THE RISE AND FALL OF EXCHANGE RATES
Granted that the obligations to each other of any two given countries
foot up to the same amount, it is evident that the rate of exchange
will remain exactly at the gold par--that in New York, for instance,
the price of the sovereign will be simply the mint value of the gold
contained in the sovereign. But between no two countries does such a
condition exist--take any two, and the amount of the obligation of one
to the other changes every day, which causes a continuous fluctuation
in the exchange rate--sometimes up from the mint par, sometimes down.
Before going on to discuss the various causes influencing the movement
of exchange rates, there is one point which should be very clearly
understood. _Two_ countries, at least, are concerned in the fluctuation
of every rate. Take, for example, London and New York, and assume that,
at New York, exchange on London is falling. That in itself means that,
in London, exchange on New York is rising.
For the sake of clearness, in the ensuing discussion of the influences
tending to raise and lower exchange rates, New York is chosen as the
point at which these influences are operative. Consideration will be
given first to the influences which cause exchange to go up. In a
general way, it will be noticed, they conform with the sources of
demand for exchange given in the previous chapter. They may be
classified about as follows:
1. Large imports, calling for large amounts of exchange with which
to make the necessary payments.
2. Large purchases of foreign securities by us, or repurchase of
our own securities abroad, calling for large amounts of exchange
with which to make payment.
3. Coming to maturity of issues of American bonds held abroad.
4. Low money rates here, which result in a demand for exchange with
which to send banking capital out of the country.
5. High money rates at some foreign centre which create a great
demand for exchange drawn on that centre.
1. Heavy imports are always a potent factor in raising the level of
exchange rates. Under whatever financial arrangement or from whatever
point merchandise is imported into the United States, payment is almost
invariably made by draft on London, Paris, or Berlin. At times when
imports run especially heavy, demand from importers for exchange often
outweighs every other consideration, forcing rates up to high levels. A
practical illustration is to be found in the inpour of merchandise
which took place just before the tariff legislation in 1909. Convinced
that duties were to be raised, importers rushed millions of dollars'
worth of merchandise of every description into the country. The result
was that the demand for exchange became so great that in spite of the
fact that it was the season when exports normally meant low exchange,
rates were pushed up to the gold export point.
2. Heavy purchasing movements of our own or foreign securities, on the
other side, are the second great influence making for high exchange.
There come times when, for one reason or another, the movement of
securities is all one way, and when it happens that for any cause we
are the ones who are doing the buying, the exchange market is likely to
be sharply influenced upward by the demand for bills with which to make
payments. Such movements on a greater or less scale go on all the time
and constitute one of the principal factors which exchange managers
take into consideration in making their estimate of possible exchange
market fluctuations.
It is interesting, for instance, to note the movement of foreign
exchange at times when a heavy selling movement of American stocks by
the foreigners is under way. Origin of security-selling on the Stock
Exchange is by no means easy to trace, but there are times when the
character of the brokers doing the selling and the very nature of the
stocks being disposed of mean much to the experienced eye. Take, for
instance, a day when half a dozen brokers usually identified with the
operations of the international houses are consistently selling such
stocks as Missouri, Kansas & Texas, Baltimore & Ohio, or Canadian
Pacific--whether or not the inference that the selling is for foreign
account is correct can very probably be read from the movement of the
exchange market. If it is the case that the selling comes from abroad
and that _we_ are buying, large orders for foreign exchange are almost
certain to make their appearance and to give the market a very strong
tone if not actually to urge it sharply upward. Such orders are not
likely to be handled in a way which makes them apparent to everybody,
but as a rule it is impossible to execute them without creating a
condition in the exchange market apparent to every shrewd observer.
And, as a matter of fact, many an operation in the international stocks
is based upon judgment as to what the action of the exchange market
portends. Similarly--the other way around--exchange managers very
frequently operate in exchange on the strength of what they judge or
know is going to happen in the market for the international stocks.
With the exchange market sensitive to developments, knowledge that
there is to be heavy selling in some quarter of the stock market, from
abroad, is almost equivalent to knowledge of a coming sharp rise in
exchange on London.
Perhaps the best illustration of how exchange can be affected by
foreign selling of our securities occurred just after the beginning of
the panic period in October of 1907. Under continuous withdrawals of
New York capital from the foreign markets, exchange had sold down to a
very low point. Suddenly came the memorable selling movement of
"Americans" by English and German investors. Within two or three days
perhaps a million shares of American stocks were jettisoned in this
market by the foreigners, while exchange rose by leaps and bounds
nearly 10 cents to the pound, to the unheard-of price of 4.91. Nobody
had exchange to sell and almost overnight there had been created a
demand for tens of millions of dollars' worth.
3. The coming to maturity of American bonds held abroad is another
influencing factor closely kept track of by dealers in exchange. So
extensive is the total foreign investment in American bonds that issues
are coming due all the time. Where some especially large issue runs off
without being funded with new bonds, demand for exchange often becomes
very strong. Especially is this the case with the short-term issues of
the railroads and most especially with New York City revenue warrants
which have become so exceedingly popular a form of investment among the
foreign bankers. In spite of its mammoth debt, New York City is
continually putting out revenue warrants, the operation amounting, in
fact, to the issue of its notes. Of late years Paris bankers,
especially, have found the discounting of these "notes" a profitable
operation and have at times taken them in big blocks.
Whenever one of these blocks of revenue warrants matures and has to be
paid off, the exchange market is likely to be strongly affected.
Accumulation of exchange in preparation is likely to be carried on for
some weeks ahead, but even at that the resulting steady demand for
bills often exerts a decidedly stimulating influence. Experienced
exchange managers know at all times just what short-term issues are
coming due, about what proportion of the bonds or notes have found
their way to the other side, just how far ahead the exchange is likely
to be accumulated. Repayment operations of this kind are often almost a
dominant, though usually temporary, influence on the price of exchange.
4. Low money rates are the fourth great factor influencing foreign
exchange upward. Whenever money is cheap at any given center, and
borrowers are bidding only low rates for its use, lenders seek a more
profitable field for the employment of their capital. It has come about
during the past few years that so far as the operation of loaning money
is concerned, the whole financial world is one great market, New York
bankers nowadays loaning out their money in London with the same
facility with which they used to loan it out in Boston or Philadelphia.
So close have become the financial relationships between leading
banking houses in New York and London that the slightest opportunity
for profitable loaning operations is immediately availed of.
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. During long periods of low
money, indeed, it often happens that large lending institutions here
send away a considerable part of their deposits, to be steadily
employed for loaning out and discounting bills in some foreign market.
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.
5. 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 centers 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.
Particular attention will be given later on to the way in which the
Bank of England and the other great foreign banks manipulate the money
market and so control the course of foreign exchange upon themselves,
but in passing it is well to note just why it is that when the interest
rate at any given point begins to go up, foreign exchange drawn upon
that point begins to go up, too. Remittances to the point where the
better bid for money is being made, are the very simple explanation.
Bankers want to send money there, and to do it they need bills of
exchange. An urgent enough demand inevitably means a rise in the
quotation at which the bills are obtainable. Which suggests very
plainly why it is that when the Directors of the Bank of England want
to raise the rate of exchange upon London, at New York or Paris or
Berlin, they go about it by tightening up the English money market.
The foregoing are the principal causes making for high exchange. The
causes which make up for low rates must necessarily be to a certain
extent merely the converse, but for the sake of clearness they are set
down. The division is about as follows:
1. Especially heavy exports of merchandise.
2. Large purchases of our stocks by the foreigners and the placing
abroad of blocks of American bonds.
3. Distrust on our part of financial conditions existing at some
point abroad where there are carried large deposits of American
capital.
4. High money rates here.
5. Unprofitably low loaning rates at some important foreign centre
where American bankers ordinarily carry large balances on deposit.
1. Just as unusually large imports of commodities mean a sharp demand
for exchange with which to pay for them, unusually large exports mean a
big supply of bills. In a previous chapter it has been explained how,
when merchandise is shipped out of the country, the shipper draws his
draft upon the buyer, in the currency of the country to which the
merchandise goes. When exports are heavy, therefore, a great volume of
bills of exchange drawn in various kinds of currency comes on the
market for sale, naturally depressing rates.
Exports continue on a certain scale all through the year, but, like
imports, are heavier at some times than others. In the Fall, for
instance, when the year's crops are being exported, shipments out of
the country invariably reach their zenith, the export nadir being
approached in midsummer, when the crop has been mostly exported and
shipments of manufactured goods are running light.
From the middle of August, when the first of the new cotton crop begins
to find its way to the seaport, until the middle of December, when the
bulk of the corn and wheat crop exports have been completed, exchange
in very great volume finds its way into the New York market. Normally
this is the season of low rates, for which reason many shippers of
cotton and grain, who know months in advance approximately how much
they will ship, contract ahead of time with exchange dealers in New
York for the sale of the bills they know they will have. By so doing,
shippers are often able to obtain very much better rates. They can then
protect themselves, at least, from the extremely low rates which they
may be forced to take if they wait and accept going rates at a time
when shippers all over the country are trying to sell their bills at
the same time.
How great is the rush of exchange into market may be seen from the
statistics of cotton exports during the period given below. Not all of
this cotton goes out during the last four months of the year, but the
greater part of it does and, furthermore, cotton, while the most
important, is only _one_ of the domestic products exported in the
autumn.
MONEY VALUE OF COTTON EXPORTED
1913 $547,357,000
1912 565,849,000
1911 585,318,000
1910 450,447,000
1909 417,390,000
During the autumn months, under normal conditions, the advantage is all
with the buyer of foreign exchange. By every mail huge packages of
bills, drawn against shipments of cotton, wheat and corn, come pouring
into the New York market. Bankers' portfolios become crowded with
bills; remittances by each steamer, in the case of some of the big
bankers, run up, literally, into the millions of dollars. Naturally,
any one wanting bankers' exchange is usually able to secure it at a low
price.
2. With regard to the second influence making for low exchange, sale of
American bonds or stocks abroad, no season can be set when the
influence is more likely to be operative than at any other, unless,
possibly, it be the Spring, when money rates are more apt to be low and
bond issues larger than at any other time of the year. No time,
however, can be definitely set--there are years when the bulk of the
new issues are brought out in the Spring and other years when the Fall
season sees most of the new financing. But whatever the time of the
year, one thing is certain--the issue of any amount of American bonds
with Europe participating largely means a full supply of foreign
exchange not only during the time the issues are actually being brought
out, but for long afterward.
There used to be a saying among exchange dealers that cotton exports
make exchange faster than anything, but nowadays bond sales abroad have
come to take first place. For foreign participation in syndicates
formed to underwrite new issues almost invariably means the drawing of
bills representing the full amount of the foreign participation. A
syndicate is formed, for instance, to take off the hands of the X Y Z
railroad $30,000,000 of new bonds, the arrangement being that the
railroad is to receive its money at once and that the syndicate is to
take its own time about working off the bonds. Half the amount, say,
has been allotted to foreign houses. Immediately, the drawing of
L3,000,000, or francs 75,000,000, as the case may be, begins. The
foreign houses have to raise the money, and in nine cases out of ten,
their way of doing it is to arrange with some representative abroad to
let them draw long drafts, against the deposit of securities on this
side. These drafts, in pounds or francs, at sixty to ninety days'
sight, they can sell in the exchange market for dollars, thus securing
the money they have agreed to turn over to the railroad. In the
meantime, during the life of the drafts they have set afloat and before
they come due and have to be paid off, the bankers here can go about
selling the bonds and getting back their money. Perhaps before the
sixty or ninety days, as the case may be, are over, the syndicate may
have sold out all its bonds and its foreign members have been put in a
position where they can pay off all the drafts they set afloat
originally in order to raise the money.
Very often, however, it will happen that on account of one reason or
another, sixty days pass or ninety days pass without the syndicate
having been able to dispose of its bonds. In that case the long bills
drawn on the foreign bankers have to be "renewed"--that being a process
for which ample provision has, of course, been made. In a succeeding
chapter, full description of how long bills of exchange coming due are
renewed will be made. Just here it is only necessary to say that most
or all of the money necessary to pay off the maturing bills is raised
by selling another batch of "sixties" or "nineties," an operation which
throws the maturity two or three months further ahead.
From this outline of the way foreign participation in American bond
issues is financed, it can be seen that every time a big issue of bonds
of a railroad or industrial in which European investors are actively
interested, is brought out, it means a large supply of foreign exchange
created and suddenly thrown on the exchange market for sale. Not any
more suddenly or publicly than the bankers concerned can help, but
still necessarily so to a great degree, because big bond issues can
only be made with the full knowledge and cooeperation of a large part of
the public. Bankers who know in advance of large issues likely to be
made and in which they know they will be asked to participate, often
sell "futures" covering the exchange they foresee their participation
will bring into existence, but as a general rule it may be set down
that heavy issues, involving the sale abroad of large amounts of bonds,
are a most depressing factor on the foreign exchange market. Especially
so, as the participants who have agreed to turn over the money to the
railroad, must sell bills to raise it, even if the horde of speculators
and "trailers" who are always on the lookout for such opportunities,
make every effort to sell the market out from under their feet.
3. Uneasiness with regard to the stability of the financial situation
at some point abroad where American bankers usually carry large
balances is another circumstance which often depresses the exchange
market sharply. "Trouble in the Balkans" and "trouble over the Moroccan
situation" are two bugbears which have for years back furnished the
keynote for many swoops downward in the exchange market, and for years
after this book is published will probably continue to do so. Money on
deposit at a point several thousand miles away is naturally very
sensitive, and the least suspicion of financial trouble is sufficient
to cause its withdrawal. Withdrawal of bankers' balances from a foreign
city means offerings of exchange drawn on that point with resultant
decline in rates.
In the everyday life of the exchange market, political developments of
an unfavorable character and war rumors are about the most frequent and
potent influences toward the condition of uneasiness above referred to.
Few war rumors ever come to anything, but there are times when they
circulate with astonishing frequency and persistence and cause decided
uneasiness concerning financial conditions at important points. At such
times bankers having money on deposit at those points are apt to become
influenced by the drift of sentiment and to draw down their balances.
Here, again, operators in exchange, keenly on the alert for such
chances, will very likely begin to sell the exchange market short and
often succeed in breaking it to a degree entirely unwarranted by the
known facts.
4. But of all the sure depressing influences on exchange, none is more
sure than a rise in the money market. More gradual usually than a
decline caused by such an influence as the sale of American bonds
abroad, the influence of a rising level of money rates is nevertheless
far more certain.
The theory of this "counter" movement in money rates and exchange is
simply that when money rates rise, say at a point like New York,
American bankers find it profitable to draw in their deposits from all
over Europe for the purpose of using the money in New York. Such a
process means a wholesale drawing of bills of exchange on all the
leading European cities, with consequent offering of the bills and
price-depression in the leading American exchange markets.
The number of banks scattered all over the United States which keep
running deposit accounts in the leading European cities has become
surprisingly great during the past ten years, and a movement to bring
home this capital has to go only a little way before it reaches very
large proportions. That is exactly what happens when money rates at a
point like New York become decidedly more attractive than they are over
on the other side. Arrangements with foreign correspondents usually
call for a minimum balance of considerable size, which must be left
intact, but under ordinary circumstances there is considerable leeway,
and when the better opportunity for loaning presents itself here,
drafts on balances abroad, in large aggregate amount, are apt to be
drawn and sold in this market. Especially is this the case when the
cause of the higher money level appears to be deep-rooted and the
outlook is for a continuance of the condition for some time to come.
5. Lastly, as a depressing factor, there is to be considered the
condition which arises when money at some important foreign center,
such as London or Paris, begins to ease decidedly. Large receipts of
gold from the mines, a bettering political outlook--these or many other
causes may bring it about that money in London, for instance, after a
period of high rates, may ease off faster than in Berlin or Hamburg. As
a result, American bankers having large balances in London and finding
it difficult to employ them profitably there, any longer, either
withdraw them entirely or have the money transferred to some other
point. In either case the operation will result in depressing the rate
of exchange on London, for the American banker will either draw on
London himself or, if he wants to transfer the money to Berlin or
Hamburg, will instruct the German bankers by cable to draw for his
account on London. In whatever way it is accomplished, the withdrawal
of capital from any banking point tends to lower the rate of foreign
exchange on that point.
These are the main influences bearing on the fluctuation of exchange.
Needless to say they are not exerted all one way, or one at a time, as
set forth. The international money markets are a most decidedly complex
proposition, and there is literally never a time when several
influences tending to put 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.