§ 1. Money passes from country to country as a Medium of Exchange, through
the Exchanges.
We have thus far considered the precious metals as a commodity, imported
like other commodities in the common course of trade, and have examined
what are the circumstances which would in that case determine their value.
But those metals are also imported in another character, that which
belongs to them as a medium of exchange; not as an article of commerce, to
be sold for money, but as themselves money, to pay a debt, or effect a
transfer of property.
Money is sent from one country to another for various purposes: the most
usual purpose, however, is that of payment for goods. To show in what
circumstances money actually passes from country to country for this or
any of the other purposes mentioned, it is necessary briefly to state the
nature of the mechanism by which international trade is carried on, when
it takes place not by barter but through the medium of money.
In practice, the exports and imports of a country not only are not
exchanged directly against each other, but often do not even pass through
the same hands. Each is separately bought and paid for with money. We have
seen, however, that, even in the same country, money does not actually
pass from hand to hand each time that purchases are made with it, and
still less does this happen between different countries. The habitual mode
of paying and receiving payment for commodities, between country and
country, is by bills of exchange.
A merchant in the United States, A, has exported American commodities,
consigning them to his correspondent, B, in England. Another merchant in
England, C, has exported English commodities, suppose of equivalent value,
to a merchant, D, in the United States. It is evidently unnecessary that B
in England should send money to A in the United States, and that D in the
United States should send an equal sum of money to C in England. The one
debt may be applied to the payment of the other, and the double cost and
risk of carriage be thus saved. A draws a bill on B for the amount which B
owes to him: D, having an equal amount to pay in England, buys this bill
from A, and sends it to C, who, at the expiration of the number of days
which the bill has to run, presents it to B for payment. Thus the debt due
from England to the United States, and the debt due from the United States
to England, are both paid without sending an ounce of gold or silver from
one country to the other.(274)
[Illustration.]
This implies (if we exclude for the present any other international
payments than those occurring in the course of commerce) that the exports
and imports exactly pay for one another, or, in other words, that the
equation of international demand is established. When such is the fact,
the international transactions are liquidated without the passage of any
money from one country to the other. But, if there is a greater sum due
from the United States to England than is due from England to the United
States, or _vice versa_, the debts can not be simply written off against
one another. After the one has been applied, as far as it will go, toward
covering the other, the balance must be transmitted in the precious
metals. In point of fact, the merchant who has the amount to pay will even
then pay for it by a bill. When a person has a remittance to make to a
foreign country, he does not himself search for some one who has money to
receive from that country, and ask him for a bill of exchange. In this, as
in other branches of business, there is a class of middle-men or brokers,
who bring buyers and sellers together, or stand between them, buying bills
from those who have money to receive, and selling bills to those who have
money to pay. When a customer comes to a broker for a bill on Paris or
Amsterdam, the broker sells to him perhaps the bill he may himself have
bought that morning from a merchant, perhaps a bill on his own
correspondent in the foreign city; and, to enable his correspondent to
pay, when due, all the bills he has granted, he remits to him all those
which he has bought and has not resold. In this manner these brokers take
upon themselves the whole settlement of the pecuniary transactions between
distant places, being remunerated by a small commission or percentage on
the amount of each bill which they either sell or buy. Now, if the brokers
find that they are asked for bills, on the one part, to a greater amount
than bills are offered to them on the other, they do not on this account
refuse to give them; but since, in that case, they have no means of
enabling the correspondents on whom their bills are drawn to pay them when
due, except by transmitting part of the amount in gold or silver, they
require from those to whom they sell bills an additional price, sufficient
to cover the freight and insurance of the gold and silver, with a profit
sufficient to compensate them for their trouble and for the temporary
occupation of a portion of their capital. This premium (as it is called)
the buyers are willing to pay, because they must otherwise go to the
expense of remitting the precious metals themselves, and it is done
cheaper by those who make doing it a part of their especial business. But,
though only some of those who have a debt to pay would have actually to
remit money, all will be obliged, by each other’s competition, to pay the
premium; and the brokers are for the same reason obliged to pay it to
those whose bills they buy. The reverse of all this happens, if, on the
comparison of exports and imports, the country, instead of having a
balance to pay, has a balance to receive. The brokers find more bills
offered to them than are sufficient to cover those which they are required
to grant. Bills on foreign countries consequently fall to a discount; and
the competition among the brokers, which is exceedingly active, prevents
them from retaining this discount as a profit for themselves, and obliges
them to give the benefit of it to those who buy the bills for purposes of
remittance.
When the United States had the same number of dollars to pay to England
which England had to pay to her, one set of merchants in the United States
would want bills, and another set would have bills to dispose of, for the
very same number of dollars; and consequently a bill on England for $1,000
would sell for exactly $1,000, or, in the phraseology of merchants, the
exchange would be at par. As England also, on this supposition, would have
an equal number of dollars to pay and to receive, bills on the United
States would be at par in England, whenever bills on England were at par
in the United States.
If, however, the United States had a larger sum to pay to England than to
receive from her, there would be persons requiring bills on England for a
greater number of dollars than there were bills drawn by persons to whom
money was due. A bill on England for $1,000 would then sell for more than
$1,000, and bills would be said to be at a premium. The premium, however,
could not exceed the cost and risk of making the remittance in gold,
together with a trifling profit; because, if it did, the debtor would send
the gold itself, in preference to buying the bill.
If, on the contrary, the United States had more money to receive from
England than to pay, there would be bills offered for a greater number of
dollars than were wanted for remittance, and the price of bills would fall
below par: a bill for $1,000 might be bought for somewhat less than
$1,000, and bills would be said to be at a discount.
When the United States has more to pay than to receive, England has more
to receive than to pay, and _vice versa_. When, therefore, in the United
States, bills on England bear a premium, then, in England, bills on the
United States are at a discount; and, when bills on England are at a
discount in the United States, bills on the United States are at a premium
in England. If they are at par in either country, they are so, as we have
already seen, in both.(275)
Thus do matters stand between countries, or places which have the same
currency. So much of barbarism, however, still remains in the transactions
of the most civilized nations, that almost all independent countries
choose to assert their nationality by having, to their own inconvenience
and that of their neighbors, a peculiar currency of their own. To our
present purpose this makes no other difference than that, instead of
speaking of _equal_ sums of money, we have to speak of _equivalent_ sums.
By equivalent sums, when both currencies are composed of the same metal,
are meant sums which contain exactly the same quantity of the metal, in
weight and fineness.
The quantity of gold in the English pound is equivalent to
$4.8666+ of our gold coins. If the bills offered are about equal
to those wanted, a claim to a pound in England will sell for
$4.86. If many are wanted, and but few to be had, their price will
go up, of course; but it can not go more than a small fraction
beyond $4.90, since about 3-¼ cents is sufficient to cover the
brokerage, insurance, and freight per pound sterling in a shipment
of gold to London. Therefore, in order to get money to a creditor
in London, no one will pay more for a pound in the form of a bill
than he will be obliged to pay for sending it across in the form
of bullion. Bills of exchange, then, can not rise in price beyond
the point ($4.90 +) since, rather than pay a higher sum for a
bill, gold will be sent. This point is called the “shipping-point”
of gold. When the exchanges are at $4.90, it will be found that
gold is going abroad. On the other hand, when the supply of bills
is greater than the demand, their price will fall. A man having a
bill on London to sell—i.e., a claim to a pound in London—will not
sell it at a price here lower than $4.86, by more than the expense
of bringing the gold itself across. Since this expense is about
3-¼ cents, bills can not fall below about $4.83. When exchange is
at that price, it will be found that gold is coming to the United
States from England. This price is the “shipping-point” for
imports of gold. This, of course, applies to sight-bills only.
Formerly, we computed exchange on a scale of percentages, the real
par being about 109. This was given up after the war.
When bills on foreign countries are at a premium, it is customary to say
that the exchanges are against the country, or unfavorable to it. In order
to understand these phrases, we must take notice of what “the exchange,”
in the language of merchants, really means. It means the power which the
money of the country has of purchasing the money of other countries.
Supposing $4.86 to be the exact par of exchange, then when it requires
more than $1,000 to buy a bill of £205, $1,000 of American money are worth
less than their real equivalent of English money: and this is called an
exchange unfavorable to the United States. The only persons in the United
States, however, to whom it is really unfavorable are those who have money
to pay in England, for they come into the bill market as buyers, and have
to pay a premium; but to those who have money to receive in England the
same state of things is favorable; for they come as sellers and receive
the premium. The premium, however, indicates that a balance is due by the
United States, which must be eventually liquidated in the precious metals;
and since, according to the old theory, the benefit of a trade consisted
in bringing money into the country, this prejudice introduced the practice
of calling the exchange favorable when it indicated a balance to receive,
and unfavorable when it indicated one to pay; and the phrases in turn
tended to maintain the prejudice.
§ 2. Distinction between Variations in the Exchanges which are
self-adjusting and those which can only be rectified through Prices.
It might be supposed at first sight that when the exchange is unfavorable,
or, in other words, when bills are at a premium, the premium must always
amount to a full equivalent for the cost of transmitting money. But a
small excess of imports above exports, or any other small amount of debt
to be paid to foreign countries, does not usually affect the exchanges to
the full extent of the cost and risk of transporting bullion. The length
of credit allowed generally permits, on the part of some of the debtors, a
postponement of payment, and in the mean time the balance may turn the
other way, and restore the equality of debts and credits without any
actual transmission of the metals. And this is the more likely to happen,
as there is a self-adjusting power in the variations of the exchange
itself. Bills are at a premium because a greater money value has been
imported than exported. But the premium is itself an extra profit to those
who export. Besides the price they obtain for their goods, they draw for
the amount and gain the premium. It is, on the other hand, a diminution of
profit to those who import. Besides the price of the goods, they have to
pay a premium for remittance. So that what is called an unfavorable
exchange is an encouragement to export, and a discouragement to import.
And if the balance due is of small amount, and is the consequence of some
merely casual disturbance in the ordinary course of trade, it is soon
liquidated in commodities, and the account adjusted by means of bills,
without the transmission of any bullion. Not so, however, when the excess
of imports above exports, which has made the exchange unfavorable, arises
from a permanent cause. In that case, what disturbed the equilibrium must
have been the state of prices, and it can only be restored by acting on
prices. It is impossible that prices should be such as to invite to an
excess of imports, and yet that the exports should be kept permanently up
to the imports by the extra profit on exportation derived from the premium
on bills; for, if the exports were kept up to the imports, bills would not
be at a premium, and the extra profit would not exist. It is through the
prices of commodities that the correction must be administered.
Disturbances, therefore, of the equilibrium of imports and exports, and
consequent disturbances of the exchange, may be considered as of two
classes: the one casual or accidental, which, if not on too large a scale,
correct themselves through the premium on bills, without any transmission
of the precious metals; the other arising from the general state of
prices, which can not be corrected without the subtraction of actual money
from the circulation of one of the countries, or an annihilation of credit
equivalent to it.
It remains to observe that the exchanges do not depend on the balance of
debts and credits with each country separately, but with all countries
taken together. The United States may owe a balance of payments to
England; but it does not follow that the exchange with England will be
against the United States, and that bills on England will be at a premium;
because a balance may be due to the United States from Holland or Hamburg,
and she may pay her debts to England with bills on those places; which is
technically called arbitration of exchange. There is some little
additional expense, partly commission and partly loss of interest in
settling debts in this circuitous manner, and to the extent of that small
difference the exchange with one country may vary apart from that with
others.
A common use of bills of exchange is that by which, when three
countries are concerned, two of them may strike a balance through
the third, if both countries have dealings with that third
country. New York merchants may buy of China, but China may not be
buying of New York, although both may have dealings with London.
[Illustration.]
A, we will suppose, is a buyer of £1,000 worth of tea from F, in
Hong-Kong; B is an exporter of wheat (£1,000) to C in London; D
has sent £1,000 worth of cotton goods to E in Hong-Kong. A can now
pay F through London without the transmission of coin. A buys B’s
claim on C for £1,000, and sends it to F. E wishes to pay D in
London for the cotton goods he bought of him; therefore, he buys
from F for £1,000 the claim he now holds (i.e., a bill of exchange
on London) against C for £1,000. E sends it to D, and, when D
collects it from C, the whole circle of exchanges is completed
without the transmission of the precious metals.