Ludwig von Mises Institute

Chapter 35
Of the Balance of Trade and the Course of Exchange

The late William M. Gouge, one of the best political economists of the United States, says, in his History of Banking, "Nothing is more certain than political economy. Nothing is more uncertain than political arithmetic." Now the "balance of trade," as it is understood in Washington, is a sort of political arithmetic that is very unsound political economy. It is relied upon by our political leaders in legislating for a resumption of specie payments; as if an excess in the value of exports over imports is necessarily a balance of account returnable in money.

The doctrine of the "balance of trade" was exploded by Adam Smith a century ago, and is emphatically contradicted by statistics—especially in England. In the Statistical Abstract of the United Kingdom, copies of which are before me beginning with 1854 and including 1875, there is not during the whole twenty-two years a single year in which the imports do not exceed the exports of merchandise in money value very largely. The returns for the three following years present, in Federal money at $4 7/8 to the £ sterling, a fair average example of the whole period:

Years		Imports		Exports		Excess of Imports
1854	.....	$742,896,633	.....	$564,627,823	.....	$178,268,810
1858	.....	802,346,181	.....	681,441,048	.....	120,905,133
1875	.....	1,822,955,438	.....	1,372,860,075	.....	450,095,363

This exhibit, it will be observed, is of merchandise only. The imports of bullion and specie were not registered at the British customhouse till the month of November, 1857; they exceeded the exports of the same every year from 1858 to 1875 inclusive, with the exception of small balances in 1860, '61 and '72, the two former, '60 and '61, being years of contraction of the currency here by the repudiation of Southern debts, failures in business, and consequent annihilation of current bank deposits, at the beginning of the rebellion. This contraction turned the course of exchange effectively against England in favor of our loyal States. In the eighteen years, '58 to 75 inclusive, the British imported $2,520,744,676, and exported $2,099,745,190, of gold and silver, the excess of imports being $420,999,486, notwithstanding the so-called adverse balance of trade every year of the whole series.

The imports of money exceeded the exports of the same $47,101,030 in 1858, and $27,479,141 in 1875. Add these balances to the merchandise returns, and with such figures before him, can an intelligent merchant say that the balance of trade is against Great Britain? If I send out a foreign adventure costing $20,000, and get as a final recompense $25,000 of money value in merchandise in return, I think the balance of trade is $5,000 in my favor; if I get back but $15,000, I think the balance of trade is $5,000 against me; and it is in favor of or against my country as it is in favor of or against the merchants of the country altogether. The true balance of trade, then, is a balance of profits.

Great Britain receives interest on her foreign loans in her imports; but that does not begin to account for the great excess and continual increase in the value of her imports over her exports. The truth is she maintains, under the screw of the Bank of England, a better currency, i.e., less currency in proportion to capital, than most of the commercial nations, and consequently a higher value of money, so that she produces cheaply and sells steadily at a profit; but there is room for improvement; the seesaw of her currency by the Bank of England, in fickle and fictitious expansion by discount deposits, alternated by sharp contraction, is distressing; we can do better if we will.

Because of her restricted territory England does not feed her own population, nor supply nearly sufficient raw material for her manufactures, directly with her own products; hence the preponderating volume of her foreign commerce. Obviously she must import and export more than countries which utilize their own products more directly and more extensively. The balance of trade, except as a balance of profits, is a chimera; there are no figures to be found for it.

But the balance of exchange is another matter and a very simple one. It is the difference in the exchange value or purchasing power of money in different cities and countries. Of course, the exchange value of money is to be found in what money will fetch in other things; that is to say, in general prices reduced to bullion value. If general prices in real money are sufficiently high here and low elsewhere, it is clear that we must buy goods and sell money. If such prices are sufficiently low here and high elsewhere, it is equally clear that we must sell goods and buy money. We may make high and false prices with false money in overvalued silver or in uncovered promises of banks or government, convertible or otherwise; but foreign merchants will not pay such prices for our commodities; they will sell us their commodities abundantly at such prices; they will take here our overvalued currency of silver and paper, but they will carry away specie at the bullion value for it; and, if we are so ignorant of political economy as to make the spurious currency interchangeable with real money by legislation, we lose the difference infallibly. Foreigners get the high prices of our false money for their goods, but leave the dross with us, taking away our good gold in exchange for base money at par. This is what Secretary Sherman and his questioners of the Congressional Banking and Currency Committee ought to know, but do not. Another thing they do not seem to know is that the current demand deposits of banks form the chief part of the currency; the bank deposit being the principal item in the running cash balance of every merchant and man of enterprise. This is too plain a fact to admit of argument, yet it is constantly ignored in legislation upon the currency.

I have now to say, if Mr. Sherman directs legislation, or takes his measures, after his notion of the balance of trade, and expects to maintain specie payments by accumulating a hundred or two millions more or less of coin, he will be cruelly disappointed whenever business assumes an average degree of activity. Rapidity of circulation is a prime element in the value of money—it raises prices. A rise of prices and a fall in the value of money are one and the same thing, and any appreciable fall in the value of money below its present level will send it out of the country rapidly under an adverse course of exchange.

Money is simply a commodity when employed in commerce; that is to say, it is a material value that is bought and sold, and, like every other commodity, as already demonstrated, it will be exported when cheaper and imported when dearer at home than abroad. Every bond we owe in Europe might be returned here for sale at once without causing the export of a dime of specie, if we should maintain money at a higher value than merchandise, as we can by suppressing the uncovered paper currency, including the fictitious discount "deposits," the current uncovered inscribed credits of the banks. We should necessarily export the more merchandise, and have more and a brisker business. We have an abundance of capital for this purpose, but it is disorganized by a currency which, to create and maintain it with false prices, involves in needless debt and embarrassment almost every enterprising businessman in the nation. What we want to obviate this difficulty is simply noninterference with the normal value and circulation of money.

The currency now organized by the banks and the government, and waiting demand with a crippled business, is more than the capital of the country can maintain in active use. Including specie, the currency is, I think, some $500,000,000 beyond the natural money volume with which capital can be circulated at its bullion price and value, and an active, healthy, business conducted; it is so much more than can be maintained under specie payment. Accumulating specie, therefore, is not the thing to do, especially at the cost of interest by increasing or maintaining the bonded national debt. The true policy is to reduce the paper currency, and the reduction should be of that which costs interest, viz.:—the bank currency. Doubtless the banks would object to this. I believe they would be benefited by it in the long run.

I have endeavored to show in previous contributions to the Banker's Magazine, that the principle of discounting an evidence of debt out of itself, and lending credit as money, is damaging to the business of banking in the end, as well as to all other business. It is making false money, raising price without value, and imposing an obligation upon the bank customer to return real money or value for it, which obligation, multiplied by circulation, must end in bankruptcy somewhere, since there is no real money or value created or existing to pay it with. Ultimately it reacts upon its creator, the bank, and bankruptcy becomes, in specious phrase, "the suspension of specie payments." The losses that are falling upon the banks at this time, and have yet to be set off in their accounts between their loans and their liabilities, form a practical illustration of this truth.

But I wish to repeat, what I have formerly said, that no one objects to the lending of credit, as credit, by a bank any more than by a merchant. A merchant may buy goods on his own credit, or on a letter of credit of a bank or banker, with no more or different effect upon the market in the one case than in the other. In either case the credit is not offered or mistaken for money; it enters into no cash account; it is an honest, undisguised postponement of the use of money; it is lending credit in borrowing capital without completing the exchange. What possible difference can it make whether the credit so employed is that of the merchant or the banker? All that is necessary for legitimate and useful banking in the case is, that the banker shall pay his debt in money, like the merchant, when the use of money is required to complete the exchange; that is, when payment is demanded, so that fictitious dollars shall not be created in the transaction. The seller then recovers his capital in a commodity that everybody wants—the most desirable commodity known to commerce. It is therefore simple nonsense to prate of money as a mere medium of exchange, the purpose of which may be served by an evidence of debt which pays nothing. Clearly it is the object of exchange, in value as the common equivalent, which constitutes the essence of money.

The question of profit to the banks is, whether they can make as much by lending their credit as money, with their loans consequently crippled by current uncovered demand liabilities, as they could make by borrowing and lending capital at a proper difference of interest through the instrumentality of money, with no such demand liabilities and all the loanable capital of the country to borrow from. The capacity of the banks to lend does not depend upon their power to produce currency in notes or current deposits, nor upon the quantity of currency or money in the country, except so far as money is capital; it depends upon the quantity of loanable capital at their command, for the same dollar of currency will serve to circulate in banking, as in any other business, many times its amount of capital according to the activity of circulation.

It is simply impossible to have too little currency, as such, and equally impossible to have too much capital, including money, since the less currency we have in relation to capital the higher is the value of our money, or, what is the same thing, the lower are our general prices, so that we necessarily keep the course of exchange in our favor, produce cheaper, attract more trade and sell at a greater profit than nations having relatively more currency and less capital. It is not as currency, therefore, but as capital that we gain by the increase of money, and the more circulating capital of any sort, the wider is the field for banking. A sluggish commerce and a steadily favorable course of exchange are incompatibilities; they cannot exist together.

The returns at Washington show that the loans of the commercial banks, so long as they maintain specie payments, do not exceed their capital more than about two-thirds on the average, taking the years together. According to this an average bank of $600,000 capital would lend $1,000,000, and probably in the Atlantic cities the interest would average six per cent per annum, say $60,000 gross income for the year. A bank that should make one per cent per annum on its loans by borrowing the excess and lending ten times its capital of $600,000 would aggregate the same income without inflating the currency or crippling its business or the business of the country with fictitious money. Now there are trust companies in the Atlantic cities lending twenty times their capital, and savings banks, with no stock capital, lending twenty millions of dollars each; they are enabled to do this business because they lend only what they own or borrow; they avoid the pernicious principle of lending their credit as money; hence they do nothing to degrade the value of money or to force it abroad.

There is no reason in the world that I can discover why commercial banking should not be done upon this plain, honest principle, which would put an end to the ruinous fluctuation of prices and the vast amount of needless bad debts that result from the operations of the present system, and are as injurious to banking as to any other business. I say, then, in view of the great losses they bring upon themselves periodically with their fictitious money, I believe the banks would make greater profits in the long run by abandoning the principle of discounting an evidence of debt out of itself, which is the groundwork of false money in banking.

Goethe makes Mephistopheles say: "It is a law binding on devils and phantoms that they must go out the same way they stole in." The phantom of "paper money" stole in through legislation; it must go out through legislation, or it will ruin not merely the dominant party but the politics, industry, commerce, and social order of the country. The true policy, in my opinion, is to tax out of existence the uncovered bank currency, prospectively, and then gradually retire the greenbacks, or cover them with specie, so as to keep the foreign exchanges continually in our favor, until, by exporting merchandise and importing money, in addition to the product of our own mines, the money channel is filled with the solid capital in gold and silver which belongs to it. This will, if adopted, set industry in motion, silence the idle brawling of labor against capital, and the more reasonable and just complaints against privileged legislation for the banks; it will cause the production and export of merchandise, and the addition to our active circulating capital of some eight hundred millions of dollars that we cannot have while the present paper blockade is maintained; it will give an immediate start to shipbuilding, and ready employment of navigation for the shipment of bulky cargoes abroad; it will give security to property and contracts in the future, and success to the well-planned enterprises of honest men; and it will dry up that fountain of needless debt which overwhelms in bankruptcy some time in his life, or leaves in poverty at his death, nearly every man who ventures into trade.

The key to this policy is to be found in the course of exchange; let us keep this in our favor, by adherence to natural laws, and we command the commerce of the world until we have, as capital in the product of labor, an excess of money when we shall have a desirable commodity to dispose of profitably, like an excess of wheat or cotton, instead of selling it for nothing under the degrading power of an overvalued currency.

Whether we shall do well or ill in this matter depends chiefly, as we see, upon the management of the banks either by themselves or by the government. A sluggish and an obstructed circulation reduces prices, as if the currency were partially hoarded, and accordingly raises the value of money; it may extinguish the gold premium entirely and make a temporary show of specie payment, but that the export of money can be checked for any considerable time, and specie payments maintained with the demand liabilities of the banks and the government as they are now, or within several hundred millions of their present amount, I conceive to be impossible.