Let's say we have two economically and geographically isolated islands, each with the rough size and population of New Zealand. They are virtual clones of one another, and each has a functioning monetary economy based on a gold standard, with all prices expressed in ounces of gold in any physical form. If inter-island trade has suddenly become feasible due to technological advances in transportation, what possible economic effects may result?

[ed] The uncontrolled variable that may differentiate one island from the other is its gold money supply. If one island has ten times as much physical gold as the other, its gold prices of goods will not be exactly ten times those of the other island, but they could be, and will certainly be much higher. If trade has become possible, there will be a large flow of gold in one direction and goods in the other. The island with less gold will experience a large price inflation and a loss of goods available for consumption. The island with more gold will experience a large price deflation and a collapse of production as its producers cannot compete with lower-priced imported goods.

The common currency can produce an artificial comparative advantage even if the physical productivities of the two economies are identical in every respect.

This kind of problem also occurs when Congress tries to apply a Federal minimum dollar wage to Pacific island territories that use dollars, but for whom a fixed mainland minimum wage is entirely inappropriate.

A common currency can be expected to result in comparable prices in different regions only after a substantial equilibrating period of widespread trade.

Regards, Don