THE MYSTERIES OF THE MARKET: Keywords: Mercantilism, zero-sum trade, American communism, Mamdani, bullionism, Physiocrats, pirates, colonialism and independence, Say's Law, barter and money, greed and profits, slavery and independence.

 “Everything can be taken from a man but one thing:

 the last of human freedoms - to choose one's attitude

 in any given set of circumstances, 

to choose one's own way.”

Viktor E. Frankl

Endless maritime wars between empires during Mercantilism

VIII

THE MYSTERIES OF THE MARKET

A meditation about forgotten lessons of American Exceptionalism

By Xuan Quen Santos 

THE EIGHTH MYSTERY

ZERO-SUM TRADE

                

                 THE MONEY-PROFIT ENIGMA, AGAIN

`             The appearance of money, prices in monetary units, and accounting more than two millennia ago made evident that merchants make a profit. In fact, to stay in business, they have to end up with a profit in their sales to cover their costs and have some left  for themselves. The buyer -the consumer- does not make a “money-profit” and his mind goes blank forgetting he receives his profit by benefitting with a dose of “happiness, satisfaction, usefulness, etc.” I pointed out this enigma in previous chapters.

              Simple arithmetic seems to confirm what the consumer’s perception had already suspected: the merchant overcharged him and stole some of his money. Had he bought an orange for fifty cents, the merchant may have kept five cents after covering all his costs. This would mean the consumer actually paid forty-five cents for the orange and was overcharged another five cents. The price agreed of fifty cents should have been an equal exchange for both parties. If the result does not total a gain of zero for both participants, ONE OF THE PARTIES GAINED (THE MERCHANT) AND THE OTHER ONE LOST (THE BUYER).

                Zero-sum trading is what happens when people barter goods or services for goods or services. Both parties are happy and the same things just changed hands. It is also what happens in a game of poker. All the players put some money in, and at the end, the same amount of money has only changed hands. Some players won and others lost, but the total amount of money did not change.

                Merchants discovered several ways by which they can gain more at the expense of the customers. They always need to partner with those in power in order to do it. In the absence of a better understanding of prices, profits, competition and the internal mental process that buyers go through when deciding to buy or not to buy, accessing the power to interfere in the economic system of the market has been an easy road to enrichment. The totally regulated or controlled process of production and exchange came together with the rise of the “public administration”, also known as “the bureaucracy”.

                RECOGNIZING THE POWER OF THE MARKET     

                The last contributions of the “ethical” stage about the market process were made by who recent historians have labelled “The Late Scholastics”, many associated with the ancient Medieval university of Salamanca, in Spain. Their experiences during the Rennaisance were enriched with the vision of a new world already previewed after two centuries of increased trade between Europe and the Orient. The discovery and colonization of the American continent that begun in 1492, and the age of exploration that followed during the next century, exposed the opportunities for increased trading that we now take for granted in the world market.

Map of Mercantilist trading from the XVI to the XIX centuries

Major colonies and trading routes where trading ports and trading stations were established.

                Many of the Late Scholastics dared to confront Aristotle’s propositions and corrected Thomas Aquina’s in many respects concerning justice in the market’s operations. They dared to confront the expansive power of Charles V, who was not only king of Spain but also the Holy Roman Emperor and Archduke of Austria. At that moment, he controlled the power of most of the European kingdoms and the growing Spanish empire around the world. The phrase “ruler of an empire where the sun never sets” referred to him. Spain and Portugal became the wealthiest powerhouses of Europe.

Atahualpa, the Inca Emperor, tried to ransom himself by filling a room with gold.
Instead, Pizarro's greed led him to conquer Peru

                But, their definition of wealth was an economic error and within two centuries they lost their influence and power. The love of gold, the mistaken idea that wealth was a treasure of gold bullion possessed by the king and circulated as money in the kingdom’s economy was called “bullionism”. Instead of going to war with the neighbors to take their gold, which had been a millenary political economy policy, some merchants that traded in foreign lands discovered a new method of getting the neighbors’ gold. The change of policy covered the XVI, XVII and XVIII centuries. It became known as mercantilism.

                FOR THE LOVE OF GOLD

                The initial success of Spain in America, and of Portugal in Africa and the Orient motivated imitation. Soon, the maritime powers of France, England and Holland, and later Denmark and Sweden, enlarged their ships and fleets to establish colonies dispersed all over the globe. Their initial “share” of the gold had been through piracy at the high seas, stalking the Spanish galleons returning to Seville with the gold of the Aztecs and the Incas, or seizing the cargo of Portuguese multi-deck slave traders such as how the first African people ended in 1619 in Chesapeake Bay.

Sir Francis Drake, navigator, English hero, pirate or privateer,

terror of the Spanish fleets in the Caribbean, one of the first slave traders.

                English history calls “privateers” the pirate business partners of the English kings. When trading for gold was discovered as a less risky method to acquire it, privateers disappeared and only a few of the real pirates remained. They are still active in the minor islands of the Caribbean, on the Arabian and African sides of the Horn of Africa, in the straits of Hormuz, and in the many navigation channels of Indonesia and Southeast Asia.

                Coveting gold and silver was a source of power and money since antiquity. Mining and minting them into money gave kings power. The new vision of the world began when it was perceived as a market; kings discovered the formula for obtaining more gold by trading. They partnered with merchants and bankers, chartered corporations with trading monopolies, and later financed expeditions to research new markets and collect seeds and specimens for planting in other places. This opened a new era of economic thinking labeled “mercantilism” for its connections to commerce.

                IS TRADE A “ZERO-SUM” GAME?

                The idea is simple: If I sell you something, I want to be paid in gold; the more I sell, the more gold I will receive. There was no economic theory.  If no gold was available, the powerful party took advantage manipulating prices. The idea behind is one of the biggest errors in primitive economic thinking: When two parties trade, one is the winner, and the other the loser. This is called a “zero sum” interpretation of trade. A reminder: Adam Smith logically proved that in any voluntary trade, both parties benefit. This is a conclusion that I discussed when profit in money introduced what looks like a correct conclusion in accounting, but that turns out to be an error in economic thinking. This was only recognized when the mystery of value was finally unveiled in the late XIX century.

Description of a slave-trader ship with multiple cargo decks

                The economic activity that promoted mercantilism was the scheme of ambitious merchants and kings. Controlled trading led to the era of navigation and trading ports; where there was no gold, slaves were accepted. They had already become a commodity promoted by Muslim traders in the African shores since the VII century. Slowly, other goods became commodities that Europeans would sell for gold in their own markets or to their neighbors inland Europe. Much coveted were Chinese porcelain, paper and ink, and silks; also, exotic spices from the “Spice Islands” such as cinnamon, ginger, pepper, and nutmeg; later, tea and opiates from India became important. Controlling the production of those valuable commodities that were eventually sold for gold, led to establishing permanent settlements.

A XVIII century plantation in Jamaica, where the entire native Taino and Carib populations were substituted by slave labor imported from west African slave trading ports

                The settlements in faraway lands began as trading ports or trading stations. A few later turned into permanent colonies and towns to run pre-industrial agribusinesses, known as plantations, where farmers were sponsored to plant cash products like tobacco, sugar and indigo. The English colonization process of Virginia is a good example. Roanoke (1585) and Jamestowne Fort (1607) were pirate havens; Jamestown (1609) was a colonial settlement, and finally Williamsburg (1638) was a plantation town.

                The colonies would supply raw materials cheaply and buy the overpriced manufactures of the mother country. This was the “zero-sum” idea in trade that was proven to be an error. Since the expectation is that the sponsoring country must be the winner in the “zero-sum” trade, a “balance of trade” must be kept with the aid of royal custom houses and accountants. Custom houses were not designed for protection against foreign dangers, nor for collecting taxes. They come with borders and barriers. They were designed to prevent smuggling of cheap foreign products that competed with the Royal Charters (monopolies), or to “increase” artificially the prices of imports by charging “tariffs” to enter that would reduce their local sales in favor of local producers. The government controlled economic scheme of “mercantilism” favored the merchants and producers of the “mother country” at the expense of the producers in the colonies and the producers of other colonial powers. And of course, mainly at the expense of the local consumers who had to pay for more expensive imports and more expensive local products.

                This last aspect implies several conclusions. The mass of the people in the “mother country” did not benefit. In fact, they saw their wealth reduced while the wealth of the privileged royal merchants and the court increased. It also means that part of the wealth created by the colonies did not increase the local wealth as the value of their products was underpaid. Over time, this slow process means the empires end up having to subsidize the colonies that will eventually become losing ventures and drain the king’s treasure. Of course, the way to stop this system of exploitation by a form of centrally controlled economy is independence.

The Boston Massacre of 1770 depicted in an engraving of Paul Revere
The Royal Army used firearms to disperse a crowd of protesters

                Royal fleets led to empires. We are still living in a time where the forces of decolonization and self-determination are active in many parts of the world. The establishment of colonies to plant the same harvests the rival empires were selling also had unforeseen impacts in the world’s human geography and the natural habitats.

                AN ECOLOGICAL TRANSFORMATION

                Plantation economies became a force for transforming the native flora and fauna in many places. Sugar and bananas from the Pacific islands are now mainly produced in the American and African tropics. Tobacco from the Caribbean and Central America is now mainly produced in China, Brazil and India. Cocoa from southern Mexico and Guatemala is now produced mainly in Africa. Rubber from the Amazon now comes from South-East Asia. Coffee from the Horn of Africa is associated with productions in Brazil, Colombia and Central America. Indigo, originally from India, had spread to many tropical areas in the world but its plantations almost disappeared with the advances of chemistry in the production of dyes and tints. With the increased new interest in natural colorants and dyes, it will soon become a commodity again.

The East India Company was a joint-stock company, chartered in 1600 to monopolize trade with Asia. It became a quasi-government with its own armies. It took mercantilism to the extreme. It was dissolved in 1874. The monarchy established direct rule in India. Independence was not granted until 1947. 

                The development of plantation economies as the base of many European colonies around the world also had great impact on populations. Millions of enslaved Africans were uprooted and sent to foreign lands where their descendants, in many countries, are still searching for a cultural identity. Many Europeans were also sent to the colonies to start new settlements with a promissing future, only to find hardship in unfamiliar climates and diseases. A few succeeded. Other settlers were sent away as a form of ethnic or social cleansing as alternatives to prison or “poor houses”. Two centuries later, peaking during the XX century, the process of decolonization created a wave of emigration from the original colonies to the former European colonizing powers that is becoming a growing source of political tension.

The French, Dutch and Danish kings copied the model of the English East India Co. They were not as successful, but some of their operations in Africa, the Caribbean and Southeast Asia continued until WWII. They had all followed the early lead of the Portuguese that also relinquished some of their colonies until the XX century.

                MERCANTILISM BECOMES THE POLICY

                The famous American Libertarian academic Murray Rothbard (1926-1995) was an economist in the tradition of the Austrian School. In 1963, he wrote the following description: “Mercantilism, which reached its height in the Europe of the seventeenth and eighteenth centuries, was a system of statism which employed economic fallacy to build up a structure of imperial state power, as well as special subsidy and monopolistic privilege to individuals or groups favored by the state. Thus, mercantilism held that exports should be encouraged by the government and imports discouraged. Economically, this seems to be a tissue of fallacy; for what is the point of exports if not to purchase imports, and what is the point of piling up monetary bullion if the bullion is not used to purchase goods?”

                One of the consequences of the policies adopted under the label of mercantilism was the emergence of a “merchants” class, accompanied by what we now call corporations and mercantile societies. Insurance schemes and shared participation in the commercial adventures were the seeds of important financial centers. The required financing, which seldom could be provided by the kings because they were usually in debt, came from “investors”. They sought concessions and monopolies from the kings who were happy to be invited as “partners”. The investors saw it as a way to collect what they were owed. All the states of the USA that bear the name of a royal originated in a “charter” that was a business venture. Even Pennsylvania was the product of a monarch paying what he owed to William Penn’s father. Louisiana was the product of one of the largest banking and investment frauds involving what historians now label “The Louisiana Bubble” created by business promoter John Law to capitalize a royal bank to issue paper money.

                The new merchant class largely blended with the lower nobility which was losing their power as the kings became more autocratic. Marx labeled them “the bourgeoisie” as he described the end of the feudal period in his writings in the early XIX century when industrialization had begun.

                ENDLESS WARS

             The increasing adoption of mercantilism as a policy in Europe led to another direct consequence of the idea of “zero-sum”. In order to be “winners”, kings promoted territorial expansion into foreign lands that invariable led to wars. The first victims were the precursor empires of Spain and Portugal. The European powers entered into numerous military conflicts against each other as they were establishing their ports or their colonies, or looking for new markets.

                Because the feudal system and its “bloodlines” way of arranging marriages was still in effect, the activities of the ambassadors looking for suitors for the next generations were always influenced by the territories that would be negotiated as “dowries”. Vacant thrones led to wars of succession in England and Spain.

                The conflicts over territories and markets was not limited to the European continent. The armed conflicts took place all over the world. Four Anglo-Dutch Wars took place during the XVII and XVIII centuries. In 1664, New Amsterdam passed under English control and was renamed New York. In 1673, the Netherlands recovered it  but a year later was returned to England. In 1686 became the first city in the English colonies to receive a royal charter. The Spanish Wars of Succession (1701-1714) that led to the French Bourbon dynasty taking over the Spanish empire, changed control of the Louisiana territory to Spain. The chapter of US history called “The French and Indian War” was a dispute over the Ohio River valleys into the Mississippi River between France and England. That was the third such conflict that had other fronts and in world history is better known as “Seven Years’ War” (1756–1763). It was preceded by “King William’s War” and “Queen Anne’s War”.

                As the burdens imposed on the colonies became evident, the residents began to demand changes. Among them were political rights equal as the citizens of the mother country had, elimination of the royal monopolies, reduction of tariffs or import duties, and self-rule. The Wars for Independence followed.

                THE CRITICS OF MERCANTILISM APPEAR

                It took three centuries of mercantilist policies by the European powers to establish trading ports for their fleets and colonies. During this period, the intellectual ideas identified as “The Enlightenment” had introduced discussions about equal rights, the nature of government and the power of the kings. This is also the period during which science became an important source of new knowledge and new technologies.

                Mercantilism was finally challenged by advocates of natural rights and the first treaties of international law.

                In the middle decades of the eighteenth century, two schools emerged critical of the of the mercantilist policies required for managing trade and industry; one in France and the other in Great Britain,

                THE FRENCH PHYSIOCRATS

                In France, the proponents of the new ideas of economic freedom are known as the Physiocrats. Three personalities are worthy of mention: Francois Quesnay (1694-1774), Pierre-Paul Mercier de la Riviere (1719-1791),  and Jacques Turgot (1727-1781).

                Quesnay was for two decades the royal physician to the king of France, Louis XV. He proposed that the basis of all economic activity was the production of the land (resources and food). In 1758, he prepared for the king an illustration of what we identify today with the “chains of production”, or the “chains of value-added”. His famous “Tableau Economique” showed the interdependency and harmony of the opposite flows of goods and money through the various sectors of the economy. Government had no essential role directing or controlling the economic process. “Do not attempt to fix the prices,” Quesnay declared, “Only competition can regulate prices with equity.” 

Francois Quesnay, the first to illustrate the "chain of value added" or "chain of production",
that begins with production from the land, to transformation into consumer
 and capital goods through the harmonious market process. Possession of land
and the cost of labor were considered the source of value in exchange.

                Adam Smith had travelled extensively after the publication of  “The Theory of Moral Sentiments” (1759). He met many of the French intellectuals of the time and became familiar with their ideas. It is easy to see the similarity of concepts he had with Quesnay about the roles of government, the market and competition. Smith expanded those ideas in his 1776 “The Wealth of Nations…”.

                Mercier de la Riviere was the clearest in his defense of natural rights as the foundation for the economic system. In “The Natural and Essential Order of Political Societies” (1767) he stated that every man has a natural right to secure what was necessary to live: “Now, it must be clear that man’s right to secure his own survival includes the right to acquire, by his own work, those things that are useful to his existence as well as the right to keep them after their acquisition. Further down, he adds as natural rights “Property and, consequently, security and liberty of enjoyment are the essence of the natural and fundamental order of society. This order is part of the physical order, and therefore its principle characteristics are in no way arbitrary.”

                The ideas that a decade later appeared in the “Declaration of Independence” of the United States were first developed by Mercier de la Riviere: Natural rights of any person to life, to his labor and his product, and to security and liberty of enjoyment. The previous contributions of Locke and Montesquieu can be identified in the Physiocrats.

                A third critic of the mercantilist policies was Jacques Turgot. More than an intellectual, he was a public administrator we could call a politician with new ideas. He put in practice several policies that created greater economic freedom.  In 1761, Turgot was appointed governor of the province of Limoges. He abolished a much hated Medieval tax that forced peasants and rural men to construct and repair roads with no pay. With paid crews, soon the roads of Limoges were praised as the best. Later, when Turgot served after 1774 as the Comptroller-General of Finance for all of France, he abolished it in the whole territory.

                His success as a public administrator was happening as the new reign of King Louis XVI was facing financial chaos. A firm proponent of free trade as opposed to the regulated trade of the mercantilist predecessors, he abolished all restrictions on the free trade in grain within France, declaring, “It shall be free to all persons whatever to carry on, as it may seem best to them, their trade in corn and flour, to sell and to buy it, in whatever places they choose throughout the kingdom.” The Medieval provinces of France were subjected to similar policies as the colonies, with custom houses at the borders, and prohibitions that limited the movement of people and goods.

                He became increasingly unpopular as he abolished many Medieval corrupt practices of paying bribes to obtain appointments for public service posts, such as tax collectors, or customs inspectors. He eliminated restrictions to foreign traders and eliminated discriminatory taxing practices levied on specific trades and industries. He broke the power of privileged monopolies and opened many of the markets to competition by reducing restrictions and regulations. Finally, Turgot confronted the corrupt bureaucracy and eliminated many layers from the payrolls.

                Before the benefits of his reforms were recognized, the conspiracies against him at the court and the many enemies he had made by the loss of their privileges succeeded in his removal in 1776. He withdrew to a quiet life of study and died in 1781.

                LAISSEZ FAIRE – LAISSEZ PASSER

                The Physiocrats did not advance economic theory as they remained within the scope of political economy, linked to governmental policies. Nevertheless, they illustrated many of the connections between government interventions and the burdens they created on the wealth of the people.

                Nothing illustrates more their importance than the attack they continue to receive because of two iconic phrases that became the popular motto of what people began to demand; we now refer to it as “free trade”. Just like Smith’s “invisible hand” remains the target of the enemies of liberty, the phrases “laissez faire; laissez passer” are mocked by the defenders of governmental management of the economic system. The history of the phrases is very simple.

                The terms “laissez faire; laissez passer” are often attributed to French businessman Vincent de Gournay,  a close friend and advisor of Quesnay. But, the phrases were already in use as demands by the clothmakers, weavers and lacemakers of France that wanted to sell across the borders. They were protesting against the policies of Jean-Baptiste Colbert, Comptroller General of Finance under King Louis XIV. The phrases only mean “let us produce and let us pass through the borders”.

                THE ENLIGHTENED SCOTTSMEN

                In Great Britain, the primary critics of mercantilism were members of a group that has become known as the Scottish Moral Philosophers. We have mentioned  Ferguson, Hutcheson, Hume and Smith as contributors to solving the First and Second Mysteries. Their contributions helped to identify the divide that separates the economic order of society, the lives of the people, from the political system that the people create for their own service. They also identified orders or systems that result from human action but that are not the result of human design.

                Of the Scottsmen, Adam Smith, who was a Professor of Logic and of Moral Philosophy, receives credit for clearly identifying the existence of orders of rules of human behavior that allow communities to succeed and prosper. He is known for his research into what we now call “the economy”, also known since antiquity simply as “the market”. He clearly demonstrated that “bullionism”, the treasuring of gold, is not the source of the wealth of nations. It is the people’s production of goods  voluntarily exchanged in the market that generates the wealth of nations.

                Smith provided many examples of the logical errors of mercantilist policies. It is easier to understand them from the point of view of the consumer, or any individual in the nation. If we recognize that the whole objective of the legislation was to confer special privileges and subsidies to favored groups, it becomes obvious they are at the expense of the general public. Chartered monopolies are protected from competition and can charge higher prices and sell at lower quality. Consumers understand these situations without any theory or diploma.

                Adam Smith gave the example that linen yarn could be imported into England without paying tariffs, but imported finished woven linen cloth was barred by high tariffs. The reason, as explained by Smith, was that the numerous English yarn-spinners did not constitute a strong pressure-group, whereas the master-weavers, organized in guilds, were able to pressure the government to impose high duties on their foreign competition, while making sure that their raw material could be bought at as low a price as possible. Obviously, the buyers of linen cloth were paying a higher price than the prices that would exist with no tariff and with plenty of competition.

The English colonies in North America

                There is a very important connection between the work of the anti-mercantilist philosophers, but particularly the publications of Adam Smith, and the American Revolution. After the publication of “Theory of Moral Sentiments” in 1759, Smith became a celebrated Professor. This led to his appointment as tutor of a young wealthy nobleman. Smith travelled across Europe with him between 1764 and 1767. This gave him the opportunities to engage with many intellectuals of his time, such as the Physiocrats. At the end of his service, he was granted a comfortable pension for life. He devoted his time to research and prepare the drafts of what later became “The Wealth of Nations…”.

Adam Smith
Admirer and supporter of the future United States of America

 

                It was during this period the English monarchy began asserting real dominion over the American colonies after a period of “benign neglect”. England had gone through revolutions and the English Civil War that finally resulted in the installation of the Hanoverian dinasty on the throne. English soldiers became a permanent presence in 1765 paid by the “Stamp Tax”, and by 1770, hostilities between the “continentals” and the king’s authorities were close to becoming a civil war.

                England had developed its colonial expansion, mainly in the Caribbean and North America, following the mercantilist policies approved in the English Navigation Acts. The first law was passed in 1651, primarily targeting Dutch shipping. Increased restrictions and controls were approved in 1660, 1663, 1673, and 1696. They became a burden on the infant American industry, the plantation production, and the shipping activities. Trade was monopolized by English purveyors, and taxes were levied on all transactions. Gradually, the colonial settlers realized they were no longer being treated equally as English subjects.

                The “continentals” presented to Parliament their grievances and proposals that were ignored. Discussions about independence and going to war were accelerated when King George III sent a mercenary army to establish positions of control. The grievances are clearly listed in the 1776 “Declaration of Independence”.

                The English public was also alarmed and divided. A few opinion leaders sided with the “continentals”. Among them was Adam Smith, whose public views he later published in “The Wealth of Nations…” They were prophetic. He concluded the English royals and parliament would not accept the negotiations proposed by the Americans, which he thought were just and reasonable. He saw the “parting” in unfriendly terms as a great loss to England, mainly because he saw in the American Spirit the force for a great future.  This is the prophecy:

                “…it is not very probable that they will ever voluntarily submit to us…”. “The persons who now govern the resolutions of what they call their continental congress, feel in themselves at this moment a degree of importance which, perhaps, the greatest subjects in Europe scarce feel.” “From shopkeepers, tradesmen, and attornies, they are become statesmen and legislators, and are employed in contriving a new form of government for an extensive empire, which, they flatter themselves, will become, and which, indeed, seems very likely to become, one of the greatest and most formidable that ever was in the world.”

                Smith gave the rebuttal to the mercantilist idea of a regulated “zero-sum” commerce by his proposition that in any free, voluntary market transaction both parties benefit. He concluded that the wealth of nations is created by the people engaged in free exchanges of what they create with a higher productivity than others. He also proposed that the larger the size of the market, the more opportunities appear for a more extensive division of labor, leading to further increases in productivity and competition. If people are free to pursue their happiness, wealth will follow.   

The Battle of Yorktown. The English army surrenders to General G. Washington