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Question on the specie flow mechanism.

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Prashanth Perumal posted on Thu, Mar 15 2012 6:56 PM

Assuming equal price levels, lets say country A inflates its money supply, while country B doesn't. Hume's specie flow mechanism suggests prices in country A would increase, causing gold to flow out of A (as prices in country B are relatively lower, making imports from B cheaper, and exports from country A become expensive).

My question: if country A's central bank expands credit, does it necessarily have to be that prices in country A should increase first? If, lets say, investments in country B offer a higher return, won't any increase in credit in country A directly flow into country B, thereby preventing an increase in prices in country A first (although it might happen later when prices begin to equalize across the countries)?

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 exports from country A become expensive

Perhaps I am thinking of a different theory, or I did not understand it well when explained in class, but I thought that the whole point of currency devaluation as it relates to trade balance is to lower the price of your money so that you export more, because your exports are cheaper (because your money becomes less valuable, and hence easier to obtain, and hence the goods (at least in the short run) are bought by this easily acquired currency).

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Jargon replied on Thu, Mar 15 2012 10:59 PM

Doesn't this happen after? Country A prints money, people of A have more money to spend, buy goods from country B. Prices of Country B's goods are bid up, Country A's less so. Country B is then holding currency of Country A, while goods of Country A are relatively cheap, not having been bid up. 

So as long as the money printing continues faster in A than it does in B, won't A continue to get cheap imports?

EDIT: Also, as long as A is on gold and continues printing money, won't B buy gold from A, drawing down reserves and eventually forcing A to stop? I'm terrible with balance of payments and how it differs between gold/fiat.

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tunk replied on Mon, Mar 26 2012 8:56 PM

You guys didn't really answer his question. I'm reading The Mystery of Banking right now and I have the same issue.

If a country's money supply increases and the demand to hold money remains constant, people will spend that extra money on goods and services, raising the price level. Okay, I get that. But the specie price flow mechanism seems to assume that people will only spend their money on goods sold by members of the same country, and that nobody from other countries purchases those same goods, so that only prices within the country will rise and only the purchasing power of the domestic currency will decline, leading to a balance of trade deficit, etc.

But why assume that? And I got even more confused when Rothbard claimed that the mechanism also applies to clients of different banks under free banking. At least you could maybe plausibly make a case that Frenchmen will typically buy goods from other Frenchmen as an empirical fact. But I don't think clients of one bank necessarily discriminate in their purchases so as to only buy from other clients of the same bank, and in fact Rothbard explicitly says elsewhere that that doesn't happen. Can someone explain?

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To OP:

If we define "increase" as "higher than they would have been without the credit expansion", then we are can see what is going on. If there was some good reason for money to flow onto country B, then without the expansion prices in A would have dropped. The expansion prevented that, meaning prices were "higher" as a result.

To tunk,

A little research job for you.

1. Go here: http://mises.org/Community/forums/p/28314/458960.

2. Find and read the section of HA it discusses.

3. Read the thread about it.

4. Be enlightened.

 

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It's easy to refute an argument if you first misrepresent it. William Keizer

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xahrx replied on Wed, Mar 28 2012 10:15 AM

All else being equal the prices would be higher in A than they otherwise would have been.  An inflation on one level means people have a surpus of currency for holding in their own judgement.  Assuming they all invest it in country B you're still left with a situation where, had they done that without the inflation, prices in A would have had to drop.  And in a more realistic scenario some would be invested in while some would be spent domestically.  The end result either way is (some) prices in A are higher than they would have been absent the inflation, and if the government continually inflated you'd likely end up with a more or less general price rise in A over time.

Everything in economics is ceteris paribus; all else being equal.

"I was just in the bathroom getting ready to leave the house, if you must know, and a sudden wave of admiration for the cotton swab came over me." - Anonymous
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