The lesson is thus clear: Welcome multiple banks of issue and make sure there is always full convertibility, and bankers will be prudent and the economy will be stable and prosperous. Today we do not have banks of issue and notes cannot be converted into gold and silver, yet Smith’s lesson still applies: competition is the most effective instrument to generate and guarantee prudence in banking.

What is wealth? How do we increase it? These are some of the questions Adam Smith asks in his Wealth of Nations ([1776] 1981) and in particular in Book II. Smith opens the Wealth of Nations explaining that wealth is a product of the improvement of the productive power of labor, which is to say of division of labor. He then continues explaining that division of labor is possible when there is enough capital to support it. So how do we have enough capital to develop, support, and promote a productive division of labor and thus economic growth? This is the topic of Book II.

Smith attributes the remarkable economic growth that Scotland experienced in the 18th century to the development of a vigorous banking system, made prudent through competition.

In the 18th century, banks are a bit controversial. Some believe that banks, by introducing paper money, increase the quantity of money in a country, thus making it richer. Others claim that banks make a country poorer instead, because paper money substitutes for gold and silver as a means of domestic payment, thus decreasing the quantity of gold and silver, thereby decreasing the country’s wealth. Smith differs. For Smith, banks do help an economy to grow richer (not poorer) by decreasing (not increasing) the quantity of gold and silver in the country!

Smith’s logic relies on economic forces and government regulations to generate the prudent financial conduct needed for stable growth.

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