FOREIGN EXCHANGE
THE NATURE OF FOREIGN EXCHANGE
[103]The bill, or order to pay money in a foreign centre, is the
commodity that is actually bought and sold by dealers in foreign
exchange, but it is better for the moment to leave bills out of
consideration. They are only the tangible expression of the claim for
money in another centre, and at this early stage of our inquiry it is
better to keep our minds fixed on what is at the back of the bill,
namely, the money in a foreign centre to which it gives its holder a
claim. The French buyer of a bill on London buys it, as a rule, because
by sending it to his English correspondent he can discharge a debt to
him in English money. What he really buys with his francs is so many
English pounds, and the labyrinth of the foreign exchanges is much
easier to thread if, before we complicate the question by talking about
bills, we keep our eye on the comparatively simple problem which is the
key to the puzzle, namely, the exchange of one country's money for
another's.
Thus stripped to its naked simplicity, the problem begins to look as if
it were not a problem at all, and a critical inquirer may be excused for
thinking that at least in the case of countries that use currencies
based on the same metal, there ought to be no need for daily quotations
of rates of exchange, because the relative value of their moneys ought
to be constant. It is a natural question to ask, why should there be
these daily fluctuations, and, since they are evidently there, what is
the sense or purport of them? The answer is, that money in France and
money in England are two different things, and the relative value of two
different things is almost certain to fluctuate. Quite apart from any
differences in the fineness of gold coined by two different countries,
or the ease or difficulty with which a credit instrument can be turned
into gold, mere distance is quite enough to make the difference that
will create fluctuation in price. New York and Chicago use exactly the
same currencies, but money in New York differs from money in Chicago by
being nearly a thousand miles away, and consequently there are frequent
variations in their relative value. The English and Australian
sovereigns are identical in weight and fineness, but there is constant
fluctuation in the buying power of the English sovereign as expressed in
its brother that is circulating in the Antipodes.
These fluctuations are based on the same influence that sways the
movements in the prices of all goods and services that are bought and
sold, that is, the influence of supply and demand. Just as the price of
boots, Consols, medical advice, football professionals, or anything else
that can be the subject of a bargain, will depend in the end upon the
number of people who want to buy them compared with that of those who
want to sell them, at or near a certain figure, so the price of English
pounds, when expressed in francs, guilders, milreis, or Australian
sovereigns, depends on the number of people abroad who have to buy money
in England as compared with the number of those who have money in
England to sell. People abroad have to buy money in England when they
owe money to Englishmen and want to pay it; and they have money in
England to sell when Englishmen owe them money.
Jacques Bonhomme in Paris has been selling shiploads of Christmas
kickshaws to John Robinson in London, and so has thousands of English
pounds due to him by the said Robinson. But English pounds, as such, are
not wanted by M. Bonhomme. He wants to sell them, to turn them into
francs, the currency of his own country, with which he makes his daily
payments at home. On the other hand, there are always plenty of
Frenchmen who have imported English goods or have had services rendered
by English bankers, or shipowners, or insurance companies, and so want
to buy English money wherewith to pay their English creditors. So it
follows that the price that M. Bonhomme will get for his English pounds
will depend on the value of goods and services that other Frenchmen have
been selling to England, so producing English pounds to be sold in
Paris, as compared with the value of the claims that have to be met in
London, for the satisfaction of which English pounds have to be bought.
If the amount of English money on offer is bigger than the amount
wanted, down will go the price of the English pound as expressed in
francs, and the seller in francs will get less in francs for his pound.
If the amount of English money wanted is the bigger, the price will go
up, and the seller will get more for his pound. When the price goes
down, the exchange is said to move against London, because there is a
depreciation in the value of the sovereign as expressed in francs. When
it goes up the exchange moves in favour of London, because the buying
power of the sovereign is enhanced.
The process is exactly the same, and is even more simple and easy to
understand when we take away the complication of the exchange of the
moneys of two different nations, and look at it at work between two
distant towns of the same country. If in the course of trade New York
has large payments to make in Chicago, money in Chicago will be wanted
in New York, and competition there will send up the price of it, so that
a dollar in Chicago will be worth more for the time being to New Yorkers
than a dollar in New York, and any New York bank or firm that has a
balance or a credit in Chicago will be able to dispose of it at a
premium. The extent of this premium, however, will obviously be limited
by the expense involved in sending lawful money, as the Americans call
it, from New York to Chicago. If we suppose, for the sake of simplicity,
that the cost of sending a dollar and insuring it is covered by a cent,
no one in New York will pay much more than one dollar and a cent for a
dollar in Chicago. Rather than do so he will send his dollar. He will
probably pay a small fraction more to save himself the trouble and time
involved by sending and insuring money, and this minute fraction that he
will sacrifice is the opportunity of the exchange dealer, who will send
money to Chicago, and put himself in funds there, and so be able to
supply money in Chicago to any one in New York who will pay for it at
the rate of one dollar and one cent plus any profit that the exchange
dealer can squeeze out of him.
Viewed in this simple example the problem of exchange has few terrors.
It is merely a question of the price of money in one place, as expressed
in the same money in another, with fluctuations governed by supply and
demand and limited by the cost of sending money from place to place.
This limitation does not mean that supply and demand cease to govern the
market, but merely that at a point supply can be increased to meet any
demand by the despatch of currency.
"FAVOURABLE" AND "UNFAVOURABLE" EXCHANGES
[104]The general feeling with regard to the function of the exchanges,
as giving evidence of the mercantile (or rather monetary) situation of
any country, is indicated by the usual phrase of a "favourable or
unfavourable state of the exchanges." A phrase which occurs so
frequently in all banking discussions that it cannot be passed over
without remark. It may originally have implied the erroneous theory that
the object of commerce is to attract gold, and that that country towards
which the tide of bullion sets with the greatest force is _ipso facto_
the most prosperous. Political economists, from their point of view, are
correct in their statement that, as regards the country at large and the
interchange of commodities, exports and imports are always balanced, and
that both the words "unfavourable balance of trade" and "unfavourable
exchanges" involve fallacy. But merchants and bankers are influenced by
the feeling, that at any given moment they may be under greater
liabilities for imports than they can temporarily meet, owing to the
system of credit which disturbs the coincidence of payments for exports
and imports, though their value may actually be equal; and further, by
the anxiety as to the possibility of meeting these liabilities in that
specific mode of payment to which they are pledged, namely, in gold or
convertible notes. When, therefore, in banking treatises, it is said
that the exchanges are favourable to any particular country, it should
be understood that the intention is simply to state the fact that bills
of that country upon foreign cities are difficult of sale, whilst bills
drawn upon it from abroad are at a premium, indicating an eventual
influx of specie. So, when it is said that the exchanges are
unfavorable, a situation is described in which foreign bills are in
great demand, and when, consequently, their value seems likely to be so
enhanced as to render the export of bullion an unavoidable alternative.
THE ORIGIN AND SUPPLY OF FOREIGN EXCHANGE
[105]Underlying the whole business of foreign exchange is the way in
which obligations between creditors in one country and debtors in
another have come to be settled--by having the creditor draw a draft
directly upon the debtor or upon some bank designated by him. John Smith
in London owes me money. I draw on him for 100 pounds, take the draft
around to my bank and sell it at, say, 4.86, getting for it a check for
$486.00. I have my money, and I am out of the transaction.
The fact that the gold in a new British sovereign (or pound sterling) is
worth $4.8665 in our money by no means proves, however, that drafts
payable in pounds in London can always be bought or sold for $4.8665 per
pound. To reduce the case to a unit basis, suppose that you owed one
pound in London, and that, finding it difficult to buy a draft to send
in payment, you elected to send actual gold. The amount of gold
necessary to settle your debt would cost $4.8665, in addition to which
you would have to pay all the expenses of remitting. It would be
cheaper, therefore, to pay considerably more than $4.8665 for a
one-pound draft, and you would probably bid up until somebody consented
to sell you the draft you wanted.
Which goes to show that the mint par is not what governs the price at
which drafts in pounds sterling can be bought, but that demand and
supply are the controlling factors. There are exporters who have been
shipping merchandise and selling foreign exchange against the shipments
all their lives who have never even heard of a mint par of exchange.
All they know is, that when exports are running large and bills in great
quantity are being offered, bankers are willing to pay them only low
rates--$4.83 or $4.84, perhaps, for the commercial bills they want to
sell for dollars. Conversely, when exports are running light and bills
drawn against shipments are scarce, bankers may be willing to pay 4.87
or 4.88 for them.
For a clear understanding of the mechanics of the exchange market there
is necessary a clear understanding of what the various forms of
obligations are which bring foreign exchange into existence. Practically
all bills originate from one of the following causes:
1. Merchandise has been shipped and the shipper draws his
draft on the buyer or on a bank abroad designated by him.
2. Securities have been sold abroad and the seller is
drawing on the buyer for the purchase price.
3. Foreign money is being loaned in this market, the
operation necessitating the drawing of drafts on the lender.
4. Finance-bills are being drawn, _i. e._, a banker abroad
is allowing a banker here to draw on him in pounds sterling
at 60 or 90 days' sight in order that the drawer of the
drafts may sell them (for dollars) and use the proceeds
until the drafts come due and have to be paid.
1. Looking at these sources of supply in the order in which they are
given, it is apparent, first, that a vast amount of foreign exchange
originates from the direct export of merchandise from this country.
Not all merchandise is drawn against; in some cases the buyer abroad
chooses rather to secure a dollar draft on some American bank and to
send that in payment. But in the vast majority of cases the regular
course is followed and the seller here draws on the buyer there.
2. The second source of supply is in the sale abroad of stocks and
bonds.
Origin of bills from this source is apt to exert an important influence
on rates, in that it is often sudden and often concentrated on a
comparatively short period of time. The announcement of a single big
bond issue, often, where it is an assured fact that a large part of it
will be placed abroad, is enough to seriously depress the exchange
market. Bankers know that when the shipping abroad of the bonds begins,
large amounts of bills drawn against them will be offered and that rates
will in all probability be driven down.
3. The third great source of supply is in the draft which bankers in one
country draw upon bankers in another in the operation of making
international loans. The mechanism of such transactions will be treated
in greater detail later on, but without any knowledge of the subject
whatever, it is plain that the transfer of banking capital, say from
England to the United States, can best be effected by having the
American house draw upon the English bank which wants to lend the money.
The arranging of these loans means the continuous creation of very large
amounts of foreign exchange.
4. Drawing of so-called "finance-bills," is the fourth source whence
foreign exchange originates. Whenever money rates become decidedly
higher in one of the great markets than in the others, bankers at that
point who have the requisite facilities and credit, arrange with bankers
in other markets to allow them (the bankers at the point where money is
high) to draw 60 or 90 days' sight bills. These bills can then be
disposed of in the exchange market, dollars being realized on them,
which can then be loaned out during the whole life of the bills.
These are the principal sources from which foreign exchange
originates--shipments of merchandise, sales abroad of securities,
transfer of foreign banking capital to this side, sale of finance-bills.
Other causes of less importance--interest and profits on American
capital invested in Europe, for instance--are responsible for the
existence of some quantity of exchange, but the great bulk of it
originates from one of the four sources above set forth.
THE SOURCES OF THE DEMAND FOR FOREIGN EXCHANGE[106]
Turning now to consideration of the various sources from which spring
the demand for foreign exchange, it appears that they can be divided
about as follows:
1. The need for exchange with which to pay for imports of
merchandise.
2. The need for exchange with which to pay for securities
(American or foreign) purchased by us in Europe.
3. The necessity of remitting abroad the interest and
dividends on the huge sums of foreign capital invested here,
and the money which foreigners domiciled in this country are
continually sending home.
4. The necessity of remitting abroad freight and insurance
money earned here by foreign companies.
5. Money to cover American tourists' disbursements and
expenses of wealthy Americans living abroad.
6. The need of exchange with which to pay off maturing
foreign short-loans and finance-bills.
1. Payment for merchandise imported constitutes probably the most
important source of demand for foreign exchange. Practically the whole
amount of our huge importations has had to be paid for with bills of
exchange. Whether the merchandise in question is cutlery manufactured in
England or coffee grown in Brazil, the chances are it will be paid for
by a bill of exchange drawn on London or some other great European
financial centre.
2. The second great source of demand originates out of the necessity of
making payment for securities purchased abroad. So far as the American
participation in foreign bond issues is concerned, the past few years
have seen very great developments.
Security operations involving a demand for foreign exchange are,
however, by no means confined to American participation in foreign bond
issues. Accumulated during the course of the past half century, there is
a perfectly immense amount of American securities held all over Europe.
The greater part of this investment is in bonds and remains untouched
for years at a stretch. But then there come times when, for one reason
or another, waves of selling pass over the European holdings of
"Americans," and we are required to take back millions of dollars' worth
of our stock and bonds. Such selling movements do not really get very
far below the surface--they do not, for instance, disturb the great
blocks of American bonds in which so large a proportion of many of the
big foreign fortunes are invested. The same thing is true with stocks,
though in that case the selling movements are more frequent and less
important.
3. So great is the foreign investment of capital in this country that
the necessity of remitting the interest and dividends alone means
another continuous demand for very large amounts of foreign exchange.
Estimates of how much European money is invested here are little better
than guesses. The only sure thing about it is that the figures run well
up into the billions and that several hundred millions of dollars' worth
of interest and dividends must be sent across the water each year. At
the interest periods at the beginning and middle of each year it becomes
apparent how large a proportion of our bonds are held in Europe and how
great is the demand for exchange with which to make the remittances of
accrued interest. At such times the incoming mails of the international
banking houses bulge with great quantities of coupons sent over here for
collection. For several weeks on either side of the two important
interest periods, the exchange market feels the stimulus of the demand
for exchange with which the proceeds of these masses of coupons are to
be sent abroad.
4. Freights and insurance are responsible for a fourth important source
of demand for foreign exchange. A walk along William Street in New York
is all that is necessary to give a good idea of the number and
importance of the foreign companies doing business in the United States.
In some form or other all the premiums paid have to be sent to the other
side. Times come, of course, like the year of the Baltimore fire, when
losses by these foreign companies greatly outbalance premiums received,
the business they do thus resulting in the actual creation of great
amounts of foreign exchange, but in the long run--year in, year out--the
remitting abroad of the premiums earned means a steady demand for
exchange.
With freights it is the same proposition, except that the proportion of
American shipping business done by foreign companies is much greater
than the proportion of insurance business done by foreign companies. An
estimate that the yearly freight bill amounts to $150,000,000 is
probably not too high. That means that in the course of every year there
is a demand for that amount of exchange with which to remit back what
has been earned from us.
5. Tourists' expenditures abroad are responsible for a further heavy
demand for exchange. The sums spent by American tourists in foreign
lands annually aggregate a very large amount--possibly as much as
$175,000,000--all of which has eventually to be covered by remittances
of exchange from this side.
Then again there must be considered the expenditures of wealthy
Americans who either live abroad entirely or else spend a large part of
their time on the other side. By these expatriates money is spent
extremely freely, their drafts on London and Paris requiring the
frequent replenishment, by remittances of exchange from this side, of
their bank balances at those points. Furthermore, there must be
considered the great amounts of American capital transferred abroad by
the marriage of wealthy American women with titled foreigners. Such
alliances mean not only the transfer of large amounts of capital _en
bloc_, but mean as well, usually, an annual remittance of a very large
sum of money. No account of the money drained out of the country in this
way is kept, of course, but it is an item which certainly runs up into
the tens of millions.
6. Lastly, there is the demand for exchange originating from the paying
off of the short-term loans which European bankers so continuously make
in the American market.
These loaning operations, it must be understood, both originate exchange
and create a demand for it. They were mentioned as one of the sources
from which exchange originates, and now as one of the sources from
which, during the course of every year, springs a demand for a very
great quantity of exchange.
In a general way, it may be pointed out, the sources of demand for
exchange conform with influences which cause exchange to go up, and the
sources of supply of exchange constitute causes which make for low
rates.
It is to be noted, however, that money rates are a great factor
influencing foreign exchange. Whenever money is cheap at any given
centre, and borrowers are bidding only low rates for its use, lenders
seek a more profitable field for the employment of their capital.
Money rates in the New York market are not often less attractive than
those in London, so that American floating capital is not generally
employed in the English market, but it does occasionally come about that
rates become abnormally low here and that bankers send away their
balances to be loaned out at other points. Such a time was the long
period of stagnant money conditions following the 1907 panic. Trust
companies and banks who were paying interest on large deposits at that
time sent very large amounts of money to the other side and kept big
balances running with their correspondents at such points as Amsterdam,
Copenhagen, St. Petersburg, etc.--anywhere, in fact, where some little
demand for money actually existed. Demand for exchange with which to
send this money abroad was a big factor in keeping exchange rates at
their high level during all that long period.
High money rates at some given foreign point as a factor in elevating
exchange rates on that point might almost be considered as a corollary
of low money here, but special considerations often govern such a
condition and make it worth while to note its effect. Suppose, for
instance, that at a time when money market conditions all over the world
are about normal, rates, for any given reason, begin to rise at some
point, say London. Instantly a flow of capital begins in that direction.
In New York, Paris, Berlin, and other centres it is realized that London
is bidding better rates for money than are obtainable locally, and
bankers forthwith make preparations to increase the sterling balances
they are employing in London. Exchange on that particular point being in
such demand, rates begin to rise, and continue to rise, according to the
urgency of the demand.
The international money markets are a most decidedly complex
proposition, and there is literally never a time when several influences
tending to put exchange rates up are not conflicting with several
influences tending to put rates down. The actual movement of the rate
represents the relative strength of the two sets of influences. To be
able to "size up" the influences present and to gauge what movement of
rates they will result in, is an operation requiring, first, knowledge,
then judgment. The former qualification can perhaps be derived, in small
degree, from study of the foregoing pages. The latter is a matter of
mental calibre and experience.
METHODS OF FINANCING IMPORTS AND EXPORTS[107]
The foreign trade of the United States has increased during the last
forty years about 370 per cent.... This increase ... reflected not alone
our own marvellous development, but as well the wonderful growth of
trade throughout the world. The United States stands third among the
countries of the world, its foreign trade being exceeded only by that of
the United Kingdom ... and Germany....
Our imports and exports[108] are being financed more and more by means
of what are known as commercial letters of credit.... An explanation of
the operation of the commercial letter of credit will ... disclose the
methods and conditions under which our imports are financed.
The commercial letter of credit is an authorization, say of an American
bank to its London correspondent, to honor drafts for its account drawn
at various tenors by foreign shippers or others against shipments of
merchandise to this country. These credits are of two kinds, documentary
and clean. Under the documentary credit the London bank is authorized to
accept drafts for the account of the American bank only when the bill of
exchange is accompanied by certain documents described in the letter of
credit. These documents may be the bills of lading for the goods,
consular invoices, insurance certificates and possibly other papers.
Probably a large proportion of such credits requires that drafts be
drawn at sixty or ninety days' sight. So many elements of danger are
involved in financing commodities under commercial letters of credit,
even where the control of the goods is given to the bank issuing the
credit or its agents, that the financial standing of those asking for
credits must be the first consideration in their issuance. Dishonesty on
the part of the shipper, resulting in a drawing under the credit against
forged documents or against shipments of inferior merchandise, is always
possible, and the financial responsibility of the buyer of the credit is
all that stands between the banker issuing the credit and a loss in such
cases.
In order to obtain a clear understanding of the working of a commercial
letter of credit, we will take a concrete example and follow its every
transaction. An importer of coffee (A) in New York purchases a certain
number of bags of coffee from an exporter (B) in Brazil. A agrees to
furnish B with a commercial letter of credit. B is not in position, we
will say, to await the arrival of the coffee in New York and the return
of a remittance before receiving his pay. A on the other hand is unable
to remit B for the coffee before its receipt and sale to his customers.
A goes to his banker in New York and requests him to authorize B to draw
upon the New York banker's London correspondent at ninety days' sight
with bills of lading for coffee to the amount of the purchase attached
to the draft, consular invoice and insurance certificate, if B is to
furnish insurance. If A's banker is willing to extend the credit he
writes a letter (or uses a printed form), requesting his London banker
to accept B's drafts upon presentation under the conditions already
mentioned and others of minor importance. This letter is issued in
duplicate, one copy going to the London banker, the other being
delivered to A. A then mails the copy received by him to B. B thereupon
arranges to ship the coffee, obtains the bill of lading, invoice, etc.,
and takes them with the copy of the credit to his banker in Brazil. A
draft is then drawn on the London bank under the terms of the credit at
ninety days' sight and is discounted by the Brazilian banker, the
proceeds being placed to the credit of B's account or given to him in
the form of a check or cash. The Brazilian banker then forwards the
draft and documents, except such documents as the instructions may
require to be forwarded direct to New York, to his London banker. He
may secure discount of the bill at once by cable or await its arrival in
London before doing so, or he may request his London banker to have the
bill accepted and hold it for maturity. If the bill is discounted the
Brazilian banker may draw against it immediately and thus put himself in
funds to purchase other coffee bills. Upon receipt of the bill by the
London correspondent it is presented to the London banker on whom it is
drawn for acceptance. The acceptor bank examines the documents and if
they are drawn according to the terms of the credit accepts the draft
and returns it to the correspondent of the Brazilian bank, retaining the
documents, which it then forwards to the New York bank which opened the
credit. In accepting the draft the London bank has in effect agreed to
pay it at the end of ninety days, or, figuring grace, ninety-three days.
Upon maturity payment is made and the amount is charged to the account
of the issuing New York bank. Upon receipt of the documents the New York
bank delivers them to its customer under a trust receipt or against
collateral, and the latter is then in position to obtain the goods. Ten
days before the bill of exchange is due in London the New York bank
collects the amount from A, together with the commission agreed upon
when the credit was opened, and remits the amount to its London banker
to meet the draft. On all such transactions the London banker, while not
himself advancing any money, is extending a credit for which he charges
the New York bank a commission. The result is that we are paying tribute
to European bankers amounting to an immense sum annually for the purpose
of financing our imports.
The fact that London exchange is more marketable generally throughout
the world than New York exchange is one of the principal reasons why it
is necessary for us to issue credits upon London instead of upon New
York.
Our imports are distributed generally throughout the United States. The
importers, however, are mostly situated at the ports of entry. A very
large proportion of them obtain their credits through New York
institutions, although some of them deal direct with foreign bankers.
Probably a smaller proportion of our exports is financed by means of
commercial letters of credit than of our imports. Different commodities
are handled in accordance with special customs which have grown up
around them, due partly to trade conditions and partly to the nature of
the products. Sellers of grain usually draw at sixty days' sight upon
the foreign buyer instead of under a bank credit. These bills, under the
customs prevailing in most foreign countries, may be rebated by the
foreign buyer whenever he desires to obtain the goods at the "bank rate"
or 1 per cent. under the bank rate, or such other rate as custom in the
country on which the drafts are drawn requires. Such drafts, with bills
of lading and such other documents as are necessary, are purchased by
American banks and are forwarded by them to their European
correspondents. The American banker is obliged to advance the money on
such paper, unless he draws his own time bills against them, until such
time as they are rebated. In the case of grain bills the average time
rebated is probably around fifty-six days, which places the American
bank in possession of demand foreign exchange, against which it can draw
in order to reimburse itself with the loss of a very few days' interest.
Flour bills, which are financed in the same manner as grain bills,
usually run nearly to maturity before they are rebated, although the
condition of the discount market sometimes influences the purchaser, and
causes him to take the bills up more promptly. Many foreign shipments
are made under three-day sight bills, which uses the money of the
American banks making the advance from four to seven days or more,
depending upon whether the laws of the country on which the bills are
drawn allow grace or not and whether the bills are purchased with
intervening days before the sailing of steamers. Other classes of bills
are drawn at sight. This includes a portion of our lumber shipments and
miscellaneous articles. Where shipments are made on sailing vessels,
drafts are frequently drawn at four or six months' sight, and many other
transactions go through against cable payments.
As nearly 40 per cent. of our exports consist of cotton, the method
under which it is financed is worthy of special consideration. Cotton
bills are ordinarily of two kinds: documentary payment bills and bills
drawn upon bankers. Documentary payment bills, which are drawn upon
cotton merchants or spinners at sixty or ninety days' sight or other
tenors, are handled in the same manner as flour bills. The cotton
merchant accepts the draft upon presentation and rebates it when the
goods arrive, or when he desires to obtain the cotton. A small
percentage of cotton is handled in this way. Most of the commodity is
financed by means of credits opened by the foreign buyer through his
banker. Various abuses have developed under this system, which have
caused losses running into millions of dollars to all of the various
parties engaged in carrying the transactions to their close. These
losses have only been possible because of the turning over of credits by
the foreign buyers to irresponsible concerns in America in their
endeavor to obtain cotton at lower prices than their competitors. A
foreign buyer makes arrangements with certain American concerns to cable
him offers of cotton. The American firms whose offers are accepted
receive cablegrams from the buyer advising them of the acceptance of
their offers and giving them the names of the foreign bankers on whom
the drafts in payment of the cotton are to be drawn. The American
sellers thereupon ship the cotton to the buyer under bills of lading
drawn to the shipper's order and endorsed in blank. The bills of lading
are then attached to drafts drawn upon the bankers designated by the
buyer at the given tenor, which is usually sixty or ninety days. This
exchange is then sold in the market to the highest bidder or it is
forwarded to New York to be sold in the same manner upon arrival. The
American exchange buyers have no means whatever of designating whose
bills shall be upon the market, as the sellers are all agents of the
European buyers. The American exchange houses in their need for exchange
to meet the demands of their importers have accepted the bills offered
in the market, each exchange man endeavoring to keep his "water line" on
weak names as low as possible. If the European buyers only dealt with
first-class houses only first-class bills would be offered, but when
they deal with second- or third-rate houses, or houses with no standing
whatever, such bills drawn upon prime European banks come upon the
market.
The American exchange buyers having the cotton as collateral while the
drafts are on the water, and then having the acceptance of a prime
European bank for the sixty or ninety days following before maturity of
the draft, have accepted these risks, although unwillingly, for want of
better bills. They endeavor to protect themselves as far as possible by
trying to buy bills only of those in whose honesty they have reason to
believe, whether they have any capital back of them or not. If the
cotton were actually shipped under a bona fide order, any fluctuation in
the value of the cotton which they accepted as collateral, although
taken entirely without margin, would probably cause them neither loss
nor friction. They have run the risk, however, of having forged
documents forced upon them which did not represent goods, or exchange
that was drawn without authority. Lines which exchange buyers are
willing to take from each cotton shipper before acceptance, and before
the name of a prime European banker is added to the paper, have to be
based upon this consideration.
The old form of the cotton bill of lading which has been signed by
freight agents or their assistants or others has been an instrument not
possible to authenticate. This was particularly dangerous, due to the
manner in which bills of lading were issued. They were formerly given
out to the shippers, who filled them in and returned them to the
railroad agent, who in turn often signed them without having any
knowledge as to whether the goods called for by the bill of lading were
in his possession or not. Under a new system bills of lading are not to
be given up until the goods are actually in possession of the railroads.
This system, which calls for validation certificates, numbered and
printed upon a specially protected water-mark paper, to be attached to
the bills of lading in such manner as to make it practically impossible
to remove them without detection, went into effect September 1, 1910,
and it is confidently hoped that it will give sufficient added safety to
the bills of lading of American railroads to satisfy the foreign
bankers.
The very act of guaranteeing such bills is recognized by foreign bankers
as being wrong in principle, and while they are requesting that American
exchange buyers guarantee bills of lading for exports yet on the other
hand they particularly call attention to the fact that no bills of
lading which pass through their hands for imports to the United States
are guaranteed by them in any way, shape, or manner.
CREDIT RISKS OF DRAFTS DRAWN ON BUYERS ABROAD
[109]Many American manufacturers do not realize the essential "credit"
element of transactions on the basis of drafts drawn on _foreign
customers_.... The exporter has received an order; he purchases the
goods covered by this order from the manufacturer, and should the
customer change his mind the exporter may suffer a loss. Or the customer
refuses to accept the goods, and the exporter may again suffer a loss.
Or the customer may accept the goods and the draft, but fail to pay, and
the exporter once more is the loser....
... The turning over of the bill of lading vests the property right to
the goods in the customer. The customer either pays the value of the
draft in cash ("documents against payment," abbreviated d/p) or accepts
the draft for payment at some future date, which is the more customary
course ("documents against acceptance," d/a). Even in the case of d/p
drafts, payment by the customer may be postponed; instead of paying cash
he accepts the draft at one to three months, but neither the documents
nor the goods are turned over to him. He may want to wait until he has
sold the goods, on the basis of samples, perhaps, and the goods are
warehoused until he can pay the amount of the draft into the bank or to
the forwarding agency. This is frequently done in the Far East. Here the
banks maintain so-called "godowns" for this purpose. The goods are
occasionally turned over to the customer for warehousing purposes
against the so-called "trust receipt." One important feature of
"acceptance" of the draft by the customer is the fact that it forms an
acknowledgment of indebtedness, which it is then unnecessary to prove
item by item in case of litigation. In most countries acceptances are
far simpler to collect judicially than open accounts. When an accepted
draft is unpaid it is "protested," and the debtors may be proceeded
against without further trouble.
Frequently open accounts may be neglected by a customer who may find
himself for some reason short of immediately available funds, but to
neglect the payment of an accepted draft is regarded in the trade and by
banks as so serious a matter that the drawee would lose caste with the
banks; oversea buyers endeavor in most cases to honor accepted
drafts....
ENGLAND DRAWS FEW BILLS, BUT ACCEPTS MANY--THE REASON AND THE RESULT
[110]It has been shown that, if two countries buy of each other to the
same amount, their transactions need not give rise to two separate sets
of bills, but that on the contrary, if the foreigner draws on us to the
full value of his exports, the bills so created will be sent as
remittances to the exporter on this side and will pay him for his sales.
Conversely, if the British exporter draws, there is no necessity for the
other side to do so.
What, then, are the facts? Does the United Kingdom, generally speaking,
draw on abroad, or does the foreigner take the initiative by drawing on
London?
As a matter of fact, both sides draw; but, as all who are acquainted
with the customs of trade are well aware, the bills drawn by Great
Britain on abroad are vastly outnumbered by those drawn from abroad on
London.
Owing chiefly to the magnitude of our trade, but also to several
contributory causes--such as the stability of our currency; the
certainty that a bill on London means gold and nothing but gold; the
facility with which those who deserve credit can obtain it here; our
freedom from invasion, etc.--London has become to a great extent the
settling-place of Europe and the world, and the seller, wherever he may
be, of a good bill on London can always be sure of finding a buyer and
of realizing a fair price. As the sale of a bill, moreover, carries the
valuable advantage of ready money and a speedy turnover of capital, it
is invariably preferred by the foreign exporter, who has consigned or
sold produce to us, to the alternative plan of awaiting remittances from
this side. The foreign importer, too, who has to pay for the goods he
has bought, would rather do so by remitting to London than by allowing
us to draw upon him. In the former case, the rate he has to pay depends
upon his own success in higgling; in the latter, it is fixed by a London
bill-broker, who has not the same interest in the matter.
If the same considerations held good on this side also, our merchants
and manufacturers might perhaps object to letting the foreigner have it
all his own way; but, on the contrary, it appears to suit both buyers
and sellers very well--the former, because in the majority of cases they
would scarcely know how or where to buy suitable bills, and the latter,
because the drawing and negotiation of a foreign bill requires a certain
amount of knowledge of the exchanges, which they do not always possess,
and entails a certain amount of trouble, which they would gladly be
spared. There is also more risk of loss in drawing. In the latter case
they have only their correspondent to look to, while on a London
remittance they have the additional security of the other parties to the
bill.
Practically speaking, therefore, the settlement of our foreign trade is
effected by means of bills of exchange which are drawn and negotiated
abroad, and are accepted and paid in London.
To the student of the exchanges this fact is of considerable importance,
for, as the rate of exchange between two countries--the price at which
bills on the one are sold in the other--must be _fixed by the one that
draws and negotiates the bill_, it follows that the exchanges between
England and most other countries are controlled from the other side, and
that we in London have scarcely part or say in the matter. The rate of
exchange, for example, between England and the United States is fixed in
New York; between England and Brazil, in Rio; between England and
Turkey, in Constantinople; and so on. There may be exceptions, of which
the Indian exchange is the most notable, but that is the general rule,
and it is one that should be carefully borne in mind.
The same fact also supplies a reason for the solicitude with which the
foreign trader watches the fluctuations of the exchange, and for the
utter indifference with which they are regarded by the British trader.
To the former, who intends maybe to draw a few hundred pounds on London
in a day or two against the shipment he is preparing, the difference
between selling his draft next week instead of this may mean, if the
rate should move in his favor, the gain of an additional half per cent.;
but to our home manufacturers, who sell their wares in sterling and
stipulate for payment in bills on London, the see-saw of rates is but of
academic interest. They pay attention to the _course of discount_,
because they may have to melt some of their paper before pay-day comes
round; but the course of the exchange--the question of the rate rising
or falling--hardly concerns them at all.
It is not sought to detract from the influence of the English-drawn
foreign bill, or, as might be imagined, to explain it away altogether.
On the contrary, paper to a considerable amount is, and will continue to
be, negotiated on the Royal Exchange (though the total, if compared with
that of the paper on London negotiated abroad, would appear quite
insignificant).[111] The object in view is merely to bring into
prominence, and to impress on the reader, the essential principle that,
while the position of every rate of exchange is the outcome of the
market conditions _in the two countries combined_, the predominant mass
of the dealings take place on the other side, so that, as a consequence,
the real significance of the fluctuations can only be grasped by viewing
them from the foreign [_e. g._, American] standpoint.
THE RECENT RISE OF THE AMERICAN ACCEPTANCE MARKET
[112]Probably the most important effect at this time [1915] of the
Federal Reserve Act is the establishment of the American acceptance
market. It may well be said that heretofore America has had no real
money market. The only semblance of a money market previously existing
in this country was the call loan market of New York City. That,
however, did not truly reflect money conditions in this country, as it
has more often reflected the secondary effect of some movement of the
stock market.
The development of a real money market in this country was greatly
hampered by the lack of a standardized credit instrument. In every other
country the bank acceptance in which the element of credit risk has been
practically eliminated is the standard instrument of credit, and the
discount rate of such paper marks the level of the money market.
Bank acceptances were not known in this country prior to the operation
of the Federal Reserve Act. For the benefit of those who may not be
familiar with bank acceptances, I will briefly describe an operation
giving rise to such acceptances. Jones, an importer of coffee in New
York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes
to his bank in New York and arranges with them to finance the deal.
Smith, the grower of the coffee in Brazil, makes the shipment to New
York and draws a ninety days' sight draft on the New York bank for the
amount of his invoice. This draft he then sells to some Brazilian
bank.... The Brazilian bank then sends the draft to New York. It is
there presented to the New York bank for acceptance. The New York bank
accepts the draft by writing the word "accepted" across the face of the
draft and affixing its official signature thereto. The draft now becomes
the primary obligation of the New York bank. Of course, Jones, for whose
account the New York bank accepted the draft, has obligated himself to
provide the New York bank with funds to meet the draft, but if he
should fail to do so the New York bank must pay the acceptance
nevertheless. It is, therefore, the direct obligation of the New York
bank, and as such it commands the best discount rates current. This
briefly is what is known as a bank acceptance, _i. e._, a draft drawn on
and accepted by a prime bank or banker.
Although this business is still in its infancy, it has reached important
proportions and there is an active market for them in New York City. A
number of brokers have taken up the business of buying and selling
acceptances. Every morning they make the rounds of the various banks
with the list of the acceptances they have for sale and the rates at
which they are willing to sell them. Incidentally, they also learn
whether the banks have any acceptances for sale and at what rates. As
the credit risk is practically eliminated, acceptances are a very
attractive form of secondary reserve; they are, as a London banker once
expressed it, a means of enabling the banker to eat his cake and have it
too--the banker by investing his money in acceptances earns the discount
and at the same time he knows that his money is instantly available in
case of need, so that they are almost as available as cash. This
explains why the discount rate on acceptances ranges so low. Ninety
days' sight acceptances sold in New York City at one time as low as 2
per cent. per annum and to-day prime acceptances command the excellent
rate of 2-3/8 per cent.
THE ECONOMIES AND ADVANTAGES OF "DOLLAR CREDITS"[113]
Many radical changes in the mechanism of international finance have
occurred during the past fifteen months, since the beginning of the
European war. Not the least important among these changes, viewed from
the standpoint of the American importer, is the evolution in the methods
of financing our importations.
Our imports in the way of commodities such as hides, coffee, rubber,
wool, etc., etc., run into hundreds of millions of dollars annually, and
these are financed generally through the medium of commercial credits
established by the purchaser in favor of the vendor of the merchandise.
Commercial credits, so called, are in effect a bank guarantee to the
seller that his drafts covering certain merchandise, when drawn in
accordance with the conditions prescribed in the credit, will meet with
due honor on presentation to the accepting bank named in the credit
instrument.
In order merely to gain an idea as to the importance and volume of such
transactions, it is only necessary to glance at the totals of a few of
our principal imports. In the year 1914 we imported, among other
commodities, the following:
Hides and skins $120,289,781.00
Coffee 110,725,392.00
Rubber 131,995,742.00
Wool (unmanufactured) 53,190,767.00
Prior to the outbreak of the war in Europe, it is safe to assume that
fully 95 per cent. of the credits issued to cover these importations
were passed through London in the form of sterling credits; that is to
say, credits available by drafts drawn in pounds sterling on London.
Requests for the issuance of credits available by drafts drawn in United
States dollars on New York were extremely rare, and they were issued
only in exceptional cases.
Conditions have changed materially in this respect. The Federal Reserve
Act grants to national banks the privilege of accepting drafts or bills
of exchange growing out of transactions involving the importation or
exportation of goods. This acceptance privilege was accorded to national
banks only a short time before the commencement of hostilities abroad,
and this fact in conjunction with the resulting dislocation in the
delicate machinery of international credit brought about by the war,
together with the coincidental establishment of American branch banks in
South America, has contributed in a large measure to bring about the use
of what is known now as "Dollar Credits."
As a factor in creating the existing demand for Dollar Credits, the
establishment of American branch banks abroad cannot be emphasized too
strongly. Through these branch banks, a new and adequate medium for the
liquidation of transactions as between the United States and certain
South American countries, especially the Argentine, Brazil, and Uruguay,
has been placed at the disposal of our merchants. A direct channel is
now open to the ebb and flow of credit transfer between the United
States and the countries mentioned, and, as a natural sequence, the
former disparity existing against the dollar, as compared with pounds
sterling and the principal continental exchanges, has disappeared. The
resulting equalization in the rates of exchange benefits the American
merchant to the extent of relieving him of the tribute formerly paid to
the indirect channels of liquidation, or, in other words, to the foreign
banker.
The Dollar Credit is of capital importance to every American merchant
who is interested either directly or indirectly in the importation of
commodities of any character. A study of the advantages accruing from
this form of credit will demonstrate the desirability of its general
employment as the vehicle for financing not only our own imports but
also those of other countries. Primarily, it is more economical than the
Sterling or Continental Credit, for the initial commission cost of
issuance is lower. Secondly, it is based on a known quantity, the
dollar, a factor of supreme importance in these days of extreme and
violent fluctuations in the exchange rates, and therefore all exchange
risk is eliminated from the operation as far as the importer is
concerned. Maturities drawn under Dollar Credits are due and payable in
dollars on a given date, and no question arises as to what the exchange
rate on London may be ninety days after acceptance of the bill.
Under existing conditions in the New York money market, and considering
the present low rates of interest actually in effect, the use of Dollar
Credits is proving to be particularly attractive to the American
importer as the medium for financing his importations. The rate of
discount in New York for prime bank acceptances is 2-1/8@2-1/4 per cent.
per annum, and a broad, well-developed discount market now exists, with
an ever-increasing demand in evidence for this class of paper. On the
other hand, the rate of discount in London for prime ninety-day bills
is 4-3/4 per cent. per annum, with operations restricted in a far from
normal market. A comparison of these two discount rates will show a
difference in favor of New York of 2-1/2@2-5/8 per cent. per annum. In
addition to this difference in interest, there is also a difference in
the initial cost in the form of commission for issuance, as between
credits available by ninety-day drafts drawn on New York in dollars and
those available by ninety-day drafts drawn on London in pounds sterling.
This difference in commission in favor of New York will average 1/2 per
cent. per annum, and when added to the saving in discount or interest
already noted, will show a net saving on the Dollar Credit of 3@3-1/8
per cent. per annum, which accrues to the importer through the use of
Dollar Credits in his operations.
Quite apart from the direct economy to the individual resulting from the
use of Dollar Credits, is the broader question of the economic value
accruing to the nation as a whole through the designation of the dollar
as the basis of value in our credit transactions with the rest of the
world. Since 1903, when the total of our imports amounted to
$1,025,719,237, the volume of our imports has increased rapidly, and in
1914, the total imports reached the enormous sum of $1,893,925,657.
These figures cover products from all parts of the world shipped direct
to our own shores, and while no nation enjoys higher international
credit than the United States, yet it is a fact that in order to finance
the movement of our imports we have been compelled to have recourse to
indirect channels and call on foreign money centers to furnish us with
the necessary credit facilities to take care of a large part of our
importations. Naturally, we have been obliged to pay for this
accommodation, and the service has cost us millions of dollars annually
in interest, commissions, etc.
These charges can be saved and an important economy effected, thus
benefiting our commerce as a whole by the general designation of dollars
in our foreign credit transactions. The purchasing power of the dollar
in foreign markets is much greater to-day than it is in normal times
because of the varying premium which the dollar commands at present
practically throughout the world. The time is unquestionably opportune
to increase the prestige of the dollar and to standardize its use in the
liquidation of our direct purchases abroad. Co-operation and concerted
action on the part of our merchants to the end of generalizing the use
of Dollar Credits is therefore a duty, which will bring about lasting
benefit to the economic fabric of our commerce.
THE NEW YORK FOREIGN EXCHANGE MARKET[114]
A market may be defined as the coming together of buyers and sellers. It
therefore involves all the mechanism necessary to facilitate their
intercourse. One may speak of a general market or of a local market, of
a market in one or in another place. Thus, there is the New York market
for the buying and selling of exchange on London. A bank in New Haven,
Connecticut, may be a part of that market if it buys from and sells to
it. That market includes, besides the commercial and industrial
organizations which buy or sell drafts, all middlemen of whatever class
who engage in the trade.
The middlemen may be divided roughly into three classes. First may be
mentioned banks which do a regular foreign exchange business, buying
bills from those who have them to sell and selling their own drafts on
foreign correspondents to persons desiring to remit. Much of this
business is done by foreign exchange banks which carry on little or no
other business. Some of it is done by ordinary commercial banks, such as
United States National Banks, in addition to their other banking
business. Second, we may call attention to those exchange dealers whose
principal business is to buy commercial and bankers' bills, and to
resell them, chiefly to banks. Third are the independent brokers who
make small commissions by bringing buyers and sellers together. These do
not invest their own capital, do not, that is, buy bills of exchange in
the market, but assist those desiring to sell bills to find buyers, and
_vice versa_....
NEW YORK CITY PRACTICALLY ABSORBS BY PURCHASE ALL AMERICAN FOREIGN
EXCHANGE
[115]There is, perhaps, no feature pertaining to banking throughout the
country so dependent upon New York financiers, as foreign exchange. The
very foundation of this branch of banking is constructed by the New York
bankers, and from their banking houses emanate the basic prices and
quotations upon which foreign bills are bought and sold throughout the
United States.
It is the custom of New York foreign exchange brokers to furnish their
Western clients, direct, or through their local representatives, daily
market quotations, and to promptly advise them of fluctuations
throughout the day. So closely is the West allied to the East, in this
respect, that any interruption caused by delayed or suspended
telegraphic service, immediately superinduces a practical standstill of
exchange transactions, and operations thereafter must necessarily be
made in the "dark" until free communication is again renewed between the
cities....
The absorptive power of the New York market, to digest not only the
surplus foreign exchange of the Chicago market, but that of the entire
United States as well, has been demonstrated for many years. The reason
for this can be attributed to the fact that international trade balances
are at the present day, and always will be, adjusted by the financiers
of New York City.
HOW MONEY IS MADE IN FOREIGN EXCHANGE--THE OPERATIONS OF THE FOREIGN
DEPARTMENT
[116]Complete description of the various forms of activity of the
foreign exchange department of an important firm would fill a large
volume, but there are certain stock operations in foreign exchange which
are the basis of most of the transactions carried out and the
understanding of which ought to go a long way toward making clear what
the nature of the foreign exchange department's business really is.
I. SELLING "DEMAND" AGAINST "DEMAND"
The first and most elementary form of activity is, of course, the buying
of demand bills at a certain price and the selling of the banker's own
demand drafts against them at a higher price. A banker finds, for
instance, that he can buy John Smith & Co.'s sight draft for L1,000, on
London, at the rate of 4.86, and that he can sell his own draft for
L1,000 on his London banking correspondent at 4.87. All he has to do,
therefore, is to buy John Smith's draft for $4,860, send it to London
for credit of his account there, and then draw his own draft for L1,000
on the newly created balance, selling it for $4,870. It cost him $4,860
to buy the commercial draft, and he has sold his own draft against it
for $4,870. His gross profit on the transaction, therefore, is $10.
As may be imagined, not very much money is made in transactions exactly
of this kind--the one cited is taken only because it illustrates the
principle. For whether the banker sends over in every mail a bewildering
assortment of every conceivable form of foreign exchange to be credited
to his account abroad, or whether he confines himself to remittances of
the simplest kind of bills, the idea remains exactly the same--he is
depositing money to the credit of his account in order that he may have
a balance on which he can draw. That is, indeed, the sum and substance
of the exchange business of the foreign department of most banking
houses--the maintaining of deposit accounts in banks at foreign centres
on which deposit account the bank here is in a position to draw
according to the wants and needs of its customers.
II. SELLING CABLES AGAINST DEMAND EXCHANGE
A "cable," so-called, differs from a sight draft only in that the banker
abroad who is to pay out the money is advised to do so by means of a
telegraphic message instead of by a bit of paper instructing him to "pay
to the order of so and so."
Under ordinary circumstances foreign exchange dealers who engage in the
business of selling cables carry adequate balances on the other side,
balances which they keep replenishing by continuous remittances of
demand exchange.
III. SELLING "DEMAND" BILLS AGAINST REMITTANCES OF LONG BILLS
If there is a stock operation in the conduct of a foreign exchange
business it is the selling by bankers of their demand bills of exchange
against remittances of commercial and bankers' long paper. Bills of the
latter class make up the bulk of foreign exchange traded in, and its
disposal naturally is the most important phase of foreign exchange
business. What the foreign exchange business really is grounded on is
the existence of commercial bills called into existence by exports of
merchandise.
Buying and remitting commercial long bills is no pastime for an
inexperienced man. Entirely aside from the question of rate, and profit
on the exchange end of the transaction, there must be taken into
consideration the matter of the credit of the drawer and the drawee, the
salability of the merchandise specified in the bill of lading, and a
number of other important points.
Where documents accompany the draft and the merchandise is formally
hypothecated to the buyer of the draft, it might not be thought that the
standing of the drawer would be of such great importance. Possession of
the merchandise, it is true, gives the banker a certain form of security
in case acceptance of the bill is refused by the parties on whom it is
drawn or in case they refuse to pay it when it comes due, but the
disposal of such collateral is a burdensome and often expensive
operation. The banker in New York who buys a sixty-day draft drawn
against a shipment of butter is presumably not an expert on the butter
market and if he should be forced to sell the butter, might not be able
to do so to the fullest possible advantage. Employment of an expert
agent is an expensive operation, and, moreover, there is always the
danger of legal complication arising out of the banker's having sold the
collateral. It is desirable in every way that if there is to be any
trouble about the acceptance or payment of a draft, the banker should
keep himself out of it.
The successive steps in an actual transaction are as follows:
The banker in New York having ascertained by cable the rate at which
bills "to arrive" in London by a certain steamer will be discounted,
buys the bills here and sends them over, with instructions that they be
immediately discounted and the proceeds placed to his credit. On this
resulting balance he will at once draw his demand draft and sell it in
the open market. If, from selling this demand draft, he can realize more
dollars than it cost him in dollars to put the balance over there, he
has made a gross profit of the difference.
To illustrate more specifically: A banker has bought, say, a L1,000
ninety days' sight prime draft, on London, documents deliverable on
acceptance. This he has remitted to his foreign correspondent, and his
foreign correspondent has had it stamped with the required "bill-stamp,"
has had it discounted, and after having taken his commission out of the
proceeds, has had them placed to the credit of the American bank. In all
this process the bill has lost weight. It arrived in London as L1,000,
but after commissions, bill-stamps, and ninety-three days' discount have
been taken out of it, the amount is reduced well below L1,000. The net
proceeds going to make up the balance on which the American banker can
draw his draft are, perhaps, not over L990. He paid so-and-so many
dollars for the L1,000 ninety-day bill, originally. If he can realize
that many dollars by selling a demand draft for L990 he is even on the
transaction.
IV. THE OPERATION OF MAKING FOREIGN LOANS
In its influence upon the other markets, there is perhaps no more
important phase of foreign exchange than the making of foreign loans in
the American market. The mechanics of these foreign loaning operations,
the way in which the money is transferred to this side, etc., will now
be taken up.
To begin at the very beginning, consider how favorable a field is the
American market for the employment of Europe's spare banking capital.
Almost invariably loaning rates in New York are higher than they are in
London or Paris. This is due, perhaps, to the fact that industry here
runs on at a much faster pace than in England or France, or it may be
due to the fact that we are a newer country, that there is no such
accumulated fund of capital here as there is abroad. Such a hypothesis
for our own higher interest rates would seem to be supported by the fact
that in Germany, too, interest is consistently on a higher level than in
London or Paris, Germany, like ourselves, being a vigorous industrial
nation without any very great accumulated fund of capital saved by the
people. But whatever the reason, the fact remains that in New York money
rates are generally on so much more attractive a basis than they are
abroad that there is practically never a time when there are not
hundreds of millions of dollars of English and French money loaned out
in this market. All through the past ten years London has at various
times opened her reservoirs of capital and literally poured money into
the American market.
To take up the actual operation of loaning foreign money in the American
market, suppose conditions to be such that an English bank's managers
have made up their minds to loan out L100,000 in New York--not on joint
account with the American correspondent, as is often done, but entirely
independently. Included in the arrangements for the transaction will be
a stipulation as to whether the foreign bank loaning the money wants to
loan it on the basis of receiving a commission and letting the borrower
take the risk of how demand exchange may fluctuate during the life of
the loan, or whether the lender prefers to lend at a fixed rate of
interest, say 6 per cent., and himself accept the risk of exchange.
What the foregoing means will perhaps become more clear if it is
realized that in the first case the American agent of the foreign lender
draws a ninety days' sight sterling bill for, say, L100,000 on the
lender, and hands the actual bill over to the parties here who want the
money. Upon the latter falls the task of selling the bill, and, ninety
days later, when the time of repayment comes, the duty of returning a
_demand_ bill for L100,000, plus the stipulated commission. In the
second kind of a loan the borrower has nothing to do with the exchange
part of the transaction, the American banking agent of the foreign
lender turning over to the borrower not a sterling draft but the dollar
proceeds of a sterling draft. How the exchange market fluctuates in the
meantime--what rate may have to be paid at the end of ninety days for
the necessary demand draft--concerns the borrower not at all. He
received dollars in the first place, and when the loan comes due he pays
back dollars, plus 4, 5, or 6 per cent., as the case may be. What rate
has to be paid for the demand exchange affects the banker only, not the
borrower.
Loans made under the first conditions are known as sterling, mark, or
franc loans; the other kind are usually called "currency loans." At the
risk of repetition, it is to be said that in the case of sterling loans
the borrower pays a flat commission and takes the risk of what rate he
may have to pay for demand exchange when the loan comes due. In the case
of a currency loan the borrower knows nothing about the foreign exchange
transaction. He receives dollars, and pays them back with a fixed rate
of interest, leaving the whole question and risk of exchange to the
lending banker.
To illustrate the mechanism of one of these sterling loans. Suppose the
London Bank, Ltd., to have arranged with the New York Bank to have the
latter loan out L100,000 in the New York market. The New York Bank draws
L100,000 of ninety days' sight bills, and, satisfactory collateral
having been deposited, turns them over to the brokerage house of Smith &
Jones, the borrowers. Smith & Jones at once sell the L100,000, receiving
therefor, say, $484,000.
The bills sold by Smith & Jones find their way to London by the first
steamer, are accepted and discounted. Ninety days later they will come
due and have to be paid, and ten days prior to their maturity the New
York Bank will be expecting Smith & Jones to send in a _demand_ draft
for L100,000, plus 3/8 per cent. commission, making L375 additional.
This L100,375 less its commission for having handled the loan, the New
York Bank will send to London, where it will arrive a couple of days
before the L100,000 of ninety days' sight bills originally drawn on the
London Bank, Ltd., mature.
What each of the bankers concerned makes out of the transaction is plain
enough. As to what Smith & Jones' ninety-day loan cost them, in addition
to the flat 3/8 per cent. they had to pay, that depends upon what they
realize from the sale of the ninety days' sight bills in the first place
and secondly on what rate they had to pay for the demand bill for
L100,000. Exchange may have gone up during the life of the loan, making
the loan expensive, or it may have gone down, making the cost very
little. Plainly stated, unless they secured themselves by buying a
"future" for the delivery of a L100,000 demand bill in ninety days at a
fixed rate, Messrs. Smith & Jones have been making a mild speculation in
foreign exchange.
If the same loan had been made on the other basis, the New York Bank
would have turned over to Smith & Jones not a _sterling bill_ for
L100,000, but the _dollar proceeds_ of such a bill, say a check for
$484,000. At the end of ninety days Smith & Jones would have had to pay
back $484,000, plus ninety days' interest at 6 per cent., $7,260, all of
which cash, less commission, the New York Bank would have invested in a
demand bill of exchange and sent over to the London Bank, Ltd. Whatever
more than the L100,000 needed to pay off the maturing nineties such a
demand draft amounted to, would be the London Bank, Ltd.'s profit.
From all of which it is plainly to be seen that when the London bankers
are willing to lend money here and figure that the exchange market is on
the down track, they will insist upon doing their lending on the
"currency loan" basis--taking the risk of exchange themselves.
Conversely, when loaning operations seem profitable but rates seem to be
on the upturn, lenders will do their best to put their money out in the
form of "sterling loans." Bankers are not always right in their views,
by any means, but as a general principle it can be said that when big
amounts of foreign money offered in this market are all offered on the
"sterling loan" basis, a rising exchange market is to be expected.
From what has been said about the mechanism of making these foreign
loans, it is evident that no transfer of cash actually takes place, and
that what really happens is that the foreign banking institution lends
out its credit instead of its cash. For in no case is the lender
required to put up any money. The foreign lender is at no stage out of
any actual capital, although it is true, of course, that he has
obligated himself to pay the drafts on maturity, by "accepting" them.
Where, then, is the limit of what the foreign bankers can lend in the
New York market? On one consideration only does that depend--the amount
of accepted long bills which the London discount market will stand. For
all the ninety days' sight bills drawn in the course of these transfers
of credit must eventually be discounted in the London discount market,
and when the London discount market refuses to absorb bills of this kind
a material check is naturally administered to their creation.
V. THE DRAWING OF FINANCE-BILLS
Approaching the subject of finance-bills, the author is well aware that
concerning this phase of the foreign exchange business there is a wide
difference of opinion. Finance-bills make money, but they make trouble,
too. Their existence is one of the chief points of contact between the
foreign exchange and the other markets, and one of the principal reasons
why a knowledge of foreign exchange is necessary to any well-rounded
understanding of banking conditions.
Strictly speaking, a finance-bill is a long draft drawn by a banker of
one country on a banker in another, sometimes secured by collateral, but
more often not, and issued by the drawing banker for the purpose of
raising money. Such bills are not always distinguishable from the bills
a banker in New York may draw on a banker in London in the operation of
lending money for him, but in nature they are essentially different.
Whether or not any collateral is put up, the whole purpose of the
drawing of finance-bills is to provide an easy way of raising money
without the banker here having to go to some other bank to do it.
The origin of the ordinary finance-bill is about as follows: A bank here
in New York carries a good balance in London and works a substantial
foreign exchange business in connection with the London bank where this
balance is carried. A time comes when the New York banking house could
advantageously use more money. Arrangements are therefore made with the
London bank whereby the London bank agrees to "accept" a certain amount
of the American banker's long bills, for a commission. In the course of
his regular business, then, the American banker simply draws that many
more pounds sterling in long bills, sells them, and for the time being
has the use of the money. In the great majority of cases no extra
collateral is put up, nor is the London bank especially secured in any
way. The American banker's credit is good enough to make the English
banker willing, for a commission, to "accept" his drafts and obligate
himself that the drafts will be paid at maturity. Naturally, a house has
to be in good standing and enjoy high credit not only here but on the
other side before any reputable London bank can be induced to "accept"
its finance paper.
The ability to draw finance-bills of this kind often puts a house
disposed to take chances with the movement of the exchange market into
line for very considerable profit possibilities. Suppose, for instance,
that the manager of a house here figures that there is going to be a
sharp break in foreign exchange. He, therefore, sells a line of
ninety-day bills, putting himself technically short of the exchange
market and banking on the chance of being able to buy in his "cover"
cheaply when it comes time for him to cover. In the meantime he has the
use of the money he derived from the sale of the "nineties" to do with
as he pleases, and if he has figured the market aright, it may not cost
him any more per pound to buy his "cover" than he realized from the sale
of the long bills. In which case he would have had the use of the money
for the whole three months practically free of interest.
It is plain speculating in exchange--there is no getting away from it,
and yet this practice of selling finance-bills gives such an opportunity
to the exchange manager shrewd enough to read the situation aright to
make money, that many of the big houses go in for it to a large extent.
During the summer, for instance, if the outlook is for big crops, the
situation is apt to commend itself to this kind of operation. Money in
the summer months is apt to be low and exchange high, affording a good
basis on which to sell exchange. Then, if the expected crops
materialize, large amounts of exchange drawn against exports will come
into the market, forcing down rates and giving the operator who has
previously sold his long bills an excellent chance to cover them
profitably as they come due.
VI. ARBITRAGING IN EXCHANGE.
Arbitraging in exchange--the buying by a New York banker, for instance,
through the medium of the London market, of exchange drawn on Paris--is
another broad and profitable field for the operations of the expert
foreign exchange manager. Take, for example, a time when exchange on
Paris is more plentiful in London than in New York--a shrewd New York
exchange manager needing a draft on Paris might well secure it in London
rather than in his home city.
Between such cities rates are not apt to be wide enough apart to afford
a wide margin of profit, but the chance for arbitraging does exist and
is being continuously taken advantage of. So keenly, indeed, are the
various rates in their possible relation to one another watched by the
exchange men that it is next to impossible for them to "open up" to any
appreciable extent. The chance to make even a slight profit by shifting
balances is so quickly availed of that in the constant demand for
exchange wherever any relative weakness is shown, there exists a force
which keeps the whole structure at parity. The ability to buy drafts on
Paris relatively much cheaper at London than at New York, for instance,
would be so quickly taken advantage of by half a dozen watchful exchange
men that the London rate on Paris would quickly enough be driven up to
its right relative position. If a chance exists to sell a draft on
London and then to put the requisite balance there through an
arbitration involving Paris, Brussels, and Amsterdam, the chances are
that there will be some shrewd manager who will find it out and put
through the transaction. Some of the larger banking houses employ men
who do little but look for just such opportunities.
The foregoing are the main forms of activity of the average foreign
department, though there are, of course, many other ways of making money
out of foreign exchange.
GOLD MOVEMENTS
[117]When there is a heavy demand for exchange and little supply, the
price of exchange gradually advances. The banker, called on by his
customers to draw exchange for them, finding few bills in the market
that he can remit to cover his drafts, sends gold and directs its
equivalent in foreign coin to be placed to his credit, and against this
credit he draws. There may be no market abroad for our crops or
manufactures; but gold need not be sold in order to produce money; it
need only be coined. As this process can be carried on indefinitely, the
cost of sending gold is obviously the limit beyond which the price of
demand bills cannot advance. Let us follow this transaction in detail.
The pure gold contained in one English sovereign is exactly equal to the
pure gold contained in $4.8665 of our gold coins; so that, apart from
charges and expenses, $4.8665 of our gold will, when sent abroad,
produce a credit of L1; to this cost must be added freight, insurance,
and other expenses, amounting to about one-fourth of 1 per cent. This
brings the cost of L1 through shipment of gold to about $4.88, which is,
roughly, the gold export point for full weight coin. The exporting
banker obtains his gold either by drawing gold coin from his bank or
else by drawing suitable currency from his bank, and obtaining gold coin
for it at the subtreasury. In either case, he obtains coin that has
suffered more or less abrasion by handling, and this loss of weight by
abrasion, amounting to perhaps one-tenth of 1 per cent., increases the
cost of his remittance. Generally, however, the banker can obtain gold
bars from the United States Assay Office at the nominal charge of one
twenty-fifth of 1 per cent., although at times a larger charge is made.
The banker prefers bars, because on these there is no loss by abrasion;
the Government can afford to give bars, because their export prevents
the export of coin, and so saves the cost of coining new money to
replace that shipped.
Now for gold import. When there is a large volume of bills offered to
bankers, perhaps by grain and cotton exporters, and but little demand
from buyers of exchange, the market gradually declines in price, while
New York bankers, sending abroad the bills they buy, with little
occasion to draw against them, accumulate large sums to their credit in
London, with no way of getting the money back to New York through
operations in the exchange market. They are not, however, helpless; they
can order gold sovereigns sent here, and, once here, can have them
melted down at the United States Assay Office and coined into eagles and
double eagles, which they can deposit with their banks. Obviously, the
amount received in dollars for each melted sovereign will mark the price
the banker can afford to pay for sterling bills, and competition among
bankers will prevent the rate of exchange from declining below this
point by more than a fair margin of profit. The British sovereign, if
full weight, will, when sent here and melted down, yield gold for which
the United States Assay Office will pay $4.8665; the expense of sending
the sovereign, freight, insurance, cartage, and kegs, will amount to
about one quarter of 1 per cent., so that the net yield of the full
weight sovereign in dollars will be $4.85-3/8. But between the day on
which the banker buys the bill of exchange in New York and the day on
which he receives in New York the gold which the bill entitled him to
collect in London, there must elapse the time needed to send the bill to
London, plus the time needed to send the gold back (roughly fifteen
days), during which period the banker loses the use of the money. This
loss of interest must be deducted from the net yield of the imported
sovereign, and thus, if money is worth 6 per cent. per annum, the net
yield of full weight sovereigns is brought down to about $4.84-1/4,
which is the gold import point for demand exchange, when money is worth
6 per cent. per annum. Losses by abrasion will bring down this point by
perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is
higher, the import point will be lower, and _vice versa_. There is
therefore a margin of profit in buying demand bills and importing gold
sovereigns against the purchase, whenever the rate for demand bills
falls below the gold import point. Active exchange bankers take
advantage of this profit whenever exchange prices decline to the proper
point, and their competition in buying bills to cover their gold
importations stops further decline in exchange rates. It is interesting
to note that during the recent crisis, when gold and currency were at a
premium, bankers could sell the imported gold at a premium, and this
constituted an additional and very large profit; gold importers could
therefore pay higher prices than ordinarily for exchange bought to cover
the importations, and the stress of competition so drove up the rate of
exchange that gold was being imported at a profit, though exchange rates
stood at what, under ordinary circumstances, would have been the gold
export point.
Gold is, however, not always imported from England in the form of
sovereigns. The Bank of England has in its vaults large quantities of
American eagles and double eagles exported to England in the past and
held without melting. The bank also holds foreign coin and bar gold. Any
holder of Bank of England notes can get sovereigns on demand--other gold
he can get only as the result of a special bargain. When gold is wanted
for export, the bank is often glad to sell bar gold or double eagles at
rates somewhat more advantageous to the exporter than would be the
export of sovereigns; this the bank can afford to do, for the expense
of coining sovereigns to replace those exported is thus saved, while
the exporter, if he can get bar gold on the same basis as sovereigns,
avoids the losses of abrasion. Eagles are even more advantageous to
the exporter, for they are bought in England by weight and used in
America by count; the banker therefore gets an advantage if they are
light, so long as that lightness is not so great as to make them
uncurrent--practically he buys them as light and uses them as full
weight....
The mechanism of gold import to, and export from, Germany is practically
the same as with England, the Reichsbank being required to give gold
coin in exchange for its circulating notes. At times, however, German
exchange has fallen below the theoretical gold import point, owing, not
to the refusal of the Reichsbank to give gold, but to the practical
obstacles that at times are somehow placed in the way of free export of
gold. The Reichsbank does not refuse gold for its bank-notes, but
German bankers say to their correspondents: "Don't ask us to get gold
for you, or we shall lose caste," and on such occasions German exchange
rates drop to a point that is theoretically impossible. I do not mean to
criticise them: German banks, when they refuse to demand gold of the
Reichsbank, do no more than our own banks and bankers did recently, when
asked by foreign correspondents to collect in gold the maturing
obligations of railroads and other corporations. As will be remembered,
clearing-house funds rather than cash were at that time current here,
and New York banks and bankers sent to their foreign correspondents the
same answer as the Germans have at times sent us. I cite the German
instance in partial mitigation of censure of our own course rather than
as a reproach to them.
The Bank of France is not compelled to give gold in exchange for its
circulating notes; it may at its option give silver. Thus, when it is
inconvenient to give gold, the bank can refuse, or, if it prefers, it
can exact a premium. This power has been very moderately and very wisely
used by the bank to modify foreign demands on the one hand, and, on the
other, to keep interest rates low for the requirements of internal
trade. Of course, when a premium is exacted, the French gold import
point drops accordingly.
Between the gold export point and the gold import point, exchange
fluctuates under the sway of conflicting currents and tendencies--I had
almost said emotions, for these currents and tendencies have their rise
in emotions, needs, and passions as varied as life itself, whether they
be hunger as expressed in the grain bill, or love of elegance in the
importation of silk, or forethought in the profitable investment of
capital.
This brief review will have made clear what is meant by a free gold
market--a market in which current money can at all times be exchanged
for gold without delay and without premium. Such a market has great
commercial advantages; its stability draws business to it. London is
such a market, and its commercial and financial pre-eminence is in great
measure due to that fact. Paris is not such a market and does not
pretend to be; Berlin pretends to be, but cannot always be counted on;
New York was believed to be before our recent panic.
I have spoken of the exchange market as an economical mechanism,
automatically making delicate international adjustments. In
justification of that observation, let me direct attention to the manner
in which gold, in moving from financial centre to financial centre,
always travels by the most direct route, and that, too, not because some
public official is charged with the duty of preventing waste, but
because a private trader is trying to make a profit, and is incidentally
serving the community; serving it perhaps better than if he had
consciously determined to serve it.
Useful acts springing from self-interest have one very comforting
aspect--we need have no misgivings as to their continuance. Charity may
grow weary or disgusted, but self-interest, once enlisted, may be
counted on to continue in operation, whether it be the business man's
self-interest in a profit or the professional man's self-interest in
advancement and fame. Of course, both the business man and the
professional man, in addition to seeking the direct rewards of their
labor, take an interest in their work as work and make it yield them
pleasure.
It is therefore satisfactory to know that, so long as the banker looks
after his profits, gold will move by the most direct route. Let us
suppose the United States to be exporting a large quantity of cotton to
England at a time when little merchandise is being imported here from
England, but when much is being imported from France. If the volume of
exports to England and of imports from France were large enough, we
might conceivably be importing gold from England in payment of our
produce, and exporting it to France in payment for her luxuries; but, in
practice, gold does not move that way. Every morning, the New York
exchange banker learns by cable the Paris market rate for demand bills
on London. When, therefore, he finds a large volume of bills on London
offered for sale, and little demand for such bills, while there is large
demand for bills on Paris and little supply, he determines, instead of
drawing from New York against his purchases of London bills, to let his
Paris agent draw against these purchases, placing the proceeds to his
credit in Paris; against this credit in Paris, the New York banker draws
his bill in francs, having thus supplied via London the New York demand
for bills on Paris. He knows how many dollars each pound sterling costs
him in New York, and the Paris rate for bills on London tells him how
many francs each pound sterling will net him in Paris, and so he can
calculate how many cents each franc will cost him. Moreover, he is not
the only banker in New York that receives cable quotations; and so with
a large volume of London bills offered and little direct demand for such
bills, and large demand for Paris bills with little direct supply, we
get a situation where New York bankers, competing with each other to buy
the London bills for use via Paris, prevent the price of sterling from
falling to the gold import point; and then, as a result, these same
bankers, competing with each other to supply the demand for Paris bills,
by their competition prevent the Paris rate from rising to gold export
point. Lastly, they compete with each other in Paris, where all are
sellers of bills on London against their New York purchases of London
bills, and by that competition they reduce the rate for London bills in
Paris to the point, at which, other things being equal, gold will go
from London to Paris. What has happened, therefore, is that instead of
our importing gold from London, and then exporting it to Paris, it has
gone direct from London to Paris.
COMPLICATIONS IN THE DETERMINATION OF GOLD POINTS
[118]It is safe to assert that when the exchanges go down to the point
at which it pays better to ship gold from London than to buy a bill,
gold will go. But in the first place, experts always differ as to where
that point begins; and in the second, gold often leaves London long
before there is any question of its being the more profitable form of
remittance. In fact, it may be asserted that the foreign exchanges very
seldom go down to the export gold point, because gold begins to go
before they can get there.
It has often happened to me, when I was a financial journalist and had
to try to find out the how and why of gold movements, to ask several of
the most experienced and well-informed cambists in the city whether a
gold shipment which had taken place had been made as a genuine exchange
transaction or was done for some other reason, and to hear from one that
there was a reasonable exchange profit on it, from another that there
might be just a shade of a turn to be got out of it if you scraped it
very hard with a knife, and from another that you could not find a
particle of profit in it if you put it under a microscope for a week. So
many complications have to be considered that the most eminent doctors
may be pardoned for disagreeing.
It may be objected that dealers in exchange, and the comparatively few
firms that make a special study of gold shipping, are not in the
business for their health, and that shipments would not happen if there
were not some profit in them. This is perfectly true, but the profit
need not be got from the exchange. As an exchange transaction it only
pays to ship gold to America when bills on London can only be sold in
New York at a lower price than gold would fetch if brought from London
and exchanged into dollars in New York. If bills on London are selling
at 4.83-3/4, and gold can be bought and shipped and turned into dollars
at the rate of 4.83-7/8, after allowing for all charges and commissions
and the loss of interest during transit, then the operation pays as an
exchange transaction. If the dollars realized by the gold were at the
rate of only 4.83-3/4 the importer would be no better off than if he had
sold a bill; if they were at the rate of 4.83-5/8 he would be out of
pocket on the business, viewed strictly as an exchange transaction. But
this is by no means the only consideration. Gold has such a magical
fascination for moneyed mankind, and its movements are so eagerly
discussed in their markets and newspapers, that it is often handled and
shipped at a loss, especially in America, for the sake of the
advertisement that the importing firm thereby gains for itself.
Moreover, imports of gold have a very stimulating effect on speculative
stock markets, because an increase in the amount of gold available means
a roughly corresponding increase in the amount of credit that bankers
can give, so that when gold is known to be coming speculators know that
credit will be cheaper for carrying their commitments, and will come in
and buy, with a light heart, stock that they could not possibly pay for,
but hope to pawn with their bankers until they can sell it at a higher
price. And so unless the loss on the exchange side of the business is
too great, it often pays the leaders of a bull campaign to import gold,
having first laid in a line of stock, and make their profit by unloading
during the fit of exhilaration produced by the news that the gold is on
the way.
Or, again, quite apart from any speculative and spectacular motives
behind gold shipments, it may pay bankers, in a country where rates for
money are ruling high, to import gold at an apparent loss, because of
the high rates that they get for the credit that they are thereby
enabled to give. They thus, in effect, borrow gold, and recoup
themselves by being able to lend, on profitable terms, larger amounts
than they borrow, since they can always create credit to larger amounts
than that of the gold in their vaults. Sometimes, in fact, in times of
pressure banks find themselves obliged to import gold so as to
strengthen their position, whatever the loss on exchange may be.
For instance, last September, when the Berlin exchange was at the point
at which, if theory ruled in these matters, Berlin ought to have been
thinking of packing up some gold to send to London, Berlin was buying
gold in London and shipping it to the Fatherland, because there is
always great pressure for currency in Germany at the end of September
when the interest on mortgages falls due and has to be paid in cash,
with the result that the Reichsbank's note circulation expands very
rapidly and the backing of gold behind it has to be increased.
Sometimes, again, in order to attract gold, a central bank will give
importers credit for gold that is on the way, so that they may be saved
from loss of interest while the metal is afloat. Thus the actual
importer may make a profit on the shipment, not as a genuine exchange
transaction, but at the expense of the central bank.
In these cases two of the many functions performed by gold have to be
considered. As a means of international remittance, it may not be as
cheap as a bill, but it may have to be sent, not as a means of
remittance, but because it is urgently wanted in the importing country
as a make-weight for the balloon of credit.
So we see that the grumbling bill broker who ... [said] that these
confounded exchanges only work one way, was actually understating his
case. Not only do we [Englishmen] always lose gold when the exchanges go
against us, and often get none when they go in our favour, but we also
often lose gold long before the exchanges are sufficiently against us to
justify its going, and sometimes even when they are strongly in our
favour.
The effect on the exchange of an import or export of gold is, of course,
just the same as that of the import or export of any other commodity--an
import turns the exchange against us and an export turns it in our
favour. If we send gold, for example, to Germany we thereby meet a
German claim on us or create a claim for ourselves on Germany; in the
former case the bills drawn on us will be less by the amount of the gold
shipped, and the supply in Berlin of bills on London will be less in
relation to the demand, so that the tendency will be for the price of
sovereigns, as expressed in marks, to rise. In the latter case some one
in Berlin will have a claim to meet in London and will have to bid there
for a bill on London, and his bidding will have the same beneficent
effect on the exchange. When we import gold, whether brought out of
bankers' vaults, or dug out of the bowels of the earth, the country that
sends it to us meets claims of ours on it or establishes claims on us.
In either case the tendency is for the exchange to move against us.
THE HANDLING OF GOLD SHIPMENTS
[119]Whether in coined pieces or bars (bullion), the gold is packed in
strong kegs or boxes, securely strapped with hoop iron, and carefully
sealed with private seals; the latter to discover if tampered with en
route. Space is chartered from the steamship company, as in the case of
merchandise, although nearly all large fast steamers have rooms
especially constructed for such valuable cargo.... As an extra safeguard
in case of large shipments, the steamship company details special armed
men to guard the room day and night, and sometimes the shipper employs
special detectives in citizens' clothes to watch the passengers on the
trip, since it is generally known several days in advance when large
shipments of gold are to be made.
THE SILVER EXCHANGES
[120]... It is acknowledged that commerce between gold standard
countries is satisfactory to all classes of traders, for both importers
and exporters know exactly the return they may expect, but in trade
between a silver-using country and one on a gold basis, a large measure
of uncertainty invariably exists. Whenever there is a fall in the gold
value of silver, either the exporter in the gold standard country or the
importer in the silver country must suffer.
Let us take the case of the exporter. We will suppose that A. Blank &
Company, of Manchester, calico printers, send goods to Shanghai, which
they hope to sell there for a total sum of, say, L1,000. The price of
silver when the shipment was despatched was, we will say, 25_d._ per
standard ounce, and on this basis A. Blank & Company have calculated the
selling price which is to yield them L1,000. By the time the calico
arrives in Shanghai, the gold price of silver has dropped, we will
suppose, to 20_d._ per standard ounce, and this obviously indicates that
the manufacturers will receive one-fifth less for their wares, since
they are paid in the currency of the province (taels in this instance),
and when Blank & Company's money comes to be converted back into British
gold pieces, they are face to face with the fact that the outturn is
L200 less than they had calculated: they have lost one-fifth, and
receive L800 only. This is, of course, an extreme case, as in the
ordinary course silver would be unlikely to drop 5_d._ in the period
between shipment and arrival of the goods in Shanghai; but whatever the
fall, the principle is the same, and the illustration serves to show
exactly what happens.
It is not only the British exporters who stand to lose in the lottery of
trade with countries which have an unstable silver exchange; the
capitalist also, and every class of investor, is liable to be adversely
affected in operations with silver standard countries. The rate of
exchange between such countries and gold standard countries is plainly
the exchange between gold and silver; therefore, if a person has
invested in undertakings in the silver country, when he receives his
dividends in the currency of that country, he will obtain less for his
dividend warrant on the London market in proportion to the fall in the
price of silver--assuming that it does fall. Conversely, he may reap a
higher return on his investment if silver has gone up before the
encashment of his dividend.
Finally, the principal is affected in the same way, whenever it is
desired to convert it back into gold. A further example will show how
this works out in practice.
We may assume that an investor, encouraged by the chance of earning 6
per cent. on his money, remits to China L1,000. The price of silver on
the 1st January, 1914, was 26-7/16_d._ per ounce standard; on the 31st
December, 1914, 22-11/16_d._ For the sake of argument, we will imagine
our investor sent the money out to the Eastern country on the 1st
January, 1914, but circumstances made it advisable for him to recall his
money at the end of December in the same year, when the metal had
depreciated to 22-11/16_d._; in converting his principal back to British
currency he will find himself faced with a sharp loss. Silver, in which
the investment stood, has dropped 3-3/4_d._ of its gold equivalent,
roughly, one-seventh; consequently on conversion the gold value of his
original L1,000 has fallen to about L857....
... The exchanges of these silver standard countries ... [are] quoted in
shillings and pence to the dollar, tael, or rupee, as the case may be,
that is, the gold value of the respective silver coins. Hong-Kong, for
instance, is quoted 1_s._ 10-3/8_d._ to the dollar, and Shanghai, 2_s._
5-5/8_d._ to the tael. The rates from these centres ... indicate the
price for telegraphic transfers on London: the unit of exchange in the
centres named being by general consent the rate for telegraphic
transfers on London.
Let us take the Shanghai rate as an example: 2_s._ 5-5/8_d._ per tael,
means that for every silver tael the remitter hands over to the exchange
bank in Shanghai, 2_s._ 5-5/8_d._, or, to give it its real significance,
a little less than one-eighth of a sovereign in gold, will be paid to
the person in whose favour the remittance is made, as soon as a telegram
can reach the bank's London branch....
... Besides the T. T. rate, as it is called for the sake of brevity, we
have the four months' sight and six months' sight rates, which are the
quotations for first-class bank bills. Both quotations are higher than
for the telegraphic transfers, that is to say, for every silver tael
paid in Shanghai the bank will allow more shillings and pence where it
is a question of paying the gold value in London four or six months
hence, than it would if the payment is to be made on demand or by wire.
The reason is, that if a bill drawn on London, payable four months after
sight, is sent, the remitter is bound to place the receiver in such a
position that if the latter chooses to turn the bill into cash after it
has been "sighted" and accepted, he will not be worse off than if the
money had been sent by cable....
As may be gathered, therefore, the discount rates ruling on the London
market are of great importance to the Eastern bankers and exchange
dealers: so important are they in fact, that it is necessary for each
side to keep in direct telegraphic communication regarding the existing
discount quotations and the probable trend of the markets....
... The rate at which they are able to cover their drawing operations
... governs the price at which they will sell bills. If a banker has
funds deposited with his correspondent upon which he can draw, well and
good: if he has no balance with the agent, he must either provide the
wherewithal to meet the bills which he has drawn, or, alternatively, he
can instruct the agent to draw on him in reimbursement. Finally, there
comes a time,... when, as all other means of placing his correspondent
in funds have been exhausted, the banker will be obliged to ship ...
silver to be sold for what it will fetch....
It is fairly clear that the real trouble in Eastern exchange lies in the
fact that we have three main factors to deal with instead of two. In the
gold exchanges we have simply the demand for and supply of bills and
telegraphic transfers; in the silver exchanges the matter is complicated
by the way in which we also have to depend upon the fluctuations in the
price of silver on the London market....
Shanghai draws on London for the cost of her exports and remits to
London for the value of her imports, and the principal reason for this
procedure is that the manufacturer in Great Britain does not wish to be
bothered with the variations in exchange, although as the reader has
seen, he may be pretty severely affected if silver has depreciated
before his goods are sold. Leaving that out of the question, however, we
may take it that as all his expenses are payable in gold, he naturally
prefers to deal in terms of that metal. Consequently, goods shipped to
China are nearly always paid for by remittances, or drawn for in
sterling, which comes to the same thing. The Chinese producer is on
rather a different footing. His expenses are in silver, and in silver he
wishes to be paid. His produce, however, he has sold to Great Britain
for a gold price, and either he cannot afford to, or does not want to
wait until a remittance can be sent by mail from London. The one way
open to him is to draw in sterling and settle the rate of exchange on
the spot, which he does and so makes an end of the matter....
FOOTNOTES:
[103] Hartley Withers, _Money Changing_, pp. 30-35. E. P. Dutton and
Company. New York. 1914.
[104] Adapted from the Rt. Hon. Viscount Goschen, _The Theory of the
Foreign Exchanges_, pp. 85-88. Effingham Wilson. London. 1913.
[105] Adapted from Franklin Escher, _The Elements of Foreign Exchange_,
pp. 3-14. Bankers Publishing Company. New York. 1913.
[106] _Ibid._, pp. 15-24, 26, 31-33, 44.
[107] Adapted from Frederick I. Kent, _Financing Our Foreign Trade_, The
Annals of the American Academy of Political and Social Science, Vol.
XXXVI, No. 3, November, 1910, pp. 492-500.
[108] [The method explained would apply without qualification to our
imports generally prior to 1914, whether coffee from Brazil, hides from
the Levant or textiles from France. The recent and growing practice of
drawing on New York rather than on London is discussed later in this
chapter.]
[109] Adapted from Archibald J. Wolfe, _Foreign Credits_, pp. 22, 23,
Special Agents Series--No. 62. Department of Commerce and Labor.
Washington. 1913.
[110] George Clare, _The A B C of the Foreign Exchanges_, pp. 11-15.
Macmillan and Company. London. 1911.
[111] [English bills drawn on our banks have increased in volume since
1914, through the operation of the Federal Reserve Act and the amended
New York State Bank Law which make provision for the acceptance of time
drafts by National and New York State banks, respectively.]
[112] John E. Rovensky, _How the War Affects Practical Operations in
International Exchange_, Journal of the American Bankers Association,
Vol. 7, No. 12, June, 1915, pp. 1008, 1009.
[113] Joseph T. Cosby, _The Economies and Advantages of "Dollar
Credits."_ The National City Bank. New York. 1915.
[114] Harry G. Brown, _International Trade and Exchange_, pp. 65-66. The
Macmillan Company. New York. 1914.
[115] Anthony W. Margraff, _International Exchange_, pp. 104-105. Fergus
Printing Company. Chicago. 1903.
[116] Adapted from Franklin Escher, _Elements of Foreign Exchange_, pp.
68-101. Bankers Publishing Company. 1910.
[117] Albert Strauss, _Gold Movements and the Foreign Exchanges_, The
Currency Problem and the Present Financial Situation. A Series of
Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The
Columbia University Press. 1908.
[118] Hartley Withers, _Money Changing_, pp. 159-164. E. P. Dutton and
Company. New York. 1914.
[119] Address by H. K. Brooks. _Lectures on Commerce_, Edited by Henry
Rand Hatfield, University of Chicago Publications of the College of
Commerce and Administration, Vol. I., pp. 283-4. The University of
Chicago Press. Chicago. 1904.
[120] William F. Spalding, _Foreign Exchange and Foreign Bills in Theory
and in Practice_, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New
York and Melbourne. 1915.