A Cheesy Example
Not all economists share Ricardo's confidence that the price-specie-flow mechanism would work. In particular, it may be that a cut in the money supply will not lead directly or very quickly to a cut in the price level. Even if the price-specie-flow mechanism would work, a conservative free-market economist, Milton Friedman, expressed some doubt that it would be a good idea, suggesting that to change the overall price level as a means of balancing imports and exports is a little like using a cannon to kill a gnat. Friedman's alternative -- accepted by many modern economists, especially those oriented to free-market conservatism -- was to let supply and demand regulate international trade and currencies. That is pretty much the way the modern international economy works.
Supply and demand, together, determine a price. The price, in this case, is the exchange rate.
The exchange rate between two currencies is a kind of price. For example: the number of Dollars per Pound is the price of a Pound in dollars -- the number of Dollars you have to pay to buy a British Pound.
** Here's a web site that will tell you the exchange rate between any two currencies.**
Many economists (especially conservative, free-market oriented economists) say "Since it is a price, let it be determined by supply and demand. If the demand for Pounds exceeds the supply, the price will rise -- more Dollars per Pound -- and that will bring about equilibrium." From this point of view, tying the currency to gold is a kind of price fixing. If the U. S. and Britain both tie their currencies to gold, the result is to fix the price of Dollars in terms of Pounds. The price-specie-flow mechanism has to wait for thousands of prices to change, when really only one price needs to change: the price of Pounds in terms of Dollars.
When the number of Dollars per Pound rises, the number of Pounds per Dollar falls, so the Dollar has less value measured in pounds. This is called "devaluation." Let's see how that would work in an example.
A Cheesy Example
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