And we understand the need for social institutions to constrain our actions. Since Smith, economists have underplayed the importance of institutions, although there have been notable exceptions such as Douglas North and Ronald Coase. Over the centuries, theories of a competitive market economy have been refined. From these theories flows the remarkable result that, under certain conditions, the pursuit by each person of their individual self interest leads to a more efficient outcome for society as a whole. That work reached its apogee in the post-war work by Kenneth Arrow and Gerard Debreu. Those economic models are, however, silent about many of the institutions that are fundamental to the results. 12 But without the appropriate institutions we tend to anarchy not prosperity. The challenge facing us is to design and maintain the right set of institutions or  8  Theory of Moral Sentiments, II,ii,3.3,p86. 9  In her 2002 Reith lectures “A Question of Trust”, Onora O’Neill argued that in order to interact with others, both as individuals and institutions, trust plays a crucial role. 10  Wealth of Nations, I,11,2,p26. 11  Rothschild (2001) puts Smith’s writings in the context of the Enlightenment and, while pointing to the complexity of Smith’s views and his caution in expressing them in public, paints an overall picture of a man who is not best described as a split personality. 12  Economists have grappled with the challenge of understanding worlds in which there are not markets for everything.
Smith’s close friend, the chemist Joseph Black, said that he was “obliged to weigh when strange students come, there being a very large number who bring light guineas, so that I should be defrauded of many pounds every year if I did not act in self-defence against this class of students." 16 And so we reach paper money. I have here a £ note. What is it? Money you say. Surely it is just a piece of paper. What is the difference between a piece of paper and money? You can “buy stuff with it”. 17 Why can we get anything in exchange for these intrinsically worthless pieces of paper? It is because those to whom we give the paper expect that they will, in turn, be able to get something for it. That rests on the expectation that whoever they pass the paper to will in their turn be able to get something for it, and so on, ad infinitum. In short, the value of money depends on trust. But it is not easy to trust paper money unless we trust the issuer. Much of the financial history of the past 150 years is the story of our collective attempts to manage paper money. In a democracy, we  13  Wealth of Nations ,I, iv,p38. 14  See Kiyotaki and Moore (2002). 15  Wealth of Nations ,I, iv,p38. 16  Rae (1895), p 49.