STL #6: Wealth of Nations Book 2: Impressions

My Thoughts On: January 19th, 2004

The Wealth of Nations, Adam Smith's grand economic treatise that established most modern thought behind economics is perhaps one of the most important books when dealing with society, government and the economy ever written. But it's hard to get even halfway through the damn thing. I'm almost there. Join me as I recap the teachings of Book 2.

Well, it's time once again for me to weigh in on Adam Smith's economic treatise, the Wealth of Nations. As I said before, I'm reading it slowly, and slowly consuming a lot more knowledge about the economy and how it works. It's really an important document to read. That said... it's dry as the core of the Sahara desert.

Yes, it's hard to read. That's why I'm doing this short impressions article, to collect my personal thoughts about the compilation as I go from book to book, recapping my points and maybe even explaining some of it for you. I recently finished Book 2, "Of the Nature, Accumulation, and Employment of Stock". Of course, I will refer to it as "Book 2" because that title is WAY too long.

We start Book 2 by noting that stock, those material things we own, isn't really needed in a primitive society like it is today. Before Division of Labour (Book 1), if a man wanted food, he hunted for it, if his roof broke, he went out to find wood for it, whatever he occassioned for he had to get up and get it himself. This made his life very hard, and was probably the primary cause for such high mortality rates back in those times. But as people started accumulating and trading, they became specialists, relying on one another. This made it more important and valued for people to save up material goods, thus, we started gathering stock.

As society divides itself more, naturally, stock is further accumulated. As stock is accumulated, the same amount of work becomes more productive, because there are more tools and supplies to use, advancing industry. He writes the remainder of the book exploring the nature of stocks, how they are accumulated and used, to demonstrate how this all comes about.

Chapter 1 begins by talking about people's tendencies to use stock. If someone only has enough supplies to last him a few days or a week, he's not going to think about putting the rest of it to other uses, or to get some kind of revenue from it. It's simply too little to warrant using like that. But if he has enough to satisfy himself for a month, and then some, he's going to want to use the rest in a way that gets him a little extra revenue. After all, there is no immediate or pressing need for it. Smith divides the kinds of stock this guy can collect into two categories, "circulating capital" and "fixed capital". Circulating capital is always on the move, it's that cash set aside to keep business moving. Paying for maintenance, wages, investing into production... only by keeping this type of stock on the move, can someone keep getting money from it. Without circulating capital, businesses would grind to a hault. The other kind of stock is fixed capital, the more permanent improvements a business has. Long-lasting machines, improvement of machines, buildings, the other kinds of things that industry needs but retains for long periods of time to keep producing. For example, I work at a movie theater. The popcorn popper, the cash registers, the fridges, the computers for our box office, the doorman's podium, brooms and dustpans for keeping the place clean... these things are "fixed" capital. Circulating capital would be the cash resevoir that they pay my wage out from, the cash we keep on hand to open our cash registers every day, and not just cash, it's also the popcorn seed that we buy, the candy, other things that are incoming and outgoing and typically only produce revenue by fluxuating. The frequency of circulating/fixed capital of course depends on the type of business you're talking about, and Smith is sure to take note of that.

Just as an individual person's or company's stock is divided up this way, Smith divides up the stock of society as a whole. There's the stock set aside for immediate consumption (most of which is taken from circulating capital - popcorn seed, candy, for instance). This is the stuff we're going to use soon to get us a revenue. Then there's the various forms of fixed capitals. With useful machines, like the popcorn popper, we can continue to produce more than we could otherwise. With useful buildings, we can house our projects, and some industries (such as our theater example) need special buildings (with auditoriums for movie screens) and those improvements are very valuable. Land improvements typically are things in agriculture, but an example for our theater might be turning an empty grass lot next to our theater into a parking lot so the people coming in to see the movie has someplace to park. The last kind of fixed capital is less tangible, but if we invest in educating and training our workmen, that results in something of a permanent improvement. Skilled labor is another, less material way to think about fixed capital. The last major group Smith defines is circulating capital - the source of the stuff we're going to immediately consume and the backbone of our fixed capital. Circulating capital means money (that we might use to open up cash registers before a business day in our box office or concessions stand), the produce we're going to sell (the popcorn seed and candy we have still in the stock rooms, ready to be pulled and put to immediate use whenever we need to), any buildings/clothes/furniture which doesn't fit into the first two groups (such as a house we plan to rent - nothing comes to mind in line with the movie theater example), and finally any completed products we have in the hands of the manufacturer. This is the popcorn after it's been popped, waiting in the warmer. Of course, this popcorn can instantly be moved to the immediate consumption category when we get customers. Every part of the circulating capital besides the core financial savings of the company are always being taken from the circulating capital category and being moved to support fixed capital or being put into the stock ready for immediate use.

Moving on through Chapter 2, I'm going to try to make my notes more brief. We're going to take what we talked about in the opening chapter and start talking about stock as it's used generally for society. We discussed in Book 1 that prices are split up into three parts, wages/profits/rents, and that annual produce is too. To determine how much money we've made over the course of a year, we have to distinguish gross revenue (all the money the theater made all year) from net revenue (how much we left after deducting the maintenance of fixed and circulating capital). After all, net revenue indicates their real wealth, and that's what Wealth of Nations is all about, differentiating real wealth from imagined wealth.

Money is the only part of the circulating capital that affects the net revenue, because unlike the circulating goods we're using, the accumulation of money requires we spend money and continue to spend it to bolster it's circulation. Without extra cash coming into the flow of business, the cash we use to bolster it would slowly widdle away. We can never recover the cash we spend to make the money flow (we might make more money to replace it, but it is not being replaced through spending, it's being replaced from someplace else). We deduct money from net revenue for another reason as well - makes no part of gross or net revenue. That may sound odd to say, but a basic principle of Capitalism is that a unit of money is a unit of exchange. Money, thus, is only as valuable as what you exchange it for (otherwise you must be forced to weigh it on it's physical composition - and bunches of metal pieces and paper bills are worth next to nothing on their own). The real value of money is either it's exchange value or it's value in pure bullion. This is a fundamental tenet of Capitalism, yet one of the lesser known ones. So long as cash is circulating, it isn't a part of how much wealth you really have. When it comes out of circulation and is exchanged, that's when it becomes real wealth.

If a man has two hundred dollars a week, he enjoys two hundred dollar's worth of subsistence, and his real revenue is that subsistence. The food he buys, the drink, anything he gets with that money is real wealth. This real wealth should not be confused with the dollar amount he gets. If money inflates, for instance, he might have 200 dollars a week, but it'll only mean he's half as wealthy as he was before. If we're talking about the wealth he actually has, it's in the things he uses his money for, not in the money bills themselves, and we should be careful not to confuse the two.

Thus begins the long section of the chapter were Smith discusses the benefits of having paper money. Since domestically we don't use all the money we collect, it becomes a larger expense to deal with the money as the money grows. So banks collect the money (typically in precious metals, gold and silver) and distribute paper reserve notes, such as our dollar bills. Each paper note exchanges for the universally recognized metals. This lets one body save all the metal and the other domestic traders to use their recognized paper instead, making the cost of upkeeping the great fortunes of the communities much less. At the same time, people don't have to sit on their gold money due to having little to do with it. Since few use gold and silver for everyday matters, a bank can collect all the gold and silver, distribute paper notes, and then take a huge chunk of the gold and invest it. If they take away too much gold, the bank would have to go through a desperate attempt to get more gold back when reserve notes are turned back in. If they lend out too little, then the gold sits there unused, when it could be making someone a revenue in the form of circulating capital. This forces the bank to balance, and allows business domestic and abroad to have money better managed to fit the needs of the occassion, thus meaning people have to invest less to keep it circulating.

Now, here comes my rant about the gold standard. This policy was American policy until about 1974. Although we did meddle with the balance, we never totally destabalized it until that year. Since then, inflation of our dollar has skyrocketed at an before unseen rate. This is of course because government is not good at balancing how it prints money, yet with gold reserves, you had an automatic balance.

Smith then goes into some common issues with banks not recognizing this and other common faults, the policy of lending, borrowing. How sometimes people slip into lending too much and too little for common faults. Banks must be moderate in how they give out loans and be sure they know who they are lending to, or else they could lose a lot of money. Borrowers who draw and redraw should be watched carefully. These tricks of the trade ruin money and often the people who borrow it. Smith also comments on how trade differs between traders and consumers, when traders trade between themselves, big bills are needed, but when consumers trade between themselves or traders, bills shouldn't be too inconvienently small or too large. He also says the paper money should be payable in gold on demand, and that if it isn't, or if there are extenuating circumstances, that can reduce it's value (*cough* 1974-present inflation spike *cough*).

I thought I was going to make this more brief? Go figure. Chapter 3 talks about productive and unproductive hands, unproductive hands are those employed who produce nothing longstanding or returning (celebrities make a great example), while productive hands do (farmers, factory workers, the everyday Joes). The proportion of the revenue going to productive hands affects the produce of the future, and is a better, more frugal investment. The prodigal perverts who have a lot of money and spend it to frivolous ends (celebrities, again, make a great example), and who employ unproductive hands, rarely retain their wealth for long, and take away from what could be produced. Too many of these prodigal perverts and the country's riches can't help but depreciate. Smith notes that one of the worst prodigal perverts are government officials, who often employ many who are unproductive to the ends of the real wealth of the state. Smith brings up the good point that those who save and spend on durable commodities will be richer than those who spend on disposable ones, and as much as that applies to you or me, it applies to the whole nation.

Chapter 4 and 5 sum up the discussion about the nature of stock by talking about stocks that are lent at an interest, and stock that is employed by producers. Smith says that lending can sometimes be of much greater value than the dollar amount - through lending, a series of people can get enough money to reproduce and recoup the expense of borrowing, then some. Interest grows as the amount of stock available for lending goes up, and interest falls as the amount of stock available for lending goes down. Then he migrates to the employment, where he says all capital is either put to work in securing raw materials, manufacturing them, transporting them or distributing them through wholesalers and retail outlets. He discusses the importance of foreign trade, reminding us that foreign trade always replaces capital with revenue (or else they wouldn't happen), just sometimes the returns take longer than domestic trade. A lot of foreign trade comes through national opulence, which causes exchange in the form of imports/exports to become a source of soaking up surpluses and bringing in other useful surplus. This is because most domestic industry cannot soak up most circulating wealth, and because many core industries cannot soak up all the capital they can absorb, splashing back extra money to foreign trading. Why? I don't know yet, he says that's the reason behind the next two books.

Well, that's another lengthy reading and review. Personally, I enjoyed it, learned a lot, but now I'm straight sleepy. I try to dress up Smith in a way that's edible. I hope I did the job.

- Good ol' PA