accurate description

Smith’s view of money is obviously not an accurate description of today’s money.  Even in Smith’s time, the late 18^th century, money was not solely gold coins.  Bank notes and other forms of paper money orders were being increasingly widely used ³.   There was also a chronic shortage of low value coins, which led to the widespread use of various forms of tokens distributed by local manufacturers and shops ⁴.

A specialised form of transaction

Smith describes the need for money to enable the exchange of different types of goods.  At first sight, this seems quite straightforward.  But, on further consideration, the transaction Smith describes is quite specialised and relatively rare.  He describes the exchange of two different goods between two people who already possess these goods and only meet on one occasion.

But in reality, even today, most transactions occur between people who already have some connection with eachother and at least one of the parties has already purchased or produced  the goods with the intention of selling them.  For example, most people visit a small group of local shops regularly and these shops stock a selection of goods that they know people will buy.

In reality, most transactions do not require precious metal coins, they require credit, planning and trust.  This is particularly evident today when plastic cards and digital transactions are common.  It was also true in pre-historic times when small local communities could manage exchanges on the basis of personal knowledge ⁵.

The archaeological records show the use of credit records (written on clay) for transactions in Bablyon thousands of years before coins were invented ⁶.  It is likely that the use of coins was connected with political organisation and military needs rather than primarily as a means of exchange ⁷.

A changed monetary system needs a new economics

Smith’s analysis of money was too simple.  But it was convenient for his purpose to advocate for a specific type of economic system, his system of “perfect liberty”. (link)

In Smith’s time, his description of money was believable though incomplete.  During the last 300 years, bank transactions, paper money and credit have played an ever greater role in exchange and payments, so that Smith’s description is completely inaccurate today.

Smith’s economics assumed the stock of money (gold) was not easily expanded because gold is not easily found.  Today we rely on credit which can be created by typing a data entry. We need to manage a totally different situation when money can be easily created.  In technical terms, we need a monetary analysis instead of the real analysis used by conventional economics (see here).