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• 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

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.

[1]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.

[2]“International trade under depreciated paper. The United States, 1862-79,” Quarterly journal of economics, XXXVI (1922), 223.

[3]Feis, “The mechanism of adjustment of international trade balances,” American economic review, XVI (1926), 602 ff. (at p. 603).

[4]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.

[5]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....”

[6]Cf. G. W. Norman, Letter to Charles Wood, Esq., M.P. on money, 1841, p. 20:

There is one circumstance worth attention on account of its tendency to increase the transmission of specie under an adverse exchange. The articles of export which might replace gold and silver are usually few in number, speaking practically, and the increased quantity of such goods received by the creditor country lowers their price in it to an extent which, partially at least, lessens the effect produced by the enlargement of its currency. If Norman means by this passage that a sufficient large flow of specie must occur to offset any otherwise disequilibrating influence on prices of the flow of commodities, then the position taken here corresponds with his.