The Negative Externality of a Common Currency at the Lowest Level of Trade

Assume a fictitious, isolated French economy on the gold standard. Assume that the original non-monetary uses of gold, though necessary for the evolution of the gold standard, have now decayed away to insignificance and that all remaining demand for gold is a monetary demand to hold.

The Rockechilde family owns a large part of southern France, and its holdings include extensive wine producing properties and a gold mine.

All of the wine is sold and consumed domestically and the gold resulting from both wine sales and mining are used to buy goods from the rest of the French economy.

The Rockechilde family has encountered a problem in that its gold mine is rapidly becoming exhausted and the gold yielded by wine sales is not sufficient to buy everything that is desired from the rest of the French economy.

After due consideration, the Rockechilde family comes up with a plan.

It will withdraw the highest quality 10% of its wine from the domestic market and instead export it to the US, also under the gold standard, for gold. This gold will tend to replace the purchasing power lost with the exhaustion of the gold mine.

What we now have is a low level of trade that only moves consumption goods (wine) in one direction in exchange for money (gold).

While both US consumers and the Rockechildes benefit from this trade, the consumers in the rest of the French economy do not. They have lost access to the wine exported to the US and have seen prices rise due to the increase in the gold money supply. This is even worse than the stand-alone price rise due to the gold mined before the mine became exhausted. In both cases the Rockechildes use their added gold to bid up the prices of consumer goods in the rest of the French economy.

If the US and France did not have a common currency, the one way trade would have been impossible. For example, the US could be on a silver standard, again assuming only monetary silver demand.

In this case, any silver acquired in exchange for wine would have to be used to buy, directly or indirectly, consumer goods from the US, or elsewhere. The rest of the French economy is now not impacted by an increase in the gold money supply, does not use silver for money, and will also benefit from an increase in the supply of consumer goods from the US.

Thus, the common currency of gold can be said to produce a negative externality for the rest of France.

Note that the US benefits from even the 100% trade deficit present in the case of a common currency gold standard. It not only sees an increase in the supply of consumer goods, but prices fall as gold money is exported and the gold money supply is decreased.

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