12. The Founding Father of Modern Economics: Richard Cantillon

0:00Chapter 12, The Founding Father of Modern Economics, Richard Cantillon Most people, economists and laymen alike, think that economists sprang full-blown, so to speak, from the head of Adam Smith in the late 18th century. What has become known as the first or classical period of modern economic thought then developed, out of Smith, through David Ricardo, including an aggregative approach and a cost of production or even a labor theory of value? We now know, however, that this account is flatly incorrect, for modern economic thought, that is, analysis centering on explaining the market economy, developed a half-century before Smith's wealth of nations, not in Britain, but in France.

1:00More significantly, the French writers, despite their diversity, must be set down not as pre-Ricardian, but as proto-Austrian, that is, forerunners of the individualistic, micro, deductive and subjective value approach that originated in Vienna in the 1870s. 1. Catiole the Man The honor of being called the father of modern economics belongs then not to its usual recipient, Adam Smith, but to a gallicized Irish merchant, banker and adventurer who wrote the first treatise on economics more than four decades before the publication of The Wealth of Nations.

1:48Richard Cantillon, circa early 1680s to 1734, is one of the most fascinating characters in the history of social or economic thought. Little is known about Cantillon's life despite the fact that he died a multimillionaire, but the best modern researches show that he was born in Ireland in County Kerry of a family of Irish-landed gentry who had been dispossessed by the depredations of the English Puritan invader Oliver Cromwell. Cantillon's first cousin, once removed, also named Richard, emigrated to Paris to become a successful banker, thereby perpetuating the tradition, born in the 16th century, of religio-political exiles from Britain emigrating to France. The Cantillon's were part of the The Catholic Emigration, centering by the end of the 17th century around the Stuart Pretender to the throne of Great Britain.

2:52Richard Cantillon joined the emigration to Paris in 1714, quickly becoming the chief assistant to his cousin at the latter's bank. Moreover, Richard's mother's uncle, Sir Daniel Arthur, was a prominent banker in London and and Paris, and Arthur had named Richard's cousin as the Paris correspondent of his London-based bank. In two years, Catillon was in a position to buy his cousin's ownership of the bank. Richard Catillon was now in the important position of banker for the Stuart Court in exile as well as for the bulk of the British and Irish emigres in Paris, but his most important Koo came from his association with the Scottish adventurer and arch-inflationist John Law, 1671-1729, who had captured the imagination and the greed of the regent of France.

3:53The death of the aged Louis XIV in 1715 had inaugurated a looser and more optimistic regime, The control of which had been seized by the regent, the duke of Orléans. John Law persuaded the regent that France could find permanent prosperity and need have no further worries about the public debt. The French government need only finance heavy deficits by a massive infusion of the relatively new device of government paper money. Becoming the leading financier of the French government, and even controller general of the finances of France, Law set loose a rampant inflation that generated the wildly speculative Mississippi Bubble, 1717-1720.

4:45The bubble created instant millionaires before it collapsed, leaving John Law in poverty and disgrace. Indeed, the very word millionaire was coined during the heady years of the Mississippi bubble. But when the dust had settled, the shrewd Richard Cantillon emerged after being a top partner in John Law's Mississippi speculations as a multimillionaire. Legend has it that at the beginning of his meteoric career running French finances, John One law had come to Catillon and warned him that if we were in England we would have to strike a deal and settle matters, but as we are in France I can send you this evening to the Bastille if you do not give me your word to leave the kingdom within 24 hours.

5:37To which Catillon is supposed to have replied, Hold on, I will not go and I will make your system succeed. In any case, we know that Law, Cantillon and the English speculator Joseph Edward Beau Gage formed a private company in November 1718. Gage was so wealthy from paper speculation in Law's government-sponsored paper-issue bank, the Mississippi Company, that he seriously attempted in this period to purchase the Kingdom of Poland from its king, Augustus. As the Mississippi bubble careened onward, Catillon, an astute analyst of monetary affairs, saw deeply that the bubble was bound to burst soon, and he took steps to make millions out of the foolishness of his partners and clients.

6:32Lending money to Gage and others with which to buy inflated Mississippi Company shares, Catillon quietly sold all of his own shares, as well as the inflated shares that his borrowers After Gage and the other Cantillon clients went broke in the 1720 crash, Cantillon pursued them to repay his loans, for which they had been happy to pay a rate of interest up to Richard Catillon returned to Paris, a multimillionaire, albeit unpopular with his former associates and debtors.

7:29Soon he married Mary Anne, daughter of the late Count Daniel O'Mahony, an Irish general. His mother-in-law, Charlotte Bulkley, was the sister-in-law of James Fitz-James, the The Duke of Berwick, Marshal of France, and the natural son of the English King James II. He was, therefore, the Stuart Pretender, James III. Catillon thus married into an Irish military family, closely connected with the Stuarts and with the French court. At some time during the early 1730s, probably around 1730, This successful banker and speculator wrote his great work in French, the Essai sur la nature du commerce en general.

8:21In the fashion of the day, the result of the censorship of that era, this treatise was not published, but circulated widely in manuscript, in literary and intellectual circles, until it was finally published two decades later, in 1755. Richard Catillon's exit from this life was as mysterious and adventurous as his overall career. In May 1734, while living in London in one of his many houses in the leading cities of Europe, Catillon died in a fire that burned his house to the ground. It was subsequently found that he was murdered inside the house, the fire being presumably set to cover the murder.

9:07Three of his servants were tried for his murder and found not guilty, while his French cook, who had been dismissed three weeks earlier, fled overseas with a considerable amount of valuables. The runaway cook was never found. Earl Egmont, whose brother lived next door to Catillon, wrote in his diary that Catillon was a debauched man and his servants of bad reputation, and so ended, under highly mysterious Circumstances, the only leading economist in history who lost his life as a victim of murder. 2. Methodology. Richard Catillon's essay has been justly called by W. Stanley Jevons the first treatise on economics, and the historian of economic thought, Charles Gide, referred to it as the first systematic treatment of political economy.

10:07The best overall assessment is that of F. A. Hayek, the Austrian economist who has done important work in the history of thought. This gifted independent observer, enjoying an unsurpassed vantage point in the midst of the action, coordinated what he saw with the eyes of the born theoretician and was was the first person who succeeded in penetrating and presenting to us almost the entire field, which we now call economics. The scholastics had written general treatises on almost all of human knowledge, in which discussions of economics or the market played a subordinate part, and in the mercantilist era the mercantilists and their critics delivered at best intelligent aperçus on particular Economic, usually economic policy, topics.

11:02But Richard Catillon was the first theorist to demarcate an independent area of investigation, economics, and to write a general treatise on all its aspects. One reason that Catillon was the first of the moderns is that he emancipated economic economic analysis from its previous intertwining with ethical and political concerns. The mercantilists, dominant in economic thought for the preceding century or two, were special pleaders whose titbits of analysis were pressed into the service of political ends, either in subsidizing particular interests or in building up the power of the state. The Medieval and Renaissance scholastics, while incomparably more thoughtful and systematic, had embedded their economic analysis in a moral and theological framework.

11:59To break out of the mercantilist morass, it was necessary to step aside, to focus on the economic features of human action and to analyze them, abstracting them from other concerns, however important. Separating out economic analysis from ethics, politics, or even concrete economic data did not mean that these matters were unimportant or should never be brought back in, for it was impossible to decide the ethics of economic life, or what government should or should not do, without finding out how the market worked, or what the effect of interventions might be. Catillon, presumably, at least dimly, saw the need for this at least temporary emancipation of economic analysis.

12:53Furthermore, Catillon was one of the first to use such unique tools of economic abstraction as what Ludwig von Mises would later identify as the indispensable method of economic reasoning, the geduncan experiment, or thought experiment. Human life is not a laboratory where all variables can be kept fixed by the experimenter, who can then vary one in order to determine its effects. In human life, all factors, including human action, are variable and nothing remains constant. But the theorist can analyze cause and effect relations by substituting mental abstractions for laboratory experiment.

13:42We can hold variables fixed mentally, the method of assuming all other things equal, and then reason out the effects of allowing one variable to change. By starting with simple models and introducing successive complications as the simpler ones are analyzed, the economist can at last discover the nature and operations of the market economy in the real world. Thus, the economist can validly conclude from his analysis that all other things equal, Ceteris Paribus, and increase in demand will raise price. In the 1690s, as we have seen in Chapter 9, a leader of the emergent classical liberal opposition to the statism and mercantilism of Louis XIV, the provincial judge, the Sûre de Bois-Gilbert had introduced into economics the method of abstraction and successive approximations, beginning with the simplest model and proceeding in increasing complexity.

14:50In illustrating the nature and advantages of specialization and trade, Bois-Gilbert had begun with the simplest hypothetical exchange, two workers, one producing wool, the other Tweet, and then extended his analysis to a small town and, finally, to the entire world. Richard Catillon greatly developed this systematic method of abstractions and successive approximations. He liberally used the Ceteris Paribus method. Through this analytic method he uncovered natural cause and effect relations in the market economy. The France of Cantillon's day was a country of great landed feudal estates, the result of the conquests of previous centuries.

15:41And so, Cantillon brilliantly began the economic analysis in his essay with the assumption that the whole world consists of one giant estate. In that admittedly unrealistic but illuminating construct, all production is dependent on and the wishes, the desires of the monopoly owner, who simply tells everyone what to do. Put another way, production depends on demand, except that here there is in effect one demander, the monopoly landowner. Catillon then makes one simple realistic change in his model. The landowner has farmed out the land to various producers of all kinds.

16:29But as soon as that happens, the economy cannot continue with one man giving orders. For its continued operation, the individual producers must exchange their products, and a free market economy comes into being, with its attendant competition, trade and price system. Furthermore, money arises out of this exchange as a commodity serving as a much-needed medium of Exchange and Measure of Values 3. VALUE AND PRICE Catillon engaged in the first sophisticated modern analysis of market pricing, showing in detail how demand interacts with existing stock to form prices.

17:22In contrast to the later Smith-Ricardo classicists and foreshadowing the Austrians, Cantillon was largely interested in price formation in the real world, that is, actual market prices, rather than in the chimera of long-run normal pricing. In an important recent interchange on Cantillon, Professor Vincent Tarascio interprets him This was the Smith-Ricardo theory of equilibrium pricing, which has been basically expanded into Walrassian General Equilibrium Theory.

18:20But while there are passages in Cantillon justifying this approach, and the term intrinsic value is certainly an unfortunate one, Professor David O. Mahoney, in a perceptive comment on the Tarascio article, points out that Cantillon's approach was in reality pre-Austrian. First, O. Mahoney shows that Cantillon's market price analysis was the Austrian one of a given existing stock of a good evaluated and demanded by consumers. Quoting from Cantillon, it is clear that the quantity of product or of merchandise offered for sale in proportion to the demand or number of buyers is the basis on which is fixed or Demand, in turn, is subjective, dependent on humours, fancies, mode of living, etc.

19:24These subjective valuations are what impart value to the products offered for sale. It is the consent of mankind, says Cantillon, which gives value to lace, linen, fine cloths, Power and Other Metals. For Cartillon, actual market prices are determined by demand. It often happens that many things which actually have this intrinsic value are not sold in the market at that value. That will depend on the humours and fancies of men and on their consumption. Thus the value of products is imparted by consumer valuation, a crucial Proto-Austrian insight derived from medieval and late Spanish scholastics.

20:15For centuries, in fact, the scholastic and post-scholastic position had been that the value of goods is determined by utility and scarcity, by subjective valuation of a given supply. The more utility, the higher the value, and the more abundant the supply, the lower the value and price of any good on the market. Catillon's is a sophisticated and elaborated development of the scholastic approach. While Catillon considers the intrinsic value of a thing, the measure of the land and labor Going into detail on intrinsic value, Catillon refers to the hypothetical case of an American who travels to Europe to sell beaver skins for hats, but is then rightly astonished to to learn that woolen hats are as serviceable as those made of beaver, and that all the difference which causes so long a sea journey is in the fancy of those who think beaver hats lighter and more agreeable to the eye and the touch.

21:40In short, the entire cost of production, all the labor and effort that went into the production Production and transport of beaver skins means nothing unless the product satisfies the consumer enough to pay for the costs and to enable the product to compete with another commodity made more cheaply at home. It is consumer demand that determines sales as well as price. Omohony goes on to point out that Kantian's monopoly estate model clearly shows that demand, in this case that of the world monopoly landowner, and not cost of production determines price.

22:26Kantian, then, did not foreshadow the classical equilibrium theory that cost of production Constitution constituted the long run and, presumably therefore, the most important determinant of market price. On the contrary, for Cartillon, cost of production had a very different function, deciding whether a business could make profits or else have to suffer losses and go out of business. If consumer value and therefore the selling price of a product is high enough to more More than cover costs, the firm makes a profit. If not high enough, it suffers losses and eventually has to go out of business. This is an important part of the Austrian view of the role of costs. Thus Catillon discusses costs and prices in the manufacture of Brussels lace. If the price which the ladies pay for the lace does not cover all the costs and and Profits, there will be no encouragement for this manufacture, and the undertaker will cease to carry it on or become bankrupt.

23:41But as we have supposed this manufacture is continued, it is necessary that all costs be covered by the prices paid by the ladies of Paris. Hence the movement toward long-run equilibrium is not a process of adjusting market prices to Intrinsic Long-Run Costs of Production, but one of laborers and entrepreneurs moving in and out of various lines of production until costs of production and selling prices are equal. As O'Mahoney well puts it, for Catillon, then, it is not so much that intrinsic values In other words, it is the prices offered that determine what production costs can be incurred, not that production costs determine what the prices must be.

24:52Of course, there is a big gap, both in Cantillon's approach and that of the later Smith-Ricardo classicists, as well as of the modern Ricardian neo-classicists. Where do the costs of production come from? In contrast to the Cantillon and classical approach, they are neither intrinsic nor mandated from some mysterious force outside the economic system. Prices of production, as it took the Austrians to finally point out, are themselves determined by the expected consumer demand for goods and services. 4. Uncertainty and the Entrepreneur One of Cartillon's remarkable contributions to economic thought is that he was the first to stress and analyze the entrepreneur.

25:50To this real-world merchant, banker and speculator, it would have been inconceivable to fall into the Ricardian, Walrassian and neo-classical trap of assuming that the market is characterized by perfect knowledge and a static world of certainty. The real-world marketplace is permeated by uncertainty, and it is the function of the The businessman, the undertaker, the entrepreneur, to meet and bear that uncertainty by investing, paying expenses, and then hoping for a profitable return. Profits, then, are a reward for successful forecasting, for successful uncertainty-bearing in the process of production.

26:38The crucial Smithian, Ricardian and Walrassian classical and neo-classical assumption that the economy is perpetually in a state of long-run equilibrium, fatally rules out the real world of uncertainty. Instead, it focuses on a never-never land of no change, and hence of perfect certainty and perfect knowledge of present and future. Thus, Catillon divides producers in the market economy into two classes, hired people who receive fixed wages or fixed land rents, and entrepreneurs with non-fixed, uncertain returns. The farmer-entrepreneur bears the risk of fixed costs of production and of uncertain and Selling Prices, while the merchant or manufacturer pays similar fixed costs and relies on an uncertain return.

27:39Except for those who only sell their own labor, business entrepreneurs must lay out monies which, after they have done so, are fixed or given from their point of view. Since sales and selling prices are uncertain and not fixed, their business income becomes an uncertain residual. Catillon also sees that the pervasive uncertainty borne by the entrepreneurs is partly the consequence of a decentralized market. In a world of one monopoly owner, the owner himself decides upon prices and production, And there is little entrepreneurial uncertainty. But in the real world, the decentralized entrepreneurs face a great deal of uncertainty and must bear its risks.

28:33For Catillon, competition and entrepreneurship go hand in hand. As in the case of Frank Knight and the modern Austrians, Catillon's theory of entrepreneurship focuses on his function, his role as uncertainty-bearer in the market, rather than, as in the case of Joseph Schumpeter, on facets of his personality. Catillon's concept also anticipates von Mises and the modern Austrians in another respect. His entrepreneur performs not a disruptive, as in Schumpeter, but an equilibrating function. That is, by successfully forecasting and investing resources in the future, the entrepreneur helps adjust and balance supply and demand in the various markets.

29:26Professor Tarascio points out that Catillon's pioneering insight into the pervasive uncertainty of the market was largely forgotten, and before long dropped out of economic thought until People independently resurrected in the 20th century by night and by such modern Austrians as Ludwig von Mises and F. A. Hayek. But as Professor O. Mahoney wryly comments, to acknowledge his, Kantian's, recognition of uncertainty when we look at him as Professor Tarascio does from a current perspective, is thus more of a reflection on many modern economists whose capacity to ignore uncertainty is nothing short of bizarre than a tribute to Catillon's prescience.

30:18Bizarre it may well be, but there is a method to the madness. For as Professor O'Mahony himself understands full well, modern economics is a set of formal Formal Models and Equations purporting to fully determine human behaviour, at least in the economic realm. And there is no way that uncertainty can be compressed into determinate mathematical models. As O'Mahoney puts it, one might ask if entrepreneurial activity can in the nature of things be made the subject of formal representations or models at all. If they could, would there be any room for uncertainty in the true sense of the term, and therefore any room for entrepreneurship itself?

31:10Economic theory, in short, must choose between formally elegant but false and distorting mathematical models and the literary analysis of real human life itself. 5. Population Theory Richard Catillon's theory of wages is dependent on population in a way that was copied almost word-for-word by Adam Smith in The Wealth of Nations, which in turn inspired Malthus' famous anti-populationist hysteria. Catillon's long-run wage theory depends on the supply of Labor, which in turn depends on levels and growth of population.

32:00In contrast to the later Malthus, however, Cantillon engaged in a sophisticated analysis of the determinants of population growth. Natural resources, cultural factors, and the state of technology, he diagnosed as particularly important. He saw prophetically that the colonization of North America would not be a simple displacement of one people by another, but that new agricultural technology would support a far larger population per acre of land. Hence the extent to which existing resources, land and labor can be utilized depends on the existing state of technology.

32:45This pre-colonial North America was not over-populated by Indians, as some had believed. Instead, the Indian population level had adjusted to the given resources and technology available. In short, Catillon foreshadowed the modern theory of optimum population, in which the size of population tends to adjust to the most productive level given the resources Tools and Technology Available. While Catillon described a pre-Malthusian alleged tendency of human beings to multiply like rats in a barn, without limit, he also recognized that religious and cultural values can modify such tendencies.

33:35An increase in the demand for agricultural products that are land-intensive would tend to reduce the demand for agricultural labor, and eventually cause a fall in the supply of such labor, and hence of the population as a whole. Catillon, it must be remembered, was writing in an age when the overwhelming bulk of the population was engaged in agriculture. An increase in the demand for labor-intensive farm products, on the other hand, would bring Talking about an increase in the demand for labor, and hence of the population. Living once again in a country and an era of large feudal landed estates, Catillon observed that it was the tastes of the proprietary classes that determined the consumer tastes and values of society, and hence the demand for products.

34:32It should be noted that in an unusually sophisticated way, Catillon pointed out that it was outside the scope of economic analysis to decide whether it is better to have a large population of poorer people or a smaller population of people who enjoy a higher standard of living. That must be for the values of the citizenry to decide. Professor Tarascio points out that Cantillon's population analysis was far more subtle and modern than that of Smith, Ricardo or Malthus. Rather than worry about a future unchecked population explosion, Cantillon's theoretical framework accounted for the current cultural change to smaller families in industrialized countries, as well as the likelihood that Population will adjust itself downward to any future depletion of resources.

35:34Catillon pointed out, for example, that as ancient civilizations declined, their population size declined along with them. The number of inhabitants of the Roman state in Italy, for example, declined from 25 million Richard Catillon was also the founder of Spatial Economies, of the analysis of economic activity in relation to geographical space. In a sense, of course, mercantilists, by advocating a favorable balance of geographical Spatial trade analyzed, even if badly, economic activities to the extent that they crossed national borders.

36:29Spatial analysis, as Professor Hebert has pointed out, deals with distance, transportation cost and its relation to prices as well as to the location of economic activities, and area, the geographical development and boundaries of markets. Catillon not only developed location theory but integrated it into his general microeconomic analysis. In particular, he saw that the prices of produce, even when money and monetary prices were in equilibrium, would always be higher in the cities than in their place of production by an amount needed to cover the costs and risks of transport.

37:16In consequence, products that are bulky and or perishable would be too costly or impossible to transport to the cities, and hence would be far cheaper at their places of production. Such products, then, would generally be grown in border areas around the cities, where the transport costs to the urban markets are not prohibitive. In manufacturing, furthermore, Catillon saw that in cases where plants have to use bulky, low value per unit weight raw materials, they would tend to locate near the output of such materials. For in that case, it would be less costly to transport the less bulky, more valuable finished products to urban markets than to ship the raw materials.

38:09In the location of areas of urban markets, Catillol was highly suggestive, pointing out that it is far less costly for buyers and sellers to gather at one spot than to travel around the periphery seeking each other out and finding out the various prices that buyers were willing to pay or sellers were willing to accept. In modern terms, Catillon might say that central markets develop naturally because they enormously lower the transaction, transport, information and other costs of trade. While Catillon therefore saw how markets and the location of economic activity were able to regulate themselves harmoniously, he was not a consistent free trader internally, just Money and Process Analysis A highlight of Cantillon's theory of money is his treatment of the value of money as a as a special case of the value of market commodities in general.

39:36As in the case of any product, the alleged intrinsic value of gold is the cost of its production. The value of gold and silver, like other commodities, is set by the values and hence the demands of users in the market, by the consent of mankind. As in the case of other commodities, too, Cantillon has no cost of production theory of the value of gold and silver. He simply holds, as elsewhere, that these products can only be produced if costs can be covered by the value of the product. The process of aligning costs and values in gold, however, takes a relatively long time, Since its annual output is a small proportion of the total stock in existence, if the nominal value of gold falls below its cost of production, it will cease being mined.

40:36And if costs fall sharply, production of gold will be stepped up, thus tending to align costs and normal values. All recognize that government paper and bank money virtually have no costs of production, and therefore no intrinsic value in his terminology. But he pointed out that market forces keep the value of such fiduciary money at par with the value of the gold or silver in which that paper can be redeemed. As a consequence, an increase in the supply of fictitious or imaginary money has the same effect as increase in the circulation of real money.

41:22But, Catillon noted, let confidence in the money be damaged and monetary disorder issues and the fictitious money collapses. He pointed out, too, that government is particularly subject to the temptation to print fictitious Money, a lesson he had undoubtedly learned from, or at least seen embodied in, the John Law experiment. Catillon also provided a sound analysis of how the market determines the ratio of the values of gold and silver. One of the superb features of Catillon's essay is that he was the first in a pre-Austrian and Analysis to understand that money enters the economy as a step-by-step process and hence does not simply increase or raise prices in a homogeneous aggregate.

42:19Hence he criticized John Locke's Naive Quantity Theory of Money, a theory still basically followed by monetarist and neoclassical economists alike, which holds that a change in the total The actual supply of money causes only a uniform proportionate change in all prices. In short, an increased money supply is not supposed to cause changes in the relative prices of the various goods. Thus Cantillon, asking, in what way and in what proportion the increase of money raises In general, an increase of actual money causes in a state a corresponding increase of consumption, which gradually brings about increased prices.

43:14If the increase of actual money comes from mines of gold and silver in the state, the owner of these mines, the adventurers, the smelters, the refiners, and all the other where workers will increase their expenses in proportion to their gains, they will consume more commodities, they will consequently give employment to several mechanics who had not so much to do before, and who for the same reason will increase their expenses. All this increase of expense in meat, wine, wool, etc., diminishes the share of the other Other Inhabitants of the State who do not participate at first in the wealth of the minds in question.

44:02The alteration of the market, or the demand for meat, wine, wool, etc., being more intense than usual, will not fail to raise their prices. These high prices will determine the farmers to employ more land to produce them in another year. These same farmers will profit by this rise of prices and will increase the expenditure of their families like the others. Those then who will suffer from this dearness and increased consumption will be first of all the landowners during the term of their leases, then their domestic servants and all the workmen or fixed wage earners who support the families on their wages.

44:48All these must diminish their expenditure in proportion to the new consumption. It is thus approximately that a considerable increase of money from the mines increases consumption. In short, the early receivers of the new money will increase spending according to their preferences, raising prices in these goods at the expense of a lower standard of living among the late Receivers of the New Money, or among those on fixed incomes who don't receive the new money at all. Furthermore, relative prices will be changed in the course of the general price rise, since the increased spending is directed more or less to certain kinds of products or merchandise according to the idea of those who acquire the money, and market prices will rise more for certain things than for others. Moreover, the overall price rise will not necessarily be proportionate to the increase in the supply of money. Specifically, since those who receive new money will scarcely do so in the same proportion as their previous cash balances, Catillol summed up his insights splendidly, while hinting at the important truth that

46:27economic laws are qualitative but not quantitative. An increase of money circulating in a state always causes there an increase of consumption and a higher standard of expenses. But the dearness caused by this money does not affect equally all the kinds of products and merchandise proportionably to the quantity of money, unless what is added continues in the same circulation as the money before. That is to say, unless those who offered in the market one ounce of silver be the same and only ones who now offer two ounces when the amount of money in circulation is doubled in quantity, and that is hardly ever the case.

47:17I conceive that when a large surplus of money is brought into a state, the new money gives a new turn to consumption and even a new speed to circulation, but it is not possible to say exactly to what extent. Not only that, but as Professor Hebert has pointed out, Cantillon also provided a remarkable proto-Austrian analysis of the different effects of the money going into consumption or investment. If the new funds are spent on consumer goods, then goods will be purchased according to the inclination of those who acquire the money, so that the prices of those goods will be driven up and relative prices necessarily changed.

48:07If in contrast, the increased money comes first into the hands of lenders, they will increase the supply of credit and temporarily lower the rate of interest, thereby increasing Banking Investment. Repudiating the common superficial view brought back to economics in the 20th century by John Maynard Keynes that interest is purely a monetary phenomenon, Catillon held that the rate of interest is determined by the number and interactions of lenders and borrowers, just as the prices of particular goods are determined by the interaction of buyers and sellers. Thomas Cartillon pointed out that, if the abundance of money in a state comes into the hands of moneylenders, it will doubtless bring about the current rate of interest by increasing the number of moneylenders.

49:03But if it comes into the hands of those who spend, it will have quite the opposite effect, and will raise the rate of interest by increasing the number of entrepreneurs who will find activity by this increased spending and who will need to borrow in order to extend their enterprise to every class of customers. An increased supply of money, therefore, can either lower or raise interest rates temporarily depending on who receives the new money, lenders or people who will be inspired by their new found wealth to borrow for new enterprises. In his analysis of expanding credit lowering the rate of interest, furthermore, Cartillan provides the first hints of the later Austrian theory of the business cycle.

49:56In addition, Cartillan presented the first sophisticated analysis of how the demand for money, or rather its inverse, the speed or velocity of circulation, affects the impact of money, and hence the movement of prices. As he put it, an acceleration or greater rapidity in circulation of money in exchange is equivalent to an increase of actual money up to a point. One of the reasons why prices do not change in exact proportion to a change in the quantity of money is alterations in velocity. A river which runs and winds about in its bed will not flow with double the speed when and the amount of water is doubled.

50:45Catillon also saw that the demand for cash balances will depend on the frequency of payments made in the society. As Monroe sums up Catillon's position, the longer the interval between payments, the larger are the sums which have to accumulate in the payer's hands and the more money is required in the country. If people save large sums, furthermore, they may have to keep money locked up for considerable periods. On the other hand, the development of more efficient clearing systems for debts, as well as of paper money, will economize on cash. The rapidity of circulation is increased by the practice of offsetting accounts between merchants and by the use of bankers and goldsmiths' notes.

51:38For these men do not keep an equivalent amount of money on hand. Catillon summed up his analysis of the interaction of quantity and velocity. According to the principles we have established, the quantity of money circulating in exchange fixes and determines the price of everything in a state, taking into account the rapidity or sluggishness of circulation. Cantillon also provided a masterful discussion of the relations between gold and silver and advocated freely fluctuating exchange rates between gold and silver, attacking any attempts, certainly any long-lived attempts, to fix the exchange rate between them.

52:26For such a rate is soon bound to vary from the market rate. Thus, Cantillon saw the problem in trying to maintain a bimetallic standard with fixed parities between two precious metals. All in all, we can understand Hayek's enthusiasm when he concludes that Cantillon's monetary theory constitutes without doubt the supreme achievement of a man who was the greatest 8.

53:12INTERNATIONAL MONETARY RELATIONS One of the most notable features, and certainly the one drawing the most attention from historians of Kantian's Extensive Monetary Theory was his pioneering analysis of the tendency towards international monetary equilibrium, or the specie flow price mechanism that has been generally attributed to the later writings of David Hume. Kantian applied his micro-analysis of changes of the money supply within a country to changes in the distribution of money between countries. For over two centuries, mercantilist writers and statesmen in Europe had advocated an increased supply of specie in a country as a means of building up state power, and they were increasingly clear that, short of having gold or silver mines, a nation could only increase its stock of money by having a favorable balance of trade.

54:16It was clear to the mercantilists that this was not a policy every nation could successfully pursue, for the favorable balances of trade of some nations would necessarily have to be offset by the unfavorable balances of others. In this disequilibrium situation it was every nation for itself, as each attempted to benefit at the Expense of Other Nations by Restrictionist and Warlike Policies. But there was a further problem in the background. Since most writers were at least roughly familiar with the quantity theory or supply-demand analysis of the value of money, an inner contradiction loomed.

55:01For if Nation A managed to acquire a favorable balance of trade and to accumulate specie, The increase of specie would raise prices in nation A, make the country's products uncompetitive in the world markets, and bring the favorable balance to an end. No one was more lucid about the problem of money and international payments than Cantillon. He pointed out that specie can either be acquired within a country by mining ore, or through subsidies, warfare, invisible payments, borrowing, or a favorable balance of trade with other countries. But then, in the cation process analysis, either the mine owners or the exporters would spend or lend the money.

55:54Part of the expenditure of the new money would surely be spent abroad, and furthermore the The increased stock of money would raise prices at home, making domestic goods less competitive. Exports would fall, and imports of cheaper foreign products would increase, and gold would flow out of the country, reversing the favorable balance of trade. In this way, Cantillon worked out an international monetary theory integrated with his domestic Analysis and was one of the first to work out a theory of international monetary equilibrium. For the world market managed to frustrate, at least in the long run, governmental attempts to intervene and secure favorable balances of trade.

56:45It should be noted further that Cantillon's analysis contained the basis of both major Richard Cantillon understood the grave inner contradiction of mercantilism, increased specie His unsatisfactory way out was to advise the king to hoard much of the increased stock, so as not to drive up prices.

57:37Unsatisfactory because money is meant to be spent eventually, and once spent, the dreaded price increase would willy-nilly take place. Prof. Salerno, however, has introduced a cautionary note in the Encomiums to Cantillon, pointing out that he has been called only a semi-equilibrium theorist, because he did not portray a satisfactory picture of what the equilibrium state would be like, and he did not think of the world economy as tending firmly towards equilibrium. As a result, Catillon did not present a theory of the international distribution of gold and silver in equilibrium.

58:24He thought of the economy instead as engaging in endless cycles of disequilibrium, rather than as tending towards equilibrium. 9. The Self-Regulation of the Market There is no point wasting time in fruitless speculation on whether or not Richard Cantillon was a mercantilist. Eighteenth-century writers did not group themselves into such categories. While he inconsistently suggested, in accordance with state-building notions of the age, that the king should amass treasure from a favorable balance of trade, the entire thrust of Cantillon's The world's work was in a free-trade, laissez-faire direction, for it was clear that mercantilist measures would ultimately be self-defeating.

59:21More important, Cantillon was the first to show in detail that all parts of the market economy fit together in a natural, self-regulative, equilibrating pattern, with existing supply Why and Demand determining prices and wages, and ultimately the pattern of production. Consumer values furthermore determined demand, with population adjusting to cultural and economic factors. The equilibrators of the economy were the entrepreneurs, who adjust to and cope with the all-pervasive uncertainty of the market. And if the market economy, despite the chaos it might seem to superficial observers, is really harmoniously self-regulating, then government intervention as such is either counterproductive or unnecessary.

1:00:20Particularly instructive is Catillon's attitude toward usury laws, that vexed question which which had at last brought unwarranted discredit on the entire economic analysis of the Medieval Renaissance Catholic scholastics. This shrewd merchant and banker saw that particular interest rates on the market are proportionate to the risks of default faced by the creditor. High interest is the result of high risk, not of exploitation or oppression. As Catillon wrote, all the merchants in a state are in the habit of lending merchandise or produce for a time to retailers and proportion the rate of their profit or interest to that of their risk.

1:01:09High rates of interest bring about only a small profit because of the high proportion of default on risky loans. Catillon observed, too, that the later Catholic scholastics had eventually, if reluctantly, agreed to allow high rates of interest for risky loans. Furthermore, there should be no imposed maximum on interest, since only the lenders and borrowers can determine their own fears and needs. For they would be hard put to find any certain limit, since the business depends in reality on the Fears of the Lenders and the Needs of the Borrowers. Finally, Cantillon saw that usury laws could only restrict credit and thereby drive up interest rates even further on the inevitable black markets.

1:02:04Hence, usury laws would not lower interest rates, but rather raise them, because the contracting parties, obedient to the force of competition or the current price settled by the Proportion of Lender or Borrowers will make secret bargains, and this legal constraint will only embarrass trade and raise the rate of interest instead of settling it. 10. Influence Richard Cantillon's pioneering essay was widely read and highly influential throughout the 18th century. It was widely read, as was the custom of the day, in underground manuscript form, by literary, scientific and intellectual people interested in the advance of thought and in the practical problems of the day.

1:03:01The wide reliance on such manuscripts resulted from the severe French censorship of that period. The essay then was widely read from its writing in the early 1730s, and still more so after after its publication in 1755. It was read eagerly and thoroughly by the first school of economists, the physiocrats, and by their great associate or fellow traveler, A. R. J. Turgot. In that cosmopolitan 18th century society where British and French intellectuals intermingled, the essay was certainly read and echoed by the eminent Scottish philosopher David Hume. has the honor of being one of the very few books cited by Hume's close friend Adam Smith, a man whose hyperdeveloped sense of his own originality prevented him from citing or recognizing many predecessors. Catillon was thus highly influential among continental and British economists until the After the publication of that work, however, the knowledge and influence of Cantillon fell prey to the general post-Smithian custom of ignoring any and every economist preceding Adam Smith.

1:04:27The general 19th century habit of obliterating knowledge of economists before Adam Smith committed grave injustice against earlier economists and gave rise to the erroneous, and still widely held, illusion that economic science sprang full-blown out of the head of one great man, much as Athena was supposed to have sprung, fully grown and fully armed from the brow of Zeus. But the most malignant aspect of this Smith worship is that the lost economists were in in many respects far sounder than Adam Smith, and in forgetting them, much of sound economics was lost for at least a century.

1:05:13In many ways, as we shall see, Adam Smith deflected economics, the economics of the continental tradition beginning with the medieval and later scholastics, and continuing through French and Italian writers of the eighteenth century, from a correct path, and on to a Smithian classical economics, as we have come to call it, was mired in aggregative analysis, cost of production, theory of value, static equilibrium states, artificial division into micro and macro, and an entire and erasure of pre-Smithian economics enabled Smithian classical economics to take hold and dominate economic thought for a hundred years.

1:06:08The marginal revolution of the 1870s, especially the Austrian theory beginning in that decade, in many ways returned economics to the proper individualistic, micro and subjective value Pre-Smithian Path on the European Continent. It is no accident that Cantillon himself was rediscovered in 1881 by the quasi-Austrian English marginal revolutionist W. Stanley Jevons, who was commendably eager to rediscover lost economists buried by the dominant Smith-Ricardo orthodoxy. But economics has unfortunately far from rid itself of the Smith-Ricardo baggage.

1:06:56The current revival of Austrian theory, and the increasing search for a way out of contemporary orthodoxy by many mainstream economists, is an attempt to complete the promise of the badly named marginal revolution, really an individualist-subjectivist revolution, and to complete the casting out of the classical British paradigm.