Update -- I'm just not lucid enough anymore. I'll have to do it tomorrow afternoon. Till then -- Rasmus]

Surely some more substantive notion of money can be found. That's the task that Smith sets himself in Chapter IV, "Of the origin and use of money", and the immediately following chapters. It is a task to which I, for one, do not feel entirely equal. So I shall tread gingerly through this summary.

(If someone has the MIT dictionary of Economics, or something like it, perhaps they could reproduce the definition of "money" given there.)

As is my wont, I am writing this late at night, though today I'm particularly groggy for some reason. I'll make necessary corrections later.

Smith starts with the plausible scenario of a baker being unable to exchange his produce for that of the butcher, when the butcher has meat to offer, but has no need of bread. Once again I must point out that Smith's examples are totally ahistorical and speculative, and depend on a picture of linear, determinate evolution of human societies (Smith's so-called "stadialism") which had a lot to do with the basic assumptions of the enlightenment and the appeal to its thinkers of mechanistic models of explanation (like, of course, Newtonian mechanics). In reading such examples, therefore, I exercise extreme scepticism about their ability to help us understand present institutions. They do, of course, do some work in rhetorically justifying those institutions.

Well, moving along. The baker finds it bad not to get any meat, and the butcher finds it bad not to be able to exchange his surplus meat for goods he (it's all hes in the text, sorry) can use. Eventually, to obviate such inefficiencies, communities settle on using the commodity most readily exchangeable for other goods as the medium of all exchange. Smith gives as examples, among others, cod in Newfoundland or cattle in the rude ages of mankind. Well I have a few problems here: Smith discounts that the butcher may use this as an opportunity for arbitrage. Since, if there is someone who (even on Smith's account of the money economy) will exchange the baker's bread for the most exchangeable commodity, there must be some unsatisfied demand for bread which the butcher himself could exploit by buying from the baker at less than the price which his bread could otherwise command. This is called arbitrage, or in plain English, ripping the baker off. The fact is that Smith's explanation doesn't help us understand how, to this day, large and complex economies can still be conducted mostly on the barter system. Also, what happens when there are too many cows, more than there is demand for cows, for example; and how is this different from the case that Smith starts with?

At any rate, Smith remarks, plausibly but speculatively, that metal was eventually adopted as the medium of exchange because of its ready divisibility; it made it possible to buy goods in more finely graded quantities than would the use of whole cattle as the basic currency. That seems simple enough, as does the discussion of the origin of coin stampage later in the chapter. I don't think those things require commentary.

Later Smith mentions the chronic tendency of the sovereign to reduce the quantity of metal used in the production of currency. One might think that this should not matter, since the exchange value of the currency ought to remain the same (as it did when Canada switched from a paper one-dollar note to the more expensive loonie). But of course, if one can exchange the quantity of metal in old coinage for a nominally greater amount of the new coinage, the reality is that the new coinage has been devalued.

The most interesting part of this chapter, which is not the most interesting chapter of this section, is the part where Smith essays a definition of two kinds of value. Value is another vexed notion, as anyone who has tried to explain the Marxist notion of surplus value will know. At any rate, Smith's distinction, whether or not originally his, is quite astute. Value in use is quite detached from value in exchange. (Are these the only kinds of value we can imagine? What kind of value is sentimental value, or moral value, for example? Can value in use be quantified?)

Anyway, there's not a whole lot that strikes me as controversial about this chapter. So I'm going to leave my comments as they are, and save up for the next chapter, which is more interesting, and which I'll write about tomorrow.

Ok, first off. Money is conventionally defined as a medium of exchange. As such, it does not have to necessarily have intrinsic value - only that it be widely accepted as a common exchange mechanism. For example, look at cigarettes in prisons. They're not intrinsically valuable, since you can grow tobacco anywhere, but they become used as currency. Another example I have heard of is the use of sea shells in some aboriginal tribes.

Adam Smith's fretting about the debasement of currency in a gold/silver standard period is not so different from today's fretting over whether inflation is too high or too low. Why? Because inflation is simply a fall in the value of money. Everybody knows the old saw, "a dollar doesn't buy what it used to" - that's an aphorism which captures the fall in the value of money.

What *is* different between the Smithian period and ours is that since the 1940s, we have not had a true gold standard and in fact since the 1970s no major country's currency is backed by any precious metal whatsoever. They are backed solely by the requirement by the government to use it as the legal medium of exchange and the requirement to use that currency to pay taxes. This is what defines a "fiat" currency as distinct from a metal-backed currency. "Fiat" means by regulatory edict.

In regard to exchange rates, in Adam Smith's time the gold and silver standards implied fixed exchange rates between currencies because so many units of any country's currency could buy a given defined weight of gold or silver. Based on gold or silver as the "anchor", exchange rates could be set. Under the "Keynesian period" from the 1940s to the 1970s, a strange hybrid was created where gold became the mechanism of settlement of international trade only, but currencies were fiat-based for domestic purposes in the industrial economies. Exchange rates were simply fixed by treaty with the proviso that trade imbalances be worked out either by using gold deposits with the IMF (or, later, post-1971, by "special drawing rights" which, as I understand it, were fixed amounts of currency put on deposit with the IMF) or by direct agreement between two nations to adjust tariffs as appropriate or to negotiate an orderly change to the exchange rate.

As you can see, the above required several things, any one of which, if it went haywire, would bring the whole thing crashing down. First, it presupposed balanced trade. Second, it was assumed that no country would try to "export" inflation by keeping its currency overvalued. Third, it assumed that there would not be serious gold outflows either from the gold on deposit with the IMF or from a country's vaults. And fourth, it assumed that popularly elected governments, intent on a collectivist approach to solving domestic problems, would also adopt a collectivist approach to solving international problems.

In fact, all four of these preconditions were failed in the 1970s.

OPEC countries began demanding gold as settlement of trade imbalances when inflation started ramping up in the late 1960s and early 1970s. This led directly to Nixon's slamming-shut of the "gold window" and declaring an end to any vestiges of a gold standard. The USA had been exporting inflation by refusing to devalue its currency to fix a looming trade imbalance (as we now know, it has still not been able to bring its trade deficit under control).

So the only solution was to change the mechanism of adjustment: Instead of controlling capital flows to prevent speculators from arbitraging exchange rates or trade imbalances, exchange rates themselves would freely float, in theory to respond to trade imbalances. In fact, deregulation of capital flows, coupled with a brand-new forex (foreign exchange) market, created the conditions for sharp speculators to take advantage of the most minute imbalances in exchange rates between nations, or by betting against a nation's currency based on economic imbalances. A real-life example was George Soros and other speculators essentially blowing Britain out of the ERM (Exchange Rate Mechanism) by shorting an overvalued Pound Sterling.

A more hypothetical example involves three nations and their exchange rates:

Suppose Country A has an exchange value of its currency with B and C of 1:1.25 and 1:0.75 respectively. Countries B and C, therefore, to maintain parity, have exchange rates of:

B (to A) - 1:0.80 and (to C) 1:1.67
C (to A) - 1:1.33 and (to B) 1:0.60

These exchange rates all imply equilibrium conditions. (Someone check my assumptions here, wouldya )

These rates, in theory, should move in absolute lockstep. If A's value changes with respect to B, it should change in proportion also to C. But, and here's the rub - what if A's value changes less than proportionately to C than it does to B, for whatever reason? Can we say opportunity for arbitrage? Bingo!

Or, suppose speculators want to get a better deal on B's currency in the future if they live in A. Well, they would hang onto their A-currency units and watch over time and see if B's currency falls in value. If it does, they cash in and get to buy loads of stuff cheap.

However, speaking of speculation in regard to physical goods, as you mentioned, I don't think that ever even occurred to Adam Smith. Although the notion of fluidity in prices leading to possible speculation is easy to see today, I think his acceptance of fixed exchange rates and the hypercompetitiveness of the markets at that time (no large monopolies except in state-sanctioned enterprises, which were all over in North America anyway) led to a natural assumption that price differentials would not be arbitrageable due to the fluidity, not of price, but of supply and demand.

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Price is simply one mechanism of adjustment to changed supply/demand relationships. Another mechanism of adjustment is for supply or demand to change relative to the other.

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As for the rest, I don't think I can add anything.

One of the things pointed out in that Shutt book is how the deregulation of exchange permitted banks to borrow freely abroad, thus expanding credit in most markets and limiting governments' ability to control debt levels by any means beyond the crudest, interest rates. This has led to an overall deterioration of credit quality, at the same time as governments' fiscal health, and so their ability to act as lender of last resort, has also deteriorated. Just a side note here. Not entirely relevant.

Briefly, from Ch.4:

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WHEN the division of labour has been once thoroughly established, it is but a very small part of a man's wants which the produce of his own labour 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 labour as he has occasion for.

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"supplies a far greater part..." This is truer the wealthier a society is, of course.

In Ch. 5 Smith expands on the idea that money is the medium of exchange we use to buy commodities with our surplus labour to explain how labour itself is the "real" measure of the value of commodities.

Now, my question, first off, on reading Ch. 5 is, what's the cash value of saying

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Labour, therefore, is the real measure of the exchangeable value of all
commodities. The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people.

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(First, I note that saying that real labour is the measure of the value, and that the real price of acquiring anything is the toil and trouble taken in the acquiring, are not quite the same thing, are they? If you think about it the latter way, then things are quite cheap for people who have worked little or not at all; but what Smith really wants to do is establish a basic measure of value that doesn't fluctuate that much across the ages, and it seems to me that this little passage confuses things a bit.)

I ask this in part because Smith himself later says how it is very difficult to ascertain the value of labour (in a thing); and that people, since they mostly purchase stuff, tend to think of money as being worth so much stuff, and stuff as being worth so much money.

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Every commodity, besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour. It is more natural, therefore, to estimate its exchangeable value by the quantity of some other commodity than by that of the labour which it can purchase. The greater part of people, too, understand
better what is meant by a quantity of a particular commodity than by a quantity of labour. The one is a plain palpable object; the other an abstract notion, which, though it can be made sufficiently intelligible, is not altogether so natural and obvious.

[...]

Hence it comes to pass that the exchangeable value of every commodity is more frequently estimated by the quantity of money, than by the quantity either of labour or of any other commodity which can be had in exchange for it.

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It's clear that not only labour determines value. Scarcity relative to demand and novelty are two things I can think of in this groggy state that don't have much to do with labour but do determine value.

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Gold and silver, however, like every other commodity, vary in their value, are sometimes cheaper and sometimes dearer, sometimes of easier and sometimes of more difficult purchase. The quantity of labour which any particular quantity of them can purchase or command, or the quantity of other goods which it will exchange for, depends always upon the fertility or barrenness of the mines which happen to be known about the time when such exchanges are made.

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The labour in extracting gold may not be greater proportionate to the difference in price than that in extracting copper, for example. Undoubtedly gold can buy more labour, but its high value does not, it seems to me, lie in the labour itself. It may lie in part in the capital needed to fund exploration, etc. (and if one treats this capital as essentially the value of labour it can command... )

Now, Smith goes on to say, that since gold and silver, the most common media of exchange, vary in their value,

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as a measure of quantity, such as the natural foot, fathom, or handful, which is continually varying in its own quantity, can never be an accurate measure of the quantity of other things; so a commodity which is itself continually varying in its own value, can never be an accurate measure of the value of other commodities.

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Now, why not just say that the value of labour varies, as we know it does? Why isn't the choice of "anchor" merely arbitrary? Well, Smith at first gives a reason that is mostly philosophical:

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Equal quantities of labour, at all times and places, may be said to be of equal value to the labourer. In his ordinary state of health, strength and spirits; in the ordinary degree of his skill and dexterity, he must always laydown the same portion of his ease, his liberty, and his happiness. The price which he pays must always be the same, whatever may be the quantity of goods which he receives in return for it. Of these, indeed, it may sometimes purchase a greater and sometimes a smaller quantity; but it is their value which varies, not that of the labour which purchases them. At all times and places that is dear which it is difficult to come at, or which it costs much labour to acquire; and that cheap which is to be had easily, or with very little labour. Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.

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But it still seems a tad arbitary to me to say:

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But though equal quantities of labour are always of equal value to the labourer, yet to the person who employs him they appear sometimes to be of greater and sometimes of smaller value. He purchases them sometimes with a greater and sometimes with a smaller quantity of goods, and to him the price of labour seems to vary like that of all other things. It appears to him dear in the one case, and cheap in the other. In reality, however, it is the goods which are cheap in the one case, and dear in the other.

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Why not just say it depends on our interest? In some cases we may be interested in the value of goods relative to labour, in other cases in something else?

Again, what's the cash value of this Smith's claim? What purchase does it give him? Obviously, labour can help explain *some* differences in price. In general, all other things being equal, of two items, the one which requires more labour to produce will be more expensive. Smith in fact believes that since the real price of labour consists in the quantity of necessaries and conveniences that are given for it, and its nominal price in the quantity of money. He makes the historical claim that equal quantities of labour will more nearly be purchased with equal quantities of grain in distant times than with equal quantities of money. So that relative to some basic commodity, the value of labour is more or less constant. Labour is therefore the basis of the "real value" of things; money the measure of the nominal value, though Smith is clear that at any given time and place the quantity of labour you can purchase varies with the amount of money you have to purchase it with. "At the same time and place, therefore, money is the exact measure of the real exchangeable value of all commodities. It is so, however, at the same time and place only."

Smith wants to find a relationship of exchange that remains relatively constant through the ages, and claims that the relation between grain and the labour it buys (or the labour that buys a certain amount of grain) is it; grain being pretty much as necessary to one generation as the next, Smith takes this as an adequate average measure of the value of labour, and finds that this value is reasonably constant over long periods of time. Well it's certainly an impressive idea, if true; I wonder how well Smith's claim has held up under historical examination.

From all of which, the following moral question: what entitles a person who has never laboured to purchase other people's labour? If labour is the real measure of value, why should some, who have worked no more than others, be entitled (morally) to the purchase of so many others' labour?

As to the economic question of how this happens, that will be dealt with, of course, under a later chapter -- the accumulation of capital, I suppose.

I know I had other things to say, but I can't remember them now.