Chapter 2e

Cash Accounts and Discounted Bills of Exchange

by Adam Smith Icon

Cash Accounts

44 Scotland’s commerce is not very great at present. It was smaller when the first two banks were established. Those banks would have had little trade had they confined their business to discounting of bills of exchange.

They invented cash accounts – another method of issuing their promissory notes.

  • They give credit (£2,000-3,000 for example) to anyone who could procure two persons of undoubted credit and good landed estate to become surety for him.
  • Whatever money lent to him based on the given credit should be repaid on demand, with the legal interest.
  • This kind of credit is granted by banks around the world.

But Scotch banks peculiarly give them on easy terms.

  • The easy terms perhaps were the principal cause of the great trade of those banks and the benefit the country received from it.

45 People with this credit borrow £1,000 in form of the bank’s promissory notes, and may repay it piecemeal, by £20-30 at a time.

The bank discounts some of the interest of the £1,000 from the day each of those small sums are paid, until the total is paid. All merchants and almost all businessmen, find it convenient to keep such cash accounts.

They are interested in promoting the banks=

  • by readily receiving their notes in all payments, and
  • by encouraging others to receive their bank notes too.

The merchants use these notes to pay the manufacturers for goods. The manufacturers pay these notes to the farmers for raw materials and provisions. The farmers pay these to their landlords for rent. The landlords pay these to the merchants for goods. The merchants return these to the banks to balance their cash accounts or to replace what they borrowed. Thus, almost the whole money business of the country is transacted by promissory notes, creating the great trade of those banks.

46 Through those cash accounts, every merchant can carry on a greater trade.

Let us say that there is one merchant in London and another in Edinburgh, both employing equal stocks in the business.

  • The Edinburgh merchant uses cash accounts.
  • The London merchant has no cash accounts.

The Edinburgh merchant can facilitate more trade and employ more people than the London merchant. The London merchant must always keep money to answer the payment demands for the goods which he buys on credit.

  • If this amount is £500, he must keep £500 in money instead of spending it to add £500 of goods in his warehouse.
  • If he is able to sell all his goods in the year, he would have lost the sale of £500 worth of goods.

His annual profits must be less, by the profits from those £500 of goods. The number of his workers must be less, by the employment generated by those £500 of goods.

On the other hand, the Edinburgh merchant keeps no money unemployed for answering such occasional demands.

  • He satisfies occasional demands with his cash account.
  • He gradually repays the bank with the metal or paper money from the sale of his goods.

With the same stock, he can have more goods than the London merchant. He makes a bigger profit and provides more employment. Hence the great benefit which Scotland has derived from this trade.

47 Discounting bills of exchange gives the English merchants a convenience equivalent to the cash accounts of the Scotch merchants.

But the Scotch merchants can also have discounted bills of exchange as easily as the English merchants, in additional to their cash accounts.

48 All kinds of paper money which can easily circulate in any country can never exceed the value of the gold and silver it substitutes.

If 20 shilling notes are the lowest paper money in Scotland, all the paper money which can easily circulate there cannot exceed the amount of gold and silver needed for transactions worth 20 shillings or more.

If the circulating paper exceeds that sum, it must immediately return to the banks to be exchanged for gold and silver, because the excess could not be sent abroad nor employed in the country’s circulation. Many people would immediately perceive that they had more of this paper than was needed for business transactions at home.

Since they could not send it abroad, they would immediately demand payment of it from the banks. By converting it into gold and silver, they can easily use it abroad. But they could find no use for it while it remained as paper. There would immediately be a run on the banks to the whole extent of this superfluous paper. If the banks showed any backwardness in payment, a greater alarm would be created, increasing the run.


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