17. Balance of Payments Doctrine, Purchasing Power Parity and Foreign Trade

CHAPTER

SEVENTEEN

Balance of Payments Doctrine, Purchasing Power Parity and Foreign Trade

If a government doesn’t know what to do, it wants to “bribe” people by paying something to them, paying without having collected by taxation the means required for this payment. And this is what the governments are doing. This is inflation, you know. Everywhere today you hear the governments talk about inflation. They describe inflation as higher prices, as something that happens—one doesn’t know why. Or, according to another version, they say that it is due to the activities of some people, to the bad actions of people. The people are responsible. Let us take the most popular case, the problem of foreign exchange. We have today a situation in which the various governments in their inflationary measures do not act in concert. That means, one government goes farther in its inflationary measures than others. And therefore, there are continual changes in the mutual exchange ratios of the various countries’ governmental money.

What the government that embarks upon inflation does not want to admit is that the paper money that it has issued is in any way less valuable than the money which it wants to replace. We have, in fact now all over the world, inflation. We have also inflation in this country, and tremendous deficits in the budget that are covered by the issuance of additional new paper money. And the government maintains that this has nothing to do with monetary problems.

What we have to realize is that on the market, on all markets without any exception, whether they are domestic markets or whether it is the world market, there prevails the purchasing power parity principle. This is a fundamental principle of the market. It means there prevails a tendency toward the equalization of exchange ratios between the various commodities and money—between the commodities themselves, between the commodities and money, and between the various kinds of money circulating in the world. This is the interpretation, the correct interpretation of what is going on in connection between the various commodities.

If there is a deviation from this purchasing power parity, then there is a way open for businessmen to make profits. And the purpose of all transactions on the market is to make such occasions to earn profits disappear by buying in one currency and selling in another currency. It is impossible for a state of affairs to remain in which such differences between the purchasing powers of the various currencies could prevail. As far as the governments try to make such exchanges impossible there is an end of business, an end of buying and selling, but not an equalization of the prices expressed in the various currencies of the world. Therefore, it is impossible for a country or a government to prevent the devaluation of its currency, if this currency is being increased, without preserving its parity against the original money with which the government pretends the parity still exists. All this means finally that the gold standard alone, the full and pure gold standard, is free from government interference with prices and with the value of all those items that are expressed in terms of money.

When our monetary problems are discussed, you never hear the representatives of the government or the official economists of all these committees that are established for this purpose refer to the fact that there is deficit spending, that there is an increase in the quantity of money. And if there are some problems to deal with, the lower valuation, the lower purchasing power, of the government-issued money as against the money which it was once thought to represent, the gold money, then the governments, and also first of all the American government and its advisors, refer to a doctrine that has been discredited long, long ago—the balance of payments doctrine. I don’t want to give the history of this doctrine, nor to demonstrate how it was discredited. I want rather to analyze the remedy that the government has suggested for healing the monetary evils, the remedy from the point of view of the balance of payments doctrine.

In the eyes of the government, the evil is the lower valuation of the government-issued money as against the money which it was once thought to represent. And this, they say, is due to the fact that there are some very “bad citizens” in the country who are spending “our money”—I want to put “our money” in quotation marks. People who are using “our money” are squandering “our money” in order to buy absolutely bad commodities abroad—in France champagne and other French wines, for instance. And the remedy recommended is to make it impossible by acts of legislation for these people to use “our money”—again in quotation marks—for the purchase of such useless things as French wines. They say the reason why prices expressed in dollars and prices expressed in other currencies are going up is due to you, the people. The people are responsible, according to the governments, because they are drinking imported champagne and because they are traveling in foreign countries. Why do they speak about champagne and about traveling in foreign countries? Because, as the governments consider it, these are luxury things. Therefore, what the government does is simply, “Look at these bad people who are drinking champagne. They are responsible for the inflation, for the higher prices; they are responsible for all evils under the sun.” The way in which the American government deals with the problem is only one of the ways in which the government justifies its action. This is “the luxury excuse.”

But there is a second excuse, “the necessities of life” excuse, which countries give when imports consist predominantly of goods that are considered, by public opinion, as necessary and indispensable. In such countries—for instance, in all those European countries that are predominantly industrial, exporting industrial products, manufactures, in order to import food and raw materials. They say: “What is responsible for our unfavorable development of foreign exchange rates is the fact that we are poor insofar as we cannot produce on our own territory all the foodstuffs and raw materials needed and we have to import them. These other nations, the ‘have’ nations, are exploiting us.” This is the version which, for instance, was used by Mussolini in order to justify his aggression: “Why must we go to war against other countries? Because we are forced to import things which are absolutely necessary for the support of the life and health, and so on, of our population.”

What the government does not say—when it blames the balance of payments for the effect of inflation on the purchasing power parity—is that if people are prevented from spending dollars to import champagne, they would buy something else. They would not put the dollars in a package and send this package to the government so it would have more money for paying the deficits of its enterprises, the post office, for instance. If instead of buying imported champagne, they are buying other things on the domestic market, the prices of those things would go up on account of the fact that there is now a greater demand for them. This will bring about higher prices for some things which previously were exported. And those things would become more expensive, less available and would no longer be exported. If the governments were consistent, or could be consistent in this regard, they would make all imports impossible and prevent all business with foreign countries; they would necessarily restrict exports to the same extent that they are restricting imports and this would bring about restriction, the complete end of international trade. And every country would remain isolated economically.

Now why does this bad balance of payments situation develop only between national units and not within the national unit? In Europe, there are several governments, or several nations, the population of which is either smaller or not much larger than the population of many American states. Why don’t you hear the same complaints about the various American states which you hear about the comportment of some people who are buying champagne and are therefore enriching France and impoverishing the United States? Because the various American states of the union do not have an independent monetary policy; there cannot be inflation in Iowa that is not at the same time and to the same extent also an inflation in the 49 other states of the union. And you need not go to the states. When people say what is bad in the relationship between the United States and France is that France produces and sells to the United States only goods which are very frivolous, very bad, immoral goods—books, novels, theatrical performances, opera productions and concerts in Paris, and champagne which is the worst of all things—you could say the same thing also about, let us say, Brooklyn and Manhattan. Manhattan sells theatrical performances, conferences, concerts, and so on, in greater numbers to the people from Brooklyn while these people of Brooklyn are spending money in Manhattan. Typically, a man in Brooklyn might say: “Why does my neighbor spend his money to attend the performance of an opera in Manhattan? Why does he not spend his money in Brooklyn?” And if you go step by step farther in the same direction, you arrive at perfect autarky, self-sufficiency, isolation, economic isolation of every individual family and perhaps even within the family. Why should not a boy, as opposed to his brother or sister or his parents, say consequently and consistently “I want to be autarkic” for the same reasons that one of the countries in the world wants to be autarkic and prevent the importing of things from other countries.

Now let us analyze what will be the effect of such a measure—preventing Americans from importing French wine, champagne, or otherwise. It will certainly bring about an impairment of the business of the French producers of wine. And the prices which they will have to charge will have to drop in order to make it possible for them to sell all their production, their whole production, somewhere else, either in France or in other countries. They will have to sell at lower prices than those which they would have received if the Americans had bought this French product. That means that there will be in France now people who are no longer in a position to maintain the standard of living which they maintained before. They will have to restrict their consumption. They will, for instance, have to restrict purchases of imported commodities, let us say, of American cars. And in this way they will adjust themselves to the new situation. This means that when you prohibit the importation of some goods from foreign countries, you necessarily make, not only American imports decrease, but also those American exports which would have been sold in payment for these imports of French luxury goods. And this does not refer only to France. The connection is a little bit more complicated; other countries are included; the French do not only restrict their consumption of American goods, but they restrict also the importation of goods from other countries. And then these other countries are in the chain of causation which finally brings about necessarily a drop in American exports also.

If all countries of the world, consistently keeping to this balance of payments theory, were to proceed in the same way in order to make their domestic currencies independent of international valuation, i.e., their purchasing power parity, this system would finally bring an end to any kind of international trade. All imports would be prevented. And the result of stopping all imports will mean, of course, also the end of export trade. Every country will be self-sufficient, autarkic, as the Greek term says. Now there was such a period in history. Not so long ago there were many countries in the world that had no commercial relations with other countries, especially not with far distant countries. And there was once, long, long ago, a period of history in which there was no foreign trade at all. And when foreign trade developed it always meant both exporting and importing.

Foreign trade is not one-sided. It is always necessarily a mutual exchange of commodities and services between various countries. This has nothing to do with the appraisal of the purchasing power of the monetary unit. It is not the import of French wines that makes the price of domestic commodities go up. The price of these domestic commodities goes up on account of the fact that the government has increased the quantity of money and, therefore, as expressed in a very questionable way, “an increased quantity of American paper bills is now chasing a not-increased quantity of goods available for consumption.” If all imports and exports were stopped, the various countries would return to autarky; they would have to forego all the advantages which result from exchange in other countries.

Now the only thing we can learn from the whole situation is this. The market, the people buying and selling on the market outside of the government, have developed in the course of centuries a system of money based on the precious metals, silver and gold. The governments interfered again and again. Government interference excluded silver from the monetary system which the market had developed, leaving only gold as money. Yet governments—the individual governments, the various governments, and now the cooperation of the various governments in the International Monetary Fund—have not succeeded yet in bringing about the demolition of this system. Whatever one says about it, one has to realize that money is a creation of the market, a creation of the people buying, selling, and producing. It is not something that the government can manipulate just to make it possible for the government to spend more than the people are prepared to pay.