[This article is Part 7 of a series. See Part 1 and Part 2 and Part 3 and Part 4 and Part 5 and Part 6.]
In the previous six articles in this series, I have focused on showing the wide-ranging implications of analyzing the effects of monetary expansion on international trade. A review of the modern mainstream literature leads to the conclusion that for contemporary international economics, money is merely a veil covering barter exchange ratios. Thus, the fact that international economics often falls short of a satisfactory explanation of current events does not represent a series of isolated shortcomings, nor should it come as a surprise. It results from the central assumption of modern economic theory, that money and the money supply are a neutral element in the economic process, whose evolution cannot affect the real phenomena of the market in the long run.
While Cantillon effects are neglected by this entire theoretical corpus, Ludwig von Mises and a handful of other economists give a pivotal role to money in international transactions, and treat the international monetary process as an integral part of the general economic analysis. Money begets the world-embracing division of labor, because economic calculation in monetary terms is essential for entrepreneurial production and trade specialization. Entrepreneurs in this sector are also very sensitive to monetary changes, because they must constantly monitor the evolution of capital markets and exchange rates. Their business decisions are therefore dependent on the availability of working capital loans, trade credit, or on the evolution of commercial and sovereign risks. Unfortunately, however, monetary expansion allows financial institutions to provide new money to these entrepreneurs for little conditionality, for poor collateral, and at artificially low interest rates, such that more firms find international projects profitable, or international transactions less risky or costly.
The new available capital is allocated internationally to the most profitable investment opportunities through flows of FDI, FPI, and trade finance, which brings about an artificial lengthening of the structure of production as a result of lower-than-market interest rates. Consequently, the allocation of the capital stock and labor force throughout the world is modified: raw materials, labor, and capital goods are bid up into the higher stages of production, which only temporarily appear to be more profitable. Furthermore, because international companies are part of global supply chains, or expand vertically and horizontally, the demand and production of capital goods increases, as does the global trade in capital goods. Products in the intermediate stages cross borders to be assembled and sold in different countries. The artificial reduction of risk, which is due to the lower standards for bank loans and trade insurance, boosts trade flows in these capital goods, as well as for consumer goods and services. Existing firms expand their activities and existing trade flows grow in volume and value – the so-called intensive margin growth of global trade. But also, new firms enter global markets, and new commercial partnerships and new trade flows appear—so trade also grows at the so-called extensive margin. Monetary expansion not only entails changes in the volume and value of trade, but also in the structure of trade (biased toward higher order goods) and in the direction of trade (depending on the pattern of entrepreneurial decisions and consumer preferences).
The evolution of global trade over the last decades has thus been influenced to a significant and yet unrecognized extent by the expansionist monetary policies of governments around the world. That said, the monetary explanation for the changes in the pattern of international trade, while of a central importance, should not be used to explain real-world events in a contextual vacuum, but taken in conjunction with aspects concerning international demand, foreign policies, or other social and political considerations. Furthermore, the exact quantitative impact of monetary expansion on trade is difficult, if not impossible to tease out of empirical evidence, because it is often camouflaged by changes coming from the commodity side of the economy—such as changes in technology or demand—or postponed by the particular circumstances of the international monetary system.
These limitations only show, however, that the key implications of Mises’s insight into Cantillon effects carry in their wake a transformed landscape of both international economic theory and policy through understanding the impact of money changes on the structure of prices and wealth, and thus the repercussions of government intervention in international trade. We know that the fiat money fractional reserve banking system represents the linchpin of steadily recurring booms and busts. Its interference with trade and trade finance leads to the falsification of economic calculation, as entrepreneurs are maneuvered into undertaking otherwise unprofitable ventures, and have difficulties accounting for the islands of calculational chaos of governments’ trade policies.
In such a monetary system, financial intermediaries no longer facilitate the coordination of international trade; instead, they become hubs of distortion in the spatial and temporal allocation of economic resources across the globe. As a result, the pattern of international trade and specialization that emerges in this system—and thus, the current pattern of international trade and specialization—is fundamentally incongruent with the most efficient worldwide allocation of resources, and thus with the unhampered-market configuration of comparative advantage.
