Price–specie flow mechanism

Under Gold automatism is understood with gold or gold-backed currencies, an automatic balancing mechanism for the balance of payments in trade between countries. The concept proposed in particular by David Hume came eg during the period of so-called gold standard until 1914 used.

• 2.1 Implied conditions
• 2.2 Effects

Hume's remarks on the gold automatism

The Gold Standard includes many strong, automatically acting mechanisms. These work towards a simultaneous balance of payments of all countries. The most significant case is the gold automatism ( gold standard mechanism ), which was declared in 1752 by David Hume, a Scottish philosopher.

" Assuming that overnight four-fifths of the entire money would be destroyed in the UK, which means that the nation would be put in the same state in terms of hard cash as at the time of the government of Henry and Edward, what could be the impact? The price of all labor and goods would drop accordingly and sold as cheaply as in those days. This raises the question of whether a nation then contact us in foreign markets in competition or operate at comparable prices or shipping could sell goods, so that sufficient profit can be achieved. In what period of time then could the money that was lost, be brought back to raise us to the level of all the neighboring nations? If we had but this is reached, all the advantage would be lost due to cheap labor and goods and the more cash flow slowed down by fullness and satiety. Would you continue to assume that all of the money Britain would multiply overnight by five times, then the opposite effect could occur. All work and goods would rise to infinite heights and no adjacent region would be able to buy our goods. Again, would their goods so cheap that they would inundate us with it and withdraw our money. The consequence would be that we would fall to a level with the foreigners and would lose the great superiority in wealth, which would have turned us is such disadvantages? "

Hume's description of gold automatic translated means that it is assumed that the current surplus of power and capital account Britain's deficit is greater than that of the capital account (excluding reserves). Because the net imports of foreign countries from the UK are not fully funded by British loans, you have a certain part due to the inflow of international reserves - ie Gold - are covered by the UK. Of the increase of gold automatically lowers the foreign money supply and expands the British money supply. As a result, the foreign prices go down and the UK prices are pushed up. Hume figured develop the level of prices and the amounts of money in long -term proportional.

The increase simultaneously the British prices and the fall in foreign prices lowers foreign demand for British goods and services and at the same time increases the British demand for foreign goods and services. These shifts in demand lead to a reduction of the British power surplus and the foreign current account deficit. Therefore come over a longer period the reserve movements to a halt and both countries achieve a balance of payments equal Wicht. The process also works in the other direction and would thus eliminate a starting point, there is a deficit in excess abroad and in the UK.

Reference to the money-price mechanism

Originally, this mechanism was developed under the assumptions of the gold standard. In this monetary system the central banks are obliged to buy and sell gold at a fixed price. Therefore, in the countries of a fixed relationship between the unit weight of gold and the face value of the currency unit. Thus, the exchange rate is determined: Are namely all currencies in a fixed relation to gold, so they are also among each other in a fixed ratio.

In Hume's work Political Discources he treated the role of money and interest rates in the economy, international trade policy or the funding of the state via taxes and loans, for example. If you look at the discussions on the importance of money, all agree that money is essential as a means of exchange for the national and international trade, otherwise the specialization of production and exchange, are completely unprofitable or even completely lost the gains from exchange went. Hume emphasizes this argument in his essay Of Money. He uses the medium of exchange, ie money, gold and silver coins, so with hard money, equal and distrusted paper money if it can not be immediately converted into hard cash. Furthermore, one agrees that there is a correlation between the change in the money supply and a change in the price level. However, the exact mechanism and the exact quantitative relationship over time out, in which the change in the money supply causes price changes, one is in disagreement. Hume noted that over a longer period the money supply more slowly than prices climb. The result is indeed a stable relationship between money and prices, but not proportional. According to Hume's statement is so because any price regulation takes time and a gradual increase in demand, which arises due to an increased amount of money can be compensated by adjusting product selection. Hume concludes: " The well-being of a state does not depend on whether the money is available in a larger or smaller amount. The correct policy of the government is to increase the money supply if possible, as this is maintained in the nation's industriousness, and the working potential increases, which forms the actual economic power and wealth. "

In his Essay On Republic Credit Hume gives to understand that the state should not rely solely on the multiplication of paper money as a means of controlling the money supply. A growing national debt and the issue of state bonds would reduce only the confidence in the currency and much more likely to trigger an inflationary effect as an expansion of production. The government could its money supply, that is, the amount of gold and silver coins only affect you if it provides for conditions that would an expansion and development of trade with the money owners or the gold and silver producers allow the citizens. " A government has good reasons to treat their citizens and manufacturers with care. In money matters, they may rely safely on the course of events " ( from the essay Of the Balance of Trade ). Hume's view of money is the starting point to discuss another important economic problem, namely Hume's theory of interest. It was in his time as secured thesis that one of the benefits of the money supply increase lies in the reduction of the interest rate. Hume raises the question of how one can test the statement. Assume that the assertion is true, then would countries with a relatively large amount of money have relatively low interest rates. But this is not the case. He notes that this assumption is implausible anyway. A doubling of the money supply just means that a greater quantity of labor and goods you borrow and you would have to pay back the equivalent money value plus the interest, the interest rates are a certain portion of the money equivalent. There is no reason for believing that this share of the value of money would simply be changed because the value of the work or the goods has ( in terms of money ) is changing.

Respect to the quantity theory

The description of Hume based on the quantity theory of prices, a key theory about general price level, with which the macroeconomics busy. " The quantity theory states that the domestic price level changes each in the same direction develop as the changes in the money supply relative to the demand for money. " Under the gold standard, gold was an important part of the money supply, either directly, in the form of gold coins, or indirectly when the States Gold used to cover their paper money. Hume's theory of the balance of payments:

Suppose that the U.S. had a large trade deficit and would therefore start to lose gold. True to the quantity theory reduces this loss of gold the U.S. money supply and thus lowers prices and costs in the United States. As a result, the U.S. is reducing its imports of British and other foreign goods. These have become relatively more expensive. Since the goods produced in the United States have become relatively cheap on world markets, increase American exports.

The opposite effect occurs in the UK and other countries. With a huge increase in UK exports, the country receives in return gold. The British money supply increases. This drives, according to the quantity theory, the British prices and costs in the amount. Two other phases of the mechanism of Hume added: The British and other foreign exports have become more expensive, thus decreases the volume of products exported to the United States and in other countries goods. The British citizens now import the face of a higher domestic price levels, larger quantities of cheap American goods. The result is an improvement in the balance of payments of a country that loses gold, and a deterioration in the balance of payments, the gold wins.

Hume and the mercantilists

The second starting point of the monetary theory of Hume can be found in his analysis of international trade. Hume examined the known mercantilist view that international trade and payments would be subject to severe restrictions, otherwise the UK could threaten the impoverishment and lack of its circulating gold currency as a result of balance of payments deficits. Hume refuted their arguments by showing that the adjustment of the balance of payments would automatically ensure a sufficient supply of money in all countries. Mercantilism saw in silver and gold, the mainstays of national wealth and the essential precondition for a lively trade. Therefore, any outflow of precious metals prepared the mercantilists great concern. Its main political goal was to ensure a constant balance of payments surplus.

Hume showed that a constant surplus is impossible. Because of the influx of precious metals increased domestic prices and the balance of payments balances, the excess will disappear with time. Similarly, a lack of cash lowers the domestic prices and produced a surplus in payment transactions with foreign countries. This puts money in the required amount in the country. According to Hume, any intervention of the state in international trade would harm the economy without generating the increase in " wealth and prosperity " which envisioned the mercantilists. Hume pointed out that the mercantilists a single and relatively minor part of the national wealth, namely precious metals, overvalued, meanwhile they overlooked his main source, the productive capacity.

Formation

In a country grows the demand for its currency stronger than supply, eg because this country exports a lot, so the exchange rate of that currency rises to the so-called " gold dot". Is this gold point is reached, it must be paid for the importer " cheaper " place in the currency of the exporting country directly in gold, as the price increase this currency is higher than the transport and insurance costs for the transport of gold in the exporting country. This reduces the amount of gold in the importing country and increased the same in the exporting country. Because in countries with currencies gold quantity of gold is equal to money supply, thus also reduces the money supply in the importing country.

Implied conditions

Conditions for the functioning of the gold automatism are flexible prices and wages, ie in money and earn gold propagation in an economy through export surplus prices and wages must rise there and vice versa. Another requirement is that international free trade, ie no customs duties or other import and trade restrictions and finally world peace and international confidence.

Effects

By reducing the amount of gold money and thus in the importing country, the prices tended to go there ( deflation) and the importing country is competitive. In contrast, the money and amount of gold increases in the exporting country, so there is always tend to have higher prices ( inflation) and the competitiveness on the world market decreased. This mechanism, at least in theory, ensures that the economies that have a gold currency, tend to develop uniform and the balance of payments of the participating economies remain balanced in the long run. This system ensures that no economy can gain a competitive advantage by unilateral devaluation of the domestic currency on the world market. A unilateral devaluation is therefore not possible, as in the gold countries gold amount is equal to money supply and thus the money supply can not be influenced by administrative measures of a government or central bank.

"Rules" of the gold standard

The gold automatism could theoretically work by itself, but the steps taken by the central banks actions reinforced this, since they also hinwirkten on a balance of payments of all countries. The reactions of central banks on inflows and outflows of gold also presented a mechanism dar. central banks with permanent gold losses had the risk of someday not being able to meet their obligations to the exchange of banknotes. They were therefore made in phases of domestic gold losses to sell assets, raise interest rates and attract capital from abroad. Central banks, which recorded an inflow of money, felt far less incentive to stop their imports of the precious metal. The biggest incentive was in the higher returns of interest-bearing domestic assets compared to gold. A central bank, the accumulated gold, the temptation was exposed to acquire domestic assets in order to reduce domestic interest rates to increase the outflow of capital and drive gold abroad.