While reading Chapter 6 "Of Treaties of Commerce" in Adam Smith's monumental work, I was reminded of my neighbor, Mr. Johnson. He's a fruit vendor who always gives special discounts only to his loyal customers. "Small profits are fine, as long as the customers keep coming," he says with a laugh. Without realizing it, Mr. Johnson has been practicing what Adam Smith explains in his book about trade treaties. Just like Mr. Johnson's special discounts, trade agreements between countries also provide benefits to certain parties, but don't always benefit everyone involved. Let's explore this important concept in greater depth.
Trade Treaties: Two Sides of a Different Coin
Imagine a country that grants privileges to another country in terms of trade, either by allowing the entry of certain goods or exempting them from import duties. This situation creates a sort of monopoly for merchants and manufacturers from the favored country. They gain a market that is both more extensive and advantageous because competition from other nations is either restricted or subjected to higher costs.
Like a bakery that gets exclusive rights to sell in a large mall, merchants from the favored nation can sell their goods at higher prices due to lack of competition. Consumers have no choice but to buy from them, making profits flow abundantly into the pockets of these merchants and manufacturers. This explains why many countries work hard to obtain trade privileges from other nations.
However, Adam Smith reminds us that not all that glitters is gold. Treaties that benefit merchants and manufacturers from the favored country actually disadvantage those from the country granting the privileges. It's like giving your store key to a competitor and letting them run the business on terms that benefit them.
When a monopoly is granted to a foreign nation, citizens of the granting nation must buy imported goods at higher prices. Consequently, the exchange value of their domestic products becomes cheaper, because when two goods are exchanged, the cheapness of one is a logical consequence of the dearness of the other. It's like an economic seesaw: if one side goes up, the other must come down.
When Trade Treaties Become Double-Edged Swords
Although it sounds disadvantageous, Adam Smith argues that the loss from such trade treaties doesn't always mean an absolute loss. The country granting privileges may still gain from such trade, albeit less than if there were free competition.
This reminds me of a food festival in my town last year. The organizers gave exclusive rights to one ice cream vendor, who then sold ice cream at higher prices than usual. Visitors still bought the ice cream despite the high price, and the organizers still profited from their share of sales. Although the profit might be smaller compared to if they had allowed several ice cream vendors to compete, they still received income.
However, some trade treaties are considered advantageous based on very different principles. Sometimes, a country grants a monopoly against itself for certain goods from a foreign nation because it expects that in the whole commerce between them, it will annually sell more than it buys, so that a balance in gold and silver will be returned to it every year.
The Methuen Treaty: A Classic Tale of Wine and Wool
Now let's turn to one of the most famous examples of trade treaties: the Methuen Treaty between England and Portugal signed in 1703. This treaty has often been praised as a masterpiece of English commercial policy, but Adam Smith viewed it through a different lens.
This simple agreement consisting of only three articles stipulated that Portugal would allow English woolen cloths to enter without hindrance, while England promised to always grant a one-third reduction in import duties for Portuguese wines compared to French wines. At first glance, this treaty seems more beneficial to Portugal than England, doesn't it?
I'm reminded of a story about two friends exchanging birthday gifts. One gives an expensive watch, the other only gives a simple notebook. However, the watch-giver is actually a rare book collector, and the notebook he receives is a limited edition worth far more to him. That's how complex trade relationships are—true value isn't always visible at first glance.
Although the Methuen Treaty appears to favor Portugal, it has been praised as a masterpiece of English commercial policy. Why? Because Portugal received large amounts of gold from Brazil annually, more than could be used in its domestic trade. This gold surplus was too valuable to be left idle, and since it couldn't find an advantageous market at home, it was sent abroad, including to England.
Gold Rush: When Brazilian Gold Flowed to England
According to Mr. Barretti, the weekly packet-boat from Lisbon brought more than £50,000 in gold to England every week. Although this figure might be exaggerated, if true, it would amount to more than £2,600,000 a year, a sum even greater than what Brazil was supposed to produce.
It's like setting up a coffee shop near an office with hundreds of employees—their money flows into your business endlessly. However, as Adam Smith reminds us, not everything that glitters is truly beneficial in the long run.
A few years before Adam Smith wrote his book, English merchants were dissatisfied with the Portuguese crown. Some privileges that had been granted to them, not by treaty, but by the goodwill of the Portuguese crown (probably in return for protection and defense from the British crown), had been violated or revoked. As a result, people who usually praised the Portuguese trade began depicting it as less advantageous than had commonly been imagined.
They argued that most of this annual gold import was not for the benefit of England, but for other European nations. The fruits and wines of Portugal annually imported into England nearly compensated for the value of English goods sent there.
Direct vs. Roundabout Routes: Efficiency in Trade
Adam Smith then makes an interesting argument: even if this entire gold import was indeed for the benefit of England and the amount was greater than what Mr. Barretti imagined, this trade would not be more advantageous than any other where the same value sent out receives an equal value in consumable goods in return.
Imagine this like a journey from New York to Boston. You could take the direct highway (direct trade), or you could take a roundabout route through Albany (indirect trade). Although you eventually reach the same destination, the roundabout route requires more time, fuel, and expense.
Smith argues that only a very small part of this gold import is used as an annual addition to plate or coinage in the kingdom. The rest must be sent abroad and exchanged for consumable goods. If these consumable goods were purchased directly with the produce of English industry, it would be more advantageous for England than first purchasing Portuguese gold, and then using that gold to purchase consumable goods.
A direct foreign trade of consumption is always more advantageous than a roundabout one. Bringing the same value of foreign goods to the home market requires a much smaller capital in the direct way than in the roundabout way.
The Myth of Dependence on a Single Trading Partner
Next, Adam Smith challenges the notion that England was heavily dependent on the Portuguese trade, especially for obtaining gold. He argues that even if England were entirely excluded from the Portuguese trade, England could still procure all the annual supplies of gold it needs, whether for plate, coinage, or foreign trade.
This is like the situation when your favorite bookstore closes. You might panic initially, but then you realize there are many other bookstores in town, and you can even buy books online. The loss of one source doesn't mean you can't get what you need.
Gold, like every other commodity, can always be obtained somewhere for its value by those who have that value to give for it. The annual surplus of gold in Portugal would still be sent abroad, and if not carried away by Great Britain, would be carried away by some other nation that would gladly sell it again for its price.
In buying gold from Portugal, England does indeed buy it at first hand. Whereas, in buying gold from any other nation except Spain, England would buy it second-hand and might pay somewhat dearer. However, this difference would be too insignificant to deserve public attention.
Debunking the Balance of Trade Myth
Adam Smith also questions the common notion that almost all of England's gold comes from Portugal and that the balance of trade with other nations tends to be unfavorable to England. He reminds us that the more gold imported from one country, the less must necessarily be imported from all others.
The effective demand for gold, like that for any other commodity, is limited to a certain quantity in every country. If nine-tenths of this quantity are imported from one country, there remains only one-tenth to be imported from all others.
This is like managing your monthly household budget. If you spend 90% of your food budget at one supermarket, only 10% remains to be spent elsewhere. Your total expenditure remains the same, regardless of where you shop.
Moreover, the more gold that is annually imported from some particular countries, above what is needed for plate and coinage, the more must necessarily be exported to some others. And the more the balance of trade appears to be in our favor with some particular countries, the more it must necessarily appear to be against us with many others.
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A Nearly Forgotten Diplomatic Tale
Adam Smith then recounts an interesting episode in diplomatic history. Based on the "silly notion" that England could not subsist without the Portugal trade, towards the end of the last war, France and Spain, without any clear reason, required the king of Portugal to exclude all British ships from his ports, and for the security of this exclusion, to receive French or Spanish garrisons.
If the king of Portugal had submitted to those ignominious terms proposed by his brother-in-law the king of Spain, Britain would have been freed from a much greater inconvenience than the loss of the Portugal trade, the burden of supporting a very weak ally unprepared to defend himself.
The loss of the Portugal trade would certainly have occasioned a considerable embarrassment to the merchants engaged in it at that time, who might not, perhaps, have found, for a year or two, any other equally advantageous method of employing their capital. And in this would probably have consisted all the inconvenience which England could have suffered from this notable piece of commercial policy.
Gold and Silver: Universal Instruments of Trade
Adam Smith explains that the great annual importation of gold and silver is neither for the purpose of plate nor of coinage, but of foreign trade. A roundabout foreign trade of consumption can be carried on more advantageously by means of these metals than of almost any other goods.
As the universal instruments of commerce, gold and silver are more readily received in return for all commodities than any other goods. And on account of their small bulk and great value, it costs less to transport them backward and forward from one place to another than almost any other sort of merchandise, and they lose less of their value by being so transported.
Of all the commodities bought in one foreign country, for no other purpose but to be sold or exchanged again for some other goods in another, there are none so convenient as gold and silver. In facilitating all the different roundabout foreign trades of consumption carried on in Great Britain consists the principal advantage of the Portugal trade; and though it is not a capital advantage, it is, no doubt, a considerable one.
The Reality of Gold Requirements in an Economy
Adam Smith then reviews that any reasonable annual addition to the plate or coinage of the kingdom would require but a very small annual importation of gold and silver. Though the goldsmiths' trade is very considerable in Great Britain, the far greater part of the new plate they annually sell is made from other old plate melted down; so that the addition annually made to the whole plate of the kingdom cannot be very great, and could require but a very small annual importation.
It is the same case with coinage. Nobody imagines that even the greater part of the annual coinage, amounting, for ten years together, before the late reformation of the gold coin, to upwards of £800,000 a year in gold, was an annual addition to the money previously current in the kingdom.
Seignorage: The Overlooked Solution
Seignorage is a fee charged by the government for minting coins. Adam Smith argues that a reasonable seignorage, while the coin contains its full standard weight, would prevent the melting down or export of the coin. It is the best and heaviest pieces that are commonly either melted down or exported, because it is upon such that the largest profits are made.
In France, for instance, a seignorage of eight percent does not cause any sensible inconvenience. The dangers to which a false coiner is everywhere exposed, whether living in the country of which he counterfeits the coin, or the dangers his agents or correspondents are exposed to if he lives in a foreign country, are by far too great to be incurred for the sake of a profit of six or seven percent.
The seignorage in France raises the value of the coin higher than in proportion to the quantity of pure gold which it contains. Thus, by the edict of January 1726, the mint price of fine gold of twenty-four carats was fixed at seven hundred and forty livres nine sous and one denier one-eleventh the mark of eight Paris ounces.
Lessons from History and Policy Implications
The law for the encouragement of coinage, by rendering it duty-free, was first enacted during the reign of Charles II for a limited time, and afterwards continued, by different prolongations, until 1769, when it was rendered perpetual. The Bank of England, in order to replenish their coffers with money, are frequently obliged to carry bullion to the mint; and it was more for their interest, they probably imagined, that the coinage should be at the expense of the government than at their own.
Adam Smith criticizes this policy and argues that a moderate seignorage would not increase the expense of the bank or of any other private persons who carry their bullion to the mint to be coined; and the lack of a moderate seignorage does not diminish it. Whether there is or is not a seignorage, if the currency contains its full standard weight, the coinage costs nothing to anybody; and if it is short of that weight, the coinage must always cost the difference between the quantity of bullion which ought to be contained in it, and that which actually is contained in it.
Therefore, when the government defrays the expense of coinage, it not only incurs some small expense but loses some small revenue which it might get by a proper duty; and neither the bank nor any other private persons are in the smallest degree benefited by this useless piece of public generosity.
Trade Treaties in Modern Perspective
Adam Smith concludes his discussion by stating that some of the foregoing arguments and observations might perhaps have been more properly placed in those chapters of the first book which treat of the origin and use of money, and of the difference between the real and the nominal price of commodities. But as the law for the encouragement of coinage derives its origin from those vulgar prejudices which have been introduced by the mercantile system, he judged it more proper to reserve them for this chapter.
Nothing could be more agreeable to the spirit of that system than a sort of bounty upon the production of money, the very thing which, it supposes, constitutes the wealth of every nation. It is one of its many admirable expedients for enriching the country.
In today's modern world, Adam Smith's lessons on trade treaties remain highly relevant. Although the form of international trade has changed drastically since the 18th century, the basic principles outlined by Smith still apply. Countries still struggle for trade advantages, and protectionist versus free trade policies remain hot debates among economists and policymakers worldwide.
As Mr. Johnson the fruit vendor reminded me: "In trade, there are always winners and losers. The important thing is to ensure that the gains are greater than the losses in the long run." Perhaps this is the essence of what Adam Smith wanted to convey in his discussion about trade treaties—that short-term gains may be tempting, but we must always consider the long-term impact of our trade policies.
Adam Smith, through his careful analysis of trade treaties, has provided us with tools to understand the complex dynamics of the global economy. And that is a legacy that remains relevant today, even after more than two centuries have passed since he first penned his brilliant thoughts.
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