Thursday, August 14, 2008

7. Balance of Trade

“Nothing can be more absurd than this whole doctrine of the balance of trade.”

Adam Smith, The Wealth of Nations


The idea that a country needs a positive balance of trade is a fallacy that has been creating wars and destroying jobs for over five-hundred years. Empires have fallen and ill-gotten fortunes have been made under the spell that it has held over the economically naïve. Yet, under the examination of common sense, it can be quickly exposed as the absurdity that Adam Smith proclaimed it to be.


The doctrine of balance of trade is the underlying principle behind the political theory of mercantilism, the fallacy that a country can get rich independently of its people’s productivity. To the mercantilist, gold is wealth and the country that hoards the most gold must be the wealthiest – even if its people have no bread.


Gold is not wealth. It cannot be digested; it is too soft to be useful in making tools; and it cannot warm the body on a cold night. Gold’s only value is as a medium of exchange, a material used as a standardized way of executing trades among people who do not want to be restricted to the practice of barter.


While the mercantilist wants to trade for gold as an end in itself, the wise free trader only accepts gold as a means of trading for something really useful. Gold in itself may be pretty useless, but, if everyone accepts it as an intermediary unit in a complex trading system, gold can be used to obtain food, tools, and a warm shelter on a cold night. Ironically, gold is only useful when it is creating what the mercantilist refers to as a “negative trade balance,” the importing of something useful.


By hoarding his country’s gold, the mercantilist only denies his citizens what is useful while increasing the gold used to obtain what is useful – he only causes inflation.


How gold is used determines whether it is a practical substance or a false idol. In the hands of a trader, it can be a means of making a series of related exchanges that would be impossible by primitive barter; in the hands of a hoarder, it can be a way of slowing down the market system.


Gold and other forms of money can either enhance a society’s wealth by increasing the comparative advantages of its diverse members or it can be limited to serving as the object of the obsessive hoarder’s worship.