Money and Mercantilism, Economic Mercantilism

Adam Smith devoted nearly two hundred pages of Wealth of Nations to a harsh and only partly justifiable criticism of mercantilistic theory and practice, particu­larly its equating of the wealth of a nation with the stock of precious metals internally held. Early mercantilists were very impressed with the significance of the tremendous flow of precious metals into Europe, particularly into Spain, from the New World. However, later mercantilists did not subscribe to this view and were able to develop useful analytical insights into the role of money in an economy. The relationship between the quantity of money and the general level of prices was recognized as early as 1569 by the Frenchman Jean Bodin. He offered five reasons for the rise in the general level of prices in Western Europe during the sixteenth century, the most important being the increase in the quantity of gold and silver there resulting from the discovery of the New World.

Nonetheless, in the early 1500s there was little comprehension of the conse­quences of trade balances between nations and almost no understanding of the consequences of increases in the money supply. By the middle of the eighteenth century, however, considerable analytical progress had been made in under­standing these issues. During the intervening period, there was a fairly steady increase of analytical insight into the operation of a market economy. Develop­ment during the period from 1660 to 1776 was particularly noteworthy.

A central feature of mercantilist literature is its conviction that monetary factors, rather than real factors, are the chief determinants of economic activity and growth. Mercantilists maintained that an adequate supply of money is particularly essential to the growth of trade, both domestic and international. Changes in the quantity of money, they believed, generate changes in the level of real output—in yards of cloth and bushels of grain.

All this would change with the advent of Adam Smith and classical economics, which would contend that the level of economic activity and its rate of growth depend upon a number of real factors: the quantity of labor, natural resources, capital goods, and the institutional structure. Any changes in the quantity of money, classical economists averred, would influence the level of neither output nor growth, but only the general level of prices.