International Trade

0:00Before we begin today with our discussion of international trade again, I want to go back to yesterday's lecture, last class, and introduce another example of the problem of incentives. And as I said at the very beginning of this class, we're looking to develop ideas about the basic toolbox of the economist. So we're looking at relative prices and we're looking at incentives matter In the last lecture we talked about the coffin ships and how so many people died because the incentives weren't right. There's another case involving the shipment of prisoners from the United Kingdom to Australia.

0:49The English decided that the cost of keeping prisoners in prison was too high.

1:26Australia, which was not very well developed at all. And so you would be putting them out into the wilderness, so to speak. And so what they did was they shipped prisoners from England to all the way over here to Australia and what they found is that the ships would end in Australia and most of the prisoners would have died on the way over on the crossing and in some cases the whole ship the whole passenger list was dead in other cases a large percentage of them had died and so the parliament looked into this and found that they were paying the captains at the beginning of the voyage per prisoner and so that the captains would take the prisoners on take them and essentially invested as little in the upkeep of these prisoners as possible so they became malnourished, they became dehydrated, there was no medical services, disease was rampant and many people died either on the ship or shortly after arriving.

2:38So, what they did after looking at the problem was they decided to pay the captains in Australia for the safe arrival of the prisoners rather than in London or wherever they were shipping them out of, Southampton perhaps, and lo and behold all the prisoners started arriving alive. So this is a good example of where you, the economist, can investigate a problem, find a simple solution and a simple solution that works incredibly well. So on to international trade, now what we've seen so far is that England allowed the Americans The English wanted us to participate in the shipbuilding and the shipping industry within the British Empire, so that the Americans were included in whatever was considered English, and the English wanted us to be building ships for them, and building ships for international trade, especially between America and England.

3:55So, it was an open competition. They really didn't disable the Americans from competing in this process. Something interesting, however, develops with the major trade routes. One of the major trade routes is from the northern or New England states to England. Another trade route is between the southern states and England. And a third trade route is with the West Indies of goods being shipped, primarily sugar, from the West Indies to New England and commodities and food products from New England to the West Indies. Well, it just so happens that the colonists actually captured more than 85% of the market between New England and England.

4:47And they also captured almost 95% of the trade between New England and the West Indies, with sugar producing islands. However, the British controlled 80 to 90% of the trade between the southern states and the UK. Now, what kind of explanation can we come up for something like that?

5:43The main explanation for this result is the principle of comparative advantage, that one side would have a particular cost benefit structure that was higher than the other force, the other fleet in this case, and would dominate that trade route. So let's take a look at some of the factors that would lead to route domination in the shipping business. Well, the first factor to begin with is to recognize that this is a risky business, that a lot of cargoes simply didn't make it from point A to point B. And so merchants would tend to be very careful about who they trusted their products to, and insurance companies might have played a role here as well. And so merchants tended to deal with people that The Theory of Money and Credit

7:03The second factor is going to be related to information. Information about the marketplace. This is always going to be a factor, of course, in any economic process, but knowing market conditions is going to help create comparative advantage for one side or the other. and if you're locally based you're going to have better access to information, information about the harbor, information about services for shippers, information about warehousing, information about prices, labor availability, all sorts of things related to knowing the marketplace, so whoever had a better composite picture of the market, in this case the cities between a particular

8:27For ships to be unloaded and to be reloaded, they were also getting paid, and they would get paid on the return journey back, but if they were in their home port, they would be paid before they left, and then they wouldn't be paid for the days that they and the ships stayed in the harbor, so that a business received, in some sense, a cost reduction when the crew was in their home port. So if we look at the map up here and we look at who's dominating the trade routes, if we take all of these factors into consideration, the information problem, the risk that's associated with the business and the savings that crews had because they weren't being paid while in their home port, we can see why New England tended to dominate the route with the West West Indies 96%, where they dominated the route with the UK at 85%, but the British dominated the route between the UK and the South.

9:34England might have, New England, excuse me, might have dominated the South to the UK route, but in that particular route they would have had to pay their crews while in the Southern The New England Shippers had a cost disadvantage on that particular route, and that was an advantage that the British shippers took advantage of and essentially dominated that particular marketplace. Is there any questions on that? And we can wrap up the section on trade there and turn our attention to colonial money and trade.

10:22And as I mentioned briefly in one of the earlier lectures, the colonists were on a monetary system based on gold and silver coins. And that is essentially true, but the picture, the historical picture is much more complex and much more interesting than that, in that the colonial monetary situation is going to be impacted by British mercantilism and it's also going to be a process of innovation on the part of the colonists. So we'll start with one of the curiosities of colonial money and that is the use of Indian Money, or WAMPM. And WAMPM was a product that the Indians made which was for ceremonial purposes and also is indicated to be a kind of memory aid or a device for storing historical information in the way that the beads were sewn into the textile belt, essentially. And To give you some idea of what wampum is, is that the Indians would take shells, some sea shells and they would work those into small beads and the beads would be either rounded

11:48or cylinder shaped and then the beads would be, a small hole would be drilled in those beads or cylinders and the beads would be sewn together in a pattern of different colored World Shell Beads The Dutch were highly valued and it was something that was hard to produce and so it was relatively scarce.

12:36And the colonists sort of mistook this as an Indian form of money and they began to use it in their trading patterns with the Indians. The Dutch actually used it in an arbitrage fashion between the coastal Indians who were very adept at making this wampum. The Dutch would buy the wampum from the coastal Indians, where it was relatively abundant, and then trade it with the inland Indians, where wampum was more scarce, where they didn't have seashells, and where they were not as adept at making wampum. So the Dutch, through this arbitrage process of buying the wampum and then reselling it, an indirect exchange process, were making profits.

13:32The Dutch were located in New York at this time, and they used the wampum, they would trade European goods with the coastal Indians for the wampum, The Wampum, take the Wampum inland and trade the Wampum for things like furs and pelts that the Indians had hunted, that's what their comparative advantage was, and then they would trade the furs and pelts back to Europe in exchange for European commodities and the process would repeat. So the Dutch were making money in several different ways, making profits I should say, through the use of wampum as money.

14:17Interesting to note that the Dutch decided that they could start manufacturing wampum, that they could displace the slow handmade process with better tools for shaping the beads and better tools for making the holes in the beads and so forth and so through developing In the manufacturing process of wampum, they were able to produce it at a much lower cost and acquire more furs and pelts as a result and this sort of leads into one of the more interesting economic stories about the early colonial period and that is the buying of of Manhattan from the Indians, where the Dutch, as legend has it, Henry Hudson discovered Manhattan Island or visited it for the first time on September 11th, 1609, and in 1613 the Dutch purchased the island of Manhattan, which is really the center of New York City, The Dutch established a fur trading outpost and established a fur trading outpost in the

16:02It's long been thought that the Indians were taken advantage of for selling Manhattan, which means, in the original language, the place of intoxication, ironically. But as it turns out, the Dutch actually purchased the island from a tribe that didn't really own and control it. So the tribe that took the $24 in beads actually got a great deal because they weren't actually giving up anything.

17:00system of silver shillings and gold guineas and they were on a bimetalism system where both monies were official mediums of exchange however the British set an exact ratio between the value of a gold coin and the value of a silver coin so that one gold coin was equal The Market Economy does not really obey such government dictates like a price control or something of that nature. If market conditions are out of line with that 15 to 1 ratio, the market is going to respond in some form or fashion.

17:58and what we're going to resort to here is called Gresham's Law and Gresham very early on saw that when a country tried to set up a bi-metalism system with an exact ratio between different types of metal coins that ultimately bad money drives out good money, so that under Under that kind of system, as market conditions change, bad money will stay in the economy and the good money will be driven out of circulation. And at this time, the British system overvalued gold and undervalued silver compared to world prices.

18:49So basically, because silver was undervalued, it disappeared from circulation. So all of the good silver coins that would have been in circulation from Britain disappeared as a result of Gresham's Law and the colonists were stuck with gold coins. But gold coins weren't very useful for the colonists because they represented too much

19:46at British Mercantilism because British Mercantilism was designed to sell British products to the colonies. They wanted to sell more and to buy the products or the commodities of the colonies at artificially low prices. So they want to monopolize the export of manufactured goods to the colonies and they wanted to be a monopsony buyer of the commodities of the colonies so that they would get a little advantage in both import and export and drive money into the British economy. More money was a goal of British mercantilism.

20:33They prohibited the export of coins to the colonies. of the Colonies. You could import coinage from the colonies, but you couldn't export coins from England to the colonies. So that would sort of also dry up a source of coinage for the colonies. And they also prevented the colonies from minting their own coins. So they really were putting the proverbial screws to the colonies in terms of money. Naturally, we would expect that there would be a big trade deficit with Britain, except for the fact that ships and shipping services would also play into the international trade picture. The British wanted the colonies to produce ships and shipping services, and so all the money that the colonies earned from ships and shipping services sort of brought

22:03The Northern colonies in Canada used fur and pelts as a medium of exchange for trade. Fur pelts were relatively uniform in size and quality of a given animal of a given size they were reasonably durable and they were of not a small value but small enough so that they could be traded for many different types of items so the northern colonies used fur and fur pelts they also used dried fish which was of a smaller value and dried corn

23:331. Tobacco is a leading export product, so it was always readily sellable. In Virginia In Maryland in particular, tobacco served as a medium of exchange and actually tobacco at warehouses, people would put their tobacco in warehouses and they would be issued warehouse receipts for every unit of tobacco that they brought there and they could then use these These receipts for their tobacco that was held in the warehouse as money.

24:28They could do their shopping and buy their commodities and services and use these paper receipts as a form of money. In other areas, people referred to it just as country pay and that was basically any Many of the commodities that were produced locally had the characteristics of money that it could be divisible to a certain extent, that it was relatively durable, that it was relatively homogeneous. Alcohol products, for example, served as a medium of exchange. Alcohol had the advantage that it was more readily transportable than the grain.

25:14Green was also used as a medium of exchange but green was relatively bulky compared to the product of alcohol which it would be used to produce. So alcohol and grain products and anything that was relatively uniform, even musket balls that were produced in the colony served as money and musket balls were something that everybody used. There was a historian a number of years ago who tried to prove that Americans really didn't own and use guns on any kind of scale and that weren't really necessary. They later found out that he basically used fraudulent research techniques and sources to come to that conclusion and basically almost all Americans in the early colonial days had

26:36all of the qualities of coin money, of silver and gold coins. This is especially true of the problem of quality, tobacco products for example, the tobacco could be a rather fine tobacco or it could be a rather crude tobacco, it could be a nicely cured and fresh tobacco or it could be a badly handled or older type of tobacco, in the state of Maryland even passed a law in 1747 to inspect the tobacco and establish minimum quality standards. This was considered an important improvement. However, for most people, would not be fooled by lower quality tobacco in the state of Maryland or Virginia, certainly. The real problem appears that tax collectors were taken advantage of and that it was a common practice to pay your taxes in

28:06The Spanish peso is where we get our dollar from. The German Thaler coin was based on the Spanish peso and the word Thaler somehow gets transmuted into the term that we use when we use the word dollar. Based on the Spanish peso and the word thaler somehow gets transmuted into the term that we use today which is dollar and this coin was in wide circulation in the colonies. It was probably the most dominant coin. The Spanish were minting the Spanish peso in Mexico City in Mexico and in Lima, Peru with silver that was being locally mined there and they picked it up in the trade in the West Indies and the sugar markets down there and brought it back to the United States and this money would just be more or less filtering into the U.S. as needed and these were one ounce silver coins just like the dollar used to be.

29:21The peso was valued by the Spanish at what's called 8 reals, which was 27 grams of 92% silver and 27 grams is just short of 1 ounce. We basically based our dollar and our silver dollar exactly on that Spanish peso. The Spanish peso was also designed so that it could be divisible by citizens, and it could be cut in half, so you'd have a half peso, or it could be cut in quarters, so you'd have a quarter peso, or even into eight, or eight reals.

30:07So you weren't breaking the law by cutting the coin up, it was meant to equal eight reals The American colonists referred to the Spanish peso as pieces of eight. Each of those little pieces were one piece of eight that would equal the Spanish peso or the American dollar later on. And so, of course some of you probably are starting to get the hint here, this is where Where we get the little saying, two bits, four bits, six bits, a dollar, all for Auburn stand up and holler.

31:14So that's really where that all came from and so we are indebted to the Spanish for the basis of our monetary system from the earlier colonial days right up onto the present

31:56on a wide scale until they were outlawed in 1857 and there was a question earlier about why would the British set that ratio at 15 to 1 knowing that one form of coinage or the other would drop out of circulation and there's not a lot of great answers for that except for possibly the silver and gold interests The people who were mining, providing the gold and silver would want their coins to come into favor and their opponents coinage being at a disadvantage. So when we look at this issue that they circulated until 1857, we have to wonder why it circulated so long and why it stopped in 1857.

32:51Now why was that? Well, certainly a part of the reason is you all have heard of the San Francisco 49ers, the football team. Well, their name is based on the 49ers, who were Americans who went to California in 1849. And of course the reason they all went to California in 1849 was that the gold has been in the American economy, gold discoveries in the Alaska and Yukon Territory, silver was being discovered in the western regions of the United States as well, but it was gold discoveries that really hit big in the United States in the 1850s, and that may be a large part of the reason why Spanish coinage was outlawed in 1857.

34:01So we get to the question here, was there really a shortage of money in the colonies? And in economic terms we'd have to say that no, there really wasn't a shortage in a traditional sense. Despite all the contrivances of the British, the colonies seem to have established a sort of monetary equilibrium, where they always had access to commodity-based monies for purposes of a medium of exchange and that sort of thing, and that's a good solid monetary system to work on, although it does have its problems and its drawbacks, particularly the quality issue that those commodities don't necessarily have all of the wonderful properties of coined metal money.

35:04So there is kind of some imbalances there in the commodity based monetary system, but then we have the supplementation from the Spanish coinage and coinage from other places around the world as well. There were coinages of various types, but they were, you know, coins at that time were basically all just units of weight. And so the peso represented, you know, one ounce of silver and that could be further divided up into pieces of eight. And so the colonists actually through some ingenious developments of developing their In the next class, we will see that this ingenuity was actually taken a step too far, and trying to address the problems of British mercantilism, they adopted the idea of a monetary system that really fits all of their needs.

36:02Now what we're going to see in the next class is that this ingenuity was actually taken a step too far and trying to address the problems of British mercantilism, they adopted commodity based monies and fixed that system up pretty well and they adopted foreign systems but What we're going to find is that they took it a step too far and actually hurt their own monetary system and economy as a result.