Thursday, October 6, 2011

Adam Smith on the Real Measure of Exchangeable Value

In my opinion, the only sound monetary policy is one that maintains a constant average price of work [kWh], such as electricity, by increasing or decreasing the amount of currency in circulation. The ability to arbitrarily print or remove currency from circulation would be taken away from private banks (i.e. the Federal Reserve.) In this post, I'd like to show that Adam Smith was perhaps one of the first people to realize that wealth can measured by the amount of labor (i.e. work) it can purchase. It is labor (i.e. work done by humans, animals, and power plants), and not gold or paper currency, that is the best way to measure the value a commodity.

In this post, I quote from Adam Smith's "The Wealth of Nations,"  while making a few changes to modernize Smith's words. The goal of this post is to show that Adam Smith was on the right track when he stated, "Labour is the real measure of exchangeable value." While quoting Adam Smith, I'll stop every so often to expand upon his thoughts by using brackets [ ], and to discuss what he's saying by replacing the term 'labour' with the term 'work', which has units of [kW-hr]. (Note: a work-based currency maintains a constant average price for purchasing electrical & mechanical work [kW-hrs].) By replacing the term 'labour' with the term 'work', we'll see that the real measure of exchangeable value is work. In Adam Smith's society, the main sources of work were: a) the wind, b) rivers, c) human labor and d) animal labor. In our society, the main sources of work are:  a) electricity and b) mechanical work in our vehicles. We generate different types of work and orders of magnitude more work globally today than back in 1776 when Smith's book was first published. But the idea that both work and the rate of return on work invested should be the measures of value is timeless.
 
And so, now we start with Chapter V of Book I of "An Inquiry into the Nature and Causes of the Wealth of Nations." (Note that the italics are subsection titles.)

Ch V. Of the Real and Nominal Price of Commodities, or their Price in Labour and their Price in Money

Labour is the real measure of exchangeable value.  Every man is rich or poor according to the degree in which he can afford to enjoy the necessaries, conveniences, and amusements of human life. [Note: I disagree with Smith's last statement. He seems to be implying the wealth has something to do with happiness.] But after the division of labour has once thoroughly taken place, it is but a very small part of these with which a man's own labour [work in kWh] can supply him. The greater part of them he must derive from the labour of other people [or machines], and he must be rich or poor according to the quantity of that labour [work in kWh] which he can command, or which he can afford to purchase. [Now Smith is back on track. A person is rich according to how much labour he or she can purchase.] The value of any commodity, therefore, to the person who possesses it, and who means not to use or consume it himself, but to exchange it for other commodities, is equal to the quantity of labour which it enables him to purchase or command. Labour, therefore, is the real measure of the exchangeable value of all commodities.


And the first price paid for all things.  The real price of everything, what everything really costs to the man who wants to acquire it, is the toil and trouble of acquiring it. What everything 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 himself, and which it can impose upon other people. What is bought with money or with goods is purchase 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. They contain the value of a certain quantity of labour which we exchange for what is supposed at the time to contain the value of an equal quantity. Labour was the first price, the original purchase-money that was paid for all things. It was not by gold or by silver, but by labour [i.e work], that all the wealth of the world was originally purchased; and its value, to those who possess it, and who want to exchange it for some new productions, is precisely equal to the quantity of labour which it can enable them to purchase or command. [And note that he is subtlety pointing out that gold and silver have nothing to do with the real measure of worth of an item.]

Wealth is power of purchasing labour. Wealth, as Mr. Hobbes says, is power. [Note: the units of this statement do not match. Wealth has units of [kWh] and power has units of [kW], but let's forget that for a second.] But the person who either acquires, or succeeds to a great fortune, does not necessarily acquire or succeed to any political power, either civil or military. His fortune may, perhaps, afford him the means of acquiring both, but the mere possession of that fortune does not necessarily convey to him either. The power which that possession immediately and directly conveys to him, is the power of purchasing; a certain command over all the labour, or over all the produce of labour which is then in the market. His fortune is greater or less, precisely in proportion to the extant of this power; or to the quantity either of other men's labour, or, what is the same thing, of the produce of other men's labour, which it enables him to purchase or command. The exchangeable value of every thing must always be precisely equal to the extent of this power which it conveys to its owner.  [Note: replace labour with work, and this paragraph will correctly account for work generated by human, animals, and machines. I don't like Smith's use of the word labour because it implies to me only the human forms of work, and potentially ignores the largest forms of work in our society...those from power plants and vehicles. Also, this paragraph  highlights the important facts that there is often more money in circulation than 'work' available for immediate use.]

But the value is not commonly estimated by labour, because labour is difficult to measure. But though labour be the real measure of the exchangeable value of all commodities, it is not that by which their value is commonly estimated. It is often difficult to ascertain the proportion between two different quantities of labour. The time spent in two different sorts of work will not always alone determine this proportion. The different degrees of hardship endured, and of ingenuity exercised, must likewise be taken into account. There may be more labour in an hour's hard work than in two hours easy business; or in an hour's application to a trade which it cost ten years labour to learn, than in a month's industry at an ordinary and obvious employment. But it is not easy to find any accurate measure either of hardship or ingenuity. In exchanging indeed the different productions of different sorts of labour for one another, some allowance is commonly made for both. It is adjusted, however, not by any accurate measure, but by higgling and bargaining of the market, according to that sort of rough equality which, though not exact, is sufficient for carrying on the business of common life. [Note: this paragraph, while rambling a bit, hits the nail on the head as far as realizing that there is a problem in defining wealth in terms of any quantity, such as labour or even mechanical and electrical work. The problem is that even electricity in an electricity-backed currency will cost more during the day than at night. Is there any perfect one-to-one correspondence between wealth and some measurable quantity? My own gut feeling is that there is no perfect one-to-one correspondence at the microscale, but at the macroscale, there should be an average one-to-one correspondence between wealth and the generation of electrical and mechanical work, i.e. a currency backed by work.]

And commodities are more frequently exchanged for other commodities. Every commodity besides, is more frequently exchanged for, and thereby compared with, other commodities than with labour. It is more natural therefore, to estimate its exchangeable value by the quantity of some other commodity than by that of the labour which it can purchase. The greater part of people too understand better what is meant by a quantity of a particular commodity, than by a quantity of labour. [This is a good point. It's often difficult to know how much labor went to both the product itself as well as the potential labor that can be purchased with the seller's profit. This is why we use dollars as the medium of exchange, and would continue to use dollars even in a society with an electricity-backed currency.]

But gold and silver vary in value... Gold and silver, however, like every other commodity, vary in their value, are sometimes cheaper and sometimes dearer, sometimes of easier and sometimes of more difficult to purchase. The quantity of labour which any particular quantity of them can purchase or command, or the quantity of other goods which it will exchange for, depends always upon the fertility or barrenness of the mines, which happen to be known about the time when such exchanges are made. [i.e. the price of gold and silver is a function of the expected ability to mine more of it in the future. This is one of the major problems with moving to a gold or silver backed currency. If we find a new deposit of gold or silver, we are forced to increase the amount of currency, however, there has been no increase in the amount of labour or electrical/mechanical work. This means that the introduction of the gold or silver would devalue the purchasing power of the dollar in terms of its only measurable quantity...work. As I've mentioned many times before, do not be mislead into thinking that returning to a gold or silver standard is a good thing. Gold and silver are just as arbitrary as a fiat currency. The only sound money policy is one that prints or removes currency from circulation to maintain an average price of work (electrical and mechanical work) a constant.] The discovery of the abundant mines of America reduced, in the sixteenth century, the value of gold and silver in Europe to about a third of what it had been before. As it cost less labour to bring those metals from the mine to the market [and all of the stolen gold and silver], so when they were brought thither, they could purchase or command less labour;...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.

Although the employer regards labour as varying in value. But though equal quantities of labour are always of equal value to the labourer, yet to the person who employs him they appear sometimes to be of greater and sometimes of smaller value. He purchases them with a greater and sometimes with a smaller quantity of goods, and to him the price of labour seems to vary like that of all other things. It appears to him dear in the one case, and cheap in the other case. In reality, it is the goods which are cheap in the one case, and dear in the other.  [I think that Adam Smith is headed in the right direction here, but I think that most of what he is saying can be summarized by...the labourer is paid based off of his capability to sell his abilities and hard work to an employer.]

So regarded, labour has a real and a nominal price. In this popular sense, therefore, labour, like commodities, may be said to have a real and a nominal price. Its real price may be said to consist in the quantity of the necessaries and conveniences of life which are given for it; its nominal price , the quantity of money. The labourer is rich or poor, is well or ill rewarded, in proportion to the real, not the nominal price of his labour. [Once again, the labourer is paid based off of his capability to sell his abilities and hard work to an employer, and this might have very little to do with the amount of work required to do the task for which he wants to be paid.]

...[I'm skipping over a few subsections here on using corn instead of money as a form of payment of rents, which is fascinating, especially given the fact that Donald Trump recently stated that he would accept gold as a form of rent payment in one of his office buildings.]...

So that labour is the only  universal standard.  Labour, therefore, it appears evidently, is the only universal, as well as the only accurate measure of value, or the only standard by which we can compare the values of different commodities at all times and at all places. We cannot estimate, it is allowed, the real value of different commodities from century to century by the quantity of silver which were given for them. We cannot estimate it from year to year by the quantity of corn. By the quantity of labour we can, with the greatest accuracy, estimate it both from century to century and from year to year.

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And so now, we see Adam Smith would probably agree that a currency that maintained the average price of work would be the most beneficial.
And what's great about Smith's analysis is that wealth is clearly not a constant with time. If wealth is equal to the amount of labour (work) that it can purchase, then we can see that wealth will grow both as society grows in size and as society develops more equipment to generate work, such as turbines, piston engines, solar cells, and fuel cells. And this leads us to the inevitable conclusion that society can only grow if its people and its equipment can generate a positive rate of return on labour (work) invested.

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