Disturbances, therefore, of the equilibrium of imports and exports, and
consequent disturbances of the exchange, may be considered as of two
classes: the one casual or accidental, which, if not on too large a scale,
correct themselves through the premium on bills, without any transmission
of the precious metals; the other arising from the general state of
prices, which can not be corrected without the subtraction of actual money
from the circulation of one of the countries, or an annihilation of credit
equivalent to it.
It remains to observe that the exchanges do not depend on the balance of
debts and credits with each country separately, but with all countries
taken together. The United States may owe a balance of payments to
England; but it does not follow that the exchange with England will be
against the United States, and that bills on England will be at a premium;
because a balance may be due to the United States from Holland or Hamburg,
and she may pay her debts to England with bills on those places; which is
technically called arbitration of exchange. There is some little
additional expense, partly commission and partly loss of interest in
settling debts in this circuitous manner, and to the extent of that small
difference the exchange with one country may vary apart from that with
others.
A common use of bills of exchange is that by which, when three
countries are concerned, two of them may strike a balance through
the third, if both countries have dealings with that third
country. New York merchants may buy of China, but China may not be
buying of New York, although both may have dealings with London.
[Illustration.]
A, we will suppose, is a buyer of ￡1,000 worth of tea from F, in
Hong-Kong; B is an exporter of wheat (￡1,000) to C in London; D
has sent ￡1,000 worth of cotton goods to E in Hong-Kong. A can now
pay F through London without the transmission of coin. A buys B’s
claim on C for ￡1,000, and sends it to F. E wishes to pay D in
London for the cotton goods he bought of him; therefore, he buys
from F for ￡1,000 the claim he now holds (i.e., a bill of exchange
on London) against C for ￡1,000. E sends it to D, and, when D
collects it from C, the whole circle of exchanges is completed
without the transmission of the precious metals.
Chapter XVII. Of The Distribution Of The Precious Metals Through The
Commercial World.
§ 1. The substitution of money for barter makes no difference in exports
and imports, nor in the Law of international Values.
Having now examined the mechanism by which the commercial transactions
between nations are actually conducted, we have next to inquire whether
this mode of conducting them makes any difference in the conclusions
respecting international values, which we previously arrived at on the
hypothesis of barter.
The nearest analogy would lead us to presume the negative. We did not find
that the intervention of money and its substitutes made any difference in
the law of value as applied to adjacent places. Things which would have
been equal in value if the mode of exchange had been by barter are worth
equal sums of money. The introduction of money is a mere addition of one
more commodity, of which the value is regulated by the same laws as that
of all other commodities. We shall not be surprised, therefore, if we find
that international values also are determined by the same causes under a
money and bill system as they would be under a system of barter, and that
money has little to do in the matter, except to furnish a convenient mode
of comparing values.
All interchange is, in substance and effect, barter; whoever sells
commodities for money, and with that money buys other goods, really buys
those goods with his own commodities. And so of nations: their trade is a
mere exchange of exports for imports; and, whether money is employed or
not, things are only in their permanent state when the exports and imports
exactly pay for each other. When this is the case, equal sums of money are
due from each country to the other, the debts are settled by bills, and
there is no balance to be paid in the precious metals. The trade is in a
state like that which is called in mechanics a condition of stable
equilibrium.
But the process by which things are brought back to this state when they
happen to deviate from it is, at least outwardly, not the same in a barter
system and in a money system. Under the first, the country which wants
more imports than its exports will pay for must offer its exports at a
cheaper rate, as the sole means of creating a demand for them sufficient
to re-establish the equilibrium. When money is used, the country seems to
do a thing totally different. She takes the additional imports at the same
price as before, and, as she exports no equivalent, the balance of
payments turns against her; the exchange becomes unfavorable, and the
difference has to be paid in money. This is, in appearance, a very
distinct operation from the former. Let us see if it differs in its
essence, or only in its mechanism.
Let the country which has the balance to pay be the United States,(276)
and the country which receives it, England. By this transmission of the
precious metals, the quantity of the currency is diminished in the United
States, and increased in England. This I am at liberty to assume. We are
now supposing that there is an excess of imports over exports, arising
from the fact that the equation of international demand is not yet
established: that there is at the ordinary prices a permanent demand in
the United States for more English goods than the American goods required
in England at the ordinary prices will pay for. When this is the case, if
a change were not made in the prices, there would be a perpetually renewed
balance to be paid in money. The imports require to be permanently
diminished, or the exports to be increased, which can only be accomplished
through prices; and hence, even if the balances are at first paid from
hoards, or by the exportation of bullion, they will reach the circulation
at last, for, until they do, nothing can stop the drain.
When, therefore, the state of prices is such that the equation of
international demand can not establish itself, the country requiring more
imports than can be paid for by the exports, it is a sign that the country
has more of the precious metals, or their substitutes, in circulation,
than can permanently circulate, and must necessarily part with some of
them before the balance can be restored. The currency is accordingly
contracted: prices fall, and, among the rest, the prices of exportable
articles; for which, accordingly, there arises, in foreign countries, a
greater demand: while imported commodities have possibly risen in price,
from the influx of money into foreign countries, and at all events have
not participated in the general fall. But, until the increased cheapness
of American goods induces foreign countries to take a greater pecuniary
value, or until the increased dearness (positive or comparative) of
foreign goods makes the United States take a less pecuniary value, the
exports of the United States will be no nearer to paying for the imports
than before, and the stream of the precious metals which had begun to flow
out of the United States will still flow on. This efflux will continue
until the fall of prices in the United States brings within reach of the
foreign market some commodity which the United States did not previously
send thither; or, until the reduced price of the things which she did send
has forced a demand abroad for a sufficient quantity to pay for the
imports, aided perhaps by a reduction of the American demand for foreign
goods, through their enhanced price, either positive or comparative.
Now, this is the very process which took place on our original supposition
of barter. Not only, therefore, does the trade between nations tend to the
same equilibrium between exports and imports, whether money is employed or
not, but the means by which this equilibrium is established are
essentially the same. The country whose exports are not sufficient to pay
for her imports offers them on cheaper terms, until she succeeds in
forcing the necessary demand: in other words, the equation of
international demand, under a money system as well as under a barter
system, is the law of international trade. Every country exports and
imports the very same things, and in the very same quantity, under the one
system as under the other. In a barter system, the trade gravitates to the
point at which the sum of the imports exactly exchanges for the sum of the
exports: in a money system, it gravitates to the point at which the sum of
the imports and the sum of the exports exchange for the same quantity of
money. And, since things which are equal to the same thing are equal to
one another, the exports and imports which are equal in money price would,
if money were not used, precisely exchange for one another.(277)
§ 2. The preceding Theorem further illustrated.
Let us proceed to [examine] to what extent the benefit of an improvement
in the production of an exportable article is participated in by the
countries importing it.
The improvement may either consist in the cheapening of some article which
was already a staple production of the country, or in the establishment of
some new branch of industry, or of some process rendering an article
exportable which had not till then been exported at all. It will be
convenient to begin with the case of a new export, as being somewhat the
simpler of the two.
The first effect is that the article falls in price, and a demand arises
for it abroad. This new exportation disturbs the balance, turns the
exchanges, money flows into the country (which we shall suppose to be the
United States), and continues to flow until prices rise. This higher range
of prices will somewhat check the demand in foreign countries for the new
article of export; and will diminish the demand which existed abroad for
the other things which the United States was in the habit of exporting.
The exports will thus be diminished; while at the same time the American
public, having more money, will have a greater power of purchasing foreign
commodities. If they make use of this increased power of purchase, there
will be an increase of imports; and by this, and the check to exportation,
the equilibrium of imports and exports will be restored. The result to
foreign countries will be, that they have to pay dearer than before for
their other imports, and obtain the new commodity cheaper than before, but
not so much cheaper as the United States herself does. I say this, being
well aware that the article would be actually at the very same price (cost
of carriage excepted) in the United States and in other countries. The
cheapness, however, of the article is not measured solely by the
money-price, but by that price compared with the money-incomes of the
consumers. The price is the same to the American and to the foreign
consumers; but the former pay that price from money-incomes which have
been increased by the new distribution of the precious metals; while the
latter have had their money-incomes probably diminished by the same cause.
The trade, therefore, has not imparted to the foreign consumer the whole,
but only a portion, of the benefit which the American consumer has derived
from the improvement; while the United States has also benefited in the
prices of foreign commodities. Thus, then, any industrial improvement
which leads to the opening of a new branch of export trade benefits a
country not only by the cheapness of the article in which the improvement
has taken place, but by a general cheapening of all imported products.
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).
§ 3. The precious metals, as money, are of the same Value, and distribute
themselves according to the same Law, with the precious metals as a
Commodity.
It is now necessary to inquire in what manner this law of the distribution
of the precious metals by means of the exchanges affects the exchange
value of money itself; and how it tallies with the law by which we found
that the value of money is regulated when imported as a mere article of
merchandise.
The causes which bring money into or carry it out of a country (1) through
the exchanges, to restore the equilibrium of trade, and which thereby
raise its value in some countries and lower it in others, are the very
same causes on which the local value of money would depend, if it were
never imported except (2) as a merchandise, and never except directly from
the mines. When the value of money in a country is permanently lowered (1)
[as a medium of exchange] by an influx of it through the balance of trade,
the cause, if it is not diminished cost of production, must be one of
those causes which compel a new adjustment, more favorable to the country,
of the equation of international demand—namely, either an increased demand
abroad for her commodities, or a diminished demand on her part for those
of foreign countries. Now, an increased foreign demand for the commodities
of a country, or a diminished demand in the country for imported
commodities, are the very causes which, on the general principles of
trade, enable a country to purchase all imports, and consequently (2) the
precious metals, at a lower value. 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)
[A] new issue would again set in motion the same train of consequences by
which the gold coin had already been expelled. The metals would, as
before, be required for exportation, and would be for that purpose
demanded from the banks, to the full extent of the superfluous notes,
which thus could not possibly be retained in circulation. If, indeed, the
notes were inconvertible, there would be no such obstacle to the increase
in their quantity. An inconvertible paper acts in the same way as a
convertible, while there remains any coin for it to supersede; the
difference begins to manifest itself when all the coin is driven from
circulation (except what may be retained for the convenience of small
change), and the issues still go on increasing. When the paper begins to
exceed in quantity the metallic currency which it superseded, prices of
course rise; things which were worth $25 in metallic money become worth
$30 in inconvertible paper, or more, as the case may be. But this rise of
price will not, as in the cases before examined, stimulate import and
discourage export. The imports and exports are determined by the metallic
prices of things, not by the paper prices; and it is only when the paper
is exchangeable at pleasure for the metals that paper prices and metallic
prices must correspond.
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.
It thus appears that a depreciation of the currency does not affect the
foreign trade of the country: this is carried on precisely as if the
currency maintained its value. But, though the trade is not affected, the
exchanges are. When the imports and exports are in equilibrium, the
exchange, in a metallic currency, would be at par; a bill on England for
the equivalent of $25 would be worth $25. But $25, or the quantity of gold
contained in them, having come to be worth in the United States $30, it
follows that a bill on England for $25 will be worth $30. When, therefore,
the _real_ exchange is at par, there will be a _nominal_ exchange against
the country of as much per cent as the amount of the depreciation. If the
currency is depreciated 10, 15, or 20 per cent, then in whatever way the
real exchange, arising from the variations of international debts and
credits, may vary, the quoted exchange will always differ 10, 15, or 20
per cent from it. However high this nominal premium may be, it has no
tendency to send gold out of the country for the purpose of drawing a bill
against it and profiting by the premium; because the gold so sent must be
procured, not from the banks and at par, as in the case of a convertible
currency, but in the market, at an advance of price equal to the premium.
In such cases, instead of saying that the exchange is unfavorable, it
would be a more correct representation to say that the par has altered,
since there is now required a larger quantity of American currency to be
equivalent to the same quantity of foreign. The exchanges, however,
continue to be computed according to the metallic par. The quoted
exchanges, therefore, when there is a depreciated currency, are compounded
of two elements or factors: (1) the real exchange, which follows the
variations of international payments, and (2) the nominal exchange, which
varies with the depreciation of the currency, but which, while there is
any depreciation at all, must always be unfavorable. Since the amount of
depreciation is exactly measured by the degree in which the market price
of bullion exceeds the mint valuation, we have a sure criterion to
determine what portion of the quoted exchange, being referable to
depreciation, may be struck off as nominal, the result so corrected
expressing the real exchange.
The same disturbance of the exchanges and of international trade which is
produced by an increased issue of convertible bank-notes is in like manner
produced by those extensions of credit which, as was so fully shown in a
preceding chapter, have the same effect on prices as an increase of the
currency. Whenever circumstances have given such an impulse to the spirit
of speculation as to occasion a great increase of purchases on credit,
money prices rise, just as much as they would have risen if each person
who so buys on credit had bought with money. All the effects, therefore,
must be similar. As a consequence of high prices, exportation is checked
and importation stimulated; though in fact the increase of importation
seldom waits for the rise of prices which is the consequence of
speculation, inasmuch as some of the great articles of import are usually
among the things in which speculative overtrading first shows itself.
There is, therefore, in such periods, usually a great excess of imports
over exports; and, when the time comes at which these must be paid for,
the exchanges become unfavorable and gold flows out of the country. This
efflux of gold takes effect on prices [by withdrawing gold from the
reserves of the banks, and so by stopping loans and the use of credit, or
purchasing power]: its effect is to make them recoil downward. The recoil
once begun, generally becomes a total rout, and the unusual extension of
credit is rapidly exchanged for an unusual contraction of it. Accordingly,
when credit has been imprudently stretched, and the speculative spirit
carried to excess, the turn of the exchanges and consequent pressure on
the banks to obtain gold for exportation are generally the proximate cause
of the catastrophe.
A glance at Chart No. XIII will give illustration to the situation
here described. After the war, and until 1873, while the United
States was under the influence of high prices and a speculation
which has been seldom equaled in our history, the resulting great
excess of imports became very striking. It was an unhealthy and
abnormal condition of trade. The sudden reversal of the trade by
the crisis in 1873 is equally striking, and, as prices fell,
exports began to increase. The effect on international trade of a
collapse of credit is thus clearly marked by the lines on the
chart.
Chapter XIX. Of The Rate Of Interest.
§ 1. The Rate of Interest depends on the Demand and Supply of Loans.
The two topics of Currency and Loans, though in themselves distinct, are
so intimately blended in the phenomena of what is called the money market,
that it is impossible to understand the one without the other, and in many
minds the two subjects are mixed up in the most inextricable confusion.
In the preceding book(285) we defined the relation in which interest
stands to profit. We found that the gross profit of capital might be
distinguished into three parts, which are respectively the remuneration
for risk, for trouble, and for the capital itself, and may be termed
insurance, wages of superintendence, and interest. After making
compensation for risk, that is, after covering the average losses to which
capital is exposed either by the general circumstances of society or by
the hazards of the particular employment, there remains a surplus, which
partly goes to repay the owner of the capital for his abstinence, and
partly the employer of it for his time and trouble. How much goes to the
one and how much to the other is shown by the amount of the remuneration
which, when the two functions are separated, the owner of capital can
obtain from the employer for its use. This is evidently a question of
demand and supply. Nor have demand and supply any different meaning or
effect in this case from what they have in all others. The rate of
interest will be such as to equalize the demand for loans with the supply
of them. It will be such that, exactly as much as some people are desirous
to borrow at that rate, others shall be willing to lend. If there is more
offered than demanded, interest will fall; if more is demanded than
offered, it will rise; and in both cases, to the point at which the
equation of supply and demand is re-established.
The desire to borrow and the willingness to lend are more or less
influenced by every circumstance which affects the state or prospects of
industry or commerce, either generally or in any of their branches. The
rate of interest, therefore, on good security, which alone we have here to
consider (for interest in which considerations of risk bear a part may
swell to any amount), is seldom, in the great centers of money
transactions, precisely the same for two days together; as is shown by the
never-ceasing variations in the quoted prices of the funds and other
negotiable securities. Nevertheless, there must be, as in other cases of
value, some rate which (in the language of Adam Smith and Ricardo) may be
called the natural rate; some rate about which the market rate oscillates,
and to which it always tends to return. This rate partly depends on the
amount of accumulation going on in the hands of persons who can not
themselves attend to the employment of their savings, and partly on the
comparative taste existing in the community for the active pursuits of
industry, or for the leisure, ease, and independence of an annuitant.
§ 2. Circumstances which Determine the Permanent Demand and Supply of
Loans.
In [ordinary] circumstances, the more thriving producers and traders have
their capital fully employed, and many are able to transact business to a
considerably greater extent than they have capital for. These are
naturally borrowers: and the amount which they desire to borrow, and can
give security for, constitutes the demand for loans on account of
productive employment. To these must be added the loans required by
Government, and by land-owners, or other unproductive consumers who have
good security to give. This constitutes the mass of loans for which there
is an habitual demand.
Now, it is conceivable that there might exist, in the hands of persons
disinclined or disqualified for engaging personally in business, (1) a
mass of capital equal to, and even exceeding, this demand. In that case
there would be an habitual excess of competition on the part of lenders,
and the rate of interest would bear a low proportion to the rate of
profit. Interest would be forced down to the point which would either
tempt borrowers to take a greater amount of loans than they had a
reasonable expectation of being able to employ in their business, or would
so discourage a portion of the lenders as to make them either forbear to
accumulate or endeavor to increase their income by engaging in business on
their own account, and incurring the risks, if not the labors, of
industrial employment.
The low rates of interest, rather, tempt people to take some
additional risk, and enter into investments which offer a higher
rate of dividends; so that a period of low interest is a time when
speculative enterprises find victims, and then by bad and
worthless investments much of the loanable funds is actually lost;
thereby reducing the total quantity of loans more nearly to that
demand which will give an ordinary rate of interest. |
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