The Online Library of Liberty

A project of Liberty Fund, Inc.

• Preface
• Studies In the Theory of International Trade
• Chapter I: English Theories of Foreign Trade, Before Adam Smith: I
• I. Introduction
• II. “ Mercantilism” and “bullionism”
• III. the Balance-of-trade Doctrine
• IV. Reasons For Wanting More Bullion
• V. Employment and the Balance of Trade
• Chapter II: English Theories of Foreign Trade, Before Adam Smith: Ii
• I. Legislative Proposals of Mercantilists
• II. the Collapse of Mercantilist Doctrine
• III. Some Modern Interpretations of English Mercantilism
• Chapter III: The Bullionist Controversies: I. The Inflation Phase
• I. the Participants In the Controversy
• II. the Factual Background
• III. Premium On Bullion As Evidence of Excess Issue: the Bullionist Position
• IV. Qualifications Conceded By the Bullionists
• V. Possible Objections to the Bullionist Position
• VI. the Anti-bullionist Position
• VII. the Balance of Payments Argument
• VIII. the Possibility of Excess Issue By Banks
• IX. Responsibility For the Excess Issue: Bank of England Vs. Country Banks
• X. Responsibility For Excess Issue: the Credit Policy of the Bank of England
• Chapter IV: The Bullionist Controversies: II. The Deflation Phase
• I. the Resumption of Cash Payments
• II. Responsibility of Resumption For the Fall In Prices
• III. the Economic Effect of Changing Price Levels
• IV. Ricardo's Position On the Gold Standard
• V. Reform Without Departure From the Metallic Standard
• VI. Paper Standard Currencies
• Chapter V: English Currency Controversies, 1825–1865
• I. Introduction
• II. the “currency School” -“banking School” Controversy
• III. the “palmer Rule ”
• IV. the Bank Act of 1844
• V. the Possibility of Overissue of Convertible Bank Notes
• VI. the Role of Deposits, Bills of Exchange, and “credit” In the Currency System
• VII. the Technique of Credit Control
• VIII. the Relation Between Bank of England Operations and Specie Movements
• IX. Currency Reform Proposals
• Chapter VI: The International Mechanism Under a Simple Specie Currency
• I. Introductory
• II. the Mechanism According to Hume
• III. an Omitted Factor? Relative Changes In Demand As an Equilibrating Force
• IV. Prices In the Mechanism: the Concept of “price Levels ”
• V. the “terms-of-trade” Concept
• VI. the Prices of “domestic” Commodities
• VII. the Mechanism of Transfer of Unilateral Payments In Some Recent Literature
• VIII. a Graphical Examination of Pigou's Analysis 1
• IX. Some Elaborations On the Basis of Pigou's Analysis
• X. an Alternative Solution
• XI. Types of Disturbance In International Equilibrium
• XII. Specie Movements and Velocity of Money
• XIII. Commodity Flows and Relative Price Levels
• XIV. Exchange Rates
• XV. A Criticism of the Purchasing-power Parity Theory 1
• Chapter VII: The International Mechanism In Relation to Modern Banking Processes
• I. Automatic Vs. Managed Currencies
• II. Primary and Secondary Expansion of Means of Payments
• III. Short-term Loans In the International Mechanism
• IV. Primary and Secondary Expansion In Canada , 1900–13
• V. the International Mechanism and Business Cycles
• Chapter VIII: Gains From Trade: the Doctrine of Comparative Costs
• I. the Nature and Origin of the Doctrine
• II. the Division of the Gain From Trade
• III. Trade In More Than Two Commodities
• IV. Trade Between More Than Two Countries
• V. Transportation Costs
• VI. Increasing and Decreasing Costs
• VII. Prices, Money Costs, and Real Costs
• VIII. Dependence of Comparative Cost Doctrine On a Real-cost Theory of Value
• IX. Differences In Wage Rates In Different Occupations
• X. Variable Proportions of the Factors and International Specialization
• XI. Variable Proportions of the Factor and Comparative Real Costs
• XII. “ Opportunity Cost” Analysis As a Substitute For Real Cost Analysis
• Chapter IX: Gains From Trade: the Maximization of Real Income
• I. “ Mass of Commodities” and “sum of Enjoyments”: Ricardo and Malthus
• II. Reciprocal Demand and the Terms of Trade
• III. Terms of Trade and the Amount of Gain From Trade
• IV. “ Net Benefit” In International Trade: Marshall
• V. Total Net Utility Derived From International Trade: Edgeworth
• VI. the Gain From Trade Measured In Money
• Appendix: a Note On the Scope and Method of the Theory of International Trade

VII. The Balance of Payments Argument

The anti-bullionists, however, had a more serious objection to raise against the acceptance of the premium on bullion over paper as a proof of excess currency. It was agreed on both sides that under an inconvertible as under a convertible standard the price of bullion was governed by the foreign exchanges. Both sides were also agreed that under convertibility the exchanges could not ordinarily fall below the gold export point, since below that point, representing by its distance from mint parity of the two currencies the cost of transmitting bullion, it would be more profitable to ship bullion than to buy foreign bills. The anti-bullionists argued, however, that under inconvertibility this limit to the fall in the exchanges did not exist; that the exchanges and the premium on bullion would be governed solely by the state of the balance of international payments;1 and that in a period when heavy military remittances and extraordinary importations of grain because of deficient English harvests had to be made, there was no definable limit beyond which the exchanges could not fall or the premium on bullion rise without demonstrating that the currency was in excess.

In their treatment of this crucial issue, the bullionists were divided into two groups, offering different answers. One of these groups consisted of only two men, Wheatley and Ricardo.2 To the argument that foreign remittances would under inconvertibility operate to depress the exchanges, Wheatley and Ricardo both replied that foreign remittances would have no effect on the exchanges whether under convertibility or inconvertibility; in both cases, they maintained, the demands of England and the rest of the world for each other's products would so adjust themselves automatically to the remittances that they would be transferred in goods without changes either in relative prices or in exchange rates. If under inconvertibility, therefore, there appeared a depreciation of sterling exchange, this was evidence of excess issue of currency. Ricardo later made some minor concessions to his critics,3 but Wheatley adhered rigidly to this doctrine to the end.4 The other bullionists took an intermediate position. They conceded that foreign remittances would affect the exchange rates, and conceded also, though without adequately explaining why, that while such remittances were under way a premium on bullion and exchanges below parity were not proof that the amount of currency in circulation was in excess of what could be maintained under a metallic standard currency. They confined themselves to the argument that a continued and substantial premium of gold over paper, and fall of the exchanges below parity, established strong presumptions that the currency was in excess of what could be maintained under a metallic standard. The Bullion Report, for instance, cited the persistence of a high premium on gold and low foreign exchanges “for a considerable time” as the evidence pointing to the existence of excess currency.5

It is arguable that the above account exaggerates the difference between Ricardo and the other bullionists, although the publications of the latter and Ricardo's correspondence show that they were conscious of their existence and were unable to reach a mutually satisfactory reconciliation. Ricardo could very rarely interest himself in the immediate and transitory phases of an economic process sufficiently to trace it in detail through its successive stages, and he frequently confined his analysis to the end results, either passing over without mention or even denying the existence of the intermediate stages. Ricardo, moreover, tended to omit at times explicit mention of qualifications whose validity he was prepared to acknowledge, if he regarded these qualifications as of minor importance or if he had already in some other connection conceded them. The result of these two habits was a rigor and a precision in his formulation which perhaps gave added force to his exposition when he was dealing with the general public, but which enabled more sophisticated critics to expose him to rebuttal often more damaging in appearance than in fact. These characteristics of Ricardo's methods of thought are now familiar to economists, and Ricardo was to some extent conscious of them himself.6 They are well illustrated by the following passages from Ricardo, of which the first appears to involve an absolute denial of the existence of intermediate stages in the process of international adjustment to a currency disturbance, while the second recognizes their existence but reveals that his interest lay wholly in what occurs after they have fully worked themselves out:

To me ... it appears perfectly clear, that a reduction of bank notes would lower the price of bullion and improve the exchange, without in the least disturbing the regularity of our present exports and imports.... Our transactions with foreigners would be precisely the same....7

I am not disposed to contend that the issues of one day, or of one month, can produce any effect on the foreign exchanges; it may possibly require a period of more permanent duration; an interval is absolutely necessary before such effects would follow. This is never considered by those who oppose the principles of the Committee. They conclude that those principles are defective, because their operation is not immediately perceived.8

After a time Ricardo gave way somewhat to the pressure of dissent from his views not only by the anti-bullionists but by the bulk of the bullionists. In response to criticism by Malthus, he conceded that when remittances were under way the currency in the remitting country would be in excess unless it were reduced in the proportion which the commodity export surplus constituted of the total stock of goods in that country, which still implied that the remittances could be effected under a convertible standard, or without depreciation of the currency under an inconvertible standard, without involving a relative fall in the level of prices in the remitting country.9 He later introduced into his exposition qualifying words and phrases of a kind not to be found in his first writings and which brought him closer to the position of the other bullionists.10

The bullionists other than Wheatley and Ricardo conceded that extraordinary remittances would affect the exchanges adversely, but insisted, as against either the express denial of or the failure to give consideration to this factor by the anti-bullionists, that the quantity of note issues, through its effect on commodity prices, and thus on the trade balance, was an additional factor determining the exchange value of the English currency, and ordinarily would be the dominant factor.11 Perhaps the best brief statement of the moderate bullionist position was the following by Malthus:

The real state of the case seems to be, that though the effects of a redundancy of currency upon the exchange are sure, they are slow, compared with the effects of those mercantile transactions not connected with the question of currency; and, while the former of these causes is proceeding in its operations with a steady and generally uniform pace, the more rapid movements of the latter are opposing, aggravating or modifying these operations in various ways, and producing all those complex, and seemingly inconsistent, appearances, which are to be found in the computed exchange.12

Wheatley and Ricardo, it appears to me, were clearly wrong in their denial that extraordinary remittances would operate to depress the value of the English currency on the exchanges and in their insistence that in the absence of currency changes the demands of England and the rest of the world for each other's products would necessarily so immediately and completely adjust themselves to extraordinary remittances as to result under both a metallic and an inconvertible paper standard in the maintenance of equilibrium in the balance of payments without the aid of specie movements, changes in the relative level of prices in the two areas, or movements of the exchange rates. The theoretical grounds for holding these views to be erroneous are presented at length in a later chapter.13 Silberling and Angell, moreover, have shown, in the case of Silberling by a comparison of the English foreign remittances with the price of silver in English paper currency, and in the case of Angell by a comparison of the premium on silver and the Hamburg exchange, that there was a close correlation between these remittances and the status of the English currency. These comparisons are reproduced in table I and chart I. Adequate data do not exist to permit a tabulation of the international balance of payments of Great Britain for the period, or even of its trade balance. In the absence of such data, it is reasonable to assume that the extraordinary remittances are a fair presumptive index of the degree of pressure operating to force upwards the foreign exchanges and the price of silver in terms of English paper currency. The correlation shown is in fact closer than could reasonably have been expected, given the partial character of the data made use of for the purpose of the comparison, and I know of no equally striking results from similar comparisons for other countries or periods. Whether by design or by accident the English paper currency remained at or near parity with silver and with foreign metallic currencies in the years in

which no, or small, foreign remittances had to be made, and departed from parity in roughly corresponding degree in the years in which heavy foreign remittances were necessary.14

Ricardo could, however, have conceded to his opponents the point that extraordinary remittances tend to depress the exchanges without surrendering his main contention that actual depreciation of the exchanges was evidence of greater issue of currency than could be maintained in circulation under a metallic standard. Extraordinary remittances tend to depress the exchanges alike under a metallic and under a paper standard, but under a metallic standard this depreciation is prevented from going beyond the gold export point by contraction of the currency. If speculative factors be abstracted from, or if it be assumed that their mode of degree of operation is not affected by extraordinary remittances, then such remittances, if accompanied by equal contractions of the currency of the remitting country in the two cases, should not result in appreciably greater15 depreciation of the exchange under a paper than under a metallic standard. It was primarily because under the paper standard the English currency was not contracted as it would necessarily have been contracted under a metallic standard that the foreign remittances resulted in such marked depreciation of the paper pound on the exchanges.

If Wheatley and Ricardo erred in their exposition of the relation under inconvertible currency between the exchange rates and the state of the balance of payments, the anti-bullionists erred more grievously. The anti-bullionists insisted rightly that under inconvertibility the exchanges were immediately determined solely by the demand for and supply of foreign bills, but failed to see that this was equally true of a metallic standard and that a very important factor determining the relative demand for and supply of foreign bills was the relative level of prices in the two countries, which in turn was determined largely by the relative amounts of currency. Many of the anti-bullionists, moreover, must have thought that in some way a fall in the foreign exchanges made possible the payment of foreign remittances without the need of a commodity export surplus. No other explanation is available of their repeated insistence that throughout the period of low exchanges England either had an unfavorable balance of payments on trade account, or else had a balance insufficiently favorable to offset the military expenditure abroad. As Ricardo pointed out, in reply to reasoning of this sort by Bosanquet, this left it a mystery how the military expenditures abroad were actually met, since specie was not available.16

Not all the anti-bullionists, however, were confused on this point. One of them stated very compactly and clearly the possibilities under such circumstances:

[Under a depreciated paper currency] it would be literally impossible that the balance of payments should be any longer against us, because we could have no means of paying an unfavorable balance. Our receipts from, and payments to, foreign nations must therefore be reduced to an equality (or the balance must be turned in our favor) either by an increase of our exports of merchandise, a diminution of our imports and of the foreign expenditure of government, or by some ... international transfers of capital....17

Another anti-bullionist, Herries, explained that foreign remittances could exceed the export surplus for a time if the balance was met by borrowing abroad, and, writing no doubt from first-hand knowledge, since he had been engaged in the task of making the remittances for the government, said: “This is, probably, the case, with respect to our drafts from abroad at this time:—we are borrowing money to carry on our foreign expenditure, at a high rate of interest.” 18

There are passages in Silberling's critique of the bullionists which seem to indicate that Silberling also subscribes to the notion that the fall in the exchange value of a remitting country's currency can operate to supply it with foreign funds with which to meet its foreign liabilities in some other way than by stimulating its exports and restricting its imports.19 Silberling cannot consistently fall back on the argument that a decline in the exchanges under inconvertible currency would lead to a debt-liquidating shipment of bullion, for he and Angell have characterized this as one of the erroneous doctrines of the bullionists, and especially of Ricardo. As I have elsewhere shown,20 Ricardo distinguished carefully between an inconvertible paper currency depreciated in terms of bullion and one not so depreciated—a distinction which Silberling and Angell fail to make—and denied the possibility of bullion shipments as a part of the regular mechanism of adjustment of international balances in the case of the former. Curiously enough, both Silberling and Angell place some emphasis on bullion shipments as part of the regular mechanism of adjustment of international balances in the case of the former. Curiously enough, both Silberling and Angell place some emphasis on bullion shipments as part of the explanation of the phenomena of the Restriction period, and tacitly, and probably wrongly, assuming that the Bank of England's gold losses were mainly to the government, that when the Bank sold gold it ordinarily did not charge the market price, and that most or all of the gold exported while the Restriction was in effect came from the Bank's holdings instead of from private stocks, cite these bullion shipments as an item in the meritorious record of the Bank of England during the period of suspension of cash payments.21

The notion that even under depreciated inconvertible paper exchange fluctuations will give rise to bullion movements as an ordinary everyday occurrence is not as absurd on a priori grounds as Silberling and Angell regard it for any inconvertible currency. While there is no internal demand for bullion for monetary purposes at a market price in excess of the mint price, there still remains an internal demand for industrial use, for hoarding, and for speculative purposes. A rise in the paper premium on bullion resulting from a fall in the exchanges will operate to induce some of the holders of bullion to offer it for sale for export. There is considerable evidence, both for the Restriction period in England and for other past and present cases of countries with depreciated paper currencies, that, where legal restrictions do not prevent, bullion moves fairly freely into and out of such countries in response to changes in its paper price.22 It is quite conceivable that the net export of bullion from England during the suspension period was even greater than it would have been if the metallic standard had been retained, and that the absence of the direct debt-liquidating effect of bullion shipments cannot therefore be invoked as even a partial explanation of the depreciation of the paper currency.

[1]Cf. Boase, A letter, 1804, pp. 22–23: “the rate of exchange is governed by the balance of exchange operations, and (great political convulsions apart) by no other principle whatever....”

[2]There was, therefore, substantial justification for the comment of William Blake, with reference to this doctrine of Wheatley and Ricardo, that “the opinions of these gentlemen are peculiar to themselves.” (Observations on the effects produced by the expenditure of government, 1823, p. 26.) Cf., however, the following from the Minutes of evidence of the Committee on the Irish circulation, 1804, p. 22, cited with apparent approval by Lauderdale (Thoughts on the alarming state of the circulation, 1805, p. 20, note): From August, 1801, to the present time, no remittances of consequence have ... been made to London in specie. Bank [of Ireland] notes, however, have never ceased, whether the specie was coming into Ireland or going out of it, whether the exchange was under par or above par, whether the balance of debt was favorable or unfavorable, to be depreciated; and the depreciation appears to have been higher when the balance of debt was more favorable, and lower when it was less so; and, upon the whole, it is evident, that the depreciation has not been influenced by the balance of debt.

[3]See infra, pp. 140–41.

[4]Cf. Remarks on currency and commerce, 1803, pp. 52–57; An essay on the theory of money and principles of commerce, I (1807), 64–71; II (1822), 134–35; Report on the reports of the Bank committees, 1819, pp. 20–21.

[5]Bullion Report, p. 45.

[6]Cf. Ricardo to Malthus, Jan. 24, 1817, in Letters of Ricardo to Malthus, 1887, p. 127.

[7]Reply to Mr. Bosanquet's practical observations, Works, p. 360.

[8]Ibid., Works, p. 364. He here concedes, with the Bullion Committee, that “a considerable time” may be necessary for the effects fully to show themselves, but remarks that “we should once have thought a year a considerable time, when speaking of a discount on bank notes.” Ibid., p. 363, note. (Italics in original.)

[9]High price of bullion, appendix to 4th ed., Works, p. 293.

[10]Cf. especially his testimony before the Parliamentary Committees of 1819: Q. Assuming that the balance of payments should be against this country, must the payment not necessarily be made either in specie or in bullion? A. (Ricardo) It appears to me, that the balance of payments is frequently the effect of the situation of our currency, and not the cause. (Report from the [Commons] Committee, 1819, p. 141. Italics mine.) Q. Can you therefore conclude, from the degree to which the exchange is at any moment against any country, that the whole percentage of that unfavorable exchange is owing to the amount of its circulating medium? A. (Ricardo) A part may be owing to other causes. (Report of [Lords] Committee on resumption of cash payments, 1819, p. 200.)

[11]Cf. Thornton, The paper credit of Great Britain, 1802, pp. 277–78:

It thus appears, that “the coming and going of gold” does not (as Mr. Locke expresses it, ...) “depend wholly on the balance of trade.” It depends on the quantity of circulating medium issued; or it depends, as I will allow, on the balance of trade, if that balance is admitted to depend on the quantity of circulating medium issued. Silberling takes Hawtrey to task for characterizing the anti-bullionist position in this connection as erroneous. “Financial and monetary policy of Great Britain,” loc. cit., p. 434, note. His statement that the extraordinary remittances were a “hitherto virtually ignored element in Great Britain's balance of indebtedness during the period involved” (Ibid., p. 226) is without basis, since their significance was a matter of endless debate, then and later.

[12]“Depreciation of the currency,” Edinburgh review, XVII (1811), 360.

[13]See chap. vii, infra.

[14]Similar results were obtained by similar methods by an anonymous contemporary writer. From a chart presenting the foreign expenditures of the government, the amounts paid for imported grain, and the rates of the exchange on Hamburg, this writer derived the following conclusions: The exchanges are affected by two great principles of political economy, namely, by the foreign expenditure, and by the amount paid for grain imported. When, therefore, the importation of grain, and the foreign expenditure have been great, the exchange has become unfavorable, and the latter has, vice versa, increased nearly in the same ratio as the two former have diminished. In the accompanying table it will be seen, that each protruding line of demarcation, specifying the variation of the exchange, has, with very trifling exceptions, a corresponding sinus in the two lines which designate the increase or diminution of the foreign expenditure and the amount paid for imported grain.—“Two tables ... illustrative of the speeches of the ... Earl of Liverpool and the ... Chancellor of the Exchequer,” in Pamphleteer, XV (1819), 286.

[15]Under a metallic currency the contraction of the currency takes the form, in part, of an actual export of specie, and this specie exercises a direct liquidating effect on foreign obligations which is absent in the case of a paper standard currency. To this extent, a greater currency contraction will be necessary under a paper than under a metallic standard to prevent exchange depreciation when foreign remittances of a given amount are to be made. See pp. 135–36, supra.

[16]Reply to Mr. Bosanquet's observations, Works, pp. 334–35.

[17]John Hill, An inquiry into the causes of the present high price of gold bullion in England, 1810, pp. 8–9.

[18]J. C. Herries, A review of the controversy respecting the high price of bullion, 1811, pp. 43–44.

[19]Cf. “Financial and monetary policy of Great Britain,” Quarterly journal of economics, XXXVIII, p. 229, note: “We may conclude, however, that the adverse balance of military payments of itself caused no important readjustments in the volume of foreign commerce which might have compensated the rise of the exchange rates against England”; Ibid., pp. 433–34: “In the absence of data, the Committee resorted to hypothesis: if the foreign payments of the State had created marked deviations from exchange parities, this could be only a very temporary matter, since foreigners, attracted by low prices of sterling, would forthwith begin to buy British commodities and thus immediately expand British exports, with the result of readjusting the balance of payments. It happened that many erstwhile foreign buyers had other preoccupations at the moment.”

[20]“Angell's theory of international prices,” Journal of political economy, XXXIV (1926), pp. 603–06.

[21]Silberling, “Financial and monetary policy,” Quarterly journal of economics, XXXVIII, 226; Angell, Theory of international prices, p. 478.

[22]Cf. on this point, the excellent analysis of the Argentine experience in J. H. Williams, Argentine international trade under inconvertible paper money, 1880–1900, 1920.