Principles of Political Economy

by Arthur Latham Perry

7. Which party in foreign trade pays the Costs of Carriage, or do each pay them in equal proportion? It is plain, that the aggregate cost of transportation to the foreign markets is just so much added to the Cost of Production, and is a deduction of so much from what would otherwise be the whole gain of the Commerce; but it is plainly not true, that each party necessarily pays the whole of his own freights; and, therefore, that the party carrying bulky articles is at a disadvantage compared with the other. He may or may not be at a disadvantage on that account. That will depend on the effect of the new expense for freight, however divided, on the Demand in each country for the product of the other. We will suppose, that in the outset England pays the whole cost of carrying cottons to France, and France the whole cost of sending silks to England; but as cottons are many times more bulky than silks proportionably to value, a larger bill of freights would fall of course to England; and cottons would therefore fall in value relatively to silks; but cottons and silks have both risen absolutely, that is, with reference to any given effort, or with reference to a money standard.

Suppose now that France, instead of 80 for 96, has to render 82 for 96; and England, instead of 100 for 120, now has to give 105 for 120. The French gain in the trade is reduced from 20 to nearly 17%, and the English gain from 20 to nearly 14%; but it is by no means certain, that the commerce would go on precisely on these terms; the enhanced value of silks might well deaden the demand for them in England, more than the relatively less enhanced value of cottons in France would affect the demand for them. Silks have risen in England 5%, but cottons have risen in France only 2½%; it is therefore very likely that thereafter the demand for cottons will be stronger than the demand for silks, and if so, the French will have to offer better terms, or, what is the same thing, to be obliged to pay a part of the English freights; so that there is nothing in the true state of the case to justify the conclusion jumped at by some people, that they who carry heavy goods are at a disadvantage compared with those who carry light goods. That will depend wholly upon the Equation of International Demand as between the two kinds of goods. Nothing in the nature of things hinders, that each party shall in effect pay the freights of the other, or one even really pay the freights of both.

8. Lastly, what is the effect upon international commerce of the constant play of the Par of Foreign Exchange. This is a point of great importance, that has been but little discussed in this connection, because it has not been popularly understood or scarcely even popularly explained. In the light of the full unfolding of "Credits" in our Fourth Chapter, and in the light of these simple principles now under discussion, there will be no great difficulty to any intelligent reader in fully understanding this matter of Foreign Exchange,—a matter never before so vital to the commercial interests of the United States as now. For the sake of general illustration we will take the "Exchange" as between the United States and Great Britain, since the same fundamental principles apply as between all commercial countries.

When merchants export goods, say from New York to London, or vice versa, they do not wait for their pay till the goods be actually marketed abroad, but draw at once Bills of Exchange to the amount of the home value of the goods on the parties to whom the goods are sent, and then put these bills on present sale with brokers or middlemen at home. There thus becomes a market or prices current in New York for commercial bills drawn on London, and similarly a market in London for bills drawn on New York. The New York exporter, accordingly, is not certain of getting in money the full face of his bill minus interest for the time it has to run, because a great many such exporters may have thrown their similar bills upon the market the same day, which always tends so far forth to depress the price of the bills in accordance with an universal law of Economics. Scarce is ever costly: plenty is ever cheap.

Who buys these bills when exposed for sale in New York? Who wants them? Clearly, only those who have commercial debts to pay in London. A bill of exchange drawn in New York on London is nothing but a debt due from somebody in London to anybody whom the drawer in New York chooses to make the payee. The debtor lives in London, and it is every way cheap and convenient for all parties, that he settle his debt with a creditor living in London. So it happens, that parties in London who have sold goods in New York and drawn bills on them for present payment, expose those bills for sale in London to the parties who have debts to pay in New York. If now, London or those whom London represents in these transactions, have sold but few goods to New York or to those whose business is settled in New York relatively to the amounts sold by New York to London, then London bills will be relatively scarce as compared with the New York bills drawn on London. In other words, New York has more debts to pay in London than London has in New York, and, consequently, the parties in London who want bills to pay New York debts with, have to buy them in a relatively scarce market. They have to bid for them, as it were. The effect of this is always to carry up the price of that, for which the buyers are many and the sellers relatively few. So, under perfectly natural causes, London bills on New York come to a premium; that is to say, the London sellers get more than the face of their bills drawn, and the trade with New York becomes extra profitable to them.

Suppose London bills of Exchange on New York are selling for 101, thus giving 1% extra profit to English exporters; for precisely the same reasons that they are so selling, New York bills on London are selling in New York for 99, thus subtracting 1% from what would otherwise be the gains of the New York exporters to England under the common principles of Foreign Trade. It is evident, therefore, that the causes of the course of the international Par of Exchange are an essential part of the principles of foreign Commerce; and whatever tends to derange or upset the natural course of the Par, as a constant or constantly recurring cause, must receive careful attention in a book like the present. We have begun at the very beginning of this matter, and we are now going to follow it up to the very end.

The Diversity of relative advantage in the Production of the two commodities exchanged, is the first and chief ground of mutual Profit in foreign trade; the varying Intensity of relative Desire on the part of each exchanger for the product of the other, is the second and secondary ground on which foreign trade must go on; and the third and final difference as between the two parties, which goes to make or mar the profit of each of them in the trade, is the current Price of the Bill of Exchange drawn by each creditor on his debtor abroad. It is plain that these three things must always be taken into account simultaneously by prudent exporters and importers, in order to estimate the prospect of a profitable trade then and there; and it is plain also, that one or even two of these three differences of relative advantage might fade out for a time, and a profitable trade still proceed, provided the other two or one of these differences were sufficiently pronounced. For example, to take an extreme case, silks from France might still go to England for cottons to the advantage of both countries for a time, though "exchange" were exactly at "par" between them and the "demand" for silks were precisely met by the "demand" for cottons, on the strength of a marked and persistent diversity in relative cost of production of the two textiles.

Here is another of the trinities of Political Economy. Here is complication indeed, but a complication regulated and beautified by inflexible laws of Nature and the scarcely less inflexible laws of human Motives.

So far the argument has proceeded on the supposition of a common standard of Value, say gold, between England and France, London and New York, and by implication all other commercial countries. Commerce rejoices in, and progresses by, a common measure of Values. By an experience of 2000 years the world has proven gold to be the best international Measure. From a simple comparison of the weights of pure metal in the standard coins of the nations is established a fixed monetary "par" as between them. Thus the dollar of the United States contains 23.22 grains of pure gold, and the English pound sterling contains 113.001 grains of the same; consequently, there are $4.8665 to the £ sterling, and this is and has been since 1834 the monetary "par" between the United States and Great Britain. Similarly, the par between France and the United States is $1 to 5 fr. 18 centimes, since the franc is 19.29 cents gold for gold. The monetary par, accordingly, as between any two nations using the gold standard, is a matter easily ascertained and kept in mind; while the constantly variable prices current of Bills of Exchange are reckoned in and from this monetary par. Thus, if a commercial bill drawn in New York on London sells for $4.8665 minus current interest for the time it has to run, English "exchange" with us is said to be at "par"; if it sell for more than that, exchange is technically said to be "against" us, although the excess in price is just so much additional profit to the American exporter; and if it sell for less than that, exchange is said to be in our "favor," although the difference is just so much subtracted from the gains of the American exporter.

The close of the second week in July, 1890, found in New York "Sterling exchange dull but firm, with actual business at $4.84¾ for 60-day bills and $4.89 for demand bills: the posted rates were $4.85½ and $4.89½ respectively." Exchange, accordingly, had turned "against" the United States, that is to say, American exporters could get a little more for their bills on London than the monetary par. Under such circumstances it may be cheaper to send the gold to liquidate a British debt than to buy bills and send them. Just this happened last week: $2,000,000 in gold went (mainly under this impulse) from New York to London. There is a limit, therefore, to any further rise in the price of "exchange," when it reaches in an upward direction the then present cost of sending gold to foreign creditors. The limit in the downward direction to the price of exchange is the last margin of profit to the exporter as such. Thus, when the New York exporter can only get, say, $4.83 for his sight bill of exchange on London, his loss in the trade so far forth is 1%; and it may be doubtful, whether his possible gains at the other two points, namely, relative cost of production and relative intensity of demand, will overbalance this certain loss and leave a sufficient margin of profit.