Transcript the Gold Standard International Trade

International Trade
& the Gold Standard
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014
International Trade
Basis for trade:
Comparative Advantage
Who has the lower “opportunity cost?”
Every country has a C.A. in some good.
Mistaken basis for trade:
Absolute Advantage
Who has the lower resource cost?
Not every country has an A.A. in some good.
Trade Lessons
We specialize our production on the basis of
our comparative advantage.
In the real world – no complete specialization.
Trade raises our material standard of living.
Trade barriers lower our standard of living.
Responding to trade barriers
in kind makes us worse off.
Trade Barriers
Import quotas to keep foreign goods out.
Tariffs that serve as a tax on foreign goods.
Subsidies for producers of export goods.
Impose standards on foreign goods ( costs).
The false rhetoric of protection:
cheap foreign labor, infant industry,
national defense, beggar-thy-neighbor
Bob Murphy on the 5 most common
myths about free trade.
1. We have free trade.

When our “free” trade bills are 1000 pages …
2. Trade deficits are bad.

The trade flow is equally offset by the capital flow.
3. Trade only helps poorer countries.

Does “Buy American” make us richer? Not “us!”
4. Free trade destroys jobs.

Odd sentiment vis-á-vis Texas & Mexico; Bastiat & candlemakers.
5. Free trade creates jobs.

No, it raises average wages and our standard of living.
Trade Fundamentals
We have different categories of trade:
Goods
Services
Merchandise
Trade Balance
Net Exports, aka
Current
Acct. of
Balance
Payments
Financial Account
• Value of assets.
• Net change in securities.
• Other.
Balancing error
Goods
Ex Im
Services
Ex Im
Net
Financial
error
2013 Q4: (405.4 b – 577.2 b) + (173.7 b – 115.8 b) + 173.7 b – 92 b
Net Ex: Feb. 2014: (131.7 – 193.4) + (58.7 – 39.3) = -42.3 b
Trade Fundamentals
Financial Account
Current Account
Trade Fundamentals
The Role of Trade in the Government’s Budget
GDP = C + I + G + (Ex-Im)
NI = C + S + T … and by definition GDP=NI
C + I + G + (Ex-Im) = C + S + T
Rearrange: G = T + (S-I) + (Im-Ex)
All government spending comes from:
Tax revenue raised.
Net private sector savings.
Net foreign sector savings. [i.e., the trade deficit]
Or, (G-T) = (S-I) + (Im-Ex)
The gov’t deficit = crowded out investment + trade deficit
The Role of Trade in the Government’s Budget
Gov’t Deficit
Trade Deficit
The Role of Trade in the Government’s Budget
$5.8 Tr. 2013
The Gold Standard
A gold standard implies that we have “fixed” exchange rates between currencies.
$20.67 = 1 oz.
$50 mill.
1 oz. = £4.25
$4.86 = £1
£10.29
mill.
• American firms export goods to England … tractors. Value = $50 m.
• British firms export goods to U.S. … fish & chips. Value = £10.29 m.
• At exchange rate of $4.86 = £1, the £ earned by U.S. firms will just
trade for the $ earned by the British firms.
• Suppose that British exports fall by 23% and that there is only £8 mill
available in foreign exchange market (to buy $).
The Gold Standard
$20.67 = 1 oz.
$50 mill.
1 oz. = £4.25
$4.86 = £1
£8
mill.
• Now, American exporters can’t exchange all of their £10.29 mill. for $.
• They can only exchange £8 mill. at the going exchange rate.
. . . receiving $38,880,000. But, they aren’t going to lose here…
• They would cash the rest out in gold: £2.29 mill. = 538,823 oz.
• They would redeem in U.S. for dollars: 538,823 oz. = $11,120,000
• Total value received = $50,000,000
The Gold Standard
$20.67 = 1 oz.
$50 mill.
1 oz. = £4.25
$4.86 = £1
£10.29
mill.
• The flow of gold from England to U.S. won’t persist over time.
 gold =  MS
 MS =  P
inflation
M•V=P•Q
 gold =  MS
 MS =  P
deflation
U.S. exports fall and British exports rise until trade flows balance.
The Gold Standard
Advantages to the Gold Standard
• It promotes trade by eliminating uncertainty.
• It keeps governments from creating money.
• It insures that a nation’s currency will maintain
its value over time.
Confounding the Gold Standard
In England, the outflow of gold will lead
to price deflation and probably a
recession (or a depression).
So, the Bank of England raises interest rates. This attracts
foreign investment (capital inflows) which ends outflow of gold.
In the U.S., expanding the money
supply means inflation and falling
exports.
So, the Fed can buy this gold by selling Treasury
securities, so not allowing the money supply to increase.
But, this will also raise U.S. interest rates which works
against British policy and encourages more gold inflows!
The Gold Standard
Stress & Collapse
WWI - Combatant countries go off
gold standard to spending.
After, move back to gold standard.
We now
live in an
Gold stocks insufficient for existing price levels.
era of
Worldwide deflation (i.e., depression) is required.
“flexible”
Only U.S. and U.K. go back to gold standard.
exchange
rates and
U.K. depression through 1924-25.
there is no
Great Depression adds in more stress.
restraint
on
1933 – FDR abolishes gold std.
monetary
1971 – Nixon abolishes int’l gold payments.
policy.
International Trade
& the Gold Standard
ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014