‘Balance of Payments’

September 23, 1963

It is unfortunate that even most of the professional economists who discuss our “balance-of-payments” problem seem never to have heard of, or have completely forgotten, what their predecessors of the eighteenth century wrote on the matter. In a famous essay “Of the Balance of Trade,” written about 25 years even before the appearance of Adam Smith’s Wealth of Nations in 1776, the British philosopher David Hume showed that in a world of free trade and metallic money the problem of an “adverse” balance of payments could hardly arise.

“There still prevails,” he wrote, “even in nations well acquainted with commerce, a strong jealousy with regard to the balance of trade, and a fear that all their gold and silver may be leaving them. This seems to me, almost in every case, a groundless apprehension; and I should as soon dread that all our springs and rivers should be exhausted, as that money should abandon a kingdom where there are people and industry.”

MONEY SEEKS A LEVEL

After showing that fears of this kind had proved unfounded, he went on to demonstrate why such fears were groundless. Suppose, he asked, that four-fifths of all the money in Britain were annihilated in one night. What would be the consequence?

Hume pointed out that there would be such a fall in prices, because of the scarcity of money, that Britain would be a wonderful market for foreigners to buy from and an impossible market to sell to. In very little time, therefore, Britain would get back the money it had lost. If, on the other hand, all the money in Britain were multiplied fivefold in a night, the contrary effect would follow. British labor and commodities would “rise to such an exorbitant height, that no neighboring nations could afford to buy from us; while their commodities, on the other hand, became comparatively so cheap that . . . they would be run in upon us, and our money would flow out.”

In a free market, in other words, and with a metallic currency, the precious metals will tend to distribute themselves among countries in proportion to goods so as to equalize prices (allowing for transportation costs) of goods in different countries. Money will seek its international level for much the same reasons as “all water, wherever it communicates, remains always at a level.”

HOW TO LOSE GOLD

Has all this been invalidated by the development of bank credit and paper money? On the contrary, though bank credit was then only in its infancy (1752), Hume correctly diagnosed its effects: “I scarcely know any method of sinking money below its level, but those institutions of banks, funds, and paper credit which are so much practiced in this kingdom. These render paper equivalent to money, circulate it throughout the whole state, make it supply the place of gold and silver, raise proportionably the price of labor and commodities, and by that means either banish a great part of those precious metals, or prevent their farther increase. What can be more shortsighted than our reasonings on this head? We fancy, because an individual would be much richer were his stock of money doubled, that the same good effect would follow were the money of everyone increased; not considering that this would raise as much the price of every commodity, and reduce every man in time to the same condition as before.”

In brief, Hume saw clearly what our monetary authorities have either failed to see or have seen only belatedly and inadequately—that the certain way for a country to lose gold is to inflate faster than other countries. This is the cause of our balance-of-payments problem.

But poor Hume, our “new” economists may reply, did not see that inflation can have a stimulative effect. He did see it, and he also saw through it: “Money when increasing, gives encouragement to industry, during the intervals between the increase of money and the rise of prices. A good effect of this nature may follow too from paper credit; but it is dangerous to precipitate matters, at the risk of losing all by the failing of that credit, as must happen upon any violent shock in public affairs.”