buyer a bill for £100 can sell it for £111. It is clear, then. that those £11 are so much added to his profits on the sale. Instead of gaining 10 per cent, as he perhaps expected, he gains II per cent. These additional profits for all those who have sold abroad will induce a large number of merchants to follow their example; in other words, "the rise in the rate of exchange acts as a premium on exportation." For instance, after the war of 1870 the exports of France increased enormously for several years. Why? Because, the huge payments that the French had to make to Germany having caused foreign paper to rise greatly above par, the profits that exporters obtained from the paper they drew on their foreign debtors were such that they could content themselves with an extremely small profit on the price of their goods, and could, if necessary, sell them at a loss. Thus the French had come to sell to the foreigner, less in order to gain on the price of the goods than to gain on the price of the bill.

Now, in direct ratio to the increase of exports will be the multiplication of the bills of exchange to which they give rise, and the value of these bills, according to the general law of supply and demand, will fall progressively, until it has descended below par.

Inversely, if the paper falls below par, it is easy to prove by the same reasoning that this depreciation will entail a loss on the merchants who have sold goods abroad, and will consequently tend to reduce exports, and then by reaction to reduce the supply of foreign paper, until its value has risen again to par.

In the whole matter there is nothing more than the ordinary mechanism of supply and demand, which, whenever the value of a commodity is disturbed from its equilibrium, tends to bring it back to that position, either by an increase or by a restriction of production.

Nevertheless, this general law produces in this instance. a very curious effect, the consequences of which are very important from the point of view of international trade. Whenever the balance of trade is unfavorable to a country, i. e., when its imports exceed the exports, the resulting rise in the rate of exchange tends to reverse the position and to

make the balance of trade favorable by increasing exports and reducing imports. The rate of exchange, then, constantly acts on trade like those regulators of steam-engines, which always tend to restore the velocity of the engine to a state of equilibrium, and a variation of a few pence is thus enough to restore to equilibrium balances which amount in value to many thousand millions sterling.

C. HOW A RISE IN THE RATE OF DISCOUNT CHECKS AN OUTFLOW OF MONEY.

*Take a nation that is likely to be obliged to ship large amounts of specie abroad. A rise in the rate of discount, effected at the right time, reverses the economic situation by making the country a creditor of foreign nations for considerable sums, and thus gives rise to an influx of money from abroad, or at least prevents the outflow of a nation's own supply of money. Let us consider what really takes place in such a case as this.

The first result of a rise in the rate of discount is the depreciation of all commercial paper. A bill of exchange for $1,000, which sold for $970 when the rate was 3 per cent, can be negotiated only for $930 when the rate has risen to 7 per cent; this is equivalent to a fall in value of more than 4 per cent. Henceforward the bankers of all nations, especially so-called arbitrage brokers, will purchase bills of exchange in this country, because they can be bought here at a low price; foreign nations will thus become our debtors to the extent of these purchases.

The second result is the depreciation of all stockexchange securities. Every financier knows that the stock exchange is greatly interested in the rate of discount, and that a rise in the rate of discount almost always entails a fall in the value of stocks. Stock-exchange securities (especially those that are designated as international, because they are quoted on the principal stock-exchanges of the world), are frequently employed by merchants or at least

*From Gide's Principles of Political Economy. Copyright 1891 and 1903, by D. C. Heath & Co. By permission. American edition, pp. 391-393.

by bankers in place of commercial paper, to pay their debts abroad. Business men who cannot negotiate their commer. cial paper, or can do so only at a heavy loss, prefer to get money by selling whatever shares or stock securities they may possess. Hence these stocks tend to fall in value, just as commercial paper falls. But as a fall in the value of commercial paper results in an increased demand for it on the part of foreign bankers, similarly a decline in the value of stock-exchange securities gives rise to increased purchases of them by foreign capitalists; and thus the United States will become the creditor of foreign nations to the extent of these purchases.

Finally, if the rise in discount is great, and sufficiently lasting, it will cause a third result, viz., a fall in the price of commodities. We have just explained that business men who need money begin to obtain it by negotiating their commercial paper. When that resource fails or becomes too costly, they make use of whatever stock securities they possess; and finally, if these various measures do not suffice, they must, in order to get money, sell the goods they have on hand. The natural consequence of this last measure is a general fall in prices. But this fall produces the same effects as those already considered, only on a larger scale: it stimulates purchases from abroad, increases the exportation of goods from this country, and thus makes the United States a creditor of foreign nations to the amount of these purchases.

All these effects may be summed up by declaring that a rise in the rate of discount creates an artificial scarcity of money, and thus involves a general decline in values. This is undoubtedly an evil. But it also gives rise, as a consequence, to large purchases from abroad and to the importation of money. The ultimate effect is therefore beneficial, and is precisely the remedy best suited to the situation.

READING XVII.

THE DETERMINATION OF SUBJECTIVE VALUE BY MARGINAL UTILITY.

It is probable that marginal utility has been somewhat overworked in recent economic literature, particularly by writers of the Austrian School. Still there can be no doubt that this concept must play a considerable part in explaining certain cases of value. The student, therefore, can not afford to neglect it. One of the best expositions of the process whereby this factor would determine value in an ideally simple case is to be found in the following from Boehm-Bawerk.

*In asking what is the principle that regulates the amount of value, we pass to a sphere where lies the chief task of a theory of value, and where at the same time lie its greatest difficulties. These difficulties are the result of a peculiar coincidence of circumstances. From one point of view the true principle almost suggests itself. If the value of a good is its importance to human wellbeing, and if the "importance" means that some portion of our wellbeing is dependent on our having the good, it is clear that the amount of the good's value must be determined by the amount of wellbeing which depends on it. Goods will have high value if our wellbeing depends on them to any important extent, low value if it does not.

But from another point of view, there are certain facts in the economical world which seem to give the lie to this very simple and natural explanation. Everybody knows that, in practical economic life, precious stones possess a

* Boehm-Bawerk-Positive Theory of Capital, (1888). Translation published by Macmillan & Co. 1891. Book III, Chapters III and IV.

high value, while bread and iron have a moderate value, and air and water usually no value at all. Now everybody knows that without air and water we simply could not exist, and that the uses of bread and iron are extremely important, while precious stones, for the most part, only satisfy the love of ornament, and have, accordingly, a very inferior importance for human wellbeing. It would appear, then, that one who holds fast by the principle that the amount of a good's value is determined by the importance of the services which it may render to human wellbeing, must expect to find in precious stones a low value, in bread and iron a high value, and in water and light the very highest value. But facts show that exactly the opposite of this is the case.

This startling phenomenon has been a veritable rock of offence in the theory of value. The highest utility accompanied by the smallest value is a strange paradox. It is true that, in confusing Usefulness and Use Value, economists did not apprehend and describe the state of the case quite exactly. When they falsely ascribed to the iron a high "use value" and to the diamond a low "use value," the only reason for surprise was that the "exchange value" of these goods went so entirely in the opposite direction. But this was only to change the name of the opposition, not to take away any of its sharpness. There were plenty of attempts to bridge the fatal contradiction by involved explanations, but these were unsuccessful; and so it happens that, from Adam Smith's time to our own, innumerable theorists have despaired of finding the nature and measure of value in any relation to human wellbeing, and have fallen back upon quite foreign and often wonderful lines of explanation, such as labor or labor time, costs of production, resistance of nature to man, and the like. But, unable to get rid of the feeling that the value of goods must have something to do with utility and human wellbeing, they put down the want of harmony between the utility and the value of goods as a rare and perplexing contradiction, a contradiction economique.

In what follows I mean to prove that the older theory had no need to abandon the most natural explanation. The