Principles of Political Economy · John Stuart Mill
Chapter XVI. Of The Foreign Exchanges.
Let us now change the hypothesis, and suppose that the improvement, instead of creating a new export from the United States, cheapens an existing one. Let the commodity in which there is an improvement be [cotton] cloth. The first effect of the improvement is that its price falls, and there is an increased demand for it in the foreign market. But this demand is of uncertain amount. Suppose the foreign consumers to increase their purchases in the exact ratio of the cheapness, or, in other words, to lay out in cloth the same sum of money as before; the same aggregate payment as before will be due from foreign countries to the United States; the equilibrium of exports and imports will remain undisturbed, and foreigners will obtain the full advantage of the increased cheapness of cloth. But if the foreign demand for cloth is of such a character as to increase in a greater ratio than the cheapness, a larger sum than formerly will be due to the United States for cloth, and when paid will raise American prices, the price of cloth included; this rise, however, will affect only the foreign purchaser, American incomes being raised in a corresponding proportion; and the foreign consumer will thus derive a less advantage than the United States from the improvement. If, on the contrary, the cheapening of cloth does not extend the foreign demand for it in a proportional degree, a less sum of debts than before will be due to the United States for cloth, while there will be the usual sum of debts due from the United States to foreign countries; the balance of trade will turn against the United States, money will be exported, prices (that of cloth included) will fall, and cloth will eventually be cheapened to the foreign purchaser in a still greater ratio than the improvement has cheapened it to the United States. These are the very conclusions which [would be] deduced on the hypothesis of barter.(278)
The result of the preceding discussion can not be better summed up than in the words of Ricardo.(279) “Gold and silver having been chosen for the general medium of circulation, they are, by the competition of commerce, distributed in such proportions among the different countries of the world as to accommodate themselves to the natural traffic which would take place if no such metals existed, and the trade between countries were purely a trade of barter.” Of this principle, so fertile in consequences, previous to which the theory of foreign trade was an unintelligible chaos, Mr. Ricardo, though he did not pursue it into its ramifications, was the real originator. On the principles of trade which we have before explained, the same rule will apply to the distribution of money in different parts of the same country, especially of a large country with various kinds of production, like the United States. The medium of exchange will, by the competition of commerce, be distributed in such proportions among the different parts of the United States, by natural laws, as to accommodate itself to the number of transactions which would take place if no such medium existed. For this reason, we find more money in the so-called great financial centers, because there are more exchanges of goods there. In sparsely settled parts of the West there will be less money precisely because there are fewer transactions than in the older and more settled districts. So that there could be no worse folly than the following legislation of Congress to distribute the national-bank circulation: “That $150,000,000 of the entire amount of circulating notes authorized to be issued shall be apportioned to associations in the States, in the District of Columbia, and in the Territories, _according to representative population_” (act of March 3, 1865).
There is, therefore, no contradiction, but the most perfect accordance, in the results of the two different modes [(1) as a medium of exchange; and (2) as merchandise] in which the precious metals may be obtained. When money [as a medium of exchange] flows from country to country in consequence of changes in the international demand for commodities, and by so doing alters its own local value, it merely realizes, by a more rapid process, the effect which would otherwise take place more slowly by an alteration in the relative breadth of the streams by which the precious metals [as merchandise] flow into different regions of the earth from the mining countries. As, therefore, we before saw that the use of money as a medium of exchange does not in the least alter the law on which the values of other things, either in the same country or internationally, depend, so neither does it alter the law of the value of the precious metals itself; and there is in the whole doctrine of international values, as now laid down, a unity and harmony which are a strong collateral presumption of truth. § 4. International payments entering into the “financial account.” Before closing this discussion, it is fitting to point out in what manner and degree the preceding conclusions are affected by the existence of international payments not originating in commerce, and for which no equivalent in either money or commodities is expected or received—such as a tribute, or remittances, or interest to foreign creditors, or a government expenditure abroad.
To begin with the case of barter. The supposed annual remittances being made in commodities, and being exports for which there is to be no return, it is no longer requisite that the imports and exports should pay for one another; on the contrary, there must be an annual excess of exports over imports, equal to the value of the remittance. If, before the country became liable to the annual payment, foreign commerce was in its natural state of equilibrium, it will now be necessary, for the purpose of effecting the remittances, that foreign countries should be induced to take a greater quantity of exports than before, which can only be done by offering those exports on cheaper terms, or, in other words, by paying dearer for foreign commodities. The international values will so adjust themselves that, either by greater exports or smaller imports, or both, the requisite excess on the side of exports will be brought about, and this excess will become the permanent state. The result is, that a country which makes regular payments to foreign countries, besides losing what it pays, loses also something more, by the less advantageous terms on which it is forced to exchange its productions for foreign commodities.
The same results follow on the supposition of money. Commerce being supposed to be in a state of equilibrium when the obligatory remittances begin, the first remittance is necessarily made in money. This lowers prices in the remitting country, and raises them in the receiving. The natural effect is, that more commodities are exported than before, and fewer imported, and that, on the score of commerce alone, a balance of money will be constantly due from the receiving to the paying country. When the debt thus annually due to the tributary country becomes equal to the annual tribute or other regular payment due from it, no further transmission of money takes place; the equilibrium of exports and imports will no longer exist, but that of payments will; the exchange will be at par, the two debts will be set off against one another, and the tribute or remittance will be virtually paid in goods. The result to the interests of the two countries will be as already pointed out—the paying country will give a higher price for all that it buys from the receiving country, while the latter, besides receiving the tribute, obtains the exportable produce of the tributary country at a lower price.
It has been seen, as in Chart No. XIII, that, considering the exports and imports merely as merchandise, there is, in fact, no actual equilibrium at any given time in accordance with the equation of International Demand. Another element, the “financial account” between the United States and foreign countries, must be considered before we can know all the factors necessary to bring about the equation. If we had been borrowing largely of England, Holland, and Germany, we should owe a regular annual sum as interest, and our exports must, as a rule, be exactly that much more (under right and normal conditions) than the imports. Or, take another case, if capital is borrowed in Europe for railways in the United States, this capital generally comes over in the form of imports of various kinds; but, if our exports are not sufficient at once to balance the increased imports, we go in debt for a time—or, in other words, in order to establish the balance, we send United States securities abroad instead of actual exports. This shipment of securities is not seen and recorded as among the exports; and so we find a period, like that during and after the war, from 1862 to 1873, of a vast excess of imports.
Since 1873 the country has been practically paying the indebtedness incurred in the former period; and there has been a vast excess of exports over imports, and an apparent discrepancy in the equilibrium. But our government bonds and other securities have been coming back to us, producing a return current to balance the excessive exports.(280) In brief, the use of securities and various forms of indebtedness permits the period of actual payment to be deferred, so that an excess of imports at one time may be offset by an excess of exports at another, and generally a later, time. Moreover, the large expenses of people traveling in Europe will require us to remit abroad in the form of exports more than would ordinarily balance our imports by the amount spent by the travelers. The financial operations, therefore, between the United States and foreign countries, must be well considered in striking the equation between our exports and imports. As formulated by Mr. Cairnes,(281) the Equation of International Demand should be stated more broadly, as follows: “The state of international demand which results in commercial equilibrium is realized when the reciprocal demand of trading countries produces such a relation of exports and imports among them as enables each country by means of her exports to discharge _all her foreign liabilities_.” If we were a great lending instead of a great borrowing country, we should have, as a rule, a permanent excess of imports.
Chapter XVIII. Influence Of The Currency On The Exchanges And On Foreign Trade. § 1. Variations in the exchange, which originate in the Currency. In our inquiry into the laws of international trade, we commenced with the principles which determine international exchanges and international values on the hypothesis of barter. We next showed that the introduction of money, as a medium of exchange, makes no difference in the laws of exchanges and of values between country and country, no more than between individual and individual: since the precious metals, under the influence of those same laws, distribute themselves in such proportions among the different countries of the world as to allow the very same exchanges to go on, and at the same values, as would be the case under a system of barter. We lastly considered how the value of money itself is affected by those alterations in the state of trade which arise from alterations either in the demand and supply of commodities or in their cost of production. It remains to consider the alterations in the state of trade which originate not in commodities but in money.
Gold and silver may vary like other things, though they are not so likely to vary as other things in their cost of production. The demand for them in foreign countries may also vary. It may increase by augmented employment of the metals for purposes of art and ornament, or because the increase of production and of transactions has created a greater amount of business to be done by the circulating medium. It may diminish, for the opposite reasons; or, from the extension of the economizing expedients by which the use of metallic money is partially dispensed with. These changes act upon the trade between other countries and the mining countries, and upon the value of the precious metals, according to the general laws of the value of imported commodities: which have been set forth in the previous chapters with sufficient fullness. What I propose to examine in the present chapter is not those circumstances affecting money which alter the permanent conditions of its value, but the effects produced on international trade by casual or temporary variations in the value of money, which have no connection with any causes affecting its permanent value. § 2. Effect of a sudden increase of a metallic Currency, or of the sudden creation of Bank-Notes or other substitutes for Money.
Let us suppose in any country a circulating medium purely metallic, and a sudden casual increase made to it; for example, by bringing into circulation hoards of treasure, which had been concealed in a previous period of foreign invasion or internal disorder. The natural effect would be a rise of prices. This would check exports and encourage imports; the imports would exceed the exports, the exchanges would become unfavorable, and a newly acquired stock of money would diffuse itself over all countries with which the supposed country carried on trade, and from them, progressively, through all parts of the commercial world. The money which thus overflowed would spread itself to an equal depth over all commercial countries. For it would go on flowing until the exports and imports again balanced one another; and this (as no change is supposed in the permanent circumstances of international demand) could only be when the money had diffused itself so equally that prices had risen in the same ratio in all countries, so that the alteration of price would be for all practical purposes ineffective, and the exports and imports, though at a higher money valuation, would be exactly the same as they were originally. This diminished value of money throughout the world (at least if the diminution was considerable) would cause a suspension, or at least a diminution, of the annual supply from the mines, since the metal would no longer command a value equivalent to its highest cost of production. The annual waste would, therefore, not be fully made up, and the usual causes of destruction would gradually reduce the aggregate quantity of the precious metals to its former amount; after which their production would recommence on its former scale. The discovery of the treasure would thus produce only temporary effects; namely, a brief disturbance of international trade until the treasure had disseminated itself through the world, and then a temporary depression in the value of the metal below that which corresponds to the cost of producing or of obtaining it; which depression would gradually be corrected by a temporarily diminished production in the producing countries and importation in the importing countries.
The same effects which would thus arise from the discovery of a treasure accompany the process by which bank-notes, or any of the other substitutes for money, take the place of the precious metals. Suppose(282) that the United States possessed a currency, wholly metallic, of $200,000,000, and that suddenly $200,000,000 of bank-notes were sent into circulation. If these were issued by bankers, they would be employed in loans, or in the purchase of securities, and would therefore create a sudden fall in the rate of interest, which would probably send a great part of the $200,000,000 of gold out of the country as capital, to seek a higher rate of interest elsewhere, before there had been time for any action on prices. But we will suppose that the notes are not issued by bankers, or money-lenders of any kind, but by manufacturers, in the payment of wages and the purchase of materials, or by the Government [as, e.g., greenbacks] in its ordinary expenses, so that the whole amount would be rapidly carried into the markets for commodities. The following would be the natural order of consequences: All prices would rise greatly. Exportation would almost cease; importation would be prodigiously stimulated. A great balance of payments would become due, the exchanges would turn against the United States, to the full extent of the cost of exporting money; and the surplus coin would pour itself rapidly forth, over the various countries of the world, in the order of their proximity, geographically and commercially, to the United States.
A study of Chart No. XIV will show how exactly this description fits the case of our country, when the rise of prices stimulated imports of merchandise (see Chart No. XIII) in 1862, and sent gold out of the country. The efflux would continue until the currencies of all countries had come to a level; by which I do not mean, until money became of the same value everywhere, but until the differences were only those which existed before, and which corresponded to permanent differences in the cost of obtaining it. When the rise of prices had extended itself in an equal degree to all countries, exports and imports would everywhere revert to what they were at first, would balance one another, and the exchanges would return to par. If such a sum of money as $200,000,000, when spread over the whole surface of the commercial world, were sufficient to raise the general level in a perceptible degree, the effect would be of no long duration. No alteration having occurred in the general conditions under which the metals were procured, either in the world at large or in any part of it, the reduced value would no longer be remunerating, and the supply from the mines would cease partially or wholly, until the $200,000,000 were absorbed.(283)
Effects of another kind, however, will have been produced: $200,000,000, which formerly existed in the unproductive form of metallic money, have been converted into what is, or is capable of becoming, productive capital. This gain is at first made by the United States at the expense of other countries, who have taken her superfluity of this costly and unproductive article off her hands, giving for it an equivalent value in other commodities. By degrees the loss is made up to those countries by diminished influx from the mines, and finally the world has gained a virtual addition of $200,000,000 to its productive resources. Adam Smith’s illustration, though so well known, deserves for its extreme aptness to be once more repeated. He compares the substitution of paper in the room of the precious metals to the construction of a highway through the air, by which the ground now occupied by roads would become available for agriculture. As in that case a portion of the soil, so in this a part of the accumulated wealth of the country, would be relieved from a function in which it was only employed in rendering other soils and capitals productive, and would itself become applicable to production; the office it previously fulfilled being equally well discharged by a medium which costs nothing.
The value saved to the community by thus dispensing with metallic money is a clear gain to those who provide the substitute. They have the use of $200,000,000 of circulating medium which have cost them only the expense of an engraver’s plate. If they employ this accession to their fortunes as productive capital, the produce of the country is increased and the community benefited, as much as by any other capital of equal amount. Whether it is so employed or not depends, in some degree, upon the mode of issuing it. If issued by the Government, and employed in paying off debt, it would probably become productive capital. The Government, however, may prefer employing this extraordinary resource in its ordinary expenses; may squander it uselessly, or make it a mere temporary substitute for taxation to an equivalent amount; in which last case the amount is saved by the tax-payers at large, who either add it to their capital or spend it as income.
When [a part of the] paper currency is supplied, as in our own country, by banking companies, the amount is almost wholly turned into productive capital; for the issuers, being at all times liable to be called upon to refund the value, are under the strongest inducements not to squander it, and the only cases in which it is not forthcoming are cases of fraud or mismanagement. A banker’s profession being that of a money-lender, his issue of notes is a simple extension of his ordinary occupation. He lends the amount to farmers, manufacturers, or dealers, who employ it in their several businesses. So employed, it yields, like any other capital, wages of labor, and profits of stock. The profit is shared between the banker, who receives interest, and a succession of borrowers, mostly for short periods, who, after paying the interest, gain a profit in addition, or a convenience equivalent to profit. The capital itself in the long run becomes entirely wages, and, when replaced by the sale of the produce, becomes wages again; thus affording a perpetual fund, of the value of $200,000,000, for the maintenance of productive labor, and increasing the annual produce of the country by all that can be produced through the means of a capital of that value. To this gain must be added a further saving to the country, of the annual supply of the precious metals necessary for repairing the wear and tear, and other waste, of a metallic currency.
The substitution, therefore, of paper for the precious metals should always be carried as far as is consistent with safety, no greater amount of metallic currency being retained than is necessary to maintain, both in fact and in public belief, the convertibility of the paper. But since gold wanted for exportation is almost invariably drawn from the reserves of the banks, and is never likely to be taken directly from the circulation while the banks remain solvent, the only advantage which can be obtained from retaining partially a metallic currency for daily purposes is, that the banks may occasionally replenish their reserves from it. § 3. Effect of the increase of an inconvertible paper Currency. Real and nominal exchange. When metallic money had been entirely superseded and expelled from circulation, by the substitution of an equal amount of bank-notes, any attempt to keep a still further quantity of paper in circulation must, if the notes are convertible [into gold], be a complete failure. This brings up the whole question at issue between the “Currency Principle” and the “Banking Principle.” The latter, maintained by Fullerton, Wilson, Price, and Tooke (in his later writings), held that, if notes were convertible, the value of notes could not differ from the value of the metal into which they were convertible; while the former, advocated by Lord Overstone, G. W. Norman, Colonel Torrens, Tooke (in his earlier writings), and Sir Robert Peel, implied that even a convertible paper was liable to over-issues. This last school brought about the Bank Act of 1844.(284)
Let us suppose that the United States is the country which has the depreciated paper. Suppose that some American production could be bought, while the currency was still metallic, for $25, and sold in England for $27.50, the difference covering the expense and risk, and affording a profit to the merchant. On account of the depreciation, this commodity will now cost in the United States $30, and can not be sold in England for more than $27.50, and yet it will be exported as before. Why? Because the $27.50 which the exporter can get for it in England is not depreciated paper, but gold or silver; and since in the United States bullion has risen in the same proportion with other things—if the merchant brings the gold or silver to the United States, he can sell his $27.50 [in coin] for $33 [in paper], and obtain as before 10 per cent for profit and expenses.
Text from Project Gutenberg, public domain in the United States.