Smith on Banking Regulation

Dr Hugh Goodacre, a teaching fellow at University College London, writes to the Financial Times (10 November) HERE on the subject of the “arbiter’s” role of the ‘invisible hand’ as presented earlier by Michael Rossman, who “praised” the “invisible hand” as “the arbiter of success and failure”.

Hugh Goodacre disagrees, pointing out that Adam Smith “makes it clear “that for an economy to be guided by his ‘invisible hand’ is not a reality, but an ideal”.

Moreover, says Goodacre, “the Bank of England acts “not only as an ordinary bank, but as a great engine of state”, and, according to Smith, “the stability of the Bank of England is equal to that of the British government” and ‘is too big to fail”.

Comment
Apart from the usual myth and invention about the role of the “invisible hand”, Goodacre is surely right.

Smith considered it permissible to override the imperatives of “Natural Liberty”, especially in banking (I have quoted many times his insistence of regulation to stop low-value ‘promissory notes’ being issued by banks at WN II.ii.94: 324), so those who quote him as an authority against regulation where it is appropriate, as defined by Smith, mislead their readers.

[Incidentally, the Financial Times, adds this proviso to the above brief letter:

“Copyright The Financial Times Limited 2009. You may share using our article tools. Please don't cut articles from FT.com and redistribute by email or post to the web.” I am not sure why they are so draconian, though I am also sure my quotation meets the “fair use” criterion, but I am not sure that such necessary treatment portrays Michael Rossman's point of view adequately.]

Another Great Smithian Metaphor

Peter Boettke writes in The Austrian Economists (HERE):

“Is Adam Smith's discussion of governmental "juggling trick" relevant to our policy discourse today?

Scott has already talked about this at The Economic Way of Thinking, but we should dig a bit deeper into the discussion from Smith's Wealth of Nations, Vol. 2, pp. 929-230. Smith argues in those pages that: (1) when the public debt reaches a certain level, the fiscal system is threatend, but there is not a single instance where a government has paid off the debt fairly and completely; (2) rather than pay down the debt with increased taxes, government's choose "pretended payment"; (3) the prefered method of pretend payment is repudiation through debasement of the currency; (4) this method extends the 'calamity to a great number of other innocent people'; and (5) rather than do the right thing -- which would be least dishonorable to the debtor, and least hurtful to the creditor -- government instead choses to engage in "juggling trick".

Comment
This is a case of the appropriate use of a quotation from Adam Smith’s Wealth Of Nations because it is still relevant, as government debt has increased significantly since the 18th century – in those days debt was raised mainly to fund wars or bribe foreign powers – whereas nowadays government debts fund just about anything that modern, BIG, governments spend taxpayers’ and lenders’ money upon.

Smith wrote while governments were happily inventing new forms of raising revenue for governments from the private economy. ‘Sinking Funds’ to pay-off debt soon became sources of new funds to spend more money, not always, if ever, wisely. Then they added, on a ‘temporary’ basis, income tax , and so it has gone on and on. Today, in Britain’s case, we have ‘stealth taxes’ and ‘quantitative easing’ (printing money), and unheard of levels of debt.

Smith observed that governments managed to avoid paying back all of their debt through various “juggling tricks” (beware: another one of Smith’s metaphors!).

Congratulations to Peter Boettke for picking upon Scott's (HERE) references to government debt and 'juggling tricks'.

I recommend that you follow the links.

Adam Smith on Banking Behaviour and Misbehaviour

‘Vino S’ writes on ‘Adam Smith on Banking’ on ‘My political blog and other musings’, HERE:

“Adam Smith had more complicated views on economic, philosophical and political questions that some of his supporters or detractors assume. Here is a quote from him on banking, a sector which has contributed so much to our current financial crisis:

"It is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country. " - Adam Smith”

Comment
I made the following comment on the ‘Vino S’ selected quote:

It is better if people read the whole of Adam Smith’s chapter on banking in Wealth Of Nations, ‘Of Money considered as a particular Branch of the general Stock of the Society, or of the Expense of maintaining the National Capital’ (Book II, chapter ii, pp 286-320; Oxford University Press, 1976, or pp 270-313, Edwin Canaan’s 1937 edition, Random House edition).

They will find Smith’s late 18th-century grand panorama of banking practices in Britain including the role of money as the ‘Great Wheel of Circulation’ of the economy, of the prudent banking that adds to the capital stock and to productive labour, of the imprudent and fraudulent behaviour of some individuals and, alas, some bankers, and the need on occasion for government intervention by laws and regulations to prevent the contagion of malpractice and dangerous behaviour.

Of the latter he had this to say about necessary government intervention (perhaps of great relevance for those of who reject any intervention on principle:

“To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them, or to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support. Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.” (WN II.ii.94: p 324; Canaan, page 308)

Adam Smith on Natural Liberty

Sauvik Chakraverti writes, 19 November, in Antidote, (‘libertarian opinion from Indyeah)’: "Adam Smith... And Marathi Politics’ HERE

“The news that the government of Maharashtra has dictated 80 per cent reservations in jobs for locals must be viewed as an Injustice, given that Justice demands a Rule of Law in which there is neither Preference nor Restraint.

This is preferential treatment for locals – and it brings to mind what Adam Smith wrote on the subject. This quote is from The Wealth of Nations:

“All systems either of preference or of restraint, therefore, being thus completely taken away, the obvious and simple system of natural liberty establishes itself of its own accord. Every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. The sovereign is completely discharged from a duty, in the attempting to perform which he must always be exposed to innumerable delusions, and for the proper performance of which no human wisdom or knowledge could ever be sufficient; the duty of superintending the industry of private people, and of directing it towards the employments most suitable to the interest of the society. According to the system of natural liberty, the sovereign has only three duties to attend to; three duties of great importance, indeed, but plain and intelligible to common understandings: first, the duty of protecting the society from violence and invasion of other independent societies; secondly, the duty of protecting, as far as possible, every member of the society from the injustice or oppression of every other member of it, or the duty of establishing an exact administration of justice; and, thirdly, the duty of erecting and maintaining certain public works and certain public institutions which it can never be for the interest of any individual, or small number of individuals, to erect and maintain; because the profit could never repay the expense to any individual or small number of individuals, though it may frequently do much more than repay it to a great society.”

Comment
Sauvik Chakraverti's quotation is to be found at WN IV.ix.51: pp 687-8. From what is reported to be happening in Maharashtra the quotation appears to be apt, though I do not know enough about the circumstances to comment authoritatively.

However, Sauvik Chakraverti gives me an opportunity to make a comment on Natural Liberty and Adam Smith.

Adam Smith was educated at Glasgow University in the principles of Natural Liberty, a school of thinking notably espoused by the distinguished lineage of Grotius, Pufendorf, Carmichael, and Hutcheson, and it was taught in the Scottish universities in the 18th century.

Many readers of Wealth Of Nations, however, mistakenly confuse the precepts of Natural Liberty – philosophically an element of moral philosophy – with those associated with laissez-faire economics.

Smith was careful to distinguish the jurisprudential roots of Natural Liberty which was applicable in all societies, independently of their subsistence basis of their economies, from the political economy of commercial societies.

Cointrary to myth, he did not advocate laissez-faire economics though he was familiar with the Physiocratic terminology of some of its members (he met and discoursed with them in Paris and elsewhere, and in correspondence and the exchange of manuscripts but he never used the words laissez-faire in anything he wrote).

Tellingly, he made many references to either curbs on the behaviours of ‘merchants and manufacturers’ and to interventions that he considered necessary by governments to curb the freedoms of some of the same people, of whom he was suspicious of their tendency to act against the interests of consumers. There are over 50 instances of him mentioning the less than beneficial actions of sel-interested individuals in Books I, II and III of Wealth Of Nations.

On such set of commercial entrepreneurs that he wrote extensively about were the bankers of Scotland and the rest of the UK at the time. After a long discourse in Book II, chapter 2, on banking operations and some of managers and customers' dangerous failings on occasion, he drew a line between Natural Liberty and total commercial freedom:

“To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them, or to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support. Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.” [WN II.ii.95: p 324]

I think this is clear enough.

It separates ‘freedom’ as a legal concept and as a practical policy by a qualifying restraint where a person’s freedom has deleterious consequences on the public good.

Clearly, not all individual putsuits of self interest necessarily and unintentionally benefit society; hence mythical theories of the invisible hand imposed on Adam Smith by 20th-21st century economists are a manifest violation of Adam Smith’s intellectual integrity and a gross abuse of his legacy. In short, a violation of his Natural Liberty rights.

My thanks to Sauvik Chakraverti for creating this opportunity to comment on this important distinction.