prior probability

Adam Smith concludes his chapter on bilateral trade treaties — Chapter 6 of Book IV of The Wealth of Nations — with a detour on the practice of “seigniorage”. In summary, seignorage refers to the portion of metal retained by a sovereign (the government mint authorized to produce coins) when minting bullion into coins, i.e. the difference between the face value of these coins and their production cost. (As an aside, no less a figure than Sir Isaac Newton was appointed Master of the Royal Mint in 1699, a lucrative post he held for almost 30 years! See, for example, this fascinating 2022 paper by Alice Marples on “The science of money: Isaac Newton’s mastering of the Mint.”)

But Smith’s true target in this chapter is “that most insignificant object of modern policy” and “this silly notion”, the balance of trade. (WN, IV.vi.13 & 14) Why is the doctrine of the balance of trade so silly and insignificant in substance for Smith? The Scottish philosopher gives two reasons for this conclusion. One is that even if a country does end up importing more gold and silver coins from foreign countries than she exports abroad, some fraction of those coins will end up being melted down and exported abroad anyways. (WN, IV.vi.18) The other reason is that “no precaution of government could prevent it [i.e. the melting down of coins].” (ibid.)

But what does Smith’s critique of the balance of trade doctrine have to do with seignorage? The connection is this: Smith concedes that “a seignorage is the most effectual preventative of the melting down of the coin” (WN, IV.vi.21) He therefore devotes the last part of this chapter to the following question: how high or low should this seignorage be? That is, what is the optimal level of seignorage? If the seignorage is too low, it will not stop enterprising arbitrageurs from melting down minted coins and exporting them abroad, but if the seignorage is too high, the face value of such minted coins will not reflect their true value. In the end, Smith concludes that the seignorage of his day is a futile and ineffectual practice:

“If there was a reasonable seignorage, while at the same time the coin contained its full standard weight, as it has done very nearly since the last recoinage, whatever the bank might lose by the seignorage, they would gain upon the price of the bullion; and whatever they might gain upon the price of the bullion, they would lose by the seignorage. They would neither lose nor gain, therefore, upon the whole transaction, and they would in this, as in all the foregoing cases, be exactly in the same situation as if there was no seignorage.” (WN, IV.vi.26)

Is Smith’s survey of seigniorage still relevant today? Although the mechanics of 18th-century coin production have changed (the United States, for example, abandoned the gold standard in the 20th century), I suspect that Smith’s survey — and his analysis of money in Book I of his magnum opus — might shed some light on the mysterious economics of cryptocurrency.

N.B.: To commemorate the 250th anniversary of the publication of The Wealth of Nations (9 March 1776), I will be posting my chapter-by-chapter reflections on Adam Smith’s timeless magnum opus on my blog.

What’s better: bilateral or multilateral trade agreements? Adam Smith scrutinizes bilateral trade treaties in the first half of Chapter 6 of Book IV of The Wealth of Nations. More specifically, he singles out the Methuen Commercial Treaty of 1703 between the kingdoms of England and Portugal in which England agreed to reduce its duties (taxes) on wines from Portugal in exchange for Portugal opening up its market to English textiles. (For more information about this historic treaty, see here and here.) Although mercantilists celebrated this treaty “as a masterpiece of the commercial policy of England” (WN, IV.vi.8), Smith the skeptic pushes back. But his argument in this chapter is a subtle one: it’s not that these types of treaties are “bad” in some absolute sense. Instead, Smith’s critique is that a country that negotiates selective or bilateral trade treaties ends up leaving money on the table, so to speak:

“Such treaties, however, though they may be advantageous to the merchants and manufacturers of the favoured, are necessarily disadvantageous to those of the favouring country. A monopoly is thus granted against them to a foreign nation; and they must frequently buy the foreign goods they have occasion for dearer than if the free competition of other nations was admitted. That part of its own produce with which such a nation purchases foreign goods must consequently be sold cheaper, because when two things are exchanged for one another, the cheapness of the one is a necessary consequence, or rather the same thing with the dearness of the other. The exchangeable value of its annual produce, therefore, is likely to be diminished by every such treaty…. Even the favouring country, therefore, may still gain by the trade, though less than if there was a free competition.” (WN, IV.vi.6)

In other words, although he concedes that English textile companies are able to sell more textiles to Portugal than they would have in the absence of the treaty, his larger point is that England as a country would have been even more better off overall if she had opened her markets to all foreign countries instead of negotiating selective or bilateral trade treaties. The gains to consumers from free trade outweigh the gains from English textile companies under the 1703 Methuen Treaty. As such, the end result of this treaty was to line the pockets of English wine merchants and English textile manufactures at the expense of the general public.

Although Chapter 6 of Book IV of Smith’s magnum opus is titled “Of Treaties of Commerce”, the Scottish philosopher changes gears (so to speak) in the second half of this chapter (Paragraphs 16-32). There, he takes direct aim (yet again!) at his true target: the “silly” doctrine of the balance of trade. (To be continued …)

I will resume my grand series on The Wealth of Nations in my next post; in the meantime, shout out to my daughter Adys Ann for introducing me the music of Laufey!

“The laws concerning corn may everywhere be compared to the laws concerning religion. The people feel themselves so much interested in what relates either of their subsistence in this life, or to their happiness in a life to come, that government must yield to their prejudices, and, in order to preserve the public tranquillity, establish that system which they approve of. It is upon this account, perhaps, that we so seldom find a reasonable system established with regard to either of those two capital objects.” (WN, IV.v.b.40)

Adam Smith concludes Book IV, Chapter 5 of The Wealth of Nations with his famous “Digression concerning the Corn Trade and Corn Laws.” Don’t be fooled by the word “digression” in this subtitle, however. Here, Smith makes three points that are timeless: (1) he defends the role of middlemen in the grain trade; (2) he explores the economics of famines; and (3) he explains the wealth of nations, i.e. why some countries are poor, while others are wealthy. In short, if I could read only one section of Smith’s magnum opus, this “digression” might be it!

1. Smith’s solution to the middleman paradox. Smith begins his digression with a paradox: “The interest of the inland dealer, and that of the great body of the people, how opposite soever they may at first sight appear, are, even in years of the greatest scarcity, exactly the same.” (WN, IV.v.b.3) But how can this paradox be true? How can the private interest of middlemen, who want to obtain the highest possible price for their products, be aligned with the public interest of consumers, who want to pay the lowest possible price? Smith’s solution to this paradox is as elegant as it is surprising and is therefore worth quoting in full:

“Without intending the interest of the people, he [the middleman] is necessarily led, by a regard to his own interest, to treat them, even in years of scarcity, pretty much in the same manner as the prudent master of a vessel is sometimes obliged to treat his crew. When he foresees that provisions are likely to run short, he puts them upon short allowance. Though from excess of caution he should sometimes do this without any real necessity, yet all the inconveniences which his crew can thereby suffer are inconsiderable in comparison of the danger, misery, and ruin to which they might sometimes be exposed by a less provident conduct. Though from excess of avarice, in the same manner, the inland corn merchant should sometimes raise the price of his corn somewhat higher than the scarcity of the season requires, yet all the inconveniences which the people can suffer from this conduct, which effectually secures them from a famine in the end of the season, are inconsiderable in comparison of what they might have been exposed to by a more liberal way of dealing in the beginning of it. The corn merchant himself is likely to suffer the most by this excess of avarice; not only from the indignation which it generally excites against him, but, though he should escape the effects of this indignation, from the quantity of corn which it necessarily leaves upon his hands in the end of the season, and which, if the next season happens to prove favourable, he must always sell for a much lower price than he might otherwise have had.” (WN, IV.v.b.3; my emphasis)

In other words, middlemen perform a crucial economic function: they set prices, and they have a powerful and self-regulating economic incentive — the profit motive — to set their prices based on how plentiful or scarce the supply of grain is at any given time relative to consumer demand. How so? Because in order to maximize their profits, middlemen must ensure that the supply of grain lasts the entire season: if they set the price of grain too low, their supplies of grain will be wiped out too soon, resulting in a famine. If they set the price too high, however, supply will exceed demand and they will eventually have to sell at a loss because grain is a semi-perishable commodity.

2. The economics of famine. Next, Smith presents another paradox: he shows how well-intentioned government policies designed to prevent or ameliorate famines always end up making matters worse. How so? According to Smith, price controls are counterproductive because they interfere with the freedom of middlemen to set prices, and forcing prices to stay low can turn a localized shortage into a full-blown famine by discouraging middlemen from bringing food to market in the first place:

“When the government, in order to remedy the inconveniences of a dearth, orders all the dealers to sell their corn at what it supposes a reasonable price, it either hinders them from bringing it to market, which may sometimes produce a famine even in the beginning of the season; or if they bring it thither, it enables the people, and thereby encourages them to consume it so fast as must necessarily produce a famine before the end of the season. The unlimited, unrestrained freedom of the corn trade, as it is the only effectual preventative of the miseries of a famine, so it is the best palliative of the inconveniences of a dearth; for the inconveniences of a real scarcity cannot be remedied, they can only be palliated. No trade deserves more the full protection of the law, and no trade requires it so much, because no trade is so much exposed to popular odium.” (WN, IV.v.b.7; my emphasis)

3. The wealth and dearth of nations. Smith concludes his digression with a ringing defense of property rights (“security”) and natural liberty (“freedom”):

“The improvement and prosperity of Great Britain, which has been so often ascribed to those laws [regulating grain trade], may very easily be accounted for by other causes. That security which the laws in Great Britain give to every man that he shall enjoy the fruits of his own labour is alone sufficient to make any country flourish, notwithstanding these and twenty other absurd regulations of commerce …. The natural effort of every individual to better his own condition, when suffered to exert itself with freedom and security is so powerful a principle that it is alone, and without any assistance, not only capable of carrying on the society to wealth and prosperity, but of surmounting a hundred impertinent obstructions with which the folly of human laws too often incumbers its operations; though the effect of these obstructions is always more or less either to encroach upon its freedom, or to diminish its security. In Great Britain industry is perfectly secure; and though it is far from being perfectly free, it is as free or freer than in any other part of Europe.” (WN, IV.v.b.43; my emphasis)

Simply put, countries like Britain are wealthy not because of their mercantilist and protectionist policies, but because people are allowed to enjoy the “fruits of their own labour.” (WN, IV.v.b.43) That is, Britain is prosperous in spite of its mercantilist and protectionist policies! Again, how so? Because our innate or built-in desire to “better [our] own condition” is so strong that we are able to figure out a way around these laws and regulations! This observation, however, presents yet another paradox: what is the optimal amount of law? On the one hand, some laws are necessary in order to protect property rights and freedom, but at the same time, laws can also do more harm than good. (To be continued …)

[Alternative title: “The Dearth of Nations: How Government Subsidies Make Us Poorer”]

Adam Smith takes dead aim at yet another mercantilist policy in Chapter 5 of Book IV of The Wealth of Nations, a foolish and futile scheme that continues up to this day (see, for example, the infographic pictured below): crony capitalism in the form of “bounties upon exportation”, i.e. government subsidies that are paid directly to potent and powerful and well-connected producers in certain strategic industries like (in Smith’s day) grain. Smith tells us right off the bat what the mercantilist rationale of such bounties upon exportation is — to promote exports in certain industries in order to obtain a favorable balance of trade:

“Bounties upon exportation are, in Great Britain, frequently petitioned for, and sometimes granted to the produce of particular branches of domestic industry. By means of them our merchants and manufacturers, it is pretended, will be enabled to sell their goods as cheap, or cheaper than their rivals in the foreign market. A greater quantity, it is said, will thus be exported, and the balance of trade consequently turned more in favour of our own country.” (WN, IV.v.a.1)

But as the Scottish philosopher-economist explains in the first half of Chapter 5 (see especially Para. 24), bounties upon exportation are almost always injurious to a country’s overall economic health. Although Smith makes a limited exception for “bounties upon the exportation of British-made sail-cloth, and British-made gun-powder,” two goods that Smith says are necessary for national defense (WN, IV.v.a.36), such government subsidies are otherwise counterproductive. More specifically, bounties upon exportation make nations poorer in three ways: they misallocate capital, impose a double-burden on taxpayers, and distort prices:

1. Misallocation of capital. To begin, Smith observes how government subsidies divert the flow of capital. Simply put, bounties prop up business firms and entire industries that would not otherwise survive:

“Those trades only require bounties in which the merchant is obliged to sell his goods for a price which does not replace to him his capital, together with the ordinary profit; or in which he is obliged to sell them for less than it really costs him to send them to market.” (WN, IV.v.a.2)

In other words, bounties subsidize trades and industries where the cost of production exceeds the value of returns. As a result, the aggregate effect of government subsidies is to inhibit economic growth and development. Why? Because bounties cause capital assets to be misallocated into unproductive industries instead of being put to better or more productive uses, or in the immortal words of Adam Smith, “The effect of bounties, like that of all the other expedients of the mercantile system, can only be to force the trade of a country into a channel much less advantageous than that in which it would naturally run of its own accord.” (WN, IV.v.a.3)

2. Double-taxation. Next, Smith turns to the example of the corn bounty to show more generally how bounties and subsidies are a form of double taxation, i.e. a massive redistribution of income from the public to the beneficiaries of these mercantilist policies. Taxpayers must not only fund the cost of the government subsidy program itself; the public at large will end up paying higher prices overall for the goods being subsidized:

“The corn bounty, it is to be observed, as well as every other bounty upon exportation, imposes two different taxes upon the people; first, the tax which they are obliged to contribute in order to pay the bounty; and secondly, the tax which arises from the advanced price of the commodity in the home market, and which, as the whole body of the people are purchasers of corn, must, in this particular commodity, be paid by the whole body of the people. In this particular commodity, therefore, this second tax is by much the heavier of the two.” (WN, IV.v.a.8)

3. Distortion of the price signal. As the last sentence in the passage quoted above indicates, bounties (especially bounties upon exportation) distort prices. How so? When bounties are tied to exports of certain goods (such as grain or corn), such bounties end up reducing the supply of those goods at home and thus increasing their price:

“The extraordinary exportation of corn, therefore, occasioned by the bounty, not only, in every particular year, diminishes the home, just as much as it extends the foreign, market and consumption, but, by restraining the population and industry of the country, its final tendency is to stunt and restrain the gradual extension of the home market; and thereby, in the long run, rather to diminish, than to augment, the whole market and consumption of corn.” (WN, IV.v.a.8)

As it happens, Smith has much more to say about the grain market: the second half of Chapter 5 of Book IV of his magnum opus contains a “Digression concerning the Corn Trade and Corn Laws”. (WN, IV.v.b) Why does Smith devote so much attention to the grain trade? By some accounts, this trade represented a large chunk (if not the largest share) of the total trade of the British Isles. (See, e.g., Dennis Baker, “The Marketing of Corn in the First Half of the Eighteenth Century: North-East Kent”, Agricultural History Review, Vol. 18, No. 2 (1970), pp. 126-150, available here.) Suffice it to say, then, we will take a closer look at Smith’s digression in my next post.

“The revenue of excise would in this case, indeed, suffer a little, and that of the customs a good deal more; but the natural balance of industry, the natural division and distribution of labour, which is always more or less disturbed by such duties, would be more nearly re-established by such a regulation.” (WN, IV.iv.14)

Adam Smith turns his attention to another mercantilist trade policy in Book IV, Chapter 4 of The Wealth of Nations: drawbacks, i.e. targeted tax breaks on exports. In Smith’s day, most exports were subject to the payment of excise taxes. That is, when a merchant wants to export goods abroad, then, in the absence of a drawback, he must pay excise taxes on those goods. With a drawback, however, the merchant gets a partial or full refund on those paid excise taxes. For his part, Smith concludes that drawbacks are “reasonable” but only to the extent they promote foreign trade:

“To allow the merchant to draw back upon exportation, either the whole or a part of whatever excise or inland duty is imposed upon domestic industry, can never occasion the exportation of a greater quantity of goods than what would have been exported had no duty been imposed.” (WN, IV.iv.2)

Nevertheless, Smith also identifies two potential problems with drawbacks. One is fraud: unscrupulous exporters might try to “clandestinely” re-import or otherwise divert their tax-free goods back into the home market. (IV.iv.16) The other is monopoly: when a merchant already enjoys a government monopoly on the export of X goods, providing him a tax break on those goods is just pure payola. (IV.iv.15) In both of these cases, drawbacks reduce the amount of tax revenue the government is able to collect without increasing the overall level of trade:

“The drawback, therefore, may frequently be pure loss to the revenue of excise and customs, without altering the state of the trade, or rendering it in any respect more extensive.” (WN, IV.iv.15)

Do these costs outweigh the benefits? For Smith, the answer is, It depends. More specifically, it depends on whether the net effect of a country’s drawback policy is to increase trade. Although the original purpose or goal of drawbacks was to promote what Smith calls the “carrying trade” — i.e. the business of transporting the goods of one country to another country — drawbacks are good (in the Smithian sense) to the extent they leave the carrying trade free:

“Drawbacks were, perhaps, originally granted for the encouragement of the carrying trade, which, as the freight of the ships is frequently paid by foreigners in money, was supposed to be peculiarly fitted for bringing gold and silver into the country. But though the carrying trade certainly deserves no peculiar encouragement, though the motive of the institution was perhaps abundantly foolish, the institution itself seems reasonable enough. Such drawbacks cannot force into this trade a greater share of the capital of the country than what would have gone to it of its own accord had there been no duties upon importation. They only prevent its being excluded altogether by those duties. The carrying trade, though it deserves no preference, ought not to be precluded, but to be left free like all other trades. It is a necessary resource for those capitals which cannot find employment either in the agriculture or in the manufactures of the country, either in its home trade or in its foreign trade of consumption.” (WN, IV.iv.12)

So, why does Smith defend drawbacks at all? Why not call for getting rid of excise taxes altogether? After all, we wouldn’t even need give exporters tax breaks (i.e. drawbacks) if there were no excise taxes in the first place! For me, the answer is clear: because what this chapter goes to show is that Adam Smith is no ideologue or zealot. He is a pragmatist who is able to judge any given mercantilist policy on its merits, by weighing both the costs and the benefits of the policy. (To be continued …)

“There is no commercial country in Europe of which the approaching ruin has not frequently been foretold by the pretended doctors of this system [i.e. mercantilism] from an unfavourable balance of trade. After all the anxiety, however, which they have excited about this, after all the vain attempts of almost all trading nations to turn that balance in their own favour and against their neighbours, it does not appear that any one nation in Europe has been in any respect impoverished by this cause. Every town and country, on the contrary, in proportion as they have opened their ports to all nations, instead of being ruined by this free trade, as the principles of the commercial system would lead us to expect, have been enriched by it.” (WN, IV.iii.c.14; my emphasis)

Adam Smith concludes Chapter 3 of Book IV of The Wealth of Nations with a scathing critique of mercantilism/protectionism: “Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded.” (WN, IV.iii.c.2; my emphasis) For Smith, this doctrine is not only motivated by racism, by “the violence of national animosity” (WN, IV.iii.c.13); it is also logically unsound and absurd! Why absurd? Because wealth and money are not the same thing. True wealth consists of goods and services:

“There is another balance, … very different from the balance of trade, and which, according as it happens to be either favourable or unfavourable, necessarily occasions the prosperity or decay of every nation. This is the balance of the annual produce and consumption.” (WN, IV.iii.c.15)

But how does trade increase this alternative balance, i.e. “the balance of annual and produce consumption”? Simply put, how does free trade make a nation more wealthy? According to Smith, when nations open up their markets and freely trade with each other, they can specialize in what they do best. If France, for example, produces cheaper and higher-quality wine than England does, then England would be better off importing French wine instead of trying to produce her own lower-quality higher-cost wine, and this conclusion holds regardless whether England’s importation of wine creates a trade deficit. Why? In a word (two words): opportunity cost. If the owners of capital in England use their capital to produce wine, then that capital cannot be used to produce other goods and services. Capital assets are finite, scarce resources. (See WN, IV.iii.c.2-7.)

Free trade thus allows a country to put her capital assets to their highest-valued, most productive uses. To drive home this point, Smith presents the following memorable analogy:

“It is a losing trade, it is said, which a workman carries on with the alehouse; and the trade which a manufacturing nation would naturally carry on with a wine country may be considered as a trade of the same nature. I answer, that the trade with the alehouse is not necessarily a losing trade. In its own nature it is just as advantageous as any other, though perhaps somewhat more liable to be abused. The employment of a brewer, and even that of a retailer of fermented liquors, are as necessary divisions of labour as any other. It will generally be more advantageous for a workman to buy of the brewer the quantity he has occasion for than to brew it himself, and if he is a poor workman, it will generally be more advantageous for him to buy it by little and little of the retailer than a large quantity of the brewer. He may no doubt buy too much of either, as he may of any other dealers in his neighbourhood, of the butcher, if he is a glutton, or of the draper, if he affects to be a beau among his companions. It is advantageous to the great body of workmen, notwithstanding, that all these trades should be free, though this freedom may be abused in all of them, and is more likely to be so, perhaps, in some than in others. Though individuals, besides, may sometimes ruin their fortunes by an excessive consumption of fermented liquors, there seems to be no risk that a nation should do so.” (WN, IV.iii.c.8; my emphasis)

But if free trade is so good, why does self-defeating Trumpian mercantilism and protectionism still prevail? Smith blames both the owners of capital and labor, i.e. “the sneaking arts of underling tradesmen” (IV.iii.c.8) as well as the “monopolizing spirit” (IV.iii.c.9) and “interested sophistry” (IV.iii.c.10) of “merchants and manufactures”:

That it was the spirit of monopoly which originally both invented and propagated this doctrine cannot be doubted; and they who first taught it were by no means such fools as they who believed it. In every country it always is and must be the interest of the great body of the people to buy whatever they want of those who sell it cheapest. The proposition is so very manifest that it seems ridiculous to take any pains to prove it; nor could it ever have been called in question had not the interested sophistry of merchants and manufacturers confounded the common sense of mankind. Their interest is, in this respect, directly opposite to that of the great body of the people.” (WN, IV.iii.c.10)

Once again, we see a deep tension in Adam Smith’s thought: on the one hand, when markets are free, the owners of capital and labor have an incentive to put their assets to their most productive uses, but when a country is free (in the political sense), these same owners of capital and labor will use their power and clout to try to shut down competition and protect their economic interests at the expense of the public good!

🐎 Happy Lunar New Year! 🐎 Tucked in between Parts 1 and 2 of Chapter 3 of Book IV of The Wealth of Nations is Adam Smith’s “Digression concerning Banks of Deposit, particularly concerning that of Amsterdam” (available here). But why does Smith discuss the inner workings of a foreign bank in a chapter otherwise devoted to trade restrictions based on balance-of-trade arguments? Simply put: because the Bank of Amsterdam is central to Smith’s critique of the balance-of-trade doctrine. To see why, let’s compare and contrast the Bank of England with the Bank of Amsterdam:

In brief, although the Bank of England was created in 1694 by an Act of Parliament and Royal Charter, it was a privately-owned bank, i.e. a joint-stock company (corporation), and its original purpose was to finance the “Nine Years’ War” (1688 to 1697) between France and England. The Bank of Amsterdam (Amsterdamsche Wisselbank), by contrast, was publicly-owned. It was founded in 1609 by Amsterdam’s municipal council and housed in the Town Hall (pictured below).

That is, while the Bank of England was a private for-profit institution created to contribute to a public purpose (fund a war), the Bank of Amsterdam was a publicly-owned entity established to promote private commerce!

In summary, Dutch merchants were often paid in foreign and local trade coins (gold and silver). The problem, however, was that many — if not most — of these coins were “worn, clipt, or otherwise degraded below [their] standard value.” (WN, IV.iii.b.1) The Bank of Amsterdam solved this pesky problem by creating a uniform and standard form of accounting currency called “florins”. That is, the Bank of Amsterdam acted as a central repository where Dutch merchants deposited their foreign and local coins in exchange for “florins”. But here’s the rub: these fictional florins were not a physical currency; florins were merely a unit of account on the bank’s ledgers, and the Bank of Amsterdam charged a fee for converting this bank-account money back into physical coins (Dutch guilders).

So, what incentive did Dutch merchants have for doing business with the Bank of Amsterdam? In a word: security. The city government assumed full and direct liability for all deposits, thus guaranteeing that every “florin” or “guilder” on deposit was fully backed by physical gold or silver bullion kept in the vaults of the bank in City Hall. In other words, as Adam Smith points out in his digression, the Bank of Amsterdam operated as a 100% reserve bank:

“At Amsterdam, … no point of faith is better established than that for every guilder, circulated as bank money, there is a correspondent guilder in gold or silver to be found in the treasure of the bank. The city is guarantee that it should be so.” (WN, IV.iii.b.15)

Smith, however, is skeptical about the true amount of gold and silver reserves being held in the bank’s coffers: “What may be the amount of the treasure in the bank is a question which has long employed speculations of the curious. Nothing but conjecture can be offered concerning it.” (WN, IV.iii.b.16) But for Smith that is precisely the point! Simply put, Amsterdam was a wealthy city not because of the large amounts of reserves in the city’s coffers. She was prosperous because the city-owned bank facilitated commerce by offering safe and secure accounts for Dutch merchants!

This digression thus supports one of Smith’s main insights in Book IV of his magnum opus: the idea that balances of trade don’t really matter. What matters is having a stable and solid currency, which in turn facilitates trade, and that is precisely what the Bank of Amsterdam provided: a stable and solid currency. Nota bene: I will proceed Part 2 of Chapter 3 of Book IV The Wealth of Nations (available here) in my next post.

To my North American readers, 🇺🇸 Happy Presidents’ Day 🇺🇸! Now, let’s pick up where we left off, with Chapter 3 of Book IV of The Wealth of Nations. Recall that Adam Smith launches an all-out, no-holds-barred attack on mercantilism and protectionism in Book IV of his magnum opus. To this end, Smith identifies two types of restraints on trade with foreign nations:

“First, restraints upon the importation of such foreign goods for home consumption as could be produced at home, from whatever country they were imported.

“Secondly, restraints upon the importation of goods of almost all kinds from those particular countries with which the balance of trade was supposed to be disadvantageous.” (WN, IV.i.a.37-38)

Accordingly, Chapter 2 of Book IV reveals the many mercantilist fallacies regarding the first kind of restraint — i.e. economic protectionism or “restraints upon the importation of such foreign goods for home consumption as could be produced at home” — while Chapter 3 (available here), which we explore in this post, exposes the truth about “balance of trade” arguments. [1] As such, both of these Smithian chapters are directed towards Donald Trump and his sundry MAGA followers!

But that said, what is the main difference between these two types of justifications in favor of restraints of trade? Among Adam Smith’s many deep insights in these first three chapters of Book IV — e.g. the absurdity of the doctrine of the balance of trade, the conspiracy of the merchants, the invisible hand of self-interest, etc., etc. — the one that is most surprising to me is Smith’s analysis in Chapter 3 of the cultural politics of the doctrine of the balance of trade. To see why, let’s go back for a moment to Chapter 1 of Book IV. In that chapter, Smith explores the economics of the balance of trade doctrine, and he shows why this protectionist doctrine is bullshit: restrictions on trade retard economic growth and thus make us poorer.

So, what does Smith add to his analysis of the doctrine of the balance of trade in Chapter 3? That is, what does he say in Chapter 3 that hasn’t already been said in the previous two chapters of Book IV of his magnum opus? Simply put, Smith makes an astute political observation in Ch. 3: restraints on free trade based on outright economic protectionism are motivated by “private interest and the spirit of monopoly” (WN, IV.iii.a.1), but restraints on trade based on “balance of trade” arguments are, at bottom, motivated by racism or xenophobia, i.e. “national prejudice and animosity.” (ibid.)

In other words, “balance of trade” arguments are not only economic nonsense; they are morally evil and racist! Here (yet again!) is another reason why Adam Smith is still relevant today. For Smith, if you want to be an effective “anti-racist”, and not just virtue-signal about being so, then the most effective way of fighting racism is by exposing the folly and futility of “balance of trade” arguments, in other words, by supporting free trade!

[1] That is why Chapter 3 of Book IV of The Wealth of Nations is titled “Of the Extraordinary Restraints upon the Importation of Goods of almost all Kinds from those particular Countries with which the Balance was supposed to be disadvantageous.”