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Adam Smith, Henry Thornton, and Ludwig von Mises

A recent article in Econ Journal Watch surveying the favorite dead and living economists of 299 respondents caught my eye. It is also tangentially relevant to Brad’s question about the free banking classics. As you would have expected, Adam Smith was the respondents’ favorite economist before the 20th century, while John Maynard Keyes was the favorite dead economist of the 20th century.

Smith was the founder of modern economics in the sense that his Inquiry into the Nature and Causes of the Wealth of Nations made such an impression that thereafter it was impossible to ignore economic reasoning in debates about human society. Smith was also perhaps the first prominent advocate of free banking. In the last paragraph of book II, chapter 2 of the Wealth of Nations, he claimed that “If bankers are restrained from issuing any circulating bank notes, or notes payable to the bearer, for less than a certain sum, and if they are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented, their trade may, with safety to the public, be rendered in all other respects perfectly free.” In a later post I will return to the reasons for Smith’s proviso regarding small-denomination notes, but for now the important point is that he thought of regulation as the exception in banking, not the rule.

It surprised me that Henry Thornton got no votes.  Thornton is not as well known as Smith, but he almost deserves to be. His 1802 Enquiry into the Nature and Effects of the Paper Credit of Great Britain (link is to a 1935 reprint edited by Friedrich Hayek) is, as its title suggests, a kind of reply to Smith’s book. Thornton can be said to be the (neglected) founder of macroeconomics.  He integrated ideas on money, banking, interest rates, and business cycles with insight that had no equal for a century, and consequently he was too far ahead of  his time to be properly appreciated. One aspect of Thornton’s criticism of Smith is that Thornton advocated central banking. His argument included ideas that were independently rediscovered 70 years later by Walter Bagehot, whose 1873 book Lombard Street is considered the intellectual foundation of modern central banking. Bagehot seems to have been unaware that he was on a path Thornton had already blazed.  The same applies to Knut Wicksell and his rediscovery of the idea of the natural rate of interest a century after Thornton. Thornton remains worth reading today. Economists today know much more about many individual topics than Thornton did, but I think we have not yet surpassed him in integrating those ideas into a coherent macroeconomic theory.

Thornton was a man of overflowing talents. He was a banker in the City of London, a member of the British Parliament, and the major financier of the movement to abolish the slave trade in the British Empire.  (The 2006 movie Amazing Grace, about the abolitionist movement, has Thornton, played by Nicholas Farrell, in a number of scenes.) His involvement in the abolitionist movement sprang from his deep religious faith: he was an important member of the Evangelical movement of the Church of England. Several books of his religious writings and prayers, published after his death, have remained almost continuously available in print, unlike his economic writings.

Moving on to the 20th century, it surprised me that Ludwig von Mises received so few votes in the poll. The big economic question of the century was whether central planning worked better than the market economy. It was such a big question that roughly 100 million souls perished in China, Russia, and other communist countries proving that the answer was “no.” Mises’s book Socialism (1922), written at a still early stage of the debate, proved to be magnificently right. He should have received more recognition for being 70 years ahead of mainstream opinion. Mises placed 14th in the poll, whereas his student Friedrich Hayek was fourth. In later posts I will have more to say about Mises’s views on free banking and other aspects of monetary theory.



  1. Great quote by Adam Smith!

    When he says, "if they [bankers] are subjected to the obligation of an immediate and unconditional payment of such bank notes as soon as presented," it seems to me that the idea of a paper or electronic note that can't be redeemed for coin was inconceivable to Adam Smith. Would you agree with this assessment?

    1. Shortly before the passage I cite in the Wealth of Nations, Smith briefly mentions the paper currency issued by the colony of Pennsylvania, which depreciated against gold and silver. Smith expresses disapproval for Pennsylvania laws enforcing penalties on people who accepted the paper currency for less than its nominal value in gold or silver, but clearly Smith could conceive of an irredeemable currency.

      1. A similar, more recent conflict over linking paper currency to gold content occurred in U.S. v. Bankers' Trust, 294 U.S. 240 (1935), where parties are sued over a devaluation, claiming they had a right to be paid in dollars containing the amount of gold at the time of contract, not after Congress devalued the dollar. The Supreme Court seems to say that Congress' power to determine what constitutes a "dollar" has little to do physical measuring standards and that parties receiving dollars in a devalued currency "must yield to the new standard."

        "We are of the opinion that the gold clauses now before us were not contracts for the payment in gold coin as a commodity, or in bullion, but were contracts for the payment of money . . ."

        "To subordinate the exercise of the federal authority to the continuing operation of previous contracts would be to place to this extent the the regulation of interstate commerce in the hands of private individuals and to withdraw from the control of Congress so much of the field as they might choose by 'prophetic discernment' to bring within the range of their agreements. The Constitution recognizes no such limitation . . ."

        And, finally: "We are not concerned with the consequences, in the sense that consequences, however serious, may excuse an invasion of constitutional right. We are concerned with the constitutional power of the Congress over the monetary system of the country and its attempted frustration."

        This case is a major reason I think we can rule out a free banking model based on state-chartered banks.

  2. The trouble with Thornton's monetary theory is that he was very, very wrong. Here's an excerpt from a paper of mine about Thornton:

    Henry Thornton (1802) is largely responsible for a popular misconception that bank credit will not be adequately limited by the requirement that loans only be granted on the basis of sufficient security:

    "Real notes," it is sometimes said, "represent actual property. There are actual goods in existence, which are the counterpart to every real note. Notes which are not drawn, in consequence of a sale of goods, are a species of false wealth, by which a nation is deceived. These supply only an imaginary capital; the others indicate one that is real."
    "In answer to this statement it may be observed, first, that the notes given in consequence of a real sale of goods cannot be considered as, on that account, certainly representing any actual property. Suppose that A sells one hundred pounds worth of goods to B at six months credit, and takes a bill at six months for it; and that B, within a month after, sells the same goods, at a like credit, to C, taking a bill; and again, that C, after another month, sells them to D, taking a like bill, and so on. There may then, at the end of six months, be six bills of 100 pounds each existing at the same time; and every one of these may possibly have been discounted. Of all these bills, then, only one represents any actual property." (Thornton, 1802, p. 86.)

    Thornton's mistake was in failing to realize that no matter how we look at it, 600 pounds of debt will not be created unless security worth 600 pounds is offered in exchange. Suppose A sells wheat worth 100 pounds to B, and receives B's IOU in exchange. B then sells the wheat to C, in exchange for C's IOU, and the process repeats six times. If B is respected in the community, then his IOU might serve as money, and the exchange would have increased the money supply by 100 pounds. Alternatively, as Thornton states, B’s IOU might be discounted by a banker, and the banker’s IOU would then serve as money. In either case, each exchange potentially increases the supply of money, and it is possible, as Thornton states, that six successive sales of the same wheat could increase the money supply by 600 pounds.
    Thornton’s error becomes apparent once we realize that A would only accept B's IOU if it were backed by something worth 100 pounds. For example, B might own property that A could take from him in court. It is as if B’s IOU were actually backed by a lien on B’s property, C’s IOU by a lien on C’s property, etc. Every additional sale of the wheat would create new IOU's backed by new goods, and no matter how far the process went, the self interest of the parties involved would assure that every new IOU would be backed by goods of commensurate value.

    Thornton’s argument that the six IOU’s are backed only by the single unit of wheat is plainly indefensible, and it is surprising that a banker such as Thornton would have forgotten the importance of collateral to the value of an IOU.

    1. Thornton knew what he was talking about. There is an analogue in the recent financial crisis. Securities were created from pools of other securities. Supposedly they were of good quality because they were overcollateralized or backed by insurance guarantees. When the crisis came, people found out that the underlying assets were not worth as much as they had thought. To use the language of your example, security that people had thought was worth 600 pounds could be sold only for 60 pounds. As a result, certain securities markets formerly considered fairly liquid dried up. Creditors, like all of us, make mistakes, and sometimes they are very bad mistakes.

  3. Nobody denies that when you try to back $600 with assets worth $60, the money will lose value. That's not what Thornton was talking about. He clearly just forgot that in the normal process of issuing $600 of money on loan, there will be $600 of assets acquired as backing for the money issued. Whether that $600 of assets later drops in value to $60 is another matter.

  4. Had I known about the survey, Henry Thornton would have had one vote. I've spent a lot of years writing on 19th-century British monetary theory and policy, and in my view, Thornton is easliy the best monetary theorist of the classical writers. He understood credit, he understood banking, he understood policy. No doubt some will denigrate him because he laid out a "Keynesian" approach to monetary policy, though he also noted that the money supply could be managed in a monetarist fashion. The opening chapter of Paper Credit, which focuses on the credit market, is classic. In my mind, no one superseded Thornton until Wicksell came along.

  5. Thomas Joplin was another great monetary theorist from the 19th Century. According to Schumpeter, Joplin was the first to propose a 100% reserve system of banking. Whether that's true or not, Joplin's reasoning is worthy of study.

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