The Wealth of Nations
Book 2, Chapter 2
Money, Considered as a Particular Branch of the General Stock of the Society, or of the Expense of Maintaining the National Capital
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Chapter 2 Summary
The price of a product can be divided into three parts: one which pays the wages of labor, another the profits of stock, and a third the rent of land. The value of produce must resolve itself into the same three parts, divided among the inhabitants of the country in the form of wages of labor, profits of stock, or rent of land.
The gross rent of an estate consists of the amount paid by the farmer; the net rent is what is left over for the landlord after deducting expenses. His real wealth is in proportion not to his gross but net rent. The gross revenue of a country's inhabitants comprises the whole annual produce of their land and labor; the net revenue is what remains. Their real wealth is in proportion not to their gross but their net revenue.
The expense of maintaining fixed capital does not come from a society's net revenue. Fixed capital is used to increase productivity. Any streamlining improvements to production processes and workforce are viewed as beneficial to a society. The expense of maintaining a large country's fixed capital may be compared to the expense of repairs made to a private estate.
Money is the only part of a society's circulating capital, and its maintenance can result in a decrease in neat revenue. Fixed capital, and that part of circulating capital which consists of money, are similar.
The amount of money circulating in a particular country incurs expense in terms of its collection and replenishment; both expenses are deducted from a society's net revenue. A quantity of gold and silver, and of labor, instead of increasing the stock reserved for immediate consumption, is used to maintain commercial tool.
When we talk of a particular sum of money, we are referring to physical money. But when we say that a man is worth a hundred pounds a year, we mean not only his annual wage, but the value of the goods he is able to purchase annually.
Though a country's inhabitants may receive monetary wages, their real revenue is measured in terms of the quantity of consumable goods they can purchase.
This is even more the case for a society. As money changes hands repeatedly, it can never be equal to the revenue of all of a society's members; so the amount of money circulating in a country must always be of less value than the annual sum paid using it.
Machinery, which represents fixed capital, forms the monetary part of circulating capital: savings made in purchasing and maintaining these machines increases net revenue, so savings in terms of collecting and replenishing the monetary part of circulating capital is an improvement of the same kind.
Replacing gold and silver with banknotes replaces a very expensive tool of trade with a less costly one, making circulation less expensive to implement and maintain.
When people trust a banker implicitly in terms of lending promissory notes, these notes will have the same value as gold and silver. Such a banker can grant loans to his customers, of his own promissory notes; for example, for an amount of a hundred thousand pounds. His customers pay him the same interest as if he had lent them money; this interest will be his profit. Though he generally has notes in circulation of up to a hundred thousand pounds, amounts of twenty thousand pounds in gold and silver often suffice for occasional demands. If different operations of the same kind are carried out simultaneously by many different banks and bankers, the entire circulation may be conducted with only a fifth of the gold and silver which would otherwise have been required.
For example, say the entire circulating money of a particular country amounts to one million sterling; let us suppose that bankers issue promissory notes for an amount of one million, reserving two hundred thousand pounds for occasional requests; there would be eight hundred thousand pounds in gold and silver, and a million bank notes, or eighteen hundred thousand pounds of banknotes and money in circulation. But the annual produce of the land and labor of the country had before required only one million to circulate. This means there is an excess of eight hundred thousand pounds over and above what can be circulated in the country. This money cannot be absorbed by the country's economy and will therefore be sent abroad to a market that can employ it. Banknotes cannot go abroad since it cannot be used far from its issuing bank, so gold and silver, to the amount of eight hundred thousand pounds, will be sent abroad.
If they employ it in purchasing foreign goods for home consumption, they may purchase unproductive goods such as wines, or they may purchase materials, tools and provisions to employ and maintain additional workforce.
Three things are required in order to establish an industry: materials to work on, tools to work with, and wages to pay for the labor involved. Money is neither a material to work on, nor a tool to work with, and though a worker's wages are commonly paid to him in money, his real revenue consists not of the money but the money's worth; i.e., not in the physical metal coins but in what he can buy for them.
Many years ago, Scotland saw the establishment of some of the first banking companies in almost every town. The effects of this were those described above. The country's business is almost entirely carried out using the banknotes issued by various banking companies, for purchases and payments of all kinds. Silver and gold are used only rarely. Although the performance of these various companies has not been exceptionable, and required an act of parliament to regulate it, the country derived great benefit from their trade. Trade in Glasgow doubled within fifteen years of the establishment of the first banks there, and in Scotland it more than quadrupled since the establishment of the first two public banks in Edinburgh, of which the one, the Bank of Scotland, was established by act of parliament in 1695, and the other, Royal Bank, by royal charter in 1727.
The amount of banknotes circulating in a particular country should never exceed the amount of gold and silver that country possesses. Should this occur, there would be a run on the banks for these superfluous banknotes, and if they showed any problems in terms of payment, the alarm would necessarily increase the run.
The Bank of Britain is the main circulating bank in Europe. Incorporated through an act of parliament, by charter dated 27 July 1694, it at that time advanced a sum to the newly established government of £1,200,000 for an annuity of £100,000, or for £96,000 a year, at an eight percent interest rate, and £4,000 a year to cover management expenses. We can assume that the new government's credit must have been very low for it to have been obliged to borrow at such a high interest rate.
The stability of the bank of Britain is equal to that of the British Government. All that it has advanced to the public must be lost before its creditors can sustain any loss. No other banking corporation in Britain can be established through an act of parliament or can consist of more than six members. It acts not only as an ordinary bank but as a great engine of state. It receives and pays the greater part of the annuities due to public creditors; it circulates exchequer bills; and it advances an annual amount to the government to cover land and malt taxes, which are frequently not reimbursed before several years. Due to these various operations, it may, at no fault of its directors, sometimes overstock in terms of the amount of banknotes in circulation.
A country's monetary circulation can be divided into two types: that from one dealer to another; and that between dealers and consumers. Although the same pieces of money, whether notes or metal, may be employed in both of these circulations, since both are constantly ongoing simultaneously, each requires a certain stock of money, of one kind or another, in order to carry it out. The value of the goods circulated between the various dealers should never exceed the value of those circulated between dealers and consumers; whatever is bought by dealers is ultimately sold to consumers. Circulation between dealers, which is carried out wholesale, requires a relatively large stock of money; whereas between dealers and consumers, which generally involves retail, requires a relatively small stock.
In the currencies of North America, banknotes were used for sums as small as a shilling, and formed the bulk of the entire circulation. It is preferable not to issue bank notes for a value of under £5; as such, banknotes would probably be confined to circulation between dealers, as is the case currently in London where no bank notes are issued for a value of under £10.
Where banknotes is pretty much confined to circulation between dealers, as is the case in London, there is always plenty of gold and silver. Where banknotes is also used for much of the circulation between dealers and consumers, as is the case in Scotland and even more so in North America, gold and silver are practically not used at all in the country, with almost all ordinary transactions being carried out in banknotes.
The paper currencies of North America consisted not of bank notes payable to the bearer on demand but of a government paper, of which payment was not guaranteed until several years after its issue; and though the colony governments paid no interest to the holders of this paper, they made it legal tender of payment for the full value for which it was issued.
Indeed, the Government of Pennsylvania, when they first issued banknotes in 1722, pretended to render their paper of equal value with gold and silver, by enacting penalties against all those who made any difference between the price of their goods when selling them for a colony paper as opposed to for gold and silver.
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