Adam Smith and David Hume, possibly the two most prominent scholars of the Scottish Enlightenment, were close friends. Their intellectual friendship is celebrated as one of the most wonderful and exemplar friendships of the modern Western world (Rasmussen Reference Rasmussen2017). And, given the similarity of topics on which both thinkers wrote, the tendency has been to assume that the two friends thought in unison, either as teacher-follower or as intellectual equals (Phillipson Reference Phillipson2010). Yet friends do not have to copycat each other to be and stay friends. In recent years the differences between Hume and Smith have increasingly been brought to light (see Trincado Reference Trincado2019, among many). But one area in which friendship still overshadows differences is money.

Possibly the most famous statement that the friendship between Hume and Smith should have made them think alike comes from Jacob Viner (Reference Viner1937, p. 87). He thinks Smith’s not citing Hume’s work on money is a mystery:

I do not believe there is any mystery in Smith’s omission of Hume’s monetary thought. I suggest that Smith omits Hume’s monetary ideas because he thinks Hume is incorrect. Hume’s problem is that he leans too much toward mercantilism, in Smith’s view. What may be a mystery instead is how Viner read Smith’s account of Hume in the Lectures on Jurisprudence (hereinafter LJ) “approvingly.” These are Smith’s words describing Hume’s price-species flow mechanism in the Lectures: “Mr. Hume’s reasoning is exceedingly ingenious. He seems however to have gone a little into the notion that public opulence consists in money” (LJ Reference Smith1978, 253, p. 507).

For Smith, his Wealth of Nations 1776 [Reference Smith1981] (WN hereafter) was a “very violent attack … upon the whole commercial system of Great Britain” (Smith Reference Smith1987, p. 251)—it was a violent attack against the mercantile system. If indeed Smith thinks his friend fell into the mercantilist trap, it may be a very good reason to avoid using his model while violently attacking the system.

That Hume has mercantilist tendencies is not necessarily a new interpretation of Hume. As we just saw, Smith himself noted it. Among the most prominent later readers, we have John M. Keynes. A year before Viner’s stating of the alleged mystery, Keynes recognized that Hume was “still enough of a mercantilist” (Keynes [1936] Reference Keynes2018, p. 306n11). Keynes did not give any explanations for his claim. He limited himself to quoting a long paragraph from Hume’s essay Of Money, ending with the following words of Hume: “A nation, whose money decreases, is actually at that time, weaker and more miserable than another nation which possesses no more money but it is on the increasing trend” (Keynes [1936] Reference Keynes2018, p. 306n11). Decades later, Andrew Skinner (Reference Skinner, Norton and Taylor2008) hints at Hume’s possible mercantilist leanings as well. But Skinner refers instead to the idea shared by both Hume and other mercantilists that low wages would give an advantage to a country. Yet, Skinner does not elaborate further about how, for Hume, a country would achieve those beneficial low wages and his potential mercantilist leaning. On the other hand, Frank Petrella (Reference Petrella1968) explicitly tackles the problem Viner poses. He recognizes that Smith may think Hume is leaning toward mercantilism but then suggests that Smith does not use Hume’s theory because it would threaten Smith’s own system. Yet, Petrella sees the “brilliance of Hume’s analysis” (p. 374) and not the depth of the mercantilist ideas, as Smith instead does.

Smith, on the other hand, even if not always explicitly referring to Hume, seems to explain step by step the problems with Hume’s analysis. Accusing Hume of being a mercantilist today may sound controversial for several reasons: first, because the definition of mercantilism is ambiguous, to put it mildly; and, second, because Hume’s argument is generally presented as an argument against mercantilism. But here I do not wish to question Smith’s judgment. I would just offer a possible way to solve Viner’s mystery.

We know now that “mercantilism” is an ambiguous term, a sort of straw man. Adam Smith may possibly be the dominant source of creating the mercantilist straw man. Contra to Smith, mercantilism is not a systematic doctrine but rather a prism of positions loosely connected with each other, usually argued through hundreds of pamphlets (Viner Reference Viner1930; Magnusson Reference Magnusson1994, Reference Magnusson2015). The so-called mercantilists have a wide variety of contradicting policy prescriptions more or less aimed at increasing the power of a state via economic means. Money is seen as an instrument of state power, and thus an increase in money as an increase in this power. An increase in the quantity of money could be hoped for by concentrating on the direct accumulation of precious metals or by a favorable balance of trade. A favorable balance of trade could be achieved via prohibitions, restrictions, taxations, and all sorts of market interferences or artifices to increase international competitiveness, including monopolies and colonies. Trade is thought of as a zero-sum game, and low wages are generally thought of as an effective way to move the balance in one’s favor (Steiner Reference Steiner, Béraud and Faccarello1992). Despite all this, Smith presents mercantilism as an actual “system” (WN IV).

Hume gained a place of fame among monetary economists due to his explanation of how mercantilist policies fail to achieve their goals because of the quantity theory of money and the price-specie flow mechanism (e.g., among many, Berdell Reference Berdell1995, Reference Berdell1996; Friedman Reference Friedman1987; Lucas Reference Lucas1996; Perlman Reference Perlman1987; Vickers Reference Vickers1957). In the standard reading of Hume’s Of the Balance of Trade and Of Money, if one country somehow increases the quantity of its money above its natural level (a level proportioned to its industry), domestic prices will rise. This will make the country less competitive at the international level, giving people incentives to buy foreign goods, which are now cheaper. To pay for these increased imports, people will have to use money, so money will leave the country, returning to its natural level. The same thing happens in reverse. If a country artificially decreases the quantity of its money below its natural level, domestic prices will fall, making domestic products attractive to foreigners. Exports will increase, and the payment of these exports will bring the quantity of money back to its natural level ([1752] Reference Hume1985, pp. 311–312). Mercantilist policies are thus futile.

Traditionally this is seen as Hume’s greatest contribution to economics. He understands and emphasizes that trade is not a zero-sum game, and his reasoning proves the failure of the prohibitions that mercantilists believe would increase the quantity of gold and silver and thus the wealth of a country (Diatkine Reference Diatkine, Béraud and Faccarello1992).

Smith seems to agree with Hume, as both believe that the prohibition of the export of metals is not an effective way to keep precious metals in a country. But the similarities seem to end here. Hume uses the price-specie flow mechanism, with its unspecified time frame (Schabas Reference Schabas2001). Smith tells us instead that smuggling would prevail, given the high value and small size of precious metal (WN IV.1.13–14, pp. 436–437).

But both Of Money and Of the Balance of Trade have more to them than the price-specie flow mechanism, or, better, have applications of it that show, through that very mechanism, how it is possible to alter the quantity of money to a level different from its natural one. “There is indeed one expedient by which it is possible to sink, and another by which we may raise money beyond its natural level in any kingdom; but these cases, when examined, will be found to resolve into our general theory, and to bring additional authority to it” (Hume [1752] Reference Hume1985, p. 316).

It is these exceptions, proving the rule, that show the mercantilist side of Hume’s thinking, which Smith sees and criticizes. According to Hume, current policies fail to achieve their results. But if one understands the model that Hume shows, one can, through the working of these exceptions, achieve the wished-for results of accumulating money above its natural level: “Our modern politics embraces the only method of banishing money, the using of paper-credit; they reject the only method of amassing it, the practice of hoarding; and they adopt a hundred contrivances, which serve to no purpose but to check industry, and rob ourselves and our neighbours of the common benefits of art and nature” (Hume [1752] Reference Hume1985, p. 324).

In a sense, for Smith, Hume is a directionalist, to use an idea Michael Munger (Reference Munger2011) presented, although in a different context. A directionalist shares a goal but criticizes the means, as opposed to a destinationalist, who instead criticizes the goal as well as the means. A directionalist shares the destination but wants to get there by way of a different direction. A destinationalist wants to go to a different destination altogether. Hume criticizes the use of tariffs, trade barriers, monopolies, and colonies—the means. These means are ineffective to achieve the goal—the direction is not the correct one. But, for Smith, Hume shares the destination with mercantilists. The goal for mercantilists and for Hume is the same: the accumulation of precious metals. They just want to get there in different ways. Smith understands Hume’s argument and distances himself from it.

I put Hume’s two essays and the Wealth of Nations in dialogue with each other to show my point.

Hume starts Of Money by saying that money is irrelevant in a closed economy. But he does not stop there. He goes on to say that money becomes relevant in an open economy, because it is through the accumulation of gold and silver that a country can afford its military might.

Hume explains that, especially in rich countries, soldiers are expensive. It is thus cheaper and more effective to hire mercenaries from poorer neighbors. But soldiers need to be paid in gold and silver. So, the more precious metals a country has, the better off and the more powerful a country is.

Smith starts Book IV of the Wealth of Nations, the book that deals with the mercantile system, saying that mercantilists mistakenly think that precious metals are wealth. The mistake is so common and so alluring that even thinkers of the caliber of “Mr. Locke” fell for the trap of it (WN IV.i.3, p. 430). But what is relevant here is that also some unnamed “others” fell for the trap of it (WN IV.i.4, p. 430). These “others” say that in a closed economy money is irrelevant, but in an open economy we need to accumulate money. For these “other” thinkers, money is needed to finance foreign wars.

Smith explains that wars are not financed with gold and silver. Manufactures maintain fleets and armies instead. Sending abroad gold and silver accumulated in a country to pay for the military operations is ludicrous for Smith: “The whole gold and silver annually imported into both Spain and Portugal … would scarce have paid four months expense of the late war” (WN IV.1.28, p. 444).

To see the relevance of these claims, we need to go back to some less frequently quoted parts of Hume. After describing the price-specie flow mechanism, Hume tells us that there are two ways to short-circuit it: one is to increase money above its natural level, and one is to decrease it below its natural level. Money “will never heap up beyond its level, while it circulates” ([1752] Reference Hume1985, p. 324), Hume says. This means that the only way to effectively increase money above its natural level is to take some of it out of circulation. Indeed, Hume says, “the only expedient, by which we can raise money above it, is … locking them up, and absolutely preventing their circulation. The fluid, not communicating with the neighbouring element, may, by such artifice, be raised to what height we please” (p. 320).

By “annihilating” money, effectively reducing money supply, labor and prices would decrease. Decreasing prices would incentivize foreigners to buy domestic goods, so that more gold and silver would come in as payment. This would bring back money to the natural level. But if that money is also taken out of circulation, prices would remain low and the process would continue. Thus, the “good policy of the magistrate consists only in keeping it [money], if possible, still encreasing” (p. 288), because this is the way to increase industry and thus the quantity of money. But the only way to keep money still increasing is to take it out of circulation.

The good policy of the magistrate is, thus, to take money out of circulation, lock it up in the country’s treasure, or use it as private plate for home or church decoration. It has the double advantage of stimulating economic growth and increasing the military power of the country (Paganelli Reference Paganelli2007).

Let me unpack Hume’s logic a little more. Locking money in a treasure seems “destructive” (p. 320), but it results in having a lot of money in case of need. It has the additional advantage of lowering prices, which incentivizes industry. A treasure is the easiest and fastest way to accumulate money above its natural level. Hume gives several historical examples of this, but he is also aware that a large treasure may hold some risks. It can be dangerous for a small state because it may attract conquerors. It can be dangerous for a large state, too, because it may induce “ill-conceived projects” (p. 321). So Hume suggests a better policy, shared by some of his mercantilist predecessors and contemporaries: using money as private plate to take it out of circulation.

William Petty ([1664] Reference Petty1899, p. 193) in fact suggests: “There may be … too much money in a country … as to the best advantage of its trade; only the remedy is very easy, it may be soon turned into the magnificence of gold and silver vessels.” Jacob Vanderlint ([1734] Reference Vanderlint1914, pp. 93–94) recommends not only the use of plate but also of silver and gold cloth and garments:

I can’t pass over this Fact without remarking, that it must be beneficial to Trade, that our Princes, Nobility, and Gentry, should wear the richest Gold and Silver Cloathing, and use such Utensils, and adorn their Palaces and Houses with these shining Metals.… I am induced to make this Remark, from the Practice of the East-Indians, who, as I have often heard, carry this Matter so far, as to bury the Money they get by Trade.

Joseph Harris ([1757] Reference Harris1966, pp. 99–100) explains:

Let an increased stock of bullion get out again into trade, and it will soon turn the balance the other way [“to prevent its getting into trade as money,” it has to be stored up]. But people in general will not hoard up cash; all like to display their wealth, and to lay out other superfluity in some costly things. There seems then no method so effectual for the securing of dead stock of treasure in any country, as encouraging the use of plate, by making it fashionable, preferable to more brittle or more perishable commodities.

And Hume agrees. This is wise, if not the wisest policy, according to Hume.

Hume ([1752] Reference Hume1985) explains that the policy of banning CHINA-ware incentivizes the use of silver-ware. And that is a good policy.

He premises this claim saying that

Thus, Hume recommends to “lock money up” to take it out of circulation. He tells us that a country should accumulate precious metals to increase its military might and should do it through hoarding. And thus, for Hume, having such a large amount of hoarded money available is undisputably advantageous for both the economy and for the military of a country.

But Smith will dispute it. For Smith, Hume’s logic is a mercantile logic, given his insistence on the accumulation of precious metals. Smith seems to break down Hume’s argument to refute all its components, or at least he does break down what he considers mercantile arguments in Hume’s account. Smith explains that one country does not need gold and silver to pay for wars, and actually it cannot pay for wars with gold and silver even if it wanted to. Smith, like Hume, but more explicitly, explains that gold and silver in a country consist of circulating money, the plate of private families, and the treasure of the prince.

But, for Smith, one cannot take out of circulation the gold and silver used as money because usually that is what is used to exchange, and “[i]t can seldom happen that much can be spared from the circulating money of the country” (WN IV.i.23, p. 441). Melting private plate is insignificant. Families may have a lot of gold and silver artifacts but not enough to finance a war. Just like Hume, Smith mentioned France’s attempt to finance the last war through the melting of private plate, but, Smith claims, France “did not derive so much advantage from this expedient as to compensate the loss of the fashion” (WN IV.i.24, p. 441). The treasure of the prince may have worked in the past, but “in the present times … to accumulate treasure seems to be no part of the policy of European princes” (WN IV.i.25, p. 441). The expenses of war are enormous. The last war that Britain fought cost three times the amount of gold and silver present in Britain!

Smith believes wars are paid with manufactures instead. Merchants sell goods in foreign countries and are paid with foreign bills. The government buys the foreign bills from merchants and uses them to pay for provisions for troops abroad. That is how wars are financed, not with gold or silver (WN IV.i.27–29, pp. 443–444). Hume is mistaken. What about burying money in the ground, the extreme version of “lock it up”? Smith claims it is “perfectly crazy” (WN II.ii.30, p. 285). The only circumstance under which it is not nonsense, for Smith, is if there is significant violence.

So one of Hume’s preferred policies is hoarding. Smith seems to answer: it is “perfectly crazy.” What about the other side of the coin? Hume’s mercantilist logic can be seen in reverse, too, when he laments a decrease in money. Smith seems to reply to it, too.

If Hume prescribes hoarding as a way to increase money and thus the military might of a country, he also condemns paper money as a way to decrease money and thus a sure way to the destruction of a country: “I scarcely know any method of sinking money below its level, but those institutions of banks, funds, and paper-credit, which are so much practiced in the kingdom” ([1752] Reference Hume1985, p. 316). Hume’s logic is the following. Paper money is “counterfeit money, which foreigners will not accept of in any payment” (p. 284). When paper money is introduced domestically, prices and wages will rise, people will buy the now cheaper foreign goods, and gold and silver will go abroad to pay for those imports. At home, one is left with a decreased industry and a bunch of paper, which will be useless in a war.

For Hume, there is no better way to decrease money supply (read: gold and silver) in a country than banking and its paper money. Hume even jokes that Lycurgus should have used paper, not iron, to make sure there would be no gold or silver in Sparta, because paper money is the most effective way to make gold and silver disappear. “What a pity LYCURGUS did not think of paper-credit, when he wanted to banish gold and silver from Sparta!” (p. 318), he tells us.

Hume goes as far as proposing the abolition of all banks and substituting them with one public bank with 100% reserves, so that it would be impossible to increase money supply with paper (Paganelli Reference Paganelli2014):

Paper credit, both private and public, is therefore a threat for a nation. By increasing prices, it contracts the country’s industry by making a country less competitive internationally, and, more worrisomely, it will destroy its military might and capacity to defend itself in wars (Paganelli Reference Paganelli2012).

And what does Smith do? This time, Smith calls out Hume by name. Hume attributed high prices to the presence of banks and paper money. Smith replies that the high prices were actually caused by bad weather: “In 1751 and in 1752, when Mr. Hume published his Political Discourses, and soon after the great multiplication of paper money in Scotland, there was a very sensible rise in the price of provisions, owing, probably, to the badness of the seasons, and not to the multiplication of paper money” (WN II.ii.96, p. 325).

And the contraction of the economy that allegedly followed the introduction of paper money and its necessary increase in prices and decrease in competitiveness? Smith again answers loud and clear: “That the trade and industry of Scotland, however, have increased very considerably during this period, and that the banks have contributed a good deal to this increase, cannot be doubted” (WN II.ii.41, p. 297)

This is the exact opposite of Hume’s catastrophic fears. Hume’s price-specie flow mechanisms, when seen as a mercantilist tool to artificially increase money in a country, implies the banning of all banks and all credit, with the establishment of a sole public bank of deposit, with 100% reserves. Smith sees through this. He sees the benefits of a functioning banking system and healthy credit market instead. A competitive system of private banks of issue is instead, for Smith, a source of stability and increased wealth.

Indeed, for Smith, the introduction of paper money has no effect on the price level. Paper simply substitutes metals as a medium of exchange. The metals used previously as domestic currency seek a more profitable use abroad, without increasing domestic prices.

This is possible because, for Smith, the circulation of gold and silver as money has a cost. They cannot be used as capital. I think Alvaro Perpere (Reference Perpere2024) is correct when he suggests that Smith adopts the medieval distinction that money can be both pecunia (medium of exchange) or capitale (capital). The cost of using metallic money as pecunia is that it cannot be used as capitale. But when gold and silver money are substituted with paper money, gold and silver are liberated from their use as pecunia and can instead be capitale. Gold and silver, which are more universally accepted abroad than paper, will be used as money-as-capital and will immediately seek profit opportunity abroad. Money-as-capital will be invested abroad without causing any effect on the price level. To the contrary, their departure will actually benefit the country because the investment abroad will be in activities that are more productive than activities at home. As John Berdell and Jose Menudo note (Reference Berdell and Menudo2024), for Smith, an outflow of precious metals is thus more likely to stimulate economic growth than inflow of species. This is the exact opposite of the mercantilist view. And of Hume’s.

Both Hume and Smith see the ineffectiveness of the mercantilist policies that favor trade restrictions in an attempt to increase the quantity of precious metals in a country. Both Hume and Smith see trade as a positive-sum game and recognize the power of commerce for the well-being of a country. Both see the quantity of money as a consequence of the industry of a country and not as a cause of the industry (Paganelli Reference Paganelli2006). But they part on the ways to increase industry. For Smith, growth comes from the expansion of markets and the possibility to divide labor. The military strength of a country also depends on the division of labor and the possibility of maintaining a specialized army (Paganelli and Schumacher Reference Paganelli and Schumacher2018a). For Hume, growth comes from maintaining low domestic prices via hoarding money, and trade will do the rest. The military strength of a country also comes from the possibility of paying militia soldiers with that gold and silver (Paganelli and Schumacher Reference Paganelli and Schumacher2018b).

Smith, thus, cannot use the quantity theory of money as Hume uses it because in Smith’s analysis, Hume uses it in a mercantilist way, to accumulate gold and silver. Hume is different from other mercantilists because he does not favor trade restrictions or colonial grandeur to increase money in a country. He favors commerce as a way to increase money in a country. Yet, even if it is through an increase in trade, Hume still seeks to increase money as a way to increase a country’s power. The mystery that Viner saw may not be a mystery after all, if one reads Hume’s essays as Smith suggested: that Hume “ha[s] gone a little into the notion that public opulence consists in money.”

Good friends can disagree and still be friends.