Chapter 5: Bubbles and Adam Smith.


This chapter explores how laws enabling debt to be bought and sold transformed Britain. Suddenly, vast quantities of money and value were being created out of nothing. The effect was dramatic and widely commented on. Some people thoroughly approved, while others saw a new kind of tyranny taking over – a tyranny of fictitious wealth.

Speculators and ‘projectors’[1] soon realized that when money and other types of value can be created out of nothing, different types of debt can be created and used to raise prices, and therefore value. Assets can be bought with money made from nothing, prices can be talked up, more money can be created to fuel and satisfy demand, and – hey presto! – when the assets are re sold, sky-high profits are made. The table was laid for an orgy of speculative greed – and the orgy began almost immediately.

‘It was as if all the lunatics had escaped from the madhouse at once’ commented a Dutch observer.[2] Hysteria for speculation took hold of public life. English poets, novelists, and playwrights wrote and argued about the virtues and vices of ‘Lady Credit’ – and joined in the orgy themselves. A whole century of literature – Daniel Defoe, Jonathan Swift, Alexander Pope, along with many less famous writers – was given over to satirising the new society of speculators and credit-worshippers.[3] Hogarth did the same in art.

The profits of speculation left ‘honesty with no defence against superior cunning’ wrote Jonathan Swift in Gulliver’s Travels.[4] Speculations in credit ‘ruin silently… like poison that works at a distance… by the strange and unheard-of engines of interest, discounts, tallies, transfers, debentures, shares, projects, and the devil-and-all of figures and hard names,’ wrote Daniel Defoe, author of Robinson Crusoe.[5]

The risks and downside of this orgy-making soon became apparent. In 1720, sixteen years after the Promissory Notes Act, two massive financial ‘bubbles’ burst, causing widespread distress: suicides and murders, bank failures, fortunes lost. These were the South Sea Bubble in England and the Mississippi Bubble in France – the latter masterminded by the renegade Scotsman, John Law.

The manufacture of credit-money out of nothing made corruption much easier. A series of plays satirising corruption so enraged the Prime Minister, Robert Walpole, that eventually (in 1737) he shut down all of London’s theatres: only three of them were allowed to reopen, subject to heavy censorship.[6] The Prime Minister himself was helping cover up the buying and selling of fake share certificates involving the King’s mistress. New levels of corruption were being reached. The poet Alexander Pope’s satirical comment was (to ‘imp’ means to ‘maliciously impersonate’);

Blest paper credit! Last and best supply!

That lends Corruption lighter wings to fly!

Gold imp’d by thee can compass hardest things,

Can pocket States, can fetch or carry Kings! …

Pregnant with thousands flits the Scrap unseen,

And silent sells a King, or buys a Queen.[7]


John Law (1671-1729) was one of many colourful characters who flourished in this new milieu. A professional gambler, he escaped from an English prison after killing a fellow gambler in a duel. Making his way to France, he charmed his way (and made a fortune) in the gambling salons of Paris. Law was a ‘projector’ – an inventor of dodgy schemes to benefit humanity and (only incidentally, of course) himself. In the low/high life of Paris, Law found a willing listener and co-conspirator in the Regent and effective ruler of France: Philippe D’Orléans, a man suspected of many crimes including incest with his daughter and the murders of several close relations.

Law had no problem recognising that credit is money.[8] If bank-credit could circulate as money, why not claims on other things: land, for instance? In 1700 Law had presented a plan for a ‘land bank’ to the Parliament of Scotland (known at the time as the ‘Parliament of Drunkards’). His plan was rejected. In France, Law directed the Regent’s attention to two other kinds of paper claim: certificates representing government debt, and shares in colonial ventures licensed by the monarch. Why could not this kind of paper invade the money supply, displacing gold and silver?

John Law founded a bank to create credit and at the same time a company speculating in imaginary profit made far away – in North America. With the help of royal decrees, the two men merged the variety of paper claims – government debt, bank-notes and share certificates – into the shares of his Mississippi Company. Shares could be purchased by small payments upfront: by the time full payment was required, the shares had already shot up in value. Bank-paper was issued in extravagant quantities to pay for the shares. Speculative fever took hold: a classic bubble grew ridiculously big and popped. The finances of France were plunged into disarray.

Both bubbles – the Mississippi and the South Sea – involved companies with (largely imaginary) foreign projects buying government debt, selling shares in the debt, then talking up share prices sky-high – until, inevitably, there was a crash.[9] The herd mentality behind booms-and-busts has been called ‘irrational’ and ‘mad’, but vast amounts of money can be made while credit is being created: the trick is to sell before the rest of the herd realises that the bonanza is about to end and makes a stampede for the exit.

A lesson was learnt from these two bubbles – temporarily at least: the engine of credit-creation must be managed with restraint, or it will run amok and shake down the whole edifice of property and power. The reaction in France was to suppress banking, whereas in Britain banking was only restrained.

Once bank-credit was established as a legitimate form of money, the power of Britain in the world began to increase exponentially, helped along by bank-credit supplied for making war. Credit and military success reinforced each other: ‘The credit of a country depends largely upon its successes, and conversely, its success depends upon its credit,’ wrote the banker Henry Hope in 1787.[10] Successful wars provided enough real wealth to repay those who lent credit – ‘fictitious cash’ – many times over.

There was growing admiration (and international envy) for a system that could provide power with such resources. During the 18th century, a new ethic established itself: economists began to speak less of equity and justice, and more of productivity and management. Or, more accurately: economists who talked of equity and justice were increasingly ignored by the establishment in favour of economists who spoke of management, efficiency and productivity.[11]

Internationally, credit was useful for making war and creating ‘spheres of economic influence’ in which currency created by the home nation could be used to buy up assets. Domestically, created credit was used for appropriating assets: independent workers were dispossessed and thrown into dependence upon employment.[12] A systematic transfer of resources was under way, from productive workers to people engaged in acquisition, management and profit-taking.

All this became known as ‘the financial revolution’. The wealth of ‘the few’ grew at the expense of ‘the many’ both at home and abroad. A new ethic was developed to justify the wealth of predators. It declared that inequality is God’s reward for a superior type of human, the ‘rational and industrious’ type. For two centuries, the Christian hymn of choice was ‘The rich man in his castle / The poor man at his gate / God made them, high or lowly / And ordered their estate’.[13]

John Locke (1632-1704), ‘philosopher of government by the gentry’[14] articulated the new ethic. Among civilized people, he asserted, inequality is good, for it is the basis for management by industrious and rational people.[15] God gave the Earth ‘to the use of the industrious and rational’, ‘not to the fancy or covetousness of the quarrelsome and contentious’.[16] He praised money because it enhances inequality; he buried the fact that the banking system was actually creating money for the new ruling class – in effect, creating a ruling class whose business was making money out of money.

Locke was perhaps the first ‘economist’ to bury this fact, and his example set the agenda for subsequent mainstream economists. The role of government, Locke said, was to protect property and the status quo: ‘Political power, then, I take to be a right of making laws, with penalties of death, and consequently all less penalties for the regulating and preserving of property.’[17] At that time, of course, only men with substantial property could vote; political power was for the few.

The effect, in the words of historian Lord Acton, was that the ‘divine right of Kings’ was replaced by the ‘divine right of freeholders’.[18] Some writers approved, some disapproved. Daniel Defoe, author of Robinson Crusoe, wrote in 1702: ‘When therefore I am speaking of the right of the people, I would be understood of the freeholders, for all the other inhabitants live upon sufferance… and have no title to their living in England other than as servants.’[19]

The new ethic of efficiency, productivity, and management favoured large workforces managed on an industrial scale. Just as a disciplined army conquers more effectively than a gathering of individuals, so organised mass labour may produce more than individuals operating on their own.[20] The extra profit does not go to the workers, however; it goes to the person with the newly-created money.

‘Freedom’ and ‘democracy’ obviously take a back seat in this vision of things. As the system developed and consolidated, so did calls for ‘democracy’. In defiance of all previous opinion – which held that democracy and representation are opposites – a new class of political philosophers arose to declare that ‘representation’ is ‘democracy’.[21] Robespierre, mass-murderer of the French Revolution, was the first to articulate this vision in a political speech, justifying terror in the name of democracy.

‘Democracy is not a state in which the people, continually assembled, itself directs public affairs. Democracy is a state in which the people, as sovereign, guided by laws of its own making, does for itself all that it can do well, and by its delegates what it cannot…’[22]

The idea that representation is democracy helped pacify ‘the people’, who were flattered and deceived into believing they held power while the system took the fruits of their labour. Workers are given – in wages – as little as possible for subsistence and diverting entertainment.

When large amounts of money are created out of nothing, there will obviously be inflation. Those with a fixed amount of money will get poorer as prices rise. To live, they may go into debt then need to sell assets. This initiated a great transfer of land ownership in Britain. Land was bought up by large landowners on created credit, and independent farmers were turned off. In this way the ‘financial revolution’ enhanced inequality and provided a hungry workforce for the ‘agricultural’ and ‘industrial’ revolutions which followed. Both needed large, dependent workforces.[23]

The new financial system was powered not just by bank-credit, but also by national debt. Adam Smith, Montesquieu and David Hume all noticed that national debt creates assets for the lending class at the expense of productive workers. Montesquieu: ‘(Public) Debt takes the wealth of the state from those who work, and gives it to those who are idle; in other words, it gives the wherewithal to work to people who do not work, and difficulties to people who do work.’[24] Adam Smith, ‘The merchant or monied man makes money by lending money to government, and instead of diminishing, increases his trading capital.’[25] David Hume: ‘…our national debts furnish merchants with a species of money, that is continually multiplying in their hands, and produces sure gain… the greater part of the public stock being always in the hands of idle people, who live on their revenue, our funds, in that view, give great encouragement to a useless and inactive life.’[26]

National debt, bank-money and war went hand-in-hand from the start of the ‘financial revolution’. The English government first authorised banks to create credit on the condition that they would lend to the nation’s war machine.[27] National debts grew in the collusion between banks, governments, the ‘money power’ and war-making, in support of empire-building and trade.[28] This collusion continues today, with the added factor that government debt now forms the ‘reserve’ of commercial banks.

The most interesting economist/philosopher of his age was Adam Smith (1723-90), nowadays regarded as the father of modern economics. There is no doubting Smith’s concern with moral and ethical behaviour: it is present throughout his work. But when it comes to banking, he appears to be caught in a dilemma, between the morality of justice and the new morality of management and power.

Smith spent 13 years (1751-63) as professor of moral philosophy at The University of Glasgow. He spent a great deal longer, however, in the pay of the third Duke of Buccleuch, a Scottish landowner and owner of one of Britain’s largest landed estates.[29] Smith entered the Duke’s service in 1763 as his tutor (the Duke was then 17 years old) and stayed in the Duke’s employ for 27 years. During those years, the Duke was using all the techniques of the new age, including bank-borrowing, to modernise his estate and make it profitable. The Duke was first financially destroyed, and then saved, by successive involvements in two banks: the Bank of Ayr, which was brought down by illicit transfers of money, and the Royal Bank of Scotland, which funded the Duke’s recovery.

Smith writes a great deal on bank-money.[30] He recognises that bank-credit becomes money – and therefore, banks create money.[31] He praises banks, because they put money to use which would otherwise lie dormant.[32] He was concerned by the tendency of banks to collapse. To protect the poor, who are most vulnerable to a bank going bust and its notes becoming worthless, he recommended that banks not be allowed to issue notes of low value.[33] He writes that banks increase the wealth of a nation by replacing expensive gold and silver with cheap paper.[34] He asserts that bank-money makes a nation and its economy less secure.[35] He recognises also that money created by banks may be used in good or bad ways: to fritter on idle consumption, or to increase productive work and capacity.[36] He declares that banking must not be a free-for-all activity; it is dangerous, so it must be regulated.[37] He praises the Bank of Amsterdam for lending no more in credit than it held in gold-and-silver (what we would now call ‘100% reserve’); but he stopped short of recommending this practice for all banks.[38]

However, it is Smith’s omissions that set the stage for subsequent economic ‘thinking’ – or lack of it. Smith omits certain observations and connections which others had noted before him. He omits the fact that payments made in-bank (from one deposit account to another) are every bit as much ‘money’ as paper notes are. His omission set a precedent for the next two hundred years, during which most economists and politicians also ignored this simple and basic fact.[39] The voting public accepted the omission; and as a result, two great attempts – in England in 1844, in the US in 1863-4 – to rein in the bad effects of banking were fruitless: banking activity merely switched from paper notes to in-bank payments and cheques.[40]

But Smith’s greatest failure was (in retrospect) that he didn’t apply his very important moral observations on money and society to banking.

Smith observed that a working economy feeds money to ‘three different orders of people; to those who live by rent, to those who live by wages, and to those who live by profit’. ‘Those who live by profit’ have ‘not the same connection with the general interest of the society’ as owners and wage-earners.[41] Individuals of the first two orders desire prosperity for all, he wrote, because it is in their own interests that everyone should prosper.[42] Only the third order – those who live by profit – get more by taking everything for themselves and leaving everyone else with nothing.[43]

What Smith failed to examine is that banks create money when they lend and they lend on one single consideration: whether both parties will make a profit. In other words, banks encapsulate the order of profit-seekers, that has no interest in the general prosperity. Banks also annul money once that profit is taken. They therefore advantage precisely that order which wants to rob and dispossess. This was not perhaps so clear in Smith’s day as it is in our own. But his failure, and his immense influence on subsequent economic thinking, have licensed subsequent economists to ignore the subject too.

Smith came down morally harder on public debt than he did on banking. ‘The interest (on public debt),’ he wrote, ‘is paid by industrious people, and given to support idle people who are employed in gathering it. Thus industry is taxed to support idleness.’[44]

When Smith makes his moral assessment of whether banks are a ‘good thing’ he switches to the new morality of efficiency, in which productivity is a good thing – full stop. In Book Two, Chapter Two of The Wealth of Nations, after long and confusing argument, he concludes that banking (when judiciously conducted) is on balance a good thing, because the operations of banking turn dead stock into productive capital.[45]

The Wealth of Nations is a ‘great’ book. It set the stage for two and a half centuries of empire-building and became the economic Bible of the new ruling class, a place it still holds today. But sadly, its neglect of the effects of negotiable debt set a precedent for mainstream economics which has been followed ever since. This neglect has permeated and distorted every area of economics. ‘Since Adam Smith, the development of economics has been one long chain of making rules, refuting them, qualifying them, forgetting them.’[46]

After Smith, economics became less a scientific endeavour to understand, more a series of efforts at shoring up the great and overweening powers which succeed one another, each hoping to use the power of created credit for its own ends: predatory capitalism, socialism, communism, fascism and now the ‘enterprise state’.[47]

Since Smith, it is mostly outsiders who have written of injustice in money-creation. Their insights do not form part of what is taught as ‘economics’ across the generations. Instead, their ideas drift like icebergs in fog, slowly melting unnoticed.

The idea that economics should, like other human disciplines, serve justice rather than power resurfaced with early American economists: John Taylor (1753-1824), Daniel Raymond (1786-1849), William M. Gouge (1796-1863) and Amasa Walker (1799-1875). The story is intimately bound up with the disappointments of people (like founding fathers Thomas Jefferson and John Adams) who hoped the United States would eventually become a New World of justice, equity and peace. The story of how ‘English banking’ turned it instead into a corrupt plutocracy will be the subject of the next chapter.



[1] Projectors was people who took up (often wild) schemes to make themselves rich.

[2] Charles Wilson, England’s Apprenticeship p.316 and Patrick Brantlinger, Fictions of State p.57.

[3] David Nokes, Raillery and Rage.

[4] I, vi, 39: the actual quote is ‘honesty hath no fence against superior cunning.’

[5] Defoe had previously been in favour of credit; in his eyes she was a lady bountiful whose virtue was easily compromised. Many of the quotes in this paragraph are taken from Fictions of State by Patrick Brantlinger and Writing and the Rise of Finance by Colin Nicholson.

[6] ‘There began for the English stage a melancholy epoch of over a hundred years of sterility, which was broken only by the comedies of Sheridan and Goldsmith.’ (Noel Annan, proposing a relaxation of the rules of censorship in Parliament. Hansard, 1966.) The censorship body set up by Walpole was abolished only in 1966.

[7] Epistle to Bathurst, II, 69-78; quoted in Patrick Brantlinger Fictions of State p.63.

[8] For instance: ‘They (workmen) may be brought to work on credit, and that is not practicable, unless the credit have a circulation, so as to supply the workman with necessaries; if that is supposed, then that credit is money and will have the same effects on home and foreign trade.’ Money & Trade Considered (1705) p. 21.

[9] In this way they could be seen as precursors of the 2008 crash, which was also set off by securitization of debt.

[10] Quoted by M.G. Buist in Britain and the Netherlands (1977) p. 124.

[11] Economists who continued to speak of justice and equity are still excluded from accepted ‘economic wisdom’. This makes their work hard to locate unless the writer is famous for another reason: – as a politician, perhaps, like Thomas Jefferson or John Adams; or as a banking historian (for instance William Goudge); or as the ‘first American economist’ (Daniel Raymond). Others, such as Amasa Walker (father not son) and William A. Berkey, one stumbles across only by chance.

[12] This was remarked on particularly by Americans such as Thomas Jefferson and John Taylor who were resisting the establishment of ‘English’ banking in the U.S. See Chapter Six.

[13] ‘All things bright and beautiful….’

[14]  So-called by Acton in ‘The History of Freedom in Christianity’ 1877.

[15] Civil Govt. (1690), bk. II. ch. v.

[16] Treatise on Civil Government (1690), bk. II. ch. v, 33.

[17] On Civil Government, Book II Chapter i para 3.

[18] Acton’s essay ‘The History of Freedom in Christianity’.

[19] The Original Right of the People of England, p. 19.

[20] The classic statement of this is Adam Smith’s description of a pin factory, which opens his magnum opus The Wealth of Nations.

[21] Previously, democracy and representation were thought of as opposites. For a history of this development, see In the Name of the People by Ivo Mosley (2013).

[22] Address to the National Convention, 5th February 1794. One of the first enactments of the French revolutionary government was the ‘Le Chapelier Law’ (1791) which banned associations of workers. See also ‘Notes on the Use of the Word “Democracy” 1789-1799’ by R. R. Palmer, Political Science Quarterly, Vol. 68, No. 2 (June 1953), pp. 203-226.

[23] See, for instance, Paul Mantoux, The Industrial Revolution in the Eighteenth Century (1961).

[24] De l’Esprit des Lois, Part 4 Book 22 Chapter 17.

[25] Wealth of Nations, Bk 5, Ch 3.

[26] Of Public Credit: II.IX.8 and II.IX.15.

[27] The foundation of the Bank of England ‘set a precedent for proposals to accord special privileges to those who lent their money to the State for the prosecution of war’ according to economic historian Ephraim Lipson (The Economic History of England Vol ii, p. 309).

[28] Various city-states had pioneered this integration of banking and debt; England was the first nation to formally legitimise it and make it ubiquitous and pervasive. Now, three centuries later, we see its full flowering. Not only does the money supply consist of debt which profits the rich at the expense of the productive. National debt also increases the wealth of the rich, creating assets (negotiable debt) for them as a class and charging the productive classes with interest and repayment. As many writers have pointed out, governments could create this money rather than borrow it.

[29] Brian Bonnyman, The Third Duke of Buccleuch and Adam Smith (2014).

[30] Many academic articles on Smith’s attitude to banks and banking are available by searching online: by, for instance, James A. Gherity, Maria Pia Paganelli, Nicholas A. Curott, Mathieu Carlson, Hugh Rockoff.

[31] ‘A particular banker lends among his customers his own promissory notes, to the extent, we shall suppose, of a hundred thousand pounds. As those notes serve all the purposes of money, his debtors pay him the same interest as if he had lent them so much money.’ Therefore, banking operations mean that ‘twenty thousand pounds in gold and silver perform all the functions which a hundred thousand could otherwise have performed.’ Wealth of Nations II, ii.

[32] ‘It is not by augmenting the capital of the country, but by rendering a greater part of that capital active and productive than would otherwise be so, that the most judicious operations of banking can increase the industry of the country.’ Wealth of Nations II, ii.

[33] ‘It were better, perhaps, that no bank notes were issued in any part of the kingdom for a smaller sum than five pounds.’ Wealth of Nations II, ii. Five pounds was then a large sum of money.

[34] Wealth of Nations II, ii.

[35] ‘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 Daedalian 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.’ Wealth of Nations II.ii.86.

[36] Wealth of Nations II, ii.

[37] ‘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.’ (Wealth of Nations II, ii). Smith proposes two regulations: no small-denomination bank-notes, and enforced conversion of bank-notes into valuable gold and silver upon demand.

[38] Wealth of Nations IV, iii, i: ‘Digression on the Bank of Amsterdam’.

[39] It is common today to assert that this was only noticed early in the Twentieth Century. In fact, see chapters one and two of this book for a great deal of evidence to the contrary.

[40] Morgan Ricks, The Money Problem (2016) pp. 230-2.

[41] Wealth of Nations Book 1 Chapter XI.

[42] Smith never underestimates stupidity and malevolence in the ruling class. ‘All for ourselves, and nothing for other people, seems, in every age of the world, to have been the vile maxim of the masters of mankind.’ (Wealth of Nations III, iv). Nor did he want profit-takers to displace the old order: ‘The violence and injustice of the rulers of mankind is an ancient evil, for which, I am afraid, the nature of human affairs can scarce admit of a remedy. But the mean rapacity, the monopolizing spirit of merchants and manufacturers, who neither are, nor ought to be, the rulers of mankind, though it cannot perhaps be corrected may very easily be prevented from disturbing the tranquillity of anybody but themselves.’ (Wealth of Nations IV, iii, part ii).

[43] See his Conclusion to Book 1, Chapter 11. Profit-takers are an order of men ‘whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it.’ Profit-takers are not subject to Smith’s famous ‘invisible hand’ (which makes the butcher supply good meat because his customers will come again) because they have no connection with those they profit from.

[44] Lectures on Justice, Police, Revenue and Arms (1763).

[45] ‘the judicious operations of banking enable him (a trader) to convert this dead stock (cash) into active and productive stock; into materials to work upon, into tools to work with, and into provisions and subsistence to work for; into stock which produces something both to himself and to his country. Wealth of Nations, II, ii.

[46] Written by Freeman Tilden in 1935, but just as relevant eighty-some years on.

[47] For the ‘enterprise state’ in relation to freedom and civil society, see Michael Oakeshott, On Human Conduct; also, with specific reference to economics, his essay The Political Economy of Freedom.

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