Our Adam Smith lesson for the day

Yes, he did favour maximum interest rates:

In The Wealth of Nations, Adam Smith often condemned \”projectors\”, as speculators were called in his own time. For example, he favoured a legally-imposed maximum interest rate of 5 per cent at a time when the market rate was about 4 per cent. If the legal rate of interest went up to 8 per cent, he said, then more money would be lent to \”prodigals and projectors\”, who alone would be willing to pay that much. \”Sober people\”, he argued, would only pay rates that would allow them to make a profit from solid ventures. Without a maximum of about 5 per cent money would be thrown into the hands of people who \”were most likely to waste and destroy it\”. With a legal maximum \”the capital of the country is thus thrown into the hands in which it is most likely to be employed with advantage.\”

We\’ve rather learnt that he was wrong though: for two reasons.

The projectors and speculators are right often enough that the capital of the country is employed with advantage. It\’s the insight that the entire venture capital indutry is built upon. And we could certainly argue that the consumer surplus from Google alone was worth the internet stock bubble (have to argue quite hard, yes, but it\’s possible).

But of much more importance to those who would set modern day usury laws: he\’s talking about real interest rates, not nominal. So you have to add inflation to his numbers.

And even more importantl;y, look at the rubble around us. Was this caused by people borrowing at too high interest rates? I think the general feeling is that interest rates were too low for too long, isn\’t it?

2 thoughts on “Our Adam Smith lesson for the day”

  1. Pingback: The French Physiocrats Institute « Bad Conscience

  2. Adam Smith also contradicts himself. Just before the quoted section he notes that the government can borrow at a lower rate than sober people of good rep, from memory the government could borrow at 3%, while “sober people” could borrow at 4%-4.5%. So clearly people were willing to lend to the government even though they could get a higher, non-risk adjusted, rate of return lending to “sober people”. Plausibly therefore the possibility of lending to non-sober people at 8% wouldn’t eliminate interest in lending to sober people at 4%, and we do observe that some investors prefer the low-risk sober option.

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