Thursday, November 27, 2008

Adam Smith on Banking Behaviour and Misbehaviour

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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)

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2 Comments:

Blogger michael webster said...

Was he concerned with runs on the banks or some other public bad?

3:30 p.m.  
Blogger Gavin Kennedy said...

Michael

Yes. He mentioned situations arising from runs in the chapter on banking.

At the time there were two major banks (Bank of Scotland and Royal Bank of Scotland) that traded profitably and prudently, and others that got into serious trouble, mainly from mismanaging their operations (issuing 'cheque' accounts too easily, and for too small amounts) and who had cusomters who practised 'drawing and redrawing' frauds, both of which dragged the banks down into 'runs'.

Read chapter 2, of Book II of Wealth Of Nations.

From these comments he advised some regulation under law to stop banks behaving badly and their customers who did so to be prosectued.

Banks at the time were appearing in Scotland and before long certain behaviours became so prevelant that he regarded it necessary even to breach 'Natural Liberty' to safeguard the society from them.

3:34 p.m.  

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