V. The Balance of Payments

CHAPTER V

THE BALANCE OF PAYMENTS

A. Fundamental Concepts

COMMERCIAL and financial transactions carried out from country to country are what compose the network of international economic relations, or rather the substance of these relations; the framework within which they take place is, on the other hand, determined by a number of measures adopted by States individually or collectively, measures of commercial, financial and monetary policy, which are what in fact distinguishes “nationalism” from “internationalism”.1 Whatever the framework established by national policies, the fundamental components of economic intercourse between countries remain the same. In a short enumeration they can be summarized as follows: (a) Trade; (b) Movements of capital;2 (c) Movements of short-term funds.3 Nor should movements of men from country to country be ignored since they are a most important item in economic relations and in economic processes that take place internationally, just as their interregional movements are very important in the economic processes of any single country. However, within the compass of our present inquiry the human factor of international migration, will have to be left aside, except in so far as it influences payments that are to be made from country to country.

Trade, capital movements and money transactions all have their causes in the working of national economies and in the interdependence and interrelations that exist between them within the larger entity—the world. Once they take place, they give rise to payments. And the ways and means by which the payments are made, and accounts settled, influence in turn the size and structure of the transactions themselves. Phenomena discussed under the present heading are all interdependent, with causal relationships going more often than not in either direction, from A to B and from B to A. The study of international payments is a study in economic interdependence, not only of countries in the world, but also of the different elements composing the economic life of any country.

An inquiry into these matters can be carried out according to various principles; it would exceed the scope of the present study to analyse the different approaches that have been made to the problem of international payments in connection with the theory of international trade or with the theory of monetary phenomena.4 I shall limit myself to a restatement of the fundamental concepts and relations which are necessary tools for the subsequent sections of this book.

Transactions, commercial and financial, are continuous flows of varying intensity. Their result is, at every moment, a net payment from country to country. It is the foreign exchange market which reflects the changing situations that arise daily. It is on this market that the problem of international monetary stability presents itself most directly. However the study of what happens there demands an insight into the deeper workings of the economic process.

Transactions between individuals result in an exchange of commodities and services, in debts incurred and repaid, in cash received or disbursed, whether those individuals reside in the same country or in different countries. Similarly if we take countries as a whole, and consider the total of transactions concluded by individuals, corporations and public bodies in any country with individuals, corporations and public bodies abroad, we have the aggregate of trade transactions, of credit operations and of cash payments from country to country. Some of the payments made on these different accounts cancel out; there remain residuals which constitute international settlements proper. There are several ways of representing the phenomena in question, of picturing and summarizing them. An important device is to make a statement of all the transactions that have taken place in the course of a period of time, generally a year. The statement may include some or all transactions that gave rise to international payments. If it includes all transactions, it necessarily balances; if it includes some of them it results in a surplus or a deficit, unless the items left out, if any, cancel out. One may, on the other hand, include all items that produce an increase or decrease of international indebtedness whatever the time when these obligations fall due. Thus Professor Viner opposes the “balance of international indebtedness” to the “balance of payments”; by the former term he designates “the difference between the totals of debit and credit international transactions” of a country, by the latter, “the difference between immediate debit and credit obligations, and not . . . the difference between all debit and credit transactions”.5

It is important, no doubt, to distinguish between transactions that give rise to immediate payments and such that create an obligation to make a payment in the future. For our purpose this distinction is not fundamental. Some of the payments that take place from country to country are the result of current transactions, such as e.g. purchases of goods against cash, or money transfers from country to country; others are due to past contracts such as the purchases of goods on credit, or long-term credit operations. The distinction that really matters in the present context lies in the nature of transactions, not in the fact that one takes into consideration payments that were made and received (a) at any one moment, and (b) over a period of time. For the purpose of appraising the financial situation of a country and of forecasting the future development of her “balance of payments”, even for the purpose of deciding whether to adopt certain policies or not6, a clear picture of a country’s financial assets and commitments (in her relations with other countries) is of a very great importance. Computations of that sort are certainly a most valuable source of information, though the question involved is distinct from that of the mechanism of international settlements.

Let us now turn to the notions of “balance” and “settlements”. Payments to be received in a country from abroad and those to be made abroad at each particular moment of time do not generally cancel out; there remains a balance to be settled. Means for that settlement can be obtained either by new commercial transactions or, more immediately, by short-term credit operations. Under the gold standard, shipments of gold take place in certain circumstances to settle momentary deficits in international payments. More will be said about this in discussing foreign exchanges. An important question arises in connection with the momentary or permanent character of that excess of payments to be made abroad over payments received from abroad; it is the question of lasting stability versus instability in international economic relations as defined by the existence or absence of a stable equilibrium in international payments.7 Stable equilibrium admits, by definition, deviations from it in one direction or in another, such that they cancel out over a longer period of time. If deviations from equilibrium, i.e. deficits in international payments experienced by some country, are not momentary and soon compensated by excess receipts, a situation of cumulative unbalance arises, which in order to be cured may require changes in the structure of foreign trade, or important financial measures, and which may lead to instability in foreign-exchange markets and to more or less important changes in the relative valuations of currencies in terms of one another.

It is the process of international settlements which sets daily in motion the various forces making for stability—or instability—while behind the settlements are the various commercial and financial transactions. Over a longer period of time international transactions get settled one way or another and payments received and payments made cancel each other out, compensate one another, are balanced. Thus one should speak about the structure of international payments, not about their balance, when referring, not to a momentary situation, but to a period of time. The yearly computations, now published in most countries,8 are precisely such summaries of international payments showing their structure; they are generally computed on the basis of a classification which takes into consideration the origin of payments, i.e. the nature of transactions from which they resulted. To call such summary statements “balances of payments” is hardly correct; yet the name has been generally accepted and it would be idle to suggest a change. We must merely keep in mind that in speaking of a “balance of payments of some given country for some given year” one means a statement of the size and structure of payments actually made and payments actually received by a country during a given year, and not balances to be paid, balances giving rise to international settlements. The former “balances of payments” always balance; the latter correspond to the proper use of the term and represent a momentary, changing reality, best reflected in foreign-exchange markets.

This distinction between situations arising at any moment, and recapitulative statements covering past periods appears to be both justified and important. In order to supplement the observations that precede, it may be of interest to quote the following remarks by Professor Aftalion:

“Normally . . . and except in the case of insolvency, the balance of payments is in equilibrium. But for insolvency all operations must have been settled. . . . In the end if the balance of accounts showed a deficit, one had to settle that deficit by shipping gold, by sending abroad foreign securities held, or by new borrowings. If the balance of accounts shows a surplus it is likely that one did not fail to utilize that surplus: purchases of gold, of foreign securities, of houses, of new foreign balances; in other words gold imports or new foreign investments. If one knew all the exchanges of commodities and services, and all the capital and gold movements, the balance of payments would present itself in strict equilibrium. Thus, considering that a certain number of these movements remain unrecorded, one has the right to add in the table of the balance . . . the sum necessary to bring the balance of payments into exact equilibrium. When there is no insolvency, the thing that interests us in the balance of payments is not whether its equilibrium is achieved but how it has been achieved.”9

Professor Aftalion uses the expression “balance of payments” to designate all payments that took place over a period of time between a country and countries abroad. To this he opposes what he calls “balance of accounts” (commodities and services) which includes obligations due to international trade and to past debt contracts. It thus includes a part of international transactions while the “balance of payments” includes their totality. Aftalion’s “balance of accounts” is not the same as the “balance of payments” in the sense of a momentary situation; I doubt therefore whether it is a useful concept. The passage quoted gives the impression that once the “balance of accounts” has been found to show a deficit or a surplus the problem arises how to meet the former or employ the latter. Now this is precisely what never really happens. The process of adjustment, of making payments, of settling deficits and employing surpluses is a continuous flow of transactions induced by fluctuations of prices, of exchange rates, of rates of interest, and of other changing economic conditions. The process can approach that described by Aftalion in the lines quoted only in a totalitarian State where all transactions with countries abroad, all foreign payments, are centralized and monopolized by the State. In the free economic process the distinction between “balance of accounts” and “balance of payments” is as unnecessary as the impression it conveys is inadequate. Once there is an unbalanced situation in international payments reflected in quotations of foreign exchanges, the adjustment can be made by the means of changes occurring in any and in all the items of commercial or financial relations; not only in gold movements and short-term lending, but also in trade items and long-term lending. Similarly the disequilibrium may be brought about by changes occurring in any group of international economic transactions.10 To discuss international payments otherwise than in relation to a continuous and complex stream of transactions, carried out daily and even hourly, is very dangerous and conducive to innumerable fallacious conclusions.

B. Classification of Transactions resulting in International Payments

Let us now turn to the classification of transactions that result in international payments.11 One may adopt several principles of classification; the one chosen here is based upon the distinction between (1) commodities and services; (2) capital; (3) short-term funds.12 Gold forms a separate chapter in my classification for reasons which will become more evident in the course of the following chapters. The main headings of my classification are as follows (a detailed discussion of items included under each heading follows below):

(1) Trade in commodities and services;

(2) Capital movements;

(3) Transactions with short-term funds;

(4) Gold movements.

The basic differences between my classification and that used by the Economic Intelligence Service of the League of Nations13 are the following:

(a) The League’s “Standard Scheme”14 includes gold in the same group as Commodities and Services, while I consider it to be a separate main item, on account of the monetary significance of gold movements.

(b) The “Standard Scheme” includes “Interest and Dividends” in the group “Commodities, Services and Gold”, as a group of services; in my classification it is included in the group of capital movements.15

(c) In the second main group of the “Standard Scheme”, long-term operations are included along with short-term operations, as the two subdivisions; in my classification the two are considered as main divisions, considering that they represent functionally very different elements in the economic process.16 The fundamental distinction that exists between monetary capital, on the one hand, and cash and short-term funds, on the other, is too often overlooked or deliberately underestimated in economic discussion—and in practical life—and yet it is very important. The former are funds available for investment, for financing larger productive processes, funds representing purchasing power in the producer’s goods (or “capital goods”) markets. The latter are ready cash, available at the utmost for short-term financing of trade.17

As regards the best existing computation of “balances of payments” due to the Bureau of Foreign and Domestic Commerce of the United States Department of Commerce,18 it is based on a classification which is different both from the “Standard Scheme” and from my own suggestions. In view of the importance of the American work in this field, I want to indicate the main differences between the American classification and the other two.

The schedule used by the United States Department of Commerce includes interest and dividend payments and war-debt receipts in the group “Trade and service items”, while “short-term banking funds” are included in the group of “Capital items”. In this it comes very close to the Geneva “Standard Scheme”. On the other hand it approaches my classification in making a special group of gold movements. It is true that silver and currency are included in the same division, which is less acceptable for silver than for currency. The latter may very well be included in the same category as gold. As regards silver, its position in the United States is rather peculiar. Wherever silver is a monetary metal it takes, evidently, the place of gold in my classification; wherever both are monetary metals they can both be included in the same category. On the other hand wherever silver is demonetized it belongs simply to the item “commodities”. One might argue that since 1933 silver is to a certain extent a monetary metal and if this is admitted the American classification is on that point analogous with my own.

“Standard Scheme”19 (League of Nations)	U.S. Department of Commerce20	Heilperin
I. Goods, Services and Gold:—	I. Trade and Service items (including Interest and Dividends; War-debt receipts; Tourist expenditures; Immigrant remittances, etc.)	I. Trade in Commodities and Services: Merchandise Services (including Tourist expenditures)
1. Merchandise
2. Interest and Dividends
3. Other services (including Immigrant remittances, Tourist expenditures, etc.)
4. Gold
II. Capital items:—	II. Gold, Silver and Currency	II. Gold (including Currency and Silver if it is a “monetary metal”)
1. Long-term operations
2. Short-term operations
	III. Capital items	III. Capital movements Long-term operations; Interest, Dividends, Amortization; Immigrant remittances, Gifts, etc.
	Reported movements of Short-term banking funds
	Reported Long-term capital movements
		IV. Movements of Short-term funds Commercial credit Short-term transactions connected with Long-term operations
		Other Short-term operations

There are some further differences in less important points, among which I want to mention only one: while both the League and the United States Department of Commerce include immigrant remittances and funds under the heading of services, I consider that they are capital movements, just as money gifts are movements of capital. One must not consider that capital movements necessarily create international indebtedness; immigrant remittances are not credit operations—and yet they are capital movements.

The three classifications may be summarized in the table facing (where only the main subdivisions are included).

C. Analysis of International Economic Transactions

Classifications are never an aim in themselves but a means of getting a clearer insight into a tangled mass of phenomena. The summary statements of international payments, made between a country and countries abroad, classify the different items according to the origin of the payments and into larger divisions grouping payments due to economically similar causes. The significance of the latter grouping lies in the organic links that can be established between the different categories of transactions. Before we can gain any real insight into the conditions of international economic (and monetary) stability, we must inquire into the economic significance of particular types of international transactions and into their organic interrelations.

(1) Trade in Commodities and Services

The notion of “invisible” imports and exports is fortunately disappearing from economic text-books. Trade statistics are, of course, only more or less complete,21 while the record of tourists’ expenditures and similar items are even more difficult to appraise exactly. The work of compiling “balances of payments” consists largely in making estimates of items about which direct evidence is fragmentary.22 The notion of the balance of trade is too well known to be discussed here. One can only wonder that the atavistic point of view, dating from the days of Mercantilism, still prevails to-day. One may wonder even more that in an age when trade in services has assumed such large proportions, and when capital and short-term transactions constitute a large part of international economic relations, one so often hears references made to the balance of “visible” trade as a determining factor in shaping international monetary situations and influencing stability. The daily press and sometimes even the financial press often gives the impression, when referring to these matters, as though it still lived in the eighteenth century—while the public remains ill informed about the real meaning and significance of the economic factors it reads about, such as the balance of trade.

The “balance of trade”, which usually shows a deficit or a surplus and which cannot be reasonably expected to behave otherwise, results in the need for individual countries to make or to receive payments. But it does not follow that a country whose trade is “active”, i.e. which sells abroad more commodities than it buys abroad, has an excess of payments to receive over payments to make. There are all the other items of the schedule of transactions resulting in international settlements—the point is really hardly worth arguing since it is enough to look at the “Standard Scheme” or any other such table to be convinced that it is absurd to attach too much importance to the balance of trade. It is only in connection with the other elements and with regard to special situations that the balance of trade acquires a significance of its own. We shall revert to that question later.

As regards services, the notion surely ought not to embrace payments resulting from older capital investments, or other financial payments not increasing the outstanding foreign indebtedness of countries which receive them. To include interest and dividend payments, immigrants’ and emigrants’ funds and remittances into the group of services is, in my opinion, misleading and creates a wrong impression about the economic character of such payments. They are not the quid pro quo in paying for goods or services bought; they are a capital movement, which unless otherwise compensated (vide infra), must cause ultimately a shift in trade which will accomplish the “real transfer” of the sums involved.23

(2) Capital Movements

Transactions included under the present and under the following headings are, in effect, movements of purchasing power. From this point of view they are similar to each other and fundamentally different from transactions consisting in the purchase of goods and services. Because capital movements and transactions in short-term funds consist in transmitting purchasing power (in the present case across national boundaries), there arises in connection with such transactions the problem of transfer,24 whenever they are not compensated by other financial operations in the opposite direction. “Purchasing power” can be either moving back and forth, which involves purely financial compensations, or it can be used to buy commodities and services. These latter establish a link between capital and short-term movements, on the one hand, and trade, on the other.

What shall we now include in the concept of capital movements? The concept of capital is used in economic theory in different senses which do not coincide and the clearness with which it is defined leaves much to be desired. The protracted discussions about “capital” which fill from time to time the pages of economic reviews and journals are often simply due to the fact that participants in these discussions are talking at cross-purposes.25 Generally speaking, however, there are two main notions of “capital”; the one is used in “pure theory”, the other, almost invariably, appears in the “theory of international trade”. Very often they are mixed up with each other. The former notion is that of “real capital”; the latter is that of “monetary capital”. If one adopts the former, one calls certain material goods “capital”, though various economists select various collections of goods; if one adopts the latter, “capital” consists of certain funds of purchasing power, though here also there is no universally recognized notion. Personally, and for the reasons the discussion of which would exceed the limits of the present inquiry, I favour the monetary concept of capital. Its adoption enables many misunderstandings to be cleared up, and reduces the confusion that still reigns in this field; and, what is particularly important from the point of view of the subject we are concerned with, it allows us to make away with what is surely an artificial distinction between the “general theory” and the “theory of international trade”.

In the terminology which I have adopted, “capital” is the fund of purchasing power made available for investment. It is to be distinguished from monetary funds whose destination has not yet been decided upon by the owners. These funds are cash and short-term deposits. One has to note that the organization of credit does not make possible a sharp division between the two types of funds—which is one of the great factors in economic instability. When purchasing power over which its owners are keeping full right of disposal is used for the purpose of starting new production processes, this need not lead to difficulties provided that the owners are saving de facto; if they should however ask for repayment of their deposits on demand,26 either they could not be paid back, or productive processes would have to be discontinued, or both, with great detriment to confidence on the one hand, and to production and the returns therefrom on the other hand.27 Both in transactions at home and in international relations it may happen and, under institutional arrangements that exist to-day, it does happen, that savings are used for consumption by those who borrow them from the original savers, while some short-term funds are used, by the borrowers, to finance productive investment. Thus credit transactions may lead either to dissaving or to an increase of new capital investments beyond what has been voluntarily saved. In other words the actual size of cash balances and the distribution of income between consumption and saving, and of saving between investment and hoarding may be affected by lending and borrowing of individual savings.28 This is true also in the sphere of international relations. Movements of capital and of short-term funds between countries lead to similar consequences as the movements of funds from creditor to debtor in one and the same country. This question, which can only be mentioned here, has hardly ever been explored in spite of the close bearing it has on national and international economic and monetary stability.

As has been already mentioned, institutional arrangements make a sharp distinction between capital and short-term funds very difficult, if not sometimes impossible. Some recent theories of “liquidity” would seem to make the whole distinction disappear in a haze of intermediate positions.29 They are based mostly on the confusion of “liquidity” of a short-term asset, and the possibility of selling an investment. An asset is liquid if within a short period of time it is converted back into cash through the very working of the economic process. A bill of trade is “liquid” because when the commercial transaction it represents is completed it will be repaid and will cease to exist. The fact that in the steady or rising tide of business a new transaction will cause the creation of a new bill of trade and that the total of bills outstanding may be constant or increasing does not affect the “liquidation” of the particular bill through the process of trade. The situation is different when a share, a bond, a house or a piece of land are sold on the respective markets. The possibility of converting such an investment into cash depends on the willingness of a saver to invest his savings into this type of an investment. Once an investment is sold, only the person of its owner has changed; the investment remains; it is not “liquidated”. What may also have changed is its money-value. A bond presents an analogy with a bill of trade in that it is a contract of debt which, when the time comes, and unless there is default, will yield a fixed amount of money to its owner; only the period of time is more or less long and always longer than the period for which a bill of trade is issued. Investments not involving a contract of debt are not fixed in money value; they are indeed durable commodities. They are more or less marketable, not liquid. While “liquidity” is a property of the asset, “marketability” is dependent upon the situation on the market in which the asset is to be sold. In fact it is not the asset which is more or less “marketable”, but the market which is more or less receptive, wider or narrower.

The observations that precede, while they are a digression from the main line of our argument, are intended to clarify the concepts employed; they are not supposed to give anything like a full treatment of the many questions referred to.30 Let us now turn to our discussion of the principal items composing international economic transactions.

Capital movements include, in the “Standard Scheme”, the following items:31

(1) Amortization of debts;

(2) Purchases and sales of real estate and of securities;

(3) New capital issues (loans floated abroad);

(4) Participation in new capital issues (foreign participations in new domestic capital issues and vice versa);

(5) Other long-term investments.

To this I am adding the following two items:

(6) Interests and Dividends;

(7) Immigrants’ remittances, gifts, etc.,

which as has been said before, constitute capital movements too. In supplementing these earlier remarks, it may now be observed that these last two items represent movements of purchasing power, in the same way as new loans, except that they are not to be paid back. There can be, I think, no question about their being items belonging to the category of movements of capital, not to that of goods and services. Less evident is the inclusion in this group of transactions of item (2): purchases and sales of real estate and of securities. To be quite precise one should subdivide securities into shares and bonds and exclude the latter from item (2). Shares are titles of property over enterprises, and can be therefore assimilated to goods, while bonds are titles of debt and represent financial claims. The question, therefore, is whether transactions in real estate and in shares should be considered as capital movements or, on the contrary, included into the trade items? In my opinion the former is more justified than the latter, though the case is surely one which could be legitimately decided either way. My reasons are twofold:

(1) Purchases of real estate and securities are a capital investment in the true sense of the word; if they involve a transaction between inhabitants of two countries, then it is an international capital transaction. It does not necessarily follow that it must result in a net increase of investment in the world, for

(2) Such purchases may release home capital for new uses and put the foreign capital in its place into the older investments. Now the released home capital can be either used for financing new investments, or can be hoarded, or dissaved and used for consumption expenses.

In supplementing point (1), we may add that it sometimes happens that national entrepreneurs build houses, etc. for the express purpose of selling them afterwards to foreign capitalists. In such a case an increase in home investment is due to the anticipation of an inflow of foreign capital into the market for these special types of investment. Securities also can be (and often are) issued with the hope of selling them eventually to foreign capitalists.

The fact that houses and securities yield income in succeeding years and that such income creates, if they belong to foreigners, future foreign claims on the country in question, is sometimes also employed as an argument in favour of including such purchases in capital transactions. But then the principle of classification is different from the one employed here. If the condition of including an item in the group of capital transactions is the creation of claims in the opposite direction for the years that follow, then indeed not only should the transactions we are now discussing be included, but interest and dividend payments as well as gifts and the like should be kept out. But is this not mixing up two principles of classification? The distinction between capital and goods is one thing; the distinction between transactions that create sources of yearly income and result in yearly payments abroad, and other transactions, is another thing. The one is of a direct economic significance as it keeps apart two functionally different elements of the economic system; on this is based my classification. The other is very relevant to anticipations of the future and to the framing of policy—but this is an entirely different question.32 I am discussing this question with some insistence because in my opinion it is extremely important to make it quite clear what is the exact economic significance of the various types of transactions that give occasion to payments between countries.

(3) Movements of Short-term Funds

While international capital movements can be superseded by capital movements in the opposite direction, houses previously bought can be sold again, and securities also, there are transactions which are, by their very nature, short-term and reversible in the short run. These are operations with cash and with demand deposits. The general economic distinction between monetary capital and cash (or short-term funds) is in this connection also the principle of classification. Short-term credit operations can be carried out in connection with international trade or with international capital movements. The former is carried out with the help of “commercial credit”, whose dimensions vary with the varying value of international trade (if financial and commercial habits are stable). On the other hand, the transactions listed on page 95 above may result in temporary deposits made with foreign banks and in movements of short-term funds between countries.33 Such transactions are a corollary of the long-term operations, just as commercial credits are a corollary of international trade.34

By far the most important movements of short-term funds, from the point of view of international monetary relations, are those which result from purely financial transactions, disconnected in their origin from any other international economic operations.35 It is such independent movements of short-term funds that deserve particularly careful attention.36 Why do they take place at all?

People move their short-term balances abroad, or, what amounts largely to the same thing, prefer to keep their cash reserves in one currency rather than in another, for one of two reasons:

(a) They may be attracted by more favourable terms offered to them by foreign banks, as regards the rate of interest paid on demand or short-term deposits. Other things being alike, a capitalist will prefer to deposit his cash where the rate of interest is the highest. Therefore, ceteris paribus, a change in the relative rates of interest paid on deposits by banks of different countries, will induce a movement of short-term funds from country to country. Those balances will be moved away again, either when their owners find some use for them, or when it becomes more advantageous to hold them in a third country, or to repatriate them. This type of movements plays a large part in the mechanism of maintaining a state of equilibrium in international payments.37

(b) People may move their balances in search of greater safety. This is what happens when, in a changing world, the condition of ceteris paribus is not fulfilled. Political conditions, national economic policies, social and psychological factors, may induce here and there, at certain times, a lack of confidence in the economic and monetary future of the country. The fear of political difficulties, of social troubles, of certain economic policies (such as higher taxation, or excessive credit creation, etc.) may induce capitalists to move their balances to safer surroundings. What is important is that these considerations of comparative safety may, and occasionally do, outweigh considerations of comparative returns. One then speaks of “non-economic” causes of movements of short-term funds. Whether they are non-economic or not depends, of course, on the sense attached to that word. Movements of funds of the kind we are discussing at present are influenced by anticipations regarding the future of the cash and demand deposits in question. They are just as economic as considerations relating to comparative returns. One may prefer to earn a smaller yield or no yield at all in conditions which assure (or seem to assure) safety for the capital fund, than a larger revenue combined with more or less important risks of capital loss. Whether reasons for such movements of balances are due to political, to social or to economic conditions and to anticipations about their future development, the motive is always the fear of a loss. That loss may be caused by an inflation and rise in prices; by a devaluation (combined or not with an inflation); by high taxation; by expropriation. The menace of war may mean the possibility of an inflation while social unrest may mean the possibility of one or another form of expropriation. In either case it may be preferable to convert one’s liquid resources into another currency and to shift them to another country.38 In periods of political unrest or economic instability, or both, the “independent” movements of short-term funds assume more or less considerable proportions and become the greatest single factor making for monetary instability. Not only are such movements then frequent and erratic; the volume of the “nomadic” funds becomes at the same time larger than ever. This fact is easy to account for. In periods of instability, when anticipations of the future are uncertain and when pessimism prevails, home investments are deferred and cash balances increase. Funds of purchasing power wait for an appropriate moment to be invested, and as that moment gets postponed the non-invested savings (or hoards) keep accumulating. It is those funds which are easily induced into more or less panicky movements from country to country, from currency to currency. They owe their existence and their mobility alike to the uneasiness about the present and about the future, in short, to the prevailing lack of confidence.

We shall see in a later chapter how short-term credit operations are an equilibrating factor in international settlements, when they form a part in a working system of Monetary Internationalism; but we must devote due attention to the fact also that in periods of instability their effect is to aggravate the situation, to unsettle it even more than would be the case if such movements had not occurred. In the recent crisis in international monetary relations these “independent” movements have played a most prominent part. It will be no exaggeration to say that they constitute the central problem of Monetary Internationalism.

D. Interdependence within the “Balance of Payments”39

As has been mentioned before, an inquiry into the mechanism of international payments is a study of economic interdependence. Let us emphasize this word; “interdependence” means “dependence on each other”; it is therefore to be carefully distinguished from a one-way causal relationship. The attribution of one-way causality to phenomena which are in fact interdependent has given rise to much futile discussion (some people contending that the relation of cause to effect is in one direction, and some that it is in the other, when in fact it works both ways). This is particularly true of the transfer discussions. It seems to me quite vain to try to establish either that capital movements are the cause of commodity movements or that, on the contrary, they are the effect of the state of the balance of trade. As will be seen later, movements of short-term funds or movements of gold under the gold standard, or both, are “induced” by the state of international payments at any moment of time and are the means of making an immediate, though provisional settlement. We shall also see that movements in exchange rates, themselves resulting from the state of international payments, may influence the terms of trade and therefore the volume of international trade transactions (both in commodifies and services). Besides that, however, it is necessary from the long-term point of view that the balance of trade, the balance of capital transactions and the balance of movement of short-term funds give a total of zero (under the gold standard we must also add the balance of gold movements), since in the long run all payments due are made (or cancelled by operations in the opposite direction).40

In the simplified assumption that short-term transactions and gold movements cancel out, in the long run, the balance of trade must be equal to the balance of capital movements (but with a contrary sign). An excess of imports (payments to make abroad, on balance), must then be compensated by an inflow of capital (payments received from abroad). Similarly an excess of exports must go together with an outflow of capital. Under the simplified assumptions made, these relations must take place. Yet one may ask: what if they do not take place? Then a position of instability results, and we must drop our assumptions, which imply a condition of durable stability.

If we include movements of short-term funds, but leave out gold, we shall have the following possible situations:

Trade	Capital	Short-term Funds
(1) export surplus: Te	export surplus Ce	export surplus, if Ce < Te
		import surplus, if Ce > Te
		balance zero, if Ce = Te
(2) export surplus: Te	import surplus Ci	export surplus equal to Te + Ci
(3) import surplus: Ti	import surplus Ci	3 cases analogous to (1)
(4) import surplus: Ti	export surplus Ce	import surplus equal to Ti + Ce

Cases (1) and (3) call for no special explanation. As to cases (2) and (4) they would happen if a country having an export surplus went on importing capital while keeping funds on short-term in foreign banks; or if having an excess of imports over exports a country went on lending on long term abroad, realizing a net export of capital while increasing its short-term debt.41 These two situations are characteristic of unstable conditions.

The case including gold movements will be discussed in a later chapter.

All the relations outlined are purely arithmetical ones. They are fundamental relations. There can be no doubt about their existence since they result from the very notion of “balance of payments”. The only question is how the different items of the balance of payments get adjusted to one another in a proper way. This adjustment always happens; but while it can be made in a way compatible with the maintenance of stable economic and monetary conditions on a national and international scale, it may also involve great disturbances, financial, monetary and commercial.42 Hence the importance of the problem of maintaining the equilibrium of international payments. If the mechanism works automatically the problem is essentially one of knowledge and of intellectual curiosity; if the mechanism demands management, knowledge becomes a prerequisite to action.

1There is much difference between the views that are widely held in this matter in Great Britain and the United States, and views that are commonly accepted on the Continent. This explains the emphasis laid on that issue. Vide infra, pp. 68 and 69.
2The reader may find it useful in this context to contrast the United States’ unified monetary system, now embodying a Federal Reserve System, with what would have existed had each of the 48 States of the Union sovereign powers over its particular monetary system.
3The word “international” is used, of course, with utter disregard of its etymological significance; but this usage is universally recognized.
4F. A. von Hayek, Monetary Nationalism and International Stability, London, 1937.
5loc. cit., p. 4.
6Except when a World State exists.
7i.e., “real” factors of production (goods), monetary factors (capital) and, thirdly, labour.
8“In the last analysis . . . it is the political factor which gives rise to the economic problem of international monetary transfer. If historical accident had not created independent sovereign states . . . no such ‘problem’ would have arisen”. Lionel Robbins, Economic Planning and International Order, London, 1937, pp. 279–80.
9To change the weight of a coin (“debasement”) is analogous to the modern forms of devaluation. While, as we shall see presently, the expression “changes in the gold contents of a currency unit” is open to criticism, it shows at least clearly the analogy in question. But what Sovereign Prince of the days gone by would have accepted an international undertaking never to debase the currency? And even if he did accept it, this would be an analogous matter to the type of international monetary convention mentioned in an earlier part of this chapter. The Latin Union was to some extent an example of a limited convention of this kind. But it all goes to show that not even a general limitation of monetary circulation to precious metals would automatically insure a system which would work internationally in the same manner as a monetary system works within a country in regulating the supply of money in the different regions.
10loc. cit., pp. 270–80.
11Cf. my “Monetary Internationalism and its Crisis”, a chapter in The World Crisis, London, 1938, pp. 348 et seq.
12I expect to discuss it at considerable length in my book on the Theory of Banking which is in the course of preparation.
13For example England, the United States, etc. Vide infra, chap. ix.
14Statements to the contrary which can be found in economic literature rest obviously on a misunderstanding. Thus, for example, Professor Cassel writes (The Theory of Social Economy, New Edition, 1932, vol. ii, p. 458): “On a gold standard there is no sharp division between the quantity of money and the stock of gold.” If Professor Cassel means “an all-gold currency” then this statement is correct; but it is much more likely that the gold standard is really meant: and then this statement is essentially wrong. What is worse is that most of Cassel’s theory on the relations between gold and prices and on the role of gold in the monetary system rests on that assumption expressed in the sentence quoted. One cannot emphasize too often the fact that a gold-standard currency is a paper currency attached to gold (and sometimes convertible into gold); it is not a gold currency. Vide infra, chaps. iii and iv.
15It is important to note that the so-called “going-off the gold standard” is not tantamount to the suppression of gold as monetary metal. In the latter case we should have to speak of “demonetization of gold”. Vide infra, p. 177.
16Relations between gold and prices are particularly undetermined when the system existing is a de facto system consisting in Central Banks (or Treasuries) buying gold at prices fixed by them, while the regular gold standard is suspended. The price of gold is then subject to variations, but at the price prevailing at every particular moment, monetary authorities are buyers of gold, which as we shall see is one of the features of the gold standard. On the other hand, when the gold standard is suspended there are no longer any provisions about the gold cover of notes, and the value of gold stocks may become indeterminate. All this makes relations between gold stocks and prices very vague indeed, without making them non-existent.
17Cf. with the Macmillan Report (Committee on Finance and Industry Report), London, 1931, H.M.S.O., Cmd. 3897, para. 45.
18Thus, for example, The Economist wrote the following in its Editorial of 15 May 1937 (p. 404): “The world, in fact, has learned a new lesson. The value of a country’s gold stock does not merely depend upon the physical quantity of gold lying in the vaults of the Central Bank or the Treasury. It depends also upon the price of each ounce of gold expressed in the national currency.” (The italics are mine. I fear that for many it has really been a “new lesson”!)
19vide Appendix.
20I find myself in substantial agreement with conclusions reached by A. D. Gayer in his book on Monetary Policy and Economic Stabilization, p. 63, though his criticisms are considerably less severe than the ones I have developed in this chapter. Charles O. Hardy says, similarly, in the book Is There Enough Gold?: “Other factors, such as the use of bank deposits as money, and changes in the absorption of gold by India, are brought into Cassel’s analysis to account for the major deviations of the price trend from the ‘relative supply of gold’, (p. 22.) If, as Cassel believes, the increase in the amount of gold stock required to maintain prices during the 60 years before the war corresponded accurately or even approximately to the growth of production, it was because for the period as a whole these other important factors cancelled each other out.” (p. 24.) As a matter of fact these factors did not cancel each other out as there were considerable price movements in the course of these 60 years. Cancellation can only have existed in so far as prices were more stable than they would otherwise have been.
21In his study On Quantitative Thinking in Economics, Oxford, 1935, p. 107, Cassel says in this connection the following: “During the period within these limits Great Britain was on the gold standard and, in addition, was essentially a free-trade country. British prices, therefore, may be taken fairly well to represent gold standard prices in the world market, and British index-numbers to reflect the variations of the general price level in terms of gold.” Still it does not follow that prices in Great Britain depend upon the size of world stocks of gold! In the same context Cassel says, rightly, that “the analysis must be confined to a period in which the general system of money has been essentially unaltered”. But in the period 1850–1910 this has not been true even for Great Britain, where the great development of banking took place precisely in the second half of the nineteenth century; the fact of staying on the gold standard does not exclude the possibility of great changes taking place in the internal organization of the monetary system. If the statement that in that period of sixty years “the general system of money has been essentially unaltered” is not true for Great Britain it is much less true for the world at large; thus the condition which Professor Cassel recognizes himself as a necessary prerequisite of his analysis has not been fulfilled in the period to which he applies that analysis.
22This, not the “price level”, is the subject that deserves our interest, though it is clear that, thus formulated, the changes cannot be expressed by a single numerical time-series. How to represent them adequately is a problem for statisticians to solve!
23A change of the price of gold may, of course, affect quantities produced, besides affecting their value and the value of existing stocks.
24Gustav Cassel, The Downfall of the Gold Standard, Oxford, 1936, p. 7.
25Neither has Cassel done anything to demonstrate this sweeping statement.
26Ibid., pp. 3–4.
27Which is merely a statistical construction to be accepted for what it is worth. Vide Appendix.
28This is, for example, the position taken by Professor Rist. Vide infra.
29And, of course, the policy of commercial banks, which is more or less closely connected with that of the central bank.
30In The Theory of Social Economy (1932 edition, vol. ii, p. 494), he says that “there is no obvious reason why an increase of the gold supplies should cause a permanent alteration in the average proportion between means of payment and bank reserves. . . . We shall therefore find it quite natural that the gold supply completely controls the secular variations of the curve of the general price level.” Now the fact is that this proportion did change, and did change very considerably if we include, in the total of existing means of payment, demand deposits transferable by cheque.
31The Theory of Social Economy, 1932 edition, vol. ii, p. 495.
32In Cassel’s opinion “it is sufficient for upholding the quantity theory, to assume that the total demand for gold is proportional to the general price level” (The Theory of Social Economy, 1932, vol. ii, p. 459); this view is shared by some economists but I think that it is inaccurate and may lead to regrettable misunderstandings. There is no mention of gold as such in the “quantity theory”; it relates the total volume of monetary circulation to the “general price level”, not the “demand for gold”. Gold can be brought into the picture only indirectly, because of institutional arrangements, and never enters into the “quantity theory” as one of the variables.
33The Theory of Social Economy, vol. ii, p. 496.
34Ibid., pp. 496–7.
35Vide supra, chap. ii.
36The Theory of Social Economy, vol. ii, p. 497.
37See Wicksell’s Interest and Prices (first published in German in 1898; English translation published in 1936).
38Vide infra, chap. vii.
39See the following publications by Professor Rist:
40Rist 1938, pp. 309–10.
41Ibid., p. 308.
42A limitation which is hardly valid for England and the United States.

International Monetary Economics