THE VARIOUS KINDS OF EXCHANGE
Before taking up the question of the activities of the foreign exchange
department and the question of how bankers make money dealing in
exchange, it may be well to fix in mind clearly what the various forms
of foreign exchange are. Following is a description of the most
important classes of bills bought and sold in the New York market:
1. _Commercial Long Bills_
[Illustration: Form of Commercial Long Bill]
Drafts drawn by shippers of merchandise upon buyers abroad, or upon the
banking representatives of the buyers abroad, at thirty days' sight or
more. The drafts may be accompanied by shipping documents or may be
"clean." The former kind of bill making up the greater part of the
whole amount of foreign exchange dealt in in the New York market, will
be described first.
Suppose a cotton dealer in Memphis to have sold one hundred bales of
cotton to a spinner in Liverpool, the arrangement being that the
English buyer is to be drawn on at sixty days' sight. The first thing
the Memphis merchant does is to ship the cotton on its way to
Liverpool, receiving from the railroad company a receipt known as a
"bill of lading." At the same time he arranges for the insurance of the
cotton, receiving from the insurance company a little certificate
stating that the insurance has been effected.
The next step is for the Memphis shipper to draw the draft on the
Liverpool buyer--or upon some bank abroad designated by the buyer. This
draft is drawn in pounds sterling for the equivalent of the dollar
value of the cotton and made payable sixty days after the party abroad
on whom it is drawn has seen it and written "accepted" across its face.
This draft, the bill of lading received from the shipping company, and
the insurance certificate received from the insurance company are then
pinned together and constitute a complete "commercial long bill with
documents attached."
Other less important documents go with such a bill. Sometimes invoices
showing the weight and price of the cotton go along with it and
sometimes there is also attached a "hypothecation slip" which formally
turns over the right to the goods to the Memphis or New York banker who
buys the draft and accompanying documents from the Memphis cotton
shipper. Sometimes, too, insurance is effected by the buyer abroad, in
which case there may be no insurance certificate. But in the main, one
of these "documentary" commercial bills consists of the draft itself,
the bill of lading, and an insurance certificate.
Having pinned the document and the draft together, the Memphis cotton
shipper is in possession of an instrument which he can dispose of for
dollars. This he does either by selling it to his bank in Memphis or by
sending it to New York, in order that it may be sold there in the
exchange market at the current rate of exchange. Say, the bill of
exchange is drawn on London at sixty days' sight, for L1,000. The
buying price for such a draft will be, perhaps, 4.84. The Memphis
shipper gets his check for $4,840, and is out of the transaction. The
bill has passed into a banker's hands, who will send it abroad--deposit
it in some foreign bank where he keeps a balance.
As to the rate of 4.84 received by the shipper, it is to be noted that
had the bill been drawn at less than sixty days' sight, he would have
received more dollars for it, while if it had been drawn at more than
sixty days' sight, he would have received less for it. The longer the
banker who takes the draft off the shipper's hands has to wait until he
can get his money back on it, the lower, naturally, the rate of
exchange he is willing to pay. On the same day that demand drafts are
selling at 4.87, sixty-day drafts may be selling at 4.84 and ninety-day
drafts at 4.83.
Assume, in this particular case, that the draft has been taken off the
shipper's hands by some foreign exchange banker in New York. By the
very first steamer the latter will forward it to his banking
correspondent abroad, with instructions to present it at once to the
parties on whom it is drawn, in order that they may mark it
"accepted--payable such-and-such-a-date." After that the bill is a
double obligation of the drawer and the drawee, and may be discounted
in the open market, for cash.
Just here it is necessary to digress and state that documentary
commercial bills are of two kinds--"acceptance" bills and "payment"
bills. In the case of the first-named, the documents are delivered to
the party on whom the bill is drawn as soon as he "accepts" the bill,
which puts him in a position to get possession of the merchandise at
once. In the case of a "payment" bill, the credit of the man on whom it
is drawn is not good enough to entitle him to such a privilege, and the
only way he can get actual possession of the goods is to actually pay
the draft under a rebate-of-interest arrangement. All bills drawn on
banks are naturally "acceptance" bills; and being discountable and thus
immediately convertible into cash abroad, command a better rate of
exchange in the New York market than "payment" bills, which may be
allowed to run all the way to maturity before a single pound sterling
is paid on them.
Except in the case of the shipment of perishable merchandise--grain
shipped in bulk, for instance. In that case the buyer on the other side
cannot afford to let the draft run, because the merchandise would
spoil. He is simply forced to pay it under rebate, in order to get
possession of the grain. And the rebate being always less than the
discount rate, less pounds sterling come off the face of the bill in
the process of _rebating_ than of _discounting_. For which reason
sixty-day bills drawn against shipments of grain--documents deliverable
only on payment under rebate--command a better rate of exchange even
than the very best of cotton "acceptance" bills drawn on banks.
2. _Clean Bills_
[Illustration: Form of Clean Bill]
Where the drafts of the merchants of one country drawn upon the
merchants or bankers of another are unaccompanied by shipping documents
they are said to be "clean." Bills of this kind may originate from the
transfer of capital from one country to another or may represent
drawings against shipments of merchandise previously made. It is not
unusual, indeed, where the relationship between some foreign merchant
and some American merchant is very close, for the one to ship
merchandise to the other without drawing drafts against the shipment
until some little time afterward. It might happen, for instance, that a
cotton manufacturing firm in France wanted to import a lot of raw
cotton from the United States, but did not want to be drawn upon at the
time. Under such circumstances the American house might ship the goods
and send over the documents to the buyer, postponing its drawing for
some time. Eventually, of course, the American house would reimburse
itself by drawing, but the documents having gone forward long before,
the drafts would be what is known as "clean."
Later on, in the chapter on the actual money-making operations of the
foreign department, the risk in buying various kinds of bills will be
fully explained, but in passing it may be mentioned that "clean" bills
are of such a nature that bankers will touch them only when drawn by
the very best houses. With a documentary bill, the banker holds the
bill of lading, and if there is any trouble about the acceptance or
payment of a draft, can simply seize the goods and sell them. But in
the case of a "clean" bill, he has absolutely no security. The standing
of the maker of the bill and what he knows about the maker's right to
draw the bill is all he has to go by in determining whether to buy it
or not.
3. _Documentary Commercial Bills Drawn at Short Sight_
[Illustration: Form of Documentary Commercial Sight Bill]
A comparatively small part of our exports are sold on a basis where the
draft drawn is at less than thirty days' sight, but there are a good
many small bills of this kind continually coming into the market.
Drafts drawn against manufactured articles and against such products as
cheese, butter, dried fruits, etc., are apt to be drawn for, with
shipping documents attached, at anywhere from three to thirty days'
sight, but there is no rule about it. Where the "usance"--the time the
bill has to run--is only a few days, documents are apt to be
deliverable only on payment of the bills.
4. _Drafts Drawn Against Securities_
[Illustration: Form of Draft Drawn Against Securities]
Exchange of this kind is naturally of the highest class, the stocks or
bonds against which it is drawn being almost always attached to the
bill of exchange. In the case of syndicate participations by large
houses, the bonds may be shipped abroad privately and exchange against
them drawn and sold independently, in which case, of course, no
security is attached, but as a rule the bonds or stocks go with the
draft. A, in New York, executes an order to buy for B in London, one
hundred Union Pacific preferred shares on the New York Stock Exchange.
The stock comes into A's office, and he pays for it with the proceeds
of a sterling draft he draws on B. The stock itself he attaches to this
sterling draft. Whoever buys the draft of him gets the stock with it
and keeps possession of it till the draft is presented and paid in
London.
5. _Bankers' Checks or Demand Drafts on Their Correspondents Abroad_
[Illustration: Form of Bankers' Check]
Bankers who do a foreign exchange business, keeping large balances in
several European centers, are continually drawing and selling their
demand drafts--"checks," they are called, or "demand"--upon these
foreign balances. Such checks are always to be had in great volume in
the exchange market, the banker's business being to draw and sell
exchange, and his degree of willingness being merely a matter of rate.
There come times, of course, when bankers have every reason to leave
their foreign balances undisturbed, but even at such times the bid of a
high enough rate will usually bring about the drawing of bills.
6. _Bankers' Long Drafts_
[Illustration: Form of Bankers' Long Draft]
In describing the nature of bankers' drawings of long bills, great care
must be taken to differentiate between the _different kinds_ of long
bills being bought and sold in the exchange market. A finance bill
looks exactly the same as a long bill drawn by a banker for a
commercial customer who wants to anticipate the payment abroad for an
incoming shipment of wool or shellac, but the nature and origin of the
two bills are radically different. The three main kinds of bankers'
long bills will thus be taken up in the following order:
A. _Bills Drawn in the Regular Course of Business_
Such is the nature of foreign exchange business that bankers engaged in
it are continually drawing their sixty and ninety days' sight bills in
response to their own and their customers' needs. One example which
might be cited is that of the importer who has a payment to make on the
other side, sixty days from now, but who, having the money on hand,
wants to make it at once. Under some circumstances such an importer
might remit a demand draft on the basis of receiving a rebate of
interest for the unexpired sixty days, but more likely he would go to a
banker and buy from him a sixty days' sight draft for the exact amount
of pounds he owed. The cost of such a draft--which would mature at the
time the debt became due--would be less than the cost of a demand
draft, the importer getting his rebate of interest out of the cheaper
price he pays for the pounds he needs. Prepayments of this sort are
responsible every day for very large drawings of bankers' long bills.
B. _Long Bills Issued in the Operation of Lending Foreign Money_
Bills of this kind represent by far the greater proportion of bankers'
long bills sold in the exchange market. European bankers keep an
enormous amount of floating capital loaned out in this market, in the
making and renewing of which loans long bills are created as follows:
A banker on the other side decides to loan out, say, L100,000 in the
New York market. Arrangements having been made, he cables his New York
representative to draw ninety days' sight drafts on him for L100,000,
the proceeds of which drafts are then loaned out for account of the
foreign house. The matter of collateral, risk of exchange and, indeed,
all the other detail, will be fully described in the succeeding
chapters on how bankers make money out of exchange. For the time being
it is merely necessary to note that every time a loan of foreign
capital is made here--and there are days when millions of pounds are so
loaned out--bankers' long bills for the full amount of the loans are
created and find their way into the exchange market.
C. _Bankers' Long Bills Drawn for the Purpose of Raising Money_
Finance bills constitute the third kind of bankers' long exchange. In
this case, again, detailed discussion must be put off until the chapter
on foreign-exchange-bankers' operations, but the fact that bills of
this kind constitute so important a part of the bankers' long bills to
be had in the market, necessitates their classification in this place.
Every time a banker here starts to use his credit abroad for the
purpose of raising money--and there are times when the privilege is
pretty freely availed of--he does it by drawing sixty or ninety days'
sight drafts on his correspondents abroad. Finance bills, it may be
said without question, are one of the most interesting forms of foreign
exchange banking--at the same time one of the most useful and one of
the most abused of privileges coming to the domestic banker by reason
of his having strong banking connections abroad.