Key Arguments

• Smith recapitulates the common mercantilist view: when exchange is at par, 'it is said to be a sign that the debts due from London to Paris are compensated by those due from Paris to London'; when a premium is paid on a bill, it is taken as 'a sign that the debts due from London to Paris are not compensated by those due from Paris to London, but that a balance in money must be sent out from the latter place.'
• He notes that this view assumes 'the ordinary state of debt and credit between those two cities must necessarily be regulated ... by the ordinary course of their dealings with one another,' and thus the course of exchange is taken as 'an indication of the ordinary state of debt and credit between two places' and, consequently, of 'the ordinary course of their exports and imports.'
• He then argues that 'the ordinary state of debt and credit between any two places is not always entirely regulated by the ordinary course of their dealings with one another, but is often influenced by that of the dealings of either with many other places.'
• Using an example, he explains that if 'the merchants of England' commonly pay for goods bought from Hamburg, Dantzic, and Riga 'by bills upon Holland,' then 'the ordinary state of debt and credit between England and Holland will not be regulated entirely by the ordinary course of the dealings of those two countries with one another, but will be influenced by that of the dealings in England with those other places.'
• In this scenario, 'England may be obliged to send out every year money to Holland, though its annual exports to that country may exceed very much the annual value of its imports from thence, and though what is called the balance of trade may be very much in favour of England,' directly contradicting the inference that a regular money outflow proves an unfavourable trade balance.
• He concludes that, therefore, even if the 'ordinary course of exchange shall be allowed to be a sufficient indication of the ordinary state of debt and credit between any two places, it would not from thence follow, that the balance of trade was in favour of that place which had the ordinary state of debt and credit in its favour.'

Source Quotes

The course of exchange is, perhaps, almost equally so. When the exchange between two places, such as London and Paris, is at par, it is said to be a sign that the debts due from London to Paris are compensated by those due from Paris to London. On the contrary, when a premium is paid at London for a bill upon Paris, it is said to be a sign that the debts due from London to Paris are not compensated by those due from Paris to London, but that a balance in money must be sent out from the latter place; for the risk, trouble, and expense, of exporting which, the premium is both demanded and given.

When the exchange between two places, such as London and Paris, is at par, it is said to be a sign that the debts due from London to Paris are compensated by those due from Paris to London. On the contrary, when a premium is paid at London for a bill upon Paris, it is said to be a sign that the debts due from London to Paris are not compensated by those due from Paris to London, but that a balance in money must be sent out from the latter place; for the risk, trouble, and expense, of exporting which, the premium is both demanded and given. But the ordinary state of debt and credit between those two cities must necessarily be regulated, it is said, by the ordinary course of their dealings with one another.

But though the ordinary course of exchange shall be allowed to be a sufficient indication of the ordinary state of debt and credit between any two places, it would not from thence follow, that the balance of trade was in favour of that place which had the ordinary state of debt and credit in its favour. The ordinary state of debt and credit between any two places is not always entirely regulated by the ordinary course of their dealings with one another, but is often influenced by that of the dealings of either with many other places. If it is usual, for example, for the merchants of England to pay for the goods which they buy of Hamburg, Dantzic, Riga, etc. by bills upon Holland, the ordinary state of debt and credit between England and Holland will not be regulated entirely by the ordinary course of the dealings of those two countries with one another, but will be influenced by that of the dealings in England with those other places.

If it is usual, for example, for the merchants of England to pay for the goods which they buy of Hamburg, Dantzic, Riga, etc. by bills upon Holland, the ordinary state of debt and credit between England and Holland will not be regulated entirely by the ordinary course of the dealings of those two countries with one another, but will be influenced by that of the dealings in England with those other places. England may be obliged to send out every year money to Holland, though its annual exports to that country may exceed very much the annual value of its imports from thence, and though what is called the balance of trade may be very much in favour of England. In the way, besides, in which the par of exchange has hitherto been computed, the ordinary course of exchange can afford no sufficient indication that the ordinary state of debt and credit is in favour of that country which seems to have, or which is supposed to have, the ordinary course of exchange in its favour; or, in other words, the real exchange may be, and in fact often is, so very different from the computed one, that, from the course of the latter, no certain conclusion can, upon many occasions, be drawn concerning that of the former.

The ordinary course of exchange, therefore, being an indication of the ordinary state of debt and credit between two places, must likewise be an indication of the ordinary course of their exports and imports, as these necessarily regulate that state. But though the ordinary course of exchange shall be allowed to be a sufficient indication of the ordinary state of debt and credit between any two places, it would not from thence follow, that the balance of trade was in favour of that place which had the ordinary state of debt and credit in its favour. The ordinary state of debt and credit between any two places is not always entirely regulated by the ordinary course of their dealings with one another, but is often influenced by that of the dealings of either with many other places.

Key Concepts

• When the exchange between two places, such as London and Paris, is at par, it is said to be a sign that the debts due from London to Paris are compensated by those due from Paris to London.
• On the contrary, when a premium is paid at London for a bill upon Paris, it is said to be a sign that the debts due from London to Paris are not compensated by those due from Paris to London, but that a balance in money must be sent out from the latter place;
• The ordinary state of debt and credit between any two places is not always entirely regulated by the ordinary course of their dealings with one another, but is often influenced by that of the dealings of either with many other places.
• England may be obliged to send out every year money to Holland, though its annual exports to that country may exceed very much the annual value of its imports from thence, and though what is called the balance of trade may be very much in favour of England.
• it would not from thence follow, that the balance of trade was in favour of that place which had the ordinary state of debt and credit in its favour.

Context

Middle of Part I of Chapter III, where Smith dissects the supposed link between exchange rates and trade balances and shows how multilateral clearing of debts breaks the simple bilateral inference used by mercantilists.