4.3 Balance of Trade
When a trade is executed good-for-good, it is assumed that each party to the trade obtains value from the goods he obtains in equal measure to the goods he must offer in exchange. However, when any exchange involves money, it is assumed that the party who surrenders money for goods is disadvantaged by the exchange, that the money he has given has greater value than the good he receives, even though there is equal consideration and negotiation in the decision of the amount of money to be traded. This irrational assumption is made whether the parties involved are individuals or nations.
As such, it is assumed that the importation of goods into a nation is disadvantageous to the nation, and governments seek to establish with other nations a balance of trade, seeking to ensure that the amount of gold and silver sent abroad to purchase foreign goods is balanced by the amount of gold and silver received from the sale of domestic goods to the same nations - though with less concern when the balance is in their favor.
Smith considers the example of the trade between Britain and France. In Britain, the impost of 1692 placed a 25% tax on all goods imported from France, while the goods of other nations were subjected to much lighter duties, seldom exceeding 5%. The purpose of such a discretionary measure cannot to have been the protection of domestic manufacture, but to discourage Englishmen from doing business with the French. And the French retaliated in kind, to the point that there was a virtual cessation of all fair commerce between the two nation, to the profit only of smugglers and privateers (EN: covert support of privateers was also a tactic in the "commercial war" between England and France of Smith's time).
Principles of Trade Balance
In the natural course of progress, citizens of a nation specialize in producing the goods to the best of their capabilities, foregoing the production of other goods, and do so with such efficiency as to produce a surplus that can then be traded for those goods they have opted not to produce, but that can, by some advantages of geography or climate, be produced efficiently elsewhere.
In obtaining goods from foreign lands, domestic purchasers naturally seek out those that are best and cheapest. If the wines of France are better than the wines of Portugal, or I the linen of France is better than that of Germany, the demand will be greatest for French goods, specifically.
(EN: Smith considers both factors - quality and price - but does not consider the balance between the two, such that some customers will pay a higher price for better goods, but this notion does underlie the whole of the consideration to the consumer - though my sense is that "quality" is seldom the consideration of statesmen in their assessment of the balance of trade - they are concerned with gold alone and not the value obtained for it. The indifference to quality may, in fact, be a significant factor in the notion of trade imbalance - or at least an exacerbation of the concern.)
In other instances, goods of one country might be immediately exported to other countries, bringing to a nation the profit of trade without the necessity of production. This is especially true of the Holland and Italy, both nations in which there is greater wealth than production by virtue of their participation of trade among other nations: Italy is a trader of goods from the East by way of the Mediterranean, whereas Holland generally profits from the distribution of goods from France and Germany to other parts of Europe by way of the Baltic and North seas.
(EN: The author does not make the connection, but the use of goods in this manner makes goods function as capital in the wholesale trade. A trader takes profit from buying from one party at a lower price and selling to another party at a higher price - and it makes little difference if the price is paid in gold coin, peppercorns, or bolts of cloth.)
It's noted that Holland, in particular, has profited greatly from the commercial war between England and France by providing a conduit of goods between them. If England charges a 25% tariff on French linen and only a 5% tariff on Dutch, then the Dutch may obtain linen in France, ship it to England at a 10% markup, and appear to offer goods of equal quality at a significant discount compared to the same cloth imported directly from France.
Money and Credit
Trade is said to be at par between two nations when the amount of money and credit that flows between the two are in perfect balance. It makes no difference whether coin crosses the border twice or not at all, the latter case being one in which a note of credit given by the English for French goods is returned to England for the export of goods back to France.
Differences in currencies may obscure differences in amounts, as coins are debased by varying degrees. Ideally, the value of a coin is in consideration of the amount of precious metal it contains, which changes over time. Thus if a purchase of foreign goods requires twenty shillings when the shilling is half silver, it will require forty shillings when the coin is debased to a quarter the amount of silver. While fluctuations of this degree seldom occur in short amounts of time, it can over the course of years create the false appearance of a rise in the cost of foreign goods, if the debasement of domestic currency is ignored.
There is also the matter of the cost of coinage. In some nations, the cost of having metal minted into coin results in a discount in the value of metal - two examples being England, there is no cost of coinage, such that a pound of silver can be exchanged for coinage that contains a full pound of silver; whereas in France, there is a cost of coinage (seinorage) of some eight percent. Thus French merchants must seek to recover the cost of coinage in the prices charged to English customers, and reckon the value of their own currency to be higher than its weight in silver when importing English goods. Ultimately, the difference is to the benefit of the French mint, not to that of the French merchant or customer.
A similar offset occurs in certain cities (Amsterdam, Hamburg, and Venice) in which foreign bills of exchange are paid in bank money that is valued at more than its value in common currency due to a fee (called "agio") is charged to obtain paper money for currency, such that the redemption of a note is for greater currency than its face value, by generally about five percent, and the prices of goods are adjusted in consideration.
Also, notes of demand may function as currency in international trade. If Britain were to trade with Italy and Germany, and both states to use the notes of credit in exchange for goods with Holland, and Holland to redeem the notes with England, the net exchange of notes for coin between England and Holland would have no resemblance to the amount of trade between those two nations.
All of these factors serve to add complexity to the computation of balances of trade, such that the balance of trade may be difficult to consider with much accuracy.
Bank Money
The currency used in a wealthy state generally is its own coin, which maintains its value unless the currency is modified or debased by the issuer (save for acts of forgery and tampering, possible reduction in weight by normal wear and tear).
It is the tendency of states that issue coinage to react to temporary crises by permanently debasing their coin. A nation hopes to increase the purchasing power of its metals on reserve by issuing lighter coins, or those of cheaper alloy, expecting the population to accept the new coin as equivalent in value to the old. Coins being merely a token of exchange in the domestic market, such swindling is effective - but for foreign trade, the new coinage is valued as the weight and purity of its metal content, and drops in trade value for imported goods.
However, in other nations - those that are small or lack sufficient metal reserves to issue their own currency - the citizens and banks often use the currency of other nation, upon which token coinage and notes are issued, and its own currency thus based carries with it the uncertainty of what it is actually worth.
In such situations, it is common for the multitude of smaller transactions to be paid in local currency that is issued not on its own merit, but on the value of various currencies held by a bank of deposit, which then issues local currency. The state or bank acts as guarantor of an exchange rate of currencies that fluctuates, and the fee charged for the issue of local currency provides a measure of insurance against loss.
This "bank money," thus being guaranteed against fluctuations in exchange rates, was intrinsically worth more than other money, but states generally required transactions over a certain level (600 guilders in Amsterdam) to be made in this currency, and merchants were obliged to keep an account at the central bank to pay bills of exchange.
Smith enumerates the advantages a banking system brings to commerce: physical currency being attractive to thieves, difficult to count and transport, subject to loss or destruction, proof against forgery, no need to weigh or assess alloy, etc. The ability to arrange transfers among accounts in a central bank eliminates many of these inconveniences.
Banks also maintained deposits of bullion, in exchange for certificates of deposit, for long periods of time, though such certificates commonly expired after a number of months, it was very rarely a problem that an individual would allow his receipt to expire, and most often such receipts were renewed rather than redeemed.
The depository fee at banks, generally about five percent for issuing currency, a quarter of a percent for issuing certificates of deposit, and was seen as well worth the value of such conveniences.
The reputation of a bank relied on its ability to redeem notes and certificates on demand, and banks of the highest repute, such as the bank of Amsterdam, professed to lend out no part of deposits, but to keep in its vaults at all times exactly the amount of money for which it had issued, the whole profit of the bank being made from fees for depositing money.
In other banks, the balance of funds in the vault may be at times less than the notes in circulation, the banker having discovered the rate at which notes are redeemed and calculating the amount he must hold in reserve to meet practical demands, a seeing a practical means to earn income by loaning out any surplus.
This practice, viewed with some suspicion by depositors, has been upheld by law, and decreases the fees such banks are able to command for the deposit of gold, a less reliable bank being able to command less of its depositors, even to the point of paying depositors a fee for the use of their money in lending operations.
During times of public calamity, there would arise a sudden panic, causing the holders of receipts, all at once, to seek to redeem bank money for physical metal. At such times, the value of receipts suffered from uncertainty and panic, as the ability of the bank to cover its notes is in question. The Bank of Amsterdam suffered such a panic from the fear invasion and was able to redeem all notes and certificates, granting the bank tremendous esteem and depositor confidence.
The author digresses a bit further to consider the various methods of income for banks, as the service of exchanging metal or coin for bank money was more in the nature of public utility than profit.
- As mentioned, bank charges a fee of 5% for issuing bank money, though this is reduced when the currency is redeemed at a premium of 4%
- Also said, the bank charges a 0.25% fee for certifying the deposit of bullion and a periodic fee for renewal of such certificates
- The bank claims the bullion or currency of depositors upon the expiration of their certificates, the amount of which is unknown, and considered to be more common for accounts held by foreigners
- A flat fee is charged for opening an account
- Another fee is charged for any transfer of funds among accounts
- A person who authorizes a transfer of more than he has on account pays a fee, and an ongoing fee until the account is balanced
- Banks that loan funds on deposit also make the profits of a money-lender, through the profit is subject to the amount and rate of loans
These different amounts total to "a good deal more" than what is necessary to pay the salaries of employees and other expenses of the operation: they are modest in terms of each transaction, but considerable in the aggregate.
Smith reiterates the fundamental point, germane to trade, from which he has taken "a long digression" - that the exchange between bank money and common currency favors the former, the reduction of value (or increase in expense) of bank fees being significantly less than seignorage of a mint for issuing coins.
Restricting to Discourage Consumption
Smith addresses the trade of wine and spirits, the restriction of which is advocated not only for economic means, but for those of morality - in effect, to address the problems of drunkenness and the wasteful spending on the pursuit of alcohol by restricting its manufacture and banning its importation.
He does not dispute that the excess consumption of alcohol can be a social problem: some individuals do, indeed, ruin their health and fortune in pursuit of drink, though there is as yet no evidence that this occurs on sufficient scale to pose a risk to any nation. Nor is it evident that raising the cost of alcohol causes individuals to consume less, merely to consume more.
He notes with some sense of irony that drunkenness seems to be less of a problem in wine-producing areas such as Spain, Italy, and southern France, where it is available in greater quantity at lower cost. He figures that it's a matter of luxury - "people are seldom guilty of excess in what is their daily fare" - but in nations where it is not produced, it is something of a luxury, and consumed with excess. It's even been noted that people who settle for some time in these regions tend to drink more excessively when they first arrive, but in time, settle into the more sober habits of the residents.
He also notes that "drunkenness is by no means the vice of people of fashion, or those who can easily afford the most expensive liquors." Instead, it is the class who can least afford the expense that seems to be most inclined to undertake it. And in nations where consumption is most actively discouraged by taxation or prohibition, there is the greatest incidence of drunkenness.
Ultimately, the notion of using tariffs to discourage drunkenness is a flawed concept: a state could no more prevent drunkenness by restricting the sale of spirits than eradicate gluttony by restriction the sale of food. Those who wish to indulge to excess will do so, and price does not discourage them.
Restriction to Gain Political Advantage
Restrictions on trade are often the political means of rivalry with other nations. When England places a duty on imports from France, it is intended to reduce the income of a rival nation. When France, in return, places a duty on imports from England, it is taken as an attempt to do the same. England and France, in particular, have so long been embroiled in such petty bickering and vindictiveness as to virtually destroy all trade between the two nations.
Where tariffs are visited selectively upon specific nations, it is to the detriment of consumers, who left to their own devices would seek to obtain the cheapest and best goods available, but are this denied the opportunity to obtain them when the best value could be had from a nation their own political leadership has chosen to bicker with.
Moreover, it is plainly evident that nations choose to bicker the most with those nations located closest to them and from which the transportation of goods is least expensive. Englishmen cannot obtain the wines of France, which could be shipped across the channel with great efficiency, but must instead opt for the wines of Italy, inferior in quality, and which must be travel a greater distance, through the Mediterranean and past Spain and Portugal, at greater expense.
It is also noted that the wiles of politics are subject to change: a foreign power that is one day an enemy may the next day be a friend, or vice versa. In taxing the wine of France and treating favorably the product of Portugal, England seeks to impoverish the former and enrich the latter, not foreseeing a future time in which England may require the assistance of the French in defense against the Portuguese.
Conclusion
"Nothing," Smith writes, "can be more absurd than this whole doctrine of the balance of trade." To restrict trade by prohibition or tariff, or even to encourage trade by means of bounties, can improve upon the mutual benefit of commercial exchange by voluntary agreement of the parties involved. To prevent or compel two parties from engaging in exchange, or to meddle in the terms, results in a deal that is unfair and damaging to one party, and often to both. To do so on a widespread basis, by systemic means, is the institute widespread and systemic damage to all involved.
Smith reiterates, in a roundabout way, some of the basic principles already disclosed: that foreign trade at once divests a nation of surplus goods (or gives it incentive to be productive beyond a level of mere sustenance) and receive in exchange goods of foreign markets that cannot be domestically produced as efficiently, or in some instances at all.
When a tariff is placed on a good, with no regard to politics, it is driven by "the capricious ambition of kings and ministers" who collect tariffs on imported goods, unaware or perhaps merely indifferent to the fact that the cost of the tariffs is visited upon their own citizens in the increased price of such goods in the market.
Merchants and manufacturers likewise suppose that such measures are to their benefit. Protection of domestic industry seems a subterfuge for their desire to have a monopoly of the home market and be safeguarded from the competition of foreign goods. This, too, is a one-sided perspective that considers only their revenue as suppliers and does not seem to consider their cost as customers to materials in their domestic market necessary to their trade.
So, too, are the citizens of a nation distracted by the promise of greater wages for their labor by means of keeping foreign goods from local markets, such as not to consider that they are themselves consumers in their own local markets, each paying a greater amount as a consumer for the product of one another, and none gaining the benefit of a cheaper alternative to meet his needs.
This even goes so far as to retard the growth of industries and nations: where foreign goods can be had more cheaply than domestic, it is because these goods are produced more efficiently abroad than at home. When inefficient production is protected, producers have no incentive to become more efficient in their operations - and over a prolonged period of time, even become wasteful in their operations, there being no necessity to compete on price. This serves to increase, rather than diminsh, the degree to which the efficiency of industry within a nation lags that of the same industry of other nations.