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FEDERAL RESERVE OF DALLAS VOLUME 8, 1 Foundations of the Classical School of

Adam Smith is the founder of the nomic essays] are all clearly written classical school of economics, but eco- and often contain an excellent sum- nomic theorizing predates Smith. The mary and synthesis of the of his philosophic foundations of classical eco- predecessors. In that respect, how- nomics are found in the work of the ever, Cantillon’s Essai sur la thinkers of the du commerce en général, published early to mid-, centered in 1755, but written over twenty years David Hume is primarily known as around the University of . previously, is superior. a and chronicler of English Notable among these great thinkers and writers is David Hume. It is impossible to know whether history. Less well known is his work on eco- Hume was born in Edinburgh, Smith was more influenced by Can- nomic and several political econ- , on , 1711. The extent to tillon’s book or by personal discussions which Hume influenced Smith, his close with Hume. Schumpeter (1954, 124) omy issues, some of which remain salient friend, has to be inferred from their argues that Hume did influence Smith, today. Studying his economic work respective writings, but the warmth and and Rothbard (1995, 430) suggests that depth of their relationship is incon- Hume was one of Smith’s mentors. enables us to see how he reshaped John testable. Smith said of Hume: O’Brien (1975) gives Hume a large role Locke’s quantity theory of and how in the development of classical econom- Upon the whole, I have always con- ic because of his participation he influenced the great Smith, sidered him, both in his lifetime and in spreading natural . Hume’s close friend and fellow Scottish since his death, as approaching as On the question of -’s nearly to the of a perfectly wise role in human affairs, Hume seems to Enlightenment philosopher. Hume is one and virtuous man as perhaps the have influenced Smith greatly. For of the pillars of the classical school of eco- nature of human frailty admit. Hume, and for much of the Western (Goldberg 1961) world after him, self-interest became the nomics, primarily founded by Smith. This primary motivating force that explained issue of Economic Insights offers some of Like Smith, Hume tried to use Isaac most of social (Herman 2001, Newton’s method of analysis in his in- 170). Hume’s early book expounding Hume’s economic theorizing for those who quiries. Hume also borrowed from phi- his idea of self-interest, A of want to pursue the history of losopher ’s as (1734), may have cost he related mostly moral concerns. Hume him a university teaching position. The modern economic theory. saw such moral concerns as the thread work so horrified other that connected his various writings, that some—notably Francis Hutcheson— — Bob McTeer which included political . actively sought to deny him such a pos- President While shouldn’t overemphasize ition. He later repudiated this first Federal Reserve Bank of Dallas Hume’s economic influence on Smith, book. However, this was not the last their relationship—especially in light Hume offended prevailing sensi- of the similarities of some of their bilities and challenged majority opinion analyses—is intriguing. As Roll (1953, on an issue. 117–18) writes: Hume’s view that self-interest could be channeled profitably only through In recent years the tendency has even economic cooperation and competi- arisen to regard him [Hume] as the tion—making civil a possibility most important of the pre-Smithian so long as the prevailed— ….[T]hey [Hume’s eco- was a pillar of Smith’s thinking as well. In this regard, Hume’s influence on erally pro-free and antimercan- automatically adjusts international trad- Smith is both clear and profound. Gov- tilist. Because of his extreme ing partners’ domestic levels. As ernment is required, they argued, be- and presumed , as well as his such, its intellectual lineage comes di- cause instinct may cause people to act view of human nature, academe was rectly from the quantity theory of against their , even though closed to him. He pursued instead a money—traceable back to Locke—as it they are driven primarily by those self- career in public , traveling for tutor- was applied to bal- interests (Rotwein 1987, 693). ing positions, becoming British chargé ances. Philosophers see Hume as a direct d’affaires in and eventually Hume’s economic writings were link between the empiricist political becoming undersecretary of . He usually concerned with the idea of eco- philosophy of Locke, the French lais- retired from public life in 1769 and nomic growth and its causes, perhaps sez-faire Physiocratic movement led by returned to Edinburgh. another example of an intellectual Francois Quesnay and early British pol- Hume’s most important foray into focus that he bequeathed to Smith. itical economy. Hume’s economic economic theory was his discussion of Hume was sometimes inconsistent in views overlapped both the mercantilist the price-specie-flow mechanism. The his economic theorizing. In one place and classical , depending on movement of specie (gold and silver) he might praise the growth of the the topic he addressed, but were gen- between countries balances trade and , while in another he would correctly show that larger sup- plies of money lead to rising . Smith might also have taken from Public Debt: Does Anything Ever Really Change? Hume the deeply flawed labor theory of , as Hume routinely argued that But though the injury that arises to commerce and industry from our public funds will appear, only labor conveyed value. On bal- upon balancing the whole, not inconsiderable, it is trivial in of the prejudice that results ance, Hume favored “hard money”— to a state considered as a body politic, which must support itself in the society of nations, and have that is, money made of precious metals various transactions with other states in wars and negotiations. The ill there is pure and unmixed, that had “intrinsic value.” He also seemed without any favorable circumstance to atone for it; and it is an ill too of a nature the highest and to support ultrasound banking, as when most important. We have indeed been told, that the public is no weaker on account of its debts, since they are he praised the for mostly due among ourselves, and bring as much to one as they take from another. It is its of 100 percent specie-backed like transferring money from the right hand to the left, which leaves the neither richer nor deposit reserves (Rothbard 1995, 428). poorer than before. Such loose reasoning and specious comparisons will always pass where we While arguing that an increase in judge not upon . I ask, Is it possible, in the nature of things, to overburden a nation with the money supply is neutral regarding , even where the sovereign resides among them? The very doubt seems extravagant, since it the rate of interest, he also concluded is requisite, in every community, that there be a certain proportion observed between the laborious that, in the long run, such a continuing and the idle part of it. But if all our present taxes be mortgaged, must we not invent new ones? And increase might actually lower the inter- may not this be carried to a length that is ruinous and destructive? est rate. Although Hume had insights In every nation there are always some methods of levying money more easy than others, into many important economic issues, agreeably to the way of living of the people, and the they make use of…. Duties upon his analysis was primarily one of com- consumptions are more equal and easy than duties upon possessions. What a loss to the public that the former are all exhausted, and that we must have recourse to the more grievous method of parative statics, or examinations of levying taxes!… equilibrium positions. He seldom dis- It will scarcely be asserted, that no bounds ought ever to be set to national debts, and that the cussed in detail the microeconomic public would be no weaker were twelve or fifteen shillings in the pound, land-, mortgaged, with adjustment processes that occur be- all the present customs and . There is something, therefore, in the case, beside the mere tween these equilibria, with the excep- transferring of property from the one hand to another. In five hundred years, the posterity of those tion of his Of Money. now in the coaches, and of those upon the boxes, will probably have changed places, without affect- Smith’s analysis of economic ing the public by these ….The funds, created and mortgaged, will by that time bring in growth and society owes a great deal a large yearly revenue, sufficient for the defense and security of the nation: money is perhaps lying to his having read Hume’s massive The in the exchequer, ready for the discharge of the quarterly interest: necessity calls, fear urges, rea- History of . Hume wrote the son exhorts, compassion alone exclaims: the money will immediately be seized for the current ser- four-volume work between 1754 and vice, under the most solemn protestations, perhaps of immediately replaced. But no more is requisite. The whole fabric, already tottering, falls to the ground, and buries thousands in its ruins. 1762 while at the ’ And this, I think, may be called the natural death of public credit; for to this period it tends as nat- Library in Edinburgh after failing for urally as an animal body to its dissolution and destruction. ■ the second time to secure a university appointment at Glasgow. Hume con- —“Of Public Credit,” Economic Essays, 207–14 tended that commercial society’s birth and growth generated more ben- Paper Money and Sound Banking The of Foreign Trade

This [the dearness of things due to excessive quantities of money] has made me entertain a If we consult history, we shall find, that doubt concerning the benefit of and paper-credit, which are so generally esteemed advanta- in most nations foreign trade has preceded geous to every nation. That provisions and labor should become dear by the increase of trade and any refinement in home manufactures, and money is, in many respects, an inconvenience; but an inconvenience that is unavoidable, and the given birth to domestic luxury. The temptation effect of that public and prosperity which are the end of all our wishes. It is compensated by is stronger to make use of foreign commodi- the advantages, which we reap from the possession of these precious metals, and the weight, which ties which are ready for use, and which are they give the nation in all foreign wars and negotiations. But there appears no for increas- entirely new to us, than to make improve- ing that inconvenience by a counterfeit money, which foreigners will not accept of in any payment, ments of any domestic , which and which any great disorder in the state will reduce to nothing. There are, it is true, many people always advance by slow degrees, and never in every rich state, who having large sums of money, would prefer paper with security; as affect us by their novelty. The is also being of more easy transport and more safe custody. If the public provide not a bank, private very great in exporting what is superfluous at bankers will take advantage of this circumstance; as the goldsmiths formerly did in London, or as home, and what bears no price, to foreign the bankers do at present in Dublin. And therefore it is better, it may be thought, that a public com- nations whose soil or climate is not favorable pany should enjoy the benefit of that paper-credit, which always will have place in every opulent to that commodity. Thus men become kingdom. But to endeavor artificially to increase such a credit, can never be the interest of any trad- acquainted with the of luxury, and ing nation; but must lay them under disadvantages, by increasing money beyond its natural pro- the profits of commerce; and their delicacy portion to labor and commodities, and thereby heightening their price to the and manu- and industry being once awakened, carry facturer. And in this view, it must be allowed, that no bank could be more advantageous, than such them on to further improvements in every a one as locked up all the money it received, and never augmented the circulating coin, as is usual, branch of domestic as well as foreign trade; by returning part of its treasure into commerce. A public bank, by this expedient, might cut off much and this perhaps is the chief advantage which of the dealings of private bankers and money-jobbers; and though the state bore the charge of arises from a commerce with strangers. It salaries to the directors and tellers of this bank (for, according to the preceding supposition, it rouses men from their indolence; and, pre- would have no profit from its dealings), the national advantage, resulting from the low price of labor senting the gayer and more opulent part of and the destruction of paper-credit, would be a sufficient compensation. Not to mention, that so the nation with objects of luxury which they large a sum, lying ready at command, would be a convenience in of great public danger and never before dreamed of, raises in them a distress; and what part of it was used might be replaced at leisure, when and tranquillity was of a more splendid way of life than restored to the nation. ■ what their ancestors enjoyed. And at the same time, the few who possessed the —“Of Money,” Essays, Moral, Political, and Literary secret of this importation and exportation, make great profits and, becoming rivals in wealth to the ancient nobility, tempt other adventurers to become their rivals in com- efits than costs, a stance he developed finished with it, mercantile theory was merce. Imitation soon diffuses all those , while writing his history of Britain. intellectually dead, although its protec- while domestic manufacturers emulate the He was not a typical of tionist tendencies have always been a foreign in their improvements, and work up laissez-faire , though, even part of international trade policy and every home commodity to the utmost perfec- supporting some mild protectionist remain so for many nations even today. tion of which it is susceptible. Their own steel and iron, in such laborious hands, become , as did Smith in his Wealth It is perhaps fitting that Hume equal to the gold and rubies of the Indies. of Nations. died in 1776, the year Smith published When the affairs of society are once For Hume, and then Smith, com- his famous work of , brought to this situation, a nation may lose mercial society was a form of social Wealth of Nations, most of which most of its foreign trade, and yet continue a contract, a method of controlling Hume told Smith he agreed with. great and powerful people. If strangers will human passions in a way that in- Coming at the beginning of the classi- not take any particular commodity of ours, we creased that all might share, cal period, Hume’s own economic writ- must cease to labor in it. The same hands will regardless of the effect on . ings—as well as his impact on Smith— turn themselves towards some refinement in Smith based his own “system of natural make him still worthy of careful study other commodities which may be wanted at ” on this idea, which Hume so by anyone interested in the history home; and there must always be materials for skillfully demonstrated in his writings. of ideas generally and in the them to work upon, till every person in the state who possesses riches, enjoys as great Unsurprisingly, both men were op- of economic theory specifically. ■ plenty of home commodities, and those in as posed to gross restrictions on interna- greater , as he ; which can tional trade, and Hume in particular — Robert L. Formaini never probably happen. ■ worked out his specie-flow mechanism Senior in part to discredit protectionist, mer- —“Of Commerce,” Selected Essays, 163–64 cantile doctrine. After he and Smith had Sources and Suggested Reading O’Brien, D. P. (1975), The Classical Goldberg, Bruce (1961), “’s ‘For the Economists (Oxford: Clarendon Press). Why Commerce New Intellectual’,” New Individualist Review Encourages Both 1 (3): 21. Roll, Eric (1953), A History of Economic Thought (Englewood Cliffs, N.J.: Prentice- Low Profits and Low Herman, Arthur (2001), How the Scots Hall). Interest Rates Invented the Modern World: The True Story of Low interest and low profits of mer- How Western Europe’s Poorest Nation Created Rothbard, Murray (1995), Economic Thought chandise are two events, that mutually for- Our World and Everything in It (: Before : An Austrian Perspective ward each other, and are both originally Crown Publishing Group). on the History of Economic Thought, vol. 1 derived from that extensive commerce, (Hants, UK: Edward Elgar). which produces opulent merchants, and Hume, David (1987), Essays, Moral, Political, renders the monied interest considerable. and Literary, ed. Eugene F. Miller Rotwein, Eugene (1987), “David Hume,” in Where merchants possess great stocks…it (Indianapolis, Ind.: ), The New Palgrave: A Dictionary of must frequently happen, that, when they either become tired of , or leave www.econlib.org/library/lfbooks/hume/ Economics, vol. 2, ed. John Eatwell, Murray heirs unwilling or unfit to engage in com- hmmpl26.html. Milgate and Peter Newman (New York: merce, a great proportion of these riches Stockton Press), 692–95. naturally seeks an annual and secure rev- ——— (1993), Selected Essays, ed. Stephen enue. The plenty diminishes the price, and Copley and Andrew Edgar (New York: Oxford Schumpeter, Joseph (1954), The History of makes the lenders accept of a low interest. University Press). Economic Analysis (New York: Oxford This consideration obliges many to keep University Press). their stock employed in trade, and rather be content with low profits than dispose of their money at an under-value. On the other hand, when commerce has become exten- Do Low Interest Rates Stimulate Economic Activity? sive, and employs large stocks, there must arise rivalships among the merchants, Nothing is esteemed a more certain sign of the flourishing condition of any nation than the which diminish the profits of trade, at the lowness of interest: and with reason, though I believe the cause is somewhat different from what same time that they increase the trade itself. is commonly apprehended. Lowness of interest is generally ascribed to plenty of money. But The low profits of merchandise induce the money, however plentiful, has no other effect, if fixed, than to raise the price of labor. Silver is more merchants to accept more willingly of a low common than gold, and therefore you receive a greater quantity of it for the same commodities. interest, when they leave off business, and But do you pay less interest for it? Interest in Batavia and Jamaica is at 10 percent, in Portugal at begin to indulge themselves in ease and 6, though these places, as we may learn from the prices of every thing, abound more in gold and indolence. It is needless, therefore, to silver than either London or Amsterdam. inquire which of these circumstances, to Were all the gold in England annihilated at once, and one and twenty shillings substituted in wit, low interest or low profits, is the cause, the place of every guinea, would money be more plentiful, or interest lower? No, surely: we should and which the effect? They both arise from only use silver, instead of gold. Were gold rendered as common as silver, and silver as common as an extensive commerce, and mutually for- copper, would money be more plentiful, or interest lower? We may assuredly give the same answer. ward each other. ■ Our shillings would then be yellow, and our halfpence white; and we should have no guineas. No other difference would ever be observed; no alteration on commerce, manufactures, navigation, or —“Of Interest,” Selected Essays, 184–85 interest; unless we imagine that the color of the metal is of any consequence…. If the multiplying of gold and silver fifteen times makes no difference, much less can the doubling or tripling of them. All augmentation has no other effect than to heighten the price of labor and commodities; and even this variation is little more than that of a name. In the towards these changes, the aug- mentation may have some influence, by exciting industry; but after the prices are settled, suitably to a new abundance of gold and silver, it has no manner of influence. Economic Insights is a publication of the An effect always holds proportion with its cause. Prices have risen near four times since the Federal Reserve Bank of Dallas. The views discovery of the Indies; and it is probable gold and silver have multiplied much more: but interest expressed are those of the authors and should has not fallen much above half. The rate of interest, therefore, is not derived from the quantity of not be attributed to the Federal Reserve System. the precious metals. Money having chiefly a fictitious value, the greater or less plenty of it is of no Please address all correspondence to consequence, if we consider a nation within itself; and the quantity of specie, when once fixed, Economic Insights though ever so large, has no other effect than to oblige every one to tell out a greater number of Public Affairs Department those shining bits of metal for clothes, furniture, or equipage, without increasing any one conve- Federal Reserve Bank of Dallas nience of life. ■ P.O. Box 655906 Dallas, TX 75265-5906 —“Of Interest,” Selected Essays, 177–79 Visit our web site at www.dallasfed.org.