le LIBRARY EAR L READE OBERN UCSB LiBKART LIBRARY" ^-— THE UNIVERSITY OF CALIFORNIA SANTA BARBARA PRESENTED BY GEORGE OBERN XVIII— 1 K-3-T Modern Business A Series of Texts prepared as part of the Modern Business Course and Service Registered Trade Mark United States and Great Britain Marca Registrada, M. de F. Alexander Hamilton Institute Modern Business Texts Prepared as part of the Modern Business Course and Service 1. Business and the Man 14. Corporation Finance 2. Economics 15. Transportation The Science of Business 16. Foreign Trade and 3. Business Organization Shipping 4. Plant Management 17. Banking 5. Marketing and 18. International Exchange Merchandising 19. Insurance 6. Salesmanship and Sales 20. The Stock and Produce Management Exchanges 7. Advertising Principles 21. Accounting Practice and 8. Oflfice Administration Auditing 9. Accounting Principles 22. Financial and Business 10. Credit and Collections Statements 11. Business Correspondence 23. Investments 12. Cost Finding 24. Business and the • 13. Advertising Campaigns Government EDITOR-IN-CHIEF JOSEPH FRENCH JOHNSON EDITORS,' WRITERS AVW CONSULTANTS [ See list on page V of Volume 1 ] International Exchange By Alexander Hamilton Institute in coUaboration with E. L. Stewart Patterson Superintendent, Eastern Townships Branches Canadian Bank of Commerce Modern Business Texts Volume 18 Alexander Hamilton Institute New York Copyright, 1921, by Alexander Hamilton Institute Copyright in Great Britain, 1921, by Alexander Hamilton Institute All rights reserved, including translation into Scandinavian Latest Revision, 1922 Made in U. S. A. PREFACE International exchanges have an unusual interest at the present time, and there is much confusion of thought in regard to the influences which fix exchange rates. They are in a highly sensitive state and like a person with shattered nerves react somewhat violently to changes in external conditions. This obscures to the onlooker the working of the fundamental princi- ples which govern international payments. An ex- amination of the seemingly mysterious but in reality simple underlying principles of international ex- change should prove interesting not only to the exporter and the importer, but to business men in general who are concerned in watching the factors which make for a nation's welfare. It would be impossible to understand exchange in its present dislocated and abnormal state without a thoro knowledge of its operation under normal condi- tions, and for this reason the basic principles which govern exchange under the latter have been fully ex- plained, altho reference to the more important factors which influence the exchanges today has been fre- quently made. In preparing the present volume, we have drawn largely upon the material furnished by Mr. E. L. vi PREFACE Stewart Patterson, Superintendent of Eastern Town- ships Branches of the Canadian Bank of Commerce, to whose ripe experience and profound knowledge of the subject of international exchange the greater part of the work is due. Joseph French Johnson. TABLE OF CONTENTS CHAPTER I. THE EXCHANGE SITUATION TODAY SECTIOM PAGE 1 . The Established Order Crumbles 1 2. International Exchange and Civilization . . 1 3 . Interest of the Unusual 2 4. Fluctuating Standards, National and Inter- national 3 5 . Normal Exchange Relations 4 6. Internal Change Wrought by War .... 5 7. Monetary Disturbance 6 8. External Relations in Wartime ..... 7 9. Exchange Before the War 8 10. Present Exchange Situation 9 11. Plan of Discussion 10 CHAPTER II. FUNDAMENTALS OF EXCHANGE 1 . Clearing Process in Exchange 2. Settlement of Equal Debts 3. Settlement of Unequal Debts 4 . The Dealer in Exchange 5 . The Exchange Rate 6. Exchange at a Discount 7. The Exchange Market 8. Exchange Centers . 9. Gold Points . . . 10. Demand and Supply . 12 12 13 13 14 15 16 17 18 18 viii INTERNATIONAL EXCHANGE SECTION PAGE 11. Exchange as a Trade Factor 19 12. The Role that Money Plays 21 13. Exchange with Foreign Centers 22 14 . Countries Using the Same Money .... 23 15. Countries Using Different Coinages .... 25 16. Countries with Different Money Standards . 25 CHAPTER III. INTERNATIONAL PAYMENTS ORIGIN 1. How Indebtedness Between Two Countries Arises 27 2 . Interdependence of Exports and Imports . . 28 3. Origin and Supply of Foreign Exchange . . 30 4 . "The United States in Account with the World" 33 5. Significance of the Elements in the Balance . . 36 CHAPTER IV. GOLD EXCHANGE RATES 1. Gold Standard 39 2. Gold Exchange Standard 40 3. Monetary Systems ' 40 4 . Mint Par of Exchange 42 5. Par of Exchange 44 6. Rates of Exchange 45 7. What Makes the Rate 46 8. Coinage Ratio 47 9. Fluctuation in the Rate of Exchange ... 47 10. Rates Tend to Correspond 48 11. Gold Points 49 12. Significance of Gold Movements . . . .51 13. Actual Gold Points 51 14. Computing the Gold Point 52 CONTENTS ix SECTION PAGE 15. Gold Shipments from New .York .... 53 16. Avoiding Gold Shipments 55 17. Reading the Exchange Rates . . . . .55 18. Exchange Quotations 56 19. Range of Quotations 58 20. Fixed and Movable Exchange 59 21. Premium and Discount 61 22. Exchange Tables 62 CHAPTER V. EXPORTS AND IMPORTS 1 . Payments for Exports 65 2. The Place of the Transaction 67 3. Financing Foreign Exports by Means of Dollar Credits 69 4. Dollar Acceptances 71 5 . Export Letters of Credit . * 75 6. Commercial Letters of Credit and Importing 77 7. British Acceptances Lender Letters of Credit . 78 8. History of the Draft in London 80 9. Position of the Obligants on the Bill . .81 10. The Part London Plays 82 11. Dollar Exchange 84 12. Exports and Imports are Complementary . 85 CHAPTER VI. INVESTMENT AND ARBITRAGE 1. International Finance 90 2. Investments 90 3. Foreign Investments in the United States . 93 4. United States a Creditor Nation .... 94 5. International Securities 95 X INTERNATIONAL EXCHANGE SECTION PAGE 6. TMiat is Arbitrage? 96 7. When Arbitrage is Transacted 96 8. Parity 97 9. Parity in Stocks 99 10. Chain Rule 100 11. Simple Arbitrage 101 12. Compound Arbitrage 103 13. Arbitrage in Gold 105 CHAPTER VII. FINANCE BILLS 1. Definition of a Finance Bill 108 2. Finance Bill for New York Account . . . 109 3. Method of Using Finance Bills 110 4. Loan of a Finance Bill 112 5. A Finance Bill on London Account . . . .113 6. Other Uses of Finance Bills 114 7. Forward Exchange 115 CHAPTER VIII; RATES OF INTEREST 1. Interest an Important Factor in Exchange Quotations 119 2. Long Bills 119 3. Bank Rate 120 4. Market Rate 121 5. Retirement Rate 122 6. Importance of the Bank of England Rate . . 122 7. What the Bank of England Rate Effects . . 124 CONTENTS xi CHAPTER IX. BILLS OF EXCHANGE SECTION PAGE 1. Bills of Exchange 127 2. Sight Drafts : .... 128 3. Cable Transfers 132 4. Unusual Rates for Cables 133 5. Long Exchange 134 6. Influence of the Interest Rate 136 7. Commercial Long Bills 138 8. Bankers' Long Bills 139 9. Bills of Exchange That Involve More or Less Risk 139 10. Letters of Credit 144 CHAPTER X. FOREIGN REMITTANCES 1 . Non-Commercial Exchange 147 2. Principles Underlying the Issuance of Drafts . 148 3. Advices 150 4. Specimen Forms and Signatures 152 5. Cost of Drafts to Purchasers 152 6. Travelers' Checks 153 7. Payment of Checks 154 8. Payment to Holders 154 9. Redemption of Checks 157 10. Letter of Indication 158 11. Lost Travelers' Checks 159 12. Letters of Credit 160 13. Payment to the Holder 167 14. Circular Notes 168 15. Foreign Money Orders 168 16. Payment of Orders 171 17. Mail Remittances 172 xii IXTERNATIOXAL EXCHANGE CHAPTER XI. THE SILVER STANDARD SECTION PAGE 1. Silver Standard 175 2. Silver Mint Par 176 3. No Mint Par Between Countries on Different Standards 177 4. Exchanges between Gold and Silver Countries . 177 5. Gold Prices of Silver 178 6. Real Situation as to Silver 179 7. Silver and International Exchange .... 18:2 8. Asia's Historic Influence 184 9. How Silver is Marketed .185 10. The Silver Price Flurry 187 11. Effects on Eastern Exchange 188 12. Silver Melting Points 189 13. Silver Standard 191 14. Eastern Exchange 193 15. Currency of China 193 16. Chinese Exchanges 195 CHAPTER XII. FIAT OR IRREDEEMABLE PAPER MONEY 1. Money and the War 197 2. Trade on a Paper Basis 199 3. Fruits of War 202 4 . Current Exchange Rates 203 5. Paper Currencies 204 6. Paper Money as a Standard 205 7. Results of Depreciation 206 8. ChiJe 217 CONTENTS xiii CHAPTER XIII. NEW YORK AND LONDON AS FINANCIAL CENTERS SECTION PAGE 1. New York's Prominence in World Finance . . 212 2. What Makes a Financial Center 212 3. Finance Follows Trade 213 4. World Exchange Must Mean Gold . . . .215 5. Liquid Discount Market 216 6. New York's Advantages 217 7. Physical Conditions Favorable to London . .219 8. Mail and Cable Facihties 220 9. Time Advantages 220 10. National Characteristics 221 11. Willingness to Seek Fortune Abroad . . . 222 12. London's Discount Market 223 CHAPTER XIV RESTORATION PROSPECTS FOR EXCHANGE 1. Existing Conditions 225 2. The Position of New York and of London . . 227 3. Reasons for Disorganization 229 4. Spending More than National Income . . . 229 5. Inflation 230 6. Loss of Means of Production 232 7. Disorganization of Working Forces .... 233 8. Commercial Parity 234 9. The Sensitive Condition of Exchange . . .236 10. Financial Reconstruction and its Effects . .237 11. Exportation of Capital 238 12. Efforts for Concerted Action 240 xiv INTERNATIONAL EXCHANGE SECTION PAGE 13. International and National Issues . . . .241 14. National Duty 242 15. DiflSculties in Extending Credit 242 16. Need of Increased Production 244 APPENDIX A The Brussels Conference 246 B Domestic Exchange 261 INTERNATIONAL EXCHANGE CHAPTER I THE EXCHANGE SITUATION OF TODAY 1. The established order crumbles. — "In August, 1914," says Hartley Withers, "civilization went into the hands of a receiver, the God of Battles." His grip on the destinies of mankind has been broken but not entirely shaken off. What has been rescued from his grim hands is frayed and tattered, and the patient la- bor of many years will be required to repair the rav- ages of war and bring the affairs of the world, both political and economic, to an orderly basis. No nation of the world, whether a belligerent or not, has failed to feel in some degree the consequences of the World struggle. Into every nook and corner of our business life its destructive fingers have reached and have twisted out of shape the old established or- der. It is only natural that these many changes should find their chief expression in international ex- change, for here business relations appear in their world aspect. 2. Interiiational exchange and civilization. — That foreign exchange, the adjustment of all our financial 2 INTERNATIONAL EXCHANGE relations with the world beyond our borders, lies at the very basis of civilization is no mere figure of speech. Attempts to formulate in words just what the mind pictures by such comprehensive ideas as *'civilization" are likely to be unsatisfactory. They say too little to be satisfying or they say too much to be concise and definite. One essential of civiliza- tion which all recognize, however, is that of orderly intercourse among men of the same nation and, as civilization advances, of different nations. Isolation whether of the individual or the nation is the contrast to civilization. Whatever hampers and impedes such intercourse promotes isolation, whatever facilitates in- tercourse between men and nations promotes civiliza- tioUc The first effect of the Great War on the United States was to break down the long established ex- change relations between New York and London and other financial centers. It seems not unlikely that the reestablishment of stable exchange among the na- tions of the world may be the last step in the economic reconstruction thru which the world is passing. In- ternational exchange touches the heart of the eco- nomic situation past, present and future. 3. Interest of the unusual. — When business moves along in its accustomed gait we think very little of its operations, and we take as a matter of course the deli- cate adjustments of its various parts, just as a man in good health gives little thought to his digestive sys- tem. In normal times the slight fluctuations of inter- EXCHANGE SITUATION S national exchange may be of moment to the ex- porter and the banker — they are his professional in- terest — but they are of little concern to the business men of the nation at large. International payments which involve no shipment of gold arouse little inter- est in the business world. But when gold is exported or imported attention is immediately drawn to the fact, and from one end of the country to the other the daily press gives explanations more or less accurate of what is taking place. Ever since the great conflict of the nations broke out in August, 1914, the disorder in our exchange re- lations with foreign countries has been followed from day to day with absorbing interest by men of business, as well as by the general and financial press. The machinery w^hich determined the in-and-outflow of gold and thus regulated the rates at which adjust- ments between different countries were made was stopped. Violent fluctuations in these rates appeared and while, thru governmental rather than commercial means, these rates were steadied during the war, the period since the Armistice has been one of great vari- ation and uncertainty. 4. Fluctuating standards, national and interna- tional. — In international relations such fluctuations in exchange rates cause disorders of the same nature as follow in domestic affairs from variations in the money standard. It is not necessary to depict in de- tail the difficulties which grow out of a fluctuating paper standard of money. Changes in its value in- 4 INTERNATIONAL EXCHANGE troduce an element of uncertainty into every business relation. Men live from day to day not knowing what the morrow will bring forth. Business arrange- ments become a series of temporary makeshifts. Men are unable to work and plan for the future be- cause that futui^e is vague and uncertain. Business is reduced to a minimum, and under these conditions the foundations of progress cannot be laid. Busi- ness does not stop, — it cannot stop — but it lacks en- terprise and hope. It is the same in international relations. The needs of nations remain as before. Interchange of commodities between the different parts of the world cannot cease. But with rates of exchange fluctuating from day to day intercourse between the nations is hampered in the same way as if tariff barriers were shifted frequently and capriciously. 5. Normal exchange relations, — In part the out- growth of national needs for commodities which could not be produced at home, in part the outgrowth of pohtical and financial relations, there had grown up in the years that preceded the War well-established commercial and financial relations among the nations of the earth. They were not fixed and immutable, but subject to constant tho from year to year rela- tively slight changes as conditions in the different countries varied. The economic literature of the day consisted in no small part of a discussion of how changes in one country affected conditions in another. It is a truism that the business structure of one coun- EXCHANGE SITUATION 5 try is only part and parcel of the business structure of the world at large. International exchange there- fore reflects both internal and external conditions. 6. Internal change wrought by war, — Separating, as far as it is possible to do so, internal from external conditions, let us briefly summarize the events and legacies of the Great War which have entirely thrown out of balance the traditional exchange relations among the nations. Among the belligerents there was a great destruc- tion of productive property, and this destruction was not evenly distributed. Belgium and northern France were laid waste, and the fruits of centuries of the up-building process were wiped out. Other belligerents escaped this fate tho the Allied nations, particularly Great Britain, and some neutrals suf- fered considerable losses in shipping. Among the belligerents again there was a great de- struction of man power thru the sacrifices of battle and disease. Tho the phrase man power is frequently given a purely military meaning its significance for the world's production cannot be overlooked. Econo- mists may speculate whether in certain areas there may not be overpopulation, but with a given popula- tion, none of them would look for any benefit from the destruction of its most active and productive ele- ments. And again it may be noted that this destruc- tion of life was not evenly distributed among the bel- ligerent nations. In all the nations participating in the Great War 6 INTERNATIONAL EXCHANGE there was further a great destruction of potential wealth, thru the diversion of industry to the manu- facture of the means of warfare, thru the attendant taxes and the huge legacy of debt which has been left for future generations to liquidate. Nor was this burden evenly distributed. Nor could the neutral nations wholly escape the di- rect internal effects of the war. This was especially true of the Netherlands and Switzerland which were obliged to make relatively large military expenditures for the defence of their neutrality. The smaller neu- trals in Europe and the larger ones of Latin America were indirectly drawn into the economic turmoil thru being cut off from sources of supply for their manu- factures and personal consumption, and thru the diffi-, culty in some instances in finding an outlet for their native products. 7. Monetary disturbance, — Thus during and after the war the nations have staggered under its burden. Their whole economic life was directed to the single purpose of warfare and all the checks and balances which guided it in times of peace were set aside. No- where could the monetary standard be maintained in its full integrity. Gold which had generally been the background if not the actual embodiment of the mone- tary circulation became exclusively a factor of gov- ernment finance rather than the mainstay of com- merce. The convertibility of currency into gold was suspended, and the only check on the issue of currency which civilization has established as effective ceased EXCHANGE SITUATION 7 to operate. Paper money under various names mul- tiplied in the different countries at different rates., and suffered varying degrees of depreciation as re- vealed in the rise of local prices. With such changes going on in the currencies of nations it was impossible for exchange rates not to be powerfully affected. When depreciation is uniform among a group of states it is conceivable that, other things being equal, exchange rates would not change. But "other things" were far from being equal in the world crisis and depreciation was far from being uniform in the nations concerned. Hence the fiscal re- lations of these nations not only with those which were able to maintain the integrity of their currency but also among themselves were shifted. 8. Ejcternal relations in tcartijne. — Let us turn our attention to certain external relations. Western Europe is unable to produce all the food required for its dense population. Even before the war it drew large quantities of food from Eastern Europe and from other continents, exchanging manufactured products for it. It was the manufacturing center of the world, tho it had to draw upon other lands for many of its raw materials. The extensive commer- cial relations to which these exchanges gave rise had made London the financial center of the world, ex- tending its influence into all the corners of the earth„ To London, lands far and near looked for financial assistance. The loans of many governments were floated there, and both British and native enterprises 8 INTERNATIONAL EXCHANGE in all parts of the world — drew their capital from the same source. Europe at war had more imperative needs than be- fore. It needed more food, since its own production was curtailed. It needed arms and munitions and supplies for the murderous conflict in which it was en- gaged. In its extremity it turned to the United States, and the increased exports of food and of war materials from this country went far to supply its need. Enormous payments had to be made in the United States by the allied governments and a violent shifting of the usual trade relations occurred. Crip- pled by the war and the demands which it entailed, the London market was no longer in a position to lend capital to the rest of the world. Those in South America, Canada, even in Europe itself who were wont to borrow money in the markets of the old world, were forced to come to New York. 9. Eocchange before the "war. — In brief outline these are the chief changes — there are innumerable smaller ones — which have shifted and changed almost beyond recognition the customary exchange relations among the nations. What are the outstanding fea- tures of that situation then and now as they affect foreign exchange? The significant thing before the War was the exist- ence over large areas of international standards of value. Gold was the accepted medium of exchange in foreign payments over the greater part of the civilized world. A smaller group of nations used EXCHANGE SITUATION 9 silver as its basis of money. Within the group the same interchangeability existed as in the gold group. Moreover it is to be noted that as silver is a commodity of world commerce a relationship to the gold group was always calculable. Outside of these two groups there were a few nations having only a paper currency with no metalHc background. It was common to speak of them as being on a paper standard, but it is to be noted that such a standard is necessarily local and is not an international standard conmion to a group of countries. Exchange with any one of them therefore will be governed by considerations which do not apply, or apply in different measure, to another country. 10. Present eocchange situation, — The distribution of the nations of the earth into gold standard, silver standard and paper standard countries has been com- pletely changed by the war. Most of the leading na- tions are actually on a paper standard. They have not loosened their hold on gold, and in some cases their gold holdings have even increased since 1914. But paper money has greatly multiplied and gold is no longer available for local or for international com- merce. Silver indeed has held its own in international payments, but gold has lost for the time its former importance. How long the present conditions will be maintained no one can foretell. Certain it is that the nations which have heretofore used gold for local and inter- national payments are looking forward to a return to 10 INTERNATIONAL EXCHANGE that basis. They hope to return sooner or later to the normal condition of the free use of gold in interna- tional exchanges. Such normal conditions embracing both the past and it is hoped the future, have a perma- nent interest which does not attach to the present more or less temporary conditions. 11. Plan of discussion. — Before the War it was not necessary to explain or defend the traditional ap- proach to the detailed study of international ex- changes. Writers depicted exchange conditions with gold standard countries, with silver standard coun- tries, and with paper standard countries in this se- quence, not only because it treated the different groups in the order of their importance but because the discussion proceeded naturally from the simple to the complex. If we were to follow today the importance of the different groups we should have to deal first with the paper standard, but in so doing we should plunge the reader into the most difficult phase of the entire sub- ject. If we are to understand the principles of in- ternational exchange under conditions as they are, we must first comprehend them under conditions as they ought to be. That means that it would not be wise to depart from the traditional presentation of the subject which presumes the existence of gold as the international money. It does not mean that the un- usual conditions of the present day can be ignored in the treatment. Nor does it mean that the emphasis on the different aspects of the subject will be the same EXCHANGE SITUATION 11 as heretofore. Obviously greater attention must at this time be given to the factors underlying interna- tional payments between countries on a paper basis. Should any of our readers deem that the assumption? underlying the discussion of international exchange principles are somewhat remote from conditions as they are now, it would be well to remember that the conditions assumed are those which the future, it is hoped, will restore before the world grows much older. REVIEW In what sense are stable exchange and civilization linked to- gether ? Describe the exchange situation before the Great War. What internal and external changes wrought by war have affected the exchange situation? WTiat has been and is now the relative importance of countries '''ing respectively, a gold, silver and paper standard of value? CHAPTER II FUNDAMENTALS OF EXCHANGE 1. Clearing process in exchange, — The funda- mental principles of foreign exchange are simple. The actual methods of making international pay- ments, however, and the calculations involved are somewhat technical. A student beginning the sub- ject often rivets his eyes upon the maze of exchange calculations, technical methods and the myriads of varying circumstances which work together to fix the actual rates, thus losing sight of the underlying prin- ciples which are few and easily understood. Every one knows that in foreign exchange the business world applies the familiar principle of off- setting one debt against another and arranging to adjust the balance either thru money or credit. This principle will be understood better if portrayed first in a simple illustration stripped of all the mechanism which civilization and commerce have developed. 2. Settlement of equal debts, — Let us suppose that Durant in Montreal has sold to Rogers in New York a bill of goods for $1,000. He draws a draft for this amount on Rogers who must make payment in Montreal. If Rogers sends currency or gold, he must pay insurance and transportation costs, and this 12 FUNDAMENTALS OF EXCHANGE 13 is an added burden to his business. Xow suppose that at the same time Peters in Xew York has sold a $1,000 bill of goods to Martin in Montreal, making it necessary for Martin to send $1,000 to Xew York. Clearly, if all four parties were aware of these trans- actions, ^Martin the ^Montreal buyer could pay $1,000 to Durant the Montreal seller, and Rogers the New York buyer could pay Peters the Xew York seller. This would eliminate the necessity for any shipment of money. 3. SettJement of unequal debts. — Xow let us assume that the debts in the foregoing case were not equal, that $1,500 is due to Montreal and only $1,000 to Xew York. In iNIontreal, jNIartin can settle with Durant just as before; but, in Xew York, after Rogers has paid $1,000 to Peters he must still remit $500 to Durant at Montreal. To ship this $500 will cost something but it will be less expensive than ship- ping the entire $1,500. Furthermore, the cost of shipping $1,000 from ^Montreal to Xew York has been saved. Multiply the four men of our illustration by thou- sands, and we have a picture which more clearly cor- responds to the actual situation. The multiplication increases the amount of debts to be adjusted; it may also diminish the proportion of the entire debt to be settled by currency shipments. 4. The dealer in ejrehange. — It may be objected that the above illustration is unreasonable, that we could not possibly expect the four men, much less 14 INTERNATIONAL EXCHANGE thousands, to discover one another's doings. The objection would be well taken. But suppose that no business man in either Montreal or New York under- takes to ship currency on his own account and that there is only one banker or exchange dealer in each place who is equipped to handle such transactions. Say, further, that the Bank of Montreal sends all remittances direct to the Bank of New York which distributes the payments to those entitled to receive them in New York and that, in like manner, the Bank of New York consigns all remittances to the Bank of of Montreal for distribution there. All business men in New York who owe money in Montreal will now pay their funds into the Bank of New York, and all those to whom money is due from Montreal will call upon the Bank of New York for it. The bank will know that it has certain remittances to make but that, on the other hand, it has certain remittances due from the Bank of Montreal. It will ship only the balance due Montreal or receive only the balance due New York. 5. The eoochange rate. — The banker or exchange dealer evidently renders a valuable service, for which it is only just that he should be paid. So long as pay- ments to Montreal equal payments to New York nothing but bookkeeping is involved, and the bank may assume the cost of this as an accommodation to its customers. Under these conditions exchange is said to be at par. The moment a currency shipment, to Montreal for FUNDAIVIENTALS OF EXCHANGE 15 example, becomes necessary, it is only natural that the Bank of Xew York should make a charge. It cannot charge more than the expense incident to procuring the money and shipping it ; if it should do so business men would ship for themselves. The bank may anticipate the necessity of shipping currency before it actually arises. If business men in Xew York seem to be buying from Montreal more than they are selling, the Bank of Xew York may begin to make a small charge for its services in re- mitting to ^Montreal, increasing the charge as the probability of shipment becomes more certain. The cost is thus distributed over a larger number of buyers, who will pay the charge rather than ship money themselves as long as it does not exceed the cost to them if they should procure the money and ship it. Under these conditions exchange on Mont- real is said to be at a premium in Xew York. 6. Exchange at a discount. — ^AVhen Montreal ex- change is at a premium in Xew York, what is hap- pening to Xew York exchange in Montreal? There the sellers overbalance the buyers. Sellers draw their drafts upon Xew York and present them to the Bank of IMontreal for cash. Some drafts are coming in from Xew York drawn upon Montreal business men who have bought goods, and cash is received for them; but not enough to meet the sellers' demand. Under these circumstances the Bank of Montreal may refuse to pay full face value for drafts on Xew York, and Xew York exchange is at a discount. 16 INTERNATIONAL EXCHANGE If the Montreal sellers have specified in their con- tracts with New York buyers that payment must be made in Montreal, they are fortunate. They need not sell their drafts to the Bank of Montreal at a discount but may simply demand that their debtors forward the mone3\ If the contract permits pay- ment to be made in New York, however, they can- not do better than sell their drafts at a discount. Of course, the discount cannot exceed the expenses of shipping the money from New York to Montreal, since they can accept payment in New York and make the shipment on their own account. This illustration shows how important it may be for a sales contract to specify whether payment is to be made in money of the seller's city or in that of the buyer's. 7. The exchange market, — The assumption that there is only one exchange dealer in Montreal or New York is, of course, incorrect. There are many dealers or banks in each city where drafts can be bought and sold. The Bank of New York is in competition with other banks and dealers, and, imder the circumstances described above, cannot charge a premium on JNIont- real exchange greater than its competitors charge if it would hold its customers. In like manner, the Bank of Montreal cannot discount New York drafts at a rate higher than that of its competitors if it wants to buy any. So far it has been assumed also that New York and Montreal trade only with each other ; but each trades FUNDAMENTALS OF EXCHANGE 17 with every other important city in the world. In Montreal, an excess of sales to New York over pur- chases from her m:iy be counter-balanced by an ex- cess of purchases from London over sales to that point. At the same time, New York may be selling more to London than she is buying. If so. New York can pay Montreal by drafts on London, thus avoid- ing shipment of money. Montreal is content, be- cause she can forward the drafts to London instead of money. 8. Exchange centers. — It would seem that the practice just described would lead to boundless con- fusion. New York might send to Montreal drafts on Madrid when Montreal had a balance due from Mad- rid. Montreal might then send these to some other point where she did owe an amount and there again they might not be needed. How could any point determine what drafts to forward to another? This difficulty was settled in the natural develop- ment of international trade. London and New York are two points with which almost every city in the world is trading. Remittances are always being made to these points and received from them. Con- sequently drafts on either may be remitted any- where in settlement of debts, and they will be ac- ceptable because points everywhere need such drafts to make payments in one or the other city. Drafts on other cities are sometimes used, but usually they are remitted to the cities on which they are drawn or to nearby cities. Drafts on any point are acceptable xviii — 3 18 INTERNATIONAL EXCHANGE in New York or London because they have remit- tances to make everywhere. These two cities are the exchange centers of the world. 9. Gold points. — In a preceding paragraph we pointed out that the premium on Montreal exchange in New York could never go above the expenses incident to procuring the gold and shipping it. Ship- ping expenses consist primarily of the cost of pack- ing, express, insurance and loss by abrasion. In a country which is not redeeming its credit money at face value in gold, it may be necessary to pay an additional amount to secure gold for shipment. The principle which limits the premium on Mont- real exchange in New York also limits the discount, except that here it is the expenses involved in pro- curing gold in Montreal and in shipping it to New York, that fixes the amount of variation. Evidently, at a given time, there is a point above par beyond which the price of exchange cannot rise, and likewise a point below par under which the price cannot drop. These are the points at which it be- comes profitable to export or import gold, and are often called the gold shipping points or gold points. It must be understood that they vary with the costs of procuring gold and shipping it. 10. Demand and supply, — The price of exchange fluctuates between the gold points according to the shifting of demand and supply. Every sale of goods by an American to an Enghshman creates a supply of drafts on London; every purchase made by an FUNDAMENTALS OF EXCHANGE 19 American from an Englishman creates a demand for London exchange. American sales to England thus tend to lower the price of London exchange and pur- chases from England tend to raise it. Lowering the price of London exchange in New York means raising the price of New York exchange in London and conversely. It will be seen then that every export from the United States tends to lower the price of exchange on the buying country, which means raising the price of New York exchange in that country. Every import into the United States tends to lower the price of New York exchange abroad. 11. Eoochange as a trade factor, — Thus far we have considered exchange as a result of trade activity. For a fuller view of the subject we must also recognize that exchange is an important factor in determining the trend of trade. How this takes place can best be explained by con- sidering a case that is hypothetical, — and, to lend force to the argument, absurdly so. Let us assume that in New York, Montreal exchange is quoted at 75. That means that $75 in New York in goods or money would be worth $100 in Montreal, and of course the converse would be true. If on the face of it, Montreal is an excellent place in which to sell, it would be a bad 2)lace in which to buy. What the New York merchant would gain on his sales would be lost on his purchases or his remittance. But since this exchange relation is wholly abnormal a return to par 20 INTERNATIONAL EXCHANGE would be expected. If then when the New York merchant expects to cash in on his sale the rate should have advanced to 80 he would be the gainer by the rise in exchange and the hope of such gain would im- pel him to sell. On the other hand if exchange is fall- ing the Montreal merchant would have no incentive to buy in New York but if from a low point it begins to rise he is likely to purchase and seek to reap the benefit of such a rise. The assumed facts are fearfully exaggerated and frankly absurd. Yet they illustrate an important principle. Exchange variations as we have seen fluc- tuate within very narrow limits and one might well be skeptical whether these variations would start any such selling and buying movements as have been sug- gested. Now the margins of profit on such operations are very slight. They would offer little incentive to trade to the grocer or the dry goods dealer. But there are other commodities and other markets which are extremely sensitive to changes such as these. First of all there is the money market, the market for securi- ties of all sorts and the organized markets for grain and other produce. They operate on very small mar- gins and thru the magnitude of their operations small profits become important sources of revenue. Just how these various financial transactions are stimulated by exchange operations and affect ex- change rates must be reserved for subsequent treat- FUNDAMENTALS OF EXCHANGE 21 ment. It is important at this point to note their ex- istence. 12. The role that money plays. — In the preceding chapter there was considerable insistence upon the role that money plays in determining exchange rela- tions. In the present chapter exchange has been ex- plained largely as a means of making payments with- out the transfer of money. These two standpoints are only in appearance contradictory. The relation that money bears to the exchanges is exactly the same as that which it bears to other forms of credit opera- tions. Banking operations dispense with one use of money, as a medium of exchange, but without money they would be inconceivable. The money function is a composite one and we are apt to speak loosely of doing away with the use of money when at best we simply economize one of its uses. Back of all credit transactions whether in local or foreign affairs stands money. It is the language in which they are expressed and, more than that, it is the medium thru which credit differences are adjusted. The more highly de- veloped the credit system the smaller will be the amount which requires such cash adjustment, but we have not yet reached a point where we can entirely dispense with its use for such purposes. Our explanations of exchange operations have thruout had the background of the existence of money equally acceptable to all parties to the transac- tions. When such a condition obtains the phenomena of exchange present their simplest forms. 22 INTERNATIONAL EXCHANGE 13. Eocchange with foreign centers, — The fact that two communities which trade with one another belong to different nations does not of itself affect exchange relations. Exchange operations may be affected by- differences in currencies but the underlying principles remain the same. Since the explanations thus far given assume the existence of money equally acceptable to all parties we may distinguish three different situations. 1. Where the money of two countries is identical and has completely free circulation in both. 2. Where the money of two countries tho identical does not circulate in both but is readily convertible from one to the other. 3. When the money basis is the same, but denomi- nations different, with ready convertibility of one to the other with or without concurrent circulation. If we go back a few years we find that the first con- dition prevailed in the relations of Paris with Brus- sels, Geneva and other points in the nations of the Latin Union, the second condition existed in the re- lations of New York to Canadian centers, while the third was found in New York's relation to London, Paris, Berlin and other centers of countries having the gold or the gold exchange currency standard. It is to be noted that the condition of such ex- changes is either concurrent circulation of money or its free convertibility or both combined. A word of explanation is perhaps needed with regard to the com- bination here noted which applies chiefly to gold. FUNDAMENTALS OF EXCHANGE 23 The chief use of gold in the monetary circulation of most nations has been as a reserve for the banks. In- asmuch as the chief foreign banks are by law per- mitted to hold a part of their gold reserve in coins of foreign nations it is in a sense proper to say that the American double eagles stored in the vaults of the Bank of England had circulation in Great Britain. At that time the converse was not true. American banks could hold no part of their reserve in foreign coin and on receiving it had to transform it into Amer- ican gold either in bars or coin. In international exchange gold circulates by weight rather than by denominations, but there are certain forms such as the coins of the leading nations and bars of the leading mints which have the preference. It may be noted that an examination of the customs re- turns for gold imported into the United States ordi- narily reveals that the greater part of it comes to the country in the form of American coin or American treasury bars and only a small part in foreign coin. 14. Countries using the same money. — If, as was formerly the case in the countries forming the Latin Monetary Union, the coins of one country circulate freely by law in another, exchange among them offers no problem. All exchange is expressed in familiar terms which allows even those not very well in- formed to perceive the premium or the discount. Quite similar is the situation in countries which use different coins which, however, have the same gold value, sometimes the same name. A\Tien before 24 INTERNATIONAL EXCHANGE the Great War New York traded with Montreal and settled its transactions by exchange operations, it was hardly aware of the fact that it was engaging in foreign exchange. The two places used the same dollar as to weight and fineness and exchange on Montreal and exchange on New York was in each case practically quoted in domestic currency. Ex- change bridges the gap between two countries very simply, so long as there is the possibility of the free movement of money of the same kind. As we shall see later even the designation or value of the money unit is quite immaterial if the kind is the same. Of recent years Canadian exchange has been at a marked discount. Such a discount would be im- possible if the money in circulation were in effect of the same kind. This is not the case. As an after- math of the Great War, Canada has been obliged to depart for the time being from the gold basis. So long as the paper money of the Dominion cannot be converted into gold, the gold standard which exists by law is in fact suspended. Under these circumstances the Canadian dollar is quite a different thing from the American dollar, tho under normal conditions they are practically identical. Exchange rates between countries having the same monetary units as was the case between the United States and Canada a few years ago are readily under- stood because they are expressed in the same mone- tary language. Deviations from exact equality are FUNDAMENTALS OF EXCHANGE 25 measured in terms with which the business world is thoroly f amihar. 15. Countries using diiferent coinages, — A few years ago when London reckoned all its transactions in gold pounds sterling, and New York figured its dealings in gold dollars, exchange relations in ap- pearance were somewhat more complicated than those which have been thus far discussed. This complexity lies however chiefly in the appearance. Both coun- tries were using the same money metal, gold, and in both it was freely available for the needs of trade. The only difference lay in the coins used. But since in international affairs gold circulates by weight it is only necessary to compare the pure gold in the sov- ereign with that in the dollar to establish the relation in which, with exchange at par, one coin could be ex- changed for the other. This ratio called the Mint par of exchange was £l = $4.8665. When exchange on London cost more than $4.86 2-3 it was at a pre- mium, when less it was at a discount. 16. Countries with different money standards. — Thus far we have discussed exchange relations be- tween countries having a like monetary standard. The existence of what then becomes international money is helpful and convenient for the development of commerce, but it is not essential to it. Trade be- tween countries on a different money standard con- tinues and as we have seen in the preceding chapter is possibly the dominant form of international trade for the time being. It introduces, however, into the 26 INTERNATIONAL EXCHANGE fixing of exchange rates a variety of new considera- tions. For the orderly development of the subject it seems advisable to defer the consideration of these exchanges until there has been a full consideration of all the phenomena of exchange based on interna- tional money — gold. These phases of the subject wiU therefore receive first attention. REVIEW Explain the exchange as a clearing process. How do you account for premiums and discounts in exchange? What is the role of banker ? What is meant by exchange mar- ket and exchange center? Within what limits will exchange usually fluctuate? How are those limits fixed? Explain how money is at the basis of exchange rates and the effect if any of different moneys of the same kind in the problems involved. CHAPTER III INTERNATIONAL PAYMENTS— ORIGIN 1. How indebtedness between two countries arises, — The mutual indebtedness of two countries arises from a combination of the following: Exports of merchandise Investments abroad The purchase of foreign securities Payments of interest and dividends to foreign shareholders Charges for transportation, insurance and com- missions paid to foreign corporations Tourists' expenditures, etc. There are, of course, many other causes which affect the course of the exchanges, but the above are the principal factors in the fluctuations, formally, the balance of payment, as it is called, is sometimes with one country, sometimes with another, and the rate of exchange accordingly rises and falls within certain well-defined limits. Between countries on the gold standard these limits are determined by the cost of shipping gold from one country to the other. The rate of exchange may be defined as the price of the money of one country reckoned in the money of any 27 28 INTERNATIONAL EXCHANGE other countn% that is, the price of the right to gold of a certain established weight and fineness. As many countries have not yet removed their embargoes against gold shipments by other agencies than the governments, this price must temporarily be consid- ered not as the price of their standard gold coin but of currency with the lessened quantity of gold behind it resulting from the increase of its amount in propor- tion to gold reserves. The principal operations of foreign exchange in- clude the issue of drafts and various forms of com- mercial paper, money orders, letters of credit payable abroad, cable transactions and the purchase and ship- ment of bullion and of foreign coin. 2. Interdependence of exports and iviports. — If merchandise were the only basis of international in- debtedness the value of the exports would have to be equal to that of the imports or else trade would prac- tically cease. Suppose a country which does not it- self produce gold, has an excess of imports, for which it could pay only by shipping gold. To a limited ex- tent this could be done, but its supply of gold would soon be exhausted and the only way to replenish it would be to reduce the amount of imports below that of its exports. Furthermore, the loss of gold from a country induces a fall in the prices of goods (a rise in the value of money) and, owing to the depletion of the bank reserves, a rise in interest rates follows. It would, therefore, become a good country to buy from, and a poor country to sell to. Automatically, exports IXTERNATIOXAL PAYMENTS 29 would be stimulated and imports checked until the balance was reversed. In practice, however, the exports of a country are not confined to merchandise but include other ele- ments known as "invisible exports," which offset im- ports of merchandise. ''Visible exports" consist of merchandise of every description, including gold; they are so called because accurate records of all goods and specie entering or leaving a country are kept by the customs and port authorities. Every vessel clearing from a port must declare its cargo be- fore leaving, and all goods entering the country are examined and valued at the custom house. This system affords a fairly accurate record of the visible exports and imports of a country. A country's "in- visible" foreign trade is so called because no such record is available owing to its nature. It consists of the import and export of services, of bonds, shares and other evidences of indebtedness and, not being the subject of government supervision, there is no certain method of ascertaining the amount and vol- ume of these transactions. For that reason they can only be roughly estimated. The disparity between the visible exports and the visible imports of the principal countries of the world for the year ending December 31, 1913, which repre- sents normal trade conditions, will demonstrate the importance played by the invisible exports and the invisible imports in adjusting the balances of pay- ments among the countries of the world. 30 INTERNATIONAL EXCHANGE Imports Exports (Last six ciphers omitted) Great Britain $3,080 $2,371 Germany 2,545 2,132 United States 1,717 2,311 France 1,589 1,296 Austria 726 591 Canada 670 356 Russia 603 782 Denmark 215 156 Sweden 185 177 Netherlands 144 188 Norway 141 87 It will be noted that the imports of the above coun- tries with the exception of those in the United States, Kussia and the Xetherlands, exceeded the "visible" exports; the difference was adjusted by "invisible" exports. Such excess of visible imports does not necessarily place a country at a disadvantage, for in the case of the older countries goods are imported to pay for services (such as freight and insurance) or to meet the interest on foreign investments. In the case of a young country like Canada, however, the excess of imports usually consists of goods purchased with money borrowed abroad for capital expenditure, such as material for railways, factories and public w^orks. 3. Origin and supply of foreign exchange. — Altho the export and imjjort of merchandise are the basic factors of international indebtedness, the other ele- ments which must be taken into consideration have a precisely similar eifect on the balances of indebted- INTERNATIONAL PAYMENTS 31 ness, and they can therefore be expressed in terms of exports and imports. Summarizing what has ah-eady been said, trade between two countries on the gold standard consists of mutual exchanges of: 1. Merchandise 2. Gold 3. Services 4. Evidences of indebtedness. For the sake of simplicity we generally consider that one country, say, the United States, trades with an- other country, England, just as if a statement of ac- count were made out daily and the relative balance arrived at and settled. Such, of course, is not the case; the transactions occur among a multitude of independent merchants and bankers, whose bills of exchange on one another furnish the supply of, and govern the demand for, foreign exchange, and thus affect the price of exchange between the two coun- tries in question. Bankers and exchange brokers in New York and London encourage the public to utilize their services for paying debts abroad, and in order that they may do this, also encourage those who have claims against persons abroad to sell these claims to the banks in the form of bills of exchange, thus enabling the banks to offset sales against purchases. In other words, the banks are both buyers and sellers of foreign exchange. A continuous process of assem- bling and distributing exchange is thus effected thru the agency of banks, which act as clearing houses, and eventually make a settlement between the financial 32 INTERNATIONAL EXCHANGE centers of the two countries. Should New York banks, for instance, be called upon for more exchange on London than they are able to buy, they must pro- vide funds to meet their withdrawals by exporting gold or by some other means. As a rule, gold ship- ments are avoided as much as possible and the re- quired balance in London is often created by : 1. Buying exchange on other centers and sending to London for credit. 2 . Shipjping securities to London to be sold or borrowed against. 3. Using finance bills. While these expedients will receive detailed atten- tion later a word or two of explanation may be in order at this point. In the trade between the United States and Canada, there is ordinarily a balance to be paid by the latter country. Before the war Canada was in the habit of discharging this obligation by drafts upon her largest customer, Great Britain. When a similar recourse is not available resort is often had to stocks and bonds. There are a large number of such securities which are international in character, with as ready a sale in London as in ISTew York. A transfer of such securities to the London market has the same effect as a shipment of gold. It can therefore be used to avoid such a shipment. More- over the market for such securities is very sensitive. Slight variations in the exchange rate may make Lon- don or New York the better market for the sale of INTERNATIONAL PAYJVIENTS 33 securities and will set in motion almost instantly a flow of securities from one market to the other. Finance bills which are frequently used in the cir- cumstances noted are more in the nature of a post- ponement than a settlement. They may be briefly described as a temporary expedient of sixty to ninety days currency, used principally between seasons to anticipate a favorable change in the exchange rates. Exports, it may be noted, especially cotton and wheat, are not uniformly distributed over the entire year. It will be readily understood therefore that exchange will normally be low at some seasons and high at others. These are the principal methods resorted to in an endeavor to adjust an excess of imports over exports; if in spite of them the balance of payments remains adverse, gold is shipped. 4. ''The United States in account with the world/' — The exports of one country form the imports of another, and a study of the foreign trade of different countries will show that the component items of the exports and imports vary only in degree. Dean Joseph French Johnson in "]Money and Currency" gives a statement of "The United States in Account with the World" (reproduced on page 35) the head- ings of which are comprehensive and self-explanatory and call for very little comment. The amounts of the various items under invisible exports and imports are, of course, only estimates. The exports of merchandise exceed the imports for 34 INTERNATIONAL EXCHANGE the typical year under consideration, as they did in 1913, and the difference was adjusted by the "invisi- ble imports." The statement shows that gold was both exported and imported, indicating that in the course of the year it was found necessary at times to import gold to correct a falling rate and at other times to export gold to adjust a rising rate. The invisible exports and imports can be considered under broader classifications as net balances offsetting the excess of visible exports, as shown in the following statement ; INTERNATIONAL PAYMENTS 35 » ^ .2 en S H en Q H S S 4> i. W i « ^ -^ "S S .1 C « .5 C a; V -r i "^ O ;- ^ ^ 55 •^ =^ S S o -s 3 -^ S o -g w o o *S g en c ^ . =- '3 ID bo „ '^ ^ ^ c ^ .£ O cc ^ "^ cC 7! « O c3 fee Hi « S O o ^ J i2 3 .:S ^ -i o -^ £ s ^ ^ c o S ii ^ tf s s O Ph tx;s S3 o c ^ S3 (U 5 -a CO . Si y o s s Ph ? H o o »o o bo C 3 cn «^ i: en be 3 « C bJO o ri- •!=: =« r5 T- > ^ 'Z ^ r bJO. o ^. B "^ O-gcn s < 5-^ o 1 1 >. ^ >. ■w Oi C ►^ Ph t:^ S 'Z J5 C« CO Si ;i be be 5:; *^ o o r* O §1 CO- •• ^ s ^ I -^ o «J -^ 5 CO C !«. « « flj V — CO (M CO 36 INTERNATIONAL EXCHANGE Excess of visible eayports: Merchandise $440,000,000 Gold 36,000,000 Total excess of exports $476,000,000 Excess of invisible exports: Interest and Profits (5 and 6) $ 55,000,000 Tourists and Embassies (9 and 10) 150,000,000 Ocean Freight (11) 100,000,000 Investments (3 and 4) 106,000,000 Special Transactions (12) 50,000,000 Balance due by Foreign Banks (T and 8) . 15,000,000 $476,000,000 The above statement shows that the United States paid $305,000,000 in goods for interest and services, took over $156,000,000 in investments, and still had a credit balance of $15,000,000 in foreign banks. 5. Significance of the elements in the balance, — In the list which has been given there are certain ele- ments whose importance is universally recognized and appreciated and which call for more extended con- sideration in subsequent chapters. First in impor- tance are the exports and imports of merchandise, the backbone of all international trade relations. They are usually the dominant element in determining the exchange rate. Next come a group of relations which might be described as financial rather than commer- cial. These concern investments, permanent and temporary, and banking relations which form the sub- ject matter of international finance and as important INTERNATIONAL PAYMENTS 37 modifying conditions must receive special considera- tions in a volume on international exchange. The other elements listed tho they may run into millions of dollars are of minor importance. It is sufficient here to note their existence. Before the Great War American travel abroad and in a lesser degree the residence of American officials and citizens in foreign countries called for a steady supply of ex- change in the form of letters of credit and traveler's checks. These in effect covered American purchases abroad and from the standpoint of international ex- change it must be wholly immaterial whether those purchases and services were consumed where bought or whether they reached the United States in the form of imports. The restriction of travel during the war period and the months following the armistice checked this stream. During 1920, however, it began to flow again at a rate which had seldom been equalled before that year. Again, the United States, with its inade- quate merchant marine, formerly paid hea^y toll to foreign countries for freight, as practically all of her exports and imports were carried in foreign bottoms. Now, however, the situation has changed. A mer- chant marine has been created and if judiciously op- erated should relieve American trade of payments to foreign ship owners. It is the combination therefore, of a wide variety of forces, some large and some small, which fixes the actual rates of exchange between nations. These must be the next subject for our consideration. 38 INTERNATIONAL EXCHANGE REVIEW How does indebtedness between countries arise ? What are the invisible factors in the balance of international payments ? What are the visible factors ? How is the balance of visible factors adjusted? Describe Dean Johnson's statement of the United States in account with the world. What seems to be the relative impor- tance of the different elements of the statement? CHAPTER IV. GOLD EXCHANGE RATES 1. Gold standard. — Before 1914 the leading com- mercial nations of the world had in fact as well as in law a gold standard of currency. Under a gold standard the money unit is a definite quantity of gold of a standard fineness which is represented in the coin- age of the country by coins equalling the standard in value or multiples or subdivisions of the same. It is not at all necessary to the existence of the gold standard that such coins should pass freely from hand to hand in the daily transactions of the people. In fact the greater part of the circulation of gold con- sists in the fact that it lies hidden in the vaults of the banks and in the coffers of the government as a guar- antee for the value of other currency, chiefly paper. The essence of the gold standard then lies in the fact that for any of the uses for which metallic gold is re- quired it can readily be obtained by presenting at the proper place an equivalent amount of other currency. In other words it is the ready convertibility of all forms of currency into gold which constitutes the gold standard. One of the chief uses of metallic gold is to settle the balances of indebtedness to foreign countries in other words to regulate exchange relations. 39 40 INTERNATIONAL EXCHANGE 2. Gold exchange standard. — There are a number of nations which have not been able to afford the lux- ury of the gold standard in the internal monetary cir- culation of the country, yet which use gold as a basis of exchange. The government fixes a definite rela- tion between the actual currency of the country and gold, and it undertakes either directly or thru the banks to maintain this relation with gold in all deal- ings with foreign countries. To do this it must pro- vide a stock of gold sufficient to meet necessary de- mands for foreign payments, while at the same time it takes such measures to maintain exchange rates as render those demands as small as possible. Thus exchange thruout the greater part of the world was a few years ago conducted on a gold basis, and if we understand thoroly the factors entering into such exchange, the present, it is hoped, abnormal conditions of the exchange market will be the more readily comprehended. 3. Monetary systems. — For an understanding of the facts of foreign exchange an acquaintance with the leading monetary systems is indispensable. Each of these money units represents in theory at least a definite weight of pure gold. When theory and prac- tice accorded the units of the chief commercial nations were as given in the following table. GOLD EXCHANGE RATES 41 Country Name of Unit Austria-Hun- gary kronen Latin Union. . .franc Canada and United States, dollar Denmark kroner Germany reichsmark Holland gulden Japan yen Mexico peso Russia rubles Great Britain, .pound Gross Weight Pure Gold DoUar ^ Sterling ^ . ^ ^ . i; 17 • 1 1. Equivalent Grains Grains of Equivalent . „ ^ in Pence 5.22776 4.97817 25.8 6.91415 6.14588 10.37054 12.86024 12.86023 13.27584 123.27447 4.70498 4.48036 23.22 6.22274 5.53134 9.33348 11.57422 11.57421 11.94826 113.00160 .20262 .19295 1. .26799 .23821 .40195 .49505 .49845 .51456 4.86656 or 4.86 2/3 .lOd 9.516 49.316 13.212 11.75 19.82 24.576 24.57 25.37 The divergence of fact from theory in the present disturbed state of the currency in most of these na- tions will engage our attention later. For the pres- ent we are concerned with rates of exchange on the gold basis of a few years ago. Since the weight of foreign coins is in most countries officially given in grammes a table has been prepared and presented as a folder opposite page 42 making a comparison of the leading and some other nations on this basis. The term Latin Union in this table embraces France, Italy, Belgium, Switzerland and Greece. This Union ceased to exist in 1920 but the name is retained here as the facts given pertain to an earlier period. Those who have interested themselves in the proj ect of an international coinage have pointed out, that with minor deviations there are in effect represented in this table not more than two distinct money systems based respectively upon the shilling (approximately 25 cents) and the franc (approximately 20 cents.) 42 INTERNATIONAL EXCHANGE This groups the franc and the Austrian krone with the Dutch gulden which is substantially the double franc. It groups Germany and Scandinavia to- gether with Russia, Mexico and Japan having a dou- ble shilling. The dollar appears as the multiple alike of the shilling and the franc, while the pound sterling is of course, the multiple of the shilling as well as of the franc. It is not to be wondered that among those whose desire to remake the world is innate, these ap- proximate relations should give rise to the dream of a pound that was exactly five times the dollar, and a dollar that should be exactly twice the yen and the rouble, two and a half times the gulden, four times the mark and five times the franc. Nor is there any doubt that if this could be brought about international financial relations would be greatly facilitated. Such approximate relations as now exist may be convenient for a rough and ready translation of one currency to another, but business is not done that way. It re- quires a more accurate calculation of these relations. The theoretical relations of nations with another are regulated by the mint par. The actual relations are governed by the rates of exchange tempered by the cost of shipping gold. These three matters are intimately associated and should receive careful at- tention. 4. Mint par of exchange. — The mint par between any two countries is the value of the monetary unit of one country expressed in terms of the monetary unit of another country using the same metal as a Portugal Uruguay Newfoundland United States Argentina Brazil Brazil (/"/"■ Russia Japan Netherlands, The Scandinavian Uni< Germany £T Sovereign Escudo Peso Dollar Dollar Jlilreis Jlilreis Rouble Yen Florin or ) Guilder i Colon Rupee Krone .51457 .49846 .40196 .46535 .32444 .26799 .23821 .20363 .19295 25.371 24.583 19.823 13.216 11.748 9.993 9.516 .77801 .532537 .448023 1.62571 1.55615 1.52551 1.50463 1.45161 .83207 .48816 .774234 .750 .6048 No gold coins minted 33.22 grains 45/31 grammes No gold coins minted 1/ 15 of £1 No gold coins minted l/l5 of £\ 25/63 grammes 100/379 grammes 35/82 grammes 9/ 31 grammes STATEMENT OF EQUIVALENT VALUES OF THE MONETARY UNITS OF VARIOUS COUNTRIES. Scandinavian Germany Austria- Latin Union Hungary Union Great Britain £i_ stg, Portugal Euudo Uruguay Pew North America Dollar India (Br.)_ Germany_ Austria-H Latin Uni( . Union Mark .222.019 .212,518 .305,484 .055,068 .048,949 .041,636 26.934,77 35.371,21 24.582,17 13.216,22 11.747,736 9.992,76 9.515,69 .964,763 .546,166 ' .514,507 .401,960 .364,993 .334,438 .338,313 .202,626 .193,953 2.400,153 1.358,760 1.280,148 1.340,079 .666,709 .592,630 .504,097 Marks 20.429,46 4.535,733 4.341,631 4.197,932 4.050,000 Crowns 34.017,426 5.333,321 5.104,140 4.935,192 2!695,'433 2.539,488 2.460,000 25.331,54 5.599,670 5.360,039 5.000,000 2.830,571 2.666,806 2.583,333 2.083,200 1.891,616 1.681,436 Calculations based on 15.432,35 grains to the gramme. GOLD EXCHANGE RATES 4b standard of value, tho the degree of fineness of the metal need not be the same. All coins, whether of gold or silver, are made of so much pure metal and so much alloy ; the latter is used to harden the coins, thus reducing abrasion to a minimum. The term "fine- ness" expresses the number of parts of pure gold or pure silver contained in a thousand parts of the com- bination. The British sovereign is 916 2-3 parts fine, or 11 parts fine gold and one part alloy. The gold coins of Turkey and Brazil are also 916 2-3 fine. Those of nearly all other countries are on a basis of 900 fine, or 9/10 fine gold and 1/10 alloy. The mint par is arrived at by dividing the number of grains or grammes of fine gold in the one coin into the number contained in the other. For instance, compare the sovereign, the unit of Great Britain, and the gold dollar, the unit of the United States: Gross weight of sovereign 123.27447 grs. Less Vi2 alloy 10.27287 grs. Fine gold in sovereign 113.00160 grs. Gross weight of dollar , 25.8 grs. Less Vio alloy 2.58 grs. Fine gold in dollar 23.22 grs. therefore, 1 dollar = T^^« = £.205484 = 49.316 pence 1 sovereign = ^^^^ = $4.86656 Similarly, the gold franc contains .2903225 gram- mes of fine gold, while the dollar contains 1.50463 grammes. Hence, 44 INTERNATIONAL EXCHANGE 1 dollar = 1^?^ = 5.18262 fcs. .2903225 .29032 25 1.50403" 1 franc = ^^f = 19.2953 cents The mint par between any two countries can be ar- rived at in the same way. The mint par between two gold using countries is constant. It varies only when one of them alters its coinage regulations by increas- ing or decreasing the quantity of pure metal in its monetary unit. 5. Par of exchange. — The mint par is the pivotal point of the rates of exchange between two countries. In other words, it is also the ratio at which the stand- ard coin of the country will be exchanged for that of another. Theoretically, a sovereign is worth par in Xew York ($4.86656) , but practically this ratio holds good only for large amounts. If a traveler wants to change ten sovereigns in Xew York he would prob- ably receive only $48.50 or $48.60 for them instead of $48.66 2/3, the difference between retained by the bank as payment for its services and to cover the in- terest on the amount until it had collected sufficient sovereigns, say, one thousand, to warrant the trouble of taking them to the United States mint where they would be exchanged for $4,866.56, less a small melt- ing charge. If a few years ago the ten sovereigns were in London to the traveler's credit and this fact was properly attested he w^ould probably have realized on them by selling to a Xew York bank the "right," in the form of a check or order, to draw these ten sov- GOLD EXCHANGE RATES 45 ereigns in London, and the New York bank would have paid him their equivalent computed according to the current rate of exchange. With an active demand for sterling exchange the seller would have obtained a good price for his check on London. If, on the other hand, there were little or no demand for sterling exchange and the supply of checks and bills of ex- change was more than ample to meet the demand he would have obtained a low price. It has already been pointed out that the mint par is merely the standard by which actual exchange rates are measured. They vary within narrow limits, fixed by the "gold points" or the cost of shipping gold. Ex- change rates find concrete expression in the prices which prevail in the sale and purchase of bills of ex- change. 6. Rates of exchange, — Bills of exchange are a commodity and as such are bought and sold, and like other commodities are subject to the law of supply and demand. The reader should, for the present, dis- miss from his mind the thought that he is dealing in the money of foreign countries and should regard bills of exchange and other credit instruments, used in transferring funds, as representing a definite kind of commodity — evidences of indebtedness. The rate of exchange is the price per foreign unit at which the right to collect these debts is sold and it does not refer, except indirectly, to the value of the gold monetary unit. A sovereign is always worth par in New York and the gold eagle always worth 46 INTERNATIONAL EXCHANGE par in London. When gold sterling is quoted at, say, $4.85 in Xew York it does not mean that the sovereign has depreciated 1 2-3 cents below par; it means that the "right" to obtain a sovereign in Lon- don is worth only $4.85 in New York. In this case the supply of these "rights" is ample and the demand small, hence the price falls. 7. What makes the rate. — The rates of exchange quoted between any two countries, therefore, are the prices for checks and bills of exchange. These are the mediums by which debts are transferred from one party to another. The rate of exchange between two gold using coun- tries charged by a bank or broker for a foreign bill of exchange includes: 1 . The mint par or price equivalent of the foreign coin . 2 . Plus or minus a premium or discount on the mint par (greater or less conversely to the supply of bills on the market as compared with the demand for them) . 3 . Plus a premium or commission which the banker .de- mands for his trouble and for the economy and superior convenience of a draft as compared with a remittance in coin or bullion. 4. Less an allowance for interest, according to the dis- tance between the two points, and the tenor of the draft. 5. Plus the cost of shipping gold. The rate of exchange paid by a bank or broker for a foreign bill of exchange includes: 1. The mint par. 2 . Plus or minus a premium or discount on the mint par . 3. Less a commission covering the dealer's profit and an allowance for his risk and trouble. GOLD EXCHANGE RATES 47 4. Less a discount, according to the tenor of the draft. 5. Minus the cost of shipping gold. . The mint par never varies. It is a constant factor in any exchange rate. The most frequent variations in the rates are found in the premium or discount on the mint par, the range of which is governed by the law of supply and demand, and reflects the relative position of two countries as regards indebtedness. The allowance for interest or discount generally tends to vary with the foreign interest rate, tho some- times in large transactions the domestic interest rate becomes a factor also, in connection with the financial operations necessary to complete them. The cost of shipping gold is modified and at times offset by the mutations in the other factors. 8. Coinage ratio. — The rate of exchange, therefore, must not be confused with the ratio at which one country will exchange its money for the standard coins of another country. If a man has one thousand sovereigns in Xew York he will receive par for them, or $4,866.56 ^ irrespective of the rate of exchange. . 9. Fluctuation in the rate of exchange, — The in- 1 The United States Mint will always pav for English sovereigrns at the rate of $18.949182 per ounce. 1,000 sovereigns weigh 123,247.47 grains (480 grains to the ounce Troy). Working this out, we get ^,866.56 as the value* of 1,000 sovereigns. As a matter of fact the United States Mint would pay the bank 90 per cent of this amount ($4,380) on delivery and the balance ten days later, less a small charge of four cents per §100 to cover melting expenses, thus the actual pro^ ceeds would be $4,864.61. Similarly the British Mint took gold eagles at £3:16 i-di/^ per ounce, paying for them a fortnight after delivery without any charge The Bank of England paid for them on delivery but made a small charge of about IVs^. per ounce to cover the interest for 14 days at 4 per cent. 48 INTERNATIONAL EXCHANGE termediate rates between the gold points and the mint par, that is, the rates at which business is usually done, in addition to being affected by the supply and de- mand of bills between two places, rise and fall in sym- pathy with the influences at work on the other ex- changes. London, for instance, while a debtor to New York, might be a creditor of Denmark, France or another country with which England has close ex- change relations. If London drafts on these places were remitted to Xew York they would improve (i.e. raise) the rate of sterling exchange for the time be- ing. If, however, the supply both of New York and Continental bills were to fall short, the point at which London would have to export gold would be soon reached. 10. Rates tend to correspond. — The rates of ex- change between two or more places either correspond or tend to correspond. Thus, when a few years ago sterling exchange was at a discount in New York, say, at $4.85, New York funds in London were at a premium ; in other words, you could purchase in New York the right to obtain a sovereign in London for $4.85, whereas for a sovereign in London you would only be able to obtain the right to $4.85 in New York, a dollar costing 49.50d. instead of 49.316d., the par value. Let us suppose that the rate in New York, in re- sponse to a demand for sterling, suddenly went to par, and a New York banker having heard from his Lon- don correspondent that New York funds were still at GOLD EXCHANGE RATES 49 $4.85, cabled him to sell $100,000 at that rate and as a result of this transaction the New York banker re- ceived a credit in London of £20,618.55. At the same time he sold his own draft at par against this amount in London. In actual practice he would have sold a draft of, say, £20,000, but for the sake of show- ing his profit let us presume that he sold a draft for £20,618.55. For this he received $100,343.64 with which he paid the draft of $100,000 drawn on him in London, and thus makes a profit of $343.64 less cable charges and a small commission to the London banker. By such processes the exchanges automatically reg- ulate themselves between two or more places. It is obvious that under the influence of several such trans- actions marginal differences would rapidly disappear. The variations in the rates of exchange in the case cited are purposely exaggerated for the sake of illus- tration. In practice, a very slight difference in the rates will encourage these adjusting transactions, which are commonly known as arbitrage transactions. 11. Gold 2)oints. — Foreign exchange, thru the me- dium of bills of exchange and other credit instru- ments, enables countries to regulate their mutual in- debtedness without the transfer of coin or bullion. A bill of exchange is a commodity like wheat and cot- ton, and, as such, it is subject to the law of supply and demand. If the purchase rate of exchange reaches the point at which it is cheaper to remit gold XVIII — 5 50 INTERNATIONAL EXCHANGE than to pay the rate demanded for transfer by draft, gold exports usually result. The rates of exchange, produced by buying gold in one country and ship- ping it to another, are called the gold or specie points. The mint or theoretical par remains invariable among gold standard countries. If the exporting and im- porting of gold could be effected without expense or loss of interest, the mint par and gold points between any two countries would be practically identical, but heavy expenses for freight, insurance, cooperage, cart- age, abrasion, interest while in t ansit and other charges are involved in a gold shipment. These ex- penses deducted from the mint par give the "import gold point" and added to the mint par give the "ex- port gold point;" that is to say, if it should cost more to buy gold sterling exchange in New York than it would cost to buy gold to the same amount and ship it to London, the remitter naturally would take the cheaper method and export gold. On the other hand, when bills of exchange are so freely offered in New York that the rate becomes abnormally low, a seller, if he could obtain gold at par in London for his pounds there, would find it cheaper to transfer his London balance by importing the gold. Under normal conditions, the cost of shipping sov- ereigns between London and New York is about two cents per sovereign, and the mint par of the pound sterling is $4.86 2-3. Therefore, when a lower price than $4,841/2 was a few years ago offered for a bill of exchange it was cheaper to import the gold from GOLD EXCHANGE RATES 51 England, and when a higher price than $4,881/2 was asked, it was cheaper to send gold to England. 12. Significance of gold movements. — The export of gold from Xew York to London when gold is readily available in exchange for currency in both countries implies: 1. That New York owes London (exchange is fa- vorable to London and unfavorable to Xew York) . 2. That bills of exchange on London have been eagerly sought for in New York in order to liquidate this indebtedness. 3. That the premium demanded by sellers in the form of a higher exchange rate exceeds two cents per pound sterling and therefore it has become cheaper to buy gold in Xew York and export it to London. Conversely, the import of gold to Xew York from London implies: 1. That London owes New York (exchange is fa- vorable to Xew York and unfavorable to London). 2. That bills of exchange on London have been of- fered freely in Xew York to absorb this balance. 3. That the discount demanded by buyers in the form of a lower exchange rate exceeds two cents per pound sterling and therefore it has become cheaper to buy gold in London and import it to Xew York. 13. Actual gold points, — Before the war, when all the countries concerned were on a gold basis, the ex- treme range of the gold points between Xew York and London, and the continental centers was approxi- matelv as follows: 52 INTERNATIONAL EXCHANGE Imports Par Exports New York and London $ 4.84i4 ^.86 2/3 $4,881/0 per £1. New York and Paris 5.23 S.lSi/g 5.16 fcs. per $1. New York and Berlin 94.50 .OSi/g 9G.25 cents per 4 marks London and Paris 25.321/2 25.22 25.121/2 fcs. per £1. London and Berlin 20.53 20.43 20.34 mks. per £1. London and Amsterdam. . . 12.15 12.10 12.04 florins per £1. 14. Computing the gold i^oint. — Gold points are determined by the actual costs of shipping gold from one country to another and of making it available for monetary use in the country to which it is sent. The charges for freight and insurance are readily eomprehended. They have been in the last two de- cades fairly uniform and with improvements in trans- portation have tended to grow less. They may vary with unusual circumstances, as when the war forced all transportation and insurance charges upward. In August, 1914, for example, the United States could have shipped gold to Europe, only at great expense. In order to provide the necessary payments an ar- rangement was made by which gold was shipped to Ottawa, the Bank of England accepting payments in London on New York account against this deposit. Another element is the charge for interest while the gold is in transit. This depends upon the rate of interest and the duration of transit. The improve- ment of ocean shipping has considerably diminished this charge. If as is generally the case the rate of interest in New York is higher than in London it would cost more to ship a given quantity of gold from New York to London than in the contrary direc- tion. This among other things explains why the GOLD EXCHANGE KATES 53 upper and lower "gold points" are not as a rule equi- distant from the mint par of exchange. The more easily the foreign gold is made available for monetary use in the country in which it is received the smaller will be the divergence of the gold point from the mint par. Any obstructions placed upon this transfer will increase the divergence. Let us sup- pose for example, that all banks are under strict gov- ernment supervision and are allowed to hold only domestic gold coin as reserve. The foreign gold must then be transformed into domestic coin before it can be used for monetary purposes. Coinage may be gratuitous, in which case there is no added expense except the loss of interest during the delay of manu- facture into coin. This is added under such circum- stances to the cost of shipping gold to that comitry. If, as not infrequently happens, there is a small charge say one fourth of one per cent to cover the costs of coinage, this too must be added to the cost of ship- ping gold. 15. Gold shipments from New York. — The follow- ing description of a shipment of $1,000,000 in gold from Xew York to London is taken from Dean Jo- seph French Johnson's "]Money and Currency" and will serve as an example of how a shipment of gold was made under normal conditions and will illustrate the many small factors which enter into the compu- tation of costs. During the last quarter of the nineteenth century the cost of shipping gold from New York to London fell from 54 INTERNATIONAL EXCHANGE three to two cents per pound sterling. The charges for freight and insurance both declined, while the increased speed of transatlantic liners reduced the loss on account of interest. The following figures, showing the cost of shipping $1,000,000 in gold from New York to London, were fur- nished by the representative of one of the largest New York banking houses: Invested in fine bars, 23,220,000 gr. (48,375 oz.) $1,000,000.00 Assay office premium on bars, 4 cents per $100 400.00 Freight, 5/32 per cent 1,562.50 Insurance, 1/16 per cent 625.00 Packing and cartage . . 70.00 Total outlay $1,002,657.50 The Bank of England's "price" of gold varies from 77s. 9j/2d' to 77s. lOi/^d. per ounce, English standard, 916^ fine. The mint coins an ounce of gold, English standard, into 77s. lOj^d.; but the Bank of England, with which it is the custom of bullion owners to deal, usually pays a fraction less than this sum, thus saving itself from loss of" interest while the bullion is being coined. It is assumed below that the bank pays 77s. lOd. per ounce. 48,375 oz. fine — 52,772.7 oz., 916 2/'3 fine. 52,772.7 oz. @ 77s. lOd £205,374 Deduct sundry expenses 4 Net receipts in London £205,370 Cost of sovereign (1,092,657.50 -4- 205,370) ^.8822 Mint par in United States 4.8665 Cost of shipment per sovereign $ .0157 The reader will notice that no loss on account of interest is included in the foregoing. The New York banker who furnished the figures held that no such item was involved, for he sold sterling exchange as soon as he made a ship- ment, and so was never out of money in consequence. If we include interest for ten days at three per cent ($835.54) we raise the cost of the shipment to $.0197 per sovereign. GOLD EXCHANGE RATES 55 16. Avoiding gold shipments. — The principal ob- ject of exchange transactions is to avoid the transfer of money from place to place and the machinery of exchange operations is largely directed to that end. The early days of the war with the increased risk and expense of transferring gold, gave rise to various expedients which may in modified form be adapted to peace conditions. The usual method was to deposit gold in the debtor country for account of the creditor country. A part of the reserve gold of the Federal Reserve banks found safe repository for many months in the vaults of the Bank of England. The Bank of Eng- land accepted gold in Ottawa as equivalent to a ship- ment of gold to London. The Argentine Republic, Japan and other countries had gold deposited for their account in New York and London. Some more definite agreement along such lines among the finan- cial interests seems to be a not unlikely future de- velopment which will avoid still further the costs of shipping gold. 17. Reading the exchange rates. — Within the limits fixed under normal conditions by the gold points, exchange varies. Unless a man is directly con- cerned in the business of foreign exchange the in- terpretation of the exchange rates published in the papers usually escapes him. Few iren are familiar with the mint par of exchange which is the basis on which actual rates are judged, and these parities are not always given when actual rates are quoted. 56 INTERNATIONAL EXCHANGE There are two ways in which exchange can be quoted, fixed and movable exchange. When ex- change is fixed the foreign unit is expressed in terms of the domestic unit. Thus, for example, if the price of a pound sterling were quoted at $4.87 it would mean that this sum must be paid for each pound and that exchange would be above par. When on the other hand exchange is movable its price represents the amount of foreign money which can be purchased for a given quantity of domestic money. Thus be- fore the war the exchange quotations on francs meant the number of francs which could be purchased for $1.00. The par was 5.18 18 francs. If exchange was quoted at say 5.10 francs, exchange was at a premium; if it rose to 5.25 exchange was at a discount. In other words in fixed exchange the rise or fall of the quoted price varies directly with the premium or discount, but in movable exchange the rise or fall of the quoted price is inversely as the premium or dis- count. 18. Exchange quotations. — The newspapers gen- erally give exchange quotations in two columns. The first column (b) gives the price offered by buyers, and the other (s) gives the sellers' price; one ex- pressing the demand and the other the supply. The first column gives the lowest quotations — the buyers naturally offer as low a price as possible, while the sellers try to obtain the highest price — but the real or trading quotation is generally somewhere between the two. There are two classes of quotations; the GOLD EXCHANGE RATES 57 posted rate, which is used principally for small amounts, and the actual or wholesale rate, used be- tween bankers and brokers for large transactions. As a rule, however, the rate for very large trans- actions is a matter of individual negotiations owing to the frequent change in conditions during the day. Furthermore, the rates are seldom announced in time to be of much use except to show the general trend of exchange. The American method of quoting dollars and cents per foreign unit (fixed exchange) is so simple that it renders exchange quotations self-explanatory^. Canadian foreign exchange quotations are governed by the New York exchange market and differ only to the extent of the premium or discount on New York funds in Canada. Quotations given by the press lack uniformity. The method adopted by the Federal Reserve Bulle- tin of quoting per hundred units has advantages, as it not only permits fine shading if necessary, but can be read either as the dollar value of one hundred units or the cent value of one unit. At the beginning of 1920 a successful campaign was started in New York by some of the members of the Foreign Exchange Club with the object of plac- ing French and German quotations on the same basis as those of other countries. This marks the begin- ning of a movement on the part of the leading New York banks and exchange brokers to simplify ex- change procedure, which will go far to dispel some of 58 IXTERXATIOXAL EXCHANGE the mystery which has hitherto been unnecessarily thrown around exchange transactions. In the whole range of business mathematics nothing more confusing or awkward can be found than the former franc quotation. It was the only movable exchange rate among the quotations. It fluctuated by five-eighths of a centime and close quo- tations were based on the subtraction or addition of sixty-fourths of 1 per cent on the dollar amount. There was nothing scientific or practical about this method, and it merely enabled some unscrupulous dealers to take advantage of the uninitiated public. People who dealt only occasionally in French ex- change were prone to overlook the rule "Buy high, sell low," and unconsciously compared competitive rates on the basis of fixed exchange. "Buy low, sell high, the better the bill, the higher the rate." A broker for instance who offers to sell a draft on Paris for Fes 10,000 at 5.18% would in many cases obtain the business against a quotation of 5.19%. The latter price looks the higher to the customer, but it is of course the better quotation by $2.32 in this par- ticular transaction. If the same customer were sell- ing francs he would, with the same reasoning, prefer to sell at 5.193/g. 19. Range of quotations. — A study of the normal equivalents of foreign units in the following table shows an almost steady progi^ession in value from about 18 cents to 53 cents, with only one exception, sterling with its larger unit worth $4,866. Sterling GOLD EXCHANGE RATES 59 quotations range from 4.75 to 4.90, advancing by 5 100 of a cent per pound, or as it is called 5 points per pound. The other quotations advance by steps of .01 cent, or one cent per 100 units, thus 18.01, 18.02, 18.06 and so on. The last column shows the profit made on $1,000 for every advance of .01 cent, the profit on 1,000 foreign units being, of course, 10 cents for each advance of .01 cent in the quotation.^ Par Value Ordinai-y Profit per Country Unit in Dollars Range $1,000 Latin Union Franc .193 18 to 20 cents 51.8 cents Austria-Hungary Crown .203 20 to 22 " 49.2 " Germany Mark .238 22 to 25 " 42. ". Scandinavian U Crown .263 26 to 28 " 37.3 " Holland Florin .402 39 to 41 " 24.9 " ^I^^^-'^^ - 1 Silver ] . . 1 South America Dollar [ fluctuating i 41 to 50 " f 22. Japan Yen .498 50 to 53 " 19. Russia Rouble .515 50 to 53 " 10. Great Britain Pound 4.866 4.75 to 4.90 02. 20. Fijced and movable exchange. — When foreign exchange is quoted in the home currency per foreign unit, it is called fixed exchange; for instance, ex- change on London is quoted in Xew York in dollars and cents per pound sterling. The latter is the fixed basis. The value of the pound fluctuates in dollars and cents — the higher the quotation the higher the cost of the foreign unit. When the rate is quoted in foreign currency per home unit it is called movable exchange ; for instance, exchange on Paris is quoted in London in francs and centimes per pound. The fluctuation is expressed 1 The best tables for general use are to be found in "Foreign Exchange Tables" by E. D. Davis, Minneapolis, and "Foreign Exchange Explained and Simplified" by Howard K. Brooks, Chicago. Both of these books cover the whole range of the foreign exchanges. For sterling, Hartfield's "^'Sterling Conversion Tables" is the most comprehensive. 60 INTERNATIONAL EXCHANGE in the foreign currency — the higher the quotation the lower the cost of the foreign unit. The United States and Canada quote in fixed ex- change (dollars and cents per foreign unit) tho for large transactions with France and some other couu; tries movable exchange was formerly used almost exclusively. A homely illustration may make the difference between those two methods of quoting clearer. Sugar and other commodities, like fixed ex- change, are sold at so many cents per pound, or per hundred pounds, and the higher the price quoted the less sugar (or foreign money) you will receive for a dollar and therefore the dearer the exchange. Sugar, like movable exchange, is also sold at so many pounds for the dollar (as was the case with French exchange) and the more sugar (or francs) quoted for a dollar the cheaper the exchange. Fixed exchange : cents per foreign unit. Rule, buy low, sell high, the better the bill the higher the rate. Movable exchange: francs per dollar. Rule, buy high, sell low, the better the bill the lower the rate. Rule for fixed exchange. — Buy low, sell high, the lower the rate the more foreign money received. The bet- ter the bill the higher the rate. How many francs can be bought for $1,000 when the rate is 19.3 cents per franc.^ $1,000 ^19.3 =Fcs 5181.35. How much will drafts for the following named amounts cost? Fes 5181.35 at 19.35 cents =5181.35 X19.3 =$1,000. Mks 4,000 at 24 cents =4,000 X. 24 =$960. Rule for movable exchange. — Buy high, sell low, the GOLD EXCHANGE RATES 61 higher the rate the more foreign money received per dollar. The better the bill the lower the rate. How many francs can be bought for 8900 when the rate is 5.16 J^ per dollar.^ 5.16875 X900=Fcs 4651.87. TMiat is the value of a draft on Paris for Fes 5 ,000 when the rate is Fes 5.16>^ per dollar.^ 5,000 --5.16875=967.35. 21. Premhim and discount. — Those countries which are fortunate enough to have a monetary unit of the same wxight and fineness in gold have no con- versions to make, and do not require any exchange tables. Among these countries are the United States and Canada with the dollar in common, Great Britain and her colonies with the pound sterling, and the European countries with the franc or its equivalent. Fluctuations in exchange rates in these countries are quoted at either so much per cent discount or pre- mium, or, as in the case of London and Australia, so many units per so many units, as £98 for £100. In the former case, where the percentage is small under normal conditions, these rates correspond exactly, a premium in one country corresponding to the dis- count in the other country or vice versa. As the per- centage in premium increases how ever, it is necessary to allow for a difference which becomes very marked as the rate increases. In the case of the United States and Canada, for instance, the normal range of the exchange does not exceed 1/16 of 1 per cent, and a premium on Xew York funds in Canada of 1/16 w^ould mean that Canadian funds in Xew^ York ^vould 62 INTERNATIONAL EXCHANGE be at 1/16 discount. The corresponding discount of a premium of ^ of 1 per cent, or twenty-five cents a hundred, would be .24936 per cent. Two per cent premium would correspond to a discount of 1.96078 per cent and 15 per cent premium to a discount of 13.04348 per cent. In other words 100 Canadian dollars in the United States would be worth 86.95652, and not, as might be supposed, $85.^ In these days of abnormal quotations the neglect to understand thoroly the above conditions may lead to loss in exchange transactions. 22. Exchange tables. — Exchange tables, like inter- est tables, are most convenient and useful tools, and tho formidable in appearance with their serried col- umns of figures, they are simple in operation and their compilation is merely a matter of multiplication. A book of exchange tables is really nothing more than a table of reciprocals and their multiples. All exchange tables give the same information tho some give it in greater detail than others — the number of foreign units for so many dollars and the number of dollars for so many foreign units, at various rates. As an example, we will compile a brief franc table for 1 The above can be put in the form of a problem. If you obtain 100 United States dollars for 115 Canadian, how much do 100 Canadian dollars cost? This resolves itself into the proportion sum. 100x100 115 : 100 : : 100: X — =86.96 115 or a discount of 13.04%. A card compiled by Mr. Patterson, giving the premium and discount parities per $100, is published by John W. Hartfield, Inc., New York. GOLD EXCHANGE RATES 63 the rate 19.24. This represents the value of a franc in cents and we must now find the value of one dollar ViT-r rlivT^inTI 1 = ^ IQTS; T?nc TVo m^o vir^Txr U> U.l\iaiUll, IQ'24. t^.J-OrityjUV -O, T T \^ U.J. \^ iAVy TT ready to compile our table as follow Rate 19.24 c^nts s: Francs per Dollars D oUars per Francs 100 519.73052 19.24000 200 1,039.5010 38.48000 300 1,559.2516 57.72000 400 2,079.0021 76.96000 500 2,598.7526 96.20000 600 3,118.5031 115.44000 700 3,638.2536 134.68000 800 4,158.0042 153.92000 900 4,677.7547 173.16000 Suppose we wish to find the value of 5642 francs at the rate 19.24 cents to the franc. The operation becomes one of addition: 5000 francs = $96^2.000 600 francs = 115.440 40 francs = 7.96 2 francs = .3848 $1085.7848 To obtain the value of $5642 the process would be similar. Using the other column: $5,000 = 25,987.526 francs, etc., etc. By continued multiplication of the too lines, this table can be extended indefinitely, but the above is sufficient to find the equivalent of any sum up to 1,000,000 francs or dollars. Our next table would be at the rate of 19.25, and sc on for every quotation that is likely to be required. 64 INTERNATIONAL EXCHANGE REVIEW Explain what is meant by the gold standard of currency. What is the mint par of exchange ? Explain the meaning of fluctuations of the actual rates of ex- change from the mint par. What determines the rates ? Why do rates of exchange tend to correspond ? What are the gold points } What is their significance and how are they computed ? How is exchange quoted.'' How do rates in fixed exchange differ from those in movable exchange.'' What are exchange tables ? CHAPTER V EXPORTS AND IMPORTS 1. Payments for exports . — As we have seen, the movement of merchandise is not the exclusive factor in the commercial relations of nations, which give rise to transactions in foreign exchange but it is none the less the dominant element in the balance which has been studied. The transactions to which this mer- chandise movement gives rise are therefore worthy of especial attention. In the adjustment of commer- cial accounts, bills of exchange are drawn with docu- ments attached. The chief of these documents is the bill of lading to which the others, consular certificates, insurance certificate and letter of hypothecation ^ are subsidiary. The nature of these documents needs no detailed explanation here, as the form and purpose of most of them have been fully explained in the Modern Business Text on '^Foreign Trade and Ship- ping." 1 A letter of hypothecation is a certificate attached to a documentary bill of exchange and signed by the drawer. It describes the nature of the shipment, etc., and states in effect (1) that the bill of lading is lodged as collateral security for the acceptance and payment of the draft; (2) that in case of dishonor the holder is authorized to dispose of the goods and apply the proceeds toward payment of the draft and the expenses incurred; (3) that the drawer holds himself liable for any deficiency, and agrees to pay same on demand. When an exporter sells a number of bills of exchange to a bank, a general, or blanket, hypothecation certifi- cate is given to apply to any and all bills of exchange purchased from him, xviii — 6 65 66 INTERNATIONAL EXCHANGE The method of using the commercial bill of ex- change can be most conveniently explained by means of a concrete example. Suppose a cotton merchant in New Orleans had sold a quantity of cotton to a Liverpool firm against draft with documents at- tached. The merchant would draw a sixty days draft in duplicate for the amount of the invoiced goods, say £10,000, and take it, with the relative documents at- tached, to his banker in New Orleans, who would credit him with $48,500 at the rate of the day which we will assume to have been $4.85. The merchant would have sold his cotton, received his money and would be ready for a new transaction. The New Orleans bank sent the original bill and documents to its London correspondent, the dupli- cates following by a subsequent steamer. What hap- pened in London to the bill depends upon its nature and whether the documents were to be surrendered on payment or on acceptance. If the documents were to be delivered on acceptance, the bill would become a "clean" bill and could be discounted in the London discount market and the proceeds placed to the credit of the New Orleans bank. If the documents were deliverable on payment only, acceptance of the bill would be obtained, but the documents would remain attached to the bill until matm^ty, unless the acceptor took up the draft under a rebate of interest for the unexpired time. In the case of an "acceptance" bill, the proceeds became available as soon as the bill could be accepted EXPORTS AND IMPORTS 67 and discounted. In the case of a "payment" bill the American banker could not count on having the amount available until the maturity of the bill, tho prepayment under rebate might have placed the funds to his credit long before that time. If the Xew Orleans bank had no London correspondent it would have sold the draft to its Xew York correspondent, who would remit it to London in due course. All obligations on such bills remain liable until payment. 2. The place of the transaction, — Paradoxical as it may seem it makes a considerable difference whether an American exporter sells in a foreign market or a foreign importer buys in the American market. In both cases an export of American goods follows, and in both cases there must be a payment from the for- eign country to the United States. The difference arises from the fact that in the first instance the American merchant obtains a foreign price for his wares, that is one fixed in a foreign market and ex- pressed in foreign money, while in the second case he obtains an American price fixed by his own market and expressed in dollars. The first case puts the bur- den, if any, of exchange fluctuations upon the seller, the second puts it on the buyer. In the illustration given in the preceding para- graph, the price was fixed in London and this is the usual rule in the sale of cotton. Where the price is fixed depends in large measure on the higgling of the market, in other words on whether the seller is more G8 INTERNATIONAL EXCHANGE anxious to sell than the buyer is to buy or the con- trary. When the United States exported wheat before the war it had to adjust its prices to the world's markets, and wheat sold abroad was sold at a foreign price. The United States competed with other wheat pro- ducing countries in those world markets. But during the Great War we might say that the markets came to the United States and foreign demand competed directly with domestic demand. The enormous de- mand of the Allies for food stuffs had to be satisfied almost wholly by the United States and the nations of the world bought in American markets and paid American prices for what they bought. Altho every shipment of goods to a foreign coun- try involves foreign exchange the exporter need know nothing of the intricacies of the latter if payments are made in his own money. If he gets the price agreed upon he can afford to leave to his customer any consideration of how the money is brought together. It will readily be seen that transactions with foreign countries are greatly facilitated when exporter and importer deal in the terms of money with which they are familiar and in amounts that are perfectly definite. Ten years ago London's ascendency in the trade and finance of the world gave it this transcendent ad- vantage over all competitors. It enjoyed this position by virtue of the fact that it was the center of the world's commerce, and it had acquired that position largely thru the fact that for generations it had main- EXPORTS AND IMPORTS 69 tained the integrity of its monetary system. ^ATiile other currencies may have fluctuated in value the world knew that a given number of pounds sterling always meant the same weight of pure gold. The war has shaken the supremacy of London by bringing an inconvertible paper money in its train. The im- pairment of the currency is less and its fluctuations less violent than in the Continental countries and the trade position of Great Britain compared with them has not changed. But in competition with the United States where the gold standard has been maintained Britain labors at present under disadvantages. America is less disposed than formerly to clear its foreign exchange transactions thru London. It demands more and more that they be settled in Xew York. That means that in the trade of the world the dollar is taking in part the place long occupied by the pound sterling, and that international obligations whether they are those of foreign governments or those of foreign traders are more frequently ex- pressed in dollars than was formerly the case. Let us examine how this dollar exchange affects the pay- ments made for American exports. 3. Financing foreign exports hy means of dollar credits. — ]Many goods are exported against dollar credits opened with some New York bank, and the exporter has a simple dollar transaction on his hands. Since 1916 dollar credits have issued in greater vol- ume than ever before and will no doubt continue to be more largely used. 70 IXTERXATIOXAL EXCHANGE In the first instance the effort to estabhsh dollar exchange was due to the desire to give trade with foreign countries as nearly the aspects of a domestic transaction as possible. The bankers of the United States have for a number of years been seeking to establish connections in foreign countries notably in South America with a view to familiarizing foreign dealers with dollar exchange. All these efforts have been immensely stimulated by the w^ar which threw foreign currencies into disorder. The primary motive in establishing dollar credits and dollar transactions has been to avoid loss thru fluctuating exchange with foreign countries. Let us consider the case of an American exporter, say, Mr. Brown of Baltimore who has sold a bill of goods to a customer in Paris. He advises the purchaser to arrange a credit in New York in dollars for the amount of the invoiced goods, to be paid on delivery of the bill of lading and relative documents. The buyer goes to his banker, specifies the amount and the terms of the credit re- quired, and the banker writes or cables to his New York correspondent to open a credit for so many dollars in favor of Brown. In this credit are set forth the terms in which Brown is to be allowed to draw the money, and the various documents which are to accompany the drafts. In due course Brown is notified that the credit has been opened. Accord- ingly, he draws a draft on Xew York and deposits it in his local bank. The draft is paid within a few EXPORTS AND IMPORTS 71 days and, as far as Brown is concerned, the transac- tion is closed. The Xew York bank having paid the draft and taken over the documents forwards them, debiting its Paris correspondent who opened the credit. If the customer of the Paris bank is of high financial stand- ing the bank will probably turn over the documents to him at once, even before full payment is made. Otherwise the goods will be stored by the bank on their arrival and released when payment is received. This is purely a matter of arrangement between the Paris bank and its customer and does not concern the American exporter or banks. In pre-war days the Paris bank might have been unable to arrange a dol- lar credit on Xew York and so issued instead, a credit on London in pounds sterling against either time or demand drafts with documents attached. In either case the effect is to make the matter of granting credit one between the purchaser and the Paris bank, rather than between purchaser and seller. This relieves Mr. Brown of any anxiety as to the payment. But in the first case he draws against a dollar credit in New York which is a simpler operation involving less cost than drawing against a pounds sterling credit in London. 4. Dollar acceptances, — Until the establishment of the Federal Reserve banks, American foreign trade had been financed chiefly thru the medium of letters of credit issued on London banks. Establishing a credit in London, and thereby providing an Enghsh 72 INTERNATIONAL EXCHANGE acceptance, was no reflection on the high standing of the New York banks; it was due to provisions of the National Bank Act, which prohibited national banks from doing an acceptance business. Further- more, the absence of an open discount market in New York was another serious obstacle to the free move- ment of foreign credit. This inability to finance for- eign trade, except thru London, was formerly a seri- ous handicap to the United States in its exchange relations with other countries. Spam, for instance, could never settle in dollars for imports from the United States because her imports from that country were paid for by credits opened in London, and these in turn had to be utilized to pay for credits opened in London in favor of the United States. Mr. Lawrence Merton Jacobs in *'Bank Accept- ances"^ referred ten years ago to this feature as fol- lows : As a result of the inability of our banks to finance im- ports thru the acceptance of time bills, American importers are, then, made dependent to a large extent upon London, and are required to pay London a considerable annual tribute in the way of acceptance commissions. This prac- tice not only adds to the importance of London and mili- tates against the development of New York as a financial center, but it at the same time works serious injury to our export trade. Since time bills cannot be drawn on our banks from foreign points against shipments of goods to the United States, there are consequently in such foreign countries very few bills which can be purchased for remit- tance to the United States in payment for goods which 1 Publications of the National Monetary Commission, Document 569. EXPORTS AND IMPORTS 73 have been bought here. In other words, under our present banking system our imports do not create a supply of ex- change on New York, for example, which can be sold in foreign countries to those who have payments to make in New York. This means that our exporters are also, to their great disadvantage, made dependent upon London. It means that when they are shipping goods to South America and to the Orient they cannot, when they are subject to competition, advantageously bill them in United States dollars . They , naturally , do not care to value their goods in local currency — that is, in the money of the coun- try to which the goods are going — so their only alternative is to value them in francs or marks or sterling, preferably the latter, owing to the distribution and extent of British trade, creating thruout the world, as it does under the English banking system, a fairly constant supply of and demand for exchange on London. When we come to bill our goods in sterling, however, it is at once seen that our exporters are obliged to take a risk of exchange, which is a serious handicap when competing T\ath British exporters. Our exporters who are to receive payment for their goods in sterling must previously decide on what rate of ex- change will make the transaction profitable. If, in an effort to safeguard themselves against a loss in exchange, they calculate on too low a rate for the ultimate conver- sion of their sterling into dollars, their prices become un- favorable compared to those made by British exporters and they lose the business. If they do not calculate on a sufficiently low rate they get the business but lose money on the transaction thru a loss in exchange. The disadvantages of which Mr. Jacobs speaks were those which prevailed at a time when gold freely circulated in the currencies of Great Britain, France and Germany. When that free circulation ceased dollar exchange proposed by him as a convenience became an absolute necessity. 74 INTERNATIONAL EXCHANGE Under the Federal Reserve Act, however, national banks are now permitted to accept drafts based on the importation or exportation of merchandise and the Federal Reserve banks stand prepared to dis- count satisfactory paper created by this class of busi- ness. Under present conditions, the Paris bank, re- ferred to in the preceding section, would have issued a letter of credit instructing its New York correspond- ent to accept Brown's sixty- or ninety-day bill against delivery of the document, which bill after acceptance could be discounted by Brown's bank or its New York correspondent at one of the Federal Reserve banks. In other words the procedure would have been exactly the same as in the London case, except that the New York and not the London discount market would have carried the bill until maturity. The Federal Reserve Act has provided machinery for such discounting and the international financial world is making constantly increasing use of the fa- cilities offered. It is too soon to express any opinion as to the degree of permanence New York will attain as an international acceptance market. Nothing is more sensitive to restrictive conditions than interna- tional credit — it must ebb and flow freely or go else- where. Paternalistic in all things concerning banking and finance, the government has surrounded this con- cession to modern requirements with restrictions and definitions that may hamper that freedom of opera- tion which is so essential to an international money market. EXPORTS AND IMPORTS 75 5. Ecvport letters of credit. — In some countries where banking facilities are undeveloped, it was often difficult for the foreign customer to obtain a letter of credit on Xew York or London, or even to make a dollar remittance. In financing exports to such countries a different system was necessaiy in order that the American exporter could obtain his money without awaiting remittance from abroad. This sys- tem was based on the fact that in such countries bank- ing relations with London were more intimate than those with Xew York. Out of this fact grew a sys- tem of "export letters of credit" which were issued by an American banker without the intervention of a foreign bank. The service which they perform in financing exports can best be understood by a con- crete example. We will suppose that Williams of Chicago had sold a shij^ment of machineiy to a fii'm in Hondm^as, where in the absence of direct exchange facilities with Xew York, it would have been very difficult for the Honduras merchant to purchase a draft on Xew York. Under these circumstances Williams, who did not wish to wait until the remit- tance was received, would have gone to his banker with invoices, bills of lading and other documents and would have asked him for an export letter of credit. The shipment we will suppose was worth $10,000 and against this the Chicago bank would have given Wil- liams a letter of credit, authorizing him to draw at ninety days against its London correspondent for £1,800 or about 90 per cent of the amount of the in- 76 INTERNATIONAL EXCHANGE voice. This draft on London Williams would have sold in the exchange market in New York or Chicago, (letter of credit being his authorization.) In return he would have received the bulk of his money at the current rate of exchange for 90 day business. The documents would then be forwarded by the Chicago bank to his correspondent in Honduras who collects the whole amount $10,000. This sum was remitted in pounds sterling to London to the credit of the Chi- cago banker. Before the 90 day draft originally drawn would have matured there would have been received in London more than sufficient funds to re- tire it and neither the Chicago bank or its London cor- respondent would have had to disburse any money. The transaction would have been closed by the pay- ment to Williams by the Chicago banker of the dif- ference of the amount of the draft and the remittance from Honduras less any charges. As an alternative the Chicago bank would itself have drawn the draft on its London correspondent for £l,800 and have turned over to the customer the proceeds in dollars. This would have secured a better rate and the cus- tomer would have been saved the trouble of exchange transactions. Any country, or any point, which like London be- fore the war has direct relations with almost every part of the world, becomes the natural clearing house between countries whose exchange transactions with each other are limited. Under present conditions it is not likely that the EXPORTS AND IMPORTS 77 transactions would be carried on in this way. The American exporter would insist upon the payment in dollars. With the growth of banking relations be- tween South American countries and the United States he could not only insist that the merchant in Honduras should establish credit in Xew York, but the latter would be in a much better position to do so than would have been the case a few years ago. 6. Commercial letters of credit and importing. — Merchants who import goods into a country can settle for them direct either by remittance or by accepting a draft drawn by the foreign merchant but such methods are now seldom followed except in the case of minor transactions. The employment of letters of credit as a medium of settlement for import goods offers greater advantages than any other method of payment both to the exporter and importer. Altho of late public attention in the United States had been drawn rather to exports they are to a con- siderable and perhaps growing measure offset by im- ports, and the financing of such imports is a matter of great importance. Thru the use of commercial letters* of credit, the importer of merchandise is able to buy goods on a cash basis in any part of the world, even tho the actual pa\niient is deferred 60 or 90 days, which gives him a chance to dispose of the goods in the meantime. They insure for him a shipment ofl goods in the stipulated time, exactly as described in the credit. He is also able to order in advance goods to be manufactured according to his specifications and 78 INTERNATIONAL EXCHANGE requiremtnts without prepayment in advance, the letter of credit being sufficient security for the ex- porter. Formerly the majority of letters of credit were issued on London but the recent war and the Federal Reserve Act have brought out dollar credits issued on New York into more general use, especially for South American business. This is a growing business and will no doubt within a very short time become thoroly familiar to the American public. For a long time, however, such transactions were handled thru London and because this represents a somewhat more familiar relation and at the same time shows the part which a world ex- change center bears in the financing of exports and imports to which it is not directly a party we may fol- low the history of a credit established in London. 7. British acceptances under letters of credit, — Be- fore the Great War shook to its foundation the finan- cial supremacy of London its bankers granted enor- mous credits thruout the world which took two forms — acceptances granted under letters of credit or finance bills. The following illustration will show the operation of an acceptance under a letter of credit. When a merchant in Holland, France, the United States or any other country wished to buy goods in other parts of the globe he generally obtained the credit from a London banker directly or thru a banker in his own comitry. In the latter case, he instructed the foreign merchants from whom he had made his purchases to di'aw on the London banker at so many EXPORTS AND i:\IPORTS 79 months sight. Let us take the case of a tea merchant in Xew York, jNIr. Young, who had negotiated with Napier & Company, tea growers in Ceylon, for a con- signment of tea. Xapier & Company probably knew little or nothing about the financial standing of Young, and even if they had known it to be excellent they would not have been willing or able to wait for a remittance from Xew York for the shipment. Xapier therefore asked him to arrange a credit in London for the amount of the invoice say £1,000. Young went to his bankers, the Bank of Xew York and re- quested that he open up a credit in London in favor of Xapier 6c Company against 90 day bills with doc- uments attached. The Bank of Xew York then in- structed Barclay's Bank, their London correspondent accordingly, and Young was furnished with a letter which he could send to Xapier 6c Company stating that the credit had been opened in London at the terms set forth. On receipt of the letter Xapier & Company filled the order and placed the tea on ship board receiving the bill of lading therefor. Xapier & Company then drew a draft at 90 days sight for £1,000 and attaching the bill of Jading, insurance policy, invoice, etc., thereto, took it to their banker, the Bank of ^Madras, Colombo, who purchased the bill from them at the current rate of the day on Lon- don. Thus Xapier & Company obtained their money immediately. The Bank of ^Madras forwarded the draft and documents to its correspondent in London, The Bank of Conmierce, who without delay presented 80 INTERNATIONAL EXCHANGE it to Barclay's Bank, the latter accepting it, retaining the bill of lading and other documents. Later they are forwarded to the Bank of New York which was thus enabled to obtain possession of the tea when it ar- rived and either store it for their customer Young, on account, or deliver it to him on a trust receipt until he finally pays for it. 8. History of the draft in London, — To return to the draft which had now become an accepted bill with first class names on it and had an international cur- rency. It was salable in any country of the world because every country at that time found it neces- sary to remit constantly to London and every foreign bank had a London office or a London correspondent. The bill could have been held until maturity and the proceeds could have been placed to the credit of the Bank of Madras, but the usual course would have been for the latter to instruct its London agent, the Bank of Commerce, to discount the bill in the open market and place the proceeds to its credit. Or, the bill may have been remitted by the agent to another foreign center to settle some accounts there. In either case, the bill whenever returned to London at its maturity was paid to the holder on that date by Barclay's Bank altho in the meantime it may have been sold several times and passed thru one-half dozen hands. Barclay's Bank depended upon the Bank of New York to provide funds to meet the bill at maturity and would not have issued the credit unless it had had EXPORTS AND IMPORTS 81 confidence in the Bank of Xew York. The Bank of Xew York in its turn had confidence in its customer's abihty to reimburse it and of course it insured that the latter would provide the necessary funds for trans- mission to London in time to discharge the obligation. 9. Position of the ohligants on the hill. — To sum up the results of the transaction: 1. Young, the actual debtor, had the use of £1,000 for three months and yet he, himself, would probably have some difficulty in naming his actual creditor at any par- ticular moment. 2. Napier & Company in Colombo received their money as soon as the tea was delivered on ship board, tho as they had drawn the bill, they remain obligants until pay- ment. 3. The Bank of Madras bought the bill from Napier & Company and was only out of its money until the bill had reached London, was accepted, discounted and placed to the bank's credit. It, however, remained until the pay- ment of the bill liable as its indorser. 4. The Bank of Commerce advanced no money. It acted only as agent of the Bank of Madras in obtaining acceptance of the bill, selling it in the discount market and crediting the proceeds. Therefore, its name did not appear on the bill. For its services it received a com- mission. 5. Barclay's Bank was primarily liable on the bill as its acceptor, but as the Bank of New York had to provide the fund for payment the bank advanced no money on the transaction, it merely made a small commission for the use of its money. The above were all interested, directly or indirectly, in the bill, but not one of them advanced a single cent. The question still remains, "Who paid for the tea dur- XVIII— 7 82 INTERNATIONAL EXCHANGE ing the three months currency of the bill?" The an- swer is: "Those firms which discounted and purchased the bill in the open discount market of London." 10. The part London plays, — In much the same way, merchants in every country of the world had been accustomed to arrange credits in London for every other country in the world and for every con- ceivable class of goods. At the outbreak of the war it was estimated by Mr. Lloyd George that British tanks and acceptance houses were liable for over .£350,000,000 of these acceptances, the greater part of which had been discounted on the London market. Altho British signatures were primarily liable for this huge amount, it was not really for their own account, for they looked to those on whose behalf they had ac- cepted the bills, to provide the funds. The unprece- dented demand for sterling exchange at the begin- ning of the war was due to the attempt on the part of foreign obligants to provide funds for the maturing liabilities incurred by the British banks for their ac- count, and under their instructions. Exchange rates on London the world over rose far above the gold point. If Great Britain had insisted on these debts, it would have been impossible to obtain the necessary sterling funds except at a most rumous figure. Even if the English banks could have met the acceptances as they matured out of their own funds, disgrace if not ruin would have befallen a number of the foreign banks. It was to protect this vicarious liability of the English banks that a moratorium was proclaimed and EXPORTS AND IMPORTS 83 there is no doubt that this wise step saved the neutral countries, indebted to London, both financial loss and worry. Mr. Lloyd George in referring to this class of notes says : There was that amount of paper out with British signa- tures at that time. Most of that had been discounted. The cash had been found by British sources, and the fail- ure was not due to the fact that Great Britain had not paid her creditors abroad. It was due entirely to the fact that those abroad did not pay Great Britain. I think that it is very important from the point of view of British credit, to have that thoroly understood, for when the "moratorium" came, and there appeared something like a failure of British credit, it was not a British failure at all. It was because we could not get remittances from other countries. We had already paid, but it was vital to the credit and good name of this country that these bits of paper, which are circulated thruout the globe, with British names upon them, with names that have been associated with British trade and commerce — it was vital to'the good name and credit of this country, to its continuity of trade and its character, that they should not be dishonored. What really happened was that there was a complete cessa- tion of credit, a breakdown of the exchanges. It was ex- actly as if a shell had broken an arch in an aqueduct, and there was a cessation of the flow that had been going on before, and what we had to do was temporarily to repair the arch so that the flow should continue. Before the war the acceptances under such letters of credit were not, of course, confined to London, tho London was a dominant feature in such financing. They can also be drawn, and this was done to some extent, on other large financial centers such as New York and Paris. 84 IXTERXATIOXAL EXCHANGE 11. Dollar exchange. — The relative position of 'New York and London has been greatly shifted by conditions growing out of the war. American mar- kets no longer resort to London exchange because it is easier. Xot only that but in trade with places out- side of Xorth America there has been a great increase in the number of transactions financed thru such bills of exchange in New York. International conditions during the war forced upon New York the role of the world's financial center. As a result a large part of the world's trade which had heretofore been ex- pressed in terms of sterling came to be expressed in terms of dollars. For the continuance of this condi- tion the financial disturbance of European countries has been responsible and with the increase in facilities for such transactions which is constantly taking place and with the increased familiarity of the merchants of the world with them it is hoped that New York will retain what it has gained and make further advances. The Federal Reserve Bulletin for January, 1918, stated that the amount of outstanding acceptances representing the financing of foreign trade by Lon- don financial institutions was $500,000,000, while the amount of similar transactions in New York was $210,000,000. The factors which make for strength in the financial world both of London and New York will receive de- tailed consideration in a later chapter. At this point it may be remarked that there seems to be no reason why New York should not continue to finance Ameri- EXPORTS AND IMPORTS 85 can trade and also share with London in general for- eign exchanges if the present growth of the discount market continues. In his book on "Foreign Ex- change" (1920), Mr. A. C. Whitaker says: The one great factor upon which the development of New York as a foreign trade financing center depends is the main- tenance there of a discount market capable of absorbing {that is buying) the great volume of bills implied in this de- velopment, at discount rates tvtiich will aat]rage as LOW AS THOSE OF THE OTHER CENTER PREPARED TO OFFER SUCH A SERVICE, NAMELY LONDON. Otherwise the advan- tage will remain with the sterling long bill, because ex- porters will get more out of these bills for their shipments in the long run. 12. Exports and imports are complementary. — In analyzing the phenomena of international exchange as well as any other economic force it is necessary to isolate for the purpose of discussion the different fac- tors which enter into it. It should not, however, be forgotten that in the world of business they are inti- mately associated with one another and that one re- acts upon the other. In the explanation of interna- tional exchange the impression is frequently given that exports and imports are fixed by entirely ex- traneous considerations and that the other elements of exchange enter into the problem mainly for the purpose of compensating the disparity which may exist between exports and imports. While this is true in some measure it tends to oblit- erate the fact that there are compensating elements as between exports and imports wholly apart from 86 INTERNATIONAL EXCHANGE other considerations. The amounts of the exports and imports of a country depend not only upon home pro- duction and foreign needs but also are profoundly in- fluenced by the relation of prices in different com- munities. If, for example, the trade current should be such that in a given year one country should re- ceive considerable quantities of gold in payment for an excess of exports, this could not fail to have an effect upon the price levels. Prices would rise in the country receiving the gold and would fall in those which had lost it. As a result the latter on account of the high prices prevailing in the gold receiving coun- try would be much less disposed to buy from it and consequently the latter's exports would diminish. On the other hand, the lowering of prices in the countries which had lost the gold would make them good places in which to buy. In consequence, the gold receiving country would increase its imports from those coun- tries. Thus it will be seen that thru the medium of price changes there is always a tendency towards an equilibrium in the exports and imports themselves. The fact that gold shipments tend to bring about a dislocation of prices, which thru its influence on ex- ports and imports drops away with the need of gold shipments, that it tends to an equilibrium in the ship- ment of merchandise, is set forth by Dean Johnson in his "Money and Currency" in the following state- ment: The reader will notice that the movement of gold is the direct result of the differences in the price levels of Europe EXPORTS AND IMPORTS 87 and America, which represent differences in the value of gold. He must not suppose that the disparity of prices is so great as to attract the attention of the average man. Indeed, the average man is not in a position to detect it, for prices in the United States are quoted in dollars and cents, whereas in Europe they are quoted in sovereigns, francs, marks, etc. Nevertheless the prices, whatever the names used, show exactly the purchasing power of gold in the different countries. The large importer, or the arbitrager dealing in stocks and bonds, has at his elbow tables of figures showing precisely the relation between American and European prices. When there is a slight advance in the American price of a good, without any corresponding advance in the European price, he at once knows what profit he can make by purchasing abroad and selling at home. Variations in the rate of exchange are equivalent to changes in international price levels. A rise of sterling from $4.8465 to $4.8865 means a rise of almost 1 per cent in the cost to Americans of foreign goods, and it tends to lessen our imports just as would an actual rise in the prices of European goods. At the same time this rise of exchange from gold point to gold point is equivalent in foreign countries — or wherever sterling exchange is dealt in — to a fall of almost 1 per cent in the prices of all Amer- ican goods, for the purchasing power of the sovereign in the United States rises from $4.8465 to $4.8865. Hence American exports are stimulated. A decline of exchange quotations, of course, produces opposite effects, encour- aging imports into the United States and discouraging exports. When the money supply of the United States is relatively neither excessive nor deficient, the changes wrought in our foreign trade by the rise and fall of ex- change quotations are usually sufficient to prevent any movement of gold. But if the money supply is excessive, so that prices of certain goods having an international market are above the price level in other countries, then our imports of goods and securities, despite the discour- 88 INTERNATIONAL EXCHANGE agement of rising exchange rates, continue in excess of our exports until an exportation of gold becomes profit- able. On the other hand, if our money supply is relatively deficient, our exports will be stimulated until the large accumulation of sterling exchange forces the price down to the gold-import point. All these forces work automatically. No man engaged in the transactions imagines that he is doing anything to correct the monetary situation of the world or to cause an importation or exportation of gold. Altho each person is seeking personal profit only, he inevitably con- tributes to the general result. Thus, as a result of the operations of men in different countries, each acting inde- pendently in his pursuit of profit, the rates of foreign ex- change in each country are so adjusted that the value of gold in all tends to be the same, gold always moving from the country where prices are relatively high and toward the countries where prices are relatively low. • It thus appears that a country's balance of indebtedness is not determined by chance. If there were no inter- national transactions in debts or securities, no move- ments of capital from country to country, — in short, no invisible trade between nations, — then the exports and imports of merchandise would balance except when an excess of gold in one country lifted the price level there and brought about an exportation of the yellow metal. The invisible elements in the foreign trade of nations complicate the subject, but introduce no new principles and lead to no new conclusion. The balance of trade, so far as visible goods are concerned, may be more or less fortuitous , depending upon the crops and upon variations in the productive capacity of a nation; but the whole for- eign trade of a nation , by which is meant its imports and exports of goods and of debts, is subject to an immutable law. The exports of goods and debts always exactly equal the imports of goods and debts, except when a balance of indebtedness is created on one side or the other by differences in the value of gold in different countries. EXPORTS AND IMPORTS 89 This balance of indebtedness, it should be noted, is not the real cause of gold exports or imports, but is itself the effect of conditions which render imperative a readjust- ment of the gold holdings of nations. REVIEW Describe the commercial bill of exchange and its use. What is meant by dollar credits ? How are they used ? Describe dollar acceptances. Why were they not used in earlier days? Explain export letters of credit. How do letters of credit function in financing imports ? Describe the part played by the London Exchange market in financing imports before the Great War. Why do exports and imports tend to compensate and thus check gold movements? CHAPTER VI INVESTMENT AND ARBITRAGE 1. International finance. — Intimately associated with foreign trade in affecting the rates of exchange between nations is a group of operations which can be most conveniently designated as international finance. The first step in such relations upon which subsequent developments are based is the investment of one coun- try in the funds and securities of another. WTien this has been going on for a number of years there comes into being a body of securities with an international market. Speculative transactions in such securities known as arbitrage operations have similar effects on rates of exchange as do permanent investments. A second phase of international finance which is important in this connection is the growth of banking interests with wide reaching international relations. By drawing upon each other by means of long bills designated as finance bills, these banks are able to dominate the exchange situation. All these relations of international finance to the exchange market must receive consideration. 2. Investments. — It must be understood that the exchange of goods between countries involves not only goods for immediate consumption, but represents fre- quently the transfer of capital from one country to 90 IXVESTMEXT AND ARBITRAGE 91 another. In the case of the receiving country, imports are not immediately offset by exports of goods. In- stead the sending country receives various evidences of indebtedness or ownership in the form of bonds, stocks, etc. Such a transfer of capital is character- istic of the trade of all countries and if there are any without it they must be remote and inaccessible re- gions like Thibet. The effect of such capital investments upon the trade of a country^ may be considered. On the part of investing countries it first reveals itself in an excess of merchandise exports over imports, and in the coun- try where the investment is made in an excess of mer- chandise imports over exports. On this excess of goods (capital) received, interest must be paid and eventually perhaps the capital must be reimbursed. If we assume the stream of investment to become frozen, the importing country must henceforth pro- vide in its exports for interest and capital repayments. Hence its exports of goods must exceed its imports. But the stream does not freeze up after a single investment transaction has taken place. It is more likely to continue for a series of years. It is naturally the younger countries with undeveloped national re- sources and uncultivated economic opportunities which are the fields of such investment. In them cap- ital is relatively scarce. It commands a relatively high return and is inadequate to the task of opening up all the sources of wealth which such countries con- tain. This high rate of return attracts investors in 92 INTERNATIONAL EXCHANGE older lands where capital is plentiful and obtains a low rate of reward. The prospects of profits in American and Canadian railroads, in Mexican mines, in Russian oil wells, in Brazilian coffee fields and rub- ber plantations, in Argentine cattle ranches, in South African gold fields and Australian sheep farms, have drawn from the careful investors of Western Europe notably in Great Britain and France, hundreds of millions, even billions, of dollars which have been in- vested in these and similar enterprises. Concerning the value and benefit of such invest- ments Sir George Paish, perhaps the foremost au- thority on the subject, wrote in a report to the United States Monetary Commission as follows: Most of the new countries are endowed by nature with almost unlimited natural wealth which can be made avail- able for consumption by the expenditure of a relatively small amount of labor and of capital. In proportion to their natural resources the new countries possess but a small supply either of labor or of capital and they attract supplies of both from the older countries. The construction of railways across fertile prairies opens up great tracts of virgin country to cultivation at a very small expenditure both of effort and of money. The rapid expansion of agriculture which ensues gives to the new countries a large amount of agricultural produce to ex- change for the goods of the other lands and to pay in- terest upon the capital borrowed. The introduction of large sums of capital into the new countries for railways and other purposes causes, during the period of its intro- duction, large imports of manufactured goods into the countries borrowing the capital and as a consequence the imports of these countries largely exceed their exports. Aiter a time the new countries increase their production INVESTMENT AND ARBITRAGE 93 of foodstuffs and raw materials so largely that they are able to provide a much larger proportion of the capital they need for themselves and they obtain the goods they require from other countries to an increasing extent by exchange of their own production and less by capital bor- rowings. I calculate that capital wisely expended upon new railways thru districts containing fair agricultural and mineral resources brings about an annual production of wealth much more than equal to the total amount of capital spent upon the construction of the railways, a rate of production which could not possibly be secured if capital were not provided for railway construction. The capital needed for the direct development of agricul- ture, for mining, for house building, for manufactures, and for retail trade is chiefly provided by the inhabitants of the new countries themselves . Nevertheless , a portion of the capital required for these purposes is also provided by the older countries. 3. Foreign investments in the United States.— During the nineteenth century the United States of- fered the principal foreign field for the investors of Great Britain, and a few of the Continental countries. Apart from a loan of $2,000,000 floated in London in 1836 by the Baltimore and Ohio Railroad, most of the investment of British and other European capital in the United States w\^s, before 1850, placed in state and municipal bonds. But beginning in the fifties down to the middle of the eighties enormous amounts of for- eign capital were absorbed in the development of the railway systems of the United States. ]More recently some of the larger industrial enterprises have drawn upon European markets for capital. The rapid development of the wealth of the United 94< INTERNATIONAL EXCHANGE States in the last generation has supphed from local sources most of the capital needed for development of her enterprises. Investors in Europe in search of larger returns than the home market afforded have therefore turned their attention to other fields. For several years before the Great War there had been no very notable accretions of foreign investment in the United States, but the body of outstanding obliga- tions inherited from earlier days was very large. The estimate for 1909, in the report before mentioned, is fuller and more complete than any other. It may be summarized as follows : American Securities Owned Abroad. Million Dollars Great Britain 3,500 France 500 Germany 1,000 Holland 750 Belgium, Switzerland, etc 250 6,000 As a partial offset against this vast sum the report estimated one and a half billion dollars invested by Americans in JNIexico, Cuba and South America. 4. United States a creditor nation. — These esti- mates were generally accepted at the time as sub- stantially correct tho a few thought that the total was nearer four billion than six. Whatever the size of this investment in 1909 it is probable that the pur- chase of American securities on the London market INVESTMENT AND ARBITRAGE 95 and their transfer to Xew York with a consequent re- duction of America's indebtedness to foreign coun- tries had begun even before the outbreak of the Great War. One of the early financial results of the war was the transfer of large quantities of these securities to American holders. In the early stages of the con- flict these securities were largely used to meet Brit- ain's demands for war materials. Thru enormous loans made chiefly by the govern- ment and to some exten^ by private interests to Euro- pean countries during the war, the situation became reversed. From being a debtor nation, the United States became a creditor nation. Foreign securities of all kinds are now familiar features of our stock ex- changes and financial papers. 5. International securities. — ^^One result of this transfer of capital is to internationalize certain securi- ties. They are as familiar on the stock exchanges of foreign lands as on those of the land of issue. In 1909 Sir George Paish tells us, the American securities of all sorts listed on the London Stock Exchange had a nominal value of nine billion dollars, and according to his estimate given in the preceding paragraph more than one third of this amount was owned in Great Britain. With such a wide range of securities bought and sold on the European exchanges it is evident that there as well as here they could become the object of speculative transactions as well as of * 'permanent" in- vestment. We have now to examine the important 96 INTERNATIONAL EXCHANGE effect of such speculative transactions upon the rates of exchange. Such deahngs are usually known as arbitrage operations. 6. What is arbitrage? — Arbitrage, or as it is some- times called, indirect exchange, is a term applied to any transaction which takes advantage of differences of prices for the same article in different markets. Arbitrage is thus defined in the Century Dictionary: "The calculation of the relative value, at the same time at two or more places of stocks, bonds or funds of any sort, including exchange, with a view to taking ad- vantage of favorable circumstances or differences in payments or other transactions." This definition should include gold and, in a general sense, any other commodity. Wheat, for example, may be sent from one place where it is relatively cheap to another where it is relatively dear; this is arbitraging in wheat. High prices in one market induce shipments from markets with low prices and this process constantly tends to equalize prices generally. 7. When arbitrage is transacted, — Arbitrage trans- actions are confined entirely to large financial centers^ such as London, New York and Paris. The work calls for expert knowledge and a close study of finan- cial conditions, as it is essential that the arbitrageur keep in daily, if not hourly, touch with his foreign correspondents, in order that they may be prepared to carry out a transaction without delay. A recent article in the New York Financier says: INVESTMENT AND ARBITRAGE 97 In conducting such operations it is essential that the banker shall be advised, thru the cable, of the varying conditions of the markets abroad. In such markets as Paris and London, where the exchange transactions are always large, rates often fluctuate sharply and conditions change frequently. Consequently, tho the situation may be favorable one day it may suddenly become adverse, necessitating some modification of the method of arbi- traging. Moreover, it frequently happens that after a successful negotiation has been effected by a banker as the result of private information, his competitors may be ad- vised of the favorable conditions prevailing and they also may draw in a similar manner. Hence each operator seeks to obtain for himself alone all possible information regarding changes which are likely to affect his business. Sometimes a banker may find, upon calculation, that it will be profitable to conduct arbitraging of exchange be- tween three or more points; in such cases the conditions at each of the points must first be ascertained and calcu- lations have to be made with the utmost care. Occasion- ally in drawing bills the banker, in order to take advantage of arbitraging operations, will transfer credits, thru the cable, from an adverse center to a point favorable for his purpose. Indeed there are very many ways by which arbitraging can be profitably conducted by bankers having the requisite facilities and the necessary skill for such op- erations. It will be observed that operations in arbi- traging of exchange require the services of men of the largest experience; hence the business can be conducted to advantage only in most thoroly equipped offices. 8. Parity, — A parity is the price at which a bill should be quoted in order to compare it with the quo- tations for similar bills elsewhere. To make this com- parison it is of course necessary to express every quo- tation in a common form. Care must also be taken XVIII— 8 98 INTERNATIONAL EXCHANGE to bring quotations for long bills to a demand basis, by allowing for stamps and interest. If the Xew York parity on Paris had been 5.1895,^ on the old basis of francs per dollar as against the actual rate of 5.16% in Xew York for Paris checks, an opportunity for arbitrage profit of 2.075 centimes per dollar would have been offered. On $100 this would have amounted to 40 cents, and on $48,754.56 to $195. Bankers who engage in arbitrage transac- tions generally construct a parity table for ready ref- erence between the more important exchanges. The following is an example of such a table, showing pari- ties in dollars, francs and sovereigns. Similar tables may be made for sterling, marks and dollars, for francs, marks and dollars, etc. £1 = 25.20 25.21 25.22 25.23 25.24 25.25 .$1 $1 $1 $1 $1 $1 ^.85 5.1959 5.1979 5.20 5.2021 5.2041 5.2062 4.851/^ 5.1932 5.1953 5.1973 5.1994 5.2014 5.2035 4.851/2 5.1905 5.1926 5.1947 5.1967 5.1988 5.2008 4.853/^ 5.1879 5.1900 5.1920 5.1910 5.1961 5.1982 1 Attention is again called to the fact that a fixed exchange rate in one country is movable exchange in another, and both methods are used in arbitrage transactions in order to effect comparison. Paris quotes francs per dollar (i. e. fixed exchange to her but movable ex- change to New York), and it is necessary to convert one or the other in order to compare. The examples in this chapter are based upon normal conditions, those of pre-war business, and the tables and calculations are given as they were used at that time. To convert the table on this page from mov- able to fixed exchange at New York is a matter of simple arithmetic and is most easily done by dividing the New York quotation for £ sterling 4.85 by the London quotation for francs, as-————, leading to the result Zo.^0 100 francs = .$19,245 -f or nearest commercial rate $19.25. INVESTMENT AND ARBITRAGE 99 If the Xew York quotation for sterling was $4.85 and the London quotation for francs 25.20, the Xew York parity quotation for francs would be 5.1959; if the market rate differed from this there would be an opportunity for arbitrage. Conversely, given the two franc quotations, the table shows the parity of the pound sterling in Xew York, or, given the sterling and franc rate in Xew York, the table shows the parity quotation of francs in London. Intermediate rates can be arrived at by interpolation. For in- stance, in the example given in Section II, the sterling rate is -1.8560, the nearest quotation in the table is for 4.8550 — a quarter cent making a difference of .0026 centime (5.1905 — 5.1879) in the quotation. There- fore, -^X .0026 =.0010 centime deducted from 5.1906 5.1895. The table is calculated by dividing the value of the sovereign in francs by its value in dollars, thus ^'^^^^ = 5.1895. 9. Parity in stocks. — Parity, when apphed to a stock, means the price which is its equivalent when quoted in a different market. For instance, the Lon- don price of a stock exceeds the Xew York price of the same stock by about 21^ or 3 per cent, after the exchange rate and the London method of quot- ing American stocks ($5 to the pound) are taken into consideration. With a cable rate of 4.87l/^ the London parity of Xew York stock at 68 would be 69.75. 100 INTERXATIOXAL EXCHANGE ■y.r -^T •, London Quotation X rate of exch. or 69.74 X 4-8714 co N. Y. parity = : z = d8. T J .. New York quotation X 5 68 X 5 an r-'A London parity = R,te of exchange ^^ 1^^ = ^^' '^• In commodities, the prices at two different centers are at parity when the difference represents only the actual cost of transportation, insurance and interest. 10. Chain rule, — Most of the calculations in arbi- trage transactions can be put in the form of simple equations, and require only correct reasoning for their solution. A quick tho mechanical method of calcu- lation is called the chain rule. It consists of arrang- ing the terms of the exchange of the various currencies under consideration, in such a manner that the re- quired equivalent, or parity, is easily obtained. A study of the following example will make the method clear : Berlin check rate on New York is 95 cents per 4 marks, Berhn check rate on London is 20.5 marks per £l. Find the parity of the sovereign in New York. How many x = b $x = £l if b = c £l = 20.5 marks and c = d Mks. 400 = and d = 10 X 1 X 20.5 X 9-5 "^ ^ =.^.86875 1 X 400 The last term is always in the same currency as the unknown quantity, or first term. It will be noted that these quotations are arranged in such a manner that the denominations are in sequence like the links of a chain; hence the name. The value of the unknown INVESTMENT AND ARBITRAGE 101 quantity (x) is then taken as equal to a fraction, the quantities on the right-hand side forming the numera- tor, and those on the left-hand side, the denominator. The product of the numerator divided by that of the denominator will give the required answer. "Chain rule" is applicable to all kinds of exchange and mer- cantile calculations. How many dollars (x) = £l If the weight of £1 = 123.274 grains standard gold If 12 grains of standard gold =11 grains of fine gold And if 232.2 grains of fine gold = $10 1 X 123.274 X 11 X 10 X = —-^ = $4.86656 1 X 12 X 232.2 ^ 11. Simple arbitrage. — The rate of exchange be- tween two or more places corresponds or tends to cor- respond. In a preceding section it was shown how the exchange rate between two places is almost auto= matically adjusted. Similar influences in the form of arbitrage were brought into operation to synchronize the exchange rates the world over. There was thus a certain sympathy or relation between all foreign ex- change quotations. The quotations in Xew York for exchange on Berlin or Paris were largely influenced by the price of sterling exchange. If the price of marks in Xew York should fall to a point where there would be a profit in an arbitrage transaction, the de- mand for drafts on Berlin, by those who wish to make this profit, would almost immediately force the mark 102 INTERNATIONAL EXCHANGE quotation up again. Similarly New York, while a debtor to England with consequent high sterling rates, may be the creditor of France or other countries in Europe, and drafts on these countries are remitted to London and thus tend to improve (i.e., lower) the rate of sterling exchange. When only three places are involved, the transaction is called simple arbi- trage. To give a concrete case of simple arbitrage: Sup- pose a banker in New York had the following data before him: London check rate in New York. . . . .$4.8560 per £ Paris check rate in New York Fes. 5.16J^ per $ Paris check rate in London Fes. 25.20 per £ A brief calculation or a glance at his table of pari- ties showed that there was an opportunity for a profit- able arbitrage in francs between London and New York. He therefore sold a draft on Paris for Fes. 252,000 at o.lQ'/g and with the proceeds bought a draft for £10,000 at 4.8560 per <£, at the same time cabling his London correspondent to purchase a draft for Fes. 252,000 at 25.20 per £, or better, and send it to Paris to the credit of his account there. This pur- chase cost £10,000 and was provided for by a draft for the same amount remitted from New York. The banker's position was then as follows: Sale of francs 252,000 at 5.16 J^ $48,754.56 Purchase of draft for £10,000 at 4.8560 to cover purchase of Fes. 252,000 in London at 25.20 48,560.00 Profit $194.56 INVESTMENT AND ARBITRAGE 103 AVithout using any of his own capital and without any expense except the cost of a cable and a small commission to his London and Paris correspondents, the banker made a profit of over $190. The result of this and similar transactions made at the same time by other New York bankers would be to lower the New York rate for francs by increasing the supply, and to raise the London rate by absorbing the sup- ply, thus tending to equalize rates in those interna- tional exchange centers that might have been in- volved. 12. Compound arbitrage. — The foregoing example shows the simplest form of arbitrage, but it is typical of such transactions as they are normally carried out. The banker might have found it more profitable to provide cover for his draft on Paris by remitting marks to Berlin and purchasing his francs there, or he might have instructed his London correspondent to purchase and remit a draft to Berhn with instruc- tion to the Berlin bankers to remit francs to Paris. In the first instance he simply substitutes Berlin for London in the transaction, but in the second instance he would operate both thru London and Berlin; four places are involved, and the transaction is known as compound arbitrage. The study of arbitrage operations is both interest- ing and instructive. The following transaction will bring out some of the underlying principles more clearly : 104 INTERNATIONAL EXCHANGE PROBLEM: It is desired to transfer $100,000 from New York to London on the basis of the data given in the first column. Which method of remittance should be selected? It is first necessary to bring every quotation to a com- mon form; for example, how many dollars equal £l . Care must be taken to bring quotations for long bills to a check basis, allowing for stamps, etc. The lowest parity in dol- lars will be the cheapest method of remitting to London, but the dearest return (remitting from London to New York), conversely the highest parity, is the dearest re- mittance and the cheapest return: Factors: Calculation. $ Price of £1 Check 'A Berlin check in New York, $Xz=:£l check Mk. 4 = 95 cents 1 = 20.5 Mk. Berlin check in London, 4 := .95 £ = Mk. 20.5 New York check in Berlin, X = $4.8687 $4.8687 $1 = Mk. 4.21 $X = £1 check Berlin check in London, 1 z=z Mk. 20.5 £l = Mk. 20.50 4.21 = $1 C New York rate on Vienna, X = .^.8693 $4.8693 20.30 cents per kronen $X = £1 Vienna check rate on Lon- £10 = 240.171/2 don, 240.171/2 kronen per 1 = 20.30 cents £10 ." D London check in New York, £10 = .^.8755 $4.8755 $4.8760 $4.8760 E Cable transfers to London in $4.8795 less .0028 New York, $4.8795 (7 days' interest 3%) London discount rate, 3% $1.8767 F London 60-days draft in New $4.85 plus .0251 York, $4.85 (63 days' interest 3%) and stamps .0024 ^.8775 G New York check in Paris, $X = £1 check $1 = Fes. 5.I61/4 1 = 25.2 fcs. Paris check in London, 5.1625 =z $1 £l = Fcs. 25.20 X= $4.8813 ^.8813 INVESTMENT AND ARBITRAGE 105 H Paris check in New York, $X = £1 check $1 = Fes. 0.15% 1 = 2o2 fc. chk. Paris check in London, 5.15625=.$! £li=Fcs. 25.20 X = .$i.8872 ^.8872 A study of the above calculation shows that the cheapest method of remittance would be thru Berlin; a pound sterling costing $4.8687. The transfer could be made either by forwarding to London a check on Berlin or by instructing the Berhn corre- spondent to draw on Xew York in favor of London. The sterling equivalent of $100,000 on this basis would be £20,539:3:0. The dearest method of remittance is via Paris, the difference between the Paris and the Berlin rates be- ing 1.85 cents per £, or $375 on a transfer of $100,000. The sterling equivalent of $100,000 on this basis would be £20,461 :6 :0. It should be noted that as the Paris method of remittance is the dearest, it is the cheapest return and would therefore be selected for the transfer of money from London to Xew York. 13. Arbitrage in gold. — Arbitrage transactions in gold and silver are of a great variety but they are all founded on the idea of sending bullion to some point where it can be used to buy exchange cheaply on some other point. The one best known of these is the so- called "triangular operation," in which gold is shipped to Paris or some other European market for the pur- pose of buying exchange on London. The process is as follows : The gold is shipped to Paris, and exchange on London is there purchased with the proceeds. 106 INTERNATIONAL EXCHANGE This exchange is remitted to London for the credit of the American bank shipping the gold; the balance so created offsetting a demand draft drawn by the latter on London. The following are the details of an ac- tual shipment: 48.500 ounces bar gold .955 fine at $20.5684 $997^567 Freight, i/g per cent $1,247 Insurance, 41/2 cents per $100 450 Interest 6 days at 2 per cent 333 Assay office charge, 4 cents per $100 400 (From time gold is shipped to Paris until the drafts on London can be sold) Cartage and packing 60 Com. in Paris 250 2,740 $1,000,307 Bank of France buys gold .995 fine at fcs. 3419.81 per kilo (rrr 106.3705 francs per troy ounce) 48,500 ounces at fcs. 106.3705'= fcs. 5,158,969 Fcs. 5,158,969 at 25.10 = £205,536 £205,536 at 4.8670 = $1,000,342 Profit $ 35 The following are conditions under which there is practically no profit or loss: New York Exchange on London 4.8670 Paris Exchange on London , .25.10 Money in New York 2% REVIEW What is meant in general terms by international finance ? Describe the effect of capital investments upon balance of ex- ports and imports of goods. To what extent was the United States before the war indebted to European countries for capital investments.^ Explain relation between investment and arbitrage operations. What is arbitrage and what may it include? INVESTMENT AND ARBITRAGE 107 What requirements are necessary in the work of an arbitra- geur r Define a parity. Give an example. What is meant by parity in stocks ? Show, by examples, the difference between simple and com- pound arbitrage. What is the essential idea in gold arbitrage? CHAPTER VII FINANXE BILLS 1. Definition of a finance hilt — A long bill of ex- change drawn by a banker or financial house in one country on a banker in another against securities in the hands of the latter is generally called a "finance bill." The privilege of drawing such bills enables bankers to anticipate a change in the rate of exchange and also to tide over a period of high exchange which otherwise would necessitate a shipment of gold. When properly used it is an important factor in in- ternational exchange and serves not only as a cheap and efficient corrective to high rates, but aids in the development of the production and trade of the world by rendering credit more fluid and leveling money rates. There is a wide diversity in the definitions which are given of a finance bill. Franklin Escher defines it as "an unsecured long bill of exchange drawn by a banker in one country on a banker in another coun- try and sold for the purpose of raising money." Other authorities are inclined to include all long bills originating between bankers, whether secured or not. The latter is perhaps the more general understanding of the term and the following definition is suggested as comprehensive: 108 FIXANXE BILLS 109 A finance bill is a long bill of exchange, secured or other- wise, drawn by a banker in one country on a banker in another, the funds for the payment of which at maturity must be provided by the drawer. When a Xew York banker had a satisfactory draw- ing arrangement with his London correspondents he was more or less independent of market conditions, and even if there was a scarcity of commercial bills on the market, he w^as in a position to create a supply of bills at a stated price. He was reasonably sure that he would be able to buy exchange at a lower figure to meet his obligations before their maturity, as a high rate of exchange brings out a large supply of finance bills resulting in a lowering of the rate. Mr. George Clare in his book on "Foreign Exchange" says, "The bidding need only be raised a centime or two to tap an almost inexhaustible source of supply — that of bankers' drafts." In other words, if the remitter cannot obtain a ready-made bill, he need only pay a little more and have one made to order. 2. Finance hill for New York account. — The most common occasion for the use of finance bills is to an- ticipate a fall in the exchange rates. For instance, under normal conditions, during the summer months, the rate of exchange for sterling is generally high in Xew York. It drops gradually until the fall, when large shipments of cotton and wheat result in heavy offerings of sterling exchange. Before draw- ing a finance bill, it is necessary for the Xew York banker to make arrangements with the accepting 110 INTERNATIONAL EXCHANGE bank in London as to the amount, terms, etc., of the accommodations. Such arrangements are general, applying to a series of transactions, or specific, apply- ing to a single transaction only. Suppose the rate at the end of August some years ago was 4.88 for de- mand bills, and a banker, A, desirous of anticipating the probable drop in exchange in the fall, had ar- ranged wilh his London correspondent, B, against securities deposited with him, for a credit of £10,000 by way of a sixty-day draft on London. A would draw a draft on B at sixty days for £10,000, which he could either ( I ) sell in New York at the sixty-day rate for bills or else (2) send to London to be dis- counted and placed to his credit there, and then sell his own sight drafts against this credit. In either case, he would have the use of the proceeds in New York until the maturity of the bill, when he must be prepared to place funds with B to meet it. 3. Method of using finance bills. — It will be noticed that B did not advance any money; he lent his name to A and the London discount market provided the funds. The advantages and disadvantages of this procedure may be summed up in illustrations: 1. A would sell his sixty-day bill in New York if he could obtain $4.8523 per pound sterling or better. This rate is arrived at as follows: Demand rate for sterling 468. 1 Less, 63 days' interest at 3% (being the London mar- ket rate for prime bankers' bills) 2.527 1 Prior to the war, interest and stamps used to be calculated on the basis of $485 to the £100, but owing to the wide fluctuation they are now frequently calculatc^l on the actual rate itself. FINANCE BILLS 111 Stamps 1/20 of 1% 244 2.771 Per £100 485,229 or $4.8523 per pound sterling. The sixty-days bills for £10,000 should therefore net him ^8,522.90 A employed these funds in New York for sixty days at 4%, earning 323.49 $48,846.39 Seven days before the bill matured A purchased a demand draft for- £ 10,000 which he forwarded to London to provide for the payment of the bill. By this time exchange had fallen as he anticipated and was at 4.85, so that he was able to buy the covering draft for 48,500.06 A's profit (from which must be deducted B's commission of probably 1/3 of 1%) was therefore .$ 366.39 There is, of course, the risk that exchange might not fall at the end of October as anticipated, or that the interest rates in Xew York might not be main- tained above 3 per cent. 2. If A sent the sixty-day bill to London and immedi- ately sold a demand draft against the remittance, the transaction would work out as follows: Amount of 60-days draft £10,000.00 Less interest at 37f £51.781 Less stamps, 1/20 of 1% 5.00 56.78 Net proceeds in London £ 9,943.22 A would thus be in a position to sell his demand draft for the above amount and provide himself with funds in Xew York, £9,943.22 at $4.88=$48,522.90, the same amount as realized in ( 1 ) by the sale of the sixty-days bills itself in Xew York. The net proceeds, £9,943.22, are taken as the amount of the demand draft for illustrative purposes ; in actual practice the draft would have been drawn in 112 INTERNATIONAL EXCHANGE round figures, £10,000. The same result would be obtained, thus: £10,000 demand draft realized in New York $48,800.00 From which must be deducted the London charges for in- terest and stamps, £56.78 at $4.88 277.09 $48,522.91 If, at the maturitj^ of a finance bill, it was not con- venient to collect and remit the relative loan, it was generally possible to provide the necessary funds to meet the maturing bill by the sale of another bill. 4. Loan of a finance hill. — The last example shows that the New York banker assumed the risk of there being a rise in the rate of exchange before the trans- action had been completed and the acceptance in Lon- don retired by a sterling remittance. So far as the actual borrower was aware, the loan is an ordinary loan in American currency ; he had no means of knowing that there is any question of for- eign exchange connected with the transaction. He has borrowed say $50,000 at two months at 4 per cent, but with his bank the case is different. It loaned the proceeds of a sixty-day bill on London and at its maturity would have to purchase a demand bill or cable for £10,000 at the current rate of exchange. The price paid for the bill determines the gain or loss in the transaction. If exchange rates went down as anticipated a good profit on the transaction might be made, but if the rate rose, the price to be paid might mean an even break because of the wiping out of all profit, or if the rate went high enough, an actual loss. FINANCE BILLS 113 Bank A could eliminate this risk by loaning the bill of exchange instead of the dollar proceeds, and charg- ing a commission instead of a fixed rate of interest; the borrower thus assuming the risk of a rise in the exchange rate. The borrower in this case, instead of receiving a loan of $50,000, would be handed A's sixty-day draft on London for £10,000. This, he would immediately sell for dollars, but when the time for repayment came, he would have to pay back not dollars but a demand draft for £10,000 which he would have to purchase at the current rate of ex- change. The banker makes a commission of about one-half of one per cent for sixty days and runs no risk in the matter other than the loaning risk to his customer. 5. A finance hill on London account. — Another form of finance bill was created when a London banker, desirous of taking advantage of a high rate of interest in Xew York, instructed his correspondent to draw on him for £10,000 at sixty days and lend the proceeds on the Xew York market. This the New York banker did and sold the bill in New York, investing the money. Neither banker employed his own money in the operation, the money being pro- vided by the London market where the bill was dis- counted. At the maturity of the loan, the London bank was placed in funds to meet its acceptance by tjie New York banker, or if conditions continued favorable the amount might be either renewed or re- loaned in New York. A transaction of this nature 114 INTERNATIONAL EXCHANGE may have been entirely on the account of and at the risk of the London banker, or it may have been on joint account, in which case both the risk and the profit were shared. 6. Other uses of finance hills. — Finance bills, both secured and unsecured, may be drawn regardless of the conditions of interest or exchange, purely for the sake of raising money. As a rule, finance bills have a reasonable excuse for their existence. It may be objected that this is a way of getting money which might be easily abused, but in practice this does not happen. The London market is, at all times, uncan- nily in touch with the position of both the drawer and acceptor and any attempt on the part of either to issue this class of bill beyond what he is legitimately entitled to on the basis of his business or financial standing, is promptly nipped in the bud, first, by demanding higher rates and finally, by refusing to take the paper. Either action is, of course, detrimental to the credit of the party concerned, and bankers and others who operate in finance bills are most careful to leave a large margin for safety in their use of the very sensitive dis- count market. It is plain from the above explana- tions that when many of these finance bills are drawn on London they will have a tendency to lower the rate of exchange by increasing the supply of sterling bills on the market. In these illustrations, London and New York have been referred to under normal conditions; finance FINANCE BILLS 115 bills, of course, obtain between other countries but to a much less degree. 7. Forward exchange. — Operations in 'forward exchange" have several points in common with finance bills; both anticipate fluctuations in the rate of ex- change and both involve a large element of risk. In its simpler and more commercial form, forward ex- change or "futures," as it is sometimes called, is a term used to express the buying or selling of foreign ex- change for future delivery. For instance, in July, a manufacturer in Canada accepts an order for goods to be manufactured and shipped to England before Oc- tober 15. Knowing from experience that a change in the rate of exchange in October might make serious inroads into his profits, he asks his bank to quote him a rate for the amount of his shipment, and contracts to deliver the bills of exchange to the bank in October. In this way the rate is definitely fixed, and the risk of a falling rate is eliminated. The bank can protect itself in two ways ; by selling its own bills to fall due in October in London, or by selling London exchange for future delivery. As far as the obligation is concerned both cases amount to the same thing, except that in the latter no money trans- action is involved. The decision of the bank is gov- erned by the rate of interest obtaining in London in July. It is obvious that dealing in forward exchange is not necessarily based on an actual prospective trans- action. Frankhn Escher, in his book, "The Elements ^ 116 INTERNATIONAL EXCHANGE Foreign Exchange," in reference to the making of money in dealing in "futures," says: As a means of making — or of losing — money, in the for- eign exchange business , dealing in contracts for the future delivery of exchange has, perhaps, no equal. And yet trading in futures is by no means necessarily speculation. There are at least two broad classes of legitimate operation in which the buying and selling of contracts of exchange for future delivery plays a vital part. Take the case of a banker who has bought and remitted to his foreign correspondent a miscellaneous lot of foreign exchange made up to the extent of one-half, perhaps, of commercial long bills w4th documents deliverable only on "payment" of the draft. That means that if the whole batch of exchange amounted to £50,000, £25,000 of it might not become an available balance on the other side for a good while after it had arrived there — not until the parties on whom the "payment" bills were drawn chose to pay them off under rebate. The exchange rate, in the meantime, might do almost anything, and the remitting banker might, at the end of thirty or forty -five days, find himself w^ith a balance abroad on which he could sell his checks only at very low rates. To protect himself in such a case the banker would, at the time he sent over the commercial exchange, sell his own demand drafts for future delivery. Suppose that he had sent over $25,000 of commercial "payment" bills. Un- able to tell exactly when the proceeds w^ould become avail- able, the banker buying the bills would, nevertheless, pre- sumably have had experience w^ith bills of the same name before, and would be able to form a pretty accurate esti- mate as to when the drawees would be likely to "take them up" under rebate. It w^ould be reasonably safe, for in- stance, for the banker to sell futures as follows: £5,000 deliverable in fifteen days, £10,000 deliverable in thirty days, £10,000 deliverable in forty-five to sixty days. Such drafts on being presented could in all probability FINANCE BILLS 117 be taken care of out of the prepayments on the commer- cial bills. By figuring with judgment , foreign exchange bankers are often able to make substantial profits on operations of this kind. An exchange broker comes in and offers a banker here a lot of good "payment" commercial bills. The banker finds that he can sell his own draft for delivery at about the time the commercial drafts are apt to be paid under rebate, at a price which means a good net profit. The operation ties up capital, it is true, but is practically without risk. Not infrequently good commercial "pay- ment" bills can be bought at such a price and bankers' futures sold against them at such a price that there is a substantial profit to be made. The other operation is the sale of bankers' futures, not against remittances of actual commercial exchange but against exporters' futures. Exporters of merchandise fre- quently quote prices to customers abroad for shipment to be made in some following month, to establish which fixed price the exporter has to fix a rate of exchange definitely with some banker. *T am going to ship so-and-so , so many tubs of lard next May," says the exporter to the banker, "the drafts against them will amount to so-and-so much. ^^^lat rate will you pay me for them — delivery next May?" The banker knows he can sell his own draft for May delivery at, say, 4.87. He bids the exporter 4.86^ 2 for his lard bills, and gets the contract. Without any risk and without tying up a dollar of capital the banker has made one-half cent per pound sterling on the whole amount of the shipment. In ^lay, the lard bills will come in to him, and he will pay for them at a rate of 4 .86j^, turning around and delivering his own draft against 4.87. Selling futures against futures is not the easiest form of foreign exchange business to put thru, but when a house has a large number of commercial exporters among its clients there are generally to be found among them some who want to sell their exchange for future delivery. As to the buyer of the banker's ^'future," such a buyer might 118 INTERNATIONAL EXCHANGE be, for instance, another banker who had sold finance bills and wanted to limit the cost of **covering" them. The foregoing examples of dealing in futures are merely examples of how futures may figure in every-day exchange transactions. Like operations in exchange arbitrage, there is no limit to the number of kinds of business in which * 'futures" may figure. They are a much abused institu- tion, but are a vital factor in modern methods of transact- ing foreign exchange business. REVIEW What is a finance bill ? Show, by an illustration, what arrangements a New York banker makes with a London bank before drawing a finance bill. Give an example of how a finance bill on London account is created. How does the London market prevent either a drawer or an ac- ceptor of finance bills from issuing them beyond the amount to which they are legitimately entitled? Describe an operation in forward exchange. CHAPTER VIII RATES OF INTEREST 1. Interest an important factor in exchange quota- tions, — The rate of interest at which the difference between long and short bills is calculated is based on the prevailing rate of the country on which the bill is drawn. This would not materially affect the situa- tion if the rates of interest were uniform all over the world, but rates of interest in different financial cen- ters vary considerably and these differences have an important bearing on exchange. Under normal con- ditions, international money and credit circulate most freely in the most attractive channels, and a rise in the interest rate in a foreign market will accelerate the flow of outside capital to that point, while a fall in the rate of interest will retard it. So, while demand and supply govern rates of exchange, the rates of interest at home and abroad react on these influences and affect demand and supply. Their combined effect causes the rates of exchange to fluctuate from day to day and thus the floating capital of the world is at- tracted from one center to another. 2. Long hills. — When we say that exchange rates between two countries usually fluctuate between the specie points, we refer only to the rate for demand or sight bills. This is sometimes called the pure rate of 119 120 INTERNATIONAL EXCHANGE exchange as it involves no time element except that required for the actual transmission of the draft. Assuming that the rate at Xew York for a sight bill or check on London is 4.8725 how would the value of a sixty-days sight bill be ascertained? As pay- ment in the latter case is deferred for sixty-three days (60 days + 3 days grace) it will be worth less than a demand bill by the interest for 63 days at the London rate. The calculation is based on the London rate of interest, because the holder of the bill in London can always discount it at the prevailing rate. Assuming that the market discount rate for prime bills is 3 per cent, the rate for a sixty-days bill would be arrived at as follows: Demand rate per £100 $487.25 Less 63-day s interest 2.52 Stamp 1/20 24 2.76 $484.49 corresponding to the nearest commercial rate, the fig- ure would be $4,8450. If, therefore, we know the rate of interest prevail- ing in foreign markets and the stamp taxes imposed by foreign countries, the rate for any long bill can readily be computed from the demand rate. 3. Bank rate, — In London, the bank rate is the minimum rate at which the Bank of England will dis- count prime three months' bills or advance money against approved securities. This rate has a direct relation to the foreign exchange rate and the move- RATES OF INTEREST 121 ment of gold. An increase in the rate would raise the value of money and attract gold from foreign cen- ters ; the lowering of the rate would tend to lower the value of money and cause its withdrawal. The Bank of England sometimes insures the effectiveness of the rate by borrowing money in the open market, thus denuding it of supplies. The Bank of England has been governed in its action in raising or lowering the rate by the relation which its reserve of gold bore to its deposits. This proportion was seldom allowed to fall below 30 per cent, while it sometimes rose above 50 per cent, the average normal condition was about 43 per cent. The importance of keeping the gold reserve intact was appreciated and it was most im- portant to the country, as the Bank of England is primarily a bankers' bank and in a great measure controlled the gold reserve of all the British banks. In Paris, the bank rate is that fixed by the Bank of France, in Berlin that of the Imperial Bank. In Xew York, the bank rate is the uniform rate of the banks as distinguished from the varying rates of the other lenders. 4. Market rate, — The market rate of discount, also known as the open market rate or private rate, in con- tradistinction to the official or bank rate, is the rate charged by bankers, bill brokers and others discount- ing bills of exchange. Because of competition it is usually a little lower than the bank rate, but as a rule follows the latter very closely. Clean bills drawn upon bankers are discounted at 122 INTERXATIOXAL EXCHANGE the private rate, while those drawn upon firms in good standing are generally discounted at about ^ per cent above the private rate. The Bank of England rate governs the rate of in- terest paid on deposits by the London joint stock banks. This rate is generally 1^ per cent below the Bank of England rate. 5. Retirement rate. — In cases where bills have documents attached, with instructions to accept pay- ment "under a rebate of ^/o per cent above the rate of interest allowed on deposits by joint stock banks," if the bank rate were 4 per cent the deposit rate would be 2^/2 per cent and the rebate rate three per cent. This is known as the "retirement" rate, and the bill is said to be taken up "under rebate" in order that the drawer may obtain possession of the relative goods be- fore maturity. Such bills are known as D/P bills (documents on payment) and are not discounted by English banks. 6. Iviportance of the Bank of England rate, — The movement of gold from one country to another, or even the probability of such a movement, is an im- portant factor in determining the rates of exchange on the countries affected. London, owing to the ex- treme sensitiveness of the Bank of England rate to gold movements in normal times is particularly inter- ested in its discount rate. Suppose, for instance, that in normal times, on account of a low sterling rate, Xew York commences to import gold from London. The Bank of England, seeing its stock of gold be- RATES OF INTEREST 1^23 coming too low, raises its official rate of discount, which is the term applied to the minimmn rate at which it will discount approved bills. The London market, whose rate is usually a little lower than that of the Bank of England, will probably rise in sym- pathy, but if it does not do so the Bank of England, by borrowing money in the open market, will force up the rate and the effect of dear money is soon ap- parent. The foreign monej^ markets, in order to take advantage of the higher interest rate in London, will allow their balances to accumulate there for invest- ment or will purchase bills on London. British mer- chants will decrease their imports and increase their exports. In this way the balance of payments grad- ually swings around again in favor of Great Britain. Exports of gold, therefore, cause sterling rates in Xew York and elsewhere to stiffen and, if the high rate is maintained sufficiently long, it will check the export and eventually induce an inflow of gold to London. Thus, the reserves of the Bank of England will again become normal arid the rate will then be reduced. The importance of the Bank of England rate in controlling international exchange and gold movements cannot be overestimated, and its effects are so far reaching that monetary conditions thruout the world are directly or indirectly influenced by it. The rate is fixed by the directors of the bank on Thursday of each week and tho as few changes as possible are made, the publication of the rate is al- wavs a matter of interest to the financial world. 124 INTERNATIONAL EXCHANGE The Bank of England is, at all times, fully pre- pared to make advances against satisfactory collat- eral, or to rediscount approved acceptances at its minimum rate of discount. Facilities of this nature naturally create a feeling of stability and confidence among the English bankers, and the protection and assistance at their command in times of emergency enable them to conduct their business on a smaller cash reserve basis than is possible by bankers in coun- tries without similar protection. 7. What the Bank of England rate effects, — It has been said that the Bank of England rate acts in nor- mal times as a barometer of the financial condition of the world and any features of political or economic significance are reflected by its course. Mr. A. W. Margraff^ in pointing out the impor- tance attaching to the fluctuation of the discount rate of the Bank of England states the various results which are effected as follows: The discount rate: 1 . Establishes the minimum rate at which the Bank of England will discount acceptable paper. 2. Fixes the rate of interest allowed by London joint- stock companies on short deposits, since this rate is one and one-half per cent under the Bank of England rate. 3. Determines the rate of interest allowed by London bankers on cash balances to the credit of foreign corre- spondents, keeping active accounts with them, in so much that this rate is usually }/2 to 1% below the Bank rate. 4 . Serves also to fix the rate of interest charged on cash 1 "International Exchange" by A. W. Margraff. RATES OF INTEREST 125 overdrafts, on running accounts, as debit balances are generally subject to the Bank rate, or Yi to 1% above, according to agreement. 5. Establishes the open market discount rate in Great Britain at which private bankers, London joint stock com- panies and discount houses will discount paper for local or foreign account, the rate ordinarily being from 34 to 3^2% below the Bank rate. 6. Governs the "Retirement Rate of Discount" on docu- mentary payment bills, which is the rate of interest re- bated to the drawee, or acceptor of a documentary pay- ment bill for the time from the date of retirement or pre- payment to the date of maturity of the bill, this rate being Y'f/o above the rate of interest allowed by London joint- stock companies for short-time deposits, which rate is based on the Bank rate as above. 7. Affects the value of all international bills of exchange as an advance in the Bank rate either advances the rate of exchange for a demand sterling draft in a foreign country or depreciates the worth of a long time sterling bill, as the interest rate for credit balances and the discount rate for long time paper are indirectly dependent upon the Bank rate. 8. Has the power of protecting the gold reserve held by the Bank of England and of checking any protracted movements of gold importations by foreign nations, in so much as an advance in the Bank rate adjusts the rates of foreign exchange to a point where operations of this nature become unprofitable. 9. Invites and attracts the deposits of foreign banks with London correspondents as an advance in the Bank rate to a figure in excess of the earning capacity at home induces continental money lenders to seek the London market for investment of their funds. 10. Indirectly has a tendency to depress or advance the values of stocks listed on the New York Stock Exchange — an advance in the Bank rate causing a decline in stock values, and a reduction in the Bank rate usually having U6 INTERNATIONAL EXCHANGE the opposite effect, because the values of stocks are largely dependent upon the monetary conditions obtaining in New York, and as New York bankers in periods of stringency nowadays resort to relieve the situation by issuing Finance Bills drawn upon English bankers, the Bank of England rate indirectly either facilitates or precludes their course of action. REVIEW What effect has the interest rate on exchange quotations ? What is the bank rate in London and what relation has it to the foreign exchange rate and the movement of gold? What is the bank rate in: France^ Berlin, New York? Discuss the market rate of discount; the retirement rate. Show how the Bank of England rate is an important factor in determining rates of exchange. CHAPTER IX BILLS OF EXCHANGE 1. Bills of eoocliange, — It has already been indicated that the fundamental purpose of a draft or bill of ex- change is to settle debts and thus avoid the necessity of shipping gold. To satisfy a debt in one country by offsetting the amount against a debt due in another country, leaving only the difference, if any, to be re- mitted in gold, is no less effective a means of payment than a double shipment of money, and is obviously more economical. In this way, the difference or bal- ance of payments as it is called, is settled by the debtor nation shipping gold or arranging a postponement of 2)ayment by means of finance bills or other corrective transactions. A check is merely a demand bill of exchange drawn on a bank. Bills of exchange or drafts, as we shall now call them, assume a variety of forms and tenor, but, no matter what their ciu'rency or form, the un- derlying principle is the same, namely, that of a cred- itor drawing a draft upon an actual or constructive debtor. • Bills of exchange can be broadly divided into two classes according to their currency, known as short and long exchange. 128 INTERNATIONAL EXCHANGE Short exchange includes cable transfers, checks, bank drafts and sight or demand drafts. Travelers' checks, money orders and other forms of non-com- mercial remittances come under this heading. Long exchange includes all drafts with a currency of eight days or over, such as thirty and sixty-day commercial bills and bankers' long bills. 2. Sight drafts. — Checks and demand or sight drafts, whether drawn on a bank or a commercial house, have no days of grace for payment and must be paid on presentation, or protested. As a rule the sale of demand exchange is contined principally to banks, commercial drafts being usually drawn on time. The rate or price of demand or sight exchange, un- der modern conditions, may be considered as the basic rate on which all rates for time exchange are calcu- lated. The old usance or sixty-day rate, obtaining between London and New York, on which rates used to be calculated is a relic of the days of slow-going sailing vessels. In practice, of course, given the rate of interest, the rates of exchange are quickly con- verted from one to the other. Under normal condi- tions, a sight draft drawn in New York or London will be presented and paid six to eight days after nego- tiation in New York, and is therefore, as regards time lost in transit, on a par with a shipment of gold. The difference between the export gold point and the demand rate is represented by the freight, insurance* charges, etc., on the shipment of gold. It is, of course, necessary for banks transacting a regular foreign ex- BILLS OF EXCHANGE ]2ii ^ ^ O O ' I ego XVIII-IO 130 INTERNATIONAL EXCHANGE change business to maintain balances with the various foreign correspondents against which they can draw demand drafts and sell cable transfers. Funds for these balances are provided by remitting quantities of different kinds of exchange which have been purchased from customers and others. Demand and other short date items are credited immediately ; acceptance is ob- tained of the longer date items which are discounted and credited by the correspondent as occasion requires. The selhng of demand exchange and cables against remittances of the same is the most elementary form of foreign exchange. A banker, for instance, pur- chases a demand draft on London for £10,000 at the normal rate of exchange, say $4.86, and remits the bill to his London correspondent; at the same time he sells his own check or checks on London for the same amount at, say, $4.86/2; the two transactions reach London by the same mail and offset each other. Apart from the expense of conducting his business, he clears $.50 on the transaction and is not out of the use of his money for more than a few hours at the most. If the checks sold by the banker miss the mails by any chance, the banker has the use of the money in London until the mail is received ; hence the importance of watching the mail service closely in exchange transactions. This illustration is, of course, elementary and bankers do not often make money this way; but it shows the principle on which foreign exchange transactions are based. Banks are con- stantly purchasing every kind of exchange and for- BILLS OF EXCHANGE 131 o "w eg o <*^ o =: -s G s a: cs s. « > o « O n3 or s53 ^ OS ^ O :a 33HaKK0D JO xva xviavxvo shx «rt S' s &- 09 t« 5l o: 20 s o CD 8 -« ^. -s: :HXva XV 'Si « 3 KKOD JO laVXVO 3HX 132 INTERNATIONAL EXCHANGE warding it to their foreign correspondents by whom it is converted into an available balance. In any case there is constantly accumulating to the credit of the Xew York banker a balance against which he is able to sell exchange and cables and meet his maturing obligations. Under normal conditions, owing to the reliability of the mail service, a banker is able to esti- mate very closely the position of his London balance and as a rule receives a cable from his correspond- ent at the end of each day. 3. Cable transfers, — A cable transfer or "cable,'* as it is more generally called, is a transfer of funds by cable, no question of interest being involved as pay- ment is immediate. Apart from this a "cable" differs from a check only in the fact that the banker abroad is told by a cable, instead of by a written order or check sent by mail, to pay out the money. The cable dispatches should be sent the night before, or early on the morning of the day on which payment is due ; otherwise, owing to the difference of time between Xew York and London, the London bank will be closed and the payment delayed until the following day. As the money is received and paid on the same day, it is obvious that the banker must charge a higher rate of exchange for a cable than he would for a check, because he has the use of the amount of the latter while it is in transit. The mail time between the two points involved and the current interest rate at the paying point are the main factors which determine the difference in the rate of exchange between cables and BILLS OF EXCHANGE 133 demand drafts. The higher the rate of interest and the slower the mail steamer, the more the quotations diverge. With a demand rate of exchange at $4.86, an eight-day steamer and a London market rate at 4% per cent, the cable equivalent would be 4.8652, 4. 86+. 0052 (8 days' interest). These rates are ren- dered more or less divergent according to the supply of or demand for checks and cables respectively. 4. Unusual rates for cables, — It has already been noted that the outbreak of the European war raised cable rates on London to an unprecedented point. In his work on "International Exchange" Mr. A. W. Margraff summarizes the ordinary business conditions which produce abnormal rates as follow^s: 1. Flurries on the New York Stock Exchange with the incidental abnormal high rates for money, frequently in- duce New York bankers to sell their checks on London for amounts largely in excess of their cash credit balances in the hands of their London bankers, and enable them to relieve the stringency of the money market and at the same time obtain a higher rate of interest by loaning the money realized in selling their London checks. The manner of covering those checks prior to their pres- entation for payment in London is and can be effected only thru the purchase of cable transfers, and these operations when indulged in extensively, naturally create a brisk market demand for cable transfers, and fancy prices in many instances have to be paid. 2. Exceptionally high rates for London checks, caused by an unexpectedly heavy inquiry and a scant supply of commercial bills of exchange, might tempt the aggressive banker to avail himself of the high price by selling his checks on London short, basing his calculations on a de- cline in the price of exchange, during the transit of his 134 INTERNATIONAL EXCHANGE checks to a point where he can buy cable transfers in re- imbursement for approximately the same rate he sold his checks, and in that event he would have had the free use of the proceeds of his sale of checks in the interim for loaning purposes. Unforeseen circumstances often offset the calculations of the financier, and instead of the anticipated decline, the market has remained stationary or in fact had an advance and in the face of these conditions the many short sales of checks must still be covered by cable transfers at about any price the seller may dictate. 3. The fortnightly settlement days on the London Stock Exchange occurring about the middle and the end of each month influence also the price for cable transfers , and New York banking firms engaged in transactions in the London market frequently are called upon , especially in a wide and fluctuating market, to protect their operations by the cash payment on these days , of very large sums of money that are transferred by telegraph and result in a heavy demand for cable transfers. 4. There are many bankers not averse to having their foreign accounts show a debit balance at various times thruout the half-yearly account periods, and who thru a sentiment of pride and an implied request on the part of their European friends, always close their accounts on 30th June and 31st December with a liberal cash credit balance created in most cases at the last moment by the purchase of cable transfers. The demand for cable transfers thru this source is suflfi- ciently large to induce some bankers to establish large credit balances with their London friends during the months of June and December, thereby placing themselves in a position to sell cable transfers on 29th June and 30th December at the advanced prices which usually obtained then . 5. Long eocchange, — Long-time drafts may be divided into bankers' long bills and commercial long BILLS OF EXCHANGE 135 bills; both classes are drawn at sixty or ninety days after sight, except in special cases, when the time limit may be longer. Commercial long bills with or without documents attached are drawn on foreign debtors by merchants and exporters against shipments of goods abroad; they are usually purchased by bankers who remit them to their foreign correspondents for collection and credit and sell their own bills against the balance so created. When a bill of exchange is drawn for the exact value of the goods exported and has the bill of lading insurance certificates, etc., attached, it is known as a "documentary" bill of exchange. If no documents are attached to a bill, it is known as a "clean" bill of exchange. Bankers' bills are invariably clean bills, while commercial bills, unless drawn by a house of high standing on another of equal rating, are usually documentaiy. Bills of exchange and the accompanying docu- ments are usually drawn in duplicate. The originals are forwarded on, the first outgoing steamer, the duplicates are sent by the next mail. Sometimes the second bill of exchange is retained until a satisfactory^ sale can be made, in which case the maturity of the bill is based on the date that the first of exchange was accepted in London, accurately determined by the ar- rival of the mail boat. The second bill of exchange bears the name and address of the holder of the ac- cepted bill. Before payment the duplicate is at- 136 INTERNATIONAL EXCHANGE tached to the original. A bill of exchange may be taken up any number of times before it is due and be put into circulation between each payment, but once it is paid by the acceptor on its becoming due it cannot again be put into circulation. 6. Influence of the interest rate. — A bill drawn, say, on London at sixty days after sight is obviously not worth as much to the purchaser as a demand bill. He has to pay for a sixty-day bill on delivery, send it over to London, obtain acceptance, and wait sixty- three days after acceptance before the bill matures and is paid; in other words, there is sixty-three days difference between the currencies of a demand and a sixty-day bill. Should the purchaser find it incon- venient to await the maturity of the bill, he can in- struct his correspondent in London to discount it at the current rate, and have the proceeds placed to his credit. In all exchange calculations, therefore, the rate of interest is based on the current rates obtaining in the country on which the bill is drawn; this rate varies slightly according to the nature of the bill. The rates normally applicable to various classes of bills are, roughly, as follows: Clean bills drawn on bankers' private discount rate. Clean bills drawn on first-class firms — ^% above private discount rate. Bills, with documents deliverable on acceptance — %% below Bank of England minimum discount rate. Bills drawn at over sixty days sight, bear a higher BILLS OF EXCHANGE 137 rate of discount, as a rule, than the market rate for sixties, owing to the element of risk on account of the possible change in the discount rate during the cur- rency of the bill. It is obvious that if the London rate of discount happens to be higher than the Xew York rate, the purchaser of a sixty-day bill would probably prefer to allow the bill to run to maturity rather than discount it in London and use the pro- ceeds in Xew York. Conversely, if the London rate was the lower he would prefer to discount the bill and withdraw the proceeds for use in Xew York. From the foregoing it will be seen that the London rate has a powerful influence on the exchange market. The higher the rate of discount the greater the di- vergence between the rate of exchange on long and short bills on London. A change in the interest rates of either London or XeA^ York is immediately re- flected in the price of any bill. The conversion of a demand rate to a sixty-day rate includes an allowance for interest and British revenue stamps (1 shilling per £100). With a demand rate of 4.87 and a pri- vate discount rate in London of 3^ per cent, a banker's clean bill is worth 4.8385 as the following calculation shows : New York demand rate on London $487. per £100 less 63 davs' interest at3>^%. .2.93 Stamp duty V20% 24 3.17 $483.83 or the nearest commercial rate, $4.8385 per pound 138 INTERNATIONAL EXCHANGE sterling. Elsewhere it has been shown that exchange rates between two countries either correspond or tend to correspond; this applies, however, only to the de- mand rates. 7. Commercial long hills. — Commercial long bills are drafts drawn at thirty days or over by exporters on foreign customers, or upon banks abroad desig- nated by the latter. A bill of this kind is usually ac- companied by a bill of lading and other documents. Where a draft is drawn on a very good house abroad, or a bank, the documents are delivered upon the ac- ceptance of the draft. Such drafts are known as ''acceptance bills" or D/A. Where the drawee's standing is less well-known or where the merchandise is perishable, documents are delivered only on actual payment of the drafts. These drafts are known as "payment bills" or D/P. In the case of a draft marked D/A, the drawee can obtain possession of the relative goods as soon as he, or the bank representing him, has accepted the draft. If the draft be marked D/P, the drawee must pay the draft (less a rebate for any unex- pired time it has to run to maturity) before he can obtain the merchandise. When D/P bills are drawn against perishable goods they are invariably taken up "under rebate." Payment bills are not discount- able, even after acceptance, as they are liable to be paid any time before maturity and must, therefore, remain in the portfoho of the banker who presented them for acceptance. "Acceptance bills," on the BILLS OF EXCHANGE IBS' other hand, become clean bills after acceptance. They are discountable in the London discount market and may change half a dozen times before maturity. The purchase of documentary bills drawn by re- liable firms is a fairly safe operation, the buyer being protected by the bill of lading which is indorsed to him, but judgment should be exercised as regards the financial standing of the drawer and drawee, es- pecially in the case of ''acceptance bills," and consid- eration should be given to the nature of the relative goods. 8. Bankers' long bills. — Drafts drawn at sixty and ninety days sight, on foreign correspondents by bankers in the United States and Canada, form an important factor in international exchange opera- tions. These bills originate in the regular course of a foreign exchange business and are based on a variety of transactions. Many of them are thirty and sixty- day bills and are sold to customers of the bank, who prefer this method of remittance to that of purchas- ing demand drafts or cable transfers. Some arise from a desire to anticipate a change in the rate of exchange, while others represent purely financial transactions, such as placing a foreign loan in Xew York. These latter operations are explained in the rhapter on Finance Bills. 9. Bills of exchange that involve more or less risk. • — Concerning the risk incurred in the purchase of documentary exchange, A. W. Margraff in his book '^International Exchange" writes as follows; 140 INTERNATIONAL EXCHANGE Bills of exchange that may be purchased safely. — Bills ac- companied by documents covering staple, non-perishable merchandise can be readily resold in the market where con- signed in the event of forced sale by reason of non-accept- ance or non-payment by the drawees of the appertaining bill, and the inability of drawers to reimburse the purchaser of the bill upon demand for the amount originally paid them, plus expenses. The proceeds realized upon merchandise disposed of under forced sale would be applied on account of the amount of reimbursement demanded of drawers, and pro- vided the merchandise was of the nature just referred to, would almost liquidate the purchaser's claim against the drawers, and the small balance still due to the purchaser may be recovered with little difficulty from the drawers. If, however, they have failed in the meantime, then the purchaser would have a creditor's claim for such balance against the insolvent dravv^ers. The possibility of such a loss is very remote in view of the fact that the majority of drawers of bills of exchange (exporters) have all refused bills immediately referred to their own agents abroad for protection. Staple and non-perishable merchandise includes flour and other manufactured cereals such as corn meal, oat meal, hominy, etc.; farming implements, canned meats, fresh meats and other provisions, when the fresh meats and provisions are shipped in refrigerator cars and vessels of modern type, and warehoused in cold-storage plants upon the arrival at destination, if not immediately taken up by drawees. Bills involving more or less risk. — Bills accompanied by documents representing shipments of perishable merchan- dise, such as butter, cheese, fresh fruits, etc., that are liable to deterioration in quality, or to absolute loss, dur- ing transit. Bills with documents showing collateral security of live cattle, horses or other live animals, necessitating the ex- pense of help and feed during transit for the maintenance BILLS OF EXCHANGE 141 of life, as a refusal of such annexed bill would depreciate the value of the security, day by day, to the extent of such expense incurred. In addition to the liability of drawers and indorsers, if any, purchasers of documentary bills are secured by the financial responsibility of the acceptors on and after ac- ceptance until actual payment of the bills. The liability of drawers continues after the acceptance of bills, remains in force during the whole life of the bills and ceases only upon payment. The primary conditions of the desirability of the pur- chase of any bill of exchange depend upon the moral and financial standing of the parties thereto, and the liabilities just stated of the parties should be quite ample in the ma- jority of cases. Further, these bills possess another ele- ment of protection against a possible loss in this , that they are supplemented by documents covering salable mer- chandise with title continuing in the purchaser of the bills imtil payment at maturity, or retirement prior to matur- ity, of the respective bills of exchange. APPLICATION FOR COMMERCIAL CREDIT New York. GuARAKTY Trust Company of New York. Dear Sirs. Please issue for our account a Documentary Credit in favor of for £ drafts at . against cost of shipment of. from to In force until first day of Insurance effected in Kindly advise the Credit by Cable Mail Yours truly, FiGuaE 3. U2 IXTERXATIOXAL EXCHANGE Credit Xo o £ Sterling GUARANTY TRUST COMPANY OF NEW YORK New York, 19. . To the Guaranty Trust Company of New York, 33 Lombard Street, London. Gentlemen: A t the request and for account of we hereby authorize or an;i parties whose drafts you may he directed by. . . .writteii order, or by us, to accept under this credit, to value on you at for any sum or sums not exceeding in all Pounds Sterling (say £ Sterling) to be used as may direct for invoice cost of to be purchased for account of and to be shipped to a port in the United States The Bills must be drawn in prior to the first day of and advice thereof giren to you in original and duplicate, such advice to he accompanied by Bill of Lading filled up to order of the Guaranty Trust Company of New York (with copy of invoice) for the property shipped as above. All the Bills of Lading issued, except one sent to us by the vessel camiinq the cargo, and one retained by the captain of the said VPttsel, are to be for-iii'nrdcd direct to you. Copy of invoice, properly certified by the U. S. Consul to be forwarded to us by the vessel, also advice of each Bill drawn. And we hereby agree with the drawers, indorsers, and bona fide holders of Bills drawn under and in compliance with this credit, that the same shall be duly honored on presentation at your office in London. We are. Gentlemen, Your obedient servants. Guaranty Trust Company of New York, by Manager. N.B. Bills drawn under this credit must he marked Drawn under Guaranty Trust Company of New York Letter of Credit No dated for £ Insurance in order at Figure 4 . BILLS OF EXCHANGE 143 New York, 19 . . . To the GUARANTY TRUST COMPANY OF NEW YORK Gentlemen: Having received from you the Letter of Credit of which a true copy is on the other side, hereby agree to its terms, and in consideration thereof agree with you to provide in New York, twelve days previous to the Maturity of the Bills drawn in virtue thereof, sufficient funds in cash, or in Bills on London, satisfactory to you, at not exceeding sixty days' sight, and indorsed by , to meet the payment of the same with per cent commission and interest as hereinafter pro- vided, and undertake to insure at ^ expense, for your benefit, against ri^k of Fire or Sea, all property purchased or shipped pursuant to said Letter of Credit, in Companies satisfactory to you. agree that the title to all property which shall be purchased or shipped under the said credit, the bills of lading thereof, the policies of insurance thereon and the whole of the proceeds thereof, shall be and remain in you until the payment of the bills referred to and of all sums that may be due or that become due on said bills or otherwise, and until the payment of any and all other indebtedness and liability now existing or now or hereafter created or incurred by "*^ to you on any and all other transactions noio or hereafter had with you, with authority to take possession of the same and to dispose thereof at your discretion for your reimbursement as aforesaid, at public or private sale, without demand or notice, and to charge all expenses, including commission for sale and guarantee. Should the market value of said merchandise in New York, either be- fore or after its arrival, fall so that the net proceeds thereof (all ex- penses, freight, duties, etc., being deducted) would be insufficient to cover your advances there against with commission and interest, fur- ther agree to give you on demand any further security you may require, and in default thereof yon shall he entitled to sell said merchandise forth- with, or to sell "to arrive," irrespective of the maturity of the accept- ances under this Credit, being held responsible to you for any deficit, which , bind and oblige J^l'^^iJ, to pay you in cash on demand. It is understood that in all payments made by ^^ to you in the United States, the Pound Sterling shall he mlnilnted at the current rate of exchange for Bankers Bills in New York on London, existing at the Figure 5. X44 INTERNATIONAL EXCHANGE time of settlement, and that interest shall be charged at the rate of five per cent per annum, or at the current Bank of England rate in London if above five per cent. Should . anticipate the pat/ment of any portion of the amount pay- able, interest is to be allowed at a rate of one per cent under the cur- rent Bank of England rate. In case . should hereafter desire to have this credit confirmed, al- tered or extended by cable (which will be at "'^^{expense and risk), hereby agree to hold you harmless and free from responsibility from errors in cabling, whether on the part of yourselves or your Agents^ here or elsewhere, or on the part of the cable companies. This obligation is to continue in force, and to be applicable to all transactions , notwithstanding any change in the composition of the firm or firms, parties to this contract or in the user of this credit, whether such change shall arise from the accession of one or more new partners, or from the death or secession of any partner or partners. It is understood and agreed that if the documents representing the property for which the said Credit has been issued are surrendered under a trust receipt, collateral security satisfactory to the Company, such as stocks, bonds, warehouse receipts or other security, shall be given to the Company, to be held unlil the terms of the credit have been fully satis- fied, and subject in every respect to the conditions of this agreement. It is further understood and agreed in the event of any suspension, or failure, or assignment for the benefit of creditors on ^^ part, or of the nonpayment at maturity of any acceptance made by , or of the nonfulfilment of any obligation under said credit or under any other credit issued by the Guaranty Trust Company of New York on \, account, or of any indebtedness or liability on "^^ part to you, all obli- gations, acceptances, indebtedness and liabilities whatsoever shall there- upon, at your option then or thereafter exercised, without notice, mature and become due and payable. Figure 15. (Continuation) 10. Letters of credit. — There are two well-known forms of letters of credit : 1. Circular letters of credit, to be used by travelers and tourists. These are addressed to the foreign correspondent of the issuing bank in favor of the holder. 2. Commercial letters of credit, to be used in trade. These take the form of a letter addressed by a bank to a BILLS OF EXCHANGE 145 foreign merchant . authorizing him to draw on the issuing bank's correspondent in a certain place (generally a finan- cial center such as London or New York) for a specified amount representing the cost price of certain goods or- dered by the bank's customer, on whose behalf the credit is issued. The letter designates a time-limit and specifies that all drafts shall be accompanied by the relative in- voice, bill of lading, insurance policy, consular certificate, etc. Before issuing a commercial letter of credit the bank requires the customer to sign an application form (Fig. 3 on page 141) setting forth the par- ticulars and terms of the shipment and giving instruc- tion in regard to terms, insurance, etc., all of which are embodied in the letter of credit, wdiich is issued by the bank in four parts, namely, one original and three copies (these copies however vary but slightly from the original). 1 . The original is addressed to the foreign merchants in whose favor the credit is issued. This is handed to the customer, who forwards it to his correspondent. 2. A copy is addressed to the London or New York bank on which the credit is issued, authorizing it to protect the drafts against the credit when drawn in accordance with the terms and conditions thereof. 3. A copy of the original is delivered to the customer for his files. 4. A copy is retained by the bank issuing the credit. On the reverse side of the last two copies is a receipt, signed by the customer, incorporating an agreement regarding the basis on wdiich the bank is to be re- imbursed, and the amount of its commission (which varies according to the currency of the bill drawn). XVIII— 11. 146 INTERNATIONAL EXCHANGE The bank's rights in case of default in payment or other difficulties are also defined (Fig. 5). Commercial letters of credit are invaluable factors, and in the promotion of international trade and com- merce greatly facilitate the negotiation of bills of ex- change, not only in the import business of a country but also in the export business. Letters of credit, tho not themselves negotiable, render valuable service to commerce by facilitating the drawing and negotiation of bills of exchange thruout the world. REVIEW What are the two classes of bills of exchange and what does each include? How does a cable transfer differ from a check? Why are higher rates of exchange charged for it than for a check? What are the main factors which determine the difference in exchange rates between cable transfers and demand drafts? What conditions will tend to produce abnormal cable rates? What are: (a) commercial long bills; (b) documentary bills of exchange; (c) clean bills of exchange? Give an illustration of a clean bill and of a documentary bill. Describe the kind of bills of exchange which are considered safe to buy and those which involve risk. \^Tiat are the primary conditions which make the purchase of a bill of exchange desira- ble? CHAPTER X FOREIGN REMITTANCES 1. Non-commercial exchange, — Altho the greater portion of foreign exchange originates in commercial transactions, there is a constantly increasing volume of exchange business created by travelers and immi- gration. A steady stream of travelers and others leave the United States and Canada each year to visit Great Britain, Europe and other parts of the world, carrying with them the necessary funds for their ex- penses in various forms, such as circular letters of credit, travelers' checks, drafts and gold. The remittances of immigrants to their relatives and friends in their home lands amount to a surpris- ingly large figure in the course of a year. These re- mittances are generally made by means of drafts, foreign money orders, or by what are called mail re- mittances. For many years these two classes of foreign busi- ness were in the hands of foreign bankers who mado a specialty of the business of supplying banks, both in the United States and Canada, with the necessary forms and foreign machinery for issuing circular let^ ters of credit and selling travelers' checks. Gradu^ ally the larger banks both in the United States and 147 148 INTERNATIONAL EXCHANGE Canada felt the increasing pressure of their clients' requirements in this connection, and found it advis- able to establish their own systems of travelers' checks, etc. Practically every important bank has now direct correspondents in the principal cities of the world with W'hom they have made the necessary arrangements for the payment of circular letters, travelers' checks and the like. A comparison of the different methods of remit- tance and a description of the manner in which they are operated is interesting. 2. Principles underlying the issuance of drafts. — A demand draft or check is an unconditional order issued by one bank on another bank or banking firm asking the bank to whom it is addressed to pay a cer- tain sum of money to a specified person or institution. (See Figure 6.) In the case of a bank keeping an account in an- other country w^here the exchange value of the cur- rency is steady and for which rate quotations are easily obtainable, drafts are usually drawn in the cur- rency of that country and, after payment, are charged to the account w^hich the issuing bank keeps with its correspondent at the face amount. If the arrange- ment calls for payment of the drafts at par, the corre- spondent's commission (if any) is added to the face amount of the draft when charged to the account. Drafts are often made payable at the office of a third bank or banking firm for account of the issuing bank's correspondent. FOREIGN REMITTANCES 149 Drafts are also issued on correspondents with whom no account is kept. In such cases, cover-drafts in favor of the correspondent for the amounts invohei i^^^mmd&ixi^^mkoMc\^oxk '/'"''' ^/..^u i; . -< -..;;. vMiUANK.l.TI). ''L\vM:F.ni.K St. l.C'NKON.K.C. (hlicTt«ruirid'(iiiifsoauiuif^lcnrsforll, 'S^^ LoM>'>N.i;.t Figure 6. Draft plus commission, drawn against the issuing hank's ac- count in one of the large selling cities (London, Paris, Berlin, Xew York, etc.) are forwarded with the relative letters of advice, or the correspondent is re- quested to forward the paid draft to the issuing 150 INTERNATIONAL EXCHANGE bank's correspondent in one of these cities for re- demption. When a bank is requested to issue drafts on a coun- try for which it has made no draft arrangements, a sterhng draft on its London branch or correspondent was usually sold. Sterling drafts on London have been more easily negotiated than those drawn in other currencies, owing to the fact that the great majority of banks thruout the world have correspondents or ac- counts in that city, and the exchange rates for sterling were much steadier and more widely quoted than those for other currencies. To guard against loss in the case of countries in Africa, Asia or South America where silver units exist or the exchange value of the currency is subject to great fluctuations, drafts are usually drawn in sterling on the London branch or correspondent of the issuing bank and crossed "Payable at the drawees' buying rate for sight bills on London," or with a phrase similar in meanhig. The correspondent on whom such drafts are drawn pays them in local cur- rency at a rate of exchange which includes his com- mission and other charges, and afterward forwards them to London for redemption at the face amount of sterling. 3. Advices. — A letter of advice (Figure 7), au- thenticating the draft and usually containing the fol- lowing particulars, is sent to the branch or corre- spondent on vvdiom the draft is drawn: 1. Xumber of the draft FOREIGN REMITTANCES 151 2. Amount of the draft 3. Date of issue of draft 4. Name of payee 5. Name of bank at which drafts will be presented by bearer if other than correspondent drawn on (if THE NATIONAL CITY BANK OF NEW YORK OEPAHTMKMt NEW YOW^. MESSRS. LONDON CITY i MIOUND BANK. LTD, LONDON. E. C. DEAK SIRS: We b«g to advise having bsued the (ollowio^ drafts upon your goodsMves whicfc kindly protect t» our debit m account under advice. NyMBtR AMOUNT ORDER .C\ ^\^\ ^\^.^- CA^\^ „\\V ^VK,^^ \^.^ /->, \\ \x (^ ^ 1 > ' y Voun traly. FiGTTRE 7. Letter of Advice (Drafts) 152 INTERNATIONAL EXCHANGE the draft is to be readvised to bank at which it will be presented, a note to this effect is added to the advice) . 6. Particulars of the mode of reimbursement (cover-draft inclosed, debit amount to account, etc.). Should the draft be payable by a third party (see above) for account of the correspondent on whom it is drawn, this third party is also advised either by the issuing bank direct or by its correspondent on receipt of advice from the issuing bank. The relative advices should be dispatched as soon as possible after the sale of the drafts in order that payment may not be refused thru the correspondent's being unable (in the absence of advice) to authenti- cate the drafts. 4. Specimen forms and signatures. — Each bank furnishes tlie correspondents on whom it has arranged to issue drafts, with specimens of the special draft form and of the special advice form (if any) it will use, together w^ith specimen signatures of the officers who are authorized to sign drafts and advices on its behalf. If possible, a specimen signature of the payee is also forwarded with the advice of a draft, so that any possible difficulty in establishing the bona fides of the payee and draft may be avoided. 5. Cost of drafts to purchasers, — The amount to be charged by the issuing bank to the purchaser of a demand draft is ascertained by adding together the amounts mentioned below : 1. Face amount of the draft (if drawn in a for- FOREIGN REMITTANCES 153 eign currency the amount is converted into local cur- rency at the rate of exchange for the day) 2. Connnission of the issuing bank 3. Commission (if any) of the paying bank 4. Cost of postage on advices. 6. Travelers' checks. — Travelers' checks enable a traveler to provide himself with funds without delay in a convenient yet inexpensive manner, at any point of his iournev. They are issued in denominations of even amounts ($10, $20, $50, $100 and $200; £o, £10; 200 francs and 400 francs. Equivalents in for- eign money are now no longer stated upon such checks. (See Figures 8 and 9.) They may be cashed practically anywhere, are self -identifying and easily negotiated, and are therefore one of the safest and best forms in which to carry money w^hen trav- eling. They are issued by all first-class banks at a .small premium. • So far as travelers are concerned, such checks are often more convenient than drafts. The latter nuist be cashed in one lump sum which may be much larger than the traveler wishes tc carry on his person, and which may be a positive disadvantage if he passes into another country where a different currency is in use. The checks are for relatively small amoimts, can be cashed as needed and are generally accepted by hotels and large stores, without imposing on the traveler the burden of cashing them at a bank. In view of the undoubted advantages in their par- ticular sphere which travelers' checks possess over XVIII— 10 154 INTERNATIONAL EXCHANGE drafts, their greater cost, the widespread nature of the initial arrangements and the fact that the exchange charged by correspondents on the checks is met by the issuing bank, the shghtly higher commission charge which is made by banks for travelers' checks is fully lustified. 7. Payment of checks, — The issuing bank usually holds the paying agents of their travelers' checks free from responsibility in cashing such checks, provided : (a) The holder signs them in the presence of the paying agent. (b) The signature of the holder and that of the countersigning officer agree with the signatures con- tained in the relative letter of indication. (c) The numbers of the checks are entered on the letter of indication. (d) The checks are negotiated within the period specified (usually twelve months from date of issue). (e) The other general terms of the circular of in- structions are duly comphed with.^ 8. Payment to holders. — In countries other than France or Great Britain travelers' checks are now 23aid in local currency at the day's rate for the coun- try in whose currency they are drawn. When rev- enue stamps are required their price is deducted. When a fixed amount of sterling is specified for Great Britain on the face of travelers' checks, it should 1 This circular of instructions is generally printed in the principal com- mercial languages for the benefit of paying agents. FOREIGN REMITTANCES loo o M i=i 3 O >, 14 s W X u .~ "n -ii "i ^ t .-rt > ^ '^ H -d V 00 :i M ■=c p ^^^ O "I -t-> 52 |£ +3 >, •gg 156 INTERNATIONAL EXCHANGE ^ s-s .2 2I ^ > T3 o rt W c3 ^^ 2 c — < ^ rt o -^ c3 excli sale t and '^ yof ■tual lents •r* c3 C = 02 tJD — t, ^ &I g J •ST £ enl til lisl *' 3 tX) c3 nseq soni i En 3 2|i cr c S.Sj >» -aS ^ 14 ;t ;:i 2 :h ,;?. «? ^ Oi ■B.'^ % S c ^'-^ a S ■^ en O'J 2 li-^ ^ ^ ■pJIt -o ^*- rt 1< w t- ji ^^ > ^ t^ — ci •M c3 >r; fcH ^ "Jr " ^ :/: ^ o""^ 'ct >j :53"|'^' ^lili fcr.'S " rt C win, fea ates obt clui ?UH '^M ^.^ FOREIGN REMITTANCES 157 be borne in mind that the sterling current in Aus- traha, British South Africa, British West Indies, etc., is of a quite different exchange value. A sim- ilar remark may also be made regarding the colonies and dependencies of other countries which use the same currency (francs, etc.) as the respective mother country. In such places all travelers' checks are paid at the current rate for purchasing exchange on the cajiital of the respective mother country, 9. Redemption of checks. — Paid travelers' checks are redeemed as follows : (a) If paid in Xorth America, they are forwarded to the Xew York office or correspondent of the issu- ing bank of redemption at the face amount of dollars plus the commission agi^eed upon.^ (b) If paid outside Xorth America, they are for- warded to the London, England, branch or corre- spondent of the issuing bank for redemption at the current rate of exchange plus commission at the rate agreed upon or when issued in dollars are returned to New York either directly or indirectly to be redeemed to the credit of the foreign banker who cashed them. A number of purely temporary expedients have been resorted to in view of the unsettled condition of ster- 1 As travelers' checks paid in Xorth America are checks on Xew York, banks at points where Xew York exchange is usually at a premium often make no commission charge for cashing the checks. In the case of Canadian banks which issue travelers' checks, it is cus- tomary to redeem each other's checks at par when the two banks con- cerned are represented locally. In other cases they are redeemed thru the Clearing House or otherwise by any branch of the issuing bank which is convenient for the purpose, at the face ajnount plus the usual commis- sion on checks paid and redeemed in Xorth America, namely, i lo of 1 P^r cent, minimum 5 cents each. 158 INTERNATIONAL EXCHxVNGE ling. It is believed these will in time give place to the former more convenient methods. (c) Banks having extensive business relations with various European countries occasionally appoint their chief correspondents in the respective countries as cen- tral redemption agents for their travelers' checks. In such cases the paid checks are forwarded to these correspondents for redemption at the face amount of local currency plus the commission agreed upon, and are debited to the account which the issuing banks keep with these correspondents. (d) Hotels, department stores and private bankers often hand travelers' checks paid b\^ them to a local bank for redemption, such third parties being allowed a commission of, say, V20 of 1 per cent, which is added by the local bank to its own commission when forward- ing the check to a central correspondent for redemp- tion. 10. Letter of indication, — Each purchaser of trav- elers' checks is furnished with a letter of indication ( Figure 10) , usually bound with the list of paying agents, specifying the numbers of the travelers' checks sold to him and signed by the purchaser and the officer who countersigned the checks. It is indispensable to the security of the holder that this letter of indication be carried separately from the travelers' checks, as in case of loss of one or the other the one remaining serves as the basis of a claim for reimbursement. A few institutions do not issue a letter of indica- tion with their travelers' checks. In these cases two FOREIGN REMITTANCES 159 spaces, one at the top and one at the bottom (see Figure 11), are provided on the check form for the sig- nature of the holder. The first signature is made in the presence of the officer who issues the checks, and the second in the presence of the paying agent, who compares the two signatures to estabhsh their identity. This system, however, readily lends itself to forgery should the checks be lost or stolen, as the presenter of the checks has a copy of the necessary signature be- fore him while signing the checks, or the signature may be lightly traced in pencil in the space provided before jjresentation and covered with ink in the pres- ence of the paying agent. During 1913 the Federation Universalle des Soci- etes d' Hoteliers (with which the principal hotels of the world are associated) addressed a circular letter to the various issuers of travelers' checks stating that in view of the risk involved, j)ayment by the leading hotels of travelers' checks of this form would there- after be more or less uncertain, and suggesting that the banks adopt the safer method whereby the speci- men signatures of the jiurchaser and the countersign- ing officer are given in a separate letter of indica- tion. 11. Lost travelers' checks. — The same care should be taken of travelers' checks as of money, and due precautions taken to avoid risk of loss. Should this occur, however, the holder is advised to communicate immediately by telegraph with one of the redemption agencies of the issuing bank or the branch at which 160 INTERNATIONAL EXCHANGE the checks were obtained, so that the presenter of such checks may be traced without delay. The issuing bank will usually refund to the owner the face value of lost or destroyed checks, or will issue a new supply in their stead, upon receipt of sufficient evidence of loss or destruction thereof and the execu- tion of a satisfactory bond of indemnity, provided the holder immediately notifies the bank by telegraph of the loss as mentioned above. Travelers' checks are useful for those carrying com- paratively small simis of money, as they can be nego- tiated at hotels, department stores, etc., where it is impossible to secure funds under letters of credit, but those who require to provide themselves with large sums, say, $1,000 or over, will find a letter of credit more convenient. A good plan for many travelers is to carry both. 12. Letters of credit. — The principal banks of the world issue letters of credit designed specially for the use of travelers. They are accompanied by a letter of indication (Figure 12) , and are of two kinds, namely: (a) Domestic, drawn in local currency for use in the country where they are issued as, for example, dollars in America and francs in France, (Figures 13 and 13A) , and, (b) Foreign, now usually drawn in dollars and similar in form to Figure 13 tho letters in sterling and francs are available (Figures 14 and 14A). The holder of one of these credits may draw any sum he desires, up to the amount of the credit, thru correspondents at all the principal places visited by s ?'5t^i«55: ;i I ■■a xvm-12 161 To M wh as No. .No. No. No No. SIG Our Correspoxdi Gentlemen, 19. . :nts : 3se signature is to follows : X A B be found below, is the holder of "bur Travel to No. X of the denomination of $10. to No. A - ers' Checks .inclusive, . inclusive, of the denomination of $20. to No. B c of the denomination of $50. to No. C ... . .inclusive, inolii.isivft D of the denomination of $100. to No D . We commend . . NATURE or of the denomination of $200. to your usual For The courtesies. Bakk (This signature r countersignature nust on agree with the the checks.) {Must be inserted at the time the checks are purchased.) LETTER OF IXDICATIOX ACCOMPAXYIXG TRAVELERS' CHECKS Figure 10 19- To Our Correspondents: Gentlemen, M the bearer of this letter, who<;e signature is to be found below, has been su])- plied with our Circular Letter of Credit No and we commend to your usual courtesies. For The Bank SIGNATURE OF LETTER OF IXDICATIOX ACCOMPAXYIXG LETTER OF CREDIT Figure 12 1G2 FOREIGN REMITTANCES 163 li^Ht^Fyri .kiiiniiiiiimiiHi -i I »TnT) enc stattotiiii dull mmoUicm //f/',",! ^ --^N 'y/ . ., //. ',..A. //^ ./) Figure 13. Circul.\r (Dollar) Letter of Credit (Front) 164 INTERNATIONAL EXCHANGE "^ KUIT NJt^SI 1J.V. iKSCKifclBD OM J^H I S SOA.QS A.:-.I> N^I rjCJI.I->.K^ TJ ^^ CUBlfcfc.NCV - a \l Figure 13a. Circular (Dollar) Letter of Credit (Back) Xg Circular Letter of Credit £ Stg. ISSUED BY THE BANK. 19.... To the Banlers named in our Letter of Indication. This letter kHI be presented to you b// in whose favor ice haze opened a credit oi o , = Sterliiici to be availed of by demand drafts on The BanK', London. ichich we request that you will negotiate at the current rate of the day, less your usual charges. The drafts should bear the following clause: — ''Drawn under Credit Xo "; they should be drawn within one year from the date hereof y and the date and amount of each draft cashed are to be entered in the space provided on the back of this letter. M provided with a copy of our Letter of Indication, whereon s'^rpuiture may be found. For The Bank. CIRCULAR (STERLING) LETTER OF CREDIT Figure 14 SPECIFICATION Of Payments Made Under This Letter OF Credit Date When Paid Paid by Amount in Words Amount in Figures CIRCULAR (STERLING) LETTER OF CREDIT (Back) Figure 14a i:g FOREIGN REMITTANCES 167 business men and tourists thruout the world. A list of paying agents is supplied to each purchaser. 13. Payinent to the holder. — The holder draws a draft on the central correspondent of the issuing bank designated in the letter of credit for the amount of money he requires and presents it to one of the pay- ing agents designated in the list of payhig agents. The paying agent then compares the signature on the draft with that given in the relative letter of indica- tion and authenticates the signature of the officers appearing on the letter of credit by ineans of the spec- imens he has on file. If the signatures are in order he makes payment and enters the particulars of the draft on the back of the letter of credit. In accordance with the usual banking custom the paying agent deducts his commission at the time pay- ment is made to the holder of the letter of credit, but should the letter of credit request him to make pay- ments without deduction, his commission is added to the amount of the draft when forwarding it for re- demption to the branch or correspondent of the issu- ing bank named in the letter of credit. If the letter of credit is not drawn in local currency, the paying agent makes payment at a rate of exchange which in- cludes his commission. The banker who pays the draft, exhausting the let- ter of credit, forwards it to the central agent together with the draft for redemption. Advised or restricted letters of credit are similar in form to circular letters of credit, except that they are 168 IXTERNATIOXAL EXCHANGE advised direct to the correspondents to whom they vrill be presented for payment, and specimen signatures of the holder are forwarded to these correspondents, so that a letter of indication is unnecessary. Letters of credit are available for the period speci- fied thereon only (generalh' twelve months or less), and paying agents should always take care to see that this period has not expired when a letter of credit is presented to them for negotiation. 14. Circular notes. — Circular notes (often written in French) are similar in form, payment and redemp- tion to travelers' checks. They are issued for fixed even amounts of a given currency (pounds sterling, dollars, etc.), and are payable at that amount with- out deduction in countries which use that currency. In countries where the local currency differs from that designated on the circular notes, the equivalent of the amount is paid at the current rate of exchange. Al- tho formerly very popular, circular notes have largely fallen into disuse. Only two British banks were issu- ing them in Xovember, 1920, and the important tour- ist companies had practically discontinued selling them. 15. Foreign money orders. — There is no cheaper, safer or more convenient means of remitting small sums of money to any part of the world than that of foreign money orders or bankers' limited checks ( Fig- ure 16). The latter have fixed limits in various cur- rencies, the rates of exchange being determined at the time the notes are purchased in America. u o jr.9 to C « (u i .Si 4^ « 0) < ^ ^ w Ph — . 5 =^ ^ i; ^ U O .Si c« « a; "^ = a 2 o^ O ® ^ > o ® w rt ^ (U c « . • 1/3 (~ ->^ >^ - i3NOisuaj.Nno3 4oC|« »p|i Mqi* M olT niJj SEd 1S9 a laciaoaj iip-sns a| 13— 01 3 .an;^ p U^l- pu37 03? i.M Pl»lSJj.\lHAO pong 3 X\i3i ..v.. I !'. .'l I ;••!•• i ;-r:U .n II 1 1 £ " ill! 111! ill 174 INTERNATIONAL EXCHANGE In order to make sure that the amount reaches its destination safely, the purchaser is furnished by his bank with two shps, one a receipt for the money he has paid and the other a notice (with translations thereof in various foreign languages) for transmis- sion to the beneficiary, which instructs him (the bene- ficiary) to communicate with the central correspond- ent if the sum mentioned thereon is not received within the course of a fixed number of days. (See Fig- ure 17.) REVIEW What is a demand draft? Describe some of the ways in which drafts are paid. What does a letter of advice usually contain? How are travelers' checks redeemed? What is a letter of indication? Why is it issued? What kinds of letters of credit are issued? How does the holder secure payment? When are paying agents of travelers' checks free from respon- sibility in cashing such checks? CHAPTER XI THE SILVER STANDARD 1. Silver standard. — A country is upon the silver- standard when its legal tender monetary unit consists of a definite quantity of silver, free coinage being per- mitted. In such a country the money value of silver coins is practically the same as the commercial value of the bullion which they contain. In such countries of course, silver and money are regarded as identical, just as gold and money in gold standard countries are thought of as being practically one and the same thing. Only one country of commercial importance is now upon the silver standard, namely, China. The subject of silver exchange, therefore, is not of great impor- tance to the business world ; as a middle term, however, between the gold standard and the paper standard, it has far greater significance in the exposition of the principles underlying exchange operations. In the nineteenth century there was a long and bitter con- flict between the advocates of silver and gold, some important nations being on the silver basis, others on the gold basis, and still others on a joint or bimetallic basis, the free coinage of both silver and gold being permitted and the coins of both metals being legal tender. The adherents of the gold standard tri- 175 176 INTERNATIONAL EXCHANGE umphed over their silver opponents in the latter half of the nineteenth century, and in the last thirty years all the important nations of the earth have sought to put their monetary systems upon the gold basis. Altho the silver standard exists in only one great country, nevertheless it is well for the business man to understand the fundamental principles gov- erning silver exchange and the international move- ments of silver as a commodity, for all gold standard countries make large use of silver in their subsidiary coinage. 2. Silver mint jmr, — When several countries of the earth were on the silver basis, exchange relations be- tween them were determined exactly as are exchange relations between two countries on the gold basis. In the early part of the nineteenth century the United States, altho nominally on a bimetallic basis, was really upon a silver basis, for gold coins were not in circulation, being worth more as bullion than as money. At the same time many important nations of the world, such as Germany, Russia and India, were on the silver basis. In those days the mint par be- tween the American silver dollar and the German thaler was merely a question of mathematics, being determined by the quantity of silver in the one as compared with the quantity of silver in the other. That of course is the method, as has already been ex- plained by which the mint par between the moneys of countries which are upon the gold basis is de- termined. SILVER STANDARD 177 3. No mint par between countries on different standards. — When two countries use different metals as money, each being freely coined, it is obvious that there can be no stable value relation between their coins, and therefore no mint par unless the commer- cial values of the two metals move up and down in absolute unison. Of course, under ordinary condi- tions the values of two commodities never move up and down together at all times. Hence quotations of exchange between countries on different standards cannot be comparable to a mint par. It is worth while recalling, however, that in the old days of bimetallism prior to 1870, when many coun- tries were on the joint standard of gold and silver, the variations in the value fluctuations of the two metals were so slight that for the purposes of international trade something like a bimetallic mint par did exist. This is a matter which has been the subject of much debate in the last fifty years, but it possesses no prac- tical importance at the present time and therefore de- serves no further discussion. 4. Exchanges hetweeri gold and silver countries, — International trade between countries on different bases is hampered by uncertainties that do not exist in the case of trade between countries on the same stand- ard, for in the former case a certain speculative ele- ment or risk is always present. When an exporter in a country on the gold basis ships goods to a country on the silver basis, the price being quoted in terms of silver, he cannot be certain that silver will not fall in XVIII— 13 178 INTERNATIONAL EXCHANGE value with respect to gold before he receives his pay. He was inclined, therefore, to demand from his customer a higher price than he would ask if he were selling to a customer in a country on a gold basis. Or else the merchant in the gold country insisted upon trading on the gold basis and put the entire burden of fluctuating exchange on the buyer. In either case this risk operated to the detriment of business men in silver standard countries, and such countries have during the last fifty years quite generally endeavored to place themselves upon the gold basis. 5. Gold price of silver, — We have seen that the ex- ports of a country are stimulated whenever its mone- tary unit is quoted below parity in foreign exchanges, and that the opposite effect upon trade is exerted when rates of exchange rise. For example, the French franc was quoted at about eight cents in March, 1921. It is obvious that American imports from France would tend to decline if its gold value should rise to nine cents, unless at the same time a corre- sponding drop in prices took place in France. The exchange quotations between gold and silver standard countries are practically a reflex of changes in the relative values of the two metals. If the gold price of silver is rising, quotations of Chinese exchange will advance in London, and vice versa. Changes in the relative values of the two metals have in the past produced important changes in the currents of trade. For example, during the seventies and eighties of the last century the gold price of silver steadily declined. SILVER STANDARD 179i India was then upon a silver basis and her general level of prices did not undergo great changes. As the price of silver fell, it was possible for English im- porters of wheat to import that commodity from India at constantly lessening expenditm'es of gold. During this period the farmers of the United States inspired by the advocates of the free coinage of silver, complained bitterly because the price of a bushel of wheat was being steadily forced down by competition with a country which had the advantage of being on the silver basis. 6. Real situation as to silver, — Speaking of the arguments in favor of the use of silver which were drawn from the experience of India, Dean Joseph French Johnson in his "Money and Currency" says: To business men, as well as to farmers and producers generally, the silver advocate addressed an argument based upon the apparent prosperity of India. India had become our chief competitor in the wheat markets of the world. Until 1893, her money had been silver, and the friend of silver held that the wheat growers of India, on account of the falling price of silver, had been able to undersell the farmers of the United States at Liverpool year after year, without themselves making any change whatever in the price of their wheat . The Indian exporter of wheat, who sold it at from three to four rupees^ per bushel in 1873, had averaged the same price during the full twenty years, and with the money he had received he had each year been able to buy about the same quantity 1 The rupee contains 165 grains of pure silver and in 1873 was equivalent to 44 cents. After 1873 its gold value declined, until in 1893 it was worth only 26 cents in gold. 180 INTERN ATIOXAL EXCHANGE of goods or pay the same amount of debt , for general prices did not rise in India prior to 1893. But four rupees of silver after 1873 represented a lessening amount of gold, so that an American farmer, in order to compete with the Indian producer, had been obliged to lower his price year after year. Thus, when the price of silver had fallen until a rupee of 165 grains of pure silver was worth only 30 cents in gold, the American farmer in order to compete with Indian wheat at three rupees was obliged to sell his wheat at 90 cents. The advocates of the free coinage of silver, using illustrations of this sort, argued that the adoption of the silver standard would give us a tremen- dous advantage over foreign nations using gold as money. The free coinage of silver would not only have the effect of a protective tariff, lessening our imports of foreign goods but would also stimulate our exports by giving our pro- ducers an advantage like that which the producers of India had enjoyed. As for the argument based on India's apparent command of the wheat markets of the world after 1873, that also contained several grains of truth. If two competing coun- tries are using different monetary standards, say silver and gold, a change in the value relation between the two metals will give a temporary stimulus to the exports of that nation whose money metal is falling in value with re- spect to the other. This stimulus is due to the maladjust- ment of prices that always accompanies a change in the value of a money metal. \Mienever the value of silver falls in Europe or the United States because of an increas- ing supply or diminished demand, the decline is indicated by a fall of the gold price of silver before the general price level in silver-standard countries has been much affected. Before 1893, for example, a decline in the price of silver in Europe could not affect prices in India until additional silver had been added to India's money supply and put into circulation among the people. Consequently, when the gold price of silver fell because of a fall in the value of that metal the producers of India were under no induce- SILVER STANDARD 181 merit on that account to charge higher prices for their goods, for their money costs of production had not in- creased. An ounce of silver meant as much to them as it had meant before the decHne of the London or New York quotation for silver; but since it now took less gold to buy an ounce of silver, it was possible for Europeans to buy a given quantity of India's products with less gold than for- merly. In consequence American and European pro- ducers who were competing with Indian producers were obliged to lower their prices, altho the only cause therefor seemed to be a change in the relation between gold and silver. Such a condition wouid of course oe temporary unless the fall in the value of silver were continuous. India would increase her exports until a balance had been created requiring an importation of silver sufficient to raise her price level to parity with the value of silver in Europe and the L^nited States. Thus when the value of silver was falling India's exports of goods were always a little larger than they otherwise would have been, the ex- cess representing the value which India gave to the world in payment for the additional silver required in her cir- culation. ^Mien the gold price of silver fell because of a rise in the value of gold, as most commonly happened between 1873 and 1893, the effect upon India's export trade was more apparent than real or permanent, and was due to the mal- adjustment of prices in gold-using countries. AYhen the gold price of silver changes, exporters and importers are usually unaware of the cause and do not seek to discover it; it is commonly assumed in gold-using countries that the value of silver has fallen, and in silver countries that the value of gold has risen . So whenever the gold price of silver fell after 1873, whatever the cause, the first effect was always the same, namely, importers in gold countries were able to get goods from India by the expenditure of less gold than before the fall, and consequently American and European producers in competition with India were 182 INTERNATIONAL EXCHANGE obliged to lower their prices. But when the change was due to a rise in the value of gold, the value of silver not declining, there was no reason why India should import an unusual amount of silver, for India did not then need any addition to her money supply. Nevertheless the ex- porters of India had a temporary advantage in the world's markets. Without any sacrifice they were able to cut under the gold price which had prevailed for the same goods. But their advantage could be only temporary, for prices in the gold countries, since gold was increasing in value, soon fell to a level which placed the European and the American exporter on a par with the Indian exporter. Any long delay in the adjustment of prices in gold coun- tries would continue India's advantage and give her an unusual balance of trade, but the resultant importation of silver would lift her price level and so deprive her exporters of their advantage over exporters in gold countries. In fact such an importation of silver, after prices in gold coun- tries had become adjusted to the new value of gold, would put Indian exporters at a disadvantage for a time and perhaps cause an exportation of silver. 7. Silver and international eoochange. — Altho seri- ous consideration of the adoption of a bimetallic standard has practically disappeared during the last tw^enty years, silver continues to exert a powerful influence in international exchange. The flurry in the price of silver that followed the war has only served to re-emphasize the importance of the metal. There is only one commercially important country left in which silver is the standard of value — the only legal tender — namely China, but the close relation of the metal to money and exchange is maintained by its world wide use as subsidiary coinage. Moreover all the Far Eastern countries maintain a consuming de- SILVER STANDARD 183 mand for silver. Xor is the expression "consuming demand" a mere figure of speech in this case. Refer- ence is constantly being made to the 'Voracious appe- tite" of China for the precious metal and India is characterized as a "bottomless pit." The silver de- mand of these countries is due to the use of vast quan- tities for hoarding, for ornaments (especially in India), and for currency purposes. The latter use has for many years been the principal factor in the demand, but more recently hoarding is believed to have gone on to a vastly increased extent. It remains an undisputed fact that silver that once goes into China or India seldom comes out again. Conserva- tive estimates place the amount absorbed by India between 1914 and 1920 at 500,000,000 ounces and China during the same time bought fully 400,000,000 ounces of bar silver. War conditions brought about an increased demand for subsidiary coinage thruout the world. War in- dustries were extended to the silver using countries of the East. The soldiers of all the warring nations used large quantities of subsidiary coin and all troops in East Africa and Mesopotamia had to be paid in silver. The allied nations were buying the products of the Far East in immense quantities and, as every nation was conserving its gold supply, they soon be- came heavy buyers in the silver market. Industrial use, in which the manufacture of moving pictures is the chief factor, continued to require about 70,000,000 fine ounces a year. All these conditions brought 184 INTERNATIONAL EXCHANGE about, between 1914 and 1920, price fluctuations of silver that were unprecedented. 8. Asias historic influence. — One of the reasons which no doubt has contributed to the scanty atten- tion paid to the subject of Eastern exchange is the fact that few people have realized until recently the very important influence that the East has exercised from the beginning of history, and will undoubtedly continue to exercise, on the economic life of the West, or so-called civilized world. Asia has always exerted a passive influence on human enterprise, due in a great measure to her insatiable appetite for the pre- cious metals. Three thousand years before the Chris- tian Era the Phoenicans ranged far afield to Spain and distant Britain in search of gold and silver with which to maintain their trade with the Orient for silk, spices and other luxuries. Later the Venetians gained control of the caravan routes to the East, and further depleted the European supply of the precious metals. This immensely lucrative trade of Venice aroused the envy of Portugal and Spain, and inspired voyages of discovery and the search for a sea route to the East which resulted in the discovery of America by Columbus, and Vasco da Gama's successful voy- age around the Cape of Good Hope. The discoveries came at an opportune time. The gold and silver mines of Europe were practically exhausted and there was no other source of supply. The trade with the Orient thru Venice was a steady drain on a constant^ di- minishing stock, and the shortage of precious metals SILVER STANDARD 18o as a medium of exchange had long acted as a deterrent on the industrial and economic progress of Europe. The flow of gold and silver to Spain from America gave Europe the long wanted impetus, which enabled her to throw off the fetters of the Middle Ages and brought about a revival of learning and industry in every branch of human activity. 9. How silver is marketed. — A second outstanding reason for the general lack of knowledge regarding Eastern exchange is the result of the way in which silver has been marketed. The operations have been in the hands of a few highly trained experts. London for several centuries has been the chief market for silver, owing in a great measure to her long and intimate connection with the Eastern trade, first established by the old East India Company, and since maintained and increased by direct marine serv- ice and other well established interests. The course of Eastern exchange rests almost entirely on the price of silver, the market for which, for several genera- tions, has been principally in the hands of four Lon- don firms, as follows; Mocatta & Goldsmid, Samuel Montague & Company, Pixley & Abell and Sharp & Wilkins. The first mentioned firm dates back to 1684, ten years before the Bank of England was founded. Before the war these four firms determined the price of silver at a certain hour each day — 1.45 p. M. (Saturday 11.45 a. m.) and the bulk of the world's transactions in silver was based on this price, wliich in turn established the rate of Eastern ex- 186 INTERNATIONAL EXCHANGE change, the actual operation of which hes principally in the hands of the great Anglo-Asiatic banks, The Hongkong & Shanghai Banking Corporation, The Chartered Bank of India, Australia & China, and The Mercantile Bank of India, Limited. Exchange operations under these conditions required a highly- specialized knowledge, not only of the silver market, but also of Eastern conditions themselves, and were practically confined to highly trained employees of the banks and brokers above-mentioned. Intensive information therefore was only available to those ac- tually engaged in the operations. These men were evidently too busy, or not of a sufficiently literary turn of mind or inclination, to place their experience or knowledge on record. A change in the market methods seemed to be fore- shadowed in 1917. In September of that year the United States controlled silver and did not permit its export except under license. In April, 1918, the Pittman Act came into force, and for a time was re- garded as a most important piece of legislation. This act authorized the sale of silver not exceeding 350,- 000,000 silver dollars from the silver reserve of the United States. Out of this, the equivalent of 270,- 000,000 fine ounces, the share of India was 200,- 000,000 fine ounces, which was bought by the British Government and imported into India in the follow- ing year. The act further stipulates that silver sold under its provision shall be replaced by purchases made at the fixed price of $1.00 per fine ounce, and SILVER STANDARD 187 that the metal so purchased must be "the product of mines situated in the United States and of reduction works so located." As is usually the case with legis- lation that tries to combat economic laws, other than its action in placing a possible bonus on silver mined in the United States, the only result of its provisions has been to establish two separate and distinct markets and quotations. In the United States, domestic com- mercial silver is virtually pegged at 99^ cents. For- eign silver is also quoted on the Xew York market, but moves with the London price, which has returned to its position as arbiter of the silver exchange rates. 10. The silver price flurrij. — The statistics of the world's annual production of silver show that an astonishing decrease has taken place since 1913. Nearly 234,000,000 fine ounces were produced in that year. In 1914 only about 160,600,000 ounces were mined, and altho production has increased beyond that amount in later years, the 1920 figures show it to be still far below normal. Simultaneously with this decrease in production came the great increase in demand, the reasons for which were outlined in an earlier section. Erratic is the mildest word that can be applied to the market between 1915 and the end of 1920. In midsummer of 1915 the monthly average price of sil- ver fell to 481/0 cents per fine ounce, which is the lowest point it has touched since definite records were established. Thereafter the price rose gradually to about $1.00 per fine ounce in May, 1918, and main- 188 INTERNATIONAL EXCHANGE tained that level during a year of United States gov- ernmental regulation. In May, 1919, a rapid ad- vance began which carried the price to the record high point of $1,371/2 in November, 1919. The average monthly price in January, 1920, was the highest ever recorded, but in March a sharp turn downward oc- curred, and silver fell to 80 cents on June 15th. Thereafter the price rose until a figure over $1.00 was reached on August 20th. Decline again set in and before the end of the year foreign silver was quoted on Xew York market at 76^/8 cents an ounce. A money metal which sells at $1.37^ per ounce in January, at 80 cents in June, $1.01% in August and 761/4 in October, may be considered an economic curi- osity, even in a year of such wild fluctuations as these of 1920. If, for example, the American silver dollar had been the actual standard of value for the United States currency, its bullion value would have moved from $1.06 to 62 cents, back to 78% cents, and down again to 59 cents, which would fairly rival the vicissi- tudes of the German mark. 11. Effects on Eastern exchange. — The decline in the price of silver has naturally had an eff'ect on the Eastern exchanges. China in particular suffered in this movement, and there is little doubt that a num- ber of Chinese financiers who were speculating in silver sustained huge losses. Taking three dates for which quotations are available, we find that on Feb- ruary 16th, 1920, when the price of silver in the Lon- don market was 831/8 pence, the value of the Shang- SILVER STANDARD 189 hai tael was 9 shillings and 3 pence in London; on March 24th, when the price of silver had fallen to 7ll/> pence, the value of the tael had also fallen and it was worth only 7 shillings and 5 pence. The de- chne in the value of the tael kept pace with the de- cline in the price of silver, until on June 9th, when silver had fallen to 45% pence, the tael had fallen to 4 shillings and 10 pence. 12. Silver melting points. — The relation of the so- called melting points of silver coinage to interna- tional exchange has been clearly demonstrated during the reconstruction period. All nations use silver as subsidiary money and, with the exception of the United States silver dollar, all such coins are token money. With silver at its pre-war price the token coins of Europe and America were worth more as money than as commercial silver. This condition was the result of deliberate intention of the governments. The United States silver dollar was the one excep- tion. It was designed to be a standard coin, not a token, and therefore contained an amount of silver (at the old price) that very closely approximated its face value. As the price of bullion silver rises all these well planned schemes are disrupted. When silver sells for 733/3 pence per ounce in London, all British silver coins are worth as much as commercial silver as they are as money. If the price of the metal goes higher, it will pay to melt small coins and sell the bar silver. Consequently 733^3 pence per ounce is called the 190 INTERNATIONAL EXCHANGE "melting point" for British silver coins. In the United States the melting point for token coinage is $1.38 + per ounce for silver and that of the standard silver dollar is reached when $1.29 + per ounce can be obtained for the metal. As the price of silver rose in Europe during the war, because of the insatiable demands of the Orient, both England and France were forced to put em- bargoes on its exportation. This, however, failed to produce the desired result, for the price of silver went far beyond the melting points and subsidiary coinage began to disappear at an alarming rate. The ex- change rates which were adverse to Europe only ac- celerated this disappearance of silver from circula- tion. A pound sterling would purchase only, say 80 per cent of its normal value in New York, while a hundred francs would be worth only 50 per cent of their par value in dollars. On the other hand, the silver coinage of either country would bring in 'New York not only its full value as money, but a premium that grew to be of very considerable size as silver reached its highest prices. The greater the discount at which the European currencies were quoted, the more likely was silver to disappear. Silver coins had largely gone from circulation in Continental Europe in 1920 and the quantity in Great Britain was ma- terially reduced. In the United States this effect of high priced silver was not felt, altho no doubt a good many silver coins were melted down during 1920. Canada protected her subsidiary coinage by SILVER STANDARD 191 reducing slightty its silver content and thus raising the melting point. 13. Silver standard. — The silver standard exists in a country where it is enacted by law that silver alone shall be legal tender and the measure of value. China, as we have already noted, is now the only country of commercial importance that retains the silver stand- ard. This fact has not, however, altered the position of silver in the Far East. Gold standards are theoret- ically in force in Siam, French Indo-China, Straits Settlements, British Xorth Borneo, The Federated Malay States, Sarawak and India, but silver is the only currency in use. Siam's gold standard coin is the dos (or ten tical piece), but none has yet been issued. The colonial government of French Indo- China fixes the rate of exchange between the piastre or dollar, and the franc, thus giving the colonj^ the gold standard of France. The Straits Settlements, British Xorth Borneo, The Federated Malay States and Sarawak all use the same silver currency, which is maintained in a fixed ratio to the pound sterling. In each of these countries the notes of the four Anglo- Asiatic banks circulate with considerable freedom, and in certain places are preferred to the local paper issues which are, nevertheless, well supported and wisely administered paper currencies. The domestic trade of these countries is regulated by the bullion price of silver, but all outside transactions are based on gold, and in the end the value of silver is thus reg- ulated bv these international transactions. 192 INTERNATIONAL EXCHANGE The following are the principal coins used in these countries : Grammes Grammes Name Fineness gross fine British Dollar 900 26.9569 24.2612 Mexican Dollar 902.7 27.073 24.4388 Maria Theresa 833 1/3 28.0668 23.3889 Straits Settlements Dollar 900 20.2177 18.1958 Indo-China Dollar (or piastre) 900 27.000 24.300 Chinese Republican Dollar or "Yuan" 900 26.8567 24.171 India Rupee 916 2/3 11.664 10.692 Maria Theresa Dollar. This is a trade coin (one without the obligation of redemption) minted at Vi- enna, but not used in Austria. It is current with full legal tender value in Abyssinia, Arabia, East Coast of Africa, Eritrea, Oman, Persian Gulf countries, Tripoli, and countries of the Eastern Mediterranean and Asia Minor. This coin has almost disappeared from Far Eastern circulation since 1914. Mexican Peso. — This coin, also called "Mexican Dollar," is full legal tender in Hongkong and China. It is preferred by the Chinese to the coins minted by themselves. British Dollar. — This coin was created in 1894 in response to the great demand for currency in the Far East. It is legal tender in Hongkong and Labuan. Indo-China Piastre. — This coin was introduced by the French Government to help commerce in her Asiatic colonies. It is modelled after the Mexican dollar, and is accepted as equivalent to the latter coin. Straits Settlements Dollar. — This coin was origin- ally minted for circulation only in the Straits Settle- SILVER STANDARD 19S ments, but has become current in British North Bor- neo, The Federated Malay States and Sarawak. It has a fixed value of 2 shillings and 4 pence and is only given here for purposes of comparison as the Straits Settlements are on a gold exchange basis. Trade Dollar. — This dollar was coined by the United States to compete with the Mexican dollar in trade with China and the Far East. It had no status within the United States and has been withdrawn from circulation. Any still outstanding have only a bullion value. 14. Eastern exchange. — In all these countries we are now considering, exchange is either regularly quoted, or can be negotiated, on the following coun- tries or cities: Great Britain, France, Spain, Hong Kong, Singapore, Xew York, San Francisco, Van- couver, Japan, Shanghai, Amoy, Saigon and India, For many years the rate for telegraphic transfer on London has governed the rates on "sight" and "4 months' sight" bills common in the East. This cus- tom may still be regarded as in force, tho the rate of telegraphic transfer on San Francisco or Vancouver, has within the last couple ot years exerted an influ- ence on the general rates. 15. Currency of China. — China is the oldest and most important of the silver standard countries and the ancient unit, the tael or liang, continues to be used. A tael is actually a weight and not a coin and circulates in the form of shoes,i or of small bars. This 1 From resemblance in shape to a Chinese woman's shoe. XVTII — 14 194 INTERNATIONAL EXCHANGE unit is not fixed in any way. In different cities and provinces it varies in weight and in fineness of silver. Actually there are no silver ingots of one tael; the ingots usually weigh from 7 to 10 taels and are called sycee from the Chinese "Sai ssu," meaning fine silver. The variation in weight in the sixteen best known kinds of tael is from 37.5317 grammes of fine silver in the Hai Kwan tael to 34.0732 grammes fine in the Swatow tael. The Hai Kwan (or customs) tael is the most important. It is generally rated at 72 per 100 Mexican dollars. The official tael agreed upon by treaty is the Kuping or Treasury tael divided into 100 cents of 10 mills each. This unit weighs 37.313 grammes .980 fine and contains 36.56674 grammes of fine silver. The Chinese monetary system has been still further complicated by the series of revolutions the country has been passing thru. There have re- cently been issued four different mintings of republi- can dollars weighing 26.8567 grammes 900 fine. The Mexican dollar also circulates freely. Many of the silver coins are stamped or "chopped." This prac- tice arose from the fact that many light and debased coins were formerly in circulation, and having once established the value of a coin the Chinese merchant or banker marked it, not only that he might recognize it again but so that others to whom his "chop" was familiar might accept it confidently. The result of much chopping has been to mutilate and debase a very considerable part of the silver coinage in cir- culation. SILVER STANDARD 195 Like the tael, the mace and candareen are simply denominations representing certain fixed weights of silver. The weights and value vary according to the location. All domestic business is transacted in "cash," a coin of varying weight, size and metals con- tained, but of fairly constant local value, which is of- ficially considered to be at the rate of about 1000 to the United States dollar. The value of the various taels moves with the price of silver, and it is impossible to give a fixed equiva- lent, but it is easily ascertained by multiplying the amount of fine silver in the tael by the price of an ounce or a gramme of fine silver. The Shanghai tael weighs about 11-6 ounces of standard silver (.925 fine) . The Kuping tael, for instance, weighs 1.175625 ounces of fine silver. The monetary system established in Hong Kong and Labuan by the British Government is silver standard and has as its base or standard coin the Mexican dollar weighing 27.073 grammes (902.7 fine) or 24.4388 grammes fine silver. The British dollar (24.2612 grammes of fine silver) is treated as equal to the Mexican dollar and both are legal tender to any amount. 16. Chinese eocclianges, — From the foregoing facts it may easily be surmised that the operation of ex- change with China is a complicated matter, and is best dealt with by those who have made a life study of the East and its customs. The rates of exchange rise and fall with the price of silver, and owing to the 196 IXTERXATIOXAL EXCHANGE violent variations in these rates the business is a highly specialized one. Quotations and drawing facilities on the Orient are usually provided by one of the Anglo-Asiatic banks. Rates for all the customary forms of bills are governed by those of telegraphic transfers on London. The latter are arrived at by a computation based upon the degree of fineness of bar silver imported into China in comparison with that of British standard silver. The usual forces of supply and demand for bills of exchange exert the same pressure here as elsewhere and rates are consequently "at, above, or below par." It works out, therefore, that this expression as applied to Chinese exchange refers to the cost at which silver can be bought in London or Xew York and delivered in Shanghai, all charges included. REVIEV Why cannot a mint par of exchange be computed between a gold using and a silvcT using country? What effect has the gold price of silver in the exchanges ? Discuss the advantages and disadvantages of the silver standard. Describe recent variations in silver prices and discuss their causes. When does a rising price of silver menace the subsidiary coin- age of gold standard countries .^ CHAPTER XII FIAT OR IRREDEEMABLE PAPER MONEY 1. Money and the war. — The war plunged the leading commercial nations of Europe into a chaos of inconvertible paper money, comparable to that of the French Revolution, when a washerwoman was not even decently paid unless her homeward load of paper "assignats" filled the basket in which she had carried the laundry to her customer. As a result of the ex- cessive issues of bank and government notes gold dis- appeared from circulation in the belligerent countries of Europe, and the gold value of the paper money de- preciated, until a paper pound had fallen in its gold value from $4.86 2/3 to $3.20, the French franc from 19.3 cents to less than 7 cents, and the German mark from 24 cents to less than 2 cents, while the value of the Russian rouble, nominally about 50 cents, reached the vanishing point. The well known English economist. Professor Ed- win Cannan, in the introduction to "The Paper Pound of 1797-1921" (pubhshed in 1919) makes the following interesting comment on the depreciation of the paper currencies of Europe after 1914, as com- pared with the depreciation of the paper pound ster- ling during the Napoleonic Wars: 197 198 INTERNATIONAL EXCHANGE In the comparatively short war of 1914-18 currencies "not convertible at will into a coin which is exportable" (Report, p. 17) were issued by Governments and Govern- ment banks in amounts compared with which the 100 percent increase in thirteen years, which made the Bullion Committee complain so vigorously in 1810, looks abso- lutely trifling. The British Government brought out an entirely new issue of £l and 10s. notes and increased it to 293 millions at the date of the armistice: the Bank of France increased its issue from 6,000 million francs to 30,500 millions: the Italian increase was from 2,500 millions to over 8,000. The precise increase in Germany and Austria-Hungary is obscure but understood to have been much greater. The record since the armistice is still less of a kind to give the present day Europeans ground for boasting themselves better than their fathers. In twenty-three weeks the British Government had increased the note issue by 59 millions more, and the total still stood on October 1, 1919, at 335 millions. The French issue on October 2 was 36,250 millions, the Italian in July, 1919, was about 10,000 millions and the Russian rouble is being manufactured in numbers w^hich suggest astronomers* calculations rather th? i anything terrestrial. The result is what Horner and the Bullion Committee feared. The pound in October 1919 will buy just about the same amount of gold as it would when the Bullion Committee sat in 1910, that is, about 107 grains instead ofithe normal 1233^, but it is respectable compared with its colleagues in Europe: the franc will buy about 3^/2 in- stead of nearly 5 grains: the case of the lira is rather worse; the mark will buy little more than 1 grain instead of 6; the Austrian krone and the Russian rouble are worse. Politicians have certainly egregiously failed to "advert to the foreign exchanges and the price of bullion in regulating their issues": instead they amuse their ignorant subjects with fantastic explanations of the perversity of the ex- changes and chimerical schemes for "correcting" them by stopping imports or borrowing still more from abroad. IRREDEEMABLE PAPER MONEY 199 No one can contend that these paper standards are su- perior to the gold standard. In the first place they are all different, and in the second the one common property that they possess in all making prices much higher than they would be if paper and gold had not diverged, marks them as all inferior. Gold has been produced in almost the usual quantities thruout the war, it is almost alone among metals in not having been used in the manufacture of munitions of war, and it has been thrown out of cur- rency use over a wide area. Consequently it is greatly depreciated as against commodities: that is, 1233^ grains of gold or any freely exportable gold coin will buy far less of ordinary commodities than before the war — perhaps scarcely half. Consequently each of the particular local divergencies between paper and gold simply constitutes a local aggravation of a world-wide rise of prices, a great part of which is itself produced by the general introduction of the paper currencies. WTien the scales at last fall from the eyes of the people of Europe, groaning under the rise of prices they will no longer cry to their Governments: "Hang the profiteers!" but, "Burn your paper money, and go on burning it till it will buy as much gold as it used to do!" 2. Trade on a paper basis. — If a countn^ has no gold, and can therefore export none, can it possibly engage in trade with other countries ? The same ques- tion might be asked with regard to a country the Gov- ernment of wdiich has placed an embargo on the ex- port of gold. How, the reader might reasonably ask, settle an adverse balance of trade ? To answer this question intelligently the reader must understand clearly the fundamental principles of foreign trade and foreign exchange. He must perceive clearly the truth of these two statements : £00 INTERNATIONAL EXCHANGE First. — All foreign trade is essentially of the na- ture of barter, a nation's exports of goods necessarily being equal in value to its imports. Second. — The so-called balance of trade, which is settled by a shipment of gold when the trade is be- tween gold standard countries, is not a real balance and may be wiped out by the shipment of commodi- ties other than gold. Countries on a paper basis, not having any gold or not being willing to ship any gold, settle or pay the so- called balance of trade by larger exports of com- modities. Essentially the foreign trade between a country and other countries is an exchange of equal values and these values may be represented by com- modities in general or by gold and silver. Let us suppose there is trade between a country on a paper basis and one on a gold basis. Evidently the exporters in the. gold countiy will not be willing to take their pay in the money of the paper country. If then the people of the paper country import more than they export, how can they possibly pay the bal- ance since, we will suppose, their country contains no gold. They will pay that balance by an increased export of commodities and for this reason : Since the imports in the paper country, as we have assumed, have been larger than the exports, there will have been a strong demand for exchange on the gold country and the banks in the paper countrj^ or the dealers in exchange will have raised their rates for gold exchange. These IRREDEEMABLE PAPER MONEY 201 higher rates of exchange will be equivalent to a rise in the prices of goods imported from the gold comi- try and therefore will tend to lessen the tide of im- ports. At the same time in the gold country the price of exchange on the paper country will have fallen in a corresponding degree, and hence have encouraged imports from the paper country. Of course a country on a paper basis lacking a supply of gold could not conveniently engage in for- eign trade unless its bankers maintain balances to their credit in gold standard countries. They create and maintain these balances not by shipments of gold but by shipments of bills of exchange drawn by their local customers on the gold standard country. These bills have their origin of course in the exports of mer- chandise from the paper country to the gold standard country. The foregoing analysis should enable the reader to understand why the United States, a country on the gold basis, has been able since the war to carry on an enormous foreign trade with the great commercial nations of Europe which are now upon a paper basis. It should enable him also to understand the signifi- cance of a decline or of a rise in the quotations of the pound sterling and the French franc. A decline of sterling in the Xew York market, for example, indi- cates an excess of exports from the United States whether of goods or of securities, and at the same time it indicates a lower cost to Americans of English goods and securities thereby stimulating an increase 202 INTERNATIONAL EXCHANGE of imports from Great Britain. A rise in the New York quotation of sterling exchange naturally has the opposite effect. Given the characteristics of irredeemable paper money which have been described it will be readily understood that no nation willingly puts its feet into the mire of fiat money. They are dragged into it sometimes by mistaken nations of finance, more fre- quently by some national emergency. 3. Fruits of war, — Among the more progressive nations, such currency is often one of the fruits of war. Thus the United States lost the metallic basis of its currency during the Civil War, and Great Brit- ain was forced to a paper pound during the Napo- leonic struggle and in the Great World War. The significance, then of the discussion of paper money lies in the fact that Europe groans under a paper cur- rency, and that most of our trade is done at the pres- ent time with nations on a paper basis. A few months after the beginning of the Great War, the European demand for American products grew rapidly and exports began to outstrip im- ports. Exchange which at the first outbreak of hos- tilities had risen to unapproached heights, began to fall and sterling exchange fell below par. By the issue of the Anglo-French loan and the extensive credits granted by the American Government, Great Britain during the war period was enabled to hold the rate at approximately $4.75 to the pound sterling. It was to her advantage to do so both to avoid the de- IRREDEEMABLE PAPER MONEY 203 pressing moral effect of a low rate of exchange, and to make better bargains in the purchase of goods. In the language of the day sterling exchange was "pegged" at $4.75 per pound, French exchange at about 9 per cent below par and Italian exchange at about 18 per cent below par. 4. Current eccchange rates. — After the armistice foreign governments withdrew their support of the exchange rates and they fell rapidly. Rates for Feb- ruary 19, 1921, are quoted in the following table: Per cent Feb. 19, Depreciation Country Par 1921 from Par England $4.8665 $3.8525 20.8 France 193 .0710 63.2 Italy 193 .0364 81.1 Spain 193 .1390 28.0 Germany 238 .0159 93.3 Switzerland 193 .1648 14.6 Sweden 268 .2220 17.2 Holland 402 .3425 14.8 Belgimn 193 .0741 61.6 Argentina 4244 .3511 17.4 Japan 498 .4838 2.9 Canada 1.000 .8656 13.4 The leading nations of Europe are as shown by the depreciation of their currency in exchange with a gold using country for the time being on a paper basis. It is a concession to national sensibilities to call their present status a suspended gold standard. It is a concession which may be most willingly made if it im- plies that the suspension of gold payments will soon be removed by a return to convertibility of the monetary circulation. 204 INTERNATIONAL EXCHANGE The difficulties of exchange with paper using countries rest upon the absence of the automatic regu- lation of rate^ which is insured by the free movement of gold, and the more or less violent fluctuations in the rates which result from internal currency con- ditions. It is not contended that paper money even tho irredeemable, may not if carefully guarded main- tain a relative stability of value, and a reasonably even course of exchange. But it is to be remembered that such steadiness if attained rests upon the wisdom of governments, and is a less certain reliance than the automatic workings of the laws of trade. The problems of exchange with paper money coun- tries can perhaps be better explained by reference to some that have long been on such a basis than by con- sidering those in which irredeemable paper money is a recent affliction, complicated by the after effects of a great world struggle. 5. Paper cuiTendes. — The modern exponents of paper money currency have been chiefly among the South and Central American re23ublics. A number of these countries, altho they have established a theoretical gold basis for their currencies, have been for a long time embarrassed by large quantities of in- convertible paper money. During recent years, both before and since the Great War, strong efforts have been made by the more progressive of those countries to put their currencies and finances upon a sounder basis. Venezuela, Uruguay, Peru, Ecuador, Costa Rica, Honduras, Bolivia and Salvador, have all made irredee:\lvble paper money 205 progress towards this desired end. All of these countries are now regarded as having Gold Exchange Standards. Salvador in 1920 became an actual gold standard country, her recent financial history being somewhat similar to that of Columbia. Hayti, which formerly belonged in the theoretical gold standard group, is rapidly approaching a complete rehabilita- tion of her currency system. The entry of American bankers and of American Government influence into the financial problems of that republic is having a salutary effect. 6. Paper money as a standard. — We are not con- cerned in this chapter with paper money as such, but only with paper currency which has become a nation's standard of value. Convertible paper money has per- formed a very useful function in the circulation of most modern countries. So long as it is freely con- vertible into gold on demand, its presence in the cir- culation does not in any way affect the existence of the gold standard. An issue of paper monej- not supported by an adequate gold reserve, is sure to prove a curse in the long run, as all countries that have tried it have found. When a paper issue is called upon to represent in pur- chasing power a larger quantity of gold than that for which it will be redeemed in specie upon demand, it at once takes on the aspect of a non-interest bearing loan which has been forced upon a public by its gov- ernment. The natural consequence is that the more of it there is issued, the less probability there is of its 206 INTERNATIONAL EXCHANGE ultimate redemption. Conditions of this sort always produce depreciation to a dangerous degree. Depreciation means that the purchasing power of the currency as compared with that of gold has fallen. If it requires, for instance, 225 paper dollars to pur- chase 100 gold dollars, gold is at a premium of 125 per cent and paper money is at 44 4-9 per cent of gold or at a discount of 55 5-9 per cent ; or again, 300 per cent premium means that for 100 gold dollars one would have to give 400 (300 plus 100) paper dollars. In this connection the following problems will be found helpful: (1) The premium on gold is 30%; at what per cent dis- count is paper money? c, 1 ,. 300 X 100 30,000 ^^^ J. S*^^"^'^'^^ 300 plus 100 = -loo- = '^% ^'^^''""*- (2) Paper currency is at a discount of 75% as compared with gold; what is the premium on gold? c 1 ^. .75 X 100 7,500 ^^^^ Solution: — — — = ' , = 300% premmm. 100 — 7o 2o 7. Results of depreciation, — Following the course just outlined, depreciation may proceed to an extent that practically paralyzes the business of a country. As the process continues, all metallic money disap- pears from circulation, even tho there may be a strong tendency for minted coin from neighboring countries to find its way in. As depreciation progresses all goods offered for sale by merchants are quoted at two prices, a silver or gold price, and a paper money price. No more striking example of the breakdown IRREDEEMABLE PAPER MONEY 207 of a paper currency has ever been afforded than the return to conditions of barter which took place in Austria during the latter part of the war. The fol- lowing statement by Countess Szechenyi gives a con- crete illustration of this phase : "During Bela Kun's reign of terror, which lasted from March until August . . . men, formerly well off, to ob- tain food would get together remnants of old clothes, per- haps an old pair of shoes, resoled for the tenth time, and a ragged shirt, and walking out into the country would sit down in the market place of some small town and wait for the peasants to come and inspect their wares. These latter were doing their best to starve out the city and to them any one from there was a *dog of a socialist,' so they bar- gained to the utmost, and if a man got two eggs for two shoes, and a spoonful of lard for a shirt, he was lucky — and he had that to take back to his children." The deliberate destruction of all currency values in Russia may also be cited as an example. Travel- ers from that country reported late in 1920 that a very ordinary dinner cost the startling sum of eight million rubles in paper money. It is evident that such money had become nothing more than a method of counting, and bore little connection with any stand- ard of value. Inconvertible paper money has no in- trinsic value and its gold value depends entirely upon the amount of gold that the public of the country is willing to give for its own paper unit. This, quite as often as not, depends upon political conditions and not upon the factors of international trade. 8. Chile. — For many years Chile has been com- ^08 INTERNATIONAL EXCHANGE mercially the most important of the paper standard countries. An illustration of the vicissitudes of a country in progress from a paper to a gold exchange standard, the following description of the monetary system is quoted:^ Chile's monetary system has gone thru numerous vicissitudes since the establishment of the Republic. It must suffice to say that since 1898 the bulk of Chile's currency has consisted of inconvertible paper money. The Chilean peso has a gold content of 0.5991 gramme of gold, 0.916% fine, or 0.54918 gramme of pure gold, and is worth at par 36.5 cents, or 18 pence sterling in British currency, in which it is generally quoted. The different kinds of currency in circulation in Chile at the end of each year from 1912 to 1920 are shown in the table below: CHILE'S FIDUCIARY NOTE CIRCULATION, 1912-1920 (In 1,000 pesos.) Fiscal notes 4^ .is li .2 s > 4) 3 o '2 3 ji Tnents be- tween New York and other parts of the country, but also for payments between points in the United States outside of New York. A man living in Buffalo who owes $1000 to a man in New Orleans can best pay the debt by remit- ting a draft on New York City. This method is the one usually employed, for Buffalo banks maintain no balances in New Orleans, and so cannot sell drafts on that city. They can, however, sell a draft on New York, and that will usually be accepted by New Orleans banks at par. When the reader takes into account that New York checks and drafts are every day being used in this way for the cancellation of debts in all parts of the United States, he will understand why New York exchange is deservedly called "the business man's money." CAUSES OF CURRENCY SHIPMENTS. But does not a bank sometimes receive a call for more New York exchange than it can conveniently sell? This does frequently happen, and as a result bankers are some- times forced to charge a small premium for New York exchange. The price which they can charge is definitely fixed by the cost of shipping currency. This cost depends upon three items: first, the express charge; second, in- surance; third, the loss of interest. As a rule, the first two charges are linked together in a charge made by the express company, on account of its guaranty to deliver DOMESTIC EXCHANGE ^65 the currency to the consignee. The third item of cost varies with the rate of interest. The moment a bank gives money to an express company for shipment to New York City, the bank's power to use it as a reserve, or basis for loans, has gone. That money cannot again become the basis for banking transactions until it has reached New York. The amount of this item is high or low according to the rate of interest at the point from which the ship- ment is made. These three items amount to about 50 cents per $1000 on a shipment of currency between New York City and Chicago. Hence Chicago bankers are not able to charge more than 50 cents premium on a New York draft for $1000. A man who wishes to send $1000 to New York will not pay a bank over $1000.50 for a draft, for at that price he can ship the currency by express. The shipment of currency from one point to another and the fixing of the rate of exchange are matters attended to by the banks themselves. No private business man — excepting perhaps a few whose transactions foot up large totals — ever thinks of shipping currency from one point to another. If the people of a western city have been buying from the East more largely than they have sold to it, so that their calls upon the local banks for New York exchange exceed the incoming supply, the banks themselves are forced to ship currency to New York in order to cover their sales of exchange. In the large cities the banks make a business of buying and selling exchange from one another. When the First National of Chicago for example, finds that its New York balance is running low on account of the demand by its customers for New York drafts, it endeavors to buy exchange from other banks in Chicago, and will pay them a premium for it. In no case, however, will it pay more than 50 cents per $1000. The sellers will be banks which find that they have on hand more exchange on New York than they have need for, and they will ask for this exchange as high a premium under 50 cents per $1000 as they can obtain. The height of the premium is fixed by competition between '^m INTERNATIONAL EXCHANGE buying and selling banks. Sometimes the supply of New York exchange will be so great that it will be sold by one bank to another at a discount. If a bank having a large credit in New York City orders currency shipped to it, the expense on each thousand dollars will be 50 cents. The bank can better afford to sell drafts on New York to its neighborhood at a discount of 40 cents per $1000 than order the shipment made. In the long run the supply of New York exchange in any community is about equal to the demand for it . This is another way of saying that each community in the long run sells to other communities as much as it buys from them. In certain seasons of the year, however, agricul- tural districts buy much more from the East than they sell to it. This is always the case in the winter and spring. No crops are then being harvested, yet merchants all over the country are laying in their stock of spring and summer goods. As a result there is so strong a demand thru- out the country for drafts on New York that country banks are generally obliged to make some shipment of currency to New York in order to cover the drafts they sell. The opposite condition prevails in the fall when the crops are marketed and are going forward for export. Then the farmers of the West and planters of the South are receiving in payment for their goods eastern checks, which they deposit in local banks. Country banks now find their balances piling up in New York and are unable to sell New York exchange as fast as they would like. As a result New York City banks are usually ordered in the fall to make shipments of cash to the West. In the winter and spring, when the West is a heavy buyer from the East, New York exchange is usually quoted at a premium in western cities. In the autumn it is usually at a discount, all banks having an excessive supply. There is another reason for this seasonal movement of currency between New York and the country districts. In the autumn, when the crops are harvested, there is a great increase thruout the West and the South in the DOMESTIC EXCHANGE 267 need for "hand-to-hand money." This must be furnished by the country banks, and they are forced to draw on their New York balances, first by sales of New York exchange and finally by ordering the cash shipped to them. In the winter and spring cash flows back into the country banks, until they have more than they can profitably use. Then they build up their New York balances either by buying and remitting exchange or by shipping currency. ^Miat is to prevent a community from sometimes buy- ing much more from New York than it sells to that city? Indeed, is not any communit}^ always in danger of pur- chasing so much from other parts of the country that its bankers may be obliged to send out all their supply of currency in order to make the payments.^ This brings up the question of the balance of trade between communi- ties. The balance of trade is usually discussed by econo- mists only in relation to trade between different countries yet the principles governing such trade differ in no respect from those governing trade between communities within the same country. There is never any danger that a community will be stripped of its money or cash as a result of its purchase of goods from other communities. No matter how freely Chicago and the country tributary to it may purchase goods from the East, those purchases can never make any serious drain upon the cash supply of Chicago. No matter how extravagant the people of the West may be, their purchases of eastern goods can never be greatly in excess of their sales to eastern consumers. Should the people of Chicago for extraordinary reasons at any time increase their purchases from New York and other eastern cities, the first effect in Chicago would be an increase in the demand for New York exchange and in bank shipments of currency from Chicago to New York. The loss of currency in Chicago, since it would reduce the lending power of Chicago banks, would tend to cause a rise in the rate of interest and a rise in the value of money. The prices of commodities named would begin to decline; not 268 INTERNATIONAL EXCHANGE of all commodities, but of those which are subjects of speculation, such as stocks, wheat, corn, and pork. Most of the speculators in these articles are borrowers, and the interest they pay is an important item in the expenses of their business, so that when the interest rate rises they are obliged to contract their operations. Chicago would thus become a good place to lend in and also a good place in w^hich to buy stocks and bonds, wheat, and other speculative commodities. In other words, the value of money would rise in Chicago, and people in other parts of the country w^ould increase their purchases in Chicago markets, remitting New York exchange in payment. The reader must not suppose that these changes in price or in the rate of interest need be so great as to attract general attention. Nevertheless it cannot be doubted that such changes do take place, and that as a result the sales of Chicago to other parts of the country are so ad- justed that in the long run they furnish a supply of New York exchange equal to the demand. Thus it happens thruout the country that in the course of a year the debts of every community are always practically balanced by its credits on account of sales, so that large shipments of currency are never necessary. Indeed, if our monetary banking systems were perfect, no shipment of currency from one part of the country to another w^ould ever occur as a necessity result of trade transactions. Money or currency would only be shipped to a community as a result of an increasing need for it as a medium of exchange or as a basis for the expansion of bank credits. In Canada, for example, on account of the elasticity of its bank-note circulation, seasonal variations in the demand for currency are easily provided for by the local banks and their branches. The tendency of commercial nations is to reduce premiums and discount upon domestic exchange to the minimum. This is effected in the first instance by the concentration of the business in the larger I^OMESTIC EXCHANGE 269 banks. The fewer the persons concerned the less the likehhood that any currency shipments will be re- quired and hence the fundamental condition which causes payments at distant points to be more expen- sive than local payments disappears. The demand for payments between communities is then a fluctuating one, now inclining in one direction, now in the other. If we conceive that all these trans- actions were effected thru a single bank with large capital and with branches in different places, adjust- ments could be made Vvdth the minimum difficulty. To the bank it would mean in the main a different drain on the resom'ces of the different branches at different times which in the long run would equalize one another. Under these circumstances the bank, in order to facilitate to the utmost exchanges between all parts of the country, might very well agree to ac- cept all payments at face value charging no premium therefor and allowing no discount. This is in effect what has taken place in the United States thru the action of the Federal Reserve banks. Domestic exchange has disappeared as a charge on the mercantile community, and for the purpose of making payments the whole United States has become a single banking unit. That does not mean that as a theoretical possibility there is no longer such a thing as domestic exchange. It simply means that its charges have been absorbed into the operating expenses of the Federal Reserve Banking system and are no longer charged to the 270 IXTERXATIOXAL EXCHANGE customer. The case is analogous to your relations to your bank of deposit. Whenever the bank collects for you thru the Clearing House a check on another bank it incurs an expense, whenever it cashes your check it incurs an expense. But these expenses are not charged to you. The bank's operations do not appear as charges in your account, tho if the bank analyzes the latter, they are an important element in determining whether your account is profitable to the bank. INDEX Arbitrage, See Investment and Arbitrage Australia, London Exchange -with, 61 Bank Rate, Bank of England fixes, v^O; In New York, 121 Bank of England Bate, Importance of. 122; Minimum discounts, 123; Margraff on, 12-i Bankers' Long Bills, Form of draft, 96; Rates of interest, 119 See also Long Exchange Bills of Exchange, 127-146 Purpose, 127; Sight drafts, 128; Cable transfer, 132; Unusual rates, 133; Long exchange, 134; Influence of in- terest rate, 136; Commercial and bank- ers' bills, 138; Bills involving risk, 139; Letters of credit, 141 Bi-metallism, No longer an issue, 175; Fixed approx- imate par, 177 Brussels Conference 1920, 241, 246 Resolutions of, 247-260 Cables, Identity ^\-ith checks, 132; Rates at open- ing of war, 133; MargraS's summary, 133 Canada, Exchange transaction with New York, 12; Status of exchange, 24; Discounts and premiums, 61 ; Foreign remittances 147; Silver melting points, 196 Cannan, Edwin, On depreciation of European currencies, 197 Cassel, Gustav, On depreciation, 235 Ceylon, Transaction with, 79 Chain Rule Exchange Calculation, 100 Check, Travelers, 153 Chili, Monetary Situation, 207 China, Silver standard, 175; Currency, 193; Exchange on, 195 Circular Nctes, Form of remittance, 168 Civilization, and Exchange, 1 Clare, George, On finance bills, 109 Commercial Long Bills, L'se in export trade, 66; On foreign debt- ors, 135; Payment bills, 138; Accept- ance bills, 139 Credit, Letters of. Commercial, 141; Traveler's, 160 Credits, Foreign, present diflBcuIties, 242 Currency Shipments, Causes of, 264 Depreciation of currencies, 225, 235 Discount on Exchange, Cause of, 15; How expressed, 61 Discount Market, Liquid, 216; London's, 223 Documentary Bills, Protection of buyer, 138 Dollar Acceptances, National Bank Act Prohibits, 71; Jacobs on, 72; Federal Reserve Act permits, 74 Dollar Credits, Financing Exports, 60; Imports, 84 Domestic Exchange, 261 Exchange between American cities de- scribed, 261; Causes of Currency ship- ments, 264; Federal Reserve Bank absorbs exchange charges, 269 Drafts, Issue of, 148; Advices, 150; Specimen, forms and signatures, 152; Cost of drafts, 153 Edge Act, 228, 244 Escher, Franklin, Defines Finance Bills, 109; On dealing in futures, 116 Exchange, Fundamentals of, 12-26 Clearing processes, 12; Settling equal and unequal debts, 12; Dealer in exchange, 13; Rates, 14; Discounts, 15; Exchange market, 16; Exchange centers, 17; De- mand and supply, IS; Exchange, a trade factor, 19; Role of money, 21; Foreign exchange, 22; Similarity and differences in money used, 23; Dif- ferent coinage, 25; Different standards, 26 See also Restoration Prospects for 271 272 INDEX Exchange Quotations, American method, 57; Range, 58; Fixed and movable exchange, 59; Premium and Discount, 61 Exchange Tables, Use of, 62 Exports, Related to Imports, 28 Visible and invisible, 29 Exports and Imports, 65-89 Payments for Exports, 65; Plan of trans- action, 67; Dollar credits, 69; Dollar acceptances, 71; Export letters of credit, 75; Letters of credit and import- ing, 77; British acceptances, 78; Draft in London, 80; London's part, 82; Dollar exchange, 84; Exports and imports, complementary, 85 Federal Reserve Act Permits bank acceptances, 74 Federal Reserve Banks, Eliminate domestic exchange, 269 Fiat Money, See Paper Money Finance Bills, 33, 108-118 Definition, 108; For New York accounts, 109; Methods of using, 110; Loan of, 112; On London account, 113; Other uses of, 114; Forward exchange, 115 Financial Centers, New York and Lon- don, as, 212-224 New York's prominence, 212; What makes a financial center, 212; Finance follows flag, 213; World exchange re- quires gold, 215; Liquid discount market, 216; New York's advantages, 217; London's physical advantages, 219; Mail and Cable facilities, 220; Time advantages, 220; Natural char- acteristics, 221; Seeking fortune abroad, 222; London's discoxint mar- ket, 223 Fixed Exchange, 59 Foreign Money Orders, Issued by banks, 168; Payments, 171; Redemption, 172 Foreign Remittances, 147-174 Non-commercial exchange, 147; Drafts, 148; Advices, 150; Specimen forms, 152; Cost of drafts, 152; Traveler's checks, 153; Payment of checks, 154; Payment to holders, 154; Redemption of checks, 157; Letter of Indication, 158; Lost checks, 159; Letters of credit, 160; Forms, 162; Payment to holder, 167; Circular notes, 168; Foreign money orders, 168; Mail re- mittances, 172 Forward Exchange, Relation to finance bills, 115; Bank meth- ods to protect, 115; Escher on dealing in futures, 116 Freight Payments and Exchange, 37 Futures See Forward Exchange Qeorge, Lloyd, British credits before the war, 82 Gold Exchange Standard, 40 Gold Exchange Rates, 39-64 Gold standard, 39; Gold exchange stand- ard, 40; Monetary systems, 40; Mint par, 42; Exchange par, 44; Rates, 45; How fixed, 46; Coinage ratio, 47; Fluctuations of exchange rate, 47; Gold points, 49; Meaning of gold shipments, 51; Actual gold oints, 51; Computing gold points, 52; Gold shipments, 63; Avoiding shipments, 55; Reading Ex- change rates, 55; Quotations, 56; Range, 58; Fixed and movable ex- change, 59; Premium and discount, 61; Exchange tables, 63 Gold Points, Limits to exchange, 49; Significance of gold movements, 51; Computing gold points, 52; Gold shipments, 54; Avoid- ing gold shipments, 55 Gold Standard, 9, 39 Honduras, transaction with, 75 Imports, See Exports and Imports, India, Demand for silver, 179, 184; Effect on exchanges, 182 Indication, Letter of, 158 Inflation of Modem Currencies, 225,230 Interest, EfiEect on Long Bills, 136 See Rates of Interest International Payments, 27-38 Causes of, 27; Relation of exports and imports, 28; Supply of exchange, 30; Avoiding gold shipments, 32; United States in account with world, 33; Ele- ments in the account, 36 International Investments, 238 Investments, 33 Investment and Arbitrage, 90-107 International finance, 90; Investments, 90; Foreign investments in United States, 93; United States a creditor nation, 95; International securities, 95; What is arbitrage, 96; When tran- sacted, 96; Parity in, 97; Chain rule, 100; Simple, 101; Compound, 103; Calculation, 104; In gold, 105 INDEX 273 Invisible Exports, and Imports, 29 Irredeemable Paper Money, See Paper Money Jacobs, L. M., On dollar acceptances 72 Jevons, W. S., On Paper money, 231 Johnson, Joseph French, Statement of United States in account \\ith world, 35; Exports and imports complementary, 87; India and silver, 179; Domestic exchange, 261 Letters of Credit, Commercial, 141; Traveler's, 160 London, compared with New York, 17, 31, 44, 48, 51, 53, 59, 65, 69, 75, 78, 82, 84, 96, 109, 112. 115, 119, 122, 128, 132, 137, 212-224, 227, 237 See also Financial Centers London, silver market, 185 Long Exchange, Interest rates, 119; Bankers long bills, 134, 139; Commercial long bills, 135, 138; Documentary bills, 135, 140 Mail Remittances, Transactions for, 172 Margrafif, A. W., On influence of Bank of England rate, 124; Observations on cable rates, 133; On bills of exchange, 140 Melting points, for silver, 189 Mint par, 42 Monetary Systems, 40 Money Standards, Fluctuating, 2; gold, silver and paper, 10 Montreal, Exchange transactions with New York, 12 Moratorium, British credits and the war, 82 Movable Exchange, Removed from French quotations in New York, 57; Contrasted with fixed, 59; Rule for calculating, 60 New York, Compareid with London, 17, 31, 44, 48, 51, 53, 59, 65, 69, 75, 78, 82, 84, 96, 109, 112, 115, 119, 122, 128, 132, 137, 212-224, 227, 237 See also Financial Centers Paish, Sir George, On international investments, 91, 92 Paper Money, Fiat or Irredeemable, 197-211 Money and war, 197; Trading on paper xviii— 19 Paper Money — continued basis, 199; Gold standards abandoned, 202; Current exchange rates, 203; Paper currencies, 204; Paper stand- ards, 205; Results of depreciated money, 207; Chile's monetary situa- tion, 207 Parity, Quotations for and arbitrage, 97; Stock prices, 99; Chain rule calculations, 100 Putnam Act, 186 Premium on Exchange, Cause of, 15; How expressed, 61 Price, Of silver, 187 Quotations Exchange, 55 Rates of Exchange, 45 Rates of Interest, 119-126 Factor in exchange quotation, 119; Long bills, 119; Bank rate, 120; Mar- ket rate, 121; Retirement rate, 122; Bank of England, 122 Restoration Prospects for Exchange, 225 Present conditions, 225; New York and London, 227; Disorganization, 229; Spending in excess of income, 229; Inflation, 230; Means of production curtailed, 232; Working forces dis- organized, 233; Commercial parity, 234; Relative depreciation, 235; Ex- change sensitive, 236; Financial re- construction, 237; Exporting capital, 238; Efforts for concerted action, 240; International and national issues, 241; National duty, 242; Difficulty in extending credits, 242; Need of in- creased production, 244 Retirement Rate, Discounting Bills, 122 Securities, 32 Shipping Gold, cost, 53 Silver Standard, 175 Limited use, 175; Silver mint par, 176; No mint par with gold countries, 177; Exchange with gold countries 177; Gold price of silver, 178; India and silver money, 179; Silver and ex- change, 182; Asia's demand for silver, 184; Market for silver, 185; Price of silver, 187; Melting points, 189; Silver coinages, 191; China's currency, 193; China's exchange, 195 Tourists Expenditure, 37 274 INDEX Trade, Stimvilated or depressed by exchange, 19 Travelers' Checks, Convenience of, 153; Payment methods, 154; Specimens, 155, 156; Redemp- tion, 157; Letter of indication, 158; Loss risks, 159 United States in Account with the World, Foreign exchange statement, 35; Visible and invisible elements, 36; Tourist expenditxixes, 37; Ocean freights, 37 Visible Exports and Imports, 29 War, The Great, Effect on exchange, i; Causes fluctua- ting money standards, 3, 6; Other internal changes, 5; Trade currents affected, 7; Normal exchange dis- turbed, 8 See also Restoration Prospects for Exchange Whitaker, A. C, On importance of discount market, 85 J. F. TAPLEY CO. NEW YOKE UCSB LIBR-ART !! IP III Ilflj fill' I'll! ililM A 000 525 848