The price–specie flow mechanism is a model developed by Scottish economist

David Hume David Hume (; born David Home; 7 May 1711 NS (26 April 1711 OS) – 25 August 1776) Cranston, Maurice, and Thomas Edmund Jessop. 2020 999br>David Hume" '' Encyclopædia Britannica''. Retrieved 18 May 2020. was a Scottish Enlightenment ph ...

(1711–1776) to illustrate how trade imbalances can self-correct and adjust under the

gold standard A gold standard is a monetary system in which the standard economic unit of account is based on a fixed quantity of gold. The gold standard was the basis for the international monetary system from the 1870s to the early 1920s, and from th ...

. Hume expounded his argument in ''

Of the Balance of Trade On the Balance of Trade is an economic text on monetary economics that was written by David Hume and published in 1752. In the book, Hume examines various mistakes committed by nations regarding trade and suggests better alternatives. The thought ...

'', which he wrote to counter the

Mercantilist Mercantilism is an economic policy that is designed to maximize the exports and minimize the imports for an economy. It promotes imperialism, colonialism, tariffs and subsidies on traded goods to achieve that goal. The policy aims to reduc ...

idea that a nation should strive for a positive

balance of trade The balance of trade, commercial balance, or net exports (sometimes symbolized as NX), is the difference between the monetary value of a nation's exports and imports over a certain time period. Sometimes a distinction is made between a balance ...

(i.e., greater exports than imports). In short, the "increase in domestic prices due to the gold inflow would discourage exports and encourage imports, thus automatically limiting the amount by which exports would exceed imports". Hume first elaborated on the mechanism in a 1749 letter to

Montesquieu Charles Louis de Secondat, Baron de La Brède et de Montesquieu (; ; 18 January 168910 February 1755), generally referred to as simply Montesquieu, was a French judge, man of letters, historian, and political philosopher. He is the princi ...

Argument

Hume argued that when a country with a gold standard had a positive balance of trade, gold would flow into the country in the amount that the value of exports exceeds the value of imports. Conversely, when such a country had a negative balance of trade, gold would flow out of the country in the amount that the value of imports exceeds the value of exports. Consequently, in the absence of any offsetting actions by the

central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial banking system. In contrast to a commercial bank, a centra ...

on the quantity of money in circulation (called

sterilization Sterilization may refer to: * Sterilization (microbiology), killing or inactivation of micro-organisms * Soil steam sterilization, a farming technique that sterilizes soil with steam in open fields or greenhouses * Sterilization (medicine) rende ...

), the money supply would rise in a country with a positive balance of trade and fall in a country with a negative balance of trade. Using a theory called the

quantity theory of money In monetary economics, the quantity theory of money (often abbreviated QTM) is one of the directions of Western economic thought that emerged in the 16th-17th centuries. The QTM states that the general price level of goods and services is directly ...

, Hume argued that countries with an increasing money supply would see

inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reduct ...

as the prices of goods and services rose while countries with a decreasing money supply would experience

deflation In economics, deflation is a decrease in the general price level of goods and services. Deflation occurs when the inflation rate falls below 0% (a negative inflation rate). Inflation reduces the value of currency over time, but sudden deflatio ...

as the prices of goods and services fell. The higher prices would, in the countries with a positive balance of trade, cause exports to decrease and imports to increase, which will alter the balance of trade downwards towards a neutral balance. Inversely, in countries with a negative balance of trade, the lower prices would cause exports to increase and imports to decrease, which will heighten the balance of trade towards a neutral balance. These adjustments in the balance of trade will continue until the balance of trade equals zero in all countries involved in the exchange.Murray N. Rothbard
David Hume and the Theory of Money"
Mises Daily Articles, 27 April 2011. The price–specie flow mechanism can also be applied to a state's entire balance of payments, which accounts not only for the value of net exports and similar transactions (i.e., the current account), but also the financial account, which accounts for flows of financial assets across countries, and the capital account, which accounts for non-market and other international transactions. But under a

, transactions in the financial account would be conducted in gold—or

currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" is a standardization of money in any form, in use or circulation as a medium of exchange, for example banknotes and coins. A more general ...

convertible into

gold Gold is a chemical element with the symbol Au (from la, aurum) and atomic number 79. This makes it one of the higher atomic number elements that occur naturally. It is a bright, slightly orange-yellow, dense, soft, malleable, and ductile ...

—which would also affect the quantity of money in circulation.

References

Preclassical economics International economics Gold standard {{Econ-hist-stub