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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

IV. Primary and Secondary Expansion in Canada, 1900–13

“Canada's Balance.” —The Canadian experience before the war during a period of great import of capital provides an opportunity for the examination of the role of primary and secondary expansion in the international mechanism in a gold standard country where the banking system keeps part of its reserves in the form of holdings of outside short-term funds. In a study I made of the Canadian mechanism from 1900 to 1913,1 I reached the following conclusions with respect to the monetary aspects of the mechanism. The Canadian borrowings obtained transfer into Canada smoothly and without noticeable friction in the form of a net commodity and service import surplus, as the result of relative price changes (and shifts in demands) which were of the character indicated as to be expected by the older writers. The price and demand changes resulted from a relative increase in the amounts of Canadian bank money, deposits and notes, and these increases resulted in turn mainly from the exchange by Canadian borrowers abroad of the proceeds in foreign funds of their borrowings abroad for Canadian bank deposits or notes. The Canadian banks brought into Canada in the form of specie only such part of their newly-acquired foreign funds as was required to maintain their specie reserve ratios in Canada at their customary level. The remainder of the foreign funds thus acquired by the banks, to the extent that they were not absorbed in paying for the growing Canadian import surplus, was left abroad by the Canadian banks, largely in the form of call loans in New York, as additions to their “outside” or “secondary” reserves. Except toward the end of the period, when a marked credit expansion occurred in Canada, the increase in the outside reserves was not used by the Canadian banks as a basis for expansion of their loans in Canada. With the exception that fluctuations in the outside reserves operated in the Canadian mechanism in the manner attributed to specie movements in the classical doctrine, I concluded that the Canadian mechanism corresponded in all its important aspects to the mechanism as formulated in the classical doctrine.

In my study I did not use the “primary,” “secondary” terminology developed in the preceding sections of this chapter. Applied to the Canadian data, the meaning of primary expansion would have to be broadened, so as to include increases in Canadian bank deposits and notes resulting from the exchange by Canadian borrowers abroad of foreign funds for Canadian bank money, whether the Canadian banks exchanged these foreign funds for specie and brought the specie into Canada or held the foreign funds as secondary or outside reserves, as the economic significance of the two types of reserves was, dollar for dollar, the same. Restated in terms of the primary and secondary terminology, my explanation of the monetary phases of the Canadian mechanism was, therefore, that foreign borrowings by Canadians, to the extent that their proceeds in foreign funds were not used up immediately in paying for import surpluses, resulted in a primary expansion of Canadian means of payment through the exchange of foreign funds for Canadian bank money, and that the Canadian banks converted only a fraction of these foreign funds into specie. To secondary expansion, resulting from the expansion of bank loans in Canada, I attributed importance, as a supporting factor reinforcing the primary expansion, only for the last few years of the period.

Angell's Criticism of the Account in “Canada's Balance.” —Angell2 and a number of writers who follow him, have raised some important objections against my account of the Canadian mechanism. Angell finds fault with my conclusion that fluctuations in the outside reserves played the same role in the Canadian mechanism as that assigned to gold movements in the classical doctrine. His failure to state in what respects he believed the actual Canadian mechanism was different from that postulated in the classical doctrine makes it difficult to deal with this criticism. But I believe that he here interprets the classical doctrine as assigning a role only to secondary fluctuations, and as ignoring totally the primary fluctuations. In any case, he attributes to me the proposition that it was secondary expansion which did the work in the Canadian mechanism, although I am now convinced that I overemphasized the primary phase, both with reference to the facts in Canada and with reference to the classical doctrine.

Angell's own interpretation of the Canadian mechanism is that the expansion of Canadian deposits which operated to adjust the Canadian trade balances to the borrowings was a primary expansion, but a primary expansion of a very special sort, resulting from the exchange of sterling funds, but of no other sort of outside funds, for Canadian deposits. Although I carefully explained in my study that the outside reserves consisted “of funds loaned on call in New York and London, and net balances kept with New York and London banks,” 3 he always interprets my propositions with respect to “outside reserves” as if I meant them to apply only to New York funds, and uses the term in this way himself. To understand his account of the Canadian mechanism and his criticism of my account, it is necessary, therefore, to remember that Angell excludes sterling funds from “outside reserves,” wrongly attributes the same exclusion to me, and treats fluctuations in the Canadian bank holdings of sterling and of New York funds, respectively, as if they had radically different significance for the mechanism.

Angell's objections to my account of the Canadian mechanism are for the most part covered by the following paragraph:4

... Viner's verification of the general theory ... I think ... breaks down on this question of the intermediary financial mechanisms. Neither the statistical data submitted nor the reasoning based upon them show any clear sequence from the outside reserves to credit and price conditions within Canada itself. Outside reserves moved closely with bank deposits in Canada, and showed no independent relationship to prices. Rather, the sequence must have been that which Viner himself rather hesitantly suggests at another point.5 The Canadian borrowers, having sterling funds at their disposal, deposited them with the Canadian banks (except in so far as the loans were spent in England). These funds, thus converted into Canadian currency and credit, were spent in Canada and induced a rise in prices; a rise which roughly adjusted the commodity balance of trade to the volume of new borrowings. The Canadian banks recouped themselves by selling the sterling funds in New York, the proceeds being left there or taken back to Canada as needed. It does not appear from the data, however, that these changes in the New York balances had any direct and independent effect upon conditions within Canada. By providing potential additional metallic reserves, their increase made a Canadian credit expansion possible, but there is no convincing evidence, inductive or deductive, to show that it provided the initial stimulus to expansion.6 The stimulus came, rather, from the original increase in bank deposits within Canada itself.

Angell thus interprets the Canadian expansion of deposits as being solely7 a primary expansion, resulting (solely?) from the exchange of sterling funds for Canadian deposits, while he attributes to me the doctrine that the Canadian expansion of deposits was (solely?) a secondary expansion, i.e., resulted from an expansion of bank loans in Canada, into which the banks were led by the increase in their holdings of outside reserves in the form of New York funds. He presents no evidence to support his account of the role I assigned to secondary expansion, and it has no other basis, I am convinced, than Angell's assumption that when I found similarity between the role of fluctuations in the outside reserves in Canada and the role of gold movements in the classical mechanism, I must have had in mind the use of gold reserves as a basis for expansion of deposits through loans. I had in mind, on the contrary, what I now call the primary phase of gold movements in the mechanism. Instead of stressing secondary expansion in the Canadian mechanism, I ignored it except for the last few years of the period studied. And instead of comparing the fluctuations in total deposits, or in loans, or in total deposits minus outside reserves, with the fluctuations in outside reserves, as would have been appropriate if the secondary fluctuations were regarded as important, I paid no attention to the fluctuations in the aggregate volume of bank loans in Canada, and I compared the fluctuations in outside reserves with the fluctuations in “foreign loan deposits,” i.e., total deposits minus loans, i.e., the deposits not resulting from Canadian bank loans.8

The distinction which Angell draws between the role of sterling funds and the role of New York funds in the Canadian mechanism seems to me without basis, either in theory or statistically. Sterling funds and New York funds were equally “outside reserves.” The fluctuations in the net holdings of sterling funds were throughout the period small in amount, as the Canadian banks immediately converted sterling funds, if in excess of the small amounts needed as working balances for remittance purposes, into New York funds or into specie. It was, moreover, the maintenance, and not merely the acquisition, of outside funds, upon which the volume of primary Canadian deposits depended, since the reduction of outside reserves to meet the need for foreign payments would, for the banks, be balanced by a corresponding amount of debits charged against the deposits of Canadian customers for whom the foreign payments were being made. Even when first acquired, furthermore, not all the outside funds were sterling funds, since somewhat over 30 per cent of the total Canadian borrowings during the period were made elsewhere than in England (chiefly in the United States). The conversion of sterling funds into New York funds simply happened to serve the convenience of the Canadian banks, and had no other significance. Held in New York, their outside funds could earn higher rates of interest than in London and in case of need could be converted into gold and brought into Canada overnight with a minimum risk of exchange loss.9

Angell further interprets me as holding that the expansion of Canadian deposits (always?) came later in time than the expansion of outside reserves. He again presents no evidence to support this interpretation but it is probably only a logical inference from his erroneous attribution to me of the proposition that the expansion of Canadian deposits was a secondary expansion, induced by the improved secondary reserve position of the Canadian banks. He maintains that, on the contrary, the expansion of deposits preceded the expansion of outside reserves.10

Angell's claim that in fact the increase in Canadian deposits was prior to the increase in outside reserves seems to be the product of the following chain of reasoning: (1) Canadian borrowings were (solely?) from England and therefore yielded sterling funds; (2) the Canadian borrowers exchanged these sterling funds for Canadian deposits; (3) some time after11 such exchange had occurred, the Canadian banks converted the sterling funds into New York funds; (4) New York funds were, but sterling funds were not, “outside reserves” nor apparently, even “outside bank balances”; (5) the (primary) increase in Canadian deposits was therefore prior to the increase in “outside reserves.” Since, however, sterling funds were, dollar for dollar, just as much “outside reserves” as were New York funds; since Canadian borrowings occurred in the United States as well as in England, so that some of the outside reserves were originally acquired in the form of American dollars; and since the Canadian banks converted newly-acquired sterling funds into New York funds almost instantaneously rather than after a substantial delay, this argument collapses. The primary expansion in Canadian deposits was neither prior to the expansion in outside reserves, as Angell claims, nor after it, the view which he attributes to me, but was, as I contended, simultaneous with it.

Feis, after citing with approval Angell's conclusion that the increase in Canadian bank deposits is the “original” and “prior” factor operating to correct the Canadian balance of payments, attempts to explain more explicitly than did Angell what is to be understood by “original” and “prior”:12

By “original” Dr. Angell meant to distinguish, I venture to interpret, the immediate credit expansion from any increase that might result later from the strengthening of gold reserves; by “prior” is meant prior in time to any such increase of gold reserves.

That the primary expansion in Canadian bank deposits resulting from the exchange of the proceeds of foreign borrowings for Canadian deposits—which it is misleading to refer to as “credit expansion” since its significant characteristic was that it was not Canadian credit expansion—would be prior to any secondary expansion of Canadian bank deposits resulting from the improvement in the reserves is obvious. But how could this primary expansion also be prior to the increase in outside reserves? Feis states that the (primary) expansion of Canadian bank deposits and the increase in outside reserves are “both results of the same borrowing operations. In that vital sense they are interdependent; in other ways they may be said to be independent. They, therefore, must be recognized as playing separate parts in the mechanism of adjustment.” 13 But this, while not very helpful, suggests simultaneity rather than priority.14 The increase in outside reserves and the primary increase in deposits must have occurred simultaneously unless, indeed, if it should be found that in banking practice the bank clerks regularly debit the bank before they credit the customer, or vice versa, someone could be found who would attach significance to a priority of this sort and would expect it to reveal itself in “lags” in monthly (or annual!) banking data.

Carr presents the following as a summary of my findings:

The surplus of bills on London created by English loans to Canada never attained great enough proportions to force sterling rates to the gold import point for Canada. Instead of permitting London bills to accumulate on the Canadian market and depress exchange quotations, the Canadian banks sold them to New York, and thereby built up their New York balances or “outside reserves.” But on the basis of these outside reserves the Canadian banks were able to extend credit at home. Price inflation resulted as if gold had been imported. In other words, a substitute was found for the gold flow in the Canadian case in the form of increased outside reserves. The sequence of events, then, according to Professor Viner, was this: (1) foreign borrowing, (2) increase in outside reserves, (3) extension of credit at home.15

The notion that the motive of the Canadian banks in exchanging London funds for New York funds was to prevent a depression of sterling exchange on the (non-existent!) Canadian sterling exchange market is assuredly not mine.16 The notion that outside funds constituted outside reserves only if they were New York funds should have been credited to Angell, but not to me. Finally, secondary expansion of Canadian deposits through an expansion of domestic bank loans17 induced by an improved bank reserve position was not an important element in my explanation of the expansion of Canadian means of payments. The only element in my account which Carr here correctly reports, therefore, is that increases in the outside reserves operated as a substitute for inflows of specie.

White interprets my findings as differing “from the orthodox explanation in that credit expansion instead of following the increases in bank reserves appears to have preceded them.” He nevertheless does not regard the objection made by Angell and Carr to my account “on the score of chronological sequence” as serious, on the ground that since the Canadian banks treated outside reserves as if they were specie, the difference of the Canadian mechanism from the classical doctrine was due simply to “a modification arising from modern banking practice.” 18 If, as seems to be intended by White, “credit expansion” is understood to mean expansion of bank money, whether primary or secondary, and “bank reserves” is understood to mean only specie reserves in Canada, that was exactly my position.19 But it is not relevant to Angell's or Carr's criticism “on the score of chronological sequence.” It was my supposed account of the chronological order of variations in the non-specie or “outside” reserves and in primary deposits, and not in the specie reserves and total deposits, with which Angell and Carr took issue.20

Angell's Statistical Analysis. —Angell supports his findings as to the sequence of events in the Canadian mechanism by an analysis of the statistical data.21 Since he presents no data on the outside reserves, whether sterling funds, or New York funds, or total holdings, no light is thrown by this analysis on the manner in which he reached his conclusions as to the place of the outside reserves in the mechanism. On the basis of his statistical analysis, he presents two (inconsistent) sets of conclusions as to the chronological sequence of events: first, that the net import surpluses follow the net borrowings “with a lag of a year”;22 and second, that (a) “the changes in bank deposits followed, with a lag up to a year, the changes in the excess of net capital imports [=net borrowings] over final means of payment [=import surpluses]; and that the magnitudes involved were roughly similar when the lag is allowed for.... The latter set of fluctuations evidently dominate the first set”; and (b) the increase in the import surpluses followed, also with “a lag of about a year,” the increases in bank deposits,23 with an aggregate lag, therefore, of up to two years between an increase in borrowings and an increase in the import surplus. Since Angell holds that the increase in deposits was prior to the increase in New York funds, there would therefore be also, according to his account, a lag of up to a year to over a year between the fluctuations in borrowings and the fluctuations in New York funds.

Angell attributes the lag which he finds between the increases in borrowings and increases in import surpluses to two factors which received due recognition in my study: “first, to the interval between the announcement of each new loan (at which time it was usually credited to Canada) and its actual flotation; and second, to the lag between the accumulation of the capital abroad and the appearance of the resulting changes in the commodity balance.” 24 Both factors are valid. For security flotations, however, the interval between announcement of the loan and payment by subscribers of the final instalment rarely, if ever, exceeded three months, and, presumably because the winter season in Canada is unsuitable for heavy construction, few important flotations occurred in the late autumn. This lag, therefore, would scarcely reveal itself in calendar year statistical series. But direct investments in Canadian branch plants, etc., would commonly attract attention at and be assigned to the time when plans were announced, while the actual execution of the plans, and transfer of the necessary funds, might well take a year or longer. The second factor should ordinarily have been more important. The Canadian import surpluses should be expected to lag after the Canadian borrowings, since it would ordinarily take some time before the proceeds of the foreign borrowings would be completely absorbed in payment of adverse trade balances. But if Canadians borrow abroad in a given year more than the excess of what they spend abroad over what they sell abroad, and if they do not take any of the unspent borrowings in the form of specie, the unspent borrowings must be held either by Canadian individuals or by Canadian banks in the form of increased holdings of foreign funds. Assuming in turn that Canadian individuals hold only negligible and comparatively constant amounts of foreign funds and that upon the acquisition of such funds they promptly exchange them with Canadian banks for Canadian funds in the form of bank deposits, then the excess in any year of Canadian net borrowings abroad over Canadian import surpluses must result in simultaneous and corresponding increases in Canadian primary deposits and in the outside reserves of the Canadian banks, my original position. What then of Angell's statistical finding that there was a lag of up to a year of the changes in deposits after the changes in unspent borrowings? The fact that Angell, when he is not dealing with deposits, finds a lag of only a year between borrowings and the import surpluses on which they are finally spent, but finds a lag of up to two years between the borrowings and the import surpluses when he is dealing with deposits, and that none of the lags he finds stands out clearly in his charts, itself suggests that the one year lag of deposits after the initial accrual of unspent borrowings may be spurious. But whatever Angell's charts may appear to show, the defects both in my estimates upon which these charts are based and in Angell's use of them are such as to make the charts have little bearing on the questions of chronological sequence which he attempts to answer by means of them.

To obtain the amount of unspent borrowings of each year, or what he calls the “excess of net capital imports over final means of payment,” Angell subtracts my estimates of the Canadian commodity and service import surpluses of each year from my direct estimates of the net amounts of Canadian borrowings abroad for the corresponding years.25 This is logically correct procedure. But if the estimates of (a) net borrowings and (b) import surpluses were absolutely accurate, the excess of net borrowings over import surpluses should for each year be identical with the increase in the Canadian bank (plus private) holdings of outside funds. Estimates (a) and (b), however, are each net series, or series of differences between pairs of other series. Thus series (a) is a series of the differences between series (a₁), borrowings by Canada, and series (a₂), loans by Canada; and series (b) is a series of the differences between series (b₁), imports into Canada, and series (b₂), exports by Canada. Now each of the series, a₁, a₂, b₁, b₂, is inevitably subject to an appreciable margin of probable error, and the series (a) and (b) are therefore subject to much greater margins of probable error. When we come to the final series consisting of the differences between series (a) and (b), the margin of probable error must be regarded as too great to warrant reliance upon it for important conclusions. If estimates of international balances are to be used at all there must not be too much squeamishness about their accuracy, but I presented my direct estimates of Canadian borrowings only with the most serious reservations, especially with reference to their allocation to particular years, which is vital here. In my original study I advisedly made little use of them as a basis for interpreting the mechanism.

Let us suppose, however, that there are no unknown errors or omissions in the series used by Angell. Angell's “net capital imports” series is constructed by subtracting from my direct estimates of Canadian borrowings abroad my estimates of Canadian investments of capital abroad. But unfortunately for the purposes of his analysis, the latter series included as Canadian investments abroad the net increases in Canadian bank holdings of outside funds.26 Since the changes in the Canadian bank holdings of outside funds constitute the changes in the amounts of untransferred borrowings, Angell's successive operations reduce to subtraction of one estimate of the total borrowings, transferred and untransferred, from another estimate of the total borrowings, transferred and untransferred, and treatment of the remainders as the untransferred borrowings. If all the estimates were accurate, there would be no remainders. Angell's series of “excess of net capital imports over final means of payment” is in fact a series of substantial sums. But subject to the qualifications that there are assumed to have been no important fluctuations in the holdings of outside funds by individual Canadians and that Angell does not include non-commercial items such as capital brought in by immigrants as “capital imports” or funds requiring economic transfer, these remainders represent merely the net errors and omissions in the several series of estimates from which they are derived, and have no other significance.

A hypothetical illustration will perhaps bring out more clearly why Angell's series of “excess of net capital imports over final means of payment” represents, subject to the two qualifications indicated above, only the net errors in my various series. Suppose that, in a particular year, the Canadian gross borrowings abroad amount to $100,000,000; the new investments abroad by Canadians other than banks amount to $10,000,000; the net increase in holdings of outside funds by the Canadian banks amount to $20,000,000; and the Canadian commodity and service import surplus amounts to $70,000,000. The excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would in that year then be $20,000,000, which is necessarily the same as the amount of increase in the holdings of outside funds by the Canadian banks. But by Angell's procedure, namely, subtracting (a) the import surpluses from (b) the net borrowings minus the increase in the holdings of outside funds by the Canadian banks, the excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would appear to be zero. Suppose, however, that the actual amounts remain as above, but that the Canadian import surplus is wrongly estimated at $60,000,000 instead of at its true amount of $70,000,000; computed by Angell's method the excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would appear to be $10,000,000, or the amount of the error in the estimate of the Canadian import surplus.

Accepting Angell's computations, Carr comments:

An excess of net capital imports [over the commodity and service import surpluses] amounting to only 1.6 per cent of the total appears much too small to have provided Canada for the entire period with the increase in purchasing power necessary for carrying on a growing domestic trade at the sustained higher price levels. This fact is also embarrassing to the classical analysis, for it is only through the medium of the excess of net capital imports that the rise in Canadian prices can be accounted for.27

For the reason already given, the excess of borrowings over import surplus as computed by Angell must be regarded as meaningless except as a measure of the net error in the various estimates. The smallness of its ratio to the total amount of borrowings should therefore prove embarrassing only to those who attach significance to it. For individual years it is, in fact, embarrassingly large for me as the person responsible for the estimates on which it is based. If by “increase in purchasing power necessary for carrying on a growing domestic trade at the sustained higher price levels,” Carr means increase in monetary reserves, he overlooks the fact that included in the import surpluses as computed in Canada's balance and used by him was a total net import for the period of $113,000,000 of gold coin, as compared to a total stock of gold coin in Canada at the beginning of the period of only $19,000,000,28 and that the outside reserves of the Canadian banks increased during the period from $39,000,000 to $130,000,000, or an increase of $91,000,000.29

A Statistical Reexamination of the Canadian Experience. —The major obstacle to the use of direct estimates of borrowings in the analysis of the transfer mechanism is the absence, ordinarily, of sufficient information on which to base acceptable estimates of short-term credit transactions, such as international purchases and sales of securities through stock exchanges, short-term loans by others than banks, and trade debts incurred in one calendar year and not liquidated until the next calendar year. Incomplete segregation in the reported figures of loan flotations of the portions of the proceeds used to amortize older loans presents another source of possible error. While the changes in outside reserves of the Canadian banks cannot be regarded as an accurate measure of the relation of Canadian borrowings to economic or real transfers, they are as reliable a measure of the changes in the amounts of untransferred borrowings as can be derived from the data made available in my Canadian study. In tables VI and VII are presented some of the results of a reexamination of the Canadian experience. To the data presented in my original study are here added the amounts of bank loans in Canada, as representative of secondary fluctuations in the volume of means of payment in Canada. There is also some rearrangement of the data along lines similar to those followed by Angell. What I believe to be a further improvement is based on the distinction which White makes between net and total gold flows.30 In my original study I used for my banking series the amounts of deposits, reserves, etc., as reported for the last business day of each year, and the differences in the figures for successive years thus represented the net year-to-year changes. White claims that for purposes of tracing the influence of gold flows on trade balances the influence on demands for commodities of gold which entered, say, in February and departed in November would not be accounted for by data as to net annual changes in the amount of gold. To account for the influence of an inflow of gold which remained only for part of the statistical unit period, he concludes that total annual gold flows instead of net annual changes in the amount of gold should be used in analysis. But the substitution of total gold flows for net gold flows is not the proper method of giving to gold which was within the country for only part of a year its due weight, since this method would give to gold which

stayed in the country for a day equal weight with gold which stayed in the country for 360 days if entrance and departure were in the same calendar year, and would give a negative weight to gold which had entered in the previous year and stayed 360 days of the given year and a positive weight to gold which entered on the last day of the year. The procedure required to answer White's objection to the use of net year-to-year changes as of a given day is to substitute for them the year-to-year changes in the average amounts of gold within the country during the year as a whole. For Canada, an adequate approximation to such averages is made possible by the use for each year of the averages of the monthly returns made by the banks. The reasoning which makes use of such averages preferable to use of end-of-the-year data for gold applies equally to other banking series bearing on the amount of means of payment.

The close relationship, as different aspects of the same banking operations, between the primary fluctuations in bank money in Canada (the fluctuations in “foreign loan deposits”) and the fluctuations in outside reserves, is made clearly evident in table VI. With one negligible exception, the fluctuations were always in the same direction and there was also substantial correspondence in size of fluctuation. The discrepancies between the two series are to be explained mainly by: the fluctuations in Canadian bank holdings of gold and Dominion notes, which represented substantially substitutions as between “cash” reserves and outside reserves; accruals to or drafts on the outside reserves by the regular banking operations conducted by the Canadian banks outside Canada, chiefly in Newfoundland and the West Indies, which are not segregated in the official returns; and (minor) fluctuations in the Canadian bank purchases of and sales of securities within and outside of Canada.

Table VI indicates that primary and secondary expansion of means of payment in Canada both contributed to the creation of a situation in which the necessary import surpluses could develop, although the secular growth of the bank loans in Canada, associated with the general economic development of the country and with the rise of prices in Canada as part of a world rise, operates to magnify the apparent importance of the secondary expansion as a factor in the mechanism of adjustment to the borrowings. From the data in tables VI and VII it is possible to argue that at times at least the import surpluses resulted from original secondary expansion, and that the borrowings were engaged in to obtain the foreign funds necessary to liquidate trade balances already incurred and to restore reserves encroached upon in paying for past debit trade balances.31 But this is quite consistent

with the orthodox explanation,32 which recognizes the possibility that import surpluses may result from an internal (i.e., secondary) expansion of deposits made in anticipation of, or at least later supported by, borrowings abroad whose proceeds go to liquidate debit trade balances already incurred and to build up depleted reserves. It should also be remembered that fortuitous shifts in the Canadian demands as between different classes of commodities or changes in the foreign demand for Canadian exports may bring about substantial year-to-year changes in the Canadian trade balance without prior changes in the amount of Canadian means of payment, and that changes in the “final purchase velocity” of the means of payment would also influence the trade balance, even in the absence of changes in the amount of deposits or prior changes in borrowings. As far as the general trends are concerned, the Canadian experience does show that the growth of the import surplus was preceded by a growth in the amount of means of payment in Canada,33 that this growth in means of payment was both primary and secondary, that the primary fluctuations in the amount of means of payment were relatively more marked than the secondary fluctuations, and that there was a variable time-lag between borrowings abroad and economic transfer, with the recorded, or long-term, borrowings usually but not always preceding the economic transfer chronologically.

In table VII the amounts of funds requiring transfer, including not only net borrowings proper, after deduction of interest obligations, but also unilateral remittances and monetary capital brought in by immigrants, are compared with the actual amounts of net economic transfer, or the import surpluses, including the excess of imports over exports of services other than interest as well as of commodities. If all of these items were accurately estimated, and if individual Canadians held no balances abroad, an excess or deficiency in any year of the amounts of funds requiring economic transfer to Canada over the amounts of net economic transfer would be reflected by a corresponding change, in size and direction, in the holdings of outside funds by the Canadian banks. Column V reveals how serious is the lack of correspondence between these series as for as the figures for individual years are concerned, although for the period as a whole the total discrepancy, $25,000,000, is less than 2 per cent of the estimated total net acquisition of outside funds requiring transfer to Canada during the period. The discrepanicies for individual years are to be explained, I believe, mainly by defects in the allocation to particular years of net long-term borrowings, by the impossibility of accounting from the available data for short-term financial transacations of various kinds which overlapped two or more calendar years, by incomplete success in deducting from the reported amounts of new loans floated the portions thereof used to amortize old loans, and by the impossibility of making allowance, in the estimates of outside reserves, for the call loans in New York by Canadian banks without agencies there, made directly from and reported as of their Canadian head offices.

[1]Canada's balance of international indebtedness 1900–1913, 1924, chap. VIII.

[2]J. W. Angell: review of Canada's balance in Political science quarterly, XL, (1925), 320–22; “The effects of international payments in the past.” National Industrial Conference Board, The inter-ally debts and the United States, 1925, pp. 140–53; The theory of international prices, 1926, pp. 170–74, 505–10.

[3]Canada's balance, p. 177. (The italics were not in the original text.) Cf. also ibid., p. 164, and the explanation given of the constituent items in my “secondary reserves” series in chart II, pp. 166–67, as “Call loans elsewhere than in Canada, and net balances due from banks outside Canada.”

[4]Theory of international prices, pp. 172–73. (Italics in the original text.)

[5]Angell's impression that there were two versions derives from the distinction which he makes between the significance for the mechanism of fluctuations in the holdings of sterling and of New York funds, respectively, a distinction I did not make.

[6]Angell means presumably by “credit expansion” what I here call secondary expansion, and by “direct” effect on the volume of Canadian deposits what I here call primary expansion. Angell's failure to notice the meaning and importance I attached to the fluctuations in “foreign loan deposits” is responsible not only for his own error in attributing to me the doctrine that secondary expansion was the important factor, but for a similar error on the part of a number of other writers who have obviously accepted Angell's account of my position as accurate. Cf. especially, Iversen, who takes me to task for neglecting what I did my utmost to emphasize, and, I now believe, in fact overemphasized: “Here again Viner seems to underestimate the implications of his restatement, which clearly suggests a direct connection between foreign loans and volume of purchasing power.” (Aspects of the theory of international capital movements, 1935, p. 236. Italics in original.)

[7]That this is a correct interpretation of Angell's position is indicated by the following and other similar passages: “The crux of the explanation is the proposition that the importation of capital increases the supply of bills offered in the local exchange market for discount relative to the demand, thus increasing the bank's average holdings of such bills. A corresponding increase in the volume of bank deposits results; and if it is on a large scale produces the indicated effects on prices and the commodity balance of trade.” (Theory of international prices, p. 173, note. Italics not in original text.) If the fluctuations in deposits “corresponded” with the fluctuations in holdings of foreign “bills,” the fluctuations in deposits would be solely primary. Angell sometimes speaks of the bills being “discounted,” and sometimes of their being “exchanged” for deposits, and treats these as identical phenomena. The latter was the usual procedure, as the bills were predominantly sight bills, frequently drawn on an outside agency of a Canadian bank. Under the former procedure, an original secondary expansion would be transformed, after a few weeks, into a primary expansion when the bills became due and their proceeds were used by their owners to liquidate their indebtedness to the Canadian banks. The volume of Canadian deposits would not change, but the offsetting bank assets would change from loans to holdings of foreign funds.

[8]The relationship I trace for Canada between the “outside reserves” and the “foreign loan deposits” corresponds closely to the relationship emphasized in recent years by students of Australian and New Zealand banking between the holdings of London funds by Australian banks and the variations in the excess of domestic deposits over domestic advances. Cf. e.g., A. H. Tocker, “The measurement of business conditions in New Zealand,” Economic record, I (1925), 51 ff.; K. S. Isles, “Australian monetary policy,” ibid., VII (1931), 1–17; Roland Wilson, “Australian monetary policy reviewed,” ibid., 195–215.

[9]Cf. Canada's balance, p. 155.

[10]Cf. especially, Theory of international prices, p. 174:

But I think that Professor Viner's data warrant the inference—despite the opposite conclusion which he himself draws—that the classical theory is erroneous with respect to the role of gold flows, under modern conditions. The correction of the maladjustment in trade produced by the loans did not come from the effects of the gold flows, or of changes in the outside bank balances. It came from the effects of the original (and prior) increase in Canadian bank deposits.

[11]Angell seems to think that the Canadian banks converted their sterling funds into New York funds only after the increase in Canadian deposits had resulted in a rise in prices and an increase in the Canadian import surplus. (Cf. quotations from Angell, pp. 416 and 418, note 10, supra.)

[12]Herbert Feis, “The mechanism of adjustment of international trade balances,” American economic review, XVI (1925) 597. Feis explains that he uses the term “gold reserves” to include both the specie reserves held in Canada and the “outside reserves.”

[13]Ibid. pp. 598–99.

[14]Feis, however, seems to have followed Angell in excluding sterling funds from the “outside reserves,” and in taking it for granted that there was a substantial lag between the accumulation by the Canadian banks of sterling funds and their conversion into New York funds, and thus may merely be repeating Angell's argument. Cf. Feis, op. cit., p. 598: “Canadian banks sell their London funds to New York banks, thereby accumulating outside reserves.” Such sales would leave the outside reserves unchanged in amount and would change only their form.

[15]Robert M. Carr, “The role of price in the international trade mechanism,” Quarterly journal of economics, XLV (1931), 711.

[16]Cf. supra, p. 418.

[17]This, I assume, is what Carr means by “extension of credit at home.”

[18]Harry D. White, The French international accounts 1880–1913, 1933, pp. 11–12.

[19]Cf. Canada's balance, pp. 164–77.

[20]White apparently at times interprets the “orthodox” doctrine, which he accepts for himself and attributes also to me, as involving only secondary fluctuations in the amount of means of payment. Cf. White, op. cit., pp. 7–8: “A year or even more may elapse before the increased reserves in the gold receiving country result in increased demand liabilities.”

[21]Theory of international prices, appendix B, pp. 505–10, and “The effects of international payments in the past,” loc. cit., pp. 140–53.

[22]Theory of international prices, p. 506.

[23]Ibid., p. 508. (Italics are in original.)

[24]Ibid., p. 506.

[25]To get his “net capital imports” series Angell also subtracts the net interest payments by Canada from the borrowings. Since he also excludes the net interest payments from his “final means of payment” series, these operations cancel out and do not affect his “excess of net capital imports over final means of payment” series.

[26]Cf. Angell, Theory of international prices, p. 510, table 1, col. 2; ibid., “The effects of international payments in the past,” loc. cit., p. 141, table 22, col. 13 (“net capital imports”) =col. 4 (my direct estimates of Canadian borrowings abroad) plus col. 3 (interest received by Canada) minus col. 8 (my estimates of Canadian investments abroad) minus col. 9 (interest paid by Canada). For the inclusion in my estimates of Canadian investments abroad (col. 8 in Angell's table 23) of the net increases in Canadian bank holdings of outside funds, see Canada's balance, pp. 92–93, table XXIV, and p. 94, table XXV.

[27]“The role of price in the international trade mechanism,” Quarterly journal of economics, XLV (1931), 718.

[28]Cf. Canada's balance, p. 30, table II, col. IX, minus col. VIII. White has pointed this out with reference to Carr's argument. (The French international accounts, p. 15, note 1.)

[29]Canada's balance, p. 187, chart III.

[30]The French international accounts, pp. 30–31.

[31]That this sometimes occurred appears more clearly in the monthly data.

[32]Cf. especially, Taussing, International trade, 1927, pp. 207–08.

[33]Although the data are not here presented, this was not only an absolute growth but a growth relative to the trend of bank deposits in the United States and England.