The balance of international payments

Although on logical and empirical grounds we can conclude that the balance of international payments must and does balance, it must not be thought that we have reached the end of balance of payments analysis. The compelling question is, to repeat, how does it balance--what is the mechanism which sees to it that debits and credits will be equal in value? It must again be emphasized that the myriads of international transactions which, in the course of a year, require payments into and out of dollar exchange are generally separate, distinct, and unrelated unless by some underlying and pervasive link not readily apparent on the surface. Nor is it any more readily apparent that all American "visible" and "invisible exports somehow are causally interrelated with all American "visible" and "invisible" imports so that the dollar value of the two streams of international business will be approximately equal. Yet link and mechanism there must be.

Very early in modern times economists began to search for some explanation of the tendency toward equilibrium in balances of international payments. If the exports (visible and invisible) of a country failed to equal imports, specie flowed out, temporarily balancing the international accounts. This loss of specie caused a shrinkage in money, a reduction in gold reserves, an increase in rates of interest or discount, and consequently a decline in the volume of credit and in business activity and prices. The end result would be a decrease in imports (because of low prices and declining purchasing power in the home market) and an increase in exports (because prices and purchasing power were rising abroad) and ultimately a restoration of equilibrium in the balance of payments.

This is a vastly oversimplified account of the specie-flow mechanism of an international metallic standard. With its details we are not primarily concerned.

By its proponents, an international gold standard involving equilibrating gold flows of this type was regarded as essentially automatic or self-regulating. It is probable that it did, in "normal" times, involve considerably less "management" by the monetary authorities (say, the central bank) than do the modern systems of balance of payments control which revolve around exchange stabilization funds and various sorts of exchange restrictions.

Under simon-pure gold, silver, or bimetallic standard conditions, with unrestricted specie export and import, the specie-flow mechanism was--and is--the dominant explanation of the tendency toward balance in a country's international debits and credits. When international metallic standards are abandoned and some form of inconvertible currency prevails, other solutions have to be found to the ever-absorbing, as well as practically important, problem of the maintenance of equilibrium in balances of international payments. They all directly or indirectly owe much to clues first tracked down by specie-standard theorists. They all recognize that the data relevant to the problem are disequilibrium in balances of payments, changes in prices and costs, changes in exchange rates, changes in the volume of money and credit in circulation, and changes in money rates. They do not agree on the causal relationships between these data.