6. INTERNATIONAL TRADE

2. Stabilisation of the International Exchanges: Theory.
Some Facts

1. Silver five-franc pieces circulated freely before the war in the countries of the Latin Currency Union. (France, Italy, Switzerland, Belgium and Greece). These five-franc pieces were free to pass from one to another of these countries; they were legal tender at par with the national currencies, and usually circulated at par with them.
2. Yet these five-franc pieces were "fiduciary" money; they were for some time "covered" only to the extent of 50% by the silver they contained; they could buy double their weight of silver. Hence, of two such coins, one could be regarded as purely "fiduciary" money. Five-franc pieces lost half their value in the melting-pot.
3. Because of their freedom of circulation, these coins had a regulating effect upon the international exchanges, and acted as an automatic arbitrage mechanism, bringing prices to a level in the different countries.
4. The balance of trade and payments was regulated by this automatic arbitrage mechanism.
5. If one country of the Latin Currency Union increased the quantity or the rate of circulation of its currency out of proportion to the other countries, its general level of prices rose above theirs. Hence the imports of this country increased, its exports decreased, and its balance of trade and payments closed with a deficit which had to be made good by the export of five-franc pieces.
6. The export of five-franc pieces lowered prices in this country and raised them in the other countries, especially as five-franc Pieces were counted as "cover" for notes and, if removed from a Bank of Issue usually caused the withdrawal of double the quantity of notes from circulation. The effect of exporting five-franc pieces was usually, therefore, doubled. The export of five-franc pieces lasted until equilibrium was established in the balance of trade and payments.
7. If the increased issue of notes continued until the country was completely drained of five-franc pieces, it could no longer make up the deficit by exporting them. The automatic arbitrage mechanism then ceased working and an agio (premium on foreign money) appeared.
8. If the country wished to eliminate the agio, it withdrew notes from circulation. Prices then fell, imports decreased, exports increased, the deficit in the balance of trade and payments gradually decreased and was replaced by a surplus. The five-franc pieces which had been driven away by the increased issue of notes then began to flow back and conditions were reversed-until a general equilibrium was reached. Prices in the different countries were levelled by the five-franc pieces, as water, after a disturbance, is levelled by a system of communicating pipes.
9. If all the countries of the Latin Currency Union were guided, when issuing notes, by the danger-signals described in paragraphs 7 and 8, the fluctuations of their exchanges remained within the cost of transporting five-franc pieces from one country to another.
10. The countries of the Latin Currency Union therefore stabilised their exchanges by declaring one class of coins an international medium of payment, not by internationalising their whole currencies.

This was not, of course, the original purpose of the Union, whose founders could not have foreseen that silver would become "fiduciary" money.

The regulating effect of the five-franc pieces upon the exchanges can be explained only by the theory of paper-money.

Inferences from these Facts.

1. The play of forces described above is in accordance with the quantity theory of money and is a proof of its correctness.
2. The results would have been the same if five-franc notes had been substituted for the five-franc pieces - which acted as an international medium of payment because of an international agreement, and not because of the silver they contained.
3. International paper-money issued in one denomination under the supervision of the countries concerned, and for this purpose only, would circulate freely like the five-franc pieces and regulate import and export, thus keeping the exchanges in equilibrium.
4. An unusual influx of these international five-franc notes would prove that insufficient national currency was in circulation. An unusual efflux of the international notes would prove that the national currency was over-abundant.
5. The complete disappearance of the international notes and the resulting agio (premium upon the international notes) would be a warning signal that the country in question should proceed to drain the market of national notes until the agio disappeared and international notes began to flow back.
6. Too large an influx of international notes would mean that insufficient national currency was in circulation - unless all the other countries were expelling international notes by issuing too much national currency. The latter supposition leads to the question of currency standard, which must not be confused with the question of the exchanges.

We shall now give a summary of our proposals for an international union for regulating both the currency standard and the exchanges: The International Valuta Association.