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Adam Smith and banking regulation - Input Junkie
October 16th, 2011
08:34 am

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Adam Smith and banking regulation
"Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed." -- Adam Smith, on the need for banking regulations.


This is rather do-my-homeworkish, but what regulations or types of regulations did Smith favor?

Quote thanks to [personal profile] dglenn.

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From:agrumer
Date:October 16th, 2011 08:01 pm (UTC)
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An Inquiry into the Nature and Causes of the Wealth of Nations, Book 2, Chapter 2, Of Money Considered as a particular Branch of the General Stock of the Society, or of the Expence of Maintaining the National Capital, paragraphs 91, 93, and 94:

It were better, perhaps, that no bank notes were issued in any part of the kingdom for a smaller sum than five pounds. Paper money would then, probably, confine itself, in every part of the kingdom, to the circulation between the different dealers, as much as it does at present in London, where no bank notes are issued under ten pounds value; five pounds being, in most parts of the kingdom, a sum which, though it will purchase, little more than half the quantity of goods, is as much considered, and is as seldom spent all at once, as ten pounds are amidst the profuse expence of London.

[skipping paragraph 92]

Though paper money should be pretty much confined to the circulation between dealers and dealers, yet banks and bankers might still be able to give nearly the same assistance to the industry and commerce of the country as they had done when paper money filled almost the whole circulation. The ready money which a dealer is obliged to keep by him, for answering occasional demands, is destined altogether for the circulation between himself and other dealers of whom he buys goods. He has no occasion to keep any by him for the circulation between himself and the consumers, who are his customers, and who bring ready money to him, instead of taking any from him. Though no paper money, therefore, was allowed to be issued but for such sums as would confine it pretty much to the circulation between dealers and dealers, yet, partly by discounting real bills of exchange, and partly by lending upon cash accounts, banks and bankers might still be able to relieve the greater part of those dealers from the necessity of keeping any considerable part of their stock by them, unemployed and in ready money, for answering occasional demands. They might still be able to give the utmost assistance which banks and bankers can, with propriety, give to traders of every kind.

To restrain private people, it may be said, from receiving in payment the promissory notes of a banker, for any sum whether great or small, when they themselves are willing to receive them, or to restrain a banker from issuing such notes, when all his neighbours are willing to accept of them, is a manifest violation of that natural liberty which it is the proper business of law not to infringe, but to support. Such regulations may, no doubt, be considered as in some respects a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments, of the most free as well as of the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty exactly of the same kind with the regulations of the banking trade which are here proposed.

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From:subnumine
Date:October 18th, 2011 11:35 pm (UTC)
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The lower limit here is comparable to $500 or $1000, vintage 2011.
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From:subnumine
Date:October 17th, 2011 03:38 pm (UTC)
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He also advocated all joint-stock companies being reduced to strict routine, in the interests of the stock-holders; he therefore would only permit corporations in such cases, essentially banking, utilities and transport (this is part of a long passage which is also opposed to exclusive privileges):

The only trades which it seems possible for a joint stock company to carry on successfully without an exclusive privilege are those of which all the operations are capable of being reduced to what is called a routine, or to such a uniformity of method as admits of little or no variation. Of this kind is, first, the banking trade; secondly, the trade of insurance from fire, and from sea risk and capture in time of war; thirdly, the trade of making and maintaining a navigable cut or canal; and, fourthly, the similar trade of bringing water for the supply of a great city.</i>

A. Grumer's site is very useful; but Adam Smith is much better read in extenso, in print or on Gutenberg or Google Books. That way you find all the things he said which our domestic enemies do not find it convenient to quote.

[Reposted with formatting]
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From:nancylebov
Date:October 17th, 2011 04:25 pm (UTC)
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Would that translate as "publicly owned companies should only be allowed to do boring things"?

I'm inclined to think that publicly owned companies are more trouble than they're worth, but I have no idea how we could stop having them.



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From:fla_sunshine
Date:October 17th, 2011 06:12 pm (UTC)
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Well, I've argued that taking away their stockholders (owners) immunity from liability for the actions of the corporations they own which damage innocent third parties (i.e. not folks who have entered into any agreement waiving such liability) would go a long way toward restraining some of their more risky actions, assuming it would force owners or their insurers into more active oversight of such corporations.
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From:subnumine
Date:October 17th, 2011 08:19 pm (UTC)
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No, it translates to "*private* corporations should only be allowed to do boring things"; that's why he's talking about bankruptcy. Company management will be less keen after profit than individuals, so have less motivation to explore profit. In a business which is purely routine this doesn't matter: a turnpike, say, is a license to print money - on a small scale - and as long as you perform routine maintenance, your profit stream will continue.

Now he would acknowledge that if the management does engross most of the profits to themselves, this ceases to apply. But if they have that much power, they will loot the stock-holders, and everyone else around them, and the company will go bankrupt anyway.

One of his major subjects was the East India Company, which went broke six times IIRC, and routinely got a public bailout (one of them was the rebate on tea that ended in Boston Harbot). It was too big to fail. He calls government by a joint-stock company the worst form of government in the world, because the governors have no responsibility whatsoever to the governed.
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From:nancylebov
Date:October 18th, 2011 12:56 am (UTC)
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So who'd be allowed to do interesting things? Sole proprietorships and partnerships and such?

Mostly, I'm contemplating the lawsuits about whether businesses are being sufficiently boring.
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From:subnumine
Date:October 18th, 2011 04:17 pm (UTC)
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Yes, Sole proprietorships and partnerships.

The lawsuits would be simple. In Adam Smith's time, corporations were chartered for specific purposes; they might be broad purposes, like Settle Virginia, or Trade with India, but they were stated in the charter. Corporate actions outside the charter were invalid, and might be malversation. Adam Smith generally opposed limited liability as government interference (and therefore, as usual, futile in serving the overall public good), but would allow it for these routine purposes.

What he proposes, therefore that the Government only draw charters for corporations to Operate a Bank in this Town (with list of powers limited as in your post) or Build and Run that Bridge, or Operate an Aqueduct from Point A to Point B: things generally too large for a single individual.

General incorporation acts, which permitted corporations to do anything ("for such lawful purposes as the Board of Directors may approve") began after Smith's death, and reached their present broad latitude only with New Jersey's - after the Civil War. I believe Smith would have grouped them with the prospectus from the South Sea Bubble times: "A company to carry on an undertaking of great advantage, but nobody to know what it is."
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