On Adam Smith’s Straw Man

One way to interpret Adam Smith’s Wealth of Nations is as a critique of and rebuttal to what he called the “mercantile system” or today what we would call mercantilism. One critique that Smith made in the book is that mercantilists had an incorrect notion of wealth. In Smith’s view, mercantilists confused money and wealth. According to Smith, this misconception led many mercantilists to see trade surpluses as desirable because it was a way to accumulate gold (money) and therefore make the country richer. As it turns out, this is likely a straw man of Smith’s own construction.

I have recently been reading Mercantilism Reimagined and Carl Wennerlind has an interesting chapter on 17th century views on money in England. Here are some highlights:

• J.D. Gould’s work in the Journal of Economic History suggests that to understand the literature on money and trade during the 1620s, one needs to understand the circumstances in which the writers were writing. He argues that this writing must be understood in the context of a significant downturn in economic activity that was largely blamed on a shortage of money. It is unclear whether this was due to an undervalued sterling or incorrect mint ratios, but a trade surplus was seen as a way to correct this shortage. In other words, these writers were not advocating trade surpluses for their own sake, but rather to replenish the money stock.
• Smith’s attacks were on these writers of the 1620s, but he either ignored or was ignorant of a literature that emerged in the 1640s and 1650s associated with a group known as the Hartlib circle.
• Members of this group thought that the expansion of scientific knowledge would lead to permanent expansions in economic activity. This therefore required an expanding money supply to prevent deflation and other problems with insufficient liquidity.
• At least two writers within the Hartlib circle denied that the value of money came from the commodity itself (recall that gold and silver were money at this time). Wennerlind quotes Sir Cheney Culpeper, for example, as writing that “Money it self is nothing else but a kind of securitie which men receive upon parting with their commodities, as a ground of hope or assurance that they shall be repayed in some other commoditie.”
• Culpeper advocated for parliament to create a law that would allow a bill of credit to be transferred from one person to another rather than waiting for repayment.
• Another Hartlibian, William Potter had a much more ambitious proposal that called for tradesmen to set up a firm and print bills that could be borrowed with sufficient collateral. The tradesmen would agree to accept these bills in exchange for their production. At any time, a bill holder could request that it be redeemed. At that point, a bond would be issued that had to be paid by the borrower of the bill within 6 months. Since the bills were backed by collateral, the only threat to the ability to redeem a bill was a sudden decline in the value of the collateral — although Potter argued that insurance companies could be used to insure against such outcomes.
• Winnerland argues that both the Bank of England and the South Sea Company were the outgrowth of Hartlib ideas about money and credit.

The fundamental point here is that it seems that there was an influential group of individuals writing in the 1640s and 1650s that were either ignored by Adam Smith or that he simply did not know existed. However, the omission is important. One would hardly consider the views of the Hartlibians as mercantilist. This group viewed scientific advancement as the key to economic prosperity, not trade surpluses and/or the accumulation of money. Culpeper, as evidenced by his quote, did not confuse money with wealth. His quote is consistent with a Kiyotaki-Wright model of money. Similarly, Potter clearly viewed credit and collateral as important for trade and prosperity (perhaps too much so, he predicted that under his plan that the English would be 500,000 times wealthier in less than a half of a century — that’s quite the multiplier!).

In short, this raises questions about the prevalence of mercantilist views in the time before Adam Smith. The critique by Smith that previous writers confused money and wealth might simply be a straw man.