The Gold Standard and “Balanced Trade”

The Gold Standard and “Balanced Trade”
April 4, 2012

(This item originally appeared at on April 4, 2012.)

For some reason, lots of people – including gold standard advocates – have the idea that a gold standard system creates “balanced trade.” This is a rather silly term that means that the value of exports and imports are equal.

Interesting proposition. Is there any evidence of this?

The United States had a gold standard policy (with some lapses) for 182 years, from 1789 to 1971. We also have a lot of trade statistics from those times. So, was it “balanced” or not?

You don’t even have to look at the data to know the answer is: “not.”

There’s even a variant of this idea called the “price-specie-flow mechanism,” which the Keynesian economists like to refer to, while admitting rather quietly that there is actually no evidence that such a thing ever existed. (It’s a fantasy.)

In actuality, all trade is balanced. Let’s say you are a businessman or investor. You want to trade something for something else. For example, you want to trade goods, services or assets for money (sell something), or you want to trade money for goods, services or assets (buy something).

Probably you are doing both of these at the same time, so in effect you are trading the things you sell for the things you buy, with the money acting as an intermediary. You probably end the process with roughly the same amount of money that you started. Money itself is an asset, of course.

OK Mr. Businessman, have these trades ever been “imbalanced”? Did you ever give goods and services and get nothing in return? At least not on purpose, right?

If that did occasionally happen, what you have in effect is an obligation for your counterparty to deliver something in the future, which is a type of asset, so even then you receive something in return. This would show up on the Current Assets portion of your balance sheet as an Accounts Receivable or something of that sort.

Did you ever get something and give nothing in return?

Of course not. Trade is always balanced, by definition. Otherwise, it would be a gift. Gifts are, actually, a significant element in world commerce, notably remittances by immigrants to their families at home. However, that is not trade.

Notice that I said goods, services . . . and assets. For some reason, when people take assets in trade for their goods and services, this is called “unbalanced trade.” For example, if you work at your job (selling your services as an employee) and then take some of your income and buy a government bond (asset), you now have a “trade imbalance” with the rest of the world. Whatever.

Rather stupid terminology, actually.

All the governments in the world pull their hair and gnash their teeth over “imbalanced trade” all morning. Then, after lunch, they sell a bunch of government bonds to foreigners, which is “unbalanced trade” by their own idiotic definition.

Actually, a gold standard system facilitates this “unbalanced trade.” With a worldwide gold standard system, in effect everyone is using the same currency. Their currencies have different names like “dollar,” “franc” and “mark,” but they are all basically equivalent items in different denominations, all of them linked to gold. Thus, exchange rates between the currencies are fixed, just as the “exchange rate” between a $1 bill and a $10 bill is fixed.

If you were going to buy the bonds of a foreign country, it would be a lot safer and more attractive if those bonds were denominated in a currency linked to gold. Then, you wouldn’t have to worry about the effects of floating exchange rates making the value of your investment go up and down. For many decades, countries with low-quality currencies like Greece (before the euro) and Mexico issued debt denominated in U.S. dollars or German marks, because nobody would buy bonds denominated in credibility-challenged currencies like the drachma and peso.

So we can see that a gold standard system actually facilitates this cross-border financing, or international trade in assets, which goes by the laughable phrase “trade imbalance.”

It’s no different than two U.S. states, both of which use the U.S. dollar. Does anyone care that California may have a “trade imbalance” with the rest of the United States? It is totally irrelevant. What is true of California is true also of the countries of the eurozone, and indeed the world under a world gold standard system.

Talking about a “price-specie-flow mechanism” for countries using gold standard systems is as silly as talking about a “price-dollar-flow mechanism” for U.S. states that share the U.S. dollar. Gold is the same value everywhere.

(Econogeek note: this idea is attributed to David Hume in an essay entitled “Of the Balance of Trade.” Actually, Hume (1711-1776) was trying to dispel this dopey notion, which was just as common then as today, using exactly the example I use here. “What happens in small portions of mankind, must take place in greater. The provinces of the ROMAN empire, no doubt, kept their balance with each other, and with ITALY, independent of the legislature.” All trade is balanced, by definition.)

The purpose of a gold standard system is to produce a currency of stable value. With this currency, you can do everything that you can do with a floating currency today. Indeed, many things are far easier, because we wouldn’t have to worry about the difficulties of unpredictable exchange rates, not to mention governments who suggest they will outright default on their debts by devaluing their currencies. People today sometimes daydream about a “unified world currency,” but in fact that is the normal state of the world. The “unified currency” was always gold, whether in the times of the Ancient Greeks, or in the 1960s with the Bretton Woods gold standard system.