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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