CHAPTER XVII

DOMESTIC EXCHANGE

[96]The banker has become the bookkeeper and settling agent of the business world. The products of a locality, let us say the State of Georgia, move out to the markets of the world and create credits in favor of that locality on the books of banking institutions in the commercial centers, while at the same time a counter movement of commodities is under way from other localities into Georgia, in like manner creating credits for those localities which are debits against Georgia. The practical effect is that the commodities moving between these communities are exchanged and pay for themselves, the running accounts being kept and settlements effected in the banks.

To illustrate the details: A dealer in cotton in Atlanta makes a sale to a mill in Fall River and receives in payment a check or draft drawn on a New York bank, which he deposits for the credit of his account in an Atlanta bank, and which the latter forwards for the credit of its bank account in New York. Meanwhile an Atlanta merchant has bought goods in New York and in order to pay for them buys from the Atlanta bank an order for the New York credit, and this when forwarded completes the circle of payments for cotton and goods.

If we would extend the investigation to include the bank accounts of the Fall River mill and the Atlanta dealer we would find, first, that the mill account was built up constantly by deposits of checks and drafts received in payment for goods sold in all parts of the country and perhaps all over the world, with almost no deposits of cash, and that it was drawn down by checks for raw cotton, and supplies and large amounts of cash for the pay-rolls; second, that the cotton dealer's account was built up entirely by deposits of checks or drafts received for cotton shipments and drawn down by checks and cash payments to farmers for cotton.

For payments at a distance bank credit in the form of a check or draft is [commonly] used....

The foregoing illustrates the movement of the exchanges constantly proceeding ... between ... different communities.... There is a network of relationship between banks through which each local community and market is connected with all other communities and markets.... No locality is so remote as to be outside of the circle and no community's sales and purchases are so scattered but that they can be brought together in the settlements. Each bank is the center of a circle of which it is the clearing agent; all payments between its own customers may be made by a transfer of credit upon its books. If there are two banks or more banks in a town, all payments between their customers are resolved into offsets between these banks, and in like manner all payments between localities are resolved into offsets between banks, and if not settled in local centers are passed up to larger and larger clearing centers....

But while the cross-payments of trade may be depended upon in the long run to balance and settle themselves, it does not follow that they will do so from day to day, or that they coincide so closely that payments in money are never required. An individual's sales and purchases are seldom made at the same time, and the sales and purchases of communities are not constantly balanced. The trade of a one-crop farming district will not be so evenly balanced as one of a district in which mixed farming prevails, and in every industry there are periods, usually recurring every year, when the payments exceed the current income, and corresponding periods when income exceeds outgo....

A region like the cotton states, whose products move quickly to market, may have large credit balances at one season and at another be wanting to borrow....

The banker is an equalizing agency in the situation. He stands in the breach: he must either supply the missing offsets of credit, or, as a last resort, make the payments in money....

The entire system of settlements, with transfers and offsets and advances and interchange of capital and credit, is exceedingly interesting and wonderfully simple and effective, but depends for its effectiveness upon a scrupulous observance of the principle upon which it is based. That principle is the natural reciprocity of trade....

While there are balances from time to time in the exchanges ... between different localities ... which cannot be settled without shipments of money, they are usually met without inconvenience unless there is a disturbance of credit.

EXCHANGE RELATIONS BETWEEN CHICAGO AND NEW YORK

[97]... It should always be borne in mind that the fact that New York City is the country's dominating financial market results in making New York funds acceptable everywhere as a means of payment, and in making a ready market for New York exchange throughout the country for a large part of the year.

Throughout January money in Chicago relative to that in New York City is cheap. Exchange rates on New York are high and there is a considerable movement of cash from Chicago to the Eastern States--particularly to New York City....

Just prior to January 1 there is normally a large demand in Chicago for New York exchange with which to meet dividend and interest payments due in New York, and the high rates thus created continue somewhat into the new year. The crop-moving and holiday demand, however, being over, money becomes relatively cheap in Chicago and flows to New York City, where it can at least earn the 2 per cent. paid by banks on bankers' balances, and where it is absorbed somewhat in speculative activity and in the higher security prices, which normally rule the latter part of January and the fore part of February.

From the last of January to the fore part of March the demand for money in Chicago relative to that in New York rapidly rises. Exchange rates on New York fall to a low point, and shipments of cash to the Eastern States are very small....

... There is, however, no evidence of a movement of cash from the East to Chicago in February, although there is something of a westward movement in March.

During this period the relative demand for money in Chicago is increased by the anticipated opening of navigation on the Great Lakes, for the opening of navigation gives rise to a large amount of New York exchange received in payment of grain bills. There is also a demand on the part of western bankers for currency to meet the spring needs of the western farmers. The first of March in many sections of the Middle West is the commonest time for making settlements of interest and principal on farm mortgages. It is also a common date for paying farm rents.

This spring advance in the value of money in Chicago as compared with New York reaches its maximum early in March. The demand then falls off rapidly and with only temporary interruptions (the most noteworthy being about the first of May) until it reaches the low level of the early summer, the latter part of May. It continues at a low level until early in July, when the crop-moving advance begins....

About the first of July the relative demand for money in Chicago and vicinity begins to increase, advancing rapidly, with minor interruptions, until early in September, and then maintaining a high level until the fore part of November. During this period exchange rates rule low and money moves in large quantities from the Eastern States to Chicago....

The primary cause for this increasing and large demand for money in Chicago is of course the anticipated and actual crop-moving demand, there being no sufficiently strong Eastern demand for money at the time to hold it back....

It has been found ... that during the last six to eight weeks of the year, after the crop-moving demand has to a large extent subsided, the relative demand for moneyed capital in both New York City and Chicago is maintained until the time of January settlements at nearly the high level of the crop-moving period. A study of domestic exchange rates and of currency shipments shows that the relative demand for money is stronger during this period in New York City than in Chicago, that exchange rates in Chicago on New York rise, and that cash moves eastward....

Money becomes relatively cheap in Chicago and vicinity during these last six to eight weeks of the year, principally because of the return flow of currency previously shipped to the country districts for crop-moving purposes. There is also considerable demand at this time for New York exchange to meet payments in certain lines of goods, such as hardware and dry goods, that are due New York and New England houses by Western establishments, and to make purchases for the holiday trade.... Comparatively high exchange rates... [near] the end of the year are largely due to preparations for the January disbursements, which Western concerns are called upon to make in New York City....[98]

EXCHANGE RELATIONS BETWEEN ST. LOUIS AND NEW YORK

[99]... General seasonal movements in the relative demand for money in St. Louis (as compared with New York City), ... are fairly regular in their occurrence.

From the beginning of the year until the fore part of May the demand appears to be moderate, exchange rates rule near par, and there is a moderate tendency for cash to move from St. Louis to the Eastern States, with almost no tendency to move in the opposite direction....

The first eighteen weeks of the year, St. Louis bankers say, are a period of comparative inactivity in the local money market. Concerning this period, a prominent St. Louis banker writes: "For the first eighteen weeks in the year... there is comparatively no New York exchange making and also a nominal demand for it, and likewise an easy, quiet money market."...

The second noticeable movement in the St. Louis money market is the sharp decline in the relative demand for money from the fore part of May to about the first of June. Exchange on New York rises rapidly at this time, and May is the month of heaviest shipments of cash to the East....

The high exchange rates in May, and the resulting eastward movement of money, are due largely to the fact that at about this time in St. Louis the bills of boot, shoe, hardware, and dry goods merchants mature, and as their paper is held largely in the East, exchange is required in large amounts. The result is large payments to St. Louis banks, the building up of their reserves, and resulting reduction of their credit balances in New York City.

From the first of June to the first of November the demand for money in St. Louis relative to that in New York City increases rapidly, advancing from the cheapest money in the year (twenty-first week) to the dearest money (forty-fourth week)....

This greatly increasing relative demand for money in St. Louis is, of course, attributable to the crop-moving requirements.... The cashier of a St. Louis bank writes: "New York exchange... always goes to a discount here in the fall of the year, and this is caused by the large cotton drafts drawn in payment of cotton shipped out from the Southwest. The banks down there either send us drafts drawn on New England points or New York, or else they send drafts drawn on the two large cotton buyers here, who, in turn, draw their drafts on Eastern points. The result is a great deal of exchange comes in, for which there is a demand for currency." The resulting low rates of exchange continue as long as the cotton season lasts. During this crop-moving season there are heavy shipments of cash from St. Louis to the Southern States....

After about the first week in November the relative demand for money in St. Louis falls off rapidly until about the first of December, and then fluctuates at a moderate level until the end of the year....

The rise in exchange and easing up of the St. Louis money market in the latter part of November and in December is due to the decline in the crop-moving demand for cash, particularly in the South, and the return movement of cash from that section,... which begins the latter part of November. Southern banks in settling their St. Louis bills first use their eastern exchange and then ship currency. The upward movement of exchange is hastened shortly after the first of November by heavy purchases, for about four weeks, of New York exchange by dry goods, hardware, and boot-and-shoe houses for the purpose of settling their eastern accounts....

DOMESTIC EXCHANGE IN SAN FRANCISCO ON NEW YORK CITY

[100]... Before taking up the subject of seasonal variations in San Francisco domestic exchange rates on New York City, it may be well to observe that in a number of respects the San Francisco domestic exchange market is a peculiar one.

In the first place the principal kind of money in circulation is gold coin and this fact materially influences the range of domestic exchange fluctuations, _i. e._, the shipping points. Concerning this matter I can do no better than quote from letters of Mr. F. L. Lipman of the Wells Fargo Nevada National Bank. Mr. Lipman writes (under date of February 7, 1908): "In the East the medium of exchange is paper or new gold by weight. In California it is current gold coin by tale, with a mingling of paper and new gold. The first effect of an upward movement of exchange, there, is that at about 40 cents per $1,000 the currency shipping point is reached, which in due course, drains off our paper money. At approximately $1.10 per $1,000 the gold shipping point is reached. Of course the only gold that can be economically shipped is new gold. Now it not infrequently happens that the demand for remittance will be so great as to exhaust (1st) the currency and (2d) the new gold, leaving only our current gold, for which there is practically no shipping point, the discount on worn coin being practically prohibitory."

A second peculiarity of the San Francisco exchange market arises from the fact that San Francisco, being the chief port city of the Pacific coast and the seat of one of the United States mints and subtreasury offices, is the recipient of large quantities of gold from gold-producing regions, _i. e._, California, Alaska, and Australia. The United States mint will issue without any charge its transfer drafts on the subtreasury in New York in return for deposits of gold, the new product of mines, or for deposits of imported gold. "Frequently," writes Mr. Lipman, "this usage is without influence on our local market, as when large importations of Australian gold are received for New York on London account. At other times this practice of the Treasury has a decided effect on our exchange market as, for instance, when the early gold shipments come down from Alaska. These shipments command the service of the Treasury Department to the full amount thereof, while a portion at least of the proceeds is used in payment of local bills for supplies to Alaska from this city. This throws on the market an additional supply of exchange when such exchange is desired. The owners of the gold, however, have the privilege of taking gold coin instead of eastern exchange from the Treasury, and this alternative tends to bring exchange to about par. The Government also influences exchange from the other side, by its willingness to transmit money by telegraph from New York and Chicago to this city."...

Professor Carl C. Plehn of the University of California, suggests three other characteristics of the San Francisco domestic exchange market, _i. e._, (1) the close exchange relations with the Orient, (2) the fact that in San Francisco, New York bills very frequently represent merely steps in a general arbitrage transaction, and (3) the appreciable interest element involved in demand transactions because of the distance between San Francisco and New York....

From the beginning of January to about the first of March there is a rapid decline in the relative demand for money in San Francisco, resulting in the lowest level of the year during February.

The average rate of exchange rose from 30 cents discount in the first week to $1.05 premium in the seventh....

... Among the principal factors cheapening money in San Francisco at this time and forcing up exchange may be mentioned: (1) the fact that advances which have been made for the movement of general crops up and down the Pacific coast are being repaid very rapidly; (2) the demand for eastern exchange with which to pay bills incurred for holiday purchases; and, finally (3), the latter part of February, the desire of taxpayers to discharge eastern obligations and get movable funds out of the State before the tax returns of the first Monday in March are made to the assessor.

From the fore part of March to the fore part of June the demand for money in San Francisco relative to New York City tends to increase....

Among the causes at work in reducing exchange rates at this time may be mentioned: (1) the readjustment after the heavy demands for exchange which were made anticipatory of assessment day: (2) preparation for the second installment of taxes which become delinquent the last Monday in April; (3) demand for funds by the large fruit canneries with which to buy sugar and tin in preparation for the annual fruit pack which begins in May; (4) by May the shipping trade in green fruits has begun, giving rise to many eastern bills; (5) demand for funds for equipping fishing companies going on long trips....

From about the 1st of July to the fore part of September there is an almost continuous increase in the relative demand for money in San Francisco....

... During August and September, particularly the latter month, substantial transfers of cash [are made] to San Francisco by the United States subtreasury at New York.

This decline in exchange is principally due to the large amount of eastern credits available locally at this time from the shipment of California products, especially green fruits, to eastern points; the returns for such shipments being usually available in either Chicago or New York exchange.... The California hay and grain harvests cause considerable demand for funds by the middle of July, while the ships returning from the fisheries in August and September require large sums with which to pay their crews.

From about the middle of September (thirty-fourth week) to the latter part of October (thirty-ninth week) New York exchange tends to rule at near par....

During these weeks the outward movements of grain, green fruit, and fish tend to force exchange down, while the fact that this is the quarter of large receipts of gold ... from Alaska, making it a period of large receipts of gold bullion at the Mint, and that the San Francisco Mint makes returns for this gold in gold coin or New York exchange, at the option of the owner of the bullion, tends to keep New York exchange at par.

The demand for money in San Francisco relative to New York City increases rapidly from the latter part of October to about the 1st of December when it reaches its highest point in the year.... November and December are the months of largest transfers of cash to San Francisco by the United States subtreasury in New York. The fall in exchange during this period appears to be due primarily to the outward movement of dried fruits, such as raisins, prunes, and apricots. The banks pay out large amounts of actual coin which goes to the country, and receive in return drafts on eastern points which build up their eastern balances. This also represents the most active part of the northern grain season. The low point of the year for exchange is about the last week in November when the tax collector for the city and county of San Francisco withdraws large sums of actual coin from circulation and locks much of it up in the vaults of the city hall.

December is a month in which the relative demand for money in San Francisco lightens considerably as the result of the rapid falling off of the crop-moving demand.... The demand for remittances to the East for January 1st settlements tends to force up exchange rates at the end of the year....

CURRENCY MOVEMENTS BETWEEN NEW ENGLAND AND THE EASTERN STATES

[101]... The distance between New York City and the principal New England cities is very small, and there is a great community of financial interest among these cities and New York. Between New York City and Boston the currency shipping points are only about 25 cents premium and 25 cents discount. Single financial deals between New York City and Boston are frequently of sufficient moment to lead to considerable shipments of currency, although exchange rates previously were only moderate. The relations among the clearing-house banks of Boston and among those of other New England cities are close, so that when one bank is in need of New York funds it is liable to obtain them from another which may have more than it needs. For this reason, it is said, much less money is now received from New York City and shipped there than was the case a few years ago....

THE DOMESTIC EXCHANGES DURING THE CRISIS OF 1907[102]

There is no part of our banking machinery which has received so little elucidation as that of the domestic exchanges. Even for normal times the subject is obscure, and the writer therefore ventures upon an explanation of its course during a period of crisis with hesitation, and he is by no means confident that important considerations may not have been overlooked.

As in the case of foreign exchange, domestic exchange rates fluctuate within limits fixed by the cost of shipping money, and also, in the case of cities distant from New York, by the loss of interest while currency is in transit. The quoted rates apply principally to business between banks, the rates being determined by demand and supply. A Boston bank, for example, receives from its customers New York drafts and also checks drawn on banks in New York and its vicinity. All these items will serve to build up its balances in that city. On the other hand, its depositors have been sending out checks, many of which will in the course of time reach New York and reduce its balances there. The Boston bank will also have received from banks of New York and from banks elsewhere items for collection in its vicinity, and remittance in ordinary course will be made by it in New York funds. Similarly it has sent away items for collection to banks in other cities upon which it expects a like remittance. As a result of all these various influences the balances of the Boston bank may either increase or decrease. If they increase it may be ready to sell exchange to other Boston banks whose balances are running low. It may also happen that the bank is desirous of reducing its New York balances, and in that case it will also appear as a seller of exchange in the market.

Now, if in the course of a crisis clearing-house loan certificates become the principal or sole medium of payment between banks, it may well happen that a bank will be unwilling to sell exchange unless it is unusually well supplied with New York funds. By the sale of exchange it can at best only secure a favorable clearing-house balance, which will be settled in loan certificates, and if this balance should be unfavorable it can meet it by taking out certificates on its own account. Each bank, therefore, to a greater extent than in normal times, is obliged to rely upon itself for means of payment in New York. The loan certificate does indeed yield a return or involve an expense of 6 or 7 per cent., while the return on New York balances is only 2 per cent. This advantage does not, however, seem to have induced the banks to sell exchange as freely as in normal times.

This is, however, not the only disturbing influence. The Boston bank may have remitted to New York upon items collected by it for other banks--let us say those of Philadelphia--but it may happen that the Philadelphia banks delay or even discontinue remitting to New York upon items sent to them for collection by banks of Boston and other cities. The Boston bank can then no longer rely upon what would normally serve to build up its own New York balances. It will be simply acquiring a mass of unavailable credits at scattered points throughout the country. The supply of New York exchange which it might have been willing to sell is consequently diminished, and the premium on exchange must rise to a point at which it will tempt some of the banks to sell exchange, even though it intrenches upon their balances with agents which are available for reserve.

The premium would naturally be especially high in those cities where the banks were most unwilling to reduce their New York balances. Philadelphia seems a case in point, as its deposits with reserve agents, which were $30,995,000 on August 22, were reduced to only $29,389,000 on December 3. At that time the premium on currency in Philadelphia ranged from $1.50 to $3 per $1,000. It is, therefore, a reasonable conclusion that the banks were strongly disinclined to make use of their New York balances. In a few cities it is probable that the premium reached a high level because the banks had exhausted their New York balances. St. Louis may be mentioned as a probable example. Being a central reserve city, its banks would naturally have only such balances in New York as normal business requirements made necessary. The dislocation of exchange elsewhere or the course of payments between New York and St. Louis may have combined to produce such a balance of payments as would have required currency shipments if the St. Louis banks had remitted promptly to New York.

The extent to which banks in different cities delayed or refused to remit to New York on items collected by them for other banks cannot be determined. Banks in one city, very naturally and honestly, were inclined to lay the blame upon banks elsewhere. The banks in other places, however, may not have been able to secure payment of the items sent to them for collection from other banks in their locality with the usual promptness. When every allowance has been made, however, there can be no question that banks in certain cities, in these as well as in other matters, adopted a policy wholly designed to strengthen themselves regardless of consequences.

The general prevalence of the premium on New York exchange is, as we have seen, accounted for in part by the use of clearing-house loan certificates in settling balances between banks and by the delay in remitting in New York funds upon items collected for other banks. It seems probable, however, that, taking the country as a whole, the course of payments was favorable to the New York banks. At the beginning of November withdrawals for crop-moving purposes have in recent years begun to diminish, except to the South, and movements of money from eastern centers are distinctly in favor of New York at that season of the year. If this were indeed the case in 1907, it affords still another reason for thinking that the New York banks might have met the crisis successfully without restricting payments. They would probably have been obliged to meet only withdrawals arising from lack of confidence and not real needs for crop-moving purposes, such as would have increased the difficulties of the situation had the crisis begun at the beginning of September.

Finally, it should be noted that the restriction of cash payments to depositors and the currency premium seem to have increased the demand for New York exchange. Only in that city was it possible to buy any considerable quantity of money. Many banks in various parts of the country purchased gold and currency at a premium in New York and, instead of drawing on their own balances, then entered their home market as purchasers of exchange which was remitted in payment.

In the few instances where exchange was below par the currency premium was a more direct influence; but exchange could not have dropped to the low figures recorded in 1893 in the case of Chicago [$30 discount per $1,000], because the Chicago banks in 1907 did not maintain payments among themselves as they had done on previous occasions. Exchange was at a discount only in those cities where the course of payments was so strongly against New York that practically all the banks found their balances in that city increasing. Chicago might have been expected to belong to this group, but its banks made extensive use of bills derived from grain exports to secure gold which was shipped directly to them. In general, exchange was at a discount, or at par only, in the Southern States, the banks of which, by means of cotton sales, are normally in position to draw money from the northeastern part of the country during the late autumn.

In conclusion, it should perhaps be pointed out that the quoted rates of exchange were often without much significance. The ordinary course of dealings was so completely disorganized in many places that the rates were purely nominal, representing little or no actual transactions.

FOOTNOTES:

[96] Frank A. Vanderlip, _Modern Banking_, Three Addresses delivered at Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. New York. 1911 [?].

[97] E. W. Kemmerer, _Seasonal Variations in the Relative Demand for Money and Capital in the United States_. Publication of the National Monetary Commission, Senate Document No. 588, 61st Congress, _2d Session_, pp. 96-100.

[98] [Owing to the growth of deposit banking among the farming classes, the increasing diversification of industry in the agricultural States, _Sub-treasury operations_, and the offer of remunerative rates of interest on loans in New York during the fall, the net autumnal currency movement since 1907 has frequently been to New York. See E. M. Patterson, _Certain Changes in New York's Position as a Financial Center_, _Journal of Political Economy_. Vol. XXI, June, 1913, pp. 523-539.]

[99] E. W. Kemmerer, _op. cit._, pp. 101-105.

[100] _Ibid._, pp. 118-121.

[101] _Ibid._, 54. 55.

[102] O. M. W. Sprague, _History of Crises under the National Banking System_, Publications of the National Monetary Commission, Senate Document No. 538, 61st Congress, _2d Session_, pp. 293-297.