You Can’t Eat Cash: Adam Smith & Alan Greenspan on Real Wealth

Matt Johnston
May 1 · 7 min read

“The annual labour of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes”

Adam Smith (1776)


The quotation above, from the “Introduction and Plan of the Work” of Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations, speaks of labour in a way that may strike us as a bit odd. Smith describes it as a fund. We speak of all sorts of funds — mutual, pension, trust, sovereign wealth, etc. — and often use the word funding as a synonym for financing, all of which tend to provoke thoughts of a more pecuniary nature. Wages, the recompense for labour, do fall under the category of pecuniary things, but Smith does not say wages. He says labour. What exactly is he up to?

Certainly, if he had said wages, as in, “The annual [wages] of every nation is the fund which originally supplies it with all the necessaries and conveniences of life which it annually consumes,” this wouldn’t have been complete nonsense. That is how most of us procure the ‘necessaries and conveniences’ of our lives, by using our wage or salary incomes to pay for them, and to imagine a fund consisting of the pooled wages of an entire nation is by no means absurd. But Smith, in using the word labour instead of wages, has something else in mind.

He wants us to exit the cave, that shadowy world of mere appearances, and come out into the light in order to see and understand the true source of the shadows. In this instance, he is nudging us to peer behind the veil of money in order to focus our gaze on that, without which, money would be meaningless. This is not a careless use of the word ‘fund’, and it speaks to the heart of Smith’s entire inquiry into the nature of wealth and its causes.

Consider the word ‘Wealth’ in the title of his book. Once again, we are confronted with a word that tips us in the direction of looking at the world through a monetary lens and thinking about pecuniary things. Wealth is normally tallied in dollars and cents (or euros, rubles, yen. etc). But dollars and cents only represent wealth in nominal terms; Smith wants us to consider it in real terms. Money gives us a name for wealth, a convenient way to refer to it; Smith wants us to think about its essence, the underlying thing to which the name refers. That essence is the capacity to which a nation can supply itself with the ‘necessaries and conveniences of life’.

While we are accustomed to exchanging money in order to obtain our food, shelter, and clothing, we are aware that money is not the ultimate source of those things. Rather, it is the labour of the farmer, the builder, and the clothier, which transforms the resources of nature into the ‘necessaries and conveniences of life’. It is the pool of all these different types of labour that constitutes a nation’s fund of labour; it is labour’s produce — the necessaries and conveniences of life — that constitutes its wealth. From the fruits of labour, we are fed, sheltered and clothed. In contrast, money, even if it were to grow on trees, would not make it any more edible.

Cash is nice to have, but…

The distinction between nominal wealth and its real forms might seem obvious and trivial. Like, yes, yes, of course, all the money in the world is worthless if there exist none of those ‘necessaries and conveniences of life’ that one would hope to purchase with it. But it’s not actually always so obvious, and it is far from trivial. To illustrate, let’s go back nearly fifteen years to a discussion between congressman Paul Ryan and former Federal Reserve Chairman Alan Greenspan during a hearing before the House Budget Committee of the U.S. House of Representatives.

In the discussion, Mr. Ryan is worried about the solvency of the Social Security system. Specifically, it is the U.S. government’s ability to pay out retiree benefits in the context of an aging population that concerns him. With a greater number of people retiring than there are entering the labour force, the proportion of retiree benefits relative to the revenues collected from the working population will increase, thereby threatening the solvency of the current ‘pay-as-you-go’ system. Mr. Ryan proposes that the U.S. switch to a system where each individual pays into their own personal retirement account, which is to be paid out upon that individual’s eventual retirement. Listen carefully to how Mr. Greenspan responds.

Mr. Ryan is worried about the financial solvency of Social Security. Mr. Greenspan, in good Smithian fashion, reorientates the whole discussion, essentially giving Mr. Ryan a lesson on the distinction between wealth in its nominal form versus wealth in its real form: wealth in the form of cash is nice, but it’s the real resources, or what Smith calls the ‘necessaries and conveniences of life’, that ultimately matter.

Cash is of no concern for the U.S. government. As the issuer of U.S. dollars, there is no financial reason why the U.S. government would never be able to make good on its obligations denominated in U.S. dollars, including retiree benefits (there may, of course, be political and legal reasons why the U.S. government does not honour those obligations, of which we are reminded of every time the U.S. budget approaches the limits of the ‘debt ceiling’, as flimsy a ceiling as it is). “There is nothing to prevent the Federal Government from creating as much money as it wants and paying it to somebody,” Mr. Greenspan says. Well that’s an interesting comment from the head of a central bank. But what he says next is just as important and more relevant to our current discussion: “The question is, how do you set up a system which assures that the real assets are created which those benefits are employed to purchase?”

Let’s quote a few more lines, but let’s substitute where Mr. Greenspan says ‘real assets’ or ‘real resources’ with Smith’s ‘necessaries and conveniences of life’. Mr. Greenspan: “It is a question of the structure of a financial system which assures that the [necessaries and conveniences of life] are created for retirement as distinct from the cash. The cash itself is nice to have, but it has got to be in the context of the [necessaries and conveniences of life] being created at the time those benefits are paid and so that you can purchase [necessaries and conveniences of life] with the benefits, which of course are cash.” Cash is nice, but it’s not cash that procures the ‘necessaries and conveniences of life’.

What Mr. Greenspan is trying to demonstrate to Mr. Ryan is that the real problem is not about financial solvency, but about real solvency. It is not so much financial deficits as it is real deficits that should worry us. In this case, it’s a labour deficit: far more people are expected to exit the labour force (i.e. retire) than there are expected to enter, which means a fewer number of labourers will be expected to produce the ‘necessaries and conveniences of life’ for a greater number of people.

Unless the productivity of those labourers increases enough to offset the total decrease in the number of labourers, you can restructure the finances however you want, but the problem of producing the real benefits in sufficient quantity for the retirees who are expecting to consume them is going to remain a problem. Smith, in his intro, says it like this: “According therefore as [the produce of labour]…bears a greater or smaller proportion to the number of those who are to consume it, the nation will be better or worse supplied with all the necessaries and conveniences for which it has occasion.” The proportion of labour’s produce relative to those who consume it depends not on the fund of cash, but the fund of labour.

Investing in the Labour Fund

A nation’s wealth has more to do with the amount and quality of labour at its disposal rather than the amount of cash it has sitting in the royal coffers. But the confusion has led many a government astray, resulting in an obsession with bolstering those coffers at the expense of maintaining a well-stocked fund of high-quality labour. Take a government considering cutting spending on health care and education. Since the nation’s pool of labour is primarily drawn from the overall population of its citizens, cuts to health care and education that make those citizens less healthy and less educated is not the best remedy for maintaining a high-quality labour force.

Contrary to what some might think, this is not an argument against efficient economic management; indeed, it is quite the opposite. Spending on the health, education, and general welfare of the population is not so much a cost as much as it is an investment that can improve the ability of that population to produce the ‘necessaries and conveniences of life’. Oh, and let’s not forget that health and education are not just essential characteristics of a labour force producing the ‘necessaries and conveniences of life’, but are themselves things that are generally considered to be necessary and convenient aspects of a good life.

But at this point, some might interject that we have focused too much on labour’s role in the production process. What about the tools and machines (i.e. capital goods) involved in the production process, not to mention the gifts of nature (i.e. natural resources) that constitute the raw inputs to that process? Are these not also important factors in producing the ‘necessaries and conveniences of life’? Certainly, but those are questions we shall consider in another post.