into raw materials, or crude products, foodstuffs,
and manufactured products. In 1914 (i.e., before
the outbreak of the war) the exports of the United
States were very largely divided between Europe and



INTERNATIONAL TRADE 259

North America, sixty-three per cent going to Europe
and twenty-two per cent to North America. The
imports came from Europe, North and South America,
and Asia, the rough proportions being forty-seven
per cent from Europe, twenty-two per cent from North
America, eleven per cent from South America, and
fifteen per cent from Asia.

Our exports to Europe consisted largely of raw
materials and foodstuffs and our imports from that
quarter, of manufactured goods. We imported from
the other countries raw materials and exported manu-
factures. Now it is quite possible, for instance, for
Great Britain to feed all her own population, as far
as cereal foodstuffs are concerned, from her own agri-
cultural area. It has been calculated that, with
modern methods of intensive agriculture, Great Britain
could feed a population of eighty millions, or nearly
twice her present population. Britain does not do
so, however, for she finds it better and more profitable
to devote her attention very largely to manufacture,
and to rely upon the United States, Canada, Australia,
and Russia for her wheat. The other countries find
it better to devote their energies and facilities to the
production of these foodstuffs and to rely upon Great
Britain, or upon the United States for manufactures.
It will be obvious to the student now that our original
hypothesis covers the actual facts.

The war has produced a very natural effect upon
the exports of this country. Much of the capital
of Europe has been diverted from its ordinary com-
mercial and industrial channels into the manufacture
of war materials, and this has thrown the burden of



260 AN INTRODUCTION TQ ECONOMICS

manufacture upon this country. Even in the manu-
facture of war materials the resources of the warring
countries were not sufficient in themselves to supply
the immense quantity of arms and ammunition re-
quired, and hence the United States has also made
large exports of these commodities. About half
the increase in our exports of the last year (1918)
consisted of war materials and the other half com-
prised manufactured articles which the European
countries would otherwise have made for themselves.

It is true, of course, that a considerable proportion
of this increase in exports is temporary, as it is due
simply to war conditions. But there is a strong
probability that much of it will remain, owing in a
large measure to the increased facilities for production
which the forced activities of the past few years have
produced.

Theory of International Value We must now con-
sider the question of the division of the benefits result-
ing from the territorial division of labor. In all ex-
change there is a certain mutual advantage, as we have
seen in a previous chapter. Exchange will not take
place unless each of the parties conceives that he is
being benefited. Apart, however, from this inevitable
mutual advantage, we must consider the actual pro-
portionate division of the increased product.

Let us recur to our original hypothesis. In the
two countries, A and B, we found that, if the law of
comparative cost is actually carried out, there will
be a total increase of product amounting to 10 yards
of silk for every 4 units of production. How is
that 10 yards to be divided? Will it go entirely to



INTERNATIONAL TRADE 261

A which produces no silk at all, or will only the amount
(five yards) which A could have produced itself be
exchanged for the 10 yards of woolens which A has
actually produced in addition to its own requirements ?

There are many considerations to be noted before
a definite conclusion can be arrived at. In the bar-
gaining between two individuals much depends upon
the comparative knowledge and skill displayed by
two in determining the rate of exchange. In any
individual case it is almost impossible to forecast
what the rate will be. In taking the case of trade
between communities, however, the matter is some-
what easier, for the individual variations in knowledge
and ability are canceled according to the law of
averages. In any case, however, there are certain
limits. In our particular illustration, we have in A
a surplus of 10 yards of wool and in B a surplus of
15 yards of silk. A will certainly not accept less than
5 yards of silk for its 10 yards of wool, for it would
prefer to apply the labor which produced the wool
to the making of silk and thus obtain the 5 yards.
On the other hand, B will not give more than 15 yards
of silk for 10 yards of woolens, for it could produce
the 10 yards of woolens by applying the unit of pro-
duction which produced the silk, to the making of
woolens. Hence the exchange will not be less than
5, nor more than 15 yards of silk for 10 yards of
woolens.

These, however, are merely the outside limits. It
may happen that A does not require more than 10
yards of wool, nor more than 15 yards of silk,
and B's requirements are similar. In that case, the



262 AN INTRODUCTION TO ECONOMICS

exchange will be at the rate of 10 yards of woolens
for 15 yards of silk.

So simple an exchange, however, uncomplicated
by questions of cost of transport and hindrances of
duties, is seldom secured. Essentially the exchange
will be decided by the reciprocal demands of the two
countries. That is to say, the law of supply and
demand will regulate the rate of exchange. The
student must remember, in this discussion, what
was said in Chapter X in regard to the limitation of
the law of supply and demand.

The question is further complicated when we con-
sider the exchange as being between three or more
countries instead of between two only, and also when
we add the cost of transportation and the effects of
protective duties. To give a full discussion of inter-
national trade treating carefully the questions involved
in the additional difficulties suggested, would be beyond
the scope of this book. One point, however, is worth
considering, in that it appears to refute the theory
as outlined in the foregoing paragraphs. According
to this theory there would be no point in importing
into and exporting from a country the same goods,
and yet a glance at the tables of imports and exports
of many countries will show that this appears to be
the actual fact.

As a matter of fact, however, the export and import
of the same commodity is an appearance rather than
a reality. The United States both imports and
exports pig iron. To the layman, pig iron is simply
pig iron. But to the expert it is a generic name for
many different substances. The varieties imported



INTERNATIONAL TRADE 263

into this country usually have some special qualities
which the home-produced iron lacks. This is the case
in regard to the import of spiegel iron and ferro-
manganese. In the case of the import and export
of cotton goods, again, the goods are of different grades
and qualities from those manufactured in this country
and exported therefrom, and, consequently, they are
actually different commodities.

International Price We have so far argued as
if the whole of international trade were carried on
under a system of barter. In a sense, of course, that
is true, but only in the sense that all exchange is
merely the exchange of goods and services for goods
and services, the process being, as it were, lubricated
by the money and banking system. Our argument,
therefore, is not vitiated by the fact that money and
credit instruments are used to a very high degree in
the process of international exchange. We shall have
occasion in the next chapter to discuss the method of
international exchange, and at present the discussion
must be confined to the question of the comparative
prices of products in the producing country and in
the importing country.

Again it is necessary, for the sake of simplifying the
argument, to ignore at first the effect of cost of trans-
portation and of artificial interferences to the process
of exchange. Leaving these two considerations out
of account for the present, therefore, and following
the working of the laws of supply and demand in a
free market, we arrive naturally at the conclusion,
that there will be an equation of prices. The export
of the goods merely makes the market wider and the



264 AN INTRODUCTION TO ECONOMICS

full and free play of competition will result, as in the
former market, in the establishment of a market price.
It must always -be remembered, however, that the
working of the law of supply and demand is limited
in the manner explained in Chapter X.

Price is, of course, merely the statement of value
in terms of money. Consequently there must be an
equation of the value of money in the exporting and
importing countries in order that our statement
of the equation of prices may hold good. Such an
equation follows, however, from the facts that we
have presupposed, i.e., a free and open market. In
the case of countries in which the same commodity
is used as money, as, for instance, where both countries
use the gold standard, any increase in the value of
gold in one country unaccompanied by a similar increase
in the other will cause a stream of gold to flow towards
the country where its value is higher and thus, by
increasing the supply, cause a fall to the same value
as that in the country from whence the gold was
exported.

The Cost of Transport An essential variation in
the prices of the two countries is due to the cost of
transportation. But this increase in the cost due to
the expense of transporting the goods from one country
to another may be regarded as a payment for an
additional service, the services of transport. From
the price in the importing country, therefore, we may
deduct that part which is due to freight charges, as
being payment for the service of transportation
an additional utility to that possessed by the goods
imported. Hence in a theoretical discussion, such



INTERNATIONAL TRADE 265

as the present, the truth of the argument is not im-
paired by any question of increased price due to freight
charges.

The question of the influence of tariffs must be
deferred until a later chapter.

The Equation of Indebtedness It will be noticed
that care has been taken to speak of the exchange of
goods and services, rather than of goods alone. It is
frequently, but erroneously thought that international
trade consists merely in the export and import of
actual physical materials. This idea has given rise
to the theory that is known as the " balance of trade."
This theory has played a very important part in the
past history of economics and indeed is still frequently
used in commercial articles. It has always been
realized that international trade, like all other trade,
results in an equation of satisfactions, that is, each
party to the transaction conceives himself as getting
as good as he gave. Now it is obvious that in inter-
national trade the amount of actual commodity
exports seldom equals the amount of actual commodity
imports. How, then, is the difference made up ?
, It was assumed that the difference, or balance,
was made up by the import or export of bullion to
the amount necessary to restore the balance. If a
country exported a hundred million dollars' worth of
goods and imported a hundred and twenty million
dollars' worth, it was assumed that twenty million
dollars had to be exported in bullion or coin to restore
the balance. When the theory was formulated, there
was an erroneous idea that a country's wealth could
be measured by the amount of gold within that country.



266 AN INTRODUCTION TO ECONOMICS

Hence anything which tended to draw gold to the
country was regarded as being beneficial and anything
which tended to drive gold away was harmful. In
case imports exceeded exports, therefore, the country
was assumed to be in a bad position, for gold must
go out of the country to make up the difference. In
this case, the country was said to have " an adverse
balance of trade." If, on the other hand, exports
exceeded imports, the balance was favorable, for then
gold would flow into the country.

A study of the imports and exports of bullion, how-
ever, will show that they bear little relation to the
exports and imports of other commodities. The
theory, therefore, fails, for it does not fit the facts.
As a matter of fact, gold is simply a commodity like
any other, and obeys the same laws. As far, then, as
the' welfare of the country is concerned, the balance of
trade is of little importance. It must not be thought,
of course, that the balance of trade is without signifi-
cance. There is, indeed, much to be learned from
the relative amount of imports and exports of goods.
The old interpretation, however, is proved to have no
truth.

This does not answer the question of the actual
making up of the balance. If gold does not supply
the difference, how is it supplied? There are many
factors to be considered. In the first place, we must
note the services rendered by one country to another
in transport. Before the war a very large portion
of the carrying trade of the world was performed
by Great Britain. Britain was always in a condition
of " adverse balance," and the goods which were



INTERNATIONAL TRADE 267

imported over and above the exports in part paid for
the freight charges which her shipowners levied on
the carrying of goods. It has been estimated that
the carrying trade of Great Britain was responsible for
imports to the extent of nearly $500,000,000 annually.

Again loans are constantly in process from one
country to another. Merchants and capitalists of
one country invest in the securities of another country.
French capitalists held the great bulk of the Russian
loans. American securities railroad bonds, for ex-
ample, are quoted on all the European exchanges.
English railroad bonds are held in America. Now
when an Englishman buys Southern Pacific bonds he
does not pay in actual money. He pays (in the manner
which will be detailed in our next chapter) in reality
by sending goods to America. There is no immediate
and obvious per contra to this import of British goods,
but ultimately the loan has to be returned, and each
year the dividends must be paid, and these return
payments mean the export of American goods to Great
Britain.

Still further, the governments of countries must
maintain staffs of consuls and ambassadors abroad.
The payment of these representatives and their expendi-
ture in the countries in which they reside necessitate
an export of goods from the country whose govern-
ment they represent. Tourists, also, making use of
travelers' checks, are causing a flow of goods from
their home country. When one country pays an
indemnity to another, or buys a piece of territory (as
when this country purchased Alaska) goods are ex-
ported to furnish the payment.



268 AN INTRODUCTION TO ECONOMICS

There are other factors, but we have enumerated
sufficient to show that the balance is restored by
indebtedness which is not obvious in the trade returns.
These purchases of securities, lending of shipping
services, payments of consuls, and so on, may be
regarded as invisible exports and imports, as contrasted
with the visible imports and exports of goods. The
visible and invisible exports of a country, which repre-
sent its indebtedness to other countries, are balanced
by the visible and invisible imports of the country,
which represent the indebtedness of other countries
to the first. Instead of a balance of trade, therefore,
what we have is an equation of indebtedness, which
is a totally different thing.

The whole question is obscured by the apparent
lack of connection between the lenders who purchase
securities, and the exporter of the goods which really
pay for the securities. This matter will be made
clearer in our next chapter.



CHAPTER XXI

DOMESTIC AND FOREIGN EXCHANGE

Difficulties in Paying by Check The purpose
of this chapter is to discuss the mechanism of payments
made over a long distance. In a small country like
Great Britain, for instance, payments within the
country can, as a rule, be readily made by means of
the check of the payer. If a merchant in London
desires to pay for goods bought from a Glasgow firm,
all he has to do is to send his check for the amount.
The Glasgow merchant will then deposit the check
in his bank for collection.

This method is possible also in America, but it is not
so satisfactory. The country is so large that there
is necessarily a considerable period of waiting to be
done before a check drawn on, let us say a Los Angeles
bank, can be paid in New York. The New York
bank does not know the drawer of the check and
consequently will not pay the amount called for on
presentation of the check. He will send it first to
his Los Angeles correspondent for collection. This
takes time, and the merchant to whom the payment
is due hardly cares to wait until collection. He wants
his money at once. The Los Angeles merchant, there-
fore, must provide some other means of payment.
This illustrates the difficulty of making payments
over a long distance. Domestic exchange, as the
269



270 AN INTRODUCTION TO ECONOMICS

actual system is called, is similar in all essentials
to foreign exchange. The only important difference
that exists between the two is due to the fact that,
as a rule, there are different currency systems in dif-
ferent countries. This complicates the question, with-
out altering the fundamentals. Let us first consider
the question of domestic exchange.

Gold or Currency Payments There is always
the possibility of sending actual currency in payment
of debts. Our Los Angeles merchant, for example,
might send to New York the necessary amount in
gold or currency. This necessitates a certain expense,
however, for one cannot ship currency without pay-
ing for transportation charges. In reality there are
three items in the expense of a currency shipment.
First there is the actual expense of transportation
the freight, as it were; second, there is the cost of
insuring the money ; finally there is the loss of interest
on the currency during its transport. For example,
if a shipment of $10,000 is made from Los Angeles
to New York, it will take about five days to reach
its destination. That means that the merchant who
,has made the shipment will have to remove the cur-
rency from the bank, or other place where it is earning
interest, five days before he would have to do so, if
the payment were to be made in his own city. There-
fore he loses that five days' interest, and consequently
the amount of the loss must be charged to the cost of
the shipment.

If gold is used, there will be a drain of gold to the
extent of that payment from the transmitting city.
Naturally, however, the shipments are not all in the



DOMESTIC AND FOREIGN EXCHANGE 271

same direction, or else the city which sends out the
gold would soon have none left. Payments are not
only made by the merchants of a city, but to them as
well. Hence there will be a certain amount of cross
shipping, gold and- currency leaving the city and gold
and currency entering it.

As we have already seen in our discussion of the
checking system, this involves a great waste of cur-
rency. The currency is idle while in transport. Not
only is it not being used for payments during the
interval, but it cannot be used as a basis for credit
money to be issued. From every point of view, there-
fore, such a method is wasteful.

Payment by Draft The difficulty is very largely
solved by means of the banking system. Each com-
munity has some central town or city which has rela-
tions with all parts of that community. In California,
for instance, every town has direct commercial rela-
tions with San Francisco. Every bank will have
business dealings with the banks in the central city
of the community. In a similar way, every town of
any importance in the country has definite business
relations with New York, which is the money center
for the whole country. The relation between the
banks of one city and another is known as the relation
between correspondent and agent. If the First Na-
tional Bank of San Francisco deals directly with the
National City Bank of New York, it regards the latter
as its correspondent. If the New York bank sends
its checks drawn on San Francisco to the First National
for collection, then the First National is the agent
of the National City Bank.



272 AN INTRODUCTION TO ECONOMICS

The First National, in order to use the National
City Bank as its correspondent, deposits funds with
the New York bank in the same way in which a private
firm deposits its funds in the local bank. Let us
suppose, now, that the First National of San Francisco
has on deposit with the National City Bank the sum
of $100,000. If a merchant in the Pacific city wishes
to make a payment in New York, he has three choices
open to him. He may ship currency, he may draw
a check on his bank and send it in payment, or he may
buy exchange. The latter is the usual method. To
do this, he goes to the First National and asks for a
" draft " on New York, for a certain sum. He pays
for this draft and the banker hands him what is, to
all intents and purposes, a check drawn upon the
National City Bank. When that check or draft
arrives in New York, the bank there charges it against
the deposit credit of the San Francisco bank and pays
the check just as it would pay a check drawn on a
neighboring bank or upon itself.

The banker does not sell this draft out of pure
kindness of heart ; he makes a charge for his services.
There is a limit to the amount he can charge, however.
The cost of shipping currency from the Pacific Coast
to New York is about $1.50 per $1000. The actual
cost will vary, of course, according to the rate of
interest. If the bank charges more than that amount
for its draft, it will pay the merchant to ship currency.
Hence, if the bank wishes to do business at all, it
must keep its charges for exchange below the cost
of shipping currency. The point at which it pays
to ship currency is commonly called the " gold point."



DOMESTIC AND FOREIGN EXCHANGE 273

These transactions are not all one way. Just as
there are payments to be made in New York, so there
are payments to be made by New York. The National
City Bank, for instance, may have drafts drawn on
San Francisco sent to it to be collected. These drafts
it forwards to the First National for collection and
immediately sells its own drafts on San Francisco
to be paid for by the money collected in the San
Francisco institution.

This is simple enough, of course, if we deal only with
the two cities. But all payments are not made to or
by New York. What happens when a payment has to
be made, let us say between Peoria, Illinois, and Seattle,
Washington ? It is not to be supposed that the
Peoria bank carries deposits in the Seattle bank, or
vice versa. Suppose a Seattle merchant wishes to
make a payment in Peoria. He asks his bank for a
draft. The Seattle bank, thereupon, sells him a
draft, not on Peoria, but on New York. New York
exchange is always acceptable, owing to the vast
number of transactions with that city. The Peoria
bank is perfectly willing to cash the draft, for it
knows that it can deposit the draft with its own New
York correspondent and sell New York exchange itself.

This method of settling payments over a distance
is one of the commonest. There is another method,
by use of the discount system, with which we shall
deal fully in considering foreign exchange. Before
we do so, however, we must deal with the question
of the relations between different coinages.

Mint Par of Exchange In order to simplify the
discussion, we shall consider only two coinages, for



274 AN INTRODUCTION TO ECONOMICS

the principles involved are the same no matter how
many we examine. There are minor difficulties, of
course, but these can only be dealt with in a much
fuller treatment than is possible here. The British
currency is, like the American, on a gold basis. The
sovereign consists of a certain weight of gold. So
does the dollar. If an English sovereign were to be
recoined into American money, the coin would be of
the value of $4.8665. That is to say, there is as much
pure gold in an English sovereign as there is in an Amer-
ican coin (if one were actually coined) worth four dol-
lars and eighty -six and two thirds cents. The equiva-