CHAPTER XVIII

FOREIGN EXCHANGE

THE NATURE OF FOREIGN EXCHANGE

[103]The bill, or order to pay money in a foreign centre, is the commodity that is actually bought and sold by dealers in foreign exchange, but it is better for the moment to leave bills out of consideration. They are only the tangible expression of the claim for money in another centre, and at this early stage of our inquiry it is better to keep our minds fixed on what is at the back of the bill, namely, the money in a foreign centre to which it gives its holder a claim. The French buyer of a bill on London buys it, as a rule, because by sending it to his English correspondent he can discharge a debt to him in English money. What he really buys with his francs is so many English pounds, and the labyrinth of the foreign exchanges is much easier to thread if, before we complicate the question by talking about bills, we keep our eye on the comparatively simple problem which is the key to the puzzle, namely, the exchange of one country's money for another's.

Thus stripped to its naked simplicity, the problem begins to look as if it were not a problem at all, and a critical inquirer may be excused for thinking that at least in the case of countries that use currencies based on the same metal, there ought to be no need for daily quotations of rates of exchange, because the relative value of their moneys ought to be constant. It is a natural question to ask, why should there be these daily fluctuations, and, since they are evidently there, what is the sense or purport of them? The answer is, that money in France and money in England are two different things, and the relative value of two different things is almost certain to fluctuate. Quite apart from any differences in the fineness of gold coined by two different countries, or the ease or difficulty with which a credit instrument can be turned into gold, mere distance is quite enough to make the difference that will create fluctuation in price. New York and Chicago use exactly the same currencies, but money in New York differs from money in Chicago by being nearly a thousand miles away, and consequently there are frequent variations in their relative value. The English and Australian sovereigns are identical in weight and fineness, but there is constant fluctuation in the buying power of the English sovereign as expressed in its brother that is circulating in the Antipodes.

These fluctuations are based on the same influence that sways the movements in the prices of all goods and services that are bought and sold, that is, the influence of supply and demand. Just as the price of boots, Consols, medical advice, football professionals, or anything else that can be the subject of a bargain, will depend in the end upon the number of people who want to buy them compared with that of those who want to sell them, at or near a certain figure, so the price of English pounds, when expressed in francs, guilders, milreis, or Australian sovereigns, depends on the number of people abroad who have to buy money in England as compared with the number of those who have money in England to sell. People abroad have to buy money in England when they owe money to Englishmen and want to pay it; and they have money in England to sell when Englishmen owe them money.

Jacques Bonhomme in Paris has been selling shiploads of Christmas kickshaws to John Robinson in London, and so has thousands of English pounds due to him by the said Robinson. But English pounds, as such, are not wanted by M. Bonhomme. He wants to sell them, to turn them into francs, the currency of his own country, with which he makes his daily payments at home. On the other hand, there are always plenty of Frenchmen who have imported English goods or have had services rendered by English bankers, or shipowners, or insurance companies, and so want to buy English money wherewith to pay their English creditors. So it follows that the price that M. Bonhomme will get for his English pounds will depend on the value of goods and services that other Frenchmen have been selling to England, so producing English pounds to be sold in Paris, as compared with the value of the claims that have to be met in London, for the satisfaction of which English pounds have to be bought. If the amount of English money on offer is bigger than the amount wanted, down will go the price of the English pound as expressed in francs, and the seller in francs will get less in francs for his pound. If the amount of English money wanted is the bigger, the price will go up, and the seller will get more for his pound. When the price goes down, the exchange is said to move against London, because there is a depreciation in the value of the sovereign as expressed in francs. When it goes up the exchange moves in favour of London, because the buying power of the sovereign is enhanced.

The process is exactly the same, and is even more simple and easy to understand when we take away the complication of the exchange of the moneys of two different nations, and look at it at work between two distant towns of the same country. If in the course of trade New York has large payments to make in Chicago, money in Chicago will be wanted in New York, and competition there will send up the price of it, so that a dollar in Chicago will be worth more for the time being to New Yorkers than a dollar in New York, and any New York bank or firm that has a balance or a credit in Chicago will be able to dispose of it at a premium. The extent of this premium, however, will obviously be limited by the expense involved in sending lawful money, as the Americans call it, from New York to Chicago. If we suppose, for the sake of simplicity, that the cost of sending a dollar and insuring it is covered by a cent, no one in New York will pay much more than one dollar and a cent for a dollar in Chicago. Rather than do so he will send his dollar. He will probably pay a small fraction more to save himself the trouble and time involved by sending and insuring money, and this minute fraction that he will sacrifice is the opportunity of the exchange dealer, who will send money to Chicago, and put himself in funds there, and so be able to supply money in Chicago to any one in New York who will pay for it at the rate of one dollar and one cent plus any profit that the exchange dealer can squeeze out of him.

Viewed in this simple example the problem of exchange has few terrors. It is merely a question of the price of money in one place, as expressed in the same money in another, with fluctuations governed by supply and demand and limited by the cost of sending money from place to place. This limitation does not mean that supply and demand cease to govern the market, but merely that at a point supply can be increased to meet any demand by the despatch of currency.

"FAVOURABLE" AND "UNFAVOURABLE" EXCHANGES

[104]The general feeling with regard to the function of the exchanges, as giving evidence of the mercantile (or rather monetary) situation of any country, is indicated by the usual phrase of a "favourable or unfavourable state of the exchanges." A phrase which occurs so frequently in all banking discussions that it cannot be passed over without remark. It may originally have implied the erroneous theory that the object of commerce is to attract gold, and that that country towards which the tide of bullion sets with the greatest force is _ipso facto_ the most prosperous. Political economists, from their point of view, are correct in their statement that, as regards the country at large and the interchange of commodities, exports and imports are always balanced, and that both the words "unfavourable balance of trade" and "unfavourable exchanges" involve fallacy. But merchants and bankers are influenced by the feeling, that at any given moment they may be under greater liabilities for imports than they can temporarily meet, owing to the system of credit which disturbs the coincidence of payments for exports and imports, though their value may actually be equal; and further, by the anxiety as to the possibility of meeting these liabilities in that specific mode of payment to which they are pledged, namely, in gold or convertible notes. When, therefore, in banking treatises, it is said that the exchanges are favourable to any particular country, it should be understood that the intention is simply to state the fact that bills of that country upon foreign cities are difficult of sale, whilst bills drawn upon it from abroad are at a premium, indicating an eventual influx of specie. So, when it is said that the exchanges are unfavorable, a situation is described in which foreign bills are in great demand, and when, consequently, their value seems likely to be so enhanced as to render the export of bullion an unavoidable alternative.

THE ORIGIN AND SUPPLY OF FOREIGN EXCHANGE

[105]Underlying the whole business of foreign exchange is the way in which obligations between creditors in one country and debtors in another have come to be settled--by having the creditor draw a draft directly upon the debtor or upon some bank designated by him. John Smith in London owes me money. I draw on him for 100 pounds, take the draft around to my bank and sell it at, say, 4.86, getting for it a check for $486.00. I have my money, and I am out of the transaction.

The fact that the gold in a new British sovereign (or pound sterling) is worth $4.8665 in our money by no means proves, however, that drafts payable in pounds in London can always be bought or sold for $4.8665 per pound. To reduce the case to a unit basis, suppose that you owed one pound in London, and that, finding it difficult to buy a draft to send in payment, you elected to send actual gold. The amount of gold necessary to settle your debt would cost $4.8665, in addition to which you would have to pay all the expenses of remitting. It would be cheaper, therefore, to pay considerably more than $4.8665 for a one-pound draft, and you would probably bid up until somebody consented to sell you the draft you wanted.

Which goes to show that the mint par is not what governs the price at which drafts in pounds sterling can be bought, but that demand and supply are the controlling factors. There are exporters who have been shipping merchandise and selling foreign exchange against the shipments all their lives who have never even heard of a mint par of exchange. All they know is, that when exports are running large and bills in great quantity are being offered, bankers are willing to pay them only low rates--$4.83 or $4.84, perhaps, for the commercial bills they want to sell for dollars. Conversely, when exports are running light and bills drawn against shipments are scarce, bankers may be willing to pay 4.87 or 4.88 for them.

For a clear understanding of the mechanics of the exchange market there is necessary a clear understanding of what the various forms of obligations are which bring foreign exchange into existence. Practically all bills originate from one of the following causes:

1. Merchandise has been shipped and the shipper draws his draft on the buyer or on a bank abroad designated by him.

2. Securities have been sold abroad and the seller is drawing on the buyer for the purchase price.

3. Foreign money is being loaned in this market, the operation necessitating the drawing of drafts on the lender.

4. Finance-bills are being drawn, _i. e._, a banker abroad is allowing a banker here to draw on him in pounds sterling at 60 or 90 days' sight in order that the drawer of the drafts may sell them (for dollars) and use the proceeds until the drafts come due and have to be paid.

1. Looking at these sources of supply in the order in which they are given, it is apparent, first, that a vast amount of foreign exchange originates from the direct export of merchandise from this country.

Not all merchandise is drawn against; in some cases the buyer abroad chooses rather to secure a dollar draft on some American bank and to send that in payment. But in the vast majority of cases the regular course is followed and the seller here draws on the buyer there.

2. The second source of supply is in the sale abroad of stocks and bonds.

Origin of bills from this source is apt to exert an important influence on rates, in that it is often sudden and often concentrated on a comparatively short period of time. The announcement of a single big bond issue, often, where it is an assured fact that a large part of it will be placed abroad, is enough to seriously depress the exchange market. Bankers know that when the shipping abroad of the bonds begins, large amounts of bills drawn against them will be offered and that rates will in all probability be driven down.

3. The third great source of supply is in the draft which bankers in one country draw upon bankers in another in the operation of making international loans. The mechanism of such transactions will be treated in greater detail later on, but without any knowledge of the subject whatever, it is plain that the transfer of banking capital, say from England to the United States, can best be effected by having the American house draw upon the English bank which wants to lend the money. The arranging of these loans means the continuous creation of very large amounts of foreign exchange.

4. Drawing of so-called "finance-bills," is the fourth source whence foreign exchange originates. Whenever money rates become decidedly higher in one of the great markets than in the others, bankers at that point who have the requisite facilities and credit, arrange with bankers in other markets to allow them (the bankers at the point where money is high) to draw 60 or 90 days' sight bills. These bills can then be disposed of in the exchange market, dollars being realized on them, which can then be loaned out during the whole life of the bills.

These are the principal sources from which foreign exchange originates--shipments of merchandise, sales abroad of securities, transfer of foreign banking capital to this side, sale of finance-bills. Other causes of less importance--interest and profits on American capital invested in Europe, for instance--are responsible for the existence of some quantity of exchange, but the great bulk of it originates from one of the four sources above set forth.

THE SOURCES OF THE DEMAND FOR FOREIGN EXCHANGE[106]

Turning now to consideration of the various sources from which spring the demand for foreign exchange, it appears that they can be divided about as follows:

1. The need for exchange with which to pay for imports of merchandise.

2. The need for exchange with which to pay for securities (American or foreign) purchased by us in Europe.

3. The necessity of remitting abroad the interest and dividends on the huge sums of foreign capital invested here, and the money which foreigners domiciled in this country are continually sending home.

4. The necessity of remitting abroad freight and insurance money earned here by foreign companies.

5. Money to cover American tourists' disbursements and expenses of wealthy Americans living abroad.

6. The need of exchange with which to pay off maturing foreign short-loans and finance-bills.

1. Payment for merchandise imported constitutes probably the most important source of demand for foreign exchange. Practically the whole amount of our huge importations has had to be paid for with bills of exchange. Whether the merchandise in question is cutlery manufactured in England or coffee grown in Brazil, the chances are it will be paid for by a bill of exchange drawn on London or some other great European financial centre.

2. The second great source of demand originates out of the necessity of making payment for securities purchased abroad. So far as the American participation in foreign bond issues is concerned, the past few years have seen very great developments.

Security operations involving a demand for foreign exchange are, however, by no means confined to American participation in foreign bond issues. Accumulated during the course of the past half century, there is a perfectly immense amount of American securities held all over Europe. The greater part of this investment is in bonds and remains untouched for years at a stretch. But then there come times when, for one reason or another, waves of selling pass over the European holdings of "Americans," and we are required to take back millions of dollars' worth of our stock and bonds. Such selling movements do not really get very far below the surface--they do not, for instance, disturb the great blocks of American bonds in which so large a proportion of many of the big foreign fortunes are invested. The same thing is true with stocks, though in that case the selling movements are more frequent and less important.

3. So great is the foreign investment of capital in this country that the necessity of remitting the interest and dividends alone means another continuous demand for very large amounts of foreign exchange. Estimates of how much European money is invested here are little better than guesses. The only sure thing about it is that the figures run well up into the billions and that several hundred millions of dollars' worth of interest and dividends must be sent across the water each year. At the interest periods at the beginning and middle of each year it becomes apparent how large a proportion of our bonds are held in Europe and how great is the demand for exchange with which to make the remittances of accrued interest. At such times the incoming mails of the international banking houses bulge with great quantities of coupons sent over here for collection. For several weeks on either side of the two important interest periods, the exchange market feels the stimulus of the demand for exchange with which the proceeds of these masses of coupons are to be sent abroad.

4. Freights and insurance are responsible for a fourth important source of demand for foreign exchange. A walk along William Street in New York is all that is necessary to give a good idea of the number and importance of the foreign companies doing business in the United States. In some form or other all the premiums paid have to be sent to the other side. Times come, of course, like the year of the Baltimore fire, when losses by these foreign companies greatly outbalance premiums received, the business they do thus resulting in the actual creation of great amounts of foreign exchange, but in the long run--year in, year out--the remitting abroad of the premiums earned means a steady demand for exchange.

With freights it is the same proposition, except that the proportion of American shipping business done by foreign companies is much greater than the proportion of insurance business done by foreign companies. An estimate that the yearly freight bill amounts to $150,000,000 is probably not too high. That means that in the course of every year there is a demand for that amount of exchange with which to remit back what has been earned from us.

5. Tourists' expenditures abroad are responsible for a further heavy demand for exchange. The sums spent by American tourists in foreign lands annually aggregate a very large amount--possibly as much as $175,000,000--all of which has eventually to be covered by remittances of exchange from this side.

Then again there must be considered the expenditures of wealthy Americans who either live abroad entirely or else spend a large part of their time on the other side. By these expatriates money is spent extremely freely, their drafts on London and Paris requiring the frequent replenishment, by remittances of exchange from this side, of their bank balances at those points. Furthermore, there must be considered the great amounts of American capital transferred abroad by the marriage of wealthy American women with titled foreigners. Such alliances mean not only the transfer of large amounts of capital _en bloc_, but mean as well, usually, an annual remittance of a very large sum of money. No account of the money drained out of the country in this way is kept, of course, but it is an item which certainly runs up into the tens of millions.

6. Lastly, there is the demand for exchange originating from the paying off of the short-term loans which European bankers so continuously make in the American market.

These loaning operations, it must be understood, both originate exchange and create a demand for it. They were mentioned as one of the sources from which exchange originates, and now as one of the sources from which, during the course of every year, springs a demand for a very great quantity of exchange.

In a general way, it may be pointed out, the sources of demand for exchange conform with influences which cause exchange to go up, and the sources of supply of exchange constitute causes which make for low rates.

It is to be noted, however, that money rates are a great factor influencing foreign exchange. Whenever money is cheap at any given centre, and borrowers are bidding only low rates for its use, lenders seek a more profitable field for the employment of their capital.

Money rates in the New York market are not often less attractive than those in London, so that American floating capital is not generally employed in the English market, but it does occasionally come about that rates become abnormally low here and that bankers send away their balances to be loaned out at other points. Such a time was the long period of stagnant money conditions following the 1907 panic. Trust companies and banks who were paying interest on large deposits at that time sent very large amounts of money to the other side and kept big balances running with their correspondents at such points as Amsterdam, Copenhagen, St. Petersburg, etc.--anywhere, in fact, where some little demand for money actually existed. Demand for exchange with which to send this money abroad was a big factor in keeping exchange rates at their high level during all that long period.

High money rates at some given foreign point as a factor in elevating exchange rates on that point might almost be considered as a corollary of low money here, but special considerations often govern such a condition and make it worth while to note its effect. Suppose, for instance, that at a time when money market conditions all over the world are about normal, rates, for any given reason, begin to rise at some point, say London. Instantly a flow of capital begins in that direction. In New York, Paris, Berlin, and other centres it is realized that London is bidding better rates for money than are obtainable locally, and bankers forthwith make preparations to increase the sterling balances they are employing in London. Exchange on that particular point being in such demand, rates begin to rise, and continue to rise, according to the urgency of the demand.

The international money markets are a most decidedly complex proposition, and there is literally never a time when several influences tending to put exchange rates up are not conflicting with several influences tending to put rates down. The actual movement of the rate represents the relative strength of the two sets of influences. To be able to "size up" the influences present and to gauge what movement of rates they will result in, is an operation requiring, first, knowledge, then judgment. The former qualification can perhaps be derived, in small degree, from study of the foregoing pages. The latter is a matter of mental calibre and experience.

METHODS OF FINANCING IMPORTS AND EXPORTS[107]

The foreign trade of the United States has increased during the last forty years about 370 per cent.... This increase ... reflected not alone our own marvellous development, but as well the wonderful growth of trade throughout the world. The United States stands third among the countries of the world, its foreign trade being exceeded only by that of the United Kingdom ... and Germany....

Our imports and exports[108] are being financed more and more by means of what are known as commercial letters of credit.... An explanation of the operation of the commercial letter of credit will ... disclose the methods and conditions under which our imports are financed.

The commercial letter of credit is an authorization, say of an American bank to its London correspondent, to honor drafts for its account drawn at various tenors by foreign shippers or others against shipments of merchandise to this country. These credits are of two kinds, documentary and clean. Under the documentary credit the London bank is authorized to accept drafts for the account of the American bank only when the bill of exchange is accompanied by certain documents described in the letter of credit. These documents may be the bills of lading for the goods, consular invoices, insurance certificates and possibly other papers. Probably a large proportion of such credits requires that drafts be drawn at sixty or ninety days' sight. So many elements of danger are involved in financing commodities under commercial letters of credit, even where the control of the goods is given to the bank issuing the credit or its agents, that the financial standing of those asking for credits must be the first consideration in their issuance. Dishonesty on the part of the shipper, resulting in a drawing under the credit against forged documents or against shipments of inferior merchandise, is always possible, and the financial responsibility of the buyer of the credit is all that stands between the banker issuing the credit and a loss in such cases.

In order to obtain a clear understanding of the working of a commercial letter of credit, we will take a concrete example and follow its every transaction. An importer of coffee (A) in New York purchases a certain number of bags of coffee from an exporter (B) in Brazil. A agrees to furnish B with a commercial letter of credit. B is not in position, we will say, to await the arrival of the coffee in New York and the return of a remittance before receiving his pay. A on the other hand is unable to remit B for the coffee before its receipt and sale to his customers. A goes to his banker in New York and requests him to authorize B to draw upon the New York banker's London correspondent at ninety days' sight with bills of lading for coffee to the amount of the purchase attached to the draft, consular invoice and insurance certificate, if B is to furnish insurance. If A's banker is willing to extend the credit he writes a letter (or uses a printed form), requesting his London banker to accept B's drafts upon presentation under the conditions already mentioned and others of minor importance. This letter is issued in duplicate, one copy going to the London banker, the other being delivered to A. A then mails the copy received by him to B. B thereupon arranges to ship the coffee, obtains the bill of lading, invoice, etc., and takes them with the copy of the credit to his banker in Brazil. A draft is then drawn on the London bank under the terms of the credit at ninety days' sight and is discounted by the Brazilian banker, the proceeds being placed to the credit of B's account or given to him in the form of a check or cash. The Brazilian banker then forwards the draft and documents, except such documents as the instructions may require to be forwarded direct to New York, to his London banker. He may secure discount of the bill at once by cable or await its arrival in London before doing so, or he may request his London banker to have the bill accepted and hold it for maturity. If the bill is discounted the Brazilian banker may draw against it immediately and thus put himself in funds to purchase other coffee bills. Upon receipt of the bill by the London correspondent it is presented to the London banker on whom it is drawn for acceptance. The acceptor bank examines the documents and if they are drawn according to the terms of the credit accepts the draft and returns it to the correspondent of the Brazilian bank, retaining the documents, which it then forwards to the New York bank which opened the credit. In accepting the draft the London bank has in effect agreed to pay it at the end of ninety days, or, figuring grace, ninety-three days. Upon maturity payment is made and the amount is charged to the account of the issuing New York bank. Upon receipt of the documents the New York bank delivers them to its customer under a trust receipt or against collateral, and the latter is then in position to obtain the goods. Ten days before the bill of exchange is due in London the New York bank collects the amount from A, together with the commission agreed upon when the credit was opened, and remits the amount to its London banker to meet the draft. On all such transactions the London banker, while not himself advancing any money, is extending a credit for which he charges the New York bank a commission. The result is that we are paying tribute to European bankers amounting to an immense sum annually for the purpose of financing our imports.

The fact that London exchange is more marketable generally throughout the world than New York exchange is one of the principal reasons why it is necessary for us to issue credits upon London instead of upon New York.

Our imports are distributed generally throughout the United States. The importers, however, are mostly situated at the ports of entry. A very large proportion of them obtain their credits through New York institutions, although some of them deal direct with foreign bankers.

Probably a smaller proportion of our exports is financed by means of commercial letters of credit than of our imports. Different commodities are handled in accordance with special customs which have grown up around them, due partly to trade conditions and partly to the nature of the products. Sellers of grain usually draw at sixty days' sight upon the foreign buyer instead of under a bank credit. These bills, under the customs prevailing in most foreign countries, may be rebated by the foreign buyer whenever he desires to obtain the goods at the "bank rate" or 1 per cent. under the bank rate, or such other rate as custom in the country on which the drafts are drawn requires. Such drafts, with bills of lading and such other documents as are necessary, are purchased by American banks and are forwarded by them to their European correspondents. The American banker is obliged to advance the money on such paper, unless he draws his own time bills against them, until such time as they are rebated. In the case of grain bills the average time rebated is probably around fifty-six days, which places the American bank in possession of demand foreign exchange, against which it can draw in order to reimburse itself with the loss of a very few days' interest.

Flour bills, which are financed in the same manner as grain bills, usually run nearly to maturity before they are rebated, although the condition of the discount market sometimes influences the purchaser, and causes him to take the bills up more promptly. Many foreign shipments are made under three-day sight bills, which uses the money of the American banks making the advance from four to seven days or more, depending upon whether the laws of the country on which the bills are drawn allow grace or not and whether the bills are purchased with intervening days before the sailing of steamers. Other classes of bills are drawn at sight. This includes a portion of our lumber shipments and miscellaneous articles. Where shipments are made on sailing vessels, drafts are frequently drawn at four or six months' sight, and many other transactions go through against cable payments.

As nearly 40 per cent. of our exports consist of cotton, the method under which it is financed is worthy of special consideration. Cotton bills are ordinarily of two kinds: documentary payment bills and bills drawn upon bankers. Documentary payment bills, which are drawn upon cotton merchants or spinners at sixty or ninety days' sight or other tenors, are handled in the same manner as flour bills. The cotton merchant accepts the draft upon presentation and rebates it when the goods arrive, or when he desires to obtain the cotton. A small percentage of cotton is handled in this way. Most of the commodity is financed by means of credits opened by the foreign buyer through his banker. Various abuses have developed under this system, which have caused losses running into millions of dollars to all of the various parties engaged in carrying the transactions to their close. These losses have only been possible because of the turning over of credits by the foreign buyers to irresponsible concerns in America in their endeavor to obtain cotton at lower prices than their competitors. A foreign buyer makes arrangements with certain American concerns to cable him offers of cotton. The American firms whose offers are accepted receive cablegrams from the buyer advising them of the acceptance of their offers and giving them the names of the foreign bankers on whom the drafts in payment of the cotton are to be drawn. The American sellers thereupon ship the cotton to the buyer under bills of lading drawn to the shipper's order and endorsed in blank. The bills of lading are then attached to drafts drawn upon the bankers designated by the buyer at the given tenor, which is usually sixty or ninety days. This exchange is then sold in the market to the highest bidder or it is forwarded to New York to be sold in the same manner upon arrival. The American exchange buyers have no means whatever of designating whose bills shall be upon the market, as the sellers are all agents of the European buyers. The American exchange houses in their need for exchange to meet the demands of their importers have accepted the bills offered in the market, each exchange man endeavoring to keep his "water line" on weak names as low as possible. If the European buyers only dealt with first-class houses only first-class bills would be offered, but when they deal with second- or third-rate houses, or houses with no standing whatever, such bills drawn upon prime European banks come upon the market.

The American exchange buyers having the cotton as collateral while the drafts are on the water, and then having the acceptance of a prime European bank for the sixty or ninety days following before maturity of the draft, have accepted these risks, although unwillingly, for want of better bills. They endeavor to protect themselves as far as possible by trying to buy bills only of those in whose honesty they have reason to believe, whether they have any capital back of them or not. If the cotton were actually shipped under a bona fide order, any fluctuation in the value of the cotton which they accepted as collateral, although taken entirely without margin, would probably cause them neither loss nor friction. They have run the risk, however, of having forged documents forced upon them which did not represent goods, or exchange that was drawn without authority. Lines which exchange buyers are willing to take from each cotton shipper before acceptance, and before the name of a prime European banker is added to the paper, have to be based upon this consideration.

The old form of the cotton bill of lading which has been signed by freight agents or their assistants or others has been an instrument not possible to authenticate. This was particularly dangerous, due to the manner in which bills of lading were issued. They were formerly given out to the shippers, who filled them in and returned them to the railroad agent, who in turn often signed them without having any knowledge as to whether the goods called for by the bill of lading were in his possession or not. Under a new system bills of lading are not to be given up until the goods are actually in possession of the railroads. This system, which calls for validation certificates, numbered and printed upon a specially protected water-mark paper, to be attached to the bills of lading in such manner as to make it practically impossible to remove them without detection, went into effect September 1, 1910, and it is confidently hoped that it will give sufficient added safety to the bills of lading of American railroads to satisfy the foreign bankers.

The very act of guaranteeing such bills is recognized by foreign bankers as being wrong in principle, and while they are requesting that American exchange buyers guarantee bills of lading for exports yet on the other hand they particularly call attention to the fact that no bills of lading which pass through their hands for imports to the United States are guaranteed by them in any way, shape, or manner.

CREDIT RISKS OF DRAFTS DRAWN ON BUYERS ABROAD

[109]Many American manufacturers do not realize the essential "credit" element of transactions on the basis of drafts drawn on _foreign customers_.... The exporter has received an order; he purchases the goods covered by this order from the manufacturer, and should the customer change his mind the exporter may suffer a loss. Or the customer refuses to accept the goods, and the exporter may again suffer a loss. Or the customer may accept the goods and the draft, but fail to pay, and the exporter once more is the loser....

... The turning over of the bill of lading vests the property right to the goods in the customer. The customer either pays the value of the draft in cash ("documents against payment," abbreviated d/p) or accepts the draft for payment at some future date, which is the more customary course ("documents against acceptance," d/a). Even in the case of d/p drafts, payment by the customer may be postponed; instead of paying cash he accepts the draft at one to three months, but neither the documents nor the goods are turned over to him. He may want to wait until he has sold the goods, on the basis of samples, perhaps, and the goods are warehoused until he can pay the amount of the draft into the bank or to the forwarding agency. This is frequently done in the Far East. Here the banks maintain so-called "godowns" for this purpose. The goods are occasionally turned over to the customer for warehousing purposes against the so-called "trust receipt." One important feature of "acceptance" of the draft by the customer is the fact that it forms an acknowledgment of indebtedness, which it is then unnecessary to prove item by item in case of litigation. In most countries acceptances are far simpler to collect judicially than open accounts. When an accepted draft is unpaid it is "protested," and the debtors may be proceeded against without further trouble.

Frequently open accounts may be neglected by a customer who may find himself for some reason short of immediately available funds, but to neglect the payment of an accepted draft is regarded in the trade and by banks as so serious a matter that the drawee would lose caste with the banks; oversea buyers endeavor in most cases to honor accepted drafts....

ENGLAND DRAWS FEW BILLS, BUT ACCEPTS MANY--THE REASON AND THE RESULT

[110]It has been shown that, if two countries buy of each other to the same amount, their transactions need not give rise to two separate sets of bills, but that on the contrary, if the foreigner draws on us to the full value of his exports, the bills so created will be sent as remittances to the exporter on this side and will pay him for his sales. Conversely, if the British exporter draws, there is no necessity for the other side to do so.

What, then, are the facts? Does the United Kingdom, generally speaking, draw on abroad, or does the foreigner take the initiative by drawing on London?

As a matter of fact, both sides draw; but, as all who are acquainted with the customs of trade are well aware, the bills drawn by Great Britain on abroad are vastly outnumbered by those drawn from abroad on London.

Owing chiefly to the magnitude of our trade, but also to several contributory causes--such as the stability of our currency; the certainty that a bill on London means gold and nothing but gold; the facility with which those who deserve credit can obtain it here; our freedom from invasion, etc.--London has become to a great extent the settling-place of Europe and the world, and the seller, wherever he may be, of a good bill on London can always be sure of finding a buyer and of realizing a fair price. As the sale of a bill, moreover, carries the valuable advantage of ready money and a speedy turnover of capital, it is invariably preferred by the foreign exporter, who has consigned or sold produce to us, to the alternative plan of awaiting remittances from this side. The foreign importer, too, who has to pay for the goods he has bought, would rather do so by remitting to London than by allowing us to draw upon him. In the former case, the rate he has to pay depends upon his own success in higgling; in the latter, it is fixed by a London bill-broker, who has not the same interest in the matter.

If the same considerations held good on this side also, our merchants and manufacturers might perhaps object to letting the foreigner have it all his own way; but, on the contrary, it appears to suit both buyers and sellers very well--the former, because in the majority of cases they would scarcely know how or where to buy suitable bills, and the latter, because the drawing and negotiation of a foreign bill requires a certain amount of knowledge of the exchanges, which they do not always possess, and entails a certain amount of trouble, which they would gladly be spared. There is also more risk of loss in drawing. In the latter case they have only their correspondent to look to, while on a London remittance they have the additional security of the other parties to the bill.

Practically speaking, therefore, the settlement of our foreign trade is effected by means of bills of exchange which are drawn and negotiated abroad, and are accepted and paid in London.

To the student of the exchanges this fact is of considerable importance, for, as the rate of exchange between two countries--the price at which bills on the one are sold in the other--must be _fixed by the one that draws and negotiates the bill_, it follows that the exchanges between England and most other countries are controlled from the other side, and that we in London have scarcely part or say in the matter. The rate of exchange, for example, between England and the United States is fixed in New York; between England and Brazil, in Rio; between England and Turkey, in Constantinople; and so on. There may be exceptions, of which the Indian exchange is the most notable, but that is the general rule, and it is one that should be carefully borne in mind.

The same fact also supplies a reason for the solicitude with which the foreign trader watches the fluctuations of the exchange, and for the utter indifference with which they are regarded by the British trader. To the former, who intends maybe to draw a few hundred pounds on London in a day or two against the shipment he is preparing, the difference between selling his draft next week instead of this may mean, if the rate should move in his favor, the gain of an additional half per cent.; but to our home manufacturers, who sell their wares in sterling and stipulate for payment in bills on London, the see-saw of rates is but of academic interest. They pay attention to the _course of discount_, because they may have to melt some of their paper before pay-day comes round; but the course of the exchange--the question of the rate rising or falling--hardly concerns them at all.

It is not sought to detract from the influence of the English-drawn foreign bill, or, as might be imagined, to explain it away altogether. On the contrary, paper to a considerable amount is, and will continue to be, negotiated on the Royal Exchange (though the total, if compared with that of the paper on London negotiated abroad, would appear quite insignificant).[111] The object in view is merely to bring into prominence, and to impress on the reader, the essential principle that, while the position of every rate of exchange is the outcome of the market conditions _in the two countries combined_, the predominant mass of the dealings take place on the other side, so that, as a consequence, the real significance of the fluctuations can only be grasped by viewing them from the foreign [_e. g._, American] standpoint.

THE RECENT RISE OF THE AMERICAN ACCEPTANCE MARKET

[112]Probably the most important effect at this time [1915] of the Federal Reserve Act is the establishment of the American acceptance market. It may well be said that heretofore America has had no real money market. The only semblance of a money market previously existing in this country was the call loan market of New York City. That, however, did not truly reflect money conditions in this country, as it has more often reflected the secondary effect of some movement of the stock market.

The development of a real money market in this country was greatly hampered by the lack of a standardized credit instrument. In every other country the bank acceptance in which the element of credit risk has been practically eliminated is the standard instrument of credit, and the discount rate of such paper marks the level of the money market.

Bank acceptances were not known in this country prior to the operation of the Federal Reserve Act. For the benefit of those who may not be familiar with bank acceptances, I will briefly describe an operation giving rise to such acceptances. Jones, an importer of coffee in New York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes to his bank in New York and arranges with them to finance the deal. Smith, the grower of the coffee in Brazil, makes the shipment to New York and draws a ninety days' sight draft on the New York bank for the amount of his invoice. This draft he then sells to some Brazilian bank.... The Brazilian bank then sends the draft to New York. It is there presented to the New York bank for acceptance. The New York bank accepts the draft by writing the word "accepted" across the face of the draft and affixing its official signature thereto. The draft now becomes the primary obligation of the New York bank. Of course, Jones, for whose account the New York bank accepted the draft, has obligated himself to provide the New York bank with funds to meet the draft, but if he should fail to do so the New York bank must pay the acceptance nevertheless. It is, therefore, the direct obligation of the New York bank, and as such it commands the best discount rates current. This briefly is what is known as a bank acceptance, _i. e._, a draft drawn on and accepted by a prime bank or banker.

Although this business is still in its infancy, it has reached important proportions and there is an active market for them in New York City. A number of brokers have taken up the business of buying and selling acceptances. Every morning they make the rounds of the various banks with the list of the acceptances they have for sale and the rates at which they are willing to sell them. Incidentally, they also learn whether the banks have any acceptances for sale and at what rates. As the credit risk is practically eliminated, acceptances are a very attractive form of secondary reserve; they are, as a London banker once expressed it, a means of enabling the banker to eat his cake and have it too--the banker by investing his money in acceptances earns the discount and at the same time he knows that his money is instantly available in case of need, so that they are almost as available as cash. This explains why the discount rate on acceptances ranges so low. Ninety days' sight acceptances sold in New York City at one time as low as 2 per cent. per annum and to-day prime acceptances command the excellent rate of 2-3/8 per cent.

THE ECONOMIES AND ADVANTAGES OF "DOLLAR CREDITS"[113]

Many radical changes in the mechanism of international finance have occurred during the past fifteen months, since the beginning of the European war. Not the least important among these changes, viewed from the standpoint of the American importer, is the evolution in the methods of financing our importations.

Our imports in the way of commodities such as hides, coffee, rubber, wool, etc., etc., run into hundreds of millions of dollars annually, and these are financed generally through the medium of commercial credits established by the purchaser in favor of the vendor of the merchandise. Commercial credits, so called, are in effect a bank guarantee to the seller that his drafts covering certain merchandise, when drawn in accordance with the conditions prescribed in the credit, will meet with due honor on presentation to the accepting bank named in the credit instrument.

In order merely to gain an idea as to the importance and volume of such transactions, it is only necessary to glance at the totals of a few of our principal imports. In the year 1914 we imported, among other commodities, the following:

Hides and skins $120,289,781.00 Coffee 110,725,392.00 Rubber 131,995,742.00 Wool (unmanufactured) 53,190,767.00

Prior to the outbreak of the war in Europe, it is safe to assume that fully 95 per cent. of the credits issued to cover these importations were passed through London in the form of sterling credits; that is to say, credits available by drafts drawn in pounds sterling on London. Requests for the issuance of credits available by drafts drawn in United States dollars on New York were extremely rare, and they were issued only in exceptional cases.

Conditions have changed materially in this respect. The Federal Reserve Act grants to national banks the privilege of accepting drafts or bills of exchange growing out of transactions involving the importation or exportation of goods. This acceptance privilege was accorded to national banks only a short time before the commencement of hostilities abroad, and this fact in conjunction with the resulting dislocation in the delicate machinery of international credit brought about by the war, together with the coincidental establishment of American branch banks in South America, has contributed in a large measure to bring about the use of what is known now as "Dollar Credits."

As a factor in creating the existing demand for Dollar Credits, the establishment of American branch banks abroad cannot be emphasized too strongly. Through these branch banks, a new and adequate medium for the liquidation of transactions as between the United States and certain South American countries, especially the Argentine, Brazil, and Uruguay, has been placed at the disposal of our merchants. A direct channel is now open to the ebb and flow of credit transfer between the United States and the countries mentioned, and, as a natural sequence, the former disparity existing against the dollar, as compared with pounds sterling and the principal continental exchanges, has disappeared. The resulting equalization in the rates of exchange benefits the American merchant to the extent of relieving him of the tribute formerly paid to the indirect channels of liquidation, or, in other words, to the foreign banker.

The Dollar Credit is of capital importance to every American merchant who is interested either directly or indirectly in the importation of commodities of any character. A study of the advantages accruing from this form of credit will demonstrate the desirability of its general employment as the vehicle for financing not only our own imports but also those of other countries. Primarily, it is more economical than the Sterling or Continental Credit, for the initial commission cost of issuance is lower. Secondly, it is based on a known quantity, the dollar, a factor of supreme importance in these days of extreme and violent fluctuations in the exchange rates, and therefore all exchange risk is eliminated from the operation as far as the importer is concerned. Maturities drawn under Dollar Credits are due and payable in dollars on a given date, and no question arises as to what the exchange rate on London may be ninety days after acceptance of the bill.

Under existing conditions in the New York money market, and considering the present low rates of interest actually in effect, the use of Dollar Credits is proving to be particularly attractive to the American importer as the medium for financing his importations. The rate of discount in New York for prime bank acceptances is 2-1/8@2-1/4 per cent. per annum, and a broad, well-developed discount market now exists, with an ever-increasing demand in evidence for this class of paper. On the other hand, the rate of discount in London for prime ninety-day bills is 4-3/4 per cent. per annum, with operations restricted in a far from normal market. A comparison of these two discount rates will show a difference in favor of New York of 2-1/2@2-5/8 per cent. per annum. In addition to this difference in interest, there is also a difference in the initial cost in the form of commission for issuance, as between credits available by ninety-day drafts drawn on New York in dollars and those available by ninety-day drafts drawn on London in pounds sterling. This difference in commission in favor of New York will average 1/2 per cent. per annum, and when added to the saving in discount or interest already noted, will show a net saving on the Dollar Credit of 3@3-1/8 per cent. per annum, which accrues to the importer through the use of Dollar Credits in his operations.

Quite apart from the direct economy to the individual resulting from the use of Dollar Credits, is the broader question of the economic value accruing to the nation as a whole through the designation of the dollar as the basis of value in our credit transactions with the rest of the world. Since 1903, when the total of our imports amounted to $1,025,719,237, the volume of our imports has increased rapidly, and in 1914, the total imports reached the enormous sum of $1,893,925,657. These figures cover products from all parts of the world shipped direct to our own shores, and while no nation enjoys higher international credit than the United States, yet it is a fact that in order to finance the movement of our imports we have been compelled to have recourse to indirect channels and call on foreign money centers to furnish us with the necessary credit facilities to take care of a large part of our importations. Naturally, we have been obliged to pay for this accommodation, and the service has cost us millions of dollars annually in interest, commissions, etc.

These charges can be saved and an important economy effected, thus benefiting our commerce as a whole by the general designation of dollars in our foreign credit transactions. The purchasing power of the dollar in foreign markets is much greater to-day than it is in normal times because of the varying premium which the dollar commands at present practically throughout the world. The time is unquestionably opportune to increase the prestige of the dollar and to standardize its use in the liquidation of our direct purchases abroad. Co-operation and concerted action on the part of our merchants to the end of generalizing the use of Dollar Credits is therefore a duty, which will bring about lasting benefit to the economic fabric of our commerce.

THE NEW YORK FOREIGN EXCHANGE MARKET[114]

A market may be defined as the coming together of buyers and sellers. It therefore involves all the mechanism necessary to facilitate their intercourse. One may speak of a general market or of a local market, of a market in one or in another place. Thus, there is the New York market for the buying and selling of exchange on London. A bank in New Haven, Connecticut, may be a part of that market if it buys from and sells to it. That market includes, besides the commercial and industrial organizations which buy or sell drafts, all middlemen of whatever class who engage in the trade.

The middlemen may be divided roughly into three classes. First may be mentioned banks which do a regular foreign exchange business, buying bills from those who have them to sell and selling their own drafts on foreign correspondents to persons desiring to remit. Much of this business is done by foreign exchange banks which carry on little or no other business. Some of it is done by ordinary commercial banks, such as United States National Banks, in addition to their other banking business. Second, we may call attention to those exchange dealers whose principal business is to buy commercial and bankers' bills, and to resell them, chiefly to banks. Third are the independent brokers who make small commissions by bringing buyers and sellers together. These do not invest their own capital, do not, that is, buy bills of exchange in the market, but assist those desiring to sell bills to find buyers, and _vice versa_....

NEW YORK CITY PRACTICALLY ABSORBS BY PURCHASE ALL AMERICAN FOREIGN EXCHANGE

[115]There is, perhaps, no feature pertaining to banking throughout the country so dependent upon New York financiers, as foreign exchange. The very foundation of this branch of banking is constructed by the New York bankers, and from their banking houses emanate the basic prices and quotations upon which foreign bills are bought and sold throughout the United States.

It is the custom of New York foreign exchange brokers to furnish their Western clients, direct, or through their local representatives, daily market quotations, and to promptly advise them of fluctuations throughout the day. So closely is the West allied to the East, in this respect, that any interruption caused by delayed or suspended telegraphic service, immediately superinduces a practical standstill of exchange transactions, and operations thereafter must necessarily be made in the "dark" until free communication is again renewed between the cities....

The absorptive power of the New York market, to digest not only the surplus foreign exchange of the Chicago market, but that of the entire United States as well, has been demonstrated for many years. The reason for this can be attributed to the fact that international trade balances are at the present day, and always will be, adjusted by the financiers of New York City.

HOW MONEY IS MADE IN FOREIGN EXCHANGE--THE OPERATIONS OF THE FOREIGN DEPARTMENT

[116]Complete description of the various forms of activity of the foreign exchange department of an important firm would fill a large volume, but there are certain stock operations in foreign exchange which are the basis of most of the transactions carried out and the understanding of which ought to go a long way toward making clear what the nature of the foreign exchange department's business really is.

I. SELLING "DEMAND" AGAINST "DEMAND"

The first and most elementary form of activity is, of course, the buying of demand bills at a certain price and the selling of the banker's own demand drafts against them at a higher price. A banker finds, for instance, that he can buy John Smith & Co.'s sight draft for L1,000, on London, at the rate of 4.86, and that he can sell his own draft for L1,000 on his London banking correspondent at 4.87. All he has to do, therefore, is to buy John Smith's draft for $4,860, send it to London for credit of his account there, and then draw his own draft for L1,000 on the newly created balance, selling it for $4,870. It cost him $4,860 to buy the commercial draft, and he has sold his own draft against it for $4,870. His gross profit on the transaction, therefore, is $10.

As may be imagined, not very much money is made in transactions exactly of this kind--the one cited is taken only because it illustrates the principle. For whether the banker sends over in every mail a bewildering assortment of every conceivable form of foreign exchange to be credited to his account abroad, or whether he confines himself to remittances of the simplest kind of bills, the idea remains exactly the same--he is depositing money to the credit of his account in order that he may have a balance on which he can draw. That is, indeed, the sum and substance of the exchange business of the foreign department of most banking houses--the maintaining of deposit accounts in banks at foreign centres on which deposit account the bank here is in a position to draw according to the wants and needs of its customers.

II. SELLING CABLES AGAINST DEMAND EXCHANGE

A "cable," so-called, differs from a sight draft only in that the banker abroad who is to pay out the money is advised to do so by means of a telegraphic message instead of by a bit of paper instructing him to "pay to the order of so and so."

Under ordinary circumstances foreign exchange dealers who engage in the business of selling cables carry adequate balances on the other side, balances which they keep replenishing by continuous remittances of demand exchange.

III. SELLING "DEMAND" BILLS AGAINST REMITTANCES OF LONG BILLS

If there is a stock operation in the conduct of a foreign exchange business it is the selling by bankers of their demand bills of exchange against remittances of commercial and bankers' long paper. Bills of the latter class make up the bulk of foreign exchange traded in, and its disposal naturally is the most important phase of foreign exchange business. What the foreign exchange business really is grounded on is the existence of commercial bills called into existence by exports of merchandise.

Buying and remitting commercial long bills is no pastime for an inexperienced man. Entirely aside from the question of rate, and profit on the exchange end of the transaction, there must be taken into consideration the matter of the credit of the drawer and the drawee, the salability of the merchandise specified in the bill of lading, and a number of other important points.

Where documents accompany the draft and the merchandise is formally hypothecated to the buyer of the draft, it might not be thought that the standing of the drawer would be of such great importance. Possession of the merchandise, it is true, gives the banker a certain form of security in case acceptance of the bill is refused by the parties on whom it is drawn or in case they refuse to pay it when it comes due, but the disposal of such collateral is a burdensome and often expensive operation. The banker in New York who buys a sixty-day draft drawn against a shipment of butter is presumably not an expert on the butter market and if he should be forced to sell the butter, might not be able to do so to the fullest possible advantage. Employment of an expert agent is an expensive operation, and, moreover, there is always the danger of legal complication arising out of the banker's having sold the collateral. It is desirable in every way that if there is to be any trouble about the acceptance or payment of a draft, the banker should keep himself out of it.

The successive steps in an actual transaction are as follows:

The banker in New York having ascertained by cable the rate at which bills "to arrive" in London by a certain steamer will be discounted, buys the bills here and sends them over, with instructions that they be immediately discounted and the proceeds placed to his credit. On this resulting balance he will at once draw his demand draft and sell it in the open market. If, from selling this demand draft, he can realize more dollars than it cost him in dollars to put the balance over there, he has made a gross profit of the difference.

To illustrate more specifically: A banker has bought, say, a L1,000 ninety days' sight prime draft, on London, documents deliverable on acceptance. This he has remitted to his foreign correspondent, and his foreign correspondent has had it stamped with the required "bill-stamp," has had it discounted, and after having taken his commission out of the proceeds, has had them placed to the credit of the American bank. In all this process the bill has lost weight. It arrived in London as L1,000, but after commissions, bill-stamps, and ninety-three days' discount have been taken out of it, the amount is reduced well below L1,000. The net proceeds going to make up the balance on which the American banker can draw his draft are, perhaps, not over L990. He paid so-and-so many dollars for the L1,000 ninety-day bill, originally. If he can realize that many dollars by selling a demand draft for L990 he is even on the transaction.

IV. THE OPERATION OF MAKING FOREIGN LOANS

In its influence upon the other markets, there is perhaps no more important phase of foreign exchange than the making of foreign loans in the American market. The mechanics of these foreign loaning operations, the way in which the money is transferred to this side, etc., will now be taken up.

To begin at the very beginning, consider how favorable a field is the American market for the employment of Europe's spare banking capital. Almost invariably loaning rates in New York are higher than they are in London or Paris. This is due, perhaps, to the fact that industry here runs on at a much faster pace than in England or France, or it may be due to the fact that we are a newer country, that there is no such accumulated fund of capital here as there is abroad. Such a hypothesis for our own higher interest rates would seem to be supported by the fact that in Germany, too, interest is consistently on a higher level than in London or Paris, Germany, like ourselves, being a vigorous industrial nation without any very great accumulated fund of capital saved by the people. But whatever the reason, the fact remains that in New York money rates are generally on so much more attractive a basis than they are abroad that there is practically never a time when there are not hundreds of millions of dollars of English and French money loaned out in this market. All through the past ten years London has at various times opened her reservoirs of capital and literally poured money into the American market.

To take up the actual operation of loaning foreign money in the American market, suppose conditions to be such that an English bank's managers have made up their minds to loan out L100,000 in New York--not on joint account with the American correspondent, as is often done, but entirely independently. Included in the arrangements for the transaction will be a stipulation as to whether the foreign bank loaning the money wants to loan it on the basis of receiving a commission and letting the borrower take the risk of how demand exchange may fluctuate during the life of the loan, or whether the lender prefers to lend at a fixed rate of interest, say 6 per cent., and himself accept the risk of exchange.

What the foregoing means will perhaps become more clear if it is realized that in the first case the American agent of the foreign lender draws a ninety days' sight sterling bill for, say, L100,000 on the lender, and hands the actual bill over to the parties here who want the money. Upon the latter falls the task of selling the bill, and, ninety days later, when the time of repayment comes, the duty of returning a _demand_ bill for L100,000, plus the stipulated commission. In the second kind of a loan the borrower has nothing to do with the exchange part of the transaction, the American banking agent of the foreign lender turning over to the borrower not a sterling draft but the dollar proceeds of a sterling draft. How the exchange market fluctuates in the meantime--what rate may have to be paid at the end of ninety days for the necessary demand draft--concerns the borrower not at all. He received dollars in the first place, and when the loan comes due he pays back dollars, plus 4, 5, or 6 per cent., as the case may be. What rate has to be paid for the demand exchange affects the banker only, not the borrower.

Loans made under the first conditions are known as sterling, mark, or franc loans; the other kind are usually called "currency loans." At the risk of repetition, it is to be said that in the case of sterling loans the borrower pays a flat commission and takes the risk of what rate he may have to pay for demand exchange when the loan comes due. In the case of a currency loan the borrower knows nothing about the foreign exchange transaction. He receives dollars, and pays them back with a fixed rate of interest, leaving the whole question and risk of exchange to the lending banker.

To illustrate the mechanism of one of these sterling loans. Suppose the London Bank, Ltd., to have arranged with the New York Bank to have the latter loan out L100,000 in the New York market. The New York Bank draws L100,000 of ninety days' sight bills, and, satisfactory collateral having been deposited, turns them over to the brokerage house of Smith & Jones, the borrowers. Smith & Jones at once sell the L100,000, receiving therefor, say, $484,000.

The bills sold by Smith & Jones find their way to London by the first steamer, are accepted and discounted. Ninety days later they will come due and have to be paid, and ten days prior to their maturity the New York Bank will be expecting Smith & Jones to send in a _demand_ draft for L100,000, plus 3/8 per cent. commission, making L375 additional. This L100,375 less its commission for having handled the loan, the New York Bank will send to London, where it will arrive a couple of days before the L100,000 of ninety days' sight bills originally drawn on the London Bank, Ltd., mature.

What each of the bankers concerned makes out of the transaction is plain enough. As to what Smith & Jones' ninety-day loan cost them, in addition to the flat 3/8 per cent. they had to pay, that depends upon what they realize from the sale of the ninety days' sight bills in the first place and secondly on what rate they had to pay for the demand bill for L100,000. Exchange may have gone up during the life of the loan, making the loan expensive, or it may have gone down, making the cost very little. Plainly stated, unless they secured themselves by buying a "future" for the delivery of a L100,000 demand bill in ninety days at a fixed rate, Messrs. Smith & Jones have been making a mild speculation in foreign exchange.

If the same loan had been made on the other basis, the New York Bank would have turned over to Smith & Jones not a _sterling bill_ for L100,000, but the _dollar proceeds_ of such a bill, say a check for $484,000. At the end of ninety days Smith & Jones would have had to pay back $484,000, plus ninety days' interest at 6 per cent., $7,260, all of which cash, less commission, the New York Bank would have invested in a demand bill of exchange and sent over to the London Bank, Ltd. Whatever more than the L100,000 needed to pay off the maturing nineties such a demand draft amounted to, would be the London Bank, Ltd.'s profit.

From all of which it is plainly to be seen that when the London bankers are willing to lend money here and figure that the exchange market is on the down track, they will insist upon doing their lending on the "currency loan" basis--taking the risk of exchange themselves. Conversely, when loaning operations seem profitable but rates seem to be on the upturn, lenders will do their best to put their money out in the form of "sterling loans." Bankers are not always right in their views, by any means, but as a general principle it can be said that when big amounts of foreign money offered in this market are all offered on the "sterling loan" basis, a rising exchange market is to be expected.

From what has been said about the mechanism of making these foreign loans, it is evident that no transfer of cash actually takes place, and that what really happens is that the foreign banking institution lends out its credit instead of its cash. For in no case is the lender required to put up any money. The foreign lender is at no stage out of any actual capital, although it is true, of course, that he has obligated himself to pay the drafts on maturity, by "accepting" them.

Where, then, is the limit of what the foreign bankers can lend in the New York market? On one consideration only does that depend--the amount of accepted long bills which the London discount market will stand. For all the ninety days' sight bills drawn in the course of these transfers of credit must eventually be discounted in the London discount market, and when the London discount market refuses to absorb bills of this kind a material check is naturally administered to their creation.

V. THE DRAWING OF FINANCE-BILLS

Approaching the subject of finance-bills, the author is well aware that concerning this phase of the foreign exchange business there is a wide difference of opinion. Finance-bills make money, but they make trouble, too. Their existence is one of the chief points of contact between the foreign exchange and the other markets, and one of the principal reasons why a knowledge of foreign exchange is necessary to any well-rounded understanding of banking conditions.

Strictly speaking, a finance-bill is a long draft drawn by a banker of one country on a banker in another, sometimes secured by collateral, but more often not, and issued by the drawing banker for the purpose of raising money. Such bills are not always distinguishable from the bills a banker in New York may draw on a banker in London in the operation of lending money for him, but in nature they are essentially different. Whether or not any collateral is put up, the whole purpose of the drawing of finance-bills is to provide an easy way of raising money without the banker here having to go to some other bank to do it.

The origin of the ordinary finance-bill is about as follows: A bank here in New York carries a good balance in London and works a substantial foreign exchange business in connection with the London bank where this balance is carried. A time comes when the New York banking house could advantageously use more money. Arrangements are therefore made with the London bank whereby the London bank agrees to "accept" a certain amount of the American banker's long bills, for a commission. In the course of his regular business, then, the American banker simply draws that many more pounds sterling in long bills, sells them, and for the time being has the use of the money. In the great majority of cases no extra collateral is put up, nor is the London bank especially secured in any way. The American banker's credit is good enough to make the English banker willing, for a commission, to "accept" his drafts and obligate himself that the drafts will be paid at maturity. Naturally, a house has to be in good standing and enjoy high credit not only here but on the other side before any reputable London bank can be induced to "accept" its finance paper.

The ability to draw finance-bills of this kind often puts a house disposed to take chances with the movement of the exchange market into line for very considerable profit possibilities. Suppose, for instance, that the manager of a house here figures that there is going to be a sharp break in foreign exchange. He, therefore, sells a line of ninety-day bills, putting himself technically short of the exchange market and banking on the chance of being able to buy in his "cover" cheaply when it comes time for him to cover. In the meantime he has the use of the money he derived from the sale of the "nineties" to do with as he pleases, and if he has figured the market aright, it may not cost him any more per pound to buy his "cover" than he realized from the sale of the long bills. In which case he would have had the use of the money for the whole three months practically free of interest.

It is plain speculating in exchange--there is no getting away from it, and yet this practice of selling finance-bills gives such an opportunity to the exchange manager shrewd enough to read the situation aright to make money, that many of the big houses go in for it to a large extent. During the summer, for instance, if the outlook is for big crops, the situation is apt to commend itself to this kind of operation. Money in the summer months is apt to be low and exchange high, affording a good basis on which to sell exchange. Then, if the expected crops materialize, large amounts of exchange drawn against exports will come into the market, forcing down rates and giving the operator who has previously sold his long bills an excellent chance to cover them profitably as they come due.

VI. ARBITRAGING IN EXCHANGE.

Arbitraging in exchange--the buying by a New York banker, for instance, through the medium of the London market, of exchange drawn on Paris--is another broad and profitable field for the operations of the expert foreign exchange manager. Take, for example, a time when exchange on Paris is more plentiful in London than in New York--a shrewd New York exchange manager needing a draft on Paris might well secure it in London rather than in his home city.

Between such cities rates are not apt to be wide enough apart to afford a wide margin of profit, but the chance for arbitraging does exist and is being continuously taken advantage of. So keenly, indeed, are the various rates in their possible relation to one another watched by the exchange men that it is next to impossible for them to "open up" to any appreciable extent. The chance to make even a slight profit by shifting balances is so quickly availed of that in the constant demand for exchange wherever any relative weakness is shown, there exists a force which keeps the whole structure at parity. The ability to buy drafts on Paris relatively much cheaper at London than at New York, for instance, would be so quickly taken advantage of by half a dozen watchful exchange men that the London rate on Paris would quickly enough be driven up to its right relative position. If a chance exists to sell a draft on London and then to put the requisite balance there through an arbitration involving Paris, Brussels, and Amsterdam, the chances are that there will be some shrewd manager who will find it out and put through the transaction. Some of the larger banking houses employ men who do little but look for just such opportunities.

The foregoing are the main forms of activity of the average foreign department, though there are, of course, many other ways of making money out of foreign exchange.

GOLD MOVEMENTS

[117]When there is a heavy demand for exchange and little supply, the price of exchange gradually advances. The banker, called on by his customers to draw exchange for them, finding few bills in the market that he can remit to cover his drafts, sends gold and directs its equivalent in foreign coin to be placed to his credit, and against this credit he draws. There may be no market abroad for our crops or manufactures; but gold need not be sold in order to produce money; it need only be coined. As this process can be carried on indefinitely, the cost of sending gold is obviously the limit beyond which the price of demand bills cannot advance. Let us follow this transaction in detail. The pure gold contained in one English sovereign is exactly equal to the pure gold contained in $4.8665 of our gold coins; so that, apart from charges and expenses, $4.8665 of our gold will, when sent abroad, produce a credit of L1; to this cost must be added freight, insurance, and other expenses, amounting to about one-fourth of 1 per cent. This brings the cost of L1 through shipment of gold to about $4.88, which is, roughly, the gold export point for full weight coin. The exporting banker obtains his gold either by drawing gold coin from his bank or else by drawing suitable currency from his bank, and obtaining gold coin for it at the subtreasury. In either case, he obtains coin that has suffered more or less abrasion by handling, and this loss of weight by abrasion, amounting to perhaps one-tenth of 1 per cent., increases the cost of his remittance. Generally, however, the banker can obtain gold bars from the United States Assay Office at the nominal charge of one twenty-fifth of 1 per cent., although at times a larger charge is made. The banker prefers bars, because on these there is no loss by abrasion; the Government can afford to give bars, because their export prevents the export of coin, and so saves the cost of coining new money to replace that shipped.

Now for gold import. When there is a large volume of bills offered to bankers, perhaps by grain and cotton exporters, and but little demand from buyers of exchange, the market gradually declines in price, while New York bankers, sending abroad the bills they buy, with little occasion to draw against them, accumulate large sums to their credit in London, with no way of getting the money back to New York through operations in the exchange market. They are not, however, helpless; they can order gold sovereigns sent here, and, once here, can have them melted down at the United States Assay Office and coined into eagles and double eagles, which they can deposit with their banks. Obviously, the amount received in dollars for each melted sovereign will mark the price the banker can afford to pay for sterling bills, and competition among bankers will prevent the rate of exchange from declining below this point by more than a fair margin of profit. The British sovereign, if full weight, will, when sent here and melted down, yield gold for which the United States Assay Office will pay $4.8665; the expense of sending the sovereign, freight, insurance, cartage, and kegs, will amount to about one quarter of 1 per cent., so that the net yield of the full weight sovereign in dollars will be $4.85-3/8. But between the day on which the banker buys the bill of exchange in New York and the day on which he receives in New York the gold which the bill entitled him to collect in London, there must elapse the time needed to send the bill to London, plus the time needed to send the gold back (roughly fifteen days), during which period the banker loses the use of the money. This loss of interest must be deducted from the net yield of the imported sovereign, and thus, if money is worth 6 per cent. per annum, the net yield of full weight sovereigns is brought down to about $4.84-1/4, which is the gold import point for demand exchange, when money is worth 6 per cent. per annum. Losses by abrasion will bring down this point by perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is higher, the import point will be lower, and _vice versa_. There is therefore a margin of profit in buying demand bills and importing gold sovereigns against the purchase, whenever the rate for demand bills falls below the gold import point. Active exchange bankers take advantage of this profit whenever exchange prices decline to the proper point, and their competition in buying bills to cover their gold importations stops further decline in exchange rates. It is interesting to note that during the recent crisis, when gold and currency were at a premium, bankers could sell the imported gold at a premium, and this constituted an additional and very large profit; gold importers could therefore pay higher prices than ordinarily for exchange bought to cover the importations, and the stress of competition so drove up the rate of exchange that gold was being imported at a profit, though exchange rates stood at what, under ordinary circumstances, would have been the gold export point.

Gold is, however, not always imported from England in the form of sovereigns. The Bank of England has in its vaults large quantities of American eagles and double eagles exported to England in the past and held without melting. The bank also holds foreign coin and bar gold. Any holder of Bank of England notes can get sovereigns on demand--other gold he can get only as the result of a special bargain. When gold is wanted for export, the bank is often glad to sell bar gold or double eagles at rates somewhat more advantageous to the exporter than would be the export of sovereigns; this the bank can afford to do, for the expense of coining sovereigns to replace those exported is thus saved, while the exporter, if he can get bar gold on the same basis as sovereigns, avoids the losses of abrasion. Eagles are even more advantageous to the exporter, for they are bought in England by weight and used in America by count; the banker therefore gets an advantage if they are light, so long as that lightness is not so great as to make them uncurrent--practically he buys them as light and uses them as full weight....

The mechanism of gold import to, and export from, Germany is practically the same as with England, the Reichsbank being required to give gold coin in exchange for its circulating notes. At times, however, German exchange has fallen below the theoretical gold import point, owing, not to the refusal of the Reichsbank to give gold, but to the practical obstacles that at times are somehow placed in the way of free export of gold. The Reichsbank does not refuse gold for its bank-notes, but German bankers say to their correspondents: "Don't ask us to get gold for you, or we shall lose caste," and on such occasions German exchange rates drop to a point that is theoretically impossible. I do not mean to criticise them: German banks, when they refuse to demand gold of the Reichsbank, do no more than our own banks and bankers did recently, when asked by foreign correspondents to collect in gold the maturing obligations of railroads and other corporations. As will be remembered, clearing-house funds rather than cash were at that time current here, and New York banks and bankers sent to their foreign correspondents the same answer as the Germans have at times sent us. I cite the German instance in partial mitigation of censure of our own course rather than as a reproach to them.

The Bank of France is not compelled to give gold in exchange for its circulating notes; it may at its option give silver. Thus, when it is inconvenient to give gold, the bank can refuse, or, if it prefers, it can exact a premium. This power has been very moderately and very wisely used by the bank to modify foreign demands on the one hand, and, on the other, to keep interest rates low for the requirements of internal trade. Of course, when a premium is exacted, the French gold import point drops accordingly.

Between the gold export point and the gold import point, exchange fluctuates under the sway of conflicting currents and tendencies--I had almost said emotions, for these currents and tendencies have their rise in emotions, needs, and passions as varied as life itself, whether they be hunger as expressed in the grain bill, or love of elegance in the importation of silk, or forethought in the profitable investment of capital.

This brief review will have made clear what is meant by a free gold market--a market in which current money can at all times be exchanged for gold without delay and without premium. Such a market has great commercial advantages; its stability draws business to it. London is such a market, and its commercial and financial pre-eminence is in great measure due to that fact. Paris is not such a market and does not pretend to be; Berlin pretends to be, but cannot always be counted on; New York was believed to be before our recent panic.

I have spoken of the exchange market as an economical mechanism, automatically making delicate international adjustments. In justification of that observation, let me direct attention to the manner in which gold, in moving from financial centre to financial centre, always travels by the most direct route, and that, too, not because some public official is charged with the duty of preventing waste, but because a private trader is trying to make a profit, and is incidentally serving the community; serving it perhaps better than if he had consciously determined to serve it.

Useful acts springing from self-interest have one very comforting aspect--we need have no misgivings as to their continuance. Charity may grow weary or disgusted, but self-interest, once enlisted, may be counted on to continue in operation, whether it be the business man's self-interest in a profit or the professional man's self-interest in advancement and fame. Of course, both the business man and the professional man, in addition to seeking the direct rewards of their labor, take an interest in their work as work and make it yield them pleasure.

It is therefore satisfactory to know that, so long as the banker looks after his profits, gold will move by the most direct route. Let us suppose the United States to be exporting a large quantity of cotton to England at a time when little merchandise is being imported here from England, but when much is being imported from France. If the volume of exports to England and of imports from France were large enough, we might conceivably be importing gold from England in payment of our produce, and exporting it to France in payment for her luxuries; but, in practice, gold does not move that way. Every morning, the New York exchange banker learns by cable the Paris market rate for demand bills on London. When, therefore, he finds a large volume of bills on London offered for sale, and little demand for such bills, while there is large demand for bills on Paris and little supply, he determines, instead of drawing from New York against his purchases of London bills, to let his Paris agent draw against these purchases, placing the proceeds to his credit in Paris; against this credit in Paris, the New York banker draws his bill in francs, having thus supplied via London the New York demand for bills on Paris. He knows how many dollars each pound sterling costs him in New York, and the Paris rate for bills on London tells him how many francs each pound sterling will net him in Paris, and so he can calculate how many cents each franc will cost him. Moreover, he is not the only banker in New York that receives cable quotations; and so with a large volume of London bills offered and little direct demand for such bills, and large demand for Paris bills with little direct supply, we get a situation where New York bankers, competing with each other to buy the London bills for use via Paris, prevent the price of sterling from falling to the gold import point; and then, as a result, these same bankers, competing with each other to supply the demand for Paris bills, by their competition prevent the Paris rate from rising to gold export point. Lastly, they compete with each other in Paris, where all are sellers of bills on London against their New York purchases of London bills, and by that competition they reduce the rate for London bills in Paris to the point, at which, other things being equal, gold will go from London to Paris. What has happened, therefore, is that instead of our importing gold from London, and then exporting it to Paris, it has gone direct from London to Paris.

COMPLICATIONS IN THE DETERMINATION OF GOLD POINTS

[118]It is safe to assert that when the exchanges go down to the point at which it pays better to ship gold from London than to buy a bill, gold will go. But in the first place, experts always differ as to where that point begins; and in the second, gold often leaves London long before there is any question of its being the more profitable form of remittance. In fact, it may be asserted that the foreign exchanges very seldom go down to the export gold point, because gold begins to go before they can get there.

It has often happened to me, when I was a financial journalist and had to try to find out the how and why of gold movements, to ask several of the most experienced and well-informed cambists in the city whether a gold shipment which had taken place had been made as a genuine exchange transaction or was done for some other reason, and to hear from one that there was a reasonable exchange profit on it, from another that there might be just a shade of a turn to be got out of it if you scraped it very hard with a knife, and from another that you could not find a particle of profit in it if you put it under a microscope for a week. So many complications have to be considered that the most eminent doctors may be pardoned for disagreeing.

It may be objected that dealers in exchange, and the comparatively few firms that make a special study of gold shipping, are not in the business for their health, and that shipments would not happen if there were not some profit in them. This is perfectly true, but the profit need not be got from the exchange. As an exchange transaction it only pays to ship gold to America when bills on London can only be sold in New York at a lower price than gold would fetch if brought from London and exchanged into dollars in New York. If bills on London are selling at 4.83-3/4, and gold can be bought and shipped and turned into dollars at the rate of 4.83-7/8, after allowing for all charges and commissions and the loss of interest during transit, then the operation pays as an exchange transaction. If the dollars realized by the gold were at the rate of only 4.83-3/4 the importer would be no better off than if he had sold a bill; if they were at the rate of 4.83-5/8 he would be out of pocket on the business, viewed strictly as an exchange transaction. But this is by no means the only consideration. Gold has such a magical fascination for moneyed mankind, and its movements are so eagerly discussed in their markets and newspapers, that it is often handled and shipped at a loss, especially in America, for the sake of the advertisement that the importing firm thereby gains for itself.

Moreover, imports of gold have a very stimulating effect on speculative stock markets, because an increase in the amount of gold available means a roughly corresponding increase in the amount of credit that bankers can give, so that when gold is known to be coming speculators know that credit will be cheaper for carrying their commitments, and will come in and buy, with a light heart, stock that they could not possibly pay for, but hope to pawn with their bankers until they can sell it at a higher price. And so unless the loss on the exchange side of the business is too great, it often pays the leaders of a bull campaign to import gold, having first laid in a line of stock, and make their profit by unloading during the fit of exhilaration produced by the news that the gold is on the way.

Or, again, quite apart from any speculative and spectacular motives behind gold shipments, it may pay bankers, in a country where rates for money are ruling high, to import gold at an apparent loss, because of the high rates that they get for the credit that they are thereby enabled to give. They thus, in effect, borrow gold, and recoup themselves by being able to lend, on profitable terms, larger amounts than they borrow, since they can always create credit to larger amounts than that of the gold in their vaults. Sometimes, in fact, in times of pressure banks find themselves obliged to import gold so as to strengthen their position, whatever the loss on exchange may be.

For instance, last September, when the Berlin exchange was at the point at which, if theory ruled in these matters, Berlin ought to have been thinking of packing up some gold to send to London, Berlin was buying gold in London and shipping it to the Fatherland, because there is always great pressure for currency in Germany at the end of September when the interest on mortgages falls due and has to be paid in cash, with the result that the Reichsbank's note circulation expands very rapidly and the backing of gold behind it has to be increased. Sometimes, again, in order to attract gold, a central bank will give importers credit for gold that is on the way, so that they may be saved from loss of interest while the metal is afloat. Thus the actual importer may make a profit on the shipment, not as a genuine exchange transaction, but at the expense of the central bank.

In these cases two of the many functions performed by gold have to be considered. As a means of international remittance, it may not be as cheap as a bill, but it may have to be sent, not as a means of remittance, but because it is urgently wanted in the importing country as a make-weight for the balloon of credit.

So we see that the grumbling bill broker who ... [said] that these confounded exchanges only work one way, was actually understating his case. Not only do we [Englishmen] always lose gold when the exchanges go against us, and often get none when they go in our favour, but we also often lose gold long before the exchanges are sufficiently against us to justify its going, and sometimes even when they are strongly in our favour.

The effect on the exchange of an import or export of gold is, of course, just the same as that of the import or export of any other commodity--an import turns the exchange against us and an export turns it in our favour. If we send gold, for example, to Germany we thereby meet a German claim on us or create a claim for ourselves on Germany; in the former case the bills drawn on us will be less by the amount of the gold shipped, and the supply in Berlin of bills on London will be less in relation to the demand, so that the tendency will be for the price of sovereigns, as expressed in marks, to rise. In the latter case some one in Berlin will have a claim to meet in London and will have to bid there for a bill on London, and his bidding will have the same beneficent effect on the exchange. When we import gold, whether brought out of bankers' vaults, or dug out of the bowels of the earth, the country that sends it to us meets claims of ours on it or establishes claims on us. In either case the tendency is for the exchange to move against us.

THE HANDLING OF GOLD SHIPMENTS

[119]Whether in coined pieces or bars (bullion), the gold is packed in strong kegs or boxes, securely strapped with hoop iron, and carefully sealed with private seals; the latter to discover if tampered with en route. Space is chartered from the steamship company, as in the case of merchandise, although nearly all large fast steamers have rooms especially constructed for such valuable cargo.... As an extra safeguard in case of large shipments, the steamship company details special armed men to guard the room day and night, and sometimes the shipper employs special detectives in citizens' clothes to watch the passengers on the trip, since it is generally known several days in advance when large shipments of gold are to be made.

THE SILVER EXCHANGES

[120]... It is acknowledged that commerce between gold standard countries is satisfactory to all classes of traders, for both importers and exporters know exactly the return they may expect, but in trade between a silver-using country and one on a gold basis, a large measure of uncertainty invariably exists. Whenever there is a fall in the gold value of silver, either the exporter in the gold standard country or the importer in the silver country must suffer.

Let us take the case of the exporter. We will suppose that A. Blank & Company, of Manchester, calico printers, send goods to Shanghai, which they hope to sell there for a total sum of, say, L1,000. The price of silver when the shipment was despatched was, we will say, 25_d._ per standard ounce, and on this basis A. Blank & Company have calculated the selling price which is to yield them L1,000. By the time the calico arrives in Shanghai, the gold price of silver has dropped, we will suppose, to 20_d._ per standard ounce, and this obviously indicates that the manufacturers will receive one-fifth less for their wares, since they are paid in the currency of the province (taels in this instance), and when Blank & Company's money comes to be converted back into British gold pieces, they are face to face with the fact that the outturn is L200 less than they had calculated: they have lost one-fifth, and receive L800 only. This is, of course, an extreme case, as in the ordinary course silver would be unlikely to drop 5_d._ in the period between shipment and arrival of the goods in Shanghai; but whatever the fall, the principle is the same, and the illustration serves to show exactly what happens.

It is not only the British exporters who stand to lose in the lottery of trade with countries which have an unstable silver exchange; the capitalist also, and every class of investor, is liable to be adversely affected in operations with silver standard countries. The rate of exchange between such countries and gold standard countries is plainly the exchange between gold and silver; therefore, if a person has invested in undertakings in the silver country, when he receives his dividends in the currency of that country, he will obtain less for his dividend warrant on the London market in proportion to the fall in the price of silver--assuming that it does fall. Conversely, he may reap a higher return on his investment if silver has gone up before the encashment of his dividend.

Finally, the principal is affected in the same way, whenever it is desired to convert it back into gold. A further example will show how this works out in practice.

We may assume that an investor, encouraged by the chance of earning 6 per cent. on his money, remits to China L1,000. The price of silver on the 1st January, 1914, was 26-7/16_d._ per ounce standard; on the 31st December, 1914, 22-11/16_d._ For the sake of argument, we will imagine our investor sent the money out to the Eastern country on the 1st January, 1914, but circumstances made it advisable for him to recall his money at the end of December in the same year, when the metal had depreciated to 22-11/16_d._; in converting his principal back to British currency he will find himself faced with a sharp loss. Silver, in which the investment stood, has dropped 3-3/4_d._ of its gold equivalent, roughly, one-seventh; consequently on conversion the gold value of his original L1,000 has fallen to about L857....

... The exchanges of these silver standard countries ... [are] quoted in shillings and pence to the dollar, tael, or rupee, as the case may be, that is, the gold value of the respective silver coins. Hong-Kong, for instance, is quoted 1_s._ 10-3/8_d._ to the dollar, and Shanghai, 2_s._ 5-5/8_d._ to the tael. The rates from these centres ... indicate the price for telegraphic transfers on London: the unit of exchange in the centres named being by general consent the rate for telegraphic transfers on London.

Let us take the Shanghai rate as an example: 2_s._ 5-5/8_d._ per tael, means that for every silver tael the remitter hands over to the exchange bank in Shanghai, 2_s._ 5-5/8_d._, or, to give it its real significance, a little less than one-eighth of a sovereign in gold, will be paid to the person in whose favour the remittance is made, as soon as a telegram can reach the bank's London branch....

... Besides the T. T. rate, as it is called for the sake of brevity, we have the four months' sight and six months' sight rates, which are the quotations for first-class bank bills. Both quotations are higher than for the telegraphic transfers, that is to say, for every silver tael paid in Shanghai the bank will allow more shillings and pence where it is a question of paying the gold value in London four or six months hence, than it would if the payment is to be made on demand or by wire. The reason is, that if a bill drawn on London, payable four months after sight, is sent, the remitter is bound to place the receiver in such a position that if the latter chooses to turn the bill into cash after it has been "sighted" and accepted, he will not be worse off than if the money had been sent by cable....

As may be gathered, therefore, the discount rates ruling on the London market are of great importance to the Eastern bankers and exchange dealers: so important are they in fact, that it is necessary for each side to keep in direct telegraphic communication regarding the existing discount quotations and the probable trend of the markets....

... The rate at which they are able to cover their drawing operations ... governs the price at which they will sell bills. If a banker has funds deposited with his correspondent upon which he can draw, well and good: if he has no balance with the agent, he must either provide the wherewithal to meet the bills which he has drawn, or, alternatively, he can instruct the agent to draw on him in reimbursement. Finally, there comes a time,... when, as all other means of placing his correspondent in funds have been exhausted, the banker will be obliged to ship ... silver to be sold for what it will fetch....

It is fairly clear that the real trouble in Eastern exchange lies in the fact that we have three main factors to deal with instead of two. In the gold exchanges we have simply the demand for and supply of bills and telegraphic transfers; in the silver exchanges the matter is complicated by the way in which we also have to depend upon the fluctuations in the price of silver on the London market....

Shanghai draws on London for the cost of her exports and remits to London for the value of her imports, and the principal reason for this procedure is that the manufacturer in Great Britain does not wish to be bothered with the variations in exchange, although as the reader has seen, he may be pretty severely affected if silver has depreciated before his goods are sold. Leaving that out of the question, however, we may take it that as all his expenses are payable in gold, he naturally prefers to deal in terms of that metal. Consequently, goods shipped to China are nearly always paid for by remittances, or drawn for in sterling, which comes to the same thing. The Chinese producer is on rather a different footing. His expenses are in silver, and in silver he wishes to be paid. His produce, however, he has sold to Great Britain for a gold price, and either he cannot afford to, or does not want to wait until a remittance can be sent by mail from London. The one way open to him is to draw in sterling and settle the rate of exchange on the spot, which he does and so makes an end of the matter....

FOOTNOTES:

[103] Hartley Withers, _Money Changing_, pp. 30-35. E. P. Dutton and Company. New York. 1914.

[104] Adapted from the Rt. Hon. Viscount Goschen, _The Theory of the Foreign Exchanges_, pp. 85-88. Effingham Wilson. London. 1913.

[105] Adapted from Franklin Escher, _The Elements of Foreign Exchange_, pp. 3-14. Bankers Publishing Company. New York. 1913.

[106] _Ibid._, pp. 15-24, 26, 31-33, 44.

[107] Adapted from Frederick I. Kent, _Financing Our Foreign Trade_, The Annals of the American Academy of Political and Social Science, Vol. XXXVI, No. 3, November, 1910, pp. 492-500.

[108] [The method explained would apply without qualification to our imports generally prior to 1914, whether coffee from Brazil, hides from the Levant or textiles from France. The recent and growing practice of drawing on New York rather than on London is discussed later in this chapter.]

[109] Adapted from Archibald J. Wolfe, _Foreign Credits_, pp. 22, 23, Special Agents Series--No. 62. Department of Commerce and Labor. Washington. 1913.

[110] George Clare, _The A B C of the Foreign Exchanges_, pp. 11-15. Macmillan and Company. London. 1911.

[111] [English bills drawn on our banks have increased in volume since 1914, through the operation of the Federal Reserve Act and the amended New York State Bank Law which make provision for the acceptance of time drafts by National and New York State banks, respectively.]

[112] John E. Rovensky, _How the War Affects Practical Operations in International Exchange_, Journal of the American Bankers Association, Vol. 7, No. 12, June, 1915, pp. 1008, 1009.

[113] Joseph T. Cosby, _The Economies and Advantages of "Dollar Credits."_ The National City Bank. New York. 1915.

[114] Harry G. Brown, _International Trade and Exchange_, pp. 65-66. The Macmillan Company. New York. 1914.

[115] Anthony W. Margraff, _International Exchange_, pp. 104-105. Fergus Printing Company. Chicago. 1903.

[116] Adapted from Franklin Escher, _Elements of Foreign Exchange_, pp. 68-101. Bankers Publishing Company. 1910.

[117] Albert Strauss, _Gold Movements and the Foreign Exchanges_, The Currency Problem and the Present Financial Situation. A Series of Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The Columbia University Press. 1908.

[118] Hartley Withers, _Money Changing_, pp. 159-164. E. P. Dutton and Company. New York. 1914.

[119] Address by H. K. Brooks. _Lectures on Commerce_, Edited by Henry Rand Hatfield, University of Chicago Publications of the College of Commerce and Administration, Vol. I., pp. 283-4. The University of Chicago Press. Chicago. 1904.

[120] William F. Spalding, _Foreign Exchange and Foreign Bills in Theory and in Practice_, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New York and Melbourne. 1915.