Four Facts About Mercantilism

III

Professor Heckscher has a great work on Mercantilism which had 4 conclusions.

1 Mercantilist thought never supposed that there was a self-adjusting tendency for the interest rate to be at an appropriate level.

On the contrary, they were emphatic that an unduly high interest rate was the main obstacle to the growth of wealth.

They were even aware that the interest rate depended on:

• the love of money and
• the quantity of money.

They were concerned both with:

• diminishing liquidity-preference and
• increasing the quantity of money

Their preoccupation with increasing the quantity of money was due to their desire to reduce interest rates.

Money was:

• a factor of production, just as land is.
• an “artificial” wealth as distinct from the “natural” wealth

Interest on capital was the payment for the renting of money similar to rent for land.

From the abundant material available, only the most typical examples will be selected, so as to demonstrate first and foremost how lasting this notion was, how deep-rooted and independent of practical considerations.

Both of the protagonists in the struggle over monetary policy and the East India trade in the early 1620’s in England were in entire agreement on this point.

Gerard Malynes stated, giving detailed reason for his assertion, that “Plenty of money decreaseth usury in price or rate” (Lex Mercatoria and Maintenance of Free Trade, 1622).

His truculent and rather unscrupulous adversary, Edward Misselden, replied that “The remedy for Usury may be plenty of money” (Free Trade or the Meanes to make Trade Florish, same year).

Josiah Child was the omnipotent leader of the East India Company and its most skilful advocate.

He discussed in 1668 how far the legal maximum interest rate would result in drawing “the money” of the Dutch away from England.

He remedied this by making it easier to transfer bills of debt, as if these were currency. It would, to him, solve the defect of at least half of all the ready money we have in use in the nation.

Petty agreed that the remedy for a country with too much “Coin” (Quantulumcunque concerning Money, 1682) was a “natural” fall in the interest rate from 10-6%. This would be done by:

• the increase in the amount of money (Political Arithmetick, 1676), and
• the propriety of lending at interest

In 1701 and 1706, French merchants and statesmen complained of the prevailing scarcity of coin as the cause of the high interest rates. They wanted to lower usury by increasing the circulation of money.[7]

John Locke was, perhaps, the first to express the abstract relationship between the interest rate and the quantity of money in his controversy with Petty.[8]

He was opposing Petty’s proposal of a maximum interest rate on the ground that it was as impracticable as to fix a maximum rent for land. This was because “Interest Income depends on the whole quantity of Money of the Kingdom passing, in proportion to its whole Trade”.[9]

Locke explains that Money has 2 values:

1. Its value in use

• This is given by interest rate
• This has the same nature as the rent of land [10]

2. Its value in exchange

• This has the Nature of a Commodity
• This depends only on the Plenty or Scarcity of Money in proportion to the Plenty or Scarcity of those things and not on what Interest shall be

Thus, Locke was the parent of twin quantity theories. He held that:

1. The interest rate depended on the proportion of the quantity of money (allowing for the velocity of circulation) to the total value of trade.
2. The value of money in exchange depended on the proportion of the quantity of money to the total volume of goods in the market.

He stood:

• with one foot in the mercantilist world and
• with one foot in the classical world[11]

He was confused on the relation between these 2 proportions. He overlooked altogether the possibility of fluctuations in the love for future money.

He explained that a reduction in interest rates has no direct effect on the price-level.

• It affects prices “only as the Change of Interest in Trade conduces to the bringing in or carrying out Money or Commodity, and so in time varying their Proportion here in England from what it was before”, i.e. if the reduction in the rate of interest leads to the export of cash or an increase in output.

But he never proceeds to a genuine synthesis.[12]

The mercantilist easily distinguished between the interest rate and the marginal efficiency of capital as proven below:

Fortrey (England’s Interest and Improvement, 1663) affords another example of the stress laid on a low rate of interest as a means of increasing wealth.

The mercantilists did not overlook the point that, if an excessive liquidity-preference were to withdraw the influx of precious metals into hoards, the advantage to the rate of interest would be lost.

In some cases (e.g. Mun) the object of enhancing the power of the State led them, nevertheless, to advocate the accumulation of state treasure. But others frankly opposed this policy= Schrötter, for instance, employed the usual mercantilist arguments in drawing a lurid picture of how the circulation in the country would be robbed of all its money through a greatly increasing state treasury

he, too, drew a perfectly logical parallel between the accumulation of treasure by the monasteries and the export surplus of precious metals, which, to him, was indeed the worst possible thing which he could think of. Davenant explained the extreme poverty of many Eastern nations — who were believed to have more gold and silver than any other countries in the world — by the fact that treasure “is suffered to stagnate in the Princes’ Coffers”.

If hoarding by the state was considered, at best, a doubtful boon, and often a great danger, it goes without saying that private hoarding was to be shunned like the pest. It was one of the tendencies against which innumerable mercantilist writers thundered, and I do not think it would be possible to find a single dissentient voice.[13]

2 The Mercantilists knew of the fallacy of cheapness and the danger of excessive competition of trade against a country.

Thus Malynes wrote in his Lex Mereatoria (1622)= “Strive not to undersell others to the hurt of the Commonwealth, under colour to increase trade= for trade doth not increase when commodities are good cheap, because the cheapness proceedeth of the small request and scarcity of money, which maketh things cheap= so that the contrary augmenteth trade, when there is plenty of money, and commodities become dearer being in request”.[14]

Heckscher sums up mercantilist thought=

In the course of a century and a half the standpoint was formulated again and again in this way, that a country with relatively less money than other countries must “sell cheap and buy dear…”

Even in the original edition of the Discourse of the Common Weal, that is in the middle of the 16th century, this attitude was already manifested. Hales said, in fact, “And yet if strangers should be content to take but our wares for theirs, what should let them to advance the price of other things (meaning= among others, such as we buy from them), though ours were good cheap unto them? And then shall we be still losers, and they at the winning hand with us, while they sell dear and yet buy ours good cheap, and consequently enrich themselves and impoverish us.

Yet had I rather advance our wares in price, as they advance theirs, as we now do; though some be losers thereby, and yet not so many as should be the other way.” On this point he had the Unqualified approval of his editor several decades later (1581).

In the 17th century, this attitude recurred again without any fundamental change in significance. Thus, Malynes believed this unfortunate position to be the result of what he dreaded above all things, i.e. a foreign under-valuation of the English exchange.

The same conception then recurred continually. In his Verbum Sapienti (written 1665, published 1691), Petty believed that the violent efforts to increase the quantity of money could only cease “when we have certainly more money than any of our Neighbour States (though never so little), both in Arithmetical and Geometrical proportion”.

During the period between the writing and the publication of this work, Coke declared, “If our Treasure were more than our Neighbouring Nations, I did not care whether we had one fifth part of the Treasure we now have” (1675).[15]

3 The mercantilists were the originals of “the fear of goods” and the scarcity of money as causes of unemployment

The Classicals denounced these 2 centuries later as an absurdity. This is because the Classicals applied the Unemployment argument as a reason to ban imports.

The first great discussion of this matter, as of nearly all social and economic problems, occurred in England in the middle of the 16th century or rather earlier, during the reigns of Henry VIII and Edward VI. In this connection we cannot but mention a series of writings, written apparently at the latest in the 1530’s, two of which at any rate are believed to have been by Clement Armstrong….

He formulates it, for example, in the following terms= “By reason of great abundance of strange merchandises and wares brought yearly into England hath not only caused scarcity of money, but hath destroyed all handicrafts, whereby great number of common people should have works to get money to pay for their meat and drink, which of very necessity must live idly and beg and steal” The best instance to my knowledge of a typically mercantilist discussion of a state of affairs of this kind is the debates in the English House of Commons concerning the scarcity of money, which occurred in 1621, when a serious depression had set in, particularly in the cloth export. The conditions were described very clearly by one of the most influential members of parliament, Sir Edwin Sandys. He stated that the farmer and the artificer had to suffer almost everywhere; that looms were standing idle for want of money in the country, and that peasants were forced to repudiate their contracts, “not (thanks be to God) for want of fruits of the earth, but for want of money”.

The situation led to detailed enquiries into where the money could have got to, the want of which was felt so bitterly. Numerous attacks were directed against all persons who were supposed to have contributed either to an export (export surplus) of precious metals, or to their disappearance on account of corresponding activities within the country.[17]

Mercantilists were conscious that their policy killed 2 birds with 1 stone.

On the one hand the country was rid of an unwelcome surplus of goods, which was believed to result in unemployment, while on the other the total stock of money in the country was increased.[18] with the resulting advantages of a fall in the rate of interest.

It is impossible to study the notions to which the mercantilists were led by their actual experiences, without perceiving that there has been a chronic tendency throughout human history for the propensity to save to be stronger than the inducement to invest. The weakness of the inducement to invest has been at all times the key to the economic problem. To-day the explanation of the weakness of this inducement may chiefly lie in the extent of existing accumulations; whereas, formerly, risks and hazards of all kinds may have played a larger part. But the result is the same. The desire of the individual to augment his personal wealth by abstaining from consumption has usually been stronger than the inducement to the entrepreneur to augment the national wealth by employing labour on the construction of durable assets.

4 The mercantilists knew that the nationalistic character of their policies and their tendency to promote war.

It was national advantage and relative strength at which they were admittedly aiming.[19]

We may criticise them for the apparent indifference with which they accepted this inevitable consequence of an international monetary system.

But intellectually their realism is much preferable to the confused thinking of contemporary advocates of an international fixed gold standard and laissez-faire in international lending, who believe that it is precisely these policies which will best promote peace.

For in an economy subject to money contracts and customs more or less fixed over an appreciable period of time, where the quantity of the domestic circulation and the domestic rate of interest are primarily determined by the balance of payments, as they were in Great Britain before the war, there is no orthodox means open to the authorities for countering unemployment at home except by struggling for an export surplus and an import of the monetary metal at the expense of their neighbours. Never in history was there a method devised of such efficacy for setting each country’s advantage at variance with its neighbours’ as the international gold (or, formerly, silver) standard. For it made domestic prosperity directly dependent on a competitive pursuit of markets and a competitive appetite for the precious metals.

When by happy accident the new supplies of gold and silver were comparatively abundant, the struggle might be somewhat abated. But with the growth of wealth and the diminishing marginal propensity to consume, it has tended to become increasingly internecine.

The part played by orthodox economists, whose common sense has been insufficient to check their faulty logic, has been disastrous to the latest act. For when in their blind struggle for an escape, some countries have thrown off the obligations which had previously rendered impossible an autonomous rate of interest, these economists have taught that a restoration of the former shackles is a necessary first step to a general recovery. In truth the opposite holds good.

It is the policy of an autonomous rate of interest, unimpeded by international preoccupations, and of a national investment programme directed to an optimum level of domestic employment which is twice blessed in the sense that it helps ourselves and our neighbours at the same time. And it is the simultaneous pursuit of these policies by all countries together which is capable of restoring economic health and strength internationally, whether we measure it by the level of domestic employment or by the volume of international trade.[20]

IV

The Classical school ignored the problem because they introduced premises which involved the non-existence of the problem. This led to a disconnect between:

• the conclusions of economic theory and
• the conclusions of common sense.

I believe that the interest rate is not self-adjusting at a level best suited to the social advantage. Instead, it constantly tends to rise too high.

The Classical school has repudiated the above doctrine as childish. But I believe it deserves rehabilitation and honour.

A wise Government then curbs interest rates by statute and custom and even by invoking morality. Provisions against usury are amongst the most ancient economic practices.

The destruction of the inducement to invest by an excessive love for money was the outstanding evil.

• It was the prime impediment to the growth of wealth in the ancient and medieval worlds.

In an unsafe world, the interest rate would naturally rise too high to allow an adequate inducement to invest, unless it was curbed by society.

I was brought up to believe that:

• the Medieval Church’s view on interest rates was inherently absurd
• the subtle discussions distinguishing the return on money-loans from the return to active investment were merely Jesuitical attempts to find a practical escape from a foolish theory.

But I now read them in an honest intellectual effort to keep separate what the classical theory has inextricably confused together:

• interest rate*
• the marginal efficiency of capital

The schoolmen’s disquisitions were directed towards a formula allowing the schedule of the marginal efficiency of capital to be high, while using rule, custom, and the moral law to keep down interest rates.

Even Adam Smith was extremely moderate in his attitude to the usury laws. For he was aware that:

• individual savings may be absorbed either by investment or by debts
• there is no security that savings will be lent

He favoured low interest rates so that savings would be invested instead of being lent.

Bentham

This is why he defended a moderate application of the usury laws in a passage for which he was severely taken to task by Bentham.[23][24]

Bentham criticized:

• Adam Smith’s Scotch caution as too severe on “projectors”
• that a maximum interest rate would leave too little margin for the reward of legitimate and socially advisable risks.

Bentham defined “projectors” as people who pursue wealth by invention or improvement, needing wealth in the process. Of course Bentham is right in protesting the laws which stand in the way of taking legitimate risks. He says= “A prudent man will not pick out the good projects from the bad, for he will not meddle with projects at all.”[25]

Is the above what Adam Smith intended by his term? Or is it that we are hearing in Bentham (though writing in March 1787 from “Crichoff in White Russia”) the voice of 19th-century England speaking to the 18th?

For nothing short of the exuberance of the greatest age of the inducement to investment could have made it possible to lose sight of the theoretical possibility of its insufficiency.