Friday, October 10, 2008

Smith on Banking Interventions

Migeru’(?), 10 October, writing in European Tribune (HERE) quotes from Wealth Of Nations, without explanation of the context, a piece called ‘Adam Smith on Banking’ and risks giving a wrong impression of exactly what Adam Smith was discussing.

In The Wealth of Nations, when discussing Banking reform in Scotland in the latter part of the 18th century, Adam Smith had the following to say
“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 respect a violation of natural liberty

[‘Migeru’ adds: ‘Just so it cannot be said that I take the consecutive paragraph out of context’ (which has the effect of doing precisely what he/she claims they are not doing):

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 or 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.”

Reading the two parts of the same paragraph (WN II.ii.94: p 324) with the break in between raises a doubt whether ‘Migeru’ quotes them to show that the current interventions in the affairs of the world’s banks is a violation of Natural Liberty and therefore worthy of opposition by supporters of Natural Liberty, or a justification for intervening on these occasions to curb some individuals who otherwise would/might ‘endanger the security of the whole society’.

To make sure about Smith’s message here check the context. Chapter II, Book II, is a long chapter on banking: ‘Of Money considered as a particular Branch of the general Stock of Society, of the Expence of maintaining a National Capital’, pp 286-329.

It discusses the role of money and the banking facilities in the economy. It is descriptive if how banks work and their role in facilitating the ‘great wheel of circulation’. It also discusses the foibles of bank customers and also those of some bankers and how they can threaten the prosperity of society.

In the particular case of banks issuing paper bills for small sums, as low as sixpence, the risks from over issuing paper are severe on the credit worthiness of others. Smith suggested that the legislature forbid such practices and show why, as well as answering a possible objection from those who support the general principle of Natural Liberty (which Smith espouses strongly in other pages) by acknowledging that it is indeed such a ‘violation of Natural Liberty’, but it is nevertheless justified.

Now what role does this have for today’s banking crisis? It’s not clear from Migeru’s posting.

Ultra-conservatives and extreme libertarians may use it to support letting the financial system collapse as the least of the two evils, one of which includes state intervention; remnant Marxists and extreme socialists and social democrats may use it as part of their disparagement of Adam Smith in the guise of the Chicago version of him.

The best antidote to both is to read Chapter II of Book II of Wealth Of Nations and judge for yourself. The failings of politicians and rogue bankers and some of their customers was sufficient to cause the current crisis.

Smith gives several mid-18th-century examples to show decisively he was a pragmatist, not an ideologue.



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