Politics Magazine

Adam Smith: The Origin and Use of Money

Posted on the 23 February 2013 by Adask

Profile of Adam Smith

Profile of Adam Smith (Photo credit: Wikipedia)

Adam Smith (1723 – 1790) was a Scottish moral philosopher and a pioneer of political economics who’s best known for writing An Inquiry into the Nature and Causes of the Wealth of Nations (A.D. 1776). This book (usually abbreviated as “The Wealth of Nations”) is considered the first modern work of economics. Smith is cited as the father of modern economics and is still among the most influential thinkers in the field of economics today.

Chapter IV of Book I of The Wealth of Nations is entitled “Of the Origin and Use of Money”.  In that chapter, Smith explains that,


“[I]t is but a very small part of a man’s wants which the produce of his own labor can supply. He supplies the far greater part of them by exchanging that surplus part of the produce of his own labour, which is over and above his own consumption, for such parts of the produce of other men’s labor as he has occasion for.  Every man thus lives by exchanging, or becomes in some measure a merchant, and the society itself grows to be what is properly a commercial society.”

However, there’s a problem with this system of barter. Suppose one man has more of a certain commodity than he can use, and another man has less.  The former would be glad to dispose of his excess; the later would be glad to buy it.  But if the latter has nothing to trade that the former needs, no exchange can be made between them.

For example, a butcher may have more meat in his shop than he can consume.  A baker might be willing to purchase a part of that meat. But he has nothing to offer in exchange except his excess bread, and the butcher already has enough bread for his immediate needs.  If he doesn’t find someone to buy his meat, his meat will spoil.  If he trades his meat for bread he doesn’t need, the bread will spoil.  Therefore, no “exchange” can be made.

This illustrates the need for money as a means of storing wealth.  I.e., if the butcher could “exchange” his excess meat for gold, he could spend that gold one month or one year later when he finally needed to buy more bread.

The “storage” capacity of money is based on the fact that true “money” doesn’t spoil.   An ounce of gold, today, will still be an ounce of gold next year and next century.  However, a loaf of bread, today, could be a mound of mold next week, and nothing but dust a year from now.

Similarly, with a currency like Federal Reserve Notes (FRNs), the “storage” capacity is limited by the gov-co’s inclination to inflate the currency and defraud those who hold paper dollars.  FRNs don’t “perish” as rapidly as bread, but FRNs do “perish” due to inflation.

Thus, real “money” must be composed of something (like metal) that does not easily “perish”.


•  Even more importantly, once a butcher can exchange his “over-production” for a non-perishable money, he is encouraged to work harder, longer, and more efficiently so as produce more and more excess meat that he can exchange for more “money” that will store the value of his excess production.   A viable “money” makes the butcher more industrious.

However, without a “money” that won’t perish or depreciate in value, there’s no point to hard work and “over-production” since the butcher’s excess meat will rot without another buyer who has only bread to trade.

Implication:  Without real money, it would be inefficient and even unwise to “over-produce” since most over-production would simply go to waste.  Therefore a real money is conducive and even necessary to foster hard work, over-production, profits and a prosperous society.

It would seem to follow that, in the absence of real money (gold), a society would tend to suffer economic degradation, diminished profits and declining prosperity.  If so, a “legal tender” (like paper and digital “dollars”) would tend to impoverish a nation.

The “perishable” (inflatable) nature of FRNs guarantees that creditors will be robbed of at least part of the “excess production” that’s stored in their currency.  As creditors are robbed by inflation, there’s less incentive to work, more incentive to live on welfare, less incentive to save and a constant loss of the creditors’ wealth.  As creditors lose their wealth that’s stored in FRNs, there’s less and less savings to invest in new farms, factories, homes or businesses and the entire economy tends to slide towards poverty.

This analysis parallels what we’ve seen in the US ever since our currency became a pure fiat dollar in A.D. 1971.

Point:  A real “money” is indispensable for a prosperous nation.


•  Result:  Centuries ago, people realized that they needed some 3rd, common commodity that everyone always wanted that could be used a medium of exchange that would allow the butcher to sell his meat to the baker—even when he didn’t need any more bread.  Adam Smith listed some of those early “common instruments of commerce” as cattle, salt, shells, dried cod, tobacco, sugar, hides and even nails.  However,


“In all countries, men seem at last to have been determined by irresistible reasons  [non-perishable, store of value] to give the preference, for this employment, to metals above every other commodity. Metals can not only be kept with as little loss as any other commodity, . . . but they can likewise be divided into any number of parts, [and] by fusion those parts can easily be reunited again; a quality which no other equally durable commodities possess, and which more than any other quality renders them fit to be the instruments of commerce and circulation.

“The man who wanted to buy salt, for example, and had nothing but cattle to give in exchange for it, must have been obliged to buy salt to the value of a whole ox, or a whole sheep, at a time. He could seldom buy less than this, because what he was to give for it could seldom be divided without loss . . . . [But] If, on the contrary, instead of sheep or oxen, he had metals to give in exchange for it, he could easily proportion the quantity of the metal to the precise quantity of the commodity which he had immediate occasion for.

“Different metals have been made use of by different nations for this purpose. Iron was the common instrument of commerce among the antient Spartans; copper among the antient Romans; and gold and silver among all rich and commercial nations.”

“[However,] the use of metals in this rude state was attended with two very considerable inconveniencies; first with the trouble of weighing; and, secondly, with that of assaying them.”


I.e., if the butcher wants to sell his excess meat and is willing to take a chunk of iron in return, how much does that iron weigh?  Does the chunk weight a full pound—or only 10 ounces?  More, is it pure iron, or has it been adulterated with impurities that would make that “chunk” less valuable?

The difficulty inherent in both weighing and assaying each “chunk” of metallic money for each transaction would render the “chunks” of metallic money inconvenient and hard to use.  More,


“Before the institution of coined money, unless they went through this tedious and difficult operation [of both weighing and assaying each “chunk” of metallic money], people must always have been liable to the grossest frauds and impositions, and instead of a pound weight of pure silver, or pure copper, [they] might receive in exchange for their goods an adulterated composition of the coarsest and cheapest materials . . . .

“To prevent such abuses, to facilitate exchanges, and thereby to encourage all sorts of industry and commerce, it has been found necessary, in all countries that have made any considerable advances towards improvement, to affix a public stamp upon certain quantities of such particular metals, as were in those countries commonly made use of to purchase goods.

“Hence the origin of coined money . . . .  meant to ascertain, by means of a public stamp, the quantity and uniform goodness of those different commodities when brought to market.”


What is this “stamp”?  It’s a security device that consists of the total, engraved image that’s cast onto both faces (the “head” and the “tail”) and the edge of the coin.

The metallic disk (say, one ounce of gold) is the “money”.  The image that’s engraved into the two faces and edge of that metallic disk is the “stamp”.   Because the “stamp” covers the entirety of the surface of the coin, it’s virtually impossible for portions of the coin to be removed without instantly revealing the loss.  Therefore, the “stamp” essentially certifies that the particular disk is of a particular weight and fineness.


“The inconvenience and difficulty of weighing those metals with exactness gave occasion to the institution of coins, of which the stamp, covering entirely both sides of the piece and sometimes the edges too, was supposed to ascertain not only the fineness, but the weight of the metal. Such coins, therefore, were received by tale as at present, without the trouble of weighing.”


Webster’s A.D. 1828 Dictionary offers seven definitions for “tale”—one of which one seems similar to the meaning Smith intended:


“4. Number reckoned.—The ignorant reckon by tale, not by weight.”


In other words, a money “received by tale” would be received as whatever amount was declared on the face of money itself.  The “number reckoned” by the government and “stamped” on the face of the coin would be accepted as the true weight of the mass of the pure metal within the coin—without need to weigh or assay the coin, itself.  Common people would trust the governmental “stamp” on the coin to accurately reveal the value/weight of the metal in the coin.

One example of a “money” that might’ve been “received by tale” was the $1 trillion platinum coin that was recently proposed as a solution to the budget deficit.  The gov-co would take a one-ounce disk of platinum (currently worth about $1,700), stamp an image on that coin that included the words “One Trillion Dollars” and look for some sucker to accept that coin by “tale” as being worth $1 trillion.)

Here’s another example.  Until A.D. 1968, the “dollar” was defined as a particular weight of silver.  Therefore, prior to A.D. 1968, if the stamp on a coin read “One Dollar,” it would be automatically accepted and received as one dollar’s weight of silver without need for weighing or assaying the coin.  More, if the “stamp” on a paper dollar said “One Dollar,” that stamp would be deemed worth one ounce of silver since the paper bill could be redeemed for a silver dollar.

The government’s stamp on the coin created confidence in the minds of the people that the coin was truly of a particular weight and purity, without need for further measurement and that the paper dollar was also worth one ounce of silver.

As people’s confidence in the weight and purity of “stamped” coins grew, there was no need to weigh and assay the metallic money in each transaction and the “velocity” of commerce increased.  If “stamped” money didn’t truly “make the world go around,” it at least made it “go around” faster.


•  But note that Webster’s definition of “tale” also explained that “The ignorant reckon by tale and not by weight.”

In other words, the ignorant are so trusting that they believe whatever they read on the stamp on the coin, rather than taking time to actually weigh and assay the coin to ascertain it’s true weight and purity.  The ignorant/trusting are thus easily subject to counterfeit and fiat currency.

And note that today, most Americans figuratively accept whatever value is “stamped” by the government and/or Federal Reserve on a piece of paper as being the true “weight” (value) in dollars of that piece of paper.

But a $100 bill has no more intrinsic weight (value) than a $1 bill.  The only difference is the “stamp”.  Thus, if we were to judge modern Americans’ use of FRNs by Webster’s definition of “tale,” we’d have to admit that those of us who accept paper dollars based in their “stamp” rather than their weight are “ignorant”—and easily defrauded by counterfeit and fiat currency.

As Americans, we have come to “ignorantly” accept the value of any monetary instrument, be it coin or paper, to be based on the government’s “stamp” rather than its weight in metal.  Our willingness to trust in the “stamp” rather than in actual weight in metal has allowed our government to grow monstrous.  All government has to do to make more “money” is to place its “stamp” on a piece of paper.   Government can issue tons of paper stamps that we ignorantly accept as “money–but which are actually debt-instruments.

According to Webster, our willingness to accept the government’s “stamps” as if they were money means we are “ignorant”.

Webster was right.

Our willingness to ignorantly accept the government’s stamp as if it were real “money” (a physical mass of gold or silver) is based on our willingness to trust our government.  As late as A.D. 1968, that confidence in government and belief in the tale/stamp was justified insofar as a One Dollar stamp on paper could be redeemed with One Dollar’s weight in silver.  The $1 paper stamp was worth one silver dollar (one ounce of silver).

But, today, that same government stamp of “One Dollar” is worth only about 1/30th of an ounce of silver.   In the 45 years since A.D. 1968, the true value of the One Dollar “stamp” has diminished by 97%.  Nevertheless, we accept the government’s stamp as if the government was trustworthy and their stamp (rather than metal) is money.

Perhaps Webster was too kind when he described those who reckon by “tale rather than weight” as merely ignorant.  It might be more honest to describe such people as a bunch of fools headed for poverty and national self-destruction.

Mr. Smith explains why:


“For in every country of the world, the avarice and injustice of princes and sovereign states, abusing the confidence of their subjects, have by degrees diminished the real quantity of metal, which had been originally contained in their coins.

“The Roman As [an early measure of “money” by weight of iron], in the latter ages of the Republic, was reduced to the twenty-fourth part of its original value, and, instead of weighing a pound, came to weigh only half an ounce. The English pound and penny contain at present [A.D. 1776] about a third only [of their original weight in precious metal]; the Scots pound and penny about a thirty-sixth; and the French pound and penny about a sixty-sixth part of their original value.”


Nothing new under the sun.  Virtually all governments for the past 1,000 years have routinely debased their national currencies.  Currency debasement (inflation) isn’t rare or recent.  It’s what governments do.

How much “metal” is currently contained in your fiat dollar?  Zero.

The astonishing thing is not that our fiat dollar has lost 97% of its value in the past 45 years.  The astonishing thing is that it’s retained any value (3%) whatsoever.


“By means of those operations the princes and sovereign states which performed them were enabled, in appearance, to pay their debts and to fulfill their engagements [promises] with a smaller quantity of silver than would otherwise have been requisite.”

By inflating their currencies, they could figuratively “pay off their debts with cheaper (less metallic) dollars”.  If they borrowed $100,000 they would repay $100,000 and thereby appear to have repaid their debt in full.  But after inflating their currency, they might repay the $100,000 loan “nominally” with dollars worth only 50 cents each and thus rob their creditor of $50,000 in purchasing power.


“It [government’s purported ‘payment”] was indeed in appearance only; for their creditorswere reallydefrauded of a part of what was due to them. All other debtors in the state were allowed the same privilege, and might pay with the same nominal sum of the new and debased coin whatever they had borrowed in the old. Such operations, therefore, have always proved favourable to the debtor, and ruinous to the creditor, and have sometimes produced a greater and more universal revolution in the fortunes of private persons, than could have been occasioned by a very great public calamity.”

By “universal revolution,” Smith refers to the kind of catastrophic “economic depression” that can strike a nation that allows its government to issue stamps (fiat currency) rather than metallic money.  These catastrophes are caused by public ignorance and governmental avarice.


“It is in this manner that money has become in all civilized nations the universal instrument of commerce . . . .”

And, in this manner, paper, fiat “money” has also become the universal instrument of fraud whereby people have been “trained” to accept a governmental “stamp” as if it were money.


•  I never cease to be amazed at my own ignorance—or by the ignorance of others.  236 years ago, Adam Smith warned how money has been routinely devalued by governments for at least 1,000 years.  And yet, most of today’s Americans can’t even imagine that our government is intentionally robbing us by means of inflation.

Those who won’t learn from history are destined to be robbed.

You Might Also Like :

Back to Featured Articles on Logo Paperblog

These articles might interest you :