INTERNATIONAL TRADE 
 AND EXCHANGE 
 
THE MACMILLAN COMPANY 
 
 NEW YORK BOSTON CHICAGO DALLAS 
 ATLANTA SAN FRANCISCO 
 
 MACMILLAN & CO., LIMITED 
 
 LONDON _ BOMBAY CALCUTTA 
 MELBOURNE 
 
 THE MACMILLAN CO. OF CANADA, LTD. 
 
 TORONTO 
 
INTERNATIONAL TRADE 
 AND EXCHANGE 
 
 A STUDY OF THE MECHANISM AND 
 ADVANTAGES OF COMMERCE 
 
 BY 
 
 HARRY GUNNISON BROWN 
 
 INSTRUCTOR IN POLITICAL ECONOMY 
 IN YALE UNIVERSITY 
 
 THE MACMILLAN COMPANY 
 1914 
 
 All rights reserved 
 
COPYRIGHT, 1914, 
 BY THE MACMILLAN COMPANY. 
 
 Set up and clectrotyped. Published November, 1914. 
 
 NottoootJ 
 
 J. 8. Gushing Co. Berwick & Smith Co. 
 Norwood, Mass., U.S.A. 
 
PREFACE 
 
 IN this book I have aimed to cover the theory of 
 international and in^ranational trade, with due consid- 
 eratiorTof the exchange mechanism of such trade, and 
 with some reference to the effects of government inter- 
 ferences with trade. The larger emphasis, as the title 
 of the book suggests, is on international trade ; but the 
 similarity of principle in intranational trade is not over- 
 looked. 
 
 I originally planned a somewhat longer work, on the 
 Principles of Commerce, to include also, as Part 
 The Transportation Expenses of Commerce. The carry-! 
 ing out of this plan has not been given up ; but it h; 
 seemed advisable not to delay the publication of Parts 
 and II, which together make a unified whole, until 
 Part III is likewise ready for printing. My hope is 
 that the larger book may be completed and published 
 in the not distant future. In the meanwhile, the present 
 book, containing, perhaps, a more conventional combi- 
 nation of topics, may possibly fill a place which the 
 more extended work could not fill. 
 
 Part I deals chiefly with the subject of Foreign Ex- 
 change, though it also contains two introductory chapters 
 on Laws of Money and The Nature of Banking, which, 
 in my judgment, make possible a clearer understanding 
 of the economic theory of foreign exchange operations. 
 In this Part, I have endeavored to analyze, more fully 
 than is usually done, the interrelations of different per- 
 sons, buyers and sellers, et al, in the credit mechanism 
 
 Y 
 
 3438 
 
vi PREFACE 
 
 of exchange, to show who are the ultimate creditors 
 when bank checks and bank notes are used in trade 
 and when bills of exchange (especially " long bills ") are 
 used. Thus, after the explanation of the nature of 
 banking, the reader is led, in Chapter III, The Nature 
 and Method of Foreign Exchange, to an appreciation of 
 the international nature of the credit relations growing 
 out of trade. The flow of money from country to coun- 
 try having been explained briefly in Chapter I, the 
 relation of this flow to the rate of exchange and to 
 fluctuations in the rate of exchange is set forth at 
 length in Chapter V. In the last chapter of Part I, 
 emphasis is placed on the fact, ordinarily passed with- 
 out mention, that whatever may be the relation or non- 
 relation of the currency of a country to the currencies 
 of other countries, its trade with them cannot all be 
 either an export or an import trade for any great while, 
 without introducing a tendency to a reverse flow or to 
 equilibrium. 
 
 Part II begins with a discussion of the gains of trade, 
 whether the trade is between countries or wholly within 
 a single country. Attention is then turned to the con- 
 ditions determining the share which each of two or more 
 countries gets from trade between them. The remain- 
 der of Part II is devoted to a consideration of revenue 
 tariffs, protective tariffs, bounties, navigation acts, gov- 
 ernment construction of canals for the free use of com- 
 mercial interests, land grants in encouragement of 
 railroad building, etc. Proposals for such indirect en- 
 couragement to commerce as is afforded by the last two 
 policies, are perhaps no less frequent and insistent than 
 are proposals for its direct encouragement by means of 
 bounties or for its discouragement by means of pro- 
 tective tariffs. Analysis of the effects to be expected 
 
PREFACE 
 
 Vll 
 
 from such policies may be as important, therefore, as 
 analysis of the effects of a protective tariff or bounty 
 system. 
 
 The preliminary analysis of the mechanism of trade, 
 given in Part I, makes it easy to discuss international 
 trade, protective tariffs, etc., in terms of money prices 
 as well as more generally. To many students, accus- 
 tomed to think in terms of money prices, even in terms 
 of mercantilism, such a method of presentation may be 
 the only convincing one. In the case of protective 
 tariffs, not only is it shown in a general way that pro- 
 tection tends to divert a country's industry out of its 
 natural channels, but, in addition, the effects of protec- 
 tion on national wealth are traced by showing that 
 money prices are raised by this policy more than are 
 average money incomes. It is pointed out that the 
 tariff has two effects on prices, primary and secondary. 
 In the first place, the prices of protected goods are 
 directly raised by the tariff, because of the exclusion of 
 cheaper foreign goods. This rise applies only to pro- 
 tected goods, not to money incomes. Next, protection, 
 since it decreases imports, increases the quantity of 
 money in the protectionist country; and this increase 
 of money brings a secondary rise of prices affecting 
 protected goods, unprotected goods and money incomes. 
 The rise of money incomes compensates for the sec- 
 ondary rise of general prices but does not compensate for 
 the original rise of prices of the protected goods. There- 
 fore, average prosperity is decreased. In the same way, 
 the effects of protection on wages and on land rent are 
 set forth in general terms and in terms of money prices. 
 
 Throughout, I have endeavored to keep in view the 
 requirement of clearness, although not avoiding discus- 
 sion of difficult points. To this end, concreteness has 
 
viii PREFACE 
 
 been given to the arguments presented, by the use of 
 both hypothetical and real examples; and the main 
 conclusions of each chapter have been summarized in 
 the last section of the chapter. The more analytical 
 and controversial discussions have been, in large part, 
 consigned to footnotes. I have sought thus to write 
 a book which can serve as a text, but which may be 
 also not without interest to professional economists. 
 
 Acknowledgment should be here made of various 
 courtesies extended, and of the aid rendered by a num- 
 ber of friends who have done much toward removing 
 errors of statement and expression and in suggesting 
 critical and illustrative additions. To the Quarterly 
 Journal of Economics I am under obligation for permis- 
 sion to include, in Chapter II of Part I, substantially 
 without change, an article on Commercial Banking and 
 the Rate of Interest, originally published in August, 1910. 
 To Brown Brothers of New York I am indebted for 
 information on a number of special points regarding 
 foreign exchange. To one of my students, Mr. Law- 
 rence M. Marks, Yale 1914, I am indebted for the 
 calculation of seasonal sterling exchange rates, presented 
 in a footnote of Part I, Chapter IV, Section 2. Mr. 
 Franklin Escher, of New York City, editor of Invest- 
 ment, has given me the benefit of a careful criticism of 
 the manuscript of Part I, particularly regarding the 
 matter of conformity of statement to business practice. 
 To Professor F. R. Fairchild of Yale College I am 
 indebted for a searching criticism of Part I from the 
 standpoint both of theory and of form. Professor G S. 
 Callender, of the Sheffield Scientific School, Yale Uni- 
 versity, to whom I submitted the manuscript of Part II, 
 has made a number of valuable criticisms and sugges- 
 tions. I am under obligation, also, for critical reading 
 
PREFACE 
 
 IX 
 
 of a number of the more important chapters of the 
 book, to Professors Irving Fisher, Clive Day, and H. C. 
 Emery of Yale College and to Professor John Bauer of 
 Cornell University. Finally, I would acknowledge here 
 the obligation I am under to my wife, who has given me 
 valuable assistance in the gathering of data, in reading 
 and criticising the manuscript in its various stages of 
 completion, and in correcting the proof. 
 
 HARRY GUNNISON BROWN. 
 NEW HAVEN, CONN. 
 October, 1914. 
 
CONTENTS BY SECTIONS 
 
 PART I THE EXCHANGE MECHANISM OF 
 COMMERCE 
 
 FACE 
 
 CHAPTER I LAWS OF MONEY 1-25 
 
 i. Quantitative Statement of the Relation between 
 Money and Prices 
 
 2. Causa] Explanation of the Price of a Given Kind of 
 Goods 
 
 3. Causal Explanation of the General Level of Prices 
 
 4. Causal Explanation of the Value or Purchasing Power 
 of Money, the Reciprocal of the Level of Prices of 
 Goods 
 
 5. The Theory of Bimetallism 
 
 6. The Value of Subsidiary Money 
 
 7. The Value of Money as Related to the Value of a Stand- 
 ard Money Metal 
 
 8. The Level of Prices and the Value of Money in One 
 Country or Locality as Related to the Level of 
 Prices and the Value of Money in Another 
 
 9. Summary 
 
 CHAPTER n THE NATURE OF BANK CREDIT . . 26-50 
 i. How and When Credit Takes the Place of Money 
 2. How Commercial Banking is Carried On 
 3. Analysis of Relations Involved hi Commercial Bank- 
 ing 
 
 4. Why Commercial Banking Commends Itself to Busi- 
 ness Men, both as Lenders and Borrowers, so that 
 Commercial Bank Credit becomes a Substitute 
 for Money 
 5. Application of Principles Arrived at, to Bank Notes 
 
xii CONTENTS BY SECTIONS 
 
 6. Quantitative Statement of the Relation of Money, 
 
 together with Bank Credit, to Prices 
 7. Fluctuations of Bank Credit 
 8. Summary 
 
 CHAPTER III THE NATURE AND METHOD OF FOREIGN 
 
 EXCHANGE 51-76 
 
 i. The Function of Bills of Exchange 
 
 2. The Nature of Bills of Exchange 
 
 3. How Bills of Exchange Might be Used to Settle Obli- 
 gations, Assuming no Banks 
 
 4. Settlement of Obligations by Drafts (Bills of Ex- 
 change), through Intermediation of Banks, Assum- 
 ing Creditors to Draw Drafts on Debtors 
 
 5. Settlement of Obligations by Bank Drafts, when 
 Debtors Remit to Creditors 
 
 6. How Exchange Banks Make Profits 
 
 7. Various Types of Drafts 
 
 8. The Sale of Demand Drafts against Remittances of 
 Long Bills 
 
 9. Summary 
 
 CHAPTER IV THE RATE OF EXCHANGE . . . 77-102 
 
 i. The Meaning of Par of Exchange 
 
 2. The Supply of and the Demand for Bills of Ex- 
 change 
 
 3. The Effect on the Exchange Market of any Country 
 ^<> of Disturbed Political or Industrial Conditions in 
 That Country, and in Other Countries 
 
 4. Analysis of the Relations Involved in, and Explana- 
 tion of the Results of, Short Time Loans Made 
 Ostensibly by Foreign Banks, through the Inter- 
 mediation of the Exchange Market 
 
 5. Finance Bills, What they Are, Whose Accumulations 
 Make them Possible, and What are their Results 
 
 6. How a Bank in One Country and a Bank in Another 
 May, through the Aid of the Exchange Market, 
 Invest in One of the Countries for Joint Account, 
 without Either Bank Using its Own Funds 
 
CONTENTS BY SECTIONS xiii 
 
 TACK 
 
 7. Analysis of the Relations Involved in a Letter of 
 
 Credit 
 
 8. Place Speculation or Arbitraging in Exchange 
 9. Time Speculation in Exchange 
 10. Summary 
 
 CHAPTER V THE RATE OF EXCHANGE AND THE FLOW OF 
 
 SPECIE 103-125 
 
 i. The Upper Limit to Fluctuation of the Rate of Ex- 
 . change, Determined by the Cost of Exporting 
 Specie 
 
 2. Some Details Connected with the Exportation of 
 Specie 
 
 3. The Lower Limit to Fluctuation of the Rate of Ex- 
 change, Determined by the Cost of Importing 
 Specie 
 
 4. Circumstances which May Cause the Rate of Ex- 
 change to Fall Below What is Usually its Lower 
 Limit 
 
 5. The Cost of Money Shipment in Domestic Exchange 
 
 6. The Long Run Effect of a Balance of Payments from 
 One Country to Another, for Commodities or 
 Services 
 
 7) The Long Run Effect of International Investments 
 upon the Rate of Exchange and the Flow of 
 Money 
 
 8. The Long Run Effect of Various Other Payments from 
 One Country to Another 
 
 9. Summary 
 
 CHAPTER VI FURTHER CONSIDERATIONS REGARDING THE 
 
 RATE OF EXCHANGE 126-153 
 
 i. The Price of Long Drafts Determined in Part by the 
 
 Rate of Interest or Discount 
 2. How Long Drafts on Foreign Countries are Held as 
 
 Investments by American Banks 
 3. Influence on the Price of Long Drafts, of Interest 
 
 Rate in Drawing Country and of Interest Rate in 
 
 Country Drawn Upon 
 
xiv CONTENTS BY SECTIONS 
 
 4. How and Why the Bank Discount Rate Affects the 
 Price of Demand Drafts and the Flow of Specie 
 
 5. Effect of a Panic in One Country on Conditions in 
 Other Countries 
 
 6. Exchange between Two Countries when One has a 
 Gold and the Other a Silver Standard 
 
 7. Exchange between Two Countries when One has a 
 Gold and the Other an Inconvertible Paper Stand- 
 ard 
 
 8. Exchange between Two Countries when Both have 
 Inconvertible Paper Standards 
 
 9. Exchange between Two Countries, Assuming Effec- 
 tive Prohibition of Specie Shipment 
 
 10. The Effect on the Rate of Exchange of High Im- 
 port and Export Duties 
 
 11. Summary 
 
 PART II THE ECONOMIC ADVANTAGES OF 
 COMMERCE 
 
 CHAPTER I PRICES, INTERCOMMUNITY TRADE, AND THE 
 
 GAINS OF TRADE 3-18 
 
 i. The Relation of Prices in One Country to Prices in 
 Another 
 
 2. What Prices Tend to be Lower in a Given Country, 
 than Prices of the Same Kinds of Goods in Another 
 Country 
 
 (3) Trade between Two Communities when Each has an 
 Absolute Advantage over the Other, in One or 
 More Lines of Production 
 
 4. Trade between Two Communities or Countries 
 when One is More Productive than the Other 
 in Several or in All Lines, but has a Greater Advan- 
 tage in One Line or in a Few Lines, than in the 
 Rest 
 
 5. Summary 
 
CONTENTS BY SECTIONS xv 
 
 PAGE 
 
 CHAPTER II THE RATE OF INTERCHANGE OF GOODS BE- 
 TWEEN COMMUNITIES 19-38 
 
 i. The Limits to the Rate at which the Goods of One 
 Country Exchange for Those of Another 
 
 2. Conditions of Supply and Demand Determining the 
 Exact Rate of Interchange between these Limits 
 
 3. Effect on this Rate, when One of the Countries 
 Offers a Variety of Goods in Trade, and also when 
 it Receives Periodic Payments of Obligations from 
 the Other 
 
 4. Influence on Trade and the Rate of Trade of Produc- 
 tion in any Country under Conditions of Different 
 Cost 
 
 5. Extension of Hypothesis so as to Include Trade In- 
 volving More than Two Countries 
 
 6. Cost of Transportation as Related to Trade 
 
 7. Summary 
 
 CHAPTER III THE INCIDENCE OF TARIFFS FOR REVENUE 39-56 
 i. Revenue and Protective Tariffs Distinguished 
 2. When the Burden of an Import Duty Levied for Rev- 
 enue is Borne by the Levying Country 
 3. When the Burden of an Import Duty Levied for 
 Revenue is Shifted by the Levying Country 
 to Another or to Other Countries 
 4. The Ultimate Incidence of a Revenue Duty on 
 
 Exports 
 5. Summary 
 
 CHAPTER IV THE EFFECT OF A PROTECTIVE TARIFF ON 
 
 NATIONA/. WEALTH ..... 57-85 
 
 i. The EffeU of a Protective Tariff on a Country's 
 Export Trade 
 
 2. How a Protective Tariff Sets up Unprofitable Indus- 
 tries at the General Expense 
 
 3. The Effect of Potection on the Money Prices of Pro- 
 tected Goods and on the Money Prices of Unpro- 
 tected Goods 
 
rvi CONTENTS BY SECTIONS 
 
 4. Protection to Industries in which Large Scale Pro- 
 duction is Advantageous 
 
 5. Protection to Industries of Increasing Cost 
 
 6. Effect of a Country's Protective Tariff System on 
 the Cost to it of Unprotected Goods Got from 
 Other Countries 
 
 7. A Tariff "Equal to the Difference in Cost of Pro- 
 duction at Home and Abroad, together with a 
 Reasonable Profit" 
 
 8. Relative Advantages in the World's Commerce of 
 Countries having High and Countries having 
 Low or No Tariffs 
 
 9. Summary 
 
 CHAPTER V. THE EFFECTS OF PROTECTION ON THE DIS- 
 TRIBUTION OF NATIONAL WEALTH AMONG ECONOMIC 
 CLASSES AND AMONG TERRITORIAL SECTIONS . 86-115 
 
 i. Effect of Protection on the Rate of Interest and 
 Therefore on Wages 
 
 2. Brief Statement of Laws of Wages and Land Rent 
 
 3. The Effect of Protection on Wages when Protected 
 and Unprotected Goods are Produced in the Pro- 
 tectionist Country, under Conditions of Substan- 
 tially Constant Cost 
 
 4. The Effect of Protection on Wages and Rent when 
 the Protected Goods are Produced under Condi- 
 tions of Sharply Increasing Cost 
 
 5. The Effect of Protection on Wages and Rent when 
 Unprotected Goods are Produced under Conditions 
 of Sharply Increasing Cost 
 
 6. How Protection May Benefit One Section of a Coun- 
 try at the Expense of Other Sections 
 
 7. Protection as an Encouragement to Monopoly 
 
 8. Summary 
 
 CHAPTER VI A CONSIDERATION OF SOME SPECIAL ARGU- 
 MENTS FOR PROTECTION 116-143 
 
 i. The Argument that Protection is Desirable Because 
 it Keeps Money in the Protected Country 
 
CONTENTS BY SECTIONS xvii 
 
 FACE 
 
 2. The Wages Argument for Protection 
 
 3. The Make-Work Argument for Protection 
 
 4. The Home Market Argument for Protection 
 
 5. The Argument for Protection to Agriculture in the 
 
 Older Countries, against a Future when Cheap 
 
 Foods and Raw Material may not be Obtainable 
 
 from the Newer Countries 
 
 6. The Infant Industry Argument for Protection 
 7. The Argument that a Protective Policy should be 
 
 Followed hi Order to Diversify Industry 
 8. The Argument that Protection should be Applied as 
 
 a Means of Getting and Maintaining a Certain 
 
 Degree of National Self-sufficiency 
 9. Free Trade within the United States 
 10. Ethical Considerations Bearing on the Policy of 
 
 Protection 
 ii. Summary 
 
 CHAPTER VII THE NATURE AND EFFECTS OF BOUN- 
 TIES . 144-154 
 
 i. Bounties as Compared and Contrasted with Protec- 
 tion 
 
 2. The Various Possible Effects of Bounties on the Level 
 of Prices 
 
 3. The Various Possible Effects of Bounties on the 
 General Welfare in the Bounty-paying Country 
 and in the Countries with which it Trades 
 
 4. The Various Possible Effects of Bounties on Wages 
 and Rent 
 
 5. Why Bounties may be Less Objectionable than Protec- 
 tion ii Encouragement of Infant Industries is 
 in any Case to be Attempted 
 
 6. Summary 
 
 CHAPTER VIII UNECONOMICAL GOVERNMENT INTERFER- 
 ENCE WITH, AND ENCOURAGEMENT OF, TRANSPORTA- 
 TION iS5~ l88 
 
 i. Navigation Laws 
 
 2. Subsidies to Native Shipping 
 
xviii CONTENTS BY SECTIONS 
 
 PAGE 
 
 3. Indirect Subsidies, Favoring Native Ships as Com- 
 pared with Foreign Ships 
 
 4. The Free Use for Navigation of Government-built 
 Canals 
 
 5. The Improvement of Harbors 
 
 6. The Improvement of Rivers 
 
 7. Subsidies to Railroad Building 
 
 8. Summary 
 
PART I 
 THE EXCHANGE MECHANISM OF COMMERCE 
 
INTERNATIONAL TRADE 
 AND EXCHANGE 
 
 CHAPTER I 
 LAWS OF MONEY 
 
 Quantitative Statement of the Relation between Money and 
 
 Prices 
 
 PRIMITIVE trade is often a direct trading of one kind 
 of goods for another, the process called barter. The 
 exchange of knives, hatchets, guns, mirrors, etc., with 
 the Indians, in return for land and furs, with which we 
 have been made familiar in our school histories and in 
 stories of adventure, was trade of this sort. But even 
 the Indians had wampum, which they used as a medium 
 of exchange, and the highly civilized countries have 
 long since made use of money, whether of gold or silver 
 or other material, in their commerce. A study of the 
 laws of commerce involves, then, and may well involve 
 as a preliminary step, a study of the laws of money. 
 We are not likely to find that the basic principles of trade 
 are so very different with money used than they would be 
 if the world traded, supposing it conveniently could, 
 goods of one kind directly for goods of another. The 
 
2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 money-using method of trade is more efficient. The 
 motives for trade and the nature of the advantages from 
 it are the same whether money is used or not. But it 
 is worth while analyzing the commercial processes, as 
 they are actually carried on, even in many of their mod- 
 ern complications. To do so, may perhaps the more 
 clearly expose fallacies regarding trade, not uncommonly 
 held. We shall begin, then, with a study of money, 
 considered as an important part of the mechanism of 
 trade. 
 
 Money, as a medium of exchange, is a kind of wealth 
 or property for which other goods are sold and with 
 which, in turn, desired goods are bought. It may be 
 distinguished from other wealth or property by its 
 characteristic of general exchangeability. A person 
 desiring, as all do desire who are engaged in any business 
 or regular occupation or who have capital to invest, to 
 dispose of some kinds of goods or services in exchange 
 for others, does not need to seek out those who both want 
 what he has to sell and will sell what he wants to buy and 
 with whom he can make a satisfactory trade "in kind." 
 Instead, he sells for money, for a universally desired 
 medium, what he has to dispose of, to whoever desires 
 it, and, with this money as purchasing power, seeks out 
 those who have for sale what he himself wishes to buy. 
 The use of money is an intermediate step in what is still 
 the exchange of goods for goods. In order that money 
 may perform its function of facilitating trade, both goods 
 to be sold and goods to be bought must be valued in 
 terms of money. Money becomes a measure of value 
 as well as a medium of exchange. One kind of goods 
 will have a higher value, measured in money, than an- 
 other kind ; if its cost of production is greater, or if, for 
 
LAWS OF MONEY 3 
 
 any other reason, only the higher value will equalize 
 supply of and demand for this kind of goods. The same 
 relation of values, between two sorts of goods, would 
 exist if money were not used, but the use of money makes 
 it measurable in a generally familiar standard. 
 
 An analysis of the prices or values of one sort of goods 
 as compared with those of other sorts, leads us to a con- 
 sideration of the special forces of demand and supply, 
 such as utility and cost of production, acting upon such 
 goods. In studying the laws of money we need to attend 
 not so much to the conditions determining the value of 
 one kind of goods in relation to some other kind or kinds, 
 as to the conditions determining the average value of 
 goods in relation to money, and vice versa. We have to 
 consider, that is, the general level of prices, and conversely 
 the purchasing power of money. 
 
 This relation between money and other goods has sev- 
 eral times been given a mathematical form of statement. 1 
 Let S represent the total amount of money (number of 
 dollars) spent in a given community during a given 
 period of time, say a year. Let M represent the (average) 
 number of dollars in that community during the same 
 period. Then the average number of times a dollar is 
 spent during the year will be S/M. This is the velocity 
 of circulation of money and may be called V. 
 S = MS/Mj and therefore, by the method of substi- 
 tution, 5 = M V. In words, the total dollars spent for 
 goods is equal to the number of dollars in the community 
 times the average velocity of circulation of those dollars. 
 
 But the total number of dollars spent for goods is also 
 
 1 For instance, Newcomb, Principles of Political Economy, New York (Har- 
 per), 1885, p. 346; Edgeworth, "Report on Monetary Standard," Report of the 
 British Association for the Advancement of Science, 1887, p. 293; Hadley, 
 Economics, New York (Putnam), 1906, p. 197. 
 
4 THE EXCHANGE MECHANISM OF COMMERCE 
 
 equal to the sum of the quantities of all the kinds of 
 goods bought, times their respective prices. Let the 
 price per pound and the number of pounds of sugar 
 bought be represented respectively by p and q, the price 
 per bushel of wheat and the number of bushels bought 
 by p' and q f , and so on. Then the total number of 
 dollars spent for goods, i.e. S, is equal to pq + p'q' + etc. 
 Since two things equal to the same thing are equal to 
 each other, and since 
 
 S = M V and also 
 S = pq + P'<l' + etc., 
 therefore 
 
 M V = pq + p'q' + etc. 
 
 This is the mathematical statement of the so-called 
 quantity theory of money, omitting, however, any 
 reference to credit currency. 1 It asserts simply that the 
 quantity of money times its velocity of circulation, equals 
 the prices of goods bought with money, times the quan- 
 tities bought. The conclusion follows, therefore, that 
 if the quantity of money, M, increases, while the velocity 
 of circulation and the volume of trade remain the same, 
 prices will rise in the same proportion. A decrease in 
 the amount of M would, on the same assumption, be 
 accompanied or followed by a fall in the money prices 
 of goods. An increase in the q's 2 or volume of trade 
 would, other things equal, occasion a fall of prices ; and a 
 decrease in the g's, a rise of prices. 
 
 1 For consideration of credit, see Chs. II and HI (of Part I). 
 
 'The q's or quantities of goods should be held to include not only finished 
 goods exchanged in trade and goods purchased for raw material, but also the 
 additions made by labor to the utility of goods and paid for in wages and the 
 additions made by the service of "waiting" and paid for by means of interest, 
 dividends, etc. 
 
LAWS OF MONEY 5 
 
 2 
 
 Causal Explanation of the Price of a Given Kind of Goods 
 
 A quantitative or mathematical statement of a prin- 
 ciple is not, however, an adequate explanation of that 
 principle. In this case, the explanation must be found 
 in the working of the market, in competition with each 
 other of buyers and of sellers. This means that there 
 must be an analysis of the forces of supply and demand in 
 relation to general or average prices, in addition to the 
 usual study of those forces in relation to particular 
 prices. 
 
 The price of any particular kind of goods, say the 
 price of wheat per bushel, is commonly said to be fixed 
 by the equation of supply and demand. But these 
 terms are frequently misunderstood. For example, 
 supply is sometimes thought of as the total stock. 
 Demand is thought of as the amount wanted by pur- 
 chasers, but without much reference to the exact condi- 
 tions determining this amount. As a matter of fact, 
 supply is not the total stock of a good, whatever relation 
 it may have to this stock. Supply is different according 
 as price is different. Hence any reference to supply 
 should specify a price. The supply of any good at a 
 given price is the amount which sellers are ready to 
 dispose of at that price. 1 Thus, the supply of wheat 
 at a price of $1.10 per bushel may be, in a given market, 
 i ,000,000 bushels. That is, at a price of $i . 10 per bushel, 
 there are so many persons ready to sell wheat and ready 
 to sell such quantities, that 1,000,000 bushels may be had. 
 
 1 See J. S. Mill, Principles of Political Economy, Book III, Ch. II, 4- 
 One of the best recent presentations of the theory of supply and demand is to 
 be found in Fisher, Elementary Principles of Economics, New York (Macmillan), 
 1912, Ch. XV. 
 
6 THE EXCHANGE MECHANISM OF COMMERCE 
 
 In general, the higher the price, the larger, other things 
 equal, will be the supply ; and, similarly, the lower the 
 price, the smaller will be the supply. If the price of any 
 good is lower relatively to other desired goods, producers 
 and sellers will be less inclined to bring the good to market 
 for disposal, and may even turn their attention to other 
 lines. If the price is higher, they will be more inclined 
 to sell large quantities, and some may be tempted to 
 forsake other lines to produce the good in question. 
 
 In the same way, reference to demand should specify 
 a price. Analogously, the demand for any good at a 
 given price is the amount that purchasers stand ready to 
 take at that price. If at $1.10 per bushel the demand for 
 wheat is for 1,000,000 bushels, then the number of per- 
 sons wishing to buy wheat is such, and the amounts they 
 individually stand ready to buy are such, as to make 
 an aggregate of 1,000,000 bushels. Other things equal, 
 demand rises as price falls, and falls as price rises. The 
 lower the price of any good in relation to prices of other 
 goods, the more ready are purchasers to buy it ; and the 
 higher the price, the less ready. The price of any good, 
 whether of cotton, labor services, bills of exchange or 
 anything else marketable, is fixed where supply and 
 demand are equal. 
 
 It is not, however, an explanation of price merely to 
 state that it is fixed where supply and demand are equal. 
 It is necessary further to inquire why price is fixed at that 
 point. If supply of and demand for wheat in a given 
 market are equalized at $1.10 per bushel, why may not 
 the price nevertheless be $i ? If we assume $i to be the 
 price, we see that such a price represents a position of 
 unstable equilibrium. At this price, the demand would 
 be in excess of the supply. The persons anxious to buy 
 
LAWS OF MONEY 7 
 
 wheat are ready to buy, at this price, more than can be 
 had, and since even at $1.10 the amounts they will buy 
 are equal to the amounts they can get, it appears that 
 there are many who would gladly pay more than $i per 
 bushel rather than go without wheat entirely. Here, 
 then, are persons, many of whom would pay more rather 
 than not get the wheat, the aggregate of whose desired 
 purchases at $i per bushel must exceed the total supply 
 offered. If $i is the price, some who would gladly pay 
 that and more cannot get the wheat they desire. 1 Each 
 intending purchaser will fear that he will be one of those 
 who fail to get what they wish. Since all cannot be 
 satisfied and since he himself may not be, he is likely to 
 offer more than $i in the hope that sellers will be per- 
 suaded to sell to him, at least. But he is not likely to 
 offer more than $1.10. According to our hypothesis, 
 a price of $1.10 will bring forth a supply fully equal to 
 the demand. Even if other buyers are foolish enough to 
 offer a higher price and are sold to in preference, yet since 
 the demand of these others would not absorb the entire 
 supply, a purchaser who offered $1.10 would secure the 
 wheat desired. 
 
 As the price is kept from going below that height which 
 equalizes supply and demand, by the competition of 
 buyers, so, by the competition of sellers, it is kept from 
 going above that height. If $1.10 a bushel is the equal- 
 izing price, the competition of sellers will prevent the 
 price from being higher, say $1.15. For at $1.15 there 
 would presumably be a smaller demand and a greater 
 supply. That is, at $1.15 there would be sellers anxious 
 to dispose of, in the aggregate, more wheat than buyers 
 
 1 This explanation of the nature of competition is well set forth in Hadley, 
 Economics, pp. 75-77. 
 
8 THE EXCHANGE MECHANISM OF COMMERCE 
 
 would take. Some of these prospective sellers must be 
 doomed to disappointment, and those most anxious to 
 sell would therefore bid against each other in lowering the 
 price to the point where supply and demand were equal. 
 This they would do because in no other way could they 
 be sure of selling their wheat. But they need not go 
 below the equalizing price, because when that price is 
 reached there are enough more buyers or enough fewer 
 sellers, or both, to insure sales by those still in the market 
 and desiring to sell. Even if some should offer, unwisely, 
 to sell at a lower price, yet since these could not, by our 
 hypothesis, satisfy the demand, all who charged the 
 equalizing price would still find purchasers. The market 
 price of any kind of goods, therefore, tends to be that 
 price which equalizes supply and demand, and is pre- 
 vented by the forces of competition from going above or 
 below it. 
 
 3 
 
 Causal Explanation oj the General Level of Prices 
 
 Let us now apply the principles of supply and demand 
 to the general level of prices. We shall see that much the 
 same kinds of competitive forces which fix any one price 
 (as above explained) in relation to other prices, fix the 
 general level of prices of goods in terms of money. We 
 shall consider, first, the supply of goods, including the 
 services of labor and of "waiting" (i.e. investing, or 
 putting capita] into use, the service for which interest is 
 paid) offered for money, and the demand for goods by 
 those having money to spend. Afterwards we can reverse 
 our method and consider the supply of and the demand 
 for money in exchange for other goods. 
 
 Where there is only fiat (inconvertible paper) money, 
 
LAWS OF MONEY 9 
 
 the supply of goods in general, offered for money, at any 
 level of average prices of those goods, would be just the 
 same as at any other level of prices. This is very nearly 
 true no matter what the money system. 1 If wheat prices 
 are higher than corn prices, or vice versa, productive 
 effort may be diverted from one line into another. But 
 we are now not discussing changes in individual or rela- 
 tive prices. We are diseasing only changes in the 
 general level of prices, the average oTpriqes. If the gen- 
 eral level of prices should double, there is rftv .reason to 
 believe that the amount of goods produced for sale^ould 
 on that account greatly increase. Supposing a com- 
 munity to be in reasonable prosperity and business 
 activity at the lower prices, an increase of these prices 
 would not make possible a very greatly increased pro- 
 duction. It would not enable men to work longer hours 
 nor would it make machinery more efficient. Neither 
 would it stimulate the sales of goods by making such sales 
 more profitable, since a general rise of prices simply 
 means that money has a less value. If everything should 
 sell for twice as much money as before, the sellers would 
 gain nothing, for the things they desired to buy would 
 also cost twice as much. Looking at the matter from 
 any reasonable point of view, it must be admitted that 
 the supply of goods in general, at a higher level of prices, 
 would be no greater (or but slightly greater) 2 than at a 
 lower level. Likewise, at a lower level of prices, the 
 supply of goods would be no less than at a higher one. 
 A lower level of prices would not mean less activity or a 
 smaller sale of goods. It would pay as well to sell goods 
 at a low level of prices as at a high level, since at the lower 
 
 1 See remainder of this section for explanation of why it is not always entirely 
 true. 
 
 * See next paragraph. 
 
io THE EXCHANGE MECHANISM OF COMMERCE 
 
 level the money received would have correspondingly 
 greater purchasing power. 
 
 The lower level of prices would only decrease the 
 supply of other goods and the higher level increase it, in 
 one contingency, and then only to a very limited degree. 
 When the currency system is based on a precious metal, 
 e.g. gold, a lower level of prices means a higher value 
 of gold as money. It migh^herefore divert some labor 
 from the production of other goods to the production of 
 gold for coinage. A higher level of prices might tend, 
 in the same degree, to divert labor from gold production 
 towards the production of other goods. To this extent 
 only, a higher level of prices would tend to increase the 
 supply of goods in general other than money, and a lower 
 level of prices to decrease it. 
 
 On the other hand, a higher level of prices of goods 
 would tend to decrease the demand for goods by persons 
 having money to spend. For with higher prices, and no 
 greater amount of money to spend, buyers of goods would 
 be unable to purchase as much as at lower prices. Lower 
 prices of goods would mean that the money of purchasers 
 would go farther. 
 
 Let us now suppose a doubling of the amount of money. 
 Prices would tend to increase in nearly the same pro- 
 portion. Suppose prices did not rise. Then purchasers 
 of goods would buy all they were in the habit of buying 
 and still have as much money left to spend as they 
 formerly spent all together. This they would endeavor 
 to spend at once. For in modern countries money is not 
 hoarded away, but only enough is kept on hand for 
 emergency requirements, and the rest is spent. Those 
 who save are spending just as effectually as any others. 
 The difference is in what they buy. Those who save 
 
LAWS OF MONEY n 
 
 buy factories, warehouses, railroads, farms, etc. Even 
 though their savings are put into a savings bank, they are 
 none the less spent for investment goods. It follows 
 that a sudden doubling of the amount of money, if prices 
 did not increase, would mean a demand for goods far 
 exceeding the supply. The amount of land is practically 
 constant. Doubling the amount of money would not 
 enable people to work longer hours and so increase the 
 products of labor. In a busy community the supply of 
 goods to be sold simply could not be doubled except 
 with an increase of population or inventionx'The in- 
 creased money would therefore mean that at the old 
 prices the demand for goods in general would exceed the 
 supply. Purchasers would bid against each other. 
 Prices would rise. Equilibrium would only be reached, 
 supply and demand be equal, at a general level of prices 
 nearly (or, if fiat money, quite) twice that which had 
 preceded. 
 
 If prices rose equally, this would mean a doubling in 
 the money wages of labor for the same results produced 
 and, similarly, a doubling in the money interest, dividends 
 or profits received for " waiting.". Aside from disturb- 
 ing effects during the period of transition, the rate of 
 interest -would be the same with the high prices as with 
 the low. The money value of the sum waited for would 
 be doubled and the money value of the interest would be 
 doubled. The ratio between them would be the same 
 as before. In other words, since prices have doubled, 
 borrowers, for example, would require twice as many 
 dollars as before and would also, of course, pay twice as 
 many dollars in interest. 
 
 In the light of the principles above set forth, regarding 
 supply and demand, we can explain why the excessive 
 
12 THE EXCHANGE MECHANISM OF COMMERCE 
 
 amounts of inconvertible paper money sometimes issued 
 by governments, issued particularly in time of war, have 
 resulted in very exceptional rises in the price level. 
 This increased amount of money means, at any level of 
 prices, a greater demand for goods. Therefore, that the 
 demand for goods may not exceed the supply, the level 
 of prices must rise. There is another factor of impor- 
 tance at such times, viz. public confidence in the money 
 issued. If there is a general belief that the money will 
 become absolutely valueless or greatly decrease in value, 
 then many who have goods to sell will refuse to sell them 
 for this money, but will demand gold or silver or other 
 goods in exchange. This decrease in the supply of goods, 
 offered for money, will mean that only a higher level of 
 prices than otherwise would result can equalize supply 
 and demand. Thus is to be explained the high prices 
 (and, reciprocally, the great depreciation of money) in 
 such periods as the American Revolution, the Civil War, 
 etc. 
 
 4 
 
 Causal Explanation of the Value or Purchasing Power of 
 Money, the Reciprocal of the Level of Prices of Goods 
 
 Let us look at the same problem, the general level of 
 prices, from the other side, that of the purchasing power 
 of money or the value of money in terms of goods. We 
 shall consider now the supply of money offered by 
 purchasers of goods (corresponding to demand for goods) 
 and the demand for money coming from sellers of goods 
 (corresponding to the supply of these goods) . 
 
 Before defining supply of and demand for money, we 
 must select a phrase to express the price of money. The 
 value or price of money is usually expressed, not in terms 
 
LAWS OF MONEY 13 
 
 of any one thing, but in terms of all, or most other, 
 purchasable goods. Its value or its price is measured in 
 the amount of other goods it can buy. The value or 
 price of money we shall therefore call the purchasing 
 power of money. 
 
 We may now define money supply and demand con- 
 sistently with wheat or coal supply and demand. First, 
 as to supply, we may say that the supply of money at any 
 given purchasing power is the amount of money which 
 would be supplied i.e. would be offered in purchase of 
 goods at that purchasing power. Just as, at a higher 
 price of wheat, the supply in the long run would tend to 
 be greater than at a lower price, so, at a higher purchas- 
 ing power of money, the supply of money would tend to 
 be greater than at a lower purchasing power. The supply 
 would be greater at a higher purchasing power, because, 
 at a higher purchasing power, it would be worth while to 
 turn bullion into coins or even to mine more gold for that 
 purpose. The supply of fiat money (irredeemable 
 paper) would not be greater, but would be just the same 
 at a higher purchasing power as at a lower. The normal 
 supply of money at any purchasing power and during 
 any period of time, the amount that would be offered by 
 sellers of money (i.e. buyers of goods) involves, as Walker 
 has pointed out, 1 the quantity of money and its rapidity 
 or velocity of circulation. This velocity of circulation 
 may be less than unity ; that is, most of the money may 
 circulate less than once if we are dealing with an instant 
 or a short period of time. But if we are dealing with a 
 long period of time, say a year, and with the conditions 
 determining normal purchasing power, the velocity will 
 
 1 Political Economy, Advanced Course, third edition, New York (Holt) 1887, 
 p. 129. 
 
14 THE EXCHANGE MECHANISM OF COMMERCE 
 
 perhaps be 20 or more. 1 In any case, the supply, the 
 amount that would be offered at any given purchasing 
 power, is the total amount which, at that purchasing 
 power, would be on hand, multiplied by its velocity; 
 and it may be represented, therefore, as M V. 
 
 Turning to the subject of demand, we may properly 
 define the demand for money, at any purchasing power, 
 as the amount of money that would be taken by sellers 
 of goods, at that purchasing power. The demand for 
 money comes from the sellers of other goods who wish 
 to take money in exchange for those goods. They may be 
 said to buy money with the goods they sell. When the 
 money is altogether fiat (inconvertible paper) money, 
 the amount of goods offered for money will not be affected 
 by the purchasing power of money. With an exception 
 shortly to be noted, this is also true in the case of such a 
 commodity money as gold or silver. That the purchas- 
 ing power is at any time greater or less, provided only it is 
 not fluctuating, affects neither for good nor ill the sellers 
 of goods. If the purchasing power of money is greater, 
 they will still sell their goods as readily for money since 
 the smaller amount of money so received will go as far 
 as would a larger amount having a smaller purchasing 
 power per unit (e.g. per dollar). But their demand for 
 money, in the proper use of the term " demand," will 
 not be the same. If the purchasing power of money is 
 doubled, demand for money will be exactly halved. If 
 the purchasing power of money is halved, demand for 
 money will be doubled. Sellers of goods will take all the 
 money which the goods they desire to sell will bring. 
 If, therefore, the purchasing power of money is halved, 
 
 1 See Fisher, The Purchasing Power of Money, New York (Macmillan), 1911, 
 p. 290. 
 
LAWS OF MONEY 15 
 
 i.e. if it takes twice the former amount of money to buy 
 the same goods, then the demand for money, the amount 
 sellers of goods (buyers of money) will take, at this pur- 
 chasing power, will be exactly doubled. 1 
 
 The exception to be noted has already been referred 
 to in the discussion of the general level of prices. 2 It oc- 
 curs when money is based on some standard commodity, 
 as gold, having an appreciable cost of production. To 
 double the purchasing power of money would, in fact, 
 probably reduce the demand for it to something very 
 slightly less than half what it had been, for a small (rela- 
 tively a very small) amount of labor would probably be 
 diverted from the production of other goods to the mining 
 of gold. Therefore, unless the value of money more than 
 doubled (i.e. unless money prices of goods became less than 
 half), the money which would be taken by sellers of the 
 somewhat smaller stock of goods would be less than half 
 as great. Similarly, a fall of half in the value of money 
 would very probably divert some labor from gold mining 
 into other lines, and so might slightly more than double 
 the demand for money. For every one would be ready 
 to sell his goods at twice the former price, and there would 
 be more goods to sell. Normal demand, therefore, for 
 money, i.e. long-run demand, cannot be distinguished by 
 any exact proportion from demand for other goods. 
 But when the money does not involve an appreciable cost 
 of production, but is inconvertible paper, or, for any 
 money, where an extremely short period is involved, the 
 demand for money varies inversely with its purchasing 
 power. 
 
 1 Were it not for the exception next to be mentioned, the demand curve for 
 money would be always a rectangular hyperbola, 
 
 2 3 of this chapter (I of Part I). 
 
16 THE EXCHANGE MECHANISM OF COMMERCE 
 
 The demand for money by sellers of goods may be said 
 to be the money value at which they would sell those 
 goods ; therefore, the prices times the quantities ; there- 
 fore, pq + p'q' + etc. The purchasing power of money 
 is fixed where supply is equal to demand, where 
 MV = pq + p'q' + etc. The equation of exchange may 
 be regarded as simply a mathematical mode of stating 
 that the p's, the purchasing power of money, must be 
 such that supply of money equals demand, i.e. that 
 M V = pq + p'q' + etc. 
 
 5 
 The Theory of Bimetallism 
 
 The laws of supply and demand serve to explain the 
 effects of the various monetary systems which have been 
 tried in different countries. Important among those 
 monetary systems is bimetallism. Bimetallism involves 
 the concurrent circulation of two metals at a fixed legal 
 ratio. Both metals are coined by government, for those 
 bringing the metals to the mints, in any desired quantity, 
 and coined without charge or for the mere cost to gov- 
 ernment of coining. Both metals, when so coined, are 
 legal tender for the payment of debts and taxes, at the 
 value ratio fixed. Thus, bimetallism at 16 to i meant, 
 for the United States, that the amount of silver in the 
 silver dollar should be approximately 16 times the amount 
 of gold in a gold dollar, that gold and silver should both 
 be coined freely and without limit, and that a debtor 
 should be able to liquidate the same debt with 100 silver 
 dollars as with 100 gold dollars. 
 
 Bimetallism may succeed if the legal ratio is not too far 
 from the market ratio of values existing when the system 
 
LAWS OF MONEY 17 
 
 is started. If the amount of silver in the legal silver dollar 
 is worth 98 per cent as much as the gold in the gold dollar, 
 or 98 cents, then the system may succeed. 1 It will 
 succeed because the possibility of using 98 cents' worth of 
 silver, if coined, to pay a $i debt (or tax) previously 
 payable in gold, 2 will stimulate the coinage of silver. 
 This extra demand for silver will increase its value. 
 Otherwise expressing the matter, we may say that the 
 withdrawal of silver from the arts, tending to cause a de- 
 creased supply of silver for arts uses, will increase its value. 
 The greater quantity of money will tend to make some- 
 what higher prices and a somewhat lower value of a dollar 
 (whether gold or silver). This may discourage the coin- 
 age of gold or even cause the melting of some gold coin 
 into bullion. We may say that the less demand for gold 
 has made its value fall, or that the melting of gold coin 
 and the consequent greater supply of gold in the arts has 
 made its value fall. The sequence is, then, flow of silver 
 from bullion into coin, slightly depressed value of coin, 
 flow of gold from coin into bullion. Silver has risen in 
 value. Gold has fallen. Probably the silver dollar is, 
 therefore, now worth the same as the gold dollar instead 
 of 98 per cent as much. If the bullion content of the gold 
 dollar came to be of the less value, debtors would prefer 
 to coin gold and the flow would be in the opposite direc- 
 tion, but likewise towards the establishment of equilib- 
 rium. 
 
 Suppose, however, that the amount of silver in a silver 
 dollar is worth only 40 per cent of the gold dollar (which 
 was more nearly the case with the silver dollar when its 
 
 1 Cf. Fisher, Elementary Principles of Economics, pp. 230, 231. 
 
 2 Or money, on a parity with the gold, other than silver money coined for 
 account of the debtor. 
 
i8 THE EXCHANGE MECHANISM OF COMMERCE 
 
 free coinage was advocated in 1896). Then the danger 
 would be that, long before the increased demand for silver 
 as money and its decreased supply in the arts, coupled 
 with the decreased demand for gold as money and its 
 increased supply in the arts, had brought about the 
 desired equilibrium of value, the gold would be entirely 
 driven out and the money used would simply be silver 
 instead of gold. The whole question would be whether 
 the scarcity of silver in the arts and the plentifulness of 
 gold in the arts would be sufficiently marked to make 
 the relative values the same as in the legal ratio, before 
 silver enough had been taken from the arts uses to fill 
 all the money circulation ; and then, whether sufficient 
 additional supplies of silver could be got from the mines 
 to drive out the gold without forcing the margin of pro- 
 duction unprofitably low, i.e. without mining, at a loss, 
 from poor mines. 
 
 For one country alone, the prospects of success in es- 
 tablishing bimetallism would be much less bright than 
 for a group of important commercial countries. For if 
 one country tried it alone, endeavoring by free coinage 
 to make 40 cents' worth of silver equal to $i worth of 
 gold, it would have to absorb into its currency, not only 
 silver from within its own borders, but silver flowing to 
 it from all the world, and its own demand in relation to 
 such a great supply might increase the value of silver 
 relatively little. And, as the silver drove out the gold, 
 the latter would not fall rapidly in value through con- 
 gesting the arts, but would be distributed to the money 
 supplies, as well as the arts, of all other countries. 
 
LAWS OF MONEY 19 
 
 6 
 
 The Value of Subsidiary Money 
 
 At the present time, in the United States, France, and 
 elsewhere, there exists the so-called limping standard, 
 i.e. there are silver coins the bullion value of which is not 
 equal to their face value, but the amount of which is 
 strictly limited. In the United States, there are a cer- 
 tain number of silver dollars and silver certificates. The 
 silver in the silver dollars is worth perhaps about half of 
 their face value. But they cannot drive out gold because 
 not enough are coined to produce such a result. Any 
 money, even paper, if put forth in very limited quantities 
 and made legal tender for the payment of debts and taxes, 
 may circulate at par with gold. The possibility of using 
 it for debts and taxes creates a demand for it, and others 
 will take it because they in turn can pass it to those hav- 
 ing such uses for it. A general public confidence in and 
 willingness to take it at the legal value, is developed. 
 On the other hand, the limitation of its quantity means 
 a limited supply. The demand for it equals this supply, 
 at a value equal to par. Where a limited amount of 
 money is issued by coining metal of less value than the 
 money, or by printing paper, this is done by government 
 exclusively on its own account. Otherwise there would 
 be special favor shown, at the general expense, to those 
 persons for whom the coining was done. 
 
 Making paper or other money redeemable in gold is 
 merely a way of making the forces of demand and supply 
 automatic in keeping up the value of such credit money. 1 
 If for any reason, e.g. overissue or lack of confidence, the 
 value of such money sinks below the value of the gold 
 
 1 Cf . Fisher, The Purchasing Power of Money, pp. 262-263. 
 
20 THE EXCHANGE MECHANISM OF COMMERCE 
 
 in which it is redeemable, the holders of the paper money 
 at once present it in large quantities for redemption. 
 This immediately decreases the supply of it, and thus 
 automatically prevents its entire driving out of gold. 
 Prompt redemption at the same time gives confidence 
 and so maintains a demand for it. But the limitation 
 of supply, automatic or otherwise, is important, for no 
 amount of confidence can prevent a fall in the value of 
 money which increases indefinitely in quantity. An 
 increase in gold itself tends to raise prices and lower 
 the value of gold. An increase of paper money tends 
 to increase prices in paper. Redeemability prevents 
 prices in paper from ever rising higher than prices in 
 terms of gold. 
 
 In the case of paper money, the receiver is really a 
 creditor. He gets a credit claim, not real wealth. The 
 paper money evidences a right based on its general 
 acceptability, or on its redeemability by government, to 
 an amount of wealth or income services equal to the 
 value of the money. The issue of paper money is a 
 species of borrowing by government ; but no interest is 
 paid, because the holder, unlike the holder of government 
 bonds, has, if the money is generally acceptable, a demand 
 claim. He does not need, therefore, to wait for his 
 desired goods any longer than he wishes to, but can spend 
 the money and get goods at any time from another, who 
 can do likewise with a third, etc. He does not need, there- 
 fore, to be in the position of a creditor longer than his 
 own convenience dictates. The general acceptability 
 of such money, if it is generally acceptable, makes the 
 holder willing to forego any other interest. 1 
 
 The money of the United States includes gold and silver 
 
 1 See Ch. II (of Part I), 3, 4- 
 
LAWS OF MONEY 21 
 
 coins, gold certificates, silver certificates, United States 
 notes (greenbacks), treasury notes, and subsidiary coins 
 (quarters, dimes, etc.). There are also bank notes, but 
 these may be better considered, along with other bank 
 credit, in the next chapter. All the paper money except 
 silver certificates is redeemable by law in gold. Silver 
 certificates are redeemable in silver. No law expressly 
 makes the silver dollars redeemable in gold ; but it is 
 the duty of the Secretary of the Treasury to maintain the 
 parity of the silver coinage with gold, and in practice any 
 kind of our money is exchangeable at the United States 
 Treasury for any other kind. Even without this prac- 
 tice, the limitation on the number of silver dollars and 
 their full legal tender quality would doubtless maintain 
 them at par value, although the value of the contained 
 bullion is much less. 
 
 7 
 
 The Value of Money as Related to the Value of a Standard 
 Money Metal 
 
 Most countries have now the gold standard. All 
 money is redeemable in or in some way related to gold, 
 and the value of money tends to equal the value of the 
 mint equivalent in gold. So long as gold is coined freely, 
 and in any quantity desired, into money, the value of 
 gold as money and as bullion must be the same. For 
 if gold coin came to have more value than gold bullion 
 to be used in the arts, then persons having gold bullion 
 would hasten to get it coined. The consequent increase 
 of money would raise the prices of goods and lower the 
 value of money. The decrease of gold for use in the arts 
 would increase its value in that use. Equal value in the 
 two uses must soon be reached. If, on the other hand, 
 
22 THE EXCHANGE MECHANISM OF .COMMERCE 
 
 gold as money should have, at any time, a less value than 
 the same amount of gold as bullion, then all newly mined 
 gold would be used in the arts and little or none coined, 
 until gold in the arts was so plentiful and money so scarce 
 as to make the values even again. Gold money, if full 
 weight, might even be melted into bullion, if it were 
 worth enough more in the latter use to pay for the 
 trouble. 
 
 Eventually, then, since, when the gold standard is in 
 force, the value of money and the value of gold bullion 
 tend to be the same, both depend upon the amount of 
 gold mined relative to the use for it. The cost of pro- 
 duction of gold, and, therefore, the number and richness 
 of gold mines, is not without an influence, in the last 
 analysis, on the level of prices, and on its reciprocal, 
 the purchasing power of money. 1 
 
 8 
 
 The Level of Prices and the Value of Money in One 
 Country or Locality as Related to the Level of Prices 
 and the Value of Money in Another 
 
 Before concluding this chapter, something should be 
 said regarding the relation of the quantity of money and 
 prices in one locality or country to the quantity of money 
 and prices in others. 2 The subsidiary and credit money 
 of one country is commonly not received in other countries. 
 Gold or silver (at present, with the gold standard general, 
 chiefly gold) is passed from one country to another in 
 payment for goods or services or to redeem obligations. 
 
 1 These facts are mechanically expressed in Fisher, The Purchasing Power of 
 Money, pp. 96-111. 
 
 1 For a fuller statement see Fisher, The Purchasing Power of Money, pp. 90- 
 96. 
 
LAWS OF MONEY 23 
 
 Between different countries, the gold passes only by 
 weight, but since gold coin and bullion are related in all 
 gold standard countries, the effect of the flow of gold from 
 one country to another is to decrease, relatively, the 
 quantity of money in the one and to increase it, rela- 
 tively, in the other. Between parts of the same nation, 
 all legal tender money, whether gold, silver, or paper, 
 passes freely. 
 
 What are the laws of this flow? Obviously, money, 
 like all things else, flows to those places where it has the 
 greatest value, where it can buy the most of other things. 
 
 I That is, money flows from those places or countries where 
 prices of goods are high, to those places or countries 
 where prices are low. Goods are bought where they can 
 be bought the cheapest. Money goes to pay for the 
 goods. Hence, money flows to those places where there 
 are low prices. But low prices means high purchasing 
 power or value of money. Therefore money flows to 
 those places where its value is high. When, however, 
 one country has an inconvertible paper money unrelated 
 to the money of another, no such flow can take place. 
 When paper money is first issued in one country it tends, 
 by raising prices, to cause purchases abroad, where 
 prices have not thus been raised. As the paper money 
 is not legal tender elsewhere, gold must be sent to pay 
 for the goods thus bought. The continuing issue of 
 paper money may drive all the gold out of the currency 
 of the country issuing the paper. Until it does so, the 
 effect on prices applies to other countries as well ; the 
 effect is distributed over all. Though the paper circu- 
 lates only in the issuing country, it displaces gold and 
 pushes the gold into other countries. But, when enough 
 paper money has been issued completely to drive out 
 
24 THE EXCHANGE MECHANISM OF COMMERCE 
 
 gold, no such further effect on other countries can be 
 produced. Trade will still take place. 1 Commodities of 
 one sort are bought and commodities of another sort 
 are sold. Gold itself maybe traded back and forth. But 
 the currency of the one country is absolutely unrelated 
 to the currencies of others. 
 
 9 
 
 Summary 
 
 In this chapter we have been concerned chiefly with 
 the laws of money, an important part of the mechanism 
 of civilized commerce. We saw, first, that the general 
 level of prices of goods varies, other things equal, with 
 the quantity of money. This fact was mathematically 
 expressed in the so-called " equation of exchange," 
 
 MV=_pq + p'q' H-etc. 
 
 Analysis of the causal relations between quantity of 
 money and prices led us to demand and supply and the 
 ordinary forces of competition as an explanation. It 
 was seen that increased money involves higher prices of 
 goods to equalize supply of and demand for those goods, 
 and, conversely, a lower purchasing power or value of 
 money, to equalize supply of and demand for that money. 
 Supply of money might be determined by government in 
 the case of inconvertible paper but is generally a matter 
 of the production of the precious metals, especially gold. 
 The possibility of successful bimetallism was shown to 
 depend upon the ratio chosen and the relative amounts of 
 money of each metal available under that ratio. Supply 
 and demand acting through the money and bullion 
 markets tend to bring market ratio to equivalence with 
 
 1 See Ch. VI (of Part I), 7, 8. 
 
LAWS OF MONEY 25 
 
 legal ratio, but may not have the effect of doing this 
 before one metal is driven out of circulation. The 
 limping standard and paper money were shown to depend 
 upon limited quantity of the paper money or the over- 
 valued (in comparison to weight) silver (or other metallic) 
 money, and upon their legal tender qualities. The 
 supply is limited ; the demand kept up. Redeemability 
 automatically tends to prevent oversupply of credit 
 money or that loss of confidence which decreases demand 
 for the money. With free coinage of gold, the value of 
 gold as coin and as bullion tends to be the same. Finally, 
 we saw that the flow of money from place to place or 
 country to country is a flow from where it is cheap to 
 where it is dear, from where it buys little to where it buys 
 much, from where prices of goods are high to where they 
 are low. 
 
CHAPTER II 
 
 THE NATURE OF BANK CREDIT 
 
 i 
 
 How and When Credit Takes the Place of Money 
 
 CREDIT is given whenever goods are sold for a promise 
 to pay, for a tacit obligation to pay later, or for some 
 form of claim upon a third party such as a bank. The 
 characteristic of all credit is the fact that the person 
 disposing of goods to another does not immediately 
 receive payment in the form in which he is entitled, 
 ultimately, to receive it ; but receives, instead, a right to 
 future payment, a right commonly evidenced by some 
 kind of commercial paper. Most frequently this evidence 
 is the check on a bank, showing the title of the receiver 
 or payee to money from the bank on demand ; or the bill 
 of exchange, showing a title of the payee to money from 
 the drawee, sometimes on demand and sometimes on a 
 definitely agreed date. 
 
 The term "currency" we shall use generically to in- 
 clude money, which is generally acceptable in exchange 
 for other goods, and those credit rights, less generally 
 acceptable, which are, nevertheless, largely used as media 
 of exchange and therefore serve as money substitutes. 
 Such credit instruments as checks, bills of exchange, and 
 promissory notes, act as substitutes for money only if the 
 rights to the sums which they have reference to are trans- 
 ferred to third, fourth and other parties. Only in such 
 
 26 
 
THE NATURE OF BANK CREDIT 27 
 
 cases, therefore, can these credit instruments or the rights 
 which they certify be considered as currency. If a prom- 
 issory note is given by one person to another and kept 
 by the second until maturity, the use of the note merely 
 means that money is paid from the one person to the 
 other at a later date instead of an earlier. There is no 
 saving of the use of money in the sense that credit takes its 
 place. But if A owes B $100 and B owes C the same sum, 
 and if A's promissory note to B is used by the latter to 
 pay C, then the use of money is to some extent avoided. 
 A eventually redeems his note by paying C the money. 
 Money is passed once instead of twice. 
 
 The ordinary check, sometimes called the "customer's 
 check," is similarly used. A may give to B a check for 
 $100. B, though he does not perhaps use the same check 
 to pay C, uses the same demand right or claim on the 
 bank. He sends in the first check and has it credited to 
 his account. Then he gives his own check to C. C 
 may collect from the bank or may in turn pay a fourth 
 party by check, and so on. In practice, the sums owed 
 by the different parties will probably not exactly balance. 
 B may pay C by giving the latter a check evidencing the 
 right to draw the sum received by B from A plus other 
 sums received by B from D, E, F, etc. But however 
 this may be, the principle is the same. Thus, the bank 
 deposit, or right to draw from a bank, takes the place of 
 money in effecting exchanges of goods or services. The 
 use of bills of exchange also facilitates the balancing 
 off of obligations against each other, without the payment 
 of coin. 1 
 
 i See Ch. IH (of Part I), i. 
 
28 THE EXCHANGE MECHANISM OF COMMERCE 
 
 How Commercial Banking is Carried On 
 
 Credit instruments, or credit rights for the paper is 
 in each case but evidence of the underlying obligation 
 act as substitutes for money primarily through the inter- 
 mediation of commercial banking, 1 and foreign exchange 
 banking. Commercial banks constitute an important 
 part of the mechanism of trade. Their work facilitates 
 internal trade and, in connection with the work of foreign 
 exchange banks and brokers, facilitates external trade 
 as well. It is estimated that nine tenths of the total 
 business in the United States is carried on through the 
 use of bank credit. 2 
 
 Bank deposits (rights to draw from a bank or banks), 
 which circulate by means of checks, may come into being 
 in any one of several ways. One may become a de- 
 positor by directly depositing money (or the right to draw 
 money, received by check from some one else, but this 
 merely registers a transfer of a deposit and does not 
 create one) . One may become a depositor by borrowing 
 from the bank in which the deposit is to be. If A goes 
 to his bank and leaves there $50,000 cash, he thereupon 
 is said to have deposited such an amount in the bank 
 and can draw on this sum at will by issuing checks against 
 it in favor of any persons to whom he wishes to make 
 payments. But A may also go to the same bank, give 
 his endorsed note or other satisfactory security, and bor- 
 row $50,000. This money he leaves on deposit. The 
 bank is then said to lend its credit. What A has bor- 
 
 1 Savings banks and investment banks perform, of course, important functions, 
 but do not have a part in providing a substitute for money. 
 
 2 See Fisher, The Purchasing Power of Money, New York (Macmillan), 191 1, 
 pp. 317, 3i8. 
 
THE NATURE OF BANK CREDIT 29 
 
 rowed is not money but the right to draw money by check, 
 at will. The bank is under as much obligation to redeem 
 his checks on demand as if he had directly put money 
 into the bank. On the other hand, A is under obligation 
 to pay the bank, when his note matures, the amount 
 borrowed plus interest. 
 
 It should be readily apparent that a bank can, in ordi- 
 nary times, redeem all checks presented for redemption, 
 without keeping for that purpose a cash reserve which 
 at all nearly equals its liabilities. The total value of 
 deposits which a bank is under obligation to pay out on 
 demand, may be $500,000. Yet it is certain that all the 
 depositors will not call for their money at the same time. 
 Instead of drawing it out, most of them send checks back 
 and forth to and from others who do likewise. A cash 
 reserve of $100,000 may be ample. Putting the matter 
 iri ' the opposite way, we may assert that if there is 
 $100,000 in cash in such a bank, the bank can lend its 
 credit, i.e. more deposits or rights to draw, to the extent 
 of (say) $400,000. 
 
 We have said that different depositors in a bank liqui- 
 date their obligations to each other by giving checks. 
 There is, then, simply a change on the bank's books. 
 Any amount of obligations can be thus balanced. Dif- 
 ferent persons are made successively creditors of the bank 
 for larger or smaller sums/ The situation is complicated, 
 but the principle is not changed, when depositors of dif- 
 ferent banks have business dealings with each other. 
 In this case, which is a decidedly usual one, the banks 
 become successively each other's debtors and creditors 
 and have to settle through a clearing house. Bank A 
 may have accepted and paid cash for, or credited to 
 depositors, many checks on Bank B. Bank B therefore 
 
?$> THE. EXCHANGE MECHANISM OF COMMERCE 
 
 owes Bank A. Similarly, Bank C may owe Bank B, etc. 
 All of these complicated obligations are balanced by a 
 clearing house, so that each bank pays what it owes net 
 or receives what is owed to it net, and a great deal of flow 
 of money is avoided. In other words, the principle of 
 cancellation is applied whenever possible between banks, 
 just as it is in any one bank to the depositors in it. 
 
 3 
 
 Analysis of Relations Involved in Commercial Banking 
 
 But our analysis of the nature of commercial banking 
 is not complete until we go back of the banks and examine 
 the relations to each other, through the banks, of those 
 who deal with the banks and with each other. 1 
 
 When a man borrows from a bank (giving propej 
 curity and receiving credit on the bank's books), 
 getting command over present wealth in return for a 
 promise to repay wealth in the future. Those who pro- 
 vide him with this present wealth must wait before being 
 repaid. Lending always involves giving up something 
 now and getting something in the future, i.e. lending 
 always involves waiting. 2 In order, then, that any one 
 may borrow from a bank, some person or persons must be 
 the lenders, must be ready to give up goods in the present 
 for goods in the future, must provide waiting. The bank 
 itself is, for the most part, only an intermediary. It 
 brings together a supply of waiting, but it does not, to 
 any considerable extent, furnish that supply. It places 
 
 1 The argument of this and the following section is substantially the same as 
 that presented by the writer in the Quarterly Journal of Economics, August, 1910, 
 in an article entitled "Commercial Banking and the Rate of Interest." 
 
 1 Though there may also be waiting where there is no lending but only in- 
 vesting. 
 
THE NATURE OF BANK CREDIT 31 
 
 loanable funds at the disposal of borrowers, but it is not 
 itself the ultimate lender. 
 
 The persons who provide the waiting, i.e. who are the 
 real lenders, may be divided into two classes: (a) 
 those who, in return for goods, receive checks from 
 borrowers of the banks (or personal notes or "ac- 
 ceptances," which the banks discount 1 ), (b) Those 
 who have deposited money in the banks. 
 
 Both of these classes have claims on the lending banks, 
 claims which, taken all together, cannot be redeemed 
 by the banks except as those who have borrowed, those 
 who are indebted to the banks, make good the claims of 
 the banks on them. When a man has accepted a check 
 from one who has borrowed of a bank, and has given 
 in exchange for this check, he has actually given 
 jnt wealth in exchange for a mere right to draw on the 
 fank. He may, therefore, so long as he does not exercise 
 this right, be regarded as a lender. If he passes a check 
 for a like amount to another, in return for goods, the 
 other becomes the lender, since this other now has the 
 right to draw, and has given up for it present wealth. 
 If, instead of passing a check to another, the original 
 payee avails himself of this right to draw, taking money 
 from the bank, then some one who has deposited cash 
 in the bank vaults may be looked upon as the lender, 
 since his money has been taken from the bank and the 
 borrower is expected to make good the subtraction. 
 Thus, either the original receiver of a deposit right from 
 a borrower, or some one to .whom he passes this right, or 
 some depositor whose cash is withdrawn to redeem the 
 check, may be regarded as a lender. One person after 
 another holds, for a time, the right to draw money from 
 
 1 See 4 of this chapter (II of Part I). 
 
32 THE EXCHANGE MECHANISM OF COMMERCE 
 
 a bank, and delays using that right. In the aggregate, 
 there is a very great deal of such delaying or waiting on 
 the part of persons who are entitled to money whenever 
 they desire it, but who do not find it convenient to claim 
 it at once. Each of them knows that he can collect from 
 a bank, at will, or can pass his claim to another, at will, 
 for any desired goods. Yet commonly there is an interval 
 during which such a person remains a creditor or lender, 
 preferring the convenience of an available bank account 
 to the immediate possession of other goods. Commercial 
 banking has as a function to combine and coordinate 
 such sporadic potential lending or sporadic waiting, so as 
 to put at the disposal of borrowers a sum total of actual 
 lending which is fairly constant in amount. If A leaves 
 his claim on a bank untouched for one week, B for two 
 weeks, and C for a week and a half, because convenience 
 so dictates, why may not D, in the meanwhile, be using 
 the capital which they do not yet wish to use? By 
 bringing all these parties together, commercial banking 
 enables D to get the use of capital without at all incon- 
 veniencing A, B, or C. Each of these can get his capital 
 to use whenever it is convenient, but, in practice, all of 
 them will not want it at the same time. 
 
 It may be objected that the foregoing treatment is too 
 concrete to be true. In any individual case of borrowing, 
 it is perhaps not legitimate to pair off each borrower with 
 one or more ultimate lenders, assuming that a particular 
 holder of a deposit (or two or three such) is the real lender 
 to some special borrower. Banks bring together bor- 
 rowers and lenders in large numbers, and there is no log- 
 ical way to assign two or more into pairs or small groups. 
 But it cannot be denied that if the total of loans is taken, 
 the ultimate lenders are the total number of acceptors of 
 
THE NATURE OF BANK CREDIT 33 
 
 checks and depositors of money, both of which classes are 
 depositors in the broad sense, because both are possessors 
 of the right to draw. Since the receivers of checks are 
 as much holders of rights to draw, that is, of deposits, as 
 are the cash depositors, we may say that all the borrowers 
 are in debt to all the holders of deposits and that the latter 
 are lenders to the former. When a borrower of a deposit 
 has not transferred it, he may be regarded as indebted 
 to himself, since his right to draw may be regarded as in 
 the main backed up by his own promise to pay. The 
 interrelations of banks through a clearing house merely 
 extend these relations to persons depositing in, borrowing 
 from, and receiving checks on, other banks. The prin- 
 ciples are the same as in the case of a single bank. 
 
 The upshot of the matter is that modern commercial 
 banking makes it possible for men to do business with 
 each other by becoming, successively and alternately, 
 through the banks as intermediaries, each other's debtors 
 and creditors ; while yet no one of them needs to remain 
 a creditor or lender longer than suits his convenience. 
 
 4 
 
 Why Commercial Banking Commends Itself to Business 
 Men, both as Lenders and Borrowers, so that Com- 
 mercial Bank Credit becomes a Substitute for Money 
 
 Thus bank credit acts as a substitute for money. Its 
 use is simply a process by which persons become, so to 
 speak, successively each other's creditors, in such way as 
 ultimately to cancel obligations with only a little use of 
 cash. But we have yet to see, fully, just why bank 
 credit is able to displace money, to a large extent, as a 
 medium of exchange. It does this by conferring an 
 
34 THE EXCHANGE MECHANISM OF COMMERCE 
 
 advantage upon both borrowers and ultimate lenders. 
 Ultimate lenders, as such, are benefited by the conven- 
 ience of a banking service for which they do not have to 
 pay. Borrowers are benefited in that they can borrow 
 on better terms from banks than would otherwise be 
 possible. 
 
 We have already seen that commercial banking com- 
 bines and coordinates waiting which would in any case 
 be done. Such waiting includes, for example, the wait- 
 ing done by a man who has money in his pocket which he 
 intends to spend. It may be a long time before he does 
 spend it, but he knows that at any time he may spend it, 
 and when it is convenient he will do so. Practically 
 everybody finds it desirable to keep part of his assets 
 in ready cash, to use as occasion may require. The 
 convenience of having the ready cash compensates for 
 the loss of the interest that might be received from 
 various investments, and so may perhaps be regarded 
 as, itself, a kind of interest. The same holds true of bank 
 deposits subject to check demand. Business firms must 
 keep part of their assets in such form as to be able to meet 
 current expenses and occasional emergencies. They 
 usually keep considerable amounts to their credit in some 
 bank. Even in the absence of banks, money would 
 have to be kept on hand, and there would be a great deal 
 of sporadic waiting remunerated only by the convenience 
 of having cash on hand when wanted. 
 
 The lender, therefore, that is, for example, the receiver 
 of a check on a bank, who becomes a depositor and 
 supplies waiting, is not injured but rather is benefited by 
 commercial banking. He can draw upon his account at 
 will, and this account is both safer and more convenient 
 (especially for making large payments and payments of 
 
THE NATURE OF BANK CREDIT 35 
 
 odd sums) than the equivalent of ready cash would be. 
 There are, consequently, many persons who would be and 
 are lenders, without any further payment of interest than 
 the deposit service of banks. The lending involves, in 
 each case, only such waiting as is convenient and as 
 would be done anyway. And it is more satisfactory to 
 have the bank deposit, thus making this waiting available 
 as lending, than to keep all quick assets in cash. From 
 the side of the ultimate lenders, there is no difficulty in 
 seeing how bank credit may be substituted for money, 
 to a large extent, with advantageous results. It should 
 be noted that the ultimate lenders are, by making their 
 waiting available to borrowers, really adding to the 
 wealth-producing efficiency of the community. Were 
 it not for this bank credit, i.e. this combination of 
 sporadic waiting, borrowers could only be similarly 
 provided for by the use of money. But a quantity of 
 money corresponding to such possible bank credit, sup- 
 posing the money to be of standard money metal, e.g. 
 gold, would be a tremendous capital investment and 
 would involve, therefore, great expense. An equivalent 
 additional investment in other capital, if made possible by 
 a partial substitution of safe bank credit for specie money, 
 is more profitable to the community. The same total 
 amount of capital is thus made to produce larger results. 
 Let us now consider the interests of the borrowers. 
 They also will be ready to encourage the system, because 
 it enables them to secure loans at relatively favorable 
 rates. The banking system combines and coordinates, 
 as we have seen, a great deal of waiting which would be 
 done in any case. This it puts at the disposal of short- 
 term borrowers, so adding to the supply of loans. If 
 borrowers will avail themselves of these loans, which will, 
 
36 THE EXCHANGE MECHANISM OF COMMERCE 
 
 obviously, on the principles already set forth, take chiefly 
 the form of bank credit rather than of cash, a lower rate 
 of interest becomes possible. But it becomes possible 
 only because borrowers are making use of waiting which 
 would in any case be done, only because such use enables 
 society to get along with less of other currency, pre- 
 sumably with less of gold, and so enables a larger amount 
 of society's total capital to be held in other forms. 1 
 
 These conclusions apply no less when the formal ar- 
 rangement is somewhat different. Not infrequently 
 A buys goods for which he gives his promissory note to 
 B. B endorses this note and deposits it with his bank, 
 and thereby secures a deposit account. The bank is 
 under obligation to honor B's checks upon it for the 
 amount for which A's note was discounted. But A is 
 under obligation to pay the bank. Taking a large 
 number of such transactions, we may say that all the 
 makers of notes so deposited, along with other debtors 
 to banks, are in debt to all the holders of bank deposits, 
 and that the latter are creditors of the former. Business 
 takes place by means of different persons assuming, suc- 
 cessively, the position of creditors, through the banks as 
 intermediaries, to such persons as A. The fact that spo- 
 radic waiting is brought together, undoubtedly tends to 
 give A's personal note more value, i.e. makes the interest 
 
 1 The same principle applies to government paper money, as was shown in 
 Chapter I (of Part I), 6. In that case, the government is the borrower and 
 pays no interest. So far as bank credit makes impossible the issue of so much 
 paper money by government, the lower interest to borrowers from banks does 
 not involve economy in the use of gold and lower average interest. For then 
 the government itself, having to borrow by issuing more bonds than would, 
 perhaps, be necessary if it issued credit money, must pay interest which, other- 
 wise, it would not have to pay. This conclusion does not mean, of course, that 
 inelastic government paper money is to be preferred to elastic bank credit; 
 nor does it mean that government paper money is to be preferred to bank credit, 
 on other accounts. 
 
THE NATURE OF BANK CREDIT 37 
 
 he has to pay somewhat lower. The bank can give more 
 for the note than it otherwise could, just because its own 
 creditors will not all want cash at once, just because its 
 lending power (for the bank is making itself a creditor of 
 or lender to A) is made greater by the existence of the 
 sporadic waiting which it has combined ; and since the 
 bank can give more for the note to B, B can give more 
 for it (in goods) to A. 
 
 The principle is the same if B deposits, not A's promis- 
 sory note, but a bill (or draft) on A, payable in some 30 
 or 60 days, for goods shipped to A. This draft will be 
 presented to A for his signature as soon as possible. 
 That is, A will be expected to acknowledge his in- 
 debtedness by "accepting" the draft. 1 The bill (or 
 draft) thus becomes, in effect, A's promissory note 
 indorsed by B. 
 
 In Europe, particularly in England, still another 
 method of securing bank credit is common. This is the 
 method of bank acceptances. 2 The would-be borrower, 
 A, instead of directly borrowing of his bank a checking 
 account, or instead of giving his creditor, B, a promissory 
 note, for deposit, if desired, in B's bank, or instead of 
 having B make out a draft directly upon him, gets some 
 bank to agree to "accept" (i.e. become responsible for 
 the payment of) drafts which B may draw upon this 
 bank up to an agreed amount. A can then pay to B 
 whatever is owing to the latter, by arranging to have B 
 draw a draft upon the bank with which the agreement has 
 
 1 For fuller discussion of such "bills of exchange" and their security, see 
 Ch. Ill (of Part I), 7. 
 
 * For a description of acceptances and a study of their effects, see Lawrence 
 Merton Jacobs, "Bank Acceptances," National Monetary Commission, 1910. 
 See further, also in National Monetary Commission, Paul M. Warburg, "The 
 Discount System in Europe," pp. 7-13. 
 
38 THE EXCHANGE MECHANISM OF COMMERCE 
 
 been made. The bank in question will undertake to 
 pay the draft when it becomes due, say in 60 days. But 
 the agreement is that before it does become due, A shall 
 provide the bank with the necessary funds. The bank 
 with which the agreement is made, guarantees payment 
 to B, but does not expect to draw upon its own resources 
 in making such payment. B can deposit the draft with 
 his own bank for credit. B then has a right to draw 
 from his own bank on demand ; his bank has a claim upon 
 the bank with which A made the above described arrange- 
 ment; and this bank has a claim upon A. B, or those 
 receiving from him checks upon his bank, may be 
 regarded as the ultimate creditor or creditors; A is 
 obviously the ultimate debtor. The banks are inter- 
 mediaries. Also, the banks have brought together the 
 waiting of those who successively, for periods dictated 
 by their own convenience, become creditors of the bank- 
 ing system by receiving checks or deposit rights based 
 on the draft for which A is ultimately responsible. 
 Further, the fact that this sporadic waiting is made 
 available as actual lending, means that B's draft on the 
 bank will be discounted at a somewhat lower rate than it 
 otherwise probably could be, and will therefore bring a 
 better price. Since the draft for a given sum has thus 
 a somewhat higher value to B than it would else have, the 
 latter will be ready to charge A in payment for any 
 definite amount of goods sold, a somewhat lower price 
 than otherwise. In effect, because of the waiting made 
 available by the banking system, A borrows at a lower 
 rate of interest. The same principle is involved if, as 
 frequently happens, A himself draws a draft upon a 
 bank which agrees to "accept" it, and sells it to another 
 bank for credit. Those who receive A's checks on this 
 
THE NATURE OF BANK CREDIT 39 
 
 credit, in payment for goods, are then the ultimate 
 lenders in the sense above explained. 
 
 Whatever the formal arrangement by which bank 
 credit is utilized, the charges to the borrowers or debtors 
 (for, in the last analysis, it is always the borrowers or 
 debtors who pay) must be enough to cover the cost of 
 banking service. These charges must remunerate the 
 banks for concentrating waiting where it has the greatest 
 usefulness. They must cover salaries of bank officials, 
 depreciation of bank property, interest on the capital 
 invested by the banks themselves, and compensation for 
 the risk to the banks, of insolvency, for the banks, though 
 chiefly go-betweens or intermediaries, do nevertheless 
 insure the credit of borrowers. If all the borrowers 
 failed to make good, the banks must fail; but within 
 limits the banks can and do guarantee depositors. This 
 they do, largely, by maintaining cash reserves of per- 
 haps T V to J of their deposits, according to conditions 
 and the requirements of law, from which they can liqui- 
 date as many of their demand obligations as are likely 
 to be suddenly presented for payment at any one time. 
 On these reserves, as on their other capital, the banks 
 expect to realize a reasonable interest. 
 
 In other words, the payments made by borrowers must 
 cover the cost of banking plus a fair return on banking 
 capital. These payments would not do this if the 
 demand for loans from banks were very small, and if 
 such demand could be sufficiently met by the funds of 
 depositors who would be willing to pay the cost of 
 banking, for the sake of the convenience of banking 
 service. The demand for bank loans, however, is far 
 in excess of what could be supplied by means so trivial, 
 and is, indeed, sufficient to throw upon borrowers or 
 
40 THE EXCHANGE MECHANISM OF, COMMERCE 
 
 debtors as such, the whole cost of banking service. 
 When those who, through the intermediation of banks, 
 are the ultimate lenders or creditors, have become such 
 by having the promissory notes of or drafts on their 
 debtors discounted, the creditors may seem to be paying 
 the cost of banking. But, in such cases, they have, pre- 
 sumably, made allowances for the bank rate of discount, 
 in the prices they have charged for goods sold, and the 
 debtors, therefore, really pay for the services of the 
 banks. 
 
 The payments by borrowers or debtors may be re- 
 garded, then, as real interest payments in the sense that 
 the ultimate lenders profit by the existence of a place of 
 deposit other than their own vaults, for which they do 
 not have to pay, and profit further by the facility of 
 check payments thus made practicable. If no money 
 interest is received by the ultimate lenders, the amounts 
 paid by borrowers are, in the long run, because of the 
 competition of different banks, determined by the labor 
 cost of rendering the service, plus the interest (including 
 compensation for risk) on the cost value of the machinery, 
 such as buildings, necessary reserves, etc., used in bring- 
 ing borrowers and real lenders together. If, however, 
 there is not a sufficiency of this "convenience waiting" 
 to be had to supply the demand for loans at the mere 
 cost of concentration, then the banks will bid against 
 each other, not so much to cut down the charge for the 
 service performed for borrowers, as to get deposits. 
 Hence we are beginning to see direct interest, though at 
 low rates, very generally offered on deposits subject to 
 check, either on monthly balances or otherwise. 
 
THE NATURE OF BANK CREDIT 41 
 
 S 
 
 Application of Principles Arrived at, to Bank Notes 
 
 The same principles apply to bank notes as to bank 
 deposits. The bank note, when issued on the sole 
 responsibility of a bank, is, like the deposit, a credit 
 obligation of the bank to the holder. The holder is 
 entitled to specie or other legal tender money on demand. 
 As with deposits, these rights to draw circulate from 
 hand to hand in payment for goods. And as with 
 deposits, the real lender or creditor is the person who 
 receives the bank notes, which represent only a claim 
 in payment for goods sold ; while the ultimate debtor 
 is the person or the persons who has borrowed the 
 bank's credit in this form, either directly or by any of the 
 methods just described in relation to deposits, and is 
 under obligation to repay. The bank is a legally re- 
 sponsible intermediary, but is chiefly dependent, in the 
 long run, for means to redeem, on repayment of loans by 
 its debtors. The bank, in the main, is merely an inter- 
 mediary, although, as with deposits, part of its own cap- 
 ital serves as an insurance fund to cover all contingencies 
 which are reasonably likely to occur. 
 
 But the holders of bank notes are frequently given, by 
 government, greater protection against loss than the 
 holders of deposits. In Canada, for example, the note- 
 issuing banks have to contribute to a special reserve fund 
 to redeem the notes of failed banks, besides which note 
 holders have a prior lien. In the United States, note 
 holders are insured against loss by the Federal govern- 
 ment, which makes itself ultimately responsible for all 
 notes issued in conformity with the national banking 
 law, and, therefore, for all bank notes issued, since a 
 
42 THE EXCHANGE MECHANISM OF COMMERCE 
 
 10 per cent tax on other bank notes effectually keeps them 
 out of circulation. The notes issued by national banks 
 are based chiefly 1 on government bonds. Each national 
 bank must have purchased bonds of the United States, 
 the par value and also the market value of which shall 
 be at least equal to all its notes in circulation. These 
 bonds must have been deposited with the Comptroller 
 of the Currency. The banks must also have deposited 
 in cash a redemption fund of 5 per cent of the face value 
 of their notes. In consideration of these safeguards, 
 the United States assumes ultimate responsibility for 
 the redemption of the bank notes in case of the failure 
 of any bank, and, in fact, undertakes to redeem the notes 
 currently for those persons presenting them, out of the 
 5 per cent redemption fund. These bond-secured bank 
 notes will, however, be gradually withdrawn over a period 
 of years. The recent Federal Reserve Act permits their 
 gradual retirement and, in addition, the 2 per cent gov- 
 ernment bonds, on which alone they can be based, will, 
 as they mature, be permanently withdrawn. The recent 
 Federal Reserve Act, however, creates from eight to twelve 2 
 Federal reserve banks through which Federal reserve 
 notes shall be issued. Back of these the Federal reserve 
 banks must keep a 40 per cent gold reserve, of which 
 not less than J, or 5 per cent, shall be in the Treasury of 
 the United States. These notes are to be, in each case, 
 a first lien upon the assets of the bank through which 
 they are issued. But the government makes itself 
 ultimately responsible for their redemption. The notes 
 
 1 The provisions of the Aldrich-Vreeland emergency currency measure will 
 shortly be superseded by those of the Federal Reserve Act of 1913. The Aldrich- 
 Vreeland Act cannot be availed of after July i, 1915. The new law is already 
 (August 1914) being put into operation. 
 
 1 Made twelve by the Organization Board. 
 
THE NATURE OF BANK CREDIT 43 
 
 are issued to the Federal reserve banks for them to lend 
 out, at the discretion of the Federal Reserve Board, a 
 government regulating body. They partake in part of 
 the character of government paper money and in part 
 of the character of bank notes. It is customary in 
 European countries also, to safeguard especially bank 
 notes as contrasted with deposits. The holder of a 
 deposit is supposed to become a depositor only delib- 
 erately and after consideration of the financial soundness 
 of his chosen bank. But bank notes circulate from hand 
 to hand as "money," are received often in the form of 
 wages by the comparatively poor, and are not usually 
 scrutinized to see from what bank they come; nor is 
 the soundness of the bank usually considered. 
 
 6 
 
 iv'e Statement of the Relation of Money, together^ 
 with Bank Credit, to Prices f 
 
 The foregoing explanation of the nature of commercial 
 banking operations makes clear, it is hoped, that these 
 operations economize the use of money and why they do 
 economize such use. The rights to draw from banks, 
 thus circulating in place of government or "lawful" 
 money (whether these rights are evidenced by checks 
 or by bank notes) we may call M f , and the average 
 velocity 1 with which they circulate, V. Then our 
 equation becomes 2 
 
 MV + M'V = pq + p'q' + etc. 3 
 
 1 Estimated by Fisher, Purchasing Power of Money, p. 285, as averaging, in 
 recent years, towards 50. 
 
 2 Stated in Ch. I (of Part I), i, without the inclusion of bank credit. 
 
 8 The equation of exchange has been so stated as to include credit, by Kern- 
 merer, Money and Credit Instruments in their Relation to General Prices, New 
 York (Holt), 1907, p. 75 J and by Fisher, The Purchasing Power of Money, 
 P. 48. 
 
44 THE EXCHANGE MECHANISM OF COMMERCE 
 
 The general level of prices is somewhat higher and the 
 value of money is somewhat lower, because of the addi- 
 tional use of credit. The conditions of supply and 
 demand require a somewhat higher level of prices, just 
 as we have seen that they do when there is more money. 
 Gold is cheaper. The demand for it is less. It does not 
 need to be produced, and cannot profitably be produced, 
 at such a low margin, i.e. from such unfavorable sources 
 of supply, as would otherwise be worth while. But 
 this bank credit is not altogether an addition to currency ; 
 it decreases the amount of gold money, and so is largely 
 a substitution of a cheaper for a dearer currency. 
 
 But if bank credit can thus take the place of money, is 
 there any limit to such substitution? Why might not 
 credit expand and prices rise, or money be pushed out, 
 indefinitely? The answer is that the amount of bank 
 credit is pretty definitely related to the amount of money. 
 In the first place, a certain amount of cash is needed in the 
 banks, to maintain confidence. The amount so needed 
 bears a relation to the amount of bank credit, and must 
 be some reasonable per cent of such credit. Otherwise, 
 the public is likely to become frightened and demand cash, 
 and this cash cannot be paid. A margin against such 
 contingencies is always essential and, for national banks 
 of the United States and Federal reserve banks, as well 
 as frequently for State banks, is required by law. Ref- 
 erence has just been made 1 to this requirement in the case 
 of the Federal reserve notes. So the total bank credit 
 is related to the total bank reserves or cash in the banks. 2 
 Banks maintain the proper relation between deposits 
 and reserves, by adjusting their rates of interest (or dis- 
 
 1 5 of this chapter (II of Part I). 
 
 2 White, Money and Banking, third edition, Boston (Ginn), 1008, p. 197. 
 
THE NATURE OF BANK CREDIT 45 
 
 count) charged to borrowers. If the deposits are in 
 danger of becoming too great, relative to the reserves, a 
 higher charge to borrowers will discourage borrowing, and 
 so will limit the increase of those deposits which originate 
 in the borrowing of deposit rights (or in the discounting 
 of notes and acceptances). 
 
 The total bank credit is related, also, to the total cash 
 in circulation. 1 Bank deposits passed by means of checks 
 are absolutely unavailable for very many transactions. 
 They are unavailable when the maker of a check is 
 unknown, and they are unavailable, practically, for small 
 payments, such as street car fares. Even bank notes 
 cannot fill up the entire circulation when, as is usually 
 the case, the government allows them to be issued only 
 in relatively large denominations. The smaller denomi- 
 nations are needed and government money is used. 
 Business convenience, then, also compels a relationship 
 between the quantity of bank credit and the quantity of 
 government money. 
 
 Since the quantity of bank credit is related in these 
 two ways to the quantity of government coined and 
 government issued money, changes in the latter tend to 
 bring proportionate changes in the former. It is still 
 true that prices depend upon the quantity of money, 
 though the dependence is in part indirect. The demand 
 for goods comes from those who have bank credit to 
 offer as well as from those who have only money. And we 
 may now speak, not merely of the supply of money and 
 the demand for it, but of the supply of currency (includ- 
 ing both money and circulating credit), and the demand 
 for it. 
 
 1 Fisher, The Purchasing Power of Money, p. 50. 
 
46 THE EXCHANGE MECHANISM OF COMMERCE 
 
 7 
 
 Fluctuations of Bank Credit 
 
 But though the amount of bank credit is thus related 
 to the amount of money, the ratio between them is 
 slightly rhythmic rather than definitely constant. 
 During periods of hope and confidence, bank credit 
 tends to expand, and prices to rise. During periods of 
 distrust and depression, the volume of circulating credit 
 tends to be smaller, and prices to be lower. When 
 prosperity is generally expected, business men are 
 anxious to extend their credit by borrowing of the banks 
 for the purchase of merchandise and for other business 
 purposes. The banks can then increase their deposits 
 by making loans, as much as their available reserves will 
 permit. When, for any reason, doubt and fear prevail, 
 even low discount rates may not induce an equal amount 
 of borrowing. 
 
 The sharpest changes in the relation of the quantity of 
 circulating bank credit to the quantity of money come as 
 the consequence of panic. So far as a panic is foreseen, 
 the banks endeavor to prepare themselves for it by 
 decreasing their demand liabilities in relation to their cash 
 on hand or reserves. That is, they cut down their loans 
 by raising their rates of discount. As the panic spreads, 
 the necessity of such a policy becomes evident to nearly 
 all the banks. Any bank may suddenly find itself sub- 
 jected to the danger of a run upon it, and dares not 
 increase the danger by making extensive loans. Those 
 banks upon which there actually are runs, find themselves 
 with depleted reserves, and are peculiarly unable to 
 extend credit. The bank rate of discount, then, rises 
 
THE NATURE OF BANK CREDIT 47 
 
 rapidly, while the volume of bank credit, M ', decreases, 
 and prices fall. 
 
 At such a time of stress, a great national bank (or a 
 few great banks) which keeps large reserves beyond the 
 requirements of ordinary years, is a tower of strength, 
 and can usually prevent any general collapse of credit. 
 Such an institution is the Bank of England, which holds 
 itself responsible for the credit structure of the nation, 
 and maintains always an emergency reserve. In the 
 United States, the recent Federal Reserve Act (of 1913) 
 directs the establishment of not less than eight or more 
 than twelve 1 Federal reserve banks. All national banks, 
 and all other banks which become members of the 
 system, 2 are required to keep a portion of their reserves 
 in one of the Federal reserve banks. The aim is to have a 
 large part of the nation's banking reserve concentrated 
 in these few large banks so that ample means may be 
 available in time of panic for the aid of any sound bank 
 which finds itself threatened by the unreasoning fear of 
 depositors. The Federal reserve banks are themselves 
 required to keep each a 35 per cent reserve in lawful 
 money against deposits and a 40 per cent reserve in gold 
 against the Federal reserve notes which they have out- 
 standing. This requirement insures the maintenance 
 in ordinary times of a reserve which may be needed 
 in case of a financial crisis. But when there is financial 
 crisis or the fear of it and many banks are curtailing 
 their loans, one of the things most needed is the assurance 
 that credit can be secured by those whose assets are good 
 and whose business is dependent upon credit. At such 
 a time new reservoirs of credit may need to be opened 
 
 1 Made twelve by the Organization Board. 
 
 2 With a temporary exception stated in the act. 
 
48 THE EXCHANGE MECHANISM OF COMMERCE 
 
 until the old ones, temporarily closed, are again un- 
 locked. The new law therefore provides that the 
 Federal Reserve Board, the government regulating 
 body, may temporarily suspend any of the reserve re- 
 quirements, but only by levying a proportional tax on 
 the banks so favored. 
 
 But while it is desirable that the violent credit fluc- 
 tuations associated with crises should be avoided, some 
 seasonal rise and fall of bank credit is desirable. In 
 agricultural countries, particularly, the amount of trade 
 immediately after the crop season is greater than at other 
 times, and an alternate expansion and contraction of 
 bank credit, corresponding to the expansion and contrac- 
 tion of business, tends to keep prices more stable rather 
 than to make them less so. In the United States, the 
 circulation of the Federal reserve notes provided for in 
 the new currency bill, and the gradual retiring of the old 
 bond-secured bank notes, will tend to an elasticity of bank 
 credit in the form of notes, comparable to, though perhaps 
 less than, the elasticity of deposits. The new law requires 
 that no Federal reserve notes originally issued by one 
 Federal reserve bank shall be paid out by another such 
 bank but shall be sent promptly for credit or redemption 
 to the issuing bank. The effect of this provision must 
 be to give at least some slight elasticity to the volume of 
 these notes. For the notes will be lent out as business 
 conditions favor, and will pass into circulation. They 
 will then be used by borrowers, along with other means 
 of payment, to liquidate debts to the various banks, will 
 flow in considerable volume to the Federal reserve banks, 
 and must then be cancelled against other debts or re- 
 deemed. Bank deposits in the United States are nor- 
 mally elastic, and will doubtless continue to be so. The 
 
THE NATURE OF BANK CREDIT 49 
 
 banks lend perhaps nearly all their reserves will support, 
 at certain times, and at other times accumulate reserves 
 in preparation for the season or seasons of largest lending. 
 
 8 
 Summary 
 
 Let us now bring together, in brief compass, the main 
 conclusions of this chapter. We saw, to begin with, that 
 credit does not really act as a substitute for money unless \ 
 there is the possibility of cancellation, unless the same j 
 credit (though not necessarily the same paper evidence 
 of it) circulates more than once. It usually does this 
 in the case of the bank deposit or right to draw from a 
 bank. This right to draw, circulating by check or draft, 
 is a substitute in trade for legal tender money, tends 
 somewhat to increase the total supply of currency, and 
 tends to drive out other currency. 
 
 Analysis of the relations of the various parties con- 
 cerned, to each other, showed that, apart from their 
 function of insuring the credit of borrowers by risking 
 some capital of their own, banks are really but inter- 
 mediaries between those who borrow of them, and the 
 real lenders. These lenders are the depositors, since it is 
 the depositors who have given up present goods by de- 
 positing, in the banks, money which they might have 
 spent, by accepting checks in return for goods sold, 
 or by receiving the promissory notes of or drawing drafts 
 on the purchasers of the goods, and having such notes 
 or drafts discounted by banks. If the borrowers as a 
 whole were unable to repay, then the banks would be 
 unable to pay the depositors what the latter were entitled 
 to. What the banks do is to bring together borrowers 
 
50 THE EXCHANGE MECHANISM OF COMMERCE 
 
 and lenders, making available to borrowers, in the form 
 of loans, sporadic waiting which would in any case exist. 
 Through the institution of commercial banking, trade is 
 carried on by means of people becoming successively 
 and alternately each other's creditors. The demand for 
 loans from borrowers is sufficient to throw upon them the 
 cost of maintaining the banking system. Nevertheless, 
 the existence of that system^by making possible the 
 bringing together^ sporadic waiting, tends to make the 
 interest charge to borrowers lower than it would probably 
 otherwise be. Bank notes involve the same principles 
 as bank deposits, though the holders of bank notes are 
 commonly protected or insured to a greater degree by 
 government than depositors. 
 
 Bank credit is related to the quantity of money by the 
 habits and business requirements of the community and 
 by the necessity of a sufficient reserve. But the relation 
 between bank credit and money is rhythmic rather than 
 exactly constant. % The fluctuations seem to be, in large 
 part, closely connected with the alternation of business 
 confidence and business distrust, and with the occurrence 
 of panics. The banking system should be so well 
 organized and conservatively managed as to minimize 
 such fluctuations of credit. On the other hand, a certain 
 degree of elasticity in bank currency, making it expand 
 and contract according to the seasonal variations of trade, 
 appears to be desirable. 
 
CHAPTER III 
 
 THE NATURE AND METHOD or FOREIGN EXCHANGE 
 
 The Function of Bills of Exchange 
 
 IN the last chapter we saw that in the most 3|ghly 
 civilized countries, particularly the English-spe 
 countries, the largest part of trade is carried on by 
 of bank credit. This form of credit, circulating by me 
 of checks, is, in the United States, of almost unive: 
 use as to all large scale dealings within a city or other 
 circumscribed area. 
 
 We saw, also, that the use of this bank credit, through 
 checks or bank notes, is merely a means by which bor- 
 rowers and lenders are brought together, the bank 
 being but an intermediary ; that it is a means by which 
 one person or firm can become, in the sense explained in 
 the preceding chapter, a debtor successively to a second, 
 third, fourth, fifth, etc., so that money has only to pass 
 from the first through the bank or through two or more 
 banks and a clearing house, to the last. All the inter- 
 mediate transactions may then cancel, or cancellation 
 may at times be complete, so that no balance remains. 
 Cancellation of these serial and opposing debts thus be- 
 comes our principal means of carrying on modern busi- 
 ness. And trade is still, in the last analysis, as in primi- 
 tive barter or as where money is the medium, an exchange 
 of goods for other goods. We buy goods and become, in 
 
 51 
 
52 THE EXCHANGE MECHANISM OF COMMERCE 
 
 effect, debtors. We sell goods and become creditors. 
 The debts cancel and we have traded goods for goods. 
 
 Bills of exchange enable us to extend this system of 
 credit beyond the town or city, beyond the state, beyond 
 the nation. Business firms separated hundreds of miles 
 from each other can become debtors and creditors of one 
 another through the intermediation of the banking and 
 exchange system. The credit structure becomes inter- 
 national. Through the commercial and the exchange 
 banks, a New York firm can become, in effect, suc- 
 cessively the debtor of a London firm, another London 
 firm, a Glasgow firm, a Berlin firm, a Boston firm, and 
 another New York firm. That is, these different business 
 houses successively become claimants of the banking 
 system, through their receipts of checks or drafts from 
 one another, or through their drawing bills of exchange 
 on one another, or both, of the sum, or part of it, originally 
 borrowed from a New York bank, as a deposit, by the 
 first mentioned New York firm. In trade between 
 nations, or between widely separated parts of the same 
 nation, credit is used, debts in large part cancel, and 
 money is used to a relatively small degree. 
 
 Bills of exchange or drafts serve in large part, then, the 
 same purposes as ordinary checks. Over long distances, 
 however, whether business crosses national boun- 
 daries or not, the "customer's check" is not likely to be 
 satisfactory. The receiver may have hard work to cash 
 it or to get for it an immediate addition to his bank 
 balance. In the distant locality to which the check is 
 sent, nobody, probably, knows the maker well, or knows 
 whether the maker's check is good. In this regard, the 
 bank draft is superior. Or the creditor may not wish 
 to wait for what is owed to him, until a check arrives 
 
METHOD OF FOREIGN EXCHANGE 53 
 
 from his debtor. In this regard, a commercial draft is 
 superior. 
 
 Foreign and domestic exchange are in principle the 
 same. The former involves payments between persons 
 in different countries, countries which have, generally, 
 different currencies and which are often separated from 
 each other by natural barriers. Domestic exchange in- 
 volves dealing between different parts of the same coun- 
 try, but parts too far from each other for the ordinary, 
 convenient use of checks. 
 
 2 
 
 The Nature of Bills of Exchange 
 
 Let us now inquire what is the nature of the bill of 
 exchange. Suppose, to take the simplest possible case, 
 that B owes to A the sum of $1000, and that A owes a like 
 sum to C. The form of settlement will be that of the 
 bill of exchange if A orders B to pay C. When B complies 
 with the order, his debt to A and A's debt to C are both 
 liquidated. Usually the bill of exchange involves an 
 exchange banker or broker as one of the parties. But 
 in any case it is always of the form : A orders B to pay C. 
 
 The reader may at once note that in so far the bill of 
 exchange resembles the ordinary check, which is, in fact, 
 but one species of bill of exchange. But a distinction can 
 be made, based partly upon the relation of a bank or 
 banks to others concerned. In the case of the " custom- 
 er's check," A, the drawer, is a mercantile or industrial 
 establishment or a person, while B, the drawee, is always 
 a bank. In the case of the commercial draft, A and B 
 are usually persons, or commercial or industrial establish- 
 ments (except that, as with the "bank acceptances" de- 
 
54 THE EXCHANGE MECHANISM OF COMMERCE 
 
 scribed in the previous chapter, 1 B's bank may be desig- 
 nated by him as the drawee in his place), while C, the 
 payee, is usually, though not necessarily, a bank. In 
 the case of the bank draft, both A, the drawer, and B, 
 the drawee, are banks. The payee may be a person or 
 an ordinary business firm. Furthermore, a check is 
 always a demand claim (a demand draft of one bank on 
 another is frequently called a "check")? while a draft 
 may or may not be. We shall have occasion to notice, 
 later on, the significance of some of these different re- 
 lations. What we have here to emphasize is that the 
 bill of exchange or draft and the ordinary check are 
 exactly alike in involving three parties, of whom one 
 orders a second to pay a third ; and that the distinction 
 rests, in part, upon the position which the bank or banks 
 concerned, if any, occupy in relation to the other persons 
 or person. 
 
 3 
 
 How Bills of Exchange Might be Used to Settle Obligations, 
 Assuming no Banks 
 
 If credit is to serve appreciably as a medium of ex- 
 change or substitute for money, then when credit is given 
 there must generally be three parties. When there are 
 but two persons concerned, the giving of credit is usually 
 only a postponement of payment. There is not an 
 avoidance of the use of money, except in those com- 
 paratively rare cases where B's debts to A now are 
 balanced, or partly balanced, by later obligations incurred 
 by A to B. Then, of course, credit may lead to cancella- 
 tion. If three or more persons are concerned, in addition 
 to banks or other intermediaries (and even if banks are 
 
 i 4 ofCh.II(PartI). 
 
METHOD OF FOREIGN EXCHANGE 55 
 
 included in the three, this would be true in form), can- 
 cellation always takes place. 
 
 But we have yet to see just how bills of exchange or 
 drafts are used to balance obligations in foreign trade. 
 To begin with, we shall take, as being the simplest, a case 
 seldom realized in practice, namely, where four parties 
 can settle up their various debts without resort to any 
 bank, exchange broker, or other go-between. Suppose 
 that an American merchant, whom we shall designate 
 as AI, owes to an English manufacturer, EI, the sum of 
 100 ($486.65), while the latter owes as much to an 
 English merchant, E 2 , who in turn owes an equal sum to 
 an American manufacturer, A 2 . We may represent 
 the situation, graphically, as follows : 
 
 owes 
 
 U~i 
 
 t 
 
 owes 
 
 t 
 
 "> i 
 
 Obviously, if the parties all know each other and know 
 of the situation, they can very easily settle all three 
 debts with but one use of money. EI may make out a 
 bill on AI ordering him to pay E 2 . Thus EI cancels 
 his debt to E 2 . E 2 may then indorse the bill, making 
 it payable to A 2 , thus liquidating his (E 2 's) debt to A 2 . 
 Finally, A 2 presents the bill to AI, who cancels his debt 
 
56 THE EXCHANGE MECHANISM OF COMMERCE 
 
 to EI by paying it. Thus, three debts have been paid 
 with but one use of money. Suppose that, in addition 
 to the other debts, A 2 owes $486.65 to AI. Then our 
 diagram would be : 
 
 owe$ 
 
 I t 
 
 owes owes 
 
 owes 
 
 A 2 might then pay by indorsing the bill to AI, who would, 
 therefore, have only to pay himself. In that case, four 
 debts would be settled with no use of money at all. 
 
 4 
 
 Settlement of Obligations by Drafts (Bills of Exchange), 
 through Intermediation of Banks, Assuming Creditors 
 to Draw Drafts on Debtors 
 
 Our illustration, however, must be modified if it is to 
 picture the usual commercial practice. The different 
 parties having occasion to use or to pay drafts or bills of 
 exchange cannot be expected, ordinarily, to know each 
 other. They must therefore deal with middlemen, with 
 the so-called exchange bankers or exchange brokers. 
 When foreign exchange is carried on through the inter- 
 mediation of bankers or exchange brokers, each bill of 
 exchange is still of the form, A orders B to pay C. But 
 
METHOD OF FOREIGN EXCHANGE 57 
 
 an exchange banker is now in the position of both A 
 and B, or of C. 
 
 There are several ways by which debts can be settled 
 through the use of the exchange banking machinery. 
 One way is for the creditor to draw upon the debtor, 
 ordering him to pay a bank. Another is for the debtor 
 to remit to the creditor by sending the latter a bank 
 draft. Let us take up, first, cases where the creditor 
 draws on the debtor. We will suppose the same four 
 persons, AI, A2, EI and E 2 , but will now assume what 
 is the usual, if not indeed the universal, fact, that they 
 deal with each other through middlemen. These middle- 
 men may be two banking houses dealing in foreign 
 exchange, one, B a , an American bank, and the other, B e , 
 an English bank. We shall suppose, as before, that AI 
 owes EI, EI owes E 2 , E 2 owes A 2 , and A 2 owes AI. All 
 that is needed for cancellation is that the parties be 
 brought together. Diagrammatically this situation is: 
 
 Owes- 
 
 owes- 
 
 EI makes out a draft on A! ordering AI to pay B e . EI 
 may be said to sell this draft to B e . Ei's bank, B e , may 
 then give EI the money, but will more probably (since 
 EI is likely to prefer it) put the amount to his credit as 
 
58 THE EXCHANGE MECHANISM OF COMMERCE 
 
 a depositor. B e sends this draft, directly or indirectly, 
 to B a for collection. B a will subtract it from the credit 
 account of its customer, AI. So far, no money has been 
 used. Ei has an addition to his deposit account. AI 
 has suffered a subtraction from his. EI has the claim 
 on the banks which AI has lost. EI may now settle 
 his obligation to 2 by a check on B e . E 2 then realizes 
 an addition to his deposit account with B e , while EI 
 suffers a diminution of his bank account. Next, A 2 may 
 make out a draft on his debtor, E 2 (or, as where E 2 has 
 arranged for " acceptances," directly on E 2 's bank), 
 ordering E 2 (or his bank for him) to pay B a . B a may send 
 this draft to B e for collection. A 2 now has an addition 
 to his deposit account in B a . E 2 's bank account is 
 decreased. Lastly, A 2 settles with AI by check on B a . 
 AI has now an addition to his bank account which may 
 cancel the original subtraction, while A 2 suffers a sub- 
 traction which may be equal to the previous addition. 
 Four debts may have been cancelled, with no use of 
 money. In any case, there has been less use of money 
 because of the use of drafts, for the banks concerned com- 
 pare accounts, and only net balances have to be paid in 
 money or in gold. The use of bills of exchange extends 
 to trade between nations, and equally to trade between 
 widely separated parts of the same nation, the operation 
 of the bank credit system. 
 
 Even if we suppose that B a (for example), the exchange 
 bank which collects the draft on AI, is not the bank in 
 which AI regularly keeps a deposit account, nevertheless 
 the rule that trade is carried on by a cancellation of 
 credits, still holds. Though B a , upon receiving from B e 
 the draft drawn by EI upon AI, cannot then directly 
 subtract the amount from AI'S account, it can call on AI 
 
METHOD OF FOREIGN EXCHANGE 59 
 
 for payment. Either the draft will be made payable 
 to AI'S bank and by that bank subtracted from his deposit 
 there, or it will be presented directly to AI himself, in 
 which case he will probably pay it by giving B a a check 
 on his own bank. In any case, then, EI'S bank account 
 will probably be increased and AI'S bank account de- 
 creased by virtue of the draft. 
 
 On the other hand, A 2 's bank account will be increased 
 when he sells his draft on E 2 , though he sells this draft 
 to an exchange dealer not engaged in a regular banking 
 business. For such an exchange dealer will presumably 
 pay him for his draft by means of a check upon some 
 bank, which he can then deposit for credit in his own 
 bank. His deposit account is increased and E 2 's is 
 decreased by the transaction. In any case, B a , or some 
 other exchange bank, has to pay A 2 , directly or indirectly, 
 and receives payment, directly or indirectly, from AI; 
 in any case, B a collects one draft for B e and sends one 
 draft to B e for collection. In any case, there is cancella- 
 tion, and the shipment of gold is wholly or partially 
 avoided. A 2 may pay AI by check as above suggested, 
 or, if they are widely separated, AI may draw a domestic 
 draft on A 2 and deposit the draft in his bank for credit. 
 The draft will go to A 2 's bank or to A 2 for collection and 
 A 2 's bank account will be decreased. 
 
 Attending only to the international relations involved, 
 we may say that A 2 's draft on E 2 constitutes part of the 
 supply, in the United States, of bills on England. The 
 desire of an American bank, e.g. B a , to purchase this bill, 
 signifies a demand, in the United States, for bills on Eng- 
 land. This demand may be said, in the last analysis, 
 to result, partly, from the necessity which some American 
 bank (or banks) is under, of remitting to an English 
 
60 THE EXCHANGE MECHANISM OF COMMERCE 
 
 bank or banks, after collecting for the latter; and so 
 may be said to result, to some extent, from the supply, 
 in England, of commercial drafts on Americans. We 
 may assert, therefore, that the supply of such commercial 
 bills on America, in the English market, corresponds, in 
 part, to demand for bills on England, in the American 
 market, and, in part, gives rise to this demand. The 
 basic principle is of course similar in the relations between 
 different parts of the same country. In general, supply 
 in one place, of commercial bills on another, gives rise to 
 demand in the other, for bills on the first. 
 
 To avoid misunderstanding, it should be pointed out 
 that foreign exchange, in the complications of practical 
 business, is often three cornered, four cornered, etc., 
 involving merchants and banks of several countries. 
 Thus, Americans may have purchased goods of English 
 merchants ; the latter may have bought goods in Ger- 
 many ; and Germans may have imported goods from the 
 United States. Supposing the creditors in each case 
 to draw upon their debtors, 1 there would be sold in Eng- 
 land, drafts on merchants in the United States; 
 in Germany, drafts on English purchasers; and in 
 the United States, drafts on Germans. The drafts 
 in England, on Americans, would be sent to American 
 banks for collection. The American banks must then 
 settle with their English correspondents. This would 
 create a demand for drafts on foreign countries, but 
 might not directly create a demand for drafts on 
 England. For the American banks might purchase 
 drafts on Germany and send these in settlement to their 
 correspondents in England. These drafts would be 
 collectible through German banks, which might settle 
 
 i See, however, 5 of this chapter an of Part I). 
 
METHOD OF FOREIGN EXCHANGE 61 
 
 by purchasing, and sending to their English correspond- 
 ents, the drafts on England drawn by German exporters. 
 In practice, then, the supply in England of drafts on the 
 United States may not directly give rise to a demand in 
 the United States for drafts on England. Instead, it 
 may lead to a demand in the United States for drafts on 
 Germany, and to a demand in Germany for drafts on 
 England. These complications should not be over- 
 looked, but, since they introduce no new principle, they 
 may, for simplicity, be ignored in most of our study. 
 
 5 
 
 Settlement of Obligations by Bank Drafts, when Debtors 
 Remit to Creditors 
 
 Obligations between persons in widely separated places 
 may also be cancelled through the use of bank drafts. 
 Instead of creditors drawing on their debtors, the debtors 
 then remit to their creditors. What method shall be 
 adopted in each case will depend upon the understanding 
 between the parties concerned as creditor and debtor. 
 If AI owes EI and is to pay by means of a bank draft, 
 he may go to the bank, B a , and request such a draft 
 payable to EI. This he will pay for out of his deposit 
 with B a , or by a check on whatever bank he has an 
 account with, or (conceivably but rarely) with money. 
 The draft AI gets is really a kind of check made out by 
 one bank on another. B a makes out an order upon B e 
 (or some other English bank) requiring payment to EI. 
 This order is handed by the American bank to AI, who 
 sends it to EI, and the last named person is then in a 
 position to present the draft for cash or, more probably, 
 credit, to B e or to his regular deposit bank. E 2 may simi- 
 
62 THE EXCHANGE MECHANISM OF COMMERCE 
 
 larly settle with A 2 by getting a draft from B e ordering 
 B a to pay A 2 . We may suppose EI to settle with E 2 and 
 AZ with AI by check, as before. Or we may suppose that 
 they are separated from each other by considerable dis- 
 tances and likewise settle with each other by using bank 
 drafts. The matter of form is unessential. In any case, 
 most obligations, both international and intranational, 
 can be settled by cancellation, through the banks. 
 
 Where settlement is made by the use of bank drafts, 
 there must, of course, be some arrangement between the 
 banks concerned, such as deposit accounts kept by each 
 with the other, so that all of these drafts will be honored 
 without question. There is no need of any special 
 arrangement in the case of checks, since these can be sent 
 at once, and with no appreciable loss of time in transit, 
 through a clearing house, to the bank on which they are 
 drawn. But with bank drafts, used where the distances 
 are greater, the situation is otherwise. 
 
 Where bank drafts are used, these constitute part of 
 the supply of drafts, and the demand for them is a demand 
 by persons and by business houses, who have remittances 
 to make, as well as by banks. Thus, a part of the supply, 
 in the United States, of bills on England is made up of 
 the drafts of American upon English banks ; and a part 
 of the demand, in the United States, for bills on England 
 is the demand for bank drafts, by business houses having 
 obligations to meet in England and desiring to meet 
 them in that way. 
 
 Third, cancellation may take place by the use of both 
 of these methods, i.e. by both drawing and remitting. 
 For instance, A 2 makes out a bill on E 2 ordering the latter 
 to pay B a . B a sends it to B e for collection (or discount) . 
 B a thus gets a claim upon or a credit with B e . AI desires 
 
METHOD OF FOREIGN EXCHANGE 63 
 
 to remit a bank draft to EI. He seeks of B a , such a draft. 
 B a , having purchased A2 J s draft on 2 and secured a 
 credit balance in England, is able to sell AI a draft on B e 
 payable to EI. 
 
 This is the way in which, as a matter of practice, most 
 of our transactions with England are settled. When 
 Englishmen owe us, we usually draw drafts upon them or 
 their banks, i.e. we draw upon London. We do not, as 
 a rule, arrange for them to remit drafts on New York. 
 On the other hand, if we owe them, the understanding 
 commonly is that we shall purchase drafts on London and 
 remit. American banks, then, buy drafts on London 
 from those Americans having English debtors, send these 
 drafts to their London correspondents, and, on the 
 balances in London so secured, sell drafts on their 
 London correspondents to Americans having English 
 creditors. The opposite operations are indeed carried on, 
 but they are much less common. In general, it may be 
 said that other countries draw drafts on England in 
 much larger volume than England draws upon them. 1 
 
 Three-cornered exchange, also, may involve chiefly 
 bills on London. Thus, if Americans have exported cot- 
 ton to England and imported mechanical instruments 
 from Germany, while Germany has purchased cloth of 
 England, drafts on London may be used in part for all 
 three settlements. American exporters of cotton will 
 draw drafts on the English purchasers. These drafts 
 may be used, in part, by American banks, for remittances 
 to Germany, as a basis for the sale of bank drafts to 
 American importers who must remit to Germany. 
 German banks will, in turn, send these drafts on the 
 
 1 Clare, The A. B.C. of the Foreign Exchanges, London (Macmillan), 1893, 
 p. 12. 
 
64 THE EXCHANGE MECHANISM OF COMMERCE 
 
 English importers of cotton to England, in order to 
 maintain balances there for the sale of drafts to remit- 
 ting German importers of cloth. 
 
 London is, in fact, the world's greatest financial centre. 
 Partly, perhaps, because banking is most fully developed 
 in England, partly because of the magnitude of England's 
 foreign trade and the fact that payments have to be made 
 to English exporters by merchants of all other countries, 
 drafts on London are nearly everywhere in demand. 
 Sellers of goods, in most parts of the world, usually prefer 
 to take advantage of this fact and realize on their sales 
 at once. On the other hand, English exporters more 
 usually, though not always, wait for remittances from 
 foreign purchasers of their goods. The loss of time 
 necessarily incident to exchange transactions falls, then, 
 except as it is allowed for in higher prices of goods sold, 
 more largely on English manufacturers and merchants 
 and less largely on other countries. 
 
 Coming back to the consideration of trade between 
 England and the United States, we may conclude that 
 drafts drawn by American business houses on English 
 business houses (or upon banks properly designated by 
 the latter), and drafts drawn by American banks upon 
 English banks, are both part of the supply, in the United 
 States, of bills on England. The demand for such 
 bills has also a twofold source. It comes, first, from 
 those persons and firms other than banks, who have obli- 
 gations to meet in England which they wish to meet by 
 remitting bank drafts. Second, the demand comes from 
 banks which may desire bills of exchange on England 
 for either or both of two purposes : in order to maintain 
 accounts in England, against which they may sell bank 
 drafts; and, though less frequently, in order to remit 
 
METHOD OF FOREIGN EXCHANGE 65 
 
 funds to English banks which are sending to them, for 
 collection and settlement, drafts on American business 
 men. As there is, in the United States, both supply of 
 and demand for exchange on England, so there is, in 
 England, both supply of and demand for exchange on the 
 United States. The case is similar in our commercial 
 relations with other countries, and in the relations of 
 different parts of the United States itself, to each other. 
 
 6 
 
 How Exchange Banks Make Profits 
 
 A market may be defined as the coming together of 
 buyers and sellers. It therefore involves all the mecha- 
 nism necessary to facilitate their intercourse. One may 
 speak of a general market or of a local market, of a market 
 in one or in another place. Thus, there is the New York 
 market for the buying and selling of exchange on London. 
 A bank in New Haven, Conn., may be a part of that mar- 
 ket if it buys from and sells to it. That market includes, 
 besides the commercial and industrial organizations 
 which buy or sell drafts, all middlemen of whatever class 
 who engage in the trade. 
 
 The middlemen may be divided roughly into three 
 classes. 1 First may be mentioned banks which do a reg- 
 ular foreign exchange business, buying bills from those 
 who have them to sell and selling their own drafts on 
 foreign correspondents to persons desiring to remit. 
 Much of this business is done by foreign exchange banks 
 which carry on little or no other business. Some of it 
 is done by ordinary commercial banks, such as United 
 
 1 Cf . Escher, Elements of Foreign Exchange, New York (The Bankers Publish- 
 ing Company), 191 1, p. 60. 
 F 
 
66 THE EXCHANGE MECHANISM OF COMMERCE 
 
 States National banks, in addition to their other banking 
 business. Second, we may call attention to those ex- 
 change dealers whose principal business is to buy com- 
 mercial and bankers' bills, and to resell them, chiefly 
 to banks. Third are the independent brokers who make 
 small commissions by bringing buyers and sellers to- 
 gether. These do not invest their own capital, do not, 
 that is, buy bills of exchange in the market, but assist 
 those desiring to sell bills to find buyers, and vice versa. 
 
 The bankers and brokers engaged in the business of 
 foreign exchange make their money from commissions 
 and by the difference between what they pay for exchange 
 and what they get for it. Thus, when a bank sells its 
 own drafts drawn upon a correspondent bank, it will 
 probably expect to receive a better price than it is willing 
 to pay for the commercial drafts it buys and remits. Its 
 credit is probably better than the credit of most mer- 
 cantile and industrial establishments, and its drafts, 
 therefore, more to be desired. And it will hardly care to 
 engage in the business without receiving some profit as 
 a reward or payment for its services. 
 
 It might be supposed that business men, e.g. in the 
 United States, desiring to remit to foreign creditors, 
 would sometimes buy, through the intermediation of 
 exchange brokers, the identical bills drawn by other 
 American merchants on their foreign debtors, instead 
 of remitting by means of bank drafts. This, however, 
 while perfectly possible, is seldom done in practice. 
 Perhaps one reason is that the business man desiring to 
 remit has much more confidence in the credit of a bank 
 than in the credit of any other company, and hence 
 prefers to buy a claim on a bank to use in remitting. 
 Another and a very practical reason is that an exchange 
 
METHOD OF FOREIGN EXCHANGE 67 
 
 bank can give a draft enabling the debtor to pay the 
 exact sum owed. Were he to buy merchants' bills, it 
 would be difficult, if not impossible, to make out an even 
 sum, since they would be for various amounts dependent 
 on the requirements of previous transactions. It falls, 
 therefore, to the lot of the banks to buy up bills of 
 exchange or drafts of various amounts, and sell their own 
 drafts, in such sums as are desired, against the credit 
 they thus obtain abroad. 
 
 7 
 Various Types of Drafts 
 
 Bills of exchange run for various lengths of time before 
 payment. Some of them are sight drafts, payable on 
 presentation. Others, 3o-day bills and "long bills," 
 such as 6o-day and go-day bills, are payable only after 
 the lapse of a definite period following presentation to the 
 drawee. Bills of exchange, furthermore, may be drawn 
 upon and by persons of various degrees of credit. The 
 credit of both drawer and drawee is important, since, as 
 in the case of checks, if the drawee fails to honor a bill, the 
 drawer or maker of the bill is liable to the payee. Both 
 of these considerations, therefore, namely the length 
 of time a bill is to run, and the credit of the drawer and 
 drawee, affect the bill's value. 
 
 Bills of exchange may be either "clean" bills or docu- 
 mentary. 1 Clean bills are those which have no attached 
 documents giving security, but depend for their value 
 and salability solely on the reputations of the drawee 
 (who must pay the bill) and the drawer (who is respon- 
 sible to the holder if the drawee fails to pay). A bank 
 
 1 Escher, Elements of Foreign Exchange, pp. 45-52. 
 
68 THE EXCHANGE MECHANISM OF COMMERCE 
 
 draft is an example of a clean bill. Frequently a mer- 
 chant's draft on another merchant is a clean bill, but 
 this is not so universally the case. 
 
 Very usually a merchant's or manufacturer's draft 
 is documentary, i.e. has documents attached. Suppose 
 A2 ships 1000 worth of merchandise to E 2 . He may 
 then draw a bill on E 2 ordering the latter to pay 1000 
 to B a . Before doing this, however, or at any rate before 
 disposing of the draft, A 2 will get from the transportation 
 company by which the goods are shipped, a bill of lading 
 for the goods. He will also, probably, insure the goods 
 against shipwreck or other loss or damage in transit. 
 The bill of lading certifies the claim of A 2 , the shipper, 
 upon the transportation company, to have the goods 
 delivered to the consignee. The consignee eventually 
 secures the goods by presenting the bill of lading to the 
 transportation company. Likewise, the certificate of in- 
 surance certifies A 2 's claim upon an insurance company, 
 in case of damage or loss. A 2 , having made out the draft 
 on E 2 , will attach to this draft the bill of lading and the 
 insurance certificate, before disposing of it to any bank. 
 Possession of these documents is then some protection to 
 the bank in case payment is refused. If neither the 
 drawee nor the maker of the draft will or can reimburse 
 the bank, the goods may be sold, because usually hy- 
 pothecated, and the proceeds applied to that purpose. 
 
 A banker, however, is not, supposedly, an expert in the 
 business of selling the goods in question, and may not 
 be able to realize the best price for them without going 
 to considerable expense. Also, the market may not 
 remain steady and the goods may not for that reason 
 sell for enough to cover the bank's advance. The busi- 
 ness reputation and the financial standing of the maker 
 
METHOD OF FOREIGN EXCHANGE 69 
 
 and of the drawee are therefore almost always of impor- 
 tance in determining the value of a draft. If their credit 
 is not established, the maker or drawer cannot hope to 
 receive quite as large an amount for his bill as otherwise 
 he might. 
 
 Documentary commercial drafts, other than sight 
 drafts, may be "acceptance bills" or they may be "pay- 
 ment bills." Acceptance is a formal acknowledgment 
 of obligation by the drawee. When a draft is presented 
 to him for acceptance, he writes the word "accepted" 
 and his signature, across its face. Where, as in England, 
 "bank acceptances" are commonly used, a merchant's 
 bank may undertake to "accept" drafts for him and so 
 becomes the drawee. When an acceptance bill is drawn, 
 the drawee has sufficiently good credit so that his 
 acceptance of the draft gives him possession of the bill 
 of lading and therefore of the merchandise ; though the 
 draft may be for 90 or 120 days after sight, during which 
 length of time the drawee is not called upon for payment. 
 In the case of the payment bill, the drawee's credit is 
 less good. Though acknowledgment in the form of 
 acceptance will be asked for, he cannot obtain the 
 merchandise consigned to him by merely accepting the 
 bill of exchange, but must actually pay it. 1 If, however, 
 a 3o-day, 9O-day or other payment bill is paid by the 
 drawee before maturity, he is allowed a rebate or dis- 
 count from the face of the bill. 
 
 In the case of perishable goods, e.g. produce, payment 
 cannot be allowed by the purchaser to run, lest the prod- 
 uce spoil. He pays the draft at once, therefore, under 
 
 1 Escher, Elements of Foreign Exchange, p. 40. When documentary drafts 
 are made payable a very few days after sight, the documents are apt to be de- 
 livered only upon payment. Ibid., p. 52. 
 
70 THE EXCHANGE MECHANISM OF COMMERCE 
 
 the rebate of interest arrangement. 1 But this rebate will 
 be less than the market rate of discount on the draft. For 
 it is not to be expected that an exchange banker should 
 pay a high price for a draft, only to receive from the 
 drawee less than he paid the maker. The banker is 
 likely to safeguard himself against such a contingency by 
 paying for the draft as little as the least he can expect 
 to receive. Looking at the matter from another point 
 of view, we may say that the allowance made for payment 
 before maturity is not likely to be so large as seriously 
 to affect the value of the draft to the maker or seller. 
 
 Documentary payment bills sent to England by Amer- 
 ican banks for collection cannot, in general, be discounted. 
 The principal reason for this is that such a bill is payable 
 at the option of the drawee on any date prior to maturity. 
 If the goods are not perishable and the drawee does not 
 immediately require them, they may be warehoused 
 until he desires them. When this time comes, he 
 obtains the bill of lading by making payment on the 
 draft. It is convenient, therefore, that the draft should 
 remain, until payment, with the banker who originally 
 presented it for acceptance, in order that the drawee may 
 know where payment should be made, when he desires 
 to acquire possession of the merchandise. 2 On the other 
 hand, acceptance bills drawn on English merchants or 
 English banks are usually sold at a discount in the Lon- 
 don discount market by order of the American bank 
 which remits them. 
 
 ^scher, Elements of Foreign Exchange, p. 49. 
 
 *Margraff, International Exchange, Chicago (Fergus Printing Co.), 1903, 
 p. 115. German banks themselves discount payment bills remitted to them, 
 though at a rate of discount higher than the market rate, while English banks 
 do not. See Margraff, p. 135. 
 
METHOD OF FOREIGN EXCHANGE 71 
 
 8 
 
 The Sale of Demand Drafts against Remittances of Long 
 
 Bills 
 
 After what has been said regarding the discount of 
 bills of exchange, the reader will easily see how banks can 
 sell their own demand drafts against remittances of so- 
 called long bills, i.e. bills of 60 days, 90 days, etc. An 
 American bank, B a , can find out by cable at what rate 
 bills "to arrive" in London on a certain date or by a 
 certain steamer will be discounted. B a thereupon buys 
 the bills here of persons having debtors abroad, or of 
 other bankers or exchange dealers. It sends these bills 
 to its London correspondent, say B e , with orders for 
 immediate discount, i.e. sale. The sum realized con- 
 stitutes a balance abroad to the credit of the American 
 bank, a balance upon which it then sells its own demand 
 drafts * to Americans wishing to make remittances. A 
 demand draft is sometimes sent by telegraph and is 
 then called a " cable." 2 It should be noted that B a has 
 a balance abroad long before the bills sent abroad by it 
 for credit have matured, since these bills it has ordered 
 sold in the London discount market, and they have got 
 into the possession of persons or houses which buy such 
 bills as investments. In the United States there is no 
 such discount market. Drafts made out in England on 
 American debtors, after being purchased by English 
 banks, are forwarded to American correspondent banks 
 for collection, but are generally held, after "acceptance," 
 for account of the forwarding English banks, until 
 maturity, instead of being sold. 
 
 1 Escher, Elements of Foreign Exchange, p. 79. 
 
 2 Ibid., p. 71. 
 
72 THE EXCHANGE MECHANISM OF COMMERCE 
 
 It follows that, as a rule, the real creditor of an English 
 firm on which an American has drawn a 6o-day or go-day 
 draft is not the American, for he has had the draft dis- 
 counted and has received cash or credit. Nor is it the 
 American bank, which has had the draft sold in the 
 London market and received a credit balance with its 
 correspondent or has thereby liquidated a debt. It is 
 rather the purchaser of that draft, in London, who must 
 wait (unless he resells it) 60 or 90 days until it matures 
 and he can collect from the debtor firm in England. 
 Or we may go one step farther back and assert that the 
 ultimate creditors are depositors (holders of rights to 
 draw) in that English bank which buys the draft in 
 question, or from which the buyer of the draft borrowed 
 the means to buy it. 1 On the other hand, when a draft 
 is made out by an English firm on an American, payable 
 say 60 days after sight, the English bank which dis- 
 counts it is the creditor, and, therefore, ultimately, its 
 depositors are the creditors. For the draft will not 
 usually be purchased by an American investor, but will 
 be held by the correspondent bank, for account of the 
 English bank, until maturity. The original English 
 debtor has received payment, but for the time being 
 this payment has come from other English capital which 
 will only be reimbursed when the American firm pays. 
 
 As a matter of usual practice, however, long drafts are 
 not drawn upon American debtors. The absence of a 
 discount (or, more properly, a rediscount) market here 
 means that importers have one less avenue of credit open 
 to them. Were there such a market, drafts drawn upon 
 
 1 "The enormous amount of bills held by the discount companies and bill 
 brokers in England is to a very large extent carried by them through loans on 
 call from the banks." Paul M. Warburg, The Discount System in Europe, Na- 
 tional Monetary Commission, 1910, p. 18. 
 
METHOD OF FOREIGN EXCHANGE 73 
 
 them could be rediscounted and held until maturity by 
 whatever bank or person offered the best rate. Such a 
 bank (and, therefore, ultimately, its depositors) or person 
 would be the real source of credit. It is not easy to say 
 just why we have not, in the United States, a rediscount 
 market. Custom and prejudice may be largely to blame. 
 In general, bankers in the United States have regarded 
 it as evidence of financial weakness for a bank to attempt 
 to rediscount the notes of its customers. Furthermore, 
 the national banking law, as interpreted by the courts, has 
 made it illegal for any national bank to "accept," for 
 account of its customers, drafts upon it. 1 In England, 
 banks continually accommodate their customers by thus 
 accepting drafts. The customer is responsible, in each 
 case, to the accepting bank, and must reimburse the 
 latter before the draft is due, but acceptance of the draft 
 insures it and makes it salable. The Federal Reserve 
 Act of 1913 specifically permits banks which become 
 members of the system thus to "accept" drafts drawn 
 upon them, 2 and it empowers the Federal reserve banks 
 to rediscount the commercial paper of member banks. 
 The law is intended, doubtless, among other things, to 
 further the development of a rediscount market. 
 
 9 
 
 Summary 
 
 Before taking up a study of the forces determining the 
 rate (or rates) of exchange, let us briefly restate the prin- 
 cipal conclusions regarding exchange, already reached. 
 First, taking up our analysis where it was left by the 
 
 'See Jacobs, Bank Acceptances, National Monetary Commission, 1910, 
 pp. 4; 9. 
 
 2 Under conditions prescribed by the law. 
 
74 THE EXCHANGE MECHANISM OF COMMERCE 
 
 previous chapter, we saw that bills of exchange or drafts 
 simply extend to trade between widely separated dis- 
 tricts the possibilities of successive debtorship and 
 creditorship and of debt cancellation, which in circum- 
 scribed areas are brought about through the use of checks. 
 As in the case of checks, banks are really but inter- 
 mediaries through whom and by whose arrangements, 
 cancellation takes place. A consideration of the different 
 varieties of method in settling obligations over long dis- 
 tances served to reenforce the general conclusion. These 
 obligations are usually, settled in either of two ways : 
 first, the creditor may draw a draft upon his debtor 
 payable to the creditor's bank or to some other desig- 
 nated party; second, the debtor may purchase a bank 
 draft with which to remit to his creditor. Assuming, in 
 trade between England and the United States, either of 
 these methods to be used from both sides, or assuming 
 one method from one side of the water and another from 
 the other side, we reach alike the same result. The use 
 of drafts and the intermediation of banks make possible 
 an international network of credit relations which could 
 not otherwise exist. The usual practice is for American 
 creditors to draw on their English debtors and for Ameri- 
 can debtors to remit to their English creditors. 
 
 When the various ways of settling obligations through 
 the use of bills of exchange had been set forth, we were 
 ready to inquire of what, in any country, the supply of 
 drafts upon another country is made up. We found 
 it to be composed of two classes of drafts : those drawn 
 by the creditors of the first country upon their debtors 
 in the second, offered for sale to exchange bankers ; and 
 those made out by banks in the first country upon their 
 correspondent banks in the second, sold to debtors in the 
 
METHOD OF FOREIGN EXCHANGE 75 
 
 first country who desire to make remittances to the 
 second. Demand for drafts, also, proved to have a two- 
 fold source, springing, on the one hand, from debtors 
 desiring bank drafts for remittance and, on the other, 
 from banks desiring commercial or bank drafts to settle 
 with or maintain balances in, correspondent banks. 
 Analysis of the relations involved made it clear that 
 supply in one country (or territory) of drafts upon a 
 second, brings about demand in the second for drafts on 
 the first. 
 
 The exchange market was briefly described and it was 
 shown how exchange dealers make a profit from their 
 transactions, being able to buy exchange somewhat more 
 cheaply and sell it at somewhat higher rates, than mer- 
 chants, manufacturers, etc. Next, bills of exchange were 
 classified as sight drafts and long bills, according to the 
 time to elapse before payment, and as documentary bills 
 and clean bills, according as documents, such as a bill 
 of lading, do or do not secure them ; and documentary 
 bills, other than those payable at sight, were in turn 
 subdivided into acceptance bills and payment bills ac- 
 cording to what conditions the drawee must fulfill to 
 secure goods consigned to him. 
 
 Finally, the process of selling demand drafts against 
 remittances of long bills was briefly described. It was 
 pointed out that this can be done by American banks 
 by sending drafts on English firms to England for dis- 
 count ; but that in the absence of a rediscount market 
 here, the reciprocal operation is unusual. Instead, long 
 drafts on American firms, in those relatively infrequent 
 cases when they are drawn, are generally held till ma- 
 turity for account of the remitting London banks. The 
 comparatively large discounting, in England, of bills 
 
76 THE EXCHANGE MECHANISM OF COMMERCE 
 
 drawn by Americans on their English debtors, means 
 that the capital which enables the Americans to get 
 immediate funds, comes largely from those other Eng- 
 lishmen or English banks, who buy these bills in the 
 discount market, or from the depositors of the banks 
 where the funds for purchasing the drafts are secured. 
 
CHAPTER IV 
 THE RATE OF EXCHANGE 
 
 i 
 
 The Meaning of Par of Exchange 
 
 BILLS of exchange or drafts are certificates of property 
 rights, i.e. they certify rights to payment and, therefore, 
 rights to enjoy the benefits of various amounts of wealth. 
 These rights, like other property, are subjects of purchase 
 and sale, and have a price in any market where they are 
 bought and sold. Also, the ruling price, at any time, of 
 drafts, like the price of other goods, is fixed by supply and 
 demand. 
 
 Exchange between countries may be said to be at 
 par when a demand draft on either country sells in the 
 other for the equivalent in coin of its face value, plus 
 or minus only the insignificant expense of banking ser- 
 vice. 1 For instance, the mint par between England and 
 the United States is i = $4.8665. This means that 
 the material (gold 11/12 fine) in an English pound ster- 
 ling of full weight, is just equal in value, supposing both 
 to be in the same place, to the material which would 
 be contained in $4.8665 of gold coinage (9/10 fine) of 
 the United States. Exchange, therefore, would be at 
 par between England and the United States if a demand 
 draft on London for 100 was worth, in New York, 
 
 1 For a bank might be purchasing good commercial sight drafts for very 
 slightly less and selling its own drafts for very slightly more. 
 
 77 
 
78 THE EXCHANGE MECHANISM OF COMMERCE 
 
 $486.65. In domestic exchange, say between New York 
 and Chicago, par of exchange is $i = $i, for the standard 
 of value is in both places exactly the same. 
 
 The rate of exchange, however, may go above or fall 
 below par. Sight or demand drafts for the same amount 
 may realize different sums on different dates. Our 
 problem is to explain, by a study of supply and demand, 
 why the rate of exchange, e.g. between England and the 
 United States, ever varies from par, and why it is fluc- 
 tuating rather than steady. 
 
 2 
 
 The Supply of and the Demand for Bills of Exchange 
 
 At the beginning of our discussion on the rate of ex- 
 change, it is important to get clearly in mind the mean- 
 ing, in this connection, of the terms " supply" and 
 "demand." In talking about other goods, e.g. wheat, 
 we insist that " supply" means supply at a price, and 
 that "demand," likewise, means demand at a price. 
 Adopting, here, an analogous sense, we may say that 
 the supply, in the United States, at a given price or rate 
 and for any given period, of drafts on England, is the total 
 of those drafts which sellers would part with, at that 
 price or rate. The supply of bills tends to increase as 
 the price or rate rises and to decrease as the rate falls. 1 
 On the other hand, the demand, in the United States, 
 at a given price or rate and during any given period, for 
 drafts drawn upon English firms, is the total of such 
 drafts which buyers of drafts stand ready to purchase 
 at that price. The demand for drafts tends to rise as 
 the price or rate falls and to fall as the rate rises. 2 As, in 
 
 1 See 4, 5 of this Chapter (IV of Part I), i, 3 of Ch. V (Part I), 9 of 
 Ch. VI (Part I). 2 Ibid. 
 
THE RATE OF EXCHANGE 79 
 
 the United States, we have a supply of and a demand for 
 bills of exchange on England, so, in England, there is 
 a supply of and a demand for such bills on the United 
 States. Since the rate of foreign exchange is fixed by 
 supply and demand, at the point, of course, where supply 
 and demand are equal, we have next to determine what 
 forces affect supply and what forces affect demand, and 
 how these forces operate. 
 
 The supply, in this country, of drafts upon any foreign 
 country or upon all foreign countries together, is deter- 
 mined by obligations, agreements or desire of foreigners 
 to make payments to us. 1 This is obviously the case 
 with commercial drafts drawn on foreign purchasers of 
 American goods. These drafts come into our exchange 
 market because foreign debtors are under business obli- 
 gations to the makers of the drafts. But it is no less 
 true of bank drafts drawn to accommodate American 
 debtors wishing to remit. The bank draft is drawn 
 upon a foreign bank which is, or which puts itself, un- 
 der obligation to pay to the American bank's order. A 
 draft drawn on a foreign bank wishing to lend here for 
 profit, is determined by desire of the foreign bank so 
 to invest. All drafts, therefore, offered for sale in our 
 market, are based on the necessity which foreigners are 
 under or their desire to make payments to some of us. 
 
 Conversely, the demand here for drafts on foreign 
 countries, is determined by our obligations to them and 
 by our occasion to make voluntary payments to them. 
 This demand, as we have seen, 2 has a twofold source. 
 It comes from business houses, etc., which wish to buy 
 bank drafts for remitting to their creditors and other 
 
 1 See, however, paragraph after next. 
 Chapter III (of Part I), 4, 5- 
 
8o THE EXCHANGE MECHANISM OF COMMERCE 
 
 persons abroad; and it comes from American banks 
 which wish to buy commercial drafts for remitting to 
 their correspondents. These American banks have 
 occasion to remit, largely to maintain foreign balances 
 on which to sell their own drafts, but partly because 
 English firms have drawn upon American debtors and 
 settlement must be made through American banks to 
 which the drafts on Americans have been sent for col- 
 lection. These American banks will, therefore, wish to 
 buy drafts on England in order to remit. The more 
 usual practice, as we have seen, 1 is for our English credi- 
 tors to await remittances by their American debtors, 
 in drafts on London. 
 
 So far as foreign debtors choose to settle by remitting 
 drafts on American banks, obligations from abroad to 
 us do not increase the supply, here, of drafts on for- 
 eign countries. But the effect on the rate of exchange 
 is the same, for our banks, by honoring these drafts, 
 in so far are relieved from the necessity of buying drafts 
 on foreign countries to keep square with their foreign 
 correspondent banks. In other words, there is a de- 
 crease, here, of demand for drafts on foreign countries, 
 instead of an increase of supply. But the rate of 
 exchange is affected in the same way and to the same 
 extent in either case. 
 
 The supply, here, of drafts on foreign countries, may 
 be said to depend, chiefly, on the following sources of 
 obligation and voluntary payments from them to us, 
 though some of the obligations are more likely to be 
 settled by remittance and therefore to increase demand 
 abroad for drafts on the United States and decrease 
 demand here for drafts on foreign countries, rather than 
 
 i Chapter III (of Part I), 5. 
 
THE RATE OF EXCHANGE 81 
 
 to increase supply here of drafts on foreign countries. 
 The items in group 5 are perhaps most likely to be settled 
 by remittances. Following are the groups : 
 
 1. Purchase, abroad, of American merchandise. 
 
 2. Purchase by foreigners, from Americans, of trans- 
 portation, banking, insurance, and other services. 
 
 3. Purchase, abroad, of American securities, and 
 repurchase or redemption of foreign securities held 
 here. 
 
 4. Agreements by which foreigners make short time 
 loans to Americans, and (which amounts to the same 
 thing) 1 agreements by which our bankers may draw 
 finance bills on foreign banks ; repayment of such short 
 time borrowing done by foreign banks from American 
 banks. 
 
 5. Payment of interest, dividends, rent, etc., on 
 American investments abroad, remittances to Euro- 
 peans travelling in the United States, etc. 
 
 On the other hand, the demand, here, for drafts on 
 foreign countries, depends in the main on corresponding 
 sources of obligation and voluntary payments, as follows : 
 
 1. Purchase, by Americans, of merchandise from 
 foreign countries. 
 
 2. Purchase, by Americans from foreigners, of trans- 
 portation, banking, insurance, and other services. 
 
 3. Purchase, by Americans, of foreign securities, and 
 repurchase or redemption of American securities. 
 
 4. To make short time loans abroad, to repay short 
 time loans from abroad and (which is fundamentally 
 the same thing) to repay obligations incurred by Ameri- 
 can banks which have drawn finance bills on foreign 
 banks. 
 
 1 See 4, 5 of this Chapter (IV of Part I). 
 G 
 
8 2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 5. Payment of interest, dividends, rent, etc., to 
 foreigners who have invested money here, remittances 
 to Americans travelling abroad, remittances to families 
 abroad of immigrants living here, etc. 
 
 Though the lists above given correspond, it must not 
 be assumed that the payments in one direction under 
 any particular item are the equivalent of the payments 
 under the same item in the other direction. In many 
 cases the difference is very great. Thus, practically 
 nothing is paid by foreigners to Americans for the trans- 
 portation of goods, unless we include in this item the 
 transportation in the United States itself, of goods 
 eventually to be shipped abroad. But Americans 
 pay, every year, millions of dollars to Englishmen for 
 the transportation services of Great Britain's merchant 
 marine. Similarly, the balance of payments for bank- 
 ing services would be against the United States, since 
 London is the principal banking center of the world. 
 Again, remittances by immigrants in the United States 
 to their families in Europe would not be balanced by 
 payments of any similar nature made by Europeans to 
 people here. Contrariwise, payments by Europeans 
 to Americans for merchandise might be considerably 
 in excess of similarly caused payments in the opposite 
 direction. 
 
 Since the United States is still, in large part, an agri- 
 cultural country, its exports tend to be periodic rather 
 than uniform. The largest exports, - from the United 
 States are in the fall after the croDSfKave been harvested. 
 But the things we buy flow t^u^n a more steady stream. 
 Hence there is, in the fall, a^Batively large supply of 
 drafts on foreign countries, for sale in the United States, 
 and a comparatively low price for them or low rate of 
 
THE RATE OF EXCHANGE 83 
 
 exchange. 1 Banks can then purchase these bills more 
 cheaply as a rule than at other times, and will therefore 
 be able to sell their own demand drafts at lower rates. 
 
 3 
 
 The Effect on the Exchange Market of any Country 
 of Disturbed Political or Industrial Conditions in 
 That Country and in Other Countries 
 
 Investments for long periods, nowadays, take place 
 largely through the purchase of stocks and bonds, 
 though also through the purchase of real estate, the 
 loaning to individuals on mortgage security, etc. The 
 buyer of a bond is a lender to the government or company 
 whose bond he buys. The buyer of stock has a right 
 to residual gains. The entire western European world 
 is now a possible market for American securities, whether 
 these securities represent public or corporate indebt- 
 edness or rights to corporate profits. To some extent, 
 the United States furnishes a market for European 
 securities, but to a far less extent. Europeans have, in 
 the past, invested more here than Americans have in- 
 vested in Europe. The English people, for instance, 
 
 1 The truth of this statement is evidenced by statistics compiled by one of 
 my students, Mr. Lawrence M. Marks, Yale 1914, from successive volumes 
 of the Commercial and Financial Chronicle. Taking the highest and lowest 
 quotations for each month, of exchange on London, and averaging all the Janu- 
 aries, all the Februaries, etc., for the years 1906-1910 inclusive, Mr. Marks ar- 
 rived at the following results : 
 
 January 4.872 July 4.872 
 
 February 4.875 August 4.8685 
 
 March '4,8725 September 4.866 
 
 April 4-Ws October 4.8665 
 
 May 4-^P[, November 4.8695 
 
 June 4.876 December 4.869 
 
 Cf. also Clare, The A. B. C. of the Foreign Exchanges, London (Macmillan), 
 1893, PP- 135, 136. 
 
84 THE EXCHANGE MECHANISM OF COMMERCE 
 
 have been large accumulators, and so have forced the 
 rate of interest in England down to a comparatively 
 low level. Here, the rate of interest has been higher. 
 Consequently, Englishmen have made large purchases of 
 American securities. And, to a considerable extent, 
 they still hold these securities, despite the tendency 
 during the last few decades for American industry to 
 be financed in greater degree by American capital. 
 
 Largely because of foreign interest in American se- 
 curities, the exchange market may sometimes be much 
 affected by American financial troubles. If, for a while, 
 prosperity threatens to forsake us, many foreign holders 
 of our corporate securities may become alarmed and 
 endeavor to dispose of their holdings even at sacrifice 
 quotations. American capitalists may therefore be 
 induced, to some extent, to buy these securities back 
 again. So far as this effect is realized, there is a ten- 
 dency for the rate of exchange on other countries, i.e. 
 the price of drafts on these countries, to rise. For it 
 puts American investors under obligation to remit to 
 those from whom securities have been purchased; or, 
 if the foreign sellers have drawn drafts upon America, 
 then American banks must purchase drafts on foreign 
 countries in order to settle with their correspondents. 
 In either case, the demand, here, for drafts on other 
 countries rises. 
 
 If, on the other hand, investments which Americans 
 may have in other countries, e.g. in Mexico or in certain 
 of the South American republics, seem to be rendered 
 unsafe because of threatened political disturbance or 
 open revolution, then the erideavor of Americans to dis- 
 pose of such investments will |end to increase the supply 
 of drafts on such countries aiU^p may lower the rate 
 at which these drafts sell. 
 
THE RATE OF EXCHANGE 85 
 
 4 
 
 Analysis of the Relations Involved in, and Explanation 
 of the Results of, Short Time Loans Made Ostensibly 
 by Foreign Banks, through the Intermediation of the 
 Exchange Market 
 
 One of the sources given in our lists, of the supply in 
 one country of drafts on another or others, is short time 
 " loans" (e.g. 60 or 90 days) by banks. Some of the 
 banks in one country may choose to "lend" 1 in another 
 country. 2 Let us suppose that a London bank, B e , 
 wishes to "lend," in the United States, the sum of 
 $50,000. It would cable its New York correspondent, 
 B a , to draw on it a draft payable in perhaps 90 days after 
 sight. This draft could be sold in New York to another 
 exchange dealer or banker, and the sum realized loaned, 
 for account of the London bank, to an American firm 
 or business man. 
 
 The loan made may be a so-called "sterling" (like- 
 wise mark or franc) loan, or it may be a "currency" 
 loan. 3 In the case of the sterling loan, it is agreed that 
 the foreign bank shall receive a definite commission or 
 payment from the borrower, for allowing him to raise 
 money by a draft upon it. If the loan is a sterling loan, 
 the borrower (the American business house getting the 
 use of the funds) takes the risk of fluctuation in the rate 
 of exchange during the life of the loan. The American 
 bank, B a , draws a draft on B e payable to the American 
 borrower. This draft is for so many pounds sterling. 
 Hence the arrangement is called a "sterling" loan. 
 
 1 Who is the real lender will appear later in this section. 
 
 2 See descriptive discussion in Escher, Elements of Foreign Exchange, New York 
 (The Bankers Publishing Co.), 19 Ji, PP- 85, 86. 
 
 3 Ibid., p. 87. ?: 
 
86 THE EXCHANGE MECHANISM OF COMMERCE 
 
 The borrower, to whom the draft is given, gets his money 
 or his bank credit by disposing of the draft at the best 
 price he can get. When the 90 days are up, it devolves 
 upon him to purchase a demand draft, payable to the 
 lending bank, B e , and turn it over to B a for remittance. 
 The lending bank must honor, at the end of the 90 days, 
 the draft drawn on it by B a , for this will have reached 
 London, and payment will be due 90 days after pres- 
 entation. But B e will by that time have received the 
 bank draft purchased by the borrower, and so will be 
 able to pay without any drain on its resources. It has 
 gone through the form of lending while not parting with 
 a single pound. It has only taken upon itself the obli- 
 gation to pay, 90 days after sight, a sum which it was 
 practically certain to receive (although there was, of 
 course, some risk) equally soon from the American 
 borrower. 
 
 The "currency" loan is different only in the formal 
 arrangements. It serves the same purpose. B a does 
 not, in this case, hand over the draft on B c , for the bor- 
 rower to sell, but itself sells the draft to another bank 
 or dealer. It then gives the borrower cash or credit 
 in terms of American currency. That is why it is called 
 a currency loan. The borrower gets dollars, not a 
 claim to pounds sterling requiring to be converted into 
 dollars. When the time comes for repayment, the bor- 
 rower settles with B a and J3 a settles with B e . The bor- 
 rower pays an agreed rate of interest. The lending 
 bank, B e , is subject to a risjL of fluctuation in the rate 
 of exchange. If this bank 'foresees a probability that 
 exchange will fluctuate favorably to it, then it will prefer 
 to make the currency loan ; if unfavorably, it will prefer 
 to make the sterling loan. 
 
THE RATE OF EXCHANGE 87 
 
 We have seen that the so-called lending bank, B e , 
 is at no time out actual funds by virtue of its transac- 
 tion. It lends only in name. Yet the American bor- 
 rower gets funds in the form of cash or bank account, 
 and eventually buys goods with these funds. Some- 
 where there is a real lender, an ultimate creditor. Who 
 and where is he ? The answer is : he is the man or firm 
 who buys the draft when it is offered for sale in the 
 London discount market, or the depositors of the bank 
 from which this man or firm borrowed the means to 
 buy. For the draft on B e , having been sold in the United 
 States to an exchange dealer or bank, would be sent by 
 the American bank to its correspondent bank in London, 
 and by the latter sold to whoever cared to invest in it. 
 This English investor it is, or the depositors of a bank 
 from which he borrows, who gives up early income for 
 later. He (or they) is giving up present goods for future 
 goods. He is the one, or these depositors are the ones, 
 because of whose accumulations the whole transaction 
 is possible. The American business man borrower 
 gets, if not cash, a bank account, just as if he borrowed 
 it from B a , and with this bank account he buys goods. 
 But instead of being indebted to B a and through B a to 
 its depositors, 1 he is indebted, in the case of the sterling 
 loan, to B e , through B e to the English purchaser of the 
 draft, and through him to the depositors in any bank 
 from which he gets the means to purchase ; in the case 
 of the currency loan, to B a , through B a to B e , through 
 B e to the English purchasers of the draft, and finally 
 to depositors in this purchaser's bank. The English 
 bank is but a nominal lender. The English (or other) 
 purchaser of the draft in the London discount market, 
 
 i See Ch. II (of Part I), 3. 
 
88 THE EXCHANGE MECHANISM OF COMMERCE 
 
 and, in the last analysis, the depositors in his bank, are 
 the real lenders. In Chapter II we saw that commercial 
 banking combines and coordinates sporadic convenience 
 waiting so as to make available to borrowers in the form 
 of loans, a considerable amount of this waiting, waiting 
 which would in any case be done because of convenience, 
 and which, except for commercial banking, would be 
 of no use to borrowers. Here we see that the sporadic 
 waiting done by bank depositors in one country, may 
 be the means of providing borrowers in another country, 
 with funds. As is to be expected, the waiting or ultimate 
 lending, in the case of these drafts, is done more largely 
 abroad, and the borrowing so made possible is done more 
 largely by Americans. 
 
 Foreign loans of the kinds we have been describing, 
 i.e. sterling and currency loans, may, if most largely 
 made in the spring and early summer, help to tide over 
 the periods of the year when the United States has a 
 surplus of payments to make abroad, so that these 
 payments need not be so large. Instead of our sending 
 large amounts of specie abroad, English purchasers, in 
 the London discount market, of" drafts drawn upon 
 " lending" London banks, and, through these purchasers, 
 depositors in English banks, may become temporarily 
 our creditors. They lend to us by providing, for a time, 
 the capital to liquidate obligations from us to English 
 manufacturers and merchants, obligations for which, 
 if we could not get temporary credit, specie would have 
 to flow. Then when the crop season comes and the 
 pressure of obligations is more markedly the other way, 
 we pay the holders of these drafts by transferring to 
 them part of our claims upon purchasers of our exports. 
 Instead of money flowing, first from here to England, for 
 
THE RATE OF EXCHANGE 89 
 
 example, and then, in the fall, from England back to us, 
 less will have gone either way. 1 During the winter, 
 spring, and early summer, our net indebtedness abroad 
 would perhaps have required considerable gold ship- 
 ments. But any drafts drawn during this period upon 
 English banks, nominally lending banks, are available 
 for purchase by American exchange bankers who must 
 make remittances abroad. The shipment of gold abroad 
 is thus avoided. Then in the fall when we are selling 
 considerable amounts of grain and other products and 
 drafts on England are low in price, and when large im- 
 ports of gold might result, in payment for our exports 
 of wheat, cotton, etc., these imports of gold are made 
 less by the fact that those Americans who have received 
 the temporary loans (or, in the case of currency loans, 
 the banks which act for them) have now to liquidate 
 their obligations by purchasing drafts on London. 
 
 The comparatively high rates of exchange on England 
 during the seasons when we are exporting less than we 
 are importing, and the comparatively low rates in the 
 fall, tend to make these dealings worth while. Those 
 who thus borrow during our surplus importing season, 
 e.g. late spring or early summer, sell their drafts at a 
 relatively high price and buy later for remitting, if in 
 the fall, at a lower price. The London bank which 
 engages in the operation will intend to receive its share 
 of the gain resulting from this situation; at least in 
 the case of the currency loan, as we have seen, 2 it clearly 
 gets the benefit of a favorable movement in the rate of 
 exchange on London ; and we should therefore expect 
 
 1 Cf . Goschen, The Theory of the Foreign Exchanges, third edition, London 
 (Effingham Wilson), 1896, pp. 38-41. 
 
 2 See description at beginning of this section. 
 
go THE EXCHANGE MECHANISM OF COMMERCE 
 
 it, other things equal, to engage most gladly in the lend- 
 ing operation described, at the very times when its 
 doing so would avoid, or decrease in amount, successive 
 and opposite shipments of gold. 
 
 5 
 
 Finance Bills, What they Are, Whose Accumulations Make 
 them Possible and What are their Results 
 
 / 
 The case of a finance bill l is not greatly different from 
 
 that of a bill drawn on a foreign bank which expresses 
 a desire to lend. There is, indeed, a difference, but it 
 is superficial rather than fundamental. In the case of 
 the bill drawn on a foreign lending bank, the foreign 
 bank is lending as an investment for its own profit. 
 In the case of the finance bill, the drawing is done for 
 the convenience and profit of the drawing bank, in our 
 illustration the American bank. In this case, the Eng- 
 lish bank does not request the American bank to draw 
 on it to the end that the English bank can profit by so- 
 called lending. On the contrary, the American bank 
 gets the permission of the English bank to draw a draft 
 on the latter. For in the case of the finance bill the Eng- 
 lish bank is under no obligation to the American bank. 
 The latter, therefore, has no right to draw a draft on the 
 former except by permission. Arrangement is accord- 
 ingly made between the banks. The American bank, 
 B a , is given the right to draw on the English bank, B e , 
 in return for a fee or commission. B a then draws on 
 B e , sells the draft in the market, and, for the time being, 
 e.g. 90 days, has the use of so much extra currency. 
 
 1 Escher, Elements of Foreign Exchange, pp. 94-98, gives a brief description 
 of the finance bill. 
 
THE RATE OF EXCHANGE 91 
 
 B a 's credit is good enough so that B e is willing to "accept" 
 the draft or drafts, in confidence that when the 90 days 
 after sight are up, and payment is demanded, it will 
 already have received remittance from B a . It will at 
 no time be out any money. The finance bill is therefore 
 not greatly unlike the class of bills previously described, 
 drawn on foreign lending banks. 
 
 As in the case of the lending operation, so in the case 
 of the finance bill above discussed, some American (or 
 Americans), is borrowing from abroad. In the case 
 of the finance bill, the borrower is the American bank 
 which gets the 9o-day control of currency, and, through 
 the bank, any person or persons who are thus enabled 
 to borrow from it. Here, as before, the real lender is 
 the person, or firm, in England, who purchases the draft 
 in London, whither it has been sent for sale in the dis- 
 count market, and through him the depositors in the 
 English bank or banks, whose convenience waiting gave 
 him the means to invest in the draft. B a owes B e , but B e 
 owes this holder of its draft, and he, in turn, is indebted, 
 through a bank as intermediary, to the depositors of 
 that bank, whose convenience waiting provided him 
 with the means of purchase. 
 
 Like the short-term loan operation, the finance bill 
 also really a loan from abroad may serve to tide over 
 a period of surplus imports, so that gold need not so 
 largely be shipped out at one season of the year only 
 to be shipped back again in a couple of months. If, 
 in the spring and early summer, when we are perhaps 
 importing largely and exporting less, and have, there- 
 fore, a surplus indebtedness, our banks are allowed to 
 draw finance bills, these drafts come into the market 
 and are available for use in paying off part of the balance 
 
9 2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 of obligations. We therefore pay previous obligations 
 by making new ones. Considered as a nation, we post- 
 pone payment; for what one group of persons pays, 
 another group has borrowed. Then, in the fall, when 
 there would otherwise be a balance of obligations from 
 others to us, this balance is diminished by our postponed 
 obligations to them. Not only, then, are there smaller 
 shipments of gold abroad in the earlier period, but also 
 there are smaller return shipments at the later. 1 
 
 It needs, however, to be demonstrated that finance 
 bills will most probably be drawn by American banks 
 at those times when we have a balance of obligations to 
 meet, thus relieving the pressure, and serving, as above 
 suggested, to obviate the necessity of gold shipments. 
 The theory of individualism, as distinguished from so- 
 cialism, is, that in serving their own interest, men are, 
 in their economic activities (except where certain un- 
 fair methods of business are improperly permitted, or 
 certain classes of wealth or income not really earned are 
 unwisely secured to individuals), serving the public 
 interest. Let us see how the individualistic philosophy 
 applies in this case. In that part of the year when the 
 United States owes largely, the price in the United 
 States of exchange on foreign countries, is high. It 
 pays B a , therefore, to draw finance bills, and sell them 
 at this high price. 2 On the other hand, the excess of 
 obligations towards us in the fall, and the consequent 
 excess of drafts on foreign debtors, for sale here, makes 
 the price of these drafts at that time low. B a can there- 
 fore buy drafts to repay, at a low price. If necessary, 
 
 1 Goschen, The Theory of the Foreign Exchanges, pp. 38-41 ; also Bastable, 
 The Theory of International Trade, fourth edition, London (Macmillan), 1903, p. 78. 
 
 2 Or itself forward them for discount and credit abroad. 
 
THE RATE OF EXCHANGE 93 
 
 the loan can be renewed by the drawing of a new draft 
 to replace the old, in cases where it is some time before 
 the rate falls. B a therefore profits, besides the interest 
 which can be earned during the time it can invest or 
 loan the amount, by the difference between the price 
 of the drafts at one time and another, minus, of course, 
 B e 's commission. Such drafts are, therefore, other 
 things being equal, most likely to be drawn by profit- 
 seeking banks at the very times when they will serve 
 the purpose of avoiding gold shipments. 1 
 
 6 
 
 How a Bank in One Country and a Bank in Another May, 
 through the Aid of the Exchange Market, Invest in 
 One of the Countries for Joint Account, without Either 
 Bank Using its Own Funds 
 
 Another variety of this species of draft is that some- 
 times drawn when an American and a foreign bank in- 
 vest here on joint account. 2 B a may see that it can pur- 
 chase certain securities cheaply at the time, securities 
 which can probably be sold, later, at a substantial 
 profit. But B a has use for all the funds under its own 
 immediate control, and does not wish to invest any of 
 these funds in such securities. It suggests, therefore, 
 to its English correspondent, B e , that both go into this 
 investment, on joint account, securing the means through 
 the use of exchange. B a then draws on B e a draft matur- 
 ing in say 90 days after sight, which is sold in New York. 
 With the proceeds the securities are purchased and held 
 
 1 Cf. Clare, The A. B.C. of the Foreign Exchanges, 1803, p. 86; also Escher, 
 Elements of Foreign Exchange, p. 97, and Margraff, International Exchange, 
 Chicago (The Fergus Printing Co.), 1903, p. 39. 
 
 8 Process described in Escher, Elements of Foreign Exchange, pp. 133-135. 
 
94 THE EXCHANGE MECHANISM OF COMMERCE 
 
 for 90 days or perhaps a less period. They are then sold, 
 presumably at a profit, and remittance is made to B e . 
 The draft on B e was purchased in New York, sent to 
 London, and sold in the London discount market. By 
 the time the purchaser presents it to B e for payment, 
 B a has remitted. Neither bank has sacrificed the use 
 of its own funds. As in the other cases, the capital is 
 really furnished, in the last analysis, by the purchaser, 
 in the London discount market, who has bought the 
 draft, or, in all probability, by the depositors of a bank 
 from which the purchaser borrowed the means to make 
 the investment. Thus it is that an American and an 
 English bank can invest here, for joint account, in securi- 
 ties, without either of them providing the means. The 
 capital is really put up by an Englishman or Englishmen, 
 but not by the English bank on which the bill is drawn. 
 As in the case of lending by a foreign bank and the case 
 of the finance bill, so here, there would be some addi- 
 tional stimulus, other things equal, to the drawing of 
 such drafts on foreign banks at those times of the year 
 when drawing them would decrease the shipments of 
 gold. 
 
 7 
 
 Analysis of the Relations Involved in a Letter of Credit 
 
 The exportation and the importation of goods may 
 often be greatly facilitated by so-called letters of credit. 1 
 These letters of credit make possible the drawing of 
 bills of exchange on other parties than the actual debtors, 
 and at times such an arrangement is very helpful. As 
 above suggested, this form of commercial credit may be 
 used to further either import or export trade. Since 
 
 1 Described by Escher, Elements of Foreign Exchange, pp. 143-160. 
 
THE RATE OF EXCHANGE 95 
 
 it will facilitate importation and since exportation by us 
 is importation by some other country, it must facilitate 
 exportation also. 
 
 The use of a letter of credit is as follows. A man 
 importing goods, say from South Africa into the United 
 States, desires to get possession of them at once, but is 
 not in a position to pay for them until he can himself 
 dispose of them for currency. He cannot, therefore, 
 pay for them by remitting a bank draft. On the other 
 hand, the South African exporter desires to receive his 
 pay immediately. The American importer goes to his 
 bank, say B a , and asks for a letter of credit. If the 
 circumstances warrant it, B a issues such a letter, which 
 is in the form of a request on B e , the London corre- 
 spondent of B a , to accept, up to a given amount and 
 under specified conditions, the drafts of the South , 
 African exporter. The London bank is informed that>' 
 such a request on it has been issued to the importer. 
 The American importer sends this letter to South Africa, 
 and the exporter there is then in a position to draw a 
 draft on the London bank, B e , instead of on the Ameri- 
 can importer or his bank, B a . If the draft is drawn for 
 90 days after sight, the American importer has that 
 length of time to settle. The goods are billed to his v 
 bank, B a , which issued the letter of credit; and the 
 bank will probably let him take over the goods upon his 
 signing a trust, receipt securing the bank. The draft 
 drawn in South Africa is sent to London, presented, 
 " accepted," and sold in the discount market. The bill 
 of lading and insurance certificate were attached to the 
 draft to begin with, but when the latter is "accepted" 
 the London bank detaches all documents and sends 
 them to the New York bank so that the goods may be 
 
96 THE EXCHANGE MECHANISM OF COMMERCE 
 
 secured upon arrival. By the time the draft is due, the 
 American importer has paid his bank and it has settled 
 with the London bank. This then is another illustra- 
 tion of borrowing by a business man or business men in 
 the United States, the real lender or creditor being the 
 purchaser of the draft, in the London discount market, 
 and through him the depositors in some English bank. 
 
 One of the chief reasons, in fact, for the use of a letter 
 of credit, is to enable the exporter to draw on London 
 or some other well-known banking centre. His draft 
 will then bring the highest possible price. London, 
 as the principal banking and exchange centre of the 
 world and a great exchange discount market, is most 
 frequently the place drawn on. The exporter can get 
 immediate payment 1 and the importer can get credit. 
 
 8 
 
 Place Speculation or Arbitraging in Exchange 
 
 Just as there may be place speculation and time specu- 
 lation in the case of commodities, so both of these types, 
 of speculation, or something analogous to them, exist 
 in the case of drafts. Corn may be sent from a place 
 where it is relatively cheap to a place where it is rela- 
 tively dear. This is arbitraging in corn. Similarly 
 there is arbitraging in exchange. 2 Arbitraging in ex- 
 \ , change involves the purchase of drafts on one place and 
 the sale of drafts on another. Thus, if in New York 
 exchange on London is high while exchange on Paris is 
 
 1 If the letter of credit is "confirmed" by the bank made drawee, then pay- 
 ment is absolutely guaranteed to the exporter, even before his bill is "accepted." 
 See Margraff, International Exchange, Chicago (Fergus Printing Co.), 1903, pp, 
 88, 89. 
 
 2 Described in Escher, Elements of Foreign Exchange, pp. 98-101. 
 
THE RATE OF EXCHANGE 97 
 
 low ; and if in Paris, exchange on London is fairly low, 
 an arbitraging transaction would be profitable. The 
 arbitrager in New York would buy exchange on Paris, 
 would instruct his Paris correspondent to buy exchange 
 on London, and would then be able to sell in New York, 
 exchange on London. Thus the cheaper exchange on 
 London, available in Paris, is shifted to New York. 
 Exchange on London is sold from Paris where it is cheap, 
 to New York where it is dear. This activity by arbi- 
 tragers, of course, tends to limit the variations in price 
 at different places, of exchange on any one point. It 
 is seldom possible to make a very considerable per cent 
 gain by such transactions. 
 
 9 
 
 Time Speculation in Exchange 
 
 Besides arbitraging or place speculation, there is 
 also time speculation in exchange. As with produce, 
 e.g. wheat, this speculation in time may be speculative 
 holding, buying and selling of futures, and (a part of 
 future selling) selling short. Suppose a New York bank 
 to purchase bills of exchange on London and to send 
 them over for discount (i.e. sale), either for immediate 
 discount or for discount as occasion requires. The 
 New York bank is then accumulating in England a basis 
 for its own drafts. 1 If, at the time, bills of exchange 
 on England are purchasable at a low price, the New 
 York bank will be more likely to buy, and later, when 
 exchange is higher, it will be under greater temptation 
 to sell. If the New York bank buys exchange when the 
 
 1 Cf. Clare, The A, B.C. of the Foreign Exchanges, p. 87 ; and Escher, Elements 
 of Foreign Exchange, p. 30. 
 
98 THE EXCHANGE MECHANISM OF COMMERCE 
 
 rate is low, then its buying tends to keep up the rate, 
 and when it later sells, at relatively high prices, its sell- 
 ing tends to keep the rate down. This kind of trans- 
 action, therefore, acts on the exchange market just as 
 speculative holding of wheat acts on the wheat market, 
 namely in the direction of equalization. Such specula- 
 tive holding of exchange, in so far as it exists, serves to 
 decrease the alternate import and export of gold. When 
 exchange here, on England, is low because of the excess 
 of obligations from them to us, a part of this excess of 
 obligations may take the form of available credit for 
 American banks with English banks. So much, there- 
 fore, of the excess of obligations, need not be settled by 
 the shipment of gold. Later, when gold tends to flow 
 from the United States to England, this accumulated 
 credit in England obviates the necessity of so great a 
 flow of gold as would else occur. We may say that, 
 since part of the money which was collectible by Ameri- 
 can banks (though perhaps collectible only through 
 the London discount market), is allowed to remain as 
 a credit in England, either as bank credit or as long bills 
 not discounted but held for account of American banks, 1 
 the later obligations to England are paid partly by draw- 
 ing on that credit instead of shipping gold. 
 
 There is also the buying and selling of futures in 
 exchange. To illustrate, an exporter may know long 
 in advance that he is to ship goods of a certain value 
 at a given time. He will then be able to draw a draft 
 on the purchaser of these goods. But if he waits until 
 he has sold the goods before making any arrangements 
 regarding his draft, he simply takes the risk of selling 
 
 1 For further explanation of the nature and method of these transactions, see 
 Ch. VI (of Part I), 2. 
 
THE RATE OF EXCHANGE 99 
 
 the draft on his debtor for whatever is the ruling price 
 at the time of the sale. He can, however, contract 
 ahead for the disposal of his draft to some exchange 
 dealer or banker, at an agreed price. 1 He is selling or 
 agreeing to sell future exchange. 
 
 Sometimes a bank remits drafts to its foreign corre- 
 spondent, some of which, being payment bills, cannot 
 be immediately discounted for cash. 2 These bills will, 
 of course, with few if any exceptions, eventually be paid ; 
 and if there are very many of them, then the remitting 
 bank can estimate, because of the constancy of averages, 
 at about what dates they will be paid. This bank is 
 therefore in a position to promise that it will sell demand 
 drafts on its correspondent abroad, at given dates and 
 for given amounts. It promises to sell these drafts 
 at some future time when it can be sure of having the 
 balance abroad on which to draw. 3 In this case the 
 future selling is done by a bank. By making such an 
 arrangement, the bank guards itself against the risk 
 of unfavorable exchange rate fluctuations. By selling 
 futures against futures a bank can relieve itself entirely 
 from risk of such fluctuations. The bank buys or con- 
 tracts to buy, an exporter's future bills, and at the same 
 time sells or contracts to sell, its own. 
 
 As in other dealing, so in foreign exchange, one kind 
 of "future" selling is selling "short." To sell "short" 
 is to agree to sell at a future time, without having, at 
 the time of making the agreement, the means to deliver, 
 but relying upon later purchases to "cover" the shortage. 
 A man sells wheat short if he contracts, say in March, 
 
 1 See Escher, Elements of Foreign Exchange, p. 35. 
 
 See Ch. Ill (of Part I), 7. 
 
 3 Escher, Elements of Foreign Exchange, p. 101. 
 
ioo THE EXCHANGE MECHANISM OF COMMERCE 
 
 to sell for May delivery, counting on his ability to pur- 
 chase the wheat in May, in order to make good the agree- 
 ment. Similarly an exchange dealer sells short if he 
 agrees to sell a draft, e.g. in June for August delivery, 
 but has, when the contract is made, no bank balance 
 abroad or salable drafts held in his name in some foreign 
 bank, on which he may draw. He relies upon August 
 purchases of bills to provide this foreign balance. The 
 same in principle as short selling is the finance bill al- 
 ready described, and other similar bills. In the case of 
 the finance bill, one bank does not merely promise to 
 sell at a future time ; it actually does sell, in the present, 
 a draft on another bank where it has at the time no 
 credit balance and no deposit of discountable bills. 
 This draft, though sold in the present, is of course for 
 future payment. It is a draft for 60 or 90 days or for 
 some other period. It requires to be " covered " before 
 maturity. Hence it may properly be classed with or 
 alongside of other short selling. 
 
 10 
 Summary 
 
 The starting point of our discussion of the rate of 
 exchange has been supply and demand. At any given 
 time the price, say in New York, of drafts on London, 
 i.e. the rate of exchange on London, is fixed where supply 
 of and demand for such exchange are equal. Thus, 
 exchange may go above or below par, the mint equiva- 
 lent in coinage. 
 
 Going back of supply and demand, we found that 
 these depend upon purchases and sales, investments, 
 interest and dividends, etc. Whatever tends to increase 
 
THE RATE OF EXCHANGE 101 
 
 the total payments to be made by Americans to English- 
 men tends to increase the demand here for drafts on 
 England. Vice versa, whatever increases the total 
 payments to be made from them to us increases the 
 supply here of drafts on England (or decreases the de- 
 mand). 
 
 Analysis of the short time loan by a foreign bank, of 
 the so-called finance bill, and of investment here by an 
 American and a foreign bank for joint account, led to 
 the conclusion that in all cases the borrower was the 
 business firm here which profited by the loan, while the 
 ultimate lender was the person in the London or other 
 discount market who bought the bill and held it till 
 maturity, or the depositors of the bank from which such 
 a buyer obtained the means of purchase. In the case 
 of some of these bills, most of all, perhaps, the finance 
 bill, there is probably a tendency for more to be sold, 
 other things equal, at those times of year when gold 
 must otherwise be more largely exported; and to be 
 redeemed, later, when gold must otherwise be more 
 largely imported. The letter of credit is a scheme to 
 get immediate payment for an exporter, a period of 
 credit for an importer, and a chance for the exporter 
 to make out a, draft on an important financial centre and 
 therefore a more salable draft than he might else have. 
 As with the finance bill, short time loan, etc., the credit 
 is really furnished by investors or by bank depositors 
 in the discount market of the big banking centre, most 
 likely London, where the draft is sold. 
 
 Exchange is speculated in, much as are wheat, corn, 
 stocks, etc. There may be arbitraging in exchange, i.e. 
 sending exchange on some point, from where it is rela- 
 tively cheap to where it is relatively dear. Exchange 
 
102 TEE 'EXCHANGE MECHANISM OF COMMERCE 
 
 may be, in a sense, held for a rise, thus tending to steady 
 the exchange market and decrease the flow of specie; 
 it is subject to " future" dealings; it is sold "short." 
 The finance bill is really, in principle, a kind of short sell- 
 ing of exchange. An agreement to sell at some future 
 date, relying upon purchases of exchange in the mean- 
 while, to cover, is clearly selling short. 
 
CHAPTER V 
 THE RATE OF EXCHANGE AND THE FLOW OF SPECIE 
 
 ' 
 
 The Upper Limit to Fluctuation of the Rate of Exchange, 
 Determined by the Cost of Exporting Specie v/^ 
 
 WE have seen that, by the use of finance bills and other 
 similar arrangements, the excessive obligations of a 
 country to other countries during any short period may 
 be in part balanced by the reverse obligations of a later 
 period. We have also seen that, by speculative holding 
 (accumulation) of exchange, the surplus obligations to a 
 country during an earlier period may be used to offset, 
 in part, the obligations incurred by it in a later. But 
 sometimes there will be a net balance of obligations in one 
 direction for several months or a year or a series of years. 
 If so, the obligations probably will not be liquidated for 
 the most part by postponement or by exchange accumu- 
 lation. The demand for bills with which to meet a long 
 continued balance of indebtedness will hardly be satisfied 
 by the sale of finance bills or other bills of similar nature, 
 for the bankers of a country cannot be indefinitely add- 
 ing to their obligations of this sort and not repaying. 
 Neither will the supply of bills caused by a long continued 
 excess of obligations to a country be taken care of by 
 speculative purchase and holding for a rise, since there is 
 a limit to the amount which bankers can afford to invest 
 in such speculative holding. If, therefore, our obliga- 
 
 103 
 
io 4 THE EXCHANGE MECHANISM OF COMMERCE 
 
 tions are larger for any great length of time than the 
 obligations to us, there will be a great demand for bills of 
 exchange with which to remit and there will be a relative 
 scarcity of such bills. Consequently, the price of bills 
 or the rate of exchange on other countries, which will 
 equalize supply and demand, must maintain a fairly high 
 average. On the other hand, if obligations to us are for 
 a long period in excess, the rate of exchange here, on 
 foreign countries, must be fairly low, else the supply of 
 drafts on these countries will exceed the demand. 
 
 Are there any limits, upper and lower, to the rate 
 exchange may reach ? Are there any limits, for instance, 
 upper and lower, to the price that drafts on London may 
 command in New York? If there are, what forces 
 determine these limits ? 
 
 Let us consider, first, the question of an upper limit of 
 exchange. The price in the United States, of drafts on 
 England, will not go above par by much more than the 
 cost of shipping specie. For if it does so, either the 
 demand for such drafts will decrease, or the supply will 
 increase, or both, to such an extent that supply will 
 exceed demand. A rise of exchange above par by more 
 than the cost of specie shipment must decrease the 
 demand for drafts, because many of those in this country 
 who are debtors will, if their debts are large, find it 
 cheaper to ship specie than to buy drafts. It is true that 
 in some cases the debts of merchants, etc., are settled 
 by their English creditors drawing on them. But if 
 so, the bills drawn on these Americans have to be sent 
 to American banks for collection and these American 
 banks must then settle with the English banks sending 
 the drafts. And if the rate of exchange goes above par 
 by more than the cost of shipping gold, American banks 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 105 
 
 having large remittances to make will prefer to ship gold 
 rather than to buy for shipment the more expensive bills 
 of exchange. As a matter of fact, merchants, manu- 
 facturers, etc., will rarely have the facilities and knowl- 
 edge or the large indebtedness to warrant their shipping 
 gold, and will continue to send drafts. But debtor banks 
 frequently do ship gold. We may say, then, that at a 
 rate of exchange much farther above par than the cost 
 of shipping specie, the demand here for drafts on Eng- 
 land (and other foreign countries) would fall short of the 
 supply. Therefore, such a rate could not continue. 
 
 We arrive at the same conclusion from a study of the 
 supply side of the market. If the rate of exchange, i.e. 
 the price of drafts, rises above par by more than the cost 
 of specie shipment, then it will pay some banks, even 
 though they owe nothing, to export gold. The gold will 
 be exported to a consignee, say a foreign correspondent 
 bank in London. Then the American bank can count 
 on having a balance or drawing account in the London 
 bank, in the same manner as if drafts had been sent. 
 On this balance, the American bank can draw its own 
 drafts for sale in the United States, at the high ruling rate, 
 to persons having remittances to make. By so doing, 
 the bank adds to the supply, here, of drafts on England, 
 and the ordinary business man has no occasion, himself, 
 to ship gold. So a rise in the price of drafts on England, 
 beyond a certain point, will tend to increase the supply 
 of such drafts. And at a price which exceeds par by much 
 more than the cost of shipping specie, supply would al- 
 most necessarily exceed demand, because the shipment 
 of specie on which to sell drafts would be so profitable. 
 It follows that the rate of exchange cannot, ordinarily, 
 be expected to exceed par by much more than the gold 
 
 . 
 
io6 THE EXCHANGE MECHANISM OF COMMERCE 
 
 shipment cost. It is kept down by forces on the supply 
 side of the market, as well as by forces on the demand 
 side. 
 
 We may fairly assume the cost of gold shipment 
 between New York and London to be, for large quanti- 
 ties, about $2 per 100, including charge for transporta- 
 tion, insurance, and all other expenses. Then, since par 
 between New York and London is $486.65 = 100, the 
 price in New York of sight drafts on London could not 
 much exceed $488.65 = 100. So soon as it gets as 
 high as that or higher, it becomes as cheap or cheaper for 
 New York banks to settle their indebtedness to English 
 banks by purchasing and shipping gold as by purchasing 
 and shipping drafts. A draft on London for 100 would 
 cost, if exchange were at its highest point, $488.65 or 
 more. But if $486.65 in gold could be shipped to London 
 for $2, making a total expense of $488.65, no New York 
 bank, having a remittance to make, would pay a higher 
 price for a draft. Hence the demand for drafts on Eng- 
 land must fall. Likewise, so soon as exchange gets 
 higher than $488.65 = 100, it becomes profitable for 
 New York banks to purchase gold, ship it abroad, and 
 sell drafts drawn on the credit so secured. $486.65 in 
 gold plus $2 for shipment, loss of interest, insurance, etc., 
 makes $488.65, total expense. The $486.65 is worth in 
 England, mint equivalent, 100. If a draft on the 
 English consignee for 100 will sell for more than 
 $488.65, it is obviously profitable to ship gold and sell 
 drafts. To ship drafts instead of gold might be less 
 profitable, because of their high price. Because of gold 
 shipments, the supply of drafts on England must be 
 greater. 
 
 The cost of gold shipment, however, may, under the 
 
RATE OF EXCHANGE AND FLOW OF SPECIE go]] 
 
 pressure of special circumstances^ go far above $2 per 
 100; and this cost is, therefore, a somewhat elastic 
 rather than a definitely rigid limit to the possible rise 
 of exchange. For example, the prospect of a great Eu- 
 ropean war caused insurance rates on gold shipments to 
 Europe to rise as high as i per cent on July 30 and 31 
 of this year (1914) .* Such charges, nearly $5 per 100 
 for insurance alone, at a time when there was a strong 
 movement in foreign countries to sell securities and real- 
 ize gold, and when, consequently, the United States was 
 exporting gold, made possible a rise in exchange rates 
 much above the usual upper limit. In fact, the foreign 
 exchange market seems to have been, in this case, com- 
 pletely demoralized by the suddenness of the crisis. 2 
 The immediately ensuing outbreak of war on an extended 
 scale brought a sudden check to trade in general, in- 
 cluding the export of gold. One vessel, the Kronprin- 
 zessin Cecilie of the North German Lloyd Company, 
 which had left New York July 28 carrying over 
 $10,000,000 in gold and silver consigned to English and 
 French banking houses, returned with her cargo to the 
 United States (Bar Harbor, Me., Aug. 4) rather than 
 risk capture. 8 
 
 2 
 
 Some Details Connected with the Exportation of Specie 
 
 A number of details of the gold export operation may 
 now claim our attention. Let us consider first the loss 
 of interest during transportation of the gold. If it takes 
 seven days to transport the gold and if the draft drawn 
 upon it is sold when the gold is shipped and goes abroad 
 
 1 See New York World, July 31 and Aug. i, 1914. 
 
 *Ibid., July 31, 1914. 
 
 * New Haven Evening Register, Aug. 4, 1914. 
 
io8 THE EXCHANGE MECHANISM OF COMMERCE 
 
 at about the same time, this draft can hardly be honored in 
 less than seven days. The purchaser of the draft, there- 
 fore, must pay for it seven days before his foreign creditor 
 can receive the money, and so must lose seven days inter- 
 est. The alternative to such a purchase would be to 
 wait seven days and buy a cable. If he buys the banker's 
 draft on the gold he will, presumably, pay very slightly 
 less for it in consequence of this period of waiting. 
 Accordingly, the price received by the drawing bank is 
 very slightly less. Any demand draft, however, other 
 than a cable, must suffer such a deduction for interest. 
 And demand drafts drawn when goods are shipped, on 
 the consignees, cannot usually be cables, since the con- 
 signees cannot be expected to pay for goods before 
 receiving them. Any exporter, then, may be said to lose 
 interest in the same way. He ships goods which may not 
 reach their destination for several days or weeks. If they 
 arrive on the same steamer as his draft (which is at once 
 shipped by the purchasing American bank), the draft 
 may be made payable at sight. But even then there is 
 time lost. Had the goods been sold at home, this loss 
 need not have occurred. It is one of the deductions from 
 the benefits of trade between widely separated areas, 
 that wealth in transit is temporarily kept out of use. 
 The American exporter may get more for his goods, if 
 sold in England, than he could get at home, and the 
 English buyer may get these goods more cheaply than if 
 he purchased them in his own country. This gain to 
 both parties will presumably exceed all losses, including 
 the loss of time, incident to handling and transporting 
 the goods. Otherwise the trade would not take place. 
 But the cost of transportation makes the net gains con- 
 siderably less than they would else be, and the loss of 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 109 
 
 time involved makes them somewhat less. The exporter 
 of any goods, then, may be said to lose something in 
 interest when he sells a sight draft on the consignee, 
 though the price he receives for the goods may make the 
 transaction well worth while. The gold exporting bank 
 is no exception. This slight loss, however, is not ordi- 
 narily reckoned as one of the expenses of exporting gold. 
 The banker thinks of the price his draft brings, as his 
 receipts, and does not regard the slight reduction below 
 what it would yield if collectible at once, as an expense. 
 Insurance of the gold, transportation charges, etc., are 
 deductions, along with the cost of the gold, from his gross 
 returns, and these he regards as his expenses. 
 
 When gold is exported, it must be assayed, weighed, 
 etc., on arrival, and, since this requires some three days, 
 there must be subtracted interest for that time from 
 the shipper's gross profit. If the draft drawn upon the 
 gold is a sight draft, it may be presented and paid three 
 days before the gold shipped can rightly be credited 
 to the drawer. If so, there is technically an "overdraft" 
 on which interest has to be allowed by the American gold 
 exporting bank 1 to the English consignee bank. That 
 is, this interest must be deducted from the balance in 
 England on which the American bank can draw. When 
 the American bank exports gold as the cheapest means of 
 settling a debt, there is the same loss of time, and so, in 
 a sense, loss of interest, during assaying, weighing, etc., 
 as well as during transit. 
 
 Still another detail should be mentioned. In New 
 York, or at any United States sub treasury, gold is always 
 purchasable with dollars (e.g. United States notes, gold 
 
 1 See Escher, Elements of Foreign Exchange, New York (The Bankers Publish- 
 ing Co.), IQII, pp. 114, 115. 
 
no THE EXCHANGE MECHANISM OF COMMERCE 
 
 certificates or silver) at the same rate or price. An 
 ounce of pure gold is always worth $20.671, and an ounce 
 of gold 9/10 fine is worth $18.604. The subtreasuries 
 aim to have bar gold available, but if the supply is 
 exhausted, then gold coin can be secured for export. 
 There is no question, therefore, here, as to the cost of the 
 gold to be shipped. But there is some variation in the 
 amount of coin of the realm which the specie may be 
 worth on arrival in Great Britain. This is because, 
 while the bank of England is by law compelled to pay 
 3 175. gd. per ounce for gold, the mint equivalent of 
 an ounce is 3 175. iof<. Any one can get the larger 
 amount for his gold by waiting to have it coined. But 
 on account of the delay and consequent loss of interest 
 while the gold is being coined, together with the labor of 
 weighing and assaying, the bank is not compelled to give 
 the mint par for gold ; though, to relieve others of the 
 necessity of waiting, it is under obligation to give for 
 it the somewhat less price stated above. The bank, how- 
 ever, may have sufficient use for gold, for reserve, export, 
 or other purpose, so that it will bid the full mint price or 
 even more. If all gold coins were full weight, the bank 
 would never bid more than the mint price, since coined 
 gold could be used and it would be cheaper to use coined 
 gold for any purpose for which the gold bars (or bullion) 
 might be desired, than to pay a higher price for the latter. 
 The price of gold would, in that case, fluctuate between 
 3 175. gd. and 3 175. lojd. In fact, it may and some- 
 times does go slightly above the latter price, because the 
 bank may be purchasing gold with worn coins, which, 
 while within the legal limit of tolerance in England, 
 would have to pass by weight if exported. The American 
 bank which exports gold to England cannot tell, there- 
 
RATE OF EXCHANGE AND FLOW OF SPECIE in 
 
 fore, just what it will be worth on arrival (though doubt- 
 less some one could be found to guarantee a price). 
 The money value on arrival will depend, slightly, on 
 what is being offered for gold at the time. 
 
 Sometimes the export of gold involves a triangular 
 operation. 1 For instance, B a wishes to get a balance 
 with B e in England, on which to sell drafts. Drafts 
 on England, here, are high, and B a does not wish to buy 
 any in such a market. But it may happen that in Paris, 
 drafts on London are below par. The high rate in New 
 York of drafts on Paris, however, tends to discourage 
 arbitraging. Instead, B a can ship gold to its Paris 
 correspondent, Bf, and order the Paris bank to buy a 
 draft on London. This draft is sent to London for dis- 
 count, and B a then has a balance in London, with B e , 
 on which it can draw at a profit above cost. 
 
 3 
 
 The Lower Limit to Fluctuation of the Rate of Exchange, 
 Determined by the Cost of Importing Specie 
 
 As the rate of exchange has an upper limit, though of 
 course a slightly elastic one, so also it has a lower limit. 
 If exchange falls below par by much more than the cost 
 of importing specie, either the supply of drafts on foreign 
 countries must decrease, or the demand for such drafts 
 must increase, or both, to such an extent that sup- 
 ply exceeds demand. The supply of drafts on foreign 
 countries would tend to decrease, because those having 
 collectible debts abroad in any considerable quantities, 
 on which they desired to realize, would find it cheaper 
 to pay for the importation of specie than to sell at so great 
 
 1 See Escher, Elements of Foreign Exchange, p. 120. 
 
ii2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 a discount, drafts on their foreign debtors. Suppose, for 
 example, that exchange in New York on London were 
 below $484.65 = 100. Then any New York bank, or 
 other person, desiring to call back funds held in London 
 or to collect a debt from there, would prefer to pay $2 
 per 100 for importation, and have $486.65 minus $2, or 
 $484.65 for each 100, than to get less than that amount 
 by selling a draft at a very low rate of exchange. This 
 applies, of course, only when the circumstances (or 
 agreement) are such that the creditor is obliged to bear 
 the risk of exchange fluctuations. Otherwise, the debtor 
 would be expected to remit draft or specie. But wher- 
 ever settlement is to be made at, in this regard, the 
 creditor's risk (and this might be the case, for example, 
 where a creditor bank has decided to withdraw funds 
 which it has itself put on deposit abroad), the effect of a 
 very low rate of exchange on any point would be to 
 decrease the supply of drafts on that point and substitute 
 importation of specie. With exchange so low, it would 
 pay better for banks to withdraw their balances from 
 abroad than to sell drafts upon those balances. 
 
 A low rate of exchange, below $484.65 = 100, would 
 also tend to increase the demand for drafts. For such a 
 rate of exchange would make it worth while to import 
 gold for profit. 100 of full weight English money would 
 be worth, in this country, $486.65. Subtracting $2 as 
 cost of transportation, insurance, etc., there is left 
 $484.65. If the gold can be purchased with a draft on an 
 English bank, a draft which, because of the low rate of 
 exchange, costs less than the above sum, the operation 
 is profitable. (It is not intended to assert that the im- 
 portation of so small a sum would be profitable. Rather 
 is it here assumed that the 100 is only a part of a much 
 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 113 
 
 larger sum.) The low price of drafts, then, stimulates 
 the demand for drafts as a means of paying for English 
 gold. Thus, on the supply side as on the demand side, 
 there is a limitation on the extent to which exchange can 
 fall. In practice, the ordinary business man does not 
 himself import gold but takes advantage of the demand 
 for his drafts by banks which use the drafts to pay for 
 gold. With importation of gold from England, as with 
 exportation to England, allowance must be made for the 
 possible slight fluctuation in the price of gold in terms 
 of pounds sterling. 
 
 4 
 
 Circumstances which May Cause the Rate of Exchange 
 to Fall Below what is Usually its Lower Limit 
 
 Although, as we have seen, there are limits to the 
 fluctuations of exchange, yet there are occasions when 
 the rate sinks considerably below what is ordinarily 
 the gold shipping point, or so-called specie point. 1 
 These are times of panic or of great financial disturbance, 
 accompanied by a relatively large supply of exchange. 
 The principles involved are the same at such times as 
 always, and the factors to be considered are the same, but 
 one of these factors, loss of time or loss of interest, comes 
 to have exceptional importance. If, when panic con- 
 ditions prevail, sellers of goods have bills on foreign 
 purchasers, they will be anxious to realize on these bills 
 at once. In a crisis, both cash and credit are relatively 
 hard to get. 2 At the peak of the crisis, there is a so-called 
 stringency. Interest rates are high. The sellers of 
 
 1 See Goschen, The Theory of the Foreign Exchanges, London (Effingham 
 Wilson), 1896, pp. 49-52 ; also Bastable, The Theory of International Trade, Lon- 
 don (Macmillan), 1903, pp. 85, 86. 
 
 2 See Ch. II (of Part I), 7. 
 
 I 
 
ii4 THE EXCHANGE MECHANISM OF COMMERCE 
 
 drafts do not want to lose interest and will, therefore, sell 
 at a low price so as to get cash immediately. Especially 
 if their creditors are pressing them hard or bank loans are 
 difficult to get, they must make the most of every avail- 
 able resource, at once. Rather than wait for importa- 
 tion of gold, they would sell drafts at a considerable 
 reduction below the usual price. It is the same when the 
 creditor is a bank. If, at such a time, it has occasion 
 to draw on a foreign balance, it will desire, like others, to 
 get control of such resources at once, and may accept 
 an unusually low rate of exchange rather than resort to 
 importation. Neither will a bank, at such a time, be 
 likely to import gold for profit unless the profit is excep- 
 tionally great. To buy gold abroad is to subject itself 
 to a considerable wait pending the arrival of the gold, 
 during which time part of its funds are unavailable for 
 other business. But during a crisis a bank is least liable 
 to desire, even temporarily, to part with funds. It will 
 be induced to do this only by hope of an exceptional 
 profit, only, that is, if the price of the exchange which it 
 must use to buy foreign gold is below the usual gold 
 importing point. Some few creditors may be in a posi- 
 tion to secure immediate payment by cable. But 
 those whose claims are based on the export of goods 
 cannot expect thus to be paid in advance of the goods' 
 arrival. Furthermore, at a time when the balance of 
 indebtedness is from foreign countries to us (and it is 
 such a time that we are considering), a part of that 
 indebtedness must be settled by shipments of gold and so 
 necessarily requires an interval of waiting while the gold 
 is in transit. It is this necessary wait, most unwelcome 
 at a time of stringency, which forces the rate of exchange 
 below the usual specie point. 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 115 
 
 5 
 The Cost of Money Shipment in Domestic Exchange 
 
 It should be noted that the principles of domestic 
 exchange are not different from those of foreign exchange. 
 Money has to be shipped from one part of the United 
 States to another, as it has to be shipped between coun- 
 tries, and it costs something to ship it. But in domestic 
 exchange the distances average less and the expense is 
 smaller. The express companies will carry $1000 from 
 New York to Chicago for 40 cents. 1 To carry $486.65 
 across the ocean, pay for insurance, weighing, assay- 
 ing, etc., costs about $2 (in large quantities), or over 
 $4 per $1000, making an expense more than ten times 
 as great. 
 
 Of course even the trifling charge of carrying money 
 about our own country might well affect the price of drafts 
 to that extent, and in fact it does so when banks buy and 
 sell domestic exchange of and to each other. But in 
 dealing with customers, it is usual for the banks to pay 
 no attention to this expense. On the contrary, they pay 
 to their customers when buying the latters' drafts, and 
 charge them when selling drafts to them, a more nearly 
 flat rate, which includes only a proper fee for bank 
 services, reasonable interest for time elapsing before 
 maturity, and reasonable insurance for the possibility 
 of non-payment. The up and down fluctuations of ex- 
 change between the shipping limits are borne by the 
 banks, and, since they gain about as much by one set of 
 fluctuations as they lose by the reverse changes, they just 
 about make, on the average, a fair return for their service 
 to the community. 
 
 1 See Taussig, Principles of Economics, New York (Macmillan), 1911, Vol. I, 
 p. 466. 
 
n6 THE EXCHANGE MECHANISM OF COMMERCE 
 
 As a matter of fact, such a small proportion of the 
 total business done requires shipment of actual money 
 that the expense, considering the low cost of domestic 
 shipments, may well be regarded as negligible. To 
 illustrate, a New York bank might have sold $1,000,000 
 of drafts on Chicago and bought $998,000 of drafts on 
 Chicago. It might then be necessary to ship $2000 to 
 Chicago at a cost of 80 cents. But this would be an 
 expense for the entire business transacted, extremely 
 small, and the bank might well ignore it. At any rate, 
 such, in domestic exchange within the United States, is 
 the custom. 
 
 6 
 
 The Long Run Effect of a Balance of Payments from One 
 Country to Another, for Commodities or Services 
 
 So far we have discussed chiefly the more immediate 
 effects, upon the exchange market, of given conditions. 
 Let us now consider some of the long run or ultimate 
 effects. These depend mainly on the relative prices 
 or levels of prices of goods in different countries. We 
 have seen that the determination of the level of prices in 
 any country is expressed in the equation 
 
 MV + M'V = pq + p'q' + etc., 
 
 where M is money, M' is bank deposits, V and V are 
 velocities of circulation, the p's are the prices respectively 
 of different kinds of goods, and the q's are the quanti- 
 ties of these goods. We have seen, also, that M ' tends 
 to increase or decrease in sympathy with M. We have, 
 therefore, drawn the conclusion that if, in any country, 
 M increases faster than the q's, prices will rise, while 
 if M decreases, they will fall. 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 117 
 
 Bearing in mind these facts, let us now consider the 
 long run influences of the following sources of exchange, 
 on the rate of exchange and on the flow of money : 
 a Payments for commodities. 
 a r - Payments for services, e.g. freight, banking, etc. 
 b Payments of funds for investments, e.g. interna- 
 tional lending and investing. 
 
 c Payments of interest, dividends, etc. on such invest- 
 ments. 
 
 c f Payments from home funds to persons of one sec- 
 tion or country, travelling in others. 
 c"- - Payments to families of immigrants. 
 
 Regarding payments for commodities, it is to be noted 
 that these are generally purchased where they can be got 
 most cheaply. If we can buy most commodities more 
 cheaply in England than here, then there will be a demand 
 for exchange on England with which to pay for them, 
 and exchange on England will rise. If such a condition 
 (large purchases from England) lasts for any great while, 
 the rate of exchange will probably go high enough to 
 encourage the exportation of gold. As a consequence, 
 since in each country there is a relation between gold 
 bullion and money, 1 M, and therefore M' also, will 
 increase in England and decrease here. Prices will rise 
 there by comparison, and fall here. We shall cease to 
 buy so much in England, and England will buy more of 
 us. Great purchases by us of foreigners tend, therefore, 
 to cause great purchases by foreigners of us. Money 
 flows one way or the other because commodities are pur- 
 chased, all things considered, where they are cheapest. 
 Briefly, commodities are bought where prices are low; 
 the rate of exchange elsewhere on these low price places 
 
 1 See Ch. I (of Part I), 7. 
 
n8 THE EXCHANGE MECHANISM OF COMMERCE 
 
 is therefore high ; gold is therefore shipped to the low 
 price places, and, since it is in large part coined, because 
 of the law of flow between bullion and coin, prices in 
 those places tend to rise. Though equilibrium is ever 
 being departed from, it is ever tending to be restored. 
 
 But this does not mean that if, for instance, wheat is 
 cheaper in the United States than in England, and Eng- 
 land buys wheat of us, we then, when English prices 
 have fallen and ours have risen, begin in turn to buy 
 wheat of England. Wheat never becomes cheaper there 
 than here. What is more likely to happen is that, when 
 our prices rise and theirs fall, they will buy less of our 
 wheat than before, and either raise more themselves, 
 buy more elsewhere, use a substitute, or simply get along 
 with less. We, on the contrary, when prices have fallen 
 in England and risen here, will perhaps buy more cotton 
 cloth in England, and either make less here, buy less else- 
 where than in England, substitute it for another kind 
 of cloth, or use more cloth. 
 
 A purely superficial consideration might lead to the 
 conclusion that we can always buy goods in England more 
 cheaply when exchange on England is low. A lot of 
 English goods worth 100 or, in our money, at the mint 
 equivalent, $486.65, might cost $489 if exchange were 
 high and only $484 or some $5 less, if exchange on Eng- 
 land were low. But the conclusion that low exchange on 
 England means an opportunity to buy goods there more 
 cheaply applies with certainty only on the supposition 
 that other things are equal. And the very fact that 
 exchange on England is low is evidence that other things 
 are not equal. Low exchange on England indicates, as 
 we have seen, a large supply of drafts on England. 
 Therefore it probably indicates that we have been selling 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 119 
 
 to England a relatively large amount and buying from 
 England a relatively small amount of goods. The pre- 
 sumable cause of this situation is relatively high prices 
 there and relatively low prices here, as compared with 
 other times or seasons. To be specific, at the time when 
 low exchange would enable us to buy in England 100 
 worth of goods for $484, it is probable that prices in 
 England are comparatively high and that 100 will buy 
 less there than at other times, compared with what money 
 will buy here. Expressing the fact in general terms, we 
 may say that, when money has flowed from here to 
 England in such quantities as to make their prices higher 
 and ours lower, it pays to sell to them rather than to buy 
 from them, even though, at such a time, exchange on 
 England is below par. Low exchange on foreign coun- 
 tries does tend to stimulate importation, and high 
 exchange to stimulate exportation, but exchange fluc- 
 tuations are too narrow to be of determining influence. 
 If, for example, Americans purchase largely in England, 
 the necessity of remitting will make exchange on Eng- 
 land high, and will in so far discourage further purchases 
 from England, while encouraging sales to England and 
 encouraging English merchants to purchase goods here. 
 But exchange cannot rise high enough to influence, very 
 strongly, the importation and exportation of other goods, 
 because so slight a rise causes shipment of gold (which, 
 because of its great value in small bulk, is inexpensive 
 in proportion to value, to ship). 1 It is quite likely, then, 
 that excess buying of Americans from abroad, will not 
 be checked or give rise to corresponding purchases by 
 foreigners from this country, until a flow of gold has 
 changed relative price levels. 
 
 i Cf. Ch. VI (of Part I), 9. 
 
120 THE EXCHANGE MECHANISM OF COMMERCE 
 
 Payments for freight, banking, and other services 
 affect exchange in the same way as do payments for 
 commodities. For example, payments for ship trans- 
 portation services are supposedly made where these 
 services can be secured most cheaply. Thus, a maritime 
 nation like Great Britain could sell to us the services 
 of her ships; and the resulting flow of money towards 
 Great Britain and higher prices there of various goods, 
 would give rise to their purchase of such goods, e.g. 
 wheat, from us. Great Britain might be said to export 
 transportation, banking, and other services, and to 
 import food. 
 
 Summarizing the conclusions of this section and com- 
 bining them with previous conclusions, we may assert 
 
 (1) that the rate of exchange in one country on another 
 depends upon the supply of and the demand for drafts ; 
 
 (2) that the supply of and demand for drafts depends on 
 the direction of obligations and other occasions for mak- 
 ing payments between the countries ; (3) that the direc- 
 tion of obligations, etc., depends largely upon the surplus 
 of commodities and services purchased by one country 
 of another ; and (4) that the surplus of commodities and 
 services purchased by one country of another depends 
 upon the relative prices of those commodities and ser- 
 vices in (or as sold by) the countries concerned. 
 
 7 
 
 The Long Run Effect of International Investments upon 
 the Rate o] Exchange and the Flow of Money 
 
 We have next to examine the long run effect of inter- 
 national (or interterritorial) investments upon the rate 
 of exchange and upon the flow of money. If, for example, 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 121 
 
 Englishmen invest in the United States, if we borrow of 
 them or sell securities and other property to them, what 
 is the immediate effect? It is to increase the supply, 
 here, of drafts on England, or decrease the demand for 
 such drafts, 1 and so to lower the rate of exchange on 
 England; and to increase the demand in England for 
 drafts on the United States, raising there the rate of 
 exchange on us (though this fact is obscured by the cus- 
 tom of quoting the rate in England, as here, in American 
 money). Then it becomes worth while for American 
 banks to import and for English banks to export, gold. 
 As a second consequence, therefore, gold flows from 
 England to the United States. Since much of this gold, 
 because of the laws of interflow between gold bullion and 
 gold coin 2 is a subtraction from English money and an 
 addition to American money, prices will tend to fall in 
 England and will tend to rise in the United States. 
 Then it will become profitable for us to buy more goods 
 in England, while England will buy less goods of us. As a 
 next consequence, the obligations from us to them will 
 be in excess, and the rate of exchange on London will 
 rise. Therefore, gold will be shipped back again in 
 return for other goods. 3 This return flow must continue 
 until English and American prices (supposing no new 
 influences to intervene) are in about the same relation as 
 before the lending or investing began. That means that 
 in each country the quantity of money must be in about 
 the same relation as before to the quantity of goods. 
 Speaking roughly, we may say that the invested money 
 flows back for goods, or that what is really invested is 
 
 1 See Ch. IV (of Part I), 2. 
 
 2 See Ch. I (of Part I), 7. 
 
 3 See Taussig, Principles of Economics, pp. 468-471. 
 
122 THE EXCHANGE MECHANISM OF COMMERCE 
 
 usable capital. If Englishmen invest in the securities 
 of a new American railroad, what we really get from 
 England may be steel rails, engines, etc., or cloth, coal, 
 and other goods to be consumed by us while we are mak- 
 ing the rails and engines. International lending and 
 investing is most decidedly a lending and investing of 
 capital wealth in such forms as are here suggested, and 
 not merely a flow of money. 
 
 Foreign investments here may, in fact, take largely 
 the form of usable capital, without the intermediation of 
 these stages of inflow and outflow of money. The fall 
 in the rate of exchange on foreign countries, consequent 
 on such investments, itself tends to make foreign goods 
 slightly cheaper in terms of American money and so to 
 encourage, somewhat, importation of usable capital, 
 even before the tendency to importation is accentuated 
 by the change in relative price levels. 1 And if gold does 
 flow in to some extent, the tendency for it to flow out 
 for other goods may show itself so quickly that, aside 
 from the first slight inflow, the purchase of capital goods 
 abroad keeps pace -with the investments made by 
 foreigners here. In effect, the foreign investors send 
 us, perhaps almost at once, capital other than money. 
 
 8 
 
 The Long Run Effect of Various Other Payments from 
 One Country to Another 
 
 The third group of purposes for which bills of exchange 
 and money are sent from country to country, is to pay 
 interest, dividends, and profits on investments, to send 
 remittances to persons travelling abroad, and to send 
 
 1 Cf. 6 of this chapter (V of Part I). 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 123 
 
 remittances to the families of immigrants. We have 
 just seen that, when foreigners invest here, such invest- 
 ment, in the long run, is an investment of consumable 
 goods, or of the machinery of production, or both. 
 In the long run, what flows here is goods rather than 
 money. After a time, interest is earned on the bonds 
 foreign investors have purchased, dividends are declared 
 on the stock, etc. Having secured the use of foreign 
 capital, we must pay interest on it. There arises then 
 a demand for exchange on foreign countries in order to 
 pay these investors their profits. This demand makes 
 exchange on foreign countries high (while on us it is 
 low), and it becomes worth while for gold to be shipped 
 from us to them. The same kind of result occurs if 
 and when the invested capital is itself repaid (i.e. if 
 American investors buy back from foreigners American 
 land, securities, etc.). Consequently foreign prices 
 tend to rise and ours to fall. Therefore, foreigners buy 
 more goods of us than previously, and the money flows, 
 chiefly, 1 back here. In the last analysis the interest 
 and dividends received are practically all in the form of 
 food, raw material, manufactured goods, etc., and are 
 not merely money. 
 
 So, in the last analysis, remittances to Americans 
 travelling abroad and to the families of immigrants, 
 have the same result. Our countrymen travelling abroad 
 receive from home, in the long run, not money, but 
 goods. Of course they may purchase chiefly European 
 
 1 Not, perhaps, entirely, because the somewhat larger amount of goods in 
 foreign countries, consequent on the flow back to us, for goods, of the interest 
 and dividends money, may require a little more money to be circulated. But 
 the rapidity of circulation of money and the fact that it is the basis for bank 
 credit circulating even more rapidly, would seem to signify that a very large 
 increase in the quantity of goods abroad would call for but a slight increase in 
 money. 
 
i2 4 THE EXCHANGE MECHANISM OF COMMERCE 
 
 goods, but, if so, they thereby put some Europeans in a 
 position to get American goods. In the long run, it is 
 chiefly goods other than money which flow in trade. 
 
 9 
 
 Summary 
 
 Though the use of bills of exchange obviates, to a large 
 degree, the necessity of shipping money or gold, never- 
 theless, as we have seen, balances must be thus settled. 
 A continuous balance of obligations in one direction will 
 cause gold to be shipped, by affecting the rate of exchange. 
 It will become cheaper to settle indebtedness by shipping 
 gold, and the exportation or importation of gold may be 
 undertaken for profit. A high rate of exchange, here, on 
 any country, will cause shipments of gold to that country ; 
 a low rate will cause importations of gold from that 
 country. Exportation of gold to any country will tend 
 to keep down the price of drafts on that country by 
 decreasing the demand for them (debts being settled by 
 gold) and by increasing the supply of them (drafts being 
 drawn on consignees when gold is shipped for profit). 
 Importation of gold from any country will, analogously, 
 tend to keep up the price of drafts on that country by 
 decreasing the supply of drafts (gold being imported 
 instead of drafts being drawn), and by increasing the 
 demand for them (to purchase foreign gold imported for 
 profit). The rate of exchange can, therefore, go above 
 or below par by only about the cost (with perhaps a 
 reasonable profit) of shipping specie. But at a time of 
 stringency, when most business men in a country desire 
 to secure funds as quickly as possible, the rate may go 
 somewhat lower than what would usually be the gold 
 importing point. 
 
RATE OF EXCHANGE AND FLOW OF SPECIE 125 
 
 In the long run, specie tends to flow to those places 
 where other desired goods are cheapest (and specie, 
 therefore, of most value or purchasing power in com- 
 parison with those goods), and from places where goods 
 other than money are high. So lending and investing 
 between countries is really, in the main, a lending and 
 investing of capital goods rather than money ; for the 
 flow of money changes the relative levels of prices of the 
 countries concerned, and brings about a reverse flow. 
 The same principle applies to the payments of interest 
 and dividends, remittances to persons abroad, etc. The 
 use of bills of exchange and money complicates these 
 business relations of countries and territories; but it 
 does not change the essential fact that trading, lending, 
 investing, and profiting involve, in the last analysis, 
 capital and consumable goods rather than money. 
 Money (as well as bills of exchange, etc.) is a part of our 
 machinery of production, but only a part, and it is as a 
 part of this machinery that k is of use in international 
 and interterritorial business relations. 
 
CHAPTER VI 
 
 FURTHER CONSIDERATIONS REGARDING THE RATE OF 
 EXCHANGE 
 
 The Price of Long Drafts Determined in Part by the Rate 
 of Interest or Discount 
 
 THE price, here, of bills of exchange on any given 
 country, at a given time, may be regarded as being made 
 up chiefly of two factors. These are, the rate of interest 
 or discount, and the pure rate of exchange. The pure 
 rate of exchange is the rate on demand or sight drafts. 
 As to these there is no element of time except, of course, 
 the time required for the carriage of the drafts from the 
 one country to the other. Ignoring the slight interest 
 thus involved, some -$ of the yearly rate, we may say 
 that the rate of exchange on sight drafts is pure exchange. 
 It is the rate of exchange on sight drafts, which we have 
 in mind when we say that exchange can ordinarily fluc- 
 tuate only between the specie points or shipping limits. 
 
 But with other drafts, the rate of interest or discount 
 is an important fact to consider. Many of these drafts 
 are drawn to run for periods of 60, 90, and even 120 
 days after sight. Since payment on such a draft can- 
 not be required before maturity, the investing pur- 
 chaser of the draft is in the position of a lender or in- 
 vestor until then, unless, of course, he sells to another. 
 As a lender or investor, he will wish to get interest on his 
 investment, and since the amount he is to receive at 
 
 126 
 
FURTHER CONSIDERATIONS ON EXCHANGE 127 
 
 maturity is definitely fixed, he can secure interest only 
 by paying somewhat less than this amount when he buys 
 the draft. In short, the investing purchaser must dis- 
 count the draft for the time it has to run, and the amount 
 of this discount will depend upon the rate of discount or 
 the rate of interest. Since the investing purchaser is 
 sure to discount the draft, the exchange bank which buys 
 it in the first instance, intending to have it sold in the 
 exchange market, must also discount it. Thus, even 
 if exchange here, on England, were above par, say 
 $488.65 = 100, a draft for 100 having some time to 
 run might, because of the element of time, be selling 
 for $482. 
 
 It may be noted in passing that an importer can, in 
 effect, secure a cash discount on his purchases by remit- 
 ting a 6o-day or go-day draft. Suppose he has pur- 
 chased 100 worth of goods in London, payment to be 
 made in 90 days. If it is agreed that he shall remit, he 
 can, just before maturity of the debt, buy a draft and 
 send it. But he can also, if he prefers, buy immediately 
 a draft payable in 90 days. If he does this, he will get 
 the draft at a discount. His goods will cost him less 
 because he is prepared to pay at once. As a matter of 
 fact, banks frequently sell such time drafts to importers. 
 
 2 
 
 How Long Drafts on Foreign Countries are Held as Invest- 
 ments by American Banks 
 
 The fact that many drafts run for periods of several 
 months and, being purchased at a discount, yield interest 
 to the holders of them, makes these drafts desirable as 
 short term investments. Sometimes the bank which 
 
128 THE EXCHANGE MECHANISM OF COMMERCE 
 
 originally purchases long drafts, in the " drawing" 
 country, prefers to realize this interest, rather than to 
 have such drafts sold at once in the discount market of 
 the "accepting" country. Let us suppose that for a 
 time the discount rate on safe drafts, in the German 
 market, is 7 per cent, while conditions of business in the 
 United States are such that American banks cannot 
 earn more than about 5 per cent on their capital used 
 at home. Under these conditions, an American bank 
 purchasing drafts on Germany, having some time to run, 
 would probably not send them to Germany for imme- 
 diate discount at the comparatively high rates there 
 prevailing ; but would be more apt to hold them in its 
 own vaults, or have them held for its account by its 
 German correspondent, until maturity or near maturity, 
 in order to realize a larger sum. 
 
 Before describing the method of procedure commonly 
 followed when drafts on foreign countries are held in its 
 own vaults for investment by an American bank, it is 
 essential to note that bills of exchange or drafts used in 
 international trade, are generally made out in duplicate, 
 the different copies being known as firsts and seconds. 
 This has long been the custom in such trade, as a safe- 
 guard against possible loss or miscarriage of one of the 
 drafts. Whichever draft first reaches its destination is 
 presented for acceptance, and when it is paid the debt 
 is cancelled. Extra copies of bills of lading and other 
 documents may also be made. 
 
 Consider now the procedure which may be followed by 
 the investing American bank in holding the drafts on 
 Germany. 1 On the day of purchase by an American 
 
 1 Described in Margraff, International Exchange, Chicago (Fergus Printing 
 Co.), 1903, p. 61. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 129 
 
 bank of drafts on German banks or merchants, the 
 "firsts" of these drafts or bills of exchange are not 
 indorsed by the American bank to the order of its 
 German correspondent, as would be done if the drafts 
 were to be sent over for immediate discount and credit 
 or for holding abroad subject to cable order. On the 
 contrary, there are written on the faces of these firsts 
 the words "for acceptance only." Then the German 
 correspondent bank to which the drafts are forwarded, 
 is requested to have them "accepted," and to hold them 
 subject to the call of the seconds properly indorsed by 
 the American bank. Any duplicate documents, such as 
 duplicate bills of lading, attached to the seconds, are 
 detached and sent to the German correspondent bank, 
 which is instructed to turn these documents over to 
 the drawees provided the latter accept the drafts. The 
 seconds, clean of all other papers, are kept by the invest- 
 ing American bank. On the face of each of these seconds 
 
 is written: "Accepted firsts held by ," giving the 
 
 name of the bank to which the firsts were sent. The 
 American bank gets as profit the difference between the 
 discounted value paid for the drafts and the amount 
 realizable from them at maturity, minus the corre- 
 spondent's commission. 
 
 When the date of maturity approaches, the American 
 bank will indorse the seconds, presumably to the above 
 described correspondent bank, and forward them to it for 
 credit. As a matter of fact, the American bank need not, 
 if it prefers otherwise, send the indorsed seconds to the 
 foreign bank which holds the firsts. The seconds can, 
 if occasion requires, be indorsed to any bank, for the 
 firsts are held subject to the call of the indorsed seconds, 
 and must be handed over (or credited, as the case may be) 
 
130 THE EXCHANGE MECHANISM OF COMMERCE 
 
 on presentation of these indorsed seconds. 1 The two 
 together constitute a completed bill. 
 
 The drafts may be so indorsed and forwarded to the 
 correspondent bank for discount and credit at any time 
 when rates of discount make it seem profitable to send 
 them. 2 They are not necessarily held until maturity. 
 But, in any case, the amount realized (minus commis- 
 sion) is placed to the American bank's credit, and it can 
 then sell drafts on this credit. Of course, the investing 
 bank takes some risk of fluctuations in the rate of ex- 
 change. If the rate falls, the bank will get somewhat 
 less when it sells its drafts on this credit. If, on the 
 other hand, the rate of exchange on Germany was low 
 when the American bank bought the drafts for invest- 
 ment, so that they could be purchased more cheaply, 
 and is high when the bank is ready to sell its own drafts 
 on the credit secured (at maturity or before), then the 
 bank will realize an additional profit. 
 
 But the American bank, even if desiring to avail itself 
 of higher interest rates existing temporarily in Germany, 
 will often prefer to indorse the drafts it has purchased 
 to its German correspondent, and have them held by the 
 latter, after acceptance, subject to instructions by cable. 
 An advantage of this method lies in the possibility of 
 immediate sale at any time before maturity if low dis- 
 count rates make it desirable to have the drafts sold. If 
 to have them sold does not appear to be profitable, they 
 can be retained till maturity for account of the remitting 
 bank. 
 
 1 Margraff, International Exchange, p. 65. Ibid., p. 63. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 131 
 
 3 
 
 Influence on the Price of Long Drafts, of Interest Rate 
 in Drawing Country and of Interest Rate in Country 
 Drawn Upon 
 
 We have seen that the prices of bills of exchange, other 
 than sight bills, depend upon the rate of interest. We 
 have also seen that bills of exchange involve two trading 
 countries ; and in the previous section attention has been 
 called to the fact that the rate of interest in one such 
 country may be different from the rate of interest in the 
 other. Which of the two rates of interest or discount 
 will, in such a case, determine the price of a bill of 
 exchange drawn in one country on the other ? 1 
 
 In the first place, let us suppose interest to be com- 
 paratively high in the country where the bill in question is 
 drawn, say the United States, and comparatively low in 
 the country on which it is drawn, say England. On 
 this assumption, the amount of the discount, and, 
 therefore, the price of the draft, will depend on the rate 
 of interest or discount in the country on which the 
 draft is drawn, viz., England. For if the rate of discount 
 in England is very low, then the draft will sell, in England, 
 for a high price, that is, for a price comparatively near 
 the maturity value. And since it will thus sell in the 
 English discount market for a high price, therefore the 
 American bank which first allows cash for it to a mer- 
 cantile or other establishment, can afford to pay a high 
 price for the draft. The American bank which buys the 
 draft does not need to wait until maturity to realize on it, 
 but can have it discounted immediately on its arrival 
 
 1 The reasoning here followed is that of Goschen, The Theory of the Foreign 
 Exchanges, third edition, London (Effingham Wilson), 1896, p. 137- 
 
i 3 2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 at London. The American bank does not need to lose, 
 for a long period, the use of its capital. As a conse- 
 quence, competition among American banks will force 
 up the price of such drafts to somewhere near what they 
 will bring in the English discount market. Our conclu- 
 sion must be that if the interest rate in the country 
 drawn upon is the lower, this interest rate determines the 
 price of long drafts in the drawing country also. 
 
 But suppose, on the other hand, that the rate of inter- 
 est is higher in the country drawn upon, say England, 
 than in the drawing country, the United States. On this 
 hypothesis, a draft on England would be discounted in 
 England at a comparatively high rate, that is, would 
 bring a relatively low price. Would its price be equally 
 low in the drawing country? Certainly if the pur- 
 chasing bank in the United States intended to send the 
 draft at once abroad for discount, such a bank could not 
 afford to pay more. To do so would mean a definite 
 loss. But, on our present hypothesis, a draft purchased 
 at the low price based on the discount rate in England, 
 will yield a greater return on the investment than the 
 prevailing rate of interest in the United States, the draw- 
 ing country. Competition among banks in the drawing 
 country, desiring to invest in such bills of exchange, may, 
 therefore, raise the price of the draft slightly above its 
 value in the country drawn upon ; for even then it will 
 bring a larger return by way of interest than is being 
 realized generally in the drawing country. The seller 
 of the draft may hope to get for it a little more than the 
 price it would bring in England, while the purchasing 
 bank realizes more than the rate of interest in the United 
 States, enough more to induce this bank to buy and hold 
 the draft as an investment, or have it held for its account 
 
FURTHER CONSIDERATIONS ON EXCHANGE 133 
 
 abroad. When, therefore, the rate of interest is lower 
 in the drawing country, the price of the draft will be 
 determined, at least in small part, by that rate of interest. 
 It should be added that if conditions change during the 
 life of a draft, so that interest is lower in England, such 
 a draft held here as an investment is likely to be sent 
 there for immediate discount at the high price realizable. 
 As a matter of fact, the discount rate in London, as 
 also in other great European centres, is almost always 
 lower than in New York. The usual rule, therefore, is 
 for American banks to have their drafts on England 
 discounted there at once. Their capital can be more 
 profitably invested at home than in holding long drafts 
 on English debtors. On the other hand, English banks 
 do not have long drafts which they buy on Americans, 
 discounted in the United States. The absence, here, of 
 a rediscount market, makes it practically impossible for 
 them to do this, though the usually higher rates of dis- 
 count prevailing in the United States might, in any case, 
 disincline them to have such drafts sold on this side. 
 There are, in practice, very few long bills drawn upon 
 the United States, and such long bills as are drawn upon 
 this country are usually held till maturity, for account 
 of the foreign remitting banks, by their American 
 correspondents. 1 
 
 4 
 
 How and Why the Bank Discount Rate Affects the Price of 
 Demand Drafts and the Flow of Specie 
 
 Changes in the relative rates of interest in different 
 countries affect, temporarily, rates of exchange and the 
 flow of specie; though such changes in relative rates 
 
 i See Ch. Ill (of Part I), 8. 
 
i 3 4 THE EXCHANGE MECHANISM OF COMMERCE 
 
 of interest do not permanently affect the international 
 distribution of specie, independently of comparative price 
 levels. For example, much is said of the influence on 
 the rate of exchange and on the flow of gold, of the Bank 
 of England discount rate. If the Bank of England, 
 because of too rapidly expanding loans or because of 
 depletion of reserves, raises its rate of discount, being 
 followed in this move by the other English banks, its 
 doing so has a tendency to lower the rate of exchange 
 in England on the United States and other countries, 
 and to raise the rate in the United States and elsewhere 
 on England. It has this effect because the increased 
 interest in England tempts to investment there rather 
 than in the United States. English banks are more 
 likely to invest current funds at home, and may even draw 
 on debtor banks in the United States and other countries. 
 American and other banks may be tempted to make 
 short term loans in England or to hold or have held until 
 maturity, long bills which they would otherwise have 
 immediately discounted. This holding of drafts until 
 maturity will compel them to buy more drafts on Eng- 
 land than otherwise would be necessary, in order to 
 maintain their usual balances. The general result of a 
 high discount rate in England is, therefore, a high rate 
 of exchange on and a flow of gold to England. 1 Similarly, 
 a sharp rise in the discount rate in New York would tend 
 to produce elsewhere a high rate of exchange on New 
 York, and would tend to cause a flow of gold to New 
 York. 
 
 But we have seen that the flow of gold from country to 
 country is determined by comparative prices of goods. 
 If, because of a high discount rate in England, gold flows 
 
 1 Goschen, The Theory of the Foreign Exchanges, third edition, pp. 129-140. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 135 
 
 to England in large quantities, so that prices rise there 
 and fall here ; then England becomes a good place to 
 sell to, and the United States (and other countries) by 
 comparison a good place to buy from. The gold will 
 therefore flow back for goods until prices are, relatively, 
 what they were before. Americans, or American banks, 
 who. have invested in England because of the high rates 
 of interest there, will have invested, in fact, not money 
 but other capital. 
 
 But at this point a qualification must be made, based 
 on the fact that the bank rate of discount influences, in- 
 directly, the prices of goods. The bank discount rate in- 
 fluences prices by affecting credit. It was pointed out, in 
 Chapter II (of Part I), 1 that the general level of prices in 
 a modern industrial and commercial community or coun- 
 try is determined not alone by the quantity of money and 
 its velocity of circulation and by the volume of trade, but 
 also by the amount and velocity of bank credit. The 
 relationship set forth was expressed in the equation, 
 
 MV + M'V = pq + p'q' + etc. 
 
 / 
 
 Ordinarily, it was shown, M' maintains a fairly constant 
 rather than a violently fluctuating ratio to M. The 
 total amount of this M ' or bank credit in a community 
 will depend partly on the business needs and customs 
 of that community, but partly, also, on the quantity of 
 such credit which the banks can safely keep in circula- 
 tion with a given support of cash reserves. If lack of 
 confidence depletes these reserves, or if banks have 
 expanded their credit too far for their reserves safely to 
 support, contraction of this credit is necessary. The 
 banks discourage borrowing, and so decrease the amount 
 
* 3 6 THE EXCHANGE MECHANISM OF COMMERCE 
 
 of circulating bank credit by charging higher interest 
 to borrowers, i.e. by raising their rates of discount. 
 
 Suppose, then, that because of a condition of business 
 distrust and comparatively small reserves, the Bank of 
 England and other English banks raise their rates of 
 discount. As a consequence, there is a fall in the rate 
 of exchange on New York, and, in New York, a rise 
 in the rate on London. There follows a flow of gold to 
 London and the bank reserves there are replenished. 
 But this gold does not, at least for the time being, raise 
 English prices and result in a corresponding flow of gold 
 back to the United States (and other countries) ; for 
 the increase of the bank charges on loans discourages 
 borrowing from banks, and so tends to decrease M' . 
 In the equation, MV + M'V = pq + p'q' + etc., for 
 England, the />'s may not be at all increased or may even 
 be decreased. 1 Only when bank credit, in England, is 
 again allowed to expand, will the full effect of the inflow 
 of gold be felt in higher prices. So long as high discount 
 rates keep the total of circulating bank credit in England 
 less than before in relation to money, the inflow of gold 
 does not so much raise prices as substitute itself for bank 
 credit. Hence, gold will not flow out again, for goods. 2 
 
 1 Cf. Goschen, The Theory of the Foreign Exchanges, p. 129, where this idea, 
 though not developed, seems to be implied. 
 
 2 Just before the outbreak of the European war now (August, 1914) in 
 progress, the efforts of European investors to dispose of securities for gold and 
 the closing of the principal bourses of the world, caused a flood of sales on the 
 New York stock exchange, large purchases of these securities by Americans, and 
 an unusually strong tendency for gold to flow abroad. In view of the sudden- 
 ness and violence of the movement, it was perhaps not unwise that the New 
 York stock exchange should be temporarily closed (see New York World, 
 August i, 1914) and that the sale of securities here by foreigners should thus 
 be made difficult. It is true that the flow of gold abroad (and we are not here 
 concerned with any other reason for the closing of the exchange) is not ordinarily 
 a proper cause for alarm, can be checked by a rise in bank discount rates if such 
 a check is necessary, and will in any case, if long continued, give rise to a re- 
 
FURTHER CONSIDERATIONS ON EXCHANGE 137 
 
 5 
 
 Effect of a Panic in One Country on Conditions in Other 
 Countries 
 
 Since prices and interest rates in different countries 
 are related, a panic in one country cannot usually be 
 altogether without effect on other countries having close 
 commercial relations with it, 1 though these other coun- 
 tries may not be affected acutely. When, for any reason, 
 in a country of large commercial importance, business 
 confidence gives place to acute distrust, and the banks, 
 with reserves depleted or fearing that the reserves will be 
 depleted, raise their discount rates, their action will 
 affect discount rates in commercially related countries. 
 The strain on the bank reserves of the first country, and 
 the rise of the discount or interest rate, tends to draw 
 gold from other countries. 
 
 This will tend to deplete the bank reserves of those 
 countries in relation to circulating bank credit. Either 
 the gold will come directly from these bank reserves as 
 when it is drawn from the great central banks of Europe 
 for export, or it will come indirectly but just as surely 
 from bank reserves, as when gold is bought for export 
 from a United States sub treasury and is paid for by 
 lawful money which might otherwise be used as reserves. 2 
 
 turn flow. Yet so unprecedented a movement as the recent one here under 
 discussion, might conceivably, if met only by a rise in the discount rate (which 
 would also have to be great and sudden), dangerously and, considering the 
 probable temporary nature of the crisis, unnecessarily disturb credit conditions. 
 
 1 Cf. Fisher, The Purchasing Power of Money, New York (Macmillan), 1911, 
 p. 267. 
 
 1 Even if the gold is purchased with bank credit, the reserves become smaller 
 in proportion as compared with the total amount of such credit ; and they tend 
 (since, as we have seen Ch. II, 5 business men keep some relation between 
 their bank accounts and cash assets, and will draw out cash if the latter become 
 relatively too small) to become absolutely smaller. 
 
138 THE EXCHANGE MECHANISM OF COMMERCE 
 
 The conclusion is that in any case the banks in those 
 countries from which the gold is drawn, will also have 
 occasion to raise, somewhat, their discount rates, in order 
 to keep their reserves and their deposits (and notes) 
 in proper relation to each other. And if contraction of 
 credit causes a fall of prices in one country, the mitigated 
 effect of this, at least, must spread to other countries. 
 It does not follow that a severe panic in one country 
 must be accompanied by or succeeded by a correspond- 
 ingly severe panic in others ; but only that in each of 
 a group of commercially related countries there will 
 be practically simultaneous rises in price levels, nearly 
 simultaneous high prices and high discount (interest) 
 rates, and substantially simultaneous decline. The 
 goodness of its banking system (and other facts), may 
 make the changes more gradual and less severe in one 
 country than in others, but is not likely to prevent the 
 changes altogether. 
 
 6 
 
 Exchange between Two Countries when One has a Gold 
 and the Other a Silver Standard 
 
 An excess production of gold in any country raises 
 prices there compared to prices in other countries, 
 encourages buying goods in other countries, and there- 
 fore raises the rate of exchange on other countries. 
 Export of gold follows. The introduction of a cheaper 
 standard of value has the same effect. A large coinage 
 of cheaper money, e.g. silver at a ratio of 16 to i (which 
 would greatly overvalue silver and lead to a large coin- 
 age), would increase M. Prices would rise and the value 
 of money would fall. Goods would therefore be pur- 
 chased abroad. The rate of exchange on foreign coun- 
 
FURTHER CONSIDERATIONS ON EXCHANGE 139 
 
 tries would rise and gold would be exported. As long 
 as the silver and gold both circulated and were generally 
 acceptable for goods at the legal ratio, the rate of ex- 
 change would not rise much above the gold export 
 point. But if this ratio encouraged the continued coin- 
 age of silver, the gold would eventually be entirely 
 driven out of the currency of the silver coining country. 
 Then the rate of exchange would rise even higher, for 
 prices in the silver country would continue to rise until 
 silver coin had no greater value than silver bullion. But 
 once the gold had been entirely driven out, there could 
 be no further effect on the amount of money and there- 
 fore on prices, in other countries, 1 produced by the coin- 
 age of silver. Consequently, the prices of the silver 
 country would be permanently higher than formerly, 
 compared to prices abroad, and its money standard of 
 less value. Instead of the rate of exchange on England, 
 supposing the United States to be the silver standard 
 country, averaging $486.65 = 100, it might average 
 $973-3 = 100, or some other new and higher rate. 
 The rate of exchange would have risen tremendously. 
 In fact, such a rise in the rate of exchange is good evi- 
 dence of a cheaper or depreciated currency. But the 
 rate of exchange, though in figures much higher than 
 before, would not necessarily be above par. Instead, 
 there would be a new par. $973.30 = 100 might have 
 become this par. Exchange would thereafter fluctuate 
 about this new instead of about the old and lower par. 
 
 Par of exchange would no longer be steady. For with 
 one country on a silver standard and the other on a gold 
 standard, the monetary unit of one, e.g. the dollar, would 
 have no fixed relation to the monetary unit of the other, 
 
 *See, however, remainder of this section (6). 
 
140 THE EXCHANGE MECHANISM OF COMMERCE 
 
 e.g. the pound. The value ratio of these units would 
 vary with the value ratio in the bullion markets, of sil- 
 ver and gold. But exchange in neither country, on the 
 other, could go above par by much more than the cost 
 of shipping specie. Exchange in the silver standard 
 country on the gold standard country, would be limited 
 by the cost of gold in terms of silver, plus the cost of 
 shipment. 1 Vice versa, exchange in the gold country on 
 the silver country, could not go higher than the cost of 
 silver in terms of gold, plus the cost of shipment. 
 
 How would trade balance when there was no longer, 
 between two such trading countries, the influence of price 
 relations in the same precious metal, to make the flow 
 of goods one way balance a return flow ? The balance 
 might then be brought about by the flow of gold one way, 
 and of silver the other. If we should for a time buy more 
 in England than the English of us, and had a net indebted- 
 ness to meet, we might purchase gold in the bullion 
 market here, with which to settle. This (assuming the 
 United States to be on a silver standard) would not 
 directly affect our prices, but would increase the quantity 
 of money and tend to raise prices in England. In this 
 country it would tend to make gold bullion scarce and dear 
 as compared with our silver money and with other goods. 
 A given amount of English money would buy more 
 American dollars than before, and wpuld buy more 
 American goods than before, as compared with the goods 
 it would buy in England. That is, par of exchange in 
 England on the United States would be lower. There 
 would also, of course, be some tendency for prices in one 
 country to fall and in the other to rise because of the flow 
 
 1 Goschen, The Theory of the Foreign Exchanges, pp. 76-81 ; cf. Clare, The 
 A.B.C. of the Foreign Exchanges, London (Macmillan), 1893, pp. 139-142. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 141 
 
 of goods as well as because of the flow of money. The 
 greater supply of goods in the importing country, the 
 United States, in relation to money, would tend to lower 
 the price level; while the outflow of goods from the 
 exporting country, England, would tend, there, to raise 
 the price level. 
 
 The fact that a given amount of English money would 
 buy more American goods than before, would encourage 
 English buying here ; while the less purchasing power 
 over English goods, of American money, would dis- 
 courage American buying in England. 1 Hence trade 
 would reach equilibrium or would flow, for a time, in the 
 opposite direction. 2 Exchange in England on the United 
 States would rise above par, and specie would be shipped. 
 
 If exchange on England should be below par and the 
 flow of specie should be from them to us, the same prin- 
 ciple would apply. The silver sent to us in settlement 
 of balances would tend to raise our prices and lower 
 the value of silver in the United States. Its exportation 
 from England would tend to make silver in England 
 relatively scarce and dear. As a consequence, a given 
 number of American dollars would buy more pounds than 
 before and would buy more goods in England than 
 
 1 Cf. Bastable, The Theory of International Trade, fourth edition, London 
 (Macmillan), 1903, pp. 59, 60. See also Professor Marshall's "memorandum" 
 on the effect in international trade of different currencies, Appendix to Final 
 Report of the Gold and Silver Commission, 1888, pp. 47-53. 
 
 2 If we suppose American silver exported to buy English gold for settling 
 the balance against us, because of a more favorable price of gold in England com- 
 pared to silver, we shall nevertheless reach the same final conclusion. On this 
 supposition, the outflow of silver would tend to lower American prices, raising 
 here the value of silver. In England, silver would become of less value in com- 
 parison with gold. A given sum of English money would buy more American 
 money, and would buy more American goods than before as compared with the 
 goods it would buy in England. Therefore, the flow of trade must reach equilib- 
 rium or even be temporarily reversed. 
 
i 4 2 THE EXCHANGE MECHANISM OF COMMERCE 
 
 before as compared to what they would buy here. The 
 surplus flow of goods from the United States to England 
 would, other things equal, be brought to an end. If, 
 therefore, two trading countries have, respectively, a 
 silver and a gold standard, the laws of trade between them 
 are not greatly different than if both have the same 
 standard. It is still true that each will buy goods of the 
 other ; and it is still true that an excess flow of trade in 
 one direction tends so to change monetary and price 
 conditions as to bring its own termination. 
 
 7 
 
 Exchange between Two Countries when One has a Gold 
 and the Other an Inconvertible Paper Standard 
 
 Let us now suppose the case of a paper standard, i.e. 
 paper money not redeemable in specie, in one of two 
 trading countries, and a gold standard in the other, as 
 with the United States and England during our Civil 
 War period. The rate of exchange in the paper money 
 country on the other, would depend chiefly on the cost 
 of gold in terms of paper, and therefore would rise as the 
 paper money depreciated in relation to gold. 1 Thus, 
 during the Civil War, exchange in the United States on 
 other countries, e.g. England, rose to a very high figure, 
 because of the depreciation of the greenbacks. Con- 
 versely, the rate of exchange in the gold standard country 
 on the country with a paper standard would depend 
 mainly on the cost of this paper money in terms of gold, 
 and therefore would fall as the paper money depreciated. 2 
 In the paper money country, the upper limit of exchange 
 on the other cannot much exceed the cost of purchasing 
 
 1 Goschen, The Theory of the Foreign Exchanges, pp. 69, 70. * Ibid. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 143 
 
 gold with paper, plus the cost of shipping the gold. 1 
 If we regard exchange between two such countries as at 
 par (though the paper money might be depreciated far 
 below par) when the money of the paper standard coun- 
 try will buy just as much exchange on the gold standard 
 country as it will buy gold at home, 2 then we may say 
 that exchange could rise above par by the cost of shipping 
 specie. 3 In general, we may say that exchange might 
 either rise above or fall below this par, by the cost of 
 specie shipment, just as it might rise above or fall below 
 par by the cost of specie shipment if both countries had 
 the same specie as standard. 
 When one of two countries has inconvertible paper and 
 
 Ubid. 
 
 'This is the logical though not the ordinary use of the word "par" in re- 
 lation to exchange, when one country has a depreciated currency. It is custom- 
 ary to regard as par what would be par if there were no depreciation. Strictly 
 speaking, however, the departure from this rate, due to depreciation, means a 
 departure of the money from par, rather than of exchange. 
 
 8 This is not inconsistent with Bastable's statement (Theory of International 
 Trade, pp. 87, 88) regarding the possible rise of the exchanges on other countries, 
 in a country having an inconvertible but not depreciated paper money. In 
 such a case, it is said, if a sudden demand for exchange and, consequently, for 
 gold to export, is coincident, in the paper money country, with a temporarily 
 inadequate supply of gold, exchange may rise above the usual specie shipping 
 point. But though the rate may go up beyond the usual shipping point, it can 
 hardly be said to do so if the paper money is in no sense depreciated. Though 
 the paper money may not have depreciated in relation to goods in general, 
 and may not have depreciated, permanently, in relation to gold, yet, for the time 
 being, it has depreciated compared to gold in the paper standard country. Under 
 such circumstances, however, it may fairly be emphasized that the rise of ex- 
 change is due rather to a local rise in the value of gold than to a fall in that of 
 the paper. 
 
 A special case discussed by Goschen (The Theory of the Foreign Exchanges, 
 pp. 70-72), is that of a country which, having an inconvertible paper money, 
 has also forbidden the export of the precious metals. In such a country, exchange 
 on others cannot be prevented, by shipment of specie, from rising above the 
 gold shipping point, since the law forbids such shipment. Except as the law 
 may be evaded, a rising exchange rate can then only be limited by a retardation 
 of imports and a stimulation of exports (see 9 of this chapter) or, for a time, by 
 borrowing from abroad (see Goschen, Foreign Exchanges, loc. cit.). 
 
144 THE EXCHANGE MECHANISM OF COMMERCE 
 
 the other a gold standard, the effect on prices, produced 
 by the flow of specie consequent on trade between them, 
 could occur only in the gold standard country. When 
 the paper standard country has a balance to pay, gold 
 may be purchased with this paper money and exported 
 (or, which for purposes of our discussion amounts to the 
 same thing, imported by the gold standard country). 
 This will raise prices in the gold standard country to 
 which the gold flows. If the trade, however, is between 
 a paper standard country and several gold standard 
 countries, the effect on the latter will be more diffused 
 and their prices raised but slightly. But the outflow 
 of gold bullion from the paper standard country will 
 tend, if long continued, to make gold in that country 
 scarce and dear in relation to other desired goods. A 
 given amount of gold will buy not only more paper 
 money, but also more of other goods than before. Drafts 
 drawn on the gold standard country, or remitted by its 
 people, in payment for goods purchased in the paper 
 standard country, will represent less gold than previously 
 for the same goods bought. Therefore, more goods 
 will be purchased in the paper standard country by the 
 people of the other, and gold will flow back again to 
 the former country. This tendency is accentuated by the 
 flow of goods. If, at first, goods are imported by the 
 paper standard country, the larger supply of goods in that 
 country, relative to the paper money and to gold, tends 
 to make the prices of these goods lower in either standard. 
 In the exporting country, relative scarcity of goods tends 
 to make prices somewhat higher measured in gold. 
 Hence, for this reason also, more goods are bought with 
 gold in the paper standard country, and gold tends to 
 flow to that country. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 145 
 
 8 
 
 Exchange between Two Countries when Both have In- 
 convertible Paper Standards 
 
 Suppose, next, that there is in each of two trading 
 countries an inconvertible paper standard. Then the 
 rate of exchange in either upon the other, so long as gold 
 is the medium for settling international balances, will 
 depend on the value of both currencies in relation to gold. 
 Suppose the two countries to be the United States and 
 France. Then, in the United States, exchange on France 
 would rise if American money depreciated compared 
 to gold (French money remaining the same) , or if French 
 money appreciated in relation to gold (American money 
 remaining the same), or if, simultaneously, American 
 money depreciated and French money appreciated. The 
 same causes would make exchange in France on the 
 United States fall. The rise in exchange on France 
 and the fall in exchange on the United States would be 
 limited by the depreciation of the American money 
 plus the appreciation of the French money, plus the cost 
 of specie shipment. For if American money depreciated 
 one-half compared to gold, exchange on France (excluding 
 the cost of gold shipment) would double, since it would 
 take twice as many American dollars to buy the same 
 amount of gold for shipment to France, and, therefore, 
 to buy the gold equivalent of a certain number of francs. 
 Likewise, if French money doubled in value in relation 
 to gold, exchange on France would double, since it would 
 take twice as many dollars as before to buy the double 
 amount of gold which was now the equivalent of a given 
 number of the doubled value francs. Above this 
 amount, exchange could rise by the cost of shipping gold. 
 
146 THE EXCHANGE MECHANISM OF COMMERCE 
 
 Under the assumed circumstances, the currencies of 
 the two countries would be unrelated to each other. No 
 amount of buying by the merchants of the United States, 
 in France could, through a flow of money, lower Ameri- 
 can or raise French prices, for American money would 
 not be legal tender in France or (being paper) of any 
 intrinsic value there. Neither could French buying in 
 the United States produce, by the flow of money, the 
 reverse consequence. How, then, would excess buying 
 by one country in the other eventually cause more 
 buying by the second in the first ? It would have this 
 effect through the flow of gold and the consequent influ- 
 ence on the value of gold in the two countries ; and also 
 through the flow of goods and the effect of that flow on 
 prices in the two countries and so on the relative values 
 of gold, in both countries, in relation to goods. 
 
 If the United States should buy more of France in any 
 period than it sold to France, gold would flow to France. 
 Gold would therefore come to have more value in the 
 United States, where it was scarce, and less value in 
 France, than before. A given number of francs would buy 
 more gold, and a given amount of gold would buy more 
 dollars. Par of exchange, in the sense here used, would 
 be lower in France on the United States, and higher in 
 the United States on France. This means that in terms 
 of French money, goods could be purchased in the United 
 States more cheaply than before; while in terms of 
 American money, French goods would be more expensive 
 than before. As a consequence, the French would buy 
 more American goods, and Americans would buy less 
 French goods; the rate of exchange in France on the 
 United States would rise above this low par, and in the 
 United States on France it would fall ; and gold would 
 flow back from France to the United States. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 147 
 
 In addition, if the United States should buy a net 
 balance of goods from France, in any period, this would 
 tend to make goods more plentiful in the United States 
 and less so in France, in relation to gold, so that, for this 
 reason also, it would become more profitable than before 
 to send gold from France to the United States for goods. 
 
 9 
 
 Exchange between Two Countries, Assuming Effective 
 Prohibition of Specie Shipment 
 
 So far we have assumed, even when discussing trade 
 between countries having unrelated currencies, that gold 
 or silver would be used to settle international balances. 
 But suppose that the mediaeval theory of prohibiting 
 the export of specie were still in vogue and were com- 
 monly applied. Would there be, then, any limits to the 
 fluctuations of exchange (assuming obligations still to 
 be settled by using drafts), and would there still be a 
 tendency for the trade in opposite directions, to balance ? 
 Under usual existing conditions, the fluctuations of ex- 
 change with any country are limited, as we have seen, 
 by the cost of shipping specie. Any further rise or fall 
 is checked by specie shipment and by the consequent 
 effect on supply of drafts, or demand for them, or both. 
 But if specie shipment were prohibited, and prohibited 
 at all effectively, the limits to exchange fluctuations could 
 not be so narrow. The rate of exchange, for example, 
 in the United States on England, if the balance of obliga- 
 tions were markedly in England's favor, could then go 
 considerably above $488.65 without at once increasing 
 the supply of or decreasing the demand for drafts on 
 England, to such an extent as to stop the rise. Since 
 
148 THE EXCHANGE MECHANISM OF COMMERCE 
 
 gold could not be exported, Americans owing money in 
 England would have to settle by remitting drafts or by 
 redeeming drafts drawn against them. 1 In the latter 
 case, American banks must purchase drafts on England 
 in order to settle with correspondents, since the alterna- 
 tive of shipping specie is excluded. Drafts on England 
 might, therefore, sell at a rate which American debtors 
 and debtor banks would refuse to pay if they had the 
 forbidden alternative. 
 
 Yet there would still be limits, though wider and 
 perhaps less definite ones, to the fluctuations in the price 
 of drafts. The high price of drafts on England would 
 encourage and stimulate the sale of American goods in 
 England and would discourage buying goods from Eng- 
 land. Goods which would bring, in England, say 100, 
 but which would not ordinarily be sent there for sale, 
 because that sum yielded no profit, might be exported if 
 a draft on England for 100 would sell, here, for $495. 
 And the sale of goods in England, thus stimulated, would 
 tend, by increasing the supply of drafts on England, to 
 prevent further rise in the prices of such drafts. Also, 
 goods which could be purchased in England for $100 
 and which, if $486.65 would buy a draft for 100 and 
 so would pay for the goods, would be bought in England, 
 very probably would not be bought if the draft necessary 
 to pay for them cost $495. 
 
 Conversely, even though exchange on England fell 
 below the gold shipping point, because of a net balance 
 owing from England to us, combined with an English 
 prohibition on the outflow of gold from England, such a 
 fall in exchange would not be without limit. For it 
 
 1 Renewal of credit, use of finance bills, etc., would of course serve as tempo- 
 rary expedients to postpone settlement. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 149 
 
 would encourage buying in England. Goods priced 
 in England at 100 and which otherwise it would not 
 pay to buy there, might be bought if a sight draft on 
 London for 100 could be obtained here for (say) $478. 
 And such purchase of goods, by creating a larger demand 
 for drafts on England, would tend to prevent further fall 
 in the prices of these drafts. 
 
 When balances are habitually settled by the shipment 
 of gold (or other precious metals), as in modern trade, 
 the limits of fluctuation in exchange are narrow because 
 gold, having large value in small bulk, can be shipped 
 for a small per cent of its value. An excess of trade 
 in one direction, therefore, acts largely through a flow 
 of gold as an intermediate cause, in bringing about a 
 balancing flow of trade in the contrary direction. This 
 flow of gold affects prices in both countries, if both have 
 the gold standard. In any case, it affects the relative 
 purchasing power of gold in these countries, and the 
 amount of goods that the currency of the one, by being 
 first exchanged for gold, will buy in the other, compared 
 to what it will buy at home. There follows, as a result 
 of this change in relative prices or in relative values of the 
 two money standards, a change in the flow of trade. 
 This change in the flow of trade is, therefore, in large 
 part, but an indirect consequence, through the flow of 
 gold, of a rising or falling rate of exchange. But if the 
 flow of specie were effectively prohibited, and the fluc- 
 tuations in exchange were, in consequence, greater 
 (assuming drafts to be still used as the chief means of 
 settling obligations between countries), the high and low 
 prices of drafts would act with greater force directly on 
 the flow of trade. 
 
 It should be emphasized that high and low exchange 
 
150 THE EXCHANGE MECHANISM OF COMMERCE 
 
 have always, to some extent, this direct influence. If a 
 draft on England for 100 will sell for $488 in New York, 
 it may be profitable to export goods to England which it 
 would not pay to export if exchange were low. Simi- 
 larly, if drafts on England for 100 can be secured for 
 $484.70, it may be worth while to buy goods there which, 
 if exchange were higher, would not be purchased. A flow 
 of trade in one direction has always, then, some slight 
 tendency to bring about its own termination through 
 affecting the rate of exchange, and thereby the direction 
 of trade. 1 But this more direct influence would be 
 greater, because the fluctuations in exchange would be 
 greater, if specie could not be exported from either of 
 two trading countries. Our conclusion is that whatever 
 the relation of the currencies of two trading countries, 
 and whatever the mechanism of settling balances, or 
 whatever the restrictions on settlement by the use of any 
 special commodity, e.g. gold, an excess flow of trade in 
 one direction introduces always a tendency towards an 
 opposite and balancing flow. 
 
 10 
 
 The Effect on the Rate of Exchange of High Import and 
 Export Duties 
 
 Let us now give very brief consideration to the effects 
 on exchange of high import duties, e.g. the so-called 
 protective tariff. The protective tariff is a high tax on 
 imports, intentionally made so high as to prevent or 
 decrease imports, and encourage buying at home^ 
 For the time being, the country adopting such a policy 
 will export an excess, the rate of exchange on other coun- 
 
 iCf. Ch. V (of Part I), 6. 
 
FURTHER CONSIDERATIONS ON EXCHANGE 151 
 
 tries will be low, and specie will flow in. Then prices 
 rise in the protectionist country in relation to prices 
 elsewhere, exports are checked, and an equilibrium is 
 reached ; and, in the absence of other disturbing causes, 
 exchange will again average par. 
 
 On the other hand, the first effect of a high tariff on 
 exports would be to decrease exports. For a while 
 imports would be in excess. Therefore, the rate of 
 exchange would rise. Eventually specie would flow 
 out, prices would fall, imports and exports would 
 again balance (other disturbing factors absent), and 
 there would no longer be the tendency caused by excess 
 imports for the fall of prices to continue. 
 
 Summary 
 
 In this chapter the attempt has been made to bring 
 together various considerations regarding exchange, 
 which seemed to have no proper place in the chapters 
 preceding. To begin with, a distinction was made 
 between sight drafts and those payable some time after 
 sight. A study of the pure rate of exchange has to do 
 only with the former. The prices of the latter depend 
 also upon the rate of interest. Two possible methods 
 of procedure when an American bank invests, for the 
 interest, in drafts on foreigners, were described. It was 
 shown that the prices of long drafts may be influenced 
 by the rate of interest in the drawing and in the accept- 
 ing country. If the rate of interest in the accepting 
 country is the lower, this rate determines the prices of 
 long drafts ; but if the rate of interest in the drawing 
 country is the lower, purchase of the drafts by investors 
 
152 THE EXCHANGE MECHANISM OF COMMERCE 
 
 or investing banks in that country may make these drafts 
 sell for somewhat more than the higher rate of interest 
 in the accepting country would otherwise allow. 
 
 Consideration was given to the influence on the pure 
 rate of exchange and on the flow of specie, of changes in 
 interest or discount rates in different countries. It was 
 seen that a rise of the bank discount rate in any country 
 tends to create, elsewhere, high rates of exchange on that 
 country and a flow of specie to it. But it was also seen 
 that the chief effect of such a rise in bank discount is to 
 check undue credit expansion or reduce excessive credit. 
 Only as it has this effect, will the inflow of specie be pre- 
 vented from so raising prices as to result in a subsequent 
 corresponding outflow. Since interest rates and prices 
 in different countries are related, it follows that a finan- 
 cial panic in one country must produce some, though per- 
 haps comparatively mild, effects upon other countries. 
 
 The rates of exchange between countries having dif- 
 ferent monetary standards were next considered. If 
 one country has gold and another silver, exchange can 
 fluctuate as the ratio of value of silver to gold fluctuates, 
 and, in addition, by the cost of specie shipment. If one 
 country has gold and the other has inconvertible paper, 
 exchange in the latter on the former can rise (and in the 
 former on the latter, fall) by the amount of depreciation 
 of the paper in terms of gold, plus the cost of gold ship- 
 ment. If both countries have inconvertible paper, ex- 
 change in either on the other can rise by the amount of 
 depreciation in the currency of the first plus the amount 
 of appreciation in that of the second, plus the cost of 
 specie shipment. Whatever the monetary standard or 
 standards of trading countries, exchange could fluctuate 
 beyond the above assigned limits, if the movement of 
 
FURTHER CONSIDERATIONS ON EXCHANGE 153 
 
 specie were to be effectively prohibited. But whatever 
 the standard or standards, it appeared that trade cannot 
 flow continuously in one direction without introducing 
 a tendency to a reverse flow. By acting on relative 
 price levels, or on relative values of currency in relation 
 to gold, or only on rates of exchange, the surplus flow in 
 one direction will eventually bring itself to an end. 
 
 Lastly, brief attention was given to the effects on 
 exchange, of import and export duties. The former make 
 exchange on other countries temporarily lower/ The 
 latter make it temporarily higher. In the former case, 
 equilibrium is reached, after an inflow of specie, with a 
 higher level of prices in the country levying the duties. 
 In the latter case, when, after an outflow of specie, equi- 
 librium is again reached, the level of prices in the duty- 
 levying country is lower. 
 
PART II 
 THE ECONOMIC ADVANTAGES OF COMMERCE 
 
CHAPTER I 
 
 PRICES, INTERCOMMUNITY TRADE, AND THE GAINS OF 
 
 TRADE 
 
 i 
 The Relation of Prices in One Country to Prices in Another 
 
 THROUGH the influence of trade, the price in any 
 country of any special kind of goods tends toward 
 equality with the price of the same goods in other coun- 
 tries with which the first one trades. Cost of carriage, 
 of course, must enter into the selling price of any kind 
 of goods. Due to the natural productivity of land, 
 greater efficiency of labor, better capital equipment, or 
 other cause, some goods will probably be produced with 
 less relative cost in one country than in the others trading 
 with it. These goods will tend to be cheaper in the 
 country having such an advantage, and to be sold by it 
 to the others. The price of such goods in the other 
 countries cannot, for any length of time, be higher than 
 in the exporting country by much more than the expense 
 of transportation or, if trade is restricted, the expense of 
 transportation plus tariff charges ; for if the price is much 
 higher, none of the goods in question will be sold in the 
 country where they are produced, until enough has been 
 sent abroad to more nearly equalizeprices. Neither can 
 the price abroad of goods produced under competitive 
 conditions, be less than the price in the producing country 
 
4 ECONOMIC ADVANTAGES OF COMMERCE 
 
 plus cost of transportation and tariffs, if any of the goods 
 at all are sent abroad. 1 
 
 To illustrate, suppose a certain kind of cloth to be 
 selling at wholesale in England for (the equivalent in 
 English money of) $i per yard. Assuming a transporta- 
 tion and tariff expense of 50 cents a yard, it would sell 
 in Canada, wholesale, for $1.50. Suppose, next, that 
 the Canadian demand raised the Canadian price to 
 $1.75 per yard. If the carrying and tariff costs remained 
 at 50 cents, and the Canadian price $1.75, obviously no 
 one would sell the cloth in England for much less than 
 $1.25. If, on the other hand, the Canadian demand 
 should decrease so that the cloth could not be sold 
 in Canada for more than $1.25, then none of this 
 cloth would be sent from England to Canada unless 
 the English price fell to $0.75. If, because the 
 whole supply had to be sold in England, the price 
 should fall to $0.75 per yard, a surplus might be ex- 
 ported. Otherwise, it would pay better to sell all the 
 cloth in England. 
 
 It will be seen that the general level of prices in one 
 country is not by any means necessarily the same as the 
 price level in the other countries with which it trades. 
 If we imagine two countries side by side, with no tariff 
 barriers between them, and with a zero cost of transpor- 
 tation from any part of one to any section of the other, 
 we may say that the price of each commodity in one 
 country must equal, measured in the same standard of 
 value, its price in the other. Obviously, if all prices 
 
 1 Except as goods may be sold cheaper abroad temporarily In order to de- 
 velop new business, and for other special reasons of very limited application. 
 A tariff protected monopoly will purposely limit its sales at home in order to 
 realize monopoly profits, while selling abroad, where competition must be met, 
 at competitive prices. 
 
INTERCOMMUNITY TRADE 5 
 
 are exactly the same, then the general average, the level 
 of prices, must be exactly the same in one country as 
 in the other. In comparing the price levels of two 
 countries, we may take as a unit that amount of each 
 kind of goods, in one of the countries, which sells for $i 
 (or i or some other standard monetary unit). The 
 average price in that country will be $i. We may then 
 learn the price in the other country, of each such unit 
 amount of goods, and take the average of these prices. 
 This gives us the general level of prices in the second 
 country as compared with that of the first. 1 The most 
 satisfactory average is, of course, a weighted one, i.e. 
 an average in which each kind of goods is given an im- 
 portance consistent with the proportionate value of it 
 sold. By the method of averaging here described, it is 
 obvious that, given costless transfer of all goods and 
 services, the average price or price level in the one coun- 
 try would equal the average in the other ; for all prices 
 would be exactly the same in each, and an average, 
 weighted or unweighted, must be the same. 
 
 As it is, however, the goods which are the special 
 product of each country tend to be lower in that country, 
 and to be higher in other countries, by an amount equal 
 to the cost of transportation and other obstacles in the 
 way of trade. This makes it unlikely that the average 
 of prices in one country will be the same as the average 
 in another country. Thus, wheat may be lower in price 
 in Canada than in England by the cost of transporta- 
 tion. At the same time, cotton cloth may be lower in 
 price in England by the cost of transportation. There 
 
 1 Cf. Fisher's suggestion for comparing the price levels in the same country 
 for two or more years, Elementary Principles of Economics, New York (Macmil- 
 lan), 1912, p. 250. 
 
6 ECONOMIC ADVANTAGES OF COMMERCE 
 
 is no logical reason for assuming that the average of 
 prices (the level of prices) is the same. The lower priced 
 wheat, in Canada, may conceivably have so great an 
 importance as to make the weighted average of prices 
 lower there, despite the higher relative price of cotton 
 cloth. Or cotton cloth, cutlery, shoes, and machinery, 
 all lower in England, may make average prices lower 
 there even though wheat is lower in Canada. Or again, 
 though many articles may be lower in price in England, 
 yet these may be for the most part such things as houses, 
 practically non-transportable, or goods transportable 
 only at such great expense as generally not to be trans- 
 ported. A few things may be lower in Canada by enough 
 to pay for shipment to England. Under these circum- 
 stances, average prices will certainly be lower in England 
 although trade may be in perfect equilibrium. A dollar 
 (or its mint equivalent in English money) will buy more 
 in England, yet Canadian money will not flow to Eng- 
 land for goods transportable at great expense, in any 
 larger quantity than English money will flow to Canada 
 for a few goods only slightly cheaper in Canada but 
 easily transported. Wheat may be enough lower in 
 Canada to pay for export, and cotton cloth enough lower 
 in England. Everything else may be lower in Eng- 
 land, yet not enough lower for shipment to Canada. 
 If this is the situation, the general level of prices in 
 England must be, and must remain, lower than in 
 Canada. 
 
 But though the price levels of England and Canada 
 are not ; on these hypotheses, the same, they are never- 
 theless related. The level of prices in England may be 
 continuously lower, but will be lower only to a certain 
 extent. A rise of Canadian prices (the result of gold 
 
INTERCOMMUNITY TRADE 7 
 
 discoveries, expansion of bank credit, inflow of gold 
 from the United States, or other cause) will increase 
 the importations by Canada from England, despite 
 transportation and other obstacles, and will tend to 
 raise English prices also, thus leaving the relation between 
 Canadian and English prices substantially as before. 
 Similarly a rise in English prices will affect prices in 
 Canada ; and a fall of prices in either country will affect 
 prices in the other. 
 
 2 
 
 What Prices Tend to be Lower in a Given Country, than 
 Prices of the Same Kinds of Goods in Another 
 Country 
 
 It is apparent that prices of all goods are not likely 
 to be lower in one country than in another if transporta- 
 tion and tariff conditions are such as to make any appre- 
 ciable trade profitable. For unless the cost of trans- 
 portation, plus other obstacles, is very great, the low 
 prices in the one country will cause flow of gold in that 
 direction. This will continue until the price of some 
 good or goods becomes lower in the previously high price 
 country than in the other. 1 The condition of equilib- 
 rium will be realized at a point such that some prices 
 are lower in the one country and some lower in the other. 
 This may be called a moving equilibrium, or an equi- 
 librium such that, other things equal, 2 about the same 
 value of trade would flow in each direction. 
 
 1 This principle is expressed with great clearness in Taussig's Principles of 
 Economics, New York (Macmillan), 191 1, Vol. I, pp. 486, 487. 
 
 2 A gold mining country may export a surplus of gold and import a surplus 
 of other things, but exports and imports as a whole, none the less, tend to be 
 equal. A country which has large investments abroad will usually import 
 more than it exports of goods in general. See Part I, Ch. V, 7. 
 
8 ECONOMIC ADVANTAGES OF COMMERCE 
 
 The conclusion that some prices will be lower in one 
 country and some prices in others, is true in principle 
 even if the countries trading have different monetary 
 standards, e.g. if one country has a gold and the other 
 a paper standard. We saw, in the last chapter, that 
 whatever the relation or the non-relation of the monetary 
 standards of two countries, trade might take place be- 
 tween them ; and that the flow of this trade in one direc- 
 tion would tend, in the long run, to equal the flow in 
 the other. 1 Any tendency to an excess flow in one direc- 
 tion would be self-terminating. When the position of 
 equilibrium was established, some prices would be the 
 lower in each country in the sense that the money of 
 either country would, through the process of gold ship- 
 ment or through the mechanism of the exchanges, buy 
 more of some goods in the other country than at home. 
 
 What conditions determine which prices shall be lower 
 in one country than in another or others ? The answer 
 is: those goods are lower in price in any country, for 
 the production of which it has relatively great advan- 
 tages. These advantages may lie in geographical posi- 
 tion, may depend upon soil and climate or the posses- 
 sion of certain mines or other natural resources, or may, 
 in certain lines of activity, depend upon high acquired 
 efficiency of labor. Those goods in the production of 
 which a country has a relative advantage and which, 
 therefore, it sells at a low money price, will, of course, 
 assuming trade to be free, be the things it exports. The 
 people of other countries will avail themselves of the 
 opportunity to buy these goods cheaply. The advan- 
 tages for producing them will mean a large amount of 
 labor and capital specializing in their production in the 
 
 1 See Part I, Ch. VI, 6, 7, 8, 9. 
 
INTERCOMMUNITY TRADE 9 
 
 exporting country. Since the low prices at which these 
 goods are sold result from the relative advantages in 
 that country for their production, therefore these low 
 prices do not signify that the industries are unprofitable. 
 So much can be produced with a given amount of labor 
 that, even at low prices, the yield to industry is high. 
 
 Similarly, the existence of a high level of money wages 
 in any country, does not mean that in such a country 
 some goods cannot be produced, and exported, at low 
 money cost. The United States may have money wages 
 twice as high, per day, as England. Yet if the American 
 agricultural laborer can produce over twice as much 
 wheat per day, because of the extent of good agricultural 
 land, as can be produced in England with the same labor, 
 then the money cost of the American wheat will be no 
 greater and may be appreciably less per bushel. In 
 selling his wheat in the foreign market, the farmer is not 
 primarily concerned with the matter of how much he 
 has to pay his men by the day. He is greatly concerned 
 with the matter of what he must pay them per bushel 
 produced. It is obvious, therefore, that a productive 
 country can have at the same time low prices of goods 
 which it exports, and high wages to the producers of 
 those goods. 
 
 Neither is it essential, in order for a country to export 
 certain goods at a low price, that it should be able to 
 produce those goods more efficiently, i.e. with less labor 
 expenditure, than other countries. All that is neces- 
 sary is that for the production of such goods, its disad- 
 vantages shall be less than for the production of other 
 goods. The converse of this proposition is that all 
 goods will not necessarily be produced at the lowest 
 price, in the country where they can be produced with 
 
io ECONOMIC ADVANTAGES OF COMMERCE 
 
 least labor. Even if the United States can produce 
 woolen cloth with less labor expenditure than England, 
 the advantage of the United States in the production 
 of steam and electric engines and other machinery, may 
 be still greater. If a given amount of labor in the United 
 States will produce io per cent more woolen cloth or 
 zoo per cent more engines and machinery than in 
 England, then the United States gains more by produc- 
 ing the engines and machinery and importing the cloth. 
 The price at which producers in the United States could 
 afford to sell machinery, etc., would therefore be com- 
 paratively low, while it would require a relatively high 
 price of woolen cloth to induce Americans to manufac- 
 ture it. On our assumption, American labor and capital 
 can secure more money, in the English market, for the 
 product of a day's labor in making machinery than for 
 the product of a day's labor in a cloth factory, and still 
 undersell English machine makers. On the other hand, 
 English labor and capital can get more money by selling, 
 in the United States, the product of a day's labor in the 
 cloth factory, than for the product of a day's labor in 
 an English machine making factory, and yet undersell 
 American cloth. If the United States is absolutely 
 more productive in both lines, as well as in most or all 
 others, it might be better, economically, for the people of 
 England to migrate to the United States. But so long 
 as they choose to remain in England, they will be better 
 off if they specialize in the production of cloth. 
 
 It appears, therefore, that under conditions of entire 
 free trade, there would be a high degree of geographical 
 specialization ; and that each industry would be located 
 where the facilities for it were relatively the best, all 
 things, including transportation cost, considered. In 
 
INTERCOMMUNITY TRADE n 
 
 fact, of course, the location of industries is considerably 
 affected by tariffs. The higher, and the greater in 
 number, are these trade restrictions, the more largely 
 is industry turned from its natural channels. If there 
 were a sufficiently high tariff around the borders of Maine, 
 cotton could perhaps be raised in Maine hothouses. 
 Similarly, a high tariff levied by South Carolina on steel 
 rails brought in across its boundaries, might encourage 
 the manufacture of steel rails for use within the state, 
 in the midst of the South Carolina rice fields, with iron 
 brought from the Lake Superior ore regions and coal 
 imported from Pennsylvania. 
 
 3 
 
 Trade between Two Communities when Each has an Ab- 
 solute Advantage over the Other, in One or More Lines 
 of Production 
 
 Let us now illustrate how the case stands as to prices 
 and gains from trade when two communities engage 
 in trade, each having an absolute advantage in one line 
 of activity over the other. We shall suppose the trade 
 to be between two of the states of our own country, 
 South Dakota and Indiana. South Dakota we shall 
 take as an example of a wheat-producing section and 
 Indiana as an example of a corn-producing section. 
 Suppose that one day's labor in South Dakota, of one 
 man, produces 2 bushels of wheat or i bushel of corn, 
 while in Indiana the same amount of labor produces i 
 bushel of wheat or 2 bushels of corn. Assume, also, no 
 cost of transportation and no tariff interferences with 
 trade. If wheat sells in South Dakota for $i per bushel, 
 then a day's labor in the wheat fields will yield $2. No 
 
12 ECONOMIC ADVANTAGES OF COMMERCE 
 
 one, therefore, will be satisfied to produce corn in South 
 Dakota for less than $2 a day. But since only i bushel 
 of corn can be produced, $2 reward will necessitate 
 a price of $2 a bushel. Whatever the price of wheat, 
 corn must sell, if produced in South Dakota, at double 
 that price per bushel; and therefore, if we assume $i 
 per bushel for wheat, corn must sell at $2. No one 
 in South Dakota will produce it for appreciably less. 
 If it can be imported for less, it will be. 
 
 With Indiana the case is reversed. Corn, by our 
 assumption, is produced there the more easily. If the 
 corn can be sold for $i a bushel, it will give producers 
 $2 a day. Naturally they will not care to produce wheat 
 for a less return, and therefore, if Indiana is less adapted 
 to wheat production, they must get a higher price ($2 
 a bushel) in order to encourage its production in Indiana. 
 
 Both states gain by the trade. South Dakota can 
 produce in two days' labor, 2 bushels of wheat at, say, 
 $i per bushel and i bushel of corn at $2 a bushel, a total 
 of 3 bushels or $4 worth. Indiana can produce in two 
 days of labor, i bushel of wheat at $2 and 2 bushels of 
 corn at $i a bushel, making a total of 3 bushels or $4 
 worth. If they trade, each state can specialize. South 
 Dakota can produce in two days of labor, 4 bushels of 
 wheat at $i per bushel, or $4 worth ; while Indiana can 
 produce with two days of labor available, 4 bushels 
 of corn at $i each or $4 worth. Trade between the 
 two states will make it possible (assuming an even ex- 
 change) for each state to get, from its two days of labor, 
 2 bushels of corn and 2 bushels of wheat, instead of 
 2 of one cereal and i of the other. There will be no gain 
 in money values. In either case the total is $4 worth 
 for each state. But there will be a considerable differ- 
 
INTERCOMMUNITY TRADE 13 
 
 ence in what the money will buy. In the case we have 
 assumed, money incomes will be the same with the trade 
 as without it, 1 but the money "cost of living " will be 
 appreciably reduced; $4 will buy a total of 4 bushels 
 instead of only 3. 
 
 It is clear that, under our assumed conditions, Dakota 
 wheat and Indiana corn could and would be sold the 
 more cheaply; that, therefore, the people of Indiana 
 would naturally buy Dakota wheat at a lower price 
 (e.g. $i) rather than Indiana wheat at a higher (e.g. $2), 
 while the people of South Dakota would choose to buy 
 corn from Indiana ; also that this arrangement, so obvi- 
 ously to the individual interests of the persons concerned, 
 would make both states the richest. Is it necessary 
 to point out that what is true as regards two states, terri- 
 tories, or sections under the same general government, 
 is also true of two different nations? If Indiana and 
 South Dakota gain by such a trade when united as parts 
 of one nation by the government at Washington, it is 
 reasonable to suppose that they would gain in just the 
 same way and to the same extent if each were a separate 
 nation. And in an exactly analogous way, the United 
 States gains by trade with Canada. 
 
 4 
 
 Trade between Two Communities or Countries when One 
 is More Productive than the Other in Several or in All 
 Lines, but has a Greater Advantage in One Line or in 
 a Few Lines than in the Rest. 
 
 Let us next illustrate the relations of money prices, 
 and the gains from trade, when one country or community 
 
 1 See, however, Ch. IV (of Part II), 2. 
 
14 ECONOMIC ADVANTAGES OF COMMERCE 
 
 has an advantage over another in several or in all lines, 
 but a greater advantage in one than in the others. As- 
 sume that in Canada one man's labor for a week will 
 produce 20 bushels of wheat or 14 yards of linen cloth, 
 while in Ireland, a week's labor of one man will produce 
 6 bushels of wheat or 10 yards of cloth. Ireland is at 
 a disadvantage in both lines, but her disadvantage is 
 less in linen manufacture, and Canada's advantage is 
 greater in wheat production. Both gain if Ireland pro- 
 duces linen and Canada produces wheat and they trade. 
 Without trade, two weeks of labor in Canada, equally 
 divided, would produce 20 bushels of wheat and 14 yards 
 of linen. In Ireland, two weeks of labor would produce 
 6 bushels of wheat and 10 yards of linen. Similarly, 
 four weeks of labor in Ireland would produce 12 bushels 
 of wheat and 20 yards of linen. Suppose, now, that they 
 trade, and that a bushel of Canadian wheat buys a 
 yard of Irish linen. Then Canada can produce, in two 
 weeks, 40 bushels of wheat, and, by trading half of it 
 for linen, have 20 bushels plus 20 yards, instead of 20 
 plus 14. Ireland can produce in two weeks 20 yards of 
 linen, or in four weeks, 40 yards. By trading half of this 
 linen for wheat, Ireland will have 20 yards plus 20 
 bushels instead of 20 plus 12, as a reward for four weeks' 
 work. On our present hypothesis, Ireland must ex- 
 change the product of two weeks' work with the product 
 of one week of work in Canada, yet gains more by so 
 doing than can be gained by refraining from the exchange 
 of goods. 
 
 That, in the absence of trade restrictions or excessive 
 cost of transportation, such trade will automatically 
 take place, becomes evident so soon as we ask what 
 prices will be charged by the producers in each country. 
 
INTERCOMMUNITY TRADE 15 
 
 If Canadians are able to produce wheat for $i a bushel 
 (and, therefore, $20 a week), they will, of course, be 
 unwilling to produce linen for any smaller weekly re- 
 turn, i.e. for less than $20 for 14 yards, or $1.43 a yard. 
 If linen can be imported from Ireland for less than 
 $1.43, say for $i a yard, Canadian wheat producers 
 will buy it from Ireland, and would-be Canadian 
 linen manufacturers will find more profitable employ- 
 ment in wheat raising. 
 
 On the other hand, Irish producers, if selling linen to 
 Canada at $i a yard, will be earning only $10 a week, 
 though considerably more than they could earn produc- 
 ing 6 bushels of wheat at $i a bushel. To induce an 
 Irish linen worker, under these circumstances, to enter 
 wheat production, would require $10 a week or $1.67 
 per bushel. Hence, Irish linen producers will prefer 
 to buy wheat in Canada ; and, with Canada demanding 
 Irish linen, Irish wheat producers will find a more prof- 
 itable occupation in making linen. As we have seen, 1 
 it is altogether probable that some goods will be lower 
 in price in each country than in the other. All prices 
 could not long be lower in either, since the resulting in- 
 flow of gold would raise them. While there is no special 
 virtue in the particular prices of $i a bushel and $i a 
 yard here assumed for illustration, the conditions of 
 production in each country, as stated in the hypothesis, 
 are such as would make the wheat of Canada and the 
 linen of Ireland the cheaper goods. 
 
 Trade between nations, as well as trade between parts 
 of the same nation, results in a gain to both sides, for it 
 makes possible geographical specialization and therefore 
 a more productive employment of the factors of industry. 
 
 1 2 of this chapter (I of Part II). 
 
16 ECONOMIC ADVANTAGES OF COMMERCE 
 
 In theoretical discussion, international trade is sometimes 
 separated from intranational trade, because of the fact 
 that labor and capital flow, as a rule, with greater diffi- 
 culty, from one nation to another. 1 Distance and ex- 
 pense, a strange government, separation from old friends 
 and old associations, unfamiliar customs, different lan- 
 guage, different religion, any or all of these considera- 
 tions may prevent the free movement of labor from one 
 country to another. Some of them will cause hesitancy 
 in making foreign investments. The argument is that 
 within a nation, labor and capital will move freely to 
 those localities where they receive the largest return. 
 If Connecticut were more productive in every way 2 
 than Massachusetts, then labor and capital from Massa- 
 chusetts would flow freely into Connecticut until condi- 
 tions 3 were equalized, until the greater crowding of 
 Connecticut and the less crowding of Massachusetts 
 in comparison with resources, made labor and capital 
 no more productive in the former than in the latter state. 
 If Massachusetts had superiority in some lines and 
 Connecticut in others, they would trade ; while if Con- 
 necticut were superior in all lines, Massachusetts people 
 would largely migrate. But if labor in the United 
 States is more productive than in England, even in all 
 lines, most of the English people may nevertheless pre- 
 fer to stay at home. They will then simply produce 
 those things in which their disadvantage is least. There 
 is really no difference in principle between international 
 and intranational trade, as such. In any case there is 
 some immobility of labor and capital. In any case 
 a sufficient inducement will at least partly overcome 
 
 1 See Mill, Principles oj Political Economy, Book III, Ch. XVII, i. 
 
 2 At the margin of production. 3 At the margin. 
 
INTERCOMMUNITY TRADE 17 
 
 the immobility, witness the flow of Italian, Greek, 
 and Polish labor into the United States. So the differ- 
 ence is one of degree and not one of kind. Also, such 
 difference as exists may be as marked between widely 
 separated parts of the same nation or empire, e.g. 
 Maine and Montana, or Ireland and Canada, as between 
 different nations, e.g. Germany and Austria. In either 
 case, so long as labor and capital remain where they are, 
 specialization is worth while. 
 
 5 
 
 Summary 
 
 In this chapter we have discussed trade from the 
 standpoint of relations of prices and price levels, loca- 
 tion of industries, and the gains of trade. Through 
 the influence of trade, the price in any country of any 
 kind of goods tends towards equality with the price in 
 other countries. The difference will not much exceed 
 cost of carriage plus tariffs, etc. As a consequence, 
 the price level of one country is related, if they have a 
 common value standard, e.g. gold, to the price level of 
 other countries, but is unlikely to be the same. The 
 prices of some goods are lower in one country and the 
 prices of other goods are lower in other countries, accord- 
 ing to what each country can produce with greatest 
 relative advantage. 
 
 If a country has great advantages for production in 
 any line, it can produce in that line with great profit 
 and can pay high wages, while yet selling abroad at low 
 prices, the goods so produced. It is not necessary in 
 order that a country shall export certain goods at a low 
 price, that it shall be able to produce those goods with 
 PART n c 
 
i8 ECONOMIC ADVANTAGES OF COMMERCE 
 
 less effort than their production would require elsewhere ; 
 but only that its disadvantage shall be less in that line 
 than in others. On the other hand, if one country has 
 an advantage over another in nearly all lines, but a greater 
 advantage in some lines than others, it gains most by 
 specializing in those lines where its advantage is greatest. 
 Under conditions of free trade, there would be, then, a 
 large amount of geographical specialization, each country 
 devoting its energies to those lines where its productive 
 capacity is relatively the greatest. Industry is turned 
 the more from the lines it would otherwise follow in 
 each country, the more widely and intensively restric- 
 tion is followed. The gains from trade, when each of 
 two communities has an absolute advantage over the 
 other, and when each has a relative advantage in 
 some line, were illustrated by hypothetical figures. 
 
 The distinction sometimes made between international 
 and intranational trade was referred to, viz., that in 
 the latter case, greater advantages of one community 
 in all lines would cause movement of population, while 
 in the former, immobility of labor and capital is more 
 in evidence. In the former case (that of international 
 trade), therefore, differences in relative advantages may 
 sometimes be the principal basis of trade. But it was 
 pointed out that this distinction is but a distinction in 
 degree, and that, in any case, political boundaries are 
 often less important factors in immobility of labor and 
 capital than distance and natural barriers. 
 
CHAPTER II 
 
 THE RATE OF INTERCHANGE OF GOODS BETWEEN COM- 
 MUNITIES 
 
 The Limits to the Rate at which the Goods of One Country 
 Exchange for Those of Another 
 
 WE have seen that differences in relative productive- 
 ness bring about trade between communities if there are 
 no natural or artificial barriers or if these barriers are 
 not unduly great ; and that both communities concerned 
 gain by such trade. How much each community gains 
 depends on the rate at which the goods of one community 
 exchange for those of the other. There are certain limits 
 between which this rate fluctuates, and at a rate of 
 exchange of goods beyond these limits, on either side, 
 there would be no trade. 
 
 In showing what these limits are, we will again take 
 trade between Ireland and Canada for illustration. We 
 assumed that a week's labor in Canada would produce 
 20 bushels of wheat or 14 yards of linen. We saw, also, 
 that if Canadians could get $i a bushel for wheat, they 
 would be willing to produce linen for $1.43 a yard, but 
 not for less. Since Canadian wheat producers could 
 buy this cloth at home for $1.43 a yar4, they would not 
 pay more than $1.43 a yard for linen cloth brought 
 from Ireland. At a price greater than $1.43 per yard, 
 they would cease to buy. If wheat is $i a bushel, then 
 
 19 
 
t 
 20 ECONOMIC ADVANTAGES OF COMMERCE 
 
 a price of $1.43 a yard for linen means that 1.43 bushels 
 of wheat must be sold for each yard of linen bought. 
 This, then, is one of the limits beyond which trade will 
 not go. If Canadians have to give up more than 1.43 
 bushels of wheat to get a yard of Irish linen, they will 
 lose by the trade ; if less, they will gain by it, i.e. will 
 get more cloth by exchanging a week's wheat yield for 
 cloth than by devoting a week to cloth production. 
 The same principle applies if the level of prices in Canada 
 is higher or lower. Suppose Canadian wheat could be 
 sold for $2 a bushel. Then the product of a week's 
 labor, 20 bushels, would yield $40. Obviously, therefore, 
 since a week's labor in linen production would yield, 
 in Canada, but 14 yards, a price of $2.85 a yard would 
 be required for its production there. In this case, it 
 would pay Canadians to devote themselves to wheat 
 production and sell their wheat at $2 a bushel, so long 
 as they could buy linen abroad at less than $2.85 a yard. 
 At this price or a greater, they would no longer gain. 
 But we have merely restated our limit in terms of a new 
 price level. At $2.85 a yard, Canadians would be parting 
 with 1.43 bushels of wheat for each yard of linen. What- 
 ever the price level, therefore, so long as 20 bushels 
 requires, in Canada, the same productive effort as 14 
 yards, the limit beyond which Canadians would refuse 
 to trade is 1.43 bushels per yard. At any less price of 
 linen, Canadians would gain, and the lower the price, 
 the greater the gain to Canada. The principle applies, 
 also, if the trading countries have entirely different 
 monetary standards. If Canada had an inconvertible 
 paper money, there would still be some price in this 
 money, for Irish linen, some amount of this money neces- 
 sary to buy the foreign exchange or the gold to pay for 
 
THE RATE OF INTERCHANGE OF GOODS 21 
 
 Irish linen. It would still be true that a yard of linen 
 produced in Canada would cost 1.43 times as much as a 
 bushel of wheat. If the amount of this money neces- 
 sary to buy a yard of linen in Ireland should be more than 
 1.43 times the cost of a bushel of Canadian wheat, the 
 linen would not be imported. 
 
 Beyond one limit, Canada would gain nothing and 
 would, therefore, refuse to trade. Beyond the other 
 limit, Ireland would gain nothing and would refuse to 
 trade. The trade, if carried on, must benefit both, and 
 will therefore lie between these limits. 1 Let us see what 
 is the limit beyond which Ireland would not trade. If a 
 week's labor in Ireland will produce 10 yards of linen 
 or 6 bushels of wheat, and linen sells for $i a yard, then 
 Irish producers would be willing to raise wheat for $1.67 
 a bushel but not for less. Since the Irish linen manu- 
 facturing population can get wheat at home by paying 
 $1.67 a bushel, to pay more for Canadian wheat would 
 involve a loss. If linen is $i a yard, therefore, Ireland 
 will profit by purchasing Canadian wheat, at any price 
 up to $1.67 a bushel. Beyond that price, Ireland will 
 refuse to buy from Canada, preferring to produce the 
 needed wheat at home. Similarly, if linen made in 
 Ireland should sell for $0.50 a yard, Irish linen makers 
 could be induced to produce wheat for about $0.83 a 
 bushel, and that would, therefore, be approximately 
 the limit to what Irish linen makers would pay for 
 Canadian wheat. In other words, whatever the level 
 of prices, the most that Irish linen makers would pay 
 for a bushel of Canadian wheat would be 1.67 yards of 
 
 1 Mill, Principles of Political Economy, Book III, Ch. XVIII, 2. On the 
 general theory of international values the mathematical reader may be referred 
 to Edgeworth, " The Theory of International Values," Economic Journal, Vol. 
 IV, 1894, pp. 35-50, 424-443, 606-638. 
 
22 ECONOMIC ADVANTAGES OF COMMERCE 
 
 linen. At any less price they would gladly buy. At a 
 more unfavorable rate, they would lose, and so would 
 refuse to trade. We have found, then, the two limits 
 to exchange. Between 1.43 bushels for i yard and 1.67 
 yards for i bushel, the rate of interchange must lie if 
 there is to be any trade at all. 1.67 yards for i bushel 
 is the same as i yard for .60 bushels. Therefore, the 
 rate of trade must lie between 1.43 bushels = i yard, 
 and .60 bushel = i yard. At either limit, all the gain 
 from trade would go to one or the other of the two trad- 
 ing communities. Between these limits, the gain would 
 be divided equally or unequally between those commu- 
 nities. 
 
 2 
 
 Conditions of Supply and Demand Determining the Exact 
 Rate of Interchange between these Limits 
 
 The question which has how to be answered is, what 
 determines the exact rate of interchange and, there- 
 fore, the gain to each country between these limits. 
 We shall find the determining factor to be relative in- 
 tensity of demand, or, to use more familiar terms, we 
 shall find the rate to be determined by supply and demand. 
 Returning to our illustration, let us suppose that at a 
 price of $i a bushel for wheat and $i a yard for linen, 
 Ireland wants more bushels of wheat from Canada 
 than Canada desires yards of linen from Ireland. In 
 other words, Ireland's intensity of demand for wheat at 
 these prices of wheat and linen, is greater than Canada's 
 intensity of demand for linen. An excess of money would 
 then flow into Canada and prices in Canada would rise, 
 while in Ireland they would fall. 1 This would continue 
 
 1 Throughout this book it should be borne in mind that the rise and fall may 
 be only relative. There may be a general rise of prices, in which case Canadian 
 
THE RATE OF INTERCHANGE OF GOODS 23 
 
 until a scale of prices was reached at which trade would 
 be in equilibrium, i.e. at which Canada would buy as 
 many dollars' worth of linen as Ireland would buy of 
 wheat. 1 Let us suppose that this stage is reached when 
 the quantity of money in Canada is yj- of its former 
 amount, and in Ireland (having smaller population, 
 wealth, and currency, and being, therefore, affected 
 through an inflow or outflow, by a greater per cent), 
 | of its former amount. 2 Then, by the quantity theory 
 of money, prices in Canada would be some 10 per cent 
 higher than previously. Assuming Canadian prices 
 all to rise in this proportion, 3 Canadian wheat would sell 
 for $1.10 a bushel. 4 Canadians would now be unwill- 
 ing to make linen for less than |f of this, or $1.57 
 a yard. On the other hand, Irish linen would sell for 
 
 prices rise in greater degree than those of Ireland. Or there may be a general 
 fall of prices, in which case Irish prices fall in greater degree than those of Canada. 
 The important facts for our argument are the relation of Canadian to Irish prices 
 and the changes in this relation. The discriminating reader will easily see that 
 none of. our essential conclusions are affected by the qualification here set forth. 
 
 1 See Taussig, Principles of Economics, Vol. I, New York (Macmillan), 1911, 
 pp. 496, 497. We are here assuming only two kinds of goods, linen and wheat, 
 to enter into the trade. 
 
 2 If the difference in intensity of demand is slight at prices of $i per bushel 
 and $i per yard, it is conceivable that equilibrium may be reached by slight 
 changes in the rates of exchange, insufficient to cause a flow of gold. A rate of 
 exchange in Ireland, on Canada, slightly above par, and a rate in Canada, on 
 Ireland, slightly below par, will slightly discourage .Irish buying from Canada 
 (or Canadian selling to Ireland) and slightly encourage Canadian buying from 
 Ireland (or Irish selling to Canada). 
 
 3 Since the goods imported from Ireland would not rise in price, but would 
 fall, and since these goods must be handled, in Canada, by middlemen, other 
 prices must rise by more than ^ to make an average rise of that proportion. 
 But if exchanging in Canada the goods brought from Ireland, forms but a small 
 proportion of Canada's total internal trade (and it is not unreasonable to sup- 
 pose this), then a rise in all other prices of not much more than &, would make 
 an average rise of fully that. 
 
 4 The circumstances which might prevent wheat from changing to the same 
 extent as many other prices, are discussed in later chapters. For the present, 
 these circumstances are assumed to be non-existent. 
 
24 ECONOMIC ADVANTAGES OF COMMERCE 
 
 | of its former price, or about $0.88. Irish workers 
 could now be induced to produce wheat for -g - of this, 
 or 'about $1.46. This is cheaper than before ($1.67), 
 but Ireland would still gain by consuming Canadian 
 wheat, while Canada would gain more than before by 
 purchasing Irish linen. Canada gets more for her wheat 
 than before and pays less for her cloth, because Ireland's 
 demand is the more intense. One bushel of wheat now 
 gets $3^, and $f buys a yard of linen. One bushel 
 of wheat, therefore, now buys 1.26 yards. Ireland gains 
 less than before, but the trade is still inside the limit of 
 profitableness to Ireland. Ireland gives 1.26 yards for 
 one bushel, while the limit of profitableness is 1.67 yards 
 for one bushel. At the new rate of interchange, Canada 
 may be induced to buy more linen and Ireland 
 prevented from buying so much wheat. Where an 
 equilibrium is found, there will be the rate of trade. 1 
 
 Except as to relations of money prices, the conclu- 
 sion is the same if the two countries engaged in trade 
 have different monetary standards. If Canada, for 
 example, had paper money not redeemable in gold, 
 an excess demand from Ireland for Canadian wheat 
 could not, it is true, increase Canadian money or Cana- 
 dian prices ; but it would, as we saw in an earlier chap- 
 ter, 2 change the relative values of Irish and Canadian 
 money, so that buyers in Ireland of Canadian wheat 
 must spend more of their money for each bushel pur- 
 
 1 Mill suggests that there may be several rates satisfying the conditions of 
 equilibrium, Principles of Political Economy, Book III, Ch. XVIII, 6. This 
 might conceivably be the case if the trade were between two nations, each free 
 of competition from others, and if few articles entered into the trade. In the 
 complications of actual commercial relations, it is practically impossible that it 
 should be so. 
 
 2 See Part I, Ch. VI, 7, 8. 
 
THE RATE OF INTERCHANGE OF GOODS 25 
 
 chased, and so that Canadians could buy each yard of 
 linen at a cost, in Canadian money, less than before. 
 At some rate of interchange of wheat and linen, the trade 
 would balance. 
 
 The rate would be de terminable, also, if no money 
 were used and trade were all in the form of direct barter. 
 The .country having the more intense demand would, 
 as under existing forms of trade, offer a better rate. 1 
 We may, if we so desire, say that at present a trade 
 between communities is resolvable into two trades, one 
 of goods for money, and a second of money for other 
 goods. If we so look at the situation, we may further 
 say that each of the two trades, separately, illustrates 
 the effect of relative intensity of demand. The country 
 which is the more anxious to get the goods of the other 
 will show a relatively great intensity of demand for 
 money or gold, giving a comparatively large amount 
 of its own products for a given sum of money; and it 
 will then show its intensity of demand for the desired 
 products of the other country by giving large amounts 
 of money or gold for these. 
 
 In more familiar phraseology, we may say that the 
 rate at which linen exchanges for wheat is fixed by supply 
 and demand, and will be such a rate that the supply of 
 wheat offered to Ireland by Canada is equal to Ireland's 
 demand for wheat; otherwise stated, that the supply 
 of linen offered to Canada by Ireland shall be equal to 
 the amount demanded. 
 
 1 The general principle, in fact, even when actual modern trade has been in 
 view, has been frequently explained by economists without special reference 
 to the flow of money. See, for example, Mill, Principles of Political Economy, 
 Book III, Ch. XVIII, 2 ; see also Bastable, The Theory of International Trade, 
 fourth edition, London (Macmillan), 1903, p. 27. The flow of money has then, 
 as in Mill, Ch. XTX of Book HI, and Bastable, Ch. Ill, been brought under the 
 general law. 
 
26 ECONOMIC ADVANTAGES OF COMMERCE 
 
 3 
 
 Effect on this Rate, when One of the Countries Offers a 
 Variety of Goods in Trade, and also when it Receives 
 Periodic Payments of Obligations from the Other 
 
 We must now modify our hypotheses, to make them 
 conform more nearly to actual conditions. In trade 
 between two countries, there are almost certain to be 
 more than two commodities or services involved. Ire- 
 land, to recur to our illustration, will probably buy other 
 things than wheat of Canada, possibly furs, timber, 
 iron ore, etc. ; while Canada is likely to buy other 
 things than linen of Ireland. Then, even if, at $i per 
 bushel and $i per yard, respectively, Ireland wants more 
 wheat than Canada does linen, money does not neces- 
 sarily flow to Canada, changing relative prices and the 
 gains of trade. For Canada's desire to purchase other 
 Irish goods may be intense enough to keep the relative 
 distribution of money and the relative benefits of trade 
 as they were. 
 
 In general, we may say that the more varieties of 
 goods a country can offer for export, the better is its 
 position in trade. 1 England's position, for example, 
 is better if it produces several kinds of goods for foreign 
 sale than if it produces but one. The demand of France 
 or Italy or other countries for these several kinds of 
 goods will be greater than for any one thing alone. As 
 a consequence, there will be a greater tendency for gold 
 to flow into England, making English prices higher and 
 French, or other prices, lower, so giving England a 
 larger gain from the trade. The more largely English 
 merchants and manufacturers can introduce English 
 
 i Mill, Principles of Political Economy, Book III, Ch. XVIII, 6. 
 
THE RATE OF INTERCHANGE OF GOODS 27 
 
 goods into favor in the Orient, in Africa, in South America, 
 or elsewhere, the greater is the gain, not to these mer- 
 chants and manufacturers alone, but to the English 
 nation. Among the goods that England is in a position 
 to offer, must, of course, be included banking service, 
 freight service, etc., as well as commodities. The fact 
 that other countries desire to make use of her ships is 
 as much a help toward making trade more profitable 
 to England as the fact that other nations desire to buy 
 her manufactures. 
 
 In a similar way, England is helped by the fact that 
 her people have large investments abroad, on which 
 they receive interest, dividends, etc. 1 According to 
 the principles set forth in Part I, Chapter V, 2 this means 
 flow of gold to England, higher prices there, lower prices 
 where the money comes from, and, consequently, a 
 flow of money back again from England. In the long 
 run, England receives interest in the form of goods 
 rather than of money. The money tends to flow back 
 until the normal equilibrium is restored. But if Eng- 
 land has relatively permanent investments, say in 
 the United States, and is therefore receiving interest 
 and dividend payments from the United States for 
 many years in succession, the normal equilibrium of 
 prices probably will not, during all that time, be 
 reached. As fast as this equilibrium is approached, 
 further interest and dividend payments upset it. 
 For a great many years, therefore, English prices 
 are likely to be somewhat higher, and American 
 prices somewhat lower, than would be the case if 
 Americans owed nothing. During this period, then, 
 England will get somewhat more for English goods 
 
 1 Taussig, Principles of Political Economy, Vol. I, p. 499- * 8 - 
 
28 ECONOMIC ADVANTAGES OF COMMERCE 
 
 and pay somewhat less for American goods, than 
 otherwise. The rate of interchange is slightly more 
 favorable to England than it would otherwise be. 
 Even assuming all trade to be carried on in the 
 form of barter, this conclusion would still hold true. 
 For if England were getting continuous interest in 
 American goods, English desire for such goods would 
 be partly satisfied, their utility to the people of Eng- 
 land would be less (law of diminishing utility), and 
 they would have to be offered at a less value in terms 
 of English goods. 1 
 
 On the other hand, England's advantage in the rate 
 of trade, due to payments of interest, etc., which have 
 to be made to Englishmen, must be regarded as an offset 
 to a corresponding disadvantage in the rate of trade, 
 during the period when the investments (on which in- 
 terest, dividends, etc., are being received) were made. 
 During the period when England's (or any country's) 
 annual investment abroad exceeded her annual profits 
 from abroad, the tendency was for gold to flow from 
 England to other places. This tended to make prices 
 elsewhere higher, and English prices lower, to give other 
 countries, for the time being, a more favorable rate of 
 interchange of goods with England. A country whose 
 people are making large investments abroad, then, will 
 have to dispose of its goods, for the time being, at a less 
 favorable rate; but it will later, during realization of 
 
 1 The law of diminishing utility is the fundamental explanation of England's 
 gain in our illustration, even if money is used. Were it not for the law of dimin- 
 ishing utility, no change, or no appreciable change, in relative price levels would 
 be required to bring about the flow back, for goods, of the money paid in divi- 
 dends, etc. The flow back would begin to take place before the flow of money 
 into England had appreciably changed the price level there or here, and would 
 take place, therefore, without making the rate of interchange of goods appre- 
 ciably more favorable to England. 
 
THE RATE OF INTERCHANGE OF GOODS 29 
 
 profits and repayment, be able to dispose of its goods at 
 a more favorable rate. 1 
 
 4 
 
 Influence on Trade and the Rate of Trade of Production 
 in any Country under Conditions of Different Cost 
 
 Up to this point, we have assumed the commodities 
 entering into trade to be produced at constant cost per 
 unit, regardless of the amounts produced. But such is 
 by no means always the case. Let us revert to the in- 
 stance of Ireland trading with Canada. One week's 
 labor in Ireland was supposed to produce 6 bushels of 
 wheat. As a matter of fact, all land is not alike in fer- 
 tility or in convenient access to market. While, there- 
 fore, it might be true that, if Ireland produced all her 
 own wheat, one week's labor at the margin of cultiva- 
 tion (that is, on those lands least favorable to wheat 
 production of all the lands so used, but which must be 
 devoted to wheat production, to secure an adequate 
 supply) might produce but 6 bushels; a week's labor 
 in other parts of Ireland would perhaps produce a great 
 deal more. If Ireland produced all her own wheat, the 
 people of Ireland would have to produce it, perhaps, on 
 unfertile lands and where the conditions of production 
 were relatively unfavorable. It might, therefore, be 
 uneconomical for Ireland to produce her own entire 
 
 1 Since investment is really, in large part, a purchase of capital goods, e.g. 
 railways, farms, factories, etc., it may be asked why the general discussion re- 
 garding the trade of the goods of one country for th$ goods of another does not 
 cover investment also. But investment is rather the purchase of rights in goods 
 which are not themselves moved. The capital purchased remains in the foreign 
 country and yields future income to the distant investors. This yielding of 
 future income, involves a later and opposite influence on the rate of trade be- 
 tween the countries, which does not occur when the owners and the capital owned 
 are in the same place. Hence, special consideration must be devoted to the 
 effects of lending and investing, on trade. 
 
30 ECONOMIC ADVANTAGES OF COMMERCE 
 
 supply of wheat. Some wheat should rather be imported 
 from Canada. But it might well be profitable for the 
 people of Ireland to employ some of their more fertile 
 land, if not better situated and adapted for other crops, 
 in wheat production. 1 The possession of this more 
 fertile land would lessen the intensity of Ireland's demand 
 for Canadian wheat, and would thus tend to make the 
 rate of trade between the countries more favorable 
 to Ireland than if her entire supply of wheat had to be 
 secured from abroad. If linen sells for $i a yard and 
 Canadian wheat is $i a bushel, then it is of course more 
 profitable for Ireland to buy Canadian wheat than to 
 produce wheat on poor Irish land, under intensive culti- 
 vation (i.e. with but small areas of land for each unit of 
 labor), where a week's labor can only produce 6 bushels, 
 and where it can only be remunerated by a price of $1.67 
 a bushel. But it would be profitable for Ireland to pro- 
 duce wheat for home consumption on land where a 
 week's labor would yield 14 or 13 or down to 10 bushels, 
 unless this land, or part of it, was so situated and adapted 
 as to yield still more from some other use, e.g. from being 
 used to raise potatoes. A yield of 10 bushels a week 
 would require only $i a bushel (linen being $i a yard), 
 to induce wheat production in Ireland, and so to raise 
 the wheat, would, by our hypothesis, be as economical 
 as to import it from Canada. On land yielding 7, 8, 9, 
 or less than 10 bushels a week, wheat production in Ire- 
 land is uneconomical as long as a yard of linen cloth will 
 buy from Canada a bushel of wheat. So it results that, 
 because of the law of diminishing returns, it is often most 
 profitable for a country to produce, in part, its desired 
 supply of some commodity, and import the rest. If the 
 
 1 Bastable, Theory of International Trade, pp. 29 and 30. 
 
THE RATE OF INTERCHANGE OF GOODS 31 
 
 demand for wheat in Ireland became greater, poorer 
 Irish sources of production would perhaps be resorted 
 to for a small part of the supply, while somewhat more 
 would be imported from Canada and elsewhere at the 
 higher price, relative to linen cloth, resulting from this 
 greater demand. 
 
 By similar reasoning it may be shown that beyond a 
 certain point of high cost, wheat production in Canada 
 for export would not be carried, but that the people of 
 Canada would prefer to devote themselves, in part, to 
 other work, even to the manufacture of linen. Cana- 
 dians would not carry wheat production to land so poor 
 (assuming a great increase in population) as to yield 
 less than 14 bushels a week, so long as 14 yards of linen 
 could be produced in a week's labor; for, beyond that 
 point, it would pay better to produce linen at $i a yard 
 than wheat at $i a bushel. Growing density of popu- 
 lation tends, in general, to the spread of manufacturing, 
 because employment in agriculture, after a certain degree 
 of intensiveness of cultivation has been reached, becomes 
 less profitable at the margin the more persons are 
 engaged in it. 
 
 It has been the good fortune of the American people 
 that they have lived in a country not overpopulated 
 and one of very considerable natural resources. They 
 have had always, therefore, the opportunity to engage 
 in the extractive industries, particularly in agriculture, 
 and realize large returns in so doing. They have not 
 had to take up manufacturing, however small the profits, 
 merely for the lack of a profitable alternative, though 
 they have found it worth while to engage in various 
 lines of manufacturing industry which American re- 
 sources or American methods make especially productive 
 
32 ECONOMIC ADVANTAGES OF COMMERCE 
 
 in the United States. If other countries, such as Eng- 
 land and Germany, are forced by dense populations 
 and limited resources to engage in manufacturing to a 
 greater relative degree, Americans have, on that account, 
 no reason for envy, nor any reason for attempting, 
 through tariffs or other arbitrary interferences, to force 
 American industry more largely into parallel channels. 
 
 s 
 
 Extension of Hypothesis so as to Include Trade Involving 
 More than Two Countries 
 
 As we broadened our first hypothetical conditions 
 so as to include more than two kinds of goods, we shall 
 now further broaden them so as to consider more than 
 two trading communities. We have assumed Ireland 
 and Canada to be engaged in trade with each other. 
 But trade may be three-cornered or four-cornered or 
 more. Ireland may sell its linen chiefly to the United 
 States instead of to Canada ; the United States may sell 
 cotton to Canada ; and Canada may in turn export wheat 
 to Ireland. Under these circumstances, the rates of 
 interchange would still depend on relative intensities 
 of demand. The rate at which Ireland can exchange 
 linen for wheat, depends on the price which can be re- 
 alized, in the United States, for linen, and the price which 
 must be paid, in Canada, for wheat, or upon the intensity 
 of American demand for the linen compared to the in- 
 tensity of Irish demand for the wheat. The American 
 demand for the linen, at any price, will depend, in part, 
 on what Americans can get for cotton. The Canadian 
 demand for cotton will depend, in part, on what Cana- 
 dians can get for wheat. If Ireland has a surplus de- 
 
THE RATE OF INTERCHANGE OF GOODS 33 
 
 mand for wheat at $i a bushel, gold will flow to Canada 
 and Canadian prices will rise. Canadians may then 
 buy more cotton, in which case American prices will 
 rise. Irish prices will fall, and Americans will probably 
 buy more linen. When equilibrium is reached, Ireland 
 will be paying somewhat more for wheat and getting 
 somewhat less for linen. The United States will prob- 
 ably be getting somewhat more for cotton and will be 
 paying somewhat less for linen. Canada or the United 
 States or both will gain more from the trade, and Ire- 
 land will gain less. As in trade between two countries, 
 equilibrium will be reached at a set of relative prices 
 or values which equalizes supply and demand. 
 
 How are the commercial interests of three nations 
 affected by the entrance of the third into trade with 
 the other two? The general effect will be an increase 
 of prosperity, and it is entirely possible that each of the 
 three countries will gain something. Suppose, to take 
 a seemingly most unfavorable case, that France enters a 
 trade previously confined to Ireland and Canada, as a 
 competitor of Ireland, competing with the last-named 
 country in the sale of linen to Canada and in the purchase 
 of wheat from Canada. In so far as France engages 
 in this trade and no other, Ireland is deprived of a part 
 of her former gain ; but there is no net loss, for France 
 and Canada together gain as much as Ireland loses, or 
 more. In consequence of the competition of France, 
 linen will fall in price, or wheat will rise, or both, so that 
 a yard of linen buys less wheat than before. So far as 
 Ireland still engages in the trade, at the new and, to her, 
 more unfavorable rate of interchange, Canada gains, 
 besides her former profit, precisely what Ireland has 
 ceased to gain. So far as Ireland is driven out of the 
 
 PART II D 
 
34 ECONOMIC ADVANTAGES OF COMMERCE 
 
 trade by the entrance of France, France gains at least 
 as much trade as Ireland loses, though at a rate of in- 
 terchange somewhat more profitable to Canada and 
 somewhat less so to France, than would be necessary 
 were Ireland's competition absent. So far as France loses 
 through the less favorable rate of interchange caused 
 by Ireland's competition, Canada gains. If the result 
 of the competition is a larger trade for Canada with the 
 other two countries than Canada previously had with 
 the one, as well as a more favorable rate, then Canada 
 gains more than either of the others loses or than both 
 lose; for Canada's greater gain on the same trade as 
 before, at the better rate, makes up for the lessened gain 
 of the other or others ; while the additional trade, which 
 must be at least worth having to the other country or 
 countries, else it or they would not trade, is a very consid- 
 erable gain to Canada. The competing countries, there- 
 fore, though they may hurt each other, will benefit by 
 at least as much, and probably by more, the country or 
 countries for whose trade they compete. 
 
 If, now, besides competing against Ireland in the trade 
 with Canada, France also enters into trade with Ireland, 
 both Ireland and France may gain from this trade as 
 much as, or more than, they are losing by their competi- 
 tion. Then the entering of France into trade relations 
 with the other two countries will benefit Canada, Ire- 
 land, and France. It seems a perfectly fair statement, 
 therefore, that the more widely trade is voluntarily, 
 and without governmental encouragement, extended, i.e. 
 the more countries enter into it, the greater is the total 
 gain; and that there is reasonable hope for a greater 
 net gain to all countries concerned. In no case can 
 the entrance of an additional country or community 
 
THE RATE OF INTERCHANGE OF GOODS 35 
 
 cause a country or community already engaged in a trade, 
 to engage thereafter in a losing trade. It has already 
 been explained that unless a trade yields a gain to both 
 (as, of course, to all, if more than two) countries con- 
 cerned, the trade will not take place. The most that 
 the new competition can do is to decrease this gain for 
 the country or countries on one side of the trade. And, 
 as above pointed out, the countries which lower each 
 other's gains by competition for the trade of a third 
 country, may increase each other's gains by trade with 
 each other. 
 
 Any country gains more, the more numerous the other 
 countries which desire its products and the more nu- 
 merous the other countries which have goods to offer it. 
 On the other hand, the competitive entering of many 
 countries into trade makes it impossible for any one 
 country to gain so extreme a share of the advantage in 
 trade with another as otherwise it might. The one 
 country will seldom have a monopoly of the production 
 of goods needed in the other and will seldom be the only 
 place where the other can sell its products. Alternative 
 markets will generally be available, and the gains of 
 trade are therefore likely to be more nearly equal between 
 two trading countries. It is for these reasons that the 
 policy of European nations, in early colonial days, of 
 restricting the trade of colonies with other than their 
 respective mother countries, might be advantageous 
 to the mother countries, but was at the same time dis- 
 advantageous to the colonies. 
 
36 ECONOMIC ADVANTAGES OF COMMERCE 
 
 6 
 
 Cost of Transportation as Related to Trade 
 
 Cost of transportation is a factor influencing trade, 
 which must be considered before our discussion is com- 
 plete. This cost subtracts from the gains of trade the 
 amount necessary to remunerate those engaged in carry- 
 ing the goods. The principles determining how much 
 gain is realized by each country are, of course, unaffected. 
 Trade which cannot yield enough to pay for transporta- 
 tion simply does not take place, unless it is artificially 
 stimulated, as by government bounties. 
 
 7 
 
 Summary 
 
 In this chapter we have confined our attention almost 
 entirely to the rate of interchange of goods between 
 trading communities and countries. We have seen that, 
 in the case of trade between any two countries, the rate 
 at which the goods of the one exchange for the goods of 
 the other cannot lie beyond either of two limits, at the 
 one of which the one country, and at the other of which 
 the other country, gains nothing from the trade. Be- 
 tween these limits, the exact rate is fixed by the com- 
 parative intensity of demand of each country for the 
 goods of the other, or, to use familiar terms, by supply 
 and demand. Whether gold is a common standard of 
 value, or the currencies unrelated, or the trade direct 
 barter of goods for goods, the rate of interchange will 
 be fixed where intensities of demand balance. 
 
 A country is the more likely to get a large share of 
 the total gain resulting from its trade with another 
 
THE RATE OF INTERCHANGE OF GOODS 37 
 
 country or countries, the greater the variety of goods 
 it can offer to stimulate the desire of the other country 
 or countries to trade. In like manner, a country to 
 which payments have to be made by other countries, 
 e.g. of interest and dividends, is in a position to get, in 
 consequence, more favorable rates of interchange, though 
 such a country may have had, previously, during the 
 period of its investing operations, somewhat less favor- 
 able rates. 
 
 The assumption first made that each country would 
 buy of the other the goods securable most cheaply from 
 the other, was explained and qualified to conform with 
 the fact of differing cost of production of any good, within 
 the same country. It was pointed out that a country 
 might produce for itself a certain amount of a desired 
 kind of goods, from its most favorable sources of supply, 
 or up to the point where further home production would 
 involve uneconomical employment of its labor and capi- 
 tal ; and that beyond that point it would import. 
 
 Our assumptions were further broadened to include 
 trade involving more than two countries. Three-cor- 
 nered trade was alluded to, and it was shown that the 
 influence of comparative intensity of demand is of deter- 
 mining force in this case and likewise in cases involving 
 still more countries. If a third country (or a fourth 
 or fifth) enters into a trade previously confined to two 
 countries (or three or four), the result will be a greater 
 total prosperity, although if the third country enters 
 the trade only as a competitor of one of the others, that 
 one may find its gains somewhat reduced. If each trades 
 with each of the others, there is a reasonable prospect 
 for increased prosperity to all three. Any country, 
 however, is prevented by the entrance of other countries 
 
38 ECONOMIC ADVANTAGES OF COMMERCE 
 
 into competition with it from realizing exorbitant 
 profits at the expense of the countries it trades with. 
 On the other hand, any country gains the more from 
 trade, the larger the number of other countries which 
 compete with each other in buying from and selling to it. 
 
CHAPTER III 
 THE INCIDENCE OF TARIFFS FOR REVENUE 
 
 i 
 
 Revenue and Protective Tariffs Distinguished 
 
 So far we have discussed international trade mainly 
 on the assumption that such trade is wholly free. As a 
 matter of fact, trade is almost never wholly free between 
 nations, though it is frequently so within the boundaries 
 of a single nation. One of the largest, if not the largest, 
 of free trade areas in the world, is the United States. 
 Between one state and another, any tariff is unconsti- 
 tutional. We have, therefore, free trade within our 
 own borders, though not with outside nations. Almost, 
 if not quite, every nation has a tariff wall, high or low 
 as the case may be, which, usually, to a greater or less 
 extent, hampers trade. Tariff duties at the boundaries 
 of a country may be levied on goods imported or on goods 
 exported, but in practice are much more likely to be 
 levied on the former. We shall consider the economic 
 effects of both import and export duties. 
 
 Import duties are of two sorts, revenue tariffs and 
 protective tariffs. A strict revenue tariff is intended 
 to raise revenue, while not interfering with trade more 
 than is necessary. Although absolute free trade practi- 
 cally never exists between great nations, yet, in ordinary 
 usance, free trade is said to exist when the tariff levied 
 is levied according to strict revenue principles. A 
 strictly revenue tariff, or so-called "free trade," means, 
 
 39 
 
40 ECONOMIC ADVANTAGES OF COMMERCE 
 
 then, such an adjustment of taxes as will not, in any 
 great degree, divert industry in the levying country out 
 of the channels it would otherwise follow, i.e. it will 
 so divert industry to the least possible extent consistent 
 with collection of the needed revenue. A tariff levied 
 by any country only on goods not produced within it, 
 is such a tariff. An example is the British import tax 
 on tea, an article not produced in Great Britain or Ire- 
 land. An import duty on goods which are, or can be, 
 produced within the levying country, is also, properly 
 speaking, a revenue duty, if it is accompanied by an 
 internal tax of equal amount l on the domestic product. 
 Such a tax does not have, and is not intended to have, 
 any great effect on the location of industry. If the 
 domestic producer is helped by the tax levied on imported 
 goods, he is hindered to an approximately equal extent 
 by the tax laid upon his own goods. 2 His position in 
 relation to that of his foreign rivals remains, therefore, 
 substantially the same as before. 
 
 A protective tax is intended, as such, primarily to 
 divert industry from the channels it would otherwise 
 follow into channels favored and encouraged by the 
 tariff law. Its purpose is to encourage the home pro- 
 ducer in some line or lines by levying a high tax on 
 goods brought from abroad and thus discouraging the 
 importation of such goods. 
 
 1 If the domestic goods are of identical grade and therefore of the same value, 
 a tax of the same per cent is also a tax of the same amount per unit of quantity. 
 If the domestic goods are of different grade and different value, the question 
 might arise whether a per cent tax or a tax per unit should be levied equally on 
 both. 
 
 2 Of course the tax, by necessitating a higher price, may decrease the total 
 demand. If so, both home and foreign producers may make smaller sales. But 
 so far as the public still buys the goods, these goods are produced where the condi- 
 tions are relatively the best. 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 41 
 
 Expressing the matter in another way, we may say 
 that both the revenue and the protective tariff are taxes 
 on the consumer ; but that in the former case the con- 
 sumer pays this tax to the government, while in the 
 latter he pays a tax to the home producer. A revenue 
 tariff on imports can only be successful in its chief aim 
 if it allows goods to be imported, because on all such 
 goods a tax is paid which goes to the government and 
 may be used for public purposes; while, on the other 
 hand, a protective tariff is most successful in its aim 
 in so far as it prevents goods from being imported, be- 
 cause then its effect is to raise the price which the home 
 producers can charge. In this latter case, the govern- 
 ment gets little or no revenue, and the tax, if we call 
 it such, which the consumer pays, is paid, in the main, 
 to the home producers, rather than to the government. 
 In other words, the protective tariff makes the consumer 
 buy of the home producer at prices higher than the home 
 producer could otherwise charge. 
 
 When the Burden of an Import Duty Levied for Revenue 
 is Borne by the Levying Country 
 
 A revenue import duty is commonly supposed to be 
 shifted by the importers on whom it is first imposed, to 
 the consumers, in the levying country, of the taxed goods. 
 In the complications of modern trade, with many coun- 
 tries taking part, this result is perhaps very nearly 
 realized. But it is perhaps never exactly realized, and 
 it is not difficult to imagine circumstances under which 
 the main burden of the tax would fall elsewhere than 
 on the consuming public of the tariff levying country. 
 
42 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Under sufficiently favorable (to the levying country) 
 circumstances, a part, or all, of the tax might fall upon 
 the exporting country, or, conceivably, the exporting 
 country might lose more than the tax, to the profit of 
 the levying country. 
 
 Let us, in discussing the various possible shif tings of 
 an import revenue duty, use again our familiar illus- 
 tration, the assumed trade between Ireland and Canada. 
 If Canada, where a week's labor will produce, according 
 to our first assumptions, 20 bushels of wheat at $i a 
 bushel or 14 yards of linen at $1.43 a yard, levies an 
 import duty of 10 cents a yard on linen from Ireland, 
 which would otherwise sell for $i a yard, this linen will 
 sell for $1.10. Irish linen will still be bought by Cana- 
 dians in preference, 1 since Canadian linen cannot be 
 sold for less than $1.43. The tax is levied first on the 
 importers. The importers will not, perhaps cannot, 
 remain in business if they are unable to shift the tax, 
 for to pay it themselves will make their profits (if these 
 have been subject to competition and are therefore 
 approximately the same as in other kinds of business) 
 less than the same labor and capital will yield in other 
 lines, and will very likely even turn them into losses. 
 The foreign producers will not (unless combined in a 
 monopoly and previously earning monopoly profits, 
 and not then except under very improbable circum- 
 stances 2 ) consent to suffer the loss, since this will reduce 
 
 1 If there is any likelihood that such will not be the case, and if the tariff is 
 to be levied for revenue, not for protection, a tax as great should be placed on 
 the home produced goods. 
 
 2 I.e. if the monopoly will lose less to bear the whole tax than to shift it and suf- 
 fer a reduction of its sales. A monopoly will itself pay, without trying to shift, 
 a tax levied directly on monopoly profits, since the monopoly can best pay such a 
 tax by maintaining the same prices, i.e. prices yielding the highest net return. 
 But a tax which increases in proportion to the number of sales, a monopoly will 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 43 
 
 their profits below the average level in their country, , 
 in other lines. The supply of Irish linen offered in 
 Canada will not, therefore, equal the demand, unless 
 the price rises by 10 cents a yard. 
 
 If the demand of Canada for linen is absolutely in- 
 elastic, the shifting proceeds no further; the 10 cents 
 a yard remains as a continuing burden on Canadian 
 consumers of linen. A certain amount of linen was 
 wanted at the former and lower price, and the same 
 amount is wanted at the somewhat higher price. The 
 10 cents additional goes to the Canadian government. 
 The same amount as before must be paid to linen manu- 
 facturers in Ireland. Canadian wheat prices will not 
 change, and wheat consumers in Ireland will buy the 
 same amount as before of Canadian wheat. The trade 
 will be in equilibrium at just the same point, as to quan- 
 tity of money in each country and as to amount of cloth 
 required to buy a bushel of wheat, as before. The net 
 result is to take 10 cents a yard from each Canadian 
 purchaser of linen imported from Ireland, and transfer 
 this 10 cents to his government. If we omit reference 
 to money and money prices, we may say that the tax 
 has left just where it was before, the rate of interchange 
 between the two commodities, linen and wheat, which 
 equalized supply of and demand for each in terms of 
 the other ; and that the Canadian government has sim- 
 ply taken in taxation, from its own subjects, a part of 
 their gain from the trade. 
 
 be more likely to endeavor to shift, and will not so greatly fear a resulting de- 
 crease of its sales, since this involves a decreased tax also. 
 
44 ECONOMIC ADVANTAGES OF COMMERCE 
 
 When the Burden of an Import Duty Levied for Revenue 
 is Shifted by the Levying Country to Another or to 
 Other Countries 
 
 But the situation is otherwise if Canada's demand 
 for Irish linen is elastic while, at the same time, Ireland's 
 demand for Canadian wheat is inelastic. If the demand 
 of Canada for linen imported from Ireland is elastic, 
 then the effect of the ten cents tax, in raising the price 
 of the linen to $1.10 a yard, will be to decrease the Cana- 
 dian demand for the linen. In consequence, Canada 
 will have a smaller money obligation to Ireland. Yet if 
 Ireland continues to buy as much wheat as before, the 
 yearly money obligations from Ireland to Canada will 
 be the same as if the tax were not in force. There will 
 consequently be an excess flow of money to Canada. 
 Canadian prices will rise and Irish prices will fall. Of 
 course, if the Irish demand for wheat is elastic, or if 
 Ireland can as cheaply buy her wheat elsewhere, Ire- 
 land's demand for wheat will fall off as soon as the price 
 rises very slightly. Then there can be little redistribu- 
 tion of the money metal, and Canada can shift very 
 little of the tax upon Ireland. The net result is less 
 trade. Canadians buy less cloth and sell less wheat. 
 But if the Irish demand for Canadian wheat is inelastic, 
 continuing at about the same amount despite rise of 
 prices, then the tax may seriously decrease Ireland's 
 gain from the trade, to Canada's advantage. 
 
 To illustrate this possibility, let us suppose that, in 
 consequence of the tax on linen of ten cents a yard, 
 which raises 4he price to Canadian consumers, the de- 
 mand for linen is so decreased in Canada that there is 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 45 
 
 a net inflow of gold from Ireland ; and let us suppose, 
 further, that the inflow of gold does not cease until the 
 supply of money in Canada is jf of its former amount, 
 and that of Ireland $ of what it was. Then Cana- 
 dian wheat would sell for ^f of $i or about $1.09 
 a bushel, while Irish linen, not counting the tax, would 
 sell for $0.90 instead of $i per yard, or, with the ten 
 cents tax, at $i instead of $1.10. Let us suppose that, 
 at this new set of prices, Canada again has to pay Ire- 
 land as much for linen each year as Ireland has to pay 
 Canada for wheat. 
 
 How does the case stand as to gains and losses of 
 the two communities ? The Canadians are still getting 
 their linen for $i a yard, the price without the tax hav- 
 ing fallen to $0.90. And they are getting $1.10 a bushel 
 for wheat instead of $i. The Canadian government 
 is securing its ten cents tax on every yard of linen ; yet 
 Canadian consumers are paying no more than before 
 the tax was laid, and Canadian producers are getting 
 a higher price for their wheat. The people of Ireland 
 are paying to Canada the tax and more than the tax. 1 
 The linen manufacturing interests of Ireland are receiv- 
 ing $0.90 instead of $i a yard for their linen; they 
 are paying more for wheat. It is still worth while for 
 them to engage in the trade. They can still secure more 
 wheat in exchange for a week's production of linen than 
 they can themselves produce in a week (except on their 
 best lands). But they gain much less from the trade 
 than formerly. It should be added that the taxing 
 country, Canada, may gain also in lower prices of other 
 Irish goods than linen cloth, resulting from the redis- 
 tribution of money, and in their ability to buy more of 
 
 i Mill, Principles of Political Economy, Book V, Ch. IV, 6. 
 
46 ECONOMIC ADVANTAGES OF COMMERCE 
 
 these goods because of the lower prices and their own 
 higher incomes. 
 
 We must guard ourselves against the assumption that 
 the whole loss falls upon the Irish linen manufacturing 
 population as distinguished from Irish producers in 
 other lines. 1 The loss is general. The linen producers 
 would not remain in that business and alone bear all 
 the loss, since labor and capital tend always to leave 
 relatively unprofitable for relatively profitable activities. 
 They only sell linen more cheaply because of a decrease 
 of money in Ireland, which tends to lower in a like pro- 
 portion the prices of all Irish goods and Irish labor. 2 
 Likewise, the higher price of Canadian wheat falls alike 
 on all consumers of it in Ireland. 
 
 On one hypothesis, however, the price of linen made 
 in Ireland would fall by a greater per cent than other 
 Irish prices, viz. on the hypothesis (likely to be in con- 
 formity with fact) that the profits of linen production 
 are greater in some factories and on some sites in Ire- 
 land than on other sites in that country. If the tax 
 decreases the demand for the linen in Canada, the Irish 
 manufacturers on the better sites may alone be able 
 to satisfy the demand remaining; and they may be 
 willing to do so, because of their relatively advanta- 
 
 1 Mill, Principles of Political Economy, Book V, Ch. IV, 6. 
 
 2 Strictly speaking, a A decrease of money in Ireland would, under the con- 
 ditions here assumed, cause a fall in the prices of Irish goods, of more than &. 
 For it would cause a fall of A in average prices, including the price of Canadian 
 wheat and its products so far as bought and sold in Ireland, e.g. by middlemen. 
 Since these goods would be higher in price, other goods must fall in greater pro- 
 portion than 10 per cent. Whether the fall in the prices of other goods would 
 be much greater than 10 per cent, would depend upon the importance, in the 
 Irish market, of the Canadian product. If trade with Canada is assumed to 
 be of slight importance, other prices would fall by about A, otherwise by more. 
 But no good purpose would be served by complicating the text with these re- 
 finements. 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 47 
 
 geous positions, at prices lower than could be afforded 
 by marginal manufacturers (e.g. those on the poorest 
 sites), rather than go into other occupations. The loss 
 to Ireland, due to Canada's tax, would then fall with 
 greatest weight on the linen producers of Ireland, or 
 on the owners of sites adapted to linen manufacture. 
 A surplus gain, from better organization or from more 
 advantageous situation, which these classes had pre- 
 viously enjoyed, would be lessened. 
 
 As regards the ultimate burden of the tax, we reach 
 no different conclusion if we assume the currencies of 
 Ireland and Canada to be based on independent standards 
 and prices in the one country to be entirely unrelated 
 to prices in the other. 1 Suppose each to have a paper 
 money standard, not redeemable in gold. The ten 
 cents tax discourages Canadian purchase of Irish linen. 
 Ireland continues to buy about the usual amount of 
 Canadian wheat. The balance is settled in gold. In 
 Ireland, gold becomes scarcer and has more purchasing 
 power; in Canada, it becomes more plentiful and has 
 less purchasing power, per unit quantity. Irish paper 
 money will buy less gold. Canadian paper money will 
 buy more gold. Canadian wheat remains $i a bushel 
 in terms of Canadian money, but it requires more gold 
 than before to buy it, and more Irish money to buy the 
 gold. The cost to the people of Ireland of Canadian 
 goods tends to rise. The cost to Canadians of the 
 products of Ireland tends to fall. Omitting, altogether, 
 consideration of money prices, we may say that the 
 tax, by discouraging Canadians from trading, has made 
 necessary a new, and, for Canada, a more favorable 
 rate of interchange of goods, to equalize supply and 
 demand. 
 
 i Cf . Part I, Ch. VI, 6, 7, 8, 9- 
 
48 ECONOMIC ADVANTAGES OF COMMERCE 
 
 The illustrative figures which have been given show 
 a loss to Ireland greater than the amount of Canada's 
 tax. 1 Ireland's loss, however, might be the equivalent 
 
 1 Professor Edgeworth seems to take the view (Economic Journal, Vol. VII, 
 p. 397) that this extreme possibility is a consequence of the tax being collected, 
 in practice, in money, and that if it were collected in kind, Ireland (in our ex- 
 ample) could not be made to pay more than the tax. His thought apparently 
 is that, however elastic Canada's demand for linen, if Ireland paid the tax tn 
 linen, in addition to giving Canadian consumers as much linen as before for the 
 same amount of wheat as before, the trade would again be in equilibrium ; that 
 the Canadian consumers, as distinguished from the government, would then be 
 entirely unaffected by the tax, and would be as willing to buy linen with wheat 
 as previously and in as large quantities ; and that Ireland, therefore, would not 
 have to pay more than the tax to get the accustomed supply of wheat from 
 Canada. 
 
 A correct distinction between the circumstances under which more than the 
 burden of the tax might conceivably be shifted upon Ireland and the circum- 
 stances under which the full amount of the tax would be the limit of this burden, 
 is based on what the Canadian government does with the tax and not at all on 
 whether it is initially collected in money or in kind. We may rightly conclude 
 that a Canadian import tax collected in linen could not impose a greater burden 
 upon Ireland than the amount of the tax, if we suppose the Canadian govern- 
 ment to throw the linen it receives as taxes into the sea or if we assume that it 
 uses the linen so received for a purpose which would otherwise not be carried 
 out. We may reach exactly the same conclusion with equal certainty, however, 
 if we suppose the tax to be initially collected in money and the money then used 
 to buy the linen to be disposed of in one of these two ways. If the burden of this 
 tax collected in money falls entirely upon Ireland, then Ireland must sell enough 
 more linen (assuming she has no other exports) to pay it. But the Canadian 
 government expends the entire money returns from the tax for linen which, 
 otherwise, by our present hypothesis, the government would not buy. In 
 other words, Canada buys as much more linen as Ireland must sell additional 
 to pay the tax. If Ireland, therefore, thus bears the entire burden of the 
 tax by exporting extra linen, the remainder of her linen will find the same 
 market as previously and will bring her as much wheat as before. 
 
 But if the Canadian government would use about the same amount of linen 
 anyway, then for the government to get this linen by taxing linen imports in 
 kind (and likewise by taxing them in money) instead of by purchasing the de- 
 sired linen with the proceeds of internal taxes, means that, whereas the govern- 
 ment before, in effect, offered say wheat (if the money equivalent is offered, our 
 conclusion would be the same) taken in taxes for the desired linen, now it offers 
 nothing. Both individual Canadian consumers and the Canadian government 
 had been offering wheat for linen. Now only the former are doing so. The 
 people of Ireland, if the Canadian wheat is necessary for them, must now buy 
 as much wheat with linen (assuming them to have nothing else exportable) from 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 49 
 
 of the tax, or it might be considerably less than the tax. 
 Thus, the equilibrium of trade might be restored when 
 Canadian wheat had gone up to $1.03 a bushel, and 
 Irish linen down to $0.96 a yard, making $1.06 with the 
 tax. Then Canadians would be paying 6 cents of the 
 10 cents tax on each yard, but getting back 3 cents 
 of it in the higher price of wheat. Ireland would be 
 paying the larger part of the tax, but Canada would 
 have failed to shift all of it upon Ireland. 
 
 Two conditions, then, or sets of conditions, favor the 
 tax-levying country in any attempt to shift the burden 
 of the tax upon the country trading with it. In the 
 first place, the tax-levying country is advantaged by 
 
 the Canadian people individually as they previously bought from individual 
 Canadians and the Canadian government together. If the Canadian people, 
 as individuals, have a comparatively elastic demand for linen, Ireland must offer 
 them for their individual consumption, besides what their government gets, 
 about as much linen as before per bushel of wheat or they will not trade to any- 
 thing like the former extent. Ireland must therefore pay most or all of the tax. 
 But Ireland will then only be getting the wheat she previously got from Cana- 
 dians as individuals and will not be getting what she previously got as a result 
 of her trade with the Canadian government. This additional amount she must 
 now get (for we are supposing her demand to be inelastic) from Canadians as 
 individuals, and to do so she must sell more linen. The result may be, even 
 though Canada's demand for linen is somewhat elastic, that the marginal utility 
 of linen to Canadian consumers falls, and that Ireland must offer more than 
 before, per bushel of wheat, besides paying the tax. 
 
 It is true that if Canadians are released from a tax they themselves previously 
 paid, they may want more linen than before, but the probability is that their 
 greater prosperity so resulting would be enjoyed in other ways also and would 
 but slightly affect their demand for linen. And unless the entire gain from 
 remission of the taxes formerly spent by the government for linen were now 
 spent by the Canadian people for additional linen beyond their previous indi- 
 vidual consumption, the new demand resulting from their greater prosperity 
 would not take the place of the former demand by their government. 
 
 We cannot safely conclude, therefore, that if the tax is collected in kind, 
 Ireland cannot possibly lose more than its equivalent. As is shown in the text, 
 any great shifting of taxes to foreign nations is rather a theoretical possibility 
 than a practical probability, but if it is a theoretical possibility when collected 
 in money, it is also a theoretical possibility, and to the same extent, when col- 
 lected in kind. 
 
 PART H E 
 
50 ECONOMIC ADVANTAGES OF COMMERCE 
 
 having a very elastic demand for the goods of the other, 
 coupled with monopoly of consumption of the goods 
 of the other. 1 In the second place, the tax-levying coun- 
 try is aided if it has a monopoly of production of the 
 goods it sells while the other country has an inelastic 
 demand for those goods. 2 
 
 In practice, the conditions under which a country can 
 shift all or most of its import taxes upon another, are 
 unlikely to occur, or, at least, are unlikely to occur in 
 conjunction. To begin with, we cannot expect that, 
 in general, the country exporting the taxed product will 
 have an inelastic demand for the product or products 
 of the taxing country. And, secondly, a very slight 
 change in relative prices may bring additional articles 
 within the demand of the taxing country, thus main- 
 taining the equilibrium of trade nearly where it was 
 before. To illustrate, a slight rise of Canadian prices 
 and a slight fall of Irish prices may induce Canadians 
 to buy potatoes, silks, and laces, as well as linen, in Ire- 
 land. Then equilibrium may result without a sufficient 
 change in the rate of trade to throw upon Ireland much 
 of the burden of the import tax. 
 
 Thirdly, and probably most important of all, the 
 taxing country cannot ordinarily shift much of the bur- 
 den of its import duties to another, because third coun- 
 tries offer to this other a competing or alternative trade. 
 Thus, Canada probably cannot throw upon Ireland 
 the burden of a tax on Canada's imports, because Ire- 
 land has the alternative of trading with India, Argentina, 
 the United States, and other countries. If Canada 
 buys less Irish linen because of the tax, so that money 
 
 1 Bastable, The Theory of International Trade, fourth edition, London (Mac- 
 allan), 1903, p. 116. *Ibid., pp. 116, 117. 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 51 
 
 flows into Canada and Canadian prices rise, Ireland 
 will buy wheat of India, the United States, Argentina, 
 or Russia, rather than pay higher prices for Canadian 
 wheat. In short, the Canadian wheat producers must 
 take the same prices charged elsewhere, or export no 
 wheat. 1 Likewise, rather than sell their linen to Canada 
 for a much lower price than before, the people of Ireland 
 would export more to other markets. Most, if not all, 
 of the tax would be pretty likely to fall upon the people 
 of the taxing country; and even if this were not true, 
 the attempt to tax other nations is a game at which all 
 can play. 
 
 The fact that other countries than Ireland and Canada 
 are to be reckoned with, means, also, that the general 
 price level in Ireland would probably fall very little as 
 a consequence of Canada's tax. Though an inflow of 
 money into Canada due to her decreased imports might 
 somewhat raise the level of Canada's prices, any corre- 
 sponding fall in Irish prices would make Ireland a good 
 place to buy in and would cause money to flow from 
 third and fourth countries into Ireland, even if Cana- 
 dians were prevented by their import tax from buying 
 in Ireland. The fall of prices would, then, if it took 
 place, be distributed over several countries and would 
 not probably be confined to Ireland. It would be very 
 slight, therefore, in any country. The chief effect of 
 the redistribution of gold consequent on Canada's tax 
 would be seen in a rise of Canadian prices and not in a 
 fall of Irish prices. 
 
 1 The exact effect, in the absence of any disturbing factors, would be a trans- 
 ference, in part, of the Irish demand for wheat to these other countries; a very 
 slight increase, generally, of the price of wheat, and, therefore, a very slight 
 increase of the price of the Canadian wheat still exported; and a very slight 
 decrease in the price received by Ireland for linen. 
 
52 ECONOMIC ADVANTAGES OF COMMERCE 
 
 4 
 The Ultimate Incidence of a Revenue Duty on Exports 
 
 Duties for revenue may be levied on exports, if so 
 desired, as well as on imports, though the present prac- 
 tice is to levy them on imports. Here, again, there are 
 various possibilities as to shifting. Suppose that Canada 
 levies a duty of ten cents a bushel on the export of wheat: 
 The production of wheat, in Canada, for export, would 
 be decreased, unless the tax could be shifted upon foreign 
 consumers. If the tax could not be shifted, those wheat 
 producers who were making but the usual return to 
 industry (the marginal producers) would change to 
 another line of production. If the wheat consumers 
 of Ireland (and of other countries getting their wheat 
 from Canada) should have an absolutely inelastic demand 
 for wheat and could get wheat nowhere else, they would 
 pay the higher price for wheat rather than not get the 
 usual amount of it, and thereby would be paying the 
 tax. In fact, if their demand were altogether inelastic, 
 they would soon be paying more than the tax. 1 For 
 the whole amount paid by purchasers of Canadian wheat, 
 including the part collected by the Canadian govern- 
 ment as export tax, goes to Canada. This means that 
 if the wheat consumers of Ireland (and elsewhere) paid 
 the tax in addition to what they were previously paying, 
 there would be a flow of gold into Canada. Canadian 
 prices would rise. Prices in Ireland would fall. Con- 
 sumers in Ireland would then be paying more for wheat 
 by the amount of the tax plus the amount of rise (due 
 to gold flow) of net price ; while the fall of Irish prices 
 would mean cheaper linen for Canada. A bushel of 
 
 1 Mill, Principles of Political Economy, Book V, Ch. IV, 6. 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 53 
 
 wheat, even after subtraction of the tax, would buy 
 more linen than before. 
 
 . But if Ireland's demand for wheat is decidedly elastic, 
 or can be easily satisfied from other sources of supply, 
 then the increased price resulting from the export tax 
 will cause an immediate falling off of Irish purchases. 
 Let us suppose this falling off of Irish demand to be 
 sufficient so that, even with the addition to the price, 
 of the tax, the money obligations from Ireland to Canada 
 are less than before. Then a balance of gold will flow 
 from Canada to Ireland. Canadian prices will fall 
 and prices in Ireland rise. If Canadian demand for 
 linen is comparatively inelastic, this flow and change of 
 prices may go to a considerable extent before Canadian 
 demand for linen decreases and Irish demand for wheat 
 (and other Canadian products) increases enough to 
 bring equilibrium. At any rate, the fall of Canadian 
 and rise of Irish prices will mean that at least a part of 
 Canada's export tax has been shifted back upon Canada. 
 It is conceivable that Canadian wheat will fall so far 
 in price that, even with the tax, Ireland gets it as cheaply 
 as or more cheaply than before, while Canada pays more 
 for Irish linen. In that case, Canada, so far from taxing 
 another country or other countries, would herself lose 
 more than the tax. If we assume Canada and Ireland 
 to have different standards of value, our conclusions 
 will be the same. 1 
 
 It should be clearly understood that the loss to Canada 
 (assuming the result just discussed) does not fall, if the 
 taxed article is produced at nearly constant cost, on the 
 producers of that article alone. For these producers 
 would refuse to accept lower returns and remain in the 
 
 1 Cf. 3 of this chapter (III of Part II). 
 
54 ECONOMIC ADVANTAGES OF COMMERCE 
 
 same business when other lines were more profitable. 
 They accept the lower prices when and because the 
 outflow of money makes Canadian prices, generally, 
 lower. 
 
 But the goods taxed may be produced under condi- 
 tions of sharply increasing cost (i.e. by some producers 
 less advantageously than by others). This may be the 
 case with wheat, chosen as our illustration of the taxed 
 article. On this assumption, much of the loss due to 
 the tax may fall on the owners of wheat lands. Those 
 producing at the margin of cultivation (those just mak- 
 ing enough to keep them in the industry) will refuse to 
 bear this loss, and will cease producing. Those producing 
 under more favorable circumstances (on more fertile 
 or better situated land) may prefer to suffer consider- 
 able loss out of what would have been their surplus or 
 rent, 1 rather than to cease wheat raising. 2 After the 
 tax has diminished foreign demand for Canadian wheat, 
 the more advantageously situated Canadian wheat 
 producers can fill this smaller demand at lower net 
 prices than before, and still realize, because of their 
 advantages of soil and situation, a reasonable profit. A 
 price sufficient to keep the poorer situated producers 
 in business, plus the tax, will not be paid by enough 
 foreign consumers to take the previous annual supply 
 of Canadian wheat. The price will fall. Canadian 
 owners of wheat lands will derive a smaller return from 
 those lands. If there is a surplus flow of gold from 
 Canada, because of excess purchases of Irish linen over 
 sales of Canadian wheat, the price of the wheat will 
 fall still further, along with prices of other Canadian 
 
 1 Cf. Bastable, The Theory of International Trade, p. 114. 
 8 Cf. Ch. II (of Part II), 4. 
 
THE INCIDENCE OF TARIFFS FOR REVENUE 55 
 
 goods. But it will still be true that a special loss has 
 fallen upon the owners of wheat lands. 1 
 
 As in the case of the import, so in the case of the export 
 revenue tax, we must emphasize the unlikelihood that 
 a country will be able to shift the principal part of its 
 tax burden upon other countries. So soon as trade 
 with Canada becomes, because of the tax, appreciably 
 less profitable to Ireland, the latter country is likely 
 to trade more with other nations and communities, and 
 less with Canada. For this reason particularly, as well 
 as the fact that the other country, Ireland, is quite as 
 likely as the tax-levying country, to have an elastic 
 demand for the goods it imports, there is a reasonable 
 probability that the people of each country will them- 
 selves have to pay, in the main, the cost of running their 
 own government and carrying on its functions. 
 
 5 
 Summary 
 
 Revenue tariffs we have classified as import and export 
 tariffs. A revenue tariff, as such, is expected to secure 
 revenue for government with the least possible effect 
 on industry. A protective tariff is specifically intended 
 to turn industry into channels it would otherwise not 
 enter. 
 
 Revenue tariffs on imported goods may fall on the 
 consumers in the tax-levying country, or may, under 
 certain hypothetical circumstances, fall upon the country 
 (or countries) exporting the taxed goods. If the demand 
 for the goods in the taxing country is elastic; if the 
 
 1 In a similar way it might be shown that, even if Canada succeeds in throw- 
 ing the main burden of the tax upon Ireland, owners of Canadian wheat lands 
 might, as a separate class, have their prosperity decreased. 
 
56 ECONOMIC ADVANTAGES OF COMMERCE 
 
 demand for the goods produced in it is in other coun- 
 tries comparatively inelastic ; and if these other coun- 
 tries have no other place to sell their exports and buy 
 the goods they desire; then the tax burden may be 
 shifted in part, or in whole, or more, upon them. But 
 in the actual commercial world, circumstances are not 
 likely thus to favor the tax-levying country. 
 
 In the case of tariffs on exported goods, the hypotheti- 
 cally possible consequences are not dissimilar. A suffi- 
 ciently inelastic demand from other countries, for the 
 taxed goods, will throw upon them a burden perhaps 
 equal to or in excess of the tax, to the advantage of the 
 taxing country. On the other hand, the country taxing 
 its exports may, if the foreign demand for the taxed 
 goods is elastic while its demand for foreign goods is 
 inelastic, not only pay, itself, the entire tax, but may also 
 carry on its trade with foreign countries at a less favor- 
 able rate of interchange to it, than before. The general 
 rule probably is that a government is mainly supported 
 by those subject to it. If it were possible to support 
 government by shifting taxes upon foreign countries, 
 all nations would be likely to attempt it, with consequent 
 cancellation or partial cancellation of effects. 
 
CHAPTER IV 
 
 THE .EFFECT OF A PROTECTIVE TARIFF ON NATIONAL 
 WEALTH 
 
 The Effect of a Protective Tariff on a Country's Export 
 
 Trade 
 
 IN discussing the protective tariff, a natural starting 
 point is the question of its effect on the supply of goods 
 brought from foreign countries. A purely revenue tariff 
 is intended to have the least possible effect on the flow 
 of trade. A protective tariff prevents goods from coming 
 into the "protected" country, is, in fact, particularly 
 intended so to do, by, in effect, fining the importers. 
 Thus, a Canadian tariff on linen of 50 cents a yard 
 may be said to fine the importers of linen to that extent. 
 This discourages importation and so tends to decrease, 
 in Canada, the supply of linen. In consequence of the 
 decreased supply of linen in Canada, the price advances. 
 Either it must advance by about the equivalent of the 
 tax, 1 or the linen will not be imported. This high price, 
 however, causes a falling off in the demand for linen 
 brought from abroad, and a shifting of this demand 
 to the home product. If linen from Ireland was $1.00 
 and cannot now be sold for less than $1.50, and if Cana- 
 dians can manufacture it profitably for $1.43, the sales 
 
 1 See, however, discussion in this chapter (IV of Part II), 6 and 7. Cf. 
 Ch. Ill (of Part II), 3- 
 
 57 
 
58 ECONOMIC ADVANTAGES OF COMMERCE 
 
 of Canadian linen in Canada will increase. Canadian 
 production is thus encouraged, by government aid, to 
 follow a line which it otherwise would not. 
 
 This purposeful interfering with importation disturbs 
 the previously existing equilibrium of trade conditions. 
 Canada, for a time, continues to export wheat or other 
 goods, though refusing to import much linen. Gold, 
 therefore, flows out of Ireland and into Canada. This 
 raises Canadian prices and lowers prices in Ireland. 1 
 The prices, therefore, of goods which Canada has ex- 
 ported, e.g. wheat, may rise so high that the Irish and 
 other foreign demand, if it does not cease, will at least 
 grow smaller. Or, if some of these goods, such as wheat, 
 cannot be sold abroad even in smaller quantities for a 
 higher price than before, because of competition from 
 other sources of supply, then the higher money cost of 
 production in Canada will cause production for a foreign 
 market to decrease. In the long run, by so much as a 
 protective tariff directly limits imports, by just so much 
 will it indirectly injure the levying country's export 
 trade. 2 This is true whether the different trading coun- 
 
 1 Or, if there is a general tendency for prices to fall, as from a more rapid 
 increase of trade than of money, Canadian prices fall less than do Irish prices ; 
 while, if there is a general tendency for prices to rise, Canadian prices rise more 
 than Irish prices. The essential fact is, that Canadian prices rise by comparison 
 with Irish prices, while Irish prices fall by comparison with Canadian prices. It 
 would complicate and make harder to follow our arguments to add this expla- 
 nation in each chapter throughout Parts I and II, but the reader may, with 
 advantage, bear it in mind. 
 
 2 Whatever goods continue to be exported until Canadian prices have appre- 
 ciably risen, would more probably be goods produced under conditions of in- 
 creasing cost and goods in which competition from other sources of supply would 
 not prevent Canadian sales even at somewhat higher prices than before. If 
 all goods were produced under conditions of absolutely constant cost and could 
 be secured equally well from other sources, if society were in a state of economic 
 equilibrium, and if there were no economic friction, then Canadian prices could 
 change only infinitesimally as a result of money inflow caused by the tariff. For 
 
PROTECTION AND NATIONAL WEALTH 59 
 
 tries have a common standard of value, or unrelated 
 monetary systems, or no monetary systems. The 
 Irish manufacturers of linen will be forced by the more 
 direct action of the tariff to seek markets elsewhere 
 than in Canada. The Irish consumers of wheat will 
 soon make use of the alternative, in case an inflow of 
 gold into Canada raises wheat prices there (or, if the 
 currencies are unrelated, in case more Irish money than 
 before is required to buy a given amount of Canadian 
 money), of buying their wheat elsewhere. The result, to 
 Canada, is the loss of what had been a profitable trade. 
 The establishment of a few protected industries may 
 serve to discourage or cripple many unprotected indus- 
 tries, for it means higher money prices and a consequent 
 disadvantage to all lines of export trade. Among other 
 things, the services of a country's mercantile marine 
 may be regarded as exports of that country, in so far as 
 these services are rendered to and are paid for by, the 
 people of other countries. This, like other parts of a 
 country's export trade, is affected unfavorably if the 
 country follows the protective tariff policy. Besides 
 the injurious effect resulting from the general rise of 
 money prices in the protected country, on the exporta- 
 tion of any of that country's products, there is the special 
 discouragement which results if the production of these 
 exportable goods requires the use of machinery or raw 
 material directly raised in price by a tariff upon it. 
 
 the least tendency to rise of costs would at once turn all producers away from 
 lines of production for a foreign market in which prices could not be made to 
 rise equally fast, and prices in foreign markets, of the goods in question, would 
 not rise if the goods could be secured in larger quantity from other sources, at 
 no greater cost than before. A protective tariff which prevented imports would 
 immediately stop exports. Under existing conditions, exports would be corre- 
 spondingly decreased by an import tariff only after an appreciable lapse of 
 time. 
 
60 ECONOMIC ADVANTAGES OF COMMERCE 
 
 A high export tariff, intended to prevent exports, 
 would eventually, like a protective import duty, decrease 
 both exports and imports, but the export duty would 
 decrease exports first. The diminution of exports would 
 mean a temporary net outflow of specie from the duty- 
 levying country. Finally, prices in that country would 
 be so low that its people would more largely supply 
 themselves with desired goods and would buy less goods 
 abroad. 1 It is not essential, however, that we should 
 consider at length the effects of high export duties, be- 
 cause, while there have been examples of such, they have 
 been much less common than high import duties, and 
 are, at present, almost unknown. 
 
 How a Protective Tariff Sets Up Unprofitable Industries 
 at the General Expense 
 
 The fairly direct and practically immediate effect of a 
 protective tariff is to raise the prices of protected goods 
 by not more than the amount of the tariff. As we have 
 seen, if Canada levies a 50 cents tax per yard on linen, 
 to protect Canadian linen production, an almost imme- 
 diate result is that Canadian linen manufacturers can 
 charge more for linen than otherwise they would be able 
 to. For the 50 cents tax has, as a first consequence, 2 
 that linen from Ireland must sell for $1.50 instead of $i 
 a yard. The tax, therefore, makes it possible for Cana- 
 dian linen producers to charge prices (except as hindered 
 
 1 With a combination of high protection on all importable goods, and high 
 restrictive export taxes, the prices of protected goods would rise because of their 
 greater scarcity, but there would be no rise of other prices due to inflow of gold 
 nor any fall of prices due to its outflow. 
 
 2 See, however, 6 and 7 of this chapter (IV of Part II). 
 
PROTECTION AND NATIONAL WEALTH 61 
 
 by competition with each other) higher in about the 
 same proportion. Without the tariff protection, Cana- 
 dian linen producers must sell for $i a yard or less, if 
 they would have the home market. If all of them were 
 willing to do this, if employing manufacturers and their 
 employees were willing to manufacture linen for an 
 average return of $14 a week, or less, they could carry 
 on a large business and perhaps almost monopolize 
 the home market, even without a tariff. But the tariff, 
 by compelling a rise in the imported linen to $1.50, en- 
 ables the now protected Canadians to charge (say) 
 $1.43, and still be sure of most of the Canadian market. 
 Under Schedule K of the late Payne- Aldrich tariff law, it 
 was found by the Tariff Board that an average duty of 
 184 per cent levied by the United States on 16 varieties 
 of woolen fabrics, resulted in an average price for the 
 home-produced goods 67 per cent higher than the price 
 of like goods abroad. 1 The tariff has in this regard about 
 the same effect as natural barriers and resulting high 
 cost of transportation. Either natural barriers or the 
 artificial barriers of a protective tariff act tend to make 
 more difficult to get and more expensive in one country, 
 the products of another, and, therefore, to enable the 
 home producer to charge higher prices. The late Pro- 
 fessor William Graham Sumner of Yale college called 
 attention to the fact that, after the St. Gothard tunnel 
 was opened, the people of southern Germany petitioned 
 for higher taxes on Italian products so as to offset the 
 greater cheapness made possible by the tunnel. 2 
 The protective tariff on linen makes Canadian manu- 
 
 1 Report of the Tariff Board on Schedule K of the Tariff Law, 1912, Vol. I. 
 Part I, p. 14. 
 
 2 Protectionism, New York (Holt), 1885, pp. 75, ?6. 
 
62 ECONOMIC ADVANTAGES OF COMMERCE 
 
 facture of the linen much more profitable than it would 
 else be, since it enables the Canadian manufacturers to 
 charge much higher prices. It therefore diverts a cer- 
 tain amount of Canadian labor and capital, from the 
 production of wheat and from other lines, into the pro- 
 duction of linen. As has already been suggested, if 
 Canadians want to go into the linen making industry 
 and take what the industry will yield them in open com- 
 petition, they can do so without the tariff. But though 
 they can, it is obvious that they will not. For, by our 
 familiar assumption, a week's labor in Canada will 
 produce 20 bushels of wheat, and will therefore earn, if 
 wheat sells for $i a bushel, $20. A week's labor will 
 produce, however, but 14 yards of linen. If linen is 
 but $i a yard or less, the week's earnings are but $14. 
 Without the tariff, therefore, Canadians can go into 
 linen production if they want to, and they may be able 
 to make a fair living at it; but they will not want to, 
 for the reason that they can make very considerably 
 more in another line, viz. the production of wheat. 
 The tariff, by enabling them to get $1.43 a yard or more, 
 though at the expense of 43 cents a yard to every Cana- 
 dian purchaser of linen, makes the business as profitable 
 as the other, or more so, and induces some Canadians 
 to take it up. A protective tariff, therefore, causes the 
 development of an industry in a location or country 
 where it would not otherwise exist, by making possible 
 higher prices and correspondingly higher returns to 
 that industry, and in that way alone. Under free trade 
 conditions, the location of various industries within 
 different countries is determined, as we have seen, by 
 the principle of relative efficiency in production. The 
 greatest profitable degree of geographical specialization 
 
PROTECTION AND NATIONAL WEALTH 63 
 
 results. Under protection, this specialization is pur- 
 posely interfered with, and what industries shall be 
 developed and maintained in the protective tariff coun- 
 try depends, in large part, on governmental favor. 
 
 The general principle of free trade follows directly 
 from what we have learned of the benefits of international 
 trade. Geographical specialization, so far as it develops 
 naturally under free trade conditions, yields a larger 
 total product than local or national self-sufficiency ; and 
 of this larger product the several trading nations secure 
 each a share. Protection prevents this specialization, 
 makes impossible the securing of the larger total product, 
 and, therefore, makes the protected country in so far 
 poorer. 
 
 To illustrate, consider again Canada's 50 cents pro- 
 tective duty on linen. Before the laying of this duty, 
 the average Canadian could produce, in a week, 20 
 bushels of wheat, worth $20, and get, by sale and pur- 
 chase, 20 yards of linen in return. 1 With two weeks of 
 work, he could secure 20 bushels pjus 20 yards. After 
 the protective tax is laid, he is practically compelled to 
 buy linen in Canada at $1.43 a yard. He can still 
 produce 20 bushels of wheat in a week and get his $20, 
 but for the $20 he can get only 14 yards of linen. Two 
 weeks of work will net him 20 bushels plus 14 yards, 
 which is 6 yards less 2 than if the tariff did not exist. 
 
 Neither can it be said that the Canadians who are 
 tempted into linen manufacturing gain any more than, or 
 as much as, the wheat producers lose. For we have seen 
 that those who care to manufacture linen, employers and 
 employees, can have all the business they want and all 
 
 1 Minus cost of transportation, etc. 
 
 2 Ignoring cost of transportation, etc. 
 
64 ECONOMIC ADVANTAGES OF COMMERCE 
 
 the employment they want, without the tariff, if they 
 will sell the linen at a low enough price, say $i or less a 
 yard, and take what the business will earn, as wages and 
 profits, viz. about $14 a week (or perhaps, if they wish 
 to keep linen from Ireland entirely out and monopolize 
 the market, somewhat less). If the tariff enables them 
 to get $1.43 a yard instead of $i, the best that can pos- 
 sibly be said for the tariff is that it gives the linen makers 
 43 cents for every 43 cents it takes away from the wheat 
 raisers or others who buy the linen. If there is any way 
 by which protection can give 43 cents to any protected 
 interest, without taking at least 43 cents away from some 
 person or persons buying the taxed article, the exact 
 manner in which protection does this should be carefully 
 set forth by defenders of the policy. The late Professor 
 Sumner said: 1 "If Protection is anything else than 
 mutual tribute, then it is magic." 
 
 But protection does worse than take from one person 
 in the protectionist country exactly what it gives to 
 another. In our illustration, protection does worse than 
 take from the Canadian wheat producers exactly what 
 it gives to the Canadian linen manufacturers. It takes 
 more from the wheat raisers than it gives to those who 
 become linen producers. The wheat raisers have to pay 
 43 cents extra on every yard bought, in order that the 
 linen makers may receive $1.43 for what would other- 
 wise be $i worth of linen, or $20 a week in an occupa- 
 tion that would otherwise yield only $14. But, by 
 hypothesis, they could earn $20 anyhow, if they would 
 remain in the business of wheat production. Therefore, 
 the people who do engage in wheat production have to 
 lose $6 on 20 yards of linen in order that others may 
 
 1 Protectionism, p. 160. 
 
PROTECTION AND NATIONAL WEALTH 65 
 
 secure $20 a week at linen manufacturing, when these 
 others could secure $20 a week in wheat production 
 without taxing any one else. It would seem certain, 
 then, that the taxed class loses more than the protected 
 class gains, if indeed the latter class gains anything at 
 all. What the situation amounts to, in our illustration, 
 is that the people in one industry are taxed to encourage 
 and keep going another industry which pays so ill that 
 no one in the country would go into it if it were not 
 favored by this policy. This is what Professor Sumner 
 had in mind when he said that, by the whole logic of the 
 protectionist system, the industries to be aided are "the 
 industries which do not pay," l and that the process, so 
 called, of " creating a new industry" means simply the 
 taking of one industry and setting it "as a parasite to 
 live upon another." 2 
 
 Various facts brought out by the investigations of the 
 Tariff Board would seem to show that the establishment 
 in the United States by the protective tariff, of the wool 
 manufacturing industry, has thus been the establishment 
 of a parasitic industry at the general expense. We have 
 already seen 3 that many woolen goods have been greatly 
 raised in price because of the exclusion, by protection, 
 of foreign goods. The home producers must receive 
 these higher prices in order that they may receive, as a 
 whole, as large returns as they might otherwise have 
 secured in unprotected lines ; in particular, they must 
 charge these prices in order that the wages paid to em- 
 ployees may be high enough to keep the latter in the 
 wool manufacturing business, and, therefore, that the 
 wages may be as high as can be got in other employments. 
 
 1 Protectionism, p. 48. 2 Ibid., p. 45- 
 
 2 of this chapter (IV of Part II). 
 PART H V 
 
66 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Since wages in general in the United States are high and 
 since American woolen manufacturing concerns seem 
 to have no special advantages either in equipment or in 
 efficiency of labor over their foreign rivals, 1 it follows 
 that the cost per yard of woolen cloth made in this coun- 
 try is high. According to the estimates of the Tariff 
 Board, 2 the cost of turning wool into tops is about 80 per 
 cent more here than in England, of producing yarn from 
 the tops about 100 per cent more, and of manufacturing 
 the yarn into cloth from 66 to 170 per cent more, accord- 
 ing to the kind of fabric in question. The effect of pro- 
 tecting the woolen manufacturing industry in the United 
 States has been, therefore, that the consumers, that is, 
 the Americans engaged in all other lines of industry, 
 have had to pay much higher prices for woolen goods 
 than would otherwise be necessary, merely that those 
 engaged in the woolen industries might receive as high 
 profits and wages as they could get even without pro- 
 tection in other lines of activity. Were it not for pro- 
 tection they would have been engaged in these other 
 lines of activity, perhaps largely in the production of 
 articles for export, in transportation, and in various 
 commercial pursuits. Protection has drawn them out 
 of these lines at a very considerable loss to the rest of 
 the nation and with no appreciable permanent gain to 
 them, if indeed they have not eventually shared in the 
 general loss. It would appear certain, therefore, that 
 in this instance, as in general, protection has imposed a 
 cost upon those in unprotected industries, greater than 
 any gain which it can be asserted to have brought to 
 those in the lines protected. 
 
 Report of the Tariff Board on Schedule K of the Tariff Law, Vol. I, Part 
 I, p. 16. *Ibid., pp. 16, 17. 
 
PROTECTION AND NATIONAL WEALTH 67 
 
 The Effect of Protection on the Money Prices of Pro- 
 tected Goods and on the Money Prices of Unprotected 
 Goods 
 
 For a brief time after a protective tariff is levied on 
 imports, the protected country, e.g. Canada, will export 
 about as much as if trade were free ; 1 but such a flow of 
 exports will not be continuous. When, as a result of 
 the tariff, Canada diminishes its importations, there will 
 be, as has been sufficiently explained, a net inflow of 
 gold. Canadian prices rise as compared to foreign 
 prices, and, if the amount of trade and other factors 
 remain the same, rise in exact proportion to the increase 
 of money. If, for any reason, prices do not at once 
 become higher than before relatively to prices abroad, 
 the gold inflow will continue until they do. And when, 
 because of the increase of money, prices rise, this rise 
 of prices will affect protected and unprotected goods 
 alike. The increase of money, with no corresponding 
 increase of other wealth, must mean rise of prices of 
 other wealth, else, with the greater amount of money, 
 the demand for this wealth would exceed the supply. 
 And as far as the increase of money by itself is concerned, 
 it would affect all prices in Canada to the same extent. 
 The primary effect, then, of the assumed tariff, is to 
 raise the price of linen, in Canada, from $i to $1.43 a 
 yard, while not affecting the price of wheat. The 
 secondary effect results from the inflow of money. 2 
 
 1 See i (and footnotes) of this chapter (IV of Part II). 
 
 * Cf . The Purchasing Power of Money, by Irving Fisher assisted by Harry G. 
 Brown, New York (Macmillan), IQII, p. 94. In justification of the above mode 
 of presentation, it may be said that the drawing of labor into the protected in- 
 dustry (linen production), cannot permanently raise the prices of unprotected 
 
68 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Suppose money in Canada increases, because of the 
 tariff, by 10 per cent. Then the price of Canadian wheat, 
 assuming it to be produced at approximately constant 
 cost per bushel 1 regardless of whether somewhat less or 
 somewhat more is produced, would tend to rise from $i 
 to $1.10 a bushel; 2 and the price of linen would rise, 
 in addition to the rise directly occasioned by the tariff, 
 from $1.43 to $1.57 a yard, i.e. in the same ratio as the 
 price of wheat. How largely the prices of unprotected 
 goods produced in the United States have thus been 
 made higher by this indirect action of the tariff, it is 
 impossible to say, but that the prices of many such goods 
 have been so raised to some extent, we may reasonably 
 conclude. 
 
 Here we are brought again, by a somewhat different 
 route, to the conclusion that a protective tariff tends 
 towards national poverty. For, while the increased 
 quantity of money tends to raise all money incomes in 
 the same ratio that it raises the prices of goods, and so 
 tends to leave people in the same relative position ; yet 
 the original and special rise in the prices of the protected 
 
 goods, e.g. wheat, by decreasing the supply of these goods, unless there is this 
 inflow of specie. For no one, by our hypothesis, will leave the production of 
 wheat at $i a bushel unless he can get $1.43 a yard for linen, and no one would 
 leave the production of wheat at any higher price than $i unless he could secure 
 more than $1.43 for the cloth. But a rise of wheat above $i a bushel and of 
 cloth above $1.43 and of other things in proportion, could not take place without 
 a changed relation between currency and goods, without, that is, in this case, 
 an inflow of money metal. A continued foreign demand for the now less produced 
 wheat might cause a rapid readjustment, but could cause such readjustment 
 only through purchases of the wheat (or other Canadian goods), and, therefore, 
 only by influencing the flow of gold. 
 
 1 At the margin of cultivation. 
 
 2 We are supposing that the inflow of money takes place to such an extent 
 as to have this result, either because Canada continues to export wheat until 
 the price of Canadian wheat has thus risen 10 per cent, or because Canadian 
 exports of other goods, perhaps goods less subject to the competition of other 
 sources of supply, do not at once cease. 
 
PROTECTION AND NATIONAL WEALTH 69 
 
 goods is due solely to the greater scarcity of those goods 
 and the greater cost of their production, and is not coun- 
 terbalanced by any increase of money incomes. There 
 is here a net loss. The country is poorer because of 
 the tax. 
 
 If Canada has an inconvertible paper money, then 
 the protective tariff will have the same primary effect but 
 a different secondary effect. It will raise the price of 
 linen from $i to $1.43 without changing other prices. 
 There will be no increase of money due to a surplus of 
 exports. Linen will rise in price because of the greater 
 cost of production required and the greater scarcity of 
 it in relation to other goods and to money. But wheat 
 and, in general, goods other than linen will not rise in 
 price. 1 Instead of a general rise in money prices bring- 
 ing eventual equilibrium by discouraging purchase of 
 Canadian goods from abroad, this equilibrium will be 
 brought by a change in the relative values of currency, of 
 such a sort that it requires more foreign money to pur- 
 chase a given amount of exchange on Canada or to pur- 
 chase the gold equivalent of a given amount of Canadian 
 money. 2 
 
 As we have already seen, 3 a high export tariff would 
 act in a way directly contrary to the operation of pro- 
 tection, on the flow of specie and on money prices in the 
 tax-levying country. While protection causes an inflow 
 of specie and a rise of money prices, high export duties 
 would cause an outflow of specie and a fall of money 
 prices. But in its effect on national prosperity, a high 
 export tariff would not require to be thus sharply dis- 
 
 1 Assuming production under constant cost. 
 
 2 See Part I, Ch. VI, 6, 7, 8, 9- 
 
 8 i of this chapter (IV of Part II). 
 
70 ECONOMIC ADVANTAGES OF COMMERCE 
 
 tinguished from protection. It would, as protection 
 does, turn industry out of its natural channels into less 
 productive channels. The difference is that, while the 
 method of protection involves a selection of industries 
 to be established at the general expense, a high export 
 tariff would secure the establishment of new and less 
 profitable industries, indirectly, by preventing produc- 
 tion for export in the industries most profitable. Export 
 restrictions have been applied, in the past, along with 
 restrictions on imports, to divert labor from a relatively 
 large production of raw materials, into the manufacture 
 of those materials. England's statutory law, from the 
 time of Edward III through many generations, forbade 
 the export of sheep or raw wool, while aiming to prevent 
 importation of woolen cloth. 1 The desire was to stimu- 
 late the making of woolen cloth in England. 
 
 It is worth pointing out that a high tariff levied by 
 a country upon its exports, affects that country as to 
 money prices and general prosperity, in the same way as 
 high import duties levied on the same articles of its 
 production by all the countries with which it trades. 
 A high export duty levied by Canada on wheat, would 
 have the same effect as high import duties on this wheat 
 levied by other countries; it is indeed equivalent to a 
 combination of all possible consuming countries to levy 
 such an import duty against Canada. Similarly, a 
 high import tax, i.e. a "protective tariff," is equivalent 
 to high export duties levied by not one only but all 
 other countries from which the taxed goods might come. 
 
 1 Levi, The History of British Commerce, second edition, London (John Mur- 
 ray), 1880, pp. 22, 23, footnote; also Day, A History of Commerce, New York 
 (Longmans, Green & Co.)> 1907, p. 225. 
 
PROTECTION AND NATIONAL WEALTH 71 
 
 4 
 
 Protection to Industries in which Large Scale Production 
 is Advantageous 
 
 When a protected industry is one of those in which 
 large scale production is advantageous, there are, as 
 regards the carrying on of the industry in the protection- 
 ist country, two possibilities. The first possibility is 
 that the encouragement and further extension of home 
 production in that industry will mean home production 
 on a larger scale than formerly, i.e. few, if any, more 
 plants, but larger product turned out by each plant. 
 If the tariff has this effect, it means cheaper home pro- 
 duction than before, and, if the improvement is great 
 enough, cheaper production at home than abroad. 1 
 
 The second possibility is that the size of establishment 
 having the greatest efficiency is, on the average, already 
 
 1 There is another conceivable case, which may properly be mentioned at this 
 point, where protection might really increase national wealth. Suppose a coun- 
 try to be carrying on only one or a few industries and to be the only country 
 where these industries are carried on. Those engaged in them, however, we 
 shall assume to be subject to competition from others in their own country. In 
 such a case, a protective tariff which should divert labor into a line unprofitable 
 without such aid, might so restrict the supply of the goods of which the country 
 had a monopoly, as to raise very greatly the prices of those goods abroad and so 
 increase the country's prosperity at the expense of foreigners. But unless the 
 country had a monopoly of the industries from which labor is turned, it could 
 not appreciably raise the prices of the goods by so doing, for the competition of 
 other sources of supply would keep the prices down. Furthermore, unless most 
 of the industries in which the protectionist country is engaged are industries 
 in which it has a monopoly, the establishment of new industries by protection 
 will draw from other lines as well as from the monopoly lines, and will therefore 
 not so much decrease the supply of goods in the monopoly lines and not so much 
 raise their prices. If a country has a monopoly of only one or a few lines and 
 those not important, and the situation is almost certain to be no more favorable 
 than this to the protectionist country, then the effect of protection will so little 
 decrease the supplies of the monopolized goods as to have slight appreciable 
 effect on their prices. In short, as things are in the actual civilized world, the 
 circumstances under which protection can be reasonably expected to increase 
 national wealth probably nowhere exist. 
 
72 ECONOMIC ADVANTAGES OF COMMERCE 
 
 reached before protection is granted, or, if it is not, that 
 lack of a tariff is not the difficulty. On this assumption, 
 the imposition of a tariff would very probably result in 
 an increase of the number of plants engaged in the in- 
 dustry within the protectionist country, but not in any 
 saving through more efficient plants. By hypothesis, 
 increased size of plants, beyond that already reached, 
 is no longer a saving, or will not be brought about by 
 protection. If the industry was being carried on within 
 the country to any appreciable extent, before the adop- 
 tion of a protective policy, a change in the average size 
 of establishments, as a result of that policy, cannot be 
 regarded as assured. In any case, the development of 
 efficiency resulting from larger scale production must, 
 if it is to yield any net gain to the nation in question, be 
 so great that the desired goods can be secured at home 
 more cheaply than they could otherwise be imported. 
 Large scale production in other countries and purchase 
 of the goods from them may, in practice, better secure 
 the national welfare. 
 
 5 
 
 Protection to Industries of Increasing Cost 
 
 When commodities for home consumption must be 
 produced within a country under conditions of sharply 
 increasing cost and, because of limited resources, under 
 disadvantageous conditions at the margin of production, 
 the opportunity to import these commodities from abroad 
 is, perhaps, particularly to be desired. The policy of 
 protection to the home production of such goods causes, 
 in the protectionist country, production at an increas- 
 ingly greater cost according as the protection succeeds 
 in its object. Thus, Germany's policy of protection 
 
PROTECTION AND NATIONAL WEALTH 73 
 
 to agriculture, favored by the owners of agricultural 
 land, undoubtedly means the production of food at a 
 progressively higher cost in proportion as the protection 
 is effective. A high tariff protective to English agricult- 
 ure would probably raise the cost of food so high as to 
 starve to death millions of the English people. An anal- 
 ogous consequence follows from protection to manu- 
 factures when the tariff wall safeguards the more in- 
 efficient plants against loss from foreign competition, 
 compelling consumers to pay prices for the goods desired, 
 which will remunerate the inefficient as well as the effi- 
 cient home producers. Protection, then, forces con- 
 sumers to get many of the goods they require, at greater 
 cost, either because the production cost at home is 
 uniformly greater, or because protection compels the 
 use of the poorer soils, the poorer mines, the poorer sites, 
 or because it compels the giving of patronage to estab- 
 lishments which are relatively inefficient. 
 
 But may it not be desirable, in case a country has a 
 large export trade in goods produced under conditions 
 of increasing cost, e.g. wheat, to establish manufactures 
 by protection in order to draw capital and labor away 
 from the poorer or marginal lands ? Even here the pro- 
 tectionist policy involves a loss, though perhaps not so 
 great a loss. It is only if and because even the poorest 
 lands in use, following the terms of our illustration, 
 yield 20 bushels or $20 a week in Canada compared with 
 a possible 14 yards or $14 in the unprotected linen in- 
 dustry, that protection is required to establish the latter. 1 
 If it were more profitable than agriculture, even than 
 agriculture on the poorer lands, it would be established 
 without protection. If it requires protection, it is a less 
 
 1 Cf. what is said regarding protection of this sort, in Ch. V (of Part II), 5. 
 
74 ECONOMIC ADVANTAGES OF COMMERCE 
 
 profitable business from the standpoint of the whole 
 Canadian people, than agriculture on the best available 
 land and, therefore, than agriculture on the poorest 
 land actually used. 
 
 6 
 
 Effect of a Country's Protective Tariff System on the Cost 
 to it of Unprotected Goods Got from Other Countries 
 
 A protective policy, however, may conceivably give 
 to the nation which enforces it, indirect advantages 
 compensating in part or in whole for the losses incurred. 
 Though the conditions under which such advantages 
 would be at all comparable with the losses, could seldom 
 if ever occur in practice, it is perhaps worth while to show 
 what these conditions are. If Canada levies a high 
 tariff on linen from Ireland, and, as a result, following the 
 flow of gold to Canada, Canadian prices rise and Irish 
 prices fall, then other goods, e.g. laces, silks, etc., may 
 be produced in Ireland more cheaply than before. In 
 practice, the effect would be more largely a rise of Cana- 
 dian than a fall of Irish prices ; for the fall of prices due 
 to outflow of gold must eventually be distributed over 
 many countries and would be slight in each, while the 
 rise of prices would be felt in Canada alone. But, at 
 any rate, since Canadians receive more for their wheat, 
 the silk, etc., from Ireland (or other countries) can be 
 better afforded than formerly. 1 If, therefore, the result 
 of protection is that Canada receives more for her ex- 
 ports, and, while shutting out linen, gets certain other 
 
 1 This point is stated in relation to the protective policy by Taussig, Prin- 
 ciples of Economics, New York (Macmillan), 1911, Vol. I, p. 525. The prin- 
 ciple is exactly the same as was shown to apply to import revenue duties by Mill, 
 Principles of Political Economy, Book V, Ch. IV, 6, and by Bastable, The 
 Theory of International Trade, fourth edition, London (Macmillan), 1903, p. 
 118. Cf. also supra, Ch. Ill (of Part II), 3. 
 
PROTECTION AND NATIONAL WEALTH 75 
 
 foreign goods for a less price than formerly, so getting, 
 for example, more silk than previously for a given amount 
 of wheat, it is not entirely certain that Canada has lost 
 greatly by her tariff policy. 
 
 Needless to say, this is not an argument for protection 
 that would win it many votes. For a political campaign 
 speaker to tell the voters of Canada that a proposed 
 tariff will hinder a profitable trade and prevent their 
 getting linen cheaply from Ireland, but that in conse- 
 quence they may be able to buy silk somewhat more 
 cheaply than before in terms of wheat, would not be 
 likely to arouse any great enthusiasm. A more prob- 
 able result would be a demand from silk manufacturers 
 in Canada, or from would-be silk manufacturers, that 
 they also receive protection. The rising money cost of 
 production in Canada, and the tendency to falling cost 
 in Ireland, would imperil the Canadians' home market. 
 Especially would silk manufacturers in Canada be in- 
 jured, if they had to use machinery or raw material 
 directly raised in price by the tariff system. But if 
 the silk manufacturing and other lines of production 
 should also be protected, Canada would no longer gain 
 from the protection of linen the indirect benefit sug- 
 gested. The higher money incomes received in Canada 
 are no advantage if they must be spent in Canada, where 
 prices, counting prices of protected goods, have been 
 raised even more by the tariff, than have money incomes. 
 A consistently protectionist country can hope to realize 
 this indirect gain from protection, only on goods not 
 producible at home and, therefore, not protected. And 
 the direct loss in higher prices of protected goods may be 
 'very great indeed. As we have already seen, 1 many kinds 
 
 1 2 of this chapter (IV of Part II). 
 
76 ECONOMIC ADVANTAGES OF COMMERCE 
 
 of woolen goods have been costing Americans some 60 
 to 70 per cent more because of the tariff. 
 
 In the actual commercial world, Canada is the less 
 likely to realize much, at Ireland's expense (or at the 
 expense of other countries), through this indirect action 
 of the tariff, because Ireland (or any other country) has 
 the alternative of trading elsewhere, and is not obliged 
 to offer reluctant Canada bargains, in order to force a 
 trade, except as Canada may have a substantial mo- 
 nopoly of the production of certain goods. 1 Canadians 
 can get little, if any, more for wheat or other exported 
 goods than before, else Ireland will refuse to buy. And 
 rather than accept a low price for silk and other goods, 
 Ireland may sell them elsewhere than in Canada. It is 
 the more unlikely, therefore, that Canada will gain, thus 
 indirectly, as much as she loses directly, through the tariff. 
 
 In so far as a protective policy results in a larger quan- 
 tity of money and higher money prices in the protec- 
 tionist country, it is likely to lead to a demand for a 
 progressively higher and higher tariff. Assume, as 
 before, a 50 cents duty per yard levied by Canada on 
 linen. This at first makes linen cloth from Ireland 
 $1.50, while Canadian cloth can sell for $1.43 and still 
 yield as large a money return as the production of Cana- 
 dian wheat. This enables a Canadian linen manufac- 
 turer to undersell his rival of Ireland by 7 cents a yard. 
 But the flow of gold into Canada, resulting from the 
 tariff, will raise, among other prices, the money cost of 
 
 1 Even without a monopoly, if Canada supplied so much of the wheat used in 
 Ireland and other countries that for them to substitute wheat from other sources 
 would lower the margin of cultivation and raise wheat prices, Canada could con- 
 tinue to sell some wheat at slightly higher prices than before the tariff was laid. 
 There would remain, however, the probably much more important effect of the 
 tariff, for Canada, in the direct loss caused. 
 
PROTECTION AND NATIONAL WEALTH 77 
 
 producing linen. In Ireland, on the contrary, the ten- 
 dency will be towards a lower cost. Soon, therefore, the 
 Canadian manufacturer may find that $1.43 is not a 
 high enough price, while the linen manufacturer of Ireland, 
 even with the tax, may sell for less than $1.50. Unless 
 the tariff is further increased, some linen will soon be 
 secured from Ireland ; there will no longer be a net flow 
 of gold into Canada ; and Canadian prices will no longer 
 rise as compared with Irish prices. Or, as we have seen, 
 the same result is reached by Canadian purchase of other 
 Irish goods. Suppose, however, that the Canadian tariff 
 is progressively raised so as to maintain the 7 cent mar- 
 gin, and is raised on other Irish goods as well, and suppose 
 that Ireland's demand for Canadian goods is not checked 
 until money in Canada is -9- of its former amount and 
 in Ireland slightly less than before. Then, assuming 
 conditions of approximately constant cost, Canadian 
 wheat will sell for about $1.10 a bushel and Canadian 
 linen for $1.57, while linen made in Ireland will sell, 
 not counting the tariff, for slightly less than $i (not 
 much less, since any considerable fall of prices in Ireland 
 would cause an inflow of specie from Germany, France, 
 and elsewhere, so distributing over many countries the 
 effect of the outflow of money to Canada). To give 
 Canadian producers a 7 cents margin, the tariff will now 
 have to be so high that linen made in Ireland can sell, 
 in Canada, for not less than $1.64. Since this linen 
 sells, without the tariff, for $i or less, the tariff will have 
 to be $0.64 a yard 1 instead of the original $0.50. Even a 
 tariff to "equalize the cost of production" would need, 
 after this change in relative amounts of money, to be 
 $0.57 instead of $0.43. 
 
 1 We are here neglecting cost of transportation. 
 
78 ECONOMIC ADVANTAGES OF COMMERCE 
 
 But it must not be supposed that continuous extension 
 and increase of its tariff wall can raise prices in a country 
 without limit. Even if, as prices in Canada rise and in 
 Ireland, or elsewhere, fall, protection is given to each 
 article subject to foreign competition, which can be made 
 in Canada, and even if this protection is progressively 
 raised so as to prevent any purchase abroad by Cana- 
 dians as their money incomes increase, in short, even 
 if all importation of goods is effectively prohibited, the 
 rise of prices in Canada will nevertheless eventually 
 reach a limit. For, sooner or later, Canadian prices will 
 get so high that no goods whatever will be purchased in 
 Canada by people in foreign countries. 
 
 All these conclusions are the same, except as to nominal 
 prices, if we suppose Canada's currency system unrelated 
 to those of other countries. A high tariff would not 
 then raise Canadian money prices, but it would change 
 the relative value of Canadian and other monetary stand- 
 ards so as to make purchase of Canadian goods more 
 expensive to other countries in terms of their own money. 
 This fact has been frequently pointed out in preceding 
 pages. Here it is to be emphasized that it means cheaper 
 purchase of foreign goods in terms of Canadian goods. 
 A smaller amount of Canadian money than before will 
 buy drafts on foreign countries for more foreign money 
 and, therefore, goods than before, or will buy the gold 
 equivalent of more foreign money and goods than before. 
 Hence, Canadians are tempted, unless prevented by a 
 tariff, to buy foreign goods which they did not previously 
 buy and even, unless the tariff protection is increased, 
 to buy goods on which the protection seemed, at first, 
 adequate (though not excessive) . 
 
PROTECTION AND NATIONAL WEALTH 79 
 
 7 
 
 A Tariff "Equal to the Difference in Cost of Production 
 at Home and Abroad, together with a Reasonable Profit' 1 
 
 In view of these facts, together with the fact that the 
 same kinds of goods are produced simultaneously at 
 different costs, the proposition, prominently put forth 
 in recent politics, to establish a tariff which shall " equal 
 the difference in the cost of production at home and 
 abroad, together with a reasonable profit," 1 is chimeri- 
 cal. There is no fixed difference, independent of the tariff, 
 in the home and foreign costs of production. For the 
 difference in these costs is dependent, to some degree, 
 on the relative levels of prices at home and abroad, 
 which are affected by the flow of gold, which is, in turn, 
 at least in some degree affected by the tariff. The tariff 
 itself, that is, helps to cause the very difference in cost 
 of production which is set forth as a justification for it. 
 As we have seen in our illustration, a tax of 43 to 50 cents 
 per yard may be, at the start, the amount necessary to 
 equalize cost of production in the protectionist and other 
 countries, and yield a " reasonable" profit; yet later, if 
 a protective tariff policy has been followed, a higher tax 
 than 43 cents may seem equally necessary to equalize 
 conditions, and this just because the tariff itself has 
 widened the cost difference. In addition, the cost of 
 production may be directly increased by tariff duties on 
 the machinery and raw materials of industry. 
 
 Again, "cost of production," if not further defined, 
 may be taken to mean marginal cost, average cost, or 
 cost under the most favorable circumstances. Is a tariff 
 
 1 Republican party platform of 1908, Republican Campaign Text-Book, 1908, 
 p. 462. 
 
8o ECONOMIC ADVANTAGES OF COMMERCE 
 
 which equals the difference in cost of production at home 
 and abroad, to be high enough adequately to protect 
 the marginal producer, or the average producer, or only 
 the producer best situated? In manufacturing, is it 
 to protect the struggling factory hardly able to maintain 
 itself, or only the most efficient ? If protection is to be 
 given to the producer under greatest difficulties and to 
 the most inefficient producer, the burden on consumers 
 may be very great. Furthermore, inefficiency is in some 
 degree encouraged, instead of being weeded out. The 
 recent Tariff Board found in the cotton manufacturing 
 industry of the United States not only modern estab- 
 lishments, but also some of low efficiency and considerable 
 antiquity. 1 Some 6o-year old spinning and weaving 
 machinery was still in use. A system which protects 
 producers the more highly the less efficient they are, 
 though promulgated as a "scientific" solution of the 
 tariff problem, would seem, in view of these considera- 
 tions, very far from being such a solution. If, on the 
 other hand, the protection is intended only to equalize 
 conditions for the average or best producers, as opposed 
 to foreign competitors, there is still a loss to consumers, 
 and there is also the objection, from the protectionist 
 point of view, that such a policy would leave without 
 adequate protection the very producers most needing 
 help. 
 
 8 , 
 
 Relative Advantages in the World's Commerce of Countries 
 having High and Countries having Low or No Tariffs 
 
 Before closing our discussion of protective tariffs in 
 relation to national prosperity, there is one general truth 
 
 1 Report of the Tariff Board on Schedule I of the Tariff Law, Vol. 2, p. 416. 
 
PROTECTION AND NATIONAL WEALTH 81 
 
 to which we may properly give special emphasis. This 
 truth is that, among a number of trading countries, those 
 with low or with no tariff restrictions have the least to 
 lose. 1 If, for example, Great Britain alone adheres to 
 the principles of free trade, while all other nations main- 
 tain high import duties (or high export duties, or both), 
 then Great Britain's position in trade is relatively the 
 best. In the first place, purchasers in all other coun- 
 tries will buy of Great Britain rather than of countries 
 where the large quantity of money due to protection (or 
 where high export duties, if such were common) makes 
 prices of goods exported by them high ; and this very 
 turning of the demand to Great Britain will enable 
 British producers to get, for what goods they are able, 
 despite foreign protective tariffs, to export, higher prices 
 than if their rivals in selling each special kind of goods 
 in a given market, were similarly untrammelled. In 
 the second place, sellers of goods produced in all other 
 countries, being unable to sell so easily and profitably 
 to countries maintaining protective tariffs against them 
 (or to countries, if there were any such, whose export 
 tariffs make their home prices low), will be the more 
 anxious to sell all they can in Great Britain ; and they 
 will make even lower prices in selling to Great Britain 
 than otherwise they would, because it is so difficult to 
 secure a market and to sell at a profit, anywhere else. 
 Protectionist writers have sometimes hinted that free 
 trade, or tariff for revenue only, might be very good if 
 all nations practised it, but that so long as other coun- 
 tries practise protection, we must do so in self-defence. 
 The truth is that the best possible way for a nation to 
 adapt itself to the conditions caused by the bad policy 
 
 1 Cf. Bastable, The Theory of International Trade, p. 122. 
 PART H G 
 
82 ECONOMIC ADVANTAGES OF COMMERCE 
 
 (e.g. protective tariffs) of the others, is to avoid imitating 
 that bad policy. Then it has an advantage over these 
 others and gains trade and profit which they cannot. 1 
 
 It does not follow that Great Britain is better off be- 
 cause other nations have high duties. So far as other 
 countries become self-sufficient by means of their tariffs, 
 Great Britain also may be forced to be more self-sufficient 
 than would otherwise be necessary. But so far as some 
 trade still persists, despite these interferences, Great 
 Britain has an advantage in getting it and in gaining 
 from it, over all the others. Each country's tariff lessens 
 Great Britain's trade with that country and so tends to 
 decrease the wealth of both Great Britain and the country 
 levying the tariff. But each country's tariff hurts that 
 country as a competitor of Great Britain in trade with 
 third and fourth countries, and so gives Great Britain 
 an advantage over it. 
 
 Largely, we may reasonably suppose, through the 
 operation of these principles, the foreign commerce of 
 the United Kingdom long since reached a volume which 
 that of none of her protectionist rivals has yet been able 
 to attain. Not only do the people of the British Isles 
 trade extensively with the English-speaking peoples of 
 their own colonies and with the United States, but their 
 commerce is the greatest with, for example, most of the 
 South American republics, 2 as well as with many other 
 countries. Their ships plough the remotest seas and carry 
 the products of English mines and factories to parts of 
 the earth almost unknown to American exporters. Like- 
 wise, from all parts of the world come the raw materials, 
 
 1 Cf. Sumner, Protectionism, New York (Holt), 1885, pp. 138, 139. 
 
 2 See comparative statistics in any of the recent annual reports on Commercial 
 Relations oj the United States. 
 
PROTECTION AND NATIONAL WEALTH 83 
 
 the food supplies and other goods, which the British 
 people require and which they can buy more cheaply 
 abroad than they can produce at home. Raw cotton 
 they get from the United States, from Egypt, from 
 India, to be reshipped to South America and elsewhere 
 as cotton fabrics, or to be made up into wearing ap- 
 parel for themselves. Wheat they secure from the 
 United States, Canada, Argentina, and other countries, 
 and they secure it, we must conclude, all the more 
 cheaply because some of the European nations restrict 
 its importation by means of protective duties. Wool is 
 available particularly in South America and in Australia. 
 In short, the whole world is a British market so far as 
 the British people can make it so, and from countries 
 near and far they draw the riches which other nations, 
 by foolish tariff restrictions, shut away.- 
 
 9 
 
 Summary 
 
 The general conclusion of this chapter is that a pro- 
 tective tariff reduces, and may reduce considerably, 
 the total wealth of the country which adopts it. By as 
 much as it hinders imports, by so much it must, in the 
 long run, interfere with the development of an export 
 trade. It diverts the productive force of a country from 
 lines in which it is relatively effective to lines in which its 
 effectiveness is less. Even if those who are protected 
 gain some benefit from the policy, they gain less than 
 others in the country lose. Protection tends to raise all 
 money prices, including money incomes, in the protected 
 country. But there is a special rise of price of protected 
 goods, not balanced by any rise of money incomes. 
 
84 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Therefore, prices of goods rise, on the average, more than 
 money incomes, and the general prosperity is reduced. 
 It is conceivable, but improbable, that protection of 
 some industries may result in larger establishments 
 within the protectionist country and a gain in efficiency 
 enough to make home production as cheap as foreign. 
 When an industry of increasing expense (diminishing 
 returns) is protected, the injurious effects on national 
 prosperity are the greater, the more the tariff extends 
 the industry. Protection may give to a country indirect 
 advantages in the form of better rates of interchange 
 on other, unprotected goods, but this gain is not likely 
 to be great, since other countries have the option of 
 trading elsewhere than with the protectionist country. 
 If such a gain were likely to be realized, there would 
 probably be a demand, in the protectionist country, 
 for the taxation of imports of these other goods in so 
 far as they could be produced at home, and so a partial 
 prevention of the gain. 
 
 If protection is applied moderately but upon many 
 goods, so that the scale of prices in the protectionist 
 country rises compared with others, even some of the 
 protected goods may come to be imported to some extent 
 from countries whose prices have not thus been artifi- 
 cially raised. If so, there is likely to be a demand for 
 further protection^ The proposition to levy a tariff 
 which shall be equal to the difference in cost of produc- 
 tion in the protected country and abroad, overlooks the 
 fact that this difference in cost is, to some extent, a 
 consequence of high protection. It overlooks, also, the 
 fact that cost is not the same in all establishments or on all 
 sites, within a single country. 
 
 Despite the frequent claim of some protectionists that 
 
PROTECTION AND NATIONAL WEALTH 85 
 
 any one country must adopt a protective tariff system 
 because others do, the truth is that a country which, 
 among others having high import duties (or export duties 
 or both), maintains free trade or only low tariffs, has an 
 advantage, because of this policy, over all the others. 
 
CHAPTER V 
 
 THE EFFECTS OF PROTECTION ON THE DISTRIBUTION OF 
 NATIONAL WEALTH AMONG ECONOMIC CLASSES AND 
 TERRITORIAL SECTIONS 
 
 i 
 
 Effect of Protection on the Rate of Interest and Therefore 
 
 on Wages 
 
 IN discussing the effects of a protective tariff on the dis- 
 tribution of wealth and income among economic classes, 
 it is important that we have in mind some idea of the 
 laws according to which wealth and income are divided. 
 The benefits, or the wealth and income, resulting from 
 production are said to be divided among capitalists, 
 laborers, and land owners. Capitalists receive interest ; 
 laborers receive wages ; land owners receive rent. 
 
 Interest arises, in large part, from the surplus pro- 
 ductivity of indirect or roundabout production, over 
 direct. 1 Men can produce consumers' wealth and in- 
 come by applying labor with the aid of existing machin- 
 ery, or they can devote time to increasing the amount 
 of machinery in order to get, later, larger results. The 
 second method is more indirect or roundabout. It 
 
 1 It is not claimed that the theory of interest as here briefly stated is com- 
 plete, or anything but a working theory sufikient, perhaps, for the requirements 
 of this chapter. The subject of interest is so interwoven with other economics, 
 that it cannot be satisfactorily treated in a few paragraphs. The critical reader 
 is referred to the writer's article in the Quarterly Journal of Economics, August, 
 1913, entitled "The Marginal Productivity versus the Impatience Theory of 
 Interest," and to a later article in The American Economic Review, June, 1914. 
 on "The Discount versus the Cost of Production Theory of Capital Valuation." 
 
 86 
 
PROTECTION AND DISTRIBUTION 87 
 
 yields, in general, 1 a surplus product over what can be 
 secured by the more direct method. But roundabout 
 production, i.e. production by first making tools, ma- 
 chinery, etc., yields a smaller surplus the further it is ex- 
 tended. The more tools, machinery, and other capital 
 equipment we have (after a certain point is reached) , the 
 less desirable is it further to increase this equipment. 
 The gain or surplus from so doing becomes smaller and 
 smaller, yet for a long time, perhaps indefinitely, remains 
 a gain. 
 
 But thus to extend the roundaboutness of production 
 requires a supply of goods for the present maintenance 
 of those occupied in constructing the necessary capital, 
 since they, being engaged in roundabout production, 
 cannot secure this present maintenance from their 
 present labor. Possession of goods which may serve as 
 means of maintenance for laborers during the roundabout 
 production process, enables production to be carried on 
 thus indirectly with the consequent larger product. 
 For this reason, a surplus in future goods will be paid 
 for a given amount of present goods ; $100 to-day may 
 buy $105 next year, for $100 to-day makes it possible to 
 turn away from production for immediate needs and to 
 produce, by the usually larger yielding indirect method, 
 for the future. For the use of the present consumable 
 goods which make indirect production possible, a pre- 
 mium will be paid by those desiring control of the 
 present goods; and this premium will depend on the 
 gain which indirect production yields. The possessors 
 of command over present goods, on the other hand, will 
 not trade them for future goods except for a premium, 
 
 1 Not necessarily, but unless the indirect process is expected to yield more, it 
 will not be adopted. 
 
88 ECONOMIC ADVANTAGES OF COMMERCE 
 
 because these present goods can be used in support of 
 themselves and those they hire and so can make it possible 
 for them to engage in roundabout production and reap 
 the surplus. To dispose of their command over present 
 goods is, in so far, to give up this possibility, and they 
 will not give it up without compensation. The rate of 
 interest, then, is determined, on both the supply and 
 demand sides of the market, the side of those who want 
 and that of those who have command over present goods, 
 by the rate of surplus productivity 1 of roundabout over 
 more direct production. 
 
 To recapitulate, the more largely production is round- 
 about or capitalistic, the larger is the total amount of 
 wealth and income yielded ; the more largely production 
 is capitalistic, the less additional gain is realized by the 
 further extension of roundabout production ; the greater 
 the accumulations of society, and the further indirect 
 production is extended, the lower (other things equal) 
 is the rate of interest. Large accumulations and great 
 extension of roundabout production make social wealth 
 greater, the rate of interest lower, the rate of wages 
 higher. We saw, in the last chapter, that a protective 
 tariff tends to decrease the productive efficiency of a 
 country which applies it. Such a tariff makes more 
 difficult the process of accumulation. It tends somewhat 
 to lessen the degree of roundaboutness in production, to 
 lessen the extent to which production is capitalistic. 
 Protection, therefore, because it lessens national wealth 
 through turning industry into less profitable channels, 
 may lessen national wealth further by making production 
 less capitalistic. If it does this, it will tend to raise the 
 rate of interest, though not necessarily the total amounts 
 
 1 At the margin of indirect production. 
 
PROTECTION AND DISTRIBUTION 89 
 
 received as interest since the higher rate will be on smaller 
 capital ; while it will tend to reduce wages both by giving 
 to capitalists a larger proportion of the results of round- 
 about production and by making production, on the 
 whole, less roundabout and, therefore, less efficient. 
 This indirect effect which a protective tariff may have on 
 wages, through its effect on accumulation and the rate 
 of interest, is without doubt very much less important 
 than the more direct effect to be next discussed, but 
 its operation, so far as it does affect wages, is unfavorable. 
 
 2 
 
 Brief Statement of Laws of Wages and Land Rent 
 
 The general level of wages is determined, like other 
 prices, by supply and demand. The wages which will 
 equalize supply of and demand for labor will be higher 
 or lower according as labor is more or less productive. 
 Should the productivity of labor double, wages would 
 double. For if labor would produce twice as much as 
 before and wages did not rise correspondingly, the profit 
 to be realized in hiring labor would be very great. This 
 would increase the demand for labor until, if wages did 
 not rise, demand would exceed supply. Hence, wages 
 must rise and must rise in proportion. We have refer- 
 ence here to real, as distinguished from money, wages; 
 that is, to the necessaries, comforts, and luxuries which 
 wage earners receive, rather than to the mere number of 
 dollars. 
 
 If all land were equally fertile and all sites equally 
 good, and if desired land and space were unlimited, wages 
 would equal the whole product of labor except interest. 
 Those who advanced the means required to make pro- 
 
go ECONOMIC ADVANTAGES OF COMMERCE 
 
 duction more roundabout, would enjoy interest ; beyond 
 this, labor would get the entire product of industry. 
 But all land is not equally fertile ; all sites are not equally 
 satisfactory ; land and space are not unlimited ; and 
 there is to be reckoned with, the great law of diminish- 
 ing returns. Whether in agriculture, manufacturing, or 
 other work, an increase of labor upon any given space or 
 area will not, beyond a certain point, result in a pro- 
 portionate increase of the product. Two men, on a 100- 
 acre farm, may secure twice or more than twice as great 
 a result as can one. But it is pretty certain that two 
 hundred men, working on that farm, will not secure 100 
 times as large a product as can two men. So, in manu- 
 facturing, a point of maximum economy is reached, 
 beyond which it does not pay to crowd men together on a 
 limited area or to build story upon story, but beyond 
 which larger production requires more land. Since all 
 land is not equally good, this means that larger production 
 requires the use of less productive land and sites than 
 would otherwise have to be used. 
 
 To illustrate the bearing of these facts upon the theory 
 of wages and rent, let us consider the case of a loo-acre 
 farm. Upon it, two men might be able to produce wheat 
 at the rate of 3120 bushels a year or an average of 60 
 bushels a week, three men an average of 85 bushels a 
 week, four men 105 bushels, five men 120 bushels. Then 
 the third man adds 25 bushels to the product which would 
 result from two men's work ; the fourth man would add 
 20 bushels; the fifth, 15 bushels. Suppose that wheat 
 is $i a bushel. Then, if wages are not more than $25 
 a week but are enough less to pay interest on the wages 
 advanced, the owner of the land will hire three men to 
 cultivate it. He will not hire a fourth, since a fourth will 
 
PROTECTION AND DISTRIBUTION 91 
 
 add but 20 bushels, worth $20, to the product. If, 
 however, wages are slightly less than $20 a week, he will 
 hire four men; and if they are slightly less than $15, 
 he will employ five. The higher wages are, the fewer 
 men he will employ. The lower wages are, the more men 
 he will employ. This is true of all employers. Some 
 land is so poor that no one can afford to work it or hire 
 others to work it, if wages are high. If wages are low, 
 this land can be worked profitably. In general, the 
 lower wages are, the greater is the demand for labor. 
 More men are desired on the more productive sites and 
 men are desired for the utilization of sites that otherwise 
 would stand undeveloped. At any level of wages, 
 employers will hire men up to the point where the last 
 man hired just produces his wages or just produces his 
 wages plus interest. 
 
 To the extent that industry is carried on under nearly 
 constant cost, a great amount of labor can be employed 
 at wages almost as high per man as would be paid to a 
 smaller number of laborers. Very little reduction of 
 wages is required to increase, greatly, the demand for 
 labor, since many employees can be hired before the 
 worth of the last man (the marginal product of labor), 
 becomes less than his wages. If, on the other hand, 
 industry is carried on under conditions of sharply in- 
 creasing labor cost (diminishing returns), any consider- 
 able increase in the demand for labor (other things equal), 
 will not take place except at greatly reduced wages. If, 
 therefore, the industry of a country is forced into a line 
 of sharply increasing labor cost, real wages must become 
 lower ; though it is likewise true that if industry is forced 
 into a line of constant labor cost into which it would not 
 naturally go, real wages will probably become lower. 1 
 
 1 See 5 of this chapter (V of Part II). 
 
92 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Ignoring interest, the law of which we have already 
 stated, the surplus of production above the amounts paid 
 as wages constitutes land rent and goes to the owners of 
 land. In our illustration, at wages of $20 a week or 
 slightly less, not more than four men would be employed 
 on the given farm. No one of them would be employed 
 at more than $20 wages, because no one of the four adds 
 more than 20 bushels or $20 to what the product would 
 be without him. The weekly wages of all four will not, 
 therefore, exceed $80. The total product, however, with 
 four men working, is 105 bushels or $105 worth. This 
 leaves $25 a week as land rent to the owner of the farm. 
 If wages were lower, not only would more men be em- 
 ployed, but rent would be higher. If wages were higher, 
 fewer men would be employed and rent would be lower. 
 Some land will yield higher rent ; some is so poor as to 
 yield no rent. 
 
 When protection turns the industry of a country into 
 a line which it otherwise would not follow, the rents of 
 lands or sites required in this line tend to rise, and the 
 owners of these lands and sites become more prosperous. 
 On the other hand, the rents of lands or sites which were 
 used in the lines from which industry has been turned, 
 tend to fall, and the owners of these lands and sites 
 become less prosperous. Our task is to inquire what, in 
 general, is the effect of protection on the total rent pay- 
 ments and on the general level of real wages in the 
 protectionist country. 
 
PROTECTION AND DISTRIBUTION 93 
 
 3 
 
 The Effect of Protection on Wages when Protected and Un- 
 protected Goods are Produced in the Protectionist Coun- 
 try, under Conditions of Substantially Constant Cost 
 
 Let. us, to begin with, consider the effect of protection 
 on wages, when both protected and unprotected goods 
 are produced, in the protectionist country, under condi- 
 tions of substantially constant cost. Under these condi- 
 tions, a tariff will not greatly affect land rent. The first 
 effect of protection is, as we have seen, 1 to raise the prices 
 of protected goods by not more than the amount of the 
 tariff, without affecting money wages. The secondary 
 effect of protection, resulting from the inflow of money 
 (so far as protection occasions such an inflow), is to raise 
 prices of unprotected goods and money wages, and to 
 further raise the prices of protected goods. Canada's 
 protective tariff on linen has, as its first effect, a 43 cents 
 or a 43 per cent rise in price per yard, wages remaining the 
 same, viz. about $20 a week (a week's labor producing 
 20 bushels of wheat worth $i a bushel). The second 
 effect may be to raise everything 10 per cent. If, under 
 conditions of constant cost in all lines, there is such a 
 general rise of prices due to money inflow, we must 
 suppose that, until this rise reaches 10 per cent, there will 
 be some Canadian goods still sufficiently in demand else- 
 where to maintain the inflow of gold, though wheat, 
 because of competition from other sources, may not be 
 such a good. Assuming such an average secondary 
 rise of 10 per cent, and that all goods are produced under 
 conditions of constant cost, this rise must affect any one 
 kind of goods, e.g. wheat. Otherwise, those producing 
 
 i See Ch. IV (of Part II), i and 2. 
 
94 ECONOMIC ADVANTAGES OF COMMERCE 
 
 that kind of goods will turn to some other line. If wheat 
 cannot be exported at the higher price, only enough will 
 be produced for home consumption, and the other wheat 
 producers will become linen producers, etc. Then the 
 total increase of wheat in price is 10 per cent, and of 
 money wages 10 per cent, but of linen 57 per cent (43 
 per cent and 10 per cent more added to the new price 
 of $1.43 makes $1.57). Obviously, the average wage 
 earner's condition is worse because of the tariff, even 
 though his money wages are somewhat higher than 
 otherwise they would be. If the protectionist country 
 has an inconvertible money system unrelated to foreign 
 systems, money wages and unprotected goods will remain 
 the same in price as before, while protected goods rise 
 in price. Wage earners will be worse off. With a com- 
 mon money standard, gold, for the countries trading, 
 prices in the protectionist country, even of unprotected 
 goods, rise, and wages rise in the same proportion ; but 
 since wages rise in no greater proportion, and since 
 protected goods do rise in price by a greater proportion, 
 real wages are lower. 1 
 
 Our conclusion as to money wages is only that a high 
 tariff will tend to make them higher in a given country 
 
 1 A restrictive duty on the export of wheat would cause an outflow of gold 
 and a fall in the general level of prices but would likewise reduce real wages. 
 The decreased market for wheat would lower its price in Canada and would 
 lower in the same degree (assuming it to be produced under conditions of con- 
 stant cost) the money wages of producers. But the price of linen, into the pro- 
 duction of which Canadian labor might in considerable degree be eventually 
 forced, could not, since Canada is at a relative disadvantage in its production, 
 fall, to the same extent, below the price at which it was previously imported. 
 At that price, outflow of money for linen would cease. Under the conditions 
 of production assumed, Canadians could better afford to produce wheat even 
 for but 70 cents a bushel than to produce linen for appreciably less than $i a 
 yard. Twenty bushels at 70 cents a bushel or 14 yards at $i a yard would alike 
 yield but $10 a week. A week's wages would buy as much wheat as before but 
 less linen. Hence, real wages would be lower because of such a tax. 
 
PROTECTION AND DISTRIBUTION 95 
 
 than they would be in that same country in the absence 
 of the tariff. It does not follow that money wages will 
 be, necessarily, higher in a protectionist country than in 
 a free trade country. In a prosperous country, money 
 wages as well as real wages will be, other things equal, 
 higher than in a country not prosperous. In the United 
 States, for example, average money wages, as well as 
 average real wages, are higher than in Europe. This is 
 due to the fact that in many lines we have great natural 
 resources without having too dense a population. We 
 are productive in many lines of agriculture, particularly 
 perhaps in the raising of wheat, corn, and cotton. We are 
 also productive in certain lines of manufacture, having, 
 for example, in Pennsylvania and in Alabama, great 
 advantages for the manufacture of steel and steel prod- 
 ucts. In these various lines of effort, the United States 
 is so productive that, even with reasonably low prices 
 received for the goods, the daily wages of labor in these 
 lines are high compared with European standards. Since 
 we are, in these lines of activity, so productive, those in 
 all other lines of industry must get equally high wages or 
 they will go into these. That is, assuming open compe- 
 tition, the national prosperity cannot be confined to any 
 one occupation. Thus, since our wheat raisers and steel 
 producers are prosperous, our bricklayers, carpenters, 
 plumbers, etc., need to be well rewarded to keep them in 
 their work. Therefore, the prices of houses and of other 
 goods which cannot be imported, and in producing which 
 this country does not have the superiority that it has in 
 cotton, wheat, steel, etc., will be high. 
 
 From these considerations it would appear that if 
 wheat, cotton, steel, and some other lines of industry are, 
 in the United States, exceptionally productive, it is the 
 
96 ECONOMIC ADVANTAGES OF COMMERCE 
 
 most economical policy for us to import other products 
 which we can obtain more cheaply abroad, rather than to 
 employ our own high-priced labor in relatively unpro- 
 ductive effort. The prosperous country ought to have 
 higher money wages, but not higher prices of importable 
 commodities except as transportation and distributing 
 costs make them higher. The fact that we have great 
 natural resources in comparison to population, and that 
 our labor is in some lines very productive, should make 
 us immensely more prosperous than the older and more 
 crowded countries whose resources in comparison with 
 their populations are much less than ours, and should 
 make real wages markedly higher here. For decades 
 we have had a tariff policy admirably adapted to raise 
 the cost of living and decrease our prosperity. If we 
 have been prosperous and if our wages have been high, 
 it has been in spite of and not because of the tariff. 
 Comparing two European countries, England and Ger- 
 many, the former the stock example of free trade, the 
 latter a protectionist country, we find prices some 18 
 per cent higher in Germany and money wages lower. 1 
 
 1 See "A Comparative Study of Railway Wages and the Cost of Living in 
 the United States, the United Kingdom, and the Principal Countries of Con- 
 tinental Europe," Bureau of Railway Economics, Bulletin No. 34, Washington, 
 D.C., 1912, pp. ii, 35, and 67. In the same Bulletin (p. n), it is shown that 
 railway wages in the United States in 1900-1910 averaged $2.23 per day as com- 
 pared with wages in England and Wales for 1910 of $1.067. It is also shown 
 (p. 67) that prices in the United States for goods in workmen's budgets in 1909 
 were 38 per cent higher than in England and Wales. It appears, therefore, 
 that despite the tariff, naturally favoring conditions have kept American real 
 wages somewhat higher than English wages, but not so much higher as a com- 
 parison of money wages alone might lead us to suppose. Comparative railway 
 wages are probably as good an index of comparative wages in general as is 
 available. 
 
PROTECTION AND DISTRIBUTION 97 
 
 4 
 
 The Eject of Protection on Wages and Rent when the 
 Protected Goods are Produced under Conditions of 
 Sharply Increasing Cost 
 
 Still, assuming the unprotected product, wheat, to be 
 produced in Canada at so nearly constant cost that the 
 withdrawal of some labor into linen making will not 
 appreciably lower the price of wheat, let us suppose the 
 conditions to be such that linen manufacturing, in 
 Canada, can be extended only at increasing cost. We 
 may suppose, for instance, that there are a very few sites 
 favorably located near sources of cheap power and on 
 transportation lines, and that upon these sites linen can 
 be produced, even in Canada, for $i a yard, or, at worst, 
 for less than $1.43. But most of the desired supply, in 
 the absence of protection, is obtained from Ireland, 
 Protection, by shutting out the supply from abroad, 
 encourages the use of the poorer sites in Canada, since 
 the better sites, by our hypothesis, cannot produce 
 enough to satisfy the demand. To remunerate pro- 
 ducers on the poorer sites, the price must be higher, say 
 $1.43 a yard. If it is not, producers on the poorer sites 
 cannot pay the prevailing rate of wages. If it is, pro- 
 ducers on the better sites have a surplus or rent, since 
 production costs them, in wages, less money per yard 
 than it costs producers on the poorer sites. 
 
 Otherwise expressing the matter, we may say that a 
 week's labor in Canada will produce 20 yards of linen 
 on the better sites, but only 14 on the poorer sites. If 
 the poorer sites are to be used, wages cannot be more than 
 14 yards a week or the money equivalent of 14 yards. 
 But the owners of the better sites have a surplus, after 
 PART n H 
 
98 ECONOMIC ADVANTAGES OF COMMERCE 
 
 paying these wages, of 6 yards or the money equivalent 
 of 6 yards. 
 
 So far, then, as Canada supplies itself, after the protec- 
 tive policy is adopted, with Canadian linen manufactured 
 on the most favorable sites, there is no national loss. 
 Wages, that is, real wages, are lower. The rents of the 
 favorable factory sites are higher. Money wages are not 
 lower, but linen is higher in price, and the rise goes to 
 increase the incomes of land owners. So far as Canada 
 supplies itself with linen from the less advantageously 
 located factories, the higher price means a loss to wage 
 earners with no corresponding gain to the owners of land. 
 Under the conditions of production here assumed (pro- 
 duction of linen under conditions of increasing cost and 
 of wheat at nearly constant cost), the protective tariff 
 would indeed decrease the net wealth and income of the 
 protectionist country, but the land owning class would 
 gain. 1 Rents of lands required for the protected industry 
 (assumed to be of increasing cost) would rise to a greater 
 degree than rents of lands required for unprotected in- 
 dustries (assumed to be, within limits, of nearly constant 
 cost) would fall. The total national loss in yearly income 
 would therefore be less than the loss of the wage earning 
 class alone. Part of the loss of the wage earning class 
 would be absolute national loss ; the rest would be loss 
 balanced by land owners' gain. 
 
 No essential corrections need to be made in these con- 
 clusions because of the inflow of money resulting from 
 
 1 A similar result, except that there would be an outflow of money and a fall 
 of money prices, would follow, under our assumptions, from a restrictive export 
 duty on wheat. Such a duty would prevent production of wheat for export, 
 drive some Canadian labor into other lines, e.g. the manufacture of linen, even 
 though for small returns, reduce real wages, and raise the rents of land and sites 
 required in the newly expanded lines of industry. 
 
PROTECTION AND DISTRIBUTION 99 
 
 protection. Under the assumed conditions, the second- 
 ary rise of prices so caused would affect rents, wages, and 
 nearly all prices, alike. 
 
 Duties of the special kind here criticised, we have had 
 in plenty in our own various protective tariff acts. Our 
 protective tax on coal, compelling resort to the poorest 
 native mines in preference to securing some coal from 
 abroad, has doubtless tended to increase the value of 
 native mines and the profits of mine owners, but has done 
 this only at the greater expense of the wage earning pub- 
 lic. The protection accorded to raw wool by the much 
 criticised schedule K of the Payne-Aldrich tariff bill, 
 certainly tended to encourage the production of wool 
 in the United States on lands which, otherwise, it would 
 not have paid to use for that purpose. The owners of 
 lands used for sheep raising were doubtless in many cases 
 able to realize larger profits or higher rents, but only at 
 the greater expense of others, largely the wage earners. 
 
 In estimating the relative costs of production of raw 
 wool in different countries and in different parts of the 
 United States, the Tariff Board subtracted the receipts 
 to sheep raisers from other things than the wool, chiefly 
 from mutton. There was left, in their reckoning, a cost 
 which the wool must cover. This surplus cost they found 
 to be nothing in New Zealand and on the favorably sit- 
 uated runs of Australia, a very few cents a pound for 
 Australasia in general, 4 or 5 cents a pound for South 
 America, gj cents a pound for the United States, 
 ii cents for the "fine" and "fine medium" wools of the 
 American west, and 19 cents for the fine wools of Ohio 
 and the contiguous territory. 1 The effect of protection 
 
 i Report of the Tariff Board on Schedule K of the Tariff Law, 1912, Vol. I, 
 Part I, pp. 10, ii. 
 
ioo ECONOMIC ADVANTAGES OF COMMERCE 
 
 (now, fortunately, removed from raw wool) has been to 
 shut out very largely the lower priced foreign wool, 
 to compel the use of the high-priced American wool, to 
 make wool production profitable on lands relatively 
 unsuited for it, to make the rental value of these lands 
 higher, and to make real wages lower. In the opinion 
 of the tariff board, the highest production cost in the 
 world, of the merino wools largely required by American 
 mills, is in the state of Ohio and near-by surrounding 
 territory ; 1 yet a high protective tariff on raw wool so 
 shut off the supply from abroad as to cause large produc- 
 tion of it in that region. That the general effect of this 
 protection to raw wool, accorded by the Payne-Aldrich 
 tariff bill, must have been to lower wages while probably 
 raising the rents of land owners, hardly seems open to 
 serious question. 
 
 5 
 The Effect of Protection on Wages and Rent when 
 
 Unprotected Goods are Produced under Conditions of 
 
 Sharply Increasing Cost 
 
 We may now consider a third possibility as to costs of 
 production, viz. that the protected goods, e.g. linen, are 
 produced under conditions of nearly constant cost, 
 while the unprotected goods, e.g. wheat, are produced 
 under conditions of increasing cost. Under these cir- 
 cumstances, not much labor can be turned into linen 
 manufacturing without lowering the marginal labor cost 
 of producing wheat. For as labor is diverted from 
 wheat to linen production, the poorer wheat lands are 
 deserted, and on the better lands a week's labor can 
 produce more than 20 bushels. If, therefore, Canada's 
 
 1 Report of the Tariff Board on Schedule K of the Tariff Law, 1912, Vol. I, 
 Part I, pp. 10, ii. 
 
PROTECTION AND DISTRIBUTION 101 
 
 tariff effectively excludes foreign linen, either Canadian 
 linen will sell for more than $1.43 a yard or Canadian 
 wheat for less than $i a bushel or both such changes will 
 occur. Otherwise no one will desert any but the very 
 worst wheat lands in order to produce linen. Competi- 
 tion of wheat raisers who would rather sell wheat for less 
 than $i a bushel than linen for only $1.43 a yard will 
 tend to keep wheat prices down. Reluctance of such 
 persons to produce linen will tend to keep linen prices up. 
 The ratio of the value of a bushel of wheat to the value of 
 a yard of linen must lie at such a point that returns to 
 marginal producers (i.e. producers having the least favor- 
 able situations, but whose goods are nevertheless de- 
 manded), shall be about equal in both lines. Hence, it 
 will take more than 20 bushels of wheat to equal in value 
 14 yards of linen. If Canada were financially isolated 
 and the quantity of money in Canada remained un- 
 changed, we should expect that the changed conditions 
 of cost would be accompanied by both a rise of linen 
 and a fall of wheat prices. Unless there was an increased 
 quantity of currency in Canada, a rise of the price of linen 
 above $1.43 a yard could hardly take place (other things 
 equal) without a fall in the price of wheat below $i ; and 
 unless there was a decreased supply of currency, wheat 
 could hardly fall below $i without there being a rise in 
 the price of linen above $1.43. 
 
 But with Canada maintaining a gold standard, the 
 common standard of most of the commercial world, and 
 having a foreign market for her wheat, the price of the 
 wheat cannot greatly fall. Any tendency of the price 
 to fall, in Canada, would be counteracted by exportation 
 and sale abroad at world market prices. Any change in 
 relative values will be through a rise in price of linen 
 
102 ECONOMIC ADVANTAGES OF COMMERCE 
 
 above $1.43, rather than through a fall in price of wheat 
 below $i. Since importations of goods into Canada 
 are interfered with, there must be for a time a net money 
 inflow, and there must be a money inflow for wheat if 
 and so long as it sells for much less than $i a bushel. 
 This inflow of money into Canada tends to raise average 
 prices in the proportion of the money inflow. Were the 
 wheat produced under conditions of approximately 
 constant cost, the inflow of money must necessarily tend 
 to raise its price in the same proportion. For, since it 
 raises prices generally in that proportion, the industry of 
 wheat raising must yield correspondingly larger money 
 returns or it would be less profitable than others. But 
 under conditions of increasing cost, the circumstances are 
 different. On the better lands, the profits of wheat rais- 
 ing, even with the higher money cost of production and 
 at a price little if at all higher than before the tariff was 
 laid, will be sufficient to keep those lands under cultiva- 
 tion. 1 Rather than turn to the protected industries, such 
 as linen manufacture, until Canada only produces enough 
 wheat for her own use and has none for export, and until 
 wheat has risen in price in the same ratio that money has 
 increased, Canadian farmers on the better lands will 
 prefer to remain producers of wheat. This will result 
 in a supply sufficient to keep the price from rising very 
 much above the former price. In fact, if we assume 
 wheat production to be the line of industry in which 
 Canada is relatively the most efficient and wheat to be 
 Canada's chief or only export, we must conclude that 
 Canadian wheat cannot rise to a much higher price than 
 before, despite the inflow of money. For wheat can be 
 secured in large quantities from many other sources of 
 
 1 Though less intensively than before. 
 
PROTECTION AND DISTRIBUTION 103 
 
 production, and if Canadian wheat rises greatly in price, 
 foreign demand for Canadian wheat will decrease, 
 Canadian producers on the poorer lands will give up 
 wheat production, and Canadian producers on the better 
 lands will accept world wheat market prices rather than 
 abandon wheat production. The sale abroad of Ca- 
 nadian wheat and of nothing else cannot, by causing an 
 inflow of gold, raise the price of Canadian wheat very 
 much above this world market price, since, before it does 
 so, foreign purchase of Canadian wheat will cease, the 
 inflow of gold will cease, and the rise of prices will 
 cease. 1 
 
 Assume that, as a result of protection, Canadian money 
 increases by 10 per cent. We have seen that average 
 prices will tend to rise by 10 per cent, in addition to the 
 original 43 per cent rise of the protected linen. We have 
 seen that, under our supposed conditions, wheat prices 
 will remain substantially unchanged. Since wheat re- 
 mains at about $i a bushel, linen will rise to more than 
 $1.57 a yard and wages will rise to more than $22 a 
 week. 2 It follows that there is a possibility of gain, for 
 wage earners, from a limited application of protection ; 
 though, as we shall see, the probability of this gain being 
 realized in practice is remote. So far as they are con- 
 sumers of protected goods, wage earners lose because 
 of the rise in prices of these goods, occasioned by the 
 tariff. But so far as wage earners are able to buy at 
 substantially the former prices, goods produced under 
 conditions of increasing cost, while having money wages 
 
 1 Canadian prices cannot rise indefinitely in relation to foreign prices unless 
 Canada is such a centre of gold production that prices rise without export of 
 goods and unless, also, all imports are forbidden, and so outflow of this gold is 
 prevented. 
 
 2 That is, by more than 10 per cent on $ 20. 
 
io 4 ECONOMIC ADVANTAGES OF COMMERCE 
 
 greater by more than the average rise of prices, with 
 which to buy these goods, they are gainers. 
 
 On the other hand, owners of land in this case, 
 farming land are losers. And they lose more than 
 wage earners gain. Land which it previously paid to 
 cultivate can no longer be cultivated with profit. Land 
 which previously yielded a large surplus, after wages 
 were paid, now yields a smaller surplus. Since the wheat 
 land owners (and that means, in large part, the farmers), 
 get practically no higher prices for their wheat, the higher 
 money wages which they have to pay are to them an 
 unbalanced loss. So are the higher prices they must pay 
 for protected and other goods. Their loss through having 
 to pay higher wages to those they employ is not cancelled 
 for the nation as a whole by a corresponding gain to their 
 employees, since the latter have to pay higher prices for 
 linen. Neither are the higher prices which farmers and 
 other land owners must pay for linen balanced by the 
 higher money wages paid to linen makers, for these 
 wages are higher only by virtue of the secondary rise 
 resulting from the inflow of gold (the original 43 cents 
 rise directly due to the tariff merely making it possible 
 to get the same wages in linen making as were previously 
 given in wheat producing) ; while both the original rise 
 which does not raise wages and the secondary rise which 
 does, must be borne by farmers desiring to purchase 
 linen. It seems fair to conclude, therefore, that if wage 
 earners ever do gain by a protective tariff, they gain at 
 the greater expense of farmers or some other class. 
 As shown in the previous chapter, average wealth is 
 decreased. 
 
 The conclusion that a protective tariff establishing an 
 industry of relatively constant cost, and decreasing the ex- 
 
PROTECTION AND DISTRIBUTION 105 
 
 tent of an industry of increasing cost, might raise wages 
 at the expense of land rent, applies equally if we suppose 
 the protectionist country to have an inconvertible paper 
 money which will not be increased by an inflow of gold. 
 Suppose Canada to have such a currency. Then, as we 
 have. seen, 1 the original rise of linen to $1.43 is not fol- 
 lowed by the 10 per cent further rise in the average of 
 prices. But the value relation of foreign money to 
 Canadian money will change, 2 so that it takes more for- 
 eign money than before to buy a given amount of 
 Canadian money, and therefore of Canadian goods. To 
 tempt wheat producers away from any but the worst 
 lands will require a rise of linen above $1.43. On the 
 other hand, the price of wheat will fall below $i a bushel, 
 since it can be produced more cheaply on the better lands 
 and since the greater value of Canadian money compared 
 to foreign money will prevent the export of any wheat 
 except at less than $i a bushel. Money wages will remain 
 about the same, $20 a week. Wheat will be cheaper. 
 Wage earners may be better off, but, if so, only at the 
 expense of even greater loss to agricultural land owners. 3 
 The possible gain of wage earners and loss to agricul- 
 tural land owners and farmers, can perhaps be most 
 clearly shown if we omit reference to money and money 
 prices. When the Canadian tariff shuts out linen from 
 abroad, the value of linen, in Canada, will rise in terms 
 
 1 Chapter IV (of Part II), 3. 
 
 2 See, for example, Part I, Ch. VI, 6, 7, 8, 9, and Part II, Ch. IV, 3. 
 
 3 A restrictive export tax on wheat might have a like result on the relative 
 interests of economic classes, though having an opposite result on the general 
 price level. Such a tax would cause prices to fall and would drive industry 
 from wheat raising into other lines. But it might, conceivably, by preventing 
 production of wheat for export and forcing out of cultivation the poorer lands, 
 reduce wheat prices, in Canada, more than it reduced prices in general or money 
 wages. 
 
io6 ECONOMIC ADVANTAGES OF COMMERCE 
 
 of wheat until it becomes profitable for men to leave off 
 cultivating the less fertile and less desirably situated 
 lands, in order to manufacture linen. Instead of 20 
 bushels buying 20 yards, as before, when the linen was 
 purchased abroad, 20 bushels will buy less than 14 yards 
 and 14 yards will buy more than 20 bushels. For if 
 14 yards of linen would buy but 20 bushels of wheat, 
 only those on the very worst lands, if even those, would 
 find it profitable to change from wheat to linen produc- 
 tion. If, when a new equilibrium is reached, the worst 
 lands still cultivated, and the marginal labor on all 
 wheat lands, yield 25 bushels a week per cultivator, 1 
 while it requires a week's labor to make 14 yards of 
 linen, then 25 bushels will exchange for 14 yards. Since 
 considerable labor is diverted into linen manufacture at 
 a wage of not more than 14 yards (or its equivalent in 
 other form), a week's wages in wheat production will 
 be not more than and not much less than 25 bushels a 
 week (or the equivalent in other form). At any appre- 
 ciably less wage, demand for labor would exceed supply, 
 because at any less wage it would pay to hire more men, 
 to cultivate land more intensively, and to cultivate 
 worse land, while at any less wage, labor could not so 
 easily be kept from the linen factories and at work on 
 the farms. Wages in terms of linen are less (14 yards in- 
 stead of 20) because of the tariff. Wages in terms of 
 wheat are greater (25 bushels instead of 20) because of 
 the tariff. If the wage earner has occasion to consume 
 much wheat and to use little linen, his real wages, in 
 this very hypothetical case, will be higher. 2 Owners of 
 
 1 That is, if the last man hired adds that much to the total product. See 
 2 of this chapter (V of Part II). 
 
 2 Cf. Loria in the Journal of the Royal Statistical Society, Vol. L, on "Effects 
 of Import Duties in New and Old Countries," 1887, PP- 408-410; Patten, 
 
PROTECTION AND DISTRIBUTION 107 
 
 wheat lands, including farmers, will lose what the 
 wage earners they hire gain, and will lose, besides, 
 from the higher price of linen in terms of wheat. The 
 wheat-producing wage earners will not gain in real wages 
 what the farmers who pay them lose, for it will take more 
 wheat than before to buy 14 yards of linen. Neither 
 will the linen-making workmen gain as much from the 
 higher price of linen in terms of wheat, as the wheat 
 producers and owners of wheat lands lose, for the linen 
 makers gain what the wheat raisers and land owners lose, 
 only to the extent that they trade their linen wages for 
 wheat. So far as they themselves have some use for 
 linen, they also lose. 
 
 We are brought back, then, by another route, to the 
 conclusion that a protective tariff will only add to the 
 wealth or income of one person or class by taking a larger 
 amount of wealth or income away from some other 
 person or class. 1 It is conceivable, though, as we shall 
 
 Economic Basis of Protection, Philadelphia (J. B. Lippincott Co.), 1895, Ch. 
 V ; and Bastable, The Theory of International Trade, fourth edition, London 
 (Macmillan), 1003, p. 105. 
 
 1 A number of economists (e.g. Sidgwick, Edgeworth, Carver) have appar- 
 ently been led to the opinion that protection might not only raise wages but 
 might even increase the total national wealth by drawing labor out of lines of 
 increasing cost; or that the removal of protection to manufactures and other 
 industries of relatively constant cost might decrease national productiveness as 
 well as reduce wages. Sidgwick, for instance, imagined a protectionist country 
 of limited natural resources suddenly becoming a free trade country, and its 
 manufacturing population, previously protected, being thereupon undersold by 
 foreigners and driven out of business and being unable to obtain employment 
 in agriculture (The Principles of Political Economy, London, Macmillan, 1887, 
 pp. 496-498). But if agricultural resources were in such a country so limited 
 as to give little or no employment to the former manufacturing population, 
 then this population would remain chiefly or entirely in manufacturing, accept- 
 ing the lower wages required for competition with the imported goods. This, 
 however, could not possibly decrease the national wealth (except as the reduced 
 wages might affect efficiency) for the land owners would gain as much as the wage 
 earners would lose. Employment, at some level of wages, would continue, and 
 production would continue. If, with removal of protection, it proved possible 
 
io8 ECONOMIC ADVANTAGES OF COMMERCE 
 
 see, far from probable, 1 that wage earners may be the 
 gainers and land owners the losers by such a policy. 
 
 Let no one welcome this conceivable consequence of a 
 carefully devised tariff system, on the ground that the 
 situation or fertility rent secured by the owners of supe- 
 rior land, is unearned. Assuming that it is unearned (and 
 it is no part of the function of this book to discuss at 
 length whether or not land rent is unearned), a change in 
 the taxing system securing to the public its full rights 
 to any such unearned wealth or income would be more 
 sensible than a partial loss of such wealth or income 
 
 to employ more productively in agriculture even a few of those previously en- 
 gaged in manufacturing, the total national wealth would be increased even though 
 wages might fall. The discussions on this phase of protection between Profes- 
 sors Bastable and Edgeworth, in the Economic Journal (Vol. X, 1900, pp. 380- 
 393 and Vol. XI, 1901, pp. 226-229 and 582-590) seem to the present writer 
 not to bring out clearly this distinction between the effect on national wealth 
 and the effect on wages. (See also Bastable, The Theory of International Trade, 
 pp. 187-197-) 
 
 Carver (Publications of the American Economic Association, Third Series, 
 Vol. Ill, pp. 176-182) uses a different illustration to establish what seems to 
 be the same conclusion as that of Sidgwick. He supposes a piece of land which, 
 in the absence of protection or some form of legal discrimination, will allow the 
 employment of one man in sheep raising, while it might otherwise employ 20 
 men in wheat production., The total product, he assumes, would be greater 
 in the latter case ; but the land owners' rent, if trade were thus interfered with, 
 would be lower. Removal of restrictions might throw 19 men out of work. In 
 criticism of this view it is to be said that there are two extreme possibilities. 
 Either the 19 men have a preferable alternative, under the free trade regime, to 
 wheat raising, or they have not. If they have not, they will accept low enough 
 wages, rather than be unemployed and have nothing, so that the land owner 
 can realize as much rent for his land (or more) as if he used it for a sheep run. 
 Unless their efficiency is thus impaired, they will then produce as much wheat 
 as if they were protected. The effect of freedom from restriction may be seen 
 in lower wages and higher rent, but not in decreased national wealth. If, how- 
 ever, they have a preferable alternative, these 19 men will not raise wheat but 
 will occupy themselves otherwise at higher wages than wheat raising under 
 free trade would yield them, while the land owner will at the same time realize 
 the higher rent assumed to result from using his land as a sheep run. Free 
 trade would then, also, raise rent more than it would lower wages. 
 1 Shown in remainder of this section (5). 
 
PROTECTION AND DISTRIBUTION 109 
 
 because of restrictions on trade. At any rate, those 
 who support protection with the argument that it can 
 be made to benefit wage earners at the expense of land 
 rent, should be the last to oppose direct taxation of rent. 
 
 In practice, the likelihood of devising a tariff which 
 shall benefit wage workers at the expense of farmers is 
 extremely small. Such a tariff must, in the first place, 
 turn enough labor from agriculture into other lines to 
 raise, appreciably, the margin of cultivation. That is, 
 so much of the poorer land previously cultivated must 
 be left uncultivated, that the poorest land remaining in 
 use is appreciably better than the poorest land which 
 was in use. Otherwise, wages in terms of wheat cannot 
 be appreciably higher, for owners of the poorer lands 
 cannot pay higher wages, and, unless labor is so strongly 
 drawn into other lines that they have to, owners of the 
 better lands will not. To have any appreciable favorable 
 effect on wages, protection must, therefore, set up large 
 industries or many industries, giving employment to 
 many men. 
 
 But if protection is to be of benefit to wage earners, it 
 must be levied on goods consumed not at all or only to a 
 very limited extent by them, and on no other goods, 1 
 so that any rise of money wages which may take place, 
 shall not be more than offset by higher prices of goods 
 workingmen have to buy. 2 The problem of drawing a 
 large amount of labor away from agriculture (usually 
 regarded as an industry of increasing cost, though it is 
 by no means always an industry of rapidly increasing 
 
 1 Or, at least, only slightly on other goods. 
 
 2 This loss to wage earners is borne not the less if they buy goods made by 
 machinery which has been raised in price by protection, or transportation from 
 railway companies, etc., which have to charge more because of expensive ma- 
 terials. 
 
i io ECONOMIC ADVANTAGES OF COMMERCE 
 
 cost) into industries (e.g. many kinds of manufacturing) 
 of relatively constant cost, and selecting, as industries 
 into which to draw this labor, only those producing goods 
 little used by the masses, is indeed a problem hard to 
 solve and a problem which, in the exigencies of practical 
 politics, is unlikely ever to be solved. 
 
 As a matter of fact, few men in practical politics would 
 dare advocate such protection, frankly stating its in- 
 tended result and how the result was to be attained ; for 
 most men in politics would quickly realize that such an 
 advocacy would be likely to array against them the oppo- 
 sition at the polls of nearly all the farmers. Our own 
 (United States) protective tariff has been levied on raw 
 wool, woolen cloth, cotton cloth, sugar, fruit, potatoes, 
 shoes, coal, etc. It has been very far from being a tariff 
 which would raise wages at the greater expense of rent. 
 Rather has it been a general grab in which as many 
 interests as possible have tried to get something at the 
 expense of the general interest. It requires no argument 
 to show that our protection has not been designed to 
 avoid the things that the masses of working people have 
 to consume. Nor has it by any means avoided goods 
 produced under conditions of increasing cost, protection 
 of which is likely to raise land rents, to the greater loss 
 of wage earners. From the log rolling of actual political 
 struggle, there is likely to issue a hodge-podge of tariff 
 rates, causing loss to nearly all. The general average 
 of American wages might be made higher by shutting out 
 the immigrant laborers who enter this country as com- 
 petitors of those already here ; but the average American 
 real wages are distinctly not raised by shutting out and, 
 therefore, making scarce and dear, the goods which wage 
 workers desire to consume. 
 
PROTECTION AND DISTRIBUTION HI 
 
 6 
 
 How Protection May Benefit One Section of a Country at 
 the Expense of Other Sections 
 
 A protective tariff may benefit absolutely one section 
 of a country, including manufacturers, wage earners, and 
 farmers ; but if so, only at the greater expense of some 
 other section or sections. Protection to manufacturers 
 of woolen cloth, in certain sections of New England, may 
 benefit people in those sections, who are unwilling to 
 move elsewhere, by making purchasers of cloth in other 
 parts of the United States pay tribute to them. It may 
 conceivably even work a benefit to farmers and farm 
 land owners in the immediate vicinity of the protected 
 mills, since the protected mill owners and mill workers, 
 though gaining something at the expense of the rest of the 
 nation, would have to share these gains with local dairy- 
 men and truck farmers in order to get the latters' ser- 
 vices, just as they would have to share these gains with 
 local building contractors, bricklayers, and so forth. 1 
 The gain, if there is a gain, is not equivalent to the loss 
 of other sections, for the people of the locality benefited 
 have the option of seeking better opportunities in these 
 other sections, even if they do not care to carry on other 
 industries where they are. If other sections have greater 
 resources, then artificially to prevent migration into them 
 is to diminish national prosperity, is to decrease wealth 
 production in the naturally favored sections more than it 
 is increased in the less favored. And, in any case, to 
 turn industry into a line it would not otherwise follow, 
 is, presumably, to diminish national prosperity. The 
 policy, when all sections are considered, brings a net loss. 
 
 1 Cf. Taussig, Principles of Economics, New York (Macmillan), 1911, Vol. 
 p. 511. 
 
ii2 ECONOMIC ADVANTAGES OF COMMERCE 
 
 While there is reasonable ground for the opinion that no 
 large section of the United States has really gained 
 by the long continued maintenance of protective duties, 
 or could gain more than it would lose, in the general 
 compromise of protective tariff making, yet certain 
 parts of the country have felt themselves particularly 
 injured. This has been the feeling in most of the 
 Southern states, and is one explanation for the phenom- 
 enon of a "solid South." The cotton-raising states have 
 realized that their staple product must be in part ex- 
 ported, and that a protective tariff could not appre- 
 ciably, if at all, raise its price. And they have known 
 full well that the prices of many things they have had 
 to buy have been very considerably raised in price by the 
 tariff. The wheat-producing areas of the middle West 
 and, doubtless, certain manufacturing centres of the East, 
 have been in a similar situation. 
 
 It is probably such facts as these, which have appar- 
 ently produced in the minds of some of our public men 
 the feeling that a protective tariff is, in spirit, unconsti- 
 tutional, a feeling which found recent expression in the 
 National Democratic platform of 1912. The Federal 
 Constitution has given to Congress and the President 
 the right to levy import duties and the right to regulate 
 commerce with foreign nations. The passing of a 
 protective tariff law has always been regarded as but an 
 exercise of these powers. There is little reason to sup- 
 pose that any Federal court would set aside a tariff law as 
 unconstitutional merely because it was protective. A 
 court would not be likely to go behind the professed 
 intent of Congress and the letter of the Constitution, in 
 order to raise questions regarding the ultimate economic 
 effects of the laws passed. Such questions would be 
 
PROTECTION AND DISTRIBUTION 113 
 
 assumed to be questions for the legislature and not the 
 judiciary to decide. Therefore, Congress and the Presi- 
 dent must themselves decide upon the constitutional 
 justification of a protective tariff. But the contention 
 that to use either the tax-levying power or the power to 
 regulate commerce, in such a way as to compel the people 
 of some states to pay tribute to producers in other states, 
 is contrary to the real spirit of a constitution framed as 
 the basis for a federation of states, is a contention not 
 without a degree of plausibility. 
 
 7 
 Protection as an Encouragement to Monopoly 
 
 In its practical results, the tariff is likely to operate 
 in taxing the entire nation, not for the benefit of all the 
 people in any one section, but for the protection of mo- 
 nopoly profits. Though a tariff schedule may not be at 
 first devised for this purpose, and of course it would 
 not, at least openly, be so devised, it comes to have 
 this effect if it encourages combination. This the tariff 
 is likely to do. For it protects producers against foreign 
 competition and so suggests to them the hope that, by 
 combining among themselves, they may realize monopoly 
 profits. A protective tariff which has only this effect 
 cannot be said to benefit the masses of the people in any 
 section. It certainly has no effect on real wages other 
 than to lower them, if, as is usually the case, the goods 
 produced are goods largely consumed, directly or in- 
 directly, by working people. For the only way the tariff 
 can possibly create or maintain monopoly profits, is to 
 create or maintain monopoly prices ; and that means that 
 it takes money from the masses of the people, in order to 
 give it to monopolists. 
 
 PART II I 
 
ii4 ECONOMIC ADVANTAGES OF COMMERCE 
 
 8 
 
 Summary 
 
 We have now to summarize the conclusions we have 
 reached regarding the effect of protection on classes and 
 sections. Because protection tends to diminish national 
 wealth, it has a tendency to restrict the extent of round- 
 about production, to make the rate of interest higher 
 (though not necessarily the total amount of interest), 
 and to make wages lower. This is an indirect effect. 
 But there is a more obvious direct action. When 
 both protected and unprotected goods are produced, in 
 the protectionist country, under conditions of approxi- 
 mately constant cost, the effect of protection is to reduce 
 real wages^A If the protectionist country and those 
 trading with it have a common monetary standard, then 
 money wages in the former will rise and money prices 
 will rise in the same proportion, except that there will be 
 a special rise of the protected goods, in addition, so that 
 real wages will be lower. Assuming the protected in- 
 dustry to be one of increasing cost, while the unprotected 
 industries are of relatively constant cost, it appears that 
 protection may benefit land owners by raising land rents, 
 but that the gain of land owners must be less than the loss 
 of wage earners. 
 
 On the other hand, there is a conceivable case in which 
 wage earners gain at the greater expense of land owners, 
 viz. when the protected goods are produced under con- 
 ditions of relatively constant cost and unprotected goods 
 under conditions of increasing, perhaps sharply increas- 
 ing, cost, and when wage earners are chiefly concerned, 
 as consumers, with unprotected goods. Given these 
 conditions, real wages will be higher because of protection, 
 
PROTECTION AND DISTRIBUTION 115 
 
 and the rents of land (in our illustration, the profits of 
 farmers) will be lower. But the owners of land lose more 
 than the wage earners gain. Assuming the usual inter- 
 national monetary relations, money wages will rise; 
 money prices of protected goods will rise more ; money 
 prices of the unprotected goods produced under condi- 
 tions of increasing cost will rise little or not at all. 
 
 It appeared, however, that the mere devising of a 
 tariff to have this result would be difficult, since it would 
 be almost impossible to divert much labor from the indus- 
 try or industries of increasing cost and so to make possible, 
 in that industry or those industries, higher wages, without 
 protecting the production of and raising the prices of, 
 goods largely consumed by wage workers.^The practical 
 difficulties in the way of passing such a tariff act ap- 
 peared to be no less great. The conflict of various 
 interests is not likely to, and presumably never did, 
 result in a tariff act which would raise wages at the ex- 
 pense of land rent. Even supposing such an act to be 
 practically possible, and assuming that most or all of 
 land rent is an unearned income belonging properly to 
 the whole people, we must conclude that direct taxa- 
 tion of such rent would secure the larger general welfare 
 and the less waste, as compared with the indirect and very 
 partial appropriation of it and partial waste of it, in- 
 volved in the protective tariff policy. 
 
 Protection can, it was shown, benefit a considerable 
 territory within the protected group at the greater 
 expense of another section of the same nation. In the 
 United States, the South has usually felt itself to be a 
 sufferer by the policy. Protection may also build up and 
 secure against foreign competition, monopolies, and so 
 injure the general public for the benefit of a compara- 
 tively few. 
 
CHAPTER VI 
 
 A CONSIDERATION OF SOME SPECIAL ARGUMENTS FOR 
 PROTECTION 
 
 The Argument that Protection is Desirable Because it 
 Keeps Money in the Protected Country 
 
 ONE of the cruder popular arguments for protection 
 is that it keeps the people of the protectionist country 
 from spending their money in foreign countries, and so 
 gets and keeps more money in circulation at home. It 
 is, of course, true, as we have seen, 1 that the effect of 
 a protective tariff is to decrease imports, while still, for 
 a short time, not bringing about a corresponding decrease 
 of exports, and that there is, in consequence, somewhat 
 more money in a protectionist country than otherwise 
 there would be. But it is also true that the net inflow 
 of money or of gold is not perpetual, that it soon reaches 
 a limit. It is further to be emphasized that money or 
 gold is not the thing for the securing of which trade is 
 really carried on. No one, other than a miser, wants 
 money, except that he may pay it out again for other 
 goods. 
 
 The argument in favor of getting money into the 
 country and keeping it there, occasionally takes the form 
 of a comparison between a business man and a nation. 
 It is asserted that a business man is reckoned prosperous 
 
 1 Chapter IV (of Part II), i. 
 116 
 
SPECIAL ARGUMENTS FOR PROTECTION 117 
 
 in proportion as he takes in more money than he pays 
 out, in proportion as he sells more goods than he buys ; 
 that a nation's prosperity is similarly to be secured by 
 selling for money more than it buys with money; and 
 that, therefore, a limitation on purchases from abroad 
 is desirable. 
 
 The validity of such a comparison is sometimes ques- 
 tioned by free traders. It is said that, since a nation 
 is not the same as a single individual, what conduces to 
 the prosperity of the latter may not further the prosper- 
 ity of the former. But free traders have, as such, no 
 occasion to question the validity of the comparison, 
 since the comparison does not show what protectionists 
 intend it to show. The fact is that a successful busi- 
 ness man does not take in more money than he pays out. 
 On the contrary, he is always anxious to expend his 
 money (or his bank deposit) for goods. If he does not 
 spend it for enjoyments, he will wish to expend it by 
 making investments. He will buy automobiles, yachts, 
 residences, theatre tickets ; or he will purchase factories, 
 office buildings, railroad shares, machinery. It is by 
 the one type of purchases that he endeavors to enjoy his 
 prosperity, and by the other kind of purchases that he 
 hopes to add to his prosperity. A wealthy man is not 
 necessarily one who has a large amount of money in his 
 pockets or one who has a large checking account. More 
 usually his assets of that sort are small compared with 
 his property in railroads, mills, stores, farms, etc. With 
 a nation, which is a collection of individuals, the aim 
 should be similar. A nation enjoys its prosperity, in 
 proportion as it secures many services and many goods 
 for immediate consumption. It increases its prosperity 
 in proportion as it secures, from abroad if it can get more 
 
n8 ECONOMIC ADVANTAGES OF COMMERCE 
 
 by purchasing abroad, large capital equipment for aid 
 in further production. For a nation as for an individ- 
 ual, money is not the thing most to be desired, but the 
 wealth which money buys. A country which has a 
 large amount of money and high prices, benefits from that 
 fact only if it can use this money to buy goods where 
 prices are lower. There is no gain, but only loss, in 
 preventing purchase abroad in order to get and keep 
 money within a protectionist nation. 
 
 2 
 
 The Wages Argument for Protection 
 
 The argument for protection, which has, perhaps, been 
 most persistently urged in political campaigns within 
 the United States during the last half century or more, 
 is the wages argument. We have already discussed at 
 some length the effect of protection on wages, 1 and need 
 not expand greatly upon the subject, here. 
 
 The general tendency of protection is to divert industry 
 out of its most profitable into less profitable channels ; 
 and it is hardly likely that, by so doing, protection will 
 make wages higher. We may rather expect that it will 
 make wages lower. In fact, as we have seen, 2 a protec- 
 tive tariff cannot directly 3 raise any wages without 
 raising, in the same degree, the prices of protected goods. 
 And further, as we have also seen, 4 to the extent that 
 protection operates to turn men into less productive 
 lines, those whose wages are nominally raised will not 
 
 1 See Ch. V (of Part II). 
 
 2 Chapter IV (of Part H), 2. 
 
 3 The improbability of a tariff's raising wages indirectly has been sufficiently 
 discussed in Ch. V (of Part II), 5. 
 
 4 Chapter IV (of Part II), 2. 
 
SPECIAL ARGUMENTS FOR PROTECTION 119 
 
 gain (if they do gain) as much as others lose. Even if 
 they secure, in the protected industry, wages as much 
 higher than they could otherwise get in that line as their 
 employers get higher prices for the protected goods, 
 they will not be getting wages correspondingly higher 
 than they could have secured in the natural and relatively 
 more productive industries of their country. The pre- 
 sumption is, that not only average real wages, but 
 even the real wages of those employed in protected 
 industries, will be lowered by protection. For compe- 
 tition, so far as it is free, tends to equalize condi- 
 tions; and no one trade of wage earners can there- 
 fore hope to gain, for any long period, by means of 
 protection, even at the greater expense of wage 
 earners in other trades. Rather will all probably 
 share, ultimately, in the national loss. Though wages 
 measured in money may be slightly higher under pro- 
 tection because of an inflow of gold, wages measured 
 in the" necessaries, comforts, and luxuries of life, are 
 practically certain to be lower. 
 
 The emphasis, in the wages argument for protection, 
 is sometimes placed on the alleged danger of allowing 
 American workingmen to be subject to the competition 
 of cheap foreign labor, the competition of the so-called 
 "pauper labor " of Europe. The truth is that the 
 " competition" of cheap foreign labor cannot do other- 
 wise than benefit the country as a whole. Such labor, 
 e.g. labor engaged in the production of woolen cloth, can 
 only injure American workingmen employed in that 
 industry, by benefiting Americans in all other lines 
 through lower prices of woolen cloth. And the Ameri- 
 cans engaged in manufacturing woolen cloth would share 
 in this benefit when they had turned their efforts into 
 
120 ECONOMIC ADVANTAGES OF COMMERCE 
 
 other lines in which their relative efficiency was 
 greater. If it is really so dangerous to American wage 
 workers' prosperity to have goods from abroad sold 
 in the United States at a low price, and the more 
 dangerous the lower the price, then, obviously, it 
 must be the most dangerous of all if the goods are 
 given to us for nothing. 1 What ruin to our in- 
 dustries, what poverty and suffering must be caused, 
 by our getting quantities of goods from abroad with- 
 out having to produce any goods to send in return ! 
 For if we thus secure goods from other countries for 
 nothing, we are able to devote all our energies to in- 
 creasing still further our stock of wealth and our flow 
 of income services. 
 
 Frequently an inductive wages argument is attempted, 
 based on a comparison between the United States and 
 England. Attention is called to the fact that wages in 
 England are lower than wages in the United States, and 
 it is implied, if not asserted, that the difference is due 
 to the British policy of free trade as contrasted with 
 an historic American policy (now, however, possibly in 
 process of abandonment) of protection. Yet every one 
 who is familiar with and able to distinguish between the 
 legitimate and the illegitimate processes of reasoning, 
 knows that such a comparison has little or no value 
 unless other things are equal, or unless the effects of the 
 other things which are not equal are known, and can be 
 subtracted from the total result. 2 As a matter of fact, 
 other things are not, in this comparison between England 
 and the United States, at all equal. England is much 
 
 1 An effective turn to the argument given by Henry George in his very read- 
 able Protection and Free Trade, New York (Henry George), 1891, pp. 121-125. 
 J See Mm, System of Logic, Book HI, Ch. VHI, 5 on the method of residues. 
 
SPECIAL ARGUMENTS FOR PROTECTION 121 
 
 more crowded than the United States, and its resources, 
 in comparison to population, are less. With thirty- 
 three millions of people struggling to make a living in a 
 country about the size of the state of Illinois (which has 
 a population of something like two millions), England 
 can hardly be expected to be a country of as high wages 
 as the United States. Because of the law of diminishing 
 returns, wages in England must be comparatively low 
 in order that the demand for labor shall equal the supply. 
 It is true that the people of England are not confined to, 
 and are not mainly occupied in, agriculture. England 
 is primarily a manufacturing and commercial nation. 
 But the point is, that England has to engage in indus- 
 tries employing many persons per unit space, in order 
 to support, comfortably, so large a population in so small 
 an area. Hence, England has to engage in commerce 
 and manufacturing, even if competition with other 
 crowded countries and parts of countries, reduces the 
 profits and wages which can be earned to a comparatively 
 low level, and even though far distant markets must 
 be sought and raw materials imported, at considerable 
 expense, from abroad. In a country like the United 
 States, however, there is always the alternative of going 
 into agriculture, or mining, or manufacturing for which 
 resources are available near at hand, and hence wages 
 tend to remain at a higher level. Wages in the United 
 States have been high, not because of a protective 
 tariff which has tended to lower them, but because of 
 the favorable relation of population to natural resources. 
 Wages in the United States are in danger of being low- 
 ered, not by free trade, which would tend to raise them, 
 but by immigration from the crowded and low- wage 
 countries, by immigration which increases the supply 
 
122 ECONOMIC ADVANTAGES OF COMMERCE 
 
 of labor, lowers the margin of cultivation toward foreign 
 levels, and makes necessary low wages to equalize supply 
 of and demand for wage earners' services. 1 
 
 3 
 
 The Make-Work Argument for Protection 
 
 Closely associated with the wages argument is the 
 argument that protection makes employment. It is 
 said that the tariff, by shutting out various foreign goods, 
 gives encouragement to American capital and labor to 
 engage in producing such goods. If protection does this, 
 it is only because protection makes the production of 
 such goods more profitable. For even without the de- 
 fence of the tariff, home producers in any industry could 
 have the entire home market and could, therefore, sell 
 all the goods which that market would take as well 
 as some goods abroad if they would make low enough 
 prices, if employers and employees together would be 
 willing to carry on the business without aid, and take 
 what it could earn. The tariff simply enables them to 
 do a business no larger, at higher prices, and therefore 
 at the expense of persons in other industries. If em- 
 ployment is increased in one industry, it is only because 
 that industry is made more profitable than it otherwise 
 would be and because men will choose the employment 
 
 1 If immigrant wage earners always went into the lowest grade labor, and 
 if they and their descendants remained in this labor only, their competition might 
 not lower wages in other work. If it increased the demand for other work more 
 than, by pushing former low grade labor into such work, it increased the supply, 
 wages in this other work might rise. Conceivably, most "native labor would 
 find employment in this high grade work (Hadley, Economics, New York 
 Putnam , 1906, pp. 420-421). But in a few generations, the descendants of 
 immigrants are competing for the higher positions as well as the lower, and, 
 indeed, it would be more difficult to realize democratic ideals if they were not. 
 The net result is likely to be a reduction of wages for most kinds of labor. 
 
SPECIAL ARGUMENTS FOR PROTECTION 123 
 
 that pays best. Employment is made less profitable in 
 other industries than it would else be, since those em- 
 ployed in these industries must bear the tariff burden. 
 Will not the protective tariff, therefore, decrease employ- 
 ment in these other industries as much as it increases 
 employment in the favored industry or industries ? 
 
 Another way to look at this matter of employment 
 is from the viewpoint of the tariff's effect on foreign 
 trade. In a previous chapter l it was pointed out that 
 any serious restriction of imports brings, eventually, a 
 corresponding limitation on exports. It follows that 
 to give employment in a new industry started by a pro- 
 tective tariff, is to take away employment in production 
 of goods for export. 
 
 Even if the people of foreign countries would give us 
 our imports for nothing, which they will not, so 
 that our labor would not need to be employed in produc- 
 ing goods to return to them, still our labor might be 
 sufficiently employed in producing additional goods or 
 in producing goods of a different kind which we could 
 not secure by gift. A high protective tariff would shut 
 out the free goods and compel our labor to be wasted in 
 producing these goods at home ; but it would not make 
 employment greater or more steady. Our labor would 
 simply be producing goods which might have been got 
 for nothing, instead of getting such goods free and pro- 
 ducing additional goods. 
 
 Labor can be employed, and at high wages, when 
 there are fertile lands or good sites to work upon, tools 
 to use, available wealth to pay and support labor during 
 the process of production (if roundabout), and a prospect 
 of a return sufficient to compensate for the outlay. A 
 
 1 Chapter IV (of Part II), i. 
 
124 ECONOMIC ADVANTAGES OF COMMERCE 
 
 protective tariff does not increase or improve the lands 
 or the sites ; it does not multiply tools or increase wealth, 
 but tends rather towards national poverty ; it does not, 
 for industry as a whole, improve the prospects for large 
 returns, but has, rather, the reverse effect. 1 How, then, 
 can a protective tariff increase employment? 
 
 4 
 
 The Home Market Argument for Protection 
 
 In political struggle, it is usually fatal to antagonize 
 any very large class. So in order to carry through a 
 protective policy, it has been necessary, in the United 
 States, to convince not only wage workers, but farmers as 
 well, that the policy would benefit them. While many 
 products of the farms, e.g. raw wool, have been protected, 
 yet it has been difficult to show that the great agricul- 
 tural staples, such as wheat, corn, and cotton, have been 
 appreciably raised in price by the tariff 2 or that the tariff 
 could directly raise their prices. The appeal to American 
 farmers has therefore taken the form, in part, of assert- 
 ing an indirect benefit of protection, through the estab- 
 lishment of a "home market." The "home market 
 argument" points out, to begin with, that a protective 
 tariff increases the number of persons engaged in the 
 protected industries, e.g. manufacturing. Those thus 
 
 1 The Arguments of Schiitter (Schutzzoll und Freihandel, Vienna Tempsky , 
 and Leipzig Freytag ,1905, pp. 75-84) to the effect that industry in any 
 country is not rigidly limited by the factors of production, but may vary 
 within wide limits in relation to these factors, proves nothing whatever for pro- 
 tection, unless it is also shown that industry is likely to fall short of its maximum, 
 under free trade, and more nearly to approximate its maximum, under protec- 
 tion. For such a contention (aside from possible transitional effects during 
 adjustment to a changed policy), there seems, to the present writer, no reason- 
 able justification either in theory or in direct experience. 
 
 2 See Ch. V (of Part II), 5. 
 
SPECIAL ARGUMENTS FOR PROTECTION 125 
 
 led to engage in manufacturing then have to buy the 
 products of the farms, and so the farmers secure a home 
 market for these products. 
 
 The answer to such an argument has already been 
 indicated in our discussion of the effects of a protective 
 tariff on exports. 1 If we of the United States refuse to 
 buy goods from abroad, and so develop the production 
 of those goods at home, to just that extent, in the long 
 run, will we be deprived of an opportunity to produce 
 goods profitably for export. The farmers can only gain 
 a home market by losing a foreign market. And the extra 
 prices they have to pay for goods, especially protected 
 goods, because of the tariff, will cause them to suffer a 
 net loss. 
 
 Sometimes the argument in favor of the development of 
 a home market takes a slightly different form. Instead 
 of its being asserted that the protected manufacturing 
 industries will not exist or will not be so widely ex- 
 tended without a tariff, emphasis is placed on the conten- 
 tion that they will not be so prosperous. Those engaged 
 in them will earn less. If the manufacturing industries 
 are protected, it is urged, the farmers may, indeed, have 
 to pay more for manufactured goods ; but those engaged 
 in manufacturing will then have more money with which 
 to purchase the farmers' products, and so the farmers 
 will get their money back again. The truth is that they 
 will not and do not get it back again unless they give 
 something else of value in return. If a farmer pays more 
 for clothes, because of a protective tariff, than he other- 
 wise would, we may admit that the clothes makers will 
 have more money (other things equal) with which to 
 buy, if they choose to, the farmer's products; but the 
 
 i Chapter IV (of Part II), i. 
 
126 ECONOMIC ADVANTAGES OF COMMERCE 
 
 farmer does not get back this extra money for nothing ; 
 he must give extra products for it. To assume that the 
 farmer does not have to give extra products to get back 
 the additional money paid for the higher priced clothes, 
 is to assume that the protected industry is not encour- 
 aged by the higher prices the farmer pays for its goods ; 
 for this is to assume that the higher prices so paid by the 
 farmer for the protected goods, are balanced by higher 
 prices which those in the protected industry must pay 
 for the farmer's products. This would mean no change 
 in the relative positions of farmer and manufacturers 
 because of protection, save a merely nominal change. 
 The idea which protectionists who use this "get it back 
 again" argument endeavor to convey is that, somehow, 
 producers of protected goods get larger real incomes 
 because of the tariff; while, at the same time, those 
 whose purchases of goods at higher prices make these 
 larger incomes possible, lose nothing by the system. 
 
 The absurdity of such an argument is perhaps best 
 shown by an illustration. Suppose that, in a small town, 
 there are a number of robberies, as a result of which each 
 of the merchants of the town finds himself minus several 
 hundreds of dollars. Finally, the thief is apprehended. 
 But upon being accused of his crimes, he asserts in his 
 own defence that he has really done no harm. Though 
 he admits having robbed the various merchants of 
 money, yet he points out that he has lived in the town 
 and has used all of this money to buy their goods and 
 that thus they have "got it back again." The obvious 
 fact is, of course, that the merchants have only got their 
 money back by giving up for it other goods of supposedly 
 equal value. 1 
 
 1 Cf. Sumner, Protectionism, New York (Holt), 1885, p. 125. 
 
SPECIAL ARGUMENTS FOR PROTECTION 127 
 
 Protection may, as we have seen, 1 benefit one section 
 of a country at the expense of other sections ; and the 
 gains to the section benefited will perhaps be distributed 
 among all classes. If the West and the South are taxed 
 to develop manufacturing in Rhode Island, the Rhode 
 Island truck farmers and dairymen may share in the 
 local gains by virtue of having a home market provided 
 for them at the expense of others. But to say this is 
 very different from saying that they would gain if the 
 local market were provided entirely at their own expense. 
 
 5 
 
 The Argument for Protection to Agriculture in the Older 
 Countries against a Future when Cheap Foods and 
 Raw Material may not be Obtainable from the Newer 
 Countries 
 
 An argument not generally familiar to Americans, 
 has been used in favor of protection to the agriculture 
 of the more crowded European countries, in particular 
 the agriculture of Germany. 2 There is, it is claimed, 
 too great a reliance of the older and more densely settled 
 countries upon the new countries for food supplies and 
 raw materials. Eventually the new countries will be 
 more thickly settled, will, like the old, devote themselves 
 in larger part to manufacturing, and will have smaller 
 surpluses of food, etc., for export. Therefore, the old 
 and thickly settled countries, which will probably have 
 grown still more in population during the period of 
 importing food and raw materials from abroad, will get 
 
 1 Chapter V (of Part II), 6. 
 
 2 See Adolph Wagner, Agrar- und Industriestaat, Jena (Gustav Fischer), 1901, 
 p. 73. A good statement of the argument is given in Taussig, Principles of 
 Economics, New York (Macmillan), 1911, Vol. I, pp. 534, 535. 
 
128 ECONOMIC ADVANTAGES OF COMMERCE 
 
 their food supplies and raw material with increasing diffi- 
 culty. The suggested remedy is that the thickly settled 
 countries should levy, each, a protective tariff on such 
 imports, force its people to get along, in the main, with 
 what can be produced in their own country, resist thus 
 the tendency to specialize in manufacture, and so 
 prevent the growth of a population which is dependent 
 upon foreign surpluses for its food and necessary mate- 
 rials. 
 
 If the fear is that the new countries, when they come 
 to develop manufactures, will almost without exception 
 shut out, by protective tariffs, goods manufactured in 
 the older countries, and so eventually compel the latter 
 to be self-sufficient, there is reason in the suggestion that 
 these older countries remain self-sufficient from the 
 beginning. By so doing, they will avoid the intense 
 suffering which must result from a return to a sparseness 
 of population capable of securing sufficient food, etc., 
 at home. 
 
 But if the world can be expected to attain a liberal 
 attitude towards trade, if a tendency towards low tariffs 
 can be hoped for (and this is perhaps more likely to be 
 the case as the stage of infant industry is left behind), 
 then the argument for protection of agriculture has very 
 little force. For no matter how extensively the now 
 sparsely settled countries eventually go into manufac- 
 turing, they will not go into it, if not artificially encour- 
 aged, unless it yields, on the average, as satisfactory 
 returns as agriculture. 1 That manufacturing popula- 
 tions in the older countries will have to meet the compe- 
 tition of manufacturing groups in the newer, is true. 
 But assuming free trade (and if trade is not free, then in 
 
 1 On the margin of production. 
 
SPECIAL ARGUMENTS FOR PROTECTION 129 
 
 proportion as restrictions are slight), this merely means 
 that the manufacturing populations of the older countries, 
 cannot charge higher prices and therefore cannot get 
 higher wages and profits per unit product, than the manu- 
 facturing groups in the newer countries. It does not 
 mean that the condition of the old countries must be- 
 come appreciably worse than that of the new. So long 
 as many persons in the new countries care to engage in 
 manufacturing (and that they will do so is all that is 
 feared), it must be that manufacturing is about as profit- 
 able as agriculture. If it were much less so, assuming 
 free trade or any near approximation to free trade, the 
 newer countries would withdraw from manufacturing and 
 the older countries could carry it on without competi- 
 tion. If manufacturing in the new countries is as prof- 
 itable as agriculture, and if trade is free, manufacturing 
 in the older countries (assuming equal efficiency) must 
 also be, except for the greater costs of transporta- 
 tion, as profitable as agriculture in the new, because as 
 profitable, save for transportation costs, as manufactures 
 in the new. 
 
 6 
 
 The Infant Industry Argument for Protection 
 
 The argument which is usually regarded by economists 
 as stating the best case for the protective tariff, is the 
 so-called infant industry argument. The more careful 
 thinkers who advance this argument admit that protec- 
 tion involves a cost, a temporary loss of productive power. 
 They admit that it involves turning industry from a 
 more productive into a less productive line. But they 
 urge that the newly established line may be only tempo- 
 rarily less productive and may be eventually more pro- 
 PART n K 
 
130 ECONOMIC ADVANTAGES OF COMMERCE 
 
 ductive and advantageous for the country than the 
 older lines of industry. It is urged that a country may 
 have natural advantages adequate to the successful 
 carrying on of a given industry, but that, at the begin- 
 ning, the competition from more experienced manage- 
 ment and better trained workmen abroad is likely to 
 prevent the growth and development of the industry, 
 and, therefore, to prevent the attainment of the greatest 
 possible efficiency in it. Give such an industry tempo- 
 rary protection, it is said, so that it can get a start, 
 and it may eventually undersell its foreign rivals. Then 
 the protectionist country will perhaps realize a gain which 
 will more than compensate for the temporary loss. 1 
 
 It should be said, to begin with, that this argument 
 for protection applies at all, only in regard to those 
 industries in which success depends largely on acquired 
 skill and not merely on natural advantages. It is hardly 
 an argument, therefore, in favor of protection to much 
 else than new manufactures, and it is not an argument 
 in favor of perpetual protection for these. It is highly 
 probable, however, that in some cases, if the industries 
 to be protected are chosen wisely, and are not protected 
 too long, the desired results can be attained. In the 
 United States, a considerable part of the silk industry, 
 started by protection, seems eventually to have reached 
 a position where it can produce as cheaply as foreign 
 concerns and where, therefore, it does not need pro- 
 tection. 2 
 
 But while such suggestions have a great deal of force, 
 the opposing considerations, especially on the practical 
 
 1 This view was presented in Alexander Hamilton's Report on Manufactures, 
 and later, in Germany, was urged by Friedrich List. 
 
 2 Mason, "The American Silk Industry and the Tariff," American Economic 
 Association Quarterly, December, 1910, p. 177. 
 
SPECIAL ARGUMENTS FOR PROTECTION 131 
 
 side, are also not without weight. In the first place, 
 though new industries may indeed be developed in this 
 way, yet they can be thus developed only by drawing the 
 labor force required, from other lines. It follows that 
 the development of skill and the progress of invention 
 in those other lines may be retarded as much as in the 
 new lines they are forwarded. New ideas are less likely 
 to be evolved among a few than among many. And in 
 proportion as there are more persons in the new lines, there 
 are fewer persons in the old lines. Indeed, it is not 
 inconceivable that some of the older industries, indus- 
 tries still capable of further progress, may be made so 
 comparatively unprofitable especially if their neces- 
 sary machinery or materials are taxed by the tariff - 
 as to be entirely given up. We have already seen that 
 protection tends to decrease the export trade * and that 
 it may, by leading to rise of prices, 2 ruin other industries. 8 
 Before, then, protection is accorded to an infant or em- 
 bryonic or projected industry, inquiry should be made 
 as to the following points: first, as to whether that 
 industry can be expected to develop without such aid; 
 second, as to whether, if it will not, such aid will suffice 
 to develop it to a point where it can and will sell its 
 products more cheaply than they can probably be secured 
 elsewhere, and enough more cheaply to compensate, with 
 interest, for the loss incident to starting it ; third, as to 
 whether the attempt to encourage it might not involve 
 a risk of discouraging other industries, which would 
 balance any hoped-for gam. 
 
 In view of all these considerations, it becomes impor- 
 
 1 Chapter IV (of Part II), i. " 
 
 2 Or a change in value relations of money systems, which acts similarly. 
 Chapter IV (of Part II), 6. 
 
i 3 2 ECONOMIC ADVANTAGES OF COMMERCE 
 
 tant to judge the fitness of the governing body to apply 
 such a policy, decide upon its effects, and select the 
 industries to be encouraged. 1 It is a special function of 
 the enterpriser-capitalist to select for his own investment 
 (and the investments of those whom he influences) indus- 
 tries capable of succeeding. If he does not, the principal 
 loss falls upon him and upon others in like situation. The 
 community suffers only indirectly and incidentally. 
 The enterpriser-capitalist is a product of selection. 
 His power to direct industry into profitable chan- 
 nels is due to his possession of capital, or the confidence 
 of other business men and investors, or both. His pos- 
 session of capital and of this confidence, though some- 
 times due in part to inheritance from able progenitors 
 or relatives, is frequently due, in no small degree, to past 
 successes. He has the power to direct industry into those 
 lines which he believes will pay best and which, there- 
 fore, are presumably the lines most needed by the com- 
 munity, because he has successfully so directed industry 
 in the past. Men whose knowledge of law or politics 
 has made them members of a law-making body are not, 
 as a rule, the product of the same kind of selection. If 
 they were, the fact that their own fortunes are not at 
 stake does not conduce to caution. In case a new 
 industry established by protection never becomes 
 profitable, the loss which its establishment causes falls 
 upon the general public and not upon legislators as such. 
 Similarly, in case an industry is prematurely established 
 or in case its establishment retards other industries, the 
 loss is that of the public. 
 
 Given the present form of our own and other republican 
 
 1 Cf. Bastable, The Theory of International Trade, fourth edition, London 
 (Macmillan), 1903, p. 140. 
 
SPECIAL ARGUMENTS FOR PROTECTION 133 
 
 governments, there is a special pressure tending towards 
 unwise selection of lines to be favored. This is the pres- 
 sure of localities or, at least, of large interests in various 
 localities. For in republican government, legislators 
 usually represent districts, states, or other territorial 
 units. When it is proposed to encourage various indus- 
 tries, when the idea of protection is politically dominant, 
 many and influential interests in each state and district 
 are likely to desire that the industries of that state and 
 district shall get such help at the general expense. The 
 tariff eventually decided upon, the tariff to which legis- 
 lators from different sections can agree, is not likely to 
 be one which even attempts, scientifically, to apply the 
 theory of infant industry protection. Instead, it is 
 likely to be a hodge-podge of special favors, distributed ac- 
 cording to the relative strength of conflicting interests, and 
 bringing general and long-continued injury to the public. 
 The longer such a system continues and the more 
 extensive its application, the greater are the difficulties 
 in the way of its reform. More and more industries 
 are built up by tariff barriers, and their owners and work- 
 men taught to rely upon these barriers for protection 
 against foreign rivalry. Managerial effort, which might 
 otherwise be devoted to development of the highest 
 efficiency, is instead devoted to the exertion of political 
 pressure. Every effort is made by numerous interested 
 persons to retain and increase the favors secured. Those 
 engaged in the industries assisted are seldom ready to 
 consent to reduction of the tariff after a period of favor- 
 itism, however long, but endeavor, usually, to keep the 
 protection indefinitely. Proposals for reduction are 
 met by predictions of dire calamity, and strong opposi- 
 tion to reduction is thus aroused. 
 
i 3 4 ECONOMIC ADVANTAGES OF COMMERCE 
 
 To the suggestion that protected industries might 
 decline and die without protection, the answer has been 
 made that "no industry will ever be given up except in 
 order to take up a better one, and if, under free trade, 
 any of our industries should perish, it would only be 
 because the removal of restrictions enabled some other 
 industry to offer so much better rewards that labor and 
 capital would seek the latter." 1 There is doubtless 
 reason in the contention that, since many persons have 
 invested capital in the protected industries and since 
 many others have acquired skill not equally useful in 
 other lines, relying upon a continuance of the past policy 
 of our government, therefore the entire protective system 
 should not be swept away with one blow. Time should 
 be given (as, under the tariff reduction policy of the present 
 administration at Washington, it is being given) for ad- 
 justment to new conditions. Nevertheless, the public 
 cannot be held to have pledged itself or to be under any 
 obligation to maintain indefinitely the protective system. 
 Producers must be held to have taken the risk of change, 
 knowing eventual removal of tariff duties to be the 
 public's privilege. Because the people have been will- 
 ing to pay higher prices for goods during a limited 
 period, it does not follow that they are duty bound to 
 suffer an equivalent annual loss through all future time. 
 
 7 
 
 The Argument that a Protective Policy should be Fol- 
 lowed in Order to Diversify Industry 
 
 It is also sometimes argued that protection is of use 
 to diversify industrial activity within a country. We 
 
 1 Sumner, Protectionism, p. 130. 
 
SPECIAL ARGUMENTS FOR PROTECTION 135 
 
 have already seen that, while the protective policy 
 encourages protected industries, it may cause the 
 decline of others. Yet if applied carefully and consist- 
 ently with the object of diversification in view, it is 
 probable that a high tariff would increase the number 
 of industries carried on. 
 
 It does not follow that prosperity would be increased. 
 There is no special advantage in having a larger number 
 of occupations carried on when the average income is 
 reduced by having them. As a matter of fact, a large 
 country like the United States, with a wide range of 
 natural resources and a versatile population, would be 
 certain to have diversified industry within its borders, 
 under either protection or free trade. With its mines 
 of coal, iron, copper, etc., the United States could hardly 
 fail to be not alone an agricultural country, but a manu- 
 facturing country as well. 
 
 8 
 
 The Argument that Protection should be Applied as a 
 Means of Getting and Maintaining a Certain Degree of 
 National Self-sufficiency 
 
 Not all of the arguments for a protective tariff are 
 strictly economic in character. There is, for instance, 
 the argument that protection should be used to insure 
 national self-sufficiency. This argument, in so far as 
 it carries great weight, is of a military significance. It 
 is urged that a country at war with another or others, 
 is likely to have its foreign trade seriously interfered 
 with. 1 If the country in question has relied on foreign 
 
 1 It may, of course, be interfered witH to some extent if another country or 
 other countries, with which it habitually trades, are at war. But only a part 
 of its foreign commerce is likely, in that case, to be affected. 
 
136 ECONOMIC ADVANTAGES OF COMMERCE 
 
 trade for the necessaries of life, it will be subject to a 
 considerable strain during the war period, and perhaps 
 will be less able to carry the contest to a successful con- 
 clusion. If it has relied upon foreign trade for firearms 
 and ammunition, it may be in no better position. It is 
 asserted, therefore, that a country should adopt the 
 policy of producing all necessaries, including all things 
 required for war purposes, within its own borders, even 
 though to do this brings economic loss. 
 
 It must be admitted that this argument, like the argu- 
 ment for protection to infant industries, is not without 
 claims to a respectful hearing. There are, however, 
 some considerations of importance on the other side. 
 In the first place, close trade relations, such as are 
 more likely to follow from a free trade or from a low tariff 
 policy than from protection, do much to promote inter- 
 national good feeling and, therefore, to prevent the 
 occurrence of war. And in the second place, even if 
 war does occur, it may well be that the larger wealth and 
 population made possible by a liberal trade and tariff 
 policy will give greater military strength, through the 
 larger fighting force which can thus be supported, than 
 would any degree of national self-sufficiency. 1 
 
 In this connection we may cite the case of Great 
 Britain. If national self-sufficiency is imperative, there 
 would seem to be nothing which it would be more 
 important to produce in the home country than food. 
 Had Great Britain persisted in a policy of excluding for- 
 eign grain and compelled her people to live upon what 
 they could themselves produce, she would have been 
 aiming at this ideal of self-sufficiency. Had Great 
 Britain carried out such a policy, however, her population 
 
 1 Sumner, Protectionism, p. 143. 
 
SPECIAL ARGUMENTS FOR PROTECTION 137 
 
 could not have become so great by many millions as it 
 has, nor could her wealth have become so great. She 
 has chosen rather to specialize in production, to import 
 foodstuffs, to attain a numerous population and large 
 wealth. She is not, it is true, self-sufficient in time of 
 war. She must rely for her food upon lands across the 
 seas. But the wealth which a free trade policy has 
 brought her makes possible the maintenance of the most 
 powerful navy in the world, a navy by means of which 
 her commerce is protected. Is England not a stronger 
 nation, a richer nation, and a not less independent and 
 happy nation, than she could have been had the contrary 
 policy been followed ? 
 
 9 
 
 Free Trade within the United States 
 
 With the exception of political or military arguments, 
 practically every consideration advanced in favor of 
 tariff duties on goods produced in foreign countries, 
 could be urged with no less (and no greater) plausibility 
 in favor of tariff duties levied by one State or section 
 on goods produced in another State or section. Is it 
 suggested that we do not wish to send money out of the 
 country and that to do so makes us poorer ? An exactly 
 parallel argument would assert that we should adopt 
 measures to keep money from being sent out of the State 
 or the county. Do stanch protectionists tell us that 
 to let goods come in from abroad at low prices, must 
 lower American wages ? If so, then for Ohio or Illinois 
 to let low-priced goods be imported from New York or 
 from Pennsylvania, must tend to make wages in Ohio 
 and Illinois lower than they otherwise would be. If 
 to shut out English goods from the United States makes 
 
138 ECONOMIC ADVANTAGES OF COMMERCE 
 
 additional employment for American wage earners, 
 then to shut out Connecticut goods from Rhode Island 
 must make additional employment for Rhode Island 
 wage earners. It is hardly necessary to pursue the com- 
 parison further. Carried to its logical conclusion, the 
 system of protection would prohibit all trade and, there- 
 fore, all the gain in wealth which flows from trade. 
 
 Fortunately, the Federal Constitution makes tariff 
 barriers between the different states of the United 
 States impossible. If it did not, we should doubtless 
 find some of our states levying protective duties against 
 their neighbor states, as Massachusetts, New York, and 
 Pennsylvania did under the old Confederation of lySi. 1 
 As it is, trade between the states is, for the most part, 
 regarded with equanimity. The coal of Pennsylvania 
 is exchanged for the shoes, woolen and cotton goods, 
 clocks, etc., of Massachusetts, Connecticut, and other 
 New England States. The wheat, corn, and meat of 
 the Middle West, and the cotton, rice, and sugar of the 
 South, are sold throughout the country, and the special 
 products of other sections are given in payment. When 
 improvements in transportation facilities make low 
 transportation rates possible, we regard the consequent 
 reductions as cause for rejoicing, because of the stimulus 
 thus given to trade. There is no reasonable doubt that 
 free trade within the borders of the United States adds 
 greatly to our national prosperity and adds, also, to the 
 prosperity of each separate state. To widen this free 
 trade area, so far as lies within our power, would still 
 further increase our economic welfare. 
 
 1 Hart, Essentials in American History, New York (American Book Co.), 
 1905, p. 109. 
 
SPECIAL ARGUMENTS FOR PROTECTION 139 
 
 10 
 Ethical Considerations Bearing on the Policy of Protection 
 
 Before concluding this discussion of the high tariff 
 system, let us consider briefly the moral issues involved. 
 The maintenance of this system means that wealth is 
 to be gained, in the favored industries, not by serving 
 the public well, not by giving to the public better goods 
 than could otherwise be secured or goods at lower prices 
 than must otherwise be paid, but by depriving the 
 public, through influence on legislation, of such benefits. 
 The maintenance of protection means that political 
 influence calculated to injure the community will often 
 bring larger returns to those who wield it than would 
 business carried on in rivalry with others for the benefit 
 of the community. As a consequence, energies which 
 might be devoted wholly to legitimate business, that is, 
 to seeking profit through efficient service, spend them- 
 selves instead in selfish political activity, in the attempt 
 to make impossible any rivalry in service from foreign 
 producers, in the attempt to force higher prices from con- 
 sumers, and so to realize, at the expense of consumers, 
 higher profits than are earned. If the ideal of industrial 
 morality is that profit shall be in proportion to service, 
 if to seek profit by disservice is immoral, then the selfish 
 attempt of private interests to realize wealth by arbi- 
 trarily shutting out foreign competitors through tariff 
 restrictions, like the attempt to shut out domestic 
 competitors through seeking railroad discriminations, 
 violates this ideal and is immoral. 
 
i 4 o ECONOMIC ADVANTAGES OF COMMERCE 
 
 " 
 
 Summary 
 
 In this chapter the attempt has been made properly 
 to estimate the value of most of the standard arguments 
 for protection. The argument that protection increases 
 national prosperity by getting and keeping more money 
 in circulation in the protectionist country was shown 
 to be fallacious, since money is not the ultimate or prin- 
 cipal end of trade. The popular " wages argument" for 
 protection, so much used in political campaigns, was 
 shown to have little better basis. Money wages tend 
 to be somewhat higher because of the tariff, 1 but real 
 wages are almost necessarily lower. The much feared 
 "competition of cheap foreign labor" is beneficial to 
 our wage earners when it means cheap goods from abroad, 
 and is injurious to our wage earners only when it means 
 immigration of this cheap labor. Those who attempt 
 to show, inductively, e.g. by comparison of English and 
 American wages, that protection makes wages higher, 
 fail to take other things, such as relative density of 
 population, into account. The argument that pro- 
 tection increases the opportunities for employment was 
 likewise shown to be untenable. It increases employ- 
 ment in any industry only by making that industry more 
 profitable. But in so doing it makes other industries 
 less profitable. Natural resources and accumulated 
 capital, which make employment at remunerative 
 wages possible, are not increased by protective tariffs. 
 
 The third argument considered was the so-called 
 " home market" argument. This is one of the principal 
 
 1 Except, of course, in the case of unrelated currencies. See Ch. V (of Part 
 ID, 3- 
 
SPECIAL ARGUMENTS FOR PROTECTION 141 
 
 arguments by which the farmers' votes are sought for 
 the protective policy. Examination showed that the 
 gaining of a home market by protection involves the 
 losing of a foreign market in whole or in part, and that 
 the higher prices which protection makes farmers pay for 
 goods are not compensated for by the fact, supposing it 
 to be a fact, that those to whom the money is paid have 
 more money with which to buy farm produce, 
 y An argument having, if convincing, more significance 
 at present for Europeans than for Americans, is that in 
 favor of protection to agriculture, as security against 
 a time when the newer countries may be less inclined 
 to buy manufactured goods of and sell food-stuffs, etc., 
 to the older ones. We saw, however, that if future trade 
 is unimpeded or is impeded only by low tariffs, the 
 older countries can always have a market for their manu- 
 factures without having to accept returns less by much 
 more than necessary transportation costs, than those of 
 manufacturing industries, and, therefore, agriculture, 
 in the more largely agricultural countries. Unless great 
 restrictions on future trade are feared, this argument for 
 protection to agriculture has little force. 
 
 Protection to infant industries has been urged, even 
 by some careful thinkers, as a desirable temporary policy. 
 The principal objections are practical. It is difficult 
 to be certain that the development of other industries 
 is not being hindered as much as that of the favored in- 
 dustry is being helped. It is difficult to be certain that 
 the protected industry will eventually reach a point of 
 development such that the cheapness of its products will 
 repay the public for the admitted temporary loss. It is 
 doubtful if a legislative body is usually competent to 
 select industries for protection, on this principle, and it 
 
i 4 2 ECONOMIC ADVANTAGES OF COMMERCE 
 
 is probable that, in practice, political pressure from 
 interested parties in various localities will play much too 
 great a part. There is danger that the temporary pro- 
 tection will be continued much longer than is necessary 
 or desirable, since its beneficiaries seldom want to give 
 it up. 
 
 Protection is also urged as a means of diversifying 
 industry, and it probably has somewhat this effect. Yet 
 diversification can be purchased at too great a cost. 
 And a large country, with varied resources, is pretty 
 sure of a considerable diversity of industry, even without 
 protection. 
 
 The argument for protection to insure national self- 
 sufficiency is, in the main, a military argument. Na- 
 tional self-sufficiency is undoubtedly an advantage in 
 time of war. So is large population and great wealth. 
 Protection tends to increase the degree of self-sufficiency 
 and to limit wealth and (consequently) population. It 
 cannot be definitely asserted, therefore, that protec- 
 tion has often an adequate military justification. The 
 greater wealth and population resulting from a free trade 
 policy may mean the possibility of a larger army and 
 navy and a greater safety from attack. 
 
 Most of the arguments for protective tariffs on foreign 
 produced goods (though not, of course, the military argu- 
 ment) might be used with equal plausibility in favor of 
 protection by one part of a country against goods pro- 
 duced in another part. It is generally taken for granted, 
 however, at least in the United States, that free intra- 
 national trade brings benefit to each separate state or 
 other section of the country. If so, free trade with for- 
 eign countries would, in the same way, bring gain to the 
 nation as a whole. 
 
SPECIAL ARGUMENTS FOR PROTECTION 143 
 
 The industrial and commercial ideal is that wealth 
 shall be gained by service to the community and not by 
 injuring the community. Tested by this ideal, the effort 
 of interested parties to get protection for their industries 
 is morally wrong. For they are endeavoring to gain busi- 
 ness and wealth by prohibiting a foreign competition 
 beneficial to the public, instead of by serving the public 
 better than do their foreign rivals. 
 
CHAPTER VII 
 
 THE NATURE AND EFFECTS OF BOUNTIES 
 
 i 
 Bounties as Compared and Contrasted with Protection 
 
 SOMEWHAT similar in principle to an import protective 
 tariff is a bounty. A bounty is a payment made at 
 intervals by government to the persons engaged in some 
 industry which it is desired to encourage, in proportion 
 to the quantity of goods turned out or sold or in proportion 
 to the quantity exported. The purpose is, or purports 
 to be, the encouragement and development of the industry 
 receiving the periodic payment. A bounty is like pro- 
 tection in that it tends to divert industrial activity into 
 a different line or lines than such activity would other- 
 wise follow. Thus, to use our previous illustration, 
 Canada could, by means of a bounty as well as by pro- 
 tection, encourage Canadian production of linen. The 
 beet sugar industry in continental Europe has been, 
 largely, so encouraged. Likewise, by means of bounties 
 or so-called shipping subsidies, a number of countries 
 have endeavored to build up their shipping interests. 1 
 
 On the other hand, the bounty differs in several re- 
 spects, in its application, from protection. To begin 
 with, a protective tariff encourages an industry by guar- 
 anteeing it the home market, i.e. by shutting out goods 
 from abroad. But a bounty does not attempt to inter- 
 
 1 See discussion of shipping subsidies in Ch. VIII (of Part II), 2. 
 144 
 
THE NATURE AND EFFECTS OF BOUNTIES 145 
 
 fere with foreign competition. It endeavors, rather, 
 to enable the home producer more easily to meet foreign 
 competition. 1 The one method, protection, directly 
 shuts out rivals. The other method provides home 
 producers with the means to drive out rivals. 
 
 It follows, as a second and related distinction, that, 
 while a protective tariff enables the protected producers 
 to charge more for their goods, a bounty puts the favored 
 producers in a position to sell their goods for less than 
 they could otherwise afford to take. 2 It is thus that 
 these producers are enabled to capture the business. 
 A bounty may, because of this difference from protec- 
 tion, divert industry out of its natural channels to a 
 greater degree than a protective duty. For the latter 
 can do no more than guarantee the home market to pro- 
 ducers who, since they need protection at home, are 
 unlikely to get any considerable business elsewhere; 
 and in fact, protection, by causing inflow of money and 
 higher money costs, is likely to have the effect of making 
 invasion of foreign markets more difficult than before. 
 But the former, a bounty, may make it possible for an 
 industry, through competition in lower prices, to capture 
 the markets of the world, though very probably at great 
 expense to the taxpayers of the bounty-paying country. 
 
 Third, the burden of protection falls upon the buyers 
 of protected goods in proportion to their purchases of 
 these goods; while the burden of a bounty falls upon 
 taxpayers in proportion to their respective contributions 
 to the tax fund. Protection compels consumers to pay 
 higher prices. A bounty compels citizens to pay higher 
 taxes. 
 
 i Cf. R. Meeker, History of Shipping Subsidies (in Publications of the Ameri- 
 can Economic Association, August, 1905), p. 172. 
 ^ Ci. ibid., p. 173- 
 
 PART II L 
 
146 ECONOMIC ADVANTAGES OF COMMERCE 
 
 2 
 
 The Various Possible Effects of Bounties on the Level of 
 
 Prices 
 
 The effect of a bounty on the general level of money 
 prices in the bounty-paying country is similar to that 
 of protection. We may, for the purposes of our discus- 
 sion, distinguish three cases. In the first case, the 
 bounty acts like a protective tariff in that it decreases 
 imports. Thus, Canada might have a bounty of 43 
 cents a yard or slightly more, on linen cloth, which would 
 enable the Canadian cloth producers to sell at home for 
 $i or slightly less a yard, instead of $1.43. As a conse- 
 quence, we may suppose, the Canadian cloth producers 
 would be able to get complete control of the home market. 
 Then, as in the case of protection, no money would flow 
 to Ireland or elsewhere, for linen. But foreign con- 
 sumers would still buy Canadian wheat, and there would 
 be a tendency for prices in general, in Canada, including 
 the price of linen, to rise. 1 Eventually Canadian prices 
 would be enough higher than before, as compared with 
 foreign prices, to bring back equilibrium in trade. If 
 Canada's currency system were unrelated to the systems 
 of other countries, if, for example, it were based on incon- 
 vertible paper, the rise of money prices would not take 
 place, but equilibrium of trade would eventually result 
 through a change in the relative values of Canadian and 
 other currencies. 2 
 
 In the above assumed case, we have supposed a bounty 
 not quite high enough to make it easy or perhaps possible, 
 
 1 This might lead, as in the case of protection, to a demand for a greater 
 bounty, or to a demand for bounties to industries previously not encouraged. 
 See Ch. IV (of Part II), 6. 
 
 J See Part I, Ch. VI, 6, 7, 8, 9, and Part II, Ch. IV, 3. 
 
THE NATURE AND EFFECTS OF BOUNTIES 147 
 
 for Canadian linen producers to meet transportation costs 
 and invade foreign markets. Let us now suppose a 
 bounty of 60 cents a yard. With a production cost of 
 $1.43, this bounty would reduce the net cost to 83 cents 
 a yard. Even after paying transportation costs, Cana- 
 dians could then perhaps sell linen abroad for 85 or 90 
 cents a yard, thus greatly increasing their business and 
 driving out foreign competitors. In this case, not only 
 would Canadian importation of linen be decreased, but 
 Canadian exportation of linen would be greatly increased. 
 As a consequence, there would be a net inflow of money 
 into Canada and a relative rise of Canadian prices. This 
 rise would continue until equilibrium became estab- 
 lished either by larger purchases of Canadians abroad, 
 or by smaller purchases of foreigners in Canada, or by 
 both. Thus, Canadians might even, if prices should 
 rise sufficiently, buy goods abroad which they had pre- 
 viously produced at home. If so, other Canadian pro- 
 ducers would clamor for bounties or for protection. 
 Nevertheless, an equilibrium of trade must eventually be 
 established. 1 
 
 The third case would be realized if, at the time of es- 
 tablishing a bounty on linen manufacture, Canada was 
 already largely supplying the world with linen and could 
 not hope greatly to extend her foreign market. In this 
 case, the effect of the bounty (assuming free competition 
 among present and potential Canadian linen producers) 
 would be to lower the price of linen without correspond- 
 ingly increasing its sale. Less money would therefore 
 flow into Canada, while as much as before would flow 
 out. Other things equal, there would be a net outflow 
 of money, and money prices would fall. It hardly needs 
 
 1 Cf. Ch. IV (of Part II), 6. 
 
148 ECONOMIC ADVANTAGES OF COMMERCE 
 
 to be stated that, if Canada's money system is assumed 
 to be different from those of other countries, there would 
 be a change in the value of Canadian money in terms of 
 other money, rather than a fall in Canadian prices. 1 
 
 3 
 
 The Various Possible Effects of Bounties on the General 
 Welfare in the Bounty-paying Country and in the 
 Countries with which it Trades 
 
 Consideration of the effects of a bounty on the general 
 welfare of the bounty-paying country and of the countries 
 with which it trades, may profitably follow the line of 
 the above three cases. In the first case, where it decreases 
 imports by enabling the home producers to gain the home 
 market but does not enable them to gain a foreign 
 market, the bounty acts substantially like a protective 
 tariff. It tends to prevent imports but not to stimulate 
 exports. It conduces to national self-sufficiency. It 
 prevents what would else be a profitable trade. Like 
 protection, it turns labor and capital away from the chan- 
 nels they would naturally follow, away from what are 
 presumably the most profitable channels, into channels 
 favored by law. The effects on total production are 
 obviously the same, whether diversion is caused by pro- 
 tection or by bounty. 
 
 Not only is the bounty-paying country injured, but 
 also the countries with which it trades are, presumably, 
 to some extent injured. These other countries lose a 
 profitable export trade, and they do not secure goods 
 more cheaply from the bounty-paying country since the 
 bounty is not high enough, in the first case discussed, 
 
 1 See, particularly, Part I,*Ch. VI, 6, 7, 8. 
 
THE NATURE AND EFFECTS OF BOUNTIES 149 
 
 to encourage sales abroad by the recipients of this 
 bounty. 
 
 The second case to be considered is that in which the 
 bounty encourages export by the bounty-paying country, 
 of the goods on which the bounty is paid. If desired, 
 the bounty may be paid only on exported goods. In 
 this second case, as in the first, the prosperity of the 
 bounty-paying country is made less than it otherwise 
 might be. Industry is turned from more profitable 
 into less profitable channels. Trade with other coun- 
 tries is not prevented to the extent that it is in the first 
 case or in the case of protection, and may be actually 
 increased. But the trade stimulated is not relatively a 
 profitable trade. The export of linen by Canada, in 
 our illustration, takes the place of other exportation more 
 profitable to Canada or of internal trade which would 
 be more profitable. It is as uneconomical to encourage 
 a trade which would not otherwise take place, as to dis- 
 courage, by protection (or by high export taxes), trade 
 which otherwise would take place. 
 
 The effect of the bounty on other countries than the 
 one which pays it, is, in this second case, beneficial. 
 We know that other countries would gain by the trade 
 if the new industry were one which became established 
 in the bounty-paying country because of suddenly dis- 
 covered natural resources or because of acquisition of 
 skill. And as far as other countries are concerned, 
 the bounty has the same effect as either of these other 
 causes of development of the favored industry. It is 
 no longer desirable for them to produce the goods in 
 question for themselves. These goods can be got more 
 cheaply at the expense of the taxpayers of the bounty- 
 paying country. The persons in other countries, who 
 
i5o ECONOMIC ADVANTAGES OF COMMERCE 
 
 formerly produced these goods, must, it is true, change 
 their occupation. 1 But there are presumably other 
 occupations equally or almost equally, profitable, and the 
 consumers of these other countries gain, therefore, more 
 than the producers lose. 2 
 
 In the third case, the bounty does not appreciably 
 increase the sales abroad by the favored producers of the 
 bounty-paying country, but simply results in their selling 
 about the same quantity of their goods at lower prices. 
 In this case, the loss to the bounty-paying country is 
 more obvious than in the other cases, while it is even 
 clearer than in the second case, that foreign countries 
 gain. Since the bounty simply lowers prices without 
 extending trade, it benefits foreign consumers without 
 driving any foreign producers from the line of produc- 
 tion favored into other lines. 3 
 
 1 The trade between second and third countries and their relative gains from 
 trade, may be affected. A bounty on the production of linen in Canada may, 
 by encouraging export of Canadian linen, drive Irish manufacturers out of, say, 
 the German market. Irish linen producers are injured. German linen con- 
 sumers are benefited. But Ireland can get its own linen, thereafter, more 
 cheaply by importing it from Canada, and gains in so far as linen is desired to 
 use. Ireland is injured in so far as Canada enters trade as her competitor in 
 selling linen to Germany, but this loss is balanced by Germany's gain. Ireland 
 gains in so far as she secures linen from abroad more cheaply than she could 
 make it herself. It becomes more economical for Ireland to devote herself to 
 some other line or lines. If the new products which she now endeavors to ex- 
 port are less desired abroad than the old, the rate of trade will tend to become 
 somewhat less favorable to Ireland and more favorable to these other countries, 
 than before. Ch. II (of Part II), 2. Ireland will also, probably, become some- 
 what more self-sufficient. But the conclusion remains that when all other countries 
 except the bounty-paying country are considered, the general result is favorable. 
 See, however, Ch. IV (of Part II), 6. 
 
 2 See Ch. IV (of Part II), 2. 
 
 8 There is a tendency, also, for the rate of trade to become more favorable 
 to other countries and less so to the bounty-paying country. Money flows out 
 of the latter and into the former. Prices fall, relatively, in the latter and rise, 
 relatively, in the former, though this change would probably be slight in the 
 case of a bounty on only one kind of goods. Hence, foreign countries may be 
 
THE NATURE AND EFFECTS OF BOUNTIES 151 
 
 England was for a long time a very great gainer by 
 virtue of the export bounties paid on beet sugar until 
 I903, 1 by the beet sugar producing countries of conti- 
 nental Europe. 
 
 Had only one such country adopted a bounty-paying 
 policy, the effect would have been much larger exports 
 of sugar for that country and a slightly lower price of 
 sugar for buying countries. This is the kind of situation 
 discussed in our second case. But when all the Euro- 
 pean beet sugar countries were simultaneously paying 
 bounties on exported sugar, the net result was that no one 
 of them could extend its export trade to anything like 
 so great a degree, while all of them had to accept very 
 low prices for their product. There was then a closer 
 approximation to the conditions described in our third 
 case, though probably, since beet sugar largely displaced 
 cane sugar from the West Indies and elsewhere, the con- 
 ditions of case 3 were not realized. 
 
 However this may have been, it is obvious that the 
 sugar consumers of other parts of the world were great 
 gainers by virtue of these bounties, and gainers at the 
 expense of the bounty-paying countries. Particularly 
 did the bounties redound to the profit of free-trade 
 England, whose people were not prevented by tariff 
 restrictions from securing the sugar cheaply. 2 So it 
 resulted that the English were able to consume several 
 times as much sugar per capita as, for instance, the 
 
 able to buy other goods than the favored kind more cheaply than before from 
 the bounty-paying country, while having higher money incomes with which to 
 buy. 
 
 1 Fisk, International Commercial Policies, New York (Macmillan), 1907, p. 
 
 137- 
 
 2 Although eventually, because of colonial sugar interests in the West Indies, 
 England supported the general agreement to discontinue the bounty competi- 
 tion. It does not follow, of course, that England acted wisely in so doing. 
 
iS2 ECONOMIC ADVANTAGES OF COMMERCE 
 
 bounty-paying Germans. 1 Furthermore, all those Brit- 
 ish industries which depended upon the use of sugar 
 prospered in a large degree. 2 In the confectionery and 
 preserving trades, thousands of persons were employed 
 and many thousands of tons of sugar were annually used. 
 If, in some distant future, the philosophy of protec- 
 tionism comes ever upon the discredit which it deserves, 
 the descendants of those whose taxes supported the 
 favored business of sugar production may at least con- 
 sole themselves with the thought that many foreigners 
 were benefited. Though the bounties turned industry 
 from its natural channels, though they caused the con- 
 sumption of beet sugar, when cane sugar would have 
 involved a less labor cost, though they diminished the 
 economic well-being of the world as a whole, though 
 part of the taxpayers' burdens was therefore in every 
 sense a net loss ; yet another part of their burdens was 
 compensated for by extra gains, in the form of cheaper 
 sugar, to the people of a neighbor nation. 
 
 4 
 
 The Various Possible Effects of Bounties on Wages and Rent 
 
 A bounty, or system of bounties, would usually affect 
 money wages as compared with real wages, just as does 
 a protective tariff. The immediate effect of a bounty 
 would be to tax the people more than it lowered the 
 price of the goods favored. For illustration, suppose 
 that Canada can buy linen, in Ireland, for $i a yard, 
 while the cost of linen produced in Canada is $1.43. 
 By granting a bounty of 43 cents or of 53 cents, the 
 
 1 Sumner, Protectionism, New York (Holt), 1885, p. 81. 
 *Ibid., p. 86. 
 
THE NATURE AND EFFECTS OF BOUNTIES 153 
 
 Canadian government enables home manufacturers to 
 sell linen at $i or at 90 cents a yard. The people of 
 Canada lose, as taxpayers, 43 cents to gain nothing, or 
 53 cents to gain 10 cents. Unless the taxes are so levied 
 that they do not fall upon and cannot be shifted to wage 
 earners, 1 real wages must be lower. 2 This remains 
 true after the inflow of money which raises prices (or the 
 outflow case 3 which lowers prices) . For money 
 prices and money wages will tend to be affected in equal 
 proportion by the change in money supply. A bounty 
 on exports only, may lower the price of the favored goods, 
 to foreign consumers, at the expense of taxpaying 
 citizens of the bounty-giving country, while it will not 
 lower the price to domestic consumers. 
 
 5 
 
 Why Bounties may be Less Objectionable than Protection 
 if Encouragement of Infant Industries is in Any Case 
 to be Attempted 
 
 The bounty method has sometimes been recommended 
 as superior to the method of protection, for the estab- 
 lishing and developing of an infant industry. Since the 
 bounty system is more clearly seen to involve taxation, 
 public support is less likely to be given to schemes for 
 its widespread application. It is perhaps not quite so 
 unlikely that care will be used in deciding upon the 
 industry or industries to be favored. For the same rea- 
 son, the likelihood that the bounty will remain a perma- 
 nent burden upon the general pub lie may be somewhat less. 
 
 1 Even if the necessary taxes fall in no sense upon wage earners, and so really 
 raise wages, they raise wages less by turning labor into unprofitable lines than 
 if the money were directly paid to wage earners, as a forced charity. 
 
 There is, however, as with protection, a conceivable exceptional case. Cf . 
 Ch. V (of Part II), 5- 
 
154 ECONOMIC ADVANTAGES OF COMMERCE 
 
 6 
 
 Summary 
 
 A bounty, like protection, is a special favor granted 
 by government to some industry or industries. It 
 differs from protection in that it does not tax foreign 
 competition, but enables the domestic producer to meet 
 it, in that it lowers instead of raises the 'price of the 
 favored goods, and in that the burden falls upon tax- 
 payers as such rather than upon consumers. A bounty 
 may simply insure domestic producers their home mar- 
 ket, or it may be high enough to enable them to meet 
 transportation costs and increase their foreign business, 
 or it may enable them to sell the same amount of goods 
 abroad as before, at lower prices. In the first two cases, 
 the level of prices in the bounty-paying country will 
 rise as compared with the levels in the countries with 
 which it trades. In the third case, the level of prices in 
 the bounty-paying country will fall. In all three cases, 
 the effect on the national prosperity of the bounty-pay- 
 ing country will almost certainly be unfavorable. In the 
 second and third cases, other countries will be likely to 
 profit to some extent at the expense of the taxpayers in 
 the bounty-paying country. Since a bounty system 
 tends to burden the taxpayers, with no corresponding 
 gain to the general public, it tends to lower real wages, 
 for it can hardly be supposed that wage earners will be 
 unaffected by the level of taxation. If an infant indus- 
 try is in any case to be established, however, the bounty 
 method may be better than the method of protection. 
 
CHAPTER VIII 
 
 UNECONOMICAL GOVERNMENT INTERFERENCE WITH, AND 
 ENCOURAGEMENT OF, TRANSPORTATION 
 
 Navigation Laws 
 
 ONE of the important methods which governments 
 have sometimes followed in order to develop a national 
 mercantile marine, has been the method of navigation 
 acts, excluding foreign vessels from certain designated 
 commerce. For example, England's navigation acts 
 of 1646 to 1660 (act of 1651 perhaps of chief importance), 
 prohibited the importation of any goods into England or 
 Ireland or any of the British Colonies, except in British 
 ships, owned and navigated by British subjects, or in 
 ships of the country where the goods were produced; 
 also these laws prohibited the export to foreign ports of 
 any goods produced in the American colonies, except 
 in British ships. 1 Our own Federal law regarding the 
 coasting trade is of the same genus. This law requires 
 that "no merchandise shall be transported by water, 
 under penalty of forfeiture thereof, from one port of the 
 United States to another port of the United States, 
 either directly or via a foreign port, or for any part of the 
 voyage, in any other vessel than a vessel of the United 
 States." 2 
 
 1 See Lindsay, History of Merchant Shipping, London (Low, Low and Searle), 
 1847, Vol. II, pp. 182-189. 
 
 2 30 Stat. L. ch. 26, p. 248. Referred to in the Report of the Commis- 
 sioner of Corporations, on Transportation by Water in the United States, Part 
 
156 ECONOMIC ADVANTAGES OF COMMERCE 
 
 Such navigation acts are closely analogous to protec- 
 tive tariffs. Like protection, they develop the favored 
 home industry by excluding foreign competition, not, 
 as in the case of the bounty, by providing funds to help 
 meet this competition. Like protection, these laws can 
 do no more than guarantee home patronage ; they can 
 not insure successful invasions of other commerce, de- 
 pendent solely on foreign patronage. As with protec- 
 tion, the burden of these laws rests upon consumers (of 
 goods carried in the protected ships), rather than upon 
 taxpayers as such. The burden rests upon consumers, 
 because the exclusion from the designated commerce, 
 of ships presumably able to carry goods more cheaply 
 than the favored domestic ships, 1 tends towards high 
 transportation rates, and, therefore, towards higher prices 
 to consumers, of goods carried, or towards decrease of 
 domestic commerce, or both. The burden of such a 
 policy may not be equally distributed over a country 
 enforcing it, but may rest with especial weight upon those 
 sections of the country which, being on or near the coast 
 line, have most to gain from cheap water transportation. 
 A navigation policy like that established by the historic 
 navigation laws of England, above mentioned, may also 
 tend, by increasing transportation costs, to limit the 
 export trade of the country adopting such a policy. Only 
 in case other countries have no available alternative 
 source of supply for goods desired, can the extra cost of 
 
 I, 1909, pp. 118, 119. Since the above was written, Congress has passed a law 
 (August, 1914) admitting foreign-built ships to American registry if owned or 
 purchased by Americans (See New York World, Aug. 18, 1914). Such ves- 
 sels were not previously ranked as American and had to sail under alien flags. 
 But the new law does not permit foreign-built ships to engage in the coasting 
 trade. 
 
 1 If the latter carried goods more cheaply, they could drive out foreign rivals 
 without legal aid. 
 
ENCOURAGEMENT OF TRANSPORTATION 157 
 
 carrying these goods rest as a burden on the consumers 
 of those other countries. 
 
 The main argument against navigation laws is the same 
 as that against protection. Like protection, it diverts 
 labor and capital from lines which they would otherwise 
 follow, into relatively unprofitable lines. These laws are, 
 therefore, as indefensible, economically, as are protec- 
 tive tariffs. Where navigation laws would be likely to 
 develop a national marine, able, eventually, to compete 
 in the world's commerce successfully without aid, there 
 is a reasonable probability that conditions are favorable 
 to this success and that it would be attained in time 
 without government coddling. Where, in spite of navi- 
 gation laws intended to develop a national marine, abil- 
 ity to compete outside of the protected limits is never 
 attained, the protective laws involve a continuous burden 
 on the general public. Whatever military justification 
 may exist for such protection to national navigation, 
 economic justification is usually absent, and is probably 
 always of doubtful weight. 
 
 2 
 
 Subsidies to Native Shipping 
 
 Another method of encouraging a national mercan- 
 tile marine is that of paying so-called shipping subsidies. 
 Shipping subsidies are simply bounties paid to the ship- 
 ping industry. What was said in Chapter VII (of Part II) 
 regarding bounties applies, therefore, to shipping subsidies. 
 Like bounties and like protective tariffs, shipping sub- 
 sidies divert national industry out of its natural lines 
 into a line which, without such encouragement, it prob- 
 ably would not follow, or which it would not follow to 
 
158 ECONOMIC ADVANTAGES OF COMMERCE 
 
 the same extent. Unlike protection, subsidies do not 
 exclude foreign competition, but simply endeavor, by 
 money payments, to make it possible for the national 
 marine to meet this competition. As with other bounties, 
 therefore, the burden falls upon taxpayers, rather than 
 upon shippers or ultimate consumers. The two last 
 classes may even gain somewhat, if a subsidy is sufficient 
 to cause lower freight rates in spite of the greater cost of 
 transportation in native ships. But even these classes 
 will gain nothing if a subsidy is just high enough to en- 
 able native ships, previously unable to compete, to charge 
 rates no higher (and no lower) than those charged by 
 foreign ships. 
 
 One of the cruder arguments for subsidies, as for pro- 
 tective tariffs, is to the effect that when we patronize 
 foreign vessels we have to send our money abroad, and 
 that we would " save " this money if we carried the freight 
 in our own vessels. As a matter of fact, money is not 
 the one thing for which trade, in the last analysis, is 
 carried on. Furthermore, if money flows out unduly, it 
 thereupon begins to flow back again, in accordance with 
 the principles which we have so often set forth in previous 
 chapters. 1 As regards the most economical directions 
 of industrial and commercial development, it should 
 be apparent that if British or other ships can carry goods 
 more cheaply than our own merchant marine, then our 
 labor may better be devoted to the lines where it yields 
 greater returns, to services which others cannot so well per- 
 form for us, to our factories, farms, mines, and railroads. 
 If American labor is more profitable when devoted, for 
 instance, to the running of railroad trains, then it is poor 
 economic policy to draw it, by subsidies, into the running 
 of ships. 
 
 1 See, for example, Part I, Ch. V, 6, 7, 8. 
 
ENCOURAGEMENT OF TRANSPORTATION 159 
 
 Another argument for subsidies is based on the asser- 
 tion that " trade follows the flag." This assertion, used 
 in relation to subsidies, suggests that a national merchant 
 marine acts as a species of advertisement, that, for ex- 
 ample, the American flag flying at the mast head of a 
 merchant ship will stimulate a desire in South America 
 or elsewhere, to examine, and, therefore, eventually to 
 buy, American goods. Except for purposes of adver- 
 tisement, foreign ships serve as well to carry American 
 goods to market as do American ships, and better in 
 proportion as they carry these goods more cheaply. 
 
 Probably there is some advertisement for a country's 
 goods in the ubiquitousness of its merchant ships. Yet 
 we must beware of exaggerating the amount and the 
 value of this advertisement, and of overlooking its cost. 
 France has made considerable effort to develop shipping 
 and has hoped thereby to develop foreign commerce, 
 while the United States has done almost nothing to stim- 
 ulate foreign trade in American ships ; yet a practically 
 stationary foreign commerce of the former country has 
 been contemporaneous with an extensive growth of the 
 commerce of the latter. 1 "The history of the world's 
 commerce seems to show conclusively that the nation- 
 ality of ship owners is quite a secondary matter in the 
 development of trade." 
 
 So far as the presence of a nation's ships, e.g. American 
 ships, on the high seas and in foreign harbors, really tends 
 by its advertisement to stimulate American export 
 trade, it would seem that the persons having to pay for 
 this advertisement should be those who expected to 
 reap special gain from it. Why should not merchants 
 
 1 Meeker, History of Shipping Subsidies (in publications of the American 
 Economic Association, August, 1905), P- 213. 2 Ibid. 
 
160 ECONOMIC ADVANTAGES OF COMMERCE 
 
 and manufacturers who are interested in exploiting the 
 trade of any part of the world, and who seriously think 
 that the presence there of vessels flying the American 
 flag will bring them a larger market, be willing to sub- 
 scribe to the stock of American lines, or pay a little extra 
 to have their goods carried in American vessels, or both ? 
 Is it not possible that American merchants and manu- 
 facturers will not do this to any great extent, because the 
 gain would be so small as not to equal the cost ? Hard- 
 headed business men spend a great deal of money in ad- 
 vertising. Some of them are enthusiastic over the as- 
 sumed gains of this particular kind of advertising if it 
 is proposed that it shall be done at public expense by 
 means of subsidies. But would they consider the rather 
 problematical results of such indirect and indefinite 
 advertising worth paying for out of their own business 
 profits? By the subsidy method, many persons and 
 many sections of the country are taxed to secure results 
 which may be of little or no benefit to them and which 
 are probably of not very much benefit to any one. 
 
 Another argument in favor of subsidies is one that 
 corresponds to the infant industry argument for protec- 
 tion. It is urged, in this view, that subsidies should 
 be given to divert industrial and commercial activity 
 more largely into shipping, in the hope that the mer- 
 chant marine will develop in efficiency until it is able to 
 stand alone. An important counter-argument is the fact 
 that no one is able to foresee with any certainty whether 
 or not the shipping industry ever can stand alone and 
 that legislators are less likely to risk the public wealth 
 wisely than business men are to risk their own. There 
 is great danger that subsidies, once started, would con- 
 tinue indefinitely on the plea that they continued to be 
 
ENCOURAGEMENT OF TRANSPORTATION 161 
 
 necessary. 1 And if, as a consequence of a subsidy system, 
 the national mercantile marine should become larger, 
 though at the general expense, then the political pressure 
 to maintain the subsidy system would very probably 
 become greater. It is altogether too probable that if 
 the giving of subsidies is generally recognized as a proper 
 function of government, men who would otherwise de- 
 vote themselves to planning improvements and to seek- 
 ing real progress in efficiency, will instead devote them- 
 selves to influencing political action, in order that they 
 may get, or maintain, or increase, a subsidy. 2 This 
 method of acquiring gain is not consistent with the ideal 
 of industrial and commercial morality. Industry and 
 commerce should be so organized that profits will be made 
 only by serving the public, and that profits will be large 
 to any person or firm in proportion as that person or firm 
 serves the public well. The prosperity of those engaged 
 in operating a nation's merchant marine ought not to be 
 made dependent upon their political influence rather than 
 upon their economic service. 
 
 Apart from purely economic considerations, shipping 
 subsidies are sometimes urged as a means of increasing a 
 nation's naval strength. Two principal naval reasons 
 are commonly given for the maintenance of a merchant 
 marine, even at the expense of a subsidy. The first is 
 the desirability of having a " naval reserve" made up of 
 large and swift merchant steamers suitable for conver- 
 sion into cruisers, colliers, and transports, should need 
 for such arise. As a matter of fact, it is only as colliers 
 and transports that such vessels are likely to be useful, 
 since ships of war are nowadays highly specialized, and 
 
 1 Meeker, History of Shipping Subsidies, p. 81. 
 
 2 Ibid., p. 216. 
 PART II M 
 
162 ECONOMIC ADVANTAGES OF COMMERCE 
 
 merchant vessels cannot, economically, be made over 
 into cruisers. 1 The second reason is the desirability of 
 having experienced seamen from whom to recruit colliers, 
 transports, and additional righting ships when war threat- 
 ens, to replace those killed and wounded, to hold cap- 
 tured vessels, etc. 
 
 These objects may be perfectly justifiable, even laud- 
 able, in themselves. And it may be cheaper to pay 
 subsidies to certain lines, thus helping to keep them in 
 ships and men capable of emergency use by government, 
 but letting them be mainly supported by commerce, 
 than to support, continuously, and wholly at public ex- 
 pense, a larger naval force. But if the policy of sub- 
 sidizing ships appears necessary to us for military 
 reasons, we should frankly recognize that this policy 
 involves an economic loss, that it is an expense borne 
 for the same purpose as the expense of maintaining a navy. 
 We should not deceive ourselves into the belief that the 
 subsidizing of ocean navigation is an economically profit- 
 able policy. We should therefore aim to get the largest 
 military result possible at the smallest possible cost. 
 Large payments to swift mail lines and possibly to cer- 
 tain other ships constructed for speed and carrying ca- 
 pacity and conforming, in other ways, to possible emer- 
 gency requirements, mark the limit beyond which we 
 should not go in subsidizing, even if we should go so far. 
 Subsidies granted according to these principles are pay- 
 ments for certain definite services or potential services, 
 and are not to be classed with subsidies granted for 
 purely commercial reasons. 
 
 1 Meeker, History of Shipping Subsidies, p. 215. 
 
ENCOURAGEMENT OF TRANSPORTATION 163 
 
 3 
 
 Indirect Subsidies, Favoring Native Ships as Compared 
 with Foreign Ships 
 
 A country may try to extend and develop its own 
 merchant marine, to the consequent decrease (or slower 
 increase) of the number of foreign ships, by indirect as 
 well as by direct subsidies. Any service which a coun- 
 try, through its government, performs for its own ships 
 without pay, while charging foreign vessels for it, is 
 equivalent to a money subsidy. 
 
 Were it not for clear treaty obligations, there would 
 probably be, in the United States, as strong a demand 
 for free use of the Panama Canal by all of our American 
 merchant ships, as there has actually been for its free 
 use by American vessels engaged in the coasting trade. 1 
 To let American vessels use the Panama Canal free would 
 be equivalent to a money subsidy, because it would 
 amount to the same thing as to make a charge for the 
 use of the canal and then to make a payment equalling 
 this charge, to American shipping interests. In either 
 case, the taxpayers of the nation would bear a burden, 
 or lose a chance for lower taxes, that special interests 
 might be encouraged. For if letting American ships 
 use the canal free would mean that the canal could never 
 pay a reasonable return on its cost, then taxpayers must 
 meet the deficit by taxes paid to government over a 
 series of years, in order to liquidate, or at least pay in- 
 terest upon, the indebtedness caused by building. If, 
 on the other hand, though all American ships used the 
 canal free of tolls, the amounts collected from foreign 
 
 1 For a discussion of the economic advisability of giving American coasting 
 lines this special privilege, see 4 of this chapter (VIII of Part II). 
 
164 ECONOMIC ADVANTAGES OF COMMERCE 
 
 ships would suffice to pay interest on the debt contracted, 
 still this interest might be had and more besides, were 
 the American lines also made to contribute. 1 In other 
 words, to allow American ships free use of the canal must, 
 in any case, mean either a loss or a smaller net revenue 
 yielded to the government than might otherwise be 
 yielded. If the canal is to yield the nation a revenue 
 because of its use by foreign ships, that revenue should 
 be used to lighten the burden of taxation on the whole 
 people ; it should not be used to encourage a single in- 
 dustry by giving it something for nothing. Thus to en- 
 courage American shipping would be to give it an artifi- 
 cial advantage over other American industries, and would 
 be, in so far, to interfere with the tendency of labor and 
 capital to engage in the industries really most profitable 
 for the nation. There is no economic gain 2 in having 
 our commerce carried in American ships if foreign ships 
 are able to carry it more cheaply. Nor would the pros- 
 perity of the nation as a whole, including those who bear 
 the burden of taxation, be so much furthered by having 
 our commerce carried in American ships which could 
 pay little or nothing for the use of the canal, as by 
 having it carried in foreign vessels which could pay a 
 reasonable amount for its use without charging corre- 
 spondingly higher transportation rates. Assuming these 
 to be the relative abilities of native and foreign vessels, 
 
 1 It is not intended to assert that either American or foreign ships should be 
 charged exorbitant rates. Such rates on ships carrying American commerce, 
 of whatever nationality the ships might be, would tend to discourage this com- 
 merce, even when it could pay the proper costs of its own movement and would 
 therefore be profitable. As to the 'effect on American welfare of exorbitant 
 rates charged ships not carrying American commerce, see footnote at end of this 
 section. 
 
 2 Unless we assume a gain from the advertisement thus secured. See 2 of 
 this chapter (VIII of Part II). 
 
ENCOURAGEMENT OF TRANSPORTATION 165 
 
 the foreign vessels would be a more economical means 
 for us of carrying our commerce than our own; for 
 them to carry it would mean either lower rates and, 
 therefore, lower prices to consumers and higher prices 
 to producers, or larger returns to the government, favor- 
 able to taxpayers, or both such lower rates and higher 
 prices ; for them to carry our commerce would mean gain 
 to our people as producers and consumers, or as tax- 
 payers, or as both. It would be desirable, therefore, 
 for our capital and labor to seek other kinds of activity ; 
 but this is just what discrimination in the rates charged 
 for use of the canal would prevent. 1 
 
 4 
 
 The Free Use for Navigation of Government-built Canals 
 
 Since to give free use of the Panama Canal to all Amer- 
 ican ships and to no others, seemed clearly to involve 
 a violation of treaty obligations, Congress was content, 
 in the Panama Canal Act of 1912, to confer this privi- 
 lege only upon American ships engaged in the coasting 
 trade. Even this lesser tolls exemption appeared to 
 many to be a violation of treaty rights; and the law 
 has recently, 2 at the request of President Wilson, been 
 changed in this regard so as to require the same charges 
 from American coasting vessels as from all other mer- 
 chant ships. We shall discuss, here, the possible eco- 
 
 1 Were we to plan/intelligently, so to discriminate in rates charged for use of 
 the Panama Canal, as to pay for it, as largely as possible, at the expense of for- 
 eigners, we would base the discrimination on the sources and destinations of 
 goods carried, rather than on the nationality of the ships which carried them. 
 Goods going to and from the United States would be allowed, perhaps, to pass 
 through the canal at fairly low rates, lest American consumers or producers be 
 unduly taxed ; while goods going from one foreign country to another would be 
 charged the highest rates possible to collect. 
 
 'June, 1914. 
 
i66 ECONOMIC ADVANTAGES OF COMMERCE 
 
 nomic effects of tolls exemption for American coasting 
 ships. As we have already seen, 1 the Federal govern- 
 ment assures American vessels a monopoly of the coast- 
 ing trade, including the trade from any port of the United 
 States to any other port, e.g. from Baltimore to San 
 Francisco. Free use of the Panama Canal by American 
 vessels engaged in the coasting trade could not, there- 
 fore, increase our mercantile marine at the expense of 
 foreign rivals in the trade. The primary effect of free 
 tolls to this special class of ships would be to reduce the 
 expense of coast to coast trade, and therefore, supposedly, 
 to reduce rates. Possibly foreign vessels could carry at 
 the lower rates, even without free tolls. If the coasting 
 trade were open to foreign ships, the effect of discrim- 
 ination in favor of American vessels engaging in this 
 trade might simply be that the American ships would be 
 able to get part of the trade away from their foreign 
 competitors, at substantially the same rates. As it is, 
 such free tolls would tend to make rates lower than they 
 would else be, though much of the saving might be di- 
 verted to the owners of monopolistic navigation com- 
 panies. Hence traffic would be encouraged to go through 
 the canal, which otherwise would not. 
 
 The construction of a canal across the Isthmus of 
 Panama, to be used without charge by American coasting 
 vessels, would therefore mean that traffic from the East 
 to the West, and vice versa, which is not worth the 
 whole cost of carrying, might nevertheless be carried 
 at the expense of the tax-paying public. If it is worth 
 $5000 to get certain goods from New York to San Fran- 
 cisco, and the cost of carriage, including proper payment 
 for all necessary facilities, is $6000, and if this cost is 
 
 1 I of this chapter (VIII of Part II). 
 
ENCOURAGEMENT OF TRANSPORTATION 167 
 
 covered by the charge made, the goods will not be sent. 
 It will be more economical to have a greater degree of 
 local self-sufficiency and less geographical division of 
 labor. But if the taxpayers should contribute more 
 than $1000 in the form of maintenance and running 
 cost of the canal, and interest on its cost of construction, 
 then the goods would be shipped, for the charge to the 
 shippers could be made less than $5000. The total cost 
 would be $6000 and the total gain would be $5000. 
 There would be a real net loss. But this loss would be 
 borne by the taxpayers, and therefore the traffic would 
 be carried. 
 
 Again, the encouragement of the coasting trade by 
 the building of an Isthmian ship canal to be used by 
 coasting vessels, free of charge, might mean that goods 
 would be carried by water or partly by water, at the tax- 
 payers' expense, which might be more economically 
 carried by rail. Suppose that a quantity of goods can 
 be shipped from New York to Salt Lake City by rail for 
 $4000, including a proper allowance for wages of em- 
 ployees and something towards profits. Suppose that, 
 at the same time, the cost by water and rail, including 
 risk, damage, longer time in transit, maintenance cost 
 of the canal and interest on canal facilities provided, 
 is $5000. $1000 may be saved if the goods go by rail, 
 and to make them go by the other route, if we include 
 interest on the cost of partly constructing this route for 
 them, maintenance expenses, etc., would be to waste 
 $1000. The community or the nation would be so much 
 poorer, yet if the government were to provide the $1000 
 or more in the form of canal facilities paid for, eventually, 
 by the taxpayers, shippers would gain by using the water- 
 way route. 
 
i68 ECONOMIC ADVANTAGES OF COMMERCE 
 
 It is not asserted, of course, that all goods ought to 
 pay in the same proportion to use the canal, if discrimi- 
 nations should prove to be practicable. If the plant 
 is incompletely utilized, it may not be improper to let 
 some goods go through for comparatively low rates, 
 provided they would not otherwise go at all. But no 
 goods ought to be allowed to go through which cannot 
 pay at least a fair share towards running expenses, wear 
 and tear from use, and (probably) a little towards inter- 
 est. And the canal should not have been built (mili- 
 tary considerations aside 1 ), unless it was expected that 
 the traffic through it, as a whole, would be enough cheaper 
 to pay interest on it. To build it, if it could not be made 
 to pay, was economic waste, was, as above pointed out, 
 to encourage transportation not really worth its total 
 cost to the people. Now that the canal is completed, it 
 would be unfair to the American people as a whole that 
 the traffic which goes through it should not, if possible, 
 pay for it, that those who realize the chief benefit should 
 not contribute in proportion to the benefit realized. 
 
 Here, as in the case of protection, we meet the possibil- 
 ity that government interference with the direction of 
 industry may affect differently the people of different 
 sections, benefiting some at the expense of others. It is 
 obviously only that part of our population living on or 
 reasonably near the coast, which has much to gain from 
 subsidizing, directly or indirectly, coast to coast water 
 transportation. Those living in the far interior will, in 
 any event, have to rely mainly on other means of trans- 
 portation. Yet by the scheme of indirect subsidizing 
 under discussion, but which has, fortunately, been aban- 
 
 1 As a matter of fact, it is hardly to be doubted that economic considerations 
 had great weight in inducing its construction. 
 
ENCOURAGEMENT OF TRANSPORTATION 169 
 
 doned, those in the interior would be made to contribute 
 to the cost of facilities of transportation which others 
 use and which they cannot use in the same degree. 1 
 
 The principles above elaborated apply equally when 
 government builds canals in the interior, if traffic is al- 
 lowed to use these canals free of charge. New York 
 State is now enlarging the once busy and profitable Erie 
 Canal at an estimated cost of not less than $100,000,000, 
 in order that it may carry barges of 1000 tons capacity 
 from the Atlantic Ocean to the Great Lakes and vice 
 versa. The plan is to charge nothing for the use of the 
 canal. This will mean a burden on the taxpayers of 
 the state, an uncompensated loss to the taxpayers in 
 those parts of the state which cannot economically use 
 the canal either to market their produce or to obtain 
 goods for consumption. It amounts to a gift by the tax- 
 payers of the state of New York to those producers and 
 consumers in other states, who can sell their products for 
 more or buy desired goods for less, because of the free 
 use of the Erie Canal. It involves encouragement to 
 transportation via the canal of goods which might better 
 go by railway or by the St. Lawrence river. If the traffic 
 which is expected to use the canal would be able to pay 
 the cost of operation and maintenance, and interest on 
 the $100,000,000 or more sunk and to be sunk, then it 
 should be charged this cost and interest, to the end that 
 those who reap the benefit of the canal in lower cost of 
 carriage, and in prices of goods higher to producers and 
 lower to consumers, shall pay for the advantage so se- 
 
 1 An excuse for such discrimination against dwellers in the interior might 
 perhaps be found in the fact that those living on the coast chiefly bear the burden 
 resulting from the limitation of the coasting trade to American vessels. Two 
 policies, each tending towards economic waste, would partially offset each other 
 as regards inequality of effect. 
 
i;o ECONOMIC ADVANTAGES OF COMMERCE 
 
 cured; and that those who reap the most gain shall pay 
 the most ; and to the end that the burden shall not fall 
 upon the general public without any regard to propor- 
 tionate use and to benefits received. 1 If, on the other 
 hand, it is not believed that those using the canal can 
 meet such charges and still find it profitable to carry 
 goods over it, then we must conclude that the canal 
 ought not to be (or, in part, to have been) enlarged, 
 since the total expenses, including cost of this enlarge- 
 ment, of carrying goods over it, will probably be greater 
 than the benefits to be received from transporting the 
 goods, or will be greater than if the goods were carried 
 over another route, e.g. a railroad. 
 
 Before the days of railroads, much confidence was felt 
 in the possibilities of canals. A number of our states 
 expended a great deal of money in canal building. To- 
 day it is generally recognized that, since the capital cost 
 of canals is a tremendous initial expense, railroads are 
 generally cheaper. Only in a comparatively few cases 
 can canal building be expected to pay. These are, first, 
 cases where the canals connect navigable waters located 
 near to each other, and between which, if they are con- 
 nected by a canal, there will be large traffic ; second, cases 
 where comparatively short canals, like the Suez Canal, 
 save a very great sailing distance and so are extensively 
 used ; third, cases more doubtful, where short canals con- 
 nect with the ocean, great cities which have grown up not 
 
 1 It is no sufficient answer to this contention to cite the usual practice regard- 
 ing our numerous streets and roads. To charge tolls, individually, on each 
 person as he used any given street, would obviously be an intolerable nuisance. 
 These facilities we must have, anyway, and substantial justice may be secured, 
 if care is taken to avoid extravagance, by levying on local property owners accord- 
 ing to some fair system. Since land values depend largely on streets, etc., it 
 may be possible, by basing assessments or taxes on land values, to make costs 
 to different persons vary, on the whole, in proportion to benefits. 
 
ENCOURAGEMENT OF TRANSPORTATION 171 
 
 far from it. 1 "Practically all the canals now in most suc- 
 cessful use are ship canals, forming comparatively short 
 links between important natural waterways, and opening 
 up extended routes of transportation by water for large 
 vessels. Such short-link ship canals are to be clearly 
 distinguished from long inland canals, and the success 
 of the one offers no safe criterion as to the probable 
 success of the other. " 2 Moulton's study of the much 
 vaunted waterway system of Germany seems to provide 
 conclusive evidence that canals are as cheap as railways 
 for shippers, only if the taxpayers, in effect, help pay the 
 freight, and that, hi general, canals and canalized rivers 
 involve tremendous loss to the nation which undertakes 
 their construction, and are therefore a source of indus- 
 trial and commercial weakness rather than of strength. 3 
 If there were adequate reason to believe that canals, 
 generally, were cheaper and more satisfactory means of 
 transportation than railroads, it would not be necessary 
 to have public agitation and political pressure to get 
 canals built. Private companies would undertake to 
 build them for profit, just as they build railroads for 
 profit, and just as canals were built, in England particu- 
 larly, before the days of railroads. 4 As a matter of fact, 
 investors are not clamoring for a chance to buy the securi- 
 ties of such companies, nor are promoters eagerly looking 
 for opportunities to project new lines. When the build- 
 
 1 Preliminary Report of United States National Waterways Commission, 
 IQII, pp. 13, 14. Reprinted in Final Report, 1912, pp. 75, 76. See, however, 
 as to an example of the third class of cases, viz. the Manchester Ship Canal, 
 Moulton, Waterways versus Railways, Boston and New York (Houghton Mif- 
 flin Co.), 1912, Ch. VII. 
 
 2 Report of Commissioner of Corporations on Transportation by Water in 
 the United States, Part I, p. 45- 
 
 Moulton, Waterways versus Railways, Chs. IX, X. 
 4 Ibid., p. 99. 
 
172 ECONOMIC ADVANTAGES OF COMMERCE 
 
 ing of canals is mentioned favorably, the assumption is 
 always made that taxpayers shall bear the burden, or 
 at least the risk, of building them. 
 
 5 
 
 The Improvement of Harbors 
 
 Water transportation which is not worth its cost, may 
 likewise be stimulated by a wrong system of harbor im- 
 provement. In the United States, the construction and 
 care of lighthouses, the building of breakwaters, the 
 dredging of harbors, and the dredging of channels between 
 the sea and harbors, are done largely by the Federal gov- 
 ernment. 1 It cannot be said that nothing is paid to- 
 wards the expenses involved, by the traffic aided, since the 
 tonnage dues collected by the government amount to 
 $800,000 or $900,000 a year. 2 But considering the fact 
 that the Federal government appropriates about $5,000- 
 ooo a year for lighthouse maintenance alone, 3 and, on 
 the average, appropriates millions of dollars each year 
 for dredging, breakwater construction, etc., the traffic 
 entering and leaving the ports of the United States can- 
 not be said to bear the costs which it occasions. Rather 
 is this traffic, in a considerable degree, subsidized at the 
 expense of taxpayers. As with canals, so with light- 
 houses and harbors, we must conclude that those who 
 benefit by them should be the ones required to pay for 
 them, and that to place the burden of their construction 
 
 1 Report of Commissioner of Corporations on Transportation by Water in the 
 United States, Part III, 1909, pp. 39, 40. 
 
 2 Johnson, Ocean and Inland Water Transportation, New York (Appleton), 
 1911, p. 252. Given in Report of Commissioner of Corporations on Transporta- 
 tion by Water in the United States, Part I, p. 404, as $1,076,571.69 in 1908. 
 The coasting trade is free even from this. 
 
 3 Ibid., p. 262. 
 
ENCOURAGEMENT OF TRANSPORTATION 173 
 
 and support on the general public, with no reference to 
 benefit received, is undesirable and unfair. 1 We must 
 further conclude that constructions and improvements 
 made in harbors, for which the traffic using the harbors 
 cannot afford to pay, involve national economic loss and 
 ought not to be undertaken. 
 
 In many cases the money spent in harbor improve- 
 ments by the Federal government is wholly or partly 
 wasted, for appropriations are frequently made for which 
 there is no economic justification and for which there 
 would be no economic justification even if the largest 
 sums possible were to be realized by charging the users. 
 Such wasteful appropriations are doubtless in part due 
 to lack of business sense among legislators. They are 
 perhaps more largely due to the pressure of local interests. 
 The very fact that these appropriations are so largely 
 made by the central government, and that there is, or 
 seems to be, a chance for interested localities to get some- 
 thing for nothing, results in expenditures which would 
 not be made if the localities particularly concerned had 
 always to provide the means, or if private capital had to 
 be induced to do so. 2 
 
 1 It is not a sufficient answer to the above argument, to assert that our tariff 
 system taxes trade and that therefore this trade pays for itself by paying for 
 the facilities used. For the burden, nevertheless, does not fall where it properly 
 belongs. It does not fall anything like evenly on all traffic which uses the facil- 
 ities provided. On some goods the tariff has been, until recently, prohibitive, 
 artificially interfering with normal and profitable trade. On other commerce 
 and on passenger traffic, the tariff duties are little or nothing. Such commerce and 
 traffic may, in effect, be receiving a subsidy, while the remainder of commerce 
 is burdened. The principle of charging the cost of facilities provided, to those 
 who use them and upon different interests in some proper proportion to the 
 benefit received, is not conformed to. We fall far short of the economic ideal 
 when we set up contradictory policies of discouragement and encouragement. 
 These contradictory policies do not exactly neutralize each other, but in one case 
 there is a net loss in one direction, and elsewhere there is a net loss in another 
 direction. 
 
 2 Cf . Preliminary Report of National Waterways Commission, p. 20 (Final 
 Report, p. 82). 
 
174 ECONOMIC ADVANTAGES OF COMMERCE 
 
 A different system, and one which is economically 
 more defensible, is that common in Great Britain. There 
 the central government, except as naval considerations 
 may be involved, does nothing whatever by way of har- 
 bor improvement, but leaves this matter to the localities 
 immediately concerned. The British system of harbor 
 improvement and maintenance requires the creation for 
 each harbor of a so-called " public trust" or public harbor 
 trust. 1 A public harbor trust is a semi-public body or a 
 corporation, authorized by parliament, to which body is 
 granted power to own, improve, and manage a particu- 
 lar harbor. It has been compared 2 to the board of 
 trustees of an American university or charitable institu- 
 tion. The members receive no salaries, but regard their 
 position as an honorary one. The composition of a 
 harbor trust is determined by statute. Representatives 
 are usually selected by the British government, the 
 government of the city concerned, boards of trade and 
 chambers of commerce, ship owners' associations, and 
 other interested parties. Money is borrowed for neces- 
 sary improvements, usually at low rates, for the harbor 
 trust is authorized to collect port and dock charges from 
 vessels utilizing the facilities given, and this power makes 
 the security good, at least in the case of a port sure to have 
 large traffic. Sometimes money is borrowed from the 
 municipality itself. In any case, money needed in excess 
 of what has been collected in previous years from traffic, 
 is borrowed, and must be paid back out of future collec- 
 tions. There are no stockholders, and, therefore, there 
 is no attempt to make a profit above a fair interest and 
 
 1 Described in Smith, The Organization of Ocean Commerce, Philadelphia 
 (Publications of the University of Pennsylvania), 1905, pp. 129, 130. 
 
ENCOURAGEMENT OF TRANSPORTATION 175 
 
 sinking fund. Indeed, a private corporation authorized 
 to collect tolls from all the shipping of a port, for the sake 
 of dividends to stockholders, would, unless strictly regu- 
 lated, be an intolerable monopoly. 
 
 But the British system of harbor control does make 
 the traffic pay for the facilities required, and is in so far 
 consistent with the economic principles so wisely applied 
 to British trade and commerce generally. There is no 
 attempt to encourage trade which is not nationally 
 profitable, by partly supporting it, i.e. by providing free 
 harbor facilities at public expense and, therefore, at the 
 expense of other lines of economic activity, any more 
 than there is the attempt to interfere with nationally 
 profitable trade by high tariff duties. The public trust 
 unites responsibility with direct action. It furthers 
 efficiency, economy, and lowness of rates, but it does not 
 subsidize. 
 
 The function of maintaining lighthouses, however, 
 almost of necessity devolves upon a central government. 
 No city or private corporation is in a position to perform 
 this function and make the traffic benefited pay for the 
 service provided, since much of the benefit will be received 
 by vessels which have no occasion to visit the particular 
 city or to come within reach of the particular corporation. 
 The British government, therefore, maintains the light- 
 houses, but collects " light dues" in return, amounting 
 to about $2, 500,000 yearly, from vessels entering English 
 harbors. These dues pay the entire yearly cost of main- 
 taining the lighthouses and about $250,000 a year be- 
 sides. 1 Here, also, is no policy of subsidizing, no attempt 
 
 i 
 
 1 Johnson, Ocean and Inland Water Transportation, p. 262. If the slight 
 charge above yearly cost is criticised, it should be remembered that a reason- 
 able return on investment is not an improper aim. 
 
176 ECONOMIC ADVANTAGES OF COMMERCE 
 
 to foster one industry at the taxpayers' expense, or to 
 encourage an undue and uneconomical geographical 
 
 division of labor. 
 
 6 
 
 The Improvement of Rivers 
 
 The responsibility for the improvement of rivers, like 
 that for the improvement of harbors, has rested, in the 
 United States, chiefly with the Federal government. 
 The work done has included the removal of obstructions 
 to navigation, the deepening of channels by dredging, the 
 construction of revetments, and the development of slack 
 water navigation by the building of locks and dams to 
 maintain a navigable depth. Improvements of this sort 
 have been carried out, to some extent, on most of the 
 navigable rivers of the country. But the appropria- 
 tions of Congress for these purposes have not always 
 been wisely made, nor has the distribution of improve- 
 ments throughout the country been influenced solely by 
 commercial or economic considerations. 
 
 Let us notice one or two typical instances of Federal 
 activity in river improving. To improve the Mississippi 
 river, the government has spent, in all, more than 
 IgOjObOjOoo. 1 Of this amount, $15,000,000 has been 
 spent on the 200 mile stretch between the mouths of the 
 Missouri and Ohio rivers. 2 But the traffic on this 
 stretch of the river, including that of St. Louis (which 
 is located between these points near the Missouri), has 
 steadily decreased. In 1880, upwards of a million tons 
 
 1 The Report of the Commissioner of Corporations on Transportation by Water 
 in the United States, 1909, Part I, p. 47, gives $97,685,920. 
 
 2 The facts and figures in this and the next paragraph are taken chiefly from 
 an article by Herbert Brace Fuller, in the Century Magazine, January, 1913, 
 pp. 386-395, entitled "American Waterways and the Pork Barrel." 
 
ENCOURAGEMENT OF TRANSPORTATION 177 
 
 of freight were shipped from St. Louis. In 1900, the 
 amount aggregated only 245,000 tons, and in 1911, only 
 191,965 tons. Is it safe to assume that there has been so 
 much saving in the expense of carrying this traffic, as 
 compared with what it would have cost to carry it by 
 rail, or to carry it on the unimproved river, as to compen- 
 sate for the money sunk ? Would those who have used 
 this section of the river have been willing to invest, 
 jointly, the $15,000,000, in order to have the better 
 navigation conditions which that investment has made 
 possible ? 
 
 If there remains any doubt in this case that money 
 has been unwisely spent, there can be no doubt in other 
 cases that public funds have been wasted for the sake of 
 returns to private interests and to limited territories, 
 almost incomparably less than the general loss. The Big 
 Sandy river is a tributary of the Ohio river. The Big 
 Sandy and its two branches or tributaries, the Tug and 
 Levisa rivers, lie in Kentucky and West Virginia. On 
 their improvement, the Federal government has spent, 
 in all, about $1,700,000. Excluding timber, which can 
 be and commonly is floated down-stream, the average 
 yearly traffic on these rivers is about 2000 tons. Reck- 
 oning interest on this $1,700,000 as only $40,000, or less 
 than 2\ per cent a year, the annual cost to the United 
 States of providing facilities for this traffic is $20 per 
 ton a year. Adding $20,000 a year for maintenance, 
 we have a cost of $30 a ton. 
 
 Average railroad charges in the United States are con- 
 siderably less than one cent per ton mile. 1 For low 
 grade freight (the only kind which makes much use of 
 
 1 Statistics of Railways in the United States, Interstate Commerce Com- 
 mission, 1 9 10, p. 59. 
 
 PART n N 
 
178 ECONOMIC ADVANTAGES OF COMMERCE 
 
 inland waterways) going long distances, railroad charges 
 average very much less than this, probably markedly 
 less than a half cent. The facilities provided by the 
 government on the above mentioned three rivers would, 
 therefore, have to reduce the transportation cost upon 
 them to zero, in order that the construction or invest- 
 ment by the government should be proved worth while, 
 unless the traffic benefited moved an average distance 
 of over 6000 miles. For even at zero cost of carriage, 
 each ton carried one mile would secure a saving of but 
 one-half a cent. And unless it were carried 6000 miles, 
 the total saving would not amount to the $30 interest 
 and maintenance cost. 
 
 What is the reason for the numerous appropriations of 
 this sort made by our government ? A partial explana- 
 tion may be found in the current American practice of 
 donating to commerce the improvements made, and 
 letting the general public bear the burden in indirect 
 and, therefore, hardly realized taxation. Commercial 
 interests are the more ready to plead for comparatively 
 useless dredgings, revetments, and canalizations, because, 
 however small the benefits are, they reap these benefits, 
 and because, however heavy the cost is, others mainly 
 bear it. Any reform which goes to the root of the evil 
 must espouse the principle of making those contribute 
 most to the fixed charges and maintenance costs of navi- 
 gation improvements, who chiefly use those improve- 
 ments and to whom their benefits chiefly go. 
 
 A further partial explanation is suggested by noting 
 the distribution, throughout the country, of money 
 appropriated for waterways. In 'the general River and 
 Harbor Act of 1910, appropriations were received by 296 
 congressional districts in the United States, out of a 
 
ENCOURAGEMENT OF TRANSPORTATION 179 
 
 total of 391, * in other words, by over three-fourths of 
 such districts. Apparently the appropriations were 
 given to nearly every district in which there was a stream 
 or harbor offering any excuse for expenditure. This 
 River. and Harbor Act illustrates what has been called 
 the "pork barrel" system of waterway development. 
 
 The difficulty is one which seems to apply generally to 
 the activities of a democratic government. A despotic 
 or aristocratic government is based on the privilege of 
 special persons or classes. It governs largely in the in- 
 terest of legally privileged classes. It insures to those 
 classes, political and economic privileges maintained at 
 the expense of others. Such a government was that of 
 France before the Revolution. Such is that of Russia 
 to-day. In the case of a popular government and an in- 
 telligent people, privilege is probably less excessive, and 
 its forms less obnoxious. But there may still be, espe- 
 cially if the government carries on industrial functions 
 or interferes at all with the natural laws of trade, the 
 privilege which comes from bargaining. One class 
 wants a special kind of tariff law, adverse to the public 
 interest. Another class desires legislation subversive 
 of currency stability, also contrary to the general wel- 
 fare. The representatives of each, in Congress, may 
 support the desires of the other, in return for counter 
 support. 
 
 The evil shows itself most of all, perhaps, through the 
 influence exerted by localities or by special interests in 
 different localities. We have noted this particularly 
 in the case of the protective tariff. 2 And just as, in the 
 case of the tariff, congressional representatives from 
 
 1 Fuller, American Waterways and the Pork Barrel, loc. cit, 
 
 2 Chapter VI (of Part II), 6. 
 
i8o ECONOMIC ADVANTAGES OF COMMERCE 
 
 different states and districts desire, each, to get or keep 
 a high tariff for the goods produced in his district, what- 
 ever the effect on the common weal, and sometimes 
 inconsistently with their party platforms, so these repre- 
 sentatives desire appropriations of money to improve 
 waterways, each for his own district, even though the cost 
 to the country as a whole far exceeds the benefit, and 
 even though each district suffers more from its forced 
 contributions to improvements in other districts, than 
 it gains. There is, consequently, a process of " log- 
 rolling," so-called, in which A votes for B's project in 
 return for support of his own ; and the ultimate result 
 is an appropriation or set of appropriations having no 
 consistency and involving general loss. 
 
 Each Congressman thus acting, feels that he is gaining 
 favor with his constituents. The persons interested in 
 local waterway constructions make representations to 
 him regarding the importance of them. He feels that 
 the people of his district are not concerned primarily hi 
 having him act the part of a wise and conscientious 
 legislator, careful not to waste the nation's resources, 
 but that they are concerned rather in having him "do 
 something" for them. If he succeeds in getting what is 
 desired, the newspapers of the district publish the fact 
 that, through his influence, Congress has been led to ap- 
 propriate a sum to improve navigation on the local stream 
 or to deepen the local harbor. The fault is not alone 
 that of the Congressman who, under such circumstances, 
 does the thing which he believes his constituents desire, 
 but is also largely the fault of those constituents them- 
 selves, whose selfish local interests overshadow in their 
 minds the greater interests of the nation of which they are 
 a part, and whose limited intelligence will not let them see 
 
ENCOURAGEMENT OF TRANSPORTATION 181 
 
 that the system practised is likely, in the end, to hurt 
 more than to help even their own welfare. 
 
 It would seem, then, that a reform which would go to 
 the root of the difficulty must not only insist upon the 
 attempt to charge users rather than taxpayers, for facil- 
 ities provided, but must also insist that the entire first 
 cost and risk of constructing these facilities shall not fall 
 upon the nation as a whole. If government expenditure 
 rather than private investment is thought to be necessary 
 to improve certain waterways, at least the government 
 expenditure and risk should be partly borne by localities 
 most directly concerned. If such localities will not 
 support certain improvements, themselves, they should 
 not expect the nation to do so. If the nation refuses to 
 bear the burden alone, but insists, always, upon local aid, 
 there will be far less pressure for Federal appropriations, 
 and many wasteful expenditures will be avoided. 1 
 
 7 
 Subsidies to Railroad Building 
 
 The subsidizing of transportation, by government, 
 has extended, in the United States (not to mention 
 other countries), to railroads also. The railroads of the 
 United States have, it is true, been built pretty largely 
 with private capital, but they have also received aid 
 from the national government, from many of the states, 
 and even from county and city governments. The 
 states and local governments, in some instances, invested 
 in railroad securities, so enabling the roads to get capital 
 
 1 Cf. Preliminary Report of National Waterways Commission, pp. 19, 20 
 (Final Report, pp. 81, 82). See also Report of Commissioner of Corporations 
 on Transportation by Water in the United States, Part I, pp. 8, 59, for reference to 
 European practice. 
 
i8 2 ECONOMIC ADVANTAGES OF COMMERCE 
 
 which, perhaps, private persons would have been less 
 ready to provide. But the Federal government, in addi- 
 tion to making loans, made very extensive land grants to 
 companies constructing numerous desired lines, 1 chiefly 
 in the less densely settled parts of the country, the West 
 and Southwest. The grants made between 1850 and 
 1871 turned over to the railroad companies about 159 
 million acres of the public domain, an area exceeding 
 five states the size of Pennsylvania. 2 So far as the land 
 grant policy was based on military conditions, we cannot 
 judge it on economic grounds alone. But so far as it 
 can be regarded as a commercial policy, it can be judged 
 in the light of commercial principles. 
 
 We shall not, of course, be able to decide, absolutely, 
 whether the land grants and other government aid to 
 the railroads actually decreased the total of national 
 wealth. So to decide, we should have to know not only 
 what has happened, but just what would have happened 
 if business and transportation development had taken 
 its natural course. But we can lay down general prin- 
 ciples of usual application, which, in the long run, are 
 apt to be safest to follow. 
 
 To begin with, it must be admitted that there is such 
 a thing as undesirable transportation. The labor and 
 capital of a country should be applied in order of pref- 
 
 1 See, on this subject, Haney, A Congressional History of Railways in the United 
 States, Vol. II. The Railway in Congress : 1850-1887, Madison, Wis. (Demo- 
 crat Printing Co., State Printer), 1910, Chs. II, III. Also Sanborn, Congres- 
 sional Grants of Land in Aid of Railways, Madison (Bulletin of the University 
 of Wisconsin), 1899, Chs. VI, VII. A good brief account is in Johnson, A merican 
 Railway Transportation, 2d revised edition, New York (Appleton), 1909, 
 Ch. XXII. 
 
 2 Not including land forfeited by failure to conform to conditions. The 
 granting of the mere rights of way might be regarded as analogous to the grant- 
 ing of farms to actual settlers. But the granting of millions of acres additional 
 cannot be so regarded. 
 
ENCOURAGEMENT OF TRANSPORTATION 183 
 
 erence to different industries according to their relative 
 importance, according to the relative need for them. 
 In other words, the people should devote their efforts to 
 the lines which pay best. It may be said that the people 
 living in the Middle West and Far West, where railroad 
 building was encouraged by government more than in 
 the East, desired railroads as a means of reaching eastern 
 markets. But the mere existence of railroads leading to 
 markets does not in itself mean greater prosperity, since 
 the benefits so received may be appreciably less than if 
 the same capital were invested in some kind of produc- 
 tive enterprise for immediate local needs. Unless the 
 trade made possible by a railway brings as much wealth 
 and prosperity as could have been had by foregoing the 
 trade and producing more locally, unless, that is, as 
 much of desired wealth is produced by the railway as 
 would be produced were the labor and capital applied 
 instead to the farms and ranches, to building houses, 
 making furniture, etc., the building of the road is not 
 economy for the community. If a railroad when con- 
 structed will yield the people of a community a benefit 
 equivalent to what the same investment would yield in 
 another line, then those who receive this benefit can 
 afford to pay, for the use of the railroad, a proper return 
 on the capital invested. If they cannot afford to pay 
 such a return, it must be because they are not receiv- 
 ing a correspondingly valuable service and, therefore, it 
 must be that the capital invested in the railroad is not 
 producing the value which it might have produced if 
 invested otherwise. 
 
 If the territory through which a railroad is desired is 
 sparsely settled and would offer but small traffic in pro- 
 portion to trackage, thus only very partially utilizing 
 
184 ECONOMIC ADVANTAGES OF COMMERCE 
 
 the plant of the railroad, then high charges would be 
 required, in order that the railway plant might pay to 
 the owners the average rate of profit on investment. 
 But high charges may be as serious preventives of reach- 
 ing markets as absence of railroads leading to markets. 
 If, therefore, only small traffic can be hoped for, it may 
 be truer economy for the territory concerned and the 
 various communities in it, to be more self-sufficient, to 
 depend more exclusively on natural waterways, or to 
 carry goods by using horses and vans, than to build a 
 railroad. 
 
 The people of a given section of the country may 
 think that they gain nothing by having an incompletely 
 utilized railroad, if they have to pay, in high freight and 
 passenger rates, interest on its cost. They may not be 
 prepared to patronize such a road, feeling that the ser- 
 vice is not worth the charges. Yet if the road is paid 
 for in part by government aid, even though they have to 
 pay the taxes that make the aid possible, they may de- 
 lude themselves into thinking that they are gainers by 
 having the railroad. Nevertheless, the people are pay- 
 ing for the service rendered just as surely by this 
 method as by the other, and if it is unprofitable for them 
 to pay the amount in the one way, it is unprofitable to 
 pay it in the other. The chief difference is that if govern- 
 ment supports the enterprise without receiving any cor- 
 responding return, the cost of the service rendered is 
 paid for by the people without any regard to the propor- 
 tionate benefits received. 
 
 If the assistance is by grants of land, the essential 
 principle of the policy is the same. The public domain 
 belongs to the whole people. It rests with them to give 
 it to settlers, to keep it as forest reserve and for other 
 
ENCOURAGEMENT OF TRANSPORTATION 185 
 
 purposes, or to secure money revenue by selling it. To 
 contribute it to railroad companies is as much a cost as 
 to contribute the equivalent in money. 1 
 
 As a consequence of the land grant policy, capital 
 was diverted to transportation purposes which might 
 have yielded larger returns in agriculture or in manufact- 
 ures. In so far as the policy had this effect, it lessened 
 rather than increased national prosperity. Because of 
 the land grant policy, also, population tended to be di- 
 verted towards the Middle and Far West, while there 
 was still room in the East, South, and Central states. 
 As a result of this diffusion of population, goods were 
 probably carried by rail over longer distances than would 
 have been necessary had population been for a time 
 more concentrated and had its extension westward been 
 more gradual. Had the westward movement, except 
 that by water to the Pacific coast, been slower, a shorter 
 connection could have been kept by the near frontier 
 with the more densely settled parts of the country, and 
 the necessity of long hauls of meagre traffic through 
 undeveloped sections could have been, in part, avoided. 
 It is doubtless true that some sections of the West are 
 exceptionally rich and fertile, as some are exceptionally 
 mountainous or arid. That the former should event- 
 ually hold a large population was both unavoidable and 
 desirable. But that the movement westward should 
 have been artificially hastened, at the cost of millions 
 of acres of the public domain, at the cost of diverting 
 labor from other industries into transportation, at the 
 cost of unnecessary distances in transportation, and at the 
 cost of building railroads in advance of traffic, ought not 
 to be too readily taken for granted. 
 
 1 See, however, considerations later in this section, especially in footnote. 
 
i86 ECONOMIC ADVANTAGES OF COMMERCE 
 
 * 
 
 As some parts of the country presumably gained by 
 the policy, so other parts probably lost wealth. Many 
 of the eastern farmers, for instance, found themselves 
 disadvantaged by competition with producers of the 
 West. So far as western farmers, by virtue of natural 
 advantages, were able to undersell the farmers of the 
 East, the result was economical and beneficial. But 
 so far as western farmers were, in effect, given bounties, 
 by having transportation provided in part at national 
 expense, the result may very well have been a national 
 loss. If the prosperity of the government-aided western 
 farmer was increased, that of the eastern farmer was 
 decreased. If the value of western land was raised, that 
 of eastern land was lowered. 1 
 
 One type of municipal or local aid deserves particular 
 mention. This is aid which is made conditional on the 
 choice of a route through the town or city giving it. 
 Such aid introduces an uneconomical basis (from the 
 social point of view) of calculation into the choice of a 
 route. The route selected is less apt to be the one which, 
 all matters of traffic and expense considered, is most 
 profitable, and, therefore, socially most desirable, but is 
 apt, rather, to be a route favored by the largest promises 
 of local aid. 
 
 1 To the argument that the government so raised the value of the remainder 
 of its own land, it can be answered that it is not the business of a government 
 to depreciate the land of citizens in order to raise the value of public land. If 
 the principle that land rent is largely a social product and belongs mainly to 
 the whole people, were commonly accepted, depreciating some land to raise the 
 value of other land would appear clearly to be uneconomical. It is probable, 
 in the case under discussion, that enough railroads would soon have been built, 
 and that the government, even in the narrow sense here used, lost more than it 
 gained by making the grants. 
 
ENCOURAGEMENT OF TRANSPORTATION 187 
 
 .-* 
 
 8 
 
 Summary 
 
 Let us now briefly restate the principles set forth in 
 this chapter, regarding government interference with 
 and encouragement of transportation. Navigation laws 
 were first considered. These laws attempt to develop 
 the national merchant marine by excluding foreign ships 
 from certain trade. The United States excludes foreign 
 vessels from the coasting trade. Considered from the 
 purely economic viewpoint, these laws are analogous 
 to protection, and for similar reasons they are economi- 
 cally undesirable. 
 
 Shipping subsidies are in the nature of bounties. In 
 general it may be said that they are without economic 
 justification. It may be defensible, however, or even 
 desirable, to make definite payments to certain lines of 
 ships, in order to have a claim to vessels as naval reserves. 
 Subsidies may be indirect, as when certain privileges are 
 given to a nation's own merchant vessels, at the tax- 
 payers' expense, which are denied to the ships of other 
 nations. The purpose of discriminating subsidies, direct 
 or indirect, is not so much to increase commerce as to 
 have it carried in vessels of the subsidy-paying country. 
 
 Facilities for transportation are frequently provided 
 by government at the taxpayers' expense. These tend 
 to stimulate commerce which is not worth the expense 
 borne, and which could not pay this expense. Such a 
 policy is unfair to the general tax-paying public and vio- 
 lates the principle that those who gain by any facilities 
 should be the ones to pay for them. Such provision of 
 commercial facilities at public expense would have been 
 the carrying out of the plan to allow United States coast- 
 
i88 ECONOMIC ADVANTAGES OF COMMERCE 
 
 4 
 
 ing vessels to use the Panama Canal free. Such provi- 
 sion of facilities at public expense is the plan to have the 
 Erie Canal forever free from tolls. Sections of the country, 
 or of the state of New York, which have little or nothing 
 to gain by the creation of these facilities, would have 
 been, or will be, taxed that other sections might use 
 them toll free. The Federal policy of harbor and river 
 improvement is also a policy of subsidizing commerce, 
 and is, therefore, popular with and favored by the in- 
 terests subsidized. Like the protective tariff policy, 
 the policy of subsidizing water transportation is partly 
 the result of bargaining between representatives of differ- 
 ent districts, each trying to get something at the general 
 expense. The British system of a Public Harbor Trust 
 avoids private monopoly of facilities, but makes the 
 traffic using the facilities provided, pay for them. 
 
 Land grants to railways, like other aids to water trans- 
 portation, are indirect subsidies given to commerce, and, 
 as such, are open to objections. The general rule which 
 it is safest for government to follow, is that those who 
 chiefly benefit by facilities provided for commerce should 
 chiefly pay for them, rather than that these facilities 
 should be paid for by the people in general, without 
 regard to proportionate benefits received. 
 
INDEX 
 
 Acceptance bills, form of documentary 
 commercial drafts called, I. 69. 
 
 Advertising value of a nation's ship- 
 ping, II. 150-160. 
 
 Agriculture, results of a policy of 
 protection to, II. 72-73; fallacious 
 home market argument for pro- 
 tection addressed to those concerned 
 in, 124-127; the argument for 
 protection to, in the older countries, 
 against a doubtful future, 127-129. 
 
 Arbitraging in exchange, I. 96-97. 
 
 B 
 
 Bank acceptances, system of, used in 
 Europe, I. 37~39, 69. 
 
 Bank credit, nature of, I. 26 ff . ; rela- 
 tion of money, together with, to 
 prices, 43-45 ; fluctuations of, due 
 to periods of hope and confidence 
 and of doubt and fear, 46; changes 
 in, resulting from panics, 46-47; 
 means provided for avoiding violent 
 fluctuations of, 47-49. 
 
 Bank deposits, I. 28. 
 
 Bank drafts, use of, I. 52 ; both drawers 
 and drawees of, are banks, 54; 
 settlement of obligations by, when 
 debtors remit to creditors, 61 ff. ; 
 different types of, 67-70. See Long 
 drafts and Sight drafts. 
 
 Banking, commercial, I. 28-30; anal- 
 ysis of the relations to each other 
 of persons concerned in, 30-33; 
 advantages possessed by, for busi- 
 ness men, both as lenders and bor- 
 rowers, 33-40. 
 
 Bank notes, are credit obligations of 
 banks to holders of, I. 41 ; pro- 
 tection of holders against loss, 
 41-43; provisions of Federal Re- 
 serve Act relative to, 42-43- 
 
 Bank of England, emergency reserve 
 of, I. 47- 
 
 Bank reserves, I. 42, 44; method of 
 maintaining proper relation between 
 deposits and, 44-45. 
 
 Banks, function of, to act as inter- 
 mediaries between borrowers and 
 lenders, I. 30-33 ; Federal reserve, 
 42-43- 
 
 Barter, primitive trade called, I. i. 
 
 Bastable, The Theory of International 
 Trade, cited, I. 92, 113, 141, 143, II. 
 25, 30, 50, 54, 74, 81, 107, 132. 
 
 Beet sugar industry, bounty granted, 
 in Europe, II. 144 ; effects of boun- 
 ties on bounty-paying countries and 
 on sugar-consuming countries, 151- 
 152. 
 
 Bills of exchange, I. 26, 27, 51-53; 
 advantages of, over checks for long- 
 distance transactions, 52-53 ; nature 
 of, 53-54 ; relations of bank to other 
 parties concerned in, 53-54; il- 
 lustration of use of, to settle obli- 
 gations, assuming no banks, 54-56; 
 settlement of obligations by, through 
 intermediation of banks, assuming 
 creditors to draw drafts on debtors, 
 56-61 ; settlement by bank drafts, 
 when debtors remit to creditors, 
 61-65; variety of types of, 67-70; 
 sight drafts and long bills, 67; 
 "clean" bills and documentary, 
 67-69; discount of, 69-70; sale of 
 demand drafts against remittances' 
 of long bills, 71-73; method of 
 drawing of, by letters of credit, 
 94-96; speculation in, 96-100; 
 relation between price of long drafts 
 and rate of interest or discount, 
 126-127; holding of long drafts on 
 foreign countries by American banks, 
 as investments, 127-130; influence 
 on price of long drafts of interest 
 rate in drawing country and interest 
 
 189 
 
INDEX 
 
 rate in country drawn upon, 131- 
 133; effect of bank discount rate 
 on price of demand drafts and the 
 flow of specie, 133-136; fluctua- 
 tions in price of, in case of prohi- 
 bition of specie shipment, 147-150. 
 
 Bimetallism, operation of theory of, 
 I. 16-18. 
 
 Borrowers, relation between lenders 
 and, in commercial banking, I. 
 30-33; benefits to, from banking 
 system, 35-37- 
 
 Bounties, nature and effects of, II. 
 144 ff. ; as compared and contrasted 
 with protection, 144-145 ; effect of, 
 on level of money prices in bounty- 
 paying countries, 146-148; conse- 
 quences of, to general welfare of 
 bounty-paying country and of 
 countries with which it trades, 
 148-152; effects on wages and 
 rent, 152-153 ; less objectionable 
 than protection for encouraging 
 infant industries, 153; comparison 
 of shipping subsidies and, 157-158. 
 
 Canada, protection of holders of 
 bank notes, under banking system 
 of, I. 41. 
 
 Canals, the free use of government- 
 built, II. 16.3, 165-172 ; comparison 
 of railroads and, as to economy, 
 170-171 ; burden of building, borne 
 by taxpayers, 171-172. 
 
 Carver, views of, on protection, II. 
 1 08 n. 
 
 Checks on banks, common form of 
 credit, I. 26, 27 ; similarity of bills 
 of exchange to, 52; advantages of 
 bills of exchange over, in long- 
 distance transactions, 52-53. 
 
 Clare, The A. B.C. of the Foreign Ex- 
 changes, cited, I. 63, 83, 93, 97, 140. 
 
 "Clean" bills, defined, I. 67. 
 
 Clearing houses, I. 29, 30. 
 
 Coal, protective tax on, at expense of 
 wage-earning public, II. 99. 
 
 Coasting trade, United States laws 
 concerning, II. 155; plan of grant- 
 ing free use of Panama Canal to 
 American, 165-169. 
 
 Commercial drafts, use of, I. 52 ff.; 
 character of drawers and drawees of, 
 53-54; method of using, for settle- 
 ment of obligations, 54 ff. 
 
 Competition, effect of, on prices, I. 
 6-8; monopolies secured against 
 foreign, by protective tariff, II. 113. 
 
 Constitutional justification of a pro- 
 tective tariff, II. 112-113. 
 
 Cotton-raising states, disadvantages 
 of protective tariff to, II. 112. 
 
 Credit, substitution of, for money, I. 
 26-27. 
 
 Crops, relation between rate of ex- 
 change and, I. 82-83. 
 
 Currencies, effect of difference in, on 
 exchange between two countries, 
 I. 138-142. 
 
 Currency, use of term, I. 26. 
 
 Currency loans, I. 85, 86. 
 
 Customer's check, use of, for money, 
 1.27. 
 
 D 
 
 Day, A History of Commerce, cited, II. 70. 
 
 Demand drafts, sale of, against remit- 
 tances of long bills, I. 71-73. See 
 Sight drafts. 
 
 Diminishing utility, law of, II. 28. 
 
 Discount, effect of, on price of long 
 drafts, I. 126-127; effect of bank 
 discount rate on price of demand 
 drafts and the flow of specie, 133- 
 136; effect of panics on rate of, 
 137-138. 
 
 Discounting of documentary payment 
 bills, I. 69-70. 
 
 Discount market, absence of a, in 
 United States, I. 72-73. 
 
 Diversification-of -industries argument 
 for protection, II. 134-135. 
 
 Documentary commercial drafts, I. 
 67, 68-69. 
 
 Domestic exchange, cost of money 
 shipment in, I. 115-116. 
 
 E 
 
 Edgeworth, "Report on Monetary 
 Standard," cited, I. 3 ; "The Theory 
 of International Values," cited, II. 
 21 ; discussion of view of. regarding 
 effect of import duty, 48 n, 107-108 n. 
 
INDEX 
 
 191 
 
 Employment, the argument that pro- 
 tection makes, II. 122-124. 
 
 England, exchange transactions be- 
 tween America and, I. 62-65 dis- 
 counting in, of bills drawn by Amer- 
 icans on their English debtors, 71-72 ; 
 wages and prices in Germany 
 and, compared, II. 96; error made 
 in comparing conditions as to wages 
 in United States and, 120-122; 
 weakness of national self-sufficiency 
 argument for protection shown by 
 case of, 136-137; gain to, from 
 export bounties paid on beet sugar 
 by other countries, 151-152; early 
 navigation acts of, 155. See also 
 Great Britain. 
 
 Equation of exchange of money, I. 
 3-4, 24; statement of, including 
 bank credit, 43. 
 
 Erie Canal, the free use of, an injus- 
 tice to taxpayers of New York State, 
 II. 160-170. 
 
 Escher, Elements of Foreign Exchange, 
 cited, I. 65, 67, 69, 70, 71, 85, 90, 
 93, 94, 96, 97, 99, 109, in. 
 
 Ethics of the question of protection 
 or free trade, II. 139. 
 
 European war, and the exchange 
 market, I. 107 ; effect of, on flow of 
 specie abroad, 136 n. 
 
 Exchange, foreign and domestic, I. 
 52-53; par of, 77-78, 139; place 
 speculation or arbitraging in, 96-97 ; 
 time speculation in, 97-100; be- 
 tween two countries when one has 
 a gold and the other a silver stand- 
 ard, 138-142. See Bills of exchange 
 and Rate of exchange. 
 
 Exchangeability of money, I. 2. 
 
 Exchange banks and brokers, I. 53, 56 ; 
 how profits are made by, 65-67. 
 
 Exchange market, the, I. 65; effect 
 on, of disturbed political or indus- 
 trial conditions, 83-84; demoraliza- 
 tion of, by the European war, 
 107. 
 
 Exportation of specie and the rate of 
 exchange, I. 107-111. 
 
 Export duties, effect of high, on rate 
 of exchange, I. 151 ; consequences 
 of, when levied for revenue, II. 
 52-55; effect of protective, on a 
 
 country's trade, 57-60; effect of, 
 on flow of specie and on money 
 prices in tax-levying country, 69- 
 70. 
 
 Export trade, influence of rate of 
 exchange on, I. 118-119; injury 
 resulting to a country's, from policy 
 of protection, II. 58-59. 
 
 F 
 
 Farmers, a tariff for benefiting wage- 
 earners at expense of, II. loo-no; 
 home market argument for pro- 
 tection addressed to, 124-127. 
 
 Federal Reserve Act, provisions of, 
 relative to national bank notes, I. 
 42-43; function of Federal reserve 
 banks established by, 47 ; provisions 
 of, for suspending reserve require- 
 ments, 48; rediscounting permitted 
 and encouraged by, 73. 
 
 Federal reserve banks, reserves kept 
 by, I. 47- 
 
 Fiat money, I. 8, 13. 
 
 Finance bills, I. 90-93. 
 
 Financial disturbances, influence of, 
 on rate of exchange, I. 113-114. 
 
 Firsts and seconds, explanation of 
 terms, applied to drafts, I. 128. 
 
 Fisher, Irving, Elementary Principles 
 of Economics, cited, I. 5, 17, II. 5 ; 
 The Purchasing Power of Money, 
 cited, I. 14, 19, 22, 28, 43, 45, 137, 
 II. 67. 
 
 Fisk, International Commercial Policies, 
 cited, II. 151. 
 
 Foreign exchange, nature and method 
 of, I. 51 ff. 
 
 Free trade, meaning of, II. 39-40; 
 advantages to countries adhering to 
 principles of, 80-83; wages and 
 prices under protection and, com- 
 pared, 96; condition of, between 
 States of United States an argument 
 for successful operation of, between 
 nations, 137-138. See Revenue 
 tariff. 
 
 Fuller, Herbert Brace, "American 
 Waterways and the Pork Barrel," 
 cited, II. 176, 179. 
 
 Futures, speculation in, in foreign 
 exchange, I. 98-99. 
 
192 
 
 INDEX 
 
 Geographical specialization in pro- 
 duction of goods, II. 8-9; inter- 
 ference with, under conditions 
 created by a protective tariff, 62- 
 
 63. 
 George, Henry, Protection and Free 
 
 Trade, cited, II. 120. 
 Germany, comparison of wages and 
 
 prices in England and, II. 96; 
 
 argument used for protection to 
 
 agriculture in, 127-129; beet sugar 
 
 bounty in, 151-152; conclusions 
 
 concerning waterway system of, 
 
 171. 
 Gold, value of money as related to 
 
 value of, I. 21-22. See Specie. 
 Goschen, The Theory of the Foreign 
 
 Exchanges, cited, I. 89, 92, 113, 131, 
 
 134, 136, 140, 142, 143. 
 Great Britain, advantages secured by 
 
 policy of free trade in, II. 81-83; 
 
 system of harbor improvement and 
 
 lighthouse maintenance followed in, 
 
 174-176. 
 
 H 
 
 Hadley, Economics, cited, I. 3, 7, n. 
 
 122 n. 
 Haney, A Congressional History of 
 
 Railways in the United States, cited, 
 
 n. 182. 
 
 Harbors, uneconomic improvement of, 
 at public expense, II. 172 ff. ; British 
 system of improvement and main- 
 tenance of, 174-176. 
 
 Harbor trusts in Great Britain, II. 
 I74-I7S. 
 
 Hart, A. B., Essentials in American 
 History, cited, II. 138. 
 
 Home market argument for protection, 
 II. 124-127. 
 
 I 
 
 Immigration, danger to wages in 
 United States from, rather than 
 from lack of protective tariff, II. 
 121-122. 
 
 Importation of specie and the rate of 
 exchange, I. 111-113. 
 
 Importations, influence of rate of 
 exchange on amount of, I. 118-119. 
 
 Import duties, effect of high, on rate of 
 exchange, I. 150-151; two classes 
 of, II. 39; conditions where, when 
 levied for revenue, the burden is 
 borne by the levying country, 41-43 ; 
 shifting of burden by the levying 
 country to another or other coun- 
 tries, 44-51 ; effect of protective, 
 on a country's trade, 57 ff. ; un- 
 profitable industries set up at the 
 general expense by protective, 60- 
 66. See Protective tariff. 
 
 Incomes, loss in the way of, resulting 
 from system of protection, II. 68-69. 
 
 Individualism, philosophy of, applied 
 to use of finance bills, I. 92-93. 
 
 Inefficiency, encouragement of, in 
 some degree, by protective tariff, 
 II.So. 
 
 Infant industry argument for pro- 
 tection, II. 129-134; as applied 
 to bounties, 153. 
 
 Insurance rates on gold shipments, 
 I. 107. 
 
 Intercommunity trade, II. 11-17; 
 limits to fluctuations of, 19 ff. 
 
 Interest, loss of, during transportation 
 of gold, I. 107-109; relation be- 
 tween rate of, and price of long 
 drafts, 126-127, 131-133; statement 
 of theory of, II. 86; effect of pro- 
 tection on rate of, 86-89. 
 
 International trade, distinction be- 
 tween intranational and, one of 
 degree only, II. 16-17. 
 
 Investment, character of, as a part of 
 trade, II. 29 n. 
 
 Investments, long run effect of in- 
 ternational, upon rate of exchange 
 and flow of money, I. 120-122; 
 long drafts on foreign countries 
 held by American banks as, 127-130. 
 
 Jacobs, L. M., "Bank Acceptances" 
 
 by, cited, I. 37 n., 73. 
 Johnson, Ocean and Inland Water 
 
 Transportation, cited, II. 173, 175; 
 
 American Railway Transportation, 
 
 cited, 182. 
 Joint account, investment by two 
 
 banks for, I. 93-94. 
 
INDEX 
 
 193 
 
 Kemmerer, Money and Credit In- 
 struments in their Relation to General 
 Prices, cited, I. 43. 
 
 Land grants to railroads, II. 182-186. 
 
 Land rent, laws of wages and, II. 
 80-92 ; effect of protection on 
 wages and, under varying condi- 
 tions, 93-110; effect of bounties 
 on, 152-153. 
 
 Large scale production, protective 
 tariff and, II. 71-72. 
 
 Laws of money, I. i ff. 
 
 Lenders, viewed as persons who 
 provide waiting, I. 30-33; ad- 
 vantages to, of system of com- 
 mercial banking, 34-35. 
 
 Letters of credit, analysis of relations 
 involved in, I. 9496. 
 
 Levi, The History of British Com- 
 merce, cited, II. 70. 
 
 Lighthouses, maintenance of, by a 
 central government, II. 172, 175- 
 176. 
 
 Limping standard, conditions for 
 successful operation of the, I. 
 10-21. 
 
 Lindsay, History of Merchant Ship- 
 ping, cited, II. 155. 
 
 Loans, short time, made through 
 intermediation of exchange market, 
 I. 85 ff. ; sterling and currency, 
 85-86. 
 
 London, the world's financial centre, 
 I. 63-64; effect on disposal of 
 long drafts at lower discount rate 
 in, than in New York, 133. 
 
 Long drafts or bills, I. 67; sale of 
 demand drafts by banks, against 
 remittances of, 71-73 ; effect on 
 price of, of rate of interest or dis- 
 count, 126-127; method of pro- 
 cedure when held as investments 
 by American banks, 127-130; in- 
 fluence on price of, of interest 
 rate in drawing country and of 
 interest rate in country drawn 
 upon, 131-133. 
 
 Loria, "Effects of Import Duties in 
 New and Old Countries," cited, 
 II. I0 6. 
 
 M 
 
 Make-work argument for protection, 
 fallacy of the, II. 122-124. 
 
 Manufactures, consequences of policy 
 of protection to, II. 73. 
 
 Margraff, International Exchange, 
 cited, I. 70, 96 n., 128, 130. 
 
 Marks, Lawrence M., statistics of 
 rate of exchange compiled by, I. 
 83 n. 
 
 Marshall, memorandum on effect 
 in international trade of different 
 currencies, I. 141 n. 
 
 Mason, "The American Silk Industry 
 and the Tariff," cited, II. 130. 
 
 Meeker, R., History of Shipping 
 Subsidies, cited and quoted, II. 
 !4S 159, 161, 162. 
 
 Military argument for protective 
 tariff, to insure national self- 
 sufficiency, II. 135-137 ; for ship- 
 ping subsidies, as a means of in- 
 creasing a nation's naval strength, 
 161-162; for building Panama 
 Canal, 168. 
 
 Mill, J. S., Principles of Political 
 Economy, cited, I. 5, II. 21, 24, 25, 
 26, 45, 46, 52, 74; System of Logic, 
 cited, II. 120. 
 
 Mississippi River, unwise expenditure 
 of money in improvement of, II. 
 176-177- 
 
 Monetary standards, effect of differ- 
 ent, on exchange between two 
 countries, I. 138-142 ; rate of 
 interchange of goods between coun- 
 tries not affected by difference 
 in, II. 24-25. 
 
 Money, laws of, I. i ff. ; position of, 
 as a medium of exchange, 2-3; 
 relation between prices and, 3; 
 causal explanation of value or 
 "purchasing power" of, 12-16; 
 theory of bimetallism, 1 6-i 8; value 
 of subsidiary, 10-21 ; relation of 
 value of, to value of a standard 
 money metal, 21-22; relation be- 
 tween level of prices and value of, 
 
 PART n o 
 
194 
 
 INDEX 
 
 in one country or locality and level 
 of prices and value of, in another, 
 22-24; substitution of credit for, 
 2627 ; reasons why bank credit 
 is able to displace, as a medium of 
 exchange, 33 ff. ; relation of, to- 
 gether with bank credit, to prices, 
 43-45; substitutes for, in inter- 
 national and long-distance trade, 
 52 ; cost of shipment of, in domestic 
 exchange, 115-116; fallacy of the 
 argument for protection, that it 
 keeps money in the protected 
 country, II. 116-118; argument 
 for shipping subsidies based on, 
 158. 
 
 Monopolies, differing prices of goods 
 of, at home and abroad, II. 4 n. ; 
 protective system as an encourage- 
 ment to, 113. 
 
 Moulton, Waterways versus Railways, 
 cited, II. 171. 
 
 N 
 
 National banks, guaranteeing of notes 
 issued by, by Federal government, 
 
 I. 41-42 ; foreign exchange business 
 of, 65-66. 
 
 Naval reasons for shipping subsidies, 
 
 II. 161-162. 
 
 Navigation laws, II. 155-156; 
 
 analogous to protective tariffs, 
 
 156-157- 
 Newcomb, Principles of Political 
 
 Economy, cited, I. 3. 
 
 Panama Canal, question of indirectly 
 subsidizing American ships by 
 allowing them free use of, II. 
 163; lack of economic justification 
 for plan of allowing American 
 coasting trade free use of, 165-169. 
 
 Panics, effect of, on bank credit, 
 I. 46-47; lowering of rate of ex- 
 change due to, 113-114; effect of, 
 in one country on discount rate 
 and flow of specie in other coun- 
 tries, 137-138. 
 
 Paper money, exchange between 
 countries under existence of, as an 
 inconvertible standard, I. 142-147. 
 
 Parasitic industries, establishment of 
 by protective tariff, II. 60-66. 
 
 Par of exchange, I. 77-78; establis 
 ment of a new, between countries 
 with different monetary standards, 
 139. 
 
 Patten, Economic Basis of Protection, 
 cited, II. 106. 
 
 "Pauper labor" argument used by 
 protectionists, II. 110-120. 
 
 Place speculation in exchange, I. 
 96-^97. 
 
 Politics, part taken by, in the pro- 
 tection of infant industries, II. 
 132-133 J operation of, in American 
 waterway development, 178-181. 
 
 Population, density of, and rate of 
 wages, II. 1 20-i 21. 
 
 "Pork barrel" system of waterway 
 development, II. 178-181. 
 
 Prices, quantitative statement of 
 relation between money and, I. 
 3-4; causal explanation of, of 
 given kinds of goods, 5-8; causal 
 explanation of general level of, 
 8i 2 ; relation between level of, 
 and value of money in one country 
 or locality and level of, and value 
 of money in another, 22-24; re- 
 lation of money, together with bank 
 credit, to, 43-45 ; influence of, in 
 the long run, on the exchange 
 market, 116-120; affected by bank 
 discount rate, 135-136; effect of 
 a panic in one country on level of, 
 in other countries, 137-138; effect 
 on, of different currencies in two 
 different countries, 138-142 ; ten- 
 dency of, through influence of 
 trade, toward equality in different 
 countries, II. 3-7 ; tendency of, 
 to be lower in the country where 
 goods can be produced with greatest 
 relative advantage, 7-11; high 
 rate of wages does not imply high, 
 9; effects of protective tariff on, 
 6770, 7478; effect of bounties 
 on level of, in bounty-paying 
 countries, 146-148; effect of arti- 
 ficial navigation laws on, 156. 
 
 Promissory notes, use of, for money, 
 I. 26-27. 
 
 Protection. See Protective tariff. 
 
INDEX 
 
 Protective tariff, effect of, on rate 
 of exchange, I. 150-151 ; distinction 
 between revenue tariff and, II. 
 30-41 ; effect of, on a country's 
 export trade, 57-60; how unprofit- 
 able industries are set up at the 
 general expense by, 60-66; view 
 of, as "mutual tribute," 64; effect 
 of, on money prices of protected 
 and of unprotected goods, 67-70; 
 improbability of increase of national 
 wealth by, 71 n.; operation of, 
 as to industries in which large scale 
 production is advantageous, 71 
 72 ; applied to industries of in- 
 creasing cost, 72-74; effect on 
 cost of unprotected goods got 
 from other countries, 74-78; 
 chimerical proposition as to estab- 
 lishing a tariff "equal to the differ- 
 ence in cost of production at home 
 and abroad, together with a reason- 
 able profit," 70-80; not necessarily 
 conducive to efficiency in methods 
 of production, 80; relative advan- 
 tages in world's commerce of 
 countries having high and countries 
 having low or no tariffs, 80-83 ; 
 effect on rate of interest and there- 
 fore on wages, 86-89; effect of, 
 on wages and rent under varying 
 conditions, 97-110; may benefit 
 one section of a country at the 
 expense of other sections, in- 
 113; as an encouragement to 
 monopoly, 113; the argument for, 
 that it keeps money in the pro- 
 tected country, 116-118; the wages 
 argument for, 118-122; the make- 
 work argument, 122-124; the home 
 market argument, 124-127; the 
 infant industry argument, 129- 
 134; diversification of industries 
 argument, 134-135; argument con- 
 cerning national self-sufficiency, 135- 
 137 ; successful working of free 
 trade between States of United 
 States an argument against, 137- 
 138; ethical considerations bearing 
 on question of, 139; bounties as 
 compared and contrasted with, 
 144-145; analogy between naviga- 
 tion laws and, 156-157; points 
 
 of similarity of shipping subsidies 
 and, 157-158. 
 
 Purchasing power of money, a phrase 
 used to express the price of money, 
 I. 12-13; explanation of, 13-16. 
 
 Quantity theory of money, I. 3-4. 
 
 Railroads, comparison of canals and, 
 as to economy, II. 170172; com- 
 parison of transportation costs on 
 rivers and, 177-178; subsidies to 
 building of, 181-186; error made 
 in giving municipal or local aid to, 
 1 86. 
 
 Railroad wages, study of, II. 96 n. 
 
 Rate of exchange, I. 77 ff.; causes 
 of fluctuation in, 78; effect on, of 
 disturbed political or industrial 
 conditions, 83-84; short time loans 
 and, 85-90; upper limit to fluctua- 
 tion of, determined by cost of 
 exporting specie, 103-107; lower 
 limit to fluctuation, determined 
 by cost of importing specie, m- 
 113 ; influence of panics or financial 
 disturbances on, 113-114; long 
 run effects on, of a balance of pay- 
 ments from one country to another, 
 116 ff. ; long run effect of inter- 
 national investments on, 120-122; 
 long run effect of payments for 
 various purposes on, 122-124; 
 when one of two countries has a 
 gold and the other a silver standard, 
 138-142 ; when one of two countries 
 has a gold and the other an incon- 
 vertible paper standard, 142-144; 
 conditions as to, in case of pro- 
 hibition of specie shipment, 147- 
 150; effect on, of high import and 
 export duties, 150-151. 
 
 Rate of interchange of goods between 
 communities, II. 19 ff-; deter- 
 mination of, by conditions of supply 
 and demand, 22-25 ; effect on, 
 when one country offers a variety 
 of goods, 26-27; effect when one 
 country receives periodic payments 
 
xg6 
 
 INDEX 
 
 of obligations from another, 27- 
 29; effect of production in any 
 country under conditions of differ- 
 ent cost, 29-32; under conditions 
 involving more than two coun- 
 tries, 32-35; tariffs and, 39 ff. 
 
 Rate of interest, effect of protection 
 on, II. 86-89. 
 
 Rediscounting bills of exchange, I. 
 71-72; not practised in United 
 States, 72-73- 
 
 Rent. See Land rent. 
 
 Reserves in banks, I. 42, 44. 
 
 Revenue tariff, II. 39 ff.; conditions 
 under which it is borne by the 
 levying country, 41-43 ; shifting 
 of burden by the levying country 
 to another or other countries, 44 
 51 ; consequences of a, on exports, 
 52-55- 
 
 Rivers, uneconomic improvement of, 
 by United States, II. 176-181. 
 
 S 
 
 Sanborn, Congressional Grants of Land 
 in Aid of Railways, cited, II. 182. 
 
 Seasonal variations of trade, desir- 
 ability of elasticity in bank currency 
 to meet, I. 48, 50. 
 
 Self-sufficiency, argument for protec- 
 tion in order to get and maintain 
 national, II. 135137. 
 
 Selling short in foreign exchange, I. 
 99-100. 
 
 Shipping, navigation laws designed 
 to encourage, II. 155-157; ad- 
 vertising value of, 159-160. 
 
 Shipping subsidies, II. 144; shown 
 to be without economic justifica- 
 tion, 157-162; naval reasons for, 
 161-162; indirect, favoring native 
 ships as compared with foreign 
 ships, 163-165. 
 
 Short time loans made through the 
 exchange market, relations involved 
 in and results of, I. 85-90. 
 
 Sidgwick, views of, on protection, 
 II. 107 n. 
 
 Sight drafts, I. 67 ; rate on, constitutes 
 the pure rate of exchange, 126; 
 relation between bank discount 
 rate and price of, 133-136. 
 
 Silk industry in United States, an 
 example of infant industry argu- 
 ment, II. 130. 
 
 Smith, The Organization of Ocean 
 Commerce, cited, II. 174. 
 
 Southern states, effect of protective 
 system on the, II. 112. 
 
 Specie, rate of exchange and the 
 flow of, I. 103 ff. ; upper limit to 
 fluctuation of rate of exchange 
 determined by cost of exporting, 
 103-107 ; details connected with 
 exportation of, 107-111; lower 
 limit to fluctuation of rate of ex- 
 change determined by cost of im- 
 porting, 111-113; long run effects 
 on flow of, of a balance of payments 
 from one country to another, 
 116 ff. ; long run effects on flow 
 of, of international investments, 
 120-122; effect of bank discount 
 rate on price of demand drafts and 
 the flow of, 133-136; flow of, 
 abroad prior to outbreak of 
 European war, 136 n. ; effect of 
 panics on flow of, 137-138; effect 
 on flow of, of different currencies 
 in two countries, 138 ff . ; exchange 
 between two countries, assuming 
 prohibition of shipment of, 147-150. 
 
 Speculation in foreign exchange, I. 
 96-100. 
 
 Sterling loans, I. 85-86. 
 
 Stock exchange, New York, closing 
 of, to impede flow abroad of specie, 
 I. 136 n. 
 
 Subsidiary money, conditions deter- 
 mining successful employment of, 
 I. 19-21. 
 
 Subsidies, to shipping, II. 144, 157- 
 165; to railroad building, 181-186. 
 
 Sumner, William Graham, Protec- 
 tionism, cited, II. 61, 82, 126, 136, 
 152 ; quoted, 64, 65, 134. 
 
 Supply and demand, relation between 
 price of a given kind of goods and, 
 I. 5-8 ; application of principles of, 
 to the general level of prices, 8- 
 12; applied to money and prices, 
 13-16 ; effects of laws of, on various 
 monetary systems, 16; price of 
 bills of exchange or drafts deter- 
 mined by, 77; forces affecting, of 
 
INDEX 
 
 197 
 
 bills of exchange, 78-83 ; conditions 
 of, determining rate of interchange 
 of goods between countries, II. 
 22-25. 
 
 Tariffs, effect of, on location of in- 
 dustries, II. 1 1 ; revenue and pro- 
 tective, distinguished, 30-41. See 
 Protective tariff and Revenue 
 tariff. 
 
 Time drafts, I. 127. 
 
 Time speculation in exchange, I. 
 97-100. 
 
 Trade, primitive, I. i ; money as a 
 part of the mechanism of, 1-2 ; 
 conditions governing intercommu- 
 nity, ii 16; international compared 
 with intranational, 16-17; condi- 
 tions regulating rate of, between 
 communities, 19 ff . ; supply and 
 demand as the determining factor 
 in, 22-25 ; effect on rate of, when 
 one country offers a variety of 
 goods and when it receives periodic 
 payments of obligations from the 
 other, 26-29; influence of produc- 
 tion in any country under conditions 
 of different cost, 20-32; effect of 
 entrance of an additional country 
 into, 32-35; cost of transportation 
 as related to, 36; revenue tariffs 
 and, 30-56; effects of a protective 
 tariff, 57 ff. See also Rate of inter- 
 change of goods. 
 
 "Trade follows the flag" argument 
 for shipping subsidies, II. 159. 
 
 Transportation, cost of, of money, 
 in domestic exchange, I. 115-116; 
 cost of, as related to trade, II. 36; 
 navigation laws and shipping sub- 
 sidies for encouragement of, by 
 water, 155 ff. ; comparison of 
 railroads and canals for purposes of, 
 170-172; comparison of cost of, 
 on railroads and on rivers, 177-178. 
 
 Taussig, Principles of Economics, 
 
 cited, I. 115, 121, II. 7, 23, 27, 74, 
 in, 127. 
 
 V 
 
 Variety of goods, advantages to 
 country offering, for export, II. 
 26-27. 
 
 Velocity of circulation, relation be- 
 tween supply of money and, I. 
 13-14- 
 
 W 
 
 Wages, high rate of, does not imply 
 that goods cannot be produced and 
 exported at low money cost, II. 9; 
 reduction of, resulting from rise 
 in rate of interest due to protective 
 policy, 8889 > laws of wages and 
 land rent, 80-92; effect of protec- 
 tion on, when protected and un- 
 protected goods are produced under 
 conditions of substantially constant 
 cost, 93-96; effect of bounties on, 
 152-153- 
 
 Wagner, Adolph, Agrar- und Indus- 
 triestaat, cited, II. 127. 
 
 Waiting, element of, provided by 
 depositors or lenders, in commer- 
 cial banking, I. 30-33. 
 
 Walker, Political Economy, cited, 1. 13. 
 
 Wampum, medium of exchange among 
 Indians, I. i. 
 
 War, the European, and the exchange 
 market, I. 107; effect on flow of 
 specie to Europe, 136 n. 
 
 Warburg, Paul M., "The Discount 
 System in Europe," cited, I. 37 n.; 
 quoted, 72 n. 
 
 Weighted average, defined, II. 5. 
 
 Wheat-producing areas, disadvantages 
 of protective tariff to, II. 112. 
 
 White, Money and Banking, cited, I. 
 44- 
 
 Wool industry, protective tariff and, 
 in United States, II. 61 ; an illus- 
 tration of the establishment of a 
 parasitic industry at the general 
 expense, 65, 99-100. 
 
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