Abstract
It is to economic writers in the eighteenth century that we credit the first explicit statements of the international balance-of-payments adjustment mechanism. It was no small achievement for Isaac Gervaise, Richard Cantillon and David Hume to integrate three distinct dynamic processes: 1) the effect of the balance of payments on the money supply; 2) the effect of changes in the money supply on expenditure or prices; and 3) the effect of changes in expenditure on the balance of payments. Earlier writers had anticipated certain features of the mechanism but not put everything together. The three equations, implicit in the early literature, are fundamental to an understanding of the adjustment process and, starting from the 1960s, have been the subject of numerous mathematical formulations.
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Notes
Isaac Gervaise, in The System or Theory of the Trade of the World published in 1720, states the quantity theory of money in its bullionist form for the world as a whole, developed the income-expenditure (absorption) approach to the balance of trade, the effect of payments deficits on the money supply, and the effect of changes in the money supply on the difference between income and expenditure. Unfortunately Gervaise’s work was completely neglected until it was rediscovered by Foxwell, discussed by Viner and brought to the attention of economists again by J. Letiche; see the Letiche edition and its introduction (Baltimore, Johns Hopkins Press, 1954). For more recent and penetrating discussions see Thomas Sekine: “The Discovery of International Monetary Equilibrium by Vanderlint, Cantillon, Gervaise and Hume”, Economica Internazionale, n. 26, 1973, with a discussion of Gervaise’s role in relation to Cantillon and Hume (and Vanderlint). An excellent survey of the literature focussing attention on the development of the monetary approach (to both the balance of payments and exchange rates) of the entire literature can be found in a recent volume of outstanding quality: Thomas H. Humphrey and Robert E. Keleher: The Monetary Approach to the Balance of Payments, Exchange Rates and World Inflation, Praeger 1982.
See Richard Cantillon (1683–1734) major work was Essai sur la Nature du Commerce en General, a translation from the English that was published, probably in Paris, in 1755, but circulated before that time. Mirabeau said that Cantillon was: «without contradiction, the most clever man on these matters that ever existed. This work… is but the hundredth part of the writings of that ingenious man, which perished with him by a catastrophe both singular and fatal. This work itself is mutilated, for the supplement to which he often refers, and in which he had established all his calculations, is wanting», (see Palgrave, v. I, p. 216). Cantillon had amassed a huge fortune, and fell prey to a former cook, who robbed him, set fire to his house, and murdered him. Cantillon had a great influence in France but received little attention in England until Jevons’ article in 1881. Cantillon had read most of the early writings of economists, was influenced by Locke, but went beyond him in many respects. He developed the importance of the distinction between open and closed economies, the vital difference between the effects of an (exogenous) increase in the supply of money from, say, gold mines and an increase in money arising from a surplus of exports over imports; whereas the former would lead to an increase in prices the effects of the latter” are more complicated. The prices of traded goods could not rise by much (beyond the cost of transport) because they must be equal to foreign prices; whereas the prices of domestic goods could rise. Although Sekine (op. cit.) and Humphrey-Keleher (loc. cit. p. 128) argue that Cantillon does not define the conditions of monetary equilibrium, the fact that the theory of the distribution of specie was evident in many early mercantilist writings (e.g. Petty and North), and can be inferred from Locke’s work, makes it plausible to attribute that concept to Cantillon as well. Joseph Spengler has called Cantillon the “first of the moderns”, in his Essays in Economic Thought, edited by Spengler and Allen (New York, Rand McNally, 1960).
The contributions of David Hume (1711–1776) are contained in six of his Essays. His essay of the Balance of Trade contains the important section on the adjustment mechanism. The discussion in Humphrey and Keleher (loc. cit. p. 134) discusses the famous letter from a friend and critic, James Oswald, dated 10 October 1749, prior to publication, agreeing with Hume’s argument that an increase in money would raise prices in an isolated economy, but objecting to his implication that it would do so in a country trading with the rest of the world, where prices of goods that are transportable could not diverge much (in the same currency unit) from world prices. Hume willingly conceded the point to Oswald and promised to amend his draft accordingly. On this important point see the reference there to James M. Lowe, An Eighteenth Century Controversy in the Theory of Progress (The Manchester School, September 1952): 314–16, on which Humphrey and Keleher rely.
One other contemporary of Gervaise, Cantillon and Hume deserves mention: Pehr Niclas Christiernin, whose major work, Lectures on the High Price of Foreign Exchange, was published in Sweden in 1761. A good discussion of his contribution is contained in Humphrey-Keleher (op. cit., pp. 284–5), which in turn is based on Eagly Robert V.: The Swedish Bullionist Controversy (Philadelphia, American Philosophical Society, 1971). In 1745 Sweden had shifted from a metallic currency to a paper standard, which soon started to depreciate, giving rise to a bullionist controversy, not unlike that which arose four decades later in great Britain. Christiernin dealt with a different problem than Hume and accordingly arrived at a monetary theory of the exchange rate instead of a monetary theory of the balance of payments.
See Henry Thornton (1760–1815) published his The Paper Credit of Great Britain in 1802, a seminal work that, among other contributions, distinguished between drains arising from expansion of country banks and those arising from external drains; he was the first to note that short-term funds are responsive to the rate of interest; he recognized the difference between nominal and real interest rates; and that output could rise along with prices when the quantity of money was increased. His main contribution to the theory of the international adjustment mechanism is his refinement of Hume’s idea that a country could replace gold with convertible paper without causing inflation; Thornton noted that the export of gold would tend to raise prices abroad and hence also at home. The effect would be negligible in a small open economy, but not in a large country.
See John Stuart Mill: Principles of Political Economy, London, Ashley Edition, 1909, p. 627. «…The result is that a country which makes regular payments to foreign countries, besides losing what it pays, loses something more, by the less advantageous terms on which it is forced to exchange its productions for foreign commodities». This was his conclusion under conditions of barter; he then argues that the same holds under conditions of exchange under money. This notion was contrary to that held by a number of the bullionist writers including Wheatley and Ricardo, and it was explicitly refuted by Ohlin and Rueff in 1929.
See John Maynard Keynes: A Tract on Monetary Reform, London, MacMillan, 1922.
See Mundell R.A.: International Economics, New York, MacMillan, 1968, ch. 20, «The Crisis Problem».
See Del Mar Alexander: History of Monetary Systems, ch. VII, first published in 1895, and reprinted by Augustus M. Kelley Publisher, New York, 1969.
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© 1992 SIPI Srl, Rivista di Politica Economica
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Mundell, R. (1992). Trade Balance Patterns as Global General Equilibrium: The Seventeenth Approach to the Balance of Payments. In: Baldassarri, M., Paganetto, L., Phelps, E.S. (eds) International Economic Interdependence, Patterns of Trade Balances and Economic Policy Coordination. Central Issues in Contemporary Economic Theory and Policy. Palgrave Macmillan, London. https://doi.org/10.1007/978-1-349-22256-8_2
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