Front Page Titles (by Subject) XIII. Commodity Flows and Relative Price Levels - Studies in the Theory of International Trade
The Online Library of Liberty
A project of Liberty Fund, Inc.
Search this Title:
Also in the Library:
XIII. Commodity Flows and Relative Price Levels - Jacob Viner, Studies in the Theory of International Trade 
Studies in the Theory of International Trade (New York: Harper and Brothers, 1965).
About Liberty Fund:
Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.
The text is in the public domain.
Fair use statement:
This material is put online to further the educational goals of Liberty Fund, Inc. Unless otherwise stated in the Copyright Information section above, this material may be used freely for educational and academic purposes. It may not be used in any way for profit.
XIII. Commodity Flows and Relative Price Levels
Graham and Feis hold that the explanation of the mechanism of adjustment of international balances to capital borrowings offered by the classical economists and their modern followers omits reference to a factor operating to bring about relative shifts in price levels in the direction opposite to that posited in this explanation. Graham claims that since the effect of a loan is to shift goods from the lending to the borrowing country, the volume of goods relative to the volume of gold will be increased in the borrowing country and decreased in the lending country, and therefore the prices will tend to fall in the former and rise in the latter. On the assumption that the first phase of the mechanism is a transfer of gold from the lending country to the borrowing country unaccompanied by a transfer of goods, and that the transfer of goods is a later phase, Graham, calling the former the “short-range” effect of capital movements and the latter the “long-range” effect, concludes that “the short and long range effects of borrowings will run in opposite directions.” 1 He had earlier applied the same reasoning to the problem of the adjustment of international balances to capital imports under an inconvertible paper currency, on the assumption that the quantity of money in each country is held constant.2 Feis accepts Graham's argument:
The effects of the goods movements upon price levels would, therefore, tend to be in the opposite direction to those produced by changes in the volume of purchasing power in each of the countries concerned, as Professor Graham has pointed out. Apparently, two conflicting tendencies are present in each country during the process of adjustment. These tendencies may or may not be simultaneous and equal in strength.3
This reasoning seems erroneous to me. The conclusion of these writers results from a mechanical application of the formula of price determination to the international trade mechanism, on the implicit assumptions that the price level is result and not cause, and that the changes in M and the changes in T are unrelated and independent factors in the mechanism,4 and Feis, at least, explicitly attributes the same assumptions to the classical school.5 But in the classical theory, as in the preceding exposition, the establishment of international equilibrium is regarded as primarily a problem of international adjustment of prices, and the direction and extent of flow of specie, and therefore also the relative amounts of money in the two countries, instead of being treated as independent factors, are held to be determined by the relative requirements for money of the two countries given their equilibrium price levels and their respective physical volumes of transactions requiring mediation through money. The bearing of the commodity flows in the mechanism, therefore, is not their influence on the relative price levels, but is, instead, their influence on the quantity of specie flow necessary to support the price relations required for equilibrium.
Let us suppose that when the lending first begins the lending country ships sufficient commodities on consignment to the borrowing country to bring its export surplus to equality with its volume of lending per unit period, but that, in consequence of the influx of goods, prices as a whole fall in the borrowing country to a level lower than is consistent with the maintenance of its import surplus at the required amount. A new or intensified flow of specie must thereupon occur from lending to borrowing country, so as to bring prices (and demands) in the borrowing country to a level adequately high to result in a continuing import surplus equal to the borrowings.6
“Capital” movements, it is true, if they consist of funds which in the absence of such movement would have been invested at home, and if they result in an increase in the amount of investment in the borrowing country as compared to what would have been the situation in the absence of the borrowings, will eventually result in a relative increase in the output of the marketable commodities of the borrowing country as compared to those of the lending country and, therefore, will to this extent tend to result in a relative fall in the price level of the borrowing country. But Graham's and Feis's argument rests on the supposed effect on relative price levels of the relative changes in the output of commodities in the two countries.
In a review of my Canada's balance, American economic review, XV (1925), 108. I had suggested, as an explanation of a tendency which seemed to be apparent in the Canadian experience for the relative rise in prices in the borrowing country to diminish in extent as borrowings continued at an even rate, that the longer the interval between a relative price change and the actual trade transactions the fuller would be the response to such price change, and, therefore, that the degree of relative price change required to bring about adjustment of the trade balance in the first year of a period of borrowings at an even rate would tend to be more than was required in later years. Graham offered his argument as a better explanation of the shrinkage in the relative change in prices.
“International trade under depreciated paper. The United States, 1862-79,” Quarterly journal of economics, XXXVI (1922), 223.
Feis, “The mechanism of adjustment of international trade balances,” American economic review, XVI (1926), 602 ff. (at p. 603).
In Graham's exposition, this is suggested by his failure to discuss the determinants of the size of the specie flow and by his reference to his analysis of the depreciated paper case, where he had arbitrarily assumed that the quantities of money in each country would be held constant, an assumption which makes any analogy from the mechanism under depreciated paper a fallacious one in this connection for the mechanism under the gold standard.
Cf. ibid., p. 605: “The classical account of the process of adjustment both in its original sources and as presented in the preceding pages, rests upon the implicit assumption that income and price levels are the passive result of other influences. They are commonly said to be determined by the relationship between the volume of goods (trade) and the volume of purchasing power (and its velocity) within a country....”
Cf. G. W. Norman, Letter to Charles Wood, Esq., M.P. on money, 1841, p. 20: