Money

David Hume (1711-76) was a Scottish philosopher and an influence on Adam Smith. His brief works on economics consisted of several serious errors, as noted by Murray Rothbard below. As a proponent of the quantity theory of money and its corollary, the price-specie-flow mechanism, Hume recognized that the abosolute quantity of money in an economy did not matter: prices would adjust according to the quantity of money in circulation. He believed that changes to the money supply mattered in the short-term; specifically, that an injection of money would stimulate the economy in the short term. However, this effect would disappear as the new (higher) price levels reflected the increased money supply. Hume believed that this adjustment in prices would be quick and proportionate. This is problematic in the following ways. ...

Turgot recognized interest return on investment as the price paid by laborers to capitalist-entrepreneurs for advances of savings in the form of present money. He also noted that interest on money loans tend towards the natural rate of interest through the process of capital rebalancing. Demonstration: If the interest rate is lower than the natural rate, people begin to borrow more and invest in businesses where they can earn higher returns. This relative increase in borrowing will increase the interest rate, making it approach the natural rate from below. If the interest rate is higher than the natural rate, people will divest from businesses or liquidate assets and begin to loan out their funds. This will increase the relative supply of loans, which will decrease the interest rate, making it approach the natural rate from above. Capital rebalancing is consistent with this proposition of David Hume: “no man will accept of low profits, where he can have high interest; and no man will accept of low interest where he can have high profits.” He described the positive relationship between risk and interest rate: Less risky loans would have lower interest and vice-versa. Since government bonds would be the safest, they should bear the lowest rates. Along with the note on the interest rate of governement bonds, Turgot attached how pernicious to the economy such debts would be. They would effectively result in an interest rate floor, diverting funds to sterile investments. Public debts crowd out productive use of private savings by maintaining artificially high rates. Lending and borrowing at interest is a reciprocal contract, advantageous to both parties. Hence, usury laws are absurd on moral grounds: the contracts are voluntary and no one is injured. Turgot also arrived at the Austrian conception of time preference. Interest accounts for the difference in the value of the promise of a sum of money compared to the value of the money available now. The lender of funds needs to be compensated, in the form of interest, for the following: The sacrifice of the utilization of the funds at the present moment, The risk associated with the possibility of losing forever all or a part of the amount loaned. Turgot also defined the concept of capitalization: present capital value of land or other capital good on the market tends to equal the sum of its expected future rents or returns, discounted by the rate of time-preference/interest. Turgot described the relationship between quantity of money and interest. Interest rate depends on the savings-spending ratio of the population. Increase in money supply can both increase or decrease the rate of interest, depending on the spirit of thrift or the spirit of luxury. (The logic is similar to that noted in point 2.) Reference Murray Rothbard, Economic Thought Before Adam Smith (1995), Chapter 14, 15.

Anne Robert Jacques Turgot (1726-81) was a French bureaucrat following Richard Cantillon but preceding Adam Smith who made some brief but remarkable contributions to economic thought. This post focuses on his writings about Laissez-faire/free trade. Jacques Claude Marie Vincent de Gournay (1712-59), his mentor in economics, played an influential role in shaping his thoughts. Unfortunately, Turgot’s works were not sufficiently considered by his contemporaries and immediate successors. His political associations also might have dissuaded people from citing him. In the words of Joseph Schumpeter, “It is not too much to say that analytic economics took a century to get where it could have got in twenty years after the publication of Turgot’s treatise had its content been properly understood and absorbed by an alert profession.” ...

Richard Cantillon (1680-1734), an Irish-French banker/merchant predating Adam Smith, is arguably the founder of modern economics. The book he wrote shortly before his demise, Essay on the Nature of Trade in General, officially published in 1755, was an influential and highly citied document, before it was overshadowed by the retardation of economics that would follow in the form of Adam Smith’s Wealth of Nations (1776). Cantillon rescued economic analysis from its traditional conflation with politics and ethics. In the words of Friedrich Hayek, “this gifted independent observer, enjoying an unsurpassed vantage point in the midst of the action, coordinated what he saw with the eyes of the born theoretician and was the first person who succeeded in enterating and presenting to us almost the entire field which we now call economics.” ...

Passages From The Wealth of Nations The following passages from Adam Smith’s An Inquiry Into the Nature and Causes of the Wealth of Nations have received enormous attention over the centuries following their publication in 1776. “[A man] will be more likely to prevail if he can interest their self-love in his favour, and show that it is for their own advantage to do for him what he requires of them … It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity, but to their self-love, and never talk to them of our own necessities but of their advantages.” “As every individual, therefore, endeavours as much as he can both to employ his capital in the support of. . .industry, and so to direct that industry that its produce may be of the greatest value; every individual necessarily labours to render the annual revenue of the society as great as he can. He generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. . .(B)y directing that industry in such a manner as its produce may be of the greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.” “Nor is it always the worse for the society that it was no part of it. By pursuing his own interest he frequently promotes that of the society more effectually than when he really intends to promote it. I have never known much good done by those who affected to trade for the public good.” These passages are seen as evidence of Adam Smith promoting laissez-faire capitalism. Note the introduction of the “invisible hand” meme in the second passage, one that has been propagated around without much regard for context. These famous quotes convey the idea that it is through the selfish pursuit of our own goals that the good of the economy results, and this is more desirable than a direct, motivated pursuit of social good. The anti-free market positions advocated by Adam Smith, therefore, come as a shock to those who imagine him as the paragon of the laissez-faire paradigm. ...

There are two opposing thoughts regarding money I am considering at the moment. On the one hand, we have the idea that to the extent it serves a nonmonetary purpose, it is an inferior form of money. For example, gold, which is a form of money, also has various other use cases as jewelry, industrial raw material, etc. These use cases compete against the monetary use case. Until Bitcoin, there was no contender for pure money. That Bitcoin lacked any other utility was hurled as a criticism. The idea was something like this: gold has various other utilities (and corresponding demand), so its price is unlikely to fall below a certain level; Bitcoin, on the other hand, due to absence of such alternate uses, would see its price collapse to zero some day. ...

Statement The level of prices depend on the quantity of money. Early discussions on this matter can be found in the essays of John Locke, David Hume and Irving Fisher (see Reference). Discussion Provided that the item used as money can be divided and combined as necessary, any amount of money is sufficient for running an economy. Ideas about bringing lasting changes to an economy by expanding the money supply are invalid. Should the money supply increase, all else equal, the prices of goods and services would increase proportionately. Thus, the outcome would ultimately be neutral. ...

Free market interactions led to the emergence of gold as money. Gold was divisible, durable, recognizable, and most importantly, difficult to inflate. Thus, it maintained its purchasing power better than other commodities that were easier to produce. However, gold suffered from certain drawbacks. While it was divisible, dividing it physically was practical only to a certain point. Also, carrying it in large quantities was costly and cumbersome. Furthermore, verifying the authenticity of gold coins and bars was time-consuming. ...

Gresham’s Law stipulates thus. “Artificially overvalued money will drive out of circulation artificially undervalued money.” As terrible as the US Dollar has been at inflation in a century, other currencies have proven to be worse. Governments throughout the world have been egregiously inflationary. They have expanded their money supply and devalued their currencies. Entities in these countries have thus resorted to hoarding (a term without a negative connotation to me) US Dollars. The upward pressure on the demand for US Dollars is such that despite the massive expansion in US Dollar supply, we do not see the corresponding amount of price level rises in the US. The abysmal fiscal policies of the rest of the world allows the US to export its price inflation. ...

The following table depicts the major components of the fiat financial system from the Indian point-of-view. For the most part, it is similar to the table for the US case. The key differences are noted at the bottom. Components of the Indian Banking System ENTITIES LIABILITIES ASSETS EXAMPLES Individuals Mortgages, Loans, Taxes Deposits, Banknotes, Government Securities (G-Secs), Stocks, Bonds, Fund Units, SDLs, Benefit Payments High Net-Worth Individuals, Retail Investors, Family Offices, Other Individuals Businesses and Non-Profits Loans, Bonds, Equity, Commercial Paper, Taxes Deposits, Banknotes, Subsidies Tata Group, Reliance Industries, Infosys, Indian Red Cross Society, Small and Medium Enterprises Financial Institutions Deposits, Fund Units, Securities Issued, Taxes Loans, Mortgages, G-Secs, SDLs, Stocks, Bonds, Commercial Paper, Bank Reserves, Deposits, Banknotes, Bailouts State Bank of India, HDFC Bank, ICICI Bank, SBI Mutual Fund, Life Insurance Corporation of India Foreign Sector Deposits, Stocks, Bonds, Loans, Taxes G-Secs, Stocks, Bonds, Loans, Fund Units, Deposits, Banknotes Reserve Bank of Japan, Norges Bank Investment Management, Foreign Portfolio Investors (FPIs), Global Corporations Public Authorities, Government Trust Funds, State Governments Bonds, SDLs, Benefit Payments Government Securities, (State) Taxes Employees’ Provident Fund Organisation (EPFO), National Pension System (NPS Trust), State PSUs like NTPC, Indian Railways, Government of Maharashtra Reserve Bank of India (RBI) Banknotes, Bank Reserves Government Securities, Foreign Exchange Reserves, SDLs Reserve Bank of India (Mumbai, Regional Offices) Government of India Government Securities, Subsidies, Bailouts Taxes — Notes The components here are very similar to the Components of the US Banking System. Standard notes regarding the US system applies. There are some differences. ...