International Trade ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014 & the Gold Standard

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: GoodsServices Financial Account Value of assets.Value of assets. Net change in securities.Net change in securities. Other.Other. Balancing error 2013 Q4: (405.4 b – b) + (173.7 b – b) b – 92 b Net Ex: Feb. 2014: (131.7 – 193.4) + (58.7 – 39.3) = b Merchandise Trade Balance Net Exports, aka Current Acct. Balance of Payments Goods Ex Im Services Ex Im Net Financial error

Current Account Financial 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

$5.8 Tr The Role of Trade in the Government’s Budget

The Gold Standard $20.67 = 1 oz.1 oz. = £4.25 $4.86 = £1 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 $). £10.29 mill. $50 mill. A gold standard implies that we have “fixed” exchange rates between currencies.

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.1 oz. = £4.25 $4.86 = £1 £8 mill. $50 mill.

The flow of gold from England to U.S. won’t persist over time.  gold =  MS  MS =  P inflation MV=PQ  gold =  MS  MS =  P deflation U.S. exports fall and British exports rise until trade flows balance. The Gold Standard $20.67 = 1 oz.1 oz. = £4.25 $4.86 = £1 £10.29 mill. $50 mill.

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. 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. Confounding the Gold Standard 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!

WWI - Combatant countries go off gold standard to  spending. After, move back to gold standard. Gold stocks insufficient for existing price levels. Worldwide deflation (i.e., depression) is required. Only U.S. and U.K. go back to gold standard. U.K. depression through Great Depression adds in more stress – FDR abolishes gold std – Nixon abolishes int’l gold payments. The Gold Standard Stress & Collapse We now live in an era of “flexible” exchange rates and there is no restraint on monetary policy.

International Trade ECO 285 – Macroeconomics – Dr. D. Foster – Spring 2014 & the Gold Standard