Studies in the Theory of International Trade

Jacob Viner
Viner, Jacob
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New York: Harper and Brothers Publishers
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Chapter VII


... many writers have perplexed themselves and their readers by founding theories on exceptional circumstances. Others have been led astray by statistics—the characteristic form of modern research....
—G. Arbuthnot, "Sir Robert Peel's Act of 1844... vindicated," 1857, p. vii.



The assumption of a simple specie currency followed in the preceding chapter made it possible to deal with the international mechanism as an "automatic" mechanism, if by "automatic" is meant freedom from discretionary regulation or management. But if there are non-specie elements in the currency, and if the ratio of the non-specie to the specie elements is variable and subject to the discretionary control of a central authority, there result differences of some importance in the short-run mode of operation of the mechanism from the manner in which it would operate under a simple specie currency. Although most presentday writers seem to believe either that the non-automatic character of the modern gold standard is a discovery of the post-war period or that it was only in the post-war period that the gold standard lost its automatic character, currency controversy during the entire nineteenth century concerned itself largely with the problems resulting from the discretionary or management elements in the prevailing currency systems. The bullion controversy at the beginning of the nineteenth century turned largely on the difference in the mode of operation in the international mechanism of a managed paper standard currency, on the one hand, and of a convertible paper currency, on the other, with the latter treated generally, but not universally, as if it were automatic. Later, the adherents of both the currency and the banking schools distinguished carefully between the way in which a supposedly automatic "purely metallic" currency (which, in addition to specie, included bank deposits but not bank notes) would operate and the way in which the Bank of England was actually operating a "mixed" currency (which, in addition to specie and bank deposits, included bank notes). Both schools were hostile to discretionary management. The currency school thought that the currency could be made nearly automatic again merely by limiting the issue of bank notes uncovered by specie. The banking school held that there was no acceptable way of escape from the discretionary power of the Bank of England over the volume of deposits, although the "banking principle," according to which the issue of means of payment could not be carried appreciably beyond the needs of business under convertibility, set narrow limits to this discretionary power. Later discussion centered largely about the rules which the Bank of England should follow in using the discount rate and its other instruments of control to regulate the currency.


Even the terms "automatic," "self-acting," "managed," "discretionary," or their equivalents, as applied to currency systems are of long standing, as the following sample quotations from the literature of the currency school-banking school controversy show:

In the case of a [convertible] paper currency an attempt is made from considerations of convenience and economy to substitute paper notes in the place of metallic coins. In making this exchange we adopt a circulating medium which has no intrinsic value, and we therefore lose that self-acting security which we had with a metallic circulation, for the due regulation of its amount and the maintenance of its value. It therefore becomes necessary that we should resort to some artificial system or rule, which shall secure with respect to a paper currency that regulation of its amount which in a metallic currency necessarily results from its intrinsic value.*1

... from the moment that we employ figurative language at all, and speak of gold "flowing" and "fluctuating" as if it were water, or "circulating" as if it were blood, no metaphor seems so significant, or to apply so aptly to the character of the notion of the precious metals as the expression "automatic." This word indicates an action which is not determined by any particular exercise of an extrinsic volition, but one proceeding from, and attaching to, the functional, intrinsic and uncontrollable energies of the organ, or thing, which acts. The thing which acts in this case is the universal appetite of the human mind, and the effects produced on gold make it seem to be animated by that appetite, and to seek its end in active obedience to it.... I conclude therefore thus far that the idea of a safe paper currency is incompatible with the idea of any thing savoring of control, guidance, discretion, or government, and that it is a principle essential to a safe paper currency that the issue and resorption of it should be purely automatic.*2

There are some who object in limine to all "regulation of the currency," as it is termed, but such objection is founded in error; because currency being legal tender the creature of law or "regulation"; wherefore to withdraw "regulation" altogether would be to cease to have legal tender; an impracticable alternative....

But regulation is of two kinds, viz., discretionary, and self-acting. Thus, on the one hand, the Bank of England both possesses and exercises the power of regulating the currency at its discretion, by altering its rate of discount.... Whilst, on the other hand, self-acting regulation is afforded by the exportation of gold at one time in relief of excess, and its importation at another, in relief of insufficiency, such operations being undertaken upon ordinary mercantile principles; the trader simply seeking his own profit, and not concerning himself in the least about the regulation of anything whatever.*3


If a currency system could be imagined under which the specie reserves of the banking system as a whole were always maintained without central bank regulation at a constant ratio to its demand liabilities to the public, there would be only one significant difference between such a currency and a simple specie currency as far as the international mechanism was concerned. Whereas under a simple specie currency fluctuations in the quantity of specie would result in equal fluctuations, both absolutely and relatively, in the amount of means of payment, under a fixed fractional reserve currency fluctuations in the quantity of specie would result in equi-proportional but absolutely greater fluctuations in the amount of means of payment. The absolute amount of specie movement necessary for adjustment of the balance of payments to a disturbance of a given monetary size would be less under a fractional reserve currency than under a simple specie currency.


Under both types of currency the international mechanism would be "automatic" in the sense that its mode of operation would not be influenced by the discretionary management of a central authority, but would be the result of the voluntary responses of a host of individuals to changes in prices, interest rates, money incomes, money costs, and so forth. Under both types of currency, therefore, it would be possible to formulate a fairly precise description of the mechanism of international adjustment on the basis either of assumptions as to the nature of rational individualistic behavior under the circumstances specified or of the assumption of persistence in the future of such patterns of behavior, whether rational or not, as had been found upon investigation to have prevailed in the past.


Where the ratio of the amount of the currency to the amount of specie is subject to the discretion of a central authority, however, the international mechanism becomes subject to the influence of the decisions or activities of this authority and thus loses some at least of its automatic character. If the controlling agency were operating on the basis of a clearly formulated and simple policy or rule of action, which was made known to the public, it would be possible to describe the international mechanism as it would operate under such policy. But central banks do not ordinarily disclose their policy to the public, and the evidence seems to point strongly to a disinclination on the part of central bankers as a class to accept as their guide the simple formulae which are urged upon them by economists and others, or to follow simple rules of their own invention. All central banks find themselves at times facing situations which appear to demand a choice between conflicting objectives, long-run versus short-run, internal stability versus exchange stability, the indicated needs of the market versus their own financial or reserve position, and so forth, and they seem universally to prefer meeting such situations ad hoc rather than in accordance with the dictates of some simple formula. Whatever may be the merits of this attitude, it results in practice in behavior by central banks which fails to reveal to the outsider any well-defined pattern upon which can be based predictions as to their future behavior. Theorizing about the nature of the international mechanism in so far as it is subject to influence by the operations of central banks cannot therefore be forthright and categorical, but must resort to analysis of the consequences for the mechanism in different types of situations of the particular choices which central bankers may conceivably make among the various species of action—or inaction—available to them in such situations. But whatever central banks do or refrain from doing, and for whatever reasons or absence of reason, their mere existence with discretionary power to act suffices to give some phases of the international mechanism, and especially the specie-movement phase, a "managed" and variable and largely unpredictable relationship to the other phases of the mechanism.


If there is no central bank or its equivalent, and if there are a large number of genuinely independent banks with power to issue bank money, whether in the form of demand deposits or of notes, and with their specie reserves left completely or substantially free from statutory regulation, the specie-movement phase of the international mechanism can still be regarded as automatic if the average specie reserve ratio of the banking system as a whole is at any moment determined by the aggregate effect of the autonomous decisions of a large number of individuals or firms. The ratio under such circumstances of the total amount of means of payment to the amount of specie will be a variable one, but there will be some elements of regularity in this variability, discoverable by historical investigation if not by a priori cogitation alone. But this does not seem to be a common situation. In the absence of a central bank, as in the United States before the establishment of the Federal Reserve system or in Canada before 1935, either the great bulk of the banking business was in the hands of a small number of large banks necessarily following, because of their size and fewness, an essentially uniform course with respect to reserve ratios, or a few of the largest banks operated as rediscount agencies for the many small banks and the latter adhered closely to a customary or legal minimum cash reserve ratio, leaving to a few large banks the chief responsibility for the maintenance of adequate national specie reserves. From the point of view of the international mechanism, it is by no means clear that such a system differed significantly in practice from a system operating under formal central discretionary control, or that what differences did exist were uniformly such as to point to the desirability of formal central control as it has been exercised in the past. In any case, there is ordinarily under both systems some measure of more or less centralized and discretionary control over the amount of means of payment and its ratio to the amount of specie, and the mode of operation of this control is under both systems unlikely to follow any simple pattern.


Under an international metallic standard, there are various possible objectives of the central bank. (1) It may be the policy of the bank to enforce adherence of the banking system to a fixed minimum (and possibly also maximum) specie reserve ratio. (2) Or its objective may be to minimize the amount of its own non-income-earning specie reserves while maintaining at all times unquestioned convertibility of its demand liabilities. This objective calls for frequent and prompt central bank intervention to check inward or outward specie movements, with a general tendency to force close correspondence in timing and direction between the fluctuations in the national stock of means of payment and the fluctuations in the foreign exchanges. It seems to have been a dominant element in the policy of the Bank of England during the nineteenth century. (3) Another possible objective may be to minimize the frequency of central bank intervention, and to confine intervention to those occasions when price or other rigidities or the prevalence of distrust result in a dangerous depletion of reserves or in an accumulation of excess reserves to an extent burdensome to the central bank or dangerous to the position of foreign central banks. The Banque de France appears to have followed this objective with substantial constancy during the latter half of the nineteenth century. It operates to reduce the significance of the central bank, whose powers are used to support the automatic processes only to protect itself from danger and to counteract the automatic processes only to protect its profits or to protect other central banks from danger. (4) Finally, another possible objective is to exploit the possibilities of internal stabilization, whether of prices, or of amount of means of payment, or of physical volume of business activity, through control of the quantity of means of payment within the limits set by adherence to an international monetary standard. Under such a policy the automatic forces would be left alone or reinforced when they were operating in a stabilizing direction, but would be counteracted when they were acting in an unstabilizing direction, within the limits of safety with respect to maintenance of convertibility. Pursuit of this objective would involve willingness of the central bank to accumulate idle specie reserves or to permit without interference the substantial depletion of reserves. While this objective has undoubtedly been upon occasion a factor in determining the operations of central banks, it does not seem ever, at least during the nineteenth century, to have been a formally adopted and consistently applied aim of central bank policy, with the brief, and partial, exception of the period of adherence by the Bank of England to the "Palmer rule."


In terms of the distinction, examined in detail in later sections, between primary fluctuations in the amount of means of payment or those resulting directly from specie flows, on the one hand, and secondary fluctuations in the amount of means of payment, or those resulting from fluctuations in the volume of loans and investments of the banking system, gold outflows would always tend to involve primary contraction and gold inflows to involve primary expansion, but whether these primary fluctuations would be accompanied by operations of the central banks tending to produce secondary fluctuations and whether these secondary fluctuations would be in a direction supporting or offsetting the primary fluctuations, would depend on what objectives the central bank was pursuing. In terms of the classification of possible objectives of central bank policy made above, the appropriate operations of the central banks would be as indicated in tabular form on page 395.*4

Central bank objectiveCentral bank operations
Gold outflow
(Primary contraction)
Gold inflow
(Primary expansion)
(1) Fixed reserve ratio Secondary contraction Secondary expansion
(2) Minimum reserves Secondary expansion while excess reserves persist; secondary contraction when reserves are below minimum Secondary expansion to check accumulation of excess reserves
(3) Minimum intervention Secondary contraction when reserves approach safety minimum Secondary expansion when needed to protect foreign central banks
(4) Stabilization Secondary expansion if undesired deflation under way or "reflation" desired; secondary contraction if undesired inflation under way or deflation desired Secondary contraction if undesired inflation under way or deflation desired; secondary expansion if undesired deflation under way or "reflation" desired



Under a metallic standard currency system which contains both specie and non-specie elements, changes in the total stock of means of payment in the country may result either from changes in the amount of specie or from changes in the amount of non-specie currency, or from both. The amount of specie can increase as the result of an inflow of specie or bullion from abroad, of the coining of domestically-produced bullion, or of the diversion of bullion from industrial to monetary use. The amount of non-specie currency (assuming foreign issues are not generally accepted) can increase through increased issue of paper money by the government to meet current expenditures or to redeem debt obligations, or through an increase by the banking system as a whole of its note and/or deposit liabilities to the outside public by the grant of loans, purchase of securities, or payment of its own operating losses or unearned dividends in "bank money." Changes in the amount of means of payment will be here distinguished as "primary" or "secondary" according as they result from changes in the amount of specie or from changes in the amount of uncovered non-specie currency, and an attempt will be made to demonstrate that examination of the international mechanism with the aid of this distinction serves both to expose some current misinterpretations of the doctrines of the older writers and to bring out more clearly the nature of the banking aspects of the mechanism under modern conditions. To simplify the exposition, the following assumptions, involving only minor quantitative departures from the actually prevailing conditions under the gold standard, will be made: (1) that changes in the amount of specie result only from international movements of specie or bullion; (2) that bullion or specie is never borrowed or lent internationally by banks on their own account; and (3) that non-specie currency, including both notes and deposits, is issued only by banks and only as loans, in the purchase of securities, or in the exchange of one form for another form of currency. Further to simplify the exposition, it will be assumed that all actual specie is in bank reserves and that there is no non-monetary use of gold.


Given these assumptions, primary expansion or contraction of the means of payment can result only from, and must be equal to, the inflow or outflow of specie from or to the outside world. Let us suppose that as the result of increased commodity exports an inflow of specie occurs, and that the owners of such specie exchange it at the banks for either bank notes or bank deposits. This constitutes a primary expansion of the currency. If the banks increase their loans and investments—whether or not because of the increase in their specie reserves is immaterial—a further increase in bank money occurs which constitutes a secondary expansion. If for any reason the banks should reduce the amount of their loans and investments while their specie holdings were increasing, the primary expansion would be at least in part offset, and could conceivably be more than offset, by a simultaneous secondary contraction, so that the net expansion, if any, of the currency would be smaller than the primary expansion.


In tracing the development of doctrine with relation to the respective roles in the international mechanism of what are here designated as primary and secondary fluctuations of the currency, it is important to take note of the assumptions of the writers as to the kinds of means of payment comprised in the currency system. In the earliest expositions of the international mechanism, such as those of Hume and his predecessors, the analysis was as a rule carried on in terms of a simple specie currency, where there could be only primary expansion or contraction, and analysis in these terms continued to be common, both among the writers of the classical period and to the present day, when the objective was a simple and concise formulation with emphasis on other than the banking aspects of the mechanism. The further back in time we go, therefore, the greater the stress on primary fluctuations, with secondary fluctuations often left completely unmentioned. Systematic analysis of the international mechanism in terms of the role of fluctuations in the non-specie as well as in the specie elements of the currency began only*5 with the bullionists, including Ricardo. The bullionists commonly, though not universally, failed to give attention to deposits as a part of the national stock of means of payment, but their discussion of the mechanism under a metallic standard was expounded in terms of a predominantly paper circulation, with fractional specie reserves generally assumed to be maintained at a constant ratio of the total circulation. The bullionists therefore held that under a metallic standard specie movements would be accompanied by absolutely greater fluctuations in the amount of the total (specie and note). circulation, i.e., that, in the terminology here used, both primary and secondary fluctuations in the currency, in the same direction, were a part of the international mechanism. Later, the currency school held that: (1) in the absence of statutory regulation the relation between the short-run fluctuations in the total (specie and note) circulation and the fluctuations in specie was a variable one as to both direction and degree and subject to the caprice of the Bank of England; (2) the proper relationship was one in which the fluctuations in total (specie and note) circulation would be in the same direction as and absolutely equal to the fluctuations in the national stock of specie, i.e., there should be no secondary expansion or contraction through the medium of note issue; and (3) this rule would be violated if the Bank allowed an external drain of gold to operate, in part or in whole, on the amount of its deposit liabilities instead of on the amount of its note circulation. The currency school thus called for the same relationship between fluctuations in total note circulation, on the one hand, and fluctuations in specie reserves, on the other, which the Palmer rule required for fluctuations in total note and deposit circulation, on the one hand, and fluctuations in specie reserves, on the other hand. Since ordinarily, in case of an outflow of specie, if the Bank remained passive the primary contraction would be divided between the note circulation and the deposits, the currency school, and the Bank Act of 1844, in effect insisted upon a procedure which would require the Bank to support primary contraction by additional secondary contraction, whereas the Palmer rule called only for primary contraction. The banking school, on the other hand, held that it was possible for the Bank, without violating the currency principle or the Bank Act of 1844, to offset a primary contraction through the note issue by a secondary expansion through the deposits, so that the total stock of means of payment could still fluctuate differently in degree, and even in direction, from the total stock of specie, a position theoretically valid if the contention of the banking school be granted that the proportions of payments by notes and payments by checks could be freely varied by the banking system or by the public to counteract the restrictions on the amount of note issue.


Some recent writers have interpreted the classical doctrine as wholly overlooking what is here designated as primary fluctuations and as assigning to secondary fluctuations alone a direct role in the international mechanism. This interpretation appears to rest on the notion that the older writers regarded specie flows into or out of the reserves of the banks as having no effect on the total circulating medium except as, by affecting the reserve status of the banks, they induced the banks to expand or contract their loans, or, in other words, to engage in secondary expansion or contraction. In fact, however, the writers of the first half of the nineteenth century tended, as has been argued above, to over-emphasize the role of primary fluctuations in the mechanism and to ignore or minimize the role of supporting secondary expansion or contraction, and, except in the case of the banking school, this was especially true for secondary fluctuations which took the form of fluctuations in the amount of deposits. That writers of the period explicitly recognized that flows of specie into or out of the banks constituted direct changes in the amount of the national stock of means of payment when the banks acquired specie through the surrender of notes or deposits or surrendered specie in exchange for notes or checks on deposits, the following citations should suffice to demonstrate:

If, during the prevalence of an unfavorable foreign exchange, the balances [of London bankers with the Bank of England] are reduced by cheques drawn upon the Bank, and finally by payments in gold, for exportation, then—unless the bankers themselves export the gold on their own account, which seldom or never happens—the balances due to their various depositors, and consequently the quantity of money in the metropolis, is as effectually reduced as if the outstanding notes of the Bank were reduced by the redemption of securities in its possession, and the bankers' deposits at the Bank to remain unaltered.

On the other hand, during the prevalence of a favorable foreign exchange, and the consequent influx of gold from abroad, whether the imported gold is held by the bankers, or placed by them in deposit at the Bank, the quantity of money in the metropolis is as effectually increased as it would be if the Bank of England were to give notes in exchange for the gold.*6

... let us assume...that the bank, while holding £1,000,000 in coin, discounts bills and opens cash credits to the amount of £2,000,000. Now it is evident that in this case the 1,000,000 sovereigns deposited with the bank perform a double function. They constitute a money-in-hand power of purchasing, as regards the original depositors, who may draw them out on demand [i.e., primary expansion], and they form the basis of the credit-power of purchasing, which the holding of them enables the banker to extend to the customers to whom he grants discounts and cash credits [i.e., secondary expansion].*7

[In case of a crop failure] the first import of provisions would very probably be paid for in bullion. I will assume that it is paid for at once, to the extent of £4,000,000; the effect of that is, that £4,000,000 of notes are canceled; the money of this country is diminished £4,000,000 in amount.*8


In the earlier literature on the international mechanism there is one element of doctrine which does appear to give some semblance of validity to the interpretation of the classical school doctrines as ignoring the primary phase of the fluctuations in the currency resulting from specie movements, namely, the "hoards" doctrine of Fullarton, Tooke, and their followers, including, with qualifications, John Stuart Mill. These writers held that gold drains ordinarily come out of the hoards, consisting mainly of banking reserves, rather than out of the active coin or note circulation, and that the specie may be more largely withdrawn through checks on deposits than by presentation of notes for conversion into gold. It is by no means clear, however, that by their hoards doctrine these writers intended to deny that specie movements ordinarily involved corresponding primary fluctuations in notes and deposits combined. J. S. Mill did, at one point, state that if the Bank of England kept adequate specie reserves a temporary gold drain could be met from these reserves without involving a "contraction either of credit or of the circulation."*9 But as I understand the context, what Mill had in mind was that if the Bank had adequate reserves it would be in a position to permit gold to go out by way of its deposits without either a reduction in its note circulation or a reduction in its "credit" or the amount of its loans and investments, i.e., that while a gold outflow would under these circumstances involve a primary contraction of the deposits it would not be necessary to make it result also in a secondary contraction of the notes or deposits. Fullarton also does not seem to have intended to deny that an inflow of gold into the Bank's reserves would constitute, or involve, a corresponding primary expansion of the circulation;*10 what he claimed was that this primary expansion would, or might, soon thereafter be offset by a counter secondary contraction.*11


It was the later rather than the earlier, or classical, writers who tended to neglect the primary fluctuation phase. The growth of deposit banking in England resulted in a rapid growth of the ratio of bank money to specie, and in the latter half of the nineteenth century the total specie reserves appear always to have constituted less than five per cent of the total note and deposit liabilities to the public of the English banking system. Under these circumstances the primary effects of specie movements on the amount of the national stock of means of payment, unless they were of highly abnormal magnitude, could not be an important factor in maintaining international equilibrium, and it would be the supporting secondary expansion or contraction of means of payment which would bear the main responsibility for keeping or restoring an even balance of payments. There resulted from these conditions a natural tendency for writers to pass over lightly or even wholly to ignore the primary effects of specie movements on the size of the national stock of means of payment, and to lay sole or main emphasis upon the secondary expansion or contraction induced by changes in the specie reserve position of the banking system.


The following passage from Sidgwick presents an early and unusually clear instance of total omission of—and therefore at least an implied denial of the operation of—the primary effects of specie movements:*12

An increased supply of gold...tends ultimately to lower the purchasing power of money relatively to commodities generally; but, in the first stage of the process that leads to this result, the increment of coin—or in England of notes representing the new gold in the issue department of the Bank—must pass through the hands of bankers,*13 and so increase the amount of the medium of exchange that they have to lend. Hence the price paid for the use of money will tend to fall, and this fall to cause increased borrowing, and consequent extended use of the medium of exchange; and then through the resulting rise in prices generally, the greater part of the new coin or bank-notes will gradually pass into ordinary circulation. Thus the fall in the purchasing power of money, consequent on an influx of gold, will normally establish itself through an antecedent and connected fall in the value of the use of money.


In most modern expositions of the international mechanism, both English and American, the primary effects of specie movements are similarly left unmentioned, or by implication denied. Explicit denial of the role of primary fluctuations, however, appears to be about as rare as explicit recognition of their role. Laughlin expressly denied that specie flowing into bank reserves would operate to raise prices if it did not result in increased bank loans,*14 and Whitaker agreed with him on this point, but claimed that the inflow of specie would result in an increase in bank loans.*15 Marshall, on the other hand, apparently alone among modern writers until very recently, mentioned specifically both the primary fluctuation and the secondary fluctuation of the mechanism. He pointed out that while for England with its low ratio of specie to bank money the primary phase was unimportant, this might not be true for other countries where the actually circulating medium still consisted in large part of specie:

England is, in my opinion, but I speak with great diffidence, a specially bad example for India to follow in matters of currency. For, first, currency is but a small part of the means of payment used in England; and under most, though not all, conditions, bank money is the main means of payment; and that is elastic. Secondly, an imperative demand for increased currency is rare in England; and, when it does occur, it is on a very small scale relatively to England's total business and resources. The importation of the amount of ten millions of sovereigns makes an enormous difference in Lombard Street, but it is a mere nothing relatively to England's total business. Whereas, if the same difficulty arises in a country in which the main payments have to be made with currency itself, you want an importation of currency, or an increase of currency, standing in some moderately high relation to the total business of the country....*16


The following passage from Henry Seager seems to indicate recognition by him of both primary and secondary phases of the gold-flow mechanism:

Suppose...that the importation of gold has been induced by the low prices at which commodities are being sold in the importing country. Such importation will before long itself cause prices to rise, there being more money to serve as a medium of exchange than before, while the withdrawal of gold from other countries will in time cause their prices to fall. These results will follow the more promptly because ordinarily the new gold will find its way into bank reserves and will add to the use of credit as a medium of exchange much more largely than it adds to the country's supply of standard money. In the same way its exportation will serve ordinarily to deplete bank reserves and to cause a contraction of credit that will lessen the supply of media of exchange by much more than the amount of gold lost.*17



International short-term lending takes many forms; interbank credits, transfers of deposits, purchase of foreign bills of exchange, purchase of foreign treasury bills, commercial credits, purchase of long-term securities in a foreign market with the expectation of their early resale abroad, etc. Whatever form it takes, the international movement of short-term funds derives its importance for the mechanism of adjustment of international balances from the fact that these funds are highly mobile and in the absence of financial or political disturbance respond quickly, especially as between well-developed money markets, to even moderate relative fluctuations in interest rates. Since outward drains of gold ordinarily tend to result in rising rates of interest or at least to occur under circumstances which cause a rising rate of interest to be associated with them, and since inflows of gold are ordinarily similarly associated with falling rates of interest, the short-term funds and the specie are likely to move in opposite directions. Such movements of short-term funds in a reverse direction from the actual or incipient movement of specie are helpful to the international mechanism of adjustment in two main ways.


To take first the less important type of case, the balance of immediate obligations of any country is likely to be undergoing constant fluctuation and to be repeatedly shifting from a debit to a credit status. The most marked instances of such fluctuations in the balance of immediate obligations are to be found in countries whose export and import trade have marked and divergent seasonal patterns. If such countries did not resort to international short-term credit operations, specie would repeatedly have to be exported in substantial quantities to liquidate a debit balance, only to return soon thereafter upon the development of a credit balance. If such countries have well-developed money markets, such credit operations will take place through the initiative of individual banks or traders, in response to the seasonal relative shifts in interest rates at home and abroad. These operations will be further stimulated, moreover, by seasonal fluctuations in exchange rates resulting from the seasonal fluctuations in the trade balance. This goes counter to the doctrine sometimes expounded that the cost of shipping gold, or the deviation of the exchanges from the mint par, acts as a deterrent to the movement of short-term funds in response to small differentials in interest rates.*18 This doctrine overlooks the fact that the movements of short-term funds and of gold are frequently, and perhaps in the majority of cases, in opposite directions rather than in the same direction, and that when the former is the case the turn of the exchanges which is to be anticipated is a stimulus rather than a deterrent to short-term movements of funds. An individual in a country whose currency is above par in the exchange market who lends in terms of the foreign currency to a country whose currency is below par stands to profit not only from whatever interest differential he can obtain but also from the gain on the turn of the exchanges which may be expected to occur, and for which he can wait before recalling his funds.*19 When the movement of short-term funds is in the opposite direction from the actual or incipient movement of gold, it operates to reduce the extent of the gold movement to a corresponding degree.


Secondly, a major disturbance of international equilibrium requiring for its complete adjustment a more or less enduring contraction of means of payment and deflation of prices in some country may come so suddenly, or may have been so long neglected by the banking authorities of that country, that if short-term loans could not be made abroad a large amount of gold would have to be exported at once and bank credit contracted suddenly and sharply, with the danger that a major crisis would result. By resort to borrowing on short-term abroad, the necessary drain of gold can be spread over a longer period and even reduced in its total amount, and bank credit can be more gently and gradually contracted, thus avoiding or moderating the internal crisis.


This cushioning effect of short-term loans is especially important for long-term capital-exporting countries, where the flotation of foreign issues is likely to be irregularly spaced. Suppose, for instance, that country A floats the first of a series of great long-term loans in country B, whose balance of payments had previously been in approximate equilibrium. Even if the flotation of the loan were followed immediately by a substantial transfer of specie from B to A, and by supporting secondary expansion of means of payment in A and secondary contraction of means of payment in B, it would still ordinarily take some time before the demands for and the prices of commodities in the two countries would shift sufficiently to effect a transfer of the remainder of the loan in the form of commodities. In the meantime there would have been a heavy and unnecessarily large specie movement, an excessive credit expansion in the borrowing country, and an even more disturbing credit deflation in the lending country. But if the short-term money markets of the two countries are flexible and responsive to differentials in money rates, there will be a rise in short-term interest rates in B and a fall in A which will induce A to lend B on short term some of the funds it has borrowed from B on long term. The adverse balance of immediate obligations of B to A will thus be lessened; the flow of specie from B to A will be reduced; and the long-term loan will obtain transfer in the form of commodities more smoothly and with less disturbance to the economies of the two countries, even if more slowly.


The role of short-term capital movements as an equilibrating factor is limited, however, by the imperfect international mobility of such funds. While, in the absence of "fear movements," the international movement of short-term funds tends to bring about equality of short-term interest rates in different money markets, the amount of short-term funds which will move across national frontiers in response to moderate differentials in interest rates is for many frontiers always, and for all frontiers frequently, insufficient in quantity to bring about actual equality of interest rates or to reduce to-and-fro movements of gold to a minimum.*20


When a central bank, in order to check an expansion of bank credit, raises its discount rate or engages in selling operations in the open market, the resultant rise in the market rate of interest tends to attract foreign funds. It has become the custom to say that an inflow of short-term funds under these circumstances may offset or even more than offset the efforts of the central bank to bring about contraction in the amount of means of payment,*21 but this overlooks the fact that the foreign funds will flow in only as the market rate becomes higher than it was previously. The inflow of short-term funds under these circumstances will provide the member banks with increased reserve assets and thus lessen their dependence on the central bank, and will operate to reduce the degree of response of the market rate to the central bank rate. But the market rate must rise somewhat if foreign funds are to be attracted, and at this higher rate the amounts borrowers are willing to borrow will presumably fall, while the higher cost of their borrowed reserves will check the willingness of the banks to lend.


It is true, however, that variations in the market rate of interest in response to variations in the specie reserve position of the banking system, whether these variations in the market rate of interest occur automatically or as the result of central bank manipulations of its discount rate, do tend to convert the fluctuations in the exchange rates from such as would exercise a direct equilibrating influence on the trade balance to such as would exercise a direct disequilibrating influence on the trade balance. Suppose that a relative shift in demand for commodities results in an adverse trade balance and an adverse balance of payments for England. Let us first assume that no change occurs in the English market rate of interest. Sterling will fall in the foreign exchange markets, with a consequent stimulus to English exports and check to English imports. Let us next assume that the external drain of specie results in a relative rise in the English market rate of interest, and that this attracts a flow of short-term funds to England, which stops the external drain of specie and causes sterling to rise in the exchange markets, possibly to higher than the mint parities. The direct equilibrating influence of the exchange rate fluctuations on the English trade balance is lost, and may even give place to a direct disequilibrating influence. So limited, however, is the possible range of exchange rate fluctuations under an international metallic standard that their direct influence on trade balances must be of negligible proportions, and it cannot be regarded as an important drawback to the use of variations in the discount rate to maintain or restore equilibrium in international balances that it prevents exchange rate fluctuations from exercising a direct equilibrating influence.


While short-term lending has a useful role to play in the international mechanism, it is capable, nevertheless, and more so than any other element in the mechanism, of operating perversely. International short-term lending still awaits its historian, but there have been notorious cases, and especially in recent years, where the erratic and unpredictable movement of short-term funds has influenced the international mechanism during a period of stress very much in the manner in which loose cargo operates on a ship during a storm. The high degree of international mobility of short-term funds becomes a liability instead of an asset when there is alarm in the air, for short-term funds are quick to fly to foreign countries in search of safety when there is alarm at home, and are even quicker to be called back home when there are signs of trouble abroad.


Disturbances to international equilibrium resulting from the excessive mobility—or timidity—of short-term funds appear to be an ancient phenomenon. During the Napoleonic Wars, for instance, there were substantial fluctuations in the foreign holdings of British securities which were at the time believed by some to have been due more largely to the rise and fall of confidence in the military fortunes of England or in the future of the paper pound than to relative fluctuations in the interest rate,*22 and which may therefore have operated rather to accentuate than to moderate the fluctuations in the gold value of the inconvertible paper pound.*23 Later in the century, the growth in the international movement of funds attracted considerable attention, but most observers regarded this development as a wholly desirable one.*24 Some writers held that the development of international movement of short-term funds had rendered specie movements, changes in price levels, and even adjustments of trade balances unnecessary except in major disturbances.*25 An occasional note of warning was struck, however. Milner, for instance, although he regarded the development as on the whole a desirable one, saw that international capital movements could act as a disturbing as well as an equilibrating factor, and therefore recommended state control of the export of capital either directly or through regulation of the English discount rate with reference to prevailing rates abroad, both with a view to conserving ample capital resources for English industry and to guard against undue pressure on the English balance of payments.*26 It was pointed out also that if there was distrust of the financial situation funds might flow from the high-rate to the low-rate money market, and that attempts by the former to check the drain by raising the discount rate still further might serve only to increase the distrust and to accentuate the drain.*27 But scarcely a voice was raised during the nineteenth century in England to warn the banking authorities that short-term indebtedness to foreigners should be treated as special claims against specie reserves, and that extra precautions should be taken to provide the means to meet such claims.*28 The fact that in English pre-war banking practice neither the Bank of England nor the clearinghouse banks sold their own bills to banks abroad and that the English holdings of short-term claims on the rest of the world were certainly in ordinary times and probably at all times substantially in excess of the foreign holdings of short-term claims on England was at least a partial justification of this complacency. But there were always, nevertheless, substantial holdings of sterling bills abroad, and substantial deposits of foreign funds with London "foreign" banks, and when for any reason foreigners asked for their funds the clearinghouse banks and the Bank of England were indirectly called upon to meet these demands. The development in the post-war period of the practice by central and other banks of deliberately holding part of their reserves on deposit or otherwise invested in foreign money markets added to the danger, first, because it increased the amount of short-term foreign funds held in the money markets most used for this purpose, namely, London and New York, and, second, because bank funds, and especially funds regarded by the creditor banks as constituting part of their reserves, were more likely than the funds of private investors to be withdrawn simultaneously and suddenly upon the appearance of some signs of lack of safety in the investment or of impending need of extra financial resources at home. There was little outward sign of recognition by banking authorities in the countries having particularly large external short-term indebtedness that such liabilities required special treatment.*29 Bank authorities of these countries do not appear even to have made much effort to keep informed as to the amount and trend of such indebtedness, until, as the depression beginning in 1929 continued and became more intense, there occurred extraordinarily great flights of short-term funds from country to country, in which the central banks*30 participated at least as actively as did other banks and private individuals.*31


Where the agencies concerned are private individuals or business firms, there is no easy solution for the problem of excess mobility of short-term funds, since direct regulation of such movement would be troublesome, costly, and, unless reinforced by censorship of communications, easily evaded. But the chief offenders have been banks, including central banks operating under the so-called gold-exchange standard, and here certain fairly practicable remedies seem to be indicated. The only legitimate functions of the gold-exchange standard are to facilitate international payments and to eliminate the expense of to-and-fro gold movements occurring within short intervals of time. But the claim often made for it, that it enables poor countries to adhere to the gold standard without bearing the burden of maintaining non-income-earning gold reserves, makes a virtue out of the gold-exchange standard's defect. Either the expense of carrying such reserves is transferred to the country in which the reserve funds are invested, or else that country assumes dangerous liabilities against its own reserves without adopting protective measures. Properly administered, the gold-exchange standard would approximate in its mode of operation to reciprocal earmarking of gold. Central banks would still count their holdings of claims on foreign banks as part of their reserves. But they would treat their own liabilities and the liabilities of member banks to foreign banks as demand claims against their own reserves, and would enforce very high specie reserve ratios against such liabilities. No central bank would invest funds at interest in another country except in or through the mediation of the central bank of that country, at the request of such central bank, and to aid it during a crisis rather than to earn interest on reserve assets. Such a reform would not be costless, and would not completely remedy the situation, but it would reduce to much smaller proportions one of the major defects of the international gold standard as it has operated in modern times.


The Gold Delegation of the League of Nations has defended the use of the gold-exchange standard as a means of economizing for poor countries the cost of maintaining gold reserves, and has proposed, as a remedy for the problem of the excess mobility of short-term funds, that "it is necessary for lending countries to assure that foreign lending does not exceed or fall short of their net active balance on income account."*32 Taken literally, this would mean that any country having a favorable balance of immediate obligations on commodity and service account should feel obligated to lend sufficiently abroad to prevent any inflow of gold, and presumably also that any country having an unfavorable balance on commodity and service account should feel warranted in borrowing sufficiently abroad to prevent any outflow of gold. Gold flows, under such a regime, would either not occur at all, or would occur only in connection with the liquidation of old debts. This is surprising doctrine to be found in a document intended to be a plea for the maintenance and rehabilitation of the international gold standard. Under such a regime, balances, favorable or unfavorable, on income account would never be liquidated.*33


"Canada's Balance."


The Canadian experience before the war during a period of great import of capital provides an opportunity for the examination of the role of primary and secondary expansion in the international mechanism in a gold standard country where the banking system keeps part of its reserves in the form of holdings of outside short-term funds. In a study I made of the Canadian mechanism from 1900 to 1913,*34 I reached the following conclusions with respect to the monetary aspects of the mechanism. The Canadian borrowings obtained transfer into Canada smoothly and without noticeable friction in the form of a net commodity and service import surplus, as the result of relative price changes (and shifts in demands) which were of the character indicated as to be expected by the older writers. The price and demand changes resulted from a relative increase in the amounts of Canadian bank money, deposits and notes, and these increases resulted in turn mainly from the exchange by Canadian borrowers abroad of the proceeds in foreign funds of their borrowings abroad for Canadian bank deposits or notes. The Canadian banks brought into Canada in the form of specie only such part of their newly-acquired foreign funds as was required to maintain their specie reserve ratios in Canada at their customary level. The remainder of the foreign funds thus acquired by the banks, to the extent that they were not absorbed in paying for the growing Canadian import surplus, was left abroad by the Canadian banks, largely in the form of call loans in New York, as additions to their "outside" or "secondary" reserves. Except toward the end of the period, when a marked credit expansion occurred in Canada, the increase in the outside reserves was not used by the Canadian banks as a basis for expansion of their loans in Canada. With the exception that fluctuations in the outside reserves operated in the Canadian mechanism in the manner attributed to specie movements in the classical doctrine, I concluded that the Canadian mechanism corresponded in all its important aspects to the mechanism as formulated in the classical doctrine.


In my study I did not use the "primary," "secondary" terminology developed in the preceding sections of this chapter. Applied to the Canadian data, the meaning of primary expansion would have to be broadened, so as to include increases in Canadian bank deposits and notes resulting from the exchange by Canadian borrowers abroad of foreign funds for Canadian bank money, whether the Canadian banks exchanged these foreign funds for specie and brought the specie into Canada or held the foreign funds as secondary or outside reserves, as the economic significance of the two types of reserves was, dollar for dollar, the same. Restated in terms of the primary and secondary terminology, my explanation of the monetary phases of the Canadian mechanism was, therefore, that foreign borrowings by Canadians, to the extent that their proceeds in foreign funds were not used up immediately in paying for import surpluses, resulted in a primary expansion of Canadian means of payment through the exchange of foreign funds for Canadian bank money, and that the Canadian banks converted only a fraction of these foreign funds into specie. To secondary expansion, resulting from the expansion of bank loans in Canada, I attributed importance, as a supporting factor reinforcing the primary expansion, only for the last few years of the period.

Angell's Criticism of the Account in "Canada's Balance."


Angell*35 and a number of writers who follow him, have raised some important objections against my account of the Canadian mechanism. Angell finds fault with my conclusion that fluctuations in the outside reserves played the same role in the Canadian mechanism as that assigned to gold movements in the classical doctrine. His failure to state in what respects he believed the actual Canadian mechanism was different from that postulated in the classical doctrine makes it difficult to deal with this criticism. But I believe that he here interprets the classical doctrine as assigning a role only to secondary fluctuations, and as ignoring totally the primary fluctuations. In any case, he attributes to me the proposition that it was secondary expansion which did the work in the Canadian mechanism, although I am now convinced that I overemphasized the primary phase, both with reference to the facts in Canada and with reference to the classical doctrine.


Angell's own interpretation of the Canadian mechanism is that the expansion of Canadian deposits which operated to adjust the Canadian trade balances to the borrowings was a primary expansion, but a primary expansion of a very special sort, resulting from the exchange of sterling funds, but of no other sort of outside funds, for Canadian deposits. Although I carefully explained in my study that the outside reserves consisted "of funds loaned on call in New York and London,and net balances kept with New York and London banks,"*36 he always interprets my propositions with respect to "outside reserves" as if I meant them to apply only to New York funds, and uses the term in this way himself. To understand his account of the Canadian mechanism and his criticism of my account, it is necessary, therefore, to remember that Angell excludes sterling funds from "outside reserves," wrongly attributes the same exclusion to me, and treats fluctuations in the Canadian bank holdings of sterling and of New York funds, respectively, as if they had radically different significance for the mechanism.


Angell's objections to my account of the Canadian mechanism are for the most part covered by the following paragraph:*37

...Viner's verification of the general theory...I think...breaks down on this question of the intermediary financial mechanisms. Neither the statistical data submitted nor the reasoning based upon them show any clear sequence from the outside reserves to credit and price conditions within Canada itself. Outside reserves moved closely with bank deposits in Canada, and showed no independent relationship to prices. Rather, the sequence must have been that which Viner himself rather hesitantly suggests at another point.*38 The Canadian borrowers, having sterling funds at their disposal, deposited them with the Canadian banks (except in so far as the loans were spent in England). These funds, thus converted into Canadian currency and credit, were spent in Canada and induced a rise in prices; a rise which roughly adjusted the commodity balance of trade to the volume of new borrowings. The Canadian banks recouped themselves by selling the sterling funds in New York, the proceeds being left there or taken back to Canada as needed. It does not appear from the data, however, that these changes in the New York balances had any direct and independent effect upon conditions within Canada. By providing potential additional metallic reserves, their increase made a Canadian credit expansion possible, but there is no convincing evidence, inductive or deductive, to show that it provided the initial stimulus to expansion.*39 The stimulus came, rather, from the original increase in bank deposits within Canada itself.


Angell thus interprets the Canadian expansion of deposits as being solely*40 a primary expansion, resulting (solely?) from the exchange of sterling funds for Canadian deposits, while he attributes to me the doctrine that the Canadian expansion of deposits was (solely?) a secondary expansion, i.e., resulted from an expansion of bank loans in Canada, into which the banks were led by the increase in their holdings of outside reserves in the form of New York funds. He presents no evidence to support his account of the role I assigned to secondary expansion, and it has no other basis, I am convinced, than Angell's assumption that when I found similarity between the role of fluctuations in the outside reserves in Canada and the role of gold movements in the classical mechanism, I must have had in mind the use of gold reserves as a basis for expansion of deposits through loans. I had in mind, on the contrary, what I now call the primary phase of gold movements in the mechanism. Instead of stressing secondary expansion in the Canadian mechanism, I ignored it except for the last few years of the period studied. And instead of comparing the fluctuations in total deposits, or in loans, or in total deposits minus outside reserves, with the fluctuations in outside reserves, as would have been appropriate if the secondary fluctuations were regarded as important, I paid no attention to the fluctuations in the aggregate volume of bank loans in Canada, and I compared the fluctuations in outside reserves with the fluctuations in "foreign loan deposits," i.e., total deposits minus loans, i.e., the deposits not resulting from Canadian bank loans.*41


The distinction which Angell draws between the role of sterling funds and the role of New York funds in the Canadian mechanism seems to me without basis, either in theory or statistically. Sterling funds and New York funds were equally "outside reserves." The fluctuations in the net holdings of sterling funds were throughout the period small in amount, as the Canadian banks immediately converted sterling funds, if in excess of the small amounts needed as working balances for remittance purposes, into New York funds or into specie. It was, moreover, the maintenance, and not merely the acquisition, of outside funds, upon which the volume of primary Canadian deposits depended, since the reduction of outside reserves to meet the need for foreign payments would, for the banks, be balanced by a corresponding amount of debits charged against the deposits of Canadian customers for whom the foreign payments were being made. Even when first acquired, furthermore, not all the outside funds were sterling funds, since somewhat over 30 per cent of the total Canadian borrowings during the period were made elsewhere than in England (chiefly in the United States). The conversion of sterling funds into New York funds simply happened to serve the convenience of the Canadian banks, and had no other significance. Held in New York, their outside funds could earn higher rates of interest than in London and in case of need could be converted into gold and brought into Canada overnight with a minimum risk of exchange loss.*42


Angell further interprets me as holding that the expansion of Canadian deposits (always?) came later in time than the expansion of outside reserves. He again presents no evidence to support this interpretation but it is probably only a logical inference from his erroneous attribution to me of the proposition that the expansion of Canadian deposits was a secondary expansion, induced by the improved secondary reserve position of the Canadian banks. He maintains that, on the contrary, the expansion of deposits preceded the expansion of outside reserves.*43


Angell's claim that in fact the increase in Canadian deposits was prior to the increase in outside reserves seems to be the product of the following chain of reasoning: (1) Canadian borrowings were (solely?) from England and therefore yielded sterling funds; (2) the Canadian borrowers exchanged these sterling funds for Canadian deposits; (3) some time after*44 such exchange had occurred, the Canadian banks converted the sterling funds into New York funds; (4) New York funds were, but sterling funds were not, "outside reserves" nor apparently, even "outside bank balances"; (5) the (primary) increase in Canadian deposits was therefore prior to the increase in "outside reserves." Since, however, sterling funds were, dollar for dollar, just as much "outside reserves" as were New York funds; since Canadian borrowings occurred in the United States as well as in England, so that some of the outside reserves were originally acquired in the form of American dollars; and since the Canadian banks converted newly-acquired sterling funds into New York funds almost instantaneously rather than after a substantial delay, this argument collapses. The primary expansion in Canadian deposits was neither prior to the expansion in outside reserves, as Angell claims, nor after it, the view which he attributes to me, but was, as I contended, simultaneous with it.


Feis, after citing with approval Angell's conclusion that the increase in Canadian bank deposits is the "original" and "prior" factor operating to correct the Canadian balance of payments, attempts to explain more explicitly than did Angell what is to be understood by "original" and "prior":*45

By "original" Dr. Angell meant to distinguish, I venture to interpret, the immediate credit expansion from any increase that might result later from the strengthening of gold reserves; by "prior" is meant prior in time to any such increase of gold reserves.


That the primary expansion in Canadian bank deposits resulting from the exchange of the proceeds of foreign borrowings for Canadian deposits—which it is misleading to refer to as "credit expansion" since its significant characteristic was that it was not Canadian credit expansion—would be prior to any secondary expansion of Canadian bank deposits resulting from the improvement in the reserves is obvious. But how could this primary expansion also be prior to the increase in outside reserves? Feis states that the (primary) expansion of Canadian bank deposits and the increase in outside reserves are "both results of the same borrowing operations. In that vital sense they are interdependent; in other ways they may be said to be independent. They, therefore, must be recognized as playing separate parts in the mechanism of adjustment."*46 But this, while not very helpful, suggests simultaneity rather than priority.*47 The increase in outside reserves and the primary increase in deposits must have occurred simultaneously unless, indeed, if it should be found that in banking practice the bank clerks regularly debit the bank before they credit the customer, or vice versa, someone could be found who would attach significance to a priority of this sort and would expect it to reveal itself in "lags" in monthly (or annual!) banking data.


Carr presents the following as a summary of my findings:

The surplus of bills on London created by English loans to Canada never attained great enough proportions to force sterling rates to the gold import point for Canada. Instead of permitting London bills to accumulate on the Canadian market and depress exchange quotations, the Canadian banks sold them to New York, and thereby built up their New York balances or "outside reserves." But on the basis of these outside reserves the Canadian banks were able to extend credit at home. Price inflation resulted as if gold had been imported. In other words, a substitute was found for the gold flow in the Canadian case in the form of increased outside reserves. The sequence of events, then, according to Professor Viner, was this: (1) foreign borrowing, (2) increase in outside reserves, (3) extension of credit at home.*48


The notion that the motive of the Canadian banks in exchanging London funds for New York funds was to prevent a depression of sterling exchange on the (non-existent!) Canadian sterling exchange market is assuredly not mine.*49 The notion that outside funds constituted outside reserves only if they were New York funds should have been credited to Angell, but not to me. Finally, secondary expansion of Canadian deposits through an expansion of domestic bank loans*50 induced by an improved bank reserve position was not an important element in my explanation of the expansion of Canadian means of payments. The only element in my account which Carr here correctly reports, therefore, is that increases in the outside reserves operated as a substitute for inflows of specie.


White interprets my findings as differing "from the orthodox explanation in that credit expansion instead of following the increases in bank reserves appears to have preceded them." He nevertheless does not regard the objection made by Angell and Carr to my account "on the score of chronological sequence" as serious, on the ground that since the Canadian banks treated outside reserves as if they were specie, the difference of the Canadian mechanism from the classical doctrine was due simply to "a modification arising from modern banking practice."*51 If, as seems to be intended by White, "credit expansion" is understood to mean expansion of bank money, whether primary or secondary, and "bank reserves" is understood to mean only specie reserves in Canada, that was exactly my position.*52 But it is not relevant to Angell's or Carr's criticism "on the score of chronological sequence." It was my supposed account of the chronological order of variations in the non-specie or "outside" reserves and in primary deposits, and not in the specie reserves and total deposits, with which Angell and Carr took issue.*53

Angell's Statistical Analysis.


Angell supports his findings as to the sequence of events in the Canadian mechanism by an analysis of the statistical data.*54 Since he presents no data on the outside reserves, whether sterling funds, or New York funds, or total holdings, no light is thrown by this analysis on the manner in which he reached his conclusions as to the place of the outside reserves in the mechanism. On the basis of his statistical analysis, he presents two (inconsistent) sets of conclusions as to the chronological sequence of events: first, that the net import surpluses follow the net borrowings "with a lag of a year";*55 and second, that (a) "the changes in bank deposits followed, with a lag up to a year, the changes in the excess of net capital imports [=net borrowings] over final means of payment [=import surpluses]; and that the magnitudes involved were roughly similar when the lag is allowed for.... The latter set of fluctuations evidently dominate the first set"; and (b) the increase in the import surpluses followed, also with "a lag of about a year," the increases in bank deposits,*56 with an aggregate lag, therefore, of up to two years between an increase in borrowings and an increase in the import surplus. Since Angell holds that the increase in deposits was prior to the increase in New York funds, there would therefore be also, according to his account, a lag of up to a year to over a year between the fluctuations in borrowings and the fluctuations in New York funds.


Angell attributes the lag which he finds between the increases in borrowings and increases in import surpluses to two factors which received due recognition in my study: "first, to the interval between the announcement of each new loan (at which time it was usually credited to Canada) and its actual flotation; and second, to the lag between the accumulation of the capital abroad and the appearance of the resulting changes in the commodity balance."*57 Both factors are valid. For security flotations, however, the interval between announcement of the loan and payment by subscribers of the final instalment rarely, if ever, exceeded three months, and, presumably because the winter season in Canada is unsuitable for heavy construction, few important flotations occurred in the late autumn. This lag, therefore, would scarcely reveal itself in calendar year statistical series. But direct investments in Canadian branch plants, etc., would commonly attract attention at and be assigned to the time when plans were announced, while the actual execution of the plans, and transfer of the necessary funds, might well take a year or longer. The second factor should ordinarily have been more important. The Canadian import surpluses should be expected to lag after the Canadian borrowings, since it would ordinarily take some time before the proceeds of the foreign borrowings would be completely absorbed in payment of adverse trade balances. But if Canadians borrow abroad in a given year more than the excess of what they spend abroad over what they sell abroad, and if they do not take any of the unspent borrowings in the form of specie, the unspent borrowings must be held either by Canadian individuals or by Canadian banks in the form of increased holdings of foreign funds. Assuming in turn that Canadian individuals hold only negligible and comparatively constant amounts of foreign funds and that upon the acquisition of such funds they promptly exchange them with Canadian banks for Canadian funds in the form of bank deposits, then the excess in any year of Canadian net borrowings abroad over Canadian import surpluses must result in simultaneous and corresponding increases in Canadian primary deposits and in the outside reserves of the Canadian banks, my original position. What then of Angell's statistical finding that there was a lag of up to a year of the changes in deposits after the changes in unspent borrowings? The fact that Angell, when he is not dealing with deposits, finds a lag of only a year between borrowings and the import surpluses on which they are finally spent, but finds a lag of up to two years between the borrowings and the import surpluses when he is dealing with deposits, and that none of the lags he finds stands out clearly in his charts, itself suggests that the one year lag of deposits after the initial accrual of unspent borrowings may be spurious. But whatever Angell's charts may appear to show, the defects both in my estimates upon which these charts are based and in Angell's use of them are such as to make the charts have little bearing on the questions of chronological sequence which he attempts to answer by means of them.


To obtain the amount of unspent borrowings of each year, or what he calls the "excess of net capital imports over final means of payment," Angell subtracts my estimates of the Canadian commodity and service import surpluses of each year from my direct estimates of the net amounts of Canadian borrowings abroad for the corresponding years.*58 This is logically correct procedure. But if the estimates of (a) net borrowings and (b) import surpluses were absolutely accurate, the excess of net borrowings over import surpluses should for each year be identical with the increase in the Canadian bank (plus private) holdings of outside funds. Estimates (a) and (b), however, are each net series, or series of differences between pairs of other series. Thus series (a) is a series of the differences between series (a1), borrowings by Canada, and series (a2), loans by Canada; and series (b) is a series of the differences between series (b1), imports into Canada, and series (b2), exports by Canada. Now each of the series, a1, a2, b1, b2, is inevitably subject to an appreciable margin of probable error, and the series (a) and (b) are therefore subject to much greater margins of probable error. When we come to the final series consisting of the differences between series (a) and (b), the margin of probable error must be regarded as too great to warrant reliance upon it for important conclusions. If estimates of international balances are to be used at all there must not be too much squeamishness about their accuracy, but I presented my direct estimates of Canadian borrowings only with the most serious reservations, especially with reference to their allocation to particular years, which is vital here. In my original study I advisedly made little use of them as a basis for interpreting the mechanism.


Let us suppose, however, that there are no unknown errors or omissions in the series used by Angell. Angell's "net capital imports" series is constructed by subtracting from my direct estimates of Canadian borrowings abroad my estimates of Canadian investments of capital abroad. But unfortunately for the purposes of his analysis, the latter series included as Canadian investments abroad the net increases in Canadian bank holdings of outside funds.*59 Since the changes in the Canadian bank holdings of outside funds constitute the changes in the amounts of untransferred borrowings, Angell's successive operations reduce to subtraction of one estimate of the total borrowings, transferred and untransferred, from another estimate of the total borrowings, transferred and untransferred, and treatment of the remainders as the untransferred borrowings. If all the estimates were accurate, there would be no remainders. Angell's series of "excess of net capital imports over final means of payment" is in fact a series of substantial sums. But subject to the qualifications that there are assumed to have been no important fluctuations in the holdings of outside funds by individual Canadians and that Angell does not include non-commercial items such as capital brought in by immigrants as "capital imports" or funds requiring economic transfer, these remainders represent merely the net errors and omissions in the several series of estimates from which they are derived, and have no other significance.


A hypothetical illustration will perhaps bring out more clearly why Angell's series of "excess of net capital imports over final means of payment" represents, subject to the two qualifications indicated above, only the net errors in my various series. Suppose that, in a particular year, the Canadian gross borrowings abroad amount to $100,000,000; the new investments abroad by Canadians other than banks amount to $10,000,000; the net increase in holdings of outside funds by the Canadian banks amount to $20,000,000; and the Canadian commodity and service import surplus amounts to $70,000,000. The excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would in that year then be $20,000,000, which is necessarily the same as the amount of increase in the holdings of outside funds by the Canadian banks. But by Angell's procedure, namely, subtracting (a) the import surpluses from (b) the net borrowings minus the increase in the holdings of outside funds by the Canadian banks, the excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would appear to be zero. Suppose, however, that the actual amounts remain as above, but that the Canadian import surplus is wrongly estimated at $60,000,000 instead of at its true amount of $70,000,000; computed by Angell's method the excess of net borrowings over the import surplus, or the amount of untransferred borrowings, would appear to be $10,000,000, or the amount of the error in the estimate of the Canadian import surplus.


Accepting Angell's computations, Carr comments:

An excess of net capital imports [over the commodity and service import surpluses] amounting to only 1.6 per cent of the total appears much too small to have provided Canada for the entire period with the increase in purchasing power necessary for carrying on a growing domestic trade at the sustained higher price levels. This fact is also embarrassing to the classical analysis, for it is only through the medium of the excess of net capital imports that the rise in Canadian prices can be accounted for.*60

For the reason already given, the excess of borrowings over import surplus as computed by Angell must be regarded as meaningless except as a measure of the net error in the various estimates. The smallness of its ratio to the total amount of borrowings should therefore prove embarrassing only to those who attach significance to it. For individual years it is, in fact, embarrassingly large for me as the person responsible for the estimates on which it is based. If by "increase in purchasing power necessary for carrying on a growing domestic trade at the sustained higher price levels," Carr means increase in monetary reserves, he overlooks the fact that included in the import surpluses as computed in Canada's balance and used by him was a total net import for the period of $113,000,000 of gold coin, as compared to a total stock of gold coin in Canada at the beginning of the period of only $19,000,000,*61 and that the outside reserves of the Canadian banks increased during the period from $39,000,000 to $130,000,000, or an increase of $91,000,000.*62

A Statistical Reexamination of the Canadian Experience.


The major obstacle to the use of direct estimates of borrowings in the analysis of the transfer mechanism is the absence, ordinarily, of sufficient information on which to base acceptable estimates of short-term credit transactions, such as international purchases and sales of securities through stock exchanges, short-term loans by others than banks, and trade debts incurred in one calendar year and not liquidated until the next calendar year. Incomplete segregation in the reported figures of loan flotations of the portions of the proceeds used to amortize older loans presents another source of possible error. While the changes in outside reserves of the Canadian banks cannot be regarded as an accurate measure of the relation of Canadian borrowings to economic or real transfers, they are as reliable a measure of the changes in the amounts of untransferred borrowings as can be derived from the data made available in my Canadian study. In tables VI and VII are presented some of the results of a reexamination of the Canadian experience. To the data presented in my original study are here added the amounts of bank loans in Canada, as representative of secondary fluctuations in the volume of means of payment in Canada. There is also some rearrangement of the data along lines similar to those followed by Angell. What I believe to be a further improvement is based on the distinction which White makes between net and total gold flows.*63 In my original study I used for my banking series the amounts of deposits, reserves, etc., as reported for the last business day of each year, and the differences in the figures for successive years thus represented the net year-to-year changes. White claims that for purposes of tracing the influence of gold flows on trade balances the influence on demands for commodities of gold which entered, say, in February and departed in November would not be accounted for by data as to net annual changes in the amount of gold. To account for the influence of an inflow of gold which remained only for part of the statistical unit period, he concludes that total annual gold flows instead of net annual changes in the amount of gold should be used in analysis. But the substitution of total gold flows for net gold flows is not the proper method of giving to gold which was within the country for only part of a year its due weight, since this method would give to gold which stayed in the country for a day equal weight with gold which stayed in the country for 360 days if entrance and departure were in the same calendar year, and would give a negative weight to gold which had entered in the previous year and stayed 360 days of the given year and a positive weight to gold which entered on the last day of the year. The procedure required to answer White's objection to the use of net year-to-year changes as of a given day is to substitute for them the year-to-year changes in the average amounts of gold within the country during the year as a whole. For Canada, an adequate approximation to such averages is made possible by the use for each year of the averages of the monthly returns made by the banks. The reasoning which makes use of such averages preferable to use of end-of-the-year data for gold applies equally to other banking series bearing on the amount of means of payment.

(Averages of Amounts Reported Monthly in Millions of Dollars)a
Deposit and note liabilities in Canadab (Increases = Primary + Secondary Expansion) Bank loans in Canadac (Increases = Secondary Expansion) "Foreign Loan Deposits"
(Increases = Primary Expansion) (1-2)
Gold and Dominion notes held by banksdOutside reserveseTotal reserves (4 + 5)
1900f...   344 310   34   30   39   69
1901...   374 324   50   32   52   84
1902...   411 354   57   35   60   95
1903...   449 408   41   43   51   94
1904...   496 449   46   50   58 108
1905...   551 483   68   53   74 127
1906...   631 561   69   61   76 137
1907...   671 630   42   71   59 130
1908...   664 584   80   78   94 172
1909...   786 608 178   96 136 252
1910...   914 717 196 105 132 257
1911...   998 800 198 120 134 254
1912... 1122 919 203 133 143 276
1913... 1135 985 149 137 119 256
a Computed from data in monthly banking supplements of Canada gazetie.
b Notes in circulation, balances due to Dominion and provincal governments, demand and time deposits in Canada. (Notes of other Canadian banks held by the banks should be subtracted, but were not separately listed in the returns.)
c Call and short loans in Canada, current loans in Canada, loans to Dominion, provincial, and local governments, and overdue debts.
d Includes amounts held, outside Canada, not separately reported before July, 1913.
e Due from banks in United Kingdom and in foreign countries and call and short loans elsewhere than in Canada minus due to banks in United Kingdom and in foreign countries.
f Averages of amounts reported for last six months only.


The close relationship, as different aspects of the same banking operations, between the primary fluctuations in bank money in Canada (the fluctuations in "foreign loan deposits") and the fluctuations in outside reserves, is made clearly evident in table VI. With one negligible exception, the fluctuations were always in the same direction and there was also substantial correspondence in size of fluctuation. The discrepancies between the two series are to be explained mainly by: the fluctuations in Canadian bank holdings of gold and Dominion notes, which represented substantially substitutions as between "cash" reserves and outside reserves; accruals to or drafts on the outside reserves by the regular banking operations conducted by the Canadian banks outside Canada, chiefly in Newfoundland and the West Indies, which are not segregated in the official returns; and (minor) fluctuations in the Canadian bank purchases of and sales of securities within and outside of Canada.


Table VI indicates that primary and secondary expansion of means of payment in Canada both contributed to the creation of a situation in which the necessary import surpluses could develop, although the secular growth of the bank loans in Canada, associated with the general economic development of the country and with the rise of prices in Canada as part of a world rise, operates to magnify the apparent importance of the secondary expansion as a factor in the mechanism of adjustment to the borrowings. From the data in tables VI and VII it is possible to argue that at times at least the import surpluses resulted from original secondary expansion, and that the borrowings were engaged in to obtain the foreign funds necessary to liquidate trade balances already incurred and to restore reserves encroached upon in paying for past debit trade balances.*64 But this is quite consistent with the orthodox explanation,*65 which recognizes the possibility that import surpluses may result from an internal (i.e., secondary) expansion of deposits made in anticipation of, or at least later supported by, borrowings abroad whose proceeds go to liquidate debit trade balances already incurred and to build up depleted reserves. It should also be remembered that fortuitous shifts in the Canadian demands as between different classes of commodities or changes in the foreign demand for Canadian exports may bring about substantial year-to-year changes in the Canadian trade balance without prior changes in the amount of Canadian means of payment, and that changes in the "final purchase velocity" of the means of payment would also influence the trade balance, even in the absence of changes in the amount of deposits or prior changes in borrowings. As far as the general trends are concerned, the Canadian experience does show that the growth of the import surplus was preceded by a growth in the amount of means of payment in Canada,*66 that this growth in means of payment was both primary and secondary, that the primary fluctuations in the amount of means of payment were relatively more marked than the secondary fluctuations, and that there was a variable time-lag between borrowings abroad and economic transfer, with the recorded, or long-term, borrowings usually but not always preceding the economic transfer chronologically.

(In Millions of Dollars)
Net acquisition of outside fundsaAmount of net economic transferbIncrease or decrease (-) in Canadian bank holdings of outside fundscTotal accounted for (2+3)Amounts unaccounted for (-) or overaccounted for (1-4)
1901... -4 -9 19 10 14
1902...  14   2   1   3 -11
1903...  38  43 -7   36  -2
1904...  29  58 23   81   52
1905...  65  49   3   52 -13
1906...  70   73 -6   67   -3
1907...  47 132 -22 110   63
1908... 139   53  91 144    5
1909... 166   84  23 107 -59
1910... 216 168 -41 127 -89
1911... 248 254   6 260    12
1912...  183  303 -5  298   115
1913...  367  251  7  258 -109
  Totals... 1578 1461 92 1553  -25
a Canadian borrowings abroad, direct estimate (Canada's balance, p. 139, table XLIV) minus Canadian investments abroad exclusive of changes in outside reserves of Canadian banks (ibid., p. 94. table XXV and chart II. pp. 166-67) plus credit balances and minus debit balances of non-commercial transactions (ibid., p. 61, table X) minus net interest payments by Canada (ibid., p. 101, table XXVIII, col. 4 and p. 94, table XXV, final column).
b Commodity import surpluses inclusive of coin and bullion (Canada's balance p. 33, table III) plus service debit balances exclusive of interest payments (ibid., pp. 102-03, table XXIX).
c Canada's balance, p. 187, chart III, col. 3, annual changes, as of December 31 of each year, in due from banks in United Kingdom and in foreign countries plus call and short loans elsewhere than in Canada minus due to banks in United Kingdom and in foreign countries.


In table VII the amounts of funds requiring transfer, including not only net borrowings proper, after deduction of interest obligations, but also unilateral remittances and monetary capital brought in by immigrants, are compared with the actual amounts of net economic transfer, or the import surpluses, including the excess of imports over exports of services other than interest as well as of commodities. If all of these items were accurately estimated, and if individual Canadians held no balances abroad, an excess or deficiency in any year of the amounts of funds requiring economic transfer to Canada over the amounts of net economic transfer would be reflected by a corresponding change, in size and direction, in the holdings of outside funds by the Canadian banks. Column V reveals how serious is the lack of correspondence between these series as for as the figures for individual years are concerned, although for the period as a whole the total discrepancy, $25,000,000, is less than 2 per cent of the estimated total net acquisition of outside funds requiring transfer to Canada during the period. The discrepanicies for individual years are to be explained, I believe, mainly by defects in the allocation to particular years of net long-term borrowings, by the impossibility of accounting from the available data for short-term financial transacations of various kinds which overlapped two or more calendar years, by incomplete success in deducting from the reported amounts of new loans floated the portions thereof used to amortize old loans, and by the impossibility of making allowance, in the estimates of outside reserves, for the call loans in New York by Canadian banks without agencies there, made directly from and reported as of their Canadian head offices.



In the older literature there are to be found only scattered and incidental references to the repercussions on the international mechanism of cyclical fluctuations in business activity. Within the last few years the question has been more seriously tackled, but in the instances which have come to my attention the treatment has frequently been based on a somewhat mechanical application of a particular—if not peculiar—cycle theory to a superficial analysis of the mechanism of international trade. Given the disturbed—though in my opinion exceedingly promising—state of business cycle theory at the moment and the absence of the necessary inductive spadework on the international aspects of business fluctuations, it seems to me that we must await further developments in both directions before we can expect very fruitful results from any attempt systematically to incorporate cycle theory into the theory of international trade, or, a more important task, to apply international trade theory to cycle theory. A cursory survey of the recent literature bearing on this question suggests, however, some comments of a primarily methodological order.


In the formulation of an a priori description of the relation of cyclical fluctuations to the international mechanism, it is necessary to make clear which of the following possibilities is assumed to be the fact: that the cyclical fluctuations in the country in question are (a) peculiar to it, conditions in the outside world being assumed to be stable, or (b) are synchronized with, or (c) lag behind, or (d) precede fluctuations in the same direction in the outside world. Each of these situations would, a priori, be expected to have associated with it a different cyclical pattern in the international aspects of the economic phenomena of the country in question. Since any particular country may at one time be in one of these situations and at another time in another, or, as is most probable, may generally be in one of these situations with respect to some phases of business activity and in some other of the situations with respect to other phases of business activity, attempts such as are to be encountered in the literature to formulate a single and precise pattern of relationship between cyclical fluctuations and specific elements of the international mechanism without discrimination between the situations here differentiated seem to me to be based on an excessive simplification of the problem.


Recognition of the existence of close relationship between the cyclical fluctuations of business activity and the behavior of the various items in the international balances was common during the currency school-banking school controversy. As a rule, however, it was tacitly assumed either that the cyclical fluctuations in volume of means of payment, prices, etc., were confined to England (which corresponds to my assumption [a] above) or that the cycle came earlier and was more pronounced in England than abroad (which corresponds substantially to my assumption [d] above). An expansion of means of payment in England was therefore treated as resulting in a relative rise in prices in England, a decline in exports and increase in imports, a relative rise in interest rates in England, and specie exports and short-term borrowing from abroad to liquidate the adverse balance of payments. Given the assumptions this was correct analysis, but it was certainly not made sufficiently clear by those presenting such analysis that they recognized the dependence of their conclusions on the particular type of relationship, with respect to timing, direction, and degree, assumed to exist between the fluctuations within England and those in the outside world.


This can be illustrated by contrasting the probable pattern of behavior of the international phenomena when the cycle comes earlier and is more pronounced in England than abroad, as is usually assumed by these writers, with what the pattern would be if the cycle came later in England and was less pronounced than abroad. Taking first the expansion phase, in both situations the amount of means of payment in England, prices, interest rates, output, and imports, would be rising. But imports would be rising relative to exports in the first case, falling in the second, and the balance of payments on trade account would be moving against England in the first case, in her favor in the second, with reverse movements of specie in the two cases. A corresponding contrast between the two cases holds for the contraction phase.


For similar reasons, it seems a mistake to assume that there is one definite pattern of relationship between business fluctuations and international capital movements. During the expansion phase of a cycle in a particular country the volume of investment will increase. If that country is normally a capital-exporting country and is having an earlier or more marked expansion of business activity than the outside world, the ratio of investment at home to export of capital should be expected to rise. On a priori grounds alone, there would seem to be somewhat of a presumption that the volume of export of capital would fall absolutely as well as relatively to total investment, since domestic interest rates would be rising relative to interest rates abroad. It is even conceivable that the international movement of capital may under these circumstances reverse its usual direction, capital being borrowed from abroad or withdrawn from abroad instead of being exported.*67


It is easy, however, to conceive of a different pattern. Paradoxical though it may seem at first glance, the increased export of capital may be the cause, and may in fact constitute the bulk, of the internal expansion of business activity, where the export of capital and the export of capital goods are so closely associated that a marked expansion of capital directly involves a substantial increase in the production of capital goods. To the extent that international capital movements result directly and immediately in movements of capital goods in a corresponding direction they tend to operate as an inflationary rather than a deflationary factor in the capital-exporting country, and perhaps also as a deflationary instead of an inflationary factor in the capital-importing country. It is the fraction of the capital movement which takes the form of a specie movement which exercises the deflationary influence in the capital-exporting country and the inflationary influence in the capital-importing country. The specie phase of a capital movement represents for the exporting country domestic saving with which domestic investment is at least not directly associated, and for the importing country it represents domestic investment unaccompanied by domestic saving. The capital-goods phase of a capital movement, on the other hand, may represent for the exporting country an increase in domestic investment whose products are, in part only, to be transferred abroad, and for the importing country may result in decreased domestic investment.*68


Given this wide range of possibilities, I see no a priori grounds for expecting to find a significant correlation, whether positive or negative, between the fluctuations in the export of capital by particular countries and the fluctuations in their general level of business activity, unless there is ground for assuming that capital-exporting countries are typically countries whose business cycles always precede or always lag after world cycles, or are countries in which fluctuations in the volume of foreign investment are major factors in initiating fluctuations in the internal level of business activity rather than by-products of the latter.*69


Similar reasoning leads also to skepticism as to the validity of the grounds on which it is often argued nowadays that free trade exercises in general a stabilizing influence. It is held that foreign trade exercises a moderating influence on the amplitude of the cycle, since internal expansion tends to result in an adverse trade balance, with its deflationary pressure, while contraction tends to result in a favorable trade balance, with its inflationary stimulus.*70 This moderating influence, however, operates exclusively in the country where the infection starts or is making most rapid progress. For other countries the trade balance is, with capital movements, sympathetic price trends, and psychological contagion, a major vehicle for the international spread of the infection. I would agree that high tariffs bear an important share of the responsibility for the recurrence of major booms and depressions, but on different considerations. Without rigid price structures, major business cycles are inconceivable, and high tariffs are an important factor in making price rigidity possible.

Notes for this chapter

Overstone, Further reflections on the state of the currency, 1837, pp. 33-34.
John Welsford Cowell, Letters...on the institution of a safe and profitable paper currency, 1843, pp. 45-46.
Edwin Hill, Principles of currency, 1856, pp. 2-3.
The types of secondary-operations of an offsetting character should perhaps be further subclassified, so as to distinguish partially offsetting, exactly offsetting ("neutralizing"), and over-compensating secondary fluctuations.
Cf., however, Isaac Gervaise's treatment of "credit," in 1720, supra, p. 81.
James Pennington, in a letter published in Tooke, A History of Prices, II (1838), 377-78.
Torrens, Reply to the objections of the Westminster review, 1844, p. 12.
The evidence, given by Lord Overstone, before the Select Committee...of 1857, 1858, p. 181.
Principles, Ashley ed., p. 670.
Cf. On the regulation of currencies, 2d ed., 1845, p. 78: "for every ounce of gold received into the Bank of England, a corresponding weight in coin, or an equivalent in bank-notes [or in deposits?], is issued to the public."
Cf. ibid., p. 79: "The Bank meanwhile will have its notes flowing in fast, in payment of the bills of exchange previously in its hands, as they successively become due, while there will be no vent for its notes in fresh discounts; and the result of the whole will be, that, at the end perhaps of a week, the Bank will find itself with a million more of coin in its coffers, and a million less of securities." (I.e., the primary expansion of £1,000,000 would, after a week, be offset by a secondary contraction of £1,000,000.)
Henry Sidgwick, The principles of political economy, 1st ed., 1883, p. 265. The same passage appears unchanged in the later editions.
Angell comments on this passage: "No particular proof is offered to show why this is necessarily so. What we should now call the 'direct' effects of influxes of gold are rather passed by; that is, the effects proceeding from outlays by the gold importers themselves, other than through the mediation of the banks." (Theory of international prices, p. 118, note.) This seems to be recognition of the omission by Sidgwick of what I call the "primary expansion" phase of the mechanism. But Angell comments on the passage as a whole, apparently with reference to Sidgwick's recognition of the role of interest rate fluctuations in the mechanism, that "it is at once apparent...that we have here something quite new in English theory." (Ibid., p. 118.) As has been shown above, however, recognition of the part played by interest rate fluctuations was common during the currency controversies earlier in the century.
J. L. Laughlin, Principles of money, 1903, p. 387.
A. C. Whitaker, "The Ricardian theory of gold movements," Quarterly journal of economics, XVIII (1904), 241ff.
Alfred Marshall, "Evidence before the Indian Currency Committee" [1899], reprinted in Official papers by Alfred Marshall, 1926, p. 282. ("Currency" is to be interpreted here as specie.) Cf. also ibid., Money credit & commerce, 1923, p. 229.
Principles of economics, 1913, p. 370.
Cf., e.g., G. J. Goschen, The theory of the foreign exchanges, 1861, pp. 129-30, and R. G. Hawtrey, The art of central banking, 1932, p. 142.
If the gain which can be anticipated on the turn of the exchanges exceeds the loss on the interest differential, it will pay even to transfer funds from the high to the low interest rate market. The amount of differential in interest rates necessary to move short-term funds in the same direction as the gold movements will be greater than the amount of differential in interest rates necessary to move them in the opposite direction from the gold movements.
Axel Nielsen warns against exaggerating the international mobility of short-term capital: it is only a fraction of the short-term funds that is truly "cosmopolitan,"—Bankpolitik, II (1930), 279 ff., as cited by Carl Iverson, Aspects of the theory of international capital movements, 1935, p. 239.
Cf., e.g.: A. F. W. Plumptre, "Central banking machinery and monetary policy," The Canadian economy and its problems, 1934, p. 197; A. D. Gayer, Monetary policy and economic stabilization, 1935, pp. 10-11; W. Edwards Beach, British international gold movements and banking policy, 1881-1913, 1935, pp. 17-18.
Cf., however, Henry Thornton, with reference to what would happen under a metallic standard and with no legal restrictions in interest rates if England's exports were curtailed by embargoes or other wartime disturbances:

Doubtless much of our gold coin would be taken from us; and, perhaps, a larger quantity of this than of other articles. The whole, however, would not leave us; a high rate of interest would arise, and this extra profit on the use of gold, which would increase as its quantity diminished, would contribute to detain it here—some foreigners, probably, transferring property which would take the shape of the precious metals, or continuing to afford to us the use of it for the sake of this high interest. (Substance of two speeches...on the bullion report, 1811, p. 10.)
Cf. (Commons) Report...on the expediency of the Bank resuming cash payments, 1819, appendix no. 43, p. 354; Sir John Sinclair, The history of the public revenue of the British Empire, 3d ed.III [1804], appendix no. 5, pp. 160-63; John Hill, An inquiry into the causes of the present high price of gold bullion in England, 1810, p. 36; G. R. Porter, The progress of the nation, new ed., 1851, pp. 628-29.
Cf. David Salomons, A defence of the joint-stock banks, 2d ed., 1837, p. 12:

...I...assert that their transmission [i.e., of British funds for investment abroad] has on the whole been favorable to commerce, that they have tended to regulate the exchanges, instead of having had an injurious effect on them; and many most important payments could not have been made, without the powerful assistance derived from the export of foreign stock, as the most ready means of payment. It will be, indeed, difficult to show how such descriptions of foreign funds, for which a ready market exists on the Continent as well as in London, could at all injuriously affect the exchanges. Such funds are, in truth, a universal currency, and payments either at home or abroad can be made by their transmission, and the balance of trade as readily adjusted, as by an import or export of the previous metals.
Cf. Fullarton, On the regulation of currencies, 2d ed., 1845, p. 149:

Since the practice, however, of investing capital in foreign securities has become general in this country, a new element has been introduced into the economy of our exchanges. The capital required for the liquidation of a foreign debt may be transmitted as well in the form of a marketable security for money, as in gold or merchandise. And, as the price of such securities rises and falls with the fall and rise of the market rate of interest, and the securities themselves accordingly are in a continual course of transition from places where the rate of interest is high to places where it is low, the fluctuations of interest have become an engine of some importance in the regulation of the exchanges, and to the extent of their action, are found certainly a more manageable and safe instrument for facilitating foreign payments and correcting irrgularities in the distribution of the precious metals, than the fluctuations of price.

Cf. also, supra, pp. 278 ff.

T. H. Milner, Some remarks on the Bank of England, 1849, pp. 17 ff., 42. He claims that "the regulation of foreign investment is...the effectual key to the regulation of the monetary affairs of the country."(Ibid., p. 18.)
Cf. "History and exposition of the currency question," Westminster and foreign quarterly review,XLVIII (1848), 468, note: "the depression of English securities may as often induce the foreign capitalist to withdraw his gold from England, by alarming him for its safety, as to send it here for profitable investment."
Cf. supra, p. 271, for one such warning in 1857.
Cf., however, Thirteenth annual report of the Federal Reserve Board, 1927, p. 16:

Dollar balances in New York have been built up not only by foreign industrial corporations and commercial banks but also by European and South American central banks, which in many instances are authorized by law to keep a portion of their reserves in the form of foreign exchange in countries with stable currencies. These dollar balances of foreign central banks, whether they are invested or kept on deposit, are in liquid form and subject to immediate withdrawal at any time. If they were to be withdrawn in gold in whole or in part the demand for the gold, though it would first be felt by the commercial banks, both member and nonmember, would promptly reach the federal reserve banks as the only holders of gold in any considerable amount. These balances are, therefore, potential sources of demand upon the federal reserve banks for gold out of their reserves, the central banking reserves of the United States, which have thus become indirectly a part of the reserves against bank credit and currencies in other countries. The existence in America of these foreign balances consequently presents a condition in the banking situation to be taken into account in determining the federal reserve system's credit policy with a view to maintaining the country's banking system in a position to meet demands for gold from abroad without disturbing business and credit conditions in this country.
In their hasty abandonment of the gold-exchange standard, the European banks of issue, according to a computation of the Banque de France, reduced their holdings of foreign short-term funds from 48,464,405,000 francs French on January 1, 1931, to 3,921,500,000 francs French on November 30, 1933, or by more than 95 per cent. The ratio of such funds to the total reserves of these banks fell during the same period from about 35 per cent to about 2½ per cent. (Cf. Federal Reserve bulletin, March, 1934, p. 164.)
From March 31, 1931, to the middle of July, 1931, withdrawals of foreign short-term funds from Germany amounted to over 1,000,000,000 marks, or over 20 per cent of the total short-term foreign indebtedness of Germany at the earlier date—"The Wiggin report," Annex V, Economist, CXIII (Aug. 22, 1931), supplement, p. 6. From June 30, 1931, to November 30, 1931, the American dollar acceptances in Europe—mostly in Germany—were reduced from about $500,000,000 to about $300,000,000 (New York Times, Jan. 4, 1932, p. 32). These withdrawals would of course have been even greater and more rapid if the debtors had met all the demands made upon them by their creditors. During this period, money rates were substantially higher in Germany than in the creditor countries, i.e., funds were moving from a high-rate money market to low-rate money markets.
League of Nations, Report of the Gold Delegation of the Financial Committee, 1932, p. 52.
The validity of this interpretation depends on how the Gold Delegation would deal with a situation such as the following: country A has a favorable balance of trade with country B, and in accordance with the rule laid down lends to B the funds with which to meet that balance. Next week, B repays this debt. Is the payment on capital account, and therefore such as to justify gold shipments, or is it on income account, and therefore to be countered by country A by a new loan to country B or to some third country? If the former answer is correct, then the proposal of the Gold Delegation amounts merely to the recommendation that specie movements should never occur immediately whenever there is not an even balance of payments on income account, but should always be delayed until they can take the form of liquidation of capital liabilities. If the latter answer is correct, as seems to me to be the case, then no gold movements would ever occur except in connection with the amortization of borrowings not made to liquidate preexisting indebtedness on incomeaccount, while borrowings could be made only for the purpose of such liquidation.
Canada's balance of international indebtedness 1900-1913, 1924, chap. VIII.
J. W. Angell: review of Canada's balance in Political science quarterly, XL, (1925), 320-22; "The effects of international payments in the past." National Industrial Conference Board, The inter-ally debts and the United States, 1925, pp. 140-53; The theory of international prices, 1926, pp. 170-74, 505-10.
Canada's balance, p. 177. (The italics were not in the original text.) Cf. also ibid., p. 164, and the explanation given of the constituent items in my "secondary reserves" series in chart II, pp. 166-67, as "Call loans elsewhere than in Canada, and net balances due from banks outside Canada."
Theory of international prices, pp. 172-73. (Italics in the original text.)
Angell's impression that there were two versions derives from the distinction which he makes between the significance for the mechanism of fluctuations in the holdings of sterling and of New York funds, respectively, a distinction I did not make.
Angell means presumably by "credit expansion" what I here call secondary expansion, and by "direct" effect on the volume of Canadian deposits what I here call primary expansion. Angell's failure to notice the meaning and importance I attached to the fluctuations in "foreign loan deposits" is responsible not only for his own error in attributing to me the doctrine that secondary expansion was the important factor, but for a similar error on the part of a number of other writers who have obviously accepted Angell's account of my position as accurate. Cf. especially, Iversen, who takes me to task for neglecting what I did my utmost to emphasize, and, I now believe, in fact overemphasized: "Here again Viner seems to underestimate the implications of his restatement, which clearly suggests a direct connection between foreign loans and volume of purchasing power." (Aspects of the theory of international capital movements, 1935, p. 236. Italics in original.)
That this is a correct interpretation of Angell's position is indicated by the following and other similar passages: "The crux of the explanation is the proposition that the importation of capital increases the supply of bills offered in the local exchange market for discount relative to the demand, thus increasing the bank's average holdings of such bills. A corresponding increase in the volume of bank deposits results; and if it is on a large scale produces the indicated effects on prices and the commodity balance of trade." (Theory of international prices, p. 173, note. Italics not in original text.) If the fluctuations in deposits "corresponded" with the fluctuations in holdings of foreign "bills," the fluctuations in deposits would be solely primary. Angell sometimes speaks of the bills being "discounted," and sometimes of their being "exchanged" for deposits, and treats these as identical phenomena. The latter was the usual procedure, as the bills were predominantly sight bills, frequently drawn on an outside agency of a Canadian bank. Under the former procedure, an original secondary expansion would be transformed, after a few weeks, into a primary expansion when the bills became due and their proceeds were used by their owners to liquidate their indebtedness to the Canadian banks. The volume of Canadian deposits would not change, but the offsetting bank assets would change from loans to holdings of foreign funds.
The relationship I trace for Canada between the "outside reserves" and the "foreign loan deposits" corresponds closely to the relationship emphasized in recent years by students of Australian and New Zealand banking between the holdings of London funds by Australian banks and the variations in the excess of domestic deposits over domestic advances. Cf. e.g., A. H. Tocker, "The measurement of business conditions in New Zealand," Economic record, I (1925), 51 ff.; K. S. Isles, "Australian monetary policy," ibid., VII (1931), 1-17; Roland Wilson, "Australian monetary policy reviewed," ibid., 195-215.
Cf. Canada's balance, p. 155.
Cf. especially, Theory of international prices, p. 174:

But I think that Professor Viner's data warrant the inference—despite the opposite conclusion which he himself draws—that the classical theory is erroneous with respect to the role of gold flows, under modern conditions. The correction of the maladjustment in trade produced by the loans did not come from the effects of the gold flows, or of changes in the outside bank balances. It came from the effects of the original (and prior) increase in Canadian bank deposits.

Angell seems to think that the Canadian banks converted their sterling funds into New York funds only after the increase in Canadian deposits had resulted in a rise in prices and an increase in the Canadian import surplus. (Cf. quotations from Angell, pp. 416 and 418, note 10, supra.)
Herbert Feis, "The mechanism of adjustment of international trade balances," American economic review, XVI (1925) 597. Feis explains that he uses the term "gold reserves" to include both the specie reserves held in Canada and the "outside reserves."
Ibid. pp. 598-99.
Feis, however, seems to have followed Angell in excluding sterling funds from the "outside reserves," and in taking it for granted that there was a substantial lag between the accumulation by the Canadian banks of sterling funds and their conversion into New York funds, and thus may merely be repeating Angell's argument. Cf. Feis, op. cit., p. 598: "Canadian banks sell their London funds to New York banks, thereby accumulating outside reserves." Such sales would leave the outside reserves unchanged in amount and would change only their form.
Robert M. Carr, "The role of price in the international trade mechanism," Quarterly journal of economics, XLV (1931), 711.
Cf. supra, p. 418.
This, I assume, is what Carr means by "extension of credit at home."
Harry D. White, The French international accounts 1880-1913, 1933, pp. 11-12.
Cf. Canada's balance, pp. 164-77.
White apparently at times interprets the "orthodox" doctrine, which he accepts for himself and attributes also to me, as involving only secondary fluctuations in the amount of means of payment. Cf. White, op. cit., pp. 7-8: "A year or even more may elapse before the increased reserves in the gold receiving country result in increased demand liabilities."
Theory of international prices, appendix B, pp. 505-10, and "The effects of international payments in the past," loc. cit., pp. 140-53.
Theory of international prices, p. 506.
Ibid., p. 508. (Italics are in original.)
Ibid., p. 506.
To get his "net capital imports" series Angell also subtracts the net interest payments by Canada from the borrowings. Since he also excludes the net interest payments from his "final means of payment" series, these operations cancel out and do not affect his "excess of net capital imports over final means of payment" series.
Cf. Angell, Theory of international prices, p. 510, table 1, col. 2; ibid., "The effects of international payments in the past," loc. cit., p. 141, table 22, col. 13 ("net capital imports") =col. 4 (my direct estimates of Canadian borrowings abroad) plus col. 3 (interest received by Canada) minus col. 8 (my estimates of Canadian investments abroad) minus col. 9 (interest paid by Canada). For the inclusion in my estimates of Canadian investments abroad (col. 8 in Angell's table 23) of the net increases in Canadian bank holdings of outside funds, see Canada's balance, pp. 92-93, table XXIV, and p. 94, table XXV.
"The role of price in the international trade mechanism," Quarterly journal of economics, XLV (1931), 718.
Cf. Canada's balance, p. 30, table II, col. IX, minus col. VIII. White has pointed this out with reference to Carr's argument. (The French international accounts, p. 15, note 1.)
Canada's balance, p. 187, chart III.
The French international accounts, pp. 30-31.
That this sometimes occurred appears more clearly in the monthly data.
Cf. especially, Taussing, International trade, 1927, pp. 207-08.
Although the data are not here presented, this was not only an absolute growth but a growth relative to the trend of bank deposits in the United States and England.
Cf., however, Wesley Mitchell, Business cycles, 1927, p. 447:

...prosperity, with its sanguine temper and its liberal profits, encourages investments abroad as well as at home, and the export of capital to other countries gives an impetus to their trade.
Cf. K. Wicksell, Lectures on political economy, 1935, II, 100-02; Marco Fanno, "Credit expansion, savings and gold export," Economic journal, XXXVIII (1928), 126-31; and, for gold movements, Saint-Peravy, in 1786! (Supra, p. 187.) ("Investment" is used here to mean expenditures for productive purposes.)
Cf., for substantially similar conclusions, J. W. Angell, Theory of international prices, 1926, pp. 174, note; 396-97; 527-28; and the additional references listed in his index, p. 561, under "Cyclical movements of business."
Cf., e.g., Folke Hilgerdt, "Foreign trade and the short business cycle," in Economic essays in honour of Gustav Cassel, 1933, pp. 273-91.

Chapter VIII

End of Notes

12 of 16

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