Keynesianism vs. Monetarism

And other essays in financial history

Charles P. Kindleberger, Charles P. Kindleberger

• Publisher: Routledge
• Year: 2013
• ISBN:
  9781134535101
• Edition: 1
• Topic: Commerce
• Subtopic: Commerce Général

First Published in 2005. This volume offers an extended original series of essays in the field of financial history, assembled from lectures, articles for Festschriften and symposia, commissioned articles, and a few papers for the normal run of periodicals, including one or two obscure ones. They form a complement to the author's previous work Financial History of Western Europe (1984).

Part I

Keynesianism vs. Monetarism

1

Was Adam Smith a Monetarist or a Keynesian?

The title I have given this talk reminds me of the time in 1930 when 1 was a deck boy on the S.S. Bird City, a freighter of the Moore–McCormack line, at $20 a month, sailing from New York to Copenhagen, Gdynia, Helsinki and Leningrad, plus three small Finnish paper ports on the return voyage. This was the period of prohibition, but after the ship reached Copenhagen, the crew was privileged to buy liquor from the slop-chest against its pay. One able-bodied seaman, that I remember only as ‘Blackie’ – I was ‘Slim’ and my best friend was ‘Whitey’ – was continuously drunk, owed the ship money so that he could not quit without being blacklisted, and had been converted to membership in the Communist Party on the preceding voyage. One evening he rolled heavily out of his lower bunk in the fo’c’s’le, which I shared with him and a dozen others of the deck crew, grabbed a broom and waved it around wildly, asking ‘If J. P. Morgan was over there, the Russian Army was over there, and your father and mother there, who would you shoot?’ I think I have learned to call this sort of reasoning ignoratio elenchi, or the fallacy of the undistributed middle. The question addressed in this talk is of the same sort. It happens, however, that this is to be an Adam Smith lecture, and I have some remarks to get off my chest on Keynesianism and monetarism.

Let me then start by saying that Adam Smith is tops. He started our science off in growth, resource allocation, income distribution and a host of similar aspects of micro-economics. Despite a number of interesting passages, such as that on debt, however, he was not distinguished as a macro-economist. The hagiography tends either to ignore his weakness in money and banking, as does Samuel Hollander in The Economics of Adam Smith (1973), or to protest that he is much better on the balance of payments (Eagley, 1970), or on monetary economics generally (Laidler, 1981) than most observers are willing to allow. I yield to none in my admiration for The Wealth of Nations – and in fact recommend to students that they, like Bismarck’s tariff negotiator for Prussia under the Zollverein, Rudolph Von Delbriick (1905,1), read the hallowed text each night for half an hour before retiring. But it is helpful for Smith’s reputation as a human being to acknowledge that he, like the rest of us, from time to time made a mistake or overlooked a significant aspect of the economy of his day – even on the micro-economic side.

Adam Smith Lecture given to the National Association of Business Economists at Detroit, Michigan, on 29 September 1983. Published in abridged form in Business Economics, vol 9, no. 1 (January 1984), pp. 5–12.

I happened to get another vigorous going over from two critics at the Glasgow celebration of the bicentenary of The Wealth of Nations when I suggested that Adam Smith was totally unaware of the technological changes taking place in the industrial revolution cooking around him (Briggs, 1976; Hartwell, 1976). His other slips not recited in my paper on that occasion include the remark that Dutch merchants are uneasy at being separated from their capital, which is why they unload goods from East Prussia in Amsterdam to look at them before shipping them on to Italy – when the real reason was to repack the grain more carefully to prevent it from exploding from spontaneous combustion under the hot Mediterranean sun (Book IV, chap, ii, p. 422); or the amateurish and quite unsupported sociology that ascribed French interest in life annuities and tontines to the Tact’ that the farmers general (of tax collections and the like) who accumulate wealth are social upstarts, cut off from marrying into the upper classes and too proud to marry their lower-class equals, hence celibate and without heirs (Book V, chap, iii, pp. 871–2). This is the sort of implicit theorizing to which social scientists are always tempted and against which Wesley C. Mitchell warned us at Columbia in the mid-1930s. Some years ago in a book on the terms of trade, I wrote in the introduction that I would thereafter give up empirical work, disheartened that some of our most fascinating results at the three-quarter mark turned out to rest on computing errors. The statement evoked a warm response from professional friends. But the thrust of all this is to assert that Adam Smith is a marvellous economist even when he proves to be somewhat short of outstanding on money and banking.

Keynesianism and monetarism in what follows are used loosely. I am tempted to paraphrase Gilbert’s lyric in Iolanthe on Liberals and Conservatives by saying that all economists are either Keynesians who believe in expanding investment or government spending to achieve higher employment, or monetarists who want to restrict bank lending and the growth of the money supply to help fight inflation. In some cases it makes a difference when one came into the profession, whether in the 1930s when unemployment was rife, or in the period after World War II of steady growth and reasonably full employment. In a paper a few years ago on Keynesianism vs monetarism in eighteenth- and nineteenth- century France (1980; see Chapter 3 below), I lined up John Law, Napoleon I, the Saint-Simonian school (including notably Jacques Laffitte, the Pereire brothers who founded the Crédit Mobilier, and Michel Chevalier) among the Keynesians; the Paris brothers (who won out over John Law), ois Mollien (Napoleon’s Minister of the Public Treasury), and the Bank of France establishment of the hautes banques (including especially Baron James de Rothschild) among the monetarists. For England, a generation after Adam Smith, the big division occurred in the Bullionist controversy between the Currency School, which can broadly be identified with monetarism, and the Banking School, which clung to the quasi-Keynesian belief in the real bills doctrine that money can be expanded pari passu with underlying actual trade transactions. The same issue in Sweden in the mid-eighteenth century had divided the ‘Hats’, who had interests in exports and large-scale business and believed in monetary expansion, from the ‘Caps’, in small business and to a considerable extent import-competing. The Caps ascribed exchange depreciation of the period to excess expansion of the note issue, while the Hats, like the Banking School in England half a century later, attributed it to crop failures that worsened the balance of payments. A similar debate was pursued over the causes of the German hyperinflation of 1923 between monetarists like Bresciani-Turroni and Philip Cagan, who ascribed it to the expansionary policies of the Reichsbank, and the balance-of-payments school including, along with Germans such as Karl Helfferich and Moritz Bonn, such Americans as James W. Angell and John H. Williams, who blamed reparation payments. Outside Europe, the same contentious issue has been met in the Baring crisis of 1890 in Argentina, in which monetarists blamed the changes in Argentine banking laws that led to over-issue, while the Keynesian or balance-of-payments school pointed to the cut-off of British lending to Argentina, the resultant depreciation of the peso, and the necessity, with higher international prices, to issue more banknotes to support the price level (Williams, 1920).

Which side of this perennial debate was Adam Smith on? First of all, he was more interested in real than in monetary analysis. There are such folk about today. In his stupendous book on the World Economy (1978), Walt Rostow explicitly states that he is unconcerned with monetary or banking developments, believing in the dominance of real factors such as population growth, discovery and technological change, ordered in cycles of various sorts, including the Juglar eight-to-nine-year business cycle, the ‘stages of growth’ and the 50-year Kondratieff cycle. Ronald Coase (1937, 1960) holds the opinion that institutions, including financial institutions, adapt to real conditions of demand and supply – except in the rare cases that transactions costs are especially high – so that monetary and banking practice and institutions fall passively into place. Schumpeter’s History of Economic Analysis (1954, p. 283) observes that real analysis dominated economic thought prior to 1600, after which there was an interlude to 1760 in which monetary analysis was considered important, until real analysis (with Turgot and Adam Smith in the lead) took over once more.

But Adam Smith thought something about money. Of course. Book I, chapters iv and v, explain the exchange functions of money that widen the market and hence extend the limits to the division of labor. Book II, chapter ii, deals with money as part of the capital of society, and with banking in a general way. There are other scattered passages – the long digression on silver, that on banks of deposit, especially the Bank of Amsterdam, the treatment of the public debt. There is, however, no consistent orderly analysis of money and banking, either in the national or in the international dimension, despite the valiant efforts of a number of writers, in their pious defense of the Master, to find them.

Money is the great wheel (Book II, chap, ii, pp. 273,276), presumably a water wheel that powers the system. Banking goes further. If gold and silver money, which circulates in a country and allows the dead stock to be converted into active stock, may properly be compared to a highway, banking (if he, Smith, may be allowed so violent a metaphor) provides a sort of ‘waggon-way through the air’ (ibid., p. 305). These are Keynesian metaphors-although, as Bentham complained, from wheels, water and wagons one cannot get a clear idea of money and banking, which need definition and exemplification (Vickers, 1975, p. 301). On the other side of this methodological issue, however, I commend to you a recent paper by Donald McCloskey on The Rhetoric of Economics’ (1983), which maintains that a penetrating metaphor is worth more than a lot of integrals, differentials and matrices, together with scads of a + b. He cites as an illustration ‘investment in human capital’ (a Chicago metaphor of Ted Schultz and Gary Becker), which illuminates many issues in the economics of labor, of capital and of education. But the metaphors should be apposite and powerful.

To return to the waggon-way through the air provided by banks and the paper money they issue, a monetarist note creeps in when Smith goes on:

The commerce and industry of the country, however, it must be acknowledged, cannot be altogether so secure, when they are thus, as it were, suspended on Daedalian wings of paper money, as when they travel about on the solid ground of gold and silver. (Book II, chap, ii, 305)

This is the way it goes throughout the great work: passages here that sound monetarist, others there that suggest an interest in expansion.

Before going into further detail, let me pause to note that a young English economic historian has recently noted that financial history can be written in four differing modes: first, the orthodox, in which the story line is how the central bank gradually got control of the money supply, developed appropriate policy instruments., and repressed the tendency of the financial system to what Smith called ‘overtrading’; second, the ‘heroic’, in which great innovations in money and banking give a needed lift to economic growth and development; third, the Populist, with emphasis on how orthodox monetary and banking development have held back the small merchant, small farmer and small industrialist by denying them credit and favoring foreign trade, trusts, and perhaps government; and fourth, the ‘statist’, in which emphasis rests on the development of money and banking to assist government in carrying out its functions, especially the finance of war (Jones, 1982). The author of this taxonomy was making a point that the central banks of Argentina, Australia and Canada were all created to help finance governments; the same could be said of the founding of the Bank of England in 1694 during the Nine Years’ War, of the Bank of France in 1800 in the Napoleonic Wars, and of the National Bank Act of 1863 in the United States, which helped finance the Union in the Civil War. The orthodox mode of writing financial history fits into the monetarist view of money and banking, the heroic into the Keynesian as I loosely use the term, and the Populist into a frustrated Keynesian viewpoint.

On the domestic front, Smith took an orthodox position in so far as he strongly favored convertibility of bank notes into specie, opposed the issue of banknotes of small denominations, worried about chains of discount accommodation bills in which A drew on B, B on C, C on D and M or N back on A, each discounting these accommodation bills after an appropriate interval. He applauded the Bank of Amsterdam, although not for the subtle reasons that later led Henry Simon and Milton Friedman to advocate 100 percent reserves against bank deposits in order to frustrate the expansion and contraction of bank money through the money multiplier, but because of its contribution to ‘money-circulating’, or monetizing the economy and pushing back the limits on the division of labor. He opposed overtrading. The ideas of John Law are called splendid but visionary and are said to have contributed to the excess of banking that of late had been complained of both in Scotland and in other places (Book II, chap, ii, 303).

And yet, in an earlier passage, he observed that the new banking companies of Scotland of the last twenty-five or thirty years, i.e. since about 1750, in almost every considerable town, and even in some country villages, had produced great benefit:

I have heard it asserted, that the trade of the city of Glasgow doubled in about fifteen years after the first erection of the banks there; and that the trade of Scotland has more than quadrupled since the first erection of the banks at Edinburgh. . . .

But then he waffles:

Whether the trade of Scotland in general, or of the city of Glasgow in particular, has really increased in so great a proportion, during so short a period, I do not pretend to know. If either of them has increased in this proportion, it seems to be an effect too great to be accounted for by the sole operation of this cause. That the trade and industry of Scotland, however, have increased very considerably during this period, and that the banks have contributed a good deal to this increase, cannot be doubted. (Book II, chap, ii, p. 281)

It is worth noting, as it bears on a modern debate, that Smith, like most modern monetarists, believed in regulation of banking. His interest was in the convertibility of bank notes into gold and silver on demand, and the prohibition of the circulation of bank notes of small denomination such as £1 and under. But the emphasis on liberty in other fields of economic endeavor, whilst maintaining limitations in money and banking, presents philosophical problems for ‘liberals’ with a small ‘l’, or possibly I make myself clearer if I say ‘libertarians’. It is a Keynesian position sometimes to want regulation in fields other than money and banking, but to insist on easier entry, more expansion, extension of banking into the provinces, and the like in money and banking. A French monetarist, Louis Wolowski, testifying before the 1867 Inquiry into money and banking pushed by the expansionist (Keynesian) school, kept reiterating that ‘free trade in banking is free trade in swindling’, a quotation ascribed to Daniel Webster. He also pointed out that Richard Cobden, the leader of the fight for free trade and against the Corn Laws in England, had voted three times against crippling amendments to the Bank Act of 1844, a victory for the monetarist Currency School (Ministère des Finances, et al., 1865–7, II, pp. 205, 230, 383). While Mi...