This is the early version of my Fallacy of Market Equilibrium Post that was sent to a journal but was not accepted. This led me to post to the internet instead.
Juan
The Monetary Dogma
The Selfish-interest dogma naturally bears a child belief which I call the “Monetary dogma” which states that the value of a good or service is determined solely by money. This goes against Smith’s observation that value has two measures: real price and nominal price:
Smith
The real price of every thing, what every thing really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What every thing is really worth to the man who has acquired it, and who wants to dispose of it or exchange it for something else, is the toil and trouble which it can save to himself, and which it can impose upon other people. What is bought with money or with goods is purchased by labour, as much as what we acquire by the toil of our own body. That money or those goods indeed save us this toil (WN, Book 1, Chap. 5, Par. 2)…Labour alone, therefore, never varying in its own value, is alone the ultimate and real standard by which the value of all commodities can at all times and places be estimated and compared. It is their real price; money is their nominal price only.
Par. 7, emphasis added
This is now known as the labor theory of value. It is important to note that Smith’s labor theory is different from the labor theory of Marx, as the former treats each labor as unique whereas the latter creates the materialistic fallacy of treating all human labor as the same:
Smith
If then we leave out of consideration the use-value of commodities, they have only one common property left, that of being products of labour. But even the product of labour itself has undergone a change in our hands. If we make abstraction from its use-value, we make abstraction at the same time from the material elements and shapes that make the product a use-value; we see in it no longer a table, a house, yarn, or any other useful thing. Its existence as a material thing is put out of sight.
Capital, Book 1, Part 1, Chap. 1, Par. 10
Smith
Neither can it any longer be regarded as the product of the labour of the joiner, the mason, the spinner, or of any other definite kind of productive labour. Along with the useful qualities of the products themselves, we put out of sight both the useful character of the various kinds of labour embodied in them, and the concrete forms of that labour; there is nothing left but what is common to them all; all are reduced to one and the same sort of labour, human labour in the abstract.
Capital, Book 1, Part 1, Chap. 1, Par. 10
Smith observed that trade by money, although convenient, created new problems, such as a credit crunch:
Smith
It is now more than five-and-twenty years since the paper money issued by the different banking companies of Scotland was fully equal, or rather was somewhat more than fully equal, to what the circulation of the country could easily absorb and employ…Those traders and other undertakers, having got so much assistance from banks and bankers, wished to get still more.…The banks, however, were of a different opinion, and upon their refusing to extend their credits..those traders had recourse to..drawing and redrawing…
WN, Book 2, Chapter 2, Par. 65- 72
Smith
When two people, who are continually drawing and redrawing upon one another, discount their bills always with the same banker, (the banker) must immediately discover..that they are trading..with the capital which he advances to them…they discount their bills..round of a great circle of projectors, who find it for their interest to assist one another in this method..and to render it..as difficult as possible to distinguish between a real and fictitious bill…When a banker had..made this discovery, he might..find that he had already discounted the bills of those projectors..so great..that, by refusing to discount any more, he would..make them all bankrupts, and..ruin himself.
For his own interest..he might.. go on for some time, endeavouring.. to withdraw gradually.. making.. greater.. difficulties about discounting.. to force those projectors.. to have recourse..to other bankers.. so that he himself might.. get out of the circle… Their own distress (of the traders).. they called the distress of the country.
and the first economic bubble:
Smith
That the industry of Scotland languished for want of money to employ it was the opinion of the famous Mr. Law. By establishing a bank of a particular kind, which he seems to have imagined might issue paper to the amount of the whole value of all the lands in the country, he proposed to remedy this want of money…
The idea of the possibility of multiplying paper to almost any extent was the real foundation of what is called the Mississippi scheme, the most extravagant project both of banking and stock-jobbing that, perhaps, the world ever saw…The principles upon which it was founded are explained by Mr. Law himself…The splendid but visionary ideas which are set forth in that and some other works upon the same principles still continue to make an impression upon many people, and have, perhaps, in part, contributed to that excess of banking which has of late been complained of both in Scotland and in other places.
Par. 78
The credit derivatives such as collateralized debt obligations (CDOs) and credit default swaps of this generation are the redrawn bills of Smith’s generation, while “quantitative easing” is the Mississippi scheme of the past. Such dangers led Smith to favor gold and view money with caution:
Smith
The commerce and industry of the country, however, it must be acknowledged, though they may be somewhat augmented, cannot be altogether so secure when they are thus, as it were, suspended upon the Dædalian wings of paper money as when they travel about upon the solid ground of gold and silver. Over and above the accidents to which they are exposed from the unskillfulness of the conductors of this paper money, they are liable to several others, from which no prudence or skill of those conductors can guard them. (Par. 86, emphasis added)
Par. 78
He proposed to solve the hazards of money by encouraging the establishment of many small banks in free competition with the appropriate reserves, in order to isolate the natural occurrence of banking mistakes, a reality seemingly forgotten by today’s “too-big-to-fail, fractional reserve lending” banks:
Smith
The late multiplication of banking companies increases the security of the public. It obliges..them to be more circumspect in their conduct, and, by not extending their currency beyond its..proportion to their cash, to guard..against those malicious runs of..competitors. It restrains the circulation of each..company within a narrower circle..By dividing the whole circulation..the failure of any one company..becomes of less consequence to the public…In general, if any branch of trade, or..division of labour, be advantageous to the public, the freer..the competition, it will always be the more so.
Par. 106, emphasis added
Smith proposed to solve the problem of valuation of goods and services in different times and places by using a corn index because corn, aside from serving as food, is an easy-to-grow commodity which cannot be monopolized by vested interests:
Smith
..it may sometimes be of use to compare the different real values of a particular commodity at different times and places, or the different degrees of power over the labour of other people which it may, upon different occasions, have given to those who possessed it. We must in this case compare, not so much the different quantities of silver for which it was commonly sold, as the different quantities of labour which those different quantities of silver could have purchased.
But the current prices of labour at distant times and places can scarce ever be known with any degree of exactness. Those of corn, though they have in few places been regularly recorded, are in general better known and have been more frequently taken notice of by historians and other writers. We must generally, therefore, content ourselves with them, not as being always exactly in the same proportion as the current prices of labour, but as being the nearest approximation which can commonly be had to that proportion.
Book 1, Chap. 5, Par. 22
Smith
Were it possible for one great company of merchants to possess themselves of the whole crop of an extensive country, it might..be their interest to..destroy or throw away a considerable part of it in order to keep up the price of the rest. But it is scarce possible, even by the violence of law, to establish such an extensive monopoly with regard to corn; and, wherever the law leaves the trade free, it is of all commodities the least liable to be engrossed or monopolized..
Book 4, Chap. 5, Par. 43
By dividing the economy into smaller and freer parts and by basing real prices on a common global food commodity, the real value of goods and services will be isolated from the fluctuations, errors, or arbitrary decisions affecting the price of money or gold.
Unfortunately, economists have disregarded Smith’s ideas, in favor of having huge banks and corporations, and basing the entire economy on paper money, something which he had warned against:
Smith
Money in common language, as I have already observed, frequently signifies wealth, and this ambiguity of expression has rendered this popular notion so familiar to us that even they who are convinced of its absurdity are very apt to forget their own principles, and in the course of their reasonings to take it for granted as a certain and undeniable truth. Some of the best English writers upon commerce set out with observing that the wealth of a country consists, not in its gold and silver only, but in its lands, houses, and consumable goods of all different kinds. In the course of their reasonings, however, the lands, houses, and consumable goods seem to slip out of their memory, and the strain of their argument frequently supposes that all wealth consists in gold and silver, and that to multiply those metals is the great object of national industry and commerce.
Book 4, Chap. 1, Par. 34, emphasis added
The Supremacy Of Money
When did the supremacy of money over labor begin?
It can be traced to the marginal revolution which pegged quantitative value to unquantifiable subjectivity. Carl Menger and William Stanley Jevons proposed philosophies based on pleasure and satisfaction, with Jevons creating the mathematical foundation in his book The Theory of Political Economy (TPE):
Jevons
PLEASURE and pain are undoubtedly the ultimate objects of the Calculus of Economics. To satisfy our wants to the utmost with the least effort—to procure the greatest amount of what is desirable at the expense of the least that is undesirable—in other words, to maximise pleasure, is the problem of Economics.
TPE, Chap. 3, Par. 1
His inclination towards math causes him to make a critical anti-dharma (adharma) proposition to quantify and compare pleasure:
Jevons
I hesitate to say that men will ever have the means of measuring directly the feelings of the human heart. A unit of pleasure or of pain is difficult even to conceive; but it is the amount of these feelings which is continually prompting us to buying and selling, borrowing and lending, labouring and resting, producing and consuming; and it is from the quantitative effects of the feelings that we must estimate their comparative amounts.
TPE, Chap. 1, Par. 17
Menger contributes to this paradigm in his book Principles of Economics (PE) by not only refuting Smith’s labor theory of value, but by ranking satisfaction as well:
Menger
The determining factor in the value of a good, then, is neither the quantity of labor or other goods necessary for its production nor the quantity necessary for its reproduction, but rather the magnitude of importance of those satisfactions with respect to which we are conscious of being dependent on command of the good. This principle of value determination is universally valid, and no exception to it can be found in human economy.
PE, Chap. 3
Unlike Smith who views economic activity as a means to achieve the greater good of society, Menger and Jevons view it simply as a means for personal satisfaction. Since satisfaction is subjective, then value becomes subjective. Without the measure of labor or a corn index to base prices on, Menger resorts to arbitrary price setting from information from the market:
Menger
Price formation, we have seen, always takes place between two extremes, the lower of which may also be called the demand price (the price at which the commodity is asked for on the market) and the higher of which may also be called the supply price (the price at which the commodity is offered for sale on the market).
PE, Chap. 8
Thus, the problem of arbitrariness begins. Unlike Smith who sees trade as mutually beneficial, Menger’s self-interested trade is competitive between buyers and sellers and requires a great deal of information (which, implied by Smith, is beyond human limitations):
Menger
Each of the two bargainers will attempt to acquire as large a portion as possible of the economic gain that can be derived from the exploitation of the exchange opportunity, and even if he were to try to obtain but a fair share of the gain, he will be inclined to demand higher prices the less he knows of the economic condition of the other bargainer and the less he knows the extreme limit to which the other is prepared to go.
Superphysics
