Adam Smith's Simplified Wealth of Nations, Book 2, Chapter 2b: Paper money

Chapter 2b: Paper Money

27 There are many kinds of paper money.

28 When people have such confidence in the fortune, probity, and prudence of a banker, they believe that he is always ready to pay upon the presentation of his promissory notes.

29 A banker lends his own promissory notes worth £100,000 to his debtors.

30 Let us suppose, that a country's whole circulating money was £1 million.
Translator's Note: Bretton Woods allows the US paper currency to overflow, making the entire financial system unstable

31 The gold and silver sent abroad will be exchanged for foreign goods for the home country or for another foreign country.

32 If they use it to buy goods from one foreign country to sell to another, it is called the carrying trade.

33 If they employ it in buying foreign goods for home consumption, they may either:

  1. Buy goods likely to be consumed by idle people who produce nothing, such as foreign wines, silks, etc. 34 This way:
    1. promotes prodigality
    2. increases expence and consumption without increasing production
    3. does not establish any permanent fund for supporting that expence
    4. hurtful to the society in every respect
  2. Buy more materials, tools, and provisions to maintain and employ a more industrious people, who reproduce the value of their annual consumption, with a profit. 35 This way:
    1. promotes industry
    2. increases the society's consumption
    3. provides a permanent fund for supporting that consumption because the people who consume can reproduce the whole value of their consumption, with a profit
    4. increases the society's gross revenue by increasing the whole value added by labour to those materials
    5. increases their net revenue by deducting the cost of supporting the tools and instruments of their trade.
  36 Most of the gold and silver forced abroad by banking used to buy foreign goods for home consumption is almost unavoidably used to buy this second kind of goods.  

37 When we compute the amount of industry which a society's circulating capital can employ, we must always have regard only to provisions, materials, and finished work.

Three things are needed to mobilize industry:

Money is neither a material to work on, nor a tool to work with.

38 The amount of industry which any capital can employ must be equal to the number of workers whom it can supply with materials, tools, and a maintenance suitable to the nature of the work.

  39 When gold and silver money is replaced with paper, the amount of materials, tools, and maintenance (the circulating capital) may be increased by the value of gold and silver used to buy them in the past.  

40 It is perhaps impossible to determine the proportion of a country's circulating money to the whole value of its annual produce circulated by that money.

41 This operation has been done in Scotland within the past 25-30 years by the establishment of new banks in every considerable town and some country villages.
  1. The Bank of Scotland was established by act of Parliament in 1695
  2. The Royal Bank was established by royal charter in 1727
  42 Before the union in 1707, the value of the silver money circulating in Scotland was £411,117.

Discounted Bills of Exchange

43 Most banks issue their promissory notes chiefly:

Cash Accounts

44 The commerce of Scotland is not very great at present.

45 People with this credit who borrow £1,000, may repay it piecemeal, by £20-30 at a time.

46 Through those cash accounts, every merchant can carry on a greater trade.

47 Discounting bills of exchange gives the English merchants a convenience equivalent to the cash accounts of the Scotch merchants.

48 All kinds of paper money which can easily circulate in any country can never exceed the value of the gold and silver it substitutes.
Next: Chapter 2c: Bank Operations