Introduction

The seventeenth and eighteenth centuries were a time of contradiction in Europe -- as, perhaps, all times are. In Europe, in those centuries, new political units called "nations" were emerging, and at the same time international and interregional trade were making those new nations more interdependent and insecure at the very time they were groping their way to unity, independence and military security. this was the time period in which the new discipline of economics emerged, and both of these developments -- the emergence of nations and the growth of international trade -- made deep impressions on the new discipline. From the first, economists saw issues of international trade as central to the reasonable dialog of economics.

But (from the point of view of the new nations, struggling for unity and independence) why should nations trade at all? Why should every nation not be self-sufficient, producing what it needs for its own use? Some thinkers and pamphleteers had a quick answer: to get gold. People who advocated this idea were called "mercantilists." Gold, we recall, was the main form of money at that time; and the strongest armies of that time consisted of mercenaries -- professional soldiers who expected to be paid in gold. Thus, it seemed important for a country to have gold to pay mercenaries. The mercantilists saw the solution to the problem in international trade. The country must export more goods than it imported: the difference would be paid for in imported gold.

However, another school of thought saw the matter differently. The were the earliest free-traders. They argued that countries would trade with one another to gain mutual benefits from the exchange, and they saw the mercantilists' single-minded pursuit of gold as an obstacle to this mutually beneficial trade. This was the school of thought that Adam Smith represented, and his Wealth of Nations gave intellectual structure to the Free Trade school of thought as it founded economics. All the same, it was left to the next generation of economists to discover the fundamental reason why trade could be beneficial to both countries.

The discovery was made by one of the great gentleman amateurs in the history of economics, David Ricardo. He was the first to explain international trade by the theory of comparative advantage. That theory is still recognized as valid by modern economics.

In this chapter we will first explore the theory of comparative advantage, then review some realistic limits on the theory, and then we will go on to revisit the economics of money, exploring the way that the different national monetary systems adapt to international trade.

Ricardo's Insight