interest rate is highest. When it enters bank reserves, it increases the resources for credit expansion, eases the money market, and lowers the interest rate. When it seeks the country where its value is greatest in terms of purchasing power, it is seeking the country of low price level. As it increases the quantity of money in that country, it raises the price level. The gold exporting country tends as a result of its depletion of money to lower its price level and raise its interest rate. Thus the original inducement to the export of gold disappears as gold becomes worth more at home than abroad.

In the foregoing phenomena, the movements of gold, goods, and loanable funds are of primary importance. Each factor seeks the country where it is worth the most. But as its supply is added to the receiving country, that new supply tends to ease the market demand. Price levels, exchange rates, interest rates, react to the flow of gold, goods and funds. The interactions of these factors comprise the automatic correctives which tend to maintain the international equilibrium of trade and finance.

Qualifications of Exchange Theory.-The main lines of the theory of exchange are derived from the doctrines of Ricardo and of John Stuart Mill. They were worked out under simpler business conditions than obtain in the twentieth century. For example, the modern structure of bank deposits and credit was at the time largely undeveloped. Cash has been largely displaced by credit instruments as a medium of exchange. Hence gold supply affects prices only indirectly, after it first affects the volume of bank credit. Strict Ricardian theory suggests that the quantity of specie in a nation exercises a direct and certain effect upon prices and other factors in international trade. It thus rests upon a certain degree of over-simplification of the quantity theory of money and prices. A statistical comparison of prices and gold movements shows that at times when according to the strict theory of the case prices should have moved upward, they have often either remained stationary or actually declined.2 Consequently, it is necessary to repeat the caution that not one force but many are in operation in international payments, and that each new situation is original and different from any other. The peculiar and unique combination of corrective influences prevailing in that particular situation is the important consideration. The strength of each corrective influence requires measurement and estimate in light of the distinct conditions then existing. When the corrective influences are understood in this manner, they are indispensable tools for analysis of exchange problems, and they avoid the pitfalls. that would arise from treating them as fixed and independent forces.

Some writers have maintained that such qualifications leave the theory so indistinct as to be without practical value. Moreover, they have maintained that the notion of international equilibrium itself is a myth, since rates, prices, commerce, are always in movement and transition. These objections indicate that their authors expect too much of 2 I. B. Cross, Domestic and Foreign Exchange, pp. 418-426.

the principles of exchange. These principles aid in analyzing complex and many-sided problems of exchange not by laying down hard and fast rules but by serving as guides to the chief factors and underlying conditions in such problems. The notion of equilibrium, moreover, does not imply a static and motionless condition in international trade and finance, but a normal about which rates, prices and trade fluctuate within limits.

Some Fundamental Considerations.-There have constantly appeared, in the discussion of international payments, two vitally important questions: first, what amount of gold should a country have; and second, what ratio is most favorable between a nation's total exports and imports.

In analyzing the first question, the Ricardian theory teaches that gold tends automatically to distribute itself among gold standard countries in such proportions as to equalize its purchasing power over commodities. Each nation therefore needs such a supply of gold as will tend to maintain its price level roughly on a parity with the price level of other nations. With this fact in mind, it is easy to recognize the fallacy of a popular notion that the more gold a nation acquires, the more wealthy and prosperous it becomes. Gold in excess of the amount necessary to maintain a price level in line with the level of other nations is a positive danger to a country, since it tends to upset normal price levels and disarrange normal buying and selling power in the markets of the world. The country needs such a gold supply as is necessary to avoid either inflation or deflation. The popular fallacy is a left-over from the doctrine of the seventeenth and eighteenth century mercantilists that the country which had the largest store of precious metals was the favored country, and although the doctrine is adequately exploded logically and technically, nevertheless it retains a powerful grip upon the imaginations of many business men, legislators, and popular leaders.

With regard to the second question: What is the best ratio between. a nation's exports and imports?, mercantilist tradition likewise is widely found. People assume that the United States can be prosperous only by stimulating exports in every possible way and discouraging imports by tariffs and other devices. Exports are looked upon as a blessing; imports as a curse. This popular fallacy overlooks the elementary principle that every export must be paid for in some way, and that the only way is by an import of some sort. As Hartley Withers observes, "For everything that goes out something or other must come in, if the buying country is to pay for what it receives." 3 The visible and invisible imports and exports represent an interchange of goods, services and capital. Net differences may be met by shipments of gold, but the smaller such shipments have to be the better. Gold shipments do the receiving country more harm than good after its specie supply is sufficient to maintain a normal price level. Consequently the conclusion. is that the best ratio between exports and imports, both visible and in3 Money Changing, p. 176.

visible, is such an approach to equality between the two as will reduce the necessity for gold shipments to a minimum.

It is impossible to determine whether a balance of trade is favorable or unfavorable in the true meaning of the words, merely by ascertaining an excess of exports or imports of goods. It is necessary to take into account the balance of invisible payments. The combined balances of visible and invisible items will be such that total exports will approximately equal total imports. The shipments of gold will be very small in proportion to total payments, under the most favorable conditions. Further analysis is given to the factors determining national advantage in the chapters treating foreign trade and export of capital.

While the gold standard was maintained during the period before 1914, the mechanism of foreign exchange operated with a high degree of efficiency. The broad and fundamental movements of trade, of gold, and of price levels served as highly perfected safety valves in regulating international intercourse. It was a splendid illustration of the importance of money and money mechanism in regulating the whole broad field of economic life. People did not realize how important international finance had become until it was disorganized by the World War. When the old financial mechanism was destroyed, people discovered how dependent upon it they had been. But once it had been destroyed, the task of regaining it proved extremely difficult. The following chapter is devoted to the post-war problem of international finance, to the problem of reconstructing the money mechanism which alone is capable of restoring normal economic life to the nations of the world.

BIBLIOGRAPHY

BULLOCK, C. J., WILLIAMS, J. K., and TUCKER, R. S., The Balance of Trade of the United States, Review of Economic Statistics, July, 1919, 1920, 1921,

1922.

CROSS, I. B., Domestic and Foreign Exchange.

EDWARDS, G. W., Foreign Commercial Credits.

ESCHER, F., Foreign Exchange Explained.

FURNISS, E. S., Foreign Exchange.

GOSCHEN, GEO. J., The Theory of the Foreign Exchanges.

MARSHALL, A., Money, Credit and Commerce.

TAUSSIG, F. W., Principles of Economics, 3rd edition, Volume I, pp. 462 ff. WHITAKER, A. C., Foreign Exchange.

CHAPTER XXX

MONEY AND FOREIGN EXCHANGE SINCE 1914

Except for the United States, the principal commercial countries were unable to maintain convertibility of their currency into gold under the stress and strain of the World War. Some countries were able to resume the gold standard in the post-war decade, at the pre-war parity of value. Other countries may be able to resume gold convertibility at a new and lower parity. Still others may be unable to resume under any conditions for long time. And, finally, some may decide not to resume at all, but to use a regulated paper standard. Even if the postwar confusion in world finance and exchange should prove temporary, nevertheless the period would remain a classic example of financial chaos and trouble, and would demand careful examination and study. The period would offer an excellent opportunity to trace the laws of finance, and to observe the harmful results of failure to understand such. laws. But there is every evidence that the effects of this period must be much more than temporary. This being the case, it is necessary to carry the principles of exchange over into the great contemporary problem of world finance, and to make use of those principles in the endeavor to understand the new issues involved in the present situation.

The new difficulties facing the world are not so much the outcome of new forces of finance, as they are the outcome of old forces working out in new ways. Normal principles of international finance do not need to be displaced by new principles. On the contrary they need to be adapted to the new conditions, and applied to the abnormal problems. Consequently, the principles outlined in the previous chapter will be drawn upon in the analysis of conditions since 1914.

The Par of Exchange Under Irredeemable Paper.-When gold convertibility is abandoned, the normal mint par of exchange between countries is also abandoned. Since the mint par is the ratio between the weights of gold in two money units, and since irredeemable paper units have no value according to weight, it simply becomes meaningless to speak of a ratio between paper money weights. Under this condition, some authorities maintain that there are no parities at all. This rejection. of the idea of parities under abnormal exchange would seem, however, to be an extreme interpretation. Pars of exchange do exist, although their nature is somewhat different, and methods of measuring them require modification. For purposes of clearness, we may examine these new parities by taking two broad types of exchange under irredeemable paper. First, we may take exchange between two countries, one of

which is still using gold money and the other of which is using irredeemable paper. The best illustration is the relation of the United States, still using redeemable currency, with various European countries using paper currency. Second, we may take exchange between two countries, both of which are using irredeemable paper. The best illustrations are the relations between various European countries.

(1) The par of exchange between the United States and a country using irredeemable paper may be measured by two different methods. One method gives what may be called the gold price par; the other, what may be called the purchasing power par.

The gold price par of exchange is the ratio between the prices. offered for gold in the gold markets of two countries. In the United States, the price of gold is fixed by law at one dollar for 23.22 grains of fine gold. In England, the gold pound sterling contains 4.8665 times this amount of fine gold, or 113.0016 grains. But while England was off the full gold standard, paper pounds sterling were not convertible into gold sterling at face value. If an English banker wanted to buy gold sterling, he had to go into the gold market, and buy it with paper currency, just as he might attempt to buy in merchandise markets any other form of commodity. The paper price of sterling was simply the paper price of 113.0016 grains of fine gold. The difference between the paper price of gold and the face value of the gold unit, is known as the gold premium. Hence, the gold premium is the basis for computing the par of exchange.

If the gold premium in England was 25 per cent, the paper price of gold sterling was simply 25 per cent above the face or mint value of the gold coin. To state the same fact the other way around, the face value of the gold coin would be four-fifths, or 80 per cent of the paper price of gold. In that case, the par of exchange is simply 20 per cent below the old mint par of exchange, or 20 per cent of 4.8665. Sterling exchange is then said to be at a discount. Consequently, the discount on sterling exchange varies with each change in the premium on gold coin. As the gold premium rises, the discount of exchange falls.

If a New York banker desired to secure a thousand gold pounds sterling in London, his problem was to find how many paper pounds were necessary to purchase a thousand gold pounds. If the premium on gold is 25 per cent, the banker will need to secure 1,250 paper pounds wherewith to obtain 1,000 gold pounds. But from his knowledge of the old mint par, he knows that 1,000 gold pounds is the same in weight as 4866.5 gold dollars. He can afford, therefore, to give 4866.5 gold dollars to secure 1,250 paper pounds, and these paper pounds, in turn, will secure 1,000 gold pounds in London. If, then, the New York banker buys paper pounds at the rate of 3.8932 dollars each, it will cost him 4866.5 dollars to secure the 1,250 paper pounds wherewith to buy the 1,000 pounds of gold in London. The rate of $3.8932 will, therefore, be the gold price par of exchange. It is the ratio which equalizes the prices of gold in the two countries.