CONTINUED FROM LAST WEEK
Conversely, if the goods and services available are too plentiful, relative to the prevailing amount of purchasing power, the value of money will rise. It follows, therefore, that in order to prevent incessant price fluctuations and maintain the value of money, so that people’s confidence in its primary roles may remain unshaken, the volume of purchasing power, or money in circulation, at any given time and at a given price level, must be just sufficient – no more and no less – for the quantity of goods and services available.
Now, the bodies responsible for putting currency or money into circulation are usually the Central Government of a country and the bank owned by it but not run by it as a department of Government.
These two bodies constitute the monetary authorities for a country. It is they, acting jointly, whose duty it is to make sure that there is not too much and not too little money in circulation, at any given time and at a given price-level. They must, at the international level, maintain the stability and strength of their currency, and its equilibrium or purchasing power parity with other currencies.
Their job is complicated, however, by the fact that it is not only the currency issued by them that is recognised as money. Cheques, bills of exchange, and promissory notes also perform the functions of money, and are so recognized by the business community. In some highly developed economies, these monetary instruments are used in transacting a much greater volume of business than the currency issued by the monetary authorities. Speaking generally then, the only thing that differentiates money from the other monetary instruments is that it is a legal tender, which the latter are not.
The problem is still further complicated by the fact that the volume of money – that is, of all the currency and monetary instruments in circulation – can be increased by the speed or velocity with which money and all these other instruments change hands. If business is brisk and buoyant, and currency and other monetary instruments, which are worth £1, change hands ten times in one day, then that £1 is equals to £10 worth of currency and other monetary instruments in circulation. On the other hand, if business is dull and the £1 only changes hands twice in one day, then it has only done the job which £2 worth of currency and other monetary instruments in circulation would have done.
For these reasons, the monetary authorities have always had to keep their eyes intently on the monetary weather-vane. If there is too much purchasing power in people’s hands, the monetary authorities will push up its price by raising interest rates, so as to make it less easy for people to borrow money from the banks. They may also go into the money market themselves and buy purchasing power from people’s hands in exchange. for Stocks and Securities. The government, in particular, may take the excess purchasing power out of people’s hands by means of direct and/or indirect taxation. In this case, its policy would be to budget for a surplus. If there is too little purchasing power, the monetary authorities do the reverse by lowering interest rates so as to encourage borrowing, and by selling purchasing power in exchange for Stocks and Securities. The government, in particular, “may reduce tax or embark on large public works in order to put more money into circulation. To this end, it would adopt the policy of deficit budgeting. In addition to all this, administrative guidelines or directives may be issued to the banking and other financial institutions, in order to ensure the liberalization or restraint of credit or purchasing power, as and when necessary.
In spite of all this, however, experience has shown that, as time goes on, prices do tend continuously to rise. As we have noted, the monetary authorities constantly keep their eyes on the monetary weather-vane. When the volume of money and other monetary instruments shows an ominous rise, the monetary authorities go quickly into action, but not before. At this point in time, the harm is already done; and the best that is invariably achieved is the prevention of such a rise getting completely out of hand. The clear verdict of economic history, however, is this. Once the ascent is made, it may be reduced to a lesser degree, but it has never been possible to return to the base from which that ascent has been made. Hence, the purchasing power of £1 today is worth less than its counterpart ten years ago, and will be worth less than now, ten years hence.
Just as money is a commodity sold and purchased like other goods at the domestic level, so it is at the international level. If the price of money is higher in A than in B, people in B will tend to offer their country’s currency in exchange for the currency of A, in order to benefit from the higher price of money in A; provided of course, there was parity of exchange between the two currencies before the price of A’s currency goes up, and provided also that people in B have confidence in the stability of A’s government, and in the credit-worthiness of its monetary authorities and other financial institutions.
THREE: If a country can produce all the things that its people require to satisfy their wants; if it can produce these things better than any other country in the world; and if its efficiency in the production of these things is equal, it will not need to trade with other countries. But this is manifestly impossible. There are, therefore, three causes of international trade. It arises:
(i) because a country does not produce or is unable, because of lack of the requisite natural resources, to produce all that it requires;
(ii) because certain things which it can produce can be produced more cheaply or better in other countries; and
(iii) because though it can produce certain items of goods more cheaply than other countries, yet its efficiency in the production of some of these items is less than its efficiency in the production of the other items.
In economic parlance, international trade exists because every country tends to concentrate on those goods in the production of which it has greater comparative advantage or less comparative disadvantage.
CONTINUES NEXT WEEK
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