Money

The value of the monetary unit in terms of the standard metal is constant, but that does not mean that its value in terms of wealth in general is necessarily constant. Like any commodity the standard metal may be exposed to variations of price not in accordance with the general trend of the price level. But it is also exposed to special influences on account of the very fact that it is used as money. Every country that uses gold or silver as its monetary standard provides a market for the metal at the coinage price, and holds a stock in the form either of coin in circulation or of reserves against paper currency. There is an industrial demand for the precious metals for the production of plate, jewellery, etc., and for various purposes such as the use of gold in dentistry or in the manufacture of fountain pens. But this industrial demand is not easily expanded and is incapable of ab sorbing any considerable amount of surplus metal. When gold or silver is displaced from the monetary stock of any country, and has to be disposed of, the only adequate opening is in other coun tries which have the same metal for their monetary standard. If the metal is sold abroad, the proceeds will be held in the form of foreign money or credit money. The out-turn of the transaction will depend on the terms on which this foreign money can be disposed of.

The Foreign Exchange Market.

It is the business of the foreign exchange market to buy and sell foreign money. The things dealt in are pecuniary rights, embodied in bills of exchange, cheques, telegraphic transfers and similar instruments, entitling the possessors to specified sums in foreign countries. For each foreign monetary unit so offered, a price is quoted in terms of the money of the country where the market is being carried on. In order to make clear the working of the foreign exchange market, the best course will be first to consider the general case where currencies may be free to vary independently of one another, and then to pass to the particular case of countries linked by a corn mon metallic standard. The things produced or consumed in any country may be divided broadly into two classes, those which are, and those which are not, suitable for exportation and importation. The former, comprising goods actually exported and imported and goods in competition with exports or imports, may be called f or eign trade products. The latter, the goods and services unsuitable for export or import, may be called home trade products. The boundary between the two is not a precise one, but the charac teristic of the foreign trade products is that their prices are regu lated by international markets, whereas the prices of home trade products depend on local markets only. A foreign trade product has a different price in terms of the currency of every country in which it is dealt in. But these prices are in competition with one another. In virtue of the rates quoted in the foreign exchange

market, every currency can be expressed in terms of every other, and the prices of a foreign trade product in any two countries, when so expressed, cannot differ by more than the cost of trans porting the product from one to the other (so long as markets are functioning effectively).

If we suppose the consumers' outlay in any country to increase, without any corresponding increase in production, the result will be the increase of consumption. There will be increased demand both for home trade products and for foreign trade products. For the former the increased demand will soon be reflected in a rise of prices. But the prices of foreign trade products are tied down by international markets, and cannot rise appreciably, so long as foreign exchange rates remain unchanged. In the first instance therefore the increased demand will take the form of an increase in the quantity consumed. There will arise an excess of imports; the country will be consuming more than its production will pay for in international markets. The foreign exchange market has to provide for payment for this import excess; dealers will receive more than usual of the country's currency and will part with more than usual of foreign currencies. In order to preserve a balance between their holdings of different currencies, they will offer less of the currencies of which they are short for that of which they hold too much; the country's currency will become cheaper in terms of foreign currencies. When that happens, the foreign ex changes are said to become "unfavourable"; when the value of the country's currency in terms of foreign currencies rises, the exchanges are said to become "favourable." An expansion of the consumers' outlay without any increase in production tends to bring about an excess of imports and an unfavourable exchange ; a contraction of the consumers' outlay without any decrease in pro duction tends to bring about an excess of exports and a favourable exchange. The prices of foreign trade products, being approxi mately fixed in terms of foreign currencies, are raised by an un favourable exchange, and lowered by a favourable exchange. If the movements in the foreign exchange market are perfectly free, the adjustment of the prices of foreign trade products will correct the excess of imports or exports as the case may be. An unfavour able exchange will check the consumption of foreign trade prod ucts, and a favourable exchange will stimulate it. Equilibrium will thus be re-established. An expansion of the consumers' out lay will in any case have raised the price level of home trade products, or a contraction will have lowered it. Thus, provided the foreign exchange rates are free to move, there is in the one case an all round rise of prices, in the other an all round fall.