College of Humanities and Social Sciences
College of Humanities and Social Sciences

Three Essays on the History of Monetary Theory and Banking Practice: Adam Smith and the American Founders

Nicholas Curott

Major Professor: Lawrence H White, PhD, Department of Economics

Committee Members: Peter J. Boettke, Christopher J. Coyne

Enterprise Hall, #318
November 01, 2012, 04:00 PM to 06:00 PM

Abstract:

This dissertation explores Adam Smith’s theory of money and banking and its influence on banking thought and practice in post-revolutionary America. 

Chapter 1 resolves a long-running debate in the economics literature – the debate over Smith’s theory of money and banking – and thereby revolutionizes current understanding about the history and evolution of monetary analysis. Smith did not present either the real-bills theory or a price-specie-flow theory of banknote regulation, as generally presumed, but rather a reflux theory based upon the premise that the demand for money is fixed at a particular nominal quantity. Smith’s theory denies that an excess supply of money can ordinarily make it into the domestic nominal income stream or influence prices or employment. 

Chapter 2 explains why Adam Smith’s recommendation of free banking was rejected by the American founders, despite Smith’s profound influence in other respects. The explanation lies in the fact that Smith’s economic analysis of banking was incomplete. The primary economic benefit that Smith pointed to in favor of free banking was saving on the resource cost of precious metals. Jefferson thought Smith’s proposal went too far, that it would take the economy off of the safe foundation of hard money. Hamilton thought it did not go far enough toward strengthening the national credit. The opinions of Jefferson and Hamilton both shaped and reflected the views of their contemporaries, with the result that Smith’s moderate position of free banking was rejected by both sides of the political spectrum. 

Chapter 3 presents a monetary explanation of the US recession of 1797. Credit expansion initiated by Bank of the United States in the early 1790s unleashed a bout of inflation and low real interest rates which  spurred a speculative investment bubble in real estate and capital intensive manufacturing and infrastructure projects. A correction occurred as domestic inflation created a disparity in international prices that led to a reduction in net exports. Specie flowed out of the country, prices began to fall, and real interest rates spiked. In the ensuing credit crunch businesses reliant upon rolling over short term debt were rendered unsustainable. The general economic downturn which ensued throughout 1797 and 1798 involved declines in the price level and nominal GDP, the bursting of the real estate bubble, and a cluster of personal bankruptcies and business failures. The chapter details the scope of the credit expansion, price level movements, fluctuations in interest rates, and the investment errors that these conditions spawned in several sectors of the economy.

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