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Full text of "Foreign exchange"

UNIVERSITY OF CALIFORNI 
AT LOS ANGELES 




FOREIGN EXCHANGE 









'*-*•. t 



FOREIGN EXCHANGE 



BY 
ALBERT C. WHITAKER 

PROFESSOR OF ECONOMICS, STANFORD UNIVERSITY 




D. APPLETON AND COMPANY 

NEW YORK LONDON 

1926 



78 



cor\'Ki);i'T, 5.9l|, ay 
D. APPLETON AND COMPANY 



PRINTED IN THE UNITED STATES OF AMERICA 



h 



HSSf 



WITH ACKNOWLEDGMENTS 

TO 

F. L. LIPMAN, E. W. WILSON 

AND 

L. R. COFER 






PREFACE 



This book deals, not with the subject of international 
trade in its entirety, but with the plans of payment and the 
methods of banking and financing followed in that trade. 

J It treats of "foreign exchange" in the narrower, and at the 

k» same time, conventional, sense, as meaning the commercial 
paper of international trade, or the checks, drafts, and 

^ bills utilized therein. By means of these instruments, im- 
porters and exporters manage, through the aid of the bank- 
ers for foreign commerce, not only to settle their accounts, 
that is, to make and collect payments, but also to finance 

i their shipments, which is something quite distinct. Stated 

■ briefly, the subjects of study in this volume are the methods 

or proceedings and the forms or documents of foreign-trade 

settlement, banking, and financing. Belonging with these, 

the international movement of gold and the measures taken 

^ to influence it are examined at length. The contemporary 
expansion of American foreign trade and the entry of 

^American banks into the foreign field adds much to the 
importance of these matters with us to-day. 

It is hoped the book will prove useful, not only to those 
following foreign trade and banking as business call- 
ings, but to all students of the questions of national policy 
that arise out of foreign commerce. In its endeavor to 
serve the former, the volume presents itself as a practical 
business manual, while to the latter it comes as a treatise in 
economics. The union of these two has not appeared in 
the end to be detrimental to either. Most that is told herein 
is worth the economisl 's knowing, and in any case the or- 

vii 



-~ 



mii PREFACE 

ganization is such that sections dealing with matters of an 
over-technical character may readily be omitted. It is par- 
ticularly desired thai this work should find employment as 
a text in a full and independent course on foreign exchange 
in university departments of economics or of commerce and 
business administration, where heretofore the subject has 
usually been handled in an incidental way in the general 
course or in the course on money and banking. As a busi- 
ness manual the book in no wise sets up the claim that it 
will give a complete practical education to the one who is to 
enter the field of business of which it treats. For any book 
to make such a claim would be tantamount to a jest. What 
it should do is to enable the one who studies it to profit most 
from the lessons of experience, his real teacher. 

A. C. W. 



CONTENTS 

CHAPTEH PAGE 

I. Means of Payment and Commercial Paper .... 1 

1. Subject and plan of the book 1 

2. Money and means of payment 2 

3. Legal tender 6 

4. Commercial paper 9 

5. The bill of exchange 11 

6. The acceptance 15 

7. The note 17 

8. Checks, drafts, and exchange 20 

II. The Negotiability of Commercial Paper .... 22 

9. Negotiability 22 

10. The defenses against payment of negotiable in- 

struments 24 

11. Negotiation 26 

12. The liability of parties 29 

III. Discount and Interest 39 

13. Future sum and present price 39 

14. The rate of discount and the rate of interest . . 43 

15. Illustrative problems 45 

16. The terminology of discount and interest . 52 

17. Discount conceived of as interest in advance . 53 

IV. Commercial Banking 56 

18. The functions of the commercial bank . . . 56 

19. Deposits and reserve 57 

20. The loans and their limits 58 

V. The Kates of Exchange 62 

21. The general character of dealings in exchange . 62 

22. The methods of quoting a rate of exchange . . 73 

23. Specimen market reports 74 

24. Comment and explanations 78 

25. The classes of exchange quoted 84 

26. The telegraphic transfer or cable si' 

27. Sterling rates 90 

28. The rates on France 92 

29. The rates on Germany and other countries . . 95 

ix 



jv/ 



x CONTENTS 

CHAPTER PAGE 

VI. The Documentary Trade Bill 98 

30. The documentary bill of exchange &8 

31. The bill of lading 102 

32. The insurance certificate 106 

33. The hypothecation certificate and other docu- 

ments 107 

34. The documentary instructions 117 

35. Prepayment and the retirement rate of discount 119 

36. The actual mercantile receipts for and costs of 

the goods 123 

VII. The Bank Credit and Letter of Credit 131 

37. The nature of the commercial credit . . . .131 

38. The grant by one bank of the right to draw on 

another bank 133 

39. How merchants make use of commercial credits . 136 

40. Banking operations involved and the acceptance 

account 141 

41. The contract for a letter of credit 148 

42. The banker's legal interest in the merchandise . 152 

43. Kelease of the goods to the importer. The 

"trust receipt" 154 

44. The bank credit as a means of financing a ship- 

ment 160 

45. The risk of exchange 164 

46. Advantages of the letter of credit system sum- 

marized 167 

47. The confirmed credit 169 

48. The "authority to purchase" and "authority to 

draw" 171 

49. The practical nature of the right of recourse . 176 

50. The commissions charged for bank credits . . 179 

51. The traveler's letter of credit and the traveler's 

cheque 181 

VIII. Foreign Money Market Factors 190 

52. The foreign balance 190 

53. The services and compensation of correspondent 
banks 199 

54. The dealers in money in the London market: the 
joint stock banks 207 

55. The bill brokers and discount houses .... 218 

56. The branches of foreign and colonial banks . . 227 

57. The Bank of England 231 

58. The bank rate 237 

59. Kediscounting at the bank in times of stringency 244 

60. Interest and discount rates customarily in fixed 
relation with the bank rate 250 



CONTENTS xi 

CHAPTER PAGE 

61. The group of London money rates 252 

62. The "arrival" discount rate 255 

63. Stamp taxes 256 

IX. The Purchase of Bills for Direct Credit to the 

Foreign Balance 258 

64. Buying bankers' long bills 258 

65. Buying long bills drawn by merchants on banks 266 

66. Trade bills, documents for acceptance .... 267 

67. Trade bills, documents for payment .... 268 

68. Selling sight drafts and cables 271 

X. Dealings of a More Involved Character .... 275 

69. The bill drawn on a foreign country in home 
money 275 

70. The banker's buying price for such a bill . . 282 

71. The bill on a foreign country in money of a 
third country 284 

( 1 ) A third type of draft on the importer . 284 

(2) The three national currencies involved . 286 

(3) The disposal of the return draft . . .287 

(4) The risks of exchange and their incidence 288 

(5) Computing the sterling face value . . . 289 

(6) Comparison with a more familiar method 
of settlement 292 

(7) The outcome to the purchasing banker . 293 

(8) Special contracts with respect to the risk 
of exchange 296 

(9) The importer's preference for the custom- 
ary reckoning 296 

(10) Purchasing the draft on the basis of a 
discount rate 297 

(11) The reason for sterling drafts on outlying 
countries 299 

(12) Concerning the use of a long-term return 
draft 300 

(13) How London indirectly finances the Ar- 
gentine import 303 

(14) Instructions as to drawing on South 
America 304 

72. The bill with an interest clause 306 

73. The "colonial clause" 310 

74. Settlement without draft by exporter. Delega- 
tions 318 

75. Advances and local bank acceptances arranged by 
exporter 321 

76. Terms and methods of settlement summarized . 325 

77. Dealing in exchange on places where no balance 
is kept 337 



xii CONTENTS 

CHAPTER PAGE 

XI. Investment in Exchange 343 

7S. Exchange investment, borrowing, and specula- 
tion 343 

79. The method of investment 344 

SO. Computing the rate of interest received . . 347 

81. The speculation on the sight rate of exchange . 350 

82. Termination of investment prior to maturity . 353 

XII. Borrowing by Means of Exchange 359 

83. The "dollar" loan by a foreign bank in New 

York 359 

84. The "sterling" (franc or mark) loan .... 365 

85. The borrowing bank's sale of its own long bill . 367 

86. The spread between the local and the foreign 

money rates 369 

87. A joint-account transfer of loanable funds . . 372 

88. American loans in foreign monetary capitals . 377 

89. Observations on the "finance bill" 378 

Xill. Speculation in Exchange 381 

90. Futures, speculation, and hedging 381 

91. Operations in futures as a means of hedging . 382 

92. Going long of exchange 3S4 

93. Going short of exchange 389 

94. .Recovery of funds laid out for documentary pay- 

ment bills 391 

XIV. Arbitrage 397 

95. Arbitrage and arbitrated rates, parities, and 

prices 397 

96. The two methods of direct transfer of funds . 404 

97. Two-point arbitrage 408 

98. Methods of indirect transfer of funds . . .416 

99. Three-point and more complex arbitrage . . . 418 

100. Arbitrage, speculation, and futures .... 423 

101. Arbitrage in stocks 426 






XV. Coinage Laws and Exchange Rates 429 

102. The several monetary standards 429 

103. Mint pars of exchange 432 

104. Mint pars distinguished from actual values . . 435 

105. Free and gratuitous coinage 437 

106. Standard bullion: the two chief standards . . 440 



XVI. The Mint Price and the Market Price of Gold . . 443 

107. The striking stability of the market price of gold 443 

108. The mint price of standard bullion .... 445 

109. The mint price of fine bullion 446 

110. The market price of gold 448 

111. The fluctuating purchasing power of gold . . 451 



-/> *v -/' 'A 



J 



CONTENTS xiii 

CHAPTER PAGE 

XVII. Standard Money 453 

112. The several forms of money in a modern mone- 
tary system 453 

113. Standard and representative money .... 453 

114. Approved characteristcs of standard money . . 455 

115. Commodity and fiat standard money .... 456 

116. Contrasts in respect to regulation of quantity . 458 

117. The quantity of money and its value .... 460 

118. The fluctuations of the value of gold commodity 
money 462 

119. The exportability of commodity money . . . 463 

XVTI1. Representative Money 465 

120. The nominal and bullion values of token moneys 465 

121. The coining value and market value of token 
bullions 468 

122. The non-exportable character of representative 
moneys 471 

123. The features of a perfected system of token 
money 474 

124. The limping gold standard 476 

XIX. Monetary Systems of the Leading Nations . . . 479 

125. Troy and metric weight 479 

126. The standard units of value 481 

127. Tables of mint pars 484 

128. Technical detail. The United States . . . .486 

129. Technical detail. England 492 

130. The mint price of gold in the United States . . 497 

131. The mint and bank price of gold in England . 502 

132. The London market price for bar gold and its 
limits 507 

133. The mint and bank price of gold in France . . 509 

134. The mint and bank price of gold in Germany . 513 

XX. Specie Shipments 517 

135. The classification of gold movements . . . .517 
130. Gold shipments for a profit 518 

137. The gold points 522 

138. Gold export, New York to London: practical 
computations 524 

139. Gold import by New York from London . . 531 
f 140. The place of interest in the cost of gold move- 

\\j / ments .536 

\ / 141. Variant methods of calculating the interest 

charge 530 

142. The gold points and the mint par . . . . 5 42 

143. Special banking methods of influencing the gold 
movemenl 544 

144. Manipulation of the discount rate 546 




xiv CONTENTS 

CHAPTER PAGE 

145. Manipulation of the price of gold 556 

146. The gold-premium policy of the Bank of France 563 

147. Further methods of influencing the gold move- 
ment 571 

•^XXl. The Theory of the Exchange Kates 578 

148. Supply and demand and the rate 578 

149. The manner in which "supply and demand regu- 

lates" a rate 582 

150. Interpretation of apparent contradictions . . 5S3 

151. The sources of exchange supply and demand . . 588 

152. How national credits and debits affect the market 592 

153. The several spreads in the group of rates on a 

given country 596 

154. The spreads for the long rates 599 

155. The telegraphic transfer spread 601 

156. Arbitrage and the interrelation of rates . . .611 

157. The international distribution of gold . . . 618 

Addendum. The Question of Dollar Exchange .... 624 



FOREIGN EXCHANGE 



FOREIGN EXCHANGE 

CHAPTER I 
MEANS OF PAYMENT AND COMMERCIAL PAPER 

§ 1. The subject and plan of the book. — The word "ex- 
change ' ' is used in a broad sense as a synonym for trade or 
commerce. It also signifies a place or building where a 
particular kind of trade is carried on, as a stock exchange 
or a cotton exchange. The word has still another meaning, 
the meaning for example which attaches to it in such 
phrases as "New York exchange" or "sterling exchange." 
Here it refers to that class of written orders to pay money, 
known legally as bills of exchange, drawn by merchants or 
bankers at one geographical point upon those at other 
points, which are used so much oftener than money itself 
as a means of making payments or settling indebtedness 
between distant places. In good usage, "exchange" has 
come to have only this special and narrow banking significa- 
tion when it appears in the phrase "foreign exchange." 
That is, "foreign exchange" does not usually mean inter- 
national trade. Thus it comes to pass that this book, like 
others on the subject of foreign exchange or the foreign 
exchanges, is not occupied with international commerce in 
general, but merely with one of its incidents, namely, the 
system by means of which the world of business discharges 
the debts that arise out of this commerce. In a word, it is 
devoted to the subject of international means of payment. 
It will be the endeavor to combine in the present work a 

l 



2 FOREIGN EXCHANGE 

practical business manual and a treatise in political 
economy. The distinctive object of the business manual 
pure and simple is to aid in the development of individual 
business proficiency, while the distinctive object of a study 
in economics is to throw light upon questions of the public 
policy of the state or nation. It seems feasible in the 
undertaking in hand to serve the two purposes conjointly. 
As an economic treatise on the exchanges this book aims to 
unfold the principles in accordance with which this part of 
the business system operates. The result of this study, 
or of other similar studies, should constitute a section of 
our general economic knowledge — a section which would be 
relatively unimportant in connection with many questions 
but significant to a high degree in connection with prob- 
lems of public monetary and banking policy, and to a cer- 
tain degree in connection with questions of tariff policy. 
The endeavor to make the book a useful business manual 
necessitates the treatment of banking and business forms 
and procedure with much particularity. But there can 
be little question of the advantage to the economist, even 
as publicist, of knowledge of the business detail of banking 
for foreign trade, and of the exchanges and specie move- 
ments. On the other hand, an attempt to explain the sys- 
tem of the foreign exchanges after the fashion of the econ- 
omists, should exert a beneficial influence upon the book as 
a business manual. 

§ 2. Money and means of payment. — In the ordinary 
business transaction of purchase and sale, we think of the 
buyer as being obligated to make payment to the seller in 
money. But in fact he frequently settles without the use 
of actual money, finding it more convenient to employ 
other means of payment. In truth, his obligation cannot 
be described exactly as one to pay money. The strict legal 
obligation of the buyer of goods for "money," that is, the 
buyer at an ordinary price without special stipulations as 



MEANS OF PAYMENT AND COMMERCIAL PAPER 3 

to the means of payment, is to pay what is known as legal 
tender. And only some of the things that are regularly 
known as money are also legal tender. In the United 
States, for instance, gold coin is both legal tender and 
money, while bank notes and silver certificates are not 
legal tender although they are undoubtedly money. We 
shall speak of legal tender in the third section. 

The term "money" has a somewhat variable meaning, 
depending on context, whether in legal, economic, or popu- 
lar usage. Even the formal or set definitions given by 
economic writers differ in phraseology and substance. So 
it is not possible to give a definition for which unanimous 
assent can be claimed. But one can be framed which will 
correctly describe what is usually called money in every- 
day life, and which will enable us to draw the lines of 
demarcation between those means of payment employed in 
actual commerce that are best called money and those that 
are not, and which will bring out certain items of informa- 
tion worth knowing. We may then offer the following: 
Money is that article, or group of articles, which is cus- 
tomarily passed from hand to hand throughout a commu- 
nity in payment for ordinary commodities and services, 
thus acting as a medium for exchanging these commodities 
and services, (1) that is regularly taken by the person who 
receives it without the intention of applying it to any other 
use than in turn to offer it in payment to others, and (2) 
that is customarily received without assay or other special 
test of its quality or quantity, and (3) that is received 
without reference to or reliance upon the personal credit 
of the one who offers it. 1 

i Substantially this definition may be found in Francis A. 
Walker's "Money," p. 395 ; and in an article by A. P. Andrew, 
Quarterly Journal of Economics, vol. 13, p. 219; and in a decision 
of court in Moss v. Hancock, [1899], 2 Q. B. 116, cited in the ar- 
ticle on Money in the "American and English Encyclopedia of Law," 



FOREIGN EXCHANGE 



Chief Means of Payment in the United States 

Legal tender 
powers between 
private persons 



Bullion 


r 




but not 


Gold bullion 


Full 


money 


[ 






'U. S. gold coin 


Full 




XJ. S. silver dollar 


Full 2 




U. S. "subsidiary silver" coin 


Up to $10 3 




U. S. "minor coin" (5c, lc) 


Up to 25c 3 




U. S. gold certificates 


None 


Money 


U. S. silver certificates 

U. S. treasury notes (green- 


None 




backs) 


Full 2 




National bank notes 


None 




Federal Reserve Bank notes 


None 




Federal Reserve notes 


None 



Commercial 
paper 



Cashiers' and certified checks of 
banks, and certificates of de- 
posit None 
Bankers' drafts on other banks None 
Drafts of merchants on banks 

under letters of credit None 

Depositors' checks on banks None 

Merchant's drafts on merchants None 



vol. 20, p. 838. It is not to be inferred that there is any single 
authoritative definition of money in a legal sense. What the term 
is construed to mean when occurring in indictments or documents 
which appear in civil cases, depends on the circumstances. See 
the word "money" in "Words and Phrases Judicially Denned." 

2 Silver dollars and greenbacks are legal tender in unlimited 
amounts in a single payment "unless otherwise specified in the con- 
tract." See the text, p. 8, and note at end of § 3. 

3 Subsidiary silver is legal tender not to exceed $10 in a single 
payment. Minor coin is legal tender in single payments not to 
exceed 25c. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 5 

The tabulation opposite shows the chief means of pay- 
ment in use in the United States and indicates which are 
money. 

While gold bullion is sometimes referred to as the ' ' inter- 
national money" par excellence, it is not money strictly 
speaking, for it has to be weighed and assayed or subjected 
to special tests as it is passed. It is the most important 
money material and is the practically final means of pay- 
ment between different countries, including many countries 
not on the gold standard. It has the important peculiarity 
of having a virtually invariable money price per ounce (or 
other physical unit) in any gold standard country and this 
is what gives it its primacy as a means of international pay- 
ment. Commercial paper or negotiable instruments are es> 
eluded from the category of money on the grounds that these 
means of payment regularly involve the right of "personal 
recourse" 4 of the receiver upon the giver. In other words, 
they are taken with strict reference to the personal credit 
of those who have created them and who have handled 
them before they come to the one receiving them. They 
do not have the universal acceptableness of those things that 
are truly money, and this is clearly the reason why they 
are not regarded as money by people general^. That these 
instruments are always orders or promises to pay some- 
thing else is not the ground for excluding them from the 
category of money. Most forms of money are themselves 
orders or promises to pay something else, for instance, gold 
certificates, silver certificates, bank notes, treasury notes, or 
even token coin. 5 Efforts to confine the term "money" to 
the ultimate money of redemption, namely, that article 
which is not itself redeemable in anything else, as gold 

* See later, p. 32 et seq. 

5 Token coins generally throughout the world arc convertible 
into standard money, and may be looked upon as metallic orders or 
promises to pay standard money. 



G FOREIGN EXCHANGE 

coin in a gold standard country, or to confine it to coin, give 
definitions that have little utility and no correspondence 
■with the usage of daily life. 

§ 3. Legal tender. — Legal tender may be defined as any 
article or medium which the law declares capable of dis- 
charging an obligation to pay money. This applies to obli- 
gations expressed in the national "unit of value," as dollars 
in the United States and pounds in England. Person A 
may be under oral or written engagement to pay a legally 
determinate amount of money to B, their understanding 
being no more definite as regards the medium of payment 
than that "money" is due; and A and B may have a dis- 
pute, at the time when A proffers payment, with respect 
to the medium in which A has a right to discharge his debt. 
To meet the necessities of such cases the law has provided 
what the things shall be that are capable of discharging 
obligations between private persons expressed in money. 
However, the law (the reference here being to the law of 
England and the United States) does not call these things 
"money," or "legal money," or "lawful money," 6 but it 
calls them legal tender. 7 

If a creditor for money refuses to take legal tender 
proffered by the debtor when an account is due, the effect 
of the proffer, or "tender," is not to discharge the debt 
itself. That is, a rejected tender is not equivalent to pay- 
ment. The effect is, however, to stop interest running on 



e The term "lawful money" does not have an invariable legal sig- 
nificance in the United States. It generally means any form of 
money issued by the United States, but its meaning in legal docu- 
ments and statutes depends on context. It is sometimes used as 
a synonym for legal tender. See "Words and Phrases Judicially 
Defined," p. 4031. 

7 Countries with other legal systems than that of England, have 
what correspond to our laws of legal tender though they are not 
wholly similar in nature. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 7 

the debt and to relieve the debtor of liability for costs of 
collection. "A legal tender [tender is here used in the 
sense of the act of proffering] is equivalent to payment as 
to all things that are incidental or consequential to the 
debt. The creditor, while not losing his rights to the prior 
debt itself by refusal of the tender, loses all collateral 
benefit and securities" ("Words and Phrases Judicially 
Denned," p. 6910). 8 In the event that, after his rejection 
of the tender, the creditor later sues the debtor, the latter 
may plead in court that he has already made a tender and 
accompany this plea with a renewed offer to the court of 
the original sum due, and may thus escape the necessity 
of paying either costs or interest after the date of the 
original tender. To operate in this manner as a means of 
saving interest and costs, a tender must be "kept good," 
that is, the debtor must not allow the creditor to make 
a demand on him without being ready with a proffer of 
legal tender. The refusal of a creditor to accept an offered 
payment, though doubtless exceedingly rare, might arise 
out of a dispute over the medium in which payment is 
to be made, or might be occasioned by the creditor's suspi* 
cion of a particular kind of money, or b}' special circum- 
stances or captious motives. In any case, the creditor for 
money is, without prejudice to his rights, entitled to re- 
fuse to receive in payment checks or drafts or forms of 
money not legal tender. A method available to a debtor 
finally to rid himself of his obligation, after a rejected 
legal tender, is to pay the original sum due as on the 
maturity date, into court for the account of the creditor. 
Payment into the creditor's bank for his account would 
suffice in some states. 

The original and proper reason for the existence of the 

s Compare also article on "Payment" in the "American and Eng- 
lish Encyclopedia of Law," vol. 22, p. 538. 



8 FOREIGN EXCHANGE 

law of legal tender is that it is a technical legal necessity 
for the discharge of certain kinds of private contracts. 
However, in many instances, where a state has conferred 
the legal tender power upon its paper money, the motive 
has been not so much to accommodate private citizens with 
another means of payment, as to aid in forcing the circula- 
tion of the paper for the benefit of the state's own finances. 

As appears in the table, there are but four forms of 
money in the United States which have "full legal tender 
power," which means legal tender power between private 
parties in unlimited amounts in single payments. These 
are (1) gold coin, (2) silver dollars, (3) United States notes 
or greenbacks, and (4) gold certificates. Subsidiary silver 
and minor coin have limited legal tender power. 9 Other 
forms of money have special tender -powers of one sort or 
another in considerable variety. To give one example, 
a national bank note is legal tender in payment of an ob- 
ligation due any national bank, whether the bank that is- 
sued the note or any other national bank. Several forms 
of money are special legal tender in payment of taxes and 
dues owing to the Federal government itself. 

"Where a contract for the payment of money expressly 
provides for payment in a particular kind of money, the 
debtor cannot discharge his obligation (unless with the 
consent of the creditor) in any other form of money than 
that specified. Thus a note "payable in United States gold 
coin" cannot be discharged by the payment of silver dollars 
or greenbacks except by the consent of the creditor. Under 
the present monetary conditions of the United States, the 
only form of contract for a special kind of money which 
is at all common, is one calling for payment "in United 
States gold coin." But the principle of law that a binding 
contract may be made for any special form of money is 

9 See notes to table of means of payment. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 9 

general in character and does not apply merely to gold. 10 

§ 4. Commercial paper. — In practice sellers of goods and 

creditors in general almost never stand upon their strict 

legal rights to demand legal tender, or gold coin if the 



10 See the "American and English Encyclopedia of Law," article 
on "Payment," vol. 22, p. 541, and cases cited there. After the 
decision of the United States Supreme Court in Bronson vs. Rhodes, 
referred to beneath, the Federal statute reestablishing the coinage 
of the silver dollar (the Act of Feb. 28, 1878, known as the "Bland- 
Allison Silver-Purchase Act") provided in § 1 that all silver dol- 
lars coined under this Act or heretofore coined by the United States 
"shall be a legal tender, at their nominal value, for all debts and 
dues public and private, except lohere otherwise expressly stipu- 
lated in the contract." Subsequently the second silver-purchase 
Act (the "Sherman Act" of July 14, 1890) authorized a special is- 
sue of United States Treasury Notes to be used to purchase silver 
bullion for coinage, and in § 2 provided that "such Treasury notes 
shall be a legal tender," etc., "except where otherwise expressly stip- 
ulated in the contract." A later statute provided for the retirement 
and cancellation of these "Treasury Notes of 1890" and only a small 
amount remain outstanding to-day (1919). The one other element 
in the currency of the United States, apart from gold coin, which 
has "full legal tender power," consists in the regular United States 
Notes or "Greenbacks." The clause that these notes should be legal 
tender "except where otherwise expressly stipulated in the contract" 
has never been written into statute. The "Gold-Standard Act" of 
March 14, 1900, made no changes whatever in the legal tender laws. 
The original Act passed Feb. 25, 1862, conferring the legal tender 
power upon these notes was enacted without this limiting clause 
(see Revised Statutes of the United States, §3588). Nevertheless, 
there is no question that these notes lack legal tender power for 
contracts expressly payable in gold (or silver, for that matter). 
This assertion is based on the decision in Bronson v. Rhodes (1808). 

An excellent note on "special contracts and obligations to make 
payment in gold or silver" in "Lawyers' Reports Annotated," Book 
29, pp. 512-28 (1895), surveys tbe course of judicial decisions on this 
subject. In Bronson v. Rhodes, 74 U. S. (7 Wall.) 258, (1868), 
the Supreme Court held that a bond expressly payable "in gold and 
silver" could not be discharged in legal tender notes except willi 
the consent of the creditor. (This bond was issued in 1851, before 



10 FOREIGN EXCHANGE 

contract calls for the latter form of payment. But they 
readily take certain substitutes for these things, which, by 
reason of their being convertible into them, are regarded 
as equally good at the time and place. These substitutes 
maj' be forms of money that are not legal tender, or are 
not gold, or they may be forms of commercial paper. The 
latter term may be said to cover that entire mass of trans- 
ferable written orders and promises to pay money which we 
find circulating among merchants and banks as a means of 
discharging obligations which arise in commerce. It in- 
cludes bills, drafts, checks, and notes. 11 There are, however, 
only two principal classes of commercial paper, namely 
orders and promises to pay money. Those instruments 
which are orders are, if drawn in a proper manner, called 
bills, or more fully, bills of exchange. The promises, if in 
proper form, are known as notes, or more fully, promissory 
notes. Checks are merely a particular class of bills of 
exchange. An instrument known as a draft is also almost 
always some type of bill of exchange. 

The volume of commercial paper in circulation reaches 
the enormous proportions that we find partly because of 

the creation of the legal tender notes, but this fact has no deter- 
mining influence on the opinion. This decision has been followed 
uniformly by the Federal courts in a number of cases. As for the 
decisions of state courts, where the contract expresses an indubitable 
intention of the parties to make it payable in gold, or in silver, all 
the numerous state decisions subsequent to Bronson v. Rhodes follow 
it except two, and neither of these are clear cases (see the note 
above mentioned, p. 519). 

The "Legal Tender Case" (Knox v. Lee, 79 U. S. 12 Wall. 
457) has been represented by some writers as overruling the doc- 
trine of Bronson v. Rhodes, but this representation is wholly er- 
roneous (see same note, p. 518). 

n The term commercial paper is sometimes used in a narrower sense 
so as to exclude drafts drawn by bankers on bankers, and even checks 
and drafts drawn by merchants on bankers, but the better term to 
convey this narrower meaning would seem to be "trade paper." 



MEANS OF PAYMENT AND COMMERCIAL PAPER 11 

its superior convenience over money as a mere means of 
remittance. This is exemplified by the great serviceableness 
of a draft on a New York bank as an instrumentality by 
means of which a merchant, say, in Denver, may pay an 
amount due to one in Philadelphia or Boston or New York. 
This kind of convenience accounts in general for the use of 
all types of so-called sight or demand paper, that is to say, 
paper payable at sight or on demand. In great part, how- 
ever, the extensive use of commercial paper is to be attrib- 
uted to the further circumstance of the extreme utility of 
time paper, that is, paper payable a designated period after 
date or after sight, as a means of gaining the assistance 
of banks in the financing of commercial operations or 
operations in securities. Much of the present book will be 
devoted to the explanation of this subject. As is made 
clear in books on credit and banking, the effect of the 
employment of commercial paper as a substitute for cash is 
not so much merely to postpone the transfer of actual 
money as in large part to do away with it. 

§ 5. The bill of exchange. — As already stated the bill of 
exchange is an order to pay money. In making our first 
acquaintance with this instrument we- shall be content to 
learn the rudiments of its make-up and uses. Discussion 
of documentary bills, and bills under a bank credit, and 
bills drawn on a foreign country .payable at the exchange 
rate on the home country or a third country, and "finance" 
bills, and other such subjects, will come in due time. On 
page 12 is an example of a bill drawn by merchant on 
merchant, a type sometimes referred to as a trade bill. 

A legal definition 12 of a bill of exchange is "an uncoiuli- 



12 From the Uniform Negotiable Instruments Law (now in force — 
Julj', 1919 — in all jurisdictions in the United Slates except the state 
of Georgia), §210, as the sections are numbered in the New Yor^ 
law. The text of this law is in Buffcut's "Negotiable Instruments" 
or in Crawford's "Negotiable Instruments Law Annotated." 



12 1< (REIGN EXCHANGE 



$275.00 Boston, Mass., June 15, 1916. 

Sixty days after sight, pay to the order of John Doe 
Two Hundred and Seventy-Five Dollars. Value received 
and charge to my account. 

To C. D. Buyer, A. B. Seller. 

45 Nassau St., 
New York. 



Trade Bill 

The three parties to this instrument are: 

A. B. Seller the "drawer." 

C. D. Buyer the "drawee." 

John Doe the "payee." 

tional order in writing addressed by one person to another, 
signed by the person giving it, requiring the person to 
whom it is addressed to pay on demand or at a fixed or de- 
terminable future time a sum certain in money to order 
or to bearer." This definition states briefly the require- 
ments to which an instrument must conform if it is to be 
a negotiable bill. An order to pay money which fails 
to meet all these requirements cannot strictly be called a 
bill of exchange, but it would be an error to suppose that 
any precise formula of words is necessary to constitute a 
legally valid bill. In the specimen given above, omission 
of the last clause, "value received and charge to my ac- 
count," would have no effect on the instrument, at least 
where the Uniform Law prevails. The various printers' 
and engravers' embellishments on the common prepared 
blanks for checks, drafts, and other forms of bills, are with- 
out direct legal significance except for the words which 
they comprise. 

With the warning that the trade bill is but one of several 



MEANS OF PAYMENT AND COMMERCIAL PAPER 13 

types of bills of exchange, let us now explain the relations 
which exist in regular practice among the three parties to 
this instrument. The drawer, or one who writes the order, 
gives directions to the drawee to make a specified payment 
of money. He relies upon the drawee's following out his 
instructions because the latter owes him at least as much 
money as he has ordered paid in the bill. For in this 
instance the drawer is the seller of goods and the drawee 
is the one who has bought them without as yet having 
made payment. That is, the drawer is a mercantile creditor 
and the drawee is his debtor in the case. Concerning the 
conditions under which the drawee is legally bound to honor 
a bill we shall speak in the next section. The payee is 
the person (individual, firm, corporation, or bank) to whom 
the payment is ordered made. This person may be the 
original payee named in the bill, or may be some party to 
whom the original payee has transferred the instrument. 
When the drawee makes payment on the bill, to the payee, 
he cancels his debt to the drawer, to the extent of the sum 
so paid. He discharges his debt not by payment direct to 
his original creditor, but by payment to a third party 
under the original creditor's orders. 

Mr. Seller is the drawer of the specimen bill shown above. 
The payee is John Doe. The clause "pay to the order of 
John Doe" has the same significance as "pay to John Doe 
or order," a form almost equally common, and means pay 
to John Doe or to any one to whom he in turn directs 
payment to be made. Now John Doe might be a banker or 
money broker or he might be an individual creditor of Mr. 
Seller's. In any case if Seller gives Doe a bill which is 
payable some time in the future, it will be customary for 
Doe to receive the instrument as the equivalent of a sum 
of present cash somewhat less than the full amount due on 
it at its maturity. Thus on June 15 he might take the bill 
of our illustration, which presumably will yield $275 on 



14 FOREIGN EXCHANGE 

the date of its maturity, as being the equivalent of say 
$272.25 of present cash. This subject, namely, the subject 
of the reduced present value of sums due in the future, 
will be taken up in chapter ii. 

While, as said, this John Doe might be an individual 
creditor of Seller, it is much more common for him to be 
a banker, who is either buying the bill or taking it "for 
collection. ' ' Of these things we shall speak in detail later. 
In either event the bill is created as an instrumentality 
whereby the mercantile creditor procures payment for goods 
from a distant debtor, and the bank intervenes as a concern 
whose business it is to aid in the process of settlement. If 
Seller intended to dispose of the bill to the First National 
Bank, he might write in the name of this institution as the 
original payee, or he might make himself the first payee, by 
writing for instance ' ' pay to the order of myself, ' ' and then 
transfer to the bank and make it payee by indorsement. 13 
A bill to the order of "mj-self" or "ourselves" is not un- 
common. It is a convenient form if at the time when the 
instrument is drawn it is not certain to whom it will be 
sold or transferred. Concerning what happens if a bill 
does not turn out good, that is, if the drawee fails to pay, 
we shall speak in § 12 below. 

For a long period the trade bill has occupied a position 
of the greatest importance in the foreign commerce of 
all countries, including the United States. It has played 
a very important role also in the domestic commerce of a 
number of countries. But up to the present day it has 
seen little service in the domestic trade of the United 
States. There is now a movement in progress to introduce 
it here, but there is also opposition. 

It should not be inferred that the trade bill, that is to 
say, the bill of merchant on merchant, has been hitherto 

is Compare § 1 1 below. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 15 

wholly unknown in the internal trade of the United States. 
It has been in use, usually in the form of the sight bill, 
or very short terni bill, with documents attached, 14 but it 
has held a position of little consequence. Of course such 
forms of bills of exchange as checks and bankers' sight 
drafts have had a tremendous vogue in American internal 
trade, 15 while in our foreign trade the long bill on the 
American bank is now becoming of the greatest importance. 
§ 6. The acceptance. — The drawee is not legally bound to 
the holder, or payee, of a bill unless he has himself taken 
action to make the bill his own obligation. The mere writ- 
ing and signature of the distinct person, the drawer, does 
not make the bill binding upon the drawee, and this is true 
even if the latter owes the drawer the sum of money called 
for in the instrument. This proposition may be summarized 
for those familiar with the law of contracts by saying that 
the drawing and transfer of a bill of exchange does not 
operate as an assignment. The formal act whereby the 
drawee adopts the bill as his own obligation is known as 
acceptance. Acceptance is, as the Uniform Law states, the 
written signification by the drawee of his assent to the 
order of the drawer. This is accomplished in the regular 
manner by writing the word "accepted," with the date 
and the signature of the drawee, across the face of the bill, 
usually somewhat oblicpiely on the left end of the instru- 
ment. If the bill already shown is accepted, it will appear 
as beneath. 

I* Concerning the attachment of documents, see chapter VI. 

is A curious and exceptional use of the bill of exchange in small 
domestic business is as a means of forcing a slow debtor upon whom 
the creditor would never think of drawing a draft in the ordinary 
course of things. A debtor who persistently refuses payment of an 
overdue account is drawn upon for the simple purpose of forcing 
him either to pay or to disclose his refusal to some local bank to 
which the draft has been given for collection. 



16 FOREIGN EXCHANGE 

$275.00 ( Boston, Mass, Jane 15, 1916. 

iy to the order of John Doe 




Two Handred and Sgferi^ycf ive Dollars. Value received and 
charge to my ace 



To C D. Bayer, 

45 Hassau St., 

New York. 



iMA^^ 



Under English law the acceptance must be written upon 
the bill itself, but under the Uniform American Law it may 
be written on a separate paper and bind the acceptor to 
any person to whom this paper has been shown and who 
receives the bill for value on the faith of this separate 
acceptance. 16 But under the American law the holder has 
a right to demand an acceptance written on the bill itself, 
and this is the safe and regular acceptance practically al- 
ways taken. That the holder has a "right" to demand an 
acceptance written on the bill signifies that if this kind of 
an acceptance is refused by the drawee the holder may treat 
the bill as dishonored and exercise an immediate right of 
recourse on the drawer or any indorser. In § 12 there 
will be found an explanation of the nature of the right of 
recourse. 

The word "acceptance" is used to designate (1) the act 
of the drawee in assuming obligation on the bill, (2) the 
written words added to the bill, and (3) the bill itself after 
, acceptance. An accepted bill is more commonly called an 
"acceptance" than anything else. If Brown draws on 
Smith and Smith accepts, Smith is known as an " acceptor, ' ' 
and thereafter the bill is known as Smith's acceptance. 

16 See Uniform Law §§221-2 (as already cited) and § 17 of the 
English Bills of Exchange Act (to be found in Huffcut as already 
cited ) . 



MEANS OF PAYMENT AND COMMERCIAL PAPER 17 

It is evident that in general there is no occasion for the 
acceptance of bills payable "at sig-ht" or "on demand." 
For if the drawee decides to treat a demand bill as his obli- 
gation it is his duty to pay it forthwith. He takes imme- 
diate possession of it and there is no point in writing 
"accepted" upon it. 17 In the case of long or time bills, it 
is sometimes essential to procure acceptance and it is al- 
waj r s advisable and in order. With respect to the bill 
drawn payable a designated period after sight, or after 
demand, presentment for acceptance is necessary in order 
to fix the date of maturity of the instrument. The date of 
the acceptance becomes the date of sight, or demand, from 
which the due date is fixed. Further explanations respect- 
ing the question when presentment for acceptance is essen- 
tial and when not, are best postponed to § 12. 

§ 7. The note. — A bill is the order, but a note is the 
promise, of the one who writes it. The following is an 
example of a note. 



$500.00 New York, N. Y., June 15, 1919. 

Sixty days after date, for value received, I promise to 
pay to the order of Charles D. Brown, Five Hundred 
Dollars. 

Edward F. Jones. 



To this there may or may not be added a clause promising 
interest, such as the clause "with interest at 5% per 
annum." In the absence of the clause, the full sum due 
upon the note at its maturity is $500. 

17 The certification of checks by the drawee banks is an exception 
to this statement. A bank's certification of a check is an acceptance 
of a demand draft — which it is the design of the drawer or other 
holder to send in payment to some person who perhaps insists upon 
this special security. 



18 FOREIGN EXCHANGE 

Brown is the "payee" and Jones the "maker" of this 
instrument. The best usage does not permit an interchange 
of the names of the parties signatory to the two kinds of 
negotiable paper. The writer of the promise is the 
"maker" and not the "drawer" of the note. The writer 
of the order is the "drawer" and not the "maker" of 
the bill. The definition of a note, as given in the Uniform 
Law, is "an unconditional promise in writing made by 
one person to another signed by the maker engaging to pay 
on demand or at a fixed or determinable future time, a 
sum certain in money to order or to bearer. ' ' 18 Promises 
in writing to pay money might be so worded as to fail to 
meet some of the requirements of this definition and still 
be called notes in common speech, but such instruments 
would not be negotiable in the true legal sense 19 and could 
not be called promissory notes in the strict meaning of 
the law. In fact, however, practically all notes of actual 
business life are so framed as to conform to this definition. 
They are, as the saying goes, made "negotiable in form." 
No precise order or formula of words is prescribed by law 
for the note, but the writing such as it is must have a 
meaning conformable to the foregoing definition, if the in- 
strument is to be a note in the strict sense. 

The two principal sources of the ordinary short-term 
notes of commerce are (1) straight loans and (2) sales of 
goods on time. By a straight loan we here mean a direct 
advance of money, or of a right to draw money, to a person 
against the latter 's own promise to return the sum in the 
future (with something added for interest, of course). 
The straight or strict loan is distinguished from an advance 
made to a person by purchasing from him a piece of com- 
mercial paper made payable to him by some other person; 

is Uniform Negotiable Instruments Law, §320 (as in the N. Y. 
draft). 

i» Compare § 9. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 19 

or from an advance in any other form which amounts to 
a virtual though not a direct loan. The great volume of 
short-term straight loans in a country are of course made 
by the banks to their clients in all lines of business. Pre- 
sumably a note is given the bank for every loan of this type. 
If the loan is " on call " or on demand, a demand or sight 
note — which is simply one payable at any time when demand 
for payment is made — or a one-day note, will be given. 
In the ease of the eall loan in New York, the borrower 
is entitled to notice on the day preceding the demand. If 
the loan is for a specified period, the note will usually be 
made to fall due at the end of that period, though it might 
be understood that a loan is to run for a longer time than 
the first note. This implies a right or privilege of paying 
off the first note by making a second. Sometimes loans 
which are to run for a considerable though indeterminate 
period will be evidenced by demand notes. The makers 
of notes often effect their loans by disposing of them either 
to a broker or through a broker. 

As indicated, sales of goods on time are a second impor- 
tant source of short-term notes. Such sales also give rise 
to long bills of exchange, where the buyer of the goods 
is at a distance and where bills are in vogue. Also myriads 
of such transactions result only in a "book account" or 
charge against the purchaser of the merchandise upon the 
books of the seller. But sometimes the buyer may give the 
seller his note. The specimen note given at the beginning 
of this section might have arisen out of a sale of $500 
worth of goods by Brown to Jones on 60 days' time. The 
chief advantage to Brown of the note, as distinguished from 
a mere book account against Jones, is its superior avail- 
ability in Brown's hands as a means of obtaining present 
cash. Brown may sell the note for perhaps $495. Or he 
may pledge it as collateral security for a direct loan against 
his own note. For either of these uses a note is indefinitely 



20 FOREIGN EXCHANGE 

more acceptable under our law and custom than a document 
assigning (i.e., transferring) the claim witnessed by a mere 
book account. 

§ 8. Checks, drafts, and exchange. — Though the check is 
the most familiar of all forms of credit instruments, we 
give an example for the sake of completeness. 



No. 223 New York, June 15, 1913. 

The Fiftieth National Bank of New York 

Pay to the order of Charles D. Brown $275.00 

Two Hundred and Seventy-five ~ Dollars. 

Edward F. Jones. 



A check is to be denned as (1) a bill of exchange (2) drawn 
on a bank (3) payable on demand. That is, a check as a 
legal instrument is a particular sub-class under bill of 
exchange. 20 The ordinary form of domestic bank check 
specifies no time of payment. Any negotiable instrument 
which expresses no time of payment, is payable on demand. 
Checks are subject to the rules which govern bills in general, 
but there are certain subsidiary laws which apply to checks 
alone. 

The terms "promissory note," "bill of exchange," and 
"check" stand for definite legal concepts, and are given 
formal definitions in statutory law. But the term "draft" 
has neither a fixed legal nor commercial significance, beyond 
the fact that it always refers to an instrument that is drawn 
upon a drawee and therefore partakes of the nature of a 
bill of exchange. There are eases where instruments which 
do not conform to the legal requirements of a bill of ex- 

20 Compare the Uniform Negotiable Instruments Law, as already 
cited, §321. 



MEANS OF PAYMENT AND COMMERCIAL PAPER 21 

change and which have therefore been denied the name bill, 
are still spoken of as drafts by the courts. The best we 
can say of the word is that it is a loose synonym for bill 
of exchange, but that when it is used in a distinctive sense 
it usually means a bill drawn on a bank, whether at sight 
or for a term, whether drawn by another bank or by a 
merchant, and excludes the bill drawn by merchant on 
merchant. A Chicago bank's sight bill on its New York 
correspondent would virtually always be called a New York 
draft. 21 

As a term for commercial paper the word "exchange" 
is commonly used to designate bills, drafts, or checks drawn 
in one place upon another place. A promissory note held 
by a payee in one place but payable by a maker in another 
place, might possibly be called exchange, but the word is 
not usually thought of as covering such instruments. Ex- 
change takes its geographical name from the place upon 
which it is drawn, or where it is payable. Thus Chicago, 
New York, or Paris exchange, consists respectively in bills 
drawn on persons, firms, corporations, or banks, in these 
places, regardless of the place of origin of the drafts. 
Local checks, because they are local, that is, drawn on a 
bank in the same place as the drawer himself, are never 
called exchange, unless they chance to migrate to a distant 
place and thus in effect cease to be "local." 

^i In "Smith's Financial Dictionary" (New York, 1908), it is stated 
"there is practically no difference between a liill of exchange and a 
draft. The term liill of exchange, however, is commonly applied to 
an order for money payable in a foreign country, whereas the term 
draft is applied to an order payable within the country of its 
origin." This hardly seems to describe such usage as there is. The 
bills of American banks on their English correspondents are often 
called "sterling drafts," and bills drawn by merchants on foreign 
banks under letters of credit are also called drafts. 



CHAPTER II 
THE NEGOTIABILITY OF COMMERCIAL PAPER 

§ 9. Negotiability. — Bills and notes are called "negotiable 
instruments" and possess, as we say, the legal attribute of 
negotiability. We have here a subject which is capable 
of comprehensive explanation only in a technical legal 
treatise. It is highly desirable nevertheless for the student 
of exchange to gain some idea of the meaning and effect 
of the negotiability of commercial paper. We venture to 
discuss the more general aspects of the subject in the present 
chapter. Passing over certain inexact commercial uses, or 
misuses, of "negotiable" as a mere synonym for transfer- 
able or again for readily saleable, we find two meanings 
commonly attaching to the term at law, one lax and the 
other strict. The lax meaning is — transferable by indorse- 
ment and delivery so as to give the transferee (or one to 
whom transfer is made) a right of action in his own name. 
In this sense the term may be predicated of various types 
of documents, receipts, and warrants calling for the de- 
livery of money or of goods, but cannot of course be predi- 
cated of actual goods, which are unsuitable for indorsement. 
In its strict meaning the term includes all this and also 
an additional element of peculiar interest and importance. 
The tremendous circulation attained by commercial paper 
may be said to be founded upon its peculiar and strict 
negotiability. 

To proceed with an explicit statement, negotiability in 
the strict sense, namely, the legal character peculiar to 
what is known as commercial paper, means the legal attri- 
bute of transferability under laws which make it possible, 
first, that the transferee may sue in his own name ; second, 
that the rights of the transferee may under some circum- 

22 



THE NEGOTIABILITY OF COMMERCIAL PAPER 23 

stances become superior to the rights which the transferor 
had to convey. Stated in another way the second point 
means that the one who receives a note or bill may in man}' 
cases be able to collect on it when the one who transferred 
or sold it to him could not collect or enforce payment. 
Or again, the party obligated on the instrument may have 
certain defenses which would be good against the transferor 
while the transferee might be exempt from them. 

Returning to the first mentioned and less essential feature 
of negotiability, in present law most ordinary contract 
rights, for the use or receipt of property or the receipt 
of money, may be transferred by the party who has them 
to a third party, so that the latter may exercise these rights, 
but no more than these, against the person bound by the 
contract. In this case the transferee is merely substituted 
in the place of the transferor, as far as the latter 's rights 
are concerned. The transfer of contract rights is speci- 
fically known as assignment, and the transferee as an as- 
signee. In the absence of statutory provisions to the con- 
trary, an assignee can sue the obligor only in the name of 
the assignor. The power of the transferee of a negotiable 
instrument to sue upon it in his own name is then one 
point of contrast between negotiability and assignability. 
This point is of less importance than the second mentioned 
feature of negotiability because it concerns only a matter 
of procedure rather than the substantive rights of the 
holder, and also because statutes are common to-day which 
give assignees the power to sue in their own names. 

With regard to the second feature of negotiability, it 
may be stated as a general rule of law that a person who 
has a right, title, claim, or interest, cannot give to his 
transferee any better right or title than he himself has. 
That which he does not himself hold he cannot transfer. 
Thus if A, while appearing to hold a good title to a piece 
of land or a horse, really has no title, or has a title subject 



24 FOREIGN EXCHANGE 

to liens or liabilities, or to defeat, B to whom he sells will 
in general obtain either no title or a title suffering from 
the same defects, as the case may be. Again, if A has a 
contract right to receive money from C, and C can for any 
reason, such as counterclaim, lack of consideration, or 
fraud, defend himself against payment to A, he can use 
precisely the same defenses against B, the assignee of A. 
It is a general though not universal rule of law that a 
transferor can confer upon his transferee no better rights 
than he himself has. The chief, though not only, articles 
of ownership and agreement which are exceptions to this 
rule are negotiable instruments and money. This brings 
us to the subject of the defenses against payment of nego- 
tiable instruments. 

§ 10. The defenses against payment of negotiable instru- 
ments. — The defenses which an obligor or ostensible obligor 
upon a negotiable instrument may set up against its holder 
fall into two classes: (1) Real or absolute defenses, or those 
good against any holder whatsoever or good against all the 
world; (2) personal defenses, or those good against some 
persons but not against a person known as the "holder in 
due course." The latter is a person who has purchased, 
or given value for, the instrument before its maturity, and 
who is without notice of any infirmity in it or defect in 
the title to it of a party who has held it prior to himself. 
He is often called the "innocent purchaser for value." 
It is rare in actual business life for a person or company 
that holds a note not to be an example of a holder in due 
course. A person who derives his title through a holder 
in due course without himself being able to qualify as 
such, will, if he is not himself a party to some fraud or 
illegality affecting the instrument, enjoy the same exemp- 
tion from personal defenses. 1 

i On the holder in due course, see "Uniform Negotiable Instru- 
ments Law" (as already cited), Article V. 



THE NEGOTIABILITY OF COMMERCIAL PAPER 25 

The chief of the obligor's absolute defenses are: (1) 
That the instrument is a forgery; (2) that he, the obligor, 
is a person without legal capacity to make contracts ; or 
(3) that the instrument originated in circumstances which 
make it totally void under a special statute, such as a 
Pennsylvania statute which make notes given on account 
of a gambling debt utterly void. The leading personal 
defenses are: (1) Lack or failure of consideration; (2) set- 
off or counterclaim; (3) fraud; and (4) duress. Suppose 
that A has made and handed over his note to B for a horse 
which it is agreed B will deliver to A, but that thereafter 
B in fact fails to surrender the animal. Then B could 
not collect on the note because of A's defense of "failure 
of consideration." But the defense is personal. For if 
B should indorse the note to C, C being without knowledge 
of the defects in B's rights and being in other respects 
also a holder in due course, C can collect from A. C is 
exempt from this personal defense. To make a long story 
short, the immunity of the innocent purchaser for value 
from a number of defenses which might be good against 
parties prior to him is the essential feature of negotiability. 
If, in the instance of the foregoing illustration, B, who 
promised to deliver the horse and failed, had held merely 
some ordinary or non-negotiable contract claim for money 
against A, and C became his assignee, C could no more 
collect than B, no matter how "innocent" he might be nor 
what consideration he had given B. 

As has already been intimated, money is like the negotia- 
ble instrument in that a person without title to it or wrong- 
fully in possession of it may transfer it to another, who 
takes it innocently and for a consideration, with the effect 
of giving this other perfect rights, both as against the 
original owner and as against all the world. Suppose B 
steals a $20 gold piece from A and spends it in C's store. 
If C is without knowledge of the theft A cannot take the 



26 FOREIGN EXCHANGE 

coin away from him when the facts are found out or proved. 
Money is doubtless the original essentially negotiable article 
in the world. The only other class of things that usually 
possess strict and full negotiability are the particular forms 
of contracts for money known as bills and notes. In their 
negotiability these contracts are made like the money in 
which they are dischargeable. Documents such as bills of 
lading and warehouse receipts, which call for the delivery 
of goods, may, however, be given, by statute, some, or all 
of the characters of strict negotiability. In the first case 
they are properly known as quasi-negotiable. 

The negotiability of commercial paper is of the greatest 
importance to the freedom of its circulation. "When a 
banker or a broker buys an acceptance from some person, 
and thus becomes one in the series of its holders, he is not 
forced to inquire whether a consideration was given by 
every prior holder to obtain the instrument, or whether 
any counterclaim against a prior party, or fraud concealed 
somewhere in the history of the instrument, invalidates his 
rights. "Were the instrument a mere assignable contract 
for money, he would be compelled to have a care regarding 
these matters. If checks, bills, and notes were merely 
assignable, it would seem out of the question for them to 
obtain the enormous significance which they now possess 
as substitutes for money in the traffic of the world. 

§ 11. Negotiation. — The act of transferring title or owner- 
ship in a negotiable instrument is known as negotiation. 
If an instrument is, as it stands, payable to a specified 
person, negotiation can be accomplished only by indorse- 
ment and delivery. If it is payable to bearer, delivery 
alone will suffice. Indorsement consists in the payee's 
writing his signature (with or without additional words 
conveying instructions or qualifying liability) upon the 
bill or note, or sometimes upon the "allonge." The latter 
is a sticker (rarely needed) which is attached, properly 



THE NEGOTIABILITY OF COMMERCIAL PAPER 27 

upon the back of the instrument, to take additional signa- 
tures when there is insufficient space for them remaining 
on the back of the bill or note itself. The regular place 
for an indorsement is upon the back of the instrument, 
and to follow good usage the first indorser should write 
his signature across the reverse of the left-hand end, other 
indorsers being expected to place theirs beneath this and 
in the order of time in which they indorse. However, the 
stamped indorsements which are very common to-day are 
put on without much regard for the rule, except that they 
are always impressed on the back of the instrument. 

As classified in the Uniform Law, indorsements are (1) 
special, (2) blank, (3) restrictive, (4) qualified, and (5) 
conditional. A special indorsement is one which specifies 
the person to whom, or to whose order, the instrument is 
to be payable. Thus: 



Pay to the order of 
John Doe. 

Richard Roe. 



Here the indorsement of John Doe will be necessary for 
further negotiation. Thus: 



(1) 



(2) 



Pay 


to the order of 


John Doe. 




Richard Roe. 


Pay 


to the order of 


Tom Jones. 




John Doe. 



28 



FOREIGN EXCHANGE 



The first indorsement, being special, makes necessary John 
Doe's signature for any farther negotiation. The second 
indorsement might then appear as above. 

A blank indors< ment, or indorsement in blank, is one 
which, specifies no payee. If we were to change the second 
indorsement above into one in blank, the back of the bill 
or note would appear as follows : 



(1) 



(2) 



Pay 


to the 


order of 


John Doe. 






Richard Roe. 


John 


Doe. 





Blank indorsements are commonest perhaps when the payee 
negotiates a check to his bank for the credit of his account. 
The legal effect of a blank indorsement is to make the 
instrument paj^able to bearer and to make it capable of 
further negotiation by delivery only and without additional 
indorsement. The bearer or holder of an instrument so 
indorsed may be required, however, to place his indorse- 
ment upon it at the time of making a further negotiation. 
The purpose here would be to make the record clear and 
also to make this person assume the indorser's liability on 
the instrument. A bill or note indorsed which is in 
blank may easily come to bear a subsequent special indorse- 
ment. 

Omitting consideration of the third and fifth kinds of 
indorsements, into whose technicalities we had better not 
go, it remains to speak of the qualified indorsement. This 
is constituted by adding to the indorser's signature the 
words ''without recourse" or words of similar import. 
Thus: 



THE NEGOTIABILITY OF COMMERCIAL PAPER 20 



Pay to the order of 
John Doe. 

Richard Roe. 
Without recourse. 



This indorsement releases Roe from such of his liabilities as 
are imposed upon him by law as a part of the "indorser's 
contract," but leaves him with certain other liabilities 
which still belong with him as a "vendor" or seller of the 
instrument. This indorsement has itself no effect upon 
the liability of other indorsers, and no effect upon the 
negotiability of the instrument. This brings us to the sub- 
ject of the liability of parties. 

§ 12. The liability of parties. — The parties liable to make 
payment on negotiable instruments are divisible into two 
main classes. The first class consists of those that are, 
according to the terms of the instrument, unconditionally 
bound to pay, and includes the maker of a note and the 
acceptor of a bill. These parties are frequently spoken of 
as "principal obligors," and it is from them alone that 
payment is expected in regular course. The second class 
contains all parties who are liable to pay only on condition 
that the principal obligor dishonors the instrument, whether 
by non-payment in the case of a note or bill, or by non- 
acceptance in the case of a bill. Any one of these parties 
is in the position of representing to the holder that the 
principal obligor will honor the instrument. He further- 
more represents that if the principal obligor refuses to 
honor it, then he himself will pay it, provided the holder 
has made a suitable attempt to procure honor by the prin- 
cipal obligor. The principal obligor is by his own acknowl- 
edgment unconditionally bound to pay, in the sense that 
he has made himself obligor on an unconditional promise 



30 FOREIGN EXCHANGE 

or order (compare the definitions already given of the 
note and the bill). This does not mean that he may not 
avail himself of the defenses against payment heretofore 
discussed, when these defenses exist, bnt means that apart 
from such defenses his liability is not conditional upon the 
happening of any event, and not conditional upon the fail- 
ure of some other party to pay. The following conspectus 
shows the parties to negotiable instruments, classified ac- 
cording to liability. 

In this tabulation primarily is used in the sense of uncon- 
ditionally, and secondarily in the sense of conditionally* 

Parties Primarily or Unconditionally Liable. — (Parties ex- 
pected in ordinary course to pay the instrument.) 
The maker of a promissory note. 
The acceptor of a bill of exchange. 

Parties Secondarily or Conditionally Liable. — (Parties not 
expected in ordinary course to pay the instrument.) 
The ordinary indorser of either a note or a bill. 
The drawer of a bill, both before and after the drawee's 
acceptance of the instrument. 

Party not Having Liability. — The drawee of a bill prior to his 
acceptance of the same. 

It has already been explained that the drawee of a bill 
has no liability whatever on the instrument until he gives 
his acceptance, even if he owes the drawer money and even 
if the latter has ever so valid a commercial expectation 
that the bill will be honored. This applies to checks drawn 

2 A commonly accepted legal classification of parties, differing in 
the place assigned the drawer of a bill prior to acceptance, will be 
discussed in the note at the end of the present section. § 3 of the 
Uniform Law states : "The person 'primarily' liable on an instru- 
ment is the person who by the terms of the instrument is abso- 
lutely required to pay the same. All other parties are 'secondarily' 
liable." 



THE NEGOTIABILITY OF COMMERCIAL PAPER 31 

on banks unless a special statute runs to the contrary. That 
is, the payee (other than the drawer himself) of a check 
has no action against the bank if it refuses to pay, even 
when the drawer is in funds with the bank. "What he has 
is recourse on the drawer. As a matter of convenience we 
speak of the drawee as a party even prior to his acceptance, 
though before this act he is not a real contracting party. 
If we are to speak of him as a party at this time it becomes 
incumbent upon us to point out that he has for the time 
being no liability, conditional or unconditional. 

With the warning that we have here to do with an ex- 
tensive and difficult subject and that this book attempts 
only to give certain more general explanations which ought 
to be understood by the student of exchange, let us con- 
sider the liability of indorsers of bills and notes, and of 
drawers of bills. When the present holder and payee of a 
negotiable instrument indorses it and negotiates it to an- 
other person he becomes (1) an indorser, and (2) a vendor 
(or seller) of the instrument as a ''chattel." In each of 
these capacities he incurs distinct liabilities. As an in- 
dorser he is under a liability to pay the full face value of 
the instrument to any holder subsequent to himself, but 
this liability is secondary and depends upon the happening 
of three very precise events. These are (1) proper present- 
ment, (2) dishonor, and (3) due notice of dishonor. 

The act of taking a negotiable instrument to the prin- 
cipal obligor and demanding that he make payment, and 
the act of taking a bill of exchange to the drawee and 
demanding that he accept it, are both known as present- 
ment. The first is presentment for payment and the sec- 
ond presentment for acceptance. The promissory note can, 
of course, experience but one kind, that is, presentment for 
payment. With respect to bills of exchange, there is, as 
has already been explained, in regular course no occasion 
for the acceptance of sight bills as a formal act distinct from 



32 FOREIGN EXCHANGE 

payment. Long or time bills fall into two subclasses: 

(1) Those payable a stated period after sight or demand; 

(2) those payable a stated period after date. (Bills pay- 
able on a specified future date would belong to this second 
subclass if it were customary to draw them.) In the case 
of the first subclass, presentment for acceptance is required. 
In the instance of the second subclass it is not required, 
with two exceptions, namely (a) where the bill expressly 
stipulates that it shall be presented for acceptance, and 
(b) where the bill is drawn payable elsewhere than at the 
place of business or residence of the drawee. 3 

When we speak of presentment being required, we mean 
that it is required in order to prevent the parties second- 
arily liable from escaping their liability ; or, otherwise ex- 
pressed, in order "to bind the parties secondarily liable." 
Presentment for acceptance of bills payable a designated 
period after sight is necessary for this purpose. In general 
it is not necessary in the case of any other class of bills. 
But most long bills are in fact worded as payable a specified 
time after sight. The presentment of these bills is also 
necessary in order to fix the date ' ' of sight ' ' and from it the 
date of maturity. 

Speaking broadly, the party secondarily liable is liable 
on the general condition that payment cannot be obtained 
from the principal obligor. But speaking more specifically, 
he is liable on the three special conditions, provided by law, 
which are, (1) presentment, (2) dishonor, (3) notice, that 
is, notification of dishonor. The object of the rule that the 
holder of the instrument must make proper presentment or 
presentments to the principal obligor is to prevent the 
holder from having recourse upon the parties secondarily 
liable without first having made a proper effort to obtain 
payment from the party primarily liable. By a "proper" 

3 See Uniform Law, § 240, and British Bills of Exchange Act, § 39 = 



THE NEGOTIABILITY OF COMMERCIAL PAPER 33 

presentment is meant specifically one which is made at the 
time, the place, and in the manner prescribed by law as 
necessary to make the presentment serve as the first condi- 
tion for charging the secondary parties with their liability. 
There are a number of detailed rules governing proper 
presentment. To illustrate their character, suppose a note 
falls due on the business day of Wednesday, March 10. 
Presentment for payment must be made on this very date, 
and not on March 9, or March 11, if the parties secondarily 
liable are to be bound. A technically improper present- 
ment is wholly worthless for binding these parties. On the 
other hand, the reader will of course understand that fail- 
ure to make proper presentment for payment does not in 
the least affect the liability of the principal obligor. This 
liability endures until the statute of limitations brings it 
to an end. 

Proper presentment having taken place, the second event 
which must occur to bind the parties secondarily liable is 
dishonor. Dishonor is either: (1) The refusal of the prin- 
cipal obligor on a note or an accepted bill, or a bill due 
without presentment for acceptance, to make payment when 
it is presented for payment; or (2) the refusal of a drawee 
to accept a bill. 4 The first is called dishonor for non-pay- 
ment, and the second dishonor for non-acceptance. If a 
bill is dishonored for non-acceptance it is not necessary that 
it should also be dishonored for non-payment in order 
that the drawer and indorsers should be bound. Where 
presentment for acceptance of long bills is, as explained 
above, not required of the holder, he may make such a 

* A bill or note may be technically dishonored for non-payment 
where it is overdue and unpaid and the conditions are such that the 
law excuses presentment, as for instance "where after reasonable 
diligence presentment . . . cannot be made" (§ 142 of the Uniform 
Law). A bill also becomes dishonored for non-acceptance where 
presentment for acceptance is excused and the bill is not accepted 
(§§ 143 and 24G). 



34 FOREIGN EXCHANGE 

presentment voluntarily. If dishonor is then experienced, 
this (with notification) serves to charge the parties second- 
arily liable. 

If dishonor has taken place, the third condition necessary 
to bind the parties secondarily liable is that due notice of 
dishonor be sent them. Among the numerous rules relative 
to notice, the most important perhaps are that it must, 
except under special circumstances, be given or started by 
mail within one business day after the dishonor takes place, 
and that no party secondarily liable is charged unless notice 
be given him or his agent. Notice of dishonor may be dis- 
pensed with when "after the exercise of reasonable dili- 
gence, it cannot be given to or does not reach the parties 
sought to be charged" ("Uniform Law" §183). And 
delay in giving notice is excused "when the delay is caused 
by circumstances beyond the control of the holder and not 
imputable to his default, misconduct, or negligence. 
"When the cause of delay ceases to operate, notice must be 
given with reasonable diligence " (§184). Delay in making 
presentment for payment is also excused under the same 
rule. 

The holder's demand upon a party secondarily liable, for 
payment of an instrument dishonored by the drawee or by 
the principal obligor, is called recourse. The holder may 
take recourse upon any one of the parties secondarily liable. 
When one of these pays, this one may in turn take recourse 
upon the party from whom he himself received the instru- 
ment or upon any other party secondarily liable prior to 
himself. Meanwhile the obligations of the party primarily 
liable remains (except in the case of the unaccepted bill), 
and the last party secondarily liable to pay the instrument 
has this to fall back on, for whatever it is worth, this being 
just what he had when he passed the instrument on for a 
consideration. Since one party secondarily liable may be- 
come liable to another such party subsequent to him, notice 



THE NEGOTIABILITY OF COMMERCIAL PAPER 35 

of dishonor may also be passed between parties secondarily 
liable under rules too detailed for consideration here. 

The rights of the parties secondarily liable, to have pre- 
sentment take place and have notice of dishonor sent them, 
may be waived by them. A waiver to this effect is some- 
times embodied in the wording of a bill or note, or is printed 
over the place on the back for indorsements. In this case all 
general indorsers agree to the waiver. If a waiver is writ- 
ten in with his indorsement by an individual indorser him- 
self, it is his individual waiver only. In the case of a long 
bill dishonored for non-acceptance, the right of reimburse- 
ment in the sum of the full face value of the instrument 
takes immediate effect and is not held in abeyance until the 
date of maturity of the instrument. 

A protest is a formal certificate of dishonor, and to 
protest means to secure this certificate. A notary public is 
usually procured to make the certificate of protest and in 
it he cites the legally relevant facts of the dishonor, and 
thus creates evidence independent of the mere word of 
the holder himself. This certificate may, however, be made 
by any reputable resident of the place where the instru- 
ment is dishonored, in the presence of two or more credible 
witnesses. Under the American and the British law, a 
foreign bill of exchange must be protested at the time of 
its dishonor if the drawer or the indorsers are to be bound. 
The statute defines a foreign bill as other than an inland 
bill, and the latter as "a bill which is or on its face purports 
to be both drawn and payable within this state" ("Uniform 
Law" §213). In a legal sense, a bill drawn by a person 
in New Jersey on one in New York is a foreign bill. While 
in the case of notes and inland bills, protest is not tech- 
nically necessary, it is often secured nevertheless to serve 
as better evidence of the facts of presentment and dishonor 
than the mere affirmation of the holder himself. 

A person may negotiate a bill or note and still avoid 



36 FOREIGN EXCHANGE 

indorser's liability: and this in two ways. First, if the 
instrument is payable to bearer, he may effect the negotia- 
tion by the mere act of delivery without indorsement, pro- 
vided the party taking from him is willing to receive the 
instrument without his indorsement. Second, he may give 
a "qualified" indorsement or indorsement "without re- 
course." But he has certain other liabilities of which he 
cannot divest himself in these ways. The negotiation of a 
bill or note constitutes a sale, and- the transferor in his 
capacity as a vendor or seller makes, by implication of law, 
certain warranties concerning the instrument he sells. 
These were at first simply the vendor's warranties deter- 
mined by the common law relating to the sale of goods and 
chattels, but are now expressly listed in the Negotiable 
Instruments Law as follows: "Every person negotiating 
an instrument by delivery or by a qualified indorsement, 
warrants: (1) That the instrument is genuine and in all 
respects what it purports to be; (2) that he has a good 
title to it; (3) that all prior parties had capacity to con- 
tract; (4) that he has no knowledge of any fact which 
would impair the validity of the instrument or render it 
valueless. But when the negotiation is by delivery only, 
the warranty extends in favor of no holder other than the 
immediate transferee" ("Uniform Law" §115). A ven- 
dor's warranty amounts to a representation, whether ex- 
pressed or implied, as to the character of the article sold, 
which representation under the law takes the position of a 
condition of the agreement of sale. Under the statute the 
implied warranties, or the warranties implied in the mere 
act of negotiation, are those set forth in the section just 
quoted. The obligation of the seller of the instrument 
under these warranties is to make good to the buyer any 
pecuniary damage which he may suffer by reason of any 
of the representations proving untrue. The measure of this 
damage, briefly stated, is the difference between what the 



THE NEGOTIABILITY OF COMMERCIAL PAPER 37 

holder is actually able to obtain from the instrument under 
a failure of the representations, and what he would have 
received had all the representations proved true. We can- 
not develop these matters at any length, but before passing 
on may give one illustration which may help bring out their 
meaning. Suppose an instrument sold by A to B is a 
forgery without A having knowledge of the fact, and sup- 
pose A indorsed to B "without recourse." When the facts 
are exposed and collection from the ostensible principal 
obligor becomes impossible (since he has an absolute de- 
fense), B cannot have recourse on A as an indorser, but 
he may get damages from A as a vendor, on the grounds 
of the failure of A's (implied) representation that the in- 
strument was genuine. If B could have come back on A 
as the giver of an unqualified indorsement, he would have 
been entitled to collect the full face value of the instru- 
ment. When he comes back on A in fact as a vendor, he 
can claim instead damages, probably not far from the same 
sum. 

To summarize, the indorser 's obligation (when he be- 
comes charged with it) is to pay the full face or maturity 
value of the instrument on demand (1) to any holder sub- 
sequent to himself who has been unable to obtain payment 
from the principal obligor or drawee, as the case may be, 
or (2) to any indorser subsequent to himself who has had 
to pay the instrument under this rule. The regular in- 
dorser is also a seller of the instrument and he is liable 
under the vendor's warranties. Speaking now merely of 
liabilities, a general indorsement (or one not qualified by 
the words ''without recourse") has the effect simply of 
adding the indorser 's to the vendor's liabilities. With re- 
gard to presentment, dishonor, and notice of dishonor, the 
technical requirements explained in the preceding pages as 
necessary for binding the parties secondarily liable, are 
necessary for fastening upon these parties their liabilities as 






& FOREIGN EXCHANGE 

indorsers, but are not necessary to hold them to their ven- 
dor's liabilities. 6 

5 A classification of parties liable, common in legal treatises and 
given for instance in Norton on Bills and Notes (3d ed., p. 157), 
differs from the one advanced in our text, in that it places the 
drawer of a bill prior to its acceptance among the parties primarily 
liable. Thus: 

Parties Primarily Liable: 
The maker of a note. 
The acceptor of a bill. 
The drawer of a bill, prior to its acceptance. 

Parties Secondarily Liable: 

The indorser of either a note or a bill. 

The drawer of a bill, subsequent to its acceptance. 

Here the drawer of a bill while the instrument is still not accepted 
is thought of as primarily liable because (apart from indorsers, 
and there may be no indorsers) he is the only person in fact liable. 
And the drawer's liability is considered to become secondary only 
after acceptance has provided the bill with some one else as the 
party primarily liable. 

The issue between the classifications depends upon the meaning 
given the word "primarily." But the classification presented in our 
text would seem to be agreeable to the language of the statute, 
which says "the person 'primarily' liable on an instrument is the 
person who by the terms of the instrument is absolutely required 
to pay the same. All other parties are 'secondarily' liable" (§3). 
Xothing could be more obvious than that the drawer of an unac- 
cepted bill is not absolutely bound to pay it. He is bound solely 
on the condition of presentment, dishonor, and notice. He is 
secondarily liable. There is no party primarily liable. The asso- 
ciation of the drawer of an unaccepted bill with makers and ac- 
ceptors is unfortunate and misleading to say the least, because the 
character of his liability is not theirs at all but on the contrary is 
that of the indorsers"! 



CHAPTER III 
DISCOUNT AND INTEREST 

§ 13. Future sum and present price. — An understanding 
of the elements of the subject of discount and interest is 
essential to the student of the exchanges. In this book it 
will not be necessary to make the explanations on this topic 
run back into the foundations of the phenomenon of in- 
terest on capital. We may take our start from the premise 
that every loan, advance, or investment of money, under- 
taken as a "business" venture, is made with the hope that 
it will yield that type of gain known as interest. Every 
operation of this character involves an outlay of money (or 
of money's worth) for a deferred return in money (or 
money's worth). The outlay may consist in a single item 
of expenditure made all at one time, as in the case of the 
price paid for a bond or a note ; or it may consist in a plural 
number or series of expenditures made at various intervals, 
regular or irregular, as in the case of most investments in 
actual properties as distinguished from those in securities. 
The return also may consist in a single item of receipts, or 
in a plural number or series of such items. Interest calcu- 
lations are simplest in form where the outlay and return 
are both single items, as happens usually to be the case 
where short-term commercial paper is involved. In deal- 
ings in this paper, the outlay consists in the price paid for 
a note or a bill, or in the amount loaned when a note is 
taken, and it is practically universal for this outlay to be 
paid over in a single sum all on one day. The return con- 
sists in wnat is received from the purchased note or bill, 

39 



40 FOREIGN EXCHANGE 

or from repayment of the loan, usually an amount repaid 
as a single item in the sense that it is all repaid on one 
day or at one time. The return in any number of types of 
investment is, of course, made up of a series of future re- 
ceipts. In the case of long-term money contracts, interest 
at least is always payable in installments, and sometimes 
principal is so paj'able. 

We shall feel justified here in confining our attention to 
the problem of interest and discount as it appears where 
there is a single outlay followed by a single return, except 
that we should give a word to the bank loan with interest 
payable in installments. To illustrate such a loan suppose 
the Bank of A lends John Doe $1,000 for one year at an 
interest charge of 5% per annum payable quarterly. The 
outlay and returns of the bank in this operation will evi- 
dently be as follows: 

Outlay Returns 

On first of year $1,000 End of first quarter $ 12.50 

End of second quarter 12.50 
End of third quarter 12.50 

End of fourth quarter 1,012.50 

The interest for a year is 5% of $1000, or $50, and this 
divides into quarterly installments of $12.50 each. The 
$1012.50 due at the end of the fourth quarter is the $12.50 
of interest then payable plus the $1,000 of principal, also 
payable at precisely the same time. The borrower in this 
illustration would probably give the bank his note for $1,000 
bearing interest at 5% payable quarterly. The bank in 
effect buys this note for $1,000 on the day of its issue. In 
doing this it makes an investment at 5%. 1 (A slight 
change in the illustration would make the calculation of the 

i The rate of interest earned in this investment is strictly speaking 
5% per annum compounded quarterly, which is a slightly higher 
rate than 5% simple interest. 



DISCOUNT AND INTEREST 41 

rate of interest earned in this investment a somewhat more 
complex question. Suppose the bank bought this note for 
$980 on the day of its issue. The outlay would now be 
$980 instead of a thousand, but the returns would remain 
unchanged as shown in the schedule. The rate of interest 
named in the note would be 5%, but the rate of interest 
earned in the investment made by buying the note would 
be very close to 7.28% simple interest, or better than 7 1 /4%. 
Examination of this type of problem would involve us in 
too lengthy a consideration of interest.) 

"We shall deal henceforth only with the case of the single 
outlay and single return. We may call the outlay made 
to buy a bill or note, the present price, and the return 
which the instrument pays at maturity, the future sum. 
It remains to point out that with respect to the wording 
of an instrument there are two ways of expressing or in- 
dicating the future sum. For this sum may be set forth 
(1) simply and directly as such, or (2) as a "principal 
sum" plus contractual interest at a specified rate. To 
illustrate, the following two notes promise the same future 
sum, but express this sum in the two different ways. 

[1] 
$1,010.00 New York, N. Y., July 1, 1916. 

Sixty days after date, I promise to pay to the order of 
William Hill, One Thousand and Ten Dollars. 

James Alexander. 

[2] 
$1,000.00 New York, N. Y., July 1, 1916. 

Sixty days after date, I promise to pay to the order of 
William Hill, One Thousand Dollars with interest at the rate of 
6% per annum. 

James Alexander. 

Since the interest promised in the second of these notes 
is $10, both instruments have precisely the same maturity 



12 FOREIGN EXCHANGE 

value. The following acceptance by James Alexander will 
also be a practical equivalent of either of these notes. 

$1,010.00 Sr vjj^Boston, Mass., Jane 28, 1916. 

Sixty days differ kight Jfpay to the order of myself 

One Thousand anafTeni Dollars, and charge to my account. 

y / 

To James AlexaMrr,^^ _ 

100 Broadly, A fiht^t^^A^ 

New York Cit#. rf4&C~*~»^ '"^ 

Only one of the three instruments given here is an inter- 
est-bearing contract in the sense that a part of what it 
promises to pay is called interest by name in the words 
of the contract. Neither the first note nor the acceptance 
bear interest in this sense. They do not promise $1,010 plus 
interest for sixty days at some rate or other (as the legal 
rate in the state in question), but promise this sum with- 
out addition of any sort. To give them this effect it is 
not legally required that these instruments should contain 
the phrase "without interest," though the presence of 
these words will do no harm. 2 The actual rate of interest 
made in an investment in any one of these instruments 
depends on the price paid for it, and with the same price 
paid on the same date this rate of interest will be the same 
no matter which one is purchased. If $1,000 is paid for 

2 Discussions of the law governing the obligation to pay interest 
before maturity, and after the due date on overdue instruments, may 
be found in the leading legal texts on bills and notes. See also the 
articles on "Interest" in the "Century Digest," or in the "American 
and English Encyclopedia of Law,'' or in other similar compilations. 
"Where no interest is reserved [i.e., specified] in a note it will draw 
interest after maturity at the legal rate," [i.e., the rate set by 
statute]. Randolph, "Commercial Paper," § 1712. 



DISCOUNT AND INTEREST 43 

any one of the three on July 1st, the buyer makes an in- 
vestment at 6%. If $1003.31 were paid, he would make 
an investment at 4%. 

As regards business custom, notes appear in both the 
non-interest-bearing and the interest-bearing form. Where 
a note is given to a bank at the time of a straight loan for 
a designated period, it is likely to be written in the in- 
terest-bearing form. Where it is prepared for sale at the 
best present price obtainable in the money market it is 
most suitable it should be in the non-interest-bearing form 
and be ready for sale at a discount rate. So far as the 
writer's knowledge extends, the regular type of bill of ex- 
change which is dischargeable in a stipulated sum of the 
money of the country where it is payable, never takes the 
form of an interest-bearing contract, no matter what its 
term of life. That is, it never names a "principal sum" 
which is to be paid with an addition of interest for elapsed 
time at a specified rate. It simply names in full the amount 
payable at maturity. 3 The reader understands of course 
that an allowance on account of interest is made whenever 
any long bill is purchased, by the simple method of re- 
ducing the price paid for it. 4 

§ 14. The rate of discount and the rate of interest. — The 
negotiation of a bill or note prior to its maturity is a virtual 
sale of a future sum of money. This sale takes place at 
a reduced present price. Discount may be defined as the 
amount deducted from a future sum to arrive at its present 
price. Damaged commodities sold at a reduction from a 
list price are said to be offered at a discount. A depre- 
ciated currency circulating at a rate below its par in some 
other form of money is said to be at a discount. Thus 
there are various kinds of discounts, but the discount which 

s For a special type of bill of exchange with an Interest elauso 
see the one described in § 72. 

* See second problem in part B of § 16. 



1 1 FOREIGN EXCHANGE 

concerns ns here and which is a variant form of interest, 
is a deduction made for futurity. The futurity of an 
amount due on an obligation is a sort of detrimental cir- 
cumstance. On account of it something is "knocked off" 
a future sum to find its present equivalent. 

The rate of discount is the percentage per annum which 
the discount bears to the future sum; or again, it is the 
difference between any specified future sum and its present 
price, expressed as a percentage per annum of the future 
sum. To illustrate, if X sells Y an acceptance upon which 
$1,000 is due in sixty days, for a consideration of $990 
present cash, ten dollars, or the difference between these 
two quantities, is the discount on $1,000. It is the dis- 
count for a deferment of the future sum by one-sixth of 
a year. Discount is proportional to time to elapse, and 
this is a discount at a rate of $60 for a full year. $60 
being 6% of $1,000, the "rate of discount" is 6%. We 
come to the same result by reasoning that $10 is 1% of 
$1,000, and that if a 1% discount is deducted for a defer- 
ment of one-sixth of a year, 6% is deducted by the year 
or per annum. 

If A should lend B $990 for one-sixth of a year on the 
understanding that B should pay back $1,000 in complete 
discharge of the loan, we would speak of the $10 excess 
of the amount returned above the amount advanced, as 
the "interest" on the amount advanced. $10 is here the 
interest on the $990 for a sixth of a year. This interest 
is then running at a rate of $60 to the year. 60 is 6%oo% 
of 990, and the rate of interest is 6 e Aoo%, contrasting with 
the rate of discount which is 6% with the same future 
sum and present price. 

The loan by A to B is just as much the giving of a 
present price for a future sum as was the purchase by Y 
of the acceptance from X. In both cases we have a per- 
son giving up $990 of present money to receive $1,000 



DISCOUNT AND INTEREST 45 

deferred one-sixth of a year. In one case the difference 
between these two quantities is spoken of as interest, in the 
other as discount. It appears then (always confining our- 
selves to the case of the single outlay for the single de- 
ferred .return) that interest is the difference between a 
future sum and its present price when this difference is 
thought of as a fraction of the present price, and discount 
is the identical difference when thought of as a fraction of 
the future sum. To summarize: the difference between a 
future sum and its present price expressed as a percentage 
per annum of the present price is the rate of interest, and 
expressed as a percentage per annum of the future sum 
is the rate of discount. The rate of discount is not always 
conceived of in precisely this way, 5 but this is in fact the 
correct definition of that rate reduced to its ultimate and 
simplest terms. 

§ 15. Illustrative problems. — Practical problems of dis- 
count and interest may be divided into two classes. In 
one class the rate of discount or the rate of interest is 
given among the data, in the other the question is to find 
one of these rates. A number of specimen problems are 
put and solved in this section. For the sake of conven- 
ience, we shall follow the more common American method 
of treating the year as 360 days, and shall not assume 
days of grace, these having been abolished under the Amer- 
ican Uniform Negotiable Instruments Law. (In England 
the year is handled as being 365 days, and days of grace, 
three in number, are allowed by law on all time bills and 
notes unless grace is waived.) Using the term "money 
rate" to signify either a discount or an interest rate, 
group A of the following problems consists of those with 
the money rate given among the data. 

6 Compare § 17. 



46 FOREIGN EXCHANGE 

A. 

(1) An interest problem. — Given a loan of $5,000 for three 
calendar months or for 90 days (both being treated as ^th year) 
with interest at 5%, what sum will be required to discharge the 
loan at maturity? 

Interest for one year on $5,000 at 5% would be 
%oo or .05 x 5,000 or $250.00 

Interest for 90 days e= X A x 250 or 62.50 

Amount required to discharge the loan: 

Principal $5,000.00 

Plus interest 62.50 



$5,062.50 Answer. 

If the question were, "What is the amount due at ma- 
turity on a 90 daj's' note for $5,000, bearing interest at 
5% ?" we should get the same answer by the same method. 

(2) A discount problem. — A 90 days sight bill for $20,000 is 
bought by a banker on the day of acceptance on the basis of a 
discount rate of 4%. What does the banker give for the bill, or 
what are the proceeds or "avails" of the discount? 

On the day of the discount the bill has 90 days or }4th year 

to run. 
The discount for a year would be 4% of $20,000, 

or .04 x 20,000 $800 

The discount for y 4 th year = & X 800 = 200 

The price paid for the bill : 

The future sum $20,000 

The discount 200 



$19,800 Answer. 

It is evident we may also find the discount as follows: 

Discount for one year = 4%. 
Discount for ^th year = l%. 
1% of 20,000 = 200. 



DISCOUNT AND INTEREST 47 

(3) An interest problem. — With the same bill and same date 
of purchase as in question 2, suppose the banker buys the instru- 
ment at a price to yield him a. rate of interest of 4%, what would 
he pay for it? (This question might be worded, what is the 
true present worth of this bill on the basis of an interest rate 
of 4%?) 

The price paid for the bill is the banker's outlay, and 

the amount received on it at maturity is his return. 
With the rate of interest at 4% per annum, the interest 

for 90 days will amount to 1%. 
Therefore the return must exceed the outlay by 1% of 

the outlay (i.e., there must be a l^o gain on the 

outlay). 
The return then = 101% of the outlay. 
Therefore the outlay must be — of the return. 

^j X $20,000 = $19,801.98. Answer. 

Another statement: There must be $1.01 of return for 

each $1.00 of outlay, and 20000 contains 1.01, 

19801.98 times, and therefore for 20000 of return 

there must be 19801.98 of outlay. 

The present price of the bill in question is 

on a 4% discount rate $19,800 

on a 4% interest rate 19,801.98 

(4) A discount problem. — What would a 90 days' sight bill 
for £20,000 sell for in England on the day of acceptance, on the 
basis of a 4% discount rate? 

The bill has 93 days to run, there being three days of 

grace. 
The discount for one year would be 4% of 

£20,000 or £800.00 

The discount for 93 days is °y 3 05 X 800 or 203.84 

The future sum £20,000 

The discount 203.84 



Price paid for the bill £19,790.16 (£19,796 3s. 2d.) 

in -n ., « % Answer. 

(Compare with problem 2.) 



FOREIGN EXCHANGE 

(5) A discount problem. — What would a 90 days' sight bill for 
$20,000 sell for 50 days after acceptance on the basis of a dis- 
count rate of 4% ? 

The bill has 40 days to run. 

The discount for a year would be 4% of 

$20,000 or $800.00 

The discount for 40 days is 4 %eo or % of 800 or 88.89 
The price of the bill = $20,000 — $88.99 = $19,911.11 

Answer. 

(6) A discount problem. — What would a 60 days' note for 
$1,200, bearing interest at 5%, sell for on the basis of a 4% dis- 
count rate, if sold on the date of issue of the note? 

The amount due at maturity, or future sum, is found as 
follows : 

Principal $1,200.00 

Nominal interest % of 5% of $1,200 10.00 



Future sum $1,210.00 

One year's discount on $1,210 at 4% would be. .$48.40 

One-sixth of a year's discount is therefore 8.07 

Sale price of note: 
Future sum or maturity value . . .$1,210.00 
Discount 8.07 



Answer $1,201.93 

(7) An interest problem. — What can be paid for the above 
mentioned note on the day of its issue, if the buyer is to gain 
interest at 8% on his investment in the note (assuming he holds 
to maturity) ? 

The maturity value or future sum is, as before . . $1,210 
Interest at 8% per annum means 1%% for 60 days or 

%th year) 
Therefore the gain on the outlay must come to 1%% of 

the outlay 
Or $1,210 (the return) must exceed the outlay by this 

1%% and be 101%% of the outlay. 



DISCOUNT AND INTEREST 49 

The outlay itself (or 100%) must be 
10 °, X i* 210 ' which, being solved, equals $1,194.08 

Answer. 
B. 

(1) A discount problem. — An accepted bill of exchange for 
$5,000 payable in 90 days is sold to a banker for $4,937.50. 
What rate of discount did the banker charge? 

The future sum= $5,000.00 
The present price = 4,937.50 



62.50 the difference, is the discount 
for one-fourth year. 
4. 



$250.00 the discount per annum. 

The question becomes, what per cent, is 250 of 5,000? 

1% of 5,000 = 50 

250 -r- 50 = 5 

250 is 5% of 5,000. 
Therefore the rate of discount was 5%. Answer. 

(2) An interest problem. — What rate of interest did the banker 
make in his investment in this bill, assuming that he held it till 
maturity? 

The answer will be very close to 5% and above 5%. 
The practical man will usually consider it unnecessary 
to find the answer to this question. 

The future sum or return = $5,000.00 

The present price or outlay 4,937.50 

The difference 62.50 

This is the interest on the outlay for Vi year. 
4 X 62.50 = 250.00 = the interest for 1 year. 
The question becomes, what per cent, is 250 of 4,937.50 
(the outlay) 1 

1% of 4,937.50 = 49.375 

250 -=-49.375 = 5.063 4- 



50 FOREIGN EXCHANGE 

250 is 5.063% of the outlay, 

and the rate of interest in the investment is 
5.063% Answer. 

(3) A discount problem. — A 6 months' note for $1,000, bear- 
ing interest at 6%, is sold to a banker for $1,019.70 when it has 
3 months yet to run. It being known that the banker bought on 
the basis of a discount rate, what was this rate? 

$1,000 the principal sum of the note. 

the contractual or nominal interest would be 
V 2 of 6% of 1,000, or 30. 
30 the contractual interest. 



1,030 the future sum, or amount due at maturity. 
1,019.70 the price paid by the banker 



10.30 the discount for 3 months or ^th year. 
The question becomes, what % is 10.30 of 1,030 (or the 
future sum), for this multiplied by 4 will give the dis- 
count rate per annum. 
10.30 is 1% of 1,030. 

4Xl% = 4%, the rate of discount. Answer. 
(The rate of interest earned in the banker's investment 
is in this case 4.06 -(- % ) . 

(4) An interest problem. — A banker lends Smith $1,000 for 
60 days, charging interest at the rate of 5%, and takes Smith's 
60 days' note for $1,000, bearing interest at 5%. 30 days later 
the banker sells this note to a large bank on the basis of a 3^% 
discount rate. What rate of interest does the first banker make 
in his investment in this note? 

Find the banker's outlay and return. 

The outlay is the amount handed over at the time 

the note was received, or the amount of the loan, $1,000. 
The return is the price received for the note in the sale 
to the large bank. 

To calculate this price : 

Principal of note 1,000.00 



DISCOUNT AND INTEREST 51 

Interest due on it 8,33 

(%th of 5% of 1,000) 

Maturity value of note 1,008.33 

There are 30 days (or ^th year) to run on the 

note at the time of sale, and the discount taken 

out by the large bank will be M2th of 3V2% of 

1,008.33, which is 2.94. 

Future sum 1,008.33 

Discount 2.94 

Sale price of note, and 
first banker's return 1,005.39 

Final step. 

The return 1,005.39 

The outlay 1,000.00 

The interest 5.39 

If interest of 5.39 is earned in Vi2th year, or the 
time during which the first banker held the 
note, the interest per annum is 12 X 5.39, or 
64.68 per year. 

The question becomes, "What per cent, is 64.68 
of 1,000? 

1%=10 

64.68-^-10 = 6.468, and therefore 64.68 = 
6.468% of 1,000. 

Answer 6.468% 

"Whether the rate of discount is given in a problem, or 
whether it is to be found, it is always the difference between 
the future sum and the present price expressed in the 
form of a percentage per annum of the future sum. The 
rate of interest is always this same difference counted as 
a percentage per annum of the present price or outlaj'. 

When a banker quotes a customer a money rate, as say 
4%, it does not make a great difference whether it is a 
discount or an interest rate, provided the rate itself is a 



52 FOREIGN EXCHANGE 

moderate one and the period of the advance is not unusually 
long. The existence of the discount rate, as a variant upon 
the interest rate, is not to be accounted for so much by 
reason of its giving the money lender a somewhat higher 
gain as by reason of its superior convenience in calculation. 
Almost always we find discount rates in use only where they 
are more convenient than interest rates. A discount rate 
is virtually always employed in connection with a bill of 
exchange, and an interest rate is generally employed in 
connection with a straight loan, and always in connection 
with deposits which are paid earnings by the banker hold- 
ing the deposits, that is, of course, in connection with what 
we call ''interest-bearing deposits." 

§ 16. The terminology of discount and interest. — It is 
proper to explain that several meanings attach to the 
word "discount." Used as the verb, to discount, the word 
signifies either to purchase or to sell a long bill or note at 
a present price calculated on the basis of a specified rate 
of discount. Both the buyer and the seller of the paper 
are spoken of as "discounting" it. There is a somewhat 
similar usage in speaking of both landlord and tenant as 
renting a house. The price received by the person making 
the sale of the bill or note is sometimes called the "avails" 
of the discount, meaning the proceeds of the sale of the 
paper. 

One who, having bought a piece of long paper, makes 
a resale of it, is said to rediscount it. Banks to which such 
resales are often made are called banks of rediscount. 
Examples are the Bank of England and other central bank- 
ing institutions in Europe, and the new Federal Beserve 
Banks of the United States. 

Bills and notes which have been purchased by an insti- 
tution regularly engaged in discounting and which are 
carried as a part of its assets, are often called its discounts. 
The largest item of resources of a commercial bank is thus 



DISCOUNT AND INTEREST 53 

frequently entitled "loans and discounts" or sometimes 
"discounts" simply. Here the pieces of paper themselves, 
or at any rate the claims which they represent, are called 
discounts. A firm whose chief activity is the purchase of 
long paper is sometimes called a discount house. This 
term is used more in London than elsewhere. 

The phrases "bank discount" and "true discount" re- 
quire mention. The former when it appears is a mere 
synonym for what we have called simply discount. The 
latter is a synonym for interest. 

The rate of interest actually expressed in those instru- 
ments which name a rate, may be called ' ' explicit ' ' interest. 
The rate of interest really gained in making an invest- 
ment in long paper, depending on the price paid for the 
paper (whether or not an express rate is named), may be 
called "implicit" interest, or better the implicit rate of 
interest. This is the rate implied in the price paid for a 
given future sum. 6 The explicit rate of interest is also 
called the "nominal" rate, and the implicit is called the 
"effective" or "investment" rate, and also the "yield." 
Problem number A7 in the preceding section illustrates this 
distinction. It was a case of a 5% note bought at a price 
yielding the investor an actual rate of interest of 8%. 
5% is a "nominal" rate in the sense that it is the rate 
in name only, the "real" rate being 8%. 

§ 17. Discount conceived of as interest in advance. — 
Bankers often refer to the taking of discount as the "taking 
of interest in advance." This usage has found its way 
into the courts (see for example, Black v. The First Na- 
tional Bank, 96 Md. 399). We can best explain the thoughl 
here by presenting first the three examples shown below. 

(i The terms "explicit" and "implicit" interest are suggested 1)} 
Irving Fisher in his book, "The Rate of Interest" p. G. 



54 FOREIGN EXCHANGE 

Example A 

Interest Payable in the Ordinary Way, Namely at the 
Time of Repayment of the Loan 

Loan of $1,000 made on July 1st for 3 months, interest at 6%. 

Amount paid over by bank to borrower on July 1 $1,000 

Amount repaid by borrower on October 1 1,015 

Found as follows : 

Principal 1,000 

Interest 15 

(Vi of 6% of 1,000) 



1,015 



Here the future sum is $1,015 and its present price, or 
the present amount exchanged for it, is $1,000. 

The difference between the two is $15, which is l 1 /4% 
of the present price, or 6% of it per annum. That is, 
this is a case of an interest rate of 6% per annum, as we 
have defined the interest rate. 

Example B 

Interest Payable in Advance, or at the Beginning of the 

Loan 

Loan of $1,000 made on July 1st for 3 months, "interest in ad- 
vance" at 6%. 

Amount paid by bank to borrower on July 1st $ 985 

Found as follows: 

Amount loaned on July 1st by bank. .1,000 
3 months' interest at 6% payable in 
advance or on July 1 15 



Net amount paid over to borrower. . . 985 

Amount paid back by borrower on October 1 1,000 

Since the borrower has already paid the $15 of interest, 
he does not pay it again at the end, but repays merely 
the principal of the loan, or $1,000. 



DISCOUNT AND INTEREST 55 

Here the banker gains $15 for a quarter year's investment 
of $985 and the true rate of interest figures to 6.09% per 
annum. 

Example C 

An Ordinary Discount Operation 

Suppose a bill for $1,000 payable October 1st, is discounted on 
July 1st at 6% (discount rate). 

Amount paid by bank to the seller of the bill $ 985 

Found as follows: 

Future sum due 1,000 

Discount 15 

(i/4 of 6% of future sum) 

985 

Amount received back by bank at maturity 1,000 

Here the bank invests $985 for a quarter year and receives a re- 
turn of $1,000, yielding a gain of $15. 

This is a case of a 6% discount rate, and a true interest rate 
of 6.09% 

The perfect equivalence of operations B and C can be 
seen at a glance. When in operation B, the banker thinks 
of himself as lending $1,000 at interest payable in ad- 
vance, what he really does is to lend $985 for a return 
of $1,000 in one-fourth year. But if he discounted $1,000 
due in one-fourth year, on the basis of a discount rate 
of 6%, he would make precisely the same outlay for the 
same return. The conception that discount is interest in 
advance is sound enough, but it is less simple than the con- 
ception explained in this text. 



CHAPTER IV 
COMMERCIAL BANKING 

§ 18. The functions of the commercial bank. — The central 
figure among the dealers in commercial paper and ex- 
change is the commercial bank. Readers who seek an 
acquaintanceship with the subject of the foreign exchanges 
are likely to be familiar with the nature and operations 
of this institution, but a brief exposition of the rudiments 
of banking is presented at this point for those who may 
desire it. It is certainly necessary for the student of the 
exchanges to understand at least so much as is told here. 
He ought to understand more. 

While ' ' banking ' ' signifies everywhere some form of deal- 
ing in money or securities, the exact meaning of the term 
differs according to time, place, and context. But speak- 
ing for the United States and England, and for the pres- 
ent time, a commercial bank may be defined as an insti- 
tution which (1) receives demand deposits and (2) makes 
short term loans, as a regular activity at an established 
place of business. It is the combination of these two lines 
of money-dealing that makes commercial banking. It is 
from this combination that the possibility arises of a bank's 
lending more money or funds than it itself owns in its own 
right. This is what gives banking its distinctive character, 
and the pursuit of either of these lines of business singly 
does not in the least constitute banking. 

All banks, however, engage in a certain number of other 
operations more or less akin to these two major ones. The 
most noteworthy among these are (1) buying and selling 

56 



COMMERCIAL BANKING 57 

exchange, domestic and foreign, (2) buying and selling gold 
and silver bullion, and foreign coins, (3) receiving specific 
deposits (i.e. — deposits of articles, including moneys if the 
depositor sees fit, with the understanding that the identical 
articles are to be returned to the depositor), (4) making 
collections on notes and drafts for customers, distinguished 
from the purchase or discount of these instruments, and 
(5) acting as attorney-in-fact. The issue of bank notes 
to be used as currency, while an important branch of the 
business, is not an essential part of commercial banking. 
In this country banks with national charters issue these 
notes, and the state banks do not, but both classes are 
engaged in commercial banking. 

§ 19. Deposits and reserve. — In technical banking usage 
the word "deposit" does not signify the money, or the 
credit instrument, handed in to the receiving teller, that 
is, the thing deposited, but means the credit which the 
customer gets on the bank's books by reason of turning in 
the money or its equivalent. The deposit is the customer's 
right to demand payment, or his credit, and it is at the 
same time the bank's liability to make payment, or its debt. 

When receiving funds on deposit, a commercial bank 
engages with the customer that the amount clue him will be 
paid on demand, but the bank does not engage that it will 
keep all or any particular proportion of his money actually 
on hand for the purpose. The bank becomes the customer's 
debtor, and not a mere agent for holding his money. If a 
bank owes say $100,000 of demand deposits at a given 
moment, it may find that by keeping $20,000 of actual 
money on hand, it will be able in fact to meet all daily 
demands. The depositors collectively do not, except in 
cases of "runs," demand all they have a right to. On 
some days, as a body they bring in more than they with- 
draw. On other days the reverse is true. The bank knows 
that by keeping a certain amount of cash on hand it can 



58 FOREIGN EXCHANGE 

hold the fort against the demands that will be made on it. 
In ease withdrawals persistently exceed depositing, the 
bank will have to arrange to convert some of its assets, other 
than cash, into cash. "Whatever cash the bank does have 
on hand at any moment for the purpose of meeting its 
demand liabilities, is known as its reserve. A certain 
amount of reserve is essential for safety. Its quantity may 
be expressed either in the absolute amount of dollars 
(pounds, francs, etc.) or in the percentage which this 
amount bears to the total of demand liabilities protected 
by the reserve. The latter is of course the more signifi- 
cant figure. Often banks are recpiired to keep a certain 
minimum percentage of reserve. "Where this is the case, 
the requirement does not flow from a contract with the 
depositors, but from legislation by the government under 
whose jurisdiction the bank does business. Such legisla- 
tion is common. 

§ 20. The loans and their limits. — The making of short 
term loans and advances is the second part of the whole 
which constitutes commercial banking. As indicated on 
an earlier page, these advances may be made directly to 
the customer in return for his promissory note, or in- 
directly by the discount for him of the obligations of others 
held by him. The commercial bank is to be regarded 
simply as the greatest of the buj'ers or discounters of com- 
mercial paper. "While the deposits of a bank constitute its 
chief liability, the "loans and discounts" are its chief 
asset or resource. The beginner, thinking of the bank's 
lending as an act of passing out cash to the borrower, is 
inclined to regard the making of a loan as a means of 
reducing resources. But, of course, in making advances 
or loans, the institution receives promissory notes or bills 
of exchange upon which various persons are liable to pay 
it money at maturity. In the usage of the bank state- 
ment, the words "loans and discounts" mean, not the cash 



COMMERCIAL BANKING 59 

passed out (if cash is passed out), but the claim against 
outside persons which the bank holds in virtue of the pos- 
session of these notes and bills. Look through its portfolio 
of notes and bills and you see the paper evidences of the 
credits of the bank against outsiders, which constitute the 
greatest single item among its resources. 

The operation of making a loan does not necessarily 
cause a bank an immediate loss of cash, nor a loss equal 
to the amount of the loan. The borrower may ask for 
neither cash nor a draft (or exchange) but may simply 
have the proceeds of the loan credited to his deposit. In 
fact, deposits in great part arise out of loans or advances. 
Since a loan costs interest, a customer is practically cer- 
tain not to ask for one until he is ready to use it, and 
therefore may be expected to draw his checks against it 
at an early moment. But this may or may not cause the 
bank an immediate loss of cash. The checks may be drawn 
in favor of other customers of the same bank who simply 
deposit them without demanding cash. But on the aver- 
age, an expansion of the loans means a loss of a certain 
amount of cash. Nevertheless, the bank has constantly 
far more funds loaned out than it has cash on hand. 

The limits beyond which the lending operations of a 
bank may not be extended are governed at bottom simply 
by the minimum limit imposed on the bank's reserve, 
whether imposed by law or by the bank's own prudence. 
If a bank's circumstances are such that its reserve should 
not be allowed to fall below twenty per cent, of its deposit 
liabilities, then the limit of loans is reached when further 
lending would result in the fall of the reserve below this 
percentage. For every loan decreases the percentage of the 
reserve, whether the loan results in a positive loss of cash 
or not. If the loan is made by a direct out-payment of 
cash, the absolute amount of the reserve is directly reduced 
by the full amount of the loan. If the loan is made by 



60 FOREIGN EXCHANGE 

giving the borrower a deposit credit, the perceyitage of the 
reserve is still reduced, because the amount of deposits 
against which the reserve is carried is increased. Suppose 
a bank had deposits of $100,000 and a reserve of $20,000. 
If a loan of $10,000 were made it would necessarily de- 
crease the reserve percentage. If $10,000 cash were paid 
out the reserve would drop from $20,000 and 20% to 
$10,000 and 10%. If, on the other hand, a $10,000 credit 
were granted the borrower, the deposits would ascend to 
$110,000. The $20,000 reserve would then come to but 
18711% of the deposits. This drop of 19ii% is the slightest 
fall in the reserve that can result from the loan of $10,000. 
A decline of this extent will be produced even if the 
borrower's checking against his account occasions no sub- 
sequent withdrawals of cash. 

There is then a limit to the amount which a bank may 
lend, because there is a limit below which it dares not 
force the percentage of its reserve. The bank's motive to 
expand its loans rests on the fact that the interest which 
they yield is the chief element in its earnings. In addi- 
tion to the restriction on their quantity, there is another 
important one pertaining to the character of loans, which 
is that they must be for short periods. It is true, com- 
mercial banks buy a certain amount of investment bonds, 
presumably of a readily marketable type, and this consti- 
tutes the making of long-term loans (of a saleable character 
however), but the far greater portion of their advances 
must be for short periods and must be properly marshalled 
or arranged according to the dates of their maturities. 
Cash reserve normally covers only a minor fraction of the 
demand liabilities, the greater volume of the cover consist- 
ing in these short term loans and advances. It would be 
dangerous for a bank to make long loans and fixed invest- 
ments with funds which it might have to return to de- 
positors at any time. To explain what is meant by saying 



COMMERCIAL BANKING 61 

that the loans should be properly marshalled, suppose 
a bank has $100,000 of loans outstanding, the latest of 
which to mature are payable 90 days from the present date^ 
Some of these loans ought to be falling due to-day, some 
to-morrow, some the next day, and so on. That is, the ideal 
arrangement for the whole series (special circumstances 
apart) is to have the maturities flow in continuously and 
evenly. This operates to give the bank a ready command 
of cash in case of persistent withdrawals of deposits. In 
ordinary circumstances it can maintain the body of out- 
standing loans as a constant by making renewals and new 
advances (if the market for them is present 1 ) equal each 
day to the amount of loans maturing that day. But if 
excessive withdrawals take place, the reduction of renewals 
and new advances will create a cash income to meet or 
help meet the needs of the case. The chief points to learn 
in this connection are that the protection or cover which the 
commercial bank carries against its deposits, consists first, 
in a partial cash reserve, and second, in a portfolio of 
short term loans and advances properly marshalled, and 
after these in other assets. 

1 In the long run the market can be expanded by a sufficient re- 
duction in discount and interest rates, or by the same token, can be 
maintained. 



CHAPTER V 
THE RATES OF EXCHANGE 

§ 21. The general character of dealings in exchange. — 
The bill of exchange, taken in its legal sense as including 
checks and bank drafts, is the virtually exclusive means of 
international payment employed by ordinary merchants. 
If a merchant in New York purchases dry-goods from one 
in London for a stipulated price of £10,000, his full legal 
obligation is to place in the hands of the Englishman £10,000 
of British legal tender. But in virtue of the system of the 
foreign exchanges, the New York merchant is in practice 
enabled to settle his account with economy and ease, merely 
by obtaining a bill of exchange. If it were not for this 
system, he would be forced to ship gold to London for con- 
version into British coin to satisfy his legal tender obliga- 
tions there. But in fact the shipment of gold by mere 
merchants is wholly avoided. It is true, some gold has to 
be shipped between countries from time to time, but the 
amount of such shipments is by the use of exchange reduced 
to a minimum. And when made, the shipments are engi- 
neered by bankers only, and ordinary merchants do not 
have to think about them. 

"We do not mean to imply that the economy in the use of 
specie, which is effected by means of credit instruments, 
is confined to foreign commerce. Checks and drafts per- 
form the same function in internal as in foreign trade. If 
it were not for the system of domestic exchange, a San 
Francisco merchant indebted to one in Chicago would be 
compelled to ship money (although not necessarily gold) 

62 



THE RATES OF EXCHANGE 63 

from San Francisco to Chicago. In their very fundamen- 
tals, the principles of foreign and of domestic exchange 
are the same. Nevertheless in many respects the two sys- 
tems of exchange are dissimilar. The single fact that dif- 
ferent countries have different kinds of money, makes 
foreign exchange a distinct subject in practical detail. One 
consequence of this is that the economy in the use of specie 
effected in foreign trade is not only more striking to the 
imagination but is actually more important than in domes- 
tic exchange. When the coin of one gold-standard country 
is shipped to another, it has to be melted down and recoined 
if it is to become money of that other country. 1 In addi- 
tion to this, such coin when melted into bullion will fre- 
quently require to be restandardized before being recoined. 
This will always be the case when gold %o fine is shipped to 
a country having gold ai /i2 fine, and vice versa. There is 
more business and expense associated with an international 
than with a domestic shipment of money. 

Foreign exchange in any given country consists in bills 
and telegraphic orders to pay money that are dischargeable 
in some other country. Hereafter, unless the contrary is 
indicated, we may be understood as meaning foreign ex- 
change when we speak simply of exchange. The buyers 
and sellers of exchange include merchants engaged in for- 
eign trade and dealers in bonds and stocks for foreign 
account, governments and corporations that owe money 
abroad or are owed it from abroad, travelers, immigrants, 
miscellaneous persons, and the bankers. Among all these 
there are discernible two broad groups, namely (1) those 

i Sometimes, however, coin of one country shipped to another will 
he held in its existing form, though valued only as bullion, against 
the possible turn of the tide of gold movement when it may be 
shipped back to the first country to be available there without thp 
expense of recoinage. And again specie export often takes place 
without involving the melting of coin, because uncoined bullion ia 
found for shipment. 



.il FOREIGN EXCHANGE 

who deal in exchange as a business in itself, that is, bankers, 
"exchange houses," and sometimes bill brokers, and (2) 
those who deal in exchange as an incident to some other 
major transaction, operation, or undertaking, such as an 
export or import of goods or securities, a flotation or dis- 
charge of a foreign loan or the payment of interest upon 
it, a tour, and so forth. Traders — by this we mean traders 
in merchandise and securities — are of course by far the 
most important element in the second group. The trans- 
actions in the exchange market fall into two main classes, 
(1) those taking place between the traders and the bankers 
(with the intermediation of bill brokers at times) and (2) 
those taking place between banker and banker. No im- 
portant dealings in exchange are carried on directly be- 
tween merchant and merchant without the intervention of 
the banker as a middleman. For the present we shall pass 
over with mere mention the extensive traffic in drafts and 
telegraphic transfers which the banks conduct among 
themselves, but it would seem wise to give some general in- 
dications of the character of the dealings which originate 
with the traders, before we enter upon the chief subject 
of this chapter, the quotation of rates. 

International business transactions in merchandise and 
securities make necessary certain exchange operations as 
a means of settlement. The main relations of these trans- 
actions to the exchange market may be stated in brief as 
follows : 

An export from a country either increases the supply of ex- 
change for sale in that country, or it does not directly affect 
the market for exchange in the country. 

An import into a country either increases the demand for ex* 
change in that country, or it does not directly affect its 
market for exchange. 

One county's export is the other country's import. The 
importer becomes a commercial debtor, the exporter a com- 



THE RATES OF EXCHANGE 65 

mercial creditor. The kind of money that is due from the 
one to the other, depends on the manner of quoting the 
price of the article exported. It will be foreign money 
if the price was stated in foreign money, and home money 
if it was quoted in the latter medium. In either case 
the exporter will manage through some operation in ex- 
change to make final payment take the form of his home 
currency. The exchange operation to be utilized in a 
settlement and the method of quoting prices exercise much 
influence upon each other. To be brief though explicit, 
there are three chief modes of settlement by means of ex- 
change. These are 

(1) The exporter draws on the importer's countrj 7 . 2 

(2) The importer remits 3 to the exporter's country. 

(3) The exporter draws on some third country and the im- 

porter (or a bank acting for him) also remits to that 
third country. 

For purposes of illustration let us suppose a shipment of 
flour from New York by way of one of the French ports 
to Paris. In the case of the first two methods we may 
assume the price of the consignment to be 50,000 francs. 
(1) With plan number one in operation, the New York 
exporter draws a draft for 50,000 francs, the drawee being 
either (a) the French importer or (b) some French bank 
which the latter has induced to serve as drawee. (The 
reasons for securing a bank to serve as drawee will be 
brought to light in a later chapter.) The exporter then 
sells this draft in New York for as many dollars as it 
will fetch at the current rate of exchange. 4 These dollars 

2 To draw on a country means, of course, to draw on some person, 
firm, corporation, or bank in that country. 

3 To remit signifies here to send exchange to some person or firm, 
corporation, or bank in the country in question. 

1 In practice an exporter's draft will nearly always be a long or 
time bill "with documents attached" (see especially Chapter VI). 
If it is an authorized draft on a bunk it will be readily salea'uj 



6(i FOREIGN EXCHANGE 

are his compensation in its final form for the flour he has 
shipped. The francs surrendered by the Frenchman when 
he honors the draft (or when he reimburses the bank for 
paying it in case the latter was drawee) are what he on 
his side gives up to get the flour. Between the exporter 
as drawer and seller of the draft and the importer as the 
part}' to bear the ultimate expense of discharging it, there 
stands a series of banks that handle the instrument. (2) 
Under the second plan, the Frenchman expends the 50,000 
francs payable by him, for a draft on New York, purchasing 
as many dollars of this exchange as can be had at the 
current rates, and remits the same to the exporter. Here 
as before, the Frenchman gives up francs, the American 
receives dollars, and the flour is paid for. Here as be- 
fore, a chain of banks intervenes in the process of settle- 
ment. (3) In our illustration of the third method we shall 
assume the price of the consignment of flour to be quoted 
in American money, and to be, say, $9,650. Here we shall 
suppose the French merchant arranges for a "sterling 
credit" in favor of the New York exporter. This will 
involve the grant by some English bank of a permission 
to the American to draw a bill or bills upon it against 
shipment of flour to the Frenchman. This permission will 
be secured by the Frenchman, usually through the inter- 
mediation of a French banking establishment. (§ 37 to § 47 
of this book are given over to the explanation of this scheme 
of settlement.) To make a long story short, this plan 
means that at the time of shipment the American exporter 
draws a draft on an English bank for a sufficient number 
of pounds sterling to sell at the current rates of exchange 

in New York. If when drawn on the importer personally, as under 
method number one, it could not be sold in New York, it would be 
given to a New York bank for collection. The process of collection 
will ultimately bring the exporter a return in dollars, and of course 
cost the Frenchman francs. 



THE RATES OF EXCHANGE 67 

for the 9,650 dollars due him. The English bank pays 
this draft (which under standard arrangements will be 
drawn at sixty or ninety days sight), but the French mer- 
chant — or more precisely his bank acting in his behalf and 
taking reimbursement from him — furnishes the pounds re- 
quired to discharge the instrument by buying London ex- 
change in Paris and sending it over to the English bank. 
This is a case where the exporter draws on a third country, 
and the importer, or a bank acting in his behalf, remits 
to that third country. All cases conform to the rule al- 
ready given, that the exporter either draws and sells ex- 
change or does not engage in an exchange transaction in 
his country (the latter being the case under plan two), 
while the importer either buys and remits exchange or 
does not enter the exchange market of his country (the 
latter being the case under plan one). 

To summarize : If we look at a single merchandise 
movement, such as the shipment of flour from the United 
States to France, we see that it may function (as our 
export) to produce in our market a supply of exchange on 
France, or it may function (as a French import) to pro^ 
duce in France a demand for exchange on the United 
States; but it cannot produce both of these effects at once. 
It can, however, add to the supply of exchange in America 
and to the demand for exchange in France, conjointly, 
where the exchange is in both cases on a third country. 
If we view the entire commerce of a given country, exports 
and imports, we see that the exports give rise to a supply 
of exchange or else have no direct effect upon its ex- 
change market, while the imports create a demand for 
exchange or else have no direct 5 effect. 

There are a number of variants upon the three chief 

6 Indirect effects may be produced through the action of arbitrage of 
exchange, a subject discussed in Chapter XIV. 



68 FOREIGN EXCHANGE 

methods of settlement upon which we have touched. There 
is much to be said concerning the practical grounds of 
choice among these methods, which cannot be developed at 
this point because somewhat advanced questions of personal 
and documentary security and even questions of arbitrage 
are involved. But taking the commerce of the world at 
large, it is safe to say it is commoner for exporters to draw 
tli an to receive remittances of exchange. Particularly in 
the commerce of the United States with England, it is the 
predominant practice for our exporters to draw rather 
than for English importers to remit, and it seems also 
commoner in this case for our importers to remit rather 
than to be drawn upon by their English creditors. These 
customs have the effect of concentrating the exchange deal- 
ings that arise out of the commerce between the two coun- 
tries, on the American side or in our market. In other 
words we traffic a great deal in exchange on England while 
the English deal in exchange on us in much less volume. 
This condition is rather characteristic of England's com- 
merce with all countries. 6 It would be theoretically pos- 
sible for the commerce between England and the United 
States to be settled wholly by means of exchange dealings 
on our side and by supplementary gold shipments, in both 
directions according to the requirements of the conditions, 
engineered wholly from our side on the basis of our ex- 
change rates. 

It will be profitable to consider further the manner of 
utilizing the bill as a means of international payment. We 
shall give next a simplified illustration of its employment, 
which will be artificial when compared with actual practice 
in that for the moment it leaves out of consideration the 
banker as exchange middleman. When we modify the illus- 



e This is what Mr. George Clare has reference to when he states 
that "England draws few bills but accepts many," (see his "A B C 
of the Foreign Exchanges," edition of 1911, p. 11). 



THE RATES OF EXCHANGE 69 

tration so as to repair this defect, we can show most easily 
the way in which the banker intervenes and the essen- 
tial nature of his operations as a mere middleman. This 
will still leave for the future, an explanation of his serv- 
ices in "financing" commerce, that is, his services in mak- 
ing advances to merchants in connection with their foreign 
shipments. 

Let us suppose that two equal and opposed commercial 
transactions take place between the United States and 
England, namely (1) an export of our flour sold in Eng- 
land for £10,000 and (2) an import of their dry goods 
also sold our merchant for £10,000. It would be possible 
for one bill of exchange to be used in making a complete 
settlement of both of these transactions. For the sake of 
simplicity we assume at present that the bill will be drawn 
payable at sight. Settlement could be accomplished as 
follows : 

The American exporter draws a bill on his English importer. 

He sells this bill to the American importer. 

The latter in turn remits it to his creditor, the English ex- 
porter. 

This person collects payment, on the bill from the drawee or 
English importer. 

The following scheme shows the plan of settlement in 
greater detail: 

The American Flour Export Company 

(1) Ships £10,000 wortli of flour to the British Flour Import 

Company. 

(2) Draws a sight bill on the latter for £10,000. 

(3) Finds as a purchaser for this bill, the American Dry 

Goods Import Company, which buys it at a price say 
of $4.85 per pound sterling, paying a total of $48,500 
for it. 



70 FOREIGN EXCHANGE 

The American Flour Export! Company has now received 
$48,500 for its flour and is practically out of the settlement 
except for the possibility of recourse upon it as drawer in 
case of dishonor of the bill. 7 

The American Dry Goods Import Company 

(1) Receives a shipment of dry goods from the British Dry 

Goods Export Company, the price of which is stipu- 
lated at £10,000 in English money, and therefore owes 
the British company this sum of sterling money. 

(2) Buys the above mentioned bill of exchange for $48,500. 

(3) Indorses this bill to the British Dry Goods Export Com- 

pany and remits it to this company. 
The American Dry Goods Import Company is now practically 
out of the settlement except for the possibilities of recourse. 

The British Dry Goods Export Company 

(1) Ships the consignment of dry goods already mentioned. 

(2) Is therefore creditor of the American Dry Goods Import 

Company for £10,000. 

(3) Receives the above mentioned bill of exchange from the 

latter. 

(4) Takes the bill to the English drawee, namely the British 

Flour Import Company, and collects from it £10,000 in 
payment. 
The British Dry Goods Export Company is now out of the 
settlement. 

The British Flour Import Company 

(1) Receives the shipment of flour already mentioned. 

(2) Becomes a debtor, therefore, to the American Flour Export 

Company for the price of £10,000. 

(3) Discharges the debt by paying the bill of exchange for 

this sum drawn by the latter. 

To be emphatic, we repeat that this illustration is artificial 
in two respects. In the first place, an exchange middleman", 
the banker, will nearly always be involved in practical life, 

7 Compare § 12. 



THE RATES OF EXCHANGE 71 

and therefore, as we shall see, a single bill will not ac- 
complish the settlement. In the second place, exporting 
merchants will almost always draw long instead of sight 
bills, and this as a means of shifting the burden of financing 
the shipment to the shoulders of the bankers or money 
lenders. 

But taking the proceedings as given, when they are com- 
pleted both commercial transactions are settled. Both ex- 
porters have been paid for their goods, each in his home 
money ; and both importers have made payment, each in his 
home money. No money has passed between the two coun- 
tries, but a sum of local money changed hands in each 
country. In America $48,500 was transferred, this sum de- 
pending on the rate or price of exchange, and £10,000 was 
transferred in England. These same results will also be 
secured as the modified settlement is worked out in real life. 

We now introduce the banker as exchange middleman, 
while retaining the assumption that a sight bill is drawn 
by the exporter. Our exporters who have exchange to 
sell dispose of it to the banks, and such of our importers 
as need to procure exchange obtain it from the banks. 
This system is much more convenient and is also superior 
from the standpoint of credit relations, and is a necessary 
incident to the enjoyment of the aid of the banks in fi- 
nancing exports and imports. The banker does not sell 
to the importers the same bills that he buys from the 
exporters! He is not like the produce middleman who 
perforce sells the same potatoes that he buys. The banker 
sells to importers new sight bills or checks which he him- 
self draws. The system is simple. The banker sends his 
purchased exchange abroad to his correspondent bank, 8 
with which he has a deposit or "balance," and has this 
institution collect payment and place the proceeds to the 

s Or perhaps to a branch of his own establishment which he has 
abroad, or to a parent institution of which his bank is a branch. 



72 FOREIGN EXCHANGE 

credit of his deposit. In England such a deposit will, 
of course, be in pounds sterling. When the banker comes 
to sell exchange, he draws his checks on this deposit. His 
purchases of exchange build up his foreign balance and his 
sales of exchange tear it down again. He makes the two 
balance or cancel one another in the long run, and makes 
his profits out of a difference between his buying and 
selling rates. In brief (1) our banker buys the bills drawn 
by our exporters, (2) remits them for the credit of his 
foreign balance, and (3) sells his checks against this bal- 
ance to our importers. (It is checks he sells to importers 
in real life, and not his long bills.) If the exchange drawn 
by the exporter is a long bill, as it is usually, the banker 
sends it abroad just the same. He receives an immediate 
credit from it for his balance (in a reduced present sum of 
foreign money) if he has it discounted abroad, and a de- 
ferred credit if he "invests" in it. 9 

The proceedings in the illustration with which we have 
been recently dealing on the assumption that no banker in- 
tervened, would be modified by his entry to become the 
following : 

The American Flour Export Company draws a sight draft for 

£10,000 on the British Flour Import Company. 
It sells this draft to the American banker for say $48,500. 
The banker remits this bill to his London correspondent for 

credit. 
The latter collects from the drawee and credits the remitting 

banker's balance with £10,000. 
The American banker sells his check for £10,000 drawn on 

this correspondent, to the American Dry Goods Import 

Company for perhaps $48,510. 
This company remits the cheek to its English creditor, the 

British Dry Goods Export Company, which collects on it 

from the English correspondent bank on which it is drawn. 

9 Compare Chapter XI on investment in long bills. 



THE RATES OF EXCHANGE 73 

The result is, both exporters have been paid and both 
importers have made payment, each man in his local 
money. 10 

§ 22. The methods of quoting a rate of exchange. — Ex- 
change rates are in practice quoted according to three 
methods. If we were compelled to give names we might 
call them : 

(1) The premium and discount method 

(2) The direct price method 

(3) The indirect price method. 

Any rate of exchange gives us what is essentially a price, 
namely the price in local money of a unit of money payable 
on order at another place, but the rate does not necessarily 
assume the form of an ordinary price quotation. It is 
for this reason, no doubt, that it is usual to speak rather 
of the rate than the price of exchange. 

Rates of domestic exchange are quoted in the premium 
and discount fashion. This holds good of the United 
States, and probably of all countries. Thus at some mo- 
ment we might find the quotation for New York exchange 
as "10^ discount" in Chicago and "35^ premium" in 
San Francisco, signifying the discount and premium per 
$1,000 face value of sight draft on New York. As a price 
the Chicago rate would read $999.90, and the San Fran- 
cisco rate would read $1000.35, for $1,000 of draft. Speak- 
ing of the practice of the world at large, foreign exchange 
is not usually quoted according to the premium and dis- 
count method. However, a country may readily adopt this 
method in the case of exchange on another having the 
same monetary unit, as Switzerland on France, or Eng- 
land on South Africa. In some Central American coun- 

lOThe services and compensation of correspondent banks are con- 
sidered in Chapter VIII, § 53. 



74 FOREIGN EXCHANGE 

tries the quotations of exchange on foreign places having 
entirely different monetary units also take on the form of 
a percentage of premium. 

Under what we have ventured to call the direct price 
method, the quotation states the number of home money- 
units payable for 1, or 10, or perhaps 100 foreign units. 
Taking pre-war figures, sight sterling is quoted perhaps in 
Berlin at 20.40, in Paris at 25.20, in New York at 4.85, 
the figures signifying marks, francs, and dollars respec- 
tively per pound sterling. Petrograd formerly quoted 
sterling at the number of roubles per 10 pounds. 

The indirect price method is to state the number of 
foreign units that may be purchased or sold for one home 
unit. This method is common only where the country 
adopting it has a larger (or more valuable) money unit 
than the country on which the exchange so quoted is drawn. 
London rates on foreign money capitals are practically 
all stated after this fashion. New York rates on Paris 
are also so quoted. If New York quoted sterling in this 
manner, in place of a rate of 4.85 we would find the figure 
of 49 1 /6 (approximately) signifying 49 1 /& English pence 
of exchange purchasable for a dollar. To refer to an illus- 
tration given by the Dutch economist, Pierson, we com- 
monly quote sugar at so many cents, say 6, per pound, but 
we could quote sugar instead at 16% pounds per dollar. 
And when sugar falls from 6^ to 5^ per pound we could 
also say that it has fallen from 16% pounds to 20 pounds 
for a dollar. Thus London quotes its bills on Berlin and 
Paris and other continental centers in the manner analogous 
to the quoting of sugar at 20 pounds per dollar instead of 
at 5$ per pound. And when exchange on Berlin or Paris 
becomes cheaper in London, the figure expressing the rate 
goes higher and vice versa. 

§ 23. Specimen market reports. — Beneath are given ex- 
amples of exchange-market reports. The first is from the 



THE RATES OF EXCHANGE 75 

Wall Street Journal, a daily of New York City, and shows 
rates as on an ordinary day prior to the outbreak of the 
great war. 

Foreign Exchange 

The foreign exchange market opened steady with demand ster- 
ling at 4.8715 @ 4.8720, unchanged from Thursday's close. 

The market was quiet throughout the day. What bills were 
offered were quietly absorbed by the short interest, keeping rates 
steady. 

At the close, demand sterling was 4.8720 @ 4.8725, up 5 
points on the day from the opening. 







Cables 


Demand 


Sixty Days 


Ninety Days 


Sterling 


open 


4.8765 @ 4.8770 


4.8715 @ 4.8720 


4.83 @ 4.8305 


4.8160 @ 4.8165 


do 


closed 


4.8770 @ 4.S775 


4.8720 @ 4.8725 


4.S3 @ 4.8305 


4.8160 @ 4.8165 


Francs 


open 


5.171/4 plus Me 


5.171/2 


5.19% less 1/64 




do 


closed 


5.171/4 plus 1/16 


5.171/2 


5.19% less 1/64 




Marks 


open 


95% less 1/32 


953i6 less %4 


91% less %2 




do 


closed 


95% less %4 


9554e 


947^ less %4 




Guilders 


open 




40% 






do 


closed 




40i/s 







Paris exchange on London 25 fr. 21 %c, off %c. 

Berlin exchange on London 20m. 47 pf., unchanged. 

Rio exchange on London was i/32d. lower and quoted at 15%2d. against 15%2<i. 

last year, and 15 X A d. two years ago. 
London. 

Call money up to 5%%, closing at 4% to 5. 

Contingent bought bills at 4%%. 

Prevailing rate at close was 4%%. 

The next report, differing somewhat in form, is from 
the weekly, Commercial and Financial Chronicle (New 
York). The table shows the range of rates for a week, 
also as under ante-bellum conditions. 

Foreign Exchange. — Discounts in London were well main- 
tained during the week, yet sterling here closed lower than it 
was quoted a week ajjo. 

To-day's (Friday's) nominal rates for sterling exchange were 
4.84 for sixty days and 4.88 for sight. To-day's actual rates for 
sterling exchange were 4.8320 @ 4.8330 for long, 4.8720 @ 4.8725 
for short and 4.8770 @ 4.8775 for cables. Commercial on banks 
4.8280 @ 4.8290 and documents for payment 4.82 (77) 4.82%. 



76 FOREIGN EXCHANGE 

Cotton for payment 4.83 @ 4.8314 and grain for payment 4.83V4 
@ 4.83i/ 2 . 

To-day's (Friday's) actual rates for Paris bankers' francs were 
5.'20a @ 5.20 for long and 5.17y 2 d. @ 5.17V 2 for short. Ger- 
many bankers' marks were 94716 @ 94%c for long and 95yi6 @ 
95 1 / 4d. for short. Amsterdam bankers' guilders 40.12 @ 40.14 
for short. 

Exchange at Paris on London, 25f. 22 1 /2C. ; week's range, 25f. 
22y 2 c. high and 25f. 2iy 2 c. low. 

The week's range for exchange rates follows: 

Long li Short 12 Cables 

Sterling Actual: 13 

High 4.8365 @ 4.8375 4.8765 @ 4.8775 4.88 @ 4.8815 

Low 4.83 @ 4.8310 4.8695 @ .4.8705 4.8750 @ 4.8760 

Paris Bankers' Francs : 

High 5.19%h @ 5.19%a 5.16%d @ 5.16% 5.16y 4 d @ 5.161,4 

Low 5.20a @ 5.20d 5.17y 2 d @ 5.17V 2 5.16%d @ 5.16% 

Germany Bankers' Marks: 

High 947/iex @ 94 95i/ 4 d @ 9514 95^ @ 95%d 

.Low 94% @ 94% 6 d 95% 6 d @ 95?/ I6 95y 4 x @ 959ifc 

Amsterdam, Bankers' Guilders: 

High 40.19 @ 40.20 40.24 @ 40.25 

Low 40.133,4 @ 40.15 40.18 @ 40.19 

Less a Vm of 1% d y 32 of 1% h % 2 of 1% 

Plus k yi 6 of 1% x y 32 of 1% y % 2 of 1% 

The following were the rates for domestic exchange on New 
York at the undermentioned cities to-day : Chicago 5c per $1,000 
discount, Boston par. San Francisco 70c per $1,000 premium. 
Savannah, buying $1.50 per $1,000 discount, selling par. Mon- 
treal 3114c per $1,000 discount. 

The following table from the New York Times' "Annal- 
ist" for November 20th, 1916, shows war-time rates in New 
York. Quotations on a larger number of countries are 
now published in our metropolis than before the war. 

11 Long means here drawn at sixty days sight. 

12 Short means here sight or demand drafts, or checks. 

is "Actual" rates are opposed to "posted" rates. See page 82 
below. 



THE RATES OF EXCHANGE 77 

Foreign Exchange 

The range for the principal exchanges during the week were 

as follows : 

Per ct. 

Range Week Ended Disc. I—) 

Nov. 18. or pre- 

Par. High. Low. Close. mium (+) 

Sterling - 4.8665 4.75"/i 6 4.75% 4.75«A 6 — 2.2 

Francs 5.1826 5.84% 5.84% 5.84% —12.8 

Marks 95.28 69.68% 69.37% 69.37% —27.1 

Kronen 20.26 11.86 11.86 11.86 —41.4 

Guilders 40.19 40.87% 40.75 40.87% + 1.7 

Lire 5.1826 6.6714 6.71% 6.71% —29.5 

Rubles 51.45 30.45 29.60 30.45 —40.8 

Swiss francs 5.1826 5.20 5.23% 5.20 — 0.3 

Pesetas 19.20 20.35 20.35 20.35 + 0.5 

Milreis (Rio) 32.46 23.96 23.53 23.55 —27.1 

Pesos (Buen. Aires) ....42.44 43.29 43.25 43.25 + 2.0 

The last column showing premiums and discounts (or per- 
centage deviations of the rates from "par") is introduced 
because of the extraordinary dislocations of the exchanges 
occasioned by the European conflict. The "par," or more 
fully, the "mint par," is a figure showing the amount of 
gold money of one country that has the same quantity of 
pure or fine metal in it as the gold unit of some other 
given country, the units of both countries being taken as 
defined by law (compare §106). Thus the first item sig- 
nifies that 4.8665 dollars of gold coin of the United States 
contain the same quantity of fine gold (113.0015 grains 
troy) as the British sovereign, or one-pound coin. When 
stated as equations, the pars listed in the foregoing table 
become the following. The equality asserted is simply one 
of fine gold contents as defined by law. 

U. S. dollars 4.8665 = 1 sovereign, or one-pound coin 

of England. 
French francs 5.1826 = 1 U. S. dollar. 

U. S. dollars 95.28 = 400 marks of Germany. 

U. S. dollars 20.26 = 100 kronen of Austria. 

U. S. dollars 40.19 = 100 guilders of Holland. 
Italian lire 5.1826 = 1 U. S. dollar. 



78 FOREIGN EXCHANGE 

U. S. dollars 31.45 = 100 rubles of Russia. 

Swiss francs 5.1826 — 1 U. S. dollar. 

U. S. dollars 19.20 = 100 pesetas of Spain. 

The last two items, for Brazil and Argentina, are omitted 
because, although given by the reporter, they are hardly 
significant mint pars. 

§ 24. Comment and explanations. — The tables of rates 
suggest the existence of a single and unified market for 
exchange, such as is found for securities and staple com- 
modities in the stock and produce exchanges (i.e., exchange- 
buildings). Foreign exchange is not, however, bought and 
sold at any single meeting place. Dealings in it never- 
theless unite in a virtually single market. The test of 
such a market is presumably the existence of a single price 
for a given grade or kind of article at any moment of 
time. In periods of unusual activity, the great securities 
and produce markets split apart a little according to this 
test, but they tend to coalesce and usually are single. At 
any instant the prices for a given kind of exchange in 
different parts of a money capital like New 7 York will be 
so close together that there is a practically unified market. 
Primarily on account of the telephone, buyers and sellers 
of bills are in about as intimate contact and competition as 
if they stood in a group upon a single floor. The activities 
of a special class of exchange brokers, who move about 
among dealers that have fixed places of business, also con- 
tributes to the unification of the market. These brokers 
make it a practice at intervals during the day to leave 
slips with the larger dealers, which give the momentarily 
prevailing rates as they ascertain them in their comings and 
goings. 

Because rates are so nearly uniform with the different 
dealers, newspapers gather the data for their market re- 
ports from any one of the leading exchange houses or from 



THE RATES OF EXCHANGE 79 

some exchange broker. Examination shows that different 
papers give slightly different quotations for the same classes 
of exchange on the same days. The reader will observe that 
in our specimen reports many rates are given as a couple 
connected by the sign "@." Thus demand sterling 
opened at "4.8715 @ 4.8720." This signifies bid 4.8715 
and asked 4.8720. Sales may fail to take place for some 
time after the opening. But when they do occur, after mail 
has been opened and news considered, they are nearly cer- 
tain to take place at either the bid or the asked figure, and 
the reporter has become accustomed to give these as the 
record of the market's opening. The closing is often reg- 
istered in a similar pair of figures. We should note that 
4.8715 and 4.8720 are but V20 of l<j- per £ apart. Thus the 
gap between them is only about Moo of 1% of either one of 
these figures (.0005 is a little over Moo of 1% of 4.8715). 

A few of the expressions appearing in the market reports 
given in the preceding section, call for comment. The sec- 
ond report opens with the statement that discounts in Lon- 
don "were well maintained during the week, yet sterling 
here closed lower than it was quoted a week ago." This 
means that the various discount rates for different sorts of 
commercial and banking paper, ruling in the London money 
market, sustained themselves during the week at the rela- 
tively high levels at which they started. These several 
rates are intimately related and move closely together as 
a group. The height of these rates, or as we often say, 
the height of the London discount rate, helps determine 
what the position of the New York rates of exchange on 
London shall be. This is true not only of the rates for long 
sterling, but also of the sight and cable rates. A high dis- 
count rate in London tends to make New York's sight and 
cable rates on London keep high. Hence the decline of 
sight sterling during the week covered by the report, being 
to a degree contrary to expectation, is a cause for com- 



80 FOREIGN EXCHANGE 

merit by the foreign exchange writer. The rate for sight 
sterling declined in spite of the tendency of the "well main- 
tained" London discount rate to hold it up. 

Referring to the report first reproduced, it may be said 
the terms steady, firm, quiet, and the like, characterize the 
general tendency shown by rates and have the same self- 
evident meanings here as in other types of market report. 
Up or off so many points compare the rates of this day or 
week with those of the last preceding day or week, or the 
closing rates with the opening rates of the same day. What 
is meant by a "point" can be told only by context. A 
point in New York sterling rates now generally signifies 
Moo of 1^, so that an ascent from 4.8610 to 4.8620 would be 
called a "10 point" rise. 

When the term check or cheque is used in connection 
with foreign exchange, it is simply a synonym for a banker's 
sight draft on another banker. Continentals is a general 
term covering bills of exchange drawn on other countries 
of Europe than the British Isles. The chief continentals 
have been, for us, bills on France, Germany, and Holland. 

The short interest absorbs bills (first report) is a state- 
ment indicating the fact that speculation takes place in 
foreign exchange. Since the rates fluctuate with the pas- 
sage of time, and since these fluctuations are governed by 
factors which can be forecasted in part by those who study 
them, there is nearly always some systematic speculation 
going on in exchange. 14 A speculator's profit is made out 
of a future rise in the rates by going "long" of exchange, 
out of a future fall by going "short." There are various 
ways in which the operator can put himself long or short 
of the market. When he is short he will need some time 
to buy in exchange "to cover." That is, he will need to 
buy in an amount of exchange to meet his commitments. 

14 Chapter XIII deals with speculation in exchange. 



THE RATES OF EXCHANGE 81 

He hopes to buy it in cheap enough to reap a profit. On 
the occasion which the reporter had under review, he be- 
lieved he had detected the fact that dealers then short were 
quietly buying in bills to cover. Whether they cover at a 
profit or loss in this particular instance, does not appear. 
The fact that they are covering quietly would indicate 
at least that the shorts are not facing any great losses and 
are not in a panic. 

Exchange on London in Paris and Berlin, or ' ' Paris and 
Berlin sterling" is frequently quoted in the New York re- 
ports. This news is included because of its bearing upon 
the probable future course of sterling in New York itself. 
The rates for sterling exchange in Paris and Berlin have 
quite a close connection with the rate for sterling in New 
York. For instance, a rise of sterling in Paris tends to 
produce a rise in New York. This is because of the exist- 
ence of the line of operations known as arbitrage in ex- 
change. 15 

Rio exchange on London quoted at 15%2, is sterling ex- 
change in Rio Janeiro, Brazil, quoted in the "indirect" 
manner, as the number of British pence allowed for one 
Brazilian (inconvertible paper) unit, or "milreis." This 
rate is of interest to Americans who have either to make 
payments to or receive them from Rio. Remittances be- 
tween Rio Janeiro and New York in either direction were 
before the war very likely to be made either directly in 
sterling exchange, or else in ways which indirectly involved 
sterling. 

We have given no example of the more lengthy foreign 
exchange reviews which appear from time to time in the 
daily and weekly financial papers. These reviews are char- 
acterized by a remarkable breadth of view over commercial 
and political conditions. Great events which influence the 

10 See Chapter XIV. 



82 FOREIGN EXCHANGE 

chances of war, or which touch the finances of nations, and 
movements in the stock markets of the different countries, 
as well as the immediate course of commerce in merchan- 
dise, all are subject to the scrutiny and analysis of the 
foreign exchange writer, because any or all of these things 
may profoundly affect the course of exchange. "War will, 
for instance, produce perturbations in the international 
movement of securities and merchandise and cause signifi- 
cant alterations in national currency conditions, and will 
therefore create important disturbances in exchange supply 
and demand and rates. 

Posted or nominal rates are those asked by bankers for 
checks and letters of credit sold in small lots. "Actual" 
rates are those at which purchases and sales take place be- 
tween bankers and dealers themselves, or at which the larger 
purchases of merchants from bankers take place. (But a 
"nominal" rate sometimes means one quoted for a market 
so very inactive as to be practically one in name only.) 
The rates given in our specimen reports are actual unless 
otherwise indicated. Posted rates range, in the case of 
sterling, from % cent to B£ cent per pound higher than 
actual rates, and fluctuate much less. The following is an 
example of a table of posted rates, taken from the Com- 
mercial and Financial Chronicle. 

Posted Rates 

The following shows daily posted rates for sterling exchange 
by some of the leading drawers: 

Tues- Wednes- Thurs- 
Friday Monday day day day Friday 

Nov. 26 Nov. 29 Nov. 30 Dec. 1 Dec. 2 Dec. 3 



Brown 
Bros. & Co. 


60 days 
sight 


4.84% 
4.88% 


4.84% 

4.88% 


4.84% 
4.88% 


4.S4% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 


Kidder 
Peabody & Co. 


60 days 
sight 


4.84% 
4.88 


4.84% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 


Bank British 
North America 


60 days 
sight 


4.84% 

4.88V2 


4.84% 
4.88V2 


4.84% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 


4.84% 
4.88% 



THE RATES OF EXCHANGE 



83 











Tues. 


Wednes- 


Thurs- 








Friday 


Monday 


day 


day 


day 


Friday 






Nov. 26 


Nov. 29 


Nov. 30 


Dec. 1 


Dec. 2 


Dec. 3 


Bank of 
















Montreal 


60 days 


4.84% 


4.84% 


4.84% 


4.84% 


4.84% 


4.84% 




sight 


4.88 


4.88 


4.88 


4.88 


4.88 


4 


88 


Canadian Bank 


















of Commerce 


60 days 


4.84 


4.84% 


4.84% 


4.84% 


4.84% 


4 


84% 




sight 


4.88% 


4.88% 


4.88% 


4.88% 


4.88% 


4 


88% 


Heidelbach Ickel- 


















heimer & Co. 


60 days 


4.84 


4.84% 


4.84% 


4.84% 


4.84% 


4 


84% 




sight 


4.88% 


4.88% 


4.88% 


4.88% 


4.88% 


4 


88% 


Lazard 


















Freres 


60 days 


4.84% 


4.84 


4.84 


4.84 


4.84 


4 


84 




sight 


4.88 


4.88 


4.88 


4.88 


4.88 


4 


88 


Merchants' Bank 


















of Canada 


60 days 


4.85 


4.84% 


4.84% 


4.84% 


4.84% 


4 


84% 




sight 


4.88 


4.88 


4.88 


4.88 


4.88 


4 


88 



The table just beneath is copied from a card issued by 
a certain bank of Chicago, under normal or pre-war con- 
ditions. 

Foreign Department 

Rates for drafts until further notice: 





Checks 


Checks for 




Under $100 $100 to $10,000 


Pounds £ on England 


$4.8725 


$4.87 


Pounds £ on Scotland and Ireland 


4.875 


4.8725 


Pounds £ on Greece 


4.875 


4.8725 


Pounds £ on Australasia 


4.875 


4.8725 


Pounds £ on Turkey and Egypt 


4.885 


4.88 


Pounds £ on South Africa 


4.90 


4.8875 


Francs on France 


.1935 


.1932 


Francs on Belgium 


.1925 


.1922 


Francs on Switzerland 


.1935 


.1932 


Francs on Turkey and Egypt 


.1945 


.1940 


Marks on Germany 


.2380 


.2377 


Guilders on Holland 


.4035 


.4032 


Kronen on Austria 


.2028 


.2025 


Lire on Italy (checks) 


.1925 


.1922 


Lire on Italy (post remit.) 


.1930 


.1925 


Kroner on Scandinavia 


.2683 


.2680 


Pesetas on Spain 


.1825 


.1820 


Finmark on Finland 


.1950 


.1940 


Roubles on Russia (checks) 


.5155 


.5150 



.5225 


.52 


.5010 


.50 


.4650 


.4640 


.50 


.4995 


Mo% 


prem. 


%6% 


pre in. 


%% 


prem. 


y 2 % 


prem. 



SI FOREIGN EXCHANGE 

Roubles on Russia (post remit) 

Yen on Japan 

$ local currency on Hong Kong 

Pesos on Philippine Islands 

U. S. Dollars on Hawaii 

U. S. Dollars on Cuba 

U. S. Dollars on Porto Rico 

U. S. Dollars on Panama 

We will make special rates on drafts costing $10,000 or more. 

A glance at the table on page 82 shows that the posted 
rates of leading New York houses are for the most part 
the same, though some houses may give quotations varying 
by as much as Vi§ from those of the majority. No such 
differences can exist between the actual rates at which 
different houses are doing business. In the table imme- 
diately above the rates for drafts payable in American 
dollars in Hawaii, Cuba, Porto Rico, or Panama, are quoted 
according to the ordinary method followed in domestic ex- 
change, except that the premium is expressed in fractions 
of 1% instead of in cents per $1,000. A draft for $1,000 
on Cuba would at the rate quoted, cost $1,000, plus Mo of 
1% of $1,000 (or $1.87). All the other rates are expressed 
simply as the amount of American money charged for one 
unit of foreign money. It w r ill be observed that the drafts 
offered for sale on certain of the countries on the list, are 
not drawn in terms of the national moneys of those coun- 
tries. Thus drafts on Greece are in pounds sterling, and 
drafts on Turkey are offered both in pounds sterling and 
in francs. 

§ 25. The classes of exchange quoted. — A classification of 
exchange may be founded upon any one of three bases, 
(1) length of life, or the time to elapse until payment is 
due, (2) domicile, or the place where the exchange is pay- 
able, and (3) security. Distinguished according to length 
of life, the more common classes are (a) telegraphic trans- 



THE RATES OF EXCHANGE 85 

fers or "cables," (b) sight or demand bills, (c) sixty 
days' sight bills, and (d) ninety days' sight bills. By a 
sixty days' sight bill is meant, of course, one payable sixty 
days after the date of sight by drawee or date of acceptance. 
Less common types are drafts payable at 3, 7, 10, and 30 
days, and four and six months after sight, and drafts 
payable at various designated periods after date instead of 
after sight. Telegraphic transfers will be discussed in § 26. 
If the law of the place where time bills are payable, allows 
days of grace, these days must be added to the period speci- 
fied in the bill, to ascertain the legally effective date of ma- 
turity. Days of grace may be waived and a bill may be so 
written as to deny them, but commonly nothing is said about 
them and therefore they are counted. 

Classification according to domicile is too simple a mat- 
ter to call for extended comment. Distinguished accord- 
ing to domicile, we have in our market English, French, 
German, Italian, and Spanish exchange, and so forth. 
Sometimes exchange drawn on a given country is called 
by the name of the money unit of that country. Thus 
when a person means that exchange on Germany has become 
cheaper, he may say that "marks have fallen." 

The third basis of classification is security. In this con- 
nection we mean by the term security that which assures 
or helps assure the holder of commercial paper or of promis- 
sory obligations in general, that he will be able to collect 
what is due him. In this sense, security falls into two 
classes, (1) personal and (2) collateral security. Personal 
security is the liability to pay of any person 10 who is bound. 
The obligor's liability is the holder's security. Collateral 

i« A "natural" person is an ordinary individual and a "legal" or 
"artificial" person is a corporation, private <>r public. Personal 
security includes the liability to pay of both natural and artificial 
persons. A corporation as such may hind itself to make payment 
of moneys and this is legally quite a distinct thing from all the 
individuals composing the association (known as the corporation) 



86 FOREIGN EXCHANGE 

security consists in articles of value (often promissory 
obligations such as bonds, notes, or acceptances, or again 
corporation shares, or warehouse receipts and bills of lad- 
ing which entitle the holder to receive designated lots of 
merchandise) which are pledged to the holder of an obliga- 
tion or are otherwise legally placed at his disposal so as 
to enable hi m t.n realize upon their value in case the per- 
sons bound on the obligation fail to make payment, or pay- 
ments when due. This security is " collateral" in the 
sense .that it exists along side of and in addition to the 
primar}- personal security. 

There are three main classes of exchange distinguished 
according to personal security. These are 

(1) Bankers' drafts on bankers, including telegraphic 

transfers. 17 

(2) Merchants' drafts on bankers. 

(3) Merchants' drafts on merchants. 

The possible class of bankers ' drafts on merchants does not 
figure in practical life. Full explanation of the origin and 
manner of handling these several types of exchange be- 
longs to subsequent chapters. Exchange of the first class 
has a bank as drawer 18 and a bank as drawee, and in the 
case of time bills a bank as acceptor. Judged from the 
standpoint of personal security, then, this is in general 
the highest class of exchange. (Compare § 12 on the lia- 
bility of parties.) Exchange of the second class mentioned 
above (consisting almost always in long bills) is drawn 
under a letter of credit or "against a bank credit," and 

binding themselves severally or jointly and severally. The bank is 
usually a corporation. 

it Practically speaking, telegraphic transfers are sold exclusively 
by bankers to be payable abroad by bankers. 

is We may perhaps speak loosely of the drawer and drawee of a 
telegraphic order to pay money. 



THE RATES OF EXCHANGE 87 

will after acceptance have a banker as principal obligor 
and a merchant with the liability of the drawer. After 
acceptance, and even before, it has virtually the same credit 
rating as the first class. (Chapter VII treats of the bank 
credit and the letter of credit.) The third class of ex- 
change is inferior in general in point of personal security, 
since it has merchants only as parties liable. 

Personal security is much more important than collateral 
security, especially perhaps in connection with exchange, 
though one who is a novice in the subject is unlikely to 
realize this fact. Distinguished with respect to collateral 
security, exchange divides itself first of all into two main 
and obvious classes, (1) exchange without, and (2) ex- 
change with collateral security. Exchange drawn by bank- 
ing houses proper rarely if ever has collateral. 19 That 
drawn by traders in goods and securities usually has colla- 
teral. 

Every distinct class and subclass of exchange may take 
a distinct rate of exchange. But newspapers publishing 
market tables do not endeavor to give every one of these 
distinct rates. They are usually satisfied to give one main 
table which covers exchange drawn by bankers on bankers. 
The principal tables reproduced in § 23 illustrate this. In 
the first two of these, bankers' exchange is divided into sub- 
classes according to length of life on the one hand and 
domicile on the other. With four classes according to 
length of life and four according to domicile, this gives 
sixteen separate rate quotations, as the reader may have 
observed. The market report will often give the rates for 
some of the classes of bills of other grades of security than 
the bankers' drawings, but will not attempt a complete 

i» Acceptance accounts (see pp. 144-7) are presumably more often 
than not, protected by collateral, but this is not collateral security 
for the bill of exchange itself and is not open to attack by the holder 
of this instrument. 



88 FOREIGN EXCHANGE 

tabulation for all types and subclasses of these. For in- 
stance, in the report reproduced on pages 75-6, we find the 
following: 

Commercial on banks 4.8280 @ 4.8290 

Documents for payment 4.82 @ 4.82% 

Cotton for payment 4.83 @ 4.83 1 / 4 

Grain for payment 4.83 1 / 4 @ 4.83% 

These are all classes of exchange, though the names given 
do not indicate it any too clearly to the beginner. One 
who knows the subject can tell what each item means, 
though we shall not attempt at present to explain how. 
All four classes are drafts drawn on England at §ixty 
days' sight by merchants. The first item refers to the gen- 
eral class of bills drawn upon English banks under the 
authorit}- of commercial letters of credit. Documents will 
be attached to these drafts but nothing is stated in the 
table to indicate the fact. The second item covers trade 
bills, drawn by exporting merchant upon importing mer- 
chant, against shipments of miscellaneous sorts of com- 
modities. Documents are attached and will be surrendered 
to the importer when he pays the draft, hence the phrase 
"documents for payment." (See especially Chapter VI 
below.) These drafts cannot be drawn on banks abroad 
because documents are never "for payment" when a bank 
is drawee. The third and fourth items refer to special 
classes of bills — again with documents for payment — drawn 
against exports of cotton and grain respectively. These 
are types of trade bills of especial importance. Why they 
enjoy such high rates can hardly be made clear at this 
point. To be explicit, the last item "grain for payment" 
means drafts drawn at sixty days' sight by exporters of 
grain upon the importing merchants with the shipping 
documents, pertaining to the grain, attached to the drafts 
and deliverable to the importers against payment of the 



THE RATES OF EXCHANGE 89 

drafts whether at the time of maturity or prior to that 
time. 

Inspection shows that the longer the life of a given type 
of exchange, the cheaper the rate for it will be. Interest 
or discount is of course the explanation. (The methods of 
calculating the rates for long exchange will be discussed in 
Chapter IX.) In the case of the rates on France, cheaper 
rates mean higher figures because the rates are quoted in the 
reverse or indirect manner (compare §22). 

26. The telegraphic transfer or cable. — Orders directing 
the payment of money abroad which are transmitted by 
telegraph instead of by the mailing of a draft, are known 
as "telegraphic transfers" (abbreviated "t. t.") and also 
in this country as "cables." The cable does not involve 
a written and negotiable bill, but it is still classified as 
exchange because it occasions the same transactions and 
payments as a bill. The purchaser of the cable designates 
the person abroad to receive payment. The bank which 
sells the cable is analogous to the drawer of the bill, and 
the bank directed to make payment to the drawee. The 
bank which sells a cable of the amount of £10,000 for a 
price in domestic money of $48,750, will find its London 
balance reduced by £10,000 and its home office funds in- 
creased by $48,750 as a result of .the operation, in the same 
way as if it had sold a bill except that in the case of the 
cable the depletion of the foreign balance will take place 
earlier, often in fact on the same business day with the 
sale. 

In communicating telegraphic orders banks use individ- 
ual secret codes. These codes serve the twofold object of 
reducing cable charges and of guarding against the trans- 
mission of fraudulent orders by unauthorized persons. The 
genuineness of a bill of exchange is judged chiefly by the 
signature, but, in the absence of a written instrument, the 
genuineness of the cable is judged in part by secret si^ns 



90 FOKKMiX EXCHANGE 

in the code dispatch, sut'li as tost words, constituting the 
lirst or last words of the message, or other devices. The 
purchaser of this form of exchange takes a receipt for his 
money, which lecites the relevant facts of the order, and 
this lie holds as evidence of his claims for reimbursement 
in the event of the failure of the required delivery of 
English money to his foreign payee. The selling bank 
and its correspondent assume no liability for mistakes or 
delay in the transmission of messages by the cable com- 
panies. 

The fact that cables sell for a higher rate than demand 
drafts is due wholly to the priority of their payment abroad, 
and has nothing to do with the telegraph charges. The 
latter are as great for small as for large sums and are paid 
for separately. In the case of relatively small orders, say 
for less than £5,000, the purchaser pays the cable charges ; 
for larger orders the selling bank is apt to assume these 
charges. 20 

§ 27. Sterling rates. — For historical reasons the money of 
England is called sterling. Likewise exchange drawn on 
and payable in England is called sterling exchange, or 
again merely sterling. The British monetary unit, the 
pound sterling, consists of 123 171 /^23 (or 123.27447) grains 
troy of gold W12 fine, with a pure or fine contents of 113^23 
grains. The one-pound money piece of gold is called the 
sovereign. The mint par between the United States and 
Great Britain is 4.866564. That is to say, the British unit 
as defined by law contains the same quantity of fine gold 
as 4.8665 -f- United States gold dollars as they are defined 
by law. 21 The English money notation is as follows : 

1 pound = 20 shillings = 240 pence = 960 farthings. 

1 shilling <= 12 pence = 48 farthings. 

1 penny = 4 farthings. 

20 Margraff, "International Exchange," p. 51. 

2i For more extended comment on the mint par see Chapter XV. 



THE RATES OF EXCHANGE 91 

The farthing is of little practical consequence. A sum of 
English money is commonly written in figures in the follow- 
ing manner: £3. 17s. 9d. or £3. 17/9 (namely, three pounds, 
seventeen shillings, and nine pence — which is, incidentally, 
the Bank of England's minimum buying price for gold 
bullion per ounce n /i2 fine). £, s, and d, are abbreviations 
for the Latin words, libra, solidus, and denarius. Shillings 
are also abbreviated as "sh." For the purposes of com- 
putation it is often desirable to reduce shillings and pence 
to decimal fractions of pounds. "We shall attend to this 
simple arithmetical problem in a later section. 

In our market, sterling rates are at once the most im- 
portant and the simplest in form. It has already been 
made clear that these rates are expressed as the number of 
dollars paj-able for one pound of exchange. A word is in 
order regarding the standard scale of intervals along which 
they rise and fall. There are really two customary scales. 
The first and older is the scale by eighths of a cent per 
pound. Beginning say with 4.86 the rates next in order 
above according to this scale would be 4.86Ms, 4.86 : ,4, 4.86%, 
and so on. Under more recent practice, especialh' in New 
York, rates are made to rise and fall by intervals of ^ioo 
of a cent, so that the rates in order above 4.86 would be 
4.8605, 4.8610, 4.8615, 4.8620, and so forward. With this 
scale, prices may be shaded to a somewhat finer degree than 
under the earlier one. On occasion the two scales will be 
found combined. If, where the system of eighths is em- 
ployed, exchange rises from 4.86V8 to 4.86H, the reporter is 
apt to speak of an advance of \b of a "point." A point 
must therefore in this case mean 1^ per pound sterling. 
On the other hand, a rise of quotations from 4.8605 to 
4.8610 is usually called an advance of 5 points, so that in 
this instance a point means only Moo of a cent. In the 
.sterling market, dealers have managed to shade prices to a 
sufficiently fine degree by the very simple and proper method 



92 FOREICX EXCHANGE 

of extending the number of figures in the decimal part of 
the rate, ami quotations are not hampered by the peculiar 
supplementary fractions found in the French and German 
rates as given in New York. 

Under ordinary conditions the rates for bankers' sight 
sterling fluctuate between approximately 4.88 and 4.84 as 
upper and lower limits. Ascent above the upper limit is 
checked by the indefinite supply of bills which will be 
forthcoming at this point by reason of exports of gold, and 
decline below the lower is checked by the indefinite demand 
for bills which will arise because of imports of gold. These 
limits, called the "gold points," are not invariable even 
under ordinary conditions, but the range of their move- 
ment is a narrow one. The}' depend upon both countries 
being on the gold standard in point of practical fact as 
well as in legal theory. 22 It goes without saying that the 
present war-time conditions are not ordinary. In the first 
week of August 1914 there were some sales of sterling 
cables in New York at the rate of $7.00 per pound ! Again 
on September 1, 1915, New York quotations for cables 
touched $4.50 per pound, during an exchange flurry! 

§ 28. The rates on France. — The monetary unit of France, 
called the franc, is defined by French law which declares 
that 3,100 francs shall be coined from 1 kilogram of gold 
%o fine. No gold coin so small as the franc is struck, but 
the franc as a legal unit consists of .32258 grams of standard 
gold (%o fine) or .290322 grams fine. The franc as a unit 
of account is divided into 100 centimes. 

In the table of exchange rates on page 75, bankers' de- 
mand francs are quoted at 5.17 1 /! This figure signifies 
that 5 and 17% hundredths francs, or 5 francs and 
17% centimes, face value of draft in French money, 
may be bought for $1 of American money. This means 

22 Gold shipments are considered in Chapter XX and the general 
theory of exchange supply and demand and the rates, in Chapter XXI. 



THE RATES OF EXCHANGE 93 

that New York quotes francs according to the "in- 
direct" method, as we explained this term in § 22. If one 
pays at the rate of $1 for 5.17% francs, each franc costs 
19.32 -f- cents, and there is no compelling reason why the 
rate should not be quoted as cents per franc (or dollars 
per hundred francs), as it is in the smaller dealings in the 
interior cities of the United States. But in New York the 
dealers have chosen to quote bills on France according to 
the indirect method. The price of a sight draft on Paris 
for say 4191.75 francs at the rate of 5.17% is to be ascer- 
tained by dividing 4191.75 by 5.175. For every 5.175 
francs face value of the draft the purchaser must pay $1, 
and the draft will cost as many dollars as 5.175 is contained 
times in 4191.75, namely $810. 

The ordinary scale along which the French rate rises and 
falls has intervals of % of a centime. Going in one direc- 
tion from 5.17% the next rates would be in order 

'5.17% 
5.18% 

5.18% 
5.19% 
5.20 etc. 

5.18% is a cheaper rate than 5.17%, since under it the buyer 
receives more French money per dollar, or pays a less num- 
ber of dollars for a given sum of French money. Though 
the scale of intervals of % of a centime is customary, it is 
not rigidly followed. Thus in the table on page 75, cables 
are quoted at 5.17% plus %e. Disregarding the "plus He" 
for the present, 5.17!4 is a figure lying outside of the ordi- 
nary series which jumps from 5.16% to 5.17%. The expla- 
nation given for the customary intervals, is lliat r 's of a 
centime is very nearly equivalent to Vs of a cent, American 
money. The latter was for a long time the Btandard in- 
terval in sterling quotations, and so a closely corresponding 



H FOREIGN EXCHANGE 

interval was adopted in the quotations of rates on France. 23 
The supplemental fractions in the French rates. — Com- 
petition has reached the point which makes it necessary for 
dealers to shade prices to a finer degree than is possible 
with the interval of % of a centime. The device employed 
to effect this object is the addition to the main rate of the 
supplemental fractions, plus or minus Mg, %2 or %4, etc. 
Thus (table on page 75) we find the rate for bankers' 60 
day bills quoted as "5.19% less Ym." Again (table on page 
76), the Commercial and Financial Chronicle gives the high 
rate for long francs as "5.19% h @ 5.19% a," and explains 
in a note that a signifies "less Vis of 1%," and h "less 
%2 of 1%." "5.19% less %« of 1%" is of course near the 
rate of 5.19% flat. Adjacent to 5.19% flat on either hand 
in the conventional scale are 5.18% and 5.20. But 5.19% 
less Yic does not lie between 5.19% and 5.18%, but between 
5.19% and 5.20! 

With regard, now, to the precise meaning of such supple- 
mental fractions as "plus Ms" or "less Vi6," we may begin 
by explaining what they do not signify. They do not sig- 
nify simply plus or minus \i& centime. If this were their 
meaning, the rate 5.19% less Vie would merely stand for 
5.19%* and might be so written. (That is, 5.19% equals 
5.19%r, and this less Yiv would be 5.19%6.) The fraction 
"less He" means "less Vik of 1% of the price of the bill," 
and signifies that the purchaser is to pay for the bill at 
the rate of $1 for each 5.19% francs and is then to receive 
a rebate of He of 1% of the total price of the bill as first 
figured at 5.19% flat. The fraction "less ^6" means a 
drawback of Ho of 1% to the purchaser, while "plus %6" 
means that he must add this amount to the price. To 
illustrate, suppose a purchaser desires to bu} r a bill for 

207,750 francs @ 5.19% less %«. 
23 H. K. Brooks, "Foreign Exchange Text-Books," pp. 113-14. 



THE RATES OF EXCHANGE 95 

The price of this bill at the flat rate of 5.19% would be 
found as follows: 

5.19% = 5.19375 

If 5.19375 francs cost $1, 207,750 francs will cost as many 

dollars as 5.19375 is contained times in 207,750. 
5.19375) 207,750.00000 (40,000 



207,750.0 

or $40,000. 

The supplemental fraction indicates that the purchaser is 
entitled to a reduction or rebate of Vie of 1% of $40,000. 
1% of $40,000 is $400, and Vie of this is $25. Therefore, 
since $40,000 — $25 = $39,975, 

207,750 francs @ 5.19% less Via will cost $39,975. 

If the rate were 5.19% plus Viq, the price of the bill would 
be $40,025. The use of the technical supplementary frac- 
tions, taken in connection with the indirect method of 
quoting the main part of the French rate, makes the whole 
figure a puzzling one to the novice. 24 

§ 29. The rates on Germany and other countries. — The 
money unit of Germany is the mark, consisting in .398274 

24 To look a little further into the curiosities of this notation, 
we may explain that to place "minus Vio" after a rate brings that 
rate a little more than half way towards the next cheaper main 
rate. Thus 5.10% less Via is a little closer to 5.20 than it is to 
5.19%. On the other hand ~>.20 plus l Ao is a little closer to 5.19% 
than to 5.20! But the two rates, ~).l!)':s lass Vie and 5.20 plus Via 
are almost identical. The interval of % centime between the main 
rates is an interval of almost exactly Vi of 1%. Consequently an 
addition or subtraction of Vio of 1% to or from any main rale takes 
us almost exactly half way to the next rate. In point of fact it 
takes us a shade beyond the half way point. The lender will doubt- 
less be interested to note that BUCl fractions as Vfrj, %2, '-;i. etc., are 
also employed on occasion. 



96 FOREIGN EXCHANGE 

grams of gold 94b fine. It is divided into 100 pfennigs. 
The mark has a "value," as measured in gold contents, 
of about '_':!. Sc. The table on page 75 shows demand drafts 
on Germany opening at 95 : )u\ less b-,4. As in the case of 
the quotations on France, the rate here consists of a main 
price and a supplemental fraction. The German quota- 
tions, however, are not so deceiving as the French, for the 
main price is a direct rate, namely the number of American 
cents asked for 4 marks. The apparent reason for choos- 
ing 4 marks for quotation instead of 1, is that 4 marks is 
nearly the equivalent of 1 dollar. Since the rate is quoted 
in the direct manner, it is cheaper when lower and dearer 
when higher, in this respect being like the sterling quota- 
tion. 

Suppose a buyer desires a bill for 128,000 marks at the 
rate of 05%6 less Vm. Beneath is shown the method of 
calculating the price of this bill without the use of tables. 
128,000 marks contains 32,000 (128,000-1-4) units of four 
marks. 32,000 units (of 4 marks each) at 95%e^ each, 
would cost $30,460, calculated as follows : 

95% 6 = 95.1875 = $0.951875 

.951875 dollars per unit 

32,000 units bought 



1903.750000 
28556.25 



30460.000000 cost of bill in dollars. 

The supplementary fraction, less V&i, gives the purchaser 
a right to a reduction or rebate of V&i of 1%. 

1% of $30,460.00 = $304.60 
%4th of 304.60= 4.75 

The final price of the bill, therefore, will be $30,460.00 less 
$4.75 or $30,455.25. German exchange is commonly quoted 



THE RATES OF EXCHANGE 97 

by interior banks in the United States in cents for 1 mark, 
or the number of dollars for 100 marks. 

The monetary unit of Holland is the guilder, called also 
the gulden or the florin. Measured according to metallic 
contents, 1 guilder = $.402 — , or $1 = 2.48 + guilders. 
Bills of exchange payable in guilders are quoted at so 
many American cents 'per guilder. Sometimes guilders are 
quoted in cents and eighths of cents with supplementary 
fractions similar to those used in the French and German 
rates. 

With respect to New York's rates on the less important 
countries, we may content ourselves with the general state- 
ment that Italian, Swiss and Belgian exchange is quoted 
in the same manner as the French. Italy, Switzerland 
and Belgium have money units with the same metallic 
contents as the French. Exchange on Spain, Austria- 
Hungary, the Scandanavian countries, Russia, and other 
lands in general, is regularly quoted as the amount of 
American money to be paid for one foreign unit. 

Exchange on London, taking the world at large, is almost 
always quoted in the simplest and most direct manner by 
giving the number of local monetary units payable for one 
pound of draft or telegraphic transfer as the case may be. 
London itself, on the other hand, quotes exchange on coun- 
tries foreign to Great Britain in most instances in the 
indirect fashion. Thus when Paris on London stands at say 
25.20, London on Paris will be also at 25.20 or some figure 
very close to this ! 



CHAPTER VI 

THE DOCUMENTARY TRADE BILL 

§ 30. The documentary bill of exchange. — The documen- 
tary bill, or documentary draft, is a bill of exchange to 
which a bill of lading and usually certain other incidental 
documents are attached primarily for the purpose of serv- 
ing as collateral security. Not infrequently the seller of 
stocks or bonds to a foreign purchaser draws upon the 
latter, commonly at sight, and attaches the certificate of 
stock or the bonds to the draft in part to serve as collateral. 
A draft made up in this manner should probably be called 
a documentary bill, but ordinarily one would mean bj' this 
term the draft of a merchant with a bill of lading attached. 

When a draft is drawn by a seller of merchandise as a 
means of obtaining the sale price, we speak of the instru- 
ment as being drawn "against" the merchandise, or 
"against" its shipment, while we say it is drawn "upon" 
the person who is drawee. As one would suppose, typically 
the bill of lading attached to a draft is the one covering the 
particular lot of goods against which or on account of 
which the draft in question is drawn. The legal effect of 
attaching the bill of lading is, in brief, to enable the holder 
of the draft to resort to the merchandise in case the draft 
should be dishonored. 1 The vast majority of foreign bills 
of exchange drawn by merchants are documentary drafts, 
and this holds good equally whether the merchant draws 
upon another merchant, namely the importer, and thus 

i The chief discussion of the nature of the rights of the holder 
of the draft running against the merchandise, will be found in 
§ 42 below. 

98 



THE DOCUMENTARY TRADE BILL 99 

creates a "trade bill," or draws upon a bank under a letter 
of credit. 2 

The first reason for attaching documents. — Speaking at 
present of the trade bill, there are two reasons for attaching 
the shipping documents. The first is to give to the banker 
or other purchaser of the draft, a legal interest in the 
merchandise, which will enable him, or a holder subsequent 
to him, to force the sale of these goods in the event of the 
dishonor of the draft, and to reimburse himself so far as 
possible from the proceeds of this sale for his failure to 
collect the amount due upon the instrument. It is to this 
we have reference when we say the merchandise (or in- 
differently, the bill of lading) serves as collateral security. 

Collection and advance against collections. — It should be 
stated, however, that a bank is by no means always a pur- 
chaser of a draft which it takes from the drawer or holder 
subsequent to the drawer. Often the instrument is taken 
"for collection" only. This signifies that the one who de- 
posits it with the bank is to receive the proceeds which it 
will yield, only after the drawee has made payment and 
the amount so paid has been returned to the collecting bank. 
Banks receive drafts for collection generally in cases where 
they do not care to make outright purchases of the instru- 
ments. But in these instances they are often willing to 
make a cash advance of an amount somewhat less than the 
expected returns from the instrument, especially if the de- 
positor is a regular customer in good standing. These loans 
or advances are made at a stipulated rate of interest and 
against the deposited draft, and the proceeds which it 
yields, as security. 

A second reason for attaching documents. — There is a 

2 The term "trade bill" is here used to signify a draft <>f a mer- 
chant on a merchant, though it might be used more broadly t<> cover 
any draft originating in trade and thus the documentary draft of 
a merchant on a bank. 



100 FOREIGN EXCHANGE 

second reason for attaching the documents to a draft, in 
addition to the one that they may serve as collateral se- 
curity, and this reason holds good even where the draft is 
deposited for collection without an advance against it. The 
importer, or man at the other end of the mercantile trans- 
action from the drawer, cannot obtain his goods until he 
procures the bill of lading properly indorsed. The exporter 
safeguards his interests by putting this document in the 
hands of the holder or custodian of the draft, with appro- 
priate instructions, so that the importer cannot get the 
goods until he has received presentment of the draft and 
has honored it, either as in some cases by acceptance merely, 
or as in most cases by acceptance and payment both. Thus 
even if purchasing banks did not demand the bill of lading 
as their own collateral security, the exporter would still 
have a motive to make up a documentary draft, as this plan 
furnishes him with more protection against loss through 
fraud or failure on the part of the importer, than the alter- 
native plan of sending the bill of lading direct to the im- 
porter through the mails and independently of the draft. 

Clean bills. — It is not to be understood that between ex- 
porters and importers of standing, especially where there 
are established relations, bills of lading are not sometimes 
mailed direct and independently of drafts. Sometimes the 
exporter sends the bill of lading along and draws separately, 
and at other times he may send it without drawing at all un- 
der an agreement that the importer will subsequently remit 
exchange in payment. (In many instances the importer will 
be asked to remit in advance.) If a bill of exchange does 
not have documents attached it is known as a "clean bill." 
All bills drawn by purely banking houses are clean. If 
a bill begins its life with documents attached but these are 
detached before its discharge, it becomes for the last part 
of its life a clean bill. It is rare for a documentary draft 
on a merchant to become a clean bill before the drawee 



THE DOCUMENTARY TRADE BILL 101 

grants acceptance to the instrument, If a merchant can sell 
a clean bill on another merchant it will be because of his, 
the drawer's, high standing- before the banks. 

The several documents attached. — The principal papers 
which constitute what we may call the standard documen- 
tary bill are (1) the draft, (2) the bill of lading, (3) the 
insurance certificate, (4) the hypothecation certificate (un- 
less the hypothecation is provided for by a general letter of 
Irypothecation), and (5) various other documents including 
at times certain consular and inspection certificates, and 
including often the invoice, or bill of goods. A special 
document of hypothecation or pledge (compare § 33) is 
not necessarily present, the mere delivery of the bill of 
lading being taken to effect a pledge without the execution 
of special acknowledgments to this intent. 

The terms of the sale and the draft. — In general the 
terms and character of a draft are governed by the under- 
standing existing between the buyer and seller of the goods. 
This understanding may be expressed or it may be implied 
in the usages of the trade. Again it may unfortunately be 
non-existent, which often means trouble. A demand draft 
may of course be drawn with documents attached. So far 
as the bill of exchange has been used by American domestic 
shippers, demand drafts or drafts with very short lives have 
been chiefly employed. It is the hope of our Federal Re- 
serve Banks to establish the free use of long documentary 
bills in American internal commerce in the future, and this 
hope is already beginning to be realized. In foreign trade 
the usual documentary bill runs for sixty or ninety days if 
not for a longer term. The amount of the draft is com- 
monly the total sum for which the goods arc sold but oc- 
casionally a certain prearranged percentage of this sum. 

Bills in sets. — The foreign trade bill, like most other 
foreign drafts, is regularly drawn in a plural number of 



102 FOREKiX EXCHANGE 

copies, in " duplicate " or "triplicate." Whon drafts are 
thus issued "in a set," one of them will be marked "first 
of exchange" or "original," another "second of exchange" 
or "duplicate" and so on. The first of exchange will read 
as an order to pay "second and third unpaid" (i.e., pro- 
vided neither second nor third of exchange have been paid), 
and so forth, so that the payment of any one copy has the 
legal effect of making other copies void. The law makes 
possible the issue of bills in sets of any number of copies 
desired. The issue of bills in sets is taken advantage of 
for various purposes. One object is to enable the holder 
to forward the first and second of exchange by separate 
steamers as a measure of safety. A third of exchange when 
issued is likely to be kept by the holder as a matter of 
record. A bill of lading is also issued in as large a num- 
ber of copies as desired, but these are not marked "first," 
"second," and so on. Any one of these copies is, when 
properly indorsed, good for the merchandise at the terminal. 
The holder of a documentary draft has to see to it that he 
has control of or knows what is done with all the copies 
of the bill of lading. 

§ 31. The bill of lading. — A bill of lading is the written 
acknowledgment of a transportation company of the receipt 
of goods for carriage to a designated place. The instru- 
ment contains a description of the goods, with a record of 
packages and marks, if any, to identify them, and a recital 
of the terms of agreement with the shipper under which 
the company undertakes the forwarding. The shipper is 
also known as the consignor and the one to whom the goods 
are sent as the' consignee. To ship is as well to consign, and 
a shipment is also a consignment. In a narrower but 
fairly common commercial sense, "to consign" means to 
ship property to a person for sale or reshipment by him as 
a mere agent or factor of the shipper. If A sends goods 
to B "on consignment" in this sense, B is not an independ- 



THE DOCUMENTARY TRADE BILL 103 

ent purchaser of the goods but is an agent of A, and A 
takes the mercantile risks. The consignee as we are to 
speak of him in the present connection, however, is simply 
the person to whom goods are shipped, whether he is an 
independent purchaser or a mere agent of the shipper. 

Distinguished according to their manner of indicating the 
person to whom the goods are made deliverable, there are 
two classes of bills of lading. To quote the Federal Bills 
of Lading Act of August 29, 1916, "a bill in which it is 
stated that the goods are consigned or destined to a specified 
person is a straight bill. ... A bill in which it is stated 
that the goods are consigned or destined to the order of 
any person named in such bill is an order bill." 3 The 
order bill is the one in proper form for use as collateral 
security and consequently the export bill of lading almost 
always takes this form because it is designed to be attached 
to a draft. Such a bill will make the goods deliverable 
either to the order of the shipper himself or to the order 
of some bank which is about to finance or help finance the 
export whether through the direct purchase oi the ex- 
porter's draft or through the issue of a commercial letter 
of credit. If the bill of lading reads to the order of the 
shipper himself, the transportation company will surrender 
the goods only to the person to whom the shipper orders 
them delivered. This order is conveyed by an indorsement 
on the bill of lading itself. But this indorsement may be 
either (1) in blank or (2) to a specified person.' 1 In the 
latter case the person designated may himself indorse again 
either in blank or specially, and thus again transfer Hie 

3 §§ 2 and 3 of the act. The text of this act, which went into 
effect January 1, L917, may he found anions other places in I lie 
Federal Reserve Bulletin for October, l!)l(i, issued by tin- Federal 
Reserve Board, Washington, D. C. 

* Compare the indorsement in blank and special indorsement of 
bills of exchange and promissory notes, as described in § 11. 



104 FOREIGN EXCHANGE 

bill of Lading and the right to receive the merchandise. 
But the standard form of indorsement of export bills made 
out to the order of the shipper is in blank. As one could 
infer, this indorsement is constituted by the shipper's signa- 
ture without a specification of the person to whom the 
goods are to be delivered, the place for this person 's name 
being left blank. This indorsement has the effect of making 
the goods deliverable to any rightful holder of the bill of 
lading, who may procure them (commonly of course at 
destination) by writing his own name in the blank place. 
If A exports goods and procures a bill of lading to his own 
order and indorses the latter in blank, he may then make 
up a documentary draft for sale to a local bank. The bill 
of lading will remain in the possession of this bank and its 
foreign agents (or successors) until delivered to the im- 
porter and drawee of the draft, under the documentary 
instructions. 5 

"We maj* call the importing merchant the real consignee 
for it is to him the goods are really being shipped and to 
him they will in fact be delivered if he performs his duties 
towards the exporter's draft. But as has just been ex- 
plained, this real consignee's name does not appear origi- 
nally upon the regular export bill as the party to take de- 
livery of the merchandise. This is to prevent him gaining 
any rights that w'ould interfere with the use of the bill and 
the goods to which it pertains, as collateral security for the 
exporter's draft. It is nevertheless expected that in fact 
he will be the one to take delivery of the goods, and it is 
necessary that upon their arrival at destination he should 
be informed of the event by the transportation company. 
In order that he may be known for this purpose, his name 
will be entered upon the bill of lading when originally 
made out, not as consignee but as the "party to be notified." 
Although every one knows that this indicates a commercial 

s See § 34 below. 



THE DOCUMENTARY TRADE BILL 105 

expectation that this person will receive the goods, it does 
not give him any rights in advance of his performance of 
his duties towards the exporter's draft, which will be preju- 
dicial to the rights of the banker as holder of the bill of lad- 
ing as collateral security. 6 

Much merchandise for export is shipped over the lines of 
more than one transportation company. There is often in- 
volved at least one railroad company and one separate ocean 
steamship company. In these instances the company first 
receiving the goods is usually ready to issue a "through" 
bill of lading which will relieve the consignor of the neces- 
sity of attending to trans-shipment at the point where the 
second company takes over the goods for further carriage. 
That is, the through bill of itself gives a claim against the 
last?transportation company for the goods at destination. 
Through bills cannot be obtained for all routes or all classes 
of merchandise, but are generally available, and are espe- 
cially convenient to merchants and banks in the making up 
and negotiation of documentary drafts. Nevertheless a 
documentary draft can be handled without the bill of lading 
being through, although there will be in this case a certain 
amount of expense and trouble incidental to trans-shipment. 
Typically the bank which holds the documentary draft takes 
charge of the trans-shipment and employs brokers in the city 
of trans-shipment to take care of cartage and rebilling. In 
large cities +«*i- seaports brokers are found who make it 
their business to attend to matters of this sort, the payment 
of customs duties on imports, and the like. 

Though the through bill is convenient, there are many 
occasions when it is not taken out even where it can be had, 
because of the great chances of delay when trans-shipmenl is 
left in the hands of the railway or steamship company. 
Also in this connection the following may be noted from 

6 This legal principle is written into the Federal Bills of Lading 
Ait, in llic seventh section of that law. 



L06 FOREIGN EXCHANGE 

Mr. A. J. Wol IT's report on Foreign Credits. 7 "Ranks 
abroad very often refuse acceptance of bills drawn against 
railway through bills of lading, because they object to bills 
of lading signed by an ordinary railway employee, and also 
because the actual departure from port is not apparent 
therefrom." The first of these reasons has been removed, 
or at least much reduced in force, so far as exports from 
the United States are concerned, by the new Federal Bills 
of Lading Act, already mentioned, which places upon rail- 
way companies a sufficient responsibility for the signatures 
of their agents, a responsibility apparently lacking under 
common law. 8 A substantially similar act has also been 
passed by states numbering 16 at the present time. The 
standard export bill to which this section has been devoted, 
rejoices in the full name of the through order notify export 
oill of lading. 

§ 32. The insurance certificate. — The next member of the 
group of instruments constituting the documentary bill is 
the insurance certificate. Generally speaking, merchandise 
for export is not specially insured for the inland part of its 
haul, 9 because the liabilities assumed by railway companies 
take the place of insurance. But the ocean transport lines 
do not take on these liabilities and shippers procure insur- 
ance against loss at sea from the regular marine insurance 
companies. This can regularly be obtained on the mere 
evidence of the bill of lading. It is the recognized custom 
to permit insurance for sums from 10 to 20% in excess 
of the invoice value of the goods, to cover expected 
mercantile profits. Like the bill of lading, the insurance 
certificate is made out to the order of the shipper and in- 
dorsed by him in blank. Large houses enjoying the con- 

? "Foreign Credits," by A. J. Wolff, Special Agents' Series, No. 
62, U. S. Department of Commerce and Labor, p. 110. 
s See especially § 22 of this act. 
9 To this there are exceptions. 



THE DOCUMENTARY TRADE BILL 107 

fidence of the insurance companies, often obtain what are 
known as "open policies," under which they are permitted 
themselves to issue insurance certificates to their own order 
against their consignments of merchandise as shipped. 
This plan saves the time and labor required to make a 
special application for insurance against each and every 
shipment of goods. Premiums due under these open poli- 
cies will be paid at stated intervals. The insurance com- 
pany is of course to receive an advice for each certificate of 
insurance issued by the merchant to himself. 

Insurance may often be obtained abroad at lower rates, 
and therefore it is not uncommon for an arrangement to be 
made to have the consignee of the goods procure the policy. 
In these cases- the shipper has no insurance certificate to 
put in his documentary bill, but with the agreement of the 
purchaser, he substitutes a written statement "insurance 
effected abroad." 

§ 33. The hypothecation certificate and other documents. — 
The hypothecation certificate is the instrument in which the 
drawer of the draft makes the legal acknowledgments which 
constitute any holder of the draft also a holder of the bill 
of lading and insurance certificate as collateral security. 
As stated on an earlier page, in practice these express 
acknowledgments are not always regarded as indispensable 
in making up documentary bills. To "hypothecate" 
means to give personal property as a pledge to secure a 
debt or liability. But not every case of so-called hypothe- 
cation in banking practice would seem to be a strict legal 
pledge, for the banker not infrequently secures a title to 
the goods, which is inconsistent with a pledge pure and 
simple. However, following the looser usages of commer- 
cial speech, we may say that the hypothecation certificate 
is the formal legal recital which pledges the bill <>l* Lading 
and the merchandise covered by it, as collateral security 
for the draft. If a bank expects to purchase from a given 



108 FOREIGN EXCHANGE 

li tin a large number of documentary drafts, it often takes 
from this firm a general letter of hypothecation or general 
hypothecation power. This instrument will cover all bills 
of exchange with collateral security, which are negotiated 
by its issuer to the bank during the life of the letter. It 
saves the labor of drawing up a separate certificate of 
hypothecation for each and every bill. When there is such 
a separate certificate it is attached to the draft along with 
the other documents. 

The specimen letter of hypothecation to follow is one in 
actual use by an American bank though the name of the 
institution is omitted. It is given in full because of the 
great practical interest of its numerous provisions. 

General Letter of Hypothecation 

To The Hundredth National Bank of New York: 

Anticipating all future sales to you and all future negotiations 
by you for the undersigned, of bills of exchange with shipping 
documents for goods or other property attached as collateral se- 
curity and held by you for their due payment, it has been and is 
agreed between us as follows: 

1. The stipulations contained in this Memorandum shall be 
deemed to be continuing and ambulatory, and are to apply to all 
cases in which such bills of exchange may at any time either 
directly, or through other persons, be negotiated with or sold to 
you by the undersigned, and this Memorandum shall have the 
same force until the undersigned shall give you notice of inten- 
tion to terminate it, as if a separate Memorandum were signed by 
the undersigned on each purchase or negotiation. 

2. You may (but it is not imperative on you to do so) insure 
any goods or property of any kind forming the collateral secur- 
ity for any such bill or bills of exchange from sea risk and risk 
of transportation by land, including loss by capture, and also 
from loss by fire on shore, and add the premiums and expenses 
of such insurances to the amount chargeable to the undersigned 
in respect of such bill or bills, and take recourse upon such goods 
in priority to any other claims thereon, or against the under- 



THE DOCUMENTARY TRADE BILL 109 

signed, without prejudice to any claim against any indorser or 
indorsers of the said bills, for reimbursing you, or the person or 
persons paying the same, the amount of such premiums and ex- 
penses, and you may sell any portion of such goods which may 
be necessary for payment of freight, insurance and expenses, 
and generally take such measures and make such charges for 
commission, and be accountable in such manner, but not further 
or otherwise than as in ordinary cases between a merchant and 
his correspondent. And the undersigned consent to the goods 
being warehoused at any public or private wharf or warehouse 
selected by the Drawees or Acceptors of the bills, unless you 
offer an objection to such wharf or warehouse. 

3. You may take conditional acceptances to all or any of such 
bills, to the effect that, on payment thereof at maturity, or under 
discount, the Documents handed to you as collateral security for 
the due payment of such bill or bills shall be delivered to the 
Drawees or Acceptors thereof, and authorization shall be taken 
to extend to cases of acceptance for honor. Subject, neverthe- 
less, to the power hereinafter given, in case the drawee shall 
suspend payment, become bankrupt, or go into liquidation dur- 
ing the currency of any such bill or bills. 

4. You may at any time or times before the maturity of any 
bill or bills of exchange, as aforesaid, grant a partial delivery or 
partial deliveries from time to time of any part or parts of such 
goods or other property in such manner as you or the Acceptors 
of such bill or bills of exchange, or their representatives, may 
think desirable to any person or persons on payment of a pro- 
portionate amount of the invoice cost of such goods, or other 
property, or of the bill or bills of exchange drawn against the 
same. 

5. In case default be made in acceptance of the said bills on 
presentation, the undersigned immediately on receiving notice 
from you that you have been advised by telegraph or otherwise 
of such non-acceptance, and without waiting for or requiring the 
protest of said bills, will pay you the amount thereof, with all 
charges of every description incurred by you in consequence of 
such non-acceptance, and at your option the undersigned will 
give you satisfactory additional margin in cash or securities, all 



110 FOREIGN EXCHANGE 

in addition to your possession in the United Kingdom or else- 
where, of the goods or other property securing said bills or the 
documents therefor; and your account of the disbursements, com- 
missions and charges so incurred shall be received by the under- 
signed as sufficient and final evidence thereof. 

6. In case detault be made in acceptance or payment of any of 
the said bills, or if the Drawees or Acceptors should suspend pay- 
ment, or be adjudicated bankrupt, or execute any deed of ar- 
rangement, composition or inspectorship, or take any other step 
whatsoever toward effecting a compromise or arrangement with 
their creditors during the currency of said bills, you may at any 
time after any of the aforesaid events taking place, sell the goods 
or other property or any part thereof, without notice to or the 
concurrence of any person whomsoever, without waiting for the 
maturity of the said bills, and either by public auction or private 
sale, and you may act in all respects as if you had been the direct 
consignee of the goods or other property, charging such commis- 
sion as is usual between a merchant and his correspondent in 
ordinary cases, and shall apply the net proceeds of any sale, 
after deducting any payment under the powers herein contained, 
with interest thereon, and the usual commission and charges, in 
payment of the bills, with interest, re-exchange and other charges, 
and may apply the balance, if any, toward the liquidation of 
any other debt and liability of ours to you, whether or not the 
same be then payable or ascertained, it being hereby agreed that 
the goods themselves, or other property, until sale, shall be liable 
for and be charged with the payment of all such bills, with com- 
mission, interest, re-exchange and other charges, debts and lia- 
bilities; and we agree that all account sales and accounts current 
furnished by you, in respect to the said goods and produce, shall 
be received by us as sufficient and final evidence of their ac- 
curacy. 

7. In case the net proceeds of such goods shall be insufficient 
to pay the amount of any such bill or bills, with re-exchange and 
charges, you may draw on the undersigned for the deficiency, 
without prejudice nevertheless to any claim against any indorser 
or indorsers of the said bills for recovery of the same or any 
deficiency on the same; and the undersigned agree to honor such 



THE DOCUMENTARY TRADE BILL 111 

drafts on presentation, it being- understood that the account cur. 
rent rendered by you or by the holder or holders of such bill, 
shall be sufficient proof of sale and loss. 

8. Whether the aforesaid powers of sale shall or shall not have 
arisen, you may at any time before the maturity of any such bill 
or bills, accept payment from the drawees or acceptors thereof, 
if required so to do, and on payment you may deliver the bills 
of lading and shipping documents to such drawees or acceptors; 
and, in that event, you or the holder or holders of any such bill 
or bills are to allow a discount thereon, not exceeding five per 
cent, per annum, for the time they may have to run, as follows : 

At one-half per cent, per annum above the advertised rate 
of interest for short deposits allowed by the leading London 
Joint Stock Banks, if payable in Great Britain. 

At the current minimum rate of discount of the national 
banks of France, Italy, Belgium and Germany, if payable in 
those countries. 

At the current rate of rebate for documentary bills, if pay- 
able in Switzerland. 

At the current rate of rebate allowed by the Exchange Banks, 
if payable at any place east of Suez. 

9. The delivery of any collateral securities to you shall not 
prejudice your rights on any such bills in case of dishonor, nor 
shall any recourse taken thereon affect your title to such securi- 
ties to the extent of the liability of the undersigned to you as 
above. 

10. Notwithstanding any alteration by death, retirement, in- 
troduction of new partners or otherwise in the persons from time 
to time constituting the firm of the undersigned or other the style 
or firm under which the business at present carried on by the 
undersigned may be from time to time continued, this Led it and 
the powers and authorities hereby given are to hold good as the 
Agreement on the part of the undersigned or of the firm as afore 
said with you, and each negotiation of a bill or bills hereunder 
is to be treated as a renewal by or on behalf of the under 
signed and of the firm as then existing of the terms of this 
Agreement. 



112 FOREIGN EXCHANGE 

11. You are not to be responsible for the default of any broker 
or auctioneer employed by you for any purpose. 

12. All rights, powers and authorities herein given to you 
may be exercised by you or any of your managers or agents or 
the holder or holders for the time being of any bill or bills of 
exchange as aforesaid, and all agreements and provisions con- 
tained in this Letter of Hypothecation shall extend and apply to 
and for the benefit of all holders for the time being of any such 
bills. 

Dated this day of one thousand nine hundred and 

Witness to the signature of: 

Witness. 

Occupation. 

Address. 

The letters of hypothecation of different American banks 
appear to be much alike. The writer of the letter is the 
drawer of the bills of exchange to which the letter pertains. 
In the foregoing specimen, paragraph 6 contains the prin- 
cipal clauses pledging the goods as collateral, but as we 
see, there are numerous incidental provisions binding the 
drawer to the bank or its successors in various ways. The 
chief among these briefly stated are as follows: 

(a) The bank m&y insure the goods at the drawer's ex- 
pense. So far as satisfactory insurance has been provided 
by the drawer or the importer in advance, no resort to this 
power would be taken by the bank. 

(b) The bank may sell any portion of the goods required 
to pay any freight charges left unpaid by the shipper. 

(c) The drawer consents to the selection of any ware- 
house abroad by the importer which is satisfactory to the 
bank. To illustrate the application of this provision, let us 
suppose the goods have arrived and have been placed in a 
warehouse at destination, and are then destroyed by fire. 
The collateral security thus disappears except for the in- 



THE DOCUMENTARY TRADE BILL 113 

suranee. Suppose further the drawee of the draft (the im- 
porter) now refuses to honor the instrument, whether 
through financial inability or for other reasons. The pro- 
vision now before us will have the effect of preventing the 
drawer (or exporter) from setting up any counterclaim 
based on alleged improper warehousing of his merchan- 
dise, when the holder of the draft exercises his right of 
recourse. The drawer has expressly estopped himself from 
setting up such a claim. If he pays the draft and all in- 
cidental charges connected with it and the merchandise, 
the insurance will belong to him. If this insurance is 
good he will have to wait till it can be collected. If it 
should turn out to be uncollectable, it will be his loss, unless 
he should be able ultimately to obtain reimbursement 
through some action against the importer. In a word it 
is agreed that the exporter who sells his draft to the bank, 
and not the bank, is to take the risks connected with the 
merchandise. 

(d) The bank may take from the drawee a conditional 
acceptance, where the condition is that the documents must 
be delivered to the drawee for the act of payment. (We 
shall speak of this point in a moment.) 

(e) The bank may grant the acceptor partial deliveries 
from the consignment of goods in return for payment by 
him of a proportionate amount on account. (Such com- 
ment as we have to make on this subject is best reserved 
for § 36.) 

(f ) In paragraph 5, protest for non-acceptance (compare 
§ 12) is waived, but the letter does not make it certain that 
protest for non-payment is waived. Without this waiver 
protest would be necessary to prevent the drawer from 
escaping all his liabilities on the draft except his vendor's 
warranties (compare again § 12). 

(g) If in case of non-acceptance or non-payment of the 
draft, the net proceeds of the sale of the goods prove in- 



114 FOREIGN EXCHANGE 

sufficient to pay the amount due on the draft plus charges 
and commissions, the drawer agrees to honor a draft to be 
drawn upon him for the amount of the deficiency. 

(h) In the event of sale of the goods hy the bank, the 
sale may be public or private, and the bank is to be free 
of responsibility for default by any broker who makes the 
sale. 

(i) The bank's account of charges and commissions is 
to be final and not subject to contest. 

(j) All rights and powers granted the bank in the letter 
of hypothecation are granted any subsequent holder of a 
draft drawn under it for the time he holds it. 

We have seen that this letter authorizes the holder of a 
draft to take a "conditional" acceptance of a specified 
character. Acceptances have already been discussed in 
§§6 and 12. They are either general or qualified. A gen- 
eral acceptance, the kind ordinarily given, "assents with- 
out qualification to the order of the drawer. " 10 It makes 
the drawee unconditionally bound to pay the instrument 
according to its tenor. A qualified acceptance makes pay- 
ment depend upon some condition specified in the accept- 
ance (this giving us the "conditional" acceptance) or it 
binds the acceptor to pay only part of the amount for which 
the bill is drawn (this giving us the "partial" acceptance), 
or it modifies the liability of the acceptor in some other 
way. 11 We have already learned that the right of recourse 
upon the indorsers or drawer of a bill as parties second- 
arily liable, is dependent upon (1) proper presentment 
(2) dishonor, whether for non-acceptance or for non-pay- 
ment, and (3) due notice of dishonor. Suppose now on 
presentment of the bill the drawee is willing to give only a 

io See § 227 of the Uniform Negotiable Instruments Law, as al- 
ready cited. 

ii § 229 of the Uniform Law. 



THE DOCUMENTARY TRADE BILL 115 

qualified or conditional acceptance. Will or will not this 
operate as dishonor for non-acceptance? The answer is, 
the holder may treat the instrument as dishonored in this 
event and exercise an immediate right of recourse upon the 
parties secondarily liable. In other words, the law gives 
him a right either to receive an unqualified acceptance 
or to have recourse. He may take a qualified or condi- 
tional acceptance at his own option (upon the supposition 
perhaps that it will be sufficiently binding on the acceptor 
under the practical circumstances), but the effect will be 
to release the parties secondarily liable at once and for all 
time (except for such lesser liabilities as may remain under 
their vendor's warranties). 12 Without the consent of the 
parties secondarily liable, the holder cannot acquiesce in 
a qualified acceptance and retain his rights of recourse 
upon these parties. The type of conditional acceptance 
authorized by the letter of hypothecation now before us, 
is one framed in any words conveying the meaning "I, 
the drawee, bind myself to make payment of this bill pro- 
vided at the time of payment, if not before, the documents 
attached to it as collateral security are surrendered to me." 
The motive an importer might have for insisting upon such 
a condition is evident. An unconditional acceptance 
would bind him to pay at maturity even if the shipping 
documents were not present to be offered to him in return 
for payment. Commercially speaking, he might be com- 
pelled to pay for his goods without gaining control of them. 
However remote this possibility, he may guard himself 
against it by employing the form of acceptance above re- 
ferred to. Though this would seem reasonable under the 
circumstances, the acceptance would nevertheless be condi- 
tional. In our letter of hypothecation, the drawer assents 

12 Compare § 12, p. 30. The drawer is included among the parties 
secondarily liable, even if there has been no acceptance. See again 
§ 12. 



116 FOREIGN EXCHANGE 

in advance to a conditional acceptance of this specific char- 
acter. This permits the banker or holder of the bill to 
take this kind of acceptance without losing the right of 
recourse on the drawer, in the event of subsequent dishonor 
by non-payment. 

In addition to the bill of lading and the documents of 
insurance and hypothecation already discussed, certain 
other papers often accompany documentary drafts. Usu- 
ally an invoice, or bill of goods, is present, giving an 
itemized statement of merchandise shipped with prices and 
charges. 13 The regulations of different countries governing 
import duties and the laws pertaining to sanitation make 
obligatory the taking out of various types of consular cer- 
tificates by persons shipping goods into these countries. 
It is usually necessary or convenient for these certificates 
to accompany the bill of lading to enable the goods to 
be entered into the country of destination. The banker 
is interested in having all such documents in order, for if 
he should be compelled to resort to the merchandise as 
collateral, realization upon them by sale might be much 
embarrassed by any irregularity. Furthermore the chances 
of repudiation of a trade bill by the drawee might be in- 
creased by failure to attend to the requirements which must 
be fulfilled to enable him to come at the goods promptly. 

The customs regulations of the United States provide 
that "no merchandise exceeding $100 in value, except 
personal effects accompanying a passenger, shall be ad- 
mitted to entry without the production of a certified invoice 
thereof, unless the importer shall make application under 

13 In many instances the invoice may be contained in a sealed 
envelope addressed to tlie purchaser, to avoid publicity. Margraff, 
"International Exchange," p. 28. The invoice per se is of course 
not evidence of a very conclusive character for the banker as to the 
value of the merchandise collateral. The reputation of the shipper 
must be considered. 



THE DOCUMENTARY TRADE BILL 117 

oath, showing that it is impracticable to produce such 
invoice. . . ." 14 A certified invoice is obtained by the 
shipper's presenting his invoice to an American consul 
at or near the place of shipment and signing a declaration 
that the document is in all respects correct and true, where- 
upon the consul certifies. 15 Most documentary bills 
against shipments into the United States, whether drawn 
on the United States or drawn under a bank credit on some 
third country as England, will have certified consular 
invoices attached at least at first. 10 17 

The writer is informed that sometimes the drawee of a 
documentary bill, whether the importer or a bank secured 
by him to serve as drawee, stipulates that the drawer shall 
obtain and attach to the draft, a certificate of inspection 
from a designated third party, the latter being appointed 
as representative of the buyer to see that the goods called 
for by the agreement of sale and specified in the invoice, 
are actually shipped in correct quantity and quality. 

§ 34. The documentary instructions. — The importer who is 
drawee of a documentary draft has the right in any event 
to receive the attached bill of lading at the time when he 
pays the draft. But he may be treated more liberally. 
The bill of lading may be handed over in return for his 
mere acceptance of the draft. The disposition of the 

M Article 202, "Customs Regulations of the United States," edi- 
tion of 1915, Treasury Department, Division of Customs, Washing- 
ton, D. C. Chapter V of this hook of 733 pages, contains most of 
the regulations pertaining to invoices. 

is From article 200 of "Customs Regulations," as cited. Detail 
in the nature of explanations and exceptions may he found in this 
publication. 

is Compare the instructions pertaining to the draft which appear 
in the specimen commercial letter of credit to he found on p. 137 
helow. 

1 7 Considerable information on the suhject of documentary secur- 
ity may he found in Margraff's "International Exchange," fourth 
edition, 1912. 



118 FOREIGN EXCHANGE 

col lateral documents is governed by the so-called documen- 
tary instruct ions, which oughl always to be determined 
upon before the draft is drawn and sold. These instruc- 
tions may be 

1. Documents for payment (D.P.) 

2. Documents for acceptance (D.A.) 

3. Documents for delivery (D.D.) 

The last is rare. It would confer an authority to surrender 
the bill of lading even before acceptance takes place. 18 
Under the instructions of documents for acceptance there 
will be a period running from the time of acceptance until 
the time of payment, typically 60 or 90 da}-s in length 
plus any days of grace, during which the holder of the draft 
will have to rely exclusively upon the personal credit of 
the acceptor and the parties secondarily liable. Conse- 
quently the instructions documents for payment give the 
holder the greater security, preserving his interest in the 
collateral till the end, and these are the usual instructions 
when a draft is drawn on an ordinary merchant. When 
the drawee is a bank, documents for payment will never 
be the instructions, but rather documents for acceptance 
or perhaps documents for delivery. When a bank is 
drawee documents for acceptance would be understood in 
the absence of express directions. 

A draft with bill of lading attached governed by the 
instructions of documents for acceptance is called in brief 
a "documentary acceptance bill." Similarly we have the 
'"'documentary payment bill." As said, most trade bills 
are documentary payment drafts, nevertheless when the 
drawee is a mercantile house of excellent standing the in- 

is The reader bears in mind that most foreign documentary drafts 
are long bills. The instructions documents for acceptance would 
not be in point in the case of a documentary sight draft. 



THE DOCUMENTARY TRADE BILL 119 

structions may be documents for acceptance. Against 
American cotton exports, documentary acceptance bills are 
drawn in great numbers upon English spinners. The clean 
acceptances of these firms sell readily in the London dis- 
count market, though they are usually subject to a slightly 
higher rate of discount than the acceptances of bankers. 19 
In general the character of the foreign exchange which 
arises out of a given commercial transaction depends on 
the terms and understandings of the sale. These may in 
part be implied from the usages of the trade. Thus it may 
be understood that the exporter is to draw, and at sixty 
days' sight, that documents are to be attached, and that 
they are to be surrendered only against payment of the 
draft. The instructions to govern the documents are as 
much a matter for adjustment between the merchants, as 
any other agreement incidental to the sale of the goods. 
Misunderstandings and disputes concerning this matter are 
not altogether unknown. When the drawer offers a bill 
for sale to a banker, the documentary instructions will 
presumably command the banker's attention before he 
makes the purchase. If he demands that they be documents 
for payment, it is incumbent on the drawer to see to it 
that his arrangements with the importer permit him to 
create a bill with these instructions. 

§ 35. Prepayment and the retirement rate of discount. — 
In the absence of a special reason, we would hardly expect 
the acceptor of a bill to come forward and offer to discharge 
it before maturity. But it is very common indeed for 
precisely this to happen in the case of documentary pay- 
ment bills. The special reason is not hard to find. The 
goods against which a term bill is drawn often reach their 
destination long before the bill matures. It may be of the 

i« See an article upon "Financing the Cotton Crop," by Mr. John 
J. Arnold, in the Annals of the American Academy of Political and 
Social Science, September, 1911, p. 290. 



L20 FOREIGN EXCHANGE 

greatest commercial importance to the importer (drawee) 
to secure them a1 an earlier date than this maturity, and 
where they are of a perishable nature it may be imperative. 
But under the documentary instructions the bill of lading 
and merchandise are not to be released until the draft is 
paid. Suppose A of New York sends merchandise to B 
of London, the price of which is £10,000, it being under- 
stood that A is to draw a documentary payment bill on B 
for this amount at 90 days' sight. A ships and draws on 
July 1st. The draft is sold to a local banker, is forwarded 
by him to London and is there presented to B, who accepts 
perhaps on July 8th. The instrument becomes payable 93 
days after July 8th (there being three days of grace) and 
so matures on October 9th. The date of the arrival of 
the goods in London depends on the manner of their for- 
warding, but they might easily be docked say by July 15th. 
In this case they would be physically available 86 days 
prior to the maturity of the draft. If we suppose now 
that B finds it necessary to obtain these goods immediately, 
we have an illustration which makes clear the origin of 
the need to make prepayment. 

The question perhaps arises, why make the draft run at 
ninety da} r s' sight under these circumstances? Why not 
draw it at say ten days' sight? The short draft is some- 
times used, but its employment is by no means necessary. 
In point of fact the importer would, other things remain- 
ing the same, prefer to be drawn upon at ninety days rather 
than for any shorter period of "usance." We shall be bet- 
ter prepared to see why this is the case after we have looked 
further into the system of prepayment of bills. 

Assuming then that the importer has need to obtain his 
goods on July 15th, the instructions being "documents 
for payment," he can procure them either (1) by making 
a prepayment of the bill on that date, or (2) by inducing 
the bank which holds the draft to let him have the bill of 



THE DOCUMENTARY TRADE BILL 121 

lading without prepayment despite the instructions. There 
are reasonable arrangements under which a bank might 
make the latter concession on its own responsibility, 20 but 
suppose the plan of action is prepayment. Should the 
drawee 's offer mean prepayment of the full sum due on the 
draft at its maturity, there could, of course, be little ques- 
tion in practice as to the acquiescence of the holder. But 
the drawee will hardly expect to prepay on precisely these 
terms. He will request that an allowance be made him 
on account of interest for the .number of days by which 
his payment anticipates the date of maturity. That is, 
he will ask for what is sometimes called a "rebate of 
interest," and thus for the privilege of making an advanced 
retirement of the bill for a somewhat lesser sum than the 
full amount due at maturity. If he discharges the draft 
say 86 days before it is due, the bank which has held it 
will have 86 extra days "use" of the money paid over. 
On the other hand, if he waited till maturity to pay, he 
himself would have 86 more days use of this amount than 
if he makes the prepayment. Money being "worth its 
interest," it is the custom to allow the drawee a "rebate 
of interest" for payment prior to maturity. In practice 
this is really a rebate of discount rather than of interest. 

In the case of ordinary obligations, no right of prepay- 
ment with a concession in the nature of a rebate of in- 
terest, can be said to exist in law or custom. But in. the 
single case of the documentary payment bill of exchange, 
there is a customary right of this kind of great importance 
and long standing. Careful search by the present writer 
has, however, failed to disclose any reference to this matter 
in the statutory law of England or of the United States, 
and the right seems never to have been litigated before the 
courts of either country. Even the case law appears to be 

20 Compare § 43 and the discussion therein of the "trust receipt." 



L22 FOREIGN EXCHANGE 

silent on the subject. If the search has not been faulty, 
this is a singular fact. 

The right of prepayment with a rebate of discount being 
assumed, the question becomes, "At what rate shall this 
rebate or allowance be calculated?" In countries upon 
which documentary payment bills are drawn in large and 
regular volume, there is a public and so to say standard 
(though not unvarying) rate employed for this purpose. 
This is the retirement rate of discount, called also the 
"rebate rate" and again the "rebate rate of interest," the 
last designation being, strictly speaking, inaccurate. 21 It 
will be found to be a rate of discount in all cases. Where 
prepayments take place sporadically, as in the past in tht 
United States where comparatively speaking few docu 
mentary payment bills have been domiciled, the rate is left 
to private and individual adjustment between the drawee 
and the banker holding the bill. This may change in this 
country in the near future. But in countries where pre- 
payment is standardized there is a public and regular rate. 
This is better because it prevents the right of prepayment 
becoming involved in disputes as to the rate of rebate to be 
allowed. 

To give a formal definition: the retirement rate of dis- 
count is the rate used to compute the sum which the ac- 
ceptor of a "documentary payment" bill must pay to the 
holder in order to redeem or discharge it before the date 
of its maturity, this prepayment having as its purpose the 
obtaining of the bill of lading attached as collateral. The 
customary retirement rates are: 

For bills payable in England. — One-half of 1% above the ad- 
vertised rate of interest for short deposits allowed by the leading 
London joint stock banks. This will ordinarily mean that the 

21 "Interest" allowed under the rehate rate can be called such only 
in the sense of "interest in advance," and this is accurately described 
as discount. Compare § 17. 



THE DOCUMENTARY TRADE BILL 123 

retirement rate is 1% below the Bank of England's Official Mini- 
mum Discount rate (see § 60 below). 

For bills payable in France, Italy, Belgium, Germany. — 
The same as the minimum rates of discount of the national or 
central banks of these countries. 

For bills payable in other countries. — The current rate of rebate 
set by the leading banks of the countries. 

In Central and South America, and in north-west and east 
Africa, the rebate rate, according to Mr. A. J. "Wolff, is agreed 
upon by the drawer and drawee, and is usually 6% per annum. 22 

§ 36. The actual mercantile receipts for and costs of the 
goods. — The price quoted in an international transaction is 
always in a way nominal, at least for one of the parties, 
if not for both. In our most recent illustration, £10,000 
was the price of the goods, but it was neither the exact 
figure paid for them by the importer nor the amount re- 
ceived by the exporter. The latter, in fact, took in dollars 
and not pounds at all. In explaining the simple calcula- 
tions required to find true costs to importers and returns 
to exporters, we shall ignore the less usual instances of 
the quotation of price in the money of a third country, 
and consider only the tw r o cases of quotation in the money, 
first, of the importer's country, and second, of the ex- 
porter's country. Let us now continue with the illustration 
set forth in the preceding section. On July 1st, A made a 
shipment to and drew upon B, the draft being for £10,000 
and at 90 days' sight. The goods arrived on July 1 5th and 
B prepaid the draft on that date. The sum paid over to 
retire this bill is the first cost of the goods to B. If any 
charges were left for B to pay they would have to be added. 
The face value of the bill being £10,000 (or the price of the 
goods), the amount required to prepay it will depend mi the 

22 See "Foreign Credits," by A. J. Wolff, Special Agent's Series, 
No. 62, U. S. Department of Commerce and Labor, Washington, 
1913, p. 29. 



124 FOREIGN EXCHANGE 

current retirement rate of discount. Supposing the Bank t 
Rate to stand at 4 1 2% and the deposit allowance rate of 

the joint stock banks therefore to be 3%, the retirement | 

rate will be 3 1 /£%. Since retirement takes place 86 days I 

prior to maturity, the amount payable to discharge the ] 
bill is computed as follows: 

Face or maturity value of the draft £10,000.00 

Rebate of discount, for 86 days at 3}&% per 

annum 82.47 

( 8 %65><3%% of 10,000) 

Amount required for prepayment of draft £ 9,917.53 

Or 9,917 pounds, 10 shillings and 7 pence. 

A's returns from his export consist simply in the amount 
received by him from the sale of the draft for £10,000 to 
a local banker, and this depends on the current rate of 
exchange for the type of bill A has to offer. (If the draft 
were deposited for collection instead of being sold, A's 
return will be the net proceeds of the collection, when these 
proceeds come to hand, and these will be governed to a small 
extent by commission charges but principally by the future 
position of a rate of exchange, whether it be a rate in New 
York on London or one in London on New York.) A 
banker's buying rate for A's draft will hinge on factors 
to be discussed at a later point in this book. Let us sup- 
pose it to be 4.81. A's returns are then simply $48,100. 

Draft for £10,000 sold at 4.81 per pound $48,100 

If we change the length of life of the draft from 90 to 
60 days, while assuming all other independent factors un- 
changed, we shall find that the goods will cost the importer 
something more than before and pay the exporter something 
more. The cost to the importer will be increased because 
the date of the maturity has been shifted 30 days nearer to 



THE DOCUMENTARY TRADE BILL 125 

the day of retirement, and there will consequently be 30 
days less time for which the rebate of discount is allowable. 
The draft would mature 63 days after July 8th, or on 
September 9th. Being prepaid on July 15th, it has at the 
time 56 instead of 86 days to run. The first cost of the 
goods to the importer will therefore be £9946.3, found as 
follows : 

Face or maturity value of the draft £10,000. 

Rebate of discount, for 56 days at 3^% per 

annum 53.7 

( B %esX 3 ^% of 10,000) 

Amount required for prepayment of draft £ 9,946.3 

With the supposed reduction of the length of life of 
the draft, exporter A will obtain increased returns be- 
cause he will be able to sell a sixty days' sight draft at a 
somewhat higher rate than one at ninety days' sight. We 
assumed a rate of 4.81 for the longer draft. Let us assume 
roughly the rate of 4.8240 for the shorter one under the 
same conditions. The rate will be higher precisely because 
the shorter draft will be subject, to a lesser discount if pre- 
paid abroad or, at any rate, will yield its full maturity 
value at an earlier date than would the longer bill if there 
is no prepayment. A's returns in the new case will be 
simply $48,240, calculated thus : 

Draft for £10,000 sold at 4.8240 per pound $48,240 

If we compare the results from the employment of the 
two different drafts, we obtain the following : 

Cost to Importer Returns to Exporter 

Draft at sixty days £9,946.3 $48,2 10 

Draft at ninety days 9,917.53 48,100 



Result of shorter term. . . .£ 28.77 increase, $ 140 increase. 



126 FOREIGN EXCHANGE 

Thus to reduce the length of the draft is tantamount to 
raising the price. In general, of course, an importer who 
agrees to submit to a shorter draft rather than a longer 
one, will expect and receive a price quotation lowered about 
enough to compensate for the change. The exact reduction 
in price which would be necessary to effect this compensa- 
tion could always be calculated if the governing discount 
factor is known. 

In the fourth paragraph of the letter of hypothecation 
which was shown in § 33, the drawer of the bill gives assent 
to any plan of partial deliveries of the goods to the drawee, 
to which the bank or holder may care to agree, provided 
the drawee makes prepayments of proportionate amounts 
on account of the bill. The privilege of taking out partial 
deliveries might be of great convenience to the drawee. If 
he should have immediate need for say only a fifth of the 
consignment at the time of its arrival, it would be necessary 
to find only sufficient present cash to prepay a fifth part 
of the draft. Suppose then that importer B finds it de- 
sirable to take out a fifth of the goods on July 15th, and 
one-half on August 20th, and the remainder on August 
30th. The schedule beneath will show the payments on 
account required, and the manner of their calculation. 









Propor- 














tionate 














amount 




Days by 










of face 


Current 


which 








Portion 


value of 


retire- 


prepayment 








of goods 


£10,000 


ment 


anticipates Rebate of 


Amount of 


Date 




taken 


draft 


rate 


maturity discount 


prepayments 


July 


15 


One-fifth 


£2,000 


3%% 


86 £16.49 


£1,983.51 


Aug. 


20 


One-half 


£5,000 


3% 


50 £20.55 


£4.979.45 


Aug. 


30 


Three-tenths 


£3,000 


4% 


40 £13.15 


£2,986.85 



The three prepayments effect a complete discharge of the 
debt. It will suffice to explain the method of calculating 
any one of them. Take the second. On August 20th the 
importer desires to obtain one-half of the total quantity 
of goods shipped. He will therefore be required to prepay 



THE DOCUMENTARY TRADE BILL 127 

one-half of the total face value of the draft, or £5,000. 
On this date the retirement rate happens to be 3%, and 
the particular prepayment takes place 50 days before the 
due date of the instrument. Therefore the rebate of dis- 
count for this prepayment will be 5 %65 of 3% of £5,000, 
or £20.55 ; and the required prepayment will be 5,000 less 
20.55, or £4979.45. 

It remains now to calculate the mercantile costs and pro- 
ceeds of the export in the case where the exporter's price 
is quoted in the money of his own country. Suppose, then, 
that in this same export the price is quoted as $48,200. 
As before, let a 90 days' sight documentary payment draft 
be drawn upon B, the importer. Under the new supposi- 
tion everything will be as before except that the number 
of pounds of face value of the draft will not be exactly 
predetermined. The new arrangement will mean that A is 
to draw for a .sufficient number of pounds to enable him to 
sell the draft for $48,200, at the existing rate of exchange. 
At the time the price in dollars is quoted this rate of ex- 
change will not be precisely foreknown. Suppose that 
when the shipment is made and the draft is ready for sale, 
it turns out to be 4.80 1 /2. The size of the draft to be drawn 
by A would then be computed as follows : 

4.805)48200.000(10031.22 
4805 



15000 

14415 

5850 
4805 

10450 
9G10 

8400 
9G10 
For each pound of draft sold A receives $4,805. 48,200 



L28 FOR EI ON KXCIIAXGF, 

contains 4,805, 10031.22 times. Therefore 10031.22 pounds 
of draft would have to be drawn and sold. This is other- 
wise expressed £10031. 4s. 5d. In the present case, the 
importer takes what is called the "risk of exchange" for 
the number of pounds of draft which he will have to pay 
will vary according to the position of the rate of exchange 
at the time when the shipment is made. As our illustration 
has turned out, his taking this risk makes the goods cost 
him £31.22 more than before. In the earlier case the ex- 
porter took the risk of exchange, because the number of 
dollars return that he would receive was not precisely fixed 
in advance but depended on the rate at which he could 
sell the draft for the fixed amount in pounds agreed upon. 
In connection with the subject of prepayment, the ques- 
tion doubtless suggests itself, why not draw documentary 
payment drafts ' ' payable on the date of arrival of the mer- 
chandise covered by the attached bill of lading." The 
writer has been given to understand that drafts of this 
tenor are not unknown, but they are open to two objections. 
In the first place, an instrument drawn in this manner 
would not be negotiable. It would be transferable, but it 
would fail of negotiability in the peculiar legal sense ex- 
plained in § 9 of this book. The reason is because it is 
not made payable at what the law regards as a fixed or 
determinable future time (compare the definitions of ne- 
gotiable bills and notes as given on pages 11 and 18 ). 23 
A determinable future time does not mean one that is neces- 
sarily predeterminable at every stage of the instrument's 

23 "An instrument payable upon a contingency is not negotiable, 
and the happening of the event does not cure the defect." Uniform 
Law as already cited, § 23. If an instrument is to be negotiable, 
it must, as regards the time of payment, be payable either ( 1 ) on 
some definite date specified in the instrument or on a day a desig- 
nated period before or after a designated date, or (2) on demand 
or at sight, or (3) at the end of a specified period after demand or 
sight, or (4) on, or at a fixed period after, the occurrence of a 



THE DOCUMENTARY TRADE BILL 129 

existence, but one which is certain to come and which is 
precisely determinable (and not indefinite) when it does 
come. A draft payable on the date of arrival of a desig- 
nated consignment of merchandise is not payable at a time 
which is certain to come. The merchandise might be lost 
and never arrive. It is eminently desirable from the stand- 
point of a purchaser that a bill should be truly negotiable in 
form, and therefore bills paj'able on the arrival of merchan- 
dise suffer from a fundamental defect. 24 There is a second 
obvious objection to this style of draft, although it is an 
objection from the importer's standpoint only, because the 
instrument deprives the importer of the valuable and con- 
venient option which he ordinarily has of taking out the 
goods and paying for them at any time selected by himself 
within a considerable period. 

The documentary sight draft is not unknown to foreign 
trade but its use deprives the importer of the option just 
mentioned, or to make virtually the same point, this draft 
without supplementary agencies furnishes no means of shift- 
ing the burden of financing the merchandise movement 
to the bank or money lender. With regard to the em- 
ployment of time bills, but bills of short usance, a news 
item in the Wall Street Journal (of New York) for May 
21, 1913, page 8 (article on "Money") is of interest. It 
explains that at the time the North American Grain Ex- 
porters' Association had just induced the representatives 
of the British grain trade to agree to pay for grain ship- 
ments thereafter by submitting to seven days' instead of 
sixty days' sight drafts. To quote, "the origin of the prac- 
tice of drawing bills at sixty days' sight against grain 
shipments dates back to the days when it took a grain- 
specified event, which is certain to happen, though the time of 
happening may be uncertain beforehand. 

2 * Special incidental contracts might, however, be employed to 
preserve the rights of recourse on indorsees (if any) and the drawer. 



L30 FOREIGN EXCHANGE 

bearing vessel nearly two months to cross the ocean. Nowa- 
days, however, grain is carried in fast-moving steamers, 
which reach their desl inal ion in less than ten days. In 
other wonls. the cargo arrives practically at the same time 
thai the bill covering it arrives and is accepted." But 
rapid transportation is not likely to change the general 
custom of drawing documentary payment bills at sixty and 
ninety days' sight against a great variety of types of ex- 
ports, because the drawing of bills of this kind coupled 
with the privilege of prepayment, seems on the whole the 
most suitable among all methods of settlement by draft on 
the importer in person as drawee. 

The drawee may obtain the funds with which to make 
prepayment of a documentary draft, by borrowing from 
some bank against the collateral of the very goods covered 
by the draft, for as soon as the draft is retired the goods 
are released and become available as security for the new 
loan. A loan of this character would be much like any 
other loan on merchandise collateral or against warehouse 
receipts, and the detail of its terms and the subsequent 
handling of the goods would depend upon the local customs 
and circumstances affecting such arrangements. 



CHAPTER VII 
THE BANK CREDIT AND LETTER OF CREDIT 

§ 37. The nature of the commercial credit. — The purpose 
of a commercial letter of credit is to enable an exporter 
to draw his draft upon a bank instead of upon the im- 
porter. Before proceeding we had better recapitulate. An 
exporter may obtain payment (1) by receiving a remittance 
of exchange (whether directly or through some bank) or 
(2) by himself drawing exchange. If the exporter draws, 
the drawee may be either (a) the importer or (b) some 
bank which has been induced to serve in his stead. Where 
the importer is the drawee, we have the trade bill, which 
has been considered in the chapter just brought to a close. 
We come now to the case of the merchant's draft on a 
bank. The right of a merchant to draw upon a bank on 
account of an export is known as a "commercial credit" 
and also as a "bank credit." The commercial letter of 
credit is the instrument or document which bears witness 
to, or affirms the existence of the bank credit. It com- 
monly takes the form of a letter of information and au- 
thorization addressed to the merchant who is empowered 
to draw, and hence its name. There is one other kind of 
letter of credit, having a certain degree of importance in 
exchange dealings, known as the traveler's or the circular 
letter of credit. Of this we shall speak later. 

A description of the uses of the bank credit in inter- 
national trade under the conditions existing before the 
present European conflict, would necessarily be very largely 
a story of sterling exchange. Although the war has 

131 



132 FOREIGN KXCIIANGE 

broughl sonic important modifications into the exchange 
methods of the world, and although certain of these will 
probably persisl when peaceful commerce is resumed, the 
besl way at present writing, and the way we shall follow, 
to explain the system of bank credits is to deal with it 
as it was before the war broke forth, resorting to concrete 
illustrations that would be typical then. A very great part 
of llic system will almost certainly endure, and such changes 
as establish themselves will be primarily alterations in 
concrete detail, which will leave the general scheme ex- 
plicable on the same lines of argument as before. When 
we shall find New York banks accepting drafts both drawn 
abroad and authorized by banks foreign to the United 
States, we shall be confronted with nothing new in the way 
of general system. Illustrations founded on ante-bellum 
conditions will need to be altered only by changing the 
nationality of the banks involved. 

The simplest instance of the commercial letter of credit 
is the case where the bank which writes it gives an author- 
ization for drafts to be drawn upon itself. A slightly more 
complex case is one where the writer authorizes the draw- 
ing of drafts on a bank distinct from itself and located 
in a different country. To illustrate the simpler case first, 
suppose an English importer of goods from the United 
States, obtains from a London bank a credit in favor of 
the American exporter. To do this he will enter into 
certain agreements with the bank the general character 
of which we shall consider later. The bank will write 
a letter of credit, addressed to the American, which it 
may however hand over to the English merchant for for- 
warding. Assume the goods to be sold for a price named in 
pounds sterling. As the American makes the appointed 
shipment he draws a documentary draft for the number of 
pounds the consignment is worth at the price agreed upon, 
and makes the draft run for the number of days' sight 



THE BANK CREDIT AND LETTER OF CREDIT 133 

provided for in the letter, usually sixty or ninety. He 
makes the London bank the drawee. Armed with the letter 
of credit as his credentials, he approaches a local American 
bank with an offer of the draft for sale. Taking it for 
granted this bank is certain of the genuineness of the 
letter and of the correctness of the documents and draft, 
it will stand ready to buy at a higher rate than if the draft 
were drawn merely upon the English importer himself as 
a private person. Perhaps in the latter case it would be 
t willing to take the draft only for collection. Stated simply, 
the advantage of the bank credit to the exporter is that it 
gives great assurance of the salability of his draft and this 
at a favorable rate. The purchasing bank knows that 
when the draft reaches London and is accepted according 
to agreement by the drawee bank, it will become an ex- 
emplar of the highest class of paper in that money capital. 
It will become the unconditional obligation of a London 
bank. The fact that the drawer, as a party secondarily 
liable, is a mere merchant will make little or no difference. 
This acceptance will be discountable in London at the lowest 
market rates and will have the highest present value in 
pounds after its arrival. For these reasons it is a good 
purchase on this side of the water and a relatively high 
price can be paid for it. 

§ 38. The grant by one bank of the right to draw on 
another bank. — Our last illustration has shown in brief 
how an English importer might provide for settlement 
by arranging for a bank credit in favor of his foreign 
creditor to be, namely the exporter. An importer in prac- 
tically any country in the world may also take out a bank 
credit for the same purpose. Suppose an American makes 
application to one of our banks for a credit in favor of 
an Italian house which is about to make him a shipment. 
If this bank issues a letter authorizing drafts upon itself, 
the plan of settlement is as a matter of system identical 



134 FOREIGN EXCHANGE 

wit 1 1 thai of the preceding illustration. In this instance 
we have an American bank providing for an American 
importation by authorizing a draft on itself payable in 
American dollars, while in the former case we had simpjy 
an English bank providing for an English importation 
by authorizing a draft on itself payable in English pounds. 
Bui under ante-bellum conditions, and these were condi- 
tions that had persisted for a long period and ha$ become 
normalized, neither the banks in the United States nor 
those in most countries other than England did much 
business in credits permitting time drafts upon them- 
selves. 1 Instead they issued in the great majority of cases 
what are called "sterling credits." These comprise any 
credits under which the beneficiaries are empowered to 
draw drafts in pounds on English banks, whether the 
authorization issues from the English banks themselves or 
with their permission from banks in other countries. There 
are also similar and self-explanatory terms such as "dollar 
credits," "franc credits," and so on. Before the war 
American banks were driving a large and ever-increasing 
traffic with our importers in commercial credits, as we 
call them, but the vastly preponderating part of these 
were sterling credits. A few were franc or mark credits, 
while almost none were dollar credits. French and Ger- 
man banks were, however, issuing a certain volume of 
credits upon themselves. During the progress of the war 
our banks began the issue of dollar credits, in noticeable 

i It is the generally accepted opinion that prior to the enactment 
of the recent banking reform laws, national banks in the United 
States (or those chartered by the Federal government) did not have 
the legal power to submit to or accept time drafts. However, this 
question had not been passed upon by the Supreme Court of the 
United States. In any event it may safely be said this mere legal 
disability of our leading class of banks had little or nothing to do 
with the failure up to that time of the acceptance business to 
develop in this country. , 



THE BANK CREDIT AND LETTER OF CREDIT 135 

volume for the first time in our history. The extensive and 
permanent use of the dollar draft in Latin-American coun- 
tries in connection with commerce to and from the United 
States seems now assured (1919), and it is quite possible the 
sterling draft will never regain its ante-bellum importance 
in relation to this commerce. 

The authority under which an American bank, or any 
other non-English bank, issues a sterling credit, is derived 
from the grant to it by an English correspondent bank 
of a so-called "acceptance account," of which we shall 
speak in more detail later. 2 It appears then that a sterling 
credit may originate in two ways: it may be issued (1) 
by an English bank upon itself, or (2) by some foreign 
correspondent of an English bank, or by an outlying branch 
bank upon a London office. If it is written by an English 
bank itself we may assume it is to finance an import into 
Great Britain. But if issued by a bank in some country 
other than England, it may be, and in fact more frequently 
is, connected with a movement of merchandise which neither 
goes to nor comes from England. To make a statement 
general in form, an export of goods from country B to 
country C may be settled for by means of a credit on 
country A issued in country C. The country A par ex- 
cellence of the world has been England. An import by 
Italy from the United States, or an import by the United 
States from Italy, or a shipment of goods between almost 
any two countries in the world, may give rise to a sterling 
credit which will be issued by a bank in the importing 
country. This is the fact which lies at the basis of such 
statements as that the commerce of the world is settled 
"through" London. Mr. H. K. Brooks says in his "For- 
eign Exchange Text-Book" (dated 1906) that "probably 

2 This account may serve also as the basis of the drawing of so- 
called "finance bills," an operation of distinct character. Compare 
Chapter XII. 



i:;ii FOREIGN EXCHANGE 

ninety per cent, of all letters of credit issued throughout 
the world are drawn in English money" (page 7). This 
signifies doI thai ninety per cent, of the world's commerce 
•tied through London, but merely that ninety per cent. 
of the commercial and travelers' letters of credit are for 
sterling, in the next section we shall begin the serious 
development of the subject of the bank credit by presenting 
an illustration of the settlement of an export from Italy 
to the United States by means of a credit in London. 

§ 39. How merchants make use of commercial credits. — 
Let it be supposed a Chicago firm arranges to import a 
consignment of olive oil from Italy. The price at which 
the Italian agrees to sell may conceivably be expressed 
in lire, the money of Italy, or in dollars, the money of 
the United States, or in pounds sterling, the money of 
England ; not to speak of the possibility of a price in francs 
or marks, the money of some third country other than 
England. But the general practice in the case of exports 
into the United States is for the exporter to name his price 
in the currency of his own country, and in this illustration 
we shall assume that the price is set in lire. The Ameri- 
can, the importer, explains the proposed transaction to 
his bank and procures from it a sterling letter of credit 
in favor of the Italian house, upon terms to be considered 
presently. Beneath is a specimen of such a letter. 

Xo. G. C. 0000 Capital, $10,000,000.00 

£1,000. * * * Surplus, $10,000,000.00 

The Hundredth National Bank op Chicago 

Chicago, July 1st, 1913. 
The Italian Olive Oil Export Co. 

Genoa, Italy. 
Gentlemen : 

We hereby authorize you to value on the London Joint City 
and Midland Bank, Ld., Threadneedle Street, London, at sixty 
days' sight for any sum or sums not exceeding in all one thou- 



THE BANK CREDIT AND LETTER OF CREDIT 137 

sand pounds sterling for account of The American Import Co. 
for invoice cost of olive oil to be shipped to The American Im- 
port Co., Chicago, U. S. A. 

The Bills of Lading must be issued to the order of shipper 
and indorsed in blank. 

The Shipment must be completed and the Bill drawn on or 
before December 31st, 1913, and the advice thereof (in dupli- 
cate) sent to The London Joint City and Midland Bank, Ld., 
London, accompanied by Bill of Lading and abstract of Invoice, 
on receipt of which Documents the Bills will be duly honored. 

The remaining Bills of Lading with certified Invoices and 
Consular Certificates must be sent by the Bank or Banker nego- 
tiating drafts to The New York Customs Brokers Co., New York, 
U. S. A., for account of The Hundredth National Bank of Chi- 
cago, and a certificate to that effect must accompany draft. 

We hereby agree with drawers, endorsers and bona fide hold- 
ers of drafts drawn under and in compliance with the terms of 
this credit that the same shall be duly honored upon presentation 
at the counter of The London Joint City and Midland Bank, Ld., 
London. 

Drafts under this Credit must bear upon their face the words : 
Drawn Under The Hundredth National Bank op Chicago 
Credit No. G. C. 0000. Dated July 1, 1913. 

Respectfully yours, 

» # • • 

Manager of Foreign Exchange Department. 

This instrument may be divided into three parts. (1) 
In the first, it confers upon the party in whose favor it 
runs (in this case the party to whom it is addressed), an 
authority to draw upon a given bank on account of a 
specified commercial transaction or set of transactions. 
(2) In the second, it lays down certain requirements re- 
garding the manner of use of the credit so conferred. It 
prescribes the kind (as documentary) and length of life 
of the draft or drafts, and makes clear that no draft is 
to exceed in value the invoice cost 3 of the shipment against 

'■> The authorization to "value" on the London Joint City and 



FOREIGN EXCHANGE 

which it is drawn. It states the limit beyond which the 
total of all drafts musl aol ascend, iii this instance £1,000. 
It demands the presence of certain documents, such as the 
certified invoice, and provides for the disposition of the 
documents. It gives the date of expiry of the credit, after 
which oo shipments may be made and drafts drawn under 
it.* (3) The third part of the letter contains the engage- 
ment of the writer bank that all drafts drawn under it 
and in compliance with its terms shall be duly honored. 
The Italian Olive Oil Export Company is the beneficiary: 
the American Import Company is the party for whose 
account the letter is issued. The instructions that the 
bills of lading are to be made out to the order of the shipper 
and indorsed by him in blank, have the same significance 
here as in the case of the documentary trade bill (compare 
§ 31). Sometimes the shipper is directed to have the bills 
of lading made out to the order of the bank itself, that 
is, to the order of the bank which writes the letter of 
credit, this being the institution that takes the credit risks 
and the one that is in any case to have the claim upon the 
merchandise as collateral security. 

One copy of the bill of lading is to remain attached to 
the draft until the latter is presented to the drawee bank 
for acceptance. This copy serves to show the accepting 
bank that the goods have been shipped and the draft is 
in proper order. In the case of all drafts drawn on banks 
the instructions are documents for acceptance, whether 
these instructions are expressed or implied; and upon ac- 

Midland Bank "for invoice cost of olive oil to be shipped" etc., means 
a power to draw on this bank a draft against each shipment not to 
exceed the value of the shipment as stated in the "invoice" or bill 
of goods rendered by the selling to the purchasing merchant. 

* By making proper arrangements the importer may with the 
consent of his bank have the credit extendedteither with respect to 
the date of its expiration or with respect to the total value of 
drafts authorized. 



THE BANK CREDIT AND LETTER OF CREDIT 139 

cepting this draft the drawee bank will detach the accom- 
panying copy of the bill of lading and all other collateral 
documents. It will forward these to the bank which wrote 
the letter of credit. All other copies of the bill of lading 
will be detached by the banker first buying the draft and 
forwarded directly to the "New York Customs Brokers 
Company," this being the fictitious name we have chosen 
for a house engaged in the business of receiving imported 
merchandise and clearing it through the American customs 
house, acting as an agent for interested banks or merchants. 
Any bank dealing in foreign exchange in a large way will 
have established relations with such agents at various ports 
of entry or points of transhipment. 

The beneficiary of a credit may exhaust it in one draft 
or he may make a number of partial shipments and draw 
a number of separate drafts under it. In the latter case 
it is his privilege not to surrender the letter of credit 
to the banker buying the first draft. He needs to keep it 
to show his authority for subsequent drafts. To protect 
itself against mistaken or fraudulent over-drawing, the 
bank which issues the letter requests every banker that 
buys a draft under it, to make a record of the purchase 
in a space provided in the letter for that purpose. Such 
entries will show the progressive exhaustion of the credit. 
The banker who purchases the final draft is required to 
take up the letter, cancel it, and attach it to the draft, 
from which it will be separated by the drawee bank at the 
time of presentment for acceptance. We need not follow 
its history as a mere document of record from this point 
forward. 

In our illustration we are assuming that the Italian 
Olive Oil Export Company ships to the American Import 
Company a consignment of oil sold at a contract price of 
10,000 lire. Taking the bills of lading, insurance certi- 
ficate, and other documents which originate in this ship- 



140 FOREIGN EXCHANGE 

incut, it prepares a sterling documentary bill. Included 
among the documents will be the invoice certified by the 
local American consul, this paper being called for by the 
letter of credit. It is the Italian Company's privilege to 
draw upon the London Joint City and Midland Bank, Ltd., 
against this shipment, a draft for such a number of pounds 
Sterling that the instrument can sell at the exchange rate 
of the day for the 10,000 lire due on account of this ship- 
ment. 

What the precise market rate of exchange of the day is, 
will be declared by the Italian banker who buys the draft. 
The American bank and the American importer rely upon 
this banker to name a fair rate. The lower or cheaper 
this rate, the larger the number of dollars the American 
merchant will have to pay for his goods in the end. An 
existing market rate is more or less of an established fact, 
and through regular channels of information the American 
parties have a check upon the rate named by the Italian 
bank. If there were collusion between the Italian merchant 
and banker it would become manifest, and in any case most 
foreign banking is conducted on too high a plane to make 
this common or probable. As a matter of theoretical in- 
terest, however, it may be pointed out in passing that the 
draft-buying banker would profit by quoting a low buying 
rate, insomuch as the lower the rate the larger the number 
of pounds sterling payable in London he would obtain 
for a given outlay of Italian lire, whereas it would make 
no difference to the merchant who draws the draft how 
low the rate might be, since he is entitled to draw for 
enough pounds to net him a predetermined sum of lire. 
The more pounds drawn for, the larger the number of 
pounds the American merchant will have to pay for in 
the end. 

The Italian exporting company has a sixty days' sight 
draft on a London bank to offer. Assume that the rate 



THE BANK CREDIT AND LETTER OF CREDIT 141 

for this type of exchange is 25.10 lire per pound. The 
number of pounds of face value of draft required to yield 
10,000 lire to the drawer is calculated simply as follows : 

25.10)10000.00(398.406 
7530 



24700 
22590 

21100 
20080 

10200 
10040 

16000 
15060 

This shows that a sum of 10,000 is 398.4 times as great as 
a sum of 25.10, and that if the drawer receives 25.10 lire 
for each pound of exchange sold he must sell £398.4 to 
obtain 10,000 lire. By the sale of this bill the Italian 
Olive Oil Export Company receives payment for its ship- 
ment in full in present cash. In ordinary course it will 
have nothing further to do with the progress of the draft. 

§ 40. Banking operations involved and the acceptance 
account. — The use of letters of credit necessitates of course 
a number of banking operations. In discussing these we 
can do no better than to continue with the illustration al- 
ready developed. The simpler case, where a bank issues 
a credit upon itself rather than upon some other institu- 
tion, will then need no special discussion. Let us begin 
with 

I. The draft-buying bank. — The bank in Italy which 
purchases the sixty days' sight sterling draft of the Italian 
Olive Oil Export Company may, in ordinary times, make 
one of two possible dispositions of this instrument. (1) 



L42 FOREIGN EXCHANGE 

It may remil il forthwith to its London correspondent for 
discount and cash credit. (2) Exchange and money market 
conditions being appropriate, it may choose a course in some 
respects quite opposed and withhold the draft from dis- 
count, with a design to collect in London its full face value 
at maturity instead of securing an advance of the lesser 
sum of its discounted present value. The second course 
of action is called an investment in exchange. Invest- 
ments in exchange will be the special subject of a later 
chapter 5 and we shall for the present confine our attention 
to the case of remittance for immediate discount and cash 
credit. As soon then as the draft arrives in London, its 
domicile city, it will be presented by the London corre- 
spondent (or perhaps branch) of the Italian bank to the 
drawee bank for acceptance. Acceptance having been pro- 
cured, the draft will be discounted at the prevailing rate 
for the acceptance of a bank in the London money market 
and the proceeds of the discount will be credited to the 
deposit carried by the Italian bank with its London corre- 
spondent. The correspondent may effect the discount 
either (1) by selling the draft to any dealer or banker who 
may desire to purchase it, that is, by selling it in the "open 
money market" of London, or (2) by buying the draft 
itself, that is, by itself making an advance of its present 
value to the Italian bank's account. It may adopt the 
latter plan if it happens itself to be looking for an oppor- 
tunity to invest in paper of this character, amount, and 
length of life. It will in this case pay the same price as 
could be procured in the open market. "Which alter- 
native is selected makes no difference to the remitting 
bank. 6 

From this point forward the Italian bank has in regular 
course no further concern in the life of the draft itself. 

s Hee Chapter XL 

6 Compare, however, § 62 beneath, on the arrival discount rate. 



THE BANK CREDIT AND LETTER OF CREDIT 143 

We have not, however, concluded with the operations im- 
posed on this bank by reason of its purchase of the instru- 
ment. Every purchase of sterling exchange made at the 
bank's home office in Italy means an expenditure of lire 
there and a gain of pounds in the bank's London deposit. 7 
Such a purchase has, therefore, taken by itself the effect 
of transferring some of the bank's funds from Italy to 
London. In order to prevent its working capital from 
being gradually removed to London, the bank in Italy must 
in the long run manage to sell as much sterling exchange 
as it buys^/ For sales of exchange have the effect of bring- 
ing in money in Italy and of reducing the London deposit, 8 
that is, the effect of making a re-transfer of funds from 
London to Italy. And so we must conceive of each pur- 
chase of a sterling draft, whether drawn under a letter 
of credit or not, as involving ultimately the countervailing 
operation of the sale of an equivalent amount of sterling 
exchange by the purchasing bank in Italy. Our meaning 
is of course that the total .purchases of sterling for a day 
must be substantially evened up by sales on the same day 
or very shortly thereafter. Each purchase thus theoret— — 
ically involves a countervailing sale. Profits come from 
a difference between the buying and selling rates. (The 
Italian bank is naturally under an equal necessity of buy- 
ing as much exchange as it sells, if it designs to prevent 
the funds in the London balance from flowing back to the 
home office.) The issue of the letter of credit of our illus- 
tration means, then, the purchase of sterling exchange by 

7 In case the Italian bank invests in a long sterling bill, the gain 
in pounds in London is not eliminated but is merely postponed. 

8 The sale of sight bills on the London correspondent is simply a 
case of cheeking on the balance with that correspondent and reduces 
this balance or deposit in precisely the same way as the drawing 
of a check by any ordinary depositor with a bank. Regarding the 
sale of long bills on the correspondent, see Chapter XII. 



144 FOREIGN EXCHANGE 

BOme Italian bank and further in regular course a counter- 
vailing sale of Bterling exchange by the same bank upon 
the Italian market for sterling. 9 

II. Tlu accepting bank. — In the .illustration in hand, the 
accepting bank is assumed to be the London Joint City and 
Midland. (1) The first event at this bank connected with 
the letter of credit will be its receipt from its American cor- 
respondent, the Hundredth National of Chicago, of a copy 
of the letter, or perhaps some other form of advice, which 
will convey full information as to what may be expected in 
the waj- of drafts drawn by the Italian Olive Oil Export 
Company. (2) The next event will be the presentment of a 
draft of this company to the London Joint City and Mid- 
land Bank for acceptance. The presentment will be made 
by the correspondent of the Italian draft-buying bank. 
The American bank has represented that acceptance will 
be granted. 10 The London bank has made an agreement 
with the American bank that it will accept drafts authorized 
by it, within the terms of the "acceptance account." Thus 
acceptance will take place and the date of maturity of the 
draft will fall sixty-three days after the date of the accept- 
ance, unless the three days of grace allowed by English 
law are waived. The days of grace are not waived in 
usual practice. 

The Acceptance Account 

(3) In the third place will come the charging of the 
" acceptance account" of the Hundredth National of Chicago. 
It has already been stated that the grant of an acceptance 
account is the extension to the grantee of an authority to 

» This statement is based on the assumption that the Italian bank 
will desire to have its working balance in London remain at a 
practically steady figure from day to day. There are times of 
course when it will desire to expand or contract its London funds. 

io Regarding the "confirmed Utter of credit,"' sec §47 below. 



THE BANK CREDIT AND LETTER OF CREDIT 145 

draw long bills upon the grantor (that is, to draw bills for 
the latter 's acceptance) or to authorize others to draw such 
bills. To charge a draft to this account means to make a 
record of its acceptance on the date when this event takes 
place. When the draft is paid at maturity it will be 
charged off the acceptance account, and the amount paid 
will be immediately deducted from the cash credit, or bal- 
ance, of the grantee bank, which is obligated to provide 
the funds for the discharge of the instrument. At any 
moment the record will show the total amount of accept- 
ances outstanding, or the total sum of unmatured drafts 
upon which at one date or another the London bank has 
become liable as obligor, at the request of, or for the account 
of, the American bank. Almost always an acceptance ac- 
count is granted upon two conditions. These are (1) the 
amount of acceptances outstanding at any one time must 
not exceed a specified limit, and (2) the amount outstanding 
at all times must be protected by collateral security. The 
effect of the first condition is either to prevent the grantee 
bank from drawing or authorizing long drafts when this 
action would cause the total of acceptances to ascend above 
the prescribed limits, or to force it to put up cash to cover 
any such surplus drafts. The second condition signifies 
that the grantee bank must have on deposit at all times 
acceptable securities equal in value to the outstanding 
acceptances (or perhaps exceeding them in value by a pre- 
scribed percentage as margin). The securities are not 
necessarily physically on deposit with the grantor bank it- 
self, but may be placed in the custody of some agent in 
America, such as a trust company, chosen to receive them. 
The bank depositing securities as collateral retains owner- 
ship in them and receives the interest or dividends which 
they pay. 

The present writer has reason to believe that acceptance 
accounts are occasionally granted Eree from one or both <>f 



IKi FOREIGN EXCHANGE 

the conditions jusl described. If no formal limit is placed 
upon the total of acceptances, the meaning is not precisely 
thai unlimited drawings would be tolerated, but rather 
thai the limit is lefl in the discretion of the grantee bank. 
Bounds exist but arc not expressly defined. The absence 
of the requirement of collateral would indicate great con- 
fidence in the financial strength of the grantee bank. There 
are. however, probably many banks which never grant an 
acceptance account without collateral. The reason for the 
usual demand for this security is readily perceived. The 
grantor bank becomes unconditionally bound to pay at ma- 
turity all the drafts it has accepted. It pays them with 
the expectation that it will be reimbursed on the day of 
payment by the grantee bank which has drawn or author- 
ized them. But it is bound to pay without regard to 
whether this reimbursement is actually forthcoming. If 
the grantee bank should fail while acceptances were out- 
standing, the reimbursement would probably not material- 
ize, at least not when due. It would probably be much 
delayed and then would be for only a certain fraction of 
the amount owed. The unimpaired cash balance of the 
failed bank might be insufficient to provide the reimburse- 
ment. Under these circumstances the collateral could be 
seized and sold. 

The following statements are of interest as bearing upon 
the practice respecting collateral of two large London 
banks. In 1909 or 1910, Sir Felix Schuster, Governor of 
the Union of London and Smith's Bank, said in an inter- 
view given for the United States Monetary Commission : 
"We do not give what are called open credits, and every 
acceptance is covered by a deposit of security." 1X A simi- 
lar assertion was also made with respect to the London Joint 

11 See "Interviews on Banking and Currency Systems," U. S. 
Monetary Commission, p. 37. (This is Senate Document 405, 61st 
Congress, 2d session.) 



THE BANK CREDIT AND LETTER OF CREDIT 147 

Stock Bank by its General Manager, Mr. Charles Gow. 12 
Acceptance of a long bill is in one respect unlike the 
certification (i.e., acceptance) of a sight bill or check. In 
the case of certification, the drawee bank assumes a demand, 
instead of a deferred liability for the account of the 
drawer, and it therefore immediately removes or sequesters 
from his deposit a sufficient sum to discharge the instru- 
ment. 

(4) The fourth event at the accepting bank will be the 
payment of the draft at maturity. (5) The fifth and last 
will be the immediately ensuing deduction of the amount 
thus paid, from the American bank's cash balance or de- 
posit. It is the province of the latter institution to fortify 
its balance for reductions of this character. 

III. The credit-issuing bank. — The institution which 
writes the letter of credit (in this instance, the Hundredth 
National of Chicago), (1) issues this document at the re- 
quest of the importer and in return for a contract of reim- 
bursement signed by him (compare the next section). (2) 
It receives advices. That is, as the letter is put to use 
and the drafts drawn under it become the acceptances of 
the London correspondent, it receives information as to 
the amounts and dates of these acceptances. From this it 
reckons the dates of payment and the deductions that will 
be made from its London balance, and thus learns its exact 
requirements for "cover," or for sterling exchange to be 
purchased in the United States and remitted to London 
to supply or compensate for these deductions. (3) Next is 
the collection from the importer of a sum of dollars suffi- 
cient to purchase this cover and pay the commissions 
charged for furnishing the credit. (4) The final step is the 
actual purchase of the sterling and the remittance of it to 
the London correspondent for account. This should be 

12 The same, p. G5. 



L48 KOWKMJN KXOIIANGE 

conceived of as a normal final step, but it might of course 
be omitted if tin' bank at the time was desirous of reduc- 
ing its London balance, as a measure of transferring foreign 

funds home. 

§ 41. The contract for a letter of credit. — A letter of 
credit is itself a contract. The person who upon the faith 
of it purchases drafts drawn under its authority and in 
accordance with its terms, may maintain an action in his 
own name for breach of contract against the writer of the 
letter, in the event that the designated drawee dishonors 
the drafts whether by non-acceptance or by non-payment. 
This is true provided the letter was issued for a considera- 
tion and provided the drafts w r ere purchased without 
knowledge of any irregularity or fraud in their origin, and 
for value. There are certain other minor conditions into 
which we need not go. 

The consideration for which the letter of credit, itself 
a contract, usually issues is another contract, namely the 
contract for a letter of credit entered into by the importer 
with the banker who issues the letter. The provisions of 
this agreement vary in different countries and to a certain 
extent between banks in a given country. We shall be 
content to analyze and reproduce one which may be re- 
garded as typical in the United States. Its two chief pro- 
visions (1) obligate the merchant to reimburse the bank 
for the outlays w T hich it will make by reason of having 
issued the letter, and (2) give the bank a claim upon the 
imported merchandise as collateral security. Fuller analy- 
sis will disclose the following clauses. 

1. The person procuring the credit expressly acknowl- 
edges his agreement to the terms of the letter of credit 
itself. 

2. He undertakes to reimburse the bank and usually 
under the following plan. A specified number of days 
before the maturity of each draft drawn under the letter, 



THE BANK CREDIT AND LETTER OF CREDIT 149 

he promises to furnish the bank a sum of money sufficient 
to purchase at the then prevailing rate of exchange a first 
class banker's sight bill on London for the number of 
pounds required to cover or discharge the maturing draft. 
Sometimes his promise reads either to furnish this sufficient 
sum of money or else himself to provide the first class 
banker's draft. The number of days by which this inpay- 
ment by the merchant must antedate the maturity of the 
draft, was, for instance, in Chicago usually fifteen. This 
statement holds good for sterling credits as issued under 
conditions preceding the war. 

3. The applicant for the credit also agrees to pay the bank 
a certain commission for its services. 

4. He agrees to clauses establishing the bank's interest 
in the merchandise as collateral (see discussion in §42). 

5. The power of the bank to sell the merchandise in case 
of need is expressly agreed to. 

6. The merchant consents to the application of any sur- 
plus funds which might arise from such a sale, to the dis- 
charge of any other indebtedness which he might owe the 
bank. 

7. The applicant for the credit agrees that the bank is 
not to be responsible for the character of the merchandise 
or for the genuineness or correctness of the bill of lading. 
The point here is that if the foreign merchant ships goods 
different from those promised, or below the grade con- 
tracted for, so that the importer would come to have a 
right to reject the goods, this shall not affect his obligation 
to settle with the bank for the drafts which have been 
drawn upon and accepted by its London correspondent. 13 
Neither of the bankers involved is making a speculatio7i 
on the sufficiency of the goods. This is not their business. 

13 Or, in the other case, it shall not affect the obligation to settle 
for drafts which have been drawn upon and accepted by the bank 
itself. 



FOREIGN EXCHANGE 

The liability of tin* London banker to pay his acceptance 
at maturity is not conditioned on the sufficiency of the 
goods, li' it were, by the way, the acceptance would by 
do means possess the salability on the London money mar- 
ket it has. Likewise the liability of the American bank 
to reimburse the London bank for its payment of this 
acceptance is not conditioned upon the sufficiency of the 
goods. If it were, the London banker would never have 
been willing to grant the acceptance. Finally the liability 
of the American importer to reimburse the American 
banker is not, of course, to be conditioned upon his satis- 
faction with the merchandise. He would have to pay even 
if water were fraudulently shipped for say olive oil. If 
the goods fail to meet the requirements of the contract 
of sale, the importer will have some sort of action at 
law (perhaps practically worthless) for reimbursement 
from the foreign exporter, and this is all he will have. He 
cannot refuse payment for the goods to the credit-writing 
banker. 

8. The applicant for the credit often agrees to furnish 
the bank security in addition to its interest in the im- 
ported merchandise, if this is demanded. 

9. It is in some cases agreed that the bank may revoke 
the authoritj" conferred by the letter of credit, save that 
the beneficiary shall always be entitled to use so much of 
the credit as is necessary to reimburse him for goods shipped 
and goods started in process of collection or manufacture 
before he receives notice of the revocation. Revocation is 
dangerous and unsatisfactory because it is in any event good 
only against persons who have received notice of the revoca- 
tion. Any other person buying a draft on the strength of 
the letter is protected by it despite a revocation. Letters 
of credit are usually spoken of as being irrevocable. 14 

i* The specimen form of agreement for a commercial letter of 
credit given in Margraff's "International Exchange," p. 92, contains 



THE BANK CREDIT AND LETTER OF CREDIT 151 

The following is a form of agreement against which the 
International Banking Corporation issues commercial let- 
ters of credit for its clients. 

New York, 191.. 

To 

The International Banking Corporation, 
New York City. 

In consideration of your having opened for my (our) account a 

credit No , dated 

for 

with 

in favor of 

to be used within months from this date by 

, against delivery of documents, viz. : 



I (we) hereby agree to its terms and bind myself (ourselves) to 

furnish you not later than days before the maturity 

of the acceptances under it, with approved bankers' demand bills 
of exchange, for the same amount payable in London and bearing 
my (our) endorsement or to pay equivalent thereof in cash at the 
rate of exchange at which you may be then drawing upon demand 
on London. 

I (we) further agree to pay your commission at the rate of 

% for such part of this credit as shall be used together 

with all expenses incurred. 

It is also understood that you are not to be held responsible in 
any way for the description or quality of the merchandise shipped, 
or for the correctness of the documents presented by the parties 
in whose favor or to whom the credit is issued. 

And I (we) hereby recognize and admit the ownership of The 
International Banking Corporation and its right and the right 
of its Agents to the possession and disposal of all goods and the 
proceeds thereof for which The International Banking Cor- 
poration may come under any engagements in virtue of tins 

a clause authorizing revocation. The same clause also appears in a 
contract reproduced in Brooks' "Foreign Exchange Text Book," 
p. 176. 



L62 FOREIGN EXCHANGE 

ere. lit as also to the possession of all Bills of Lading for and 
policies of insurance on such goods until such time as any indebt- 
edness or liability existing as against me (us) in favor of The 
International Banking Corporation under the said credit or 
otherwise shall have been fully paid up and discharged and in the 
event o[' the said goods being entrusted to me (us) for the purpose 
of sale or otherwise 1 (we) hereby consent that the right of The 
International Banking Corporation or its Agents to repossess 
themselves of the same or of any proceeds thereof, may be exer- 
cised at their discretion. 

Any proceeds of said goods coming into the hands of The 
International Banking Corporation are to be applied against 
any acceptances under this credit, or against any other indebted- 
ness of me (us) to it, including all expenses incurred and commis- 
sion of sale and guarantee. 

The Marine Insurance to be done by 

This obligation is to continue in force and be applicable to all 
transactions, notwithstanding any change in the individuals com- 
posing any firm, parties to or concerned in this contract, whether 
such change shall arise from the acquisition of one or more new 
partners or from the death or secession of any partner or partners. 



Dated, , 191. .. 

§ 42. The banker's legal interest in the merchandise. — 
The banker who holds a bill of lading as collateral has a 
legal interest in the merchandise represented by this docu- 
ment. The general design of this interest is clear enough, 
but its technical nature and extent are not so clear in all 
cases. It often amounts to "ownership" or the holding 
of "title." But at times it is at law referred to merely 
as a jus disponendi or right of disposal or control. Some- 
times it appears to be only a "lien." In the specimen 
"trust receipt" presently to be given, acknowledgment is 
made of the banker's ownership of the merchandise. Own- 
ership, when gained, is often referred to as a "special prop- 



THE BANK CREDIT AND LETTER OF CREDIT 153 

erty" or "special title," because the banker may be di- 
vested of it if the merchant who is the real purchaser of 
the goods performs all his obligations. As a matter of 
law, the technical extent of the banker's interest depends 
on the intention of the parties concerned as shown in the 
words of their agreements and in the circumstances. 

For our purposes we shall say that the banker obtains 
an acknowledged legal interest in the merchandise, and 
that the main rights involved in the interest are fairly 
clear in most cases. (1) The banker has a power of sale 
over the goods, to be exercised upon the condition that the 
real purchaser fails to perform his obligations. (2) The 
banker is accountable to the merchant (exporter or im- 
porter as the case may be 15 ) for any surplus in the pro- 
ceeds of the sale over what is necessary to discharge in 
full the debt due him, including costs and charges and in- 
terest for delay. In practice such a surplus is rare, be- 
cause the goods go at forced sale. (3) The banker's claim 
to the merchandise is superior to that of an attaching 
creditor of either merchant. 10 

15 The party to whom the banker is accountable for any surplus 
is the one who is liable to make up to the banker any deficiency in 
the proceeds of the sale. This is the one at whose request, and 
against whose agreement of reimbursement, expressed or implied, 
the banker has either (1) bought the draft arising in the shipment 
or (2) become responsible for its payment. Thus the person is the 
exporter in the case where the banker has bought the latter's draft 
drawn directly on the importer. If the importer dishonors the bill, 
the exporter is liable for its payment (under the implied contract 
of a drawer or under the express contract of the letter of hypothe- 
cation), but if his goods are sold he will be entitled to receive the 
surplus proceeds of the sale, if any. The person to receive the same 
surplus, in the case of the ordinary commercial letter of credit, is 
the importer, who will (because of his express agreement to do so in 
the ordinary case) have to make up a deficiency in the proceeds 
when there is a deficiency. | 

10 In the footnote on page 154 will be found a few legal points re- 
specting the banker's interest in the merchandise. 



i;,l FOREIGN EXCHANGE 

§ 43. Release of the goods to the importer. The "trust 
receipt." As our studies to this point would lead us to 
expect, it is usual though not universal for the importer 
to find the bill of lading pertaining to his goods in the 

Where a l>ill of lading is made out to the order of the seller and 
indorsed by him in blank, or else made out to the order of a third 
party, the intention of the parties is the ultimate criterion by which 
we arc tn judge whether title passes to the vendee at the time of 
delivery t<> the carrier. The presumption from this form of en- 
dorsemenl is that title was withheld from the vendee, but it is 
generally recognized that this presumption is not conclusive. 2 
I. tinners' Reports Annotated (XS) 10G8-81n, and cases there dis- 
cussed. 

"Where hanker.- issued mercantile letters of credit to merchants 
under an agreement that goods purchased by means of the credit, 
as well as bills of lading of such goods, should be held by the bankers 
for security, pursuant to which agreement bills of lading were "made 
out to the order of the bankers and sent directly to them by the 
sellers of the goods, the bankers obtain title to the goods." Moors v. 
Bird, 77 X. E. 643, 190 Mass. 400 (1906), cited in J f Decennial 
Digest '06, p. 123. 

Many cases show that the real consignee does not get title until 
he pays for the draft to which the bill of lading is attached as 
collateral, and it has been held that this is true even when the bill 
of lading is made out direct to the consignee. 17 Decennial Digest 
'06, p. 1962. 

"A pledgee to whom a bill of lading is given as security gets the 
legal title to the goods and the right of possession only if such is 
the intention of the parties, and that intention is open to explana- 
tion." The Carlos F. Roses, 177 U. S. 655, as cited in the "American 
and English Encyclopedia of "Law," Second Edition, Supplement, 
Vol. I, p. 666n. 

A Uniform Bills of Lading Act designed for the purpose of sys- 
tematizing and simplifying the law governing the rights of the 
several parties concerned in this important instrument of commerce 
has been passed by a number of states of the American Union. In 
June, 1911, the list of these states included Massachusetts, Xew 
York, Pennsylvania, Maryland, Ohio, Michigan, Illinois and Iowa 
(Commercial and Financial Chronicle for June 24, 1911, p. 1676). 
The Massachusetts statute, passed March 4, 1910, constitutes Chap- 
ter 214 of the Acts of 1910 of that state. 



THE BANK CREDIT AND LETTER OF CREDIT 155 

possession of some banker at the place of import. Atten- 
tion has already been directed to three of the principal 
plans of settlement which bring about this result. These 
are settlement by documentary draft of the exporter (1) 
upon the importer personally, or (2) upon a bank in the 
importer's city procured by the latter to serve as drawee, 
or (3) upon a bank in some other city or country appointed 
by a bank in the importer's city. Under the first plan, 
the bill of lading will be held by a bank in the importer's 
city, which is the correspondent and collecting agent of 
some foreign institution that has bought the exporter's 
draft, or which has itself purchased the draft through a 
branch or correspondent. Under the second and third 
plans, the importer's own bank comes to hold the bill of 
lading, either because it has authorized and accepted a 
documentary draft upon itself (as under the second plan), 
or because it has become responsible for a draft which 
it has authorized on a bank in another city or country 
(as under the third plan). In the instance of the third 
plan, the documents are forwarded immediately to the 
credit-writing bank, or to its customs house brokers, b} r the 
banker who purchases the exporter's draft at its point of 
origin. To fortify ourselves against possible confusion, let 
us consider a new illustration of this case. 

Suppose the California Importing Company, in arrang- 
ing to buy goods from a merchant in Hongkong, procures 
from a San Francisco bank a sterling credit in favor of 
this merchant. The latter draws on the designated London 
bank and sells the draft to some banker in Hongkong, who 
will in usual course send it to London for discount and 
credit. One of the several copies of the bill of lading will 
accompany the first of exchange, or first copy of the draft, 
to London. It will be sent, however, not as collateral but 
simply as a matter of record to show that the drafl is in 
order and conforms to the instructions of the letter of 



L66 FOREIGN EXCHANGE 

credil authorizing it. The other copies of the hill of lading 
will be sent directly by the draft-purchasing banker to the 
S;ui Francisco bank thai issued the credit. The Hong- 
kong banker is content with the guarantee found in the 
San Francisco bank's letter of credit, that the London 
bank will honor t he draft. He is willing to release the 
documents against this, just as he would be against a bank's 
acceptance of the draft. Thus he does his share in for- 
warding the plan of settlement, one object of which is to 
get the bill of lading to San Francisco, the point of import, 
while keeping it in the control of the risk-taking bank, 
the credit-writing bank of that city. 

Since the draft drawn under any of the plans of settle- 
ment at present in hand, is quite likely to be at sixty or 
ninety days sight, if not for an even longer usance, 17 the 
importer's goods will commonly arrive some time before 
the date when he will be contractually bound to make 
payment. In the case of the bill drawn on the importer 
himself, this date will be the sixty or ninety days after 
his acceptance. In the case of the Hongkong draft on the 
London bank, it will be a stipulated number of days (per- 
haps 20) before the maturity of the London acceptance. 
In any event the goods are likely to arrive before the 
date when the importer is finally bound to make payment. 
Placing to one side the case of a draft on the importer with 
documents for acceptance, we come now to consider the 
question of the ways and means open to the importer to 
obtain his goods at an earlier date than the day of ma- 
turity of his contractual debt. 

At least four principal arrangements to effect this result- 
may be made between the importer and the banker hold- 

" "Usance" is a term employed to mean either (1) simply the 
length of life of any draft as it actually is, or (2) the customary 
length of life of drafts drawn in particular lines of trade, as the 
trade in silk of the Chinese coast with England or what not. 



THE BANK CREDIT AND LETTER OF CREDIT 157 

ing the collateral. I. The banker may merely hand over 
the documents, the bill of lading and the rest, without any 
special security, taking from the importer a mere receipt 
for them. This is the practice at least with some banks 
where the importer is a person in high repute, especially 
if a regular customer of the bank itself. In the instance 
where the local banker holds the documents as the agent of 
some foreign bank — as is the case when he has received 
a documentary payment draft for collection from some 
foreign correspondent — he may deliver the documents to 
the importer against the latter 's mere receipt, even with- 
out authorization from the correspondent bank. But if he 
does this, or makes any arrangement with the importer 
not contemplated in the documentary instructions, he will 
act on his own responsibility and will have to make good 
any losses which the correspondent might chance to suffer 
on account of this arrangement. With certain firms, never- 
theless, some bankers, at least, are willing to take risks of 
this kind. 

II. A second arrangement is the surrender of the docu- 
ments to the importer in return for the latter 's "trust 
receipt." This instrument is often called a "trust" re- 
ceipt whether in a technical legal sense what it creates is a 
real "trust," or an agency or a bailment. Under the sec- 
ond arrangement, we may say the importer obtains posses- 
sion of the goods as trustee, agent, or bailee, for the bank. 
Avoiding precise questions of law, the general purport or 
effect is (1) to permit the importer to obtain the goods and 
deposit them in a warehouse or place of storage agreeable 
to the banker, and (2) to keep the banker's claim upon 
the goods as creditor superior to that of any other creditor 
the importer may have. To make certain of the latter 
object, not only must the receipt be drawn in a manner 
clearly recognizing the banker's prior rights, 1ml the goods 
must be handled in such a way that they can at all times 



FOREIGN EXCHANGE 

be identified. If they wore mingled with other merchan- 
dise so that their identity should be lost, the special rights 
of the banker in them would disappear, and his position 
would become that of a general creditor among other gen- 
eral creditors. 

The importer agrees to bring the proceeds of the sale of 
the goods, or of the sales of them by lot and parcel, to the 
bank immediately upon their receipt. The writer is in- 
formed that the bank does not customarily force the im- 
porter to make known the fact of his indebtedness to it, 
to merchants or others to whom he may make sales. Mr. 
Franklin Escher states that much difference of opinion 
exists among foreign exchange men regarding the value of a 
trust receipt from the standpoint of security. 18 The trust 
receipt is employed in banking for domestic commerce, but 
by no means to the same extent as in banking for foreign 
commerce. The following is a specimen of this instru- 
ment. 19 

TRUST RECEIPT 

Received, upon the trust hereinafter mentioned, from the In- 
ternational Banking Corporation the following goods and mer- 
chandise, the property of said Corporation, specified in the bill 
of lading as follows: 

DATE VESSEL MARKS AND NOS. MERCHANDISE 



and in consideration thereof, I (we) hereby agree to hold said 
goods for the said Corporation, and as its property, with liberty 

i - •Elements of Foreign Exchange" by Franklin Escher, p. 151. 

is Other examples of trust receipts may be found in Margraff's 
"International Exchange," p. 96; and in Brooks' "Foreign Exchange 
Text-book," p. 177; and in Escher's "Elements of Foreign Exchange," 
p. 149. In the latter book, p. 150, there is also given a specimen 
"bailee receipt" of the type taken by the Guarantee Trust Company 
of New York. 



THE BANK CREDIT AND LETTER OF CREDIT 159 

to sell the same for its account, but without authority to make 
any other disposition whatever of the said goods or any part 
thereof (or the proceeds thereof) either by way of condi- 
tional sale, sale on credit, pledge, or in any other manner what- 
soever. 

In case of sale I (we) further agree to hand the proceeds, as 
soon as received, to the International Banking Corporation 

to apply against Bill No amount dated 

drawn by accepted by me (us) payable 

and for the payment of any other indebtedness of 

mine (ours) to the International Banking Corporation. 

I (we) agree to keep said goods insured, to their full value, 
against fire, the sum insured to be payable in case of loss to the 
International Banking Corporation, with the understanding 
that the Corporation is not to be chargeable with the Storage, 
Premium or Insurance, or an}^ other expense incurred on said 
goods. 

I (we) further agree that no failure or omission on my (our) 
part to fully carry out any of the provisions of this or any similar 
receipt or agreement shall be deemed a waiver by the Interna- 
tional Banking Corporation of any of its rights or remedies 
under any of said papers, unless said waiver shall be in writing 
endorsed hereon and signed by the International Banking 
Corporation. 

The International Banking Corporation may at any time 
cancel this trust and take possession of said goods, or of the pro- 
ceeds of such of the same as may then have been sold, wherever 
the said goods or proceeds may then be found; and in event of 
any suspension, or failure, or assignment for benefit of creditors, 
on my (our) part, or of the non-fulfillment of any obligation, or 
of the non-payment at maturity of any acceptance made by 
me (us) under any credit issued by the International Banking 
Corporation on my (our) account or of any indebtedness on 
my (our) part to said Corporation, all obligations, acceptances, 
indebtedness and liabilities whatsoever shall thereupon (with or 
without notice) mature and become due and payable. 

Dated 



L60 FOREIGN EXCHANGE 

III. Under a third plan of handling the goods, the banker 
may warehouse them in his own name, and arrange for 
deliveries from time to time to customers of the importer 
as the latter makes sales. Here the bank take steps to 
secure the proceeds of the sales. In the end it accounts 
for these to the importer, and the surplus of their total over 
the amount due the hank is returned to him and represents 
his commercial profits. 

IV. In the fourth place the importer may obtain pos- 
- ssion of, and clear title to, the goods, prior to the date 
of maturity of his contractual indebtedness, by the simple 
method of prepayment of this indebtedness. This is pre- 
cisely what he does in England or another foreign country, 
when he retires a documentary payment draft under the 
rebate of discount plan described some time since (in § 35). 
In the United States we do not at present have a regular- 
ized traffic in the retirement of documentary payment 
drafts, and do not have an open or market retirement rate 
of discount. One reason is that bills drawn on American 
importers have not heretofore been numerous. With re- 
spect to importations under letters of credit, it is safe to 
say that at least in the United States and probably every- 
where in the world, prepayment of the sums due the banker 
on the contract for the letter of credit is rare. The im- 
porter usually contrives to pay the bank out of the pro- 
ceeds of the sale of the imported wares themselves, and not 
before the receipt of these proceeds. However, prepayment 
could be arranged on the basis of a rebate of interest to be 
adjusted privately between the banker and the merchant. 

§ 44. The bank credit as a means of financing a shipment. 
— An "advance" is present in a commercial transaction 
whenever a buyer of goods is allowed to delay payment for 
a period after their shipment. We speak of the "burden" 
of the advance as being borne by whatever party it is that 
gives up present value in return for future payment. Most 



THE BANK CREDIT AND LETTER OF CREDIT 1G1 

frequently this is a money lender who deals either with 
the buyer or seller. But sometimes the seller himself as- 
sumes the burden, by delivering the goods and himself wait- 
ing for future payment. The presence of an advance does 
not depend on the question whether legal title passes at 
the time of the delivery of goods or is withheld until pay- 
ment is made. Commercially speaking, the disposal of the 
legal title during the period of the advance is merely a 
question of security. The seller may shift the burden of 
the advance to the money-lender or bank by drawing a 
long bill of exchange on the buyer and discounting it, or by 
taking the buyer's promissory note and discounting it. 
Here the money-lender gives up present funds and agrees 
to await the deferred payment due from the buyer. In 
many lines of domestic commerce in the United States whole- 
salers are content with mere book accounts against their 
regular customers, and in these cases the wholesalers bear 
the burden of the advances themselves, or if they borrow, 
do so merely on their own general credit. 20 When the 
seller is unwilling to give the buyer time it is still possible 

20 Occasionally we hear of the assignment of open accounts as a 
means of borrowing. Suppose A sells goods on time to B, and 
neither draws on B nor receives B's note. A has a hook claim 
against B. B is said to have bought from A on open account. 
Might not A transfer his claim against B for future payment to a 
banker in return for a reduced present sum? Such a transfer would 
be an assignment of an open account. The following is quoted 
from an opinion of the counsel for the Federal Reserve Board. "It 
appears that certain national banks located in Pennsylvania desir- 
ing to accommodate some of their customers, who are coal operators, 
have purchased written assignments of the open accounts due to 
such customers from various railroads." In answer to the question 
whether such written assignments can be discounted by a Federal 
Reserve Bank, the counsel states, "The assignment of an open ac- 
count is not negotiable paper and is not eligible for rediscount by a 
Federal Reserve Bank under the terms of section 13 of the Federal 
Reserve Act." See Federal Reserve Bulletin for May, 1916, p. 227. 



l.i'j FOREIGN EXCHANGE 

for tlit* latter to obtain an advance and shift the burden to 
a bank by borrowing from such an institution, very likely 
upon his own promissory note, perhaps with the purchased 
goods pledged as collateral. Generally speaking, the bur- 
den of a commercial advance is shifted around until it rests 
upon the shoulders of the commercial bank. The function- 
ary that carries this burden is under recent usage said "to 
finance" the venture which occasions it, or indifferently "to 
finance" the goods themselves. It is in this sense that we 
speak of the London banks as financing the American cotton 
exports, or as financing American cotton. 

As the reader must have noted, an advance is present in 
the olive oil transaction wdiich we have given to illustrate 
the use of the commercial letter of credit. For the Ameri- 
can importer pays for his oil, not when it is sold and 
.shipped, not even when it is physically delivered to him 
for use or resale, but merelj 7- at a set number of days before 
the maturity of the drafts drawn under the letter of credit. 
And the importer's delay in payment signifies that some 
one must be taking the burden of an advance. But this 
some one is not the Italian or selling merchant, because, as 
we know, he manages to obtain lire for his goods on the 
date of shipment. It is not the Italian bank to which he 
sold his draft, for this institution causes this bill to be 
discounted forthwith in London, and following this up by 
the sale of its own exchange, as already explained, it is 
thus enabled to make a practically immediate recovery of 
the lire which it has surrendered to the merchant. 21 The 
American bank makes no advance because it makes no out- 
lay of value until the drafts are about to fall due in London, 
and it provides for this outlay from funds furnished it by 
the importing merchant himself. Neither does the London 
accepting bank make the advance, for its outlay is delayed 

21 But if the Italian bank should decide to invest in the shipper's 
long sterling draft, it would assume the burden of the advance. 



THE BANK CREDIT AND LETTER OF CREDIT 163 

until its acceptance matures, and then is. made from funds 
provided by the American bank. 

Finally we come to the money lender of London who 
discounts the acceptance for the correspondent of the 
Italian bank and holds this paper till maturity. This per- 
son or company pays out value at the time of purchase of 
the acceptance and waits for reimbursement until its ma- 
turity or until a prior rediscount. If the bill is transferred 
one or more times during its life a plural number of money 
advancers will share the burden of waiting, each usually 
making interest at some rate for the period during which he 
has held it. Since the person making the advance is gen- 
erally outside the group of functionaries more directly con- 
cerned with the letter of credit, and is in any case a party 
who voluntarily selects himself, we say that the burden of 
the advance rests upon the "open money market" of Lon- 
don. One of the striking features of the system of sterling 
credits, is its tendency to shift the burden of vast numbers 
of advances, originating in merchandise traffic in all parts* 
of the world, onto the open money market of London 
However, London does not carry this load without aid, 
It receives much help from the other great money capitals 
of the world. This help is negative whenever these other 
capitals withhold long sterling bills from discount in Lon- 
don, or whenever they invest in these bills as the saying 
goes. If the Italian bank of our illustration should invest 
in the bill of the Italian Olive Oil Export Company, it 
would assume the role of paying money in advance and 
awaiting a deferred return and no one in London would 
have an opportunity to play this role. The aid received 
by the London money market is positive if outside capitals 
remit funds to that market for employment there in the 
discount of bills. The same cause which will occasion in- 
vestment in long sterling by outside capitals, will also tend 
to produce a movement of money funds from them to Lon- 



Hi l FOREIGN EXCHANGE 

don. This cause will be the existence of lower interest or 
discount rates abroad than in London, in other words 
"easier money" abroad than in London. 22 

§45. The risk of exchange. — A "risk of exchange" is a 
chance taken in connection with some mercantile, stock, 
banking, or similar transaction, which involves settlement 
by means of exchange, that the profits may be affected by a 
movement of the rate of exchange. Risks of exchange are 
taken in domestic as well as foreign commerce but are of 
more consequence in foreign. When a dealer speculates 
in exchange itself, he places himself in a position where 
his profits depend wholly upon the rise or fall of the ex- 
change rate, so in general he certainly takes a risk that the 
price of exchange may move adversely to his interests, just 
as he has a chance that it will move favorably. But the 
term risk of exchange is not usually thought of as covering 
the chances taken in an outright and purposeful speculation 
in the price of exchange, but only as signifying a chance 
with respect to exchange, taken as an incident to some 
principal operation which is designed to yield a profit de- 
rived from other sources than exchange fluctuations, a profit 
expected to accrue if the exchange rate should stand still. 
Exports and imports of merchandise or securities sometimes 
take place under circumstances involving a risk of ex- 
change, sometimes not. International borrowing by means 
of drawing long bills on foreign bankers, called "finance 
bills," and also investment in long bills, always involve a 
risk of exchange. 23 

22 Documentary payment bills drawn on English importers call for 
special comment in this connection because English bankers and 
money lenders do not discount this type of draft. The foreign bank 
which buys one of these drafts at its point of origin may neverthe- 
less contrive to shift the burden of the advance to London by draw- 
ing its own long draft against its acceptance account and securing 
the account with the documentary bill as collateral. Compare § 94. 

23 But an operator may hedge against a risk. Compare §§ 78, 81, 90. 



THE BANK CREDIT AND LETTER OF CREDIT 165 

In the illustration of the import of oil from Italy, there 
are two risks of exchange, both of which are taken by the 
American merchant, the importer. For there are two ex- 
change rates either of which may move after he has con- 
tracted to buy oil at a fixed price in lire, whose movement 
will affect his profits, by way of affecting the final cost 
of the oil to him in dollars. These rates are (1) that for 
sterling exchange in lire in Italy and (2) that for sterling 
exchange in dollars in the United States. The first becomes 
determinate when the Italian merchant "ships and draws" 
and sells his sterling bill in his country at the rate of the 
day. 

The second is fixed when the American comes, some 
fifteen days before the maturity of this bill, to deliver to 
the American bank enough dollars to purchase bankers' 
sight drafts at the rate of the day for the number of pounds 
required to discharge the maturing bill. As regards what 
we might call the direction of the risks, (1) the cheaper 
sterling exchange turns out to be in Italy, the worse for the 
American, the importer. For the cheaper this exchange is, 
the greater the quantity of it the Italian merchant will be 
compelled to draw, in order to obtain the predetermined 
sum of lire due him, and thus the greater the amount of 
the sterling acceptance for which the American merchant 
will have to provide cover. (2) The dearer sterling ex- 
change proves to be in the United States when our importer 
comes to provide cover, the worse for him because the 
greater the number of dollars the cover will cost. To illus- 
trate, suppose (1) we take two rates of exchange as dear 
and cheap in Italy, namely 25.20 and 25.00 lire per pound ; 
and (2) two as dear and cheap in the United States, say, 
$4.87 and $4.84 per pound. The best combination for our 
importer would be sterling dear in Italy, therefore at 25.20, 
and cheap in the United States, therefore at 4.84. Assum- 
ing a large shipment of oil, as 100,000 lire worth, and dis- 



ICC KOKKHiN KXCIIAXCK 

regarding minor expense, with this combination the import 
would cosl tin' American $19,206. Thus: 

Anioimt of 60 day Bterling drawn by Italian exporter. £3,968.25 

,1(111,000^25.20) 
( Josi of sighl sterling to cover this $19,206.33 

(3,968.21 X4.Mi 
The worse combination of rates would be 25.00 and 4.87, and the 
resuH this: 
Amount of 60 day sterling drawn by Italian exporter. £4,000.00 

(100.000 h- 25.00) 
Cost of sight sterling to cover this $19,480.00 

(4,000 X 4.87) 

There is a difference between the two costs of $274, or about 
Vk°fo of either. The total risk to profits then would not 
be so very great, if the exchange rates concerned were con- 
fined within substantially the above stated ranges of fluctua- 
tion. Risks of exchange have been enormous at times in 
history, especially in the cases of paper or silver exchanges 
against gold, and needless to say, the great war had the 
effect of vastly increasing them all over the world, due to 
its breaking down the stability even of gold exchanges. 

The risks of exchange in our illustration may be differ- 
ently distributed, but if this is to be the case the terms of 
sale and the detail of the method of settlement will have 
to be altered. We shall assume the necessary alterations 
merely for the purpose of illustrating further the rules of 
risk of exchange. It is to be understood the conventional 
thing is for the Italian to name his price in lire, but sup- 
pose he agrees to sell (freight and insurance included) for 
a designated amount of sterling, say, £3,980, with the un- 
derstanding that this is payable two months after shipment 
in the sense that he is to draw under a letter of credit 
for this sum in sixty-day bills. In this case the quantity 
of sterling drawn is determined in advance and invariable. 
Therefore, the American ceases to be concerned in the rate 



THE BANK CREDIT AND LETTER OF CREDIT 1G7 

for sterling exchange in Italy, because this affected him 
only by affecting the amount of sterling drafts for which 
he had to provide cover. The consequences of this method 
of making prices and effecting settlement is (a) the Italian 
assumes the first of the two risks of exchange that we have 
been discussing, and the rule is for him, the cheaper the 
sterling is in Italy the worse for him, this simply because 
the cheaper sterling is the less the number of lire he finally 
receives for the fixed sterling price at which he has sold his 
commodity, (b) The American, however, still carries the 
second risk of exchange. 

Suppose the Italian should agree to sell the oil, delivered 
in the United States, for a designated sum of dollars. 
Under any arrangement for his obtaining payment, the 
consequence would be that he would take whatever risks of 
exchange might be involved and the American would take 
none. 

§ 46. Advantages of the letter of credit system summarized. 
— The letter of credit system challenges our admiration. It 
provides d) a marvelously convenient means of payment, 
and (2) what is a distinct thing, a means of financing in- 
ternational merchandise movements, that is, means of en- 
abling those who move merchandise in international trade, 
virtually to borrow the funds required for their undertak- 
ings at the low rates of interest regularly prevailing in the 
world's monetary capitals. 

The benefits of the system to importers summarized. — (1) 
An importer can by means of a letter of credit purchase 
goods from foreign merchants who cannot know or rely 
upon his own standing; and such purchases can be made 
where the seller demands cash on shipment. (2) Advance 
orders, that is, orders for merchandise for future delivery 
may be given and can willi safety be acted upon. (3) The 
exporter cannot obtain the cash due him, and thus commil 
the importer to reimburse the credit-issuing bank, without 



FOREIGN EXCHANGE 

actually shipping the merchandise. The system of docu- 
mentary bills provides for this. That is to say, it renders 
this service unless the exporter should commit fraud in 
obtaining and preparing the bill of lading and other docu- 
ments. The possibility of this sort of fraud cannot, of 
course, be wholly eliminated by any system, but the letter 
of credil system affords the importer the maximum of pro- 
tection practically possible, against the collection of cash by 
the exporter without his performance of his part of the 
mercantile transaction, namely the shipment of the goods. 
We must bear in mind that the importer becomes respon- 
sible to the credit-issuing bank for the drafts drawn upon 
it, whether or not the goods were actually shipped or are 
actually up to grade. (4) Lastly, the system provides the 
importer with a means of obtaining the advances necessary 
to move his goods, ultimately from the world's central 
money markets, and virtually at the comparatively low 
rates of interest there prevailing. It appears then that the 
importer who purchases commercial letters of credit from 
his banker obtains adequate return indeed for the commis- 
sions he pays. 

Benefits of the system to exporters summarized. — (1) 
The exporter — in our illustration, the Italian Olive Oil Ex- 
port Compam- — is enabled to obtain cash payment in full 
for his merchandise as soon as he ships it. (2) Further- 
more, he enjoys this benefit with an absolute minimum of 
secondary liability upon the draft which he has drawn and 
sold. Since this draft is specifically authorized by a bank, 
the danger of its dishonor is reduced to an almost negligible 
minimum. On the other hand, when an exporter arranges 
to obtain payment by drawing upon the private importing 
house, his secondary liability in case of sale of the draft, is 
by no means always negligible. Indeed in many cases a 
draft on an unknown house in a distant country might 
hardly be salable. That is, a bank might refuse to take the 



THE BANK CREDIT AND LETTER OF CREDIT 169 

draft except for collection. Under the letter of credit sys- 
tem neither the exporter nor his bank need to know the 
standing of the buyer of the merchandise. For the engage- 
ment of the bank which writes the letter of credit, to the 
effect that the drafts drawn under it shall be duly accepted 
and paid, is not in the slightest degree conditional upon 
the solvency of the applicant for the letter. (3) Another 
advantage to the exporter is that, guarded by a letter of 
credit he may, upon the order of the foreign buyer, safely 
start to manufacture or collect merchandise for subsequent 
shipment. For law and custom provide that, once a letter 
of credit is issued to him, he may rightfully count upon 
drawing all drafts necessary to reimburse him for such mer- 
chandise as he has prepared, or put into process of prepara- 
tion, to satisfy the order which is supported by the letter 
of credit. This is true both under (1) the absolutely 
irrevocable credit and (2) the form which gives the bank a 
qualified right of revocation. In many agreements for 
letters of credit it is stated that the bank may revoke the 
credit "at any time to the extent that it shall not have been 
acted upon when notice of revocation is received by the 
user." This merely means that when the beneficiary of 
the credit receives notice of revocation he shall not there- 
after make further commitments looking toward the sat- 
isfaction of his buyer 's orders ; but that he has a right to 
complete payment or reimbursement for any commitments 
which he has already made. 

§ 47. The confirmed credit. — Where the drawee bank and 
the bank which grants the credit are different institutions, 
there may arise what is called the "confirmed credit." In 
the leading illustration which we have been considering 
these many pages, the Ilundreth National Bank of Chicago 
issues a letter authorizing the beneficiary, the exporter in 
Italy, to draw upon the London Joint City and Midland 
Bank. The exporter might, before preparing and shipping 



170 KOKKH1X KXCIIANGE 

the goods, desire the London Joint City and Midland to 
ratify the credit. This ratification will give what is known 
as a confirmed credit. Without confirmation the benefi- 
ciary is in the beginning protected merely by the engage- 
ment of the hank which has written the letter of credit. 
In this case the refusal of the drawee bank to accept the 
draft authorized, would give the holder who had taken 
the draft on the strength of the letter, an action in con- 
tracts in his own name but this action or suit could be 
instituted only against the bank which wrote the letter of 
credit. No right of action would exist in favor of this 
holder against the London bank itself prior to its acceptance 
of the draft, for this bank has not bound itself in any way 
to the drawer or the holder. Possibly the London bank 
might refuse to accept because of some irregularity in the 
American bank's conduct or arrangement with it, or per- 
haps because it never had agreed to accept drafts for this 
bank. These are bad cases, but we are only supposing. Be 
these things as they may, the exporter sometimes demands 
a confirmed letter of credit, very likely because the bank 
to which he plaus to sell the drafts demands confirmation. 
Confirmation is effected by the drawee bank's writing to the 
beneficiary and engaging with him that it will accept the 
drafts. For this it receives an extra commission. It writes 
a contract to accept. The effect of this is to give the holder 
of the draft a right of action in contracts against the 
London bank itself, in case the latter should in fact subse- 
quently refuse to accept the instrument. After acceptance, 
of course, a draft under an unconfirmed letter is just as 
good as one under a confirmed letter, for after acceptance 
the drawee bank is fully and unconditionally bound to pay. 
But the exporter has to prepare and ship his goods before 
acceptance and thus confirmation is not without significance. 
One point is that it gives a right of action against a bank 
which is nearer the exporter's country (in European cases) 



THE BANK CREDIT AND LETTER OF CREDIT 171 

and generally better known than the American bank, and 
adds this right of action to the one already existing against 
the American bank. A confirmed credit is regarded as an 
exceptionally secure basis for the manufacture or collection 
of goods for export. 

If the agreement of sale between the merchants calls for 
a confirmed credit, the importer will ask his bank for the 
same and pay an extra commission. This bank will then 
advise the drawee (or London) bank to issue the confirma- 
tion and will pay it its commission for this action. In the 
majority of cases confirmation of the letters of credit of our 
bankers upon foreign institutions is not demanded. It is 
obvious that where a bank issues a letter of credit author- 
izing drafts upon itself there is no point to a separate con- 
firmation. 

§ 48. The "authority to purchase" and "authority to 
draw." — The bank credit serves chiefly to give assurance 
to the exporter (1) that he will be able to sell his draft 
for cash at the time of shipment, and (2) that there will 
be no recourse upon him, or demand for reimbursement 
from him, in the event of the failure of the importer before 
the whole transaction is settled up. The importer pays the 
costs of providing this credit and under it the exporter 
takes a minimum of risk. "We come now to what is known 
to some bankers as an "authority to purchase," which 
issues at the importer's request and at his expense in com- 
missions, and for the benefit of the exporter, and which is 
in one respect, though in one respect only, a partial substi- 
tute for the bank credit. The plan of settlement through 
the agency of an authority to purchase is by no means so 
widely known nor so important as the bank credit, but it 
resembles the latter in that its design is to give the exporter 
assurance that he will be able to sell bis drafl for cash at 
the time of shipment. The exporter is not empowered to 
draw on a bank, but draws directly on the importer, and 



L72 FOREIGN EXCHANGE 

thus creates what we liave heretofo~e called a mere trade 
bill. Bui the importer takes steps to provide an assured 
or virtually assured cash purchaser for the draft. This 
purchaser will lie a bank of the importer's city, to which 
the importer is known, and not a bank in the exporter's 
city. It is true a bank in the exporter's city will con- 
summate the actual purchase, but merely in the capacity 
of agent for the bank in the importer's city. 

From this point forward explanation will best be pre- 
sented in the form of an illustration. Suppose the San 
Francisco Tea Company arranges to import 10,000 pounds 
of a certain grade of tea from an exporter of Canton, a 
number of shipments to be made within a period of six 
months, the price being say 25^, money of the United States, 
for each pound delivered on the dock at San Francisco. 
We may call the exporter the Canton Company. Against 
any shipment the Canton Company will draw upon the 
San Francisco Tea Company a draft in American dollars. 
(If the Canton Company's price were such and such a sum 
of local money of Canton, as would very likely be the case, 
the draft would be drawn for a sufficient amount in dollars 
to fetch the required sum of local money, and the risk of 
exchange would thus rest with the San Francisco company.) 
In any case the importer first of all goes to a San Francisco 
exchange bank, which we may call the Bank for Foreign 
Trade, and asks it to buy the Canton Company's drafts at 
their point of origin. To induce the bank to render this 
service the Tea Company (1) agrees to pay a designated 
commission, and (2) gives the bank a contract known as 
an "authority to draw." A specimen of the latter ap- 
pears immediately beneath. 



THE BANK CREDIT AND LETTER OF CREDIT 173 

A. P. No. 000 

Cabled 



IN DUPLICATE 

Authority to Draw 
(Letter of guarantee) 

July 1, 1916. 
BANK FOR FOREIGN TRADE, 

S. F. 
Dear Sir: 

We beg to inform you that we have authorized The Canton Co. 
to draw on us with recourse to the extent of $2,500 at 60 days' 
sight for full invoice cost against the following documents : 

Bill of Lading, Invoice, 

Insurance Certificate, Consular Invoice, 

to cover shipment of 10,000 pounds of tea from Canton to S. F. 

and indorsed in blank 



BILL OF LADING TO ORDER , 

ot Bank tor 1 oreign Irade. 

Freight to be prepaid. Marine Insurance by shipper. 
We agree, 1. To accept on presentation all bills drawn pur- 
suant hereto. 

2. To hold the Bank for Foreign Trade harmless 
because of any damage to merchandise shipped 
or deficiency or defect therein or in the docu- 
ments above described. 

3. That the said documents, or the merchandise cov- 
ered thereby, and insurance shall be held as col- 
lateral security for due acceptance and payment 
of any drafts drawn hereunder, with power to the 
pledgee to sell in case of non-acceptance or non- 
payment of the debt to them attached, without 
notice at public or private sale and after deduct- 
ing all expenses including commissions connected 
therewith, the net proceeds to be applied toward 
payment of said drafts. The receipt by you of 
other collateral, merchandise or cash, now in 
your hands, or hereafter deposited, shall not alter 



17 1 FOREIGN EXCHANGE 

your power to sell the merchandise pledged and 
the proceeds may be applied to any indebtedness 
by us to the Rank due or to become due. 
4. To pay your commission of .... % for negotia- 
tion of drafts hereunder. 
This engagement to commence from date hereof and to apply 
to all Bills drawn within six months. 

Please advise by mail. 

Yours faithfully, 

S. F. Tea Co., 

Per J. Jones, Pres. & Mgr. 

The above is our A. P. No. 000. Please do the needful. 

Yours very truly, 



Ace-t. Mgr. 

The foregoing is essentially a contract to accept, with 
incidental provisions. It first confers upon a designated 
party the right to draw drafts upon the person signing the 
contract, up to a certain sum and within a specified period, 
and second, provides that the drafts must be drawn against 
shipments of a stated kind of merchandise and must have 
certain documents attached, and third, binds the person who 
signs to accept the drafts without regard to the actual ar- 
rival of the merchandise or to its character or condition 
when it appears. In the fourth place, it is agreed that the 
bank shall have the merchandise as collateral security. The 
commission to be paid by the importer is also stated. 

To transmit to its branch or correspondent in Canton an 
authority as agent to purchase the described drafts, the 
importer's bank will commonly forward simply a copy of 
the authority to draw bearing a notation "please do the 
needful" or words of similar import. This becomes the 
"authority to purchase," abbreviated "A. P." The ex- 
porter will be notified in a suitable manner of the existence 
of this authority to purchase for his benefit. In case of 
necessity the authority may be telegraphed. 



THE BANK CREDIT AND LETTER OF CREDIT 175 

The Authority to Purchase is by no means so desirable 
from the exporter's standpoint as the bank credit, but has 
nevertheless some advantages. If the Canton Company of 
our illustration drew upon the San Francisco Tea Com- 
pany without the support of the authority to purchase 
issued by the San Francisco bank, it might not be able to 
sell its draft for cash. For if the San Francisco company 
should fail in a business way or should for other reason 
refuse to honor the draft, trouble and expense would be 
occasioned. The buying banker would have no right of 
action against the drawee if the latter refused to accept the 
bill and would have to resort to the merchandise as collateral 
and probably also to recourse upon the drawer for a bal- 
ance due after the goods were disposed of at forced sale. 
Doubtless these evil possibilities would not actually be real- 
ized in most cases, but they are frequently of sufficient 
weight to make a banker at the point of export refuse to 
go further than to receive the draft for collection, whereas 
in general the exporter would much prefer to make a sale 
of the instrument. The simple and single benefit of the 
authority-to-purchase plan is that the importer induces a 
banker of his city to whom he is known to purchase the 
draft at the time and place of its origin. This banker acts 
primarily because he knows and has confidence in the im- 
porter, and secondarily because he is also fortified by the 
latter 's engagement to accept the draft without conditions 
as to the arrival and .sufficiency of the goods. This banker 
would, in the event of the refusal of the drawee to accept, 
have three channels of reimbursement open to him for his 
outlay for the draft and his charges, namely, (1) an action 
against the drawee on the latter 's contract to accept, (2) 
resort to a sale of the goods, and (3) recourse upon the 
drawer. 24 The banker will not, however, issue an authority 

24 The contract of the drawee to accept does not operate to destiny 



L76 FOREIGN EXCHANGE 

to purchase for an importer where lie thinks there is any 
appreciable danger that the latter will fail to honor the 

draft. 

If we suppose the Canton Company to make a shipment 
to the value of $500 and to draw a draft for this amount 
upon the San Francisco Tea Company, the following would 
be the regular course of events. The Bank for Foreign 
Trade of San Francisco would through its agent buy the 
draft in Canton. The instrument would be forwarded 
immediately to San Francisco and would be presented to 
the San Francisco Tea Company for acceptance, which 
would be granted. The goods, upon arrival, might be re- 
leased to the acceptor under any of the several plans already 
discussed in § 43. 

§ 49. The practical nature of the right of recourse. — By 
way of comparison of the bank credit and the authority to 
purchase, the following may be noted. (1) The ordinary 
commercial letter of credit is a communication from a bank 
to the beneficiary and is designed to be shown by this person 
as a credential to any banker. In regular practice the 
banker to whom the exporter carries his letter of credit, 
takes his draft as an outright purchase made on his own 
account. On the other hand, the authority to purchase 
is a communication direct to a particular bank, requesting 
it to buy the draft of the beneficiary, and in this business 
to act as the agent of the bank sending the authority. (2) 
Under the letter of credit the beneficiary draws upon a 
bank, under the authority to purchase upon the importing 
merchant. Documents are attached to the draft in either 
case. (3) Unless there is a clause permitting revocation, 
bankers understand that the commercial letter of credit is 
irrevocable, whereas they understand that the authority 
to purchase is revocable at any time prior to the 

the right of recourse upon the drawer in the event of dishonor 
whether for non-acceptance or for non-payment. 



THE BANK CREDIT AND LETTER OF CREDIT 177 

actual purchase of the draft by the foreign bank acting 
as agent. An occasion for such revocation might be, for 
instance, the business failure of the importing merchant 
after he has arranged for the authority to purchase but 
before the exporter's draft is actually bought. 25 (4) The 
practical nature of the liability of the exporter to recourse, 
as drawer of the draft, is very distinct under the authority 
to purchase as compared with the bank credit. 

The trade bill, drawn on the importer instead of a bank, 
is essentially the same whether supported by an authority 
to purchase or not. In either case failure of the importer 
to honor the draft means recourse upon the drawer, unless 
the latter should enjoy the rare advantage of having the 
goods sell for enough to discharge the draft. An authorized 
draft on a bank is distinct in that the failure of the im- 
porter to pay does not involve recourse iipon the exporter 
as drawer. As has been stated before, the undertaking of 
a bank which grants a credit, that the draft will be accepted 
and paid, is not conditioned upon the solvency of the im- 
porter or the performance of his obligations, but is absolute 
after the exporter has drawn his draft in accordance with 
instructions. The bank granting the credit takes all the 
risk that the importer will fail, and the exporter is wholly 
relieved of this risk. Bankers issuing authorities to pur- 
chase take pains to make it clear to merchants that the 
drawer is subject to recourse in the event of the failure of 
the importer to accept or to pay, 2G and regard this as a Lead- 
ing point of distinction between the authority to purchase 
and the true bank credit. 

Before quitting this subject it is desirable to make clear, 
however, that the actual legal righl of recourse upon the 

-■"'With regard to the revocation of a commercial letter of credit 
see § 41. 

26 Compare the words "with recourse" in the second line of the 
main body of the specimen authority to draw given on p. 173. 



178 FOREIGN EXCHANGE 

drawer is present in the ease of the draft under a bank 
credil just as it is in the case of the draft on the importer 
in person. The truth is, not that the right of recourse is 
(lest roved in the case of the bank credit, but rather that its 
practical nature is entirely altered. As shown in §12 of 
this book, the right of recourse emerges with (1) proper 
presentment to the drawer, (2) dishonor, and (3) due no- 
tiee of dishonor (including protest as a necessary element 
in the case of foreign bills, unless waived). Suppose the 
Canton Company of our illustration were granted a credit 
at the importer's request by a San Francisco bank and sold 
its draft upon this bank to a banker of Canton. If the 
San Francisco bank should fail or should for other reason 
dishonor this draft, the banker of Canton could have re- 
course upon the Canton Company as drawer. The fact that 
the drawee was a bank, and that it had contracted to accept 
and pay the draft, has no effect on the right of recourse. 
The difference between an authorized draft on a bank and 
a draft on the importer (whether an authority to purchase 
the latter issues or not) from the standpoint of the exporter 
as drawer is clear. He is subject to a legal right of re- 
course in both cases, but in the instance of the bank credit 
it will require a failure of the drawee hank to bring recourse 
upon him, and the failure of the importer will not bring it. 
The importer is not the drawee in this instance. In the 
case of the trade bill the failure of the importing house 
alone is sufficient to produce recourse. There is a great 
practical difference in the two risks. 27 

-' The acceptance by a bank of a long bill drawn upon it by a mer- 
chant does not remove the possibility of recourse upon him as 
drawer in the event of non-payment. The certification (acceptance) 
of a check by a bank does release the drawer, but this is a distinct 
case. If A draws a check on a bank payable to B, and if B for his 
own reasons takes a certification of the check at the bank's counter, 
the effect is to destroy B's right of recourse upon A as well as upon 
any indorsers. B has had an opportunity to demand payment of 



THE BANK CREDIT AND LETTER OF CREDIT 179 

§ 50. The commissions charged for bank credits. — Im- 
porters who apply for bank credits pay the institutions 
that issue them commissions for the service thus rendered. 
Such a commission is a matter of private adjustment be- 
tween banker and customer and will vary to a considerable 
degree according to the character of the firm that is accom- 
modated. There are, however, certain average or standard 
commissions found in ordinary practice, and a table of the 
charges levied by American bankers for the issue of credits 
is presented beneath. A noteworthy feature of this class 
of commission is that it is roughly proportional to the 
length of life or usance of the drafts that are to be drawn 
under the credit. 

The following may be taken as standard or full commis- 
sions charged by American banks to-day: 





For 




For 




Sterling Credits 


Dollar Credits Granted 




On London Bankers 


By 


the Bank on Itself 




Per cent. 




Per cent. 


Drafts at sight 


Vi to y 2 




% to Vi 


Drafts at 30 days 


% to % 




V* to % 


Drafts at 60 days 


y 2 to % 




% to & 


Drafts at 90 days 


% to % 




% to % 


Drafts at 4 mos. 


% to 1 




% to % 


Drafts at 6 mos. 


1 to V/ s 




% to % 



Concessions from these rates are not infrequently made in 
favor of houses of excellent standing that have large and 
regular dealings with a bank. 

the instrument, since it is due at sight, and he cannot forego this 
opportunity and also hold the parties secondarily liable. 

If 13 holds a sight draft upon a private person as distinguished 
from a bank, and if he accepts some undertaking of that person in 
place of payment itself of the draft, this undertaking being anal- 
ogous to certification by a bank, this action by B will release the 
parties secondarily liable from all further liability in the sami 
manner as certification by a bank. 



L80 FOKKKJX K.XCll A\(iK 

A London bank's charge for confirming a credit issued 
againsl it by an American correspondent will ordinarily 
run Prom '-" to '* of mm per cent. Usually this charge is 
independenl of the Length of life of the drafts to be drawn. 
It will lie assessed against the American bank in sterling, 
ami its equivalent in dollars will be collected by the latter 
institution from the applicant for the confirmed credit. 

The question of how much commission, or whether any 
commission, is to be charged for the issue of an "authority 
to purchase," is so much a matter of special adjustment 
between banker and customer that a table of standard com- 
missions for this service can hardly be presented. 

The London bank or accepting house which accepts drafts 
drawn upon it under the authorization of an American cor- 
respondent will in all cases demand a compensation in one 
form or another for this lending of its name. The usual 
form taken by this compensation is a commission, of per- 
haps Vig of 1% for each month of life of each draft accepted. 
For example, on a 90 days' draft for £10,000, the London 
acceptor would at this rate charge 3 /w of 1% of £10,000, 
or £18.75 (that is, £18 and 15 shillings). On this same 
draft the American bank might collect from the applicant 
for the credit a commission of perhaps % of 1%, and out 
of this would pay the London banker's acceptance com- 
mission, which would take something less than half of the 
amount so collected. Commissions are assessed on the 
drafts drawn and not upon the total aomunt, or maximum 
limit, of the credit itself. The American banker pays com- 
missions due the London house, in sterling, and collects com- 
missions from the importer in dollars. It is said that some- 
times the American and London banks conduct their busi- 
ness in sterling credits on joint account, which signifies 
that they divide equally the commissions collected from the 
applicants for such credits. 

The fact that the commission charged for drafts drawn 



THE BANK CREDIT AND LETTER OF CREDIT 181 

under bank credits is a function of time — that is, varies 
roughly in proportion to the length of life of the draft, 
or the time to run between its acceptance and payment — 
gives this commission a certain superficial resemblance to 
an interest charge. Thus a charge of 3 A% on drafts at 
ninety days' sight is in a sense a charge at the rate of 3% 
a year. But these commission rates are not in the least 
interest rates. The institutions collecting them make no 
advances of money or of money's worth for a deferred 
return, but as already shown merely "lend their credit" 
(which means to become liable), whereas a real advance 
for a deferred return must be present to give rise to what 
is known as interest and a rate of interest. 

The banker who issues a credit becomes unconditionally 
liable for the payment of the drafts drawn under it. He 
takes the risk that the importer who has applied for the 
credit may suffer business failure before the time arrives 
when he is obligated to reimburse the bank for the drafts 
drawn. The banker also renders this importer a valuable 
service. It is for this risk and service that the commission 
is charged. The reason why the commission is made greater 
as the length of life of the drafts is increased, is because 
the longer this life the greater is the length of time during 
which the importer may postpone reimbursement and the 
longer is the period during which the banker carries the 
risk of his solvency. The importer engages to reimburse 
the bank a fixed number of days prior to the maturity of 
the acceptances. Obviously if the drafts run at 90 days' 
.sip lit there will be 30 days more delay open to the importer 
than if they run at 60 days' sight. The risk carried by the 
banker is a rough function of time, and it is for this reason 
commissions are approximately proportional to time. 

§ 51. The traveler's letter of credit and the traveler's 
cheque. — Persons intending to l ravel abroad may make ar- 
rangements with banks in the home country, or with express 



L82 FOREIGN EXCHANGE 

companies or tourist agencies, which will enable them to 
procure the local money of any foreign country visited. 
The traveler either pays out home money in advance or 
gives the bank or institution accommodating him a contract 
obligating him to make payment later. There are two 
plans open to him. He may procure what is known as a 
circular letter of credit, or he may buy so-called traveler's 
cheques. It is true yet another course may be followed, 
for he may carry abroad actual home money (preferably 
standard coin or governmental notes or certificates) and sell 
it from time to time for the local money of places visited, 
but this plan is neither so safe nor so convenient as either 
of those involving the aid of the home banker, and on the 
average will probably work out to be more costly in home 
funds for a given amount of foreign money secured. 

The traveler's letter of credit is an instrument addressed 
by a bank as a circular letter to its correspondents scattered 
throughout the world informing them that the traveler or 
beneficiary is authorized to draw sight drafts up to a certain 
total amount specified, either (1) upon the writer bank 
itself or (2) upon some one of its correspondents named 
in the letter, usually one in London. The letter requests 
the bankers addressed, on application to do the beneficiary 
the favor of buying his drafts, that is of exchanging local 
currency for them at the current rates of exchange, and 
also conveys the writer bank's engagement that these drafts 
will be paid by the drawee upon demand. Before the war 
at least, the vast majority of traveler's letters of credit 
issued by American banks authorized sterling drafts, or 
drafts on London banks. As in the case of the commercial 
letter of credit, drafts as drawn and sold are recorded on 
an appropriate page, and when the last draft exhausts the 
credit, the letter will be taken up by the bank cashing it 
and forwarded along with the draft to be surrendered to the 
drawee bank. As the traveler who carries a sterling letter 



THE BANK CREDIT AND LETTER OF CREDIT 183 

of credit goes about he sells sterling exchange according 
to his needs to procure local money in the various places 
he visits. The letter of credit serves as an introduction to 
and as credentials before the buying banker. The latter 
will possess specimen signatures of the officers of the bank 
which has written the letter and judges of the genuineness 
of the individual letter presented at his counters by an 
inspection of the signatures which it bears as well as by 
looking to its general form. The banker will judge of 
the genuineness of the traveler himself, so to speak, by 
requiring him to duplicate a specimen signature which he 
himself was required to place upon the letter at the time 
of its delivery to him, or else upon a separate letter of 
identification. The purpose of having the latter document 
distinct is safety. The traveler is advised to keep the two 
letters apart. The loss of one alone would not enable the 
finder, if inclined to forgery, to realize upon the credit. 
The traveler is given a list of banks, astonishingly numer- 
ous, which will buy his drafts. This list is obtained by the 
institution writing the letter, from its London correspond- 
ent, and usually includes all the banks in the four corners 
of the world which already have established relations with 
this London bank. 28 Only larger banks and banking houses 
sell their own letters of credit whether these authorize 
drafts upon themselves or upon correspondents. Many 
smaller banks have arrangements with these larger institu- 
tions enabling them to issue letters as virtual agents of the 
latter. 

When a traveler pays cash in advance for a sterling credit 
purchased from an American bank, he is charged for the 
full face value of the credit at the "posted rates" 29 for 
sterling exchange, and he also pays a commission which, 
as stated by one banker, may be "anything or nothing." 

28 Compare MargraflF, "International Exchange," p 73. 
20 Compare § 24, p. 82. 



is I FOREIGN EXCHANGE 

Margraff and Brooks place the prevailing commission at 
It", to consider an example, the posted rate is 4.88 
and the (•.iniuiissi.il) \' ', , a circular letter for £1,000 would 
cosl $4,880 plus $48.80 commission, or $4,928.80. Assuming 
the traveler uses this credit to procure French money in 
Paris, the number of francs obtainable per pound of draft 
will depend on the Parisian banker's buying rate for the 
type of bill the traveler has to sell. The cost of francs in 
dollars would be computed as follows: 

French hankers buying rate (say) 25.00 francs per £. 

Cost in dollars of £1 of the credit $4.9288 

(4D28.80 [as shown above] ^1000) 
Cost in dollars of the 25.00 francs obtained 

from £1 $4.9288 

Cost of 1 franc 19 7 t1oo cents. 

(4.9288-^25) 
Number of French units obtained for $1 . . . 5.07 -f- francs. 

(25.00 -h 4.9288) 

If the traveler comes home without having exhausted 
the credit he will obtain dollars for the part that remains 
by selling it to the bank which wrote the letter of credit 
at the latter 's buying rate of the day for small sterling 
drafts. Traveler's credits are often issued against the 
;!i:i cement of the beneficiary to furnish funds as required 
to cover the drafts drawn, both with and without the de- 
posit of collateral security to protect this engagement. 31 

The London bank upon which the traveler's drafts are 
drawn under a credit issued by an American bank, reim- 
burses itself as fast as it pa} T s these drafts by making im- 
mediate deductions from the deposit of the American bank 

30 Margraff, "International Exchange," p. 86; and Brooks, "For- 
eign Exchange Text Book," p. 140. 

si For a more detailed discussion of the traveler's credit the reader 
may see Margraffs '"International Exchange," Chapter XII, pp. 
73-87. 



THE BANK CREDIT AND LETTER OF CREDIT 185 

for the amounts thus paid out plus its commissions for 
the service. Immediate reimbursement is taken, of course, 
because the drafts are drawn and paid at sight. An Ameri- 
can bank will in regular course be under the necessity of 
buying and remitting sterling to the credit of its London 
balance against its sales of travelers' sterling credits. If 
it conducts this department of its business at a profit, this 
profit will flow from its charging the buyers of credits more 
dollars than are required to purchase the cover. The 
profit will come in part from the high posted rates charged 
and in part from the commissions. 

The Traveler's Cheque. — A comparatively recent and 
very popular instrument is the "traveler's cheque." This 
consists in a sight draft drawn not by the traveler himself, 
as under the plan of the circular letter of credit, but drawn 
by a bank to the order of the traveler as payee. Arrange- 
ments are made for the encashment of this type of check 
in local money by correspondent banks and also other 
offices scattered through the leading countries of the world. 
The following is a specimen. 




i-.-i.Tfc-i-I.TV.'-C, 







Two features distinguish this instrument from an ordinary 
cashier's check or sight bank-draft made payable to the 
person who purchases it. (1) The traveler's check carries 
a specimen signature of the payee which he is required to 
place upon it at the time of purchase. His ability to dupli- 



186 FOREIGN EXCHANGE 

rate this at the time lie cashes the check serves to identify 
him anywhere as the proper payee. "When a person cashes 
an ordinary check or draft payable specially to him, rather 
than to bearer, he must indorse it. AVhen the payee cashes 
a traveler's check he really indorses, but the signature of 
indorsement is in the case of the commoner forms located on 
the face instead of the back of the instrument, and is called 
a "counter-signature." (2) In obtaining cash on an ordi- 
nary sight draft in a place foreign to the country where the 
draft was drawn, the draft must be sold at the exchange 
rate of the day, which is a variable. The traveler's check 
is cashed in a number of leading countries for fixed and 
invariable sums of local money indicated plainly on the 
face of the instrument. Thus the check shown above, which 
may be encashed for $20 in the United States or Canada, 
will be encashed in Germany at a vast number of offices 
for 83.30 marks, irrespective of the position of the rates 
of exchange in Germany on London or New York, without 
deduction for commission or other account except for any 
local stamp tax on the instrument. This statement holds 
good, of course, only on the assumption of times of peace 
and the restoration of currency systems to the positions 
they occupied prior to the war. One who carries traveler's 
checks takes no risk of exchange with respect to encashment 
in the several leading countries. In countries where a 
designated sum is not payable on the check it is to be sold 
as New York or London exchange, according to which, 
sale is the more favorable. 

The banks which issue these instruments make arrange- 
ments for their encashment, in general with the same list of 
banks as that to which they address their circular letters 
of credit. In addition, however, many hotels, offices of 
tourist bureaus, and even railway ticket offices and ordi- 
nary stores, receive the leading kinds in payment, and 
sometimes also cash them. The system by means of which 



THE BANK CREDIT AND LETTER OF CREDIT 187 

the bank issuing the traveler's check reimburses the bank 
which cashes it, is necessarily somewhat different in detail 
from that which prevails in the case of the draft under a 
circular letter of credit. For, in cashing the latter, a for- 
eign bank merely buys it as so much exchange, and pro- 
cures compensation for handling it by paying a low enough 
price for it. Since the bank which cashes the traveler's 
check must pay out a fixed sum of local money, machinery 
must be provided by means of which the issuing bank may 
directly or indirectly place in its hands a suitable com- 
mission for his services. 

The most important traveler's check sold in the United 
States to-day is the one issued under the auspices of the 
American Bankers' Association, which is the one we have 
given as a specimen. A number of larger banks in the 
country, however, issue their own traveler's checks, and 
also dispose of them in part through smaller interior banks 
as sales agents. The leading express companies likewise 
put forth this form of exchange, and in fact, as Mr. Brooks 
tells us, the American Express Company originated the 
instrument. 32 Under the standard terms these checks are 
in this country sold for their face value in dollars plus a 
commission of M.> of 1%, or 50 cents per $100 worth, in some 
cases with a minimum commission of 50 cents. 

Speaking of the technical form of these instruments, the 
majority of them are real checks drawn by a bank upon 
another bank in favor of the purchaser, but some are strictly 
demand promissory notes of the bank of issue, though they 
are still called "cheques." The precise technical form of 
the instrument makes absolutely no practical difference in 
its use. The American Bankers' Association check is drawn 
by the bank which sells it upon the Bankers' Trust Com- 
pany of New York, and bears the acceptance of the latter 

32 Brooks, "Foreign Exchange Text Book," p. lo'.i. 



L88 FOREIGN EXCHANGE 

institution, this acceptance having been placed upon the 
instrument in advance when it was a blank form sent to the 
selling bank. 33 

77) < bank post remittance is a form utilized chiefly by 
European immigrants to the United States, as a means of 
sending money back to the old countries for parents or 
dependents. The latter are commonly a class of persons 
who would find difficulty in cashing ordinary bank checks 
or drafts. Therefore, bankers in this country who sell the 
form of exchange known as the post remittance, undertake, 
in return for dollars received from the purchaser, to have 
a foreign correspondent bank, practically always one located 
in the country of the designated payee, send the latter the 
amount of his home money which, considering the banker's 
charges, is the equivalent of the dollars paid over by the 
purchaser. The correspondent bank forwards this money 
to the payee generally by sending him local bank notes 
tli rough registered and insured mail, or sometimes by send- 
ing him a local postal money order. The purchaser of the 
post remittance makes out an application which commonly 
bears explanations in some ten or twelve languages, and 
then pays in his dollars and obtains a receipt to be retained 
by himself, and also a memorandum, likewise ornamented 
by the script of many tongues, which he is to mail to his 
payee abroad. The receipt specifies the address of the 
paj-ee, the amount of his home money he is to receive, the 
rate of exchange at which this money is sold the purchaser, 
the charges for transmission and minor expense, and the 
total number of dollars charged for the remittance. The 
memorandum sent by the purchaser to be the payee is in 
no sense a check or order, but is, technically speaking, 
simply an advice. 

To sell a post remittance in its own right, a bank must 



33 Under the general law of bills, acceptances in advance are valid. 



THE BANK CREDIT AND LETTER OF CREDIT 189 

simply have funds with or send funds to the foreign bank 
which it has directed to forward money to the payee, or 
else it must have relations with this foreign bank which 
enable the latter to obtain reimbursement for its expendi- 
tures and services in some appropriate manner, as, for 
instance, by drawing on the American bank's London cor- 
respondent a draft which is to be protected by the American 
bank's advising London to honor it. International money 
orders, whether issued by the government, by express com- 
panies, or by banks, are also a form of foreign exchange. 



CHAPTER VIII 
FOREIGN MONEY MARKET FACTORS 

§ 52. The foreign balance. — In entering now upon the 
general subject of practical dealing and rate making, it 
must be said it will hardly be our undertaking to explain 
each and every form of operation in exchange known to 
actual practice. We shall, however, try to make clear the 
more important or standard types. Such of these as involve 
exchange investment, borrowing, speculation, or arbitrage 
will be considered in special chapters. In pursuance of the 
plan already laid down, attention will be directed in the 
main to (1) operations conducted by American bankers 
(2) in sterling exchange (3) under conditions prevailing 
just prior to the present war. The exchange dealings of 
Paris or Berlin or other foreign capitals on London, or on 
one another, differ in many points of detail from the opera- 
tions of New York on London. Local and peculiar banking 
customs are to be found in any monetary capital. 1 How- 
ever, a fairly thorough explanation of the exchange deal- 
ings of some one country, as the United States, will disclose 
at least the fundamental principles which govern in opera- 
tions the world over. 2 

i The Parisian methods, for instance, of quoting long and short 
exchange on other centers constitute a Chinese puzzle to one un- 
familiar with the system. Compare Clare's "A B C of the Foreign 
Exchanges," pp. 128 et seq. 

2 It is not designed to make this book a so-called Arbitrage 
Manual. Swoboda's arbitrage manual attains a length of 977 pages 
without becoming, or attempting to become, a treatise on the foreign 
exchanges that is truly useful to the general reader or ordinary 
banker or student. [Note continued on page 191.] 

190 



FOREIGN MONEY MARKET FACTORS 191 

If a bank is to carry on a fully rounded out and inde- 
pendent business in exchange on any given foreign country, 
as say England, it must have with a banking establish- 
ment in that country (1) a deposit or balance and (2) an 

Note on the Literature of Exchange. The arbitrage manual is a 
practical foreign banking hand-book which commonly sets forth in 
much detail the particular banking and money market customs, the 
methods of handling and pricing bills of exchange, the laws and 
customs of dealing in bonds and stocks, the methods of handling 
bullion, the stamp taxes levied by governments upon dealings in 
bonds, stocks and commercial paper, and like matters, for all of the 
countries and principal money capitals of the world. The arbitrage 
manual usually assembles its subject matter country by country, and 
city by city, and is planned so as to give much of the data required 
for technical arbitrage operations in exchange. The following are 
some of the important examples of these books: Otto Swoboda, 
"Die Arbitrage (in Wertpapieren, Wechseln, Miinzen, und Edel- 
metallon)," (Thirteenth Edition, edited by Max Fiirst), Berlin, 1000; 
E. KaufFmann, "Banknotes, Monnaies et Arbitrages," Paris, 1908; 
Ottomar Haupt, "Arbitrages et Parites" (the latest edition of this 
book in the possession of the present writer is the eighth), Paris, 
1894; H. T. Easton, "Tate's Modern Cambist," Twenty-fourth edi- 
tion, London, 1908; Henry Deutsch, "Arbitrage," London, 1904; J. H. 
Norman, "Universal Cambist," London, 1897. (The latter work is 
unlike the ordinary arbitrage manual, being occupied almost wholly 
with the author's odd and elaborate [and not over-useful] monetary 
theory, and containing relatively little information on the practical 
arbitrage and exchange customs of the leading monetary countries.) 

The following books on Foreign Exchange, in the English lan- 
guage, will be found useful reading on practical exchange dealings: 
Anthony W. Margraff, "International Exchange," Fourth Edition, 
New York City, 1912; Howard K. Brooks, "Foreign P^xchange Text- 
book," Chicago, 1906; Franklin Escher, "Elements of Foreign Ex- 
change," Second Edition, New York, 1911. The first of these con- 
tains the more complete treatment of the subject. The third is a 
very brief, but nevertheless admirable essay on the exchanges for 
the American student. Two very good, but rather short books on 
Foreign Exchange are those by George Clare, "The A B C of the 
Foreign Exchanges," Fifth Edition reprinted, London, 1911; and 
"The Money Market Primer and Key to the Exchanges," Second 
Edition, London, 1903. Another book of a generally similar charac* 



L92 FOREIGN EXCHANGE 

acceptance account. Circumscribed and somewhat indirect 
operations in foreign drafts may, however, be engaged in by 
a smaller bank without having even a balance abroad, by 
aid of arrangements which it can make with some larger 
home institution posessed of complete foreign facilities. 
A greater American bank not infrequently has more than 
one balance and more than one acceptance account in Lon- 
don, but for present purposes it will suffice to speak of a 
single balance and single acceptance account and of the 
dealings in exchange which may be founded upon these as 
a basis. 1 A London deposit enables a bank, without the 
intermediation of any other home institution, to sell sterling 
sight drafts and cables and to issue both kinds of travelers' 
exchange pa\*able in sterling, and also to buy all types of 
sterling exchange, cables and sight and long drafts, and as 
well to undertake certain minor operations which need not 
be itemized. We have already paid some attention to the 
acceptance account (page 135). To have such an account 
in London enables a bank to issue commercial letters of 
credit in sterling (involving as these do the authorization 
of long drafts upon the London correspondent for its ac- 

ter is Hartley Withers' "Money Changing," London, 1913. W. F. 
Spaulding's "'Foreign Exchange and Foreign Bills," London, 1915, 
may also be mentioned. "Foreign Exchange," published by the 
Financier Company, New York, 1902, is a brief treatise on the sub- 
ject which contains certain points not readily available elsewhere, 
but which is so unsystematic as not to be suitable for the ordinary 
reader. "International Trade and Exchange," X. Y., 1914, by H. G. 
Brown, a book of the more scholarly type, is devoted in part to the 
exchanges. 

"The Theory of the Foreign Exchanges" by Viscount George J. 
Goschen, was an early and important essay on the subject which 
first appeared in 18G1 and went through many editions and was 
translated into the principal foreign languages. 

3 The writer has heard of an instance of an American bank having 
four London balances, but is unable to say whether or not this should 
be regarded as entirely exceptional. 



FOREIGN MONEY MARKET FACTORS 193 

ceptance) and also permits it when it desires to draw and 
sell its own long sterling bills. 

All operations in exchange, even those requiring an ac- 
ceptance account, rest ultimately upon the foreign balance, 
in the sense that the latter is indispensable for carding 
them through, and every completed operation will, whether 
earlier or later, produce either a debit or a credit to this 
balance, that is popularly speaking either an outpayment 
from it or an inpayment into it. We say "completed" 
operation because one might speak of the issue of a letter 
of credit as an "operation" and this mere issue of itself 
will not affect the foreign balance. It is the drawing by 
the beneficiary under the credit that does this, and con- 
ceivably he might not draw or at any rate he might not 
draw for the full amount authorized. If we think of his 
drawing as the completion of the operation of issue of a 
credit, we may generalize and say that every completed 
operation in exchange alters the foreign balance, and in the 
following manner: (1) sales of exchange and issues of com- 
mercial and travelers' credits deplete the balance and (2) 
purchases of exchange replenish or augment it. 

The time intervening between an exchange transaction at 
an American bank and the final effect of this transaction on 
the bank's London balance, may be anything from a few 
moments or a number of hours, as in the instance of the 
cable transfer, to several months, as in certain cases in- 
volving long bills. For this reason the debits and credits 
to this balance entered on any given day will be found 
to originate in a great number of operations initiated on 
many different dates in a period covering several months 
prior to that given day. Thus a debit entered to-day may 
have followed from the sale of a cable transfer to-day or 
yesterday, or from the sale of a sight draft perhaps six or 
seven days ago, or even from the issue of a travelers' or 
commercial credit a number of months back. Or a credit 



194 FOREIGN EXCHANGE 

of to-day may have resulted from the purchase of a cable 
within a few hours or of a sight draft within a week. Or 
it mighl be the consequence of a sale just effected in the 
London money market of a long sterling bill bought in New 
York about a week ago and sent over for immediate dis- 
count and cash credit. On the other hand it may come 
from collection at maturity on a 90 days' sight bill pur- 
chased in America about one hundred days since and held as 
an investment for the interest earnings that it would yield. 
A foreign balance has as a capital a high rate of turn- 
over. That is, the volume of business sent through it is 
very large in proportion to the balance itself. Any lack of 
equivalence between the debit and credit items in this busi- 
ness will therefore tend to cause large fluctuations in the 
account. In view of the fact that the business impinging 
upon it on any given day will consist of a large and mis- 
cellaneous group of exchange operations undertaken in the 
near and more remote past by the bank for its customers 
in America, determined primarily by the commercial and 
other requirements of these customers, it is manifest it 
would be a mere accident if the debits and credits of the 
given day should offset each other. Unless corrected by 
supplementary or stabilizing operations, this business might 
on some days cause the balance to be greatly reduced or 
to disappear and on others to rise to an inordinate sum. 
But there will be some appropriate figure at which it would 
best stand, depending upon the quantity and character of 
the business based upon it, and it will be the bank's policy 
to keep it as close to this figure as may be practicable. Its 
normal amount should not be allowed to fall too low lest 
the business of a day or two might in its oscillations produce 
a heavily overdrawn condition. Incidental overdrafts in 
the kind of a balance which we are now discussing are in 
no sense crimes, but the correspondent charges a relatively 
high rate of interest upon them and in any case it will be 



FOREIGN MONEY MARKET FACTORS 195 

the bank's program to keep them reduced to the lowest 
terms. It is sometimes provided in the agreement with the 
correspondent that a certain average daily balance shall 
be maintained as a minimum. On the other hand, a need- 
less surplus in this deposit above the appropriate working 
figure is undesirable because it means the depletion of 
funds available for employment in regular banking at 
home. 4 Suppose, for illustration, the existence of such an 
overplus amounting to £10,000. This will have been caused 
by excess purchases of exchange of a present value on 
arrival of £10,000, and this exchange will have cost in ordi- 
nary times something more than $48,000 of local money of 
the United States. This sum of dollars will have disap- 
peared from the resources of the bank at home and will 
have reappeared as sterling in the deposit in London. Its 
disappearance at home is not the less complete for the time 
being because of its reappearance in converted form abroad. 
Though the fund is not lost to the bank, it is in the wrong 
place and form. To bring it back home it will simply be 
necessary to sell £10,000 of sterling exchange (sight drafts 
or cables) in the home market. This sale will restore some- 
thing over $48,000 to the home resources, depending upon 
the rate of exchange. Very likely the exchange will be 
bought by some other bank or banks whose own particular 
circumstances make them have a need for it. 

In practice the surplus of £10,000 in the London deposit 
would not be allowed to build up, but would rather (if it 
tended to accumulate) be torn down progressively by sales 
of exchange on the market as they might be required for 
this purpose. When its primary business in exchange hap- 

* Certain conditions may make it advisable to place fairly large 
funds in loans or discounts in the foreign country, and this through 
the agency of the correspondent bank, but such funds would not in 
any event remain in, or be carried in, the balance with the corre- 
spondent . 



L96 FOKKKiN EXCHANGE 

pens to run in channels tending to produce a deficiency in 
the foreign balance, the bank will, of course, to provide 
againsl this, find it necessary to buy exchange in the market 
to be remitted to the correspondent. 

To maintain a policy of stabilizing its foreign balance, 
the bank must evidently keep as close track as possible of 
the daily fluctuations in this account. Suppose the natural 
flow of its business in exchange with its customers, is pre- 
destined to produce a heavy net debit to the balance on say 
July 10th, and assume that the bank is one week removed 
in mail time from its correspondent, then perfect correction 
for this fluctuation through a remittance of specially pur- 
chased sight bills would require foreknowledge on July 3d 
and the buying in of the bills on that day. A purchase of 
cables on a much later date could of course be made to serve, 
and doubtless much of the demand in the open market for 
cables is to be accounted for by their emergency utility in 
providing cover in such cases as this. Clearly the bank 
needs foreknowledge of the events to transpire in its for- 
eign balance, but what has already been said indicates that 
this foreknowledge cannot in fact be quite perfect. As 
for the credits that are about to come into being, practically 
all, or the vast majority of these, spring from the bank's 
own remittances of exchange, and with the exception of 
one class the credits are pretty closely under its control 
and foreknowledge. The only uncertainty respecting the 
precise time of the becoming effective of these credits is 
that attaching to the transmission of mail and telegrams, 
and this uncertainty is not great in times of peace. The 
exceptional class of credits are those arising from the remit- 
tance of documentary payment trade bills. As we have 
seen (in § 35) these instruments are paid off at any time 
between acceptance and maturity according to the pleasure 
of the drawee. Under the banking customs of England 
they cannot be discounted on arrival as can other long bills, 



FOREIGN MONEY MARKET FACTORS 197 

and therefore in general the precise time when they will 
produce their credits cannot be foretold. On the other 
hand, a schedule, based on experience, of the probable yield 
day by day from a known lot of these bills can be and is 
worked out in practice by the banker. 

With respect to debits, the time when many of these will 
become operative is less under the bank's foreknowledge and 
control. The dates on which drafts will be drawn under 
travelers' and commercial credits, and consequently the 
dates when these bills will finally work reductions in the 
balance, are not determined by the bank but depend, within 
the limits set by the duration of the credits, upon the con- 
venience of the beneficiaries. In the case, however, of long 
bills under commercial credits, the bank gains foreknowl- 
edge of the dates of ultimate charge to the balance, a con- 
siderable period prior to the event, from the advices for- 
warded by the correspondent telling the dates of acceptance 
of these bills as they have been presented. A ninety days' 
sight bill accepted on July 1st will become payable, 93 days 
thereafter, on October 2d, and the American bank which 
has granted the credit may well learn of this date as early 
as July the 7th or shortly thereafter. Sight drafts drawn 
by the bank itself and sold to its customers or the general 
public may be out a longer or a shorter time before present- 
ment for payment at the counters of the correspondent, de- 
pending upon the promptness and number of transfers 
made by the persons handling them, and therefore even in 
their case the time of debiting the balance is not foreknown 
with absolute precision. 

An ordinary depositor with a bank commonly judges of 
the state of his deposit by his check stubs, though he real- 
izes the record on these stubs is in error at any time when 
there are outstanding checks. But for an exchange bank 
it would be out of the question to take the mere record of 
the dates and amounts of its own remittances and drawings 



L98 FOREIGN EXCHANGE 

of exchange and issue of credits, as sufficient evidence of 
the condition of its foreign deposit. So it prepares from 
advices received and from oilier data interpreted in the 
light of experience, a corrected memorandum account de- 
signed to show from day to day in the near future the 
approximately em-feel stale of its balance as it will appear 
in fact according: to the books of the correspondent. To 
be on the safe side in making up this memorandum, it 
should assume maximum periods to transpire before credit 
items started on their way become effective, and make 
allowance for the expiry of minimum periods only before 
debits known to be in process will be charged. It will be 
on the basis of this memorandum that the bank will make 
its compensatory purchases or sales of exchange on the 
open market to stabilize its balance. 5 

To summarize we may formulate what might perhaps be 
called the rule of equal sales and purchases. This runs 
to the effect that — setting aside circumstances when it is 
desirable to change the foreign balance itself or alter the 
foreign loan funds if there are any — the bank must keep 
its current purchases and sales of exchange at a substantial 
equality. In interpreting this, the issue of travelers' and 
commercial credits are, to the extent to which these credits 
are utilized, to be treated as sales, or as being like sales of 
exchange. And it is to be kept in mind that sales of long 
bills on a given date may be offset by purchases of sight 
drafts or cables at much later dates (depending on the 
length of life of the long bills), and similarly the purchase 
of a long bill to be held as an investment will be offset by 
a subsequent and not by a contemporaneous sale of sight 
bills or cables. 

Under given conditions of commerce and travel, the 

e When the matter is regarded as of sufficient importance the bank 
may obtain from its correspondent a telegraphic report as to the 
amount of its balance at the close of any given day. A very large 



FOREIGN MONEY MARKET FACTORS 199 

clients of an individual bank will have certain exchange 
requirements which this institution will undertake to meet. 
If these requirements are such as to produce an excess of 
debits to its foreign balance, it will be forced into the open 
market as a purchaser of exchange. But another bank 
ma}* be driven into this market on the same day as a seller 
of exchange, by reason of reverse conditions which happen 
to affect it through its customers. And so some banks buy 
and some sell. If in the whole country there is an excess 
of supply of exchange or an excess of demand produced in 
this way, and this excess persists, a gold import or export 
will result. 6 The problem of tracing out the detail of this 
process belongs, however, to a later chapter. 

We have pictured the open market business in exchange, 
namely that taking place among banks and dealers inter se, 
as being determined by the commercial and other needs of 
the general mercantile and traveling public (and of the 
immigrants) as these needs make themselves felt through 
demands made on the individual banks. This picture is 
essentially correct, but it should be stated that exchange 
investment, borrowing, speculation and arbitrage also are 
responsible for a considerable portion of the open mar- 
ket dealings. Even these sources of operation are commer- 
cially determined in a fundamental, though more round- 
about way. We here think of "commerce" as including 
international traffic in bonds and stocks as well as in com- 
modities. 

§ 53. The services and compensation of correspondent 
banks. — One bank is said to be a correspondent of another 
if it is under a standing agreement to make disbursements 

bank mi;/ht desire to receive such reports regularly, expense per- 
haps being an insufficient objection. 

8 Assuming the gold standard in both countries concerned and 
assuming a free traffic in gold, practically speaking, assuming con- 
ditions of peace. 



200 FOREIGN EXCHANGE 

or take in receipts for the account of this other: or, a 
eorrespondenl is a bank that acts as agent of another bank- 
ing house under a regular and continuing arrangement. 
Assuming this definition, it is not essential that the one 
called the correspondent should hold a deposit from the 
other. The present section, however, will discuss only that 
more important type of correspondent which does hold a 
deposit, and will be content to cover the subject by exam- 
ining, as a leading example, the activities of a London 
bank in its service as correspondent for one in America. 
Its operations in behalf of the latter may be divided into 
two main classes: (1) those which result in a disburse- 
ment from or debit to this bank's balance, and (2) those 
which involve an inpayment or credit to it. There follows 
a fairly detailed list of these operations. 

I. OPERATIONS INVOLVING A DEBIT TO THE 
BALANCE 

1. The London bank cashes cable transfers and sight drafts, or 

checks, drawn upon it directly by the American bank itself. 
It pays out money or money funds against these to the par- 
ties designated, and forthwith deducts the amounts thus 
disbursed from the drawing bank's balance. 

2. It cashes sight drafts drawn upon it by travelers under circular 

letters of credit issued by the American bank, and also cashes 
"travelers' cheques" issued by the latter if there are any. 

3. It cashes checks drawn upon it by various smaller American 

banks which have no deposit with it (or any other institution 
in London) but which have procured authority from the 
American bank that has the balance, to draw against this 
balance or for payment out of it. (Compare § 77 to follow.) 

4. It makes various remittances by cable or mail on the order of 

the American bank to designated parties. 

5. It accepts, and subsequently pays, the long bills drawn upon it 

by shippers under the authority of commercial letters of 
credit issued by the American bank (compare Chapter VII). 



FOREIGN MONEY MARKET FACTORS 201 

The latter's balance is debited at the time of the payment of 
these bills. In case a commercial letter of credit should au- 
thorize a sight draft, the London bank would, of course, pay 
upon presentation without a separate acceptance. 

6. It accepts and at maturity pays any long bills drawn upon it 

by the American bank itself. 

7. If the American bank is one of the relatively few larger insti- 

tutions that make gold shipments, the correspondent may 
buy gold upon its order in London, pack and forward it, and 
charge its account for the cost of purchase and the incidental 
expenses and freight or express (all, of course, in sterling). 
To enable this operation to be carried through on anything 
like the usual scale, the American bank's London account 
would have to be fortified by special remittances of sterling 
exchange procured in the American market for the express 
purpose of engineering a gold import. (Compare Chapter 
XX to follow). Indeed the quantity of gold moved in a 
single shipment may easily have a value of ten or twenty 
times the amount in the bank's London balance. 

8. The London bank will honor overdrafts if covered by collateral 

security — at least it is safe to say that the usual and standard 
arrangement demands that collateral protect all overdrafts. 
Overdrafts that arise as mere incidents to the business in 
exchange are in no sense reprehensible, though a chronic 
state of being overdrawn would be out of the question. The 
American bank pays interest on the amount overdrawn for 
the time it is overdrawn. 

II. OPERATIONS INVOLVING A CREDIT TO THE 
BALANCE 

1. The London bank credits the balance of the American insti- 

tution with any remittances made by it by way of cable 
transfer. 

2. It gives credit for sight drafts on London bankers sent over 

for deposit with it. 

3. It also collects and credits checks drawn on other cities. 

4. It handles long sterling bills purchased in America and sent 

over to it. These will be bills (a) of bankers on bankers,., 



202 FOREIGN EXCHANGE 

or (b) of merchants on bankers under letters of credit, or 
(e) of merchants on merchants. The London correspondent 
procures the acceptance of these hills by the drawees, man- 
ages the documents (when present) according to instructions, 
and credits the remitting bank's balance with any cash pro- 
ceeds from the instruments at the actual time of the receipt 
of these proceeds whether from discount or from payment 
at maturity or prepayment by the drawee. 
5. If the American hank makes a gold export from the United 
States to England, its London correspondent will probably 
be the agent to take charge of the gold on arrival, and will 
credit the formers balance with the sterling proceeds of the 
sale of this specie. This extraordinary credit will be coun- 
terbalanced by large and special sales of sterling drafts by 
the exporting bank on the American side of the water. 
(Compare No. 7 above.) 

If a bank located outside of England has a branch in 
London, the latter would naturally take on many of or all 
the functions otherwise exercised by a correspondent, ex- 
cept that it could not so well act as an acceptor of long bills 
drawn by the parent institution. It should be said a cor- 
respondent bank will, in addition to the acts mentioned 
above, also buy or sell investment securities in the London 
market for the account of the foreign bank having relations 
with it. 

The compensation of the correspondent hank. — Petty ex- 
penses (such as postal and cable charges and stamp taxes) 
incurred by the correspondent as agent of the American 
bank, are deducted from the latter 's account. But the mere 
collection of these charges does not afford the correspondent 
a compensation for its services. This compensation is, how- 
ever, always provided for. It usually assumes the form 
of (1) interest earnings and (2) commissions. The in- 
terest element in this compensation consists in very small 
part, or perhaps in no part, of rates of interest paid directly 
as such by the American bank to the correspondent, for 



FOREIGN MONEY MARKET FACTORS 203 

such payments will be made only in case this bank over- 
draws its account or secures a straight or direct loan from 
the correspondent. 7 And in any event, such payments are 
more in the nature of special remuneration for the London 
bank's loans than in the nature of general compensation 
for its ordinary services as a correspondent. The interest 
element in this general compensation consists in the interest 
earnings gained by the correspondent from such use in its 
banking business as it is able to make of the American in- 
stitution's funds carried on deposit with it. This type of 
compensation is the same as that secured by any common 
commercial bank from the employment of the deposits of 
its ordinary mercantile and other customers. 

It should be noted incidentally that, as custodian of the 
American bank's foreign balance, the London correspondent 
will have the first chance to discount (or buy) at market 
rates a large and regular inflow of good grade long sterling 
bills which have been bought by the American company 
and forwarded in the course of its regular business in ex- 
change. If it does not care to buy these bills itself, it may 
sell them on the open London market. In any case the 
option which it has in this connection is doubtless worth 
something to it. That is, the business brought to it in 
this manner probably gives increased opportunity for the 
remunerative and safe employment of its banking funds. 
This is similar to the fact that valuable business is brought 
to the ordinary commercial bank by its depositors. 

It is not the general custom of American commercial 
banks to pay interest on ordinary deposits, and so the in- 
terest earnings gained by the banks from these funds are 
retained wholly in their hands. It is likewise not custom- 
ary for the greater London commercial banks to pay in- 
terest on the checking accounts (or demand deposits) of 

7 The reader will readily distinguish between a direct loan and 
the acceptance of long bills for the American bank. 



204 FOREIGN EXCHANGE 

merchants and common clients, but they do make arrange- 
ments In pay interest upon the working balances (namely 
checking accounts) of banks which make use of them as 
correspondents. With this may be compared the practice 
of New York banks of paying interest on the balances which 
interior hankers carry with them and use as the basis of 
a business in New York exchange. A rate of interest 
paid by a London bank or discount house upon deposits 
is, in England, called a deposit allowance rate. 

Between London and American (and presumably other 
foreign) banking establishments there are in operation two 
plans of disposing of the question of interest on balances. 
These are (1) an agreement that the depositing bank shall 
receive the deposit allowance rate on its entire daily bal- 
ance, or (2) an alternative agreement that this institution 
shall maintain with the correspondent a stipulated mini- 
mum average daily balance, as perhaps £5,000 or £10,000, 
upon which no interest is to be received. The latter is 
called an "interest-free balance." Even under the first 
of these agreements the London bank doubtless enjoys 
some gain from the use of the deposited funds, since their 
interest earnings will almost always exceed the deposit 
allowance rate. But under the plan of the interest-free 
balance, the earnings of this fund are reserved in their 
entirety by the correspondent for itself. This is less lib- 
eral to the American banker, but by way of offset there 
will be coupled with this arrangement a lower or more 
favorable schedule of commissions to be paid by the 
latter. 

The undertaking to keep on hand a certain average daily 
interest-free balance, is not an engagement that the deposit 
shall never fall below the stipulated figure. The balance 
for any given day is counted as it stands at the close of 
business on that day. If it falls below the agreed amount 
on one day, this may be made up by its being sufficiently 



FOREIGN MONEY MARKET FACTORS 205 

in excess on another. A bank operating in exchange can 
hardly control the exact figure at which its deposit shall 
stand at the close of business on any one day, but it is 
entirely feasible for it to control the average for a quarter 
or half year. If now the average is in fact maintained 
at a higher level than the required minimum, the deposit 
allowance rate would be due on the excess for the time 
during which it is present. Every quarter, or perhaps 
every half year, any interest which has thus become due 
will be credited. 

Interviews with a number of American bankers indicate 
that arrangements between our banks and their London 
correspondents pertaining to the character and amount of 
the compensation of the latter, vary in detail to no incon- 
siderable extent. The London banks make no general and 
open offers of terms under which they are ready to conduct 
foreign accounts. Each arrangement is a case by itself, 
and an American banker regards the terms of his London 
account as strictly private. Greater banks and banks with 
higher standing receive preferential treatment. It may be 
said with respect to commissions, there appear to be two 
leading classes of agreements known to practice. Under 
one there is put in force a schedule of separate commis- 
sions for various and distinct acts or operations performed 
by the correspondent. The chief commission-bearing acts 
may be listed as follows : 

The acceptance of long bills drawn under commercial letters of 

credit. 
The acceptance of long bills drawn by the American bank itself. 
The handling of trade bills including the care of the documents 

and the procuring of the drawee's acceptance. 
The encashment of traveler's drafts under circular letters of 

credit. 

Another class of agreement provides for the payment of a 



206 FOREIGN EXCHANGE 

tint rate of commission on all items going through the bal- 
ance one way, as for instance on all items credited. This 
may he called a commission on the turnover. Under this 
scheme there will he presumably no special commissions for 
distinct services except for acceptances. The commission 
on the turnover may range from V± of 1% at the highest 
to say J4o of 1% at the lowest. 

A new and distinctive plan of compensation for the cor- 
respondent has been brought forward in recent times, and 
is said to be in operation in some cases. Under this plan 
the depositing bank pays the correspondent simply an 
agreed lump sum periodically, as perhaps £200 a year, and 
goes free of detailed commission charges and receives in- 
terest on its entire balance. In proposing this scheme, the 
London banker say, as it were, ''pay us a salary." This 
plan has the advantages of simplicity, reduction of clerical 
labor, and freedom from small taxation upon individual 
operations in exchange. The fixed periodical compensation 
would depend on the business going through the balance 
on the average, and would, of course, be open to revision 
from time to time. 

The standard deposit allowance rate on bankers' balances 
carried in London with the great joint stock banks appears 
to be 1% under the Bank of England rate. 8 When the 
Bank of England rate is 3% it will be 2%, and when the 
Bank rate is 4% it will be 3%, and so on. There will, how- 
ever, usually be a maximum figure set for the deposit allow- 
ance rate, as say 4%, so that when the Bank of England 
rate under unusual conditions ascends to six or seven per 
cent, or even higher, the deposit allowance rate will not 
follow on up above 4%. 

The schedule of commissions is likely to involve something 
on the order of the following figures: 

»S'ee § 58 below. 



FOREIGN MONEY MARKET FACTORS 207 

Acceptance of bills drawn under commercial letters of credit, 

Mg of 1% per month of life of the bill. 
Acceptance of the American bank's own long bills. The same, 

or a somewhat lower commission. 
Cashing of drafts drawn under travelers' letters of credit, Vio 

of 1%. 
Confirmation of commercial letter of credit, Vio to Vs of 1% in 

general without regard to length of life. 
Handling bills with documents attached, V\q of 1%. 

It is understood these are commissions assessed by the 
London correspondent against the American bank. The 
latter will in turn make its own commission charges to such 
of its customers as are accommodated by the issue of letters 
of credit or by the collection of drafts. The reason why 
acceptance commissions are roughly proportional to the 
length of life of the drafts accepted, was discussed in 
§50. 

§ 54. The dealers in money in the London market : the 
joint stock banks. — The principal lenders of money in Lon- 
don may be grouped in four classes which are peculiar to 
that city. These are, in the order in which they will be 
considered: (1) the joint stock banks, (2) the bill brokers 
and discount houses, (3) the London branch establishments 
of colonial and foreign banks, and (4) the Bank of Eng- 
land, which may be regarded as constituting a class in it- 
self. In addition to these there are the private banking 
houses and the so-called "acceptance houses," which if not 
generally lenders of money are at least factors in the Lon- 
don money market in other ways. 

'•> The following references on the London money market may be 
mentioned: Hartley Withers, "The Meaning of Money," second edi- 
tion, London, 1909, and "Stocks and Shares," New York, 1910, and 
"The English Banking System," Publications of the U. S. Monetary 
Commission, vol. 8, 1910, and "War and Lombard Street," London, 
1915; F. Straker, "The Money Market," London, 1904; George Clare, 
"Money Market Primer" etc., London, 1903; II. T. Easton, ''Banks 



208 FOREIGN EXCHANGE 

A few words in passing on the acceptance houses: this 
term is in London applied to a class of firms which were 
formerly regular mercantile establishments, but which have 
since developed a business of granting their acceptances 
for a commission, without their becoming banks in the full 
sense of the word. They began merely by accepting long 
bills of exchange drawn upon themselves against goods 
purchased abroad by themselves, but came in the course 
of time to act as acceptors (and necessarily as drawees) of 
bills drawn against imports made by other English mer- 
chants of less consequence or inferior standing. One can 
see how a business of this character might arise. Suppose 
a relatively obscure merchant wished to import something 
from a distant country, but could not induce the exporter 
to ship it against a draft to be drawn merely upon him in 
person. Conceivably he might go to a large and well known 
house at home and ask it to make the import for him on 
commission. In such a case the exporter would draw upon 
this well known house. But another plan is possible, and 
this other plan long ago came into fashion in London. 
The greater mercantile house tells the lesser merchant, in 
effect, to make the import himself but to instruct the ex- 
porter to draw on it, and it undertakes to accept, and there- 
fore of course to pay, the draft, and to inform the ex- 
porter that it will do so. For this service the greater house 
charges an acceptance commission. It will require the 
small merchant to put it in funds in time to pay the draft 
at its maturity. This time will be deferred long enough to 
permit the arrival and sale of the goods meanwhile, this 

and Banking," London, 1904; Charles Duguid, "How to Read the 
Money Article." All these are descriptive specifically of London. 
"Interviews on Banking and Currency Systems," Publications of the 
U. S. Monetary Commission (Senate Document 405, 61st Cong., 2d 
session ) contain much of interest concerning the money market in 
England and in other countries also. 



FOREIGN MONEY MARKET FACTORS 209 

result being accomplished by having the draft of the ex- 
porter drawn at a sufficiently lengthy term or usance to 
make it possible. Evidently we have here practically the 
same piece of business as that done by a bank proper when 
it issues a commercial letter of credit authorizing a draft 
or drafts on itself, as already described in § 37. The Lon- 
don acceptance houses, originally mercantile establish- 
ments, have in general abandoned actual trade and have 
specialized in acceptances and in certain lines of finance. 
They once had possession of the acceptance business, and 
the more recent entry of the regular banks into this field 
has been something of a blow to them. In later days they 
have come to act as financial agents of foreign governments 
and corporations aiding them in the sale of securities in 
London. The acceptance house is technically distinguish- 
able from a bank in that it pays claims against itself, not 
in cash over the counter, but by a check drawn on a bank 
proper. The directors of the Bank of England are selected 
in great part from among the members of the accepting 
firms. 

The London "joint stock banks" are given this name 
because they are incorporated, but they are put in a separate 
class not for this reason, but because the business which 
they transact is of a distinct character. The classification 
is a matter of the function of these establishments and 
not of their form. At present writing (1919), there are 
three discount houses which are joint stock companies as 
well as the great banks. The business of the London joint 
stock banks is generally, though not wholly, similar to that 
of the regular commercial banks of America. On the fol- 
lowing page is given a balance sheet of the London County 
and Westminster Bank, Ltd., for June 30, 1913. This 
shows the condition of one of the largest of the London 
banks on a date not long before the outbreak of the 
war. 



210 FOREIGN EXCHANGE 
LONDON COUNTY AND WESTMINSTER BANK, LD. 10 
Balance Sheet — June 30, 1913 

Liabilities Assets 

£ Cash £ 

(1) Capital— 700,000 shares of (9) —In hand and at Bank 

Bach, £6 paid 3,500,000 of England 9,628,249 

(2) Reserve 4,000,000 (10) — At call and short no- 

(;!> Current and deposit ac- tice 11,147,811 

counts 81,442,141 (11) Bills discounted 18,340,178 

( li Circular notes, letters of (12) Investments* 9,152,174 

credit, etc., etc., in- (13) Advances to customers 

eluding provisions for and other accounts. .43,304,996 

contingencies 3,952,041 (14) Liability of customers 

(5) Acceptances for cus- for acceptances, as per 

tomers 7,158,931 contra 7,158,931 

(6) Endorsements on bills (15) Bills negotiated as per 

negotiated 627,070 contra 627,070 

(7 1 Rebate on bills not due.. 94,741 (16) Bank and other prem- 

(8) Profit and loss account.. 304,110 ises 1,719,625 



101,079,034 101,079,034 

As a means of explaining the nature of the business 
of a typical joint stock bank, we may consider the items 
in this balance sheet seriatim. It will be necessary to 
assume the reader possesses a general familiarity with the 
meaning of bank statements. 

Items on the Liabilities Side 

(1) Capital— 700,000 shares of £20 each, £5 paid. This 
is the same item as "capital" or "capital stock" in the 
statement of an American bank. But in practically all 
instances the share capitals of the London joint stock banks 
are only partly paid up. This is English custom for banks 
and is in distinct contrast with custom and with legal 
requirements in the United States. Thus the London 
County and Westminster has a subscribed capital stock of 
£14,000,000 par value (700,000 x £20), but each subscriber 
paid in only 25% of the par of his shares, so that the 

io Statement slightly abridged from one to be found in the London 
Economist, Banking Number, Oct. 18, 1913, p. 814. 
* Given in the original statement in four separate classes. 



FOREIGN MONEY MARKET FACTORS 211 

paid-up capital is, as indicated, £3,500,000. The unpaid 
balance, £11,500,000 in this instance, may be called from 
the shareholders if this action should become necessary to 
satisfy the claims of the creditors of the bank. This assess- 
able balance due on the subscribed capital is the last line 
of defense which a joint stock bank has against failure 
to pay its creditors in full. 

In the case of many of the banks, the unpaid balance is 
divided into two parts referred to respectively as ' ' callable ' ' 
and "reserved." To explain this, there are two grand pur- 
poses for which a company might demand money from the 
shareholders on account of the unpaid balance. One pur- 
pose is the development or expansion of the business, the 
other the payment of the claims of creditors of the company, 
which the assets do not suffice to meet. The entire unpaid 
balance on the shares is always assessable for the latter 
purpose. This is determined by the legal principles govern- 
ing the liability of corporation shareholders. Where the 
division of the unpaid balance into "callable" and "re- 
served" is in effect, the part (or it might be the whole) 
entitled "reserved" may not be called for the mere purpose 
of business development, being reserved for the sole object 
of paying creditors in case of need ; while the part known as 
"callable" is still assessable for general business purposes, 
provided of course proper authority within the corporation 
determines upon such an assessment. 

(2) Reserve is the item known as "surplus" in the 
United States. The Bank of England has its own peculiar 
name for this account, namely, the "Rest." 

(3) Current and deposit accounts. — The deposit liabili- 
ties of English banks, using the word deposit in the broader 
sense more common in America, are separable into two 
chief sub-divisions: (a) "current accounts" and (b) "de- 



212 I'oUKKiN KX CHANGE 

posil accounts." The first are deposits payable on demand 
and Bubjecl to check, and are commonly non-interest-bear- 
ing. They are the English equivalent of our American 
commercial deposits or checking accounts. The second, 
often referred to as "deposits at notice," are accounts 
which the customer may withdraw only after giving notice 
(of a week or two), and upon which the bank pays interest, 
at a deposit allowance rate. The American savings deposit 
has some similarity to the London deposit at notice, but 
the notice which the American bank may require is usually 
for a much longer period — as sixty da3 r s perhaps — and 
the rate of interest is higher here. Also the London de- 
posits at notice are not invested in the same way as our 
savings deposits. 

(1) Circular notes, letters of credit, etc. — This account 
contains miscellaneous liabilities, but the heading "circular 
notes" and "letters of credit" covers travelers' forms of 
exchange sold by the bank and at present outstanding. 

(5) Acceptances for customers. — This item shows the 
amount of long bills of exchange which have been drawn 
upon this bank by arrangement with it, and which have been 
accepted by it and are now outstanding and unpaid. The 
drawers of these bills may be either merchants or other 
banks. Drafts under commercial letters of credit come 
under this account. The act of acceptance makes the Lon- 
don County and AVestminster Bank unconditionally liable 
to pay the bills at maturity, and hence the liability so 
created is entered in its balance sheet, though it is counter- 
balanced by the equal liability of customers to provide funds 
for the payment of the acceptances at maturity — see item 
number 14 beneath — protected by collateral security. 

(6) Endorsements on bills negotiated. — This item shows 
the conditional or secondary liability (compare § 12 of 



FOREIGN MONEY MARKET FACTORS 213 

this book) of the bank as indorser of any bills which it has 
indorsed and negotiated, and which are as yet unpaid and 
unextinguished. This item is counterbalanced by number 
15 below. Payment of such a bill will remove it from both 
account 6 and account 15. 

(7) Rebate on bills not due. — The second largest item 
of assets shown in the balance sheet now before us, number 
11, is "bills discounted" . . . £18,340,178. This shows 
that the bank now holds long bills which have a total face 
or maturity value of this amount. As an asset strictly 
valued, these bills are worth to the bank at the present 
moment, not the sum of their full face values, but only the 
sum of their present values. Items 7 and 11 taken together 
show the following facts: the bank now holds long bills of 
a value at their maturities of £18,340,178, the total amount 
of discount on all these to be deducted to find their present 
values being £94,741, so that the present value of the entire 
lot of bills is £18,245,437. This state of facts might be 
exhibited by the entry of the last given figure as a single 
item of assets, but more information is conveyed by giving 
the two items. Item number 7 of the liabilities exists only 
to be set off against, or subtracted from, item number 11 
of the assets. 

(8) Profit and loss account. — This is the same as "undi- 
vided profits, ' ' American usage. Items of liability numbers 
1, 2, and 8, taken together constitute the total of capital, 
surplus, and undivided profits and represent the share- 
holders' "equity" or the total net business capital of the 
proprietors of this bank employed in its business. 

Items on the Assets Side 

The chief items of assets, numbers 9 to 13, appear prac- 
tically in the order of their "quickness," running from the 



214 FOREIGN EXCHANGE 

most liquid to tin 1 less liquid. They have been likened to 
successive lines of defense to be fallen back upon in case 
of unexpected demands from the creditors of the bank. 

(9) Cash in hand and at the Bank of England. — Tbis is 
the American "reserve" or "cash reserve." "Cash at the 
Bank of England" does not mean a special deposit of actual 
gold kept in the strong vaults of this institution for safety, 
but means merely an ordinary deposit claim. The concep- 
tion of a reserve consisting in a deposit credit with some 
central bank is now too familiar to require comment. At 
present writing there is but one London bank whose pub- 
lic reports state separately the amount of cash in its own 
vaults and the amount with the Bank of England. This 
is the Union of London and Smith's Bank. 

(10) Cash at call and short notice. — "Cash at call" 
signifies what are styled call loans in America. In London 
they also bear the name of "day to day" loans. They 
are characterized by the right of either borrower or lender 
to terminate the loan on (substantially) a day's notice. 
In New York call loans are made almost wholly to dealers 
in stocks, in London almost wholly to dealers in bills of 
exchange (compare §§55 and 59 below). Money placed 
by the joint stock banks with the people of the London stock 
market is loaned generally for a period of two weeks, this 
being the time which elapses between the so-called settle- 
ments on the London Stock Exchange. The New York Stock 
Exchange settles daily. The joint stock bank's loans to bill 
brokers are made largely against bills as collateral, but also 
against bonds and stocks. Loans to stock dealers are 
against bonds and stocks as collateral both in London and 
New York. 

(11) Bills discounted. — This account has been spoken 
of already in connection with item of liabilities number 7. 



FOREIGN MONEY MARKET FACTORS 215 

The greater London banks do not make a practice of re- 
selling bills which they have once bought. In other words 
they do not rediscount. 11 Therefore in practice it is not 
so much because the bills on hand are marketable for cash 
that they are to be regarded as a liquid asset, but it is 
rather because there is a certain portion of them falling 
due or maturing each day. If the bank feels the need of 
realizing cash for its reserve from the resources in the 
portfolio of bills, it may do so by refraining from putting 
out into bills again, the money which it collects from day 
to day from the maturing bills. 

(12) Investments, consisting regularly of high grade, 
readily marketable, interest-bearing securities, require no 
special comment here. 

(13) Advances to customers and other accounts. — This 
entry covers the great mass of advances or loans made by 
the bank for various periods on personal and collateral 
security, primarily to its own customers direct. It includes 
the main body of advances other than those made by way 
of the purchase of bills of exchange and the placing of 
short term money already accounted for. This is the 
greatest item among the bank's resources, and interest 
from this account is the largest element in the bank's earn- 
ings. 

(14) Liability of customers for acceptances. — The fifth 
account showed that the bank was, at the time of this state- 
ment, liable as acceptor on £7,158,931 of long bills. But 
these instruments were all accepted at the request of "cus- 
tomers," and the latter are in all cases under contract to 
provide the bank with the funds required to discharge them. 

ii Compare pp. 218, n. 15, and 242. 



•Jit; FOREIGN EXCHANGE 

The obligation of these customers thus to pay over £7,158,- 
931 is a resource of the bank and is here entered as such. 
"Customers" will in this case include other banks. In 
fact the parties that have made arrangements for accept- 
ances may. according to the nature of their relation to the 
bank, be divided into three classes. (1) There are English 
importers who have induced the bank to authorize drafts 
upon itself to be drawn by merchants who are to make ex- 
ports to them (compare §37). (2) Then there are banks 
foreign to England which have authorized exporters in 
various parts of the world to draw on this London bank at 
the time of making their shipments. Such shipments are 
not necessarily to England (compare §38). The banks 
in question have issued their sterling letters of credit and 
are obligated to supply the London bank with the funds 
necessary to pay the bills it has accepted under these letters. 
The importing merchants who applied for the letters are 
in turn liable to reimburse the banks which wrote them 
(compare §41). (3) Finally, there will be foreign banks 
which have themselves drawn long bills on the London 
bank and are likewise liable to it for the funds to discharge 
them at maturity. We first encountered these bills — 
bankers' sixty and ninety days' drafts — in the foreign ex- 
change market reports given in § 23. "We shall learn more 
of them later. 

(15) Bills negotiated as per contra. — This entry was ex- 
plained in connection with number 6. 

(16) Bank and other premises. — This entry shows the 
appraised or book value of the real estate holdings of the 
bank. 

The principal lines of business followed by the London 
joint stock bank may now be summarized : 



FOREIGN MONEY MARKET FACTORS 217 

(1) It receives deposits on demand and at short notice. 

(2) It makes the following chief types of loans or ad- 

vances : 

(a) It makes loans on call and for short periods to 

bill brokers and discount houses. 

(b) It makes advances by discounting long bills, 

bought partly from bill brokers, partly from 
foreign banks which use it as correspondent, 
partly from its own mercantile customers. 

(c) It makes loans, usually for periods of a fort- 

night, to dealers in the London stock exchange. 

(d) It makes loans direct to its own mercantile cus- 

tomers or depositors. 

(e) It places loans at times in foreign money capitals 

through an agent or correspondent (compare 
§83 below). 

(3) It accepts a great many long bills of exchange drawn 

upon itself, thus ''lending its credit." 

(4) It serves as correspondent for foreign banks dealing 

in exchange. 

The foregoing list does not include what the British would 
call dealings in ' ' foreign exchange, ' ' for by this phrase they 
would mean dealings in bills drawn (or at least negotiated) 
in England that are payable in some country foreign to 
England. The joint stock banks have much to do with bills 
of foreign origin payable in sterling in England, but the 
English banker does not ordinarily think of these bills as 
being foreign exchange, for the reason that when he comes 
into contact with them they are already in England and 
are payable there. Until recent times the joint stock banks 
have had very little concern with what the Londoner would 
speak of as foreign exchange, but they are now beginning to 
take it up. Two of them (as far as discovered by the 
writer), the London County and Westminster and the Lon- 



•J IS KOWKHiX KXCHANGE 

don City and Midland, established regular foreign depart- 
ments a few years since, 1 - and the same two have more re- 
cently made arrangements to open branches in Spain. 13 

§ 55. The bill brokers and discount houses. — In London 
there are two classes of dealers in bills whose business 
activities are confined almost exclusively to operations in 
this type of paper. These are (1) the bill brokers and 
(2 I the discount houses. 

The original or so-called ''running" broker, now, accord- 
ing to Mr. Hartley Withers, 14 comparatively rare in Lon- 
don, was a functionary who searched out those with bills 
or notes for sale and those ready to buy them, carried the 
instruments from seller to buyer, and performed this service 
for a commission. But in the British metropolis the domi- 
nant type of bill broker of the present clay actually pur- 
chases and resells the paper which passes through his hands. 
He buys sterling bills from local mercantile drawers, and 
from foreign banks with offices or correspondents in Lon- 
don, and from such other banking houses as make a practice 
of selling bills which they have once bought. Some of 
the larger banks make it a rule never to sell a bill which 
has come into their own ownership — though they sell as 
agents of foreign banks. They wait till maturity for real- 
ization upon it, and appear to regard the maintenance of 
this policy as a sign of superior strength and a point of 
pride. 15 These banks, however, buy bills from* the broker 

12 Hartley Withers, "The English Banking System," already cited, 
p. 40. 

13 London Economist, for February 10, 1917, p. 222. 
i* Compare his "Meaning of Money," pp. 139-141. 

is Sir Felix Sinister, Governor of the Union of London and 
Smith's Bank, made the following statement (in the year 1908 or 
1909), "As far as I am aware this bank has never as long as it 
has been in existence had one penny from the Bank of England, 
whether by way of an advance or by way of a rediscounted bill. 
We do not rediscount our bills in the market either, so every trans- 



FOREIGN MONEY MARKET FACTORS 219 

freely and also lend him much money for his operations, so 
they are in constant, though one-sided, business relations 
with him. 

The rate of discount named by the bill brokers as the basis 
of their purchases of any given class of bills is known as 
the "market rate" for this class. When banks buy bills 
from their ordinary customers, private persons or foreign 
banks which have them as correspondents, they likewise 
exact this same market rate. But when they buy the same 
instruments from the brokers, as distinguished from ordi- 
nary customers, they shade the market rate b} 7 about Vs 
or Vi%. The broker lives upon this special concession. 
We shall see presently why it is open to him. 

The following table shows how the profit made by the 
broker on an individual bill may be calculated. 

THE BROKER'S PROFIT ON A TURNOVER OF A 
£1,000 BILL 

Suppose a broker purchases a £1,000 bill with 93 days to run, 
on the basis of a discount rate of 3V>% per annum, and sells this 
hill on the same day to a bank at a discount rate of 3%% per 
annum. The following account results: 

Broker's purchase price of bill 

One year's discount = 3V//v of £1,000 

= £35 
93 days' discount = 9 %go X £35 

= £8.918 
(For the sake of convenience we figure in pounds and 

decimals of pounds and omit shillings and pence.) 
Price paid by broker for bill = £1,000 — £8.918 

= 991.082 

action we enter into we have to see through to the very end." "In- 
terviews," etc., as already cited, p. 5.>. A practically identical 
declaration was also made for the London Joint Stock Bank by its 
general manager. Ibid., p. 71. 



220 FOREIGN EXCHANGE 

Broker's selling /trice of bill 

One year's discount = 3%% of £1,000 

= £ 33.75 

93 days' discount = 9 %ee X £3 3-75 

= £8.599 

Selling price to bank = £1,000 — £8.599 
= 991.401 

Broker's profit 

Selling price 991.401 

Buying price 991.082 



.319 
£.319 is about 6s. 5d. This profit figures at about the 
rate of Vzi of 1% of the broker's temporary invest- 
ment in the bill. 

The broker makes in this case a profit of about %2 of 1% 
on the turnover. If he could perform this operation 300 
times a year with the capital of £991, he would make 300 
times %2 or only 9%% per annum for his capital and his 
own trouble and risk. This capital is itself largely bor- 
rowed from the joint stock banks on call, at an average 
interest cost under the conditions of this example of say 
2^4% per annum. The broker's net interest gain is then 
about 6 7 /&% per annum. These figures are not advanced so 
much as giving an accurate representation of the actual 
average gains of brokers in London, as by way of showing 
the manner in which they may be calculated. 

When a broker bu3*s a bill and resells it to a bank, he 
does not usually place his indorsement upon the instru- 
ment, but he does nevertheless in common practice guar- 
antee that the bill will be paid at maturity. This guarantee 
is effected by his giving the bank a continuing contract 
which covers during its life all bills rediscounted with the 
institution. The broker may sell bills to the same bank 



FOREIGN MONEY MARKET FACTORS 221 

from which he borrows funds to employ in the bill business. 
As security for any of his loans from a bank he deposits 
collateral consisting of first class bills or of securities of the 
best grade, payable to bearer, such as consols, London cor- 
poration bonds, Indian railway bonds, etc. These securi- 
ties are of the tjqDe called "floaters" in London. With 
respect to the bills deposited as collateral, they make up< 
part of the broker's stock on hand, and if he desires to sell 
any individual one of these bills he may obtain it by sub- 
stituting other acceptable collateral or by paying off a suffi- 
cient proportion of the loan to release it. 

Since the bill brokers operate with capital borrowed from 
the banks and sell bills to the banks under a specially 
favorable rate, and thus make a middleman's profit, the 
question arises why the banks do not take steps to eliminate 
the brokers. In fact, so far from being crowded out, the 
brokers enjoy "nearly the whole of the better class of busi- 
ness in bills." 16 The explanation is that the banks usually 
have a greater supply of funds than they can lend to their 
own direct customers or depositors, and they find it advan- 
tageous to place some of the surplus in bills bought from, 
the brokers. The latter spend their time in becoming spe- 
cialists on the personal credit of the various individuals 
and firms that offer bills for sale in the market, and g<5 
about gathering the instruments up, and sell them with a 
guarantee. One of their greatest services to the bank is 
that they enable it to purchase selected maturities and 
thus to obtain a proper marshaling with respect to due 
dates, of the whole body of bills it holds, or its so-called 
portfolio of bills. Special circumstances apart, the ideal 
portfolio will contain a body of bills maturing day by day 
in substantially equal portions, a lot falling due to-day, 
an equal one to-morrow, and so forward. Tinder this ar- 

16 Clare, "Money Market Primer," p. 141. 



1'oK'KKiN KX CHANGE 

rangemenl a fraction of the fund invested in bills will be 
released each day: no special need for cash appearing on 
the day, it may be invested again in new bills. But the 
nature of the hank's business makes it highly desirable that 
these daily releasings of funds should actually take place. 
Now tlir banker may discount many bills for his own de- 
positors. If these do not happen to be marshalled in ex- 
act ly the right manner with respect to maturities, the 
broker can furnish bills with such due dates that when they 
are added to those already on hand the whole portfolio will 
mature in proper sequence. The broker deals with so many 
banks that he is practically able to select from his stock bills 
of the character desired by the particular banking customer. 
It is doubtful whether the banks could supplant the broker 
with advantage. At any rate they do not do so. He works 
on capital largely borrowed from them and lives on a 
differential granted by them, but he appears to return full 
value in services for these concessions. 17 

The discount house differs from the bill broker or bill 
broking firm in degree rather than in kind. It is a house 
with a larger capital which makes a practice of holding a 
greater proportion of bills till their maturities. To do this 
it must employ more capital, in proportion to the number 
of bills handled, than does the broker. Historically the 
discount houses are outgrowths of the bill broking firms. 
Most are partnerships, but there are now (1919) three that 
are incorporated, or "joint-stocked" as the English say. 
The funds employed by the discount house consist (1) of 
its own capital, (2) of interest-bearing deposits on demand, 
(3) of interest-bearing deposits at notice, and (4) of monies 
borrowed from the joint stock banks at call and short 
notice. It is a little though not altogether like a savings 
bank which employs its depositors' funds in the purchase 

it Compare Straker, "The Money Market," pp. 107-8. 



FOREIGN MONEY MARKET FACTORS 223 

of bills instead of the purchase of mortgages and long term 
securities. The rate of interest allowed on deposits at no- 
tice is higher than upon those payable on demand. 

The following table, from a report of some j^ears back 
of the National Discount Company, will throw light upon 
the operations of a discount house. 

MARGINS OF DISCOUNT IN DISCOUNT COMPANY'S 
FAVOR 18 

The margins in our favor this half-year, compared with those 
of the corresponding six months in 1909, are as follows: 

1910 1909 



£ s d £ s d 

Actual discount 3 1 11 2 5 

Actual deposit interest 2 14 7 1 16 7 

Difference 

Actual yield on investments 
Deposit interest 

Difference 

Actual loan interest 
Deposit interest 

Difference 18 5 1 3 10 

The first entry "actual discount ... £3 Is. lid." shows 
the average rate of discount charged by the company in 
its purchase of bills during the first half of the year 1910, 
namely the rate of "three pounds, one shilling and eleven 
pence per cent." This is to the American reader an un- 

is From the half-yearly report of the National Discount Com 
pany, Ld., July 15, 1910, published in the London Economist, .July 
16, 1910, p. 127. 





7 


4 


3 


9 


11 


2 


14 


7 




15 


4 


4 


3 





2 


14 


7 





3 


10 


3 


9 


6 


1 


16 


7 


1 


12 


11 


3 





5 


1 


16 


7 



224 KOWKKiX KXCIIAXYJE 

familiar method of expressing a percentage rate. It signi- 
fies the Dumber of pounds, shillings and pence to the 100 
pounds. If we were to adopt a corresponding usage, we 
would speak of a rate of "three dollars and twenty-five 
cents per cent" where we now say 3 1 /4%. That is, "three 
dollars and twenty-five cents per cent" would mean 3M 
dollars to the 100 dollars, or simply 3%%. £3 Is. lid. is, 
written decimally, £3.096, and "£3 is. lid. per cent" is, 
expressed in the ordinary fashion, 3.096% or 3 9< Kooo%. 
The Englishman will on occasion write a rate of 3 1 /£% as 
' ' £3 10s. per cent, ' ' i.e., three and one-half pounds to the 
100 pounds. To convert any rate expressed in pounds, 
shillings and pence to one formulated in the usual manner, 
it is merely necessary to reduce the pounds, shillings and 
pence to pounds and a decimal fraction of a pound. 

The table entitled "margins of discount" falls into three 
parts. The first part shows that in the earlier half of 1910 
the company earned an average of £3 Is. lid. of discount 
per annum on each £100 of capital in the bill business, and 
that so much of this capital as was obtained from depositors 
cost on the average £2 14s. 7d. of interest per annum per 
£100. The "difference" of 7s. 4d. is the company's margin 
in this department of its business. 19 It amounts to a little 
more than % of 1%. The second part of the table shows 
that funds employed by the company in investments, or 
placed by it in interest-bearing securities other than bills 
or notes, yielded £3 9s. lid. per cent, and thus a margin 
of 15s. 4d. or one a little better than % of 1%. From the 
third part of the table we see that direct loans afford a 
margin of £1 8s. 5d. per cent or 1.42%. It appears the 
discount of bills is the least remunerative of the three de- 
partments of the business, nevertheless far the greater 

io A slight error is involved in subtracting an interest rate from 
a discount rate, but it is in the case of such low rates as these 
practically negligible. 



FOREIGN MONEY MARKET FACTORS 



225 



portion of the capital controlled by the company is invested 
in them. The reason for the preference for bills is that 
they make the most liquid assets to carry against deposits on 
demand and at short notice. 

Beneath is a specimen balance sheet of a discount com- 
pany. 

Balance Sheet 

UNION DISCOUNT COMPANY, Ld. 20 

June 30, 1912. 



Liabilities 

Capital— 150,000 £10 
shares, £5 paid up 

Reserve fund 

Provident reserve fund 

Loans and deposits, 
including provision 
for contingencies . . 

Bills rediscounted . . . 

Rebate on bills dis- 
counted 

Balance at credit of 
profit and loss 
for appropriation, 
£141,652; less trans- 
ferred to reserve 
fund, £15,000 



750,000 

650,000 

87,507 



18,326,937 
6,973,184 

161,262 



Assets 

Cash at bankers .... 

British Government, 
Indian Government, 
and other securities 

Loans on securities at 
call and short date 
and other accounts 

Bills discounted, etc. 

Sundry debt balances 

Freehold and leasehold 
premises, fittings 
and furniture, at 
cost, less deprecia- 
tion written ofT half- 
yearly 



!2,450 



2,853,318 



1,606,477 

21,579,852 

36,048 



117,397 



126,652 
27,075,542 



27,075,542 



An item entitled loans appears on both sides of this state- 
ment. Its presence on the side of liabilities shows that the 
discount company, unlike the joint stock bank or the ordi- 
nary commercial bank of the United States, is a literal 
borrower of money. 21 Between its direct borrowings from 

20 From the London Economist, October 19, L912, p. 764. 
2i The commercial bank is in a sense a borrower of the funds lift 
on deposit with it, but there is a great practical distinction between 



226 FOREIGN EXCHANGE 

others, presumably from joint stock banks, and its deposits 
received from individuals, the Union Discount Company 
was on June 30, 1912, indebted to outside parties for the 
enormous capital of £18,000,000 employed by it in its busi- 
ness. This sum, at ordinary rates of conversion approxi- 
mately $89, 000,000, is nearly twenty-five times its share 
capital, and constitutes practically the whole of its work- 
ing funds. On the side of assets the one item of "bills 
discounted . . . £21,597,852" is unapproached by its fel- 
lows. The net amount of bills on hand is £21,579,852 less 
£6,973,184 (bills rediscounted, appearing among the lia- 
bilities), or £14,606,668." 

How much more important the business of discounting 
bills is to the discount house than to the bank appears from 
the figures in the table at the top of page 227. 

These figures fluctuate to a degree, of course, but the dif- 
ference in the composition of the assets of the two classes of 
institutions is most pronounced. The fraction of the total 
resources invested in bills is in the case of the discount 
houses over 85%, in the case of the banks about 10%. Cer- 
tain other banks have a somewhat higher proportion of 

being a borrower in this sense and being a recipient of direct and 
literal loans. 

22 The company has f 14,606,068 of bills on hand, and there are 
still in existence unmatured bills which it once hold, but which it 
has rediscounted to the sum of £6,973,184. The latter are carried as 
a liability because the company is a "party secondarily liable" on 
these bills, either as guarantor, or else as indorser. That is, it is 
liable to make payment on these bills should their acceptors fail 
to pay. If the company should, perchance, be forced to pay these 
bills, it could, of course, look to the drawers, other indorsers, and 
also to the acceptors themselves for reimbursement, and thus these 
bills would then become at this stage a resource of the company. 
Thus, if bills rediscounted are carried as contingent liabilities, they 
are also properly carried as contingent resources. The form of state- 
ment adopted here merely conveys fuller information than it would 
if the item, £0,973,184, were omitted from both sides. 



FOREIGN MONEY MARKET FACTORS 



227 



CLASSIFICATION OF ASSETS OF DISCOUNT HOUSES 

AND JOINT STOCK BANKS 23 

(December 31, 1913) 





B 

a B 
.2 ^ 
3 .2 


O o 

Is .2 


d 

a, U 

1-4 

"S c 

cS o 
!*! u 

< s 


SI 

►J pq 


3* 




% 


% 


% 


% 


% 


Cash at bankers 


2.8 


2.2 


2.4 






Cash in hand and at Bank 












of Eng 








15.1 


15.9 


Cash at call and at short 














3.0 


2.9 


2.6 


8.1 


11.0 


Investments in securities . 


7.0 


8.0 


7.7 


9.8 


7.2 


Bills discounted 


86.7 


86.0 


87.3 


10.2 


10.8 


Loans and advances 








47.8 


47.3 




0.5 


0.9 




9.0 


7.8 




100. 


100. 


100. 


100. 


100. 



assets carried in bills. In addition to the three incorpo- 
rated discount houses there were in 1910 about twenty 
private firms engaged in the same business as these. 24 

§ 56. The branches of foreign and colonial banks. — There 
are at present (end of year 1918) 43 joint stock banks, 
exclusive of the Bank of England, which employ their 
capitals wholly or primarily in the United Kingdom. 
Twenty-six are located in England, 8 in Scotland, and 9 in 
Ireland. The English banks have collectively 6,285 
branches, and in round numbers the Scotch have 1,250 and 
the Irish 850. 2n A greatly preponderating pari of the 

23 Compiled from data to be found in the London Economist, 
Banking Number, May 23, 1914, pp. 1212 and 1223. 

24 See statement of manager of the Union Discount Company in 
"Interviews," etc., already cited, p, L04. 

25 See the London Economist's Banking Number, May 17, 1919, 
p. 823. 



228 FOREIGN EXCHANGE 

capital of this entire group of institutions is controlled in 
London and employed there, and the remainder is almost 
all represented in London, through branches, agencies or 
correspondents, in such a maner as to be a factor in the 
discount market of that city. Important activities in this 
market are also undertaken by a large number of great 
incorporated banks which have branches in London, though, 
their main fields of operation are scattered over the world 
beyond the confines of the United Kingdom. From Lon- 
don's standpoint these institutions are divisible into the 
two classes of (1) the colonial and (2) the foreign banks. 

The table beneath shows some of the more important 
facts pertaining to the colonial banks. 

COLONIAL BANKS WITH LONDON BRANCHES OR 
OFFICES 

Number Capital, 

of Surplus and Total of Assets or Liabilities 

branches Undiv. Profits In £ In $ 

African 7 547 £14,607,000 102,000,000 495,000,000 

Australasian 18 2,297 42,385,000 208,000,000 1,300,000,000 

Canadian 7 1,439 24,788,000 223,000,000 1,082,000,000 

Indian 5 91 8,097,000 66,000,000 320,000,000 

Totals 37 4,374 £89,877,000 659,000,000 3,197,000,000 

Notes: — (1) Some of these banks have their "main offices" in 
London, but in all cases the chief field of business is in the colonies. 

(2) Pounds are converted to dollars at the ratio of £1 = $4.85. 

(3) This table is condensed from one compiled by the London 
Economist for Oct. 21, 1916, p. 710, from the latest balance sheets 
of the banks available at that time. 

As a matter of interest the names of a number of the 
greater colonial banks are given, with the totals of their 
assets as shown in the latest balance sheets available on 
May 17, 1919. 

CERTAIN GREATER COLONIAL BANKS 

Total of assets in £s. 

1. Bank of Montreal 114,900,000 

2. Canadian Bank of Commerce 90,500,000 

3. Royal Bank of Canada 88,000,000 



FOREIGN MONEY MARKET FACTORS 229 

Total of Assets in £s. 

4. Bank of New South Wales 62,100,000 

5. Standard Bank of South Africa 50,300,000 

6. Chartered Bank of India, Australia and 

China 47,600,000 

7. Commonwealth Bank of Australia 47,200,000 

8. National Bank of South Africa 46,000,000 

9. Bank of New Zealand 40,800,000 

10. Bank of Australasia 31,600,000 

11. Union Bank of Australia 31,300,000 

The semi-annual Banking Number of the London 
Economist gives the latest procurable balance sheets of the 
various foreign incorporated banks that have London 
branches or offices. Examination of the issue of May 19, 
1917, 2G shows that there were at the time 34 such institu- 
tions. The total of the assets (or liabilities) of these banks 
is given below. Conversions into sterling, where necessary, 
are made at rates of exchange normal or usual just before 
the war. 

FOREIGN BANKS (i.e., not located in the British Empire) 
WITH LONDON OFFICES 

Total of Assets in £s. 
18 European banks in allied or 

neutral countries 877,800,000 

7 South American banks 121,600,000 

5 Banks in the Orient 103,800,000 

4 Banks in the United States 218,500,000 

Total 1,321,700,000 ($6,410,000,000) 

Were it not for the war we should be able to counl in 
five banks of the Central Empires, which had at the 
beginning of 1914 combined total resources of about 
£316,600,000. 

20 The latest issue containing the data in convenient form. 



230 KnWKKiN K.\< 1 1 A \< I K 

The four American institutions having branch offices in 
London are: 

Total assets in £. (1917) 

The Guarantee Trust Company 117,700,000 

Equitable Trust Company 46,400,000 

Farmers Loan and Trust Company 42,000,000 

International Banking Corporation 12,400,000 

Summary : 

34 Foreign Banks with London Offices... 1,321,000,000 
37 Colonial Banks with London Offices. . . 659,000,000 



Total £1,980,000,000 

Interpreting this colossal figure, we should take heed of 
certain warnings. In the first place, the £1,980,000,000 
constitute, not the proprietory capital of these institutions 
(namely paid-up capital plus surplus and undivided 
profits) but constitute their entire assets. The proprietory 
capital would be perhaps one-eighth as large. The next 
caution has reference to a particular circumstance of the 
present war. Since the beginning of this conflict a great 
expansion of bank credit has taken place in most parts 
of the world and the total assets of almost any system of 
banks will be found to be much inflated as compared with 
those of the year 1914. A final consideration, more general 
in character and more important in the present connection, 
is that these huge resources, though represented in London, 
are not, of course, in the main invested or employed there. 
An unknown but certainly small percentage of them are 
employed in London at any one time. Nevertheless the 
London branches of these banks serve as gateways to the 
London money market and tend to augment both the de- 
mand for and the supply of loanable funds which come 
together there. The relation of these banks to London 
tends also to maintain the custom of settling commerce by 



FOREIGN MONEY MARKET FACTORS 231 

means of sterling drafts and thus to sustain London in its 
dominant position as financier of the trade of the globe. 

It is not to be forgotten that a vast number of banks 
have almost if not quite as intimate contact with the Lon- 
don bill market through their correspondents, even if they 
possess no London offices of their own. 27 There are also 
not a few private banking houses with London agencies, 
or with joint accounts or other similar arrangements with 
local British private bankers, which enter into the English 
monej- market. Examples from the United States are J. P. 
Morgan & Company of New York coupled with Morgan, 
Grenfell & Co. of London (and also with Morgan, TIarjes 
& Co. of Paris) ; Brown Brothers & Co. of New York with 
Brown, Shipley & Co. of London ; August Belmont & Co. 
of New York with Messrs. Rothschild of London, Paris, and 
Vienna; Lee, Higginson & Co. of Boston with Higginson 
& Co. of London. 

§ 57. The Bank of England. — The famous establishment 
known as the Bank of England consists of two very distinct 
divisions called the "issue department" and the "banking 
department." The first named has entire charge of the 
issue and redemption of Bank of England notes, and this 
is its only function. On a recent date, May 16, 1917, there 
were £70,971,155 of these notes outstanding and the issue 

27 During the years 1917 and 1918 a number of important amalga- 
mations between London banks took place. The result lias been at 
this date (May, 1919) to leave live gigantic institutions far in the 
lead of all others, now called the big five. 

The list of these follows with the total of their assets or liabili- 
ties according to the latest balance sheets to be found at' the time of 
writing. 

London Joint City and Midland £363,500,000 

Lloyds Bank 300,700,000 

London County Westminster &. Parr's 287,500,000 

Barclay's Bank 258,000,000 

National Provincial and Union Bank of England 215,600,000 



232 FOREIGN EXCHANGE 

department possessed just £70,971,155 of assets to cover 
them, and these constituted all the assets it had. A com- 
mon assumption is that the resources of the issue depart- 
ment are especially pledged for the payment of notes alone, 
but the Law is not explicit on this point, and Mr. George 
('hire states that "good authority" has held that should the 
bank fail the assets of the issue department would become 
a part of the general fund of resources against which 
depositors and note-holders would have merely equal 
claims. 28 

The assets held by the issue department fall into two 
parts, (1) gold coin and bullion (amounting to £52,521,155 
on May 16, 1917), and (2) British government debt and 
other securities (amounting to £18,450,000). In conse- 
quence, the entire circulation of the bank is thought of as 
divided into the two parts known as the "covered" and 
the "uncovered issue." On May 16, 1917, the issue was 
constituted as follows: 

Covered issue £52,521,155 

Uncovered issue 18,450,000 

Entire circulation 70,971,155 

The uncovered issue is not without protecting assets but 
is uncovered so far as specie is concerned. 

Under the law governing the bank — the Peel Act or Bank 
Act of 1844 — the uncovered part of the issue is intended 
to be an unchangeable quantity with the exception that 
it may be expanded at the time when any of the few re- 
maining country banks now possessing the circulation 
privilege surrender it. In the event of such a surrender 
the Bank of England's uncovered issue may be increased 

28 "Money Market Primer," 2d ed., p. 17. Mr. Clare says, "Though 
interesting in theory, the question is, of course, of no practical 
importance." 



FOREIGN MONEY MARKET FACTORS 233 

by two-thirds of the amount surrendered. The final maxi- 
mum to which it can attain under this law will be £19,616,- 
000. The Peel Act was drawn in contemplation of the ulti- 
mate extinguishment of all issues except that of the Bank 
of England, and in contemplation of the fixity of the un- 
covered part of the issue of this institution. There is, how- 
ever, a proceeding in England known as the Suspension of 
the Bank Act which has the purpose of enabling the bank 
to expand the uncovered part of its issue in times of acute 
crisis, irrespective of the disappearance of any country 
circulation. We shall speak of this again presently. 

In normal times — and this means practically all the 
time, since the Bank Act is very rarely suspended — the 
fluctuations in the total outstanding circulation take place 
solely in the shape of the expansion or contraction of the 
"covered" part of the issue. Notes are in regular course 
paid out by the issue department only in exchange for gold, 
and they are retired only upon redemption in gold. Since 
the covered notes to-day constitute almost three-quarters 
of the whole circulation, and since the retirement of notes 
by the public in such volume as to reach the uncovered part 
is hardly within the range of practical possibility, 29 the 
Bank of England note is in its practical aspects a gold 
certificate. Suppose the United States government had 
$1,200,000,000 of gold certificates outstanding, and should 
with the consent of their holders remove about $300,000,000 
of the gold carried in the special trust fund reserve, and 
substitute an equal amount of its own bonds payable in 
gold. This would make the gold certificate very similar to 
the Bank of England note as that instrument is to-day. 30 

2» At no time when the Bank of England has been in difficulties 

has there been the slightest run upon the issue department as sueh 
based upon suspicion of the bank's note. 

so The law permits the issue department to include in the Bpecie 
held to cover the notes, a one-fifth proportion of silver coin, but the 



234 FOREIGN EXCHANGE 

Tin- banking department keeps its own separate cash 
reserve, chiefly in the form of notes of the issue department. 
It has to give up or forego gold to obtain these notes and 
holds them instead of gold for the same reason of conven- 
ience that leads our American banks to keep so large a pro- 
portion of their gold reserves in the form of gold certificates. 
On -May 16, 1917, the banking department held £32,456,660 
of notes as cash, and there were therefore but £38,514,495 
of notes held by the outside public. In many cases the 
figure given by statisticians as "the circulation" of the 
bank is merely that for the notes held by the outside public. 

Bank of England notes are issued in denominations of 
£5, 10, 20, 50, 100, 200, 500 and 1000. They are legal 
tender in England and "Wales but not in Scotland or Ire- 
land. They are not legal tender, however, when proffered 
in payment by the Bank of England itself, or as the law 
says "at the bank." Prior to the present war they were 
the only legal tender paper of the United Kingdom, but in 
August 1914 the British government issued its own new 
"Currency Notes" in denominations of 10 shillings and also 
of £1, with the legal tender power. These currency notes 
are still outstanding in large volume (£166,000,000 on July 
25, 1917). 31 

As already indicated, a number of banks located in Eng- 
land and Wales have the right to issue circulating notes, 
but the total of their issues is at present subject to an 
absolute maximum limit of £1,166,000. These notes have 
no legal tender power and have in fact only local currency. 
Since 1844 the uncovered issue of the Bank of England 
has grown, by reason of the lapse of country issues, from 
£14,000,000 to £18,450,000. Several banks in Scotland and 

bank has long since ceased to avail itself of this privilege. (See 
answers to questions addressed to the Governor and Directors of the 
Bank of England, "Interviews," etc., already cited, p. 12.) 
3i London Economist, July 28, 1917, p. 137. 



FOREIGN MONEY MARKET FACTORS 



235 



several in Ireland issue notes with local circulation and no 
legal tender power. 

The Bank of England that presides over the London 
money market — the "Old Lady of Threadneedle Street" — 
is the banking department of this institution. It is this 
department which has as deposits the reserves of the joint 
stock banks and which from time to time raises its dis- 
count rate to check over-expansion and to "correct" the 
exchange. 32 Beneath is a specimen statement of the Bank 
of England, showing its condition as it was shortly before 
the outbreak of the war. 

STATEMENT OF THE BANKING DEPARTMENT OF THE 
BANK OF ENGLAND 33 



(June 24, 1914) 



Liabilities 
Proprietors' capital. .£14,553,000 

Rest 3,160,254 

Public deposits 18,074,214 

Other deposits 44,915,911 

Seven day bills, etc.. . 12,948 



£80,716,327 



Assets 
Government securi- 
ties £11,046,570 

Other securities 39,994,619 

Notes 28,050,150 

Gold and silver coin. 1,624,988 



£80,716,327 



32 Compare § 144 below. 

33 From the London Economist, June 27, 1914, p. 1571. On July 
25, 1917, the issue department had notes outstanding in the sum of 
£68,962,690 and held £50,512,690 of gold. The banking department's 
assets and liabilities were in the following expanded condition: 



Proprietors' capital. £ 14,553,000 

Rest 3,311,696 

Public deposits .... 46,614,733 

Other deposits 126,839,973 

Seven day bills, etc. 16,076 



Government securi- 
ties £ 48,127,661 

Other securities ... 111,365,542 

Notes 29,226,320 

Gold and silver coin 2,615,955 



£191 .335,478 
From Economist, July 28, 1917, p. 137. 



£191,335,478 



236 FOREIGN EXCHANGE 

Statement of the Issue Department (same date) 

Notes issued £56,753,275 Government debt ....£11,015,100 

Other securities 34. . . 7,434,900 
Gold coin and bullion 38,303,275 



£56,753,275 £56,753,275 

The banking department is essentially a great commercial 
bank which receives demand deposits and makes short term 
loans or advances. It is distinguished by being the bank of 
the British government. It is not that the government owns 
or operates the bank, but merely that it deposits most of its 
funds with it, producing the ''public deposits" of the fore- 
going statement. The item "Government securities" shows 
the amount of debt of the British government, whether of 
short or long term, carried as an asset by the banking de- 
partment. The item "Other deposits" includes deposits of 
every description other than those of the government, de- 
posits of joint stock banks, discount houses, bill brokers, 
and private firms generally. The item in the column of 
assets, "Other securities," is the cryptic entry which shows 
the total of loans and advances made in any form to all 
other parties than the government. No detail of this very 
important account is made public. Notes and coin together 
constitute the banking department's cash reserve. 35 

3* "Other securities" here signifies "Parliamentary securities like 
the Government debt." Palgrave, "Bank Rate and the Money Mar- 
ket," p. 27. 

33 The following is a recent statement of the Bank of England, 
taken from the London Economist for May 17th, 1919, p. 939: 

BANK OF ENGLAND 

Week ended Wednesday, May 14, 1919 

Issue Department 

Notes issued £102,463,240 Government debt ...£ 11,015,100 

Other securities 7,434,900 

Gold coin and bullion 84,013,240 



£102,463,240 £102,463,240 



FOREIGN MONEY MARKET FACTORS 237 

§ 58. The Bank Rate.— The bank rate S6 is a rate of dis- 
count, determined upon and made public by the directors 
of the Bank of England, as one at which the banking de- 
partment stands ready to discount or purchase certain 
classes of bills. While this is perhaps the most widely 
reported and carefully scrutinized money rate in the world, 
its relationship with the rates at which actual business in 
bills is transacted in England is not a perfectly simple 
subject. Even the utterances of English bankers ou this 
question are often enigmatical. Thus among the queries 
put to a number of these gentlemen in the year 1909 by a 
committee acting on behalf of the United States Monetary 
Commission, was this one : "To what extent does the bank 
rate govern your discount and loan transactions?" Mr. 
Charles Gow, General Manager of the London Joint Stock 
Bank, replied, ' ' To speak in general terms, all the business 
we do has a certain relation to the Bank of England rate. ' ' 37 
The answer of Lord Avebury, at the time president of the 
Central Association of English Bankers, was no more defi- 
nite than "The bank rate is generally an expression of 
the market rate. ' ' 38 The question was also asked of the 

Banking Department 

Proprietors' capital. £ 14,553,000 Government securi- 

Rest 3,105,747 ties £ 46,433,817 

Public deposits *.. . 22,807,099 Other securities 77,984,317 

Other deposits 111,479,248 Notes 25,97(5,155 

Seven-day and other Gold and silver coin. 1,560,392 

bills 9,587 

£151,954,681 £151,954,68] 

* Including Exchequer, Savings Banks, Commissioners of National 
Debt and Dividend Accounts. 

30 Known more formally as "The Official Minimum Discount Rate 
of the Bank of England." 

37 "Interviews," etc., already cited, p. 82. 

38 Ibid., p. 120. 



238 FOREIGN EXCHANGE 

Governor and Directors of the Bank of England itself, and 
lure pertained to this bank's own practice. The reply 
brought forth was a bit Delphic, running to the effect that 
"the rates for discount and loan transactions at the bank 
usually approximate more or less closely to the bank 
rate" 39 

In discussing the bank rate we easily fall into the way 
of speaking of its relation to "the" market rate, as if to 
imply there is a single rate for money in the London mar- 
ket. In fact there are always numerous distinct discount 
and interest rates in force in any money center. Their 
differences depend primarily on term of advance and char- 
acter of security. In London a few of these rates are cus- 
tomarily set with reference to the bank rate, or are based 
upon it, such as the deposit allowance rates, the rebate 
rate, and the rate applied to many trade bills, 40 and these 
are therefore like the bank rate fairly stable. 41 Others 
are less intimately associated with the bank rate and fluctu- 
ate freely, sometimes showing daily variations. These free 
market rates however rise and fall very much as a group. 
It is true the spacings or spreads between the different 
individual rates may alter to a degree, but they move as 
a body or somewhat as a constellation. Now when one 
speaks of the relation of the bank rate to the market rate 
he really has in mind the entire group of variable market 

so Ibid., p. 23. 

4° "Although we say that bills in the market are discounted at 
a lower rate than bank rate, yet there is a vast number of trade 
bills which are purely governed by the bank rate." Statement of 
Sir Felix Schuster, Governor of the Union of London and Smith's 
Bank, in "Interviews," etc., already cited, p. 53. 

4i The bank rate may remain unaltered through a period of per- 
haps six months. Again it may be changed several times a month 
under unsettled conditions. An exhaustive statistical and historical 
studv of the bank rate is found in R. H. Inglis Palgrave's "Bank 
Rate and the Money Market" (1903). 



FOREIGN MONEY MARKET FACTORS 239 

rates rather than any single one of them. If the term 
4 'market rate" is used in a single and specific sense, it will 
usually mean the rate of discount charged by the bill 
brokers (and by the banks to customers of theirs other 
than the bill brokers) on prime bankers' acceptances with 
ninety days to run, though sometimes it refers to the rate 
on the same paper with sixty days to run. 

To make the significance of the bank rate really clear we 
must distinguish between conditions of ease and conditions 
of stringency in the London money market. In times of 
ease the bank rate is rather a nominal figure. In these 
times it derives such importance as it has from being an 
index of the market. And it is this for the simple reason 
that in these times the governing body of the bank makes it 
a practice to set the rate at some fairly even figure not 
far above the market rates for prime bills. Thus if the 
latter were at say 3!6 and 3M%, the bank rate would 
probably be standing at 3M%, unless perchance it 
had been placed at 4% in anticipation of a rise in 
the market rates in the near future. Under conditions 
of monetary ease the bank rate is symptomatic of the market 
and is governed by it. Lord Avebury evidently referred 
to this fact in his statement quoted above that "the bank 
rate is generally an expression of the market rate." In 
periods of stringency the bank rate assumes a higher degree 
of importance. As the saying goes, it becomes "effective." 

The Bank Rate in Times of Monetary Ease 

One of the important activities of the Bank of England 
is the discount of bills of exchange. But this business 
breaks into two distinct linos, namely, (1) discount for the 
bank's own regular mercantile customers, and (2) discount 
(i.e., rediscount) on occasion for the bill brokers and cer- 
tain types of banking houses which do not come to the 



240 FOREIGN EXCHANGE 

Hank of England when loanable funds are abundant. The 
first might be called the bank's private and regular, the 
second its emergency discount business. The activities of 
the institution in its private discount business are com- 
parable to those of the ordinary joint stock banks in the 
same line, and to the extent of these activities the Bank 
of England is competitive with the joint stock banks. In 
this business the Bank of England does not observe its 
own official minimum discount rate when this rate is above 
the market, but without hesitation discounts bills for its 
own customers at the rates prevailing in money dealings 
generally. (Compare, however, what appears in the next 
section regarding the bank's holding its discounting power 
in reserve for times of stringency.) In times of ease the 
bank itself does not observe its own official rate, and in 
fact no business in prime bills is anywhere being done at 
this rate. 

Authoritative statements respecting the policy of the 
Bank of England are few and far between, and therefore 
the following excerpts from the "Interviews on Banking 
and Currency Systems" published by the United States 
National Monetary Commission are of especial interest. 
Examination of the interviews for England (pp. 7-124) 
will confirm the explanations of the London money market 
being given here. Under the title of "Report of answers 
to questions addressed to the Governor and Directors of 
the Bank of England," we find these questions and answers 
among many others. 

Q. Will you state (a) the class of bills usually discounted by 
you, giving the number of names required; (b) the minimum size; 
and (c) the maximum length of time to run? 

A. (a) Two British names, of which one must be the acceptor; 
(b) no minimum; (c) four months, exceptionally six. 



FOREIGN MONEY MARKET FACTORS 241 

Q. "What are the rules governing purchase by you of foreign 
bills? 

A. The bank does not buy foreign bills. 

****** 

Q. What is the distinction between what are known as "prime" 
bills and other bills"? 

A. A "prime" bill we should define as a bill accepted by a Lon- 
don or provincial bank in first-class credit or a merchant or mer- 
chant banker of the first class whose business is to grant credits. 42 

The "merchant or merchant banker whose business it is 
to grant credits" is what we have heretofore spoken of as 
the acceptance house. When the answer states that the 
bank does not buy foreign bills, the meaning is it does not 
take bills payable in countries foreign to England, and 
not that it will not take bills payable in England in sterling 
but of foreign origin. A bill drawn by an American mer- 
chant on a London acceptance house, accepted by the 
latter and indorsed say by a bill broker, would be a foreign 
bill in the sense that it is an exemplar of foreign exchange 
when viewed from the standpoint of the world at large. 
When in England this bill is in the country where it is 
payable, though it is of foreign origin. The Bank of Eng- 
land would take such a bill as having two British names, 
including a British acceptor. 

Q. Do you discount any but prime bills? 
A. Yes. 

****** 

Q. Do you discount to any considerable amount for individuals 
and merchants? 

A. The bank discounts all approved bills offered to it by per- 
sons or firms having properly constituted accounts [i.e., deposits 
in the American sense]. 



'- See "Interviews," pp. 20 and 22. 



242 FOREIGN EXCHANGE 

Q. Do you rediscount bills for the joint stock or other banks? 

A. The bank is always prepared to rediscount for other banks 
at its official rate, and docs a large business from time to time 
with the colonial and foreign exchange-banks [foreign banks with 
London branches or correspondents] who are from the nature of 
their business always sellers of bills. The London Clearing and 
\V< -t End banks [the greater indigenous banks] who are ordi- 
narily buyers of bills and not sellers do practically no discount 
business with the bank. 

The greater London banks nevertheless manage on occasion 
to shift a heavy discounting burden onto the shoulders of 
the Bank of England. How this is accomplished will be 
related in the next section. 

Q. Do you sometimes purchase "prime bills" in the market at 
a lower rate than bank rate? 

A. The bank does not purchase bills in the market. 

This means only that the bank does not buy bills from 
sellers generally but deals alone with persons or institu- 
tions having deposits with it. The statement is misleading 
to the uninitiated because it suggests that the bank does 
not discount bills that have been in the market, whereas 
at times it does a great business of this kind by redis- 
counting for brokers and bankers having accounts with it. 

Q. Would you charge a merchant house having a good account 
with you, the bank rate or the market rate for prime bills? 
A. The market rate. 43 

The following is from the statement of Mr. Charles Gow, 
of the London Joint Stock Bank. 44 

Q. Do you regard the Bank of England as in any way a com- 
petitor of yours? 

43 "Interviews," etc., pp. 20-23, contains the preceding questions 
and answers. 
4* Hid., p. 86. 



FOREIGN MONEY MARKET FACTORS 243 

A. Yes; the Bank of England has a department in which it has 
customers just exactly as we have keeping current accounts [i.e., 
commercial deposits, American usage]. 

War time note. — Early in the year 1917, the Bank of 
England so far systematized its formerly occasional prac- 
tice of borrowing funds in the open market, as to name 
a regular rate of interest which it stood ready to pay 
any London clearing bank for short term loans to be made 
by such bank to the Bank of England. The purpose of the 
Bank of England here is the regulation of rates in the 
open market. In June the London Economist began the 
publication of the new rate in its regular weekly tables 
under the title of "Bank of England Rate to Clearing 
Banks." It would appear that it is quoted for loans at 
three days, 45 though loans for other periods may also be 
arranged. 

This gives us a second and distinct bank rate, the signifi- 
cance of which to the open market is in general greater 
than that of the original or official bank rate itself. The 
effect of the offer by the Bank of England of say 5% for 
three-day loans is to make it impossible for any one to 
obtain call or short term money from the great London 
banks, and consecpiently from any others, at a cheaper 
figure. This will cause the rates of discount for bills to be 
sustained at some figure above 5%. Why the central insti- 
tution has an interest at certain times in stiffening the open 
market, even perhaps at some expense to itself, will be dis- 
cussed later. 

The establishment of relations between the Bank of Eng- 
land and the U. S. Federal Reserve System. — On December 
20, 1916, the Federal Reserve Board approved the applica- 
tion of the Federal Reserve Bank of New York For the 
establishment of certain relations between it and the Bank 

45 Economist for June 23, l!H7, p. 1145. 



•J 14 FOREIGN EXCHANGE 

of England. The following statement regarding the char- 
acter of these relations is taken from a "communication" 
received by the London Economist and published in its 
issue of -May 5, 1917, page 766. "Negotiations for estab- 
lishing relations between the Bank of England and the 
Federal Reserve Bank of New York, which were com- 
•menced by the governors of the respective institutions some 
months ago, have now been concluded. The arrangement 
provides that the Bank of England will act as the corre- 
spondent and agent in London of the Federal Reserve Bank 
of New York, and that the Federal Reserve Bank of New 
York will act in a similar capacity in New York for the 
Bank of England. It is not the intent of the plan that 
these institutions engage in commercial foreign transactions, 
the relationship established being primarily for the purpose 
of affording greater stability to rates of exchange by main- 
taining with each other mutual accounts of deposit, and 
by representing each other in the purchase of bills. The 
plan will also create machinery by which transactions in 
gold and gold coin will be facilitated, which should result 
in normal times, in eliminating or reducing the extensive 
and unnecessary shipments of gold between nations to settle 
international balances, which have heretofore not infre- 
quently prevailed." 

§ 59. Rediscounting at the bank in times of stringency. — 
The fact that the Bank of England is to a degree a com- 
petitor of the joint stock banks appears to be a cause of 
complaint on the part of the latter, 46 for the bank has very 
large deposits from these institutions interest-free, and thus 
may be charged with using their funds to accommodate busi- 
ness which might otherwise come to them. On the other 
hand the Bank of England has its own earnings to look 

46 The fact that the Bank of England is a competitor is a "source 
of grave complaint by the other .banks." Statement of Sir Felix 
Schuster, "Interviews," etc., p. 48. 



FOREIGN MONEY MARKET FACTORS 245 

after in the long periods of monetary ease and quiet. But 
the merits of this question lie beyond our field. The great 
and outstanding fact is that the bank does not enter into 
full and unreserved competition with the other institutions 
of the open market. "Without its making any express ac- 
knowledgments that it is under any peculiar obligations, the 
Bank of England in point of practice keeps its own private 
discount business within limits and contrives to hold its 
discounting power in reserve in order to take care of the 
general money market of London in times of striugency. 
It is the custom of the bank to follow this polic} r and 
London expects it to do so, although there is no legislation 
directly or indirectly making the policy compulsory. This 
is the British way. 

The method by which the city secures relief from the 
bank under conditions of strain is simply that of redis- 
count, and it is for this reason that the Bank of England 
belongs to the class known as banks of rediscount. But, 
as already made clear, some of the great joint stock banks 
never rediscount with the Old Lady of Threadneedle Street 
or at any other place. What the policy of all these insti- 
tutions is, is not publicly known, but it seems to be generally 
assumed in the literature of the subject that there is no 
appreciable rediscounting by this group under any condi- 
tions. 47 But even if these banks do not make direct appli- 
cation to the Bank of England for aid in time of trial, they 
have a way nevertheless of passing much of the burden of 
the moment over to this establishment. 48 The proceedings 

*~ In this respect English banking practice is in sharp contrasl 
with that in France and Germany and other continental countries, 
where even the greatest ordinary incorporated hanks rediscount 
freely with their respective central hanks. 

48 For the student it may he explained that the burden in <|iies- 
tion is that of exchanging cash for time paper. A period of strain 
is one in which demands for cash on the part of the depositors "i 
creditors of the banks are too heavy for satisfaction from the exist- 



246 FOREIGN EXCHANGE 

which take place are peculiar to London and are essentially 

is follows. Tlic joint stock banks find their reserves be- 
eoming too low. Thereupon they fall back upon one of 
their most liquid assets, the one listed in their balance sheets 
next to their "cash in hand and at the Bank," namely, the 
call and short term loans which they have made to the 
bill brokers and discount houses. They exercise their privi- 
lege of terminating, or calling, these loans and this imposes 
upon the bill dealers the necessity of paying them off in 
cash. But the bill dealers have invested all this call and 
short term money in bills, and to return it to the banks 
they must sell all or most of their bills. Usually they sell 
bills to the banks themselves, but not now, because now 
the banks are not buying bills, at least in the usual quan- 
tities, being engaged in converting assets into cash rather 
than converting cash into bills or any other kind of paper 
assets. The Bank of England now stands as a place of 
refuge for the bill dealers. If the stringency is severe a 
veritable rush into the bank may ensue. As they say in 
London, "the market has come to the Bank" or "the bill 
brokers are in the Bank." On these occasions the cen- 
tral institution undertakes to provide accommodation, but 
charges the official bank rate, meanwhile, in case of need 
elevating this rate. 

The immediate results of this process are two: an in- 
crease in the reserves of the joint stock banks and a de- 
crease in the reserve of the Bank of England. The first 

ing reserves without embarrassment. So it becomes necessary to 
convert some of the assets other than cash into cash. For this pur- 
pose the joint stock banks might sell, or rediscount, bills from their 
portfolios, but this is what they do not do in practice. Instead 
they convert their call loans to bill brokers, another asset, into cash. 
They do this indirectly by the aid of the Bank of England, and it is 
practically all one to that institution which way they follow, though 
it appears not to be all one from the standpoint of the joint stock 
banks. 



FOREIGN MONEY MARKET FACTORS 247 

result comes about practically in this manner. The bill 
brokers use the proceeds of their rediscounts and loans 49 
at the Bank of England to pay off their call loans at the 
joint stock banks. They draw checks on the Bank of Eng- 
land in favor of these banks and the latter simply deposit 
the checks to the credit of their own accounts with the 
same institution. This augments their reserves by increas- 
ing that part of reserves known as "cash at the Bank of 
England." That these additional deposits, like all the de- 
posits at the Bank of England, are subject to withdrawal 
in cash on demand, goes without saying. To what extent 
the Bank of England will begin to lose cash depends on 
circumstances, but more upon the international gold move- 
ment than upon domestic conditions. If gold exports are 
taking place from London, the Bank of England is likely 
to have to supply a large part of the metal. That is, some 
one exporting gold will turn up at the bank with checks 
payable by it and demand actual specie, or will demand it 
on account of his own deposit credit. 

The decrease in the reserve of the Bank of England 
ensues whether or not the joint stock banks make cash 
withdrawals from their deposits, though the effect on the 
reserve is much greater if they do make such withdrawals. 
We have here to recall explanations first made in §§19 
and 20. If no withdrawals of deposits are made, the 
percentage of the reserve of the bank is reduced because; 
its deposit liabilities have been expanded without its having 
received any inpayments of cash. Total demand liabilities 
having increased and total cash having, as we assume, stood 
still, the cash bears a smaller proportion to the liabilities 
than before. This decline in the percentage of the reserve 
is properly spoken of as a decrease in the reserve, even 
when there has been no absolute falling off of the cash 

49 In addition to the rediscount of hills at the bank, the market 
(namely, the bill dealers) may procure some loans on collateral. 



FOREIGN EXCHANGE 

on hand, because it is the proportion of the reserve to the 
rve-bearing liabilities, and not in the least the absolute 
amount of cash in vault, which determines the strength of 
a bank's position. 

If cash withdrawals are made, the absolute amount of the 
cash on hand is reduced, and the percentage of the reserve 
is reduced in greater degree than under the first supposi- 
tion. 50 The Bank of England's discounting and lending 
power is hardly unlimited. When as a consequence of its 
aiding the market it finds its reserve beginning to decline, 
it must take steps to prevent this process from going too 
far for the reasons which govern any bank. Although it is 
fortified by the tremendous traditional public confidence 
imposed in it, it must not allow its reserve to fall to the 
point which might be provocative of a run. The chief 
preventive it applies in these junctures is an elevation of the 
bank rate. The highest point this rate has ever reached is 
10%. In the period from 1844 to 1900 inclusive, compris- 
ing 20,570 days, it stood at 6% for a total of 868 days, at 
7% for 577 days, at 8% for 268 days, at 9% for 95 days, 
and at 10% for 141 days. 51 On the first four days of 
August 1914 it was at 10%. Since 1844 the rate has been 
at this, its extreme height, in but three years, 1857, 1866, 
and 1914. 

When the bank rate is elevated as a protective measure, 
an effect is produced upon both the domestic and the for- 
eign influences impinging on the London money market, but 
the effect on the foreign influences is the more important. 
It is true an increase in the charge for discounts and ad- 
vances tends to repress the demand for accommodation 
which comes from purely domestic sources, or tends to re- 
duce the proportion which the volume of paper seeking 
discount bears to the funds available for taking care of it, 

so Compare calculations in § 20. 

si From Palgrave's "Bank Rate and the Money Market," p. 99. 



FOREIGN MONEY MARKET FACTORS 249 

and thus tends to provide relief from the drain. But for 
London, as contrasted with any other center, the domestic 
effects of increased rates for money have the smallest im- 
portance relative to what we may call the foreign effects, 
namely the effects upon dealings in other countries in ster- 
ling exchange and upon the international gold movement. 
The latter will be brought under discussion in Chapter XX 
below, after the ground has been further prepared for the 
subject. During periods of stress the bank discounts for 
and makes loans to the London market and protects itself 
when necessary by increasing its rate. At such times this 
rate is an effective one, governing actual business. When 
the monetary pressure subsides and ordinary conditions 
return the bank rate resumes its nominal character and 
becomes a mere index of the market. 

War time note. — Certain modifications in the practice 
of the London money market have been produced by the 
conditions of war. Probably various minor changes are 
now in effect that cannot be ascertained, much less clearly 
understood, by any one outside the immediate circle of 
bankers and dealers directly concerned. It is too early 
to undertake prophecy as to what alterations if any will 
be perpetuated after the war, though it seems unlikely thai 
the general framework will be modified seriously. We have 
already adverted to the new bank rate, or rate of interest 
offered by the Bank of England to the clearing banks for 
short term loans. It remains to speak of a new practice 
in borrowing from the Bank of England, as evidenced by 
the following news item, dated March 3d, 1917. "Money 
has been comfortably abundant, on the whole, though a 
little business in discounts at 5 1 /4% has been done at the 
Bank of England. It is clear that the banks are acting 
mercifully by the bill brokers, and, instead of calling in 
money from them, arc going direct to the Bank of England 



250 FOREIGN EXCHANGE 

themselves, and borrowing the sums needed in order to 
carry oul the big transfers of cash involved in the War 
Loan payment." It is stated only that the "banks" are 
acting mercifully by the bill brokers, but it may be as- 
sumed that the great joint stock banks, or some of them, 
are meant. The loans referred to are incidental to very 
special and large operations connected with the govern- 
ment 's borrowings and are doubtless undertaken for the 
laudable purpose of reducing the accompanying money 
market disturbances, and one cannot infer that they will 
hold their place in practice after the war. Nevertheless 
it appears there has been here at least some departure from 
the ante-bellum methods, under which the great banks 
customarily refrained in periods of stress from applying 
for advances from the Bank of England, and resorted ex- 
clusively to the expedient of calling in their day to day 
and short loans thus forcing the bill dealers into the bank. 

§ 60. Interest and discount rates customarily in fixed 
relation with the bank rate. — Five rates appearing in Lon- 
don banking and bill dealing are as a matter of custom 
based directly upon the bank rate, standing in ordinary 
times at a fixed or specified distance above or below this 
rate or exactly even with it. As the bank rate steps up or 
down, these rates step up or down to the same extent. 
Three are interest, and two are discount rates. 

(1) The regular deposit allowance rate. — This is the 
rate of interest paid by the joint stock banks on the de- 
posits at notice of ordinary persons or firms. It is deter- 
mined upon by these banks in concert, at meetings of their 
representatives held every time the bank rate is changed, 52 
but the usual practice has been to set it at a point VA% 
below the bank rate. "When, however, the latter ascends to 
a high figure, the deposit allowance rate does not neces- 

52 See statement of Sir Felix Schuster, '"Interviews," etc., p. 45. 



FOREIGN MONEY MARKET FACTORS 251 

sarily follow it up. For instance in the panic year of 
1907 the bank rate climbed to 7% but the deposit allow- 
ance rate did not go above 4%. During the present war 
the relation of this rate to the bank rate has become very 
much less intimate than it was in the preceding period 
of peace, the spread between the two showing great varia- 
bility. The discount houses have deposit allowance rates 
as well as the banks. These are not necessarily identical 
with the banks' rate and are allowed on deposits on demand 
as well as deposits at notice. Deposits at notice usually 
bear a higher rate than those on demand. 

(2) Rate allowed on the balances of foreign banks. — 
This rate, analogous to the foregoing, differs for different 
banks and is placed at a stipulated distance under the bank 
rate, commonly with a maximum limitation. It is usually 
Vi to 1% below the bank rate. 53 This is a rate allowed by 
the joint stock banks on the checking accounts of foreign 
banks. 

(3) Rate of interest charged on overdrafts. — Lending by 
the method of overdrafts is not regular London practice, 54 
but foreign banks arrange for overdrafts on occasion on 
their correspondents in London, and these are usually sub- 
ject to an interest charge at the Bank of England rate 
or at % to 1% above it, according to agreement. 05 

(4) The retirement rate of discount. — This rate (dis- 
cussed in § 35) is in English practice maintained at a figure 
%% above the deposit allowance rate, and thus through the 
latter is related to the bank rate. When the deposit allow- 
ance rate is at VA% below the bank rate, the retirement 
rate is 1% below it. 

(5) Rate of discount applied to many trade bills. — Trade 

gs Margraff, "International Exchange," p. 117. 

-'Statement of the manager of the London Joint Stock Bank, in 
"Interviews," etc., p. 78. 
55 Margraff, 'International Exchange," p. 117. 



FOREIGN EXCHANGE 

bills, or those drawn on merchants instead of upon banks, 
are discounted at rates which vary considerably according 
to personal security, character of documents, and term, 
hut large quantities of these bills are as a matter of in- 
formal practice discounted exactly at the bank rate. 56 

Wiih respect to the general market rates which do not 
have a fixed relation with the bank rate, such as the open 
market rate for bankers' acceptances or the rates for trade 
bills accepted by the larger mercantile houses, these rates 
usually lie in a region between say % and M% below the 
bank rate. Another and on the whole better way of stat- 
ing this is that usually the bank rate is placed a distance 
above the market rate on bankers' acceptances, and is main- 
tained at a fairly steady figure while market rates fluctuate 
freely by sixteenths and eighths of 1%. The excep- 
tion to this occurs in times when the bank rate becomes 
effective, as explained on earlier pages. 

§ 61. The group of London money rates. — The tables of 
London money rates published in the London Economist 
are the most complete among those readily accessible to 
the common man. Beneath is a specimen of the briefer 
table appearing regularly in that journal's weekly article 
on money. 57 

Aug. 24, Aug. 17, Aug. 10, Aug. 3, 
1917 1917 1917 1917 

% % % % 

Bank rate 5 5 5 5 

Bank of England rate to 

Clearing Banks 4 4 4 4 

Bank's deposit rate 4 4 4 4 

Market rate (3 months 

bills) 4% *%« 4% i% 6 4% J %6 4% ^e 

56 See "Interviews," etc., pp. 53 and 83. 

57 The first table is from the Economist for Aug. 25, 1917, p. 274. 
The longer tables are from the issue for May 5, 1917, p. 788. 



FOREIGN MONEY MARKET FACTORS 



253 



The more detailed tabulations to follow give a better idea 
of the number of rates and the extent to which they vary 
as between different days and different classes of discounts 
and advances. 

LONDON RATES 







00" 

p. 


0" 

^ i-i 

< 


rH f 


3 


CO t~ 

C3 r-l 


08 in 




% 




% 


% 


% 


% 


% 


% 




5 




a 


5 


5 


5 


5 




Market rates of dis- 


















count: — 


















60 days' bank- 


















ers' drafts 


4% 


% 


4% % 


4«/i6 


4% iVie 


4% 1%6 


« 1 VS6 


4% 


3 months' do.... 


4% 




4% l% 6 


4«A6 % 


41V16 y* 


4% 


4% 


4% 


4 months' do.. .. 


4% 




4% i-yie 


4% 


4H/16 % 


4% 


4% 


4% 


6 months' do.... 


iWm i%o 


4% 


41?i 6 % 


4W1B % 


41%6 % 


4l%e % 


4% % 


Loans: — Day to day. 


4 


% 


3% 414 


3 4 


3V 2 4% 


4V4 4% 


4% 


3% 4^ 


Short 


4% 


u. 


Wi % 


4% % 


4% % 


4% y 2 


4y* y 2 


4V 4 % 


Fortnight (at last 












5% 




5y 2 


5% 


5y 2 


5 


5 


5 


Deposit allowances : 




















4 




4 


4 


4 


4 


4 


4 


Discount houses 




















4 




4 


4 


4 


4 


4 


4 


At notice 


4% 




414 


414 


4y 4 


4Vi 


4y 4 


414 



Comparison with previous weeks : 







ll 


Trade Bills 


Rank Bills 




"2 



2 


.3 





3 




5 
a 


3 


c 


2 


BO 

a 



2 


1 









« 


«* 




«o 


CO 


■** 


ce 


1917 


Vo 


% 


% 




% 


% 


% 


% 


Feb. 


9... 


4% 5 


r, 


rj 


r, 




6% 


5% % 


5'/2 6 




16... 


5 


5^ 


5% 


BH 




5% 


5% % 


5% « 




23... 


5 


5%6 


5-yio y* 


5y* 




5% 


5% % 


5% 6 


Mar. 


2... 


4% 5 


5 


5 % 


G 


% 


5% 


5V4 % 


5V4 6 




9... 


4'/ 2 % 


4% i-Vic, 


4% % 


4y 4 


1%6 


5y* % 


5'/2 


r,i, :r, 




16... 


4*4 % 


4V 2 n /i<i 


4y 2 % 


4% 


% 


5 


5 % 


5 % 




23... 


4y 4 % 


4% 


4>/ 2 


4y 2 




5 


5 % 


5 % 




30... 


4% y 


4%8 


ma 


4%a 




5 


b y 


r> y 


April 


4... 


4% y 2 




4y °An 


4% a 




5 


5 y 


5 y, 




13... 


4 y 


4% 


4V 2 % 


4% 




4% 


5 


5 y 




20... 


4>i y 2 


4i-"K» % 


m % 


4% 


5 


5 


5 y 


5 % 




27... 


4% y 2 


4% 


i 




^lO 


5 


B 


b y 


May 


4... 


4 1 /* % 


4% 


4% 


4% 


% 


5 


5 y 


y 



254 FOREIGN EXCHANGE 

The rate for "floating money" means the rate for short 
loans (s( e the first column of the last table). By assembling 
all rales found in the foregoing tables and adding a few 
more, we shall obtain a practically complete list of dis- 
count and interest rates prevailing in the world's monetary 
capital at the present time. The list follows: 

(1) The Bank Rate, or "Official Minimum Discount Rate of the 

Bank of England." 

(2) The Bank's rate to clearing banks, or rate of interest offered 

the clearing banks by the Bank of England for short term 
loans to be made by them to it. 

(3) The market rate, or the rate of discount in the open market 

for prime bankers' acceptances with 90 days to run. As- 
sociated closely with this is the sub-group of rates for 
bankers' acceptances with other lengths of life. 

(4) The open market rates for trade bills (those drawn on mer- 

cantile firms, etc.) varying according to personal security 
and tenor. 

(5) Interest rate on "day to day" or call loans. 

(6) Interest rates on term loans, varying according to term, 

parties, and character of collateral. 

(7) Interest rate known as the "deposit allowance rate," paid 

by joint stock banks for deposits at notice. 

(8) Deposit allowance rates paid by discount houses for deposits 

at notice and also for deposits at call (the latter being 
generally a trifle lower than the former). 

(9) Interest rates paid by banks on the balances of foreign 

banks carried with them. 

(10) Overdraft rates, or rates of interest charged by banks on the 

overdrafts of other banks carrying balances with them. 

(11) The retirement rate of discount or "rebate" rate. 

(12) The arrival discount rates for divers types of bills remitted 

by foreign banks (see next section). 

Of the above rates, numbers 3, 4, 9, 11, and 12, are of the 
most direct interest to bankers outside of England in con- 
nection with their dealings in sterling exchange. 



FOREIGN MONEY MARKET FACTORS 255 

§ 62. The "arrival" discount rate. — Sufficient attention 
has already been paid to the rates listed in the preceding 
section, except the "arrival" or "forward" discount rate. 
This is a rate at which a London correspondent bank will 
undertake to discount a bill or parcel of bills "to arrive," 
to use the banker's phrase. This means it is a rate which 
a correspondent quotes, by telegraph to an exchange bank 
dealing with it, in advance of the shipment of a parcel of 
bills by the latter. The rate when accepted is applicable 
to any bills mailed on the day when the quotation is re- 
ceived. It will be applied to these bills on the day of their 
arrival, from five to fifteen days later according to circum- 
stance and location, in the case of bills shipped by Ameri- 
can banks to England. The arrival rate differs according 
to time expected to elapse before the bills are received and 
according to the character of the bills — in other words there 
are really a number of arrival rates. When the American 
banker rates a certain bill as belonging to a given class and 
as being therefore entitled to a certain quoted arrival rate, 
this rating must of course be confirmed by the London bank, 
but the American banker gets to be a good prognosticator 
in this matter respecting such bills as he sends over under 
the arrival rates. 

The quotation of such a rate by a London bank amounts 
to an undertaking to purchase long bills at a designated 
present worth in sterling on a future date, namely the date 
of their receipt. The arrival rate being accepl r<l, the 
London bank's obligation is not affected by the actual mar- 
ket rate of the day of the receipt of the bills. By obtain- 
ing and accepting arrival rates, the American bank avoids 
a speculation on the changes that may take place in the 
London money market during the journey of cadi lot of 
bills across the Atlantic. For without an arrival rale il 
would be taking its chances as to what the market rate 
will be on the day of arrival. The London hank shoulders 



FOREIGN EXCHANGE 

the speculation. Tt has superior opportunities to predict 
the future course of London rates. If its arrival quotation 
turns out higher than the actual market rate of the day 
when the lulls come in, it makes a gain, if lower a loss. On 
khe average it cannot make very great gains, otherwise the 
American hank would fall to taking its chances on the 
market rate. It is only by reason of the existence of the 
arrival rate that the calculation of the value of a long 
sterling draft in New York can be made perfectly definite 
(compare § 64). Continental banks in general quote ar- 
rival discount rates as well as the English. 

§ 63. Stamp taxes. — There remains to be considered but 
one further factor which influences the American dealer 
in exchange in his price-making for bills. This is the 
stamp tax on negotiable instruments levied by the govern- 
ment of the foreign country in which the bills in question 
are payable. As previously, we shall restrict our dis- 
cussion to the case where the foreign country is England, 
but nearly all the leading countries of the world, except 
the United States, impose stamp taxes on bills and notes. 58 

The chief provisions of the British law pertinent to deal- 
ings in exchange are as follows. Cheques: Cheques and 
drafts payable on demand, or within three days after sight, 
pay a tax of Id. regardless of the amount for which they 
are drawn. Long tills: (1) Long drafts drawn in the 
United Kingdom, and long drafts made payable in the 
United Kingdom, though of foreign origin, are taxable ac- 
cording to the following schedule, — 

Not exceeding £5 .Id. 

Above £5 and not exceeding 10 2d. 

58 A very comprehensive article giving the stamp taxes of prac- 
tically all countries of the globe, as in force at the time of writing, 
is to be found in the Journal of the Institute of Bankers, London, 
vol. XXIX, pp. 427-51. So far the war has worked no changes in 
the British stamp taxes on checks and drafts. 



FOREIGN MONEY MARKET FACTORS 257 

Above 10 and not exceeding 25 3d. 

Above 25 and not exceeding 50 6d. 

Above 50 and not exceeding 75 9d. 

Above 75 and not exceeding 100 Is. Od. 

For every additional £100 or fraction thereof. . . .Is. 

A tax of 1 shilling per £100 reduces to a rate of V20 of 1%. 
(2) Drafts drawn outside of the United Kingdom and 
payable outside of the United Kingdom, are subject to a 
tax if negotiated in the United Kingdom, payable at 
the time of the first negotiation. The rates of the pre- 
ceding schedule apply here upon drafts of £50 or less, 
while those exceeding £50 but not in excess of £100 must 
bear a stamp of 6d. Still larger drafts pay 6d. for every 
additional £100 or fraction thereof. Tkis is at a rate of 
y*o of 1%. 



CHAPTER IX 

THE PURCHASE OF BILLS FOR DIRECT CREDIT TO THE 
FOREIGN BALANCE 

§ 64. Buying bankers' long bills. — Though a bank can 
make arrangements permitting it either to buy or sell 
bills on a place where it keeps no balance, such dealings are 
not likely to be extensive. The present chapter will con- 
cern itself only with dealings on a place where a balance 
is carried and will be confined to operations based directly 
upon such balance. It will be best to begin with the pur- 
chase of a banker's long bill. This kind of exchange is 
often drawn and sold in large quantities. Its origin or 
supply will be discussed in Chapter XII. At this point 
we shall concern ourselves with the buying price offered 
for it. 

The banker who buys another banker's long bill on a 
foreign city might conceivably have a mind to invest in it, 
but practically this is not likely to be the case because the 
money market and exchange conditions which lead to 
regular drawings of this kind are unfavorable to invest- 
ment in exchange. It shall be assumed, therefore, that the 
bill is purchased with a view to its being discounted on its 
arrival abroad for an immediate credit to the balance of 
the bank that has bought it. 

Suppose then that a 60 days' sight bill for £1,000 drawn 
by a New York bank on some bank in London is offered 
for sale in New York. What can the buyer pay for this 
instrument? This will depend on three factors: (1) the 
rate of the day in New York for bankers' sight sterling 
drafts, or in short what is called the sight rate, (2) the 

258 



THE PURCHASE OF BILLS 259 

London arrival discount rate quoted this day for 60 days 
bankers' bills, and (3) the stamp tax. The price will first 
be calculated that can be paid for the bill without the pur- 
chaser making either profit or loss. This will give us what 
may be called the no-profit buying price, and the amount 
of this price per pound of face value of the bill, will be 
the no-profit buying rate. If the price of the £1,000 bill 
turns out to be $4,834.00, the rate would be 4.8340 (i.e., 
$4.8340 per pound). 

The sight rate in the open market depends upon the sup- 
ply of and demand for sight bills as determined by the 
needs of the whole body of dealers. This supply and de- 
mand is affected by the operations of the market in all 
other kinds of exchange than sight bills, being profoundly 
influenced especially by the volume of long bills originating 
in trade. The manner in which dealings in cables and long 
bills react upon the sight rate will be discussed in the 
chapter on the theory of exchange rates. The fact of 
present concern is that the position of the rate for sight 
drafts is governed primarily by the course of the foreign 
commerce of the nation and by international borrowings, 
and is to be taken by the banker, who is figuring a buying or 
selling price for any other type of exchange, as a predeter- 
mined and given factor in his calcidations. 

The long bill, whose purchase we are about to consider, 
will be converted into cash credit for the London balance 
on its arrival. The rate payable for it on this side will 
depend primarily and directly on the existing sight rate 
because this long bill will either (1) be remitted abroad ;is 
a substitute for sight exchange to increase the foreign 
balance, or (2) it will be used as cover for a sale of sight 
exchange, the latter being its employ ment if the foreign 
balance is already as large as desired. In either ease what 
the long bill is worth in New Fork will depend primarily 
upon what sight sterling is worth at the time. The second 



260 FOREIGN EXCHANGE 

supposition is best taken as the normal theoretical assump- 
tion upon which to calculate the buying price of any long 
exchange. To explain: if the purchased 60 days bill for 
CI. 000 will yield on arrival a cash credit of say £993 to the 
buying banker's London balance, and if there is no especial 
reason at the time for the addition of this sum to the 
balance, the policy indicated to the banker is the sale of 
£993 x of his sight drafts on the local market — this policy 
being founded upon what we ventured in § 52 to call the 
rule of equal sales and purchases. Clearly what the long 
bill is worth to him depends upon what he gets for the 
sight drafts which it will cover, and thus upon the sight 
rate. The completed operation in theory consists of two 
parts, (a) the purchase of the long bill and (b) the counter- 
vailing sale of sight drafts. One involves an outlay of 
dollars and the other a return of dollars. Together they 
leave the foreign balance unchanged, but afford a profit on 
this side provided the long bill is bought cheap enough. 

COMPUTATION IN UNABBREVIATED FORM OF THE 

NO-PROFIT BUYING PRICE FOR A BANKER'S 

LONG BILL 

Take a 60 days' sight bill for £1,000. 

Sight sterling rate (on day of purchase) 4.87 

London arrival discount rate 4% 

Stamp tax %o% 

No commission charges. 

Present worth of the bill on its arrival in London. 

This bill becomes payable in London 63 days after the date of its 
arrival, assuming acceptance to be procured on the day of 
arrival. 

63 days' discount at 4% will be 6 %65 of 4% of £1,000. 
(The English count the year as 365 days, and not as 360) 

i Not that it is supposed he will in fact find a purchaser for this 
precise amount. Whatever he sells, this particular long bill is re- 



THE PURCHASE OF BILLS 261 

This amounts to £6 18s. Id. 

The present worth of the bill is then £1,000 less this 
amount, or £993 Is. lid. 

Net cash value of this bill to the London deposit. 

The stamp tax on the bill (Is. per £100) 10s. 

This is paid by the London correspondent and 
charged to the remitting bank. 

The present worth of the bill as above £993 Is. lid. 

which equals £992 21s. lid. 2 

Less stamp tax 10s. 

Net cash value of the bill £992 lis. lid. 

No-profit purchase price of the bill in dollars. 
Amount of demand draft that can be sold against 

this bill £992 lis. lid. 

Which expressed decimally is £992.596 

£992.596 X 4.87 (N. Y. rate) = $4,833.94 

No-profit buying rate would therefore be 4.8339, 

nearest standard quotation being 4.8340 

Under the data given, the computation shows that the 
banker can obtain from the long bill $4,833.94 cash return 
in New York on the day he bought it. For we may assume 
that he can sell the 992 odd pounds of sight drafts on 
this day. The two parcels of exchange, the long bill bought 
and serving as cover and the sight bill sold against it, may 
well cross the ocean by the same steamer. If it were 
necessary to give the cover one day's start, the turnover 
would be theoretically chargeable with one day's interest on 
the cost of the long bill. The bill yields a return of 
$4,833.94, and therefore if the banker paid exactly this 
price for it, or bought it at the rate of 4.8339, he would 
make neither profit nor loss. 

sponsible for his ability to draw exactly £993 of demand drafts, and 
is of course to be valued accordingly. 

2 Obtained by deducting £1 from £i)!)3 and adding it, as 20 shil- 
lings to the Is. £1 =20 shillings. 1 shillings: 12 pence, or "12d." 



262 FOREIGN EXCHANGE 

The account of this operation is restated beneath in a 
modified form. 

A £1,000, 60 days' bill bought at 4.8339 costs $4,833.90 

It produces a net (tax free) cash credit abroad 

on arrival of £992.596 

It provides cover for the sale of a demand 

bill for this amount of sterling. 
£992.596 demand exchange sold at 4.87 yields 3 $4,833.90 



Profit (or loss) 

It is clear if a profit is to be obtained when the sight rate 
is 4.87 and the discount rate is 4%, the bill must be bought 
under the rate of 4.8339. If, for instance, it could be 
bought at 4.83, a profit of 3 %oo of 1 cent would be made on 
each pound. This would be a profit of about Vn of 1%, or 
$3.90 on a bill for £1,000. So large a profit could hardly 
be obtained in fact under normal conditions from the pur- 
chase of a prime banker 's bill. 

The banker's practical method of figuring the price of a 
long bill is briefer and more direct than the one just ex- 
plained. It involves a trifling theoretical error, 4 as will be 
shown, but we have begun with the longer computation not 
so much because of this fact as because this longer form 
enables one unfamiliar with exchange to understand the 
reasoning leading to the answer. The abbreviated practical 
computation is useful in obtaining the desired result, 
namely a sufficiently accurate answer to the problem, but 
the reasoning underlying it is not on the face of it per- 

3 The fixed tax of Id. on demand bills, regardless of their amount, 
is treated as negligible. 

4 The error is trifling so long as sterling remains within the nor- 
mal limits between 4.84 and 4.88. The enormous war-time fluctua- 
tions of sterling in New York have had the effect of making the error 
very significant and have forced bankers to abandon their old com- 
puting tables. 



THE PURCHASE OF BILLS 263 

fectly intelligible. It is given beneath for the same bill and 
date as before. 

TEE PRACTICAL METHOD OF CALCULATING THE 
PRICE OF THE BANKER'S 60 DAYS' BILL 

Rate for banker's sight drafts 4.87 

63 clays' discount at 4% 0335 

(Taken as 6 % 6 5 of 4% of 4.85, $4.85 being as- 
sumed as the equivalent of £1, so that the 
discount on £1 may be converted to U. S. 
money.) 

Stamp tax, at the rate of ^o% 0024 

(%o of 1% of 4.85) 

.0359 .0359 

No-profit buying price of the bill 4.8341 

The discount and stamp tax appear in the above tabulation 
as decimal fractions of an American dollar, but the real 
discount and tax are in point of fact deductions (from the 
face or maturity value of the long bill) made in London 
and in sterling money. They are really subtracted to find 
the net spot-cash value of the bill to the remitting bank'?. 
London balance. The amount of discount and tax for each 
pound of the long bill may be figured quite as easily as 
for the whole sum due upon it. Thus, 

The discount on each pound £.0069 

6 %G5 of 4% of £1 
The stamp tax on each pound 0005 

%o of 1% of £1 

Total 0074 

When we speak of a pound of long bill we mean a pound 
of its face value. If such a bill converted, on arrival in 
London, into cash credit without the deductions of discount 
and tax, so that each pound of it produced a full pound 



264 FOREIGN EXCHANGE 

of cash credit, it would be worth $4.87 per pound in New 
York on the day of purchase, provided the sight rate stood 
at 4. ST on that day. But in this conversion into cash credit, 
each pound Buffers the deductions for discount and tax 
calculated above. On the basis of these data we can per- 
form the following modified computation to find its worth 
(or no-profit buying price) in New York. 

Value of each pound of long hill without allow- 
ance for the deductions due to discount and tax. $4.87 

Loss in dollars for the deduction of the 

discount .033603 

(.0069X4.87) 
Explanation: — £.0069 being taken out 

for discount means £.0069 less of sight 

exchange saleable against £1 face value of 

the long bill, and a consequent giving up 

of .0069 X $4-87. 

Loss in dollars for the deduction of the 

stamp tax .002435 

(.0005X4.87) 
Explanation: — The same as above. 

Total loss or deductions 036038 .030038 

Net value of each pound 4.833962 

The following computation is arithmetically identical with 
the foregoing. 

Sight rate 4.87 

63 days' discount at 4% 033603 

6 %65 of 4% of 4.87 

The same as .0069 X 4.87 
Stamp tax at rate of %o% 002435 

%o of 1% of 4.87 

The same as .0005 X 4.87 

.030038 .036038 

4.833962 



THE PURCHASE OF BILLS 265 

This reckoning is strictly correct. It differs from the 
banker's practical computation (given on pages 64-6) only 
in that it makes use of 4.87, namely the existing sight rate, 
in converting the discount and tax into dollars, whereas 
the banker uses the fixed figure 4.85 for this purpose. 5 It 
is this use of 4.85 as a constant which brings into the prac- 
tical computation the trifling error of which we spoke. 
To obtain perfect accuracy the existing sight rate must 
always be employed in the foregoing conversions. It is 
only when the sight rate happens to stand at 4.85 that the 
banker's calculation is absolutely exact. 

In the illustration before us, the practical method gives 
a no-profit price that errs by being too high. Thus, 

No-profit rate 

According to the practical method $4.8341 

According to the true method 4.833962 

Difference 000138 

Though so small, this error would mean that on £100,000 
of 60 days' bills bought under the conditions of our illustra- 
tion the banker would figure his buying price $13.80 too 
high for the whole lot. When the sight rate is below 4.85 
the practical method makes the buying price come out too 
low and causes the dealer to obtain slightly more profit in 
the purchase of long bills than his computations show on the 
surface. 

The reason justifying the use of 4.85 as a constant is 
simply one of convenience. On the basis of this figure a 
single table can be prepared which will show at a glance the 
amount of deduction in dollars to be made for discount at 
all the various rates of discount commonly quoted and for 
all the different length of life of bills ordinarily bought. 

c Or did so prior to the war, when sterling rates remained within 
their normal limits, generally between 4.84 and 4.88+. 



266 FOREIGN EXCHANGE 

Tables founded on the correct method could be computed 
for all different sight rates met with in practice, but the 
single table has apparently seemed sufficiently accurate to 
actual dealers. Theoretically the stamp tax converted to 
dollars is also variable with the existing sight rate, but 
bankers are content to subtract the constant .0024, based 
on 4.85. 

§ 65. Buying long bills drawn by merchants on banks. — 
Having explained both the true and the practical methods, 
we shall be content henceforth to follow the latter alone. 
Suppose for the next problem that an American exporter 
offers for sale his 90 days' documentary draft upon a 
London bank, drawn under a latter of credit, when the 
arrival discount rate for such a bill is 3% and the sight 
rate is 4.85. What price will a local exchange bank offer 
for this bill? When this instrument becomes the accept- 
ance of the London bank, which we may assume to be one 
in first class standing, it becomes a prime bill. As such it 

BANKER'S BUYING PRICE FOR MERCHANT'S 90 DAYS' 
SIGHT DRAFT ON LONDON BANK 

Sight rate, or rate for banker's sight drafts 4.85 

93 days' discount at 3% 0371 

( 9 %6sX3% of 4.85) 
Stamp tax 0024 

06o of 1% of 4.85) 
Correspondent bank's commission 0012 

(Taken as Mo of 1% of 4.85) 

.0407 .0407 



Buying price at which the bank would make no profit 4.8093 

Profit required, a variable, say M cent per £ 0025 

Rate yielding this profit 4.8068 

Nearest standard rate 4.8070 



THE PURCHASE OF BILLS 2G7 

will be entitled to the lowest rate of discount for 90 days' 
paper in the London market. This fact will have been 
taken into consideration by the correspondent of the buying 
bank, at the time when this correspondent named an ar- 
rival rate of 3%. The documents will, of course, be "for 
acceptance" and after the act of acceptance takes place the 
bill will become a "clean" one. 

In addition to discount and stamp tax, commission ap- 
pears as a new deduction in this computation. We assume 
the correspondent charges the remitting bank a commis- 
sion at the rate of Mo of 1%, upon this bill because of 
the attached documents which it has to handle. 

The deductions of .0407 plus the profit of .0025 make 
the difference between the sight rate and the buying rate 
quoted for this bill come to .0432. Such a difference is 
sometimes called the "spread." So long as discount, tax, 
and commission are at the same rates, and the profit exacted 
remains the same, the spread is a constant no matter what 
the sight rate may be. That is, it figures as a perfect 
constant under the practical method of computation, and 
it will be a virtual though not perfect constant under the 
theoretically correct method. Thus under the practical 
method, any of the following computations hold good. 

Sight rate 4.88 4.8G50 4.85 4.84 

Spread 0432 .0432 .0432 .0432 



Buying rate .... 4.83G8 4.8218 4.8068 4.79G8 

§ 66. Trade bills, documents for acceptance. — By a trade 
bill is meant, at least in this connection, one drawn by a 
merchant on a merchant. This is the kind of bill con- 
sidered at length in Chapter VI. It becomes the accept- 
ance of a merchant or mercantile house, and not the accept- 
ance of a bank or of an acceptance house with a standing 
practically equal to that of a bank. In the case of most 



268 FOREIGN EXCHANGE 

trade bills, documents are "for payment," but if the drawee 
has a sufficiently high standing: they may be "for accept- 
ance" as is assumed in this problem. In this instance, 
then, the bill will after acceptance become clean and will 
be discountable in London at a rate depending on the stand- 
ing of the acceptor. Assume that the arrival rate under 
which the bill in hand is sent over is 3%%. 

BANKER'S BUYING RATE FOR MERCHANT'S 90 DAYS' 

SIGHT BILL ON A MERCHANT, DOCUMENTS 

FOR ACCEPTANCE 

Sight rate 4.85 

93 days' discount at 3^% 0433 

Stamp tax 0024 

Commission 0012 

.0469 .0469 

No-profit buying rate 4.8031 

Profit required, variable, say % cents per £ 0037 



4.7994 
Nearest standard rate, 4.7995. 

§ 67. Trade bills, documents for payment. — As already 
explained (compare § 34), the "documentary payment bill" 
is a trade bill whose attached documents are deliverable 
to the drawee only in return for payment of the instrument. 
Calculation of the buying rate for such a bill is a problem 
distinct from any considered in the preceding sections, for 
the reason that it cannot be discounted in England when 
sent to that country by the bank which has purchased it. 
This is a matter of the banking custom of England which, 
it happens, is in contrast with that of the principal con- 
tinental European countries. It has been stated in another 
place (see §35) that the acceptor of a documentary pay- 



THE PURCHASE OF BILLS 269 

ment bill has the privilege of prepayment under the rebate 
rate at any time during the life of the instrument. He 
may also at his own option allow it to run till maturity. 
The reason why English banks do not care to discount bills 
of this class 4s presumably because they do not desire to 
have among their assets pieces of paper with uncertain dates 
of payment, though the custom is perhaps in part attribut- 
able to the fact that these bills are in general drawn upon 
persons or firms of lower financial standing than those upon 
which the discountable classes of bills are drawn. It is 
true the legal date of maturitj r of a documentary payment 
bill is fixed, being commonly a date such and such a number 
of days after acceptance, and thus the bill has full legal 
negotiability, 6 but its date of actual discharge depends 
nevertheless upon the wishes of the acceptor. Also retire- 
ment takes place at a rate of discount which is not of the 
holder's making. 

But if the correspondent will not buy this instrument, 
why not have it sold on the open market. In the first 
place the bill dealers would not buy what the banks refuse, 
because they rely so much upon rediscount with the banks. 
In the second place there is a particular practical difficulty 
in the way of this plan, which is sufficient to make its re- 
jection necessary. If the bill were sold to any one, the 
documents would have to accompany it so that he would 
be able to present them to the acceptor when demanding 
payment at maturity. But if the bill were to go into the 
market with documents attached, the acceptor would have 
to be able to follow it up and locate it in order to exercise 

o As already indicated (compare §§5 and 9), one of the require- 
ments which a bill or note has to meet in order to possess strict 
negotiability, is that it must be "payable on demand, or at a fixed 
or determinable future time." There is no reason to suppose that 
the extra-legal commercial custom of prepayment destroys technical 
negotiability. 



270 FOREIGN EXCHANGE 

his right of prepayment, and this might be an annoyance 
to say the least. So tin* instrument stays with the corre- 
spondent bank which first received it from abroad and 
presented it for acceptance, but stays as the property of the 
foreign banker who bought it as exchange. 7 

In purchasing this class of exchange, then, the American 
bank is confronted with the problem that, in general, it 
cannot be certain whether the bill will remain unpaid till 
maturity, or will be converted into cash credit upon or some 
time after arrival. This is a problem because the value of 
the bill as a purchase on this side of the water differs 
according to which of these alternatives is realized. Thus, 
under given circumstances, if the bill were to be retired 
promptly it might be worth say 4.83, while if it were to be 
allowed to mature it would be worth perhaps only 4.8240. 

The American banker to whom one of these bills is of- 
fered by the drawer, may decline to purchase it and may be 
willing to take it only for collection. If he does purchase, 
however, the problem of calculating the buying rate is some- 
what more complex than in any of the cases we have hereto- 
fore considered. A sale by the banker of his own long 
sterling bill, or again the sale of his sight draft for future 
delivery, may be involved. For this reason it will be advis- 
able to postpone explanation of this particular calculation 
until these more technical operations involved have been 
brought under examination. (See § 94.) 

Why clean bills alone are discountable in London. — A 
"clean" bill is one without documents attached, whether it 
is one originally drawn without documents, or is a docu- 
mentary bill which has at the time of acceptance been 
stripped of documents. It is sometimes stated that London 

i It is difficult to see any positively compelling reason why British 
correspondent banks should not buy drafts of this kind, the standing 
of the drawers being assumed, and hold them until payment actually 
takes place, thus following the custom of continental banks. 



THE PURCHASE OF BILLS 271 

discounts only clean bills. This is true, but at first blush 
appears puzzling because a clean bill would in the abstract 
seem to be, from the point of view of security, inferior to 
a documentary bill. The answer to this enigma is not 
that some of the security must be stripped off a bill before 
the London market will accept it for discount, but the 
explanation runs rather in this wise: No bill drawn on 
England is likely to be discounted in regular course until 
it is accepted. Documentary bills drawn on banks are 
always governed by the instructions "documents for ac- 
ceptance," and therefore always become clean before they 
become available for discount. Where documentary bills 
drawn on merchants are under the same instructions, the 
identical observation applies. Where trade bills are drawn 
"documents for payment," they do not become clean upon 
acceptance. This, the only type of bill which is not clean 
after acceptance, happens to be non-discountable because 
of the retirement privilege which belongs to the drawee. 
Thus only bills which are clean of documents are in fact 
discountable. 

§ 68. Selling sight drafts and cables. — The preceding sec- 
tions have made it clear that the buying rates for many 
classes of bills are calculated on the assumption that each 
purchase of exchange is to have associated with it a simul- 
taneous countervailing sale of sight drafts on the open 
market by the purchasing banker. If some of these drafts 
are sold to merchant customers of the banker rather than 
on the open market, the principle of the calculation re- 
mains unchanged. Obviously in practice each distinct pur- 
chase need not be accompanied by an individually corre- 
sponding sale, it being sufficient for the total of current 
sales to be kept running on a basis of substantial equality 
with the total of current purchases. The reasons for the 
maintenance of this equality as a general policy, were dis- 
cussed in connection with what we called the rule of equal 



272 FOREIGN EXCHANGE 

sales and purchases. The banker departs from this policy 
whenever lie desires to increase or decrease his foreign bal- 
ance or other foreign funds, selling less exchange than he 
buys if he wishes to effect an increase of these funds, and 
following a reverse plan to produce an opposite result. But 
even when the equality of sales and purchases is purpose- 
fully suspended by the banker, the principle of determining 
the buying rates remains unaltered. If the banker desires 
to buy more exchange than he sells, he can obtain bankers' 
sight drafts at the open market rate. Under the condi- 
tions he may be inclined to look upon the purchase of a 
long bill as a substitute for a purchase of sight drafts on 
the open market, rather than as an operation to be counter- 
balanced by a sale of his own sight drafts; but the value 
of the long bill as a purchase will properly be calculated 
according to precisely the same method as before. That 
is, discount, tax, commission (if any), and profit (if any), 
enter into the computation in the same manner as before. 
Profit is the only one among these factors about which there 
might be a question. In his desire to procure exchange, 
might not the banker sacrifice the profit he ordinarily de- 
mands when purchasing certain types of bills ? This ques- 
tion ignores the fact that all the bankers' sight drafts 
needed can be procured at the market rate, if it is a real 
market rate, and that there is as much reason as ever for 
exacting the margin of profit that competition tolerates on 
other classes of exchange. Risk and trouble are the foun- 
dations on which this profit rests, and they are the same 
whether the exchange be bought as a substitute for bankers' 
sight bills or as cover for a sale of them. If, to reverse 
the case, the banker is at the moment engaged in selling 
more exchange than he buys, there is obviously no reason 
why he should reduce the margin of profit on purchases, 
and there is no reason why he may expect to secure a larger 
profit. 



THE PURCHASE OF BILLS 273 

While we are seeking to establish the principle that buy- 
ing rates for leading classes of long exchange are calculable 
on the uniform assumption of a countervailing sale of 
sight drafts at the open market rate, we may be required 
to consider two further questions, namely, (1) what deter- 
mines the open market rate for sight drafts, and (2) why 
may not the countervailing sale of exchange take the form 
of a sale of cables and the buying rate be calculated from 
the cable rate as basis? The first question can profitably 
be discussed at length only near the close of the book, but 
it may be said here that the sight rate itself depends in 
the end upon the totality of the supply of and demand 
for all classes of foreign exchange as determined primarily 
by international commercial and financial traffic, and sec- 
ondarily by exchange investment, borrowing, speculation, 
and arbitrage, and the export and import of specie. 

As for the second question, to wit, why not calculate all 
buying rates for bills on the basis of the market rate for 
cables, it must be confessed the thought that the cable rate 
is the "real" exchange rate, unadulterated by discount or 
interest, so to speak, is an attractive idea to both the theorist 
and the banker. But be this as it may, the various long 
rates (and also the rates for merchants' sight bills, which 
are sometimes drawn) are tied to the rate for bankers' 
sight drafts in a way in which they cannot be connected 
with the cable rate. 8 The spread between a long rate and 
the sight rate can be calculated at the time of the purchase 
of the long exchange, from factors which are then all fore- 

8 The rates for documentary payment bills are somewhat loosely 
related to the sight rate but are still more loosely related to the 
cable rate. The theorist might express himself figuratively by 
saying that under normal conditions, when the mechanism of the ex- 
changes is freely operative, the undoubted focus upon which the 
forces of exchange supply and demand are concentrated is the so- 
called market sight rate, namely the rate for bankers' sight drafts. 



•74 FOREIGN EXCHANGE 

known. 9 Neither speculation nor investment enters in. 
But. the purchase of any kind of bill cannot be counter- 
balanced by a sale of cables without both a speculation 
and an investment, of funds being involved. 10 And so a 
banker cannot base his buying rate for long bills upon the 
cable rate without putting into the spread one speculative 
element, or one factor that is guesswork. The point re- 
mains even if under very quiet conditions the degree of 
speculation may be slight. Why the speculative factor is 
necessarily present will be shown in § 155. 

The rates for exchange which takes the form of written 
instruments that have to be transmitted by mail to the 
place where they are payable, happen then to be more in- 
timately connected with each other than with the rate for 
telegraphic transfers. The sight rate is basic among this 
larger group. The sight rate and the cable rate are re- 
lated, but the spread between them contains an ineradicable 
speculative element. Whether the cable rate is in some 
theoretical sense the basic one as between these two, is a 
question that it is practically idle to discuss. In point of 
fact the sight rate is not determined by a calculation from 
the cable rate, but is forged out in the open market between 
the hammer and anvil of bid and offer. Under ordinary 
conditions at least, the market would no more think of cal- 
culating sight rates from cable rates than the tail would 
think of wagging the dog. 

a Assuming the quotation of an "arrival" discount rate. 

io The exception to this for practical purposes would appear when 
the place where the bills are payable is so near to the place where 
they are drawn, that the mail for which the bills are sold can reach 
the former on the same day as a telegraphic transfer. 



CHAPTER X 
DEALINGS OF A MORE INVOLVED CHARACTER 

§ 69. The bill drawn on a foreign country in home money. 
— The foreign bill as heretofore considered in this book 
has been an instrument calling for a specified sum of the 
money of the country upon which it is drawn or where it 
is payable. But a bill may be drawn for a sum of the 
money of the country of its origin or even of a third coun- 
try. It now becomes appropriate to examine into these to 
us new forms of exchange. We may attend first to the 
bill for a stipulated amount of the money of the country 
of its origin, or the bill "drawn on a foreign country in 
home money." Beneath is a specimen, to the order of a 
fictitious banking institution assumed to have offices both in 
New York and Rio Janeiro. 

$8,206.66 New York, N. Y., July 1, 1917. 

90 days after sight of this First of Exchange (second unpaid) 
pay to the order of the South American Banking Corporation, 
Eight Thousand and Six Dollars and Sixty-six Cents, United 
States gold, payable in Brazilian currency at the said bank's 
drawing rate on the day of payment for sight drafts on New York. 
Value received per S.S. Southern Star. 

Brown and Company. 

To Gonzales & Gallegos, 
Rio Janeiro. 

This instrument arises out of a shipment from Brown 
and Company to Gonzales and Gallegos of goods priced at 
$8,000, money of the United States, due the exporter in 
New York on the day of shipment, interest at 6% being 

275 



276 FOREIGN EXCHANGE 

chargeable for any delay in payment. It is understood 
Bettlemenl is to be effected by draft at 90 days' sight (the 
usual term of drafts of this eharacter on South America), 
drawn by the exporter on the importer in dollars. The 
draft is to be payable at the rate in Rio for sight drafts 
on New York, which means that it is to be dischargeable 
by the drawee's handing over at maturity a sufficient sum 
of Brazilian money to purchase, at that moment in Rio, 
a sight draft on New York for the number of dollars 
stipulated, in the instance in hand $8206.66. It is the 
stipulation of the number of dollars of this return draft, 
as we shall call it, which gives the exporter's original bill 
on Brazil its distinctive character. The object of this stipu- 
lation is to throw all risk of exchange upon the importer. 
The exporter draws for a specified sum of dollars instead 
of a specified sum of milreis. Were he to draw in the 
latter form, the proceeds from the collection of the bill 
might well be used in Brazil to purchase a return draft on 
New York, but the exact dollar content of this draft could 
not be foretold, and the exporter would take the risk of 
exchange. 

The sum of dollars named in the exporter 's original draft 
is computed on the assumption that a certain number of 
days will elapse before the return draft reaches New York, 
for which interest is chargeable at an agreed rate. That 
is, the dollars drawn for include the price of the goods, 
payable as of the date of shipment, plus interest on the 
same for time to elapse before New York exchange is ex- 
pected to arrive in final payment. The commission charged 
by the banker for collection of the exporter's draft is also 
included, and this is done whether or not the banker sub- 
sequently makes an outright purchase of the draft instead 
of receiving it for collection only. The face value in dol- 
lars of the draft of our illustration is computed in the fol- 
lowing manner: 



DEALINGS OF A MORE INVOLVED CHARACTER 277 

Price of goods $8,000.00 

(Under the agreement of sale, this is amount due 
the exporter as of the date of shipment.) 

Interest on this for 140 days at 6% 186.66 

(6% is the rate customary in these transactions.) 
The assumed period of 140 days is based on the 
following estimates: 

Mail time of draft to Rio 25 days 

Period from acceptance to maturity 90 days 
Mail time return draft to N. Y 25 days 

140 days 

Banker's commission at 1 / 4% 20.00 

(Taken, as a matter of usage, as Vk% of $8,000, 
or the price of the goods, instead of V±% of 
$8,186.66.) 



Total amount drawn for $8,206.66 

This draft is drawn payable to the order of the South 
American Banking Corporation either because this institu- 
tion is to purchase it or to take it for collection. In the 
one case the exporter will receive $8,000 (or approximately 
$8,000) of cash on the day of shipment, while in the other 
his takings will be $8186.66 (or $8206.66 less $20.00 com- 
mission) but these will be deferred about 140 days. The 
life history of the draft will be in its greater part the same 
under either supposition. The New York office of the 
South American Banking Corporation will forward it by 
the earliest mail to the branch at Rio, which will make the 
presentment to the drawee for acceptance, this being 
granted, we may suppose, on July 25th, fixing the date of 
maturity as October 23d. While the draft is drawn for a 
stipulated sum of dollars, the acceptor could not in regular 
course make an actual payment of money of the United 
States to discharge it, such money not being in circulation 
in Brazil. To meet the requirements of the case the in- 



278 FOREIGN EXCHANGE 

strument itself states the dollars arc "payable in Brazilian 
currency at the drawing rate on the day of payment for 

sight drafts on New York." "Drawing rate" is but an- 
other name for the selling rate of a bank. 

At the time of acceptance the precise number of milreis 
that will be required to discharge the bill cannot be fore- 
told. It will depend upon the rate in Rio for exchange 
on New York at the time of payment. There might of 
course be two or more slightly differing rates on New York 
at any one time. To obviate the danger of dispute, the 
bill names the selling rate of the Rio branch of the South 
American Banking Corporation itself. Should this be 4 
milreis per dollar, Gonzales and Gallegos will discharge 
their acceptance, on October 23d, by the payment of 
32,826.64 milreis (4x8206.66), written 32,826*640, Bra- 
zilian fashion. Upon the receipt of this sum the bank at 
Rio draws its sight draft on New York for $8206.66 and 
mails it to the office or branch at New York for the account 
of the exporter or any party holding from him. 1 

The interest charge in the present illustration was com- 
puted on the assumption that 140 days would elapse be- 
tween the date of shipment and the arrival of the returns 
in New York. In point of fact the return draft (or ticket 
of advice which may be substituted for it) might arrive 
in advance of the assumed date. This would depend upon 
steamer connections and minor circumstances. The time 
allowance is made somewhat liberal, but of course cannot 
be extended too greatly without unfair treatment of the 
importer. The importer's inpayment of milreis at Rio 
on the date of maturity of his acceptance, could of course 

i In the precise case before us the actual return draft would 
generally be omitted, for the instrument would be drawn by the Rio 
office of a given bank upon the New York office and in favor of the 
New York office of the same bank, so that the transaction as between 
the banks can be settled by the mere interchange of advices and 
making of book entries. 



DEALINGS OF A MORE INVOLVED CHARACTER 279 

be converted into dollars of bank credit in New York by a 
cable order (taking the place of a draft or advice trans- 
mitted by mail), but this would be done only in case the 
exporter's original draft stipulated that the dollars were 
payable at the cable rate in Rio on New York, which is not 
customary. 

As has been stated, the reason why our exporters insist 
upon bills in dollars, when drawing upon Brazil, is that 
they wish to avoid the risk of exchange which would be 
involved in the issue of bills for milreis. This risk is espe- 
cially great because Brazil has not as yet definitely adopted 
the gold standard, and the number of dollars into which a 
given sum of milreis can be converted is still open to great 
fluctuations. By drawing for dollars our exporter does not 
eliminate the risk of exchange from the settlement, but what 
he accomplishes is to shift it entirely to the importer. He 
contrives to make determinate the number of dollars re- 
ceived for his goods, this at the expense of making the 
number of milreis, that the Brazilian will have to pay in 
settlement, indeterminate until the day of settlement, when 
it will be fixed by the then current rate in Brazil for ex- 
change on New York. 2 

To carry the argument further, suppose our exporter 
has quoted the price of his wares as 32,850 milreis, payable 
90 days after arrival of a draft for this amount. Main- 
taining the illustration otherwise unchanged, he would on 
July 1st draw a 90 days' sight draft for 32,850 milreis, 
which would be accepted on July 25th and fall due on 
October 23d. On the latter date this sum of milreis would 
be paid into a Rio bank for his account. The only use 
he could make of it — special circumstances apart — would 
be to have this bank convert it into a dollar draft on New 
York to be forwarded to him or to his banker in New York. 

2 The Brazilian may, however, make a hedge at any time hy pur- 
chasing New York exchange for future delivery. 



280 FOREIGN EXCHANGE 

The number of dollars in this draft would depend on the 
rate of the day in Rio for drafts on New York. If the 
rate turned out to be 4 milreis per dollar, the return draft 
would be for $8212.50 (assuming that bankers' commissions 
are collected in New York) ; if it turned out to be 414 
milreis per dollar, the draft would be for $7729.41 which is 
nearly $500 less. Thus a rise in the rate at Rio upon New 
York would be unfavorable to the exporter. A reverse 
movement, it is true, would yield him an extra gain, but 
he does not desire to take a speculation upon the course 
of this rate. If he drew at sight instead of at 90 days' 
sight, the risk would still be present, though the period 
during which the exchange rate might vary would be 90 
days shorter. The question arises, could not the exporter 
protect himself against the risk of exchange by charging a 
sufficiently high price in milreis ? He could, but this would 
still leave him involved in the making of exchange prog- 
nostications — in a word, in exchange speculations — and 
whether or not he could get business on this method, it is 
not in fact usually followed. 

Another question presents itself. Might not our exporter 
quote his price in dollars and draw nevertheless in milreis? 
Might he not draw for a sufficient sum of milreis to enable 
the draft to be sold to a bank for the number of dollars 
due him ? The difficulty is that the banks would not care to 
purchase such a draft at any figure which would make its 
use worth while. The purchasing bank would then be 
taking a greater risk of exchange than it cares to. The 
methods of settlement with Brazil may change in the course 
of time if Brazil ultimately takes steps to assure the stability 
of her exchange rate on New York. Absolute stability is 
not to be expected, but measures might be put in effect to 
limit fluctuations somewhat narrowly. 

The exchange rates of Brazil on gold standard countries 
have been much more stable in recent years than in earlier 



DEALINGS OF A MORE INVOLVED CHARACTER 281 

times, the government of the country having made certain 
partially successful efforts to establish a gold-exchange 
standard. In 1896 the highest (i.e., dearest) rate in Rio 
on London was 7 2 %2 pence (November 11th) and the low- 
est (i.e., cheapest) rate was lO 11 /^ pence (June 3d). The 
difference between these two rates is about 23% of their 
average. This was 17 times greater than the maximum 
variation in New York rates on London for the same year. 
The greatest variation of rates in Rio within a period of 
two weeks in the 3 r ear 1896, took place between the 6th and 
20th of May, and was one of 8.6%. This is practically 
eight times as great a fluctuation as can possibly take place 
in any length of time in New York rates on London if 
the banks in both the United States and England are 
actually paying gold without premium and if gold can be 
freely transported, assumptions which have not held good 
during the present world war. 

Brazil has been used merely as an illustration of a country 
upon which the type of exchange we are discussing is drawn. 
If an exporter of the United States ships to any part of 
South America or to most parts of the Far East, and settle- 
ment is effected by draft on the importer, the draft is 
almost certain to be drawn for dollars. But the custom 
of drawing foreign bills for home money is not confined 
to this country nor did it originate here. It is followed 
in a number of the great commercial countries, but presum- 
ably first arose in England where exporters have for many 
years made a practice of drawing on foreign lands in 
pounds. As early as 1854 we find the London Economist 
advising British traders to draw on Russia in sterling be- 
cause of the issue of inconvertible paper by that country 
in connection with the Crimean War, and the consequent 
expectation of instability in its exchanges. 3 

s Mentioned in Clare's "A B C of the Foreign Exchanges," p. 65, 
note. 



282 FOREIGN EXCHANGE 

§ 70. The banker's buying price for such a bill. — Tn nam- 
ing a buying price for the bill considered in the preceding 
section, the bank does not (/note a rate of exchange. It 
docs not buy an instrument payable in a fixed sum of for- 
eign money but one promising to return a predetermined 
amount of home money. It pays dollars and gets back a 
foreknown sum of the same dollars. 4 It does not buy one 
kind of currency for another and foreign kind. It should 
be noted that the amount for which the bill is drawn is 
not the datum from which its price is calculated, but re- 
versely the price is first known and the amount for which 
it is to be drawn is computed from this datum. That is, 
continuing the illustration of the preceding section, the 
drawer is first of all entitled to receive $8,000 and the 
question becomes, how large is the sum of dollars for which 
the bill must be drawn to make it worth $8,000 to the 
banker as purchaser. The answer is $8206.66. 

Interest and commission are the factors in the computa- 
tion. The banker pays dollars in advance and awaits the 
return draft for dollars. In this class of operations 6% 
is the customary rate of interest charged (without regard 
to the current money market) for the period expected to 
elapse before the return draft will arrive. The charge for 
commission we may assume to be 34 of 1%. 

The computation takes the following form: 

Draft on Rio at 90 days' sight. 

Banker's buying price for the bill $8,000.00 

Banker's interest charge on this for 140 days at 6% 186.66 

Commission 20.00 

Vi of 1% of $8,000 = $20. 

Total required return $8,206.66 

Thus the bill will have to be drawn for $8206.66, and the 
4 Assuming of course that the bill is honored. 



DEALINGS OF A MORE INVOLVED CHARACTER 283 

Brazilian drawee will have to pay a sufficient sum of niilreis 
to purchase a sight draft on New York for this number 
of dollars. The importer will be able to take possession 
of the goods on their arrival because in the case of exports 
to South America custom requires the instructions, "docu- 
ments for acceptance." Prepayment of the draft with a 
rebate of interest is thus unnecessary. 

The banker's account with this operation will stand as 
follows : 

Outlay $8,000.00 

Return, after 140 days 8,206.66 

Excess of return 206.66 

This consists of 

Commission 20.00 

Interest on $8,000 for .140 days at 
6% p.a 186.66 

Total 206.66 

In the preceding calculation it has been assumed that 
the banker is willing to purchase the exporter's bill on the 
basis of 6% interest rate, that is to purchase it at a price 
which yields him 6% interest on his advance for the as- 
sumed term of the advance. If, however, the 6% rate 
quoted is a discount rate, as is sometimes the case, the 
bill as drawn will not sell for quite the full $8,000 due 
the drawer, but will fetch a price computed as follows : 

Future sum, or returns from the bill, 140 days deferred $8,206.66 

140 days' discount on this sum at 6% per annum 191.49 

( 14 %oo of 6% of $8,206.66 = $191.49) 

Gross price of bill 8,015.17 

Commission due banker 20.00 

Net price received by drawer $7,995.17 



284 FOREIGN EXCHANGE 

To avoid the loss of $4.83 hero entailed, the exporter may 
draw the bill for a sufficient sum of dollars to make il 
yield $8,000 when discounted at 6%. The method of figur- 
ing the amount for which he must draw in this case, is 
shown beneath. 

14 %co of 6%, or the percentage of discount for 140 days = 2 1 ,£% 
The price of the hill will therefore be 100% — 2%% of 

the face value or amount drawn for, or 97%% 

Since the price of the bill including commission is to be 

$8,020, $8,020 must be 97%% of the amount drawn 

for. 
The amount drawn for must therefore be $8,211.60 

(Divide $8,020 by 97%% to find 1% and multiply 
by 100) 
This is the amount, of which 97%% is just $8,020.00. To com- 
plete the account : 

Discounted present price of the bill $8,020.00 

Commission paid banker 20.00 

Net cash proceeds from sale of bill $8,000.00 5 

§ 71. The bill on a foreign country in money of a third 
country. — 

Sub-sec. 1. A Third Type of Draft of the Importer. 
— Thus far we have familiarized ourselves with two classes 
of drafts on importers, distinguishing them in accordance 
with the kind of money in which they are drawn, namely 
drafts. 

5 Compare § 14 on the distinction between an interest and a dis- 
count rate. The computation as given assumes that the banker will 
collect his commission of $20 in advance (just as, by exacting dis- 
count, he virtually takes interest "in advance"). If it is desired to 
calculate the amount to be drawn for on the assumption that the 
banker takes his commission 140 days later or from the returns, it 
will be necessary to find the amount which being discounted for 140 
days at 6% per annum will yield $8,000 present cash, and to add to 
this $20. The answer would be $8,211.12. 



DEALINGS OP A MORE INVOLVED CHARACTER 285 

(1) for the money of the importer's country, and 

(2) for the money of the exporter's country. 
It remains to examine the draft 

(3) for the money of a third country. 

Bills on the Far East and on the various countries of 
Latin America drawn in pounds sterling, but originating 
in some country distinct from England, stand forth as 
the chief practical examples of this form of exchange. If 
a bill is drawn for money of a third country, it is almost 
certain to be for money of England, whether or not this 
will always continue the case. 

Let us suppose Smith of New York ships hardware to 
Lopez of Buenos Aires, on the understanding that as ex- 
porter he is to receive $7,200 in money of the United States 
on the date of shipment, to be obtained by the sale of his 
bill on Lopez drawn for a sum of pounds sterling. The 
face value in sterling will then need to be high enough 
to enable the sale of the bill for $7,200 in New York on the 
date when it is drawn. Whereas a dollar draft on Buenos 
Aires would be dischargeable by the purchase and return of 
a bill on New York for dollars, a sterling draft on the 
same city is paid off by the purchase and return (either 
to New York or to London on instructions from New York) 
of a bill on London for pounds. The ' ' return ' ' bill, as we 
shall continue to call it, will be according to custom at sight 
when it is on New York, but at 90 days' sight when it is on 
London, not that return bills G of other lengths of life are 
out of the question. 7 

6 As stated on an earlier page, we have now (1919) in the 
United States practically discontinued drawing this type of bill. The 
war-time fluctuations of the value of the pound sterling in terms 
of the American dollar, is of course the explanation. Some of our 
bankers believe this instrument will never come back into our trade 
even when the pound sterling of actual currency becomes a gold unit 
again. Cf. Addendum infra on dollar exchange. 

7 Drafts from the United States on Australasia for sterling have 



286 FOREIGN EXCHANGE 

The draft of Smith on Lopez will take on some form 
similar to the following: 

£1,541 5s. Od. New York, N. Y., July 1st, 1913. 

Ninety days after sight of this first of exchange (second un- 
paid) pay to the order of the South American Banking Corpora- 
tion, One Thousand Five Hundred and Forty-one Pounds and 
Five Shillings, payable in legal currency at the hank's drawing 
rate on day of payment for ninety days' sight bills on London. 
Value received per S.S. Southern Star. 

William N. Smith. 
To Alfredo Lopez, 

Calle Corrientes, 1550. 

Buenos Aires, Rep. Arg. 

Sub-Sec. 2. The Three National Currencies In- 
volved. — Although a certain number of dollars are due 
and will actually be received by the drawer of this draft, 
and pesos will be the money actually paid over by the 
drawee to discharge it, the only sum specified in the instru- 
ment is a number of pounds sterling. Three distinct na- 
tional currencies are then involved. As for the relations 
among them: the number of dollars due the exporter (in 
conjunction with a rate of exchange) determines the amount 
of sterling drawn for, and the latter in turn (in conjunc- 
tion with another rate of exchange) determines the num- 
ber of pesos required to pay off the draft. 

Assume that the bill set forth above is sold on July 
1st to the New York office of the South American Bank- 
ing Corporation for $7,200. The receipt of this sum pays 
the exporter for his goods. The New York office of the 
bank named now forwards the instrument to the branch at 
Buenos Aires, whose province it will be to present the same 
for acceptance and subsequently for payment. Ninety 

been customarily drawn at sight and have also called for the return 
sterling bill at sight. 



DEALINGS OF A MORE INVOLVED CHARACTER 287 

days after the date of acceptance (there being no days of 
grace in Latin- American countries) the drawee will be 
obligated to pay over a sufficient sum of pesos to buy at the 
selling (or "drawing") rate then being quoted by the 
South American Banking Corporation in Buenos Aires, a 
90 days ' sight draft on London for £1,541 5s. In substance, 
he will purchase a draft drawn by this bank on a London 
bank, but will turn it back to this institution as holder of 
his acceptance and in discharge of the same. If the rate 
for this draft proves to be 48d. (namely, 48d. of sterling 
to one peso) it will cost the importer 7706.25 pesos, sig- 
nifying pesos of gold. There is also in the Argentine a 
national legal tender paper money. Assuming this to be 
at its official redemption value in gold (one peso of paper 
to 4 }ioo of a peso gold), 17493.19 pesos of paper would be 
required. 

Sub-Sec. 3. The Disposal of the Return Draft. — 
The return draft now belongs to the New York office of the 
South American Banking Corporation, inasmuch as this 
office paid for the original bill drawn by the exporter. It 
must be admitted that this draft can under certain circum- 
stances be eliminated, to be replaced by mere book entries 
at the branches supplemented by interchange of advices, 
but we had better complete our illustration on the assump- 
tion that it is actually drawn and mailed, as it would be 
were there, for instance, three independent banks at the 
three main points involved. The best disposition of this 
instrument the New York office can order is its remittance 
directly to London for its account or credit with some bank- 
ing establishment there. This saves the time that would 
be lost by having it go to London by way of Now York, 
and will enable its acceptance and consequently its maturity 
to occur at the earliest possible dates. 8 The New York 

s If a South American banker who holds a loii^' sterling bill for a 
New York bank, is requested to forward the instrument directly to 



FOREIGN EXCHANGE 

banker will ordinarily haw the draft discounted in London 

On its arrival, and may, about six days earlier, sell sight 
sterling in New York againsl the proceeds of the same as 
cover. In analyzing the whole operation before us, we 
assume this sale to be made, for it is solely on this assump- 
tion that we can compute the bank's gain. "When it buys 
the exporter's original draft, it makes an outlay of dollars 
to obtain a deferred return of sterling in London. The 
dollar worth of this sterling must always be counted as the 
sum it will fetch when sold out as promptly as possible 
as exchange on the New York market. By means of such 
a sale the New York banker finally recovers the dollar 
fund first laid out, normalh/ with a sufficient increment to 
cover interest and a commission or profit. 

Sub-Sec. 4. The Risks of Exchange and Their Inci- 
dence. — The owner of the original exporter's draft (the 
bank in New York, if it buys the draft, the exporter him- 
self, if the bank receives it merely for collection) takes a 
risk of exchange. For at the time this instrument is drawn 
the outcome in dollars from the sterling exchange return- 
able from Buenos Aires cannot be precisely foretold. The 
chance thus taken is called a "risk of exchange" because 
the outcome will depend on a rate of exchange, namely the 
rate for sterling in New York on the day of the sale of 
the sight sterling draft in that city against the arrival of 

London, he makes it payable to and mails it to the New York bank's 
London correspondent, accompanied by the advice that it is for the 
account of the New York bank. The bill cannot be drawn or indorsed 
payable to the New York banker, because it would then require 
his indorsement, whereas it is not to go through his hands. The 
London correspondent will indorse it and dispose of it according to 
instructions from New York. This will make the London correspon- 
dent liable as an indorser. It is understood that if this liability 
should ever cost it anything, it would look to the New York banker 
for reimbursement since it indorsed for his sake and as his virtual 
agent. 



DEALINGS OF A MORE INVOLVED CHARACTER 289 

the return bill in London. (The outcome will, under the 
conditions of our illustration, depend also in part upon the 
money rate ruling in London on the day of the discount 
of the return bill in that city. If the latter could with 
advantage be mailed from Buenos Aires to New York to be 
sold as long sterling at that point, the outcome would then, 
of course, depend merely upon the long sterling rate pre- 
vailing then and there, but this would in turn be governed 
in part by the London discount rate.) 

But the risk of exchange taken by the exporter or banker 
of New York is merely one as to the rates for sterling in 
New York. Neither will have concern with any fluctuations 
which may take place in the rate for sterling in Argentina. 
The more hazardous risk of exchange resident in these 
fluctuations, is carried solely by the importer in Argentina. 

When after the inception of the present great war, rates 
for sterling exchange fell away in New York, outstanding 
sterling drafts on South America began to bring in very 
disappointing returns in dollars. The considerable period 
to run between the inception and the settlement of opera- 
tions naturally increased the difficulty, and there were 
forced upon either the drawers or the bankers, as the case 
might be, certain most annoying losses. (A banker pur- 
chasing such a bill may make a special contract forcing 
the risk of exchange back onto the drawer or exporter.) 
Prior to the war the risk of exchange involved in the 
handling of these bills was not excessive. Also practical 
compensation for carrying it was secured in a somewhat 
hidden manner by means of a rather liberal method of 
figuring the amount of sterling to be drawn for. 

Shb-Sec. 5. Computing the Sterling Pace Value. — 
To determine the amount of sterling for which he must 
draw, it would be natural to suppose the exporter would 
ascertain from the bank its buying rate in dollars per 
pound for such a draft as he proposed to offer. Prom 



290 FOREIGN EXCHANGE 

this he might compute the pounds of face value necessary 
to yield the number of dollars due him. Tims should 
the banker's rate be $4.67' i per pound, the draft would 
have to be drawn for £1540.93 (or £1,540 18s. 7d.) in order 
to fetch $7,200. Under this plan, the exporter would 
in effect make the following statement to the importer: 
"I have this day drawn upon you at 90 days' sight a bill 
which you can discharge at its maturity by the purchase of 
a 90 days' sight draft on London for £1,540 18s. 7d. I am 
entitled to receive $7,200 to-day and since the banker at 
this place offers $4.6714 per pound for my bill I must neces- 
sarily draw for the number of pounds above mentioned. 
7,200 -=- 4.6725 = £1540.93. ' ' 

But this, the simplest method of computing sterling face 
value that could be followed, is not the one that has been 
actually customary. Before the present time banks of Brit- 
ish origin have handled most of the bills drawn in this 
country upon South America, and it has been the practice 
in dealing with these banks for our exporter to add in- 
terest and banker's commission to the dollars that are due 
him as of the date of shipment, and convert the total into 
sterling at a fixed and customary rate depending upon the 
term or usance of the return sterling draft. "With the 
latter at 90 days' sight, the regular rate of conversion was 
(prior to the present war) $4.80 per pound: with it at 
sight, this rate was $4.85, but these particular rates have 
of course all gone by the board since the outbreak of the 
war. 9 At the end of 1918, a conversion rate of 4.75 was 
being employed in certain trades for return sterling drafts 
drawn at sight. 

Smith's bill on Lopez, as given at the beginning of this 
section, is drawn for £1,541 5s. Od. This sum is computed 
according to what has just been explained as the customary 

9 The rate of conversion has been fixed or invariable except for mo- 
mentous alterations of exchange conditions. 



DEALINGS OF A MORE INVOLVED CHARACTER 291 

method. To the number of dollars due Smith on the day 
of shipment, namely $7,200, is added interest at 6% per 
annum for 150 days, and banker's commission at Vi of 1%. 
The total thus obtained, still a sum of dollars, is "con- 
verted" (i.e., translated) into sterling at the rate of $4.80 
to the pound. The amount of sterling so computed, is 
the face value of Smith's draft on Lopez, and is the face 
value of the 90 days' banker's draft on London which Lopez 
is required to provide for return to Smith or his successor 
in ownership of the original draft. Smith's computation 
takes the form shown beneath : 

Invoice cost of goods including all charges due ex- 
porter. Due in New York on July 1st $7,200.00 

Interest on the above for 150 days at 6% per annum. . 180.00 
6% per annum is the rate of interest customary in 

settlements of this kind. 
The period of 150 days consists in the following 
allowances for elapsed time: 

a. Mail to Buenos Aires 30 days 

b. Term from acceptances till payment of 

exporter's draft 90 days 

c. Return mail to New York 30 days 

Total 150 days 

Banker's commission for handling draft, at \i% 18.00 

Total dollar return required in New York after the 

expiry of 150 days $7,398.00 

Number of pounds face value of return sterling bill 

therefore required, at rate £1 = $4.80 £1,54B4 

I.e., 7,398 -4- 4.80 = 1,514%. 

The assumptions underlying this calculation are (1) that 
150 days will elapse between the drawing of the original 
draft and the realization or recovery of dollars in New 
York from the return sterling bill, and (2) that the amount 



292 FOREIGN EXCHANGE 

realized from each pound of this return bill will be $4.80. 
It happens, as already explained, that if Smith's original 
draft is sold to a banker the return bill will not in fact 
come to New York, but will be forwarded from Buenos 
Aires direct to London, for the purpose of saving time ; 
but to make as clear as possible the customary computation, 
with which we are now concerned, let us suppose for the 
moment that the return bill is sent to New York. If upon 
its arrival it could be sold in the exchange market for 
$4.80 per pound, it would yield just $7,398. Thus it would 
be the equivalent of a New York check for this sum, and 
this sum includes the $7,200 due as of the date of July 
1st, plus $180 for interest and $18 for banker's commission. 
Sub-Sec. 6. Comparison With a More Familiar 
Method of Settlement. — It will be useful to compare this 
method of settlement with a simpler and more familiar 
but essentially similar one. A buyer in Denver of goods 
from New Orleans might make payment to the shipper 
by remitting a banker's sight draft on New York. The 
shipper would "cash" this in New Orleans. In other 
words, he would sell this New York exchange for money of 
New Orleans. Now the case is not so dissimilar if an im- 
porter in Buenos Aires makes payment to the exporter at 
New York by remitting a banker's draft on London, to be 
sold for local money of New York. It is true certain com- 
plications in detail appear in the foreign transaction. The 
New York exporter draws on the Argentine merchant a 
draft which specifically calls for the return sterling bill. 
The shipper at New Orleans may not draw on the Denver 
buyer at all, being content merely to render him a state- 
ment of account and expect him to make a remittance in 
some suitable form of domestic exchange. But if the do- 
mestic shipper did draw, the draft would in all probability 
be one for dollars merely and not one for a specified kind 
of return exchange. That is to say, a draft in the special 



DEALINGS OF A MORE INVOLVED CHARACTER 293 

form of one payable in exchange or of one calling for a 
return bill of exchange of a stipulated character, is ex- 
ceedingly uncommon in domestic practice. Under our 
past custom the domestic shipper would not draw a long- 
term draft, but rather one at sight or perhaps three days' 
sight, while the exporter to foreign parts will as a rule 
draw a long-term bill. However, it is very probable that 
the long-term draft on the domestic mercantile debtor is 
about to play a role of increasing significance in our internal 
commerce, this development being especially favored by 
the recent important changes in our banking system. In 
the particular foreign illustration before us, the return, 
bill remitted to the exporter (or to the banker who suc- 
ceeds to him or to this banker's correspondent in London, 
as the case may be), is itself a long bill. Such a form of 
remittance finds no counterpart in our purely domestic 
commerce to-day. Comparison might be carried further, 
but enough has been said to show that our settlements by 
sterling drafts on South America are not so complex as 
perhaps the}' seemed at first. "When our exporter converts 
or translates his invoice puis interest and banker's com- 
mission, into sterling at the rate of £1 = $4.80, it is merely 
tantamount to counting £1 of 90 days' sight draft on Lon- 
don as the equivalent of a New York check for $4.80, on the 
theory that $4.80 can be realized from the said £1 of ex- 
change. 

Sub-Sec. 7. The Outcome to the Purchasing Banker. 
— Let us assume that Smith's personal standing being sat- 
isfactory, he is able to sell his bill to the banker in New 
York for $7,200, the amount due Smith as exporter if he 
receives paj'ment on the day of shipment. How will the 
banker fare as purchaser? Suppose first, for the sake of 
simplicity, that the return sterling draft is ordered sent 
to New York, and that 150 days elapse before its arrival, 
and that it is then sold in New York for $4.80 per pound. 



294 KOKKKiX KXCIIAXCK 

The banker's account with the operation would assume 
this form : 

Outlay for the bill $7,200.00 

Return from the same, 150 days later 7,398.00 

Procured by the sale of £1,541% of 90 days sterling 
at $4.80 per pound. 

Excess of return over outlay 198.00 

Being made up of 

Commission at Vi% on $7,200 $ 18.00 

Interest on $7,200 for 150 days at 6% 

per annum 180.00 



198.00 



Here the bank makes its commission and interest at 6% 
per annum. 

But the banker can put forward the recovery of dollars 
by about a week (in the instance before us) by having the 
return sterling bill forwarded direct from Buenos Aires 
to his correspondent in London. This alone will make the 
operation yield a better interest rate than the one shown 
in the foregoing statement. Again, the banker may be 
able to realize more than $4.80 from each pound of the 
return draft. If we assume an extremely favorable out- 
come, we might be able to make up a statement somewhat 
on the lines of the following: 

Outlay to purchase exporter's bill on July 1st $7,200.00 

Actual time elapsed before recovery of dollars 

in New York 134 days 

The original bill reaches Buenos Aires 25 days 
after July 1st, is paid 90 days later, and the long 
sterling bill sent directly to London reached there 
25 days later yet. Total time to London, 140 days. 

The return sterling draft arrives in London, there- 
fore, on November 18th. It is immediately dis- 
counted there on orders given in advance. This 



DEALINGS OF A MORE INVOLVED CHARACTER 295 

enables a sale of sight bills on London in New York 
6 days earlier, on November 12th. These are for 
the amount of cash sterling received from the dis- 
count. 

Total elapsed time till recovery of dollars, 134 days. 
Dollars recovered per pound of draft 4.8330 

If the London discount rate is 3% and the sight 
sterling rate in New York on November 12th is 
4.87, the banker will be able to realize about $4.8330 
for each pound of draft discounted in London. (Cf. 
§ 64 for method of computing this.) 

Total dollars actually recovered by banker $7,448.86 

4.8330 X 1541% (pounds face value of 
draft) =7448.86 

Gain by banker $ 228.86 

Composed of the following elements: 

Commission at %% $ 18.00 

Interest at $7,200 for 134 days at 6% 158.60 

Gain in excess of 6% interest 52.26 

Total 288.86 

Stated in another way, the banker makes interest at 8% 
per annum in addition to his commission, but this is vir- 
tually the most favorable case possible. Mails may be slow. 
Acceptance may be delayed (especially in South America) 
till the merchandise arrives, perhaps by a slow steamer. 
The customary assumptions as to the time to elapse and 
the dollar value of the return sterling draft, must be suffi- 
ciently liberal to provide against losses in the general run 
of cases, though they are doubtless hardly liberal enough 
to afford full protection in a few of the worst cases actually 
experienced. 10 

io As already stated, heavy losses were experienced by the buyers 
of these bills at the time of the great fall of sterling in New York 
not long after the beginning of the great war. 



296 FOKKKiN KXC'HANOK 

Sub-Sec. 8. Special Contracts With Respect to the 
RlSK OF EXCHANGE. — The exporter, in the illustration be- 
fore us, calculated the sterling face value of his draft on 
the assumption that eaeh pound drawn for would in the 
end yield +4.80. The banker paid $7,200 for the draft on 
the same assumption. Sometimes the banker requires the 
exporter to make a special contract promising to indem- 
nify him, the banker, for any loss sustained through his 
inability in fact to realize $4.80 per pound. This contract 
has the effect of throwing upon the exporter any unfavor- 
able risk of exchange involved in the purchase of his draft 
(see prior discussion). On the other hand, if the risk 
turns out favorably, that is, if each pound yields more than 
$4.80, the gain will belong to the banker unless the special 
contract provides that it go to the exporter. It would be 
possible to have a special agreement providing for the com- 
pensation of the banker for loss because of a failure of the 
returns to arrive within the period of 150 days assumed, but 
if the purchase of the exporter's draft by the banker should 
be cluttered with so much incidental protection, it would 
virtually come to a taking of the draft for collection coupled 
with a 100% advance against it as collateral. 

Sub-Sec. 9. The Importer's Preference for the Cus- 
tomary Reckoning. — The actual elapsed time and actual 
dollar yield of the return draft are variables depending 
upon the circumstances of each individual case. They can- 
not be determined precisely in advance, and under the cus- 
tomary method there is no attempt to make a special esti- 
mate of these factors for each separate case. It is very 
convenient to assume fixed figures which are to be used in 
all ordinary instances. If special figures were to be adopted 
for each separate export, the importer would either have 
to be informed of them and given an opportunity to concur 
in them, which would be impracticable by mail, or he would 
have to submit to their determination by the exporter or 



DEALINGS OF A MORE INVOLVED CHARACTER 297 

the banker, neither of whom have interests in the matter 
identical with his. So, as we are given to understand, he 
prefers to have the dollar charges against him converted 
or translated into sterling at a customary rate and to have 
the interest figured at a fixed rate under the assumption 
of a fixed period for completion of the settlement. This 
enables him to calculate in advance with perfect definite- 
ness the amount of sterling he will be expected to provide 
against a given dollar cost for goods, and leaves him with 
but one uncertain factor, namely the rate for sterling in his 
own city at the time when he comes to make payment. 
The problem of establishing the customary figures is one of 
making them sufficiently liberal from the point of view of 
the exporter and the banker who buys his draft, without 
making them unfair to the importer. If, for example, 
speaking of ante-bellum conditions, it were to be assumed 
in the case before us that 200 days would be the elapsed 
time and that $4.76 would be the dollar yield of each pound 
of the return draft, there would be an increased margin 
of safety for the benefit of the drawer and purchasing 
banker, but the assumptions would evidently be unfair to 
the importer. The assumptions that had in fact become cus- 
tomary or standardized before the war were known to the 
importers of South America and were acquiesced in by 
them, and according to Mr. Fred C. Harding, of the 
Anglo South American Bank, Ltd., these merchants did 
not take kindly to the adoption by our exporters of 
other methods of computation, even if they turned out 
quite as favorably to the importer as the customary. 11 

Sub-Sec. 10. Purchasing the Draft on the Basis op a 
Discount Rate. — It has been assumed up to this point that 
the banker buys the exporter's draft on the basis of a 6% 
interest rate, or at a price calculated to yield him 6% 

n See his article on the Financing of Exports in the "Exporters' 
Encyclopedia" for 1014, pp. 101-2. 



FOREIGN EXCHANGE 

interest. If, however, he insists on making the 6% a 
discount rate, the price he will pay for the instrument 
will be somewhat reduced. Should the exporter desire to 
avoid the loss that will be occasioned by this change, a loss 
of something over $6 in the case in hand, he will have 
to increase the amount for which he draws by approximately 
the sterling equivalent of this sum. In a ease of discount, 
the exact computation should take the following form. (It 
will be assumed that the banker will take his commission 
"in advance," just as by taking discount he takes "interest 
in advance.") 

Dollars due exporter $7,200.00 

Commission of banker, M% on the above 18.00 

Necessary present price of bill inclusive of commission 7,218.00 
Dollar returns deferred 150 days which will discount 

for this sum 7,403.08 

Found as follows: 

150 days' discount at 6% per annum = discount of 2%% 
2 1 /&% of the assumed future return in dollars being 
taken out of same as discount, the present dol- 
lars =97%% of the future sum 
Therefore $7,218 = 97%% of future dollars. 
If $m% = $7,218, 100% = 10 % 7 .5 X 7 > 218 = 7,403.08 

$7,403.08 converted to sterling at rate of 4.80 £1,542.31 

Face value of the draft, £1,542.31 (£1,542. 6s. 2d.). 

The accompanying statement to the importer might be made 
up as shown below. 

Amount due exporter at date of shipment $7,200.00 

Commission to banker, at M% 18.00 

Discount charged by banker 185.08 12 



$7,403.08 
The above converted to pounds at rate, $4.80= . . .£1,542 6s. 2d. 



12 Instead of $180.00 interest as shown in computation on p. 291. 



DEALINGS OF A MORE INVOLVED CHARACTER 299 

Sub-Sec. 11. The Reason for Sterling Drafts on Out- 
lying Countries. — Since drafts from the United States on 
outlying countries for dollars are simpler and involve one 
less risk of exchange than drafts for sterling, the question 
arises as to wli3 r the latter alone have been customary until 
very recent times. The answer is found in the first in- 
stance in the fact that prior to the great war there was in 
general no regular or established market for New York ex- 
change in the trade centers of these outlying countries. 
Therefore the importers located at these points were un- 
willing to be drawn upon in a manner obligating them to 
purchase and return New York or dollar drafts. They 
were, however, able and willing to buy sterling bills for re- 
mittance to this country or to London for its account. The 
established markets for sterling exchange which made this 
feasible, were the products of the large and long continued 
direct trade of the British with these outlying countries and 
of the extensive banking business conducted by British con- 
trolled capital in them. Thus previous to 1914, bills drawn 
in the United States on South American countries, South 
Africa, India, Australasia, and the Orient, were usually 
drawn in sterling. 13 Since 1914 the American practice of 
drawing upon non-English countries for sterling has been 
virtually abandoned. Not long after the outbreak of the 
war, rates for sterling exchange fell away in New York in a 
manner quite without precedent. They remained uncertain 
until the middle of January, 1916. From that time until 

18 In cases where the importers in these countries provide our 
exporters with sterling letters of credit, the drafts of the exporters 
are drawn direct upon London banks. These are, of course, sterling 
drafts, but are not the type of drafts of which we are now speaking. 
Our exporters would always prefer to have sterling letters of credit 
provided for them rather than to draw upon the importers them- 
selves, even in sterling. The reason why the use of the letter of 
credit is not universal is primarily because of its expensiveness 
to the importers. 



300 FOREIGN EXCHANGE 

.March 20, 1919, they possessed an extraordinary stability, 
the cable rate having been "pegged" at practically 4.76. 
During the period of the instability of sterling in our mar- 
kit, the draft on outlying countries for sterling returns 
became from our point of view anything but a suitable 
method of settlement. During the same period our trade 
with these countries gained in relative importance, some 
moderate beginnings in the establishment of American 
branch banks in foreign parts took place, 14 something of a 
market for exchange on the United States began to develop 
here and there, and in the case of exports to South America 
and the Orient drafts for dollars, or for return drafts on 
this country, began to make their appearance. Drawing 
for dollars upon British dominions such as Australasia and 
South Africa, has not however become the practice. 15 

Sub-Sec. 12. Concerning the Use of a Long-Term Re- 
turn Draft. — Although in some trades return sterling bills 
at sight predominate, and in our trade with Latin America 
such bills were to be found, in the latter trade return ster- 
ling drafts at 90 days' sight have been commonest under 
normal conditions. The question occurs as to what difference 
it makes whether such drafts are at this long usage or are 
at sight. It makes in normal times no great difference to 
the exporter or to the bank in the United States which buys 
his bill, because the amount drawn for in either case is 
calculated to yield a predetermined sum of dollars in New 
York, a certain number of days after shipment (as 150 
days 16 ), the number of days being the same whether the 

i* One American institution, the International Banking Corpora- 
tion, had, however, established branches in many of the outlying 
countries prior to this time. 

is This is explained by one banker as being due, at least in part, to 
the determined opposition of the local British banks to any such 
development. 

i« That is, 150 days in case of shipments to Argentina, and other 
longer or shorter periods in cases of shipments to other countries. 



DEALINGS OF A MORE INVOLVED CHARACTER 301 

return draft is at sight or at usance. If a long bill is re- 
mitted it does not (under conditions when it can be and is 
discounted in London) yield a later return of dollars than 
a sight bill, but merely a reduced return in dollars per 
pound. There is, however, a little more speculation ( in- 
volved in drawing for the remittance of a long bill since in 
this case the actual dollar outcome will depend in part upon 
the position of the London discount rate, a variable, whereas 
the dollar value of a return bill at sight will have no direct 
dependence upon this factor. 17 

Considering now the interest of the importer in the ques- 
tion whether the return bill is to run for a term or to be at 
sight, he may benefit substantially from being drawn upon 
for a long-term return bill instead of for one at sight pro- 
vided he is able to make certain arrangements with the 
banker in his city who presents the exporter 's original draft 
to him for acceptance and subsequently for payment. In our 
illustration (page 286), the branch of the South American 
Banking Corporation at Buenos Aires presents the export- 
er's draft to Lopez, the importer and drawee. This draft it- 
self runs at 90 days' sight. It is so drawn that it can be dis- 
charged at its maturity by the purchase and return of a 90 
days ' sight banker 's bill on London. This bill is to be bought 
from the banker that holds the original or exporter's own 
bill. Thus on the date of maturity of the latter instrument 
Lopez is required to obtain from the South American Bank- 
ing Corporation at Buenos Aires its 90 days' sight bill on a 
London bank. The question is, will he have to make actual 
payment (in local money, or pesos, of course) for this bill 
at this time. The Banking Corporation will not have to 
provide cover in London until the maturity of the bill, 93 
days after its arrival in that city. If it procures this cover 

17 There is an indirect relation between the position of the London 
discount rate and the rate for sight drafts on London in New York. 
Compare § 144 below. 



302 FOREIGN EXCHANGE 

in Buenos Aires (the normal assumption) it may wait about 
90 or 93 days (depending upon steamer dates) before buy- 
ing it in, if it acquires sight drafts on London as the cover, 
and about 20 or more days longer if it buys in cable trans- 
fers for the purpose. Might not the bank then permit 
Lopez to postpone payment to it until the time arrives for 
tlie purchase of this cover? If Lopez has sufficient standing 
and is able to put up acceptable collateral, the bank may 
for a commission extend him this service. Without the 
service, Lopez will be required to pay over pesos on the 
date of maturity of the draft drawn on him: with it, the 
evil day may be put off. Suppose it is put off, and cables 
are bought in as cover on the latest day that is safe. Lopez 
will then not furnish actual local money (in real payment 
for the imported goods) until perhaps 115 days after the 
maturity of the draft on him ! The postponement will cost 
him something — in addition to the special commission he 
must pay — because the cable cover will cost more per pound 
than would the 90 days' sight bill if bought outright in 
the first place. This is in the nature of an interest cost. 
Will the postponement at this cost be a benefit to Lopez? 
Yes, because the cost will be substantially at a rate 
of interest equal to the London discount rate on banker's 
acceptances, perhaps 4% per annum, plus commission, 
while money is worth perhaps 8 or 10% per annum 
locally. So when the importer secures an extension of 
time in this manner, which is possible only when the re- 
turn bill runs for a term, he enjoys the privilege of virtu- 
ally borrowing monej^ at London rates and at half the inter- 
est cost of local rates. This is a complex subject, and it 
may well be that extended explanation ought to be offered, 
but the limitations of space forbid a more thorough dis- 
cussion. There is no grant of a bank credit to a merchant 
or letter of credit involved in this case, but the service 
given by the bank at Buenos Aires in this illustration is 



DEALINGS OF A MORE INVOLVED CHARACTER 303 

closely analogous to that given by the bank which writes 
a letter of credit for an importer and permits him to post- 
pone settlement until the time when cover for the long 
draft drawn under the letter must be bought in. 18 

Sub-Sec. 13. How London Indirectly Finances the 
Argentine Import. — Some London bank or acceptance 
house accepts the 90 da3 T s' bill originating in Buenos Aires, 
and the instrument is then discounted in the London money 
market. As the saying goes, the London money market 
makes an advance upon it of 93 days. The common sup- 
position is that this advance aids in financing the shipment 
of goods in connection with which the instrument that is 
discounted originated, and this supposition is correct. It 
is said that London helps finance international trade the 
world over. The case in hand is merely one example. 
Whenever New York develops a similar acceptance and dis- 
count business it will be engaged in extending a like service 
to the commerce of the world. To cut short a story that 
might be told at considerable length, the effect of the Lon- 
don discount in the instance of our present illustration is to 
enable Lopez to postpone payment in pesos for the goods 
which he has imported, about a quarter of a year longer 
than if he had been compelled to buy a return sight bill on 
England. And this postponement by Lopez does not make 
necessary any postponement of the day when the New York 
bank, which purchased the exporter's bill, is enabled to 
recover the dollars which it laid out. The latter institu- 
tion is able to realize upon the discounted long bill as early 
as it could upon one drawn at sight, while Lopez postpones 
payment a quarter of a year longer because of being per- 
mitted to return a 90 days' bill. 

Lopez is then in the case before us the ultimate benefi- 
ciary of the London money market's advance. Some money 

is Compare especially § 44. 



304 FOREIGN EXCHANGE 

dealer in London voluntarily pays out present money and 
waits a quarter of a year for its return — reaping a reward 
of discount or interest — and this enables Lopez in far-off 
Argentina to postpone payment for his imported goods a 
quarter of a year longer than otherwise. To finance or help 
finance any undertaking means to aid it by paying out 
present funds and awaiting a deferred return. So London 
helps finance the import into Argentina. If the Argentine 
bank should refuse to give an extension of time to Lopez 
until cover for the same bill must be bought in, it, instead 
of Lopez, would be the beneficiary of the advance. 19 If the 
New York bank or banking agency should invest in the long 
sterling return bill, it would assume the burden of the ad- 
vance instead of some dealer or bank in London. 

Sub-Sec. 14. Instructions as to Drawing on South 
America. — The following memorandum has been issued by 
the New York agency of a certain British Bank. 20 

Instructions to Drawers 

1. In drafts drawn for pounds sterling, the following clause 

should be inserted : "Payable at the drawing rate of the 

Bank for 90 days' bills on London at date of maturity." 

2. Drafts drawn in dollars on Argentina should contain the 
clause : "Payable in Argentine gold currency at bankers' rate for 
sight drafts on New York." 

3. Drafts drawn in dollars on Uruguay should read : "Payable 
in gold currency at bankers' rate for sight drafts on New York." 

4. Drafts drawn in dollars on Brazil should have the clause: 
"Payable in Brazilian currency at bankers' rate for sight drafts 
on New York." 

5. Shipping documents accompanying time drafts will in every 

is Considerations of space forbid making so complete an analysis 
of this problem that answers will be given to all the questions the 
inquiring reader might ask. 

20 Reproduced in "Foreign Credits," by Archibald J. Wolfe, De- 
partment of Commerce and Labor, Special Agents Series, No. 62, 
1913, pp. 399-400. 



DEALINGS OF A MORE INVOLVED CHARACTER 305 

case be delivered to drawees against acceptance. If payment is 
required upon delivery of documents, the draft must be made 
"at sight." 

6. All drafts, the acceptance or payment of which is refused, 
will be protested, unless special instructions to the contrary shall 
have been given. The bank will not undertake legal proceedings 
without being so instructed and secured as to the payment of all 
charges. 

7. Drawers in the United States having agents in any of the 
countries named are requested to notify the bank in writing as to 
what authority said agents hold in the matter of extension of time 
of payment of drafts, delivery of documents, etc. No instructions 
by telephone will be accepted. 

8. Drawers should authorize the bank to receive payment for 
time bills, if tendered before maturity, stating the rate of discount 
to be allowed for their account to drawees. 

9. Drafts with documents must be delivered at least two hours 
before the closing of the mail by the steamer taking the goods 
drawn for. 

Specimen of instructions to be attached to drafts 

[To be detached before presentation; strike out the instructions 

not required.] 
To (Ltd.) , its head office, branches, 

agencies, and correspondents. 

Instructions to be observed in reference to draft on 

£ 

Present on receipt. 

1. Present on arrival of vessels carrying the goods, or 

days after receipt, whichever event shall first happen. 

2. Deliver documents to drawee on [acceptance — pay- 
ment] of draft. 

3. In case of need refer to , of 

4. The "in case of need" is hereby fully empowered to instruct 
you as to treatment of draft, whether by variation of the terms 
thereof or otherwise, and disposal of shipping documents or 
realization of goods, or the variation or cancellation of any pre- 
ceding clause, and you arc hereby authorized to follow his direc- 



306 FOHKKiX EXCHANGE 

tiona as to dealing with the goods, documents, and draft in any 
manner whatsoever. 

5. Protest for nonaeceptanee. 

6. Protest for nonpayment. 

7. It is understood that the negotiating bank or its agents have 
the power to decline to surrender documents unless on payment. 

8. Rebate at the rate of percent per annum may be 

allowed if paid before maturity. 

(Signature) 

§ 72. The bill with an interest clause. — In domestic com- 
merce a price is often quoted as payable a specified period 
after the shipment or delivery of goods, without the addi- 
tion of interest for the delay in payment. But if there is 
coupled with such a quotation an offer of a reduction or 
concession for immediate payment, the price itself in reality 
contains an interest charge. Such offers are very common 
and usually take the form of a "discount for cash" at a 
designated rate per cent. If an article is priced at $50 
"terms 60 days, discount for cash 2%," a buyer that takes 
the 60 days time pays interest at the rate of more than 
12% per annum. For should he make immediate payment 
the article would cost him $49 instead of $50, and in effect 
he pays $1 of interest to postpone by 60 days the delivery of 
$49. This is interest at the rate of 2.04% for one-sixth of 
a year, or at the rate of approximately 12H% per annum. 
In practice discounts for cash usually represent surprisingly 
high rates of interest. Except in the retail trade, or trade 
with ultimate consumers, the real price for cash is gener- 
ally lower than the price quoted for payment on time, and 
there is thus present in the latter a definite charge for in- 
terest. 

In foreign trade — especially in the export trade of the 
United States — the quotation of a price payable after a 
time coupled with an offer of a discount for cash is much 
less common than in internal trade. An interest charge 



DEALINGS OF A MORE INVOLVED CHARACTER 307 

for delay in payment is not however forgotten. It is merely 
not so frequently registered in the precise form of a "dis- 
count for cash." The exporter will necessarily have his 
conditions regarding the time of payment, and a delay in 
payment by the importer will in one way or another be 
made to cost him interest. 

In some cases the greater the delay the higher will be the 
price quoted for the goods. Thus in the export trade from 
the United States to England our merchants are often will- 
ing to quote prices in terms of sterling, the money of the 
importing country, and to draw a bill having a face value 
equal to the price. The longer the term of this bill the 
greater the delay in payment permitted to the importer. 
If the instrument is to be drawn at 90 days' sight the price 
will be higher than if it is to be drawn at 60 days' sight or at 
sight. A practically identical result is reached in the same 
trade if the price is quoted in dollars, the money of the ex- 
porter's country. Assuming as before that the exporter 
draws to obtain payment, he will draw a bill for a sufficient 
sum of sterling to sell for the required number of dollars. 
If the bill is at 90 days' sight he will have to draw for a 
larger sum of pounds than if it is at 60 days' sight or at 
sight, because the longer the term of the bill the lower the 
rate it will fetch in our exchange market, and the greater 
its face value will have to be. Thus the longer the importer 
postpones payment, the greater the amount of his home 
currency he will have to give up, and thus delay costs him 
virtual interest even if he does not pay straight loan or 
contract interest. 

In some cases an express interest charge will be added to 
the price or "invoice cost" of the goods before the exporter's 
draft is drawn. This procedure is most suitable where the 
draft on the importer is drawn for some kind of money 
other than the money of the importing country, as in the 
instances of the drafts on Brazil and the Argentine, in dol- 



308 FOREIGN EXCHANGE 

lars and pounds respectively, reviewed in the two preceding 
sections. 

We come now to a third plan of dealing with the interest 
charge. This is the method of introducing an interest 
clause into the bill on the importer. Substantially the same 
result is produced by this expedient as by adding interest 
to the invoice cost before making up the draft, but the two 
methods are distinct with respect to the externals or mere 
form. The reader will have observed that the drafts on 
Brazil and Argentina, considered heretofore, have no refer- 
ence within themselves to interest. As a matter of custom, 
the interest clause is commonest in drafts upon India and 
the Far East. It appears sometimes, however, in bills on 
Australasia and Latin America. 

The following is a specimen of a draft containing an in- 
terest clause, drawn in New York on India for pounds 
sterling. 

£1,000. New York, July 1, 1913. 

Sixty days after sight of this first of exchange (second unpaid) 
pay to the order of the Fiftieth National Bank the sum of One 
Thousand Pounds Sterling payable at the drawing rate of the 
Chartered Bank of India, Australia and China for demand drafts 
on London, with exchange and collection charges including inter- 
est at 6% per annum added thereto from date hereof to approxi- 
mate due date of arrival of the remittance in London. Value 
received. James P. Smith. 

To John Doe, 
Calcutta. 

It will be observed this is a draft dischargeable by the pur- 
chase and remittance of another draft or "return draft" as 
we have called it. That is, it is a draft payable in ex- 
change. This is the only form of draft which ever bears an 
interest clause. A simple bill of exchange, namely one 
drawn for a specified sum of the money local to the place 



DEALINGS OF A MORE INVOLVED CHARACTER 309 

where the bill is payable (the ordinary form), is never 
drawn with an interest clause, at least where commercial 
custom is known. It might seem reasonable on occasion to 
draw such a bill, for instance in this form: 90 days after 
date pay to the order of A. B. One Thousand Dollars with 
interest at the rate of 6% per annum. This bill would, 
however, merely call for $1,015 at maturity, and according 
to standard practice it would be drawn simply for the 
latter sum without a mention of interest. 

The specimen 60 days' draft on Calcutta for £1,000, 
given above, drawn in New York on July 1st, would be 
likely to yield returns in London about 110 days after this 
date. Assuming then that the parties in Calcutta fix upon 
the "approximate due date of arrival of the remittance in 
London" as November 10th, the drawee of the above draft 
would at its maturity have to provide a sight sterling bill 
not only for £1,000 but for this plus 110 days' interest at 
6%, making a total of £1,018 Is. 8d. Also he will have to 
make this bill cover any and all bankers' commissions, fig- 
ured in sterling. 

If then a New York banker purchases the original draft 
from the exporter on the date on which it is drawn, he buys 
a claim to receive £1,000 in London 110 days later, with 
interest on this sum for 110 days at 6%, the whole being 
net or commission free. We may assume that the banker 
will ordinarily take the bill at the buying rate then ruling 
in New York for merchants' sight bills on London. He 
has to wait much longer for actual returns in London than 
when he buys a sight bill on that city, but he receives com- 
pensation for this at the relatively high rate of 6%. 

If now the exporter can sell his draft at the prevailing 
rate for sight sterling, he draws for the number of pounds 
required at that rate to yield him his invoice, or the dollar 
value of the goods shipped. Thus if the rate is 4.84 (as- 
suming normal rather than war-time conditions), and if the 



310 FOREIGN EXCHANGE 

invoice happens to be just $4,840, he draws for £1,000. He 
adds no interest to the invoice, before drawing, because the 
interest clause introduced into the draft itself makes it an 
interest-bearing instrument. 

§ 73. The "colonial clause." — The colonial clause is a 
stipulation frequently appearing in bills on South Africa 
and Australasia. It reads, payable with exchange (British 
and colonial stamps added) at the current rate in London 
for negotiating bills on the colonies. It can properly be 
introduced only into bills (1) that are drawn upon British 
colonies and possessions in which the pound sterling circu- 
lates as a local money unit, and (2) that are drawn payable 
in these pounds of local currency. A bill drawn for pounds 
on Rio or Buenos Aires is payable, so far as pounds go, in 
pounds of London, that is, by a return draft on London. 
But a bill bearing the colonial clause, drawn let us say in 
New York upon Cape Town and for the sum of £100, is 
payable in the pounds sterling in circulation in the Union 
of South Africa (though, for reasons yet to appear, more 
than 100 such pounds would be required), and is not pay- 
able by pounds deliverable in London or by a return draft 
on London. A bill with the colonial clause is usually drawn 
upon a merchant and not upon a bank, though it can be 
drawn upon a bank for the account of a merchant when a 
special arrangement for this is made. South Africa and 
Australasia are the only large and important regions upon 
which bills with this clause are drawn. 

The phraseology of the clause leaves its meaning far from 
obvious. The parenthetical expression, "British and colo- 
nial stamps added," is designed simply to shift to the 
drawee any stamp taxes that may be levied upon the bill by 
the British or colonial governments. These words omitted, 
the stipulation reads: "payable with exchange at the cur- 
rent rate in London for negotiating bills on the colonies." 
A number of explanations now become necessary. At the 



DEALINGS OF A MORE INVOLVED CHARACTER 311 

outset, there is in fact no single rate in London "for nego- 
tiating bills on the colonies," but there are a number of 
rates differing according to the length of life of the bills 
and according to the colonies upon which they are drawn. 
When, however, the colonial clause is introduced into any 
given bill, the "current rate in London" means the par- 
ticular one of these several rates that is quoted in London 
for bills of the same term and domicile as the given bill. To 
illustrate, if the latter (whether created in New York or 
elsewhere) is drawn at 60 days' sight on South Africa, it 
will be payable at its maturity with "exchange" at the 
rate then being charged in London upon bills at 60 days' 
sight on South Africa. 

The buying rates in London for bills on the colonies are 
set by the conjoint action of the several great colonial banks 
that have branches in South Africa or Australasia and in 
London as well. In contrast with ordinary foreign ex- 
change quotations, these rates do not fluctuate daily and 
hourly but may remain quite unchanged for very consider- 
able periods, in this feature reminding one of the "posted 
rates" of New York. A rate between pounds sterling of 
England and pounds sterling of one of the colonies, bearing 
as it does a resemblance to a rate of domestic exchange, may 
readily be quoted (1) as a rate per cent, of discount or 
premium. But again it may appear (2) as a price in local 
English money of a pound or of 100 pounds of colonial 
money. In the London Economist's tables both forms ap- 
pear, as witness the following examples, taken by preference 
from an issue of that journal appearing shortly before the 
beginning of the great war. 

London on South Africa 

Buying Rates 

Sight V\r,% discount. 

30 days' sight 1 % discount. 



312 FOREIGN EXCHANGE 

Buying Rates 

60 days' sight 1% % discount. 

90 days' sight 2% % discount. 

120 days' sight 314 % discount. 

London on Australia 
Buying Selling 

Cable 100H 

98% Demand Par 

9814 30 days 

97% 60 days 

(From the Economist for June 27, 1914, page 1575.) 

There is no compelling reason why exchange on South 
Africa should be quoted one way and exchange on Australia 
the other. One must be content to say it is a matter of 
custom. The quotation of 60 days' sight bills on South 
Africa at 1%% discount means simply that the banks are 
paying for such bills £98% per £100 of face value. The 60 
da3's' buying rate on Australia means the banks are giving 
£97% for an ordinary 60 days' sight draft on Australia, it 
pays £97% cash down in London to receive £100 of Austra- 
lian money 63 days (including three days of grace) after 
the arrival and acceptance of the bill in that commonwealth. 
In other words, pounds (1) deliverable in Australia and 
(2) deferred this far in the future are at a discount of 214% 
when bought and paid for with pounds (1) in London (2) 
payable cash down. 

If we now suppose that the drawer in London of the 60 
days' bill on Australia for £100, adds to it a clause which 
will require the drawee to pay not only the face value but 
the face value plus a premium of 214%, and to pay also all 
stamp taxes, we shall have a close approximation to the 
colonial clause though not the exact thing itself. We might 
imagine the drawer explaining to the drawee the meaning 
and effect of this (the supposititious) clause, in the follow- 



DEALINGS OF A MORE INVOLVED CHARACTER 313 

ing words : "I am entitled to receive £100 in London to-day 
against goods just shipped you. Our understanding is that 
my bill on you is to be at 60 days' sight. If now I draw in 
the ordinary manner for £100, I will have to sell the bill at 
a discount of £2 T 4 and thus receive for it only £97%, saying 
nothing of the stamp taxes. Therefore I am adding a 
clause to the bill requiring you to pay £2 1 /4 extra, and the 
stamp taxes as well. I find that if I do this the banker in 
London will give me £100 for the bill. You pay enough 
extra to enable me to get £100 cash down and clear." If 
we throw this clause (still the supposititious one) into the 
phraseology most closely resembling that of the colonial 
clause itself, it would read: "payable with exchange 
(British and colonial stamps added) at the rate current on 
the date hereof 21 in London for negotiating bills on the 
colonies. ' ' This would mean payable with stamp taxes, and 
with "exchange" of £214, added to the face value. This is 
"exchange" at the rate current in London, namely, the rate 
of 2V±% discount. 

This introduces us to a meaning of the word exchange 
not heretofore encountered. For the term, as just used, 
signifies the discount in the local money of some place upon 
a bill payable in the same kind of money at a distant place. 
If a person in San Francisco having a right to $1,000 in 
New York sells a sight draft on the latter city for this sum 
and is able to get only $999.75 for it, he may call the dis- 
count of 25^ the "exchange" if he desires to, though the 
word will be used in a sense quite distinct from its other 
meanings. In a similar way the drawer in Loudon of the 
60 days' bill for £100 on Australia may speak of the dis- 
count upon it of £214 as exchange, and may communicate 
to the drawee the fact that he is to pay Z2M extra by telling 
him that he is to pay the bill "with exchange" at the rate 

21 But the colonial clause moans pai/ablc at the rate of exchange 
current on the date of payment. Sec text to follow. 



314 FOREIGN EXCHANGE 

eurrenl in London at tlic date of the bill for negotiating 
drafts on Australia. 

Returning now to the bill originating in New York, 
drawn at 60 days' sight on Cape Town for £100, we are 
prepared to understand the significance of the colonial 
clause which will be added to it. There is one point, how- 
ever, in which the colonial clause differs from the supposi- 
titious clause which we have been considering. "When the 
colonial clause states that the bill is payable with exchange 
at the rate "current" in London, etc., it means at the rate 
current in London on the date of payment of the bill in 
South Africa and not on the date of the drawing of the 
bill in New York or any other date. So the drawee of this 
bill will when he comes to discharge it, pay the £100 face 
value, and then the ' ' exchange ' ' equal to the discount ruling 
at this time in London upon ordinary 60 days' bills for £100 
on South Africa (this being in our illustration, £1 12s. 6d.), 
and finally the stamp taxes. The precise twist given to the 
word ' ' current ' ' in the colonial clause can only be explained 
by saying it is the custom. 

Assuming that on the date when the bill now before us 
falls due the table of rates which we have already copied 
from the London Economist holds good, the total amount 
payable upon it will be computed as follows : 

Amount drawn for, or "face value" £100 

"Exchange at the rate current in London," 

etc., at 1%% 1 12s. 6d. 

Stamp taxes 

Colonial Is., English 6d Is. 6d. 



£101 14s. 



The English stamp tax of 6d. is added on the supposition 
that the bill goes through London and is negotiated or sold 
there on its way to South Africa. 



DEALINGS OF A MORE INVOLVED CHARACTER 315 

It remains now to make quite clear the reason for intro- 
ducing the colonial clause into the bills which bear it. The 
advantage is that it has the effect of making a bill worth its 
face value in pounds in London if offered for sale in that 
city while on its way to the colonies. Thus the bill above 
considered, although payable 60 days after sight in South 
Africa, will sell for a full £100 in London on arrival. 
(This assumes, of course, that the instrument has a credit 
rating justifying its purchase.) A further effect is that the 
bill with the colonial clause sells in New York as if it were a 
sight draft on London. If it sells for its face value in 
London on arrival, it is obviously the equivalent of a sight 
draft of the same face value on that city, and will fetch the 
same rate in New York as this sight draft. The convenience 
of the colonial clause to the New York exporter thus be- 
comes apparent. As the saying goes, he has but to convert 
his invoice into sterling at the rate in New York for sight 
bills on London and draw for the amount thus calculated, 
and this rule works no matter what the usance or length of 
term for which he is to draw (provided always he does not 
draw for a term beyond all customary limits and thus make 
the bill unsaleable). 

To illustrate: A of New York makes a shipment to B 
of Cape Town with the understanding that he is to draw at 
60 days' sight with the colonial clause added to the bill. 
There is due A on the day of shipment $12,000, the amount 
of his invoice. Sight sterling (i.e., London sterling) is say 
at 4.85. A converts the $12,000 to sterling at this rate, 
thus :— 12,000 -r- 4.85 = £2,474.23 or £2,474 4s. 7d. Draw- 
ing the bill with the colonial clause for the latter sum as its 
face value, he may sell it at $4.85 per pound and get 
$12,000. 

Even if the bill, being bought perhaps by the New York 
agency of a British-Colonial bank, for reasons of con- 
venience to this agency should not actually be sent through 



316 FOREIGN EXCHANGE 

London, it is still worth $4.85 per pound in New York. 
The question whether the bill is to go physically through 
London is a matter of indifference to the exporter. 

From this point forward attention will be directed to 
certain more technical aspects of the colonial clause. 

A bank in London will pay the full face value for a bill 
bearing this clause despite the fact that the instrument 
matures after a considerable period and is dischargeable in 
the pounds current in a distant land. The explanation is, 
as we have learned, that this clause compels the drawee to 
pay over and above the stated face value a certain premium, 
and as well the stamp taxes. This premium serves to coun- 
terbalance the discount that would be upon the bill in Lon- 
don if it bore no colonial clause. But the discerning reader 
has probably observed already that the premium is not the 
precise theoretical equivalent of the discount foregone by 
the banker. Thus, if an ordinary 60 days' sight bill on 
South Africa for £100 sells in London at a discount of £2, 
the addition of the colonial clause to it will require the 
drawee to pay a premium at maturity of £2, 22 and for this 
consideration the London banker pays the full £100 for the 
instrument. Therefore he states, as it were, that because 
he is willing to buy 100 deferred colonial pounds for £98 
of London cash, he is also willing to buy 102 pounds of the 
same character for £100 of London cash. In the first case 
he pays 98% in London pounds for the colonial pounds, 
while in the second he pays 98.04%. This little matter is 
however ignored in practice. 23 

Referring to another curiosity of the colonial clause, the 

22 Assuming that the discount in London is still £2 at the time 
of the maturity of the bill in South Africa. 

23 Stated in ultimate terms, in the first case the banker purchases 
on the basis of a 2% discount rate, while in the second he purchases 
on the basis of a 2% interest rate which makes his gain slightly 
less. Compare § 14. 



DEALINGS OF A MORE INVOLVED CHARACTER 31? 

fact that the premium payable on the bill is determined by 
the rate of discount, on a similar instrument, current in 
London at the date of maturity, instead of the date of crea- 
tion or first negotiation, means that at the time of purchase 
of the instrument the London or other British bank takes a 
speculation as to what the premium will be some two or 
three months later. But though this speculation undeni- 
ably exists in connection with any isolated or single bill, 
the speculation involved in the whole continuing business 
in these bills is practically ironed out or cancelled out, be- 
cause while in some periods the premiums may turn out less 
than the discount foregone (these being periods of decrease 
in the rates of discount in London on colonial bills), in 
other periods (equally numerous in the long run so far as 
we know) the premiums will turn out greater. 

Bills upon South Africa or Australasia originating in 
England do not customarily bear the colonial clause. But 
a substitution for the clause is in constant use by English 
drawers. Instead of enfacing the latter on their bills they 
simply add the "exchange" to their invoices, and reach the 
same result. Thus if £100 is due the English exporter, he 
adds the £2 for exchange to the invoice and (disregarding 
stamps) draws an ordinary bill for £102. 

When reselling drafts originating in this country and 
bearing the colonial clause, American bankers are likely to 
deal with colonial banks which have New York offices as well 
as London branches or main offices. In practice they are 
therefore able to obtain for a draft either a credit in London 
(on the arrival of the instrument) for its face value in 
pounds, or the dollar value of the same in New York at the 
prevailing sight rate on London. They may take whichever 
suits their convenience. Sometimes the colonial banks offer 
our bankers a slight premium for drafts bearing the colonial 
clause. 

The American bank indorses the bill to the colonial bank 



318 FOREIGN EXCHANGE 

without introducing the latter 's place of business into the 
indorsement, to the end that the instrument may become 
transferable to and be negotiated by any one of its branches. 
If the bill can be got to the drawee more quickly by mailing 
it direct rather than through London, the first of exchange 
will be forwarded directly to the branch of the colonial bank 
nearest the drawee, for the earliest possible presentment for 
acceptance, and the second of exchange will be mailed to the 
London or New York office of the colonial bank, according 
to convenience, with advice as to what has been done with 
the first of exchange. It will in this case be the second of 
exchange which is physically sold to the colonial bank. 24 

§ 74. Settlement without draft by exporter. Delegations. 
— Despite the extreme importance of the exporter's draft as 
an instrument of commerce, settlement may be managed 
without it, and we shall at this point consider a few in- 
stances of its omission. 

Suppose first a case where the exporter demands "cash 
against documents" in his city, meaning that he must re- 
ceive full payment in local cash at the time of making the 
shipment. He may be a manufacturer or dealer who has 
no desire to develop a foreign business, or who does. not 
care to enter into operations in exchange, or perhaps he is 
merely unwilling to place any degree of confidence in the 
particular foreign buyer in the case. He ought to be satis- 
fied with a confirmed bank-credit, if that were offered 

24 The Colonial clause, considered apart from its minor provision 
regarding the payment of stamp taxes by the drawee, is in reality 
a somewhat disguised variant of an interest clause. For, so long as 
England and the colonies are both on the gold standard and there is 
freedom of traffic between them, the discount in London on a bill 
upon the colony will consist primarily (though not by necessity 
wholly) of interest. In making the drawee pay a premium equal to 
this discount, we are making him pay what is substantially interest 
until arrival of funds in London. Space is lacking for an extended 
discussion of this point. 



DEALINGS OF A MORE INVOLVED CHARACTER 319 

(under which normally he would draw a draft), but sup- 
pose he insists on the delivery of actual cash and the im- 
porter assents. The latter conceivably might buy the neces- 
sary amount of exchange on the exporter's country and send 
it to him, saying "now then please ship the goods and 
forward me the bill of lading and other papers." But this 
simple scheme would in general be open to the objection that 
it requires the importer to place too much reliance in the 
good faith or solvency of the exporter. By modifying the 
plan and enlisting the services of the banker, the importer 
may gain a greater protection for himself and still meet 
the demands of the exporter. He induces a banker of his 
own city to establish a cash fund or cash credit in a bank 
in the exporter's city under instructions that the same is to 
be paid over to the exporter upon his delivering up the 
documents covering the goods to be shipped. This meets 
the exporter's terms of "cash against documents" but 
avoids the risks of an unqualified prepayment without se- 
curity. To increase his protection the foreign merchant 
may cause to be appointed a person to inspect the goods at 
the place of origin or export, and have the bank directed not 
to exchange the cash for the documents without a satisfac- 
tory report from this inspector with regard to quantity, 
quality, and packing. 

It is apparent this case is one in which it is possible for 
settlement to be completed without the exporter's drawing a 
draft. It is true there is a sort of bank credit established 
in his favor under which he might draw a documentary 
sight draft, but when the bank in question is located in his 
own city he is likely to exchange the documents directly 
over the counter for cash or a check, a draft by himself thus 
being eliminated. 

Id a second case remittance by the importer may displace 
a draft by the exporter, not because the latter \s terms are 
onerous but rather because they are liberal. Thus sales to 



320 FOREIGN EXCHANGE 

a regular and highly trusted foreign customer may be made 
"on open account." Transactions are on open account 
when the seller simply charges the buyer's account with the 
amount due for each shipment and awaits periodical remit- 
tances from the buyer. The business of the grocer with his 
ordinary customers who settle monthly, is a very homely but 
accurate illustration, though no doubt we can hardly speak 
of the grocer's deliveries as shipments. Sales on open ac- 
count are much commoner in domestic trade, but they are 
known to foreign trade. 

Since prior to quite recent times drafts by shippers have 
been comparatively very rare in the internal trade of the 
United States and remittances of bank drafts or their per- 
sonal checks by buyers have been the rule, the question sug- 
gests itself, wdiy does not the remittance system of settle- 
ment have a greater vogue in international commerce. The 
reason is simply that exporters and importers located in 
different countries characteristically take less chance on the 
good faith or solvency of one another. So the documentary 
draft is the fashion in foreign trade. Of course the risks 
are differently distributed according to the character of 
the draft, according for instance to whether it is drawn on 
a bank under a credit or is drawn on the importer, and 
according in the latter case to whether the documents are 
for acceptance or for payment only. 

There remains a third case where a draft, in the strict 
sense of a bill of exchange, is not drawn by the exporter. 
The exporter, having made the shipment, takes the docu- 
ments to his local bank and requests it to forward them to 
a correspondent or branch in the importer's city with in- 
structions that they be surrendered in return for such and 
such a sum of foreign money, or for such and such an 
amount of exchange. If the exporter drew a documentary 
sight draft on the importer and had it forwarded through 
these same banks, practically the same result would be 



DEALINGS OF A MORE INVOLVED CHARACTER 321 

reached, but this draft is at times omitted to avoid a stamp 
tax that would be levied upon it. Some sort of written 
instrument ought, however, to accompany the documents to 
make definitive what payment is expected in return for them 
and to witness the authority of the banker to collect this. 
This instrument is known as a letter of delegation, since it 
delegates to the banker the right to collect. It is not tax- 
able as a bill of exchange. It is not negotiable in the legal 
sense and puts the parties in a somewhat different legal 
position from the one they would occupy if a bill were used, 
but in many cases this makes no great difference. 

§ 75. Advances and local bank acceptances arranged by ex- 
porter. — The right of the exporter to draw a long bill on a 
bank, as it has been known to us heretofore, has been one 
arranged for by the importer. But where the importer does 
not agree to provide such a right, the exporter may take 
steps of his own, at his own bank or a bank in his vicinity, 
to secure a similar privilege. When the importer arranges 
the bank credit, the exporter draws a bill on a bank instead 
of a bill on the importer, but in the case now to be taken up, 
he draws both a bill on a bank and a bill on the importer. 
The case is really one of the four principal arrangements 
under which a bank may take over an exporter's draft on 
the importer, and is best explained by showing its position 
in this group. The four arrangements are : 

1. Outright purchase of the draft 

2. Receipt of the same for collection only 

3. Receipt for collection coupled with a loan or advance against 

the draft and documents as collateral 

4. Receipt for collection coupled with a grant of the right to 

draw a long bill against the expected collections as cover 

(1) An outright purchase is an exchange by the bank of 
a sum of present casli in full consideration for the right to 
collect for itself all money forthcoming from the draft. | 1 1 



322 FORKKiX KXCIIAXGE 

is not necessary that the bank surrender its right of re- 
course upon the drawer to constitute the transaction a pur- 
chase.) 

\2) A bank taking a draft for collection becomes the 
agent of the holder or depositor of the instrument, acquires 
authority to receive the sum due upon it, and becomes 
charged with the duty to account to the depositor for this 
sum, or the proceeds of it after appropriate operations in 
exchange. Here the exporter receives nothing until the 
proceeds of the collection are returned, and the bank has no 
power to seize and sell the merchandise collateral in its own 
behalf and has no right of recourse upon the exporter as 
drawer. 

(3) Against the receipt of a draft (or a letter of delega- 
tion) for collection, the bank may make the exporter a loan 
of a certain proportion of the expected returns, charging 
interest according to the amount and period of this ad- 
vance, and holding the claim against the importer, and also 
the merchandise, as collateral security. The plan of col- 
lection with a partial advance of cash is very common 
indeed. 

(4) Finally against the receipt of a draft (or letter of 
delegation) for collection, the bank may grant the exporter 
the right to draw a long bill upon itself for its acceptance. 
The idea is that the exporter may enter the open market to 
sell the accepted bill thus created, and so procure the pres- 
ent cash for which he nearly always hungers. 25 The opera- 
tion will be best understood by conceiving it as a sort of 
substitute for a partial loan or advance of cash by the bank. 

The term of the new bill — the one which the bank ac- 

25 For this proceeding the name of "refinancing" has recently been 
suggested. If the accepting bank purchases its own acceptance the 
operation becomes virtually identical with the old-fashioned advance 
against the exporter's draft, except that the purchased acceptance 
now exists as a bill capable of rediscount. 



DEALINGS OF A MORE INVOLVED CHARACTER 323 

cepts — should be long enough to make certain that under 
ordinary conditions the returns from the draft on the im- 
porter will arrive in time to provide for its discharge at 
maturity. These returns are, in other words, counted upon 
to serve as cover for the acceptance. This is the "accept- 
ance arranged for by the exporter himself" referred to at 
the beginning of the present section. 

For an illustration suppose an exporter brings to his bank 
his draft on a certain foreign merchant, a draft which is 
expected through collection to yield a return of about $10,- 
000 in home money after about 80 days. Instead of making 
a partial advance of cash against this instrument as col- 
lateral, the bank proposes that it accept a 90 days' sight bill 
to be drawn on it by the exporter, for the sum let us say of 
$7,500. Since this bill becomes the unconditional obliga- 
tion of a bank, it will sell in the market on favorable terms, 
and assuming it is discounted at a rate of 4% it will fetch 
$7,425. Suppose the collections of $10,000 from the im- 
porter arrive just in time to provide for the payment of 
the acceptance at maturity by the bank. They will be ap- 
plicable first to this very purpose, under the prior claim 
created in favor of the bank at the time it grants its ac- 
ceptance. This will take $7,500. They will be applicable 
second to the payment of the bank's commission, say $37.50 
or V2%. The remainder, or $2,462.50, will go to the ex- 
porter. 

To review these proceedings from the standpoint of the 
exporter, we see that this person gave up the chance to re- 
ceive $10,000 ninety days deferred, and received instead 
$7,425 of present cash and $2,402.50 of money deferred 
ninety days. Thus he obtained a partial advance, not it is 
true directly from the bank, but through its aid. This ad- 
vance was procured at a cost of 4% per annum (discount 
rate) plus a commission of ^% per quarter, or a commission 
figuring a] 2% per annum. The interest cost was thus evi- 



324 FOREIGN EXCHANGE 

dently about 6% per annum, but if we desire to compute the 
exact rate we must proceed as follows: 

(In this computation we take 90 days as x /± of a year.) 
Exporter's repayment to bank, or sum taken from col- 
lections by bank 
Amount to discharge bank's acceptance. . $7,500.00 
Bank's commission 37.50 

$7,537.50 $7,537.50 
Present cash received by the exporter from sale of 

the acceptance 7,425.00 

Difference 112.50 

This difference is the interest cost for an advance of 

$7,425 for a period of Vi year. 
Per cent, of interest for Vi year 1.515% 

(That is, 112.50 is 1.515% of 7,425) 
Rate of interest per annum (4 X 1-515) 6.06 % 

In this operation the bank does not make interest. It 
makes no advance of actual money or money funds. The 
cash for the exporter comes from the "market," or more 
specifically, from the one with whom he discounted the ac- 
ceptance. The only takings of the bank are its commission 
of $37.50. This is a compensation for the risk it has as- 
sumed in becoming unconditionally bound upon the bill it 
accepted. If the returns from the importer were to fail 
entirely, if the merchandise were lost, and if the exporter 
became worthless in a business sense, the bank would have to 
pay the $7,500 due on its acceptance just the same. The fact 
that the rate of commission tends to be higher the longer 
the period during which the bank carries this risk, makes 
it look somewhat like a rate of interest, but it is emphati- 
cally not this. 26 The bank should, of course, exercise the 
same care in granting an acceptance against an exporter's 

26 Compare § 50. 



DEALINGS OF A MORE INVOLVED CHARACTER 325 

claim on an importer as it would in making a partial ad- 
vance of cash against the same security. 

For a bank by this means to aid an exporter to procure 
cash in the open money market is not to be regarded as 
discreditable but rather as a legitimate and useful business. 
The type of acceptance before us at the present moment, 
like any other, should be granted only with a due regard 
for the limits set by law or propriety upon the total of 
acceptances which a bank ought to have outstanding at any 
one time or ought to have outstanding in behalf of any one 
business house. Under present Federal statutes the grant- 
ing of acceptances against deposited exporter's drafts is 
strictly lawful, and there is nothing in the origin of such 
acceptances making them ineligible for rediscount with a 
Federal Reserve bank. 

The fact that in any given instance an American exporter 
draws on a home bank does not in itself show whether he 
or the importer has arranged for the right to draw. For 
the importer, although acting practically always through a 
bank in his own country, might have provided a commercial 
credit with one of our banks, that is, a so-called "dollar 
credit. ' ' This case would be but a variant form of the one 
already discussed in the chapter on the commercial credit. 
It is safe to say that until quite recently the drawing by 
American exporters of long bills on American banks was 
virtually unknown. But to-day our exports are to an extent 
being financed in this manner, and some of the instances 
are ones where the exporter himself arranges for the draft 
on the bank. London bankers have before this been grant- 
ing English exporters acceptances against their drafts on 
importers in outlying countries.'- 7 

§ 76. Terms and methods of settlement summarized. — In 
connection with the export of goods there arise many tech- 

" ,Vee W. F. Spaulding'a "Foreign Exchange and Foreign Bills," 
pp. 164-5, especially at bottom of p. 165, 



326 FOREIGN EXCHANGE 

oica] problems, such as packing, routing, insuring, trans- 
shipping, the preparation of consular invoices and certifi- 
cates of origin, and the clearing of the goods through the 
custom-houses at the ports both of export and of import, 
to say nothing of the problems of the financing of shipments 
or arranging methods of settlement. In the handling of 
foreign commerce many specialized functionaries, quite dis- 
tinct from the ordinary rail and water transportation com- 
panies, manage to find employment. Such are resident sales 
agents, manufacturers' export agents, export commission 
houses, foreign freight forwarders, and custom-house 
brokers. With the exception of problems of settling for 
and financing shipments, the special commercial art of 
export lies beyond the purview of the present book, but we 
should realize that methods of settlement are likely to be 
much influenced by the intervention of sales or export agents 
or export commission houses, especially the latter. For in- 
stance the merchant in a foreign land who wishes to buy an 
■article manufactured, let us say, in Detroit, may be able to 
arrange more satisfactory terms by dealing with or through 
a New York export commission house than by dealing 
directly with the manufacturer. 

The principal subjects of a contract of sale are : 
(1) the quantity and quality of the article to be sold (in 
brief, the goods), and (2) the amount and kind of money to 
be paid for these articles (in brief, the price). But there 
are a number of secondary or collateral matters which the 
contract must determine, whether expressly or impliedly, 
such as: 

1. The time when the buyer must make payment, 

2. The manner or mode in which he shall pay (whether 

by remittance or by submission to draft), 

3. The allocation of the incidental costs such as cartage, 

freight, insurance, customs duties, and the like, and 



DEALINGS OF A MORE INVOLVED CHARACTER 32V 

4. The allocation of the interest charge for the period of 
the transit of the goods. 

By the allocation of these costs or charges we mean their 
distribution between seller and buyer. Charges resting 
upon the seller may be spoken of as "included in the price." 
The elements of the agreement which we here distinguish 
as secondary, are in common speech known as the "terms" 
of the sale. When the seller makes known his demands 
with respect to these matters, he, as we say, states his 
terms. 

In the list to follow, we give the chief terms pertaining 
to time of payment, that are familiar to foreign commerce. 
In this list the order is from the strictest to the most liberal 
of conditions. 

TERMS Appropriate Method of 

Settlement 

I. CASH WITH ORDER Remittance by importer to ex- 

porter, in regular practice ol' 
a sight draft oh a bank in 

the exporter's country. 

II. CASH AGAINST DOCU- 

MENTS AT PLACE AND 

TIME OF SHIPMENT. ... 1 Remittance as above, but re- 
mitted draft held by agent 
of the importer until ex- 
porter exchanges shipping 
documents for draft, im- 
porter gaining control of 
documents when making 
payment. 

2 Payment for documents 

through a bank (see text). 

3 Payment for documents by ;i 

commission house which 
advances Eor the importer 



328 FOKEIGN EXCHANGE 

flic amount thus paid, 
usually against the docu- 
ments and goods as col- 
lateral. 
4 Provision by the importer of 
a good commercial credit 
with a bank (ought to be 
satisfactory under terms 
"cash against documents"). 

III. PAYMENT FOR DOCU- 
MENTS AT POINT OF 
DESTINATION 

(A) On Arrival of Docu- 

ments Sight draft or letter of delega- 
tion of exporter on importer, 
with documents attached. 

(B) On Arrival of Goods 

(to allow opportunity 

to inspect goods) Same as above, except that 

draft accompanied by in- 
structions that presentment 
for payment be deferred un- 
til arrival of goods. 

(C) Within a Designated 

Period After Arrival 

of Documents Long draft by exporter upon 

importer, documents attached 
and documents for payment, 
the privilege of prepaying 
being understood. 

(D) Within a Designated 

Period After Arrival 

of Goods Same as above, except instruc- 
tions given to withhold pre- 
sentment for acceptance until 
arrival of goods. 



DEALINGS OF A MORE INVOLVED CHARACTER 320 

IV. ACCEPTANCE 28 IN RE- 
TURN FOR DOCUMENTS 
DELIVERED AT POINT 
OF DESTINATION 

(A) On Arrival of Docu- 

ments Long draft by exporter upon 

importer, documents at- 
tached, documents for accept- 
ance. 

(B) On Arrival op Goods. . . Same as above, except instruc- 

tions given to withhold pre- 
sentment for acceptance un- 
til arrival of goods. 

V. SALE ON ACCOUNT CUR- 

RENT, "OPEN ACCOUNT" 

OR "OPEN CREDIT" Periodical remittance by im- 
porter to exporter, usually of 
a sight draft on a bank in the 
exporter's country. 

"Cash with order," the least liberal of terms recognized 
in ordinary commercial practice, signifies that the buyer 
must make payment when placing the order with the seller. 
Practically, these terms come to this, the buyer must make 
payment before the seller will act upon or incur any ex- 
penses in connection with the order. If an exporter who 
quotes these terms has the goods in stock he declares in 
effect he will not do so much as to pack and deliver them to 
the transportation company without receiving cash in ad- 
vance. If he does not have the goods in stock he will not 
purchase or assemble them without prepayment, or if a 
manufacturer, he will not start them in process or assume 
any costs of production without prepayment. The terms 

28 Acceptance having the effect of binding the drawee uncondi- 
tionally to any holder in due course, which a buyer of the instrument 
will usually be. 



330 FOREKiX EXCHANGE 

"cash wiili order" are very burdensome to the foreign 
buyer, first because they require him to find cash or lock up 
funds a considerable time before he can realize upon the 
goods (whereas what he likes best is to pay for the goods 
out of the amount he realizes from their sale), and second 
because they require him to repose a maximum of unre- 
quited confidence in the exporter, for he must trust to the 
latter to pack properly and ship within a reasonable time 
the right kind and quantity of article. 29 Considering that, 
except in cases where he has a long-standing acquaintance- 
ship with the exporter, an importer usually has a strong 
desire to inspect the goods at destination before even com- 
mitting himself to the extent of an acceptance, 30 one might 
wonder if he "would ever submit to the terms "cash with 
order." Nevertheless some foreign buying in a small way 
takes place under these terms. 

The phrase "cash against documents" signifies that the 
importer, whether acting for himself or through an agent, 
will be required to make payment before the shipping docu- 
ments, and thus the control of the goods is surrendered to 
him. 31 But the practical force of the phrase remains uncer- 
tain unless it is supplemented with an understanding as to 
the place where the importer is to make this payment and 
take up the documents. This might be the point of origin, 
the port of export, the port of import, or the place of 
destination when this is distinct from the port of import, 
but in the great majority of cases where terms are quoted 
in the exact phraseology "cash against documents" the 

29 Failure of the exporter to live up to the agreement of sale would 
of course create in the importer a right of action at law, but it is so 
difficult and so expensive to enforce a right or to get damages 
in the courts of a distant country that the aggrieved party in 
international commerce regards resort to the law with little enthu- 
siasm. 

so That is, to the extent of accepting a bill upon himself. 

8i On his agent or banker. 



DEALINGS OF A MORE INVOLVED CHARACTER 331 

place of taking up the documents will be within the ex- 
porter's country. Thus, speaking of a quotation from the 
United States, we might have "cash against documents in 
New York" or "cash against documents in Detroit," or 
some other interior point of origin. If the intention were 
to have the importer exchange money for the documents at 
the place of destination, as say Rio, the words "cash against 
documents at Rio" might be employed, but the intention 
would be better expressed and more usually expressed in 
the phrase "sight draft with documents." A sight draft, 
with the documents attached and deliverable against pay- 
ment of the draft, would of course be the most appropriate 
means of putting this intention into effect, unless perchance 
the exporter should have an agent at Rio who could per- 
sonally deliver the documents for local cash or for sight ex- 
change on New York or London. 

Under the terms ' ' cash against documents, ' ' the exporter 
buys or manufactures the goods, packs them and makes de- 
livery to the transportation company, before 'receiving 
payment. Thus, except in cases of fraud or mistake, the 
importer makes no disbursement until the wares are in 
existence and under way to him and the shipping docu- 
ments are under his control. The exporter makes all his 
expenditures connected with the transaction, before he re- 
ceives payment, but he does not give up the shipping docu- 
ments or documents of title before payment. While the 
terms "cash against documents" are by no means so strict 
as "cash with order," they are regarded by the ordinary 
importer as very illiberal. 

The more appropriate methods of settlement to be fol- 
lowed under the terms, "cash against documents" at the 
place of shipment, have been indicated in the conspectus 
already given. The importer may remit a draft payable 
in the exporter's country for the requisite sum of the money 
of that country, to an agent who will thus be put in funds 



332 FOREIGN EXCHANGE 

to take up the documents for him. Any method whereby 
this agent may be placed in funds will of course serve. 
The importer may induce his home bank to make arrange- 
ments with some bank in the neighborhood of the exporter 
to take up the documents. The institution thus paying 
for the documents will reimburse itself in some appropriate 
and convenient manner at the expense of the importer's 
bank, and the latter will sooner or later collect payment 
from the importer himself. The bankers will, of course, 
charge commissions. The importer may induce a commis- 
sion house located near the exporter to take up the docu- 
ments for him, there being several possible arrangements 
between himself and the commission house. To give one 
illustration, this house may draw on the importer a bill, 
perhaps a long one, with documents attached. In this case 
some might be inclined to regard the commission house as 
the true exporter, but this will depend upon how we define 
the term "exporter," a question which we shall avoid open- 
ing here. If the. importer provides a commercial credit 
with a good bank, especially if it is a confirmed credit, this 
ought to satisfy a reasonable exporter who has stated his 
terms as "cash against documents." For, as we already 
know, under ordinar}- conditions this will enable him to 
obtain cash in full at the time of surrendering the docu- 
ments at the point of shipment. One may object however 
that this is not quite equivalent to the receipt of an outright 
and final payment of cash, for the reason that the exporter 
incurs drawer 's liabiliy on the draft which he creates under 
the credit. The objection is genuine but not very substan- 
tial because recourse upon the drawer could come in this 
case only in the event of the failure of the drawee-bank to 
honor an authorized draft upon itself, a danger in general 
to be regarded as negligible. In this case the exporter has 
no stake in the solvency or reliability of the importer (com- 
pare § 49). 



DEALINGS OF A MORE INVOLVED CHARACTER 333 

On the other hand, draft by the exporter upon the im- 
porter in person would not meet the terms, "cash against 
documents" at the point of shipment even if this draft 
should be readily salable for cash. For here recourse upon 
the exporter would be brought about if for any reason the 
importer failed to honor the bill, and thus the exporter 
cannot regard the cash received from the sale of this in- 
strument as his own then and there as a matter of practical 
finality. 

The agreement of sale may prescribe payment for the 
documents at the point of destination, or if yet more liberal 
ma}- require merely an acceptance in return for the docu- 
ments at this point. The several methods of settlement 
suitable to these conditions are set forth in the table already 
presented, and should be in the main self-explanatory. 
However, an additional word seems advisable with regard 
to postponement of presentment until the importer has op- 
portunity to inspect the goods. It is very common of course 
for a draft and attached documents to reach destination 
prior to the arrival of the merchandise to which they apper- 
tain. If the draft is owned by the bank at the place of 
destination, or by some other bank for which it acts as agent 
— if in other words the draft has been bought from the ex- 
porter instead of having been taken merely for collection — 
it must be presented to the drawee, whether for payment or 
for acceptance (where presentment for acceptance is neces- 
sary), within a reasonable time if the right of recourse upon 
the exporter as drawer is to be preserved. But importers 
are in many cases extremely averse to paying or accepting 
a draft before the goods arrive and become open for inspec- 
1 ion. Especially is this true of importers resident in South 
America. In determining whether presentment has taken 
place within a reasonable time, regard must be had (ac- 
cording to both English and American law) to the nature of 
the instrument, the usage of trade or business (if any) with 



334 FOREIGN EXCHANGE 

respecl to such instruments, and the facts of the particular 
case. How far a bank might go in postponing presentment 
with a view to permit the arrival of the goods and inspec- 
tion, without destroying the right of recourse, is a question 
which so far as the present writer can learn has not heen 
adjudicated in America or England. But it is clear that 
the drawer's express consent to such a postponement ought 
to be a matter of record if the postponement is to be made, 
and some bankers at least, dealing in bills on South Amer- 
ica, make a practice of requiring the drawer to give in- 
struction on the matter. 32 A postponement on the drawer's 
order or with his consent will not terminate the right of 
recourse on him. (The foregoing gives such explanations 
as seem necessary in connection with cases III B, III D, 
and IY B as set forth in the table.) 

It has been stated that among the collateral matters to be 
determined bj^ the agreement of sale is the question of the 
allocation of the incidental costs of cartage, freight, in- 
surance, customs dues and brokerage, and similar charges. 
When an exporter quotes a price to a prospective buyer it 
is important there should be a definite understanding as to 
just how many of these incidentals are payable by the ex- 
porter under this quotation. If the agreement of sale is 
silent on this subject, the buyer is supposed to receive the 
goods at the place where they are when the bargain is 
struck, and to carry all expenses and risks from this point 
forward. The terms respecting incidental charges most 
common in practice are the ones represented by the abbre- 

32 Cf. p. 305. The following is quoted from a pamphlet upon 
"Export Trade to Central and South America" issued in 1917 by 
the Mechanics and Metals National Bank of New York, p. 16. "Re- 
member that practically all over South and Central America mer- 
chants have the right to await the arrival of the merchandise before 
accepting a time draft or paying a sight draft. Bear in mind that 
in those countries the documents attached to a time draft must 
always be delivered to the drawee against his acceptance." 



DEALINGS OF A MORE INVOLVED CHARACTER 335 

viations F. 0. B. and C. I. F. The meaning of these and 
certain other related symbols are given beneath. 

F. 0. B. or "Free On Board." 

F. A. S. or "Free Along Side" 

C. I. F. or "Cost, Insurance, and Freight" 

included. 
C. F. or C. A. F. or "Cost And Freight" included. 
Franco Domicile. (A European expression. See text.) 

If a quotation is F. 0. B., the seller undertakes for the 
price named to deliver the goods on board car or ship at 
a designated place, free of charges to the buyer. The terms 
become definitive only when this place is stated or under- 
stood. Goods may be sold F. 0. B. at the point of origin 
(as say Detroit), or at the port of export by sea (as New- 
York), or again at some point further on, as the port at 
the end of the sea passage (as say Genoa). In the absence 
of specification of the place where the goods are to be 
F. 0. B., the point of origin would be implied, unless an 
established usage of the trade gives rise to another implica- 
tion. Under these terms the seller agrees to take all risks 
as well as pay all costs until the goods are on the vehicle of 
transportation at the indicated place, and the buyer agrees 
to take all subsequent expenses and risks. 

F. A. S. or "free along side" the steamer at some point 
of shipment or transshipment, signifies that the seller is to 
deliver the wares on the suitable lighter or pier along side 
the ship, taking expenses and risks to this point, the bivyer 
carrying them thence forward. 

C. I. F. signifies that insurance and freight are payable 
by the seller to some stipulated point, whether an inter- 
mediate place or the place of ultimate destination. Under 
these terms delivery from seller to buyer is made at the 
initial shipping point, and the carrier becomes the agent of 
the buyer and not of the seller, so that the risks while tin' 



336 FOREIGN EXCHANGE 

goods are in transit are assumed b} r the buyer. In the 
formula C. I. F., C. means not incidental costs but means the 
cost of the goods themselves or the bare price. The price 
quoted includes this and also the insurance and the freight 
charge. "The amount of money named in the contract [of 
sale] is all that the buyer is to be required to pay for the 
goods themselves, for insuring them during transportation, 
and for the carrier's freight charges. These expenses fall 
upon the seller, all others on the buyer. Delivery is not 
made on board, but at the warehouse or wherever the 
goods may be when sold. The buyer pays for taking 
them to the cars or vessel. He pays every expense not in- 
cluded in the cost of the goods themselves, or in their in- 
surance and actual cost of carriage. Established usage in 
certain lines has decreed that the seller shall bear some 
minor expenses not falling strictly under any one of these 
three heads, but that is altogether exceptional." 33 C. F. or 
C. A. F. have the same force as C. I. F. except that they 
place the cost of insurance during transit upon the buyer 
instead of the seller 

The purport of the expression "franco domicile" is that 
the wares are to be delivered by the seller, for the price 
named, at the very place of business of the buyer in the city 
of destination. No terms respecting incidental costs could 
be more liberal to the buyer. 34 

33 Quoted from the "Exporter's Encyclopedia" already cited, p. 117, 
edition of 1914, or p. 221, edition of 1918-19. For the fullest dis- 
cussion of what we may call "commercial terms" the reader would 
best consult a legal treatise on "Sales." 

34 According to W. A. Graham Clark, European export houses that 
were before the war desirous of getting a foothold in the cotton busi- 
ness in Turkey would sometimes grant the terms "franco domicile." 
See Special Agents Series (Department of Commerce and Labor), 
No. 18, "Cotton Textile Trade in the Turkish Empire," etc., Wash- 
ington, 1908, p. 17. The following is quoted from another number 
of the same series: "Far more satisfactory results [in developing 



DEALINGS OF A MORE INVOLVED CHARACTER 337 

§ 77. Dealing in exchange on places where no balance is 
kept. — Heretofore, when we have supposed a bank to buy 
or sell bills and cables, we have assumed bills and cables 
payable in a place, or at .least in a country, where the bank 
has a balance or what is more familiarly known as a deposit. 
Now while a bank would find it a great convenience to keep 
such an account in any city in bills upon which it conducts a 
large and active business, 35 it can nevertheless both buy and 
sell exchange on a place or country where it does not main- 
tain a deposit. 

We can distinguish three classes of such transactions. 

I. The first is the purchase or sale of exchange by a cen- 
trally located bank upon a place where it has a depositing 
correspondent. By the latter we mean a bank which keeps 
a deposit with the centrally located institution but does not 
hold a deposit from it. New York banks have deposits from 
innumerable lesser interior banks without carrying deposits 
with them. The same statement will hold generally of the 
relations of the greater London banks to foreign establish- 
ments scattered over the world. If a man in London, who 
wished to make payment to one in New York, approached 
his bank for a draft on the latter city, the bank might be 
unable to draw for him a check against a balance. It might 
advise its customer to buy and send a sterling draft to his 
American creditor or friend, nevertheless it can, if it 

American cotton trade] would be obtained if prices were quoted 
c.i.f. a Turkish port, as is the rule with the European manufac- 
turers. It is even possible to quote franco domicile, as the Italians 
sometimes do, because the Turkish tariff on all imports is uniformly 
11% of the invoice value. It is far more satisfactory to the dealer 
here to know just what the goods will cost him landed at his door." 
Special Agents Series, No. 54, "Cotton Goods in Turkey." by Ralph 
M. Odell, Tart I. 1912, p. 21. 

3 r ' If the business is very large indeed it may make advisable the 
establishmenl of a branch or agency. 



FOREIGN EXCHANGE 

chooses, sell a demand draft on New York. It can draw on 
some bank in that city from which it holds a deposit, or 
which is, in other words, one of its depositing correspond- 
ents. It will send advice to this correspondent requesting 
that it pay the draft when presented, and will suggest means 
whereby the correspondent may reimburse itself, unless 
these means are already understood. There is more than 
one method possible for accomplishing the object. Not to 
go too far into detail, one plan would be for the bank at 
New York to draw a draft on the London bank in a suffi- 
cient sum to sell (at the local rate for this class of exchange) 
for the dollars it has paid out on the London bank's draft 
plus its charges, if any, for its service. This second draft, 
or reimbursement draft, the London banker would pay 
without deduction from the New York bank's deposit, and 
so reimbursement would be effected. Again the New York 
bank might omit to sell the reimbursement draft and instead 
merely send advice by mail to the London bank to credit 
its (the New York bank's) balance with the same amount 
of sterling for which this draft would have been drawn, 
the credit to be entered on the arrival of the advice. This 
change would be from the standpoint of the London bank 
a matter of indifference, 36 but would give the New York 
bank its reimbursement in the shape of London funds in- 
stead of New York funds. These London funds simply be- 
come merged in the general credit against which the New 
York bank can sell sight sterling at any time. Under either 
variation of the plan of reimbursement here outlined, the 
centrally located establishment (the London bank in this 
case) gains the use of the sum for which it sold its original 
draft, for a period at least double the mail time between 
itself and the city on w r hich it drew. 

36 Under either variation it pays the same amount of sterling 
on the same day, namely the day of the arrival of return mail from 
New York. 



DEALINGS OF A MORE INVOLVED CHARACTER 339 

Speaking of the general case, namely draft by a bank 
upon its depositing correspondent in a foreign country, the 
method of reimbursement to be arranged between the two 
institutions is a problem of two principal elements, (1) the 
time of the act of reimbursement, and (2) the rate of ex- 
change at which it takes place. To give merely one further 
example to bring out the meaning of these elements, it 
would be a conceivable method for the London bank to re- 
imburse the New York correspondent by crediting its bal- 
ance (1) on the day when the London bank sold the draft 
on New York and (2) at the rate of exchange between 
dollars and pounds then current either (a) in the London 
market or (b) in the New York market. The reader will 
perceive that the timing of the act of reimbursement deter- 
mines which of the banks enjoys the temporary use of 
funds, or a hidden interest gain, on account of the whole 
operation, and for what period. 

If the London bank were called upon to collect a draft 
drawn on some one in or near New York (whether or not 
it had bought the instrument), it could again make use 
of the facilities of its depositing correspondent. It could 
ask the latter to obtain payment and return the proceeds 
by remitting a draft on London, taking out the charges 
in dollars and cents before buying this sterling return 
draft with the dollars collected. If the New York bank 
itself draws the return draft on the London bank itself 
and payable to the London bank itself, the whole matter 
is settled. In the end the London bank reimburses itself 
by making a deduction from the sterling balance it owes 
the New York bank, and the latter has collected and kept 
the dollars paid by the drawee of the original draft on 
New York. 

II. The second case of the sale of exchange on a place 
where the drawer has no balance is one where a depositing 



340 FOREIGN EXCHANGE 

correspondent of some centrally located institution draws 
upon a fellow depositing correspondent of the same institu- 
tion, but a fellow in a foreign land. Suppose bank A in 
Africa or Asia or South America and bank B in the United 
States both cany balances with Lloyds' Bank of London. 
Either one can draw on the other and request payment and 
provide a fairly convenient plan of reimbursement, and 
either one can ask the other to make a collection for it. For 
one example, suppose that bank A in Bombay was pressed 
to sell a draft (a sight draft of course) on New York where 
bank B is located. It could draw on B, advise it of the act, 
request honor of the instrument, and propose reimburse- 
ment by B's drawing enough sight sterling on Lloyds' 
Bank to sell for the dollars it has paid out plus its charges. 
This sight sterling would of course be payable at Lloyds' 
Bank not from the balance of bank B but from that of 
bank A of Bombay, and bank A would so advise Lloyds'. 
Thus the bank in Bombay sells a dollar draft for rupees, 
and makes a payment against this operation by submitting 
to a transfer of some of its sterling credit in London to 
the American bank on which it has drawn. It can if it 
desires turn the rupees upon their receipt into sight sterling 
drafts bought in Bombay to forward to London. It takes 
one risk of exchange, the risk as to the position of the 
sight rate in New York on London on the day when the 
New York bank draws the reimbursement sterling draft. 
In this kind of business, which naturally has a sporadic 
character, B, the seller of the unusual class of exchange, 
should make the rate quoted cover the contingencies of the 
case. The bank in New York pays out dollars to honor the 
draft drawn on it, and gets the dollars back immediately 
by a sale of a sight sterling. 37 

37 If it preferred such bank could of course deposit this sterling to 
its own credit in London instead of selling it for dollars in New 
York. 



DEALINGS OF A MORE INVOLVED CHARACTER 341 

III. The third case of the sale of exchange on a place 
where the drawer has no balance is exemplified by the offer- 
ing of sterling and other foreign bills by many of the lesser 
interior banks in the United States. Suppose that A who 
resides in some smaller city or town has need of a sterling 
bill for £50, perhaps to pay for an order of books. It is 
entirely possible his local bank will be in a position to 
supply him even though it has no deposit in London, or 
elsewhere abroad. It sells him, we may suppose, a draft of 
its own drawing on the London County Westminster and 
Parr's Bank, and charges a rate something above open 
market rates in the great cities. It has an arrangement 
with some greater American bank (or with some exchange 
house) one in New York perhaps, which makes this feasible. 
This New York bank is one which has a deposit with the 
London County and Westminster. Without much of the 
detail, the plan is this : The local bank draws the draft. 
This instrument will look almost like a normal draft on a 
European bank but will in fact be on a peculiar form, which 
serves to identify it immediately at the drawee bank for 
what it is. The drawing bank quickly starts an advice on 
its way to the New York bank asking it to advise the Lon- 
don County Westminster and Parr's to honor the draft 
and reimburse itself from its (the New York bank's) bal- 
ance. The New York bank probably carries a deposit from 
our local bank, and will be authorized to collect from this 
the number of dollars due for the sterling which it has 
virtually sold the lesser bank and for its commission or 
charges. Or the local bank may remit it this number of 
dollars in New York exchange along with the advice. The 
banks act quickly to insure the arrival of advices in London 
as early as the sterling draft. It all conies to this: Mr. 
A pays his local bank dollars, it pays a New York hank 
dollars, the latter pays the London hank' pounds (out of 
its balance with this bank), and the London bank pays 



342 FOREIGN EXCHANGE 

the pounds due on the draft to the holder thereof. Banks 
and dealers that provide interior banks with the facilities 
just described, are sometimes called "exchange jobbers," 
and this particular branch of business is called "exchange 
jobbing." 



CHAPTER XI 
INVESTMENT IN EXCHANGE 

§ 78. Exchange investment, borrowing, and speculation. — 
At this point we begin the discussion of a group of opera- 
tions which do not arise out of the export and import 
of goods or securities but which are engaged in by bankers 
and exchange dealers without any object of effecting com- 
mercial settlements. Of these operations there are four 
principal kinds, (1) investments in exchange, (2) borrow- 
ing by means of exchange, (3) speculation in exchange, and 
(4) arbitrage in exchange. A chapter will be given to 
each. 

Regular long-term international borrowing and lending, 
accomplished chiefly by the international sale of bonds and 
stocks, give rise of course to vast numbers of transactions 
in exchange. Settlement must be made by importers with 
the exporters of such securities, for their original sale prices, 
and periodically the payment of interest charges and divi- 
dends from the one country to the other will force resort 
to the exchanges. But when we come now to speak of 
investment in exchange and borrowing by means of ex- 
change, we do not have reference to international invest- 
ments or loans of capital effected by the transfer of long- 
term securities, even though these have their exchange rela- 
tions. We have in mind certain entirely distinct and 
technical operations in bills of exchange themselves, such 
on the one hand as the purchase of a long foreign bill to 
be held till maturity instead of being discounted in the 
foreign money market, and such on the other hand as the 

343 



344 FOREIGN EXCHANGE 

drawing and sale of a banker's long bill on a foreign banker 
as a means of gaining the benefit of a virtual loan of funds 
for the term of the draft. 

Speculation in foreign exchange is a technical possibility 
and is much practiced by certain types of dealers. It 
bears some fundamental resemblances to speculation in 
stocks or commodities, but is a subject requiring a special 
explanation which it shall be our endeavor to give in Chap- 
ter XIII of this book. Foreign exchange investment, bor- 
rowing, and speculation are intimately related themes. The 
first two always involve a speculation on the future course 
of the sight rate of exchange. The one taking such a 
speculation may cancel it or neutralize it by a proceeding 
which is commonly known as "hedging"; this does not 
mean that the speculation is not involved, but rather that, 
being involved, it can by a special device be neutralized. 
(Compare the explanation of hedging in § 91 to follow.) 
Investment and borrowing are related to each other in that 
both are due to or are occasioned by a difference between 
discount rates at home and abroad. But the two are oppo- 
site in this respect, that investment in exchange tends to 
be produced by lower money rates at home, while borrow- 
ing, or the drawing of finance bills, tends to be produced 
by higher money rates at home. The two are opposite 
also in respect to the immediate or contemporary effect 
they tend to work upon the sight rate. 'Exchange invest- 
ment on our part tends at the time when the investments 
are taking place to raise our sight rate of exchange on the 
foreign country, and so far as it goes, tends thus to bring 
about gold exports, whereas exchange borrowing on our 
part tends towards the reverse effects, a lowering of the 
sight rate and a production of gold imports, 

§ 79. The method of investment. — Investment in foreign 
exchange, or the holding for a period of time of a long 
foreign bill that has been bought and paid for, is the op- 



INVESTMENT IN EXCHANGE 345 

posite of the earliest possible discount of the instrument 
in the money market abroad where it is payable. The act 
is regarded as one of investment because it involves the 
making of an outlay and the awaiting of a deferred return. 
It is an exchange of present money for future money. 
"We have now become quite familiar with the fact that 
if a long bill is to be discounted on its arrival abroad, a 
return can be had from it at home on the very day of its 
purchase (or at the worst perhaps, on the next business 
day) by an immediate sale of sight drafts against the pro- 
ceeds of the discount as cover. Withholding the bill from 
discount means the postponement of this return. The 
whole operation becomes an investment because a period 
intervenes between outlay and return. For this period a 
certain amount of capital is, as the business expression 
goes, employed in the bill. On this capital the banker 
expects to make, and normally does make, a gain — a gain 
which is, of course interest. Investment cannot take place 
in sight bills or cable transfers, because no gain can be 
realized from the postponement of their conversion into 
cash abroad. 

Sometimes the remittance of funds to a foreign country 
to be put out there in the purchase of bonds or notes, or 
in the making of short-term loans or advances, is referred 
to as an investment in foreign exchange. It is true, with 
the exception of a "dollar" loan made abroad, there is 
here an investment in an obligation to pay foreign money, 
and therefore the operation involves a risk of exchange, 
i.e., a chance taken with respect to the rate of conversion 
of the recovered foreign funds back into home money ; but 
there is not technically, and properly speaking, an invest- 
ment in foreign exchange. The latter means an investment 
in an instrument that is itself a piece of foreign exchange, 
a bill. The investment in an obligation payable in foreign 
money, but not itself a foreign bill of exchange, is similar 



:U6 FOREIGN EXCHANGE 

to this, but not identical with it. The transaction is best 
thought of as a foreign loan with the risk of exchange taken 
by the lender. 

Practically all foreign bills, sight or long, are drawn 
in two or more copies, the original reason being to make 
it possible for the sake of safety to hold one copy while 
transmitting another, or to forward different copies by 
separate mails. But in the case of an investment in a bill, 
the first and second of exchange are put to distinct tech- 
nical uses. 1 The first will be sent abroad for acceptance 
only. The banker will omit to indorse this copy and will 
mark it "for acceptance only," which will signify that, 
while this acknowledgment by the drawee is to be procured, 
the bill is not to be discounted in the money market but is 
to be held by the correspondent subject to the orders of 
the remitting banker. If the drawee intends to honor 
the bill he will accept this first of exchange (receiving 
the documents if they are deliverable against acceptance), 
but when he comes to make payment at maturity he will 
expect the indorsed second to be surrendered to him along 
with the unindorsed but accepted first, the two copies to- 
gether constituting the completed bill. Meanwhile, the bank 
that has purchased the bill, and is investing in it, will hold 
the second of exchange in its portfolio as the tangible 
representative of the asset which it is carrying, until the 
time when it decides to realize upon it by sale at home or 
discount abroad, or, at the latest, until the time when the 
instrument must be forwarded to reach destination by the 
date of maturity. When transmitted, this second will be 
indorsed, and should the owner desire to discount the bill 
at any time with any dealer abroad, it is understood that 
the latter will have a right to procure the accepted first 
from the correspondent holding it, upon making a demand 

i According to Margraff. See his "International Exchange," pp. 
61-2 



INVESTMENT IN EXCHANGE 347 

and showing the indorsed second. Thus the foreign pur- 
chaser will come into possession of the completed bill which 
he will need to present to the acceptor for payment at 
maturity. 

The fact that a banker purchasing a foreign bill intends 
to invest in it, instead of discounting it for immediate for- 
eign cash, does not in the least reduce his motive to obtain 
the earliest possible acceptance. There is in the first place 
what we might call the legal reason for promptness. If 
the bill is of such a character that presentment for accept- 
ance is required in order to bind the drawer in his condi- 
tional or secondary liability 2 (the ordinary form of long 
bill payable a designated period after sight is of this char- 
acter), then the presentment for acceptance must be made 
with reasonable promptness if the drawer (or an indorser, if 
any, prior to the owner-bank) is not to escape his liability. 3 
There is in the second place the financial reason for prompt- 
ness. Every day's postponement of acceptance means a 
day's postponement of the date of maturity, 4 and this post- 
ponement produces no increase in the amount due at ma- 
turity. Hence, there being no compensation in the nature 
of interest for any delay, postponement becomes financially 
bad. 

§ 80. Computing the rate of interest received. — The data 
required to compute the rate of interest received from an 
investment in exchange comprise 

(1) the amount of home money invested in the bill, or 
what we have usually called the outlay, 

2 Compare § 12. 

3 But the drawer or indorser does not escape if he makes a special 
agreement waiving his rights in regard to acceptance or promptness 
of acceptance. 

*To this there is an exception in the case of bills drawn payable 
at so and so many days after date (instead of Bight) or drawn 
payable at a named future dale, but both these forms are com- 
partively rare. 



.its FOREIGN EXCHANGE 

(2) the amount of home money in the end realized from 

the bill, or the return, and 

(3) the time intervening between outlay and return. 

It will be natural to jump to the conclusion that the invest- 
ing banker's outlay consists of the price he paid for the 
bill. It is true that this is an outlay, but strictly speak- 
ing it is not the outlay in the case. The true outlay is 
the amount the banker could realize from the bill on the 
very day of purchase by selling sight drafts against it 
and discounting it on its arrival abroad. If, for instance, 
the banker has paid $48,020 for a 60 days' sight bill on 
London for £10,000, but could immediately realize $48,045 
from it by the method of discounting it on arrival abroad, 
the latter figure, namely, the $48,045, is truly the amount 
invested, if the banker elects the alternative of investment. 
That is to say, he makes an investment of $48,045 of pres- 
ent money by foregoing this sum. This is the sum he gives 
up for the sake of the future return, and the wisdom of the 
investment depends upon the rate per cent, which the re- 
turn yields upon this sum considered as the outlay. The 
$25 by which this exceeds the price paid for the bill is a 
profit derived from the purchase, which the banker gets 
whether he invests or not, and it is not, on correct principles 
of accounting, a part of the gain or interest received from 
the investment itself. 

To obtain an illustration, let us assume the following 
facts, and compute the interest rate : 

July 1 N. Y. banker purchases and invests in a 60 
days' bill for £10,000, paying $48,020 for it. 

" Rate for bankers' sight sterling 4.85 

" Arrival discount rate quoted in London 5% 

" Rate of interest for demand loans in New York 3% 

July 9 Acceptance of bill by London drawee. 
Sept. 10 Maturity date, as fixed by this acceptance. 
(3 days of grace being allowed). 



INVESTMENT IN EXCHANGE 349 

We suppose, further, that the investment continues till 
the maturity of the bill, though, as we understand, it might 
be terminated at any intermediate date. 

Sept. 2 Assumed earliest date on which sight drafts can 
be sold to be covered 5 by this acceptance 
which matures Sept. 10. 

Sept. 2 Rate for sight sterling in New York 4.85 

Net Cash Yield of Bill in Dollars if Discounted 
Forthwith in London 

On the principle just explained, to find the theoretically correct 
amount invested we must find what could be realized from this bill in 
immediate cash by discounting it abroad on arrival. We proceed as 
follows: 6 

Net proceeds of this discount in London on July 9th. 

£10,000 less 63 days' discount at 5% 7 £9,913.7 

Tax and commission deducted by correspondent. ... 7.5 

Net yield of bill to London balance, July 9 9,906.2 

Dollar receipts from sale of sight sterling against this. 
Sight drafts for £9,906.2 sold on July 1st, at 4.85, 

yield in N. Y $48,045.07 

Dollar Return from Bill at End of Investment 
Period 

Maturity value of the bill in sterling in London 
Payment received from the acceptor on Sept. 10 ... . £10,000 
Tax and commission 7.5 



Sterling maturity value 9,992.5 

• r > That is, to be paid for in London out of the receipts from the 
maturing acceptance. 
« Compare §§ 64 and 65. 
7 The year is taken as 365 days throughout this example. 



350 I'OK'KICN EXCHANGE 

Dollar receipt* from sale of sight sterling against this 
Sight drafts for £9,992.5 sold on Sept. 2d, at 4.85. . . $48,463.62 

SUMMARY 

July 1st Amount invested (i.e., cash foregone) $48,045.07 

Sept. 2d Amount returned from investment 48,463.62 

Difference, or interest gain for 63 days 418.55 

This is interest on $48,045.07 at the rate per annum of 5.05% 
As a discount of $48,463.62 this is at the rate per 

annum of 5 % 

This computation is based on the supposition that the rate 
for bankers' sight sterling stands at the same figure on 
Sept. 2d as on July 1st, namely 4.85. This is very much 
of an assumption. The effects of a change of the sight 
rate during the period of the investment will be taken up 
in § 81. But the computation as we have it before us is 
an illustration of the fact that, if the sight rate remains 
unchanged, the investment earns the foreign money rate 
applicable to the bill in which the investment is made. This 
rate is a discount rate, and in the case in hand is 5%. The 
interest made in the investment turns out to be at the rate 
of 5.05% per annum, but this is the mathematical equiva- 
lent of a discount rate of 5%. 8 

§ 81. The speculation on the sight rate of exchange. — 
Since the dollar outcome from the investment depends upon 
the sight rate of exchange on the day of the sale (or assumed 

s The gain in the example will not figure to a discount at pre- 
cisely 5%. A slight deviation from this rate is produced by the 
manner in which we have found it most convenient to introduce the 
tax and commission charges of £7.5. For our purposes this matter 
is not worth the time it would take to ventilate it. If these charges 
are removed, or disregarded, the discount gain from the investment 
on this side of the water works out to precisely 5%. On the sub- 
ject of the relation of the discount to the interest rate, compare 
§§ 14 and 17. 



INVESTMENT IN EXCHANGE 



351 



sale 9 ) of the investing banker's demand drafts, the rate 
of interest gained in the operation is necessarily dependent 
upon this same rate of exchange. The character of this 
dependence is made plain in the table beneath. 

RATE OF INTEREST REALIZED FROM AN INVEST- 
MENT IN A SIXTY DAYS' BILL 



Dollars Invested, Sight Rate 

sight rate at Time of 
being at 4.85 Realizing 
at time of the on the 

investment Investment 



$48,045.07 
48,045.07 
48,045.07 



4.84 
4.85 
4.86 



Total 


Amount of 


Rate of 


Dollars 


Interest 


Interest 


Realized 


Yielded 


Yielded 

by the 

Investment 


$48,363.70 


$318.63 


3.83% 


48,463.62 


418.55 


5.05% 


48,563.54 


518.47 


6.25% 



If the rate of exchange happened to be invariable we 
could lay down the rule that an investment in a long foreign 
bill will yield the foreign money rate applicable to this bill 
at the time of its arrival abroad. This is the London dis- 
count rate of 5% assumed in the example in the preceding 
section. But the rate of exchange is by no means invari- 
able. The higher it turns out to be the higher will be the 
interest yield, and vice versa. With the exchange rate at 

3 If the banker omits to make this sale and so draw back home 
the sterling proceeds of the bill, he allows these proceeds to become 
a net addition to his foreign funds. But this supposition does not 
necessitate a change in the method of computing the rate of inter- 
est in the investment. The net addition to the foreign funds in 
this case comes without a contemporary expenditure of dollars for 
the purchase of sight exchange, an expenditure which would otherwise 
be required to produce the addition. This saving of dollars is the 
true theoretical return upon the investment. In amount it is the 
number of dollars needed to buy sight pounds in the open market 
equal to the net maturity value of the long bill. Bui this is the same 
as the number of dollars taken as (lie outcome in the computation 
in the text. In sum, the outcome from the investment is the aum 
ber of dollars equivalent to the proceeds from the long bill in pounds, 
at the sight rate of exchange whether or not these proceeds are in 
fact drawn back into dollars by the banker. 



352 FOREIGN EXCHANGE 

4.84 at the end of the investment period, the table shows 
the interest yield to be only about 3.8%, but with exchange 
at 4.87 the yield will be about 7.5%. Yet more extensive 
variations in this figure would be produced if we took into 
account different rates of exchange at the beginning of the 
investment period. Thus, if the exchange rate were 4.87 
at t lie beginning of the period, and 4.84 at the end, the 
interest rate gained in the investment under the conditions 
of our example would be less than Vh.% per annum. We 
hasten to state that investment would be most unlikely 
with the sight rate so high as 4.87, precisely because 
the speculation on this rate would then be so distinctly 
unfavorable. 

By way of summary: the first circumstance tending to 
produce investment in long sterling bills is a higher money 
rate in London than in New York. Unless the associated 
speculation on the rate of exchange seems unpropitious, the 
banker is attracted to this investment because he bids fair 
to make such funds as he places in long sterling bills earn 
a higher rate of interest than if employed in equally liquid 
and secure advances at home. Stated in another way, the 
existence of a higher discount rate in London tends to dis- 
suade our bankers from discounting their long sterling 
bills there, which means they invest in them. The second 
circumstance tending to produce this investment is a low 
existing sight rate of exchange in our country on London. 
The lower this rate at the time of the investment the more 
attractive the speculation upon it which is involved in the 
investment, because the greater the chances that it will be 
as high, if not higher, at the expiration of the investment. 
Often the near future of the rate of exchange seems meas- 
urably predictable to the banker and dealer, and their dis- 
position toward investment will be in large degree deter- 
mined by their prognostications on this subject. The little 
chart beneath is self-explanatory. 



INVESTMENT IN EXCHANGE 353 

INVESTMENT CONDITIONS 

(Normal times assumed: i.e., limits of fluctuation of sight sterling 
about 4.84 and 4.88) 

Very favorable to investment Very unfavorable 

London money rate say 5% London money rate say 3% 

while New York money rate while New York money rate 

is 3% is 5% 

Sight sterling in New York at Sight sterling in New York at 

4.84 with indications of a rise 4.88 with indications that it 

due in the near future will fall 

The causes of the high discount rate or tight money 
market in the foreign country should, of course, be scruti- 
nized by the banker who has in contemplation the purchase 
of long bills on that country for investment. In his 
"International Exchange" (page 60), Margraff warns 
against investment on the basis of a high discount rate 
produced by the danger of financial or economic disturb- 
ances, as contrasted with one produced by brisk commerce. 
During the panic of 1866, Paris bankers refused to invest 
in long sterling bills when the Bank of England rate 
stood at 10% and the open London rates were corre- 
spondingly high. Such of these bills as the French dealers 
in exchange purchased, they discounted immediately in 
London, despite the excessive discounts taken out there. 
This was due to distrust of London conditions. This dis- 
trust disappeared when the Bank of England finally re- 
duced its rates towards the normal level and thus "gave 
proof of its own returning confidence." 10 

§ 82. Termination of investment prior to maturity. — In 
any times approaching the normal a long sterling bill of 
good rating can be sold in the London money market, at 
one rate of discount or another, on any day within the life 
history of the instrument. (Documentary payment bills as 

io Compare Clare's "A 15 C of the Foreign Exchanges," pp. 97-9. 



354 FOREIGN EXCHANGE 

a class are not discountable under English banking custom 
and therefore must be mentioned as an exception to this 
statement.) 11 In buying long sterling our bankers presum- 
ably confine their purchases to the discountable class of 
bills (except again for such documentary payment bills 
as they purchase), and take the inferior class for collec- 
tion only. Thus, in such sterling bills as they hold for 
investment purposes, they have assets of a particularly 
liquid character. 12 If, for illustration, a New York banker 
has a 90 days' bill on London which he has been holding 
for perhaps 20 or 30 days, and he decides to realize upon 
it at the present moment, he may put it in to-day's English 
mail and to-day sell sight sterling against it, thus convert- 
ing it forthwith into dollars. Naturally, the desirability 
of this step will be much influenced by the contemporary 
position of the London discount rate and of the rate for 
sight sterling in New York, but the point is the conversion 
can, if necessary, be made at any time. L T ntil recent times 
this liquidness of foreign bills distinguished them pretty 
sharply from the other domestic commercial paper held by 
American banks. While this distinction is doubtless still 
of consequence, its importance is on a fair way to be much 
reduced b}- reason of the development of our Federal Re- 
serve Banks and the accompanying growth and alteration 
of methods in our home money market. That is to say, 
domestic commercial paper eligible for rediscount under 
our new law and practice, becomes like the long foreign bill 
in liquidness. 

Its own special and individual need for cash, due per- 
haps to an unusual demand from its depositors, might 
lead a bank to abandon its investment in a foreign bill 
before the instrument has had a chance to reach maturity. 

ii Compare §§ 67 and 94. 

12 Other long foreign bills than sterling, held for investment, are 
also presumably subject to this observation. 



INVESTMENT IN EXCHANGE 355 

The possibility of doing this is what we have in mind when 
we speak of the advantage of liquidness which is possessed 
by this bill as an asset. But a sufficient change in the 
governing conditions might lead to a general termination 
of investments in foreign exchange on the part of banking 
institutions, not because any of the banks had fallen under 
a compulsion to procure cash for safety's sake, but because 
this termination will pay in dollars and cents. 

In the first place this action might be produced by a 
shift in the relative positions of the London and the New 
York money rates, that is, by a sufficient fall of the former 
or rise of the latter. In the illustration in the preceding 
section we had a New York bank purchase and invest in 
a 60 days' sterling bill on July 1st, when the London dis- 
count rate applicable to this bill was at 5%, and the New 
York money rate 13 was at 3%, and sight sterling in New 
York was at 4.85. By way of modification of this example 
assume that on August 3d the London discount rate has 
fallen to 3^%, and that the London correspondents are 
quoting this same figure for bills to arrive, or quoting it 
as a forward discount rate, and assume also that the New 
York money rate has ascended to 4%. It will now pay 
to abandon the investment. The explanation is, in brief, 
that from this time forward a continuation of the invest- 
ment will yield only 314% on the funds which may be re- 
covered from it and which may be employed forthwith at 
4%. However, lest this explanation, sounding almost too 
simple, should be subject to suspicion, we had better verify 
it by means of an arithmetical computation. 

i- This means (among all the money rates of New York) the par 
ticular rate which is obtainable from an employment of funds judged 
by the bank in question to be equally desirable with investment 
in long sterling from the standpoint of liquidness and security; 
in general presumably the rate on call or short loans against good 
collateral. 



356 FOREIGN EXCHANGE 

On August 3d, then, the bill is started to London, sight 
sterling being sold against it on this date, and it arrives 
and is discounted, we may suppose, on August 11th. We 
need first to know the dollar proceeds of this discount. 

DOLLAR PROCEEDS OF DISCOUNT 

Maturity value of bill, due Sept. 10 £10,000 

Less 30 days' discount at 3 1 / £% £ 28.77 

Discounted present worth in sterling £ 9,971.23 

Less tax and commission £ 7.5 

Credit available for sight draft on August 3d £ 9,963.73 

Yield of this sold out at $4.85 per pound $48,324.09 

On August 3d the bank may reason as follows : If we 
realize on this bill to-day we get $48,324.09. If we hold it 
till maturity, and the sight rate remains where it is now, 
we shall realize $48,463.62 on September 2d, or 30 days 
hence. (Compare illustration in preceding section.) 
Therefore, unless we care to speculate upon the sight rate's 
being higher and thus more favorable on September 2d 
than now, 14 continuation of the investment will be equiva- 
lent to giving up $48,324 of to-day's money to receive a 
return of $48,463 thirty days hence. But this particular 
exchange of present for future money yields interest at only 
3%% per annum. Therefore we had better terminate the 
investment and employ the funds derived from it in the 
home market at 4%. 

The bank, having taken this step, may now be interested 
to learn what rate of interest it has secured for the period 
during which it did invest in the bill. It made an outlay 
of $48,045 on July 1st (as already explained on pages 50-1), 
and has just obtained on August 3d a return of $48,324. 

ii But see § 91 below on the possibility, in this connection, of sale 
of sight exchange for future delivery. 



INVESTMENT IN EXCHANGE 357 

This gives an interest gain of $279 received for the em- 
ployment of $-48,045 for 33 days, making the interest rate 
6.4% per annum. Up till August 3d the investment was 
excellent, although after this date it becomes unprofitable. 
"When the investment was inaugurated the foreign money 
rate was at 5%, and yet the outcome has been a higher rate 
than this, namely, 6.4%. This outcome has been made pos- 
sible by the reduction of the foreign discount rate from 
5% to 3V2%. If in the domestic money market an operator 
can purchase long paper under a 5% discount rate, and 
subsequently rediscount it at a reduced rate, as 3V2%, he 
will alwa} 7 s make a rate of interest on his money, for the 
time it was employed, better than the initial discount rate 
(compare example B 4 from § 15, on page 47). This is 
essentially what our bank, investing in the long sterling 
bill, has done, though the details are a trifle more complex 
in the case involving foreign exchange. 

It was stated that an investment in a long foreign bill 
might be abandoned prior to maturity, in the first place 
because of a shift in the relative positions of the foreign 
and the local money rates. It remains now to note that 
independently of any such shifting, a sufficient rise in the 
sight rate of exchange on the foreign country may tempt 
the banker to take the same step of abandonment of the 
investment. Thus, amending our former illustration once 
more, suppose that while on August 3d the London discount 
rate remains at 5%, where it was at the inauguration of 
the investment, sight sterling in New York has ascended 
to 4.88. The bank will be under strong temptation to dis- 
count the bill to arrive (say on August 11th, as assumed 
before) and sell demand against it on August 3d at 4.88. 
If it were certain that 4.88 could be procured for demand 
at the maturity of the investment, the reasons for con- 
tinuing, it would be unimpaired; but let us suppose the 
bank feels there is no such certainty and sells out on the 



358 FOREIGK EXCHANGE 

3d. It then concludes the investment with an interest yield 
of 13%, computed as shown below. 

Outlay in dollars, July 1st, as already explained. . . . $48,045 

Return in dollars, August 3d, or 33 days later 

Credit available for sight draft on this 

date £9,963.73 

(As shown in last preceding example) 

£9,963.73 sold at 4.88 bring in $48,623 

Excess of return, or interest $ 578 

For 33 days, this is interest on $48,045 at the rate 

per annum of 13% plus 



CHAPTER XII 

BORROWING BY MEANS OF EXCHANGE 

§ 83. The "dollar" loan by a foreign bank in New York. — 
As already intimated, we do not, in addressing ourselves 
to borrowing by means of foreign exchange, have refer- 
ence to the ordinary and more familiar types of borrowing 
across national boundary lines, but to a certain special and 
technical operation with a long foreign bill whereby a local 
banker manages to obtain the use of a fund at home for 
the term of the bill. The instrument in question, the 
so-called "finance bill," is drawn by a banker upon a 
banker, and is somewhat sharply distinguished from the 
long bill arising out of an export of goods and drawn by 
a merchant (whether upon a foreign merchant or a foreign 
bank). We speak of borrowing by means of exchange for 
the reason that (treating countries as units) the borrow- 
ing country sells the lending country no securities, such 
as bonds or stocks or notes, but merely deals in exchange 
upon it. In these operations bonds or stocks are usually 
deposited as collateral with the foreign accepting bankers 
(or their local agents), but such deposits are in no sense 
sales. 

Borrowing by means of exchange is not a procedure which 
must by its very nature be confined to foreign exchange 
While details vary, it comes fundamentally to borrowing 
by means of an acceptance which is granted to your long 
bill by some one else (not acting in the capacity of your 
debtor) for the purpose of enabling yon to sell the instru- 
ment for local funds. You do not borrow from, but merely 
by the aid of, this one who does the accepting. The accept - 

359 



300 FOREIGN EXCHANGE 

ance in this crse is of the kind known at law as an "accom- 
modation acceptance." There is nothing in the nature of 
the whole operation precluding resort to it within purely 
domestic limits so that it would involve and produce purely 
domestic exchange. But, in fact, it has little development 
in connection with domestic exchange, none within the 
United States, and is of consequence only in the field of 
foreign exchange. 

Let us first consider a so-called "dollar" loan made or 
placed in New York by a foreign bank. Described in more 
general terms, this is a loan by a banker of country A made 
in country B in terms of the local currency of country 
B. 1 The cause for any general placing of such loans will 
be the existence of higher discount or interest rates in coun- 
try B than in country A. Throughout the discussion we 
shall choose dealings between London and New York as 
illustrations. 

Assume the following data : 

Money can be loaned in New York for quarter-year 

periods on excellent security at 5% 

Discount rate in London for bankers' 90 days ac- 
ceptances &A% 

Rate for sight sterling in New York 4.87 

Rate for 90 days' sight sterling in New York 4.8240 

An English bank has an agent on our side of the water 
which knows of an institution in New York that is ready 
to pay 5% per annum for a loan of from forty-five to fifty 
thousand dollars for a period of 90 days or thereabouts. 

i We speak of the foreign bank initially interested in the opera- 
tion as "making" the loan. In the case before us it does in a sense 
make the loan, but it does not, nevertheless, bear the burden of 
the cash advance. To bear this burden would mean to be out present 
money (cash or money funds) in return for future money. But 
this bank is not, in consequence of the operation as an entirety, out 
any present money. See the text. 



BORROWING BY MEANS OF EXCHANGE 361 

An opportunity for profit being perceived, the agent is 
instructed to draw upon the English bank, its principal, 
a bill for £10,000 at 90 days' sight, to sell the bill forth- 
with in New York for dollars, and to place these dollars as 
a loan for 93 days with the New York house in question. 
Assume that this is done on the first of March. The bill, 
being sold at 4.8240, yields $48,240. This sum, loaned out 
at 5% for 93 days (the term of the bill including the days 
of grace), earns $623 of interest, and on June 2d a total 
repayment of $48,863 will be made to the agent. It be- 
comes the latter 's immediate duty to expend this for sight 
sterling and remit the same to the London principal to be 
used to pay off the bill for £10,000 which was originally 
drawn. This instrument, having been accepted in due 
course on March 8th, became payable on June 9th, and the 
sight sterling started from New York on June 2d or 3d 
will have time to reach London by the 9th. Without any 
specially untoward calendar of steamer sailings, the loan 
on this side can be made for the full number of days of 
life of the acceptance on the other side, in this instance 93 
days. 

Clearly the outcome to the English banker, who has engi- 
neered this operation, depends upon the position of the 
New York rate for sight sterling on June 2d. If we assume 
that at the end of the loan this rate stands at 4.87, where 
it was in the beginning, we may make up the following 
account : 

OUTCOME OF THE OPERATION TO THE LONDON 
ACCEPTING BANK 

March 1 Amount of the 90 days' draft on this hank sold 

in New York £10,000 

March 1 Dollars received from the same and 

loaned out $48,240 

June 2 Dollars returned from loan including 

interest $48,863 



3G2 FOREIGN EXCHANGE 

Juno 2 Amount of sight sterling purchased with lat- 
ter, at 4.87 £10,033 



Profit £ 33 

The effect of a deviation of the sight rate from 4.87 at 
the end of the loan period is illustrated by the figures 
beneath. 



Rate for 


Amount of 


Profit of 


Sight Sterling 


sterling purchased 


the London 


on June 2 


with $48,863 


accepting bank 


4.88 


£10,013 


£13 


4.86 


£10,054 


£54 


4.84 


£10,095 


£95 



The London accepting bank has acted as principal and 
risk-taker in this enterprise, and the gain, if any, goes to 
it. This gain is not interest, for the reason that the said 
bank does not, as a result of the operation as an entirety, 
make any advance of its own funds. It is not commission, 
for the reason that it is not a stipulated fee received from 
some outside person or establishment for a service rendered. 
It is profit. And as profit, the primary variable upon 
w r hich it depends is the New York rate for sight sterling 
on the day of maturity of the loan. On this day the London 
bank comes into the ownership of a contractually prede- 
termined number of dollars in New York, namely, $48,863. 
Its scheme is to convert these into sight sterling bills which, 
when received in London, will serve to discharge its accept- 
ance for £10,000. Any profit which it may glean will con- 
sist in an excess of the sterling so purchased over the 
£10,000 required. Clearly, the lower rate or price for 
sight sterling in New York on the critical day, the greater 
the number of pounds of it that can be bought with the 
fixed sum of dollars, and the larger the surplus or profit. 
In this case, then, though the burden of the advance is not, 



BORROWING BY MEANS OF EXCHANGE 363 

the risk of the exchange is shouldered by the accepting bank. 
This institution may hedge at the time of placing the loan, 
if it chooses so to do, by making a contract to buy sight 
sterling in New York for future delivery (see § 91 below). 

The New York bank or trust company which has served 
in the capacity of agent puts out no funds of its own 
and takes no risks. Whatever compensation it receives for 
making the immediate arrangements and taking charge of 
the collateral put up by the borrower, will be in the nature 
of a commission paid by its principal in London and charge- 
able by the latter against the profits which the venture has 
afforded. 

The New York borrower has received a loan of some 
forty-eight thousand dollars for 93 daj^s. Although these 
dollars undeniably came in the first instance from the com- 
pany we have called the agent, neither this company, nor 
its principal in London, is the true lender. The true lender 
must be that party who holds the long sterling bill during 
the length of its life, who invests in it. The normal history 
of the bill would be this: the banker who buys it in New 
York forwards it immediately to his London correspondent 
for discount and cash credit, and forthwith recovers what 
he has laid out in it, either by the sale of sight sterling 
against it, or by the refraining from the purchase of sight 
sterling which he would otherwise have had to buy. He 
makes no advance for a deferred return. Some money 
dealer in the London market, unidentified so far as our 
illustration goes, comes forward to discount the instru- 
ment after it has been accepted by the drawee bank. This 
money dealer is the real or ultimate lender. The borrower 
in New York has a loan, while this party in London does 
the corresponding waiting, 2 

2 The dollars received by the borrower from the agent of the 
London accepting bank are no doubt the property of the latter. 
This leads U8 naturally to speak of the accepting bank us "making" 



364 FOKKKiX KXCHANGK 

It is true this history might vary in some particulars. 
The banker who first buys the long sterling bill in New 
York, could refrain from discounting it in London and 
could hold it as an investment, in which case he would 
become the ultimate lender. But this would hardly be 
normal, because a banker on our side would not be likely 
to invest in exchange at a time when our local money 
rates are higher than the London discount rates, namely, 
at a time when our borrowing by means of exchange is 
appropriate. Another and more natural variation would 
be for the New York agent which draws the long bill to 
forward it to London instead of selling it for cash on this 
side. This agent may have other correspondents in London 
than the bank upon which it has drawn. It may send 
the bill to one of these for discount and itself sell sight 
sterling against it, and in this manner procure the dollars 
to lend out in New York. 3 

the loan. It certainly appears as lender if we take into view only 
what happens in this country. But the very dollars loaned came 
from the sale of a bill which the London acceptor does not pay 
until the repayment of the loan on this side of the water has taken 
place and has provided it with the necessary funds. In other 
words, as a result of the operation viewed in its entirety, the accept- 
ing bank makes no advance of cash or of its own funds. If it 
lends dollars in New York, it is itself the recipient of a virtual loan 
of dollars through the offices of the party in London that discounts 
the long bill for the one who bought it and paid dollars for it in 
New York. 

Should the London bank, still acting as principal, and still 
conceiving and engineering the operation, desire to take the burden 
of the advance as well as the risk of exchange, it might do so by 
changing its procedure. It might, for instance, say to its agent in 
Xew York, "Sell £10,000 of sight drafts on us, and lend the dollars 
which they fetch, $48,500 say, in your money market for three 
months. When you receive these dollars back with interest, convert 
the whole into sight sterling and forward it to us." 

s There is no purely legal reason why the long bill should not be 
sent to the very London bank upon which it is drawn to be offered 



BORROWING BY MEANS OF EXCHANGE 365 

§ 84. The "sterling" (franc or mark) loan. — The sterling 
loan bears its name because the borrower receives a stipu- 
lated amount of long sterling (or the proceeds in local 
money from the sale of this) and agrees to make a repay- 
ment in the same amount of sight sterling. The period 
of the loan is the length of the life of the long sterling 
bill drawn to effect it. The object and effect of the ar- 
rangement, as contrasted with the dollar loan, is to throw 
the risk of exchange upon the borrower. To illustrate : 
The New York agent of the London accepting bank draws 
upon the latter a 90 days' bill for £10,000, and delivers this 
instrument, or the forty-eight odd thousand dollars it will 
fetch on the market, over to the New York borrower against 
a deposit of collateral. The latter agrees to make a repay- 
ment of £10,000, plus a commission of say % of 1%, in 
bankers' demand sterling bills (or in dollars enough to 
buy them, this being a mere matter of detail). The 
£10,000 is the amount or face value of the long sterling 
turned over to the borrower. Upon the fact that it is 
repayable in sight sterling hangs the whole story. The 
commission of % of 1%, or whatever per cent, it may be, is 
the fee of the London bank for granting its acceptance. 
The borrowing bank makes no payment of a stipulated or 
contract amount of interest to any party. Nevertheless, for 
a reason that will soon appear, the loan will cost it interest. 

Taking the same data with respect to rates for money 
and exchange as in the last preceding section, we now 
assume that the borrowing bank proceeds to sell the 90 
days' bill which has been delivered to it. It sells at 4.8240 
and receives $48,240 for immediate employment at home. 
Niriety-three days later the bank will be obliged to return 
£10,000, plus % of 1%, or £37.5, or a total of £10,037.5, 
in bankers' sight bills on London. If the rate \'<>r such 

on the money market by this bank itself. Bui bo far as the writer 
knows, banks never like to offer their own acceptance for sale. 



366 FOREIGN EXCHANGE 

bills stands at 4.87 (which accords with the first assump- 
tion made in the preceding section) this sterling will cost 
it $48,882.63. The following then will be an account of 
the operation : 

INTEREST COST OF THE LOAN TO THE BORROWER 

Dollars received by borrower at the beginning $48,240.00 

Dollars required to discharge obligation at maturity. . 48,882.63 

Difference, or 93 days' interest cost on $48,240 $ 642.63 

Rate of this interest cost per annum 5.23% 

SAME WITH SIGHT RATE AT 4.84 4 

Dollars received by borrower in the beginning $48,240.00 

Dollars required to discharge obligation at maturity. . 48,581.50 
(£10,037.5 X 4.84 = $48,581.50) 

Difference, or 93 days' interest cost on $48,240 $ 341.50 

Rate of same per annum 2.78% 

This example shows that if the sight rate were at 4.87 
at the beginning of the loan period (and the rate for 90 
days' sterling at the correspondingly high point of 4.8240) 
and that if the sight rate had fallen to 4.84 at the expiry 
of this period, the loan would cost the borrower only 2%%. 
As a case favorable to the borrower, this is a very strong 
one, but it serves to make clear the importance of the risk 
of exchange in connection with the interest cost of a sterling 
loan. After having obtained the loan, the borrower is in 
effect short of sight sterling — that is, under a commitment 
to buy a sum of this exchange at a future date. It is 
possible to hedge by buying sight sterling for future de- 
livery (see § 91). But if the borrowing house does not 
hedge against this risk, the rule is, the cheaper sight 
sterling at the maturity of the loan the better for it. The 

♦ At time of expiration of the loan. 



BORROWING BY MEANS OF EXCHANGE 367 

rule is also that the higher sight sterling, and consequently 
also long sterling, at the time it contracts the loan, the 
better for it, because the greater the number of dollars it 
will receive at the beginning against a commitment to de- 
liver a stated amount of sterling at the end. 

In the case of the sterling loan, as in the case of the 
"dollar" loan, the real lender is the institution in the Lon- 
don money market which discounts and carries the long 
sterling bill from acceptance till maturity. The explana- 
tions given before apply here as well. 

In the case of the sterling loan, the accepting bank in 
London makes a commission merely. It takes no risk of 
exchange and makes no profit. There is due it £37.5 for 
the service rendered by accepting. This is compensation 
for that other kind of risk than a risk of exchange, which 
it takes in assuming liability to pay the bill before being 
provided with cash to make the payment. It is true it 
has the promise of the American borrower. Also, the risk 
is reduced by reason of the deposit of collateral. 

In the past, French and German banks have sometimes 
made loans in New York under the same general plan as 
that followed by the London banks. They may make 
"dollar" loans, or they may make "franc" or "mark" 
loans, the latter corresponding in nature and effect to 
"sterling" loans. 

§85. The borrowing bank's sale of its own long bill. — 
Continuing with the subject of long exchange as a means 
of procuring a virtual loan from the foreign money mar- 
ket, the bill in the case, as heretofore encountered, has 
been one drawn by the local agenl of flic London accepting 
bank. The borrowing bank's sale of its own long draft 
gives rise simply to a variant form of the sterling loan. 

If, for example, a New York bank or exchange house : 
having an acceptance account with a bank in London (corn- 
pare pages 144-7) and therefore having the power to dra^ 



308 FOREIGN EXCHANGE 

long: sterling, sells its 90 days' bill for dollars to-day and 
expends dollars some 93 days hereafter to buy sight ster- 
ling for cover, it obviously has a virtual loan. It has, as 
the saying goes, 93 days' ''use" of the dollars first procured. 
Its motive, it is true, may be primarily to speculate for a 
fall in the rate for demand sterling rather than to procure 
the use of funds, but whatever be the motive, it does have 
the use of the funds. 

The explanations regarding risk of exchange, and the 
possibility of hedging, applicable to the sterling loan placed 
through an agent, and already given, are also applicable 
here. They need not be repeated in extended order. But 
to avoid being too concise in handling these technical sub- 
jects, it will be well to give one illustration involving a 
draft by the borrowing bank itself. 

CALENDAR AND ACCOUNT OF THE OPERATION 

June 1 90 days' draft for £10,000 drawn and sold by New York 
bank 

Sight sterling rate in New York 4.85 

London discount rate for this bill .... 3 1 /6% 
90 days' sterling rate in New York. . . 4.8040 
The draft is sold by the drawer to a new York 

buyer for $48,040 

The buyer forwards it to his correspondent in 
London for discount in the London market 
and cash credit. 
June 8 The draft arrives in London and is accepted by 
the drawee bank. This sets the maturity date 
on Sept. 9th (93 days later). 
Sept. 2 Day to buy in sight sterling as cover. 

The New York drawing bank is obligated to 
put the London drawee bank in funds to en- 
able it to discharge the acceptance on 
Sept. 9th. Its deposit with the latter might 
be so large on this date that a special re- 



BORROWING BY MEANS OF EXCHANGE 369 

mittance of sight bills as cover would be 
unnecessary ; that is, the London bank might 
be able to reimburse itself from this bal- 
ance without the balance being specially 
fortified to stand such a drain, but this is 
unlikely, and in any case we have to assume 
the special remittance of cover, to find the 
outcome and interest cost of the opei'ation. 
This cover must be bought and mailed in 
time to reach London on Sept. 9th. 

Sight sterling in New York still at 4.85 

Total cover required 

To discharge acceptance £10,000 

To pay commission for ac- 
ceptance 37.5 

(At assumed rate of % of 1%) 



£10,037.5 
Cost of cover at 4.85 (10,037.5 X 4.85) . . . $48,681.87 

SUMMARY 

Dollars received by borrowing bank on June 1 $48,040.00 

Dollars paid out to discharge obligation, Sept. 2 48,681.87 

Difference, or interest cost for 93 days 641.87 

Rate of this interest per annum (on $48,040) . 5.24% 5 

§ 86. The spread between the local and the foreign money 
rates. — The interest cost of the loan just discussed (or vir- 
tual loan, speaking more precisely) turns out to be 514%, 
when the London discount rate is but 3^%. The rate of ex- 
change stood at the same figure at the end as at the be- 
ginning of the operation, and therefore neither advantage 
nor disadvantage has come out of the risk of exchange. 
What is the cause then of the interest cost's being so much 
in excess of the foreign money rate? The main cause is 

■''Computed on the liasis of .'i<i."> days to 1 1 1 « - year. 



370 FOREIGN EXCHANGE 

the acceptance commission which the New York borrowing 
bank must pay. A minor cause is the English stamp tax. 
Then again, the full theoretical worth of the 90 days' ster- 
ling sold by our bank on June 1st was $4.80435 per pound, 
whereas we supposed the sale to take place at the next 
even rate below, namely 4.8040, which gives a slight profit 
to the New York buyer of this exchange. All taken to- 
gether, the interest cost is 1%% above the London discount 
rate. 6 Of this, Vkjo is due to the acceptance commission. 
To explain : the acceptance commission assumed in our 
illustrations is Vs of 1% per month of life of the accepted 
bill, or % of 1% for what was (roughly) a three months' 
bill. These commissions vary, but this is a common figure. 
(As to the reason why the amount of commission increases 
with the term of the bill, see § 50, page 181.) A charge 
of *6 of 1% per month is one running at the rate of 1%% 
per annum. Thus a sterling loan will cost the New York 
borrower V/2% per annum above the London discount rate, 
because of the acceptance commission alone. 7 Therefore, 
it is evident that the sterling loan does not pay an operator 
on our side of the water unless one of two things make it 
pay, namely, either (1) a somewhat greater excess of the 
New York over the London money rate than VA%, or (2) 

e A small part of this excess is also due to the fact that the 
London money rate is a discount rate, while what we are here com- 
puting is an interest rate. 

» If the borrower uses a quarter-year bill, the period of his loan 
is a quarter of a year. The commission will be % of 1%. This 
is, precisely speaking, % of 1% of the face value of the sterling 
bill, but since the rate of exchange between dollars and pounds 
ordinarily fluctuates within a small compass, it will necessarily 
at the end of the loan require an expenditure to pay it, amounting 
very close to % of 1% of the dollars originally borrowed. What- 
ever percentage the extra dollars (required at the end to buy the 
extra sterling to pay the commission) bear to the dollars originally 
secured, this percentage is interest cost. An interest cost of % of 
1% per quarter is one at the rate of \V-i% per year. 



BORROWING BY MEANS OF EXCHANGE 371 

an attractive speculation on the future course of sight ster- 
ling in New York. The illustration on page 366 shows 
a case where a very fortunate speculation on this rate 
reduced the interest cost of a sterling loan to 2%% per 
annum ! 

It appears then by way of summary that a London 
bank will grant its acceptance to a bill drawn and sold 
in New York for the purpose of putting some New York 
house in funds for a period equal to the term of the bill. 
Sometimes the instrument is drawn by a mere agent of the 
London bank, sometimes by the New York borrowing house 
itself. The London accepting bank does not make the ad- 
vance of actual funds or cash which enables the American 
borrower to enjoy a loan. As the saying goes, it merely 
lends its credit. It does this by becoming unconditionally 
bound to pay the long bill in the case, that is, by accepting 
this bill. It is this giving of the strength of its name to 
the instrument that enables it to be sold so readily and 
at such a favorable rate in the London money market. 
It makes a profit in the case of the dollar loan where it 
takes the risk of exchange, and a commission in the case 
of the sterling loan where the borrower takes the risk of 
exchange. The actual advance of cash or funds which 
makes possible the enjoyment of the virtual loan by the 
New York house, is made by the party in London that 
discounts the acceptance there. It is the action of this 
party which makes it possible for any exchange bank in 
New York to pay dollars for the long bill on the day of 
its creation without itself making an advance of present 
money for a deferred return, for it is this which enables 
the said exchange bank to recover its dollars immediately 
by the sale of sight sterling. 

When the English banker, proposing to accept one of 
these loan bills drawn by his own agent, shows his prefer- 
ence as between the dollar loan and the sterling loan, we 



372 FOREIGN EXCHANGE 

can infer his opinion with respect to the probable future 
course of siprht sterling in New York. A preference for 
the dollar loan is a clear indication that he anticipates low 
Bight sterling at the end of the loan period. For if he 
places a dollar loan, this is the position of the sight rate 
that would benefit him most. The cheaper demand bills 
on London may be at the end, the more of them will be 
procurable for the fixed number of dollars to be received 
back, and consequently the larger the excess of this sterling 
over the amount required to discharge the maturing accept- 
ance. A reluctance to make dollar loans, or what is the 
same thing, a preference for sterling loans, shows naturally 
a belief in the contrary future for sight sterling in New 
York. 

The interests of the New York borrower, with respect 
to the choice between dollar and sterling loan, run exactly 
counter to those of the English acceptor. If demand ster- 
ling turns out cheap at the end of the loan period it will 
be best for him if he has agreed to a sterling rather than 
a dollar loan, and vice versa. 

§ 87. A joint-account transfer of loanable funds. — In the 
case of most operations in exchange involving activity on 
the part of a given bank and its foreign correspondent, one 
institution assumes the risks (such as they may be) and 
takes any gains, while the other acts as a mere depository 
or agent, or grants an acceptance for a commission. But 
it is possible for the two banks to establish, for the pur- 
poses of any transaction, what is known as a "joint- 
account." A joint-account operation in foreign exchange 
may be defined as one which is effected through the coopera- 
tion of two banks or exchange houses in different countries 
under an agreement to share in common the risks and 
the gains involved. It would appear that these are usually 
divided half and half, rather than in any other propor- 
tion. 



BORROWING BY MEANS OF EXCHANGE 373 

Joint-accounts are more particularly appropriate in con- 
nection with borrowing by means of exchange and arbitrage 
of exchange. When, for instance, money rates are higher 
in New York than in London, two banks, one in each of 
the cities, may form a joint-account to pump loanable funds, 
as we may express it, from the one place to the other. 
The two cooperators take action to make something for 
themselves out of an opportunity which the conditions 
present. One draws and the other accepts. From the 
language sometimes employed in the prints of London, one 
would gather the idea that the two were conspirators. 
They do conspire, or at least make common cause, but it 
is difficult to see what is reprehensible in their acts, for 
these amount simply to a form of trading, fundamentally 
a form of arbitraging or equalizing, to which, under analy- 
sis, practically all trading reduces itself. 

The illustration to be given beneath shows not only a 
joint-account (which of itself is so simple as hardly to jus- 
tify an independent example), but also shows a new use for 
the banker's long bill, that is, a use different from any here- 
tofore considered in this book. Suppose that on a given 
day, as July 1st, the Bank of A of New York has the follow- 
ing facts before it : 

Sight sterling in New York at 4.8745 

London arrival discount rate for bankers' 90 days' 

bills 3% 

Consequently 90 days' bankers' bills in New York at. . 4.8350 
The American XL Company's one-year 5% gold notes 
now having just 6 months to run can be bought 
in a large amount at 99.51, which is on a 6% basis. 

The bank now falls to reasoning in this manner: "Sight 
sterling is high. London discounts are low compared with 
rates in our money market. We can sell a 90 days' sterling 
bill at a very good figure indeed to-day. (This figure 



374 FOR El ON EXCHANGE 

is high for the double reason that the sight rate, from 
which it is derived, is high, and the spread from the sight 
rate down to the 90 days' rate is a narrow one because the 
London discount rate is low.] We can buy the notes of 
the XL Company, which we regard as a high class invest- 
ment, at a price to yield us 6% if we hold them till their 
maturity 6 months hence. These notes are a desirable pur- 
chase on this basis, but since we believe that in three months 
or so they will sell on a lower basis, as about 5%, they 
become still more attractive, in our view, as a present pur- 
chase. If our anticipation proves correct, we could sell 
them out at the end of the three months at such a price 
as to yield us better than 6% for the time we carried them. 
It would seem good to arrange with our correspondent, the 
Bank of B of London, to carry on joint-account about a 
half million of these notes by means of our 90 days' sterling 
bill. The chances for profit are enhanced by the prob- 
ability that sight sterling will not be above 4.85 three 
months hence. 

Assume that by an exchange of cables the joint-account 
is established on July 1st, and the initial steps in the 
enterprise are taken. Assume further that when the day 
arrives for buying in the cover, the predictions of the 
Bank of A are fulfilled, so that the notes are selling on 
a 5% basis, and sight exchange can be bought for 4.85. 
The following results: 

CALENDAR OF THE OPERATION 

Price of the notes 

July 1st The notes, which bear interest at 5%, payable 

semi-annually, have just 6 months to run. 

They will pay 102.50 at maturity, 100 for 

principal and 2.50 last interest installment. 

They are selling to-day at $ 99.51 

or on a 6% basis. 



BORROWING BY MEANS OF EXCHANGE 375 

Oct. 2d On this date these notes can be sold on a 5% 
basis, or for a price which as figured by prac- 
tical dealers will come to this : 8 

"Flat" price 100.00 

Accrued interest 1.26 101.26 

Transactions of Bank of A 

July 1st Buys $500,000 par of notes at 99.51 at 

cost of $497,550.00 

Sells £102,906 of 90 days' bills at 4.8350 for 497,550.50 
Oct. 2d Sells $500,000 par of notes at 101.26 for. . . 506,300.00 

Buys £102,906 sight bills at 4.85 at cost of. . 499,094.10 

SUMMARY 

Receipts 
July 1st From sale of long sterling. $497,550.50 
Oct. 2d From sale of notes 506,300.00 $1,003,850.50 

Expenditures 

July 1st For the notes $497,550.00 

Oct. 2d For sterling cover 499,094.10 

Balance PROFIT 7,206.40 $1,003,850.50 

The operation as an entirety yields a profit of $7206.40, 
which is, owing to the agreement for a joint-account, di- 
visible between the two banks. We speak advisedly of this 
gain as profit. It is true, had the Bank of A invested its 
own funds in the notes, the account would have to be made 
up as follows : 

July 1 Outlay, amount paid for notes $497,550 

Oct. 2 Return, received from sale of same 506,300 



Difference, or interest on investment for 93 days. . . 8,750 
This is interest on $497,550 at rate <>f 6.9% per annum 

* This everyday method of adding accrued nominal interest to 
flat prices gives an incorrect result. Usually the error is very 
small. 



376 FOREIGN EXCHANGE 

Tin- gain received from their sale at the advanced price 
(which they attained as they approached maturity) would 
be interest on the amount invested. But in the operation 
taken as an entirety neither the Bank of A on this side, 
nor the Bank of B on the other side, made the slightest 
advance of actual cash. What they did was to combine 
their forces in an exchange operation whereby the}' vir- 
tually borrowed money at the low London discount rate and 
employed it in New York at the higher rate there prevail- 
ing. They took the risk of exchange, to be sure a relatively 
slight one in this case because sterling was so high when 
thej' sold it in New York it was hardly likely they would 
have to buy it back at dearer rates. They took the risks 
such as they were in connection with the notes. For in- 
stance, had these notes suddenly become worthless while 
in the ownership of our two banks, the loss to these insti- 
tutions would have been about one-half million dollars. 
The gain they actually reaped was profit. It has the ap- 
pearance of something received for nothing. In this it is 
like any other pure profit. To borrow cheap and lend 
the same funds at an advanced rate is a procedure open 
to any one with sufficient credit if opportunity presents 
itself. The mere commercial bank virtually does this when 
it lends out the fund constituted by its deposits. 

If when October 2d comes round conditions should make 
unadvisable a termination of the investment in XL notes, 
its extension can be effected by replacing the expiring 
long bill by another, a species of refunding. 9 To explain : 
the dollars required on October 2d to buy sight sterling 
cover for the maturing 90 days' bill originally drawn, 
might be procured by the sale of a second 90 days' bill. 
This postpones for a quarter the necessity of realizing 

9 Refunding being strictly the discharge of one long-term, large, 
and systematically issued debt by the creation of another to re- 
place it. 



BORROWING BY MEANS OF EXCHANGE 377 

upon the security in which the fund transferred from 
London has been placed. In conclusion, it may be said 
such extensions or renewals of virtual loans effected by 
means of foreign bills are not uncommon, whether the opera- 
tion has been on joint-account or not. 

§ 88. American loans in foreign monetary capitals. — The 
distinction between loans by means of exchange or by 
means of the long bill, and ordinary international loans 
has been explained. Such loans by means of exchange 
as we have considered have consisted in the placing in 
New York of loanable funds derived from London. The 
reader should understand, of course, that as a mere mat- 
ter of mechanism the procedure which has been described 
is reversible. If, for example, London or Paris made a 
practice of dealing in long dollar bills on New York, they 
could on occasion make virtual borrowings from our money 
market in quite the same manner as we have supposed 
New York to borrow from London. Just at present (1919) 
the New York money market and "dollar exchange" have 
not developed to the point making this a regular and well 
known phenomenon. On the other hand, the making of 
ordinary short-time loans in foreign places by American 
banks is nothing new. Should money rates be higher in 
London than in New Y r ork, an American bank might place 
funds in the former city, but it would have to transfer the 
funds to the place where loaned by a remittance of sight 
bills (or some equivalent operation in exchange) and to 
rc-transfer them home at the end of the loan by a sale of 
sight bills (or some equivalent). It would thus, as an 
actual lending institution, shoulder the burden of the ad- 
vance. It would be out the use of funds at home for the 
period for which the foreign borrower would be having 
their use. If it made a sterling loan, it would assume the 
risk of exchange; if a dollar loan, the borrower would 
take the risk. 



378 FOREIGN EXCHANGE 

§ 89. Observations on the "finance bill." — The term 
"finance bill," is comparatively recent, but much used. 
From time to time before the war we would read that "the 
London market is flooded with American finance bills," 
or that "London bankers are discriminating against Ameri- 
can finance bills," or that "the Bank of England is re- 
fusing to rediscount bills for London houses suspected 
of buying American finance bills." Opinions appear 
to differ as to the exact meaning of the term, but one 
thing is clear, and that is that every finance bill is a 
long draft drawn by a banker or exchange house upon a 
foreign banking or accepting house ; in brief, it is a bankers' 
long bill. But not every bankers' long bill is a finance 
bill. Thus, if a banker who has purchased a non-discount- 
able documentary payment draft draws his own long bill 
as a means of recovering the cash thus laid out, it would 
not usually be held that he created a finance bill. 

As pointed out in § 35, the documentary payment bill, 
or time bill on a merchant, with documents attached and 
deliverable only in return for payment, is subject to the 
commercially recognized right of prepayment under rebate, 
and is not discountable in the open money market of the 
city on which it is drawn. In England this bill has not 
even been discountable with the correspondent to which 
it is remitted. This is a matter of English banking cus- 
tom. The American houses that have purchased such in- 
struments have been unable to realize sterling cash upon 
them until maturity, or until the drawees have seen fit 
at their own options to make prepayment. One method, 
however, of effecting an immediate recovery of the dollars 
expended on this side of the water for such bills, is for 
the banker to sell his own long bills against the same as 
collateral. He counts upon the proceeds of the documen- 
tary payment bills, either when prepaid or paid at ma- 
turity, to provide the funds to discharge the long bill or 



BORROWING BY MEANS OF EXCHANGE 379 

bills which he has drawn. He can make certain of this, 
except in cases where the insolvency of the drawee of a 
documentary payment bill intervenes, by seeing to it that 
the maturity of his own long bill is as late as, or later than, 
the maturity of the underlying trade bills. 

This type of bankers' long bill is drawn for the purpose 
of recovering funds that would otherwise have to remain 
invested in certain exporters' exchange that has been 
bought. In other words, the purpose is to avoid an invest- 
ment in exporters' bills, or to shift the burden of the ad- 
vance, or the burden of waiting, to the London money 
market. 

Now "to finance" any enterprise, venture, or undertak- 
ing, means to provide in advance the necessary funds and 
await the deferred return ultimately to be regained from 
the undertaking. If an American banker invests in an 
American exporter's long bill on a London consignee, this 
banker helps finance the shipment of the goods in the case. 
He provides the exporter with present funds and awaits 
a deferred return. But if, instead, our banker sells his 
own long bill against the trade bill as collateral, he shifts 
the burden of the advance to the party in London that 
discounts the said banker's long bill. This case can be 
analyzed as follows : our banker makes an advance to our 
exporter (before the importer has received and paid for 
the goods), but he gets his cash back immediately from 
some house in New York to which he sells his own long 
sterling. This house discounts the latter on its arrival 
in London, and has meanwhile sold sight sterling in New 
York against it. Thus this house passes the burden of 
the advance on to the money dealer in London who has 
made the discount. This dealer takes the burden of the 
advance, unless he shifts it to some one else in London by 
rediscount. Plainly, then, the effect of the banker's long 
bill with which we are at the moment concerned is to make 



380 FOREIGN EXCHANGE 

London finance the American export to England. In 
§ 44 uc saw how the sterling letter of credit system leads 
to London's financing commercial shipments all over the 
world. We have here an example of a similar effect. 

Why not call this class of banker's bills "finance bills"? 
Is not our finance bill presumably one which makes the 
foreign money market finance something for us? The 
answer is simply a matter of usage of the term. Usage 
excludes these particular bills. Other banker's long bills 
have the effect of making London finance some domestic 
undertaking of ours, while these at any rate only make 
her finance our export, which when it goes to her is her 
import as much as our export. Usage seizes upon this 
distinction. 

The best definition of a "finance bill" then would seem 
to be the following: It is any bankers' long foreign bill, 
except one drawn to recover a fund already invested in 
trade bills on the same place (that is, one drawn against 
documentary payment bills as collateral). It is called a 
finance bill because it has the effect of making the foreign 
money market (London) finance some domestic under- 
taking of ours for the term of the bill. Examples are the 
bills considered in our §§ 83, 84, and 85. 10 

itf In his clear, though, brief, "Foreign Exchange Explained," pp. 
88 and 102, Mr. Escher maintains that the term "finance hill" should 
be confined to the long bill drawn by the borrowing bank itself, the 
bill considered by us in § 85. He considers this "essentially dif- 
ferent" from the bill drawn by a London bank's agent to enable 
the placement of a loan in our market. But would it not appear 
that the bills here distinguished by Mr. Escher as "loan" bills 
and "finance" bills are formally different but essentially the same. 
In economic or financial nature and effect they are the same. When 
the London bank takes the initiative in transferring loanable funds 
for employment in our money market, it is responsible for the bill 
used to effect the purpose. This does not make the instrument 
any the less a finance bill. It merely removes any responsibility 
or odium for it from an American bank. 



CHAPTER XIII 
SPECULATION IN EXCHANGE 

§ 90. Futures, speculation, and hedging 1 . — A sale of ex- 
change for future delivery is a contract under which one 
of the parties agrees to deliver a stipulated amount and 
kind of exchange (as £10,000 of bankers' sight sterling) 
upon a designated future date, for a price determined 
upon when the contract is made, but payable on the fu- 
ture date when the exchange is actually delivered. The 
other part} r engages to take the exchange at the time and 
price named. Both purchases and sales of exchange for 
future delivery may be made either as speculations or as 
means of hedging against pre-existing speculations. 

The term "speculation," in a business sense, is often 
taken to mean the assumption of an unusual pecuniary 
risk in the hope of an unusual pecuniary gain. But a 
broader concept is preferable. It is better to abandon 
the test of the unusualness of the chance taken. Defined 
formally, a speculation in a business sense is the assump- 
tion of risk involved in the making of an outlay in money 
(or money's worth), or the committing of oneself to make 
such an outlay in the future (whether the commitment 
be absolute or conditional), for a return in money or its 
worth, in any instance where the relation or proportion 
between the outlay and the return is uncertain. Outlay 
may be certain and return uncertain, or reversely, or both 
may be uncertain, all these combinations being common 
in practice. 

It is apparent that many if not most business under- 

381 



382 FOREIGN EXCHANGE 

takings involve speculation as it is here defined. The 
reader may note that nothing in the definition draws the 
line between speculation and gambling, for in gambling a 
person makes a money outlay for an uncertain money re- 
turn. It is a question of definition whether we say gamb- 
ling involves or is speculation (as you prefer), or whether 
we refuse to say it. "We shall not try to settle this mat- 
ter but shall be content to say that our concern is with 
business speculation, or one kind of it — namely specula- 
tion in exchange. 

A speculation has been defined as the assumption of 
risk involved in a certain type of operation. It is also 
good English, when convenient, to call the operation itself 
a speculation, so that as a manner of speech one may say 
indifferently "the purchase of this property involves a 
speculation" or "the purchase of this property is a specu- 
lation. ' ' 

If an operation involving a speculation is undertaken 
precisely for the sake of this speculation, w r e shall call the 
operation an outright speculation. But if the assumption 
of risk is only secondary or incidental to some main piece 
of business w T hich would be profitable in the absence of 
the risk, we shall call the assumption of risk in such a 
case an incidental speculation. Both outright and in- 
cidental speculation have important bearings on the mar- 
ket for exchange. 

A hedge — the dictionaries seem to authorize only the 
verb "to hedge" but let us be high-handed and use the 
noun — a hedge is a speculation of such character that when 
added to another prior or more important speculation the 
element of risk in the latter is either eliminated or reduced. 
A hedge and the major speculation are of a complementary 
character and when merged in one larger operation make 
the whole less risky than either element alone. 

§ 91. Operations in futures as a means of hedging. — The 



SPECULATION IN EXCHANGE 383 

sale or the purchase of exchange for future delivery may 
be a hedge. 

For illustration, suppose a merchant of our country has 
committed himself to forward a certain kind and quantity 
of goods to an English buyer 60 days from now, the price 
to be £10,000, collectable b} r means of the American's draw- 
ing a sight draft for this sum at the time of the shipment. 
Suppose the exporter's standing is such that his exchange 
always meets with a ready sale. He has sold merchandise 
for future delivery. In consequence he will have sight 
sterling to sell in the future. If he decides to wait until 
the day of shipping and drawing comes round, before dis- 
posing of this, he will have to take the rate of exchange 
current on that da}\ Should this rate turn out to be 4.87 
he would receive $48,700, should it be 4.84 his takings 
would come to but $48,400, which is $300 less. Thus in 
addition to any other speculations it might embrace, the 
business would certainly involve a speculation on the fu- 
ture course of sight sterling. 

To avoid, cancel out, or neutralize this speculation, in 
a word to make a hedge against it, it is only necessary to 
sell the £10,000 of sight sterling for future delivery. Sup- 
pose the engagement to sell the goods is entered into on 
July 1st. They are to be shipped on August 30th. The 
£10,000 of sight sterling may be sold on July 1st for de- 
livery August 30th in return for payment August 30th, but 
at a rate agreed to July 1st. Suppose the buyer of this, the 
exchange for future delivery, whoever he may be and 
whatever his purpose may be, agrees to take it at 4.8550. 
His making a contract to receive it at this figure eliminates 
the exchange speculation from the exporter's operation. 1 
This contrad sets in advance the number of dollars to be 
realized from the goods by the exporter as 48,550. It will 

i Assuming, of course, the solvencj and ability of the purchaser of 
the exchange for future delivery '.<> perform his agreement. 



3te FOKEKiN EXCHANGE 

usually be possible for the latter to find the rate at which 
he can sell the exchange-future before he brings to com- 
pletion his contract for the future sale of the goods, in 
which case there is never a moment when the operation 
taken as an entirety involves an exchange speculation. 

The sale of the exchange for future delivery is in isola- 
tion an outright speculation. But combined with another 
transaction to which it possesses the proper complementary 
character, it becomes a hedge. The other transaction must 
also necessarily be a speculation if it stands alone. A 
speculation cannot be added to a certainty and produce 
the phenomenon of the hedge, namely, the phenomenon 
of the reduction of risk by the coupling on of what in 
isolation would itself be a risk. 

One who combines two speculations to form a hedge 
becomes thereby so much the less a speculator. Much of 
the interest in the market for exchange for future delivery 
comes from parties that are too conservative to speculate 
and are interested because they want to make hedges. A, 
as the seller, and B, as the buyer of the future exchange, 
may both be hedging. These are parties that are well met. 
B might be an exchange dealer who had sold long sterling 
for which he needs to buy in sight sterling as cover on or 
about August 30th. His purchase of this in advance at 
4.8550, removes the speculation on the sight rate from 
his operation. 

§ 92. Going long of exchange. — All methods of making 
a profit from a speculation in any marketable article — 
wheat, cotton, stocks, exchange — reduce to one funda- 
mental operation, buying a thing cheaper and selling it 
dearer. "When the speculator "goes long" he buys first 
and sells afterward. AYhen he goes short he sells first 
and buys afterward. In the one case he profits from a 
rise, in the other from a fall, in the price while he is op- 
erating or speculating. 



SPECULATION IN EXCHANGE 385 

In a strict sense one goes short only in case he sells some- 
thing he does not already have on hand or in stock. Either 
the sale must be for future delivery, or, if for immediate 
delivery the article or articles must be borrowed for this 
delivery and the short-seller will thus come to owe them 
to the lender, to be delivered at some future time or upon 
demand. Thus to go short means to go under a contract 
to deliver something in the future without now having it 
on hand, or to go under a commitment of some kind to 
deliver or find this something not now on hand. Such a 
commitment is not necessarily an express contract to de- 
liver this thing to some person, but may be any condition 
of practical compulsion to find the thing. Thus a manu- 
facturer of some product may by reason of sales of it for 
future delivery put himself short of the raw material 
from which it is made, without this signifying that he has 
made a contract to deliver this very substance to any per- 
son. So again the banker who has sold his long sterling 
bill puts himself short of sight sterling or of cables, no 
matter which, insomuch as he places himself under the 
necessity of finding this for cover at a future date. 

If a man having 500 shares of AB stock should sell out 
100 shares on a given date because he thought the price 
higher then than it would be subsequently, and should 
succeed later in buying back the same quantity at a lower 
figure and therefore at a profit, he would not have been 
short of AB in a technical sense. He would be like a 
short in that he profits by the same movement of prices 
that would benefit a short, but he would not be confronted 
with a certain danger that lurks in the position of a short. 
The latter can conceivably be caught in a corner, while the 
man who has sold from stock on hand cannot. 

Dealers in bills often k<> short of exchange in the true 
technical sense, so that they place themselves under 1 1n- 
positive necessity of procuring this article at some sub 



386 FOREIGN EXCHANGE 

sequent date, hoping of course to do so cheaply and at 
a profit but being open to unavoidable losses in case the 
course of exchange should go against them. It is now our 
province to consider in a little more detail the methods 
of going long of exchange. 

Pure speculation in exchange on the long side. — By a 
pure speculation we mean one not compounded with in- 
vestment or borrowing. The only way a dealer can make 
a pure speculation in exchange on the long side is to buy 
exchange for future delivery, wait till he receives it on 
the designated future date, and then sell it at the market. 
Suppose that on March 1st dealer A makes a contract 
with B to take £5,000 of bankers' sight bills from the 
latter on April 15th at the rate of 4.8550. He has bought 
a future. He pays out no money and receives none on 
March 1st, and thus has neither made an investment nor 
received an advance. He has taken a chance on purpose 
because he regarded it as a good chance, and has thus made 
what we have called an outright speculation. If on April 
15th sight sterling should happen to stand at 4.8750 in 
the market, he has made a good speculation. For on that 
day B must deliver him £5,000 at 4.8550. This will cost 
him $24,275. It can immediately be sold at 4.8750 for 
$24,375, or at a profit of $100, which is a return for noth- 
ing else than making a commitment and taking a risk. 
If the market rate on April 15th had turned out to be un- 
der 4.8550, our operator would have made a loss, insomuch 
as he is then compelled to pay more for the bills which 
he must buy than they would cost in the market. If the 
other party, B, were a speculator, he would gain in this 
case, as he could buy in the market and resell to A at the 
higher figure named in the contract. However, B may 
not have been a speculator, but some one engaged in hedg- 
ing. 

Operations on the long side involving investment or 



SPECULATION IN EXCHANGE 387 

lending. — All other methods of going long of exchange 
than the isolated operation of buying a future, by neces- 
sity involve either an investment in exchange or the mak- 
ing of a foreign loan. 

(1) Let us consider first an illustration of a speculation 
on the long side associated with an investment in exchange. 
It is true this leads us into what is essentially a repetition 
of an illustration already given, the one of an investment 
in exchange, but it is worth while to look at the same 
thing anew and from a different standpoint. If sight 
sterling is very low at present and a dealer thinks it will 
be materially higher in 60 days, a feasible way for him 
to go long and speculate for the rise, is to buy some 60 
days' bills and hold them till maturity (i.e., invest in 
them). He might of course close out at some earlier time 
than the very end if he thought it best, and this by dis- 
counting the bills in London before their maturities. 
Suppose the following data are given on March 1st. 

Sight sterling 4.84 

London arrival discount rate 3% 

60 days' bills therefore at 4.8125 

And suppose the following proves true on May 3d. 
Sight sterling 4.88 

This gives us a very favorable case. Let us see what 
comes out of it. A New York dealer goes long on March 
1st by purchasing £10,000 of 60 days' bills at a cost of 
$48,125. Allowing these to run till maturity without dis- 
counting them in London, he is enabled to sell £10,000 
of sight sterling on May 3d against them as cover. At 
4.88 this fetches him $48,800. His return exceeds his out- 
lay by $675. This gain is attributable chiefly to the very 
fortunate speculation on the course of the sight rate. To 
isolate what we may regard as the speculative profit we 



388 FOREIGN EXCHANGE 

would need to suppose that the sight rate remained on May 
3d, where it was on March 1st, that is at 4.84. In this 
case the return from the operation would have been $48,- 
400 and the gain but $275. The actual gain exceeds this 
by $400. 

It was first asserted some time back that every invest- 
ment in exchange involves a speculation on the course of 
the rate of exchange. We now see the same fact from 
another angle, for we see that whenever an operator 
speculates on the long side by the method of purchasing 
30, 60, or 90 days bills, the speculation necessarily involves 
an investment. The difference between an investment in- 
volving a speculation and a speculation involving an in- 
vestment is simply one of degree. The question is merely 
which element the operator regards as the main one. Con- 
ditions might suggest investment if it were not for a very 
bad incidental speculation. For instance money rates 
might be very low in New York and high in London, but 
the sight rate on London might be so high now, and be 
associated with prospects of being so much lower later, 
that investment would be counter-indicated and restrained. 

(2) A banker may go long of exchange by making loans 
to foreigners in foreign money, by placing a franc loan 
in Paris or a sterling loan in London. He will profit by 
having the value of the foreign money in terms of our 
money, as expressed in the exchange rates, low when he 
places the loan and high when it matures. It is conceivable 
he should place the loan not primarily because interest 
rates were high in the foreign capital but primarily be- 
cause the speculation on the exchange rate seemed attrac- 
tive, in which case we would have a speculation in foreign 
exchange on the long side coupled with a loan abroad as 
an important incident. 

Usually such speculations would not cover a long period 
and involve the purchase of long-term foreign securities. 



SPECULATION IN EXCHANGE 389 

But if before the military collapse of Eussia in the World 
War some one should have advised Americans with money 
to buy Russian government bonds on the grounds that 
the ruble had a very low value in dollars at the time 
and would probably have a much higher one some time 
in the future, when the bonds might be sold to advantage 
in Russia, this some one would be advising going long of 
Russian exchange. At the present writing (1919) it 
would appear that such advice would have been very bad. 

It would be possible for a dealer to go long of some 
kind of exchange, sterling, for instance, by purchasing 
sight drafts to be remitted for the credit of the London 
deposit, allowing the fund so established to remain un- 
touched for a time, and then selling sight drafts against 
it later. This would essentially be an example of a 
speculation involving a loan, because our deposits in Lon- 
don are virtual demand loans to London banks. But this 
method of speculating for a rise in the rate for sterling 
in New York could only be appropriate when a rather 
sharp rise, or considerable rise in a brief time, is expected. 
This is because the rate of interest received on London 
balances is so low that a loan at that rate is per se an 
unremunerative employment of funds. 2 

§ 93. Going short of exchange. — There is but one way 
to make a pure speculation in exchange on the short side, 
or for the fall. This is to make a sale for future delivery 
as an independent and isolated operation, and wait, if not 

2 Any one having some special credit abroad against which he is 
entitled to draw sight exchange, may defer the sale of this for a 
time because of a belief the rate for it will be higher later on 
than now. But a speculation for the rise, of this character, is not 
likely to be undertaken with the intention that it shall endure verj 
long, this because of the loss of interest entailed. If an exporter 
entitled to sell sight or long bills at the present moment should 
hold off for a few days on the theory that a rise is imminent, be 
would be engaging in a mild speculation on the long side. 



390 FOREIGN EXCHANGE 

until tlic day set for delivery, at least for a certain time, 
before buying in the exchange to be used to discharge the 
contract. During this period the dealer remains short 
without the speculation's being alloyed with any opera- 
tion with a finance bill or other borrowing operation. As- 
suming him to remain short until the day of maturity of 
the contract (though he might conclude to purchase cover 
at an earlier date), his profit or loss will depend on the 
relation of the market rate of that day to the rate at which 
he sold for future delivery. Thus if he sold for 4.86 and 
buys in cover at 4.84 on the day of delivery, his profit as 
a speculator is evidently 2e" a pound or $200 on a £10,000 
contract. It is clear that like other shorts, he is interested 
in seeing a low price on that day in the future when he 
is to cover. 

Operations on the short side by means of long bills. — 
We have already seen (§85) that if a banker sells a long 
sterling bill he is by this action put short of sight sterling 
(though sterling cables might be bought in later as a sub- 
situte). How this banker comes to enjo3 r a virtual loan 
made him from the London money market has already 
been explained. Heretofore we have looked upon the 
speculation in sight exchange on the short side which is 
associated with this operation as the incidental feature. 
But there may be occasions when the operation is under- 
taken not so much because the local money rates are higher 
than those of London as because the speculation is allur- 
ing. This gives us the case of speculation on the short 
side with borrowing as an incident, which contrasts with 
what we have called a "pure" speculation. Formerly 
the United States was accustomed to make exceedingly 
heavy exports of commodities in the autumn of each year, 
which produced, as a fairly regular and predictable 
phenomenon, a great drop in the rates for sterling in New 
York in that season of the year, the huge and concentrated 



SPECULATION IN EXCHANGE 391 

supplies of exporters' foreign bills being the technical ex- 
planation. 3 Extensive sales of long sterling from two to 
three months before this expected movement were very 
common. These sales were examples of what we are at the 
present moment describing, going short of sterling ex- 
change to reap a profit from its fall, the means being the 
sale of long bills. This style of operation may be expected 
to remain prominent whenever and so long as our export- 
ing shows the kind of periodicity which explains it. 

§ 94. Recovery of funds laid out for documentary pay- 
ment bills. — Merchants' long bills with documents at- 
tached deliverable against payment by the drawee, are 
subject to the right of prepayment by the latter under the 
retirement rate of discount. Bills of this character drawn 
on England are not discountable on their arrival either 
with the correspondent bank or in the open market. Each 
individual bill will convert into sterling cash on that par- 
ticular date after arrival and acceptance, when the drawee 
at his option choses to prepay it or take it up. And then 
the amount it will yield will depend upon the retirement 
rate of discount of that particular day. At the latest it 
will be paid on its date of maturity, if the drawee has not 
seen fit to exercise the right of prepayment, and will then 
yield its face value. 4 This discussion holds, of course, on 
the assumption that there is no dishonor of the bill by the 
drawee. 

The consequence of these facts is that an exact "no- 
profit" buying price (to which the banker might add 
profits at the rate he decides on according to degree of 
security, competition, etc.) simply cannot be computed 

3 Tin- majority of these bills would be drawn on England and in 
sterling, ljui even those drawn in other currencies, through the 
influence of arbitrage (see Chapter XIV) contributed aH cll'ectually 
to the main result. 

* Compare § 67. 



392 FOREIGN EXCHANGE 

for the individual documentary payment bill. Tf a given 
D. P. bill, offered on this side to-day, were destined to be 
prepaid on arrival, and we knew this in advance and also 
knew what the retirement rate of discount would be at 
the time, we could compute a no-profit buying price for it 
with the same ease and accuracy as for the discountable 
types of exchange, and according to the methods which 
apply to the latter as explained in Chapter IX. If the 
bill in question were destined to be prepaid 30 days after 
arrival, at the same or at some other retirement rate of 
discount, it would have a different theoretical value in 
dollars as a purchase to-day, and if it were to be allowed 
to run till maturity, still another value. 

Documentary payment bills that are drawn against 
perishable goods, which must be procured promptly by the 
drawee, have, of course, an excellent chance of early pre- 
payment, and the banker may take this into his reckoning, 
but speaking of the generality of these bills, the precise 
theoretical no-profit or basic buying rate for each individ- 
ual instrument cannot be determined. 

When a banker takes such a bill for collection, the un- 
certainties pertaining to it do not of course become his 
problem, but remain the concern of the drawer or ex- 
porter. Bankers, however, make outright purchases of 
these bills in large numbers, and in consequence have re- 
sorted to special methods of handling them which it is now 
our province to describe if only in a brief way. Since in 
some instances sales of the banker's own long bills, and 
in others sales of demand drafts for future delivery are 
involved, this discussion has been postponed to this point 
instead of having been undertaken in Chapter IX. 

If the banker who buys a documentary payment bill 
is willing to lock up the funds paid for it, until it is in 
the course of events discharged abroad, and is willing to 
take a speculation as to the rate at which he can, after 



SPECULATION IN EXCHANGE 393 

being notified of its retirement, sell demand sterling or 
cables against it, he need take no special action in con- 
nection with it. But since this procedure involves both 

(1) a postponement of the recovery of funds and (2) an 
exchange speculation, it is often not altogether satisfac- 
tory. An additional speculation as to the future course 
of the retirement rate of discount is likewise involved, this 
being in fact ineradicable. 

The two special plans of action which serve as partial 
solutions of the difficulties are (1) the sale of the banker's 
own long bills against the purchased documentary pay- 
ment bills as collateral for the acceptance account, and 

(2) the sale of demand bills for future delivery accord- 
ing to a schedule of probable prepayments of the mass of 
documentary payment bills bought and held abroad. The 
first has the advantage of bringing about an immediate 
recovery of funds, while the second reduces the speculation 
as to the future course of sterling rates in our market. 

To speak of these in a little more detail and in order, 
the London correspondent banker or acceptance house upon 
which our bank will draw its long bills, almost always re- 
quire collateral security for the grant of their acceptances. 5 
Documentary payment bills are freely received as such 
collateral. Now then, if our bank has some of these 
abroad it may find it an advantage to draw its own long 
bills in such amounts and maturities that the collections 
from the documentary payment bills will furnish the 
sterling required for the discharge of the same, meanwhile 
pledging the documentary payment bills as collateral to 
protect the acceptance account. It is necessary that the 
latter should be paid early enough to cover the banker's 
long bill drawn against them, and therefore presumably 
they should all have maturity dates on or before the due 

5 Compare § 40. 



394 FOREIGN EXCHANGE 

date of this bill. If they happen to be prepaid no harm 
follows except a loss of interest due to the difference be- 
tween the retirement rate and the deposit allowance rate. 

It is not customary for bankers to think of such of their 
long drafts as are drawn against previously purchased 
documentary payment exchange, as being "finance bills." 6 
For the bills that bear this name are drawn not to recover 
moneys previously laid out in the purchase of sterling ex- 
change, but to secure new funds for free employment dur- 
ing 60 or 90 days or more. The distinction has a tech- 
nical banking validity, though in both cases London 
finances us. London finances our exports to England in 
the one instance. In the other its accommodation is for 
an unidentified purpose, the purpose to which the drawer 
of the finance bill happens to devote the funds he secures 
by means of it. 

One of our bank's holding a quantity of documentary 
payment bills abroad may be able on the basis of its ex- 
perience to draw up a schedule of probable prepayments 
to come from the whole mass of them, despite the fact it 
cannot predict the dates of prepayment of each individual 
instrument. In giving an illustration of this, Margraff T 
supposes that bills held abroad which will produce about 
£50,000 in total, will yield £10,000 fifteen days after ar- 
rival, £20,000 on the thirtieth day, and £20,000 more be- 
tween the forty-fifth and sixtieth. On the basis of this 
schedule the banker may sell demand sterling for future 
delivery, to wit, £10,000 for the 15th day after purchase, 
£20,000 for the 30th day and so on. There is, to be sure, 
a certain degree of speculation left in this business. If 
prepaj^ments should prove slower than the schedule, over- 
drafts might be incurred, and if they prove faster, the 
returns will be affected to a degree, but the major specula- 

e Compare §§ 85 and 89. 

i In his "International Exchange," p. 56. 



SPECULATION IN EXCHANGE 395 

tion as to the future course of sterling in this country is 
eliminated. The reader understands, of course, that the 
scheme is to have the proceeds from the documentary pay- 
ment bills, as they are taken up abroad, provide for the 
discharge of the demand drafts promised for future de- 
livery here. 

It is not our intention to press further into this sub- 
ject. Thus we pass over the technical problem, faced by 
the exchange banker, of figuring the exact rates which he 
can offer for documentary payment bills, under these plans 
of handling them. The basic factors that must be taken 
into account here are the probable net returns at home 
in dollars to be had from the documentary payment bills, 
the time of their receipt, and if this is a future time (as 
when exchange for future delivery is sold) the rate of 
interest to be charged the operation meanwhile. 

Beneath appears a conspectus of the sources of supply 
and demand, for exchange for future delivery. 

The Supply of Futures Comes From 

1. Operators who go short of exchange as an outright 

speculation. 

2. Bankers who have invested in long foreign bills. 

3. Merchants who have sold goods abroad for future de- 

livery. 

Exporters of goods for future delivery or mer- 
chants who for any reason know in advance thai 
they will have exchange to offer in the future, may 
sell it for future delivery to eliminate specula! ion. 

4. Bankers who have purchased a line of documentary 

paymenl hills. 

These bankers may offer futures againsl an as- 
sumed schedule of payments and prepayments as 
explained just above. 



396 FOREIGN EXCHANGE 

The Demand for Futures Comes From 

1. Operators who engage in an outright speculation on 

the long side. 

2. The drawers of finance bills. 

3. Merchants who have purchased foreign goods for fu- 

ture delivery and whose arrangements for payment 
are such that they can reduce speculation by buy- 
ing some type of exchange for delivery on a fu- 
ture date appropriate to their undertaking. 



CHAPTER XIV 

ARBITRAGE 

Foreword. — Arbitrage of Exchange is a very tech- 
nical SUBJECT AND CAN ONLY BE TREATED TECHNICALLY. A 
COMPETENT EXPLANATION OP IT CANNOT MERELY BE READ BUT 
MUST BE STUDIED. 

§ 95. Arbitrage and arbitrated rates, parities, and prices. 
— The term "arbitrage of exchange" 1 signifies either 

1. An exchange operation of a certain kind, or 

2. A mere exchange reckoning or calculation of a cer- 
tain kind. 

A set definition of an arbitrage operation is a thing so 
formidable that we will do best to give a mere illustra- 
tion our first attention. Suppose a New York banker has 
telegraphic information of the fact that cable transfers 
on London are now selling in Paris at the rate of 25.15 
francs per pound sterling. At New York the rate for 
cables on London is 4.87, while that for cables on Paris 
is 5.17^ meaning that 5.17^ francs can be purchased for 
$1. Thus 

London 

Hew York 
Cables on London 4.87 
Cables on Paris 5.17-^ 

Paris 
Cables on London 25.15 



i Also known as arbitration of exchange. 

397 



.i.is FOREIGN EXCHANGE 

The relation between these rates makes possible the win- 
ning of a slight prolit from what is known as a "three- 
point" arbitrage operation. Suppose that the operator 
is at New York and for simplicity's sake that he works 
with $100. By aid of his tables or of a brief computation 
he soon determines what to do. 

1. lie first expends the $100 for a cable transfer on Paris. 

At the rate quoted this would buy 517.50 francs of such 
exchange and enable him to establish almost instantane- 
ously a credit for this amount with his Paris correspond- 
ent. 

2. He next instructs his Parisian correspondent to expend the 
credit in francs for a sterling cable, to be bought at Paris. 

517.50 francs will at the rate of 25.15 purchase 20 5 yioo 

pounds of cable transfer on London. 

(517.50^25.15 = 20.57) 
This sterling is placed to the credit of our operator's ac- 
count with his London correspondent. 

3. Finally he sells £20.57 of sterling cables in New York 
for $100.17. 

£20.57 sold at 4.87 bring in $100.17. 

The operation consists of three transactions. 

1. A conversion of dollars into francs by the purchase of a 

cable on France (which is not the only way to make this 
conversion) 

2. A conversion of francs into pounds by the purchase at Paris 

of a cable on London (which again is not the only way 
to effect such a conversion) 

3. A conversion of pounds into dollars by a sale at New York 

of a cable on London (which also is not the only way to 
effect such a conversion) 

The operator laid out $100 and got back $100.17, mak- 
ing a gross profit of 11$ or about l-6th of 1%. Out of 
this telegraphic charges and other incidental expenses 
must be paid. The gross profit would be $170 on an op- 



ARBITRAGE 399 

eration with $100,000, and an operator who could make 
a profit at this rate would, we are given to understand, 
consider himself very fortunate indeed. 

Arbitrage operations assume such a variety of forms 
that a definition, which, will at once include all these op- 
erations and exclude every kind that is not arbitrage, neces- 
sarily becomes lengthy and complex. In offering the fol- 
lowing we do not mean to suggest that the reader can gain 
from it an understanding of arbitrage without thorough 
illustration. Speaking now of arbitrage of foreign ex- 
change as an operation, we may say this is an operation 
conducted by a dealer in a given country, which always 
involves a purchase or sale of foreign exchange for his 
account in another country or in other countries, and con- 
sists in an outlay of funds at home to purchase exchange 
on some foreign country and a return of funds to the 
home office either (1) from the sale of exchange on some 
different foreign country or (2) from the receipt from 
abroad of a remittance of exchange payable or salable 
in the home country, the operation being undertaken to 
make a profit from an excess of the return over the out- 
lay which has become possible owing to the relative posi- 
tions of the several exchange rates governing the transac- 
tion. The outlay and the return in an arbitrage opera- 
tion take place as nearly simultaneously as possible, but 
the outlay may precede the return, or the return precede 
the outlay. The one who operates is called an "arbitrager" 
or an "arbitrageur." 

If the operation embraces exchange transactions in two 
places only it is known as "two-point" arbitrage. If 
transactions in three places are involved, we have ''three- 
point" arbitrage, and so forth. The example we con- 
sidered a moment ago was one of three-point arbitrage. 
(See §99). 

Arbitrage of foreign exchange (we speak as well of ar- 



400 FOREIGN EXCHANGE 

bitrage of stocks and bonds) may also be defined as the 
taking of a fund in the currency of one country, and the 
conversion of it by means of a transaction in exchange 
into a currency of another country, and the re-conversion 
of it into the original or home currency by another trans- 
action in exchange — or the conversion of it into the cur- 
rency of a third or even of a fourth country and the final 
re-creation of it as a fund in the home currency by fur- 
ther transactions in exchange — with a view to having the 
returned fund exceed the one started, when this result 
is made possible by the relative positions of exchange 
rates. A fund is, so to say, sent out on a circular journey 
and reappears as a slightly larger one in its original cur- 
rency. (Compare § 96 on the transfer of funds). 

Arbitrage as a computation. — The preceding has re- 
ferred to arbitrage as an operation. But the term also 
means a mere computation, the computation of what is 
often called a "par" or "parity." For example, 

A certain stock sells in London at £ 33. a share 

Sight sterling in New York is at 4.87 

The New York price of this stock, which is the 
equivalent of the London price for trading 
purposes, must be based on tbe rate of 
exchange and will be $160.71 a share 

Whether the sight or cable rate should be 
employed in any given computation de- 
pends on the nature of the transaction to 
which it relates. 

The $160.71 per share is an arbitrated price or arbitrated 
par or parity. It is distinct from the actual price in New 
York from which it may differ at any moment. A gap 
between the two is in fact what leads to an arbitrage op- 
eration in the stock, while the continual succession of such 
operations is what tends to drive the two prices, the ar- 



ARBITRAGE 401 

bitrated and the actual, together or make them coalesce. 

If we speak of the London price for some article, ex- 
pressed as it is in sterling, and the New York price ex- 
pressed in dollars, as being equivalent or equal or at an 
equality or at a parity, the one rational meaning our 
statement can have is that the arbitrated price and the 
actual price in one of these cities are the same. If we say 
"Atchison is higher in London than in New York" this 
means practically that New York's arbitrated price from 
London is higher than New York's actual price. It is 
solely by the comparison of the arbitrated and the actual 
prices in our currency that our dealers can tell whether 
to buy the stock in New York and sell in London, or do 
the reverse, or do nothing. 

An arbitrated price is then the price of an article in 
one country and in the currency of that country con- 
verted to a price in terms of the currency of another coun- 
try, the conversion being effected by means of the ratio 
afforded by the existing exchange rate between the two 
countries. The exchange rate may be the sight or cable 
rate and may be taken from the exchange market of either 
one of the cities, according to circumstances. It should 
be understood that in times of free intercourse the two 
cable rates (the one in the first country on the second and 
the one in the second on the first) tend to rest at exactly 
the same value ratio between the two currencies, except 
where a margin between bankers' buying and selling rates 
for cables enters in. The use made of an arbitrated price 
is to compare it with the actual domestic price to tell 
whether a profitable trade in the article is possible. In- 
cidental costs of effecting the trade must of course be 
considered. 

The mint par or mint par of exchange (for definition 
and explanations see §103 to follow), such as the figure 
$4.8665 between the money units of England and of the 



402 FOREIGN EXCHANGE 

United States, is employed in many conversions of values 
from one currency to another, instead of the rate of ex- 
change, where the purpose of the conversion is merely 
statistical. Customs houses may also commit the error of 
using the mint par. The mint par has no direct bearing 
whatever on the practical undertakings of trade and com- 
merce. 

Not only the price of a security in a foreign country 
but the price of a draft or cable transfer in that country 
on a third country, or on our country as well, may be the 
subject matter of an arbitrage computation. In other 
words, we may have an arbitrage conversion of a foreign 
quotation of exchange. 

To illustrate, 

In Amsterdam telegraphic 

transfers on London are at. 12.10 florins per pound sterling. 

In New York the cable rate on 

Amsterdam is 40.2 cents per florin. 

The New York Parity op a 
Pound through Amster- 
dam is 4.8642 dollars per pound. 

While New York's actual rate 
for telegraphic transfers on 
London might be, say 4.8645 dollars per pound. 

The "parity" of $4.8642 is derived from the two num- 
bers preceding it. So far as mere arithmetic is concerned, 
the computation takes this form : 

£1 = 12.10 florins. 
1 florin = .402 dollars. 
Therefore £1 = 12.10 X -402 or 4.8642 dollars. 

The significance of the figure is this: it shows that a 
pound bought through Amsterdam will cost the New York 



ARBITRAGE 403 

dealer $4.8642, and equally that a pound sold through 
Amsterdam will yield a New York dealer $4.8642, in- 
cidental charges being disregarded in both cases. Thus 

NEW YORK BANKER SELLS A POUND THROUGH 
AMSTERDAM 

He has a pound of credit in London. 
His agent on order sells a cable for £1 in Amsterdam. 
This yields a credit of 12.10 florins in Amsterdam. 
Banker A himself sells 12.10 florins of cable on Amster- 
dam in New York at $.402 per florin, for $4.8642 

Again 

NEW YORK BANKER BUYS A POUND THROUGH 
AMSTERDAM 

He buys 12.10 florins of cable on Amsterdam which at 

$.402 per florin cost $4.8642 

His agent in Amsterdam spends the 12.10 florins there 
for £1 of cable on London. So the pound has cost 
$4.8642. 

For every pair of rates (consisting of a rate in Amster- 
dam on London and a rate in New York on Amsterdam) 
there is a given parity. For a few examples: 



isterdam on 


New York on 




London 


Amsterdam 


Parity 


12.10 


40.20 


4.8642 


12.10 


40.25 


4.8702 


12.10 


40.30 


4.8763 


12.11 


40.20 


4.8682 


12.11 


40.25 


4.8743 


12.11 


40.30 


4.8803 



The arbitrager provides himself with extensive tables 
for ready reference. The figure known as the "parity" 
is, as already stated, really an arbitrated foreign price for 



KM FOKKKJN KX< '1 1 AN( IF 

some kind of exchange. Tts chief use is to show instantly 
what possibilities may exist for an arbitrage operation. If, 
for instance, the actual rate for a pound sterling of cable 
transfer at New York (say 4.8705) is higher than the 
parity through Amsterdam (say 4.8702), it shows that a 
profit can be gleaned by selling cables on London and 
covering by buying cables on Amsterdam and repurchas- 
ing cables on London in Amsterdam. If the actual rate 
in New York is below the parity, it shows that a profit 
can be made by buying cables on London in New York 
and selling cables on London in Amsterdam and selling 
cables on Amsterdam in New York. If the actual rate and 
the parity are the same, no profit is possible from an 
arbitrage operation. In several sections to follow, the 
subject of arbitrage and indirect remittance will be 
elaborated. 

§ 96. The two methods of direct transfer of funds. — All 
arbitrage manuals seem to be singularly faulty in the mat- 
ter of exposition, and are practically useless as text-books. 
They usually employ a very confused terminology, give too 
few definitions, and worthless ones at that. The present 
chapter of this book takes the liberty of forming its own 
terminology where necessary. 

Funds and their transfer. — Among its several meanings 
the word fund has that of a changing or moving stock of 
property which retains a given ownership or control. Ex- 
pressed, at greater length, a fund in this sense is a stock 
of money or of other forms of property for which money 
has been paid and which are convertible back into money, 
a stock which is retained in a constant ownership or con- 
trol while it changes its form or location, or both. Thus, 
I might have a sum of actual money in New York. I 
might deposit it with a bank, draw a check on this deposit 
and pay for a banker's sight draft on London, exchange 
this abroad for bank credit, use this bank credit to buy 



ARBITRAGE 405 

Union Pacific stock in London, ship the latter back to New 
York and resell it there in the stock market for a check 
on a local bank which I should finally deposit in the first 
mentioned bank. There has been a stock of propertj^ 2 
throughout these dealings that has been mine and has 
been under my control. This fund, as it is convenient to 
call it, has been embodied, so to say, first in actual money 
of the United States, second in bank credit in New York, 
third in a sterling bill of exchange, fourth in a deposit 
credit in a London bank, fifth in a certain number of 
shares of Union Pacific stock, sixth in a check on 
some New York bank, seventh and finally in a deposit 
credit with my own New York bank. It has changed 
its form a number of times and also has changed its 
place. 3 

A transfer of funds from one country to another may 
be effected 

(1) by an export of merchandise or securities, 

(2) by an export of actual money 4 or of gold 
bullion, or 

(3) by means of a pure operation in exchange. 

Hereafter in this chapter we have to do with transfers 
effected in the latter manner alone. A transfer of funds 

2 Property, not in the popular sense of land, buildings, or tangible 
goods, but in the sense which includes rights of action, credits, 
bank deposits, etc., or strictly rights against persons as well as 
in things. 

8 The fund is not represented to be a physical continuum. It is 
merely something we choose to regard as a persisting identity 
for convenience of thought and expression, just as it suits us in 
some connections to think of a chapter of a lodge or fraternity as the 
same chapter now as at the time of its foundation although all the 
original members may now be dead and gone. 

•* If the exported money is other than gold and is sent or 
carried from a gold standard country, it will ultimately return 
home. 



406 FOREIGN EXCHANGE 

between two places, as New York and London, is direct 
if it involves exchange operations only in New York and 
London. It is indirect if it involves such operations in 
a third city, as Paris, or in a number of outside cities, 
as Paris and Amsterdam both. Direct and indirect have 
then a geographical significance in this connection, this 
being a matter of arbitrary definition. 

A direct transfer of a fund may be accomplished in 
two ways. (1) The party who transfers may remit ex- 
change for his account to his agent or partner abroad. 
(2) He may as an alternative instruct the agent to draw 
upon him and sell the exchange so drawn in the foreign 
place to which the fund is to be transferred. In other 
words, the exporter of a fund may produce the required 
result either by remitting exchange or by submitting to 
draft. Either method brings about, first, a disappearance 
of a fund at home (in the shape of money or credit sur- 
rendered), and second, its appearance abroad in the 
changed form of foreign money or credit. 

Choice between the two methods of direct transfer. — 
Where each of the two centers between which a direct 
transfer of a fund is to take place possesses a free and ac- 
tive market in exchange on the other, both methods of 
transfer are feasible. But the choice between them is not 
always a matter of indifference, because now one and now 
the other may have the advantage. 

We take the liberty even in this year of writing (1919) 
to draw our next illustration from dealings between Berlin 
and Paris. Suppose a banker in Berlin has occasion to 
make a telegraphic transfer of a fund of 100,000 marks 
from his city to Paris. Should he buy a telegraphic 
transfer (or what we call a "cable" when it crosses the 
ocean) on Paris, or should he send a telegram to his agent 
in Paris to sell exchange for marks drawn on him? As- 
sume the following rates: 



ARBITRAGE 407 

In Berlin telegraphic transfers on Paris, 81.30 marks 
per 100 francs 

In Paris telegraphic transfers on Berlin, 123.10 francs 
per 100 marks 

As for Paris rate for sight drafts on Berlin, see foot- 
note. 5 

Try the two methods. 

The Purchase of a T. T. on Paris in Berlin 

100,000 marks will buy at the rate of 81.30, and 

produce in Paris 123,001 francs 

(i.e., 100,000 -=-81.30 = 123,001) 

The Sale of a T. T. on Berlin by Paris Agent 

100,000 marks sold at rate of 123.10 fetch in Paris 123,100 francs 
(i.e., 100,000 X 123.10 = 123,100) 

With the data here given the second method is prefer- 
able as yielding 99 francs more than the first. The differ- 
ence between the two is exaggerated compared with what 
could be expected in practice in times of free intercourse. 
What we have above is a mere illustration. The data 
might be so changed as to make the first the more pro- 
ductive method, or again to make the two equivalent. 
They would be equivalent, for instance, if Berlin on Paris 
were at 81.30 and Paris on Berlin at 123, or, again, if 
the pair of rates were 81.16 and 12)5.20. The members of 
a pair of rates in such a position are said to be "at a 
parity" with each other. It is an economic law that the 
two members of such a pair tend to maintain positions of 
parity under all conditions of commerce day in and day 

■> The transfer of the fund tit Paris is equally quick whether Paris 
sells telegraphic transfers or sight drafts on Berlin, but if the 
latter are sold the Berlin banker has a day or two before being 
required to disburse marks and receives slightly less francs at Paris 
owing to the lower selling price of sight drafts. 1'or the sake of 
simplicity we omit to consider the case separately. 



408 FOREIGN EXCHANGE 

out. It must bo hold in mind thorp are an indefinite num- 
ber of such positions of parity much as there are an in- 
definite number of positions of a see-saw across a log in 
which the board may remain unbent or unbroken. 6 

§ 97. Two-point arbitrage. — Two-point arbitrage is ar- 
bitrage which embraces transactions in exchange at two 
geographical points, and two only. Otherwise described, 
it is an operation in which a fund is sent from a first place 
to a second and then directly back to the first, both trans- 
fers being accomplished by dealings in exchange. It is 
arbitrage, as distinguished from a mere transfer of funds, 
in that it involves a return of the fund to the point of 
origin, or a swing round the circle. 

In arbitrage an operator may deal in telegraphic trans- 
fers, sight drafts, long bills, 7 and exchange for future de- 
livery, but our attention will be directed at present chiefly 
to arbitrage in telegraphic transfers. Setting aside any 
classification based on the different terms of life of the 
exchange employed, there are two, and only two, cases 
of the two-point arbitrage operation. These are the two 
fundamental cases. They would be found if there were 
exchange of only one term of life known throughout the 
world. It is understood there must be a dealer in exchange 

e In the case where we compare the rate in a first city upon a 
second, with the rate in the second on the first, if we have one 
rate given us as 123 francs in Paris for 100 marks* of Berlin tele- 
graphic transfers, we calculate the parity point of the other rate 
simply hy dividing the 123 into 100. Thus 100 -j- 123 = .8130. If 
123 francs equal 100 marks, then at the same ratio 81.30 marks 
equal 100 francs. This holds good if both rates are quoted "di- 
rectly" or both are quoted "indirectly" ( compare § 22 ) . But if one 
is quoted "directly" and the other "indirectly," the rates are at 
parity when they are exactly the same. Thus when sterling is 
quoted in Paris at 25.15, exchange on Paris in London (quoted 
"indirectly") is at parity when at the same figure, 25.15. 

t That is, it is possible for the purchase of long bills to become 
a part of an arbitrage operation. 



ARBITRAGE 409 

at each of the two geographical points, and these dealers 
must cooperate, whether in a relation of partnership or of 
agency. Described as briefly as possible, the two cases of 
the operation are : 

I. Each dealer draws on the other. 
II. Each dealer buys exchange to remit to the other. 

Case I is that of mutual submission to draft, or that in 
which each dealer sells exchange on the other. There are 
two reciprocal sales. Case II is that of an interchange of 
remittances, or that in which each dealer buys exchange 
in his city to be sent to the other. There are two reciprocal 
purchases. Which of the two cases transpires or material- 
izes at any time depends upon the direction in which the 
rates of exchange in the two cities (each on the other) 
break from parity. 

If required to show that these two cases exhaust the 
possibilities of two-point arbitrage, we should proceed as 
follows (it being understood that in looking for funda- 
mental cases we agree to ignore different kinds of exchange 
classified according to term of life, and to treat of ar- 
bitrage that can be accomplished in one kind alone, as say 
in telegraphic transfers). The arbitrager at each point 
can only buy or sell exchange on the other point. 8 The 
arbitrage must consist in a pair of transactions in ex- 
change, one undertaken by each dealer. There are four 
possible transactions from which this pair can be selected. 
These are 

1. Dealer A sells exchange drawn on dealer B 

2. Dealer A buys exchange in the market to remit to 

dealer B 

3. Dealer B sells exchange drawn on dealer A 

s If dealings in exclinii^r ,n n third point arc introduced t lie; case 
is no longer one of two-point arbitrage. 



4K» FOREIGN EXCHANGE 

4. Dealer B buys exchange in the market to remit to 
dealer A 

From these four separate transactions, four pairs can be 
formed, namely, 

1. A sells and B sells 

2. A sells and B buys 

3. A buys and B sells 

4. A buys and B buys 

Or, there are three pairs if we do not distinguish between 
the two dealers, namely: 

1. Both sell (No. 1 abovM 

2. One sells and the other buys (Nos. 2 and 3 above) 

3. Both buy (No. 4 above) 

In the case where one sells and the other buys (No. 2 just 
above) there can be no arbitrage, for the result can only 
be a pair of transfers of funds or credits, both in the same 
direction, or a double transfer of funds. To illustrate: if 
A sells and B buys exchange, A's transaction will put A 
in funds at B's expense, and B's transaction will also put 
A in funds at B's expense. A draws on B and sells the 
draft, and B buys exchange to remit to A ! This is clearly 
not arbitrage (cf. definitions, page 400). In truth, such 
a pair of transactions has no reason for being. As the 
saying goes, it does not make good sense. If it is desired 
to transfer a fund from B to A, to pay a debt, or for some 
other purpose, it would naturally be effected by A's draw- 
ing or by B's remitting, according to which method was 
best (see § 96) but not by a mixture of the two. 

In the cases (a) where each arbitrager draws on the 
other, and where consequently each sells exchange in his 
own city, and (b) where each remits to the other and con- 
sequently each buys exchange in his own city, there are 
two opposite or reciprocal transfers of funds. There is 



ARBITRAGE 411 

no motive for these operations except to reap an in- 
cidental profit made available by the relative position of 
the rates of exchange. Each of them is an arbitrage, and 
they constitute the only two that are possible. 

It was stated that whether (a) or (b) above is to be 
adopted depends on the direction of the departure or break 
of the rates of exchange from the position of parity. 
Curiously, a pair of rates can break from parity in only 
two ways: (1) both may become too high, or (2) both 
may become too low, each with reference to the other. 
This beyond doubt needs explanation. 

A position of parity, it must be kept in mind, does not 
mean a position at the mint par. The mint par has no 
immediate bearing on the present problem. To be in a 
position of parity the two exchange rates must simply show 
the same value-ratio between the two national currency 
units. 

Introducing Paris and Berlin with their francs and 
marks into an illustration once again, assume the follow- 
ing rates for telegraphic transfers: 

A 

RATES OF EXCHANGE 

In Paris In Berlin 

123 francs per 100 marks 81.30 marks per 100 francs 

These rates are in a position of parity, for the Paris rate 
and the Berlin rate show the same value-ratio between 
francs and marks. Thus, 

V alue-Iiatio expressed in francs per murk 

According to Paris quotation 1.23 francs = 1 mark 

According to Berlin quotation 
81.30 marks = 100 francs 

1 mark = %i.s ol LOO francs 

= 1.23 francs, or.... 1.23 francs = 1 mark 
At these rates no profit is possible from arbitrage. 



412 FOREIGN EXCHANGE 

Next assume the following : 

B 

RATES OF EXCHANGE 

In Paris In Berlin 

123 francs per 100 marks 81.40 marks per 100 francs 

The rates are no longer in a position of parity, this be- 
cause they show different value-ratios. Thus : 

Value-Ratio expressed in francs per mark 

According to Paris quotation 1.23 francs = 1 mark 

According to Berlin quotation 
81.40 marks = 100 francs 

1 mark = Vsia of 100 francs 

= 1.2285 francs, or 1.2285 francs = 1 mark 

Value-Ratio expressed in marks per franc 
According to Paris quotation 
123 francs = 100 marks 
1 franc = 10 %23 marks 

= .813 marks, or 813 marks = 1 franc 

According to Berlin quotation 814 marks = 1 franc 

Under this misadjustment, francs have a higher value 
in the Berlin ratio than in the Paris ratio. Thus: 

According to Berlin 1 franc = .814 marks 

According to Paris 1 franc = .813 marks 

But marks have a higher value in the Paris ratio than in 
the Berlin ratio; Thus: 

According to Paris 1 mark = 1.23 francs 

According to Berlin 1 mark = 1.2285 francs 

Francs are above parity in Berlin 9 and marks are above 
parity in Paris. Under the circumstances, which of the 

s Signifying only that francs are valued more highly in Berlin 
than in the Paris ratio. 



ARBITRAGE 413 

two possible two-point arbitrage operations are the dealers 
to select? Obviously that of reciprocal sales of exchange. 
Each should sell a telegraphic transfer on the other, the 
Parisian selling marks in Paris where they are higher, and 
the Berliner selling francs in Berlin where francs are 
higher. 

Suppose the Parisian acts as principal. He sells a tele- 
graphic transfer for perhaps 100,000 marks. The Ber- 
liner then should sell a telegraphic transfer for a sufficient 
number of francs to bring in 100,000 marks. Below is an 
account of the operation. 

Transactions 

100,000 marks sold in Paris at 123, fetch 123,000 francs 

122,850 francs sold in Berlin at 81.40, fetch. . 100,000 marks 
(122,850 X 81.4 = 100,000) 10 

Profit 

AT BERLIN 

Received from sale of telegraphic transfer 

drawn on Paris 100,000 marks 

Disbursed to pay telegraphic transfer 

drawn in Paris 100,000 marks 

Profit none. 

AT PARIS 

Received from sale of telegraphic transfer 

drawn on Berlin 123,000 francs 

Disbursed to pay. telegraphic transfer 

drawn in Berlin 122,850 francs 

Profit 150 francs 

Now we assume the third position of the two rates of 
exchange. 

io Exactly, 122,850 X 81.4 = 99,999.90 marks. 



414 FOREIGN EXCHANGE 

C 

RATES OF EXCHANGE 

In Paris In Berlin 

123 francs per 100 marks 81.20 marks per 100 francs 

These rates also deviate from parity. Thus: 

Value-Ratio expressed in francs per mark 
According to Paris quotation .... 1.23 francs = 1 mark 
According to Berlin quotation 
81.20 marks = 100 francs 
1 franc = 10 9i23 marks 

= 1.23153 f cs., or 1.23153 francs = 1 mark 

Value-Ratio expressed in m-arks per franc 
According to Paris quotation 
123 francs = 100 marks 
1 mark = 10 /8i.2 francs 

= .813 marks, or 813 marks = 1 franc 

According to Berlin quotation 812 marks = 1 franc 

Under this misadjustment the foreign unit is too low in 
each of the two cities as compared with its position in the 
other. Francs have a lower value in the Berlin than in 
the Paris ratio. Thus: 

According to Berlin 1 franc = .812 marks 

According to Paris 1 franc = .813 marks 

But marks have a lower value in the Paris ratio than in 
the Berlin ratio. Thus: 

According to Paris 1 mark = 1.23 francs 

According to Berlin 1 mark = 1.23153 francs 

Consequently the indicated operation is that of re- 
ciprocal purchase and remittance, an account of which 
follows : 



ARBITRAGE 415 

Transaction 

100,000 marks bought at Paris at 123, cost. . . 123,000 francs 
123,153 francs bought at Berlin at 81.20, cost. 100,000 marks 
(123,153 X -812 = 100,000) 

Profit 

AT BERLIN 

Received, remitted from Paris on tele- 
graphic order 100,000 marks 

Disbursed, for telegraphic transfer to Paris 100,000 marks 

Profit none. 

AT PARIS 

Received, remitted from Berlin on tele- 
graphic order 123,153 francs 

Disbursed, for telegraphic transfer on 

Berlin 123,000 francs 

Profit 153 francs 

To summarize : there are two directions only in which 
a pair of exchange rates may diverge or break from 
parity, and there are two fundamental cases or classes 
of the two-point arbitrage operation, and two only. The 
very taking of the arbitrage profit which a break from 
parity makes possible tends to restore the parity. Also 
the constant selection by dealers of the better of the two 
methods of transferring funds between any two exchange 
centers exerts exactly the same influence upon the mutual 
rates. Since such transfers are always being effected, the 
choice between methods has a very powerful tendency to 
keep rates in the position of parity, 11 and this effeel re- 

ii To determine that two mutual rates must stand at parity does 
not in the least mean to determine the position of the pair of 
rates. There is an indefinite number <>f different positions of parity 
for a pair of rates just as there is an indefinite number of positions 
of the see-saw obtainable withoul bending or breaking the hoard. 



416 FOREIGN EXCHANGE 

duces greatly the opportunity for profitable two-point 
arbitrage transactions. The continual choosing of the best 
means of transferring funds has the effect in great de- 
gree of forestalling arbitrage. 

§ 98. Methods of indirect transfer of funds. — An indirect 
transfer of funds by means of exchange is one which in- 
volves an exchange transaction in another city, or a trans- 
action in exchange on another city, than the two between 
which the fund is transferred. The transfer is indirect 
in a geographical sense, in the sense that the migrating 
fund pursues a circuitous course geographically. For 
example, a fund may be sent from New York to London 
through Paris. The arbitrage operation considered at the 
opening of this chapter involved as one of its parts this 
exact indirect transfer. (Any three-point arbitrage will 
contain as a component some such indirect transfer.) 

Telegraphic transfers alone being employed, there are 
just four distinct methods of transferring a fund from a 
first center to a second through a third. There are, there- 
fore, what we would call the four "fundamental cases" 
of the operation. If a New York banker is to transfer a 
fund to London through Paris, the four cases are : 

1. The New York banker buys a cable on Paris and directs his 
Parisian correspondent to buy a telegraphic transfer on London. 

(Net result: Banker's dollars disappear in New York and 
pounds emerge in London.) 

2. The New York banker buys a cable on Paris, but directs his 
London correspondent to sell a telegraphic transfer on Paris 
against this as cover. 

(Net result: the same as before.) 

3. The New York banker directs his Parisian correspondent to 
sell a cable on New York, and employ proceeds of this sale to buy 
a telegraphic transfer on London. 

(Net result: the same as before.) 



ARBITRAGE 417 

4. As in 3, Paris draws, but against the franc credit thus cre- 
ated, London sells a telegraphic transfer on Paris. 

(Net result: the same as before.) 
More briefly, the four operations are: 

1. New York buys francs : Paris buys pounds sterling. 

2. New York buys francs: London sells francs. 

3. Paris sells dollars: Paris buys pounds sterling. 

4. Paris sells dollars : London sells francs. 

The total result in all cases is a transfer of a fund or 
credit from New York to London. The Paris correspond- 
ent is neither "in" nor "out" funds as a consequence of 
this operation. 

The choice among the four possible methods depends 
upon the positions of the rates of exchange that govern 
the individual transactions which may serve as components 
to make up the whole transfer. It would lengthen our 
discussion inordinately to work out a set of practical illus- 
trations in connection with this problem. 

The four methods are the theoretical four fundamental 
cases. In practice all four would be developed only un- 
der conditions where each of the three cities had an ac- 
tive market in bills and telegraphic transfer on each of 
the other two. The same four are possible with sight 
drafts employed throughout, instead of telegraphic trans- 
fers. But where these instruments are used, there must, 
in most instances, be either a greater speculation on the 
position of certain rates, owing to the lapse of time dur- 
ing which a bill is in the mail, or there must be contracts 
for the forward or future sale or purchase of sight ex- 
change (c/. § 100 herein). 

If a bill (or actual negotiable instrument) is the Conn 
of exchange employed in the indirecl transfer, a question 
arises as to whether there is not a fit'tli case, or a case 



418 FOREIGN EXCHANGE 

distinct from the four already set forth. Suppose the 
banker buys a cheek on Paris and mails it to London, where 
he sells it for sterling, it being willingly taken in London as 
good exchange on Paris. Clearly there has been a trans- 
fer of a fund from New'' York to London, but has this 
transfer been direct or indirect, and, if the latter, is it a 
fifth case? The answer, in our view, is that the transfer 
is indirect (compare the definition at the beginning of 
this section), but that it is a disguised form of the second 
case, namely, the one in which New York buys francs and 
London sells francs. 12 

§ 99. Three-point and more complex arbitrage. — Three- 
point arbitrage, or arbitrage embracing transactions in 
exchange in or on three geographical points, may be 
analyzed into the two components of (1) a direct transfer 
of a fund from the point where the operator stands to 
another point, and (2) an indirect transfer thence through 
a third point back to the point of origin. We have now 
reached the puzzle department of foreign exchange. There 
are sixteen theoretically distinct ways of performing a 
three-point arbitrage operation with one kind of exchange 
(as telegraphic transfer) used throughout, that is, there 
are what we would call sixteen fundamental cases of the 
operation. Six different rates of exchange come under 
consideration in the planning of such an operation (un- 

12 In Tate's "Modern Cambist," 24th edition, London, 1908, p. 
275, such operations are mentioned as the purchase by a London 
dealer of a long bill drawn in London on Amsterdam, and the re- 
sale of this bill in Paris, instead of its discount in Amsterdam. 
We should be compelled to define this as indirect transfer, case 2. 

One part of an indirect transfer may consist of a gold shipment. 
For example, London may transfer a fund to New York by an 
operation in exchange, and have an agent in the latter city convert it 
into gold to be shipped to Buenos Aires. This actual operation has 
been mentioned a number of times in past years in our financial 
iournals. 



ARBITRAGE 419 

less some of these rates are omitted for lack of being the 
expression of real or active markets in exchange). Each 
of the three cities may have a rate on each of the other 
two, there being thus two rates in each city and six in all. 

Let us first search out the sixteen cases. As shown in 
§ 98, there are four ways of transferring a fund or credit 
from one city to a second through a third ; and, as shown 
in § 96, there are two ways of making what we have called 
a direct transfer. Thus New York can transfer a fund 
to London through Paris in four ways. It can then re- 
transfer directly from London to New York in two ways. 
Each of the latter two can be combined with each of the 
preceding four. This makes eight distinct methods where- 
by New York can send a fund through Paris to London 
and thence to New York again. There are also eight other 
distinct methods whereby New York can send a fund 
through London to Paris and thence to New York. This 
makes a total of sixteen combinations of transactions in 
exchange. 

The following table sets them forth in detail. 

THE 16 ARBITRAGE OPERATIONS WHICH NEW YORK 

CAN EFFECT THROUGH LONDON AND PARIS, 

EMPLOYING A SINGLE KIND OF EXCHANGE 

THROUGHOUT, AS CABLES 

First group of 8, involving an indirect transfer to London. 

(1) N. Y. remits to Paris: Paris remits to London: London remits to N. Y. 

(2) (Same) : N. Y. draws on London. 

(3) N. Y. remits to Paris: London draws on Paris: London remits to N. V. 

(4) (Same) : N. Y. draws on London. 

(5) Paris draws on N. Y.: Paris remits to London: London remits to N. Y. 
(fi) (Same) : N. Y. draws on London. 

(7) Paris draws on N. Y.: London draws on Paris: London remitB to N. Y. 

(8) (Same) : N. Y . draws on London. 

Second group of 8, involving an indirect transfer to Paris. 

(1) N. Y. remits to London: London remits to Paris: Paris remits to N. Y 

(2) (Same) : N. Y. draws on Paris. 

(3) N. Y. remits to London: Paris draws on London: Paris remits to N. Y. 

(4) (Same) : N. Y. draws on Paris. 



420 FOREIGN EXCHANGE 

(5) London draws on N. Y.: London remits to Paris: Paris remits to N. Y. 

(6) (Same) : N. Y. draws on Paris. 

(7) London draws on N. Y.: Paris draws on London: Paris remits to N. Y. 

(8) (Same) : N. Y. draws on Paris. 

Among these cases there are no duplicates. Likewise, 
there are no possible cases not included in the sixteen. 
The arbitrage may be engineered from Paris or London 
as well as from New York, but there are not three times 
sixteen cases. 

The example of three-point arbitrage placed at the head 
of the present chapter comes under method 2 of group 1 
in the above table. To give additional examples, let us 
first take an illustration of method 5 of group 1 : Let the 
arbitrager operate with $10,000. (1) The first step is 
taken by New York's directing Paris to sell $10,000 of 
telegraphic transfer upon New York. Assuming the rate 
to be 520 (that is, 520 francs for each $100 of cables) the 
result is a fund of 52,000 in Paris. (2) For the second 
step, New York directs Paris to purchase a cable on Lon- 
don, the rate for the latter being, say, 25.20 francs per 
pound. As a consequence, Paris obtains £2,063.05, ap- 
proximately, of sterling cables (i.e., 52,000-^-25.20). Lon- 
don is next directed to spend this £2,063.05 for a cable 
transfer on New York at the existing rate, which we shall 
suppose to be quoted after the London fashion, 49 1 /4d. per 
dollar. 

£2,063.05= (at 240d. per £) 495,240d. 

495,240d. will buy $10,055.60 cables at 49%d. per dollar. 

For an outlay of $10,000 the New York operator receives 
back $10,055.60, and thus obtains a gross profit of $55.60. 
For another example, take method 4 of group 2 and 
operate with $10,000 as above. (1) New York buys $10,- 
000 worth of cables on London at say 4.85, obtaining 
£2,061.85. (2) Paris is then directed to sell £2,061.85 of 
cables on London at the existing Parisian rate for this 



ARBITRAGE 421 

exchange, say 25.25. This yields a proceeds in francs 
of 52,061.70. (3) New York sells a cable for 52,061.70 
francs at, say, 5.17/£. This signifies that New York ob- 
tains $1 for every 5.17^ francs of this cable transfer, or 
$10,060.20 for the whole. The gross profit then in this 
instance is $60.20. 

The rates assumed in the foregoing examples were chosen 
arbitrarily, and are not designated to show anything as 
to the actual percentage of profits ordinarily procurable 
in arbitrage under competition. If the six rates in the 
three cities implicated in a three-point arbitrage are in 
perfect adjustment — that is, in that adjustment which 
arbitrage itself tends to produce — none of the sixteen op- 
erations could be conducted at a profit. Misadjustments, 
or departure from parity, will make some operations show 
a profit, while others, if undertaken, would show a 
loss. 

In the case of arbitrage with bills (whether sight or long) 
as contrasted with cables, there will be a more appreciable 
lapse of time between outlay and return (though a dis- 
countable long bill is not so much slower, as a remittance, 
than a sight draft). Assuming sight bills to be used 
throughout, the length of time required for the arbitrage 
operation differs very greatly, according to which of the 
sixteen theoretical cases we suppose to be chosen. 13 

Four-point arbitrage. — In three-point arbitrage a fund 
or credit travels around a triangle, making a journey in 
one direction between each two of the three cities. 
Thus: 

it If the purchase in New York of ;i si<;lit bill on Paris, its remit- 
tance to London for sale there, and the drawing <>f a sight bill on 
London against this as cover, ought to be counted as one of the 
theoretical cases of throe-point arbitrage, it might be argued that 
there are more than sixteen cases with sight bills. Bui again, we 
might assimilate this with the case (I) New York remits to I'aris; 
(2) London draws on Paris; (3) New York draws on Ixmdon. 



42a FOREIGN EXCHANGE 

§ P 




Now it is always possible that rates in or on the fourth 
city, D, should reach such an adjustment that the transfer 
from B to C might better take place through D. This 
new indirect transfer, which it might become profitable 
to engraft upon the three-point arbitrage, is in and of 
itself as simple as the operation discussed in § 98, but 
it converts the three-point into the practically more com- 
plex four-point arbitrage, represented in this manner. 




Four-point arbitrage presents no new questions of principle. 
There are 96 fundamental cases (or combinations) ob- 
tainable with telegraphic transfers alone employed through- 
out. In practice, complex forms of arbitrage are over- 
weighted with expense, and probably are comparatively 
rare. The continual flow of arbitrages of a simpler char- 
acter tends to forestall the more complex. For illustration, 
three-point arbitrage involving B, C, and D, and three- 
point arbitrage involving A, B, and C, etc., tend to fore- 
stall any four-point undertaking. Compare the tendency to 
choose the cheapest method of a mere transfer of funds to 
forestall even the simpler arbitrage operations. 



ARBITRAGE 423 

Arbitrage distinguished from other exchange operations 
involving simultaneous outlay and return. — The purchase 
of long bills on a given country and the simultaneous sale 
of sight drafts against these upon the same country is a 
transaction which in some respects resembles arbitrage, but 
which is not arbitrage. In this transaction there are pres- 
ent the purchase of one kind and the sale of another kind 
of exchange as parts of a larger single operation for a 
profit. But, if an operation is to constitute what is known 
as arbitrage, the different kinds of exchange dealt in must 
be different in nationality, if we may so express it. Two 
pieces of exchange differ in nationality, either if they are 
drawn upon different countries, or if they are drawn in 
different countries. A New York bill drawn on Paris has 
a different nationality for the purposes of our definition, 
from a New York bill drawn on London. Also, a Paris 
draft on London has a different nationality for the pur- 
poses of our definition from a New York draft on London. 
Arbitrage as an exchange operation, distinguished from 
all others, is one which involves the sale and purchase, 
as nearly simultaneously as possible, of pieces of exchange 
of different nationalities, and which involves a return of 
the fund employed to the point in which the original outlay 
was made. 

§ 100. Arbitrage, speculation, and futures. — We can easily 
conceive of an arbitrage in which there is not the smallest 
element of speculation, and doubtless operations of this 
character are carried out in great number. Thus, if banker 
X whips a fund around the triangle formed by New York, 
Paris, and London, by making a purchase in New York 
of cables on Paris, and making a purchase in Paris of 
telegraphic transfers on London, and making a sale in New 
York of sterling cables, it is entirely possible thai lie should 
have all the transactions constituting the arbitrage defi- 
nitely arranged by cable before giving any orders to for- 



124 FOREIGN EXCHANGE 

eign agents, or taking any steps of his own. "We might 
caU such an operation (one free from the slightest admix- 
ture of speculation) a "pure" arbitrage. 

The following wholly supposititious example shows an 
arbitrage which by way of contrast would involve a con- 
siderable degree of speculation. Thus, suppose X acting 
on the basis of the sight rates quoted in the three places 
at the moment of his decision, buys sight bills on Paris 
and mails them with instructions that their yield in francs 
be spent upon arrival for sight sterling bills, these to be 
forwarded to London for X's credit. After waiting two 
or three days to avoid overdraft, X completes the arbi- 
trage by making a sale in New York of demand drafts on 
London. Taking the case exactly as stated, and not con- 
cerning ourselves with the question whether a dealer would 
actually engage in such an operation, the first thing to strike 
our attention is that the rate in Paris for demand sterling 
might easily shift quite a distance during the five or six 
days required for the transit of the franc checks from 
New York to Paris. Also, the rate for demand sterling in 
New York has opportunity to move before the sale takes 
place in this city of the demand drafts on London. Thus, 
our assumed arbitrager would be taking two risks of ex- 
change or two speculations. In view of the slightness of 
the profits usually available in arbitrage, the element of 
speculation would be extremely prominent in this example. 

It is evident that here, as in cases of exchange investment 
and borrowing, the speculation may be eliminated if appro- 
priate transactions in futures can be arranged. At the 
present moment the arbitrager of our example, located 
at New York, plans to buy the checks on Paris, and then 
six days hence to buy demand sterling at Paris, and finally 
to sell demand sterling at New York two days hence. If 
he can make the rates for these transactions determinate 
in advance, by finding a seller of futures in Paris and a 



ARBITRAGE 425 

buyer of futures in New York, and can fix these rates at 
satisfactory figures or in an appropriate relation, it is clear 
he can carry through the arbitrage for a profit and without 
speculation. In other words, a suitable arrangement of 
transactions in exchange for future delivery may in whole 
or in part constitute a pure arbitrage, or there is such a 
thing as arbitrage in futures. There is nothing especially 
difficult in principle about such operations. In principle 
they are alike, but naturally a large number of combinations 
are possible and much ingenuity may be exercised in find- 
ing them out. 

Telegraphic transfers are the ideal material with which 
the arbitrager may work. But even when dealing with 
these he may undertake certain minor and incidental specu- 
lations. To him, with his special information, these specu- 
lations may well appear safe and wise. Nevertheless, if 
any chances are taken, we must say there is speculation. 
To illustrate, suppose that at the present moment informa- 
tion by cable shows that the rate in Paris for sterling tele- 
graphic transfers stands at a position of perfect parity 
with the rate for the same kind of exchange in New York. 
No arbitrage is possible. But suppose that while our 
New York banker is feeling practically certain that sterling 
cables are going to fall during the remainder of the day, 
he receives a cablegram saying that there is a decided 
tendency for sterling telegraphic transfers to rise at Paris. 
This suggests (1) a sale of sterling telegraphic transfers 
at Paris, (2) a purchase of the same at New York, and (3) 
a sale at New York of cables on Paris. Without attempt- 
ing to arrange perfectly definite contracts of sales and 
purchases in advance, our banker acts promptly on the 
strength of his prognostications and cables instructions 
to Paris to sell such and such an amount of sterling tele- 
graphic transfers. This is an act of speculation. It de- 
volves upon himself to complete the operation by adding 



426 FOREIGN EXCHANGE 

the two transactions at New York, namely, a sale of cables 
on Paris and a purchase of cables on London. If, before 
concluding these, he waits through a part of the day, in 
the hope of improving his rate position in the arbitration, 
he commits two more acts of speculation. But presumably 
he knows what he is doing and will come out well. There 
is reason to believe this extremely prompt form of arbitrage, 
arbitrage by anticipation, so to say, is quite the regular 
thing. The arbitrager by anticipation is likely to get the 
business away from the one who acts with less speed. His 
is indeed a remarkable line of money-making. Incidentally, 
we must not think of him as some clever individual working 
in and out among the great banks. He is, in fact, or 
tends even more to become, one of the great institutions 
with its tremendous volume of regular business, its exten- 
sive information-gathering machine, its many foreign con- 
nections, and its long purse. 

§ 101. Arbitrage in stocks. — Many issues of bonds and 
stocks have an international market. Dealers are contin- 
ually comparing the prices of such securities in different 
countries to discover opportunities to buy cheap and sell 
dear. As between any two countries, we cannot tell in 
which the price for a given security is the higher, without 
resort to the value-ratio between the two national curren- 
cies as shown in the current exchange rate, or one of the 
current exchange rates, between the countries. If a cer- 
tain stock sells for 80 soldas in Urallo and for 973 livos in 
the Empire of Ramko, in which country is it dearer? As 
already indicated (page 401), any method of obtaining 
the answer reduces itself to a comparison of the arbitrated 
with the actual price in one of the countries. If these 
are the same, or at parit}*, nothing can be done; but if 
they differ, a purchase in the one country and a sale in 
the other become profitable. These two transactions will 
be made as nearly simultaneous as conditions permit. To- 



ARBITRAGE 427 

gether they constitute what is known as an arbitrage in 
stocks. 

For an example, suppose the following data lie before 
a New York operator. 

(1) AB common stands in New York at $105% 

(2) Sight sterling in New York 4.8740 

(3) AB common is quoted in London, for delivery 

six days hence, at $108% 

The London quotation is not a mistake, though the reader 
probably expected pounds instead of dollars. The real 
price at which a share of any kind of stock changes hands 
in London is certainly a number of pounds sterling, but it 
is an arbitrary custom in that city to quote the price of 
leading American securities in American dollars, counting 
$5 the equivalent of £1. If the real price is £25, the Lon- 
doner in his humorous way quotes it as $125, and London 
knows that if another stock is quoted at $150, what it can 
be sold for is £30. 14 

London's fictitious dollar prices for our securities in- 
terest the arbitrager only as indexes of the real prices. 

AB common at $108% 

means AB common at (108% -=-5) £ 21% 

New York's arbitrated Loudon price (or the London 
price is sterling converted or translated into dollars) be- 
comes $106. This because 21% X 4.8740 = 106. 15 This 
exceeds New York's actual price of $105% by % of a point. 
Therefore, the indicated arbitrage is a purchase in New 
York for sale in London. Each share will cost $105% and 

14 Ours are not the onlj securities quoted in London in terms of 
the money of the country where they are issued and made payable. 
The original design of the custom was, no douht, to facilitate a 
rough and ready comparison of the price in London with the price 
in the United States itself. 

IB Plus the decimal .0005. 



•l-'S FOREIGN EXCHANGE 

will yield, through such foreign sale, $106. Prom the 
gross profit the incidental expenses must be paid. This 
example is a mere illustration, for a profit of % of a 
point exceeds anything obtainable in ordinary practice. 

The arbitrager buys the stock in New York for 105% 
a share, ships the certificates to London immediately upon 
procuring them, and draws a sight draft on the London 
buyer for an amount equal to £21% times the number of 
shares shipped ; this because the Londoner has agreed to 
take the stock at this price on the day when the steamer 
will arrive. To this draft the stock will be attached for 
delivery against payment of the instrument. It serves, of 
course, as collateral security. £21% of sight draft sold 
at 4.8740, the current rate of exchange for this type of 
bill, yields $106.00+. 



CHAPTER XV 
COINAGE LAWS AND EXCHANGE RATES 

§ 102. The several monetary standards. — In the next five 
chapters it is the design to set forth so much of the prin- 
ciples of money as seem important for a thorough under- 
standing of the subject of specie shipments. To begin with 
we must distinguish the several monetary standards known 
to the world. The list comprises 

1. The gold standard 

2. The gold-exchange standard 

3. The silver standard 

4. The bimetallic standard 

5. The "fiat" or irredeemable paper standard 

Among the several kinds of money found in any modern 
country, one serves as a money of ultimate redemption, in 
the sense that other forms are redeemable or convertible 
into it by government agencies at fixed ratios, while this 
one is not in this manner redeemable in anything, although 
each unit is, if it is a coined metal money, practically 
convertible into an almost invariable quantity of a valuable 
bullion by the method of melting down coin. This money 
of ultimate redemption constitutes what is known as the 
"standard money." "We speak of a country as having 
or being upon a certain standard, as the "gold" standard 
or the "bimetallic standard." Here we use the word 
standard in the sense of a monetary system which is defined 
and classified in accordance with the character of the stand- 
ard money employed in it. To be upon the gold or silver 

429 



430 FOREIGN EXCHANGE 

standard moans to have a gold or a silver money of ulti- 
mate redemption, though this does not completely define the 
condition of being on these standards. To be on the bime- 
tallic standard means to have both gold and silver standard 
moneys conjointly. There is no country which has this as 
a working system to-day. To be upon the gold-exchange 
standard is to have a system under which the local cur- 
rency is inter-convertible, at some officially established 
and nearly invariable rate, with exchange (i.e. bills and 
drafts) on a foreign country that has the gold standard. 
If the system is actually maintained, the gold money of 
the foreign country serves as the real money of ultimate 
redemption, though redemption in it takes place in an in- 
direct manner only. The irredeemable paper standard is a 
system under which the money of ultimate redemption is 
paper which is itself redeemable in nothing. How this 
kind of money, which has been and is very common in the 
world, comes to have and keep a purchasing power over 
services and goods, real wooden and iron commodities, has 
always been more or less of a mystery to the normal mind, 
but this seems to be only because the normal mind's con- 
ception of money possesses to-day about that degree of 
error and distortion which was shown say in the Ptolemaic 
theory of the solar system. If this offends the reader, let 
us not debate it, since in any case nearly all our energy 
henceforth will be spent in explaining the operation of the 
exchanges under the conditions of the gold standard. 1 

i The exchange rates between gold and silver countries, or between 
gold and inconvertible paper countries, or between silver and in- 
convertible paper countries, or finally between one inconvertible 
paper country and another, are subject in part to different principles 
from those which apply to the exchanges between any two gold 
standard countries. The exchanges between two silver standard 
countries would be subject to the same principles as those applying 
to gold exchanges. But there are no longer any true silver-silver 
exchanges. 



COINAGE LAWS AND EXCHANGE RATES 431 

The following may be laid down as the conditions which 
must be met before a country can lay claim to being fully 
and unreservedly upon the gold standard. 

In Domestic Relations 

1. There must be a gold money of ultimate redemption, 

actually available and not merely legally authorized 
to exist. 

2. The unit of this must be a fixed (and not a variable 2 ) 

physical quantity of gold. 

3. This money must be subject to the right of free coinage 

for private owners of bullion. 

4. It must be lawful to melt down this money at will. 

5. The collateral or subsidiary forms of money must 

actually be maintained at parity with this gold 
money. 

In Foreign Relations 

6. There must be no legal or legally recognized inter- 

ference with the free export and import of gold 
bullion. 

During the great war nearly all countries prohibited or 
laid drastic regulations upon the export of gold. Whereas 
the United States undoubtedly maintained the gold stand- 
ard throughout the period in domestic relations, it did not 
maintain it in foreign relations, because it prohibited the 
free export of the metal. 

The essence of the gold standard is the convertibility of 
the unit of any form of money (as the dollar) into a fixed 

2 Irving Fisher's plan for a dollar of variable gold contents 
(which could of course circulate only by paper proxy) would, if 
internationalized, it is believed, give us a better monetary Bystem 
than the gold standard, but it would lie idle to niiiintain that under 
this scheme we would still be on the gold standard. 



432 FOREIGN EXCHANGE 

physical quantity of gold metal at the will of the holder, 
and its counterpart, the convertibility of this same quan- 
tity of the metal into the unit of money at the will of the 
holder of the metal. It is the interchangeability of the 
fixed amount of the metal and the money unit in all its 
forms. In some instances certain subsidiary forms of 
money are maintained at a parity with gold money as a 
matter of fact, without their possessing strict legal re- 
deemability. This gives rise to what is known as the limp- 
ing gold standard. (See § 124 following.) 

§ 103. Mint pars of exchange. — What is commonly called 
the "value" of one gold money unit in terms of another, 
depends upon the relative amounts of pure or "fine" gold 
contained in the two. Thus the British unit, the pound 
sterling, is said to have a value of $4.8665+ in terms of 
the American dollar, because the pure gold required to 
make a pound sterling of coin (namely 113.0015+ grains 
troy) is 4 866J ftoooo+ times the pure gold used in making 
a dollar of United States coin (namely 23.22 grains troy). 
A somewhat objectionable but nevertheless common form of 
statement is that the pound sterling has a "fixed intrinsic 
value" of $4.8665+. This statement has no further mean- 
ing than that the pound sterling of coin contains 4.8665 
times as much pure gold as the dollar of coin (the coins 
of both countries being taken as defined by law and the 
small errors that are unavoidable in minting being disre- 
garded). The best name for the figure of 4.8665 is the 
mint par of exchange between England and the United 
States. A formal definition of this term would run as 
follows: The mint par of exchange between two countries 
is the number of the standard money units of the one 
country which contain the same quantity of the same pure 
metal as the standard money unit of the other country, 
both money units being assumed to have the exact pure 
metal contents prescribed by law. Regarding the mint 



COINAGE LAWS AND EXCHANGE RATES 433 

par the following observations should be noted: (1) There 
is no mint par between countries which lack a common 
metallic standard, as for instance between a gold and a 
silver standard country, or between a gold and an incon- 
vertible paper country. 3 . (2) There are two ways of ex- 
pressing any given mint par. One may set down, for in- 
stance, the number of German units that are equal to one 
French unit, or the number of French units that are equal 
to one German unit. Thus : 

1 franc = .81 marks ( 8 Hoo of a mark). 
1 mark = 1.23 francs. 

This recalls the two principal methods of expressing any 
given foreign exchange rate. (3) The relative average 
weights of actual coin in circulation may be (and in fact 
always are) different from the exact mint par. There 
are two causes for this difference. The first is error in 
minting. It is impossible for mints to strike coin which 
shall weigh exactly what the letter of the law requires, 
and the law itself provides certain narrow limits of per- 
missible deviation of the weight of newly minted coin 
from the exact legal standard. The amount of deviation 
allowed is in this country called tolerance. There is also 
a tolerance granted for error in fineness. In the second 
place the abrasion or wearing down of coin in actual cir- 

8 If an inconvertible paper country lias a gold unit provided for 
by law which, however, does not enter into actual circulation, it is 
possible to give the figure showing the relative contents of this unit 
compared with anj' other national gold unit. Thus the laws of 
Brazil provide for a standard gold unit called the "Milreis" con- 
taining 12.08+ grains troy of fine gold. Therefore one milreia 
"equals" 5 tioo of a dollar, and 8.01 milreis "equal" £1. The Report 
of the Director of the Mint (U. S.) gives the former of these figures 
as the value of the milreis in the general table, "Value of Foreign 
Coins." Such a figure may be called a mint par if one insi-i~, 
but it does not have the sume relation to exchange rates as does 
the normal mint pur. 



434 FOREIGN EXCHANGE 

dilation reduces its contents. If a standard coin's loss 
of weight through abrasion becomes too great, the coin 
either ceases to be legal tender, or else it becomes legal 
tender for an amount in proportion to its weight instead of 
at its nominal value. A certain amount of abrasion with- 
out loss of tender power at its nominal value, must be 
tolerated in a coin, and the law of each country provides 
what this amount shall be. While therefore according to 
the mint par, $48,665 of gold coin of the United States 
should contain the same amount of pure gold as £10,000 
of English coin, this relation would not hold to the exact 
figure in case actual coin is compared with actual coin. 
If $48,665 of American gold coin drawn from circulation 
were shipped to England to be converted into new English 
coin it would in practice fall short of a weight sufficient to 
produce a full £10,000 of new English money. It would 
be equally true of course that £10,000 of English coin taken 
from the channels of trade and shipped to the United States 
would be on the average incapable of making the full 
$48,665 of new American standard money. (4) Mint pars 
are not affected by seigniorage and brassage charges, or by 
changes in these charges, so long as the contents of the 
money units remain unaltered. If the German mint should 
change its seigniorage charge from 6 marks to 60 marks 
per kilogram (see § 134) this would not mean that the 
weight or fineness of German gold coin would be modified, 
but merely that the government would return to the pri- 
vate owner of the bullion brought in for coinage, a smaller 
share of coin than before, reserving a larger share for 
itself. For either France or Germany to change its 
seigniorage would have no effect upon the mint par between 
these countries, since it would not affect the legal weight 
of their coins, but it would affect the "gold points" be- 
tween them as it would affect the price of gold bullion in 
the country which alters its seigniorage (compare Chapter 



COINAGE LAWS AND EXCHANGE RATES 435 

XX). The effect of a very great seigniorage would be to 
make the mint par cease to be the approximate center of 
oscillation of exchange rates. 

§ 104. Mint pars distinguished from actual values. — Gen- 
erally when we speak of the "value" of one thing in terms 
of another, we mean the purchasing power of the first 
thing over the second in actual exchanges on the market, 
this purchasing power being measured merely by the 
quantity of the second thing which the first will com- 
mand in exchange. It is only proper to point out in the 
present connection that British sovereigns (or coins of one 
pound sterling) will virtually never show a purchasing 
power over American dollars at the exact rate of 4.8665 
in actual exchanges of coin against coin. Sovereigns and 
dollars may be exchanged against each other directly or in- 
directly. We would have an instance of actual and direct 
exchange in case an American traveler should take his 
home gold coin abroad and offer it for sale for British 
money. If dealing in a small way with an English coin- 
broker, the traveler might find himself compelled to give 
up as much as .$4.95 in return for one sovereign. The 
Bank of England frequently buys American gold coin in 
large lots from dealers, at the price of £3 16s. 4 1 /6d. per 
ounce Troy (gross weight of the coin). 4 What this price 
per ounce means as a price per dollar of actual coin, de- 
pends upon the condition of the coin. The more abraded 
it is, or the greater the deficiency in weight allowed in 
its original minting, the less will the fixed price of £3 16s. 
4M>d. (or £3.818 -+-) per ounce mean as a price per dollar. 
The sale of American gold coin of exactly full legal weight 
at this price would mean an exchange of about $4.87Ms Cor 
a pound sterling. If the coin had a deficiency of 1-10 of 

* The bank may change this price at its pleasure, but if it made 
the price too low the owners of the coin would decide to sell it as 
mere gold bullion. See § 131. 



lit! FOREIGN EXCHANGE 

1'. in weighi it would take about $4.87% to buy £1. But 
in all instances the value of Hie American coin in actual 
ami direct exchange for British sovereigns is likely to be 
something different from the precise mint par. 

In speaking of actual but indirect exchanges of dollars 
;i -;i i nst sovereigns, we have reference to the buying and 
selling of foreign exchange. The purchase for dollars in 
New York of a cable transfer or a sight draft on London, 
amounts to an actual exchange, in as much as there is an 
actual transfer on the market of an article for a price, (of 
a draft for dollars 5 ) and amounts to an indirect exchange 
of dollars against sovereigns because when the buyer gives 
up dollars, although he receives something convertible into 
sovereigns in England he does not receive sovereigns. We 
already know that exchange rates in the market may rest 
at figures other than the mint par. In fact examination 
of market reports will disclose that the exchange rates 
show no disposition to favor the figure of the mint par, 
or to rest upon it any oftener or longer than upon any 
other figure. The rate for sight drafts on London has no 
mobre tendency to rest at 4.8665 than it has at 4.8765 or 
4.8590 or any other figure between the upper and lower 
limits which confine its fluctuations. 

In a word, while it is good usage to refer to the mint 
par between dollars and pounds as the "value" of the 
pound in dollars (or vice versa), we must bear in mind 
that actual exchanges of dollars and pounds against each, 
other, direct or indirect, show actual values in an eco- 
nomic sense, and these values are not commonly located 
exactly at the mint par. The importance of the latter 
figure, however, lies in the fact that under normal condi- 
tions it really governs the relative value of the money 
units in actual exchange, in the sense that it closely con- 
strains the movement of this value. What one can ob- 

5 Or for bank credit convertible into dollars. 



COINAGE LAWS AND EXCHANGE RATES 437 

tain for home coin in actual sale to a broker or bank 
abroad depends on the mint par and certain other lesser 
factors of cost and profit to brokers or bankers. What an 
American can obtain for or must give for a bill of ex- 
change on England depends fundamentally on the mint 
par between the United States and England and second- 
arily on certain other factors. The mint par is the ap- 
proximate center of oscillation of the sight rate of ex- 
change between any two gold standard countries, in times 
of freedom of gold shipments, and this rate can get only 
a very small distance away from the par in either direc- 
tion. In the ease of New York rates on London, the mint 
par is somewhat to one side of the point midway between 
the upper and lower limits of rate fluctuation : that is, as 
indicated it is an approximate center of oscillation of sight 
rates. For reasons that will appear in the chapter on 
gold shipments, the lower limit is at a greater distance 
underneath than the upper limit is above the par. 

The mint par itself depends wholly on the national coin- 
age laws passed by the governments of the two countries 
concerned. This explains at bottom what the relation is 
of national coinage laws to exchange rates. The English 
government defines the pound sterling in such terms as to 
make it contain 113.0015 -f- grains of pure gold, and the 
American government has defined its monetary unit in 
words that make it contain 23.22 grains of pure gold. The 
par follows from these legally fixed figures and cannot be 
changed except by a change of legislation. No merely 
economic force, no amount of alteration in the supply of 
or demand for gold, generally or locally, could have the 
slightest effect on the mint par. 

§ 105. Free and gratuitous coinage. — Stated as briefly as 
possible, the relation of the mint par to the exchange rates 
between two countries is this: the sight rale in one coun- 
try on the other cannot rise more than a certain distance 



138 FOREIGN EXCHANGE 

above the figure of the mint par, because further rise will 
be checked by the export of gold from the country where 
the rale is rising. 6 In a similar way, a fall of the rate 
will be checked at a certain point beneath the par by the 
import of gold into the country where the rate is falling. 
The influence of the mint par upon exchange rates is con- 
fined to its regulation of these upper and lower limits, 
which are known as the "gold points." 

The action of gold shipments to confine the rise and 
fall of exchange is dependent upon the maintenance in 
both countries of what is known as the system of free 
coinage. For, as will appear more fully later, the func- 
tioning of gold shipments in this manner is due to the 
fixity, or virtual fixity, of the price of the metal gold in 
each of the countries. This in turn is conditioned on free 
coinage in each. The right of free coinage consists in the 
privilege granted any owner of the standard money metal 
to present the same to the government mint to be manu- 
factured into coin to be returned to him. It is the privilege 
of having bullion coined for oneself at the mint in quan- 
tities without a maximum limit. As a matter of con- 
venience to the mint, a minimum limit must of course be 
set. 

As the phrase is commonly used, especially in economics, 
the right of free coinage does not mean the right to have 
the service of the mint without charge. Free coinage does 
not mean costless coinage, but unlimited coinage. No. 
doubt, however, it is ordinarily implied in the idea that 
there should be no greater charge made at the mint than 
one sufficient to cover actual costs. When minting is per- 
formed without charge to the depositor of the bullion, it 
is called gratuitous coinage. As a matter of public policy 

e Hee § 137. We use the terms rise and fall on the assumption that 
the exchange rate is quoted according to the "direct" method. See 
§22. 



COINAGE LAWS AND EXCHANGE RATES 439 

England and the United States strike coin gratuitously, 
but nearly all, if not all, other gold standard countries 
make a moderate charge for this service. 

A charge levied for coinage is known as seigniorage. 7 
If merely sufficient to cover the supposed cost to the mint, 
it is known as brassage. The modern gold standard coun- 
try does not make a practice of exacting a seigniorage 
substantially greater than brassage. 8 To illustrate the 
usage of these terms we would say, for instance, that in 
England and the United States the coinage of gold is free 
and gratuitous, while in France and Germany we have 
the system of free coinage with a brassage charge. Free 
coinage is also referred to as coinage on private account 
because the coin manufactured under this system belongs 
to and is returnable to the private owners of the bullion 
from which it is made. The subsidiary forms of coin, or 
token moneys, are said to be coined on government account, 
because the government purchases the required metal on 
the open market and proceeds to make the coin for itself 
or for its own account. The government owns this coin 
after it is struck, and puts it in its treasury for expendi- 
ture, or for exchange against other forms of money on 
demand. 

When coining is done on private account, it is not to 
be understood that care is usually taken to give the de- 
positor of bullion the identical coin which is made from 
his own particular metal. The coining value of his de- 
posit having been ascertained, the duty of the mint, or 
the great bank which in many countries acts as go-between, 

7 The term seigniorage is also used in a different though related 
meaning to indicate the profits made by government mints from the 
coinage .of their subsidiary or token metallic moneys. 

8 The highest charge made anywhere is 1% of the value of the 
coin. Most countries have a charge ranging from about % of 1% 
upward. Hec table on pp. 976-7 of Swoboda's, "Die Arbitrage," 
edit, of 1909, Berlin. 



IHi FOREIGN EXCHANGE 

is fulfilled simply by giving him the amount of coin which 
is Ins due. It' the coining value (less charges if there 
are any) turns ou1 to be a fractional sum, as say $5,837.30, 
token money must of course be used to pay the odd part, 
as the $2.30 in this case. It should be understood also 
that a depositor may take his returns in the shape of a 
warrant on a government office, or a check on a bank, or 
a deposit in the bank, or notes issued by the bank, which as 
go-between has purchased his bullion. 

§ 106. Standard bullion: the two chief standards. — Gold 
coin is not struck from pure or "fine" bullion; but is 
in present times made from bullion which is either %o 
or X V\2 fine. Metal possessing the proper degree of 
fineness to be made into coin as defined by law is known 
as standard bullion. In France, Germany, the United 
States and the majority of other countries, standard 
bullion is 9io fine ; in England and a few other coun- 
tries 1 H2. A fineness of %o is usually expressed by 
the figure .900, signifying of course 900 parts fine in a 
total of 1,000 parts, the other 100 parts, or Moth, being 
of other metal (chiefly or wholly copper). A fineness of 
x %2 is expressed decimally as .916%. The copper 
or other extra metal is called the alloy. It is introduced 
into the gold to make it hard and durable. The standard 
bullion of the United States is permitted by law to contain 
both copper and silver alloy, the silver, however, not to 
exceed Vio of the alloy itself, that is, 10 parts in 1,000 
of the whole mass. Under this rule, small amounts of 
silver found in the gold as it comes from the mines may 
be left in to count as part of the alloy. If the silver ap- 
pears in the natural bullion in sufficient quantity to make 
it pay to refine it out, such a course would be pursued be- 
fore finally presenting the gold for coinage. Except in 
connection with the art of coinage, the word "alloy" is not 
used to signify one element (the baser one) in a mixture 



COINAGE LAWS AND EXCHANGE RATES 441 

of metals, but means the whole mixture itself. Thus for 
example, brass is spoken of as : 'an alloy of copper and 
zinc. ' ' 

The right of free coinage means in the first instance 
the right to have standard bullion {i.e., bullion .900 or 
.916% fine) struck into coin. If the mint were to re- 
fuse to receive for coinage bullion of any other degree of 
fineness, the owner would of course be compelled to have 
it standardized at a private refinery. As a matter of 
practice, however, some of the mints of the world stand- 
ardize gold as well as coin it ; and exchange coin for de- 
posits of bullion of other degrees of fineness than the 
standard. There are a number of rules and conditions 
governing this exchange, and these differ slightly in de- 
tail in the several countries. In some countries having a 
general brassage charge, bullion which is finer than the 
standard, and which differs from the standard (except 
for the presence of negligible quantities of impurities) 
only by the lack of a certain amount of copper as alloy, 
will be accepted at the same rating as if it contained the 
proper amount of copper. This means that the state sup- 
plies the copper without extra charge. In other words, 
if a man owns a bar containing 200 ounces of pure gold, 
he would receive just as much for it if the 200 ounces of 
pure gold were in a bar .999 fine as if they were in a bar 
exactly standard or .900 fine. It would not make his bar 
.999 fine fetch any more at the mint or bank, to add be- 
forehand enough copper to bring the fineness down to 
.900. The United States mints, however, charge the de- 
positor of bullion for the copper which may be required 
to bring it to the standard fineness of .900. After the 
bullion is brought to the standard, the United States con- 
verts it into coin gratuitously. For the refined copper 
that may be needed our mints charge the owner of the 
bullion 2f an ounce Troy. This is at the rate of 24^ per 



442 FOKKHiN KXCHANUK 

pound Troy, and 29^ per pound avoirdupois. At this 
rate the copper required to convert a fine bar to standard 
gold costs a little over 1-10,000 of the value of the fine gold 
itself figured at ^20.67 per ounce. Thus the charge for cop- 
per is relatively an exceedingly small one. 



CHAPTER XVI 

THE MINT PRICE AND THE MARKET PRICE OF GOLD 

§ 107. The striking 1 stability of the market price of gold. — 
By the price of any given thing we mean the quantity of 
money for which a unit of that thing will exchange. By 
the price of gold we mean the quantity of money for which 
a unit of gold bullion will exchange. We do not mean by 
the price of gold, the purchasing power of gold money 
over commodities in general. In the United States and 
England gold bullion is priced by the troy ounce. In 
other leading countries it is priced by the kilogram. In 
countries which have the gold standard, the fact that the 
money, in terms of which gold bullion is quoted, is itself 
made of gold, does not make the quotation cease to be a 
price. The fact does, however, lead to the one striking 
consequence that the price of gold is an almost invariable 
figure in a gold standard country. In a silver or paper 
standard country the price of gold does not show any 
peculiar fixity. 

The principal market of the world for gold is in Lon- 
don. Year in and year out, under all ordinary condi- 
tions, the price of this metal will remain between £3. 17s. 
9d. and £3. 17s. lid. per ounce 1: /i2 fine. The utmost 
possible range of variation will be between £3. 17s. 9d. 
and £3. 18s. Id. 

£3. 17s. 9d. = 933 pence per ounce 
£3. 17s. lid. = 935 pence per ounce 
£3. 18s. Id. = 937 pence per ounce 

The ordinary range from 933d. to 935d. per ounce, 
amounts to less than 14 of 1% of the average price be- 

443 



H4 FOREIGN EXCHANGE 

twees the figures, and the extreme range of the price un- 
der the influence of unusual banking conditions, amounts 
to less than , - > of \°/o} Taking such great staple com- 
modities as wheat, corn, cotton, steel, or copper, we find 
that Hit 1 highest and lowest prices touched by any of them 
within a single decade will differ by an amount equal to 
from 80 to 100% of the price midway between the ex- 
tremes. Tn other words, a staple commodity may have 
within a single decade a price range of 200 times that of 
gold, even taking the price of gold through the whole 
length of time during which a country maintains its gold 
standard statutes unaltered. 

But one thing can change the limits which confine the 
price of gold in a country which has the gold standard, 
and this is a change in the legislation of that country or 
an abandonment of its execution. Neither the discovery 
of gold in the same abundance as coal nor the entire cessa- 
tion of its production, would of themselves have any effect 
upon these limits. Either of such extreme eventuations 
w T ould doubtless force changes in money legislation and 
would in this manner, although in this manner only, re- 
act on the price of gold. According to the estimates of 
the Bureau of the Mint of the United States, 2 the world's 
production of gold in certain selected years has been as 
follows : 





Product in 


Value of Product 


Year 


Fine Ounces 


in U. S. Dollars 


1873 


4,563,000 


$ 96,200,000 


1880 


5,148,000 


106,400,000 


1890 


5,749,000 


118,800,000 


1900 


12,300,000 


254,500,000 


1909 


21,900,000 


454,400,000 



i The price of gold in dollars has in the New York market to-day 
even a narrower range than this. 

2 Report of the Director of the Mint (U. S.) 5 1910, p. 100. 



MINT PRICE AND MARKET PRICE OF GOLD 445 

Although the product of 1909 is nearly five fold that of 
1873, the price of gold has remained unaffected by this 
increase. 

§ 108. The mint price of standard bullion. — The remark- 
able approach to fixity which we find in the market price 
of gold is simply a direct consequence of the absolute 
fixit}* of its mint price. By the mint price of gold is meant 
the quantity of gold coin which the mint of a gold standard 
country will deliver per ounce (or other physical unit) 
in exchange for gold bullion deposited with it for coinage. 
This price is fixed by those statutes which (1) define the 
national standard money unit, (2) establish the system of 
free coinage, and (3) set the charge, if any, to be levied 
by the mint for converting bullion into coin. In the 
United States, for example, the standard money unit is 
defined as 25.8 grains (troy) of gold 9-10 fine, and is 
given the legal name "dollar." The right of private per- 
sons to have their bullion converted into coin by the gov- 
ernment mint was first laid down in the original coinage 
act of the United States, passed April 2, 1792. The right 
of free coinage was in the beginning given to owners both 
of gold and silver bullion. The present law governing 
the matter is the Act of Feb. 12, 1873, which explicitly con- 
firms the right of free coinage, but confines it to gold 
alone. Since 1875 the mints of the United States have 
converted standard bullion into coin without charge to 
the depositor of the bullion. In virtue of these several 
statutes the mint price of standard gold is fixed at 
$18.60465 + per ounce. 

The statutes do not expressly declai'e that this figure 
shall constitute the mint price of gold, but their provisions 
of necessity imply it. Since it is declared that one dollar 
of coin shall contain 25.8 grains of standard gold, it is a 
mere matter of arithmetic that one ounce of this gold will 
make 18 6 9ioo dollars. There are 480 grains in an 



1 M FOREIGN EXCHANGE 

oum-c and 25.8 is contained 18 6( Moo -f- times in 480. 
By providing for the "free" and "gratuitous" coinage 
of standard bullion the statutes make it compulsory for 
the mint to deliver this sum of coined money per ounce 
to the depositor of standard bullion. Thus $18.60-4- be- 
comes the mint price of standard gold per ounce troy. If 
the statutes of the United States should be altered so that 
the definition of the dollar or "standard unit of value" 
should become, say, 48 grains of gold 9io fine, this 
would change the price of gold in this country to $10 per 
ounce of standard bullion, for then 1 ounce of gold would 
make just 10 units or dollars (480 grs. -^48 grs. = 10). 
If the United States should suspend the free coinage of 
gold, while continuing the use of gold coin as standard 
money, this would abolish the mint price of gold, and 
would leave the market price of the metal free to fall be- 
low $18.60 and to fluctuate on this lower side in much the 
same manner as other prices. Such an action would 
amount to an abandonment of the gold standard. 

§ 109. The mint price of fine bullion. — In every gold 
standard country the mint price of standard bullion de- 
pends upon the same legal elements as those pointed out 
in the illustration of the United States. In most coun- 
tries, however, it is affected by a brassage charge for coin- 
ing. 3 The mint price for fine as distinguished from stand- 
ard gold, is simply deduced from that for standard gold. 
Take for example the figures for the United States. One 
ounce of standard gold contains 9-10ths of an ounce of 
fine gold, or 10 ounces of standard bullion contain 9 ounces 
of fine gold. 

1 ounce of standard bullion = $ 18.60456 -4- 
Theref ore 10 ounces of standard bullion = 186.0465 -4- 

3 See, for instance, sections to follow on the monetary systems 
of France and Germany. 



MINT PRICE AND MARKET PRICE OF GOLD 447 

Therefore 9 ounces of fine gold = 186.0465 -f- 

Therefore 1 ounce of fine gold = 20.6718 -4- 

9)186.0465 + 

20.6718 -f 

In this manner, we calculate what is called the "mint 
price of fine gold, " to be $20.67 + per ounce. It is not 
to be understood, however, that perfectly pure or fine gold 
is offered for sale at the mint. It is questionable if ab- 
solutely pure gold can be produced. The so-called "mint 
fine" bars used in international gold shipments commonly 
have had in recent years a fineness of .999 or better, and 
not long ago they varied between .992 and .999. A new 
process of refining accounts for this change. Gold which 
is refined to the most extreme purity possible and which 
is desired for chemical or other special purposes, has to 
bear an exceptionally high price to cover the expenses 
necessarly incurred in getting rid of the last elements of 
impurity. Thus the mint price of fine gold is not to be 
taken literally as a rate per ounce at which absolutely pure 
gold is in practice sold to the mint. For such sales are not 
made in fact. It is merely the base price for rating the 
coining value of the pure gold which is contained in the 
bullions of varying degrees of fineness which are in prac- 
tice presented to the mint. Thus a thousand ounces of 
bullion .995 fine will contain 995 ounces of pure gold. .995 
multiplied by $20.67 -j- gives us the basic value of the bar, 
while a bar of a thousand ounces .850 fine would contain 
only 850 ounces of pure gold, and would have a basic 
value of 850 X $20.67 4-. Whether a given bar possesses 
its full basic value for actual sale to the mint depends 
upon whether any expenses have to be paid out of this 
value by the owner to make the bar finally acceptable for 
coinage. Information on this subject will be found in the 
sections devoted to the detail of the monetary systems of 
the leading countries. 



ll> FOREIGN EXCHANGE 

§ 110. The market price of gold.— Where there is organ- 
ized and continuous dealing in gold bullion, the competi- 
tion of buyers and sellers establishes the market price of 
gold. Gold dealers have, of course, a lawful right to trade 
at any prices they see fit to make, but in a gold-standard 
country they will never see fit to make prices more than 
a small fraction of 1% away from the mint price. The 
mint price being rigidly fixed, this accounts for the re- 
markable steadiness of the market price of the yellow 
metal. 

That the market cannot stand very much below the mint 
price is evident because every holder of bullion (except in 
undersized lots) has the option of exchanging it for the 
mint price by the simple method of depositing it at the 
mint for coinage. He could not be expected to take less 
than $20.67 a fine ounce in the United States, when a fine 
ounce will make 20.67 dollars of gold coin all of which 
will be delivered over to him. 4 

Again, so long as a country is on the gold standard, the 
market price of gold metal cannot rise appreciably above 
the mint price for the reason that the metal can always 
be obtained at substantially the mint price by the method 
of melting down gold coin. 5 

In the first place, if the gold standard prevails, a unit 
of any kind of lawful local money can be converted at will 

* Except for the very small charge for standardizing the bullion. 

5 The notion sometimes held by the man on the street that it is 
unlawful to melt coin is erroneous. 

A country might be on the gold standard without having actual 
gold coins suitable for circulation. In this case it would have paper 
notes or certificates representing the gold in the circulation, which 
would be procurable by a citizen only through giving up a fixed 
physical quantity of bullion and which would be redeemable in this 
same (or nearly the same) physical quantity of bullion. Here the 
price of gold, namely the exchange rate between gold metal and 
money, would be invariable. 



MINT PRICE AND MARKET PRICE OP GOLD 449 

into a unit of gold coin. In the second place, if this coin 
has the exact weight and fineness prescribed by law, the 
metal which it will yield when melted down will cost pre- 
cisely the mint price. This is a mere matter of mathe- 
matical necessity. 

Thus suppose that instead of buying $1,000 worth of 
gold metal in the open market a manufacturing jeweler 
melts 100 U. S. eagles or $10 pieces of full legal tender 
value. The ingot of bullion obtained obviously costs 
$1,000, for $1,000 of money had to be surrendered to 
secure it. If the coin is of full weight and fineness, it will 
contain 23.22 grains of fine gold per dollar, or a total of 
23,220 grains. This makes 48% or 48.375 ounces Troy 
(23220 -=-480), and if 48% ounces cost $1,000 each ounce 
costs $20.67. This matter hardly calls for extended argu- 
ment. 

If a full weight gold coin is melted it yields an ingot 
of standard metal which can be converted back into the 
same coin at the mint, and therefore the metal is worth 
a mint price equal to that coin, so that when the coin as 
such was destroyed to get the metal, the metal costs ex- 
actly its mint price. 

The practical resort to the plan of melting coin almost 
always involves a small increase in the cost-price of the 
bullion procured, by reason of the coin's being a trifle 
short of full content. The chief cause of this condition 
is abrasion in circulation. A very minor cause is error 
in minting. Suppose the 100 eagles of the preceding illus- 
tration lack 50 grains of their full fine contents I being thus 
a little over % of 1% short), and therefore weigh 23,170 
grains fine. If 23,170 grains cost $1,000, the rate is at 
$20.71 per fine ounce. 

The foregoing is a mere illustration, but it serves to 
show that the theoretical upper limit of the market price 
of gold is a certain small distance above the mint price — 



450 FOREIGN EXCHANGE 

a distance depending to-day primarily on the average de- 
gree of abrasion of actual coin. 6 

Under conditions where an abundance of new gold flows 
from the mines into the channels of commerce, the amount 
of melting down of coin is much restrained. Perhaps in 
present da}'S over two-thirds of the world's new gold goes 
into the money use. The demand for the one-third put 
to the manufacturing and arts uses is doubtless in great 
part satisfied b}^ a direct application of new and uncoined 
bullion to these uses. The Bureau of the Mint (U. S.) 
gives the following estimates: 

In 1909 

Value in 

Pine Ounces U. S. Dollars 

World's production of gold 7 21,980,000 $454,000,000 

World's coinage of gold 8 15,150,000 313,000,000 

World's industrial consumption of 

gold 9 6,893,000 142,000,000 

Amount of gold coin used in the arts 

in U. S. 10 3,500,000 

One should bear in mind that industrial "consumption" 
does not necessarily mean the destruction of gold or even 
the fabrication of gold into forms which preclude its re- 
turn to the money use. Much old manufactured gold re- 
turns to the mints of the world for coinage. Also it should 
be noted that the world's industrial "consumption" of 
gold in any given year does not have to come out of the 
new product for that particular year, as the immense ex- 
isting stock may be drawn upon. 

e Compare § 128, pp. 489-91, on "tolerance" in the United States. 
7 Report of the Director of the Mint for 1910, p. 100. 
s The same, p. 61. 
» The same, p. 59. 
io The same, p. 57. 



MINT PRICE AND MARKET PRICE OF GOLD 451 

§ 111. The fluctuating purchasing power of gold. — "We 
perceive that the fixity of the price of gold is due to the 
fact that gold bullion is quoted in terms of the gold coin 
into which it is freely convertible under the system of free 
coinage. The fixity of the price of gold is not a sign of a 
fixed economic value. One must not infer that the steady 
price of gold gives at least some indication of the stead- 
iness of its value. The truth is it shows nothing what- 
soever about the value of gold, if we mean by the value 
of gold, as we should, its purchasing power over other 
things, that is, over the mass of other goods or commodi- 
ties. The rise or fall in the purchasing power of gold 
coin is shown solely in the fall or rise of the general aver- 
age of the prices of all commodities. To illustrate the 
point, let us consider the purchasing power of gold coin 
over some one commodity, as wheat. If the price of wheat 
is $1 a bushel, a gold dollar has the power to purchase 1 
bushel. If the price rises to $2 a bushel, the purchasing 
power of the dollar declines to Vi bushel, and if the price 
falls to 50^ a bushel, the dollar's purchasing power as- 
cends to 2 bushels. To double a price cuts the purchas- 
ing power of the money unit to one-half; to cut a price 
to one-half doubles the money unit's purchasing power. 
We express this by stating that the value of money in 
terms of any one commodity varies inversely as the price 
of that commodity. The value of money in terms of all 
commodities, or commodities in general, varies inversely 
with the average movement of the prices of all commodi- 
ties. 

If we are, for instance, able to say that in the last de- 
cade the prices of goods generally have gone up about 
1-3, or to 4-3 as high as they were ten years ago; we 
should then also affirm that the general purchasing power 
of money is % as much as it was 10 years ago. There are 
many difficult and interesting problems involved in the 



452 FOREIGN EXCHANGE 

task of getting a statistical record of the variations of 
prices and the purchasing power of money. 11 

The point with which we are concerned here is that the 
purchasing power of gold may change and that while 
tli is purchasing power is changing, no matter how much 
it is changing, the price of gold will remain as nearly in- 
variable as ever. Not far back we pointed out the fact 
which is at first thought somewhat surprising, that except 
within exceedingly narrow limits, the price of gold is not 
affected by changes in the supply of and demand for that 
metal. It is to be understood that changes in supply and 
demand may indeed have an indefinitely great effect upon 
gold, but only upon its value, or purchasing power, as dis- 
tinguished from its price. The answer to the question, 
what does the fixity of the price of gold show with respect 
to the value of gold — value being used in the sense of 
purchasing power — is that it shows nothing whatever. 

11 Series of figures which show the movement of general prices, 
or of "the general price level," are called index numbers. Among 
the best books on this subject are, "The Measurement of General 
Exchange Value," by C. M. Walsh, and "The Fundamental Problem 
of Monetary Science," by the same author, and "The Purchasing 
Power of Money," by Irving Fisher. An excellent book is also 
"Money and Credit Instruments in Relation to General Prices," by 
E. W. Kemmerer. See also "Making and Using of Index Numbers," 
by W. C. Mitchell, in Bulletin of U. 8. Bureau of Labor Statistics, 
Xo 173, July, 1915, pp. 5-1U. 



CHAPTER XVII 

STANDARD MONEY 

§ 112. The several forms of money in a modern monetary 
system. — Every modern country has a number of forms 
of money, some of which are accounted for by reasons of 
commercial convenience, others by reason of economy of 
maintenance in circulation, still others by reasons touch- 
ing the fiscal necessities of the government. Any gold- 
standard country will be found to possess to-day either 
all, or a large part, of the several forms of money shown 
in the table on page 454. 

§ 113. Standard and representative money. — The fore- 
going fall into the two grand classes of standard and rep- 
resentative money. To define the latter first, representa- 
tive money comprises all those forms which have their value 
determined by the value of the standard money. A repre- 
sentative money is one which is kept in a legally fixed value 
ratio with, or "at a parity" with, the standard money. 1 
It is in this sense "representative" of the standard 
money. The best method of maintaining the parity of 
collateral forms of currency is to provide for their con- 
stant and direct redemption in the money which they repre- 
sent. Were this method universally followed, it would 
be best to give the class the name of "redeemable money." 
But in practice other means than direct redemption are 
sometimes made to suffice in maintaining parities, and so 
we must be content with the less definite name of "repre- 
sentative money." 

i Or is designed to be kept at this parity. 

4f.:i 



454 



FOREIGN EXCHANGE 



FORMS OF MONEY FOUND IN THE MODERN GOLD 
TANDARD SYSTEM 



Stand- 
ard 



United 
States 

Gold Coin 



Pre-war Examples 

England Germany 



Gold Coin Gold 
Coin 



Money j 



Metal- 
lic or 
"Token" 



Repre- 
senta- 
tive 



Paper, 



• Of 
Govern 

inent 



'Circu- 
lating - 
Prom. 
Notes 



Silver 
Dollar 

Subsidiary 
Silver 

Minor 
Coin 
(nickel 
and 
copper) 

U. S. Notes 
(Treasury 
Notes or 
"Greenbacks") 



Of 

\Banks 



Money 
Certificates 



National 
Bank 
Notes 

Federal 
Reserve 
Bank 
Notes 

Federal 
Reserve 

Notes 

fGold Certifi- 
cates 

Silver Certi- 
ficates 



Silver Silver 

Change Change 

Nickel 
Change 

Bronze Copper 
Change Change 



Imperial 
Treas- 
ury 
Notes 

Reichs- 
bank 
Notes 



Bank of 
England 
Notes 



Joint Other 
Stock Bank 

Bank Notes 

Notes 



By standard money we mean simply the represented 
money, or the form of money with which all the others are 
maintained at a parity. And the only fundamental dis- 
tinguishing feature of standard money lies in this single 
fact that other forms of money are kept at a parity with 
it, while there is no other form of money with which it is 



STANDARD MONEY 455 

kept at a parity. It is true our literature affords other 
definitions. Jevons, for example, makes the test of stand- 
ard money that its value in exchange should depend solely 
upon the value of the material contained in it. 2 To ac- 
cept this would prevent our speaking of a "fiat" or 
"paper standard" money, since the value of such a money 
is entirely independent of its material contents. In point 
of fact we find the use of the term fiat standard money 
so convenient as to be practically compulsory. There is no 
need of adopting the definition of Jevons, for according 
to him, many countries do not have a standard money ! 
The workable conception is simply that standard money is 
the money of ultimate redemption. 

§ 114. Approved characteristics of standard money. — It is 
true, general opinion has it that standard money ought to 
possess certain other well marked attributes or characters 
besides being the money of ultimate redemption. It is 
generally agreed it should be a metal money and gold at 
that. It is held it should be subject to the right of free 
coinage, or coinage on private account, without a greater 
seigniorage charge than brassage, and should thus possess 
substantially full bullion value. To affirm the expediency 
of these characteristics is not to admit them as elements 
in the definition of standard money. The money of ulti- 
mate redemption should, and, so far as the writer's knowl- 
edge extends, always does possess full legal tender power. 
But this is not distinctive of standard money since in- 
stances abound where representative moneys possess this 
power as well. 

To summarize, the following statements hold true of 
what is generally regarded as the highest type of standard 
money, the type that has been possessed by the leading 
financial and commercial nations. 

2 "Money and the Mechanism of Exchange," p. 74. 



466 FOREIGN EXCHANGE 

L) It is gold. 

(2) It is subject to free coinage. 

(3) It has (as a consequence) full bullion value. 3 

(4) It has full Legal tender power. 

§ 115. Commodity and fiat standard money. — There are 
two grand classes of standard moneys. The one, made of 
a valuable substance, as gold, under the system of 
free and gratuitous or virtually gratuitous coinage, may 
be called commodity money, this being a term already in 
use for money with full bullion value. 4 The other, made 
either from a practically valueless substance, as paper, or 
made from metal with less value than the coin itself and 
coined only on government account, has long been known 
as fiat money. Fiat money is usually thought of as being 
irredeemable paper, but there can be no question it may 
also be a money made of metal. If a government with 
irredeemable paper should take to making the individual 
pieces in the form of aluminum or silver sheets with ap- 
propriate marks upon them, this would not remove its 
money from the flat class. Nor would changing these 
sheets to round disks called coins make any difference. 
When in 1893 the government of British India suspended 
the free coinage of the silver rupee, this money became 
a metal fiat money. Within four j^ears the value of the 
rupee coin ascended to 50% above the value of its metal 
contents. That is, in 1897 the average rate of exchange 
for the year in India on London was about 15.35d. This 
means the rupee could purchase 15.35 pence of British 

s Signifying that the ingot of metal obtained by melting any of 
it will have (substantially) a money price equal to the amount of 
money melted, e.g., a $20 gold piece when melted becomes an ingot 
salable for $20. There is no magic in this full bullion value. It is 
a mere incident to the system of free coinage. 

4 Compare J. F. Johnson, "Money and Currency," Chapter ix, 
§§ 116 and 117. 



STANDARD MONEY 457 

gold. At the average price of silver for 1897 in the cen- 
tral market of London, the metal contents of the rupee 
were worth as bullion about lOH pence. The rupee had 
become a fiat money made of silver. In 1899 the Indian 
government adopted measures to maintain the rupee at the 
practically constant value of l-15th of a pound sterling. 
These measures were of a character to place India on the 
"gold-exchange" standard. At the same time the English 
sovereign was made legal tender in India at the rating of 
15 rupees. By similar measures, the government of Brazil 
has usually in recent times maintained its paper "milreis" 
at the value of l-15th of a pound sterling. It had a fiat 
money made of paper which it decided to place in a con- 
stant ratio with a foreign gold unit. This money became 
virtually and indirectly redeemable in gold, and will con- 
tinue in this position so long as the measures of the gold- 
exchange standard are upheld. It would therefore now 
seem proper to classify it as representative money. But 
these measures are not in the least necessary to make the 
rupee and milreis have a value in the sense of purchasing 
power over commodities, and a value wholly independent 
of the material of which these moneys are made. History 
simply abounds in instances which show the permanent 
feasibility, by limitation of quantity, of maintaining the 
value of an entirely irredeemable money (once it is es- 
tablished in customary circulation) above and wholly in- 
dependent of the value of its material/' 

Suppose that England, while allowing her monetary 
system to remain otherwise unmodified, were to terminate 
the free coinage of gold. Unless the government should 
continue to coin as many sovereigns on its own account as 
would have boon struck under free coinage, the value of 

r - 'I li«- greatest collection of information on 1 li is point known to 
the writer is to be found in "Staatliche Thoorie des Geldes," by 
G. F. Knapp. 



158 FOREIGN EXCHANGE 

the sovereign would ascend above the value of its gold con- 
tents. But England would still have a standard money. 
It would have a fiat standard money made of gold! The 
thing that brings a slandard money within the fiat class 
is the fact that the value of the money pieces comes to ex- 
ceed and move independently above the value of the ma- 
terial which composes them. 

Representative moneys generally have a value much in 
excess of the value of their material contents, because the 
standard money with which they are kept at a parity has 
this superior value. In other words, representative 
moneys have material values which are nothing at all or 
which may be greatly reduced compared with their nom- 
inal or redemption values. This, however, does not make 
them belong to the class of fiat moneys. For this term 
properly applies only to standard moneys, which are not 
themselves redeemable in any other form of money. 

§ 116. Contrasts in respect to regulation of quantity. — 
The commodity and flat systems of money differ as re- 
gards their operation or behavior in two respects. And 
these differences are of fundamental importance. In the 
first place, the quantity and value of a commodity stand- 
ard money are matters which the state leaves to be de- 
termined by the free play of private interests. This is 
not the case with fiat money. In the second place, a com- 
modity money is exportable as bullion to settle accounts 
in other countries, while a fiat money is not. 

The effect of the free coinage plan of providing com- 
modity money is to make the quantity of standard money 
created and put into monetary use depend simply upon 
the action of private owners of bullion. And since this 
money, as bullion, has commodity uses and may be melted 
down for these uses, and since it is also exportable as an 
article of value to other countries, the quantity of it which 
is retired from circulation depends also upon the free ac- 



STANDARD MONEY 459 

tion of private owners of coin. Since both the entry of 
gold into and its departure from the money reservoir, de- 
pend wholly on business conduct and not upon measures 
of government, the quantity of the standard money re- 
mains independent of state regulation. This signifies that 
the value of this money — its purchasing power, as shown 
in the general level of prices, — likewise remains independ- 
ent of state regulation, at least at this point of regulation. 6 
In legal phraseology it is said that the government "de- 
termines the value" of standard coin. This holds only 
in the sense of determining the quantity of gold contained 
in that coin. Thus the United States statutes provide that 
the "eagle" shall contain 258 grains of gold %o fine. It 
is not uncommon to speak of this as a determination of 
the "value" of the coin. Value here means nothing what- 
soever beyond material contents. Without tarrying to 
argue about this questionable usage, it must be said the 
value of the money unit, in the sense of its purchasing 
power over ordinary goods, is something wholly different. 
Value in the sense of material contents is invariable and 
fixed by law, but in the true sense of purchasing power, 
it is variable and in countries with the commodit}^ stand- 
ard, its variations are independent of governmental con- 
trol. Of course the larger the metallic contents fixed by 
the government for the money unit, the larger its purchas- 
ing power will be, but once the contents are fixed the fu- 
ture course of purchasing power is uninfluenced by the 
government. 

The quantity of fiat money, once the system is running, 

o There is another point at which it is feasible for the state 
greatly to influence (though hardly to regulate) the general level 
of prices and purchasing power of money, and this is at the point of 
control of the expansion or contraction of bank credit. The Amer- 
ican state has at present an agency which can exert such an in- 
fluence, though only to a certain extent, in the shape of the Federal 
Reserve Board. 



460 FOREIGN EXCHANGE 

depends upon the amount manufactured by the govern- 
ment. It has been the custom of governments to manu- 
facture it altogether too freel} 7 , to substitute the creation 
of fresh batches of it for the collection of taxes. Hence 
fiat money has become notorious for its propensity to in- 
crease in volume and depreciate in purchasing power. 
Given wisdom of control, fiat money is theoretically su- 
perior to a commodity money, judged from the standpoint 
of social welfare, but up to the present few have had 
much confidence in our ability to achieve the requisite 
wisdom in control. 

§ 117. The quantity of money and its value. — The value 
of money depends in part upon the quantity of money, 
and if the state desires to permit the quantity of money 
to take care of itself, the state thereby rejects the only 
means open to it fully to regulate the value of money. The 
theory of the state is, of course, that to leave the economic 
value of money alone is the course of wisdom. At the 
present point this book will be brief and therefore by 
necessity frankly dogmatic. The value of money depends 
in part upon its quantity and in part upon the volume of 
exchanging, or volume of business, or amount of money 
work to be done. It depends also upon the rapidity of 
the circulation of money, and upon the extent to which 
the business world is accustomed to use credit instruments 
as substitutes for money itself in effecting exchanges. 
The value of money does not depend solely upon the quan- 
tity of money, but the quantity of money is the one factor 
among all those we have named which we might conceive 
of being regulated by the state. Such factors as rapidity 
of circulation, employment of credit substitutes to effect 
exchanges, and the volume of exchange itself, are beyond 
government control, 7 though the use of credit substitutes 

7 Furthermore, these factors are relatively stable, depending upon 
business and banking habits that are quite slow to change. 



STANDARD MONEY 461 

is not wholly beyond governmental influence. We may 
explain the substance of the relation of the quantity of 
money to its value — and thus give the substance of the 
so-called quantity theory — in various formulas. Thus, if 
at any given time (i.e., under any given set of commercial 
conditions) there should be more standard money than in 
fact there is, the money would have a lower value than it 
in fact has, and vice versa. Or again, other things remain- 
ing unchanged, the more money the less its purchasing 
power, and vice versa. Essentially the same proposition is 
that an increase in the quantity of money tends to de- 
crease its purchasing power, and vice versa. The latter 
form of statement gives perhaps the clearest recognition 
to the fact that an increase in the quantity of money may 
be accompanied actually by an increase in its value, 
or a decrease by a decrease in its value (although both 
of these are, as it were, contrary to expectation) sim- 
ply because other factors may act in opposition to and 
overcome the tendency of the change in the quantity of 
money. The doctrine has at times been criticized as being 
"barren" or without consequence. It is, however, both 
true and consequential. 8 The consequence which flows 
from it is that any action affecting the quantity of money 

b In general the quantity theory proves of basic importance in 
accounting for the behavior of monetary systems, notwithstanding 
certain misguided attacks made upon it in recent times. Should a 
reader unacquainted with the literature of the subject desire to 
examine into it, he would do well to begin with Irving Fisher's 
"Purchasing Power of Money," and J. F. Johnson's "Money and 
Currency" (appropriate chapters), and pursue references found 
in these works for further investigation. These are works which 
from the present writer's standpoint may be recommended as giv- 
ing the best explanation in form and substance of the quantity 
theory. In them references to the literature of criticism of the 
theory will be found. A leading critic has been J. L. Laughlin. 
See his "Principles of Money." Any book on money gives some at- 
tention to the subject. 



462 FOREIGN EXCHANGE 

affects its value, and makes its value different from what 
it would otherwise have been. Indeed, given the power to 
regulate the quantity of money, there is given the power 
to regulate its general purchasing power or the general 
level of prices, despite such changes as can take place in 
the other institutional factors which help determine this 
level. To deny the significance of this would be on a par 
with denying the significance of the proposition that con- 
trol of the supply of wheat would mean control of its 
value, on the grounds, forsooth, that the value of wheat 
also depends upon the demand for it. No government 
controls the demand for circulating medium, for this de- 
pends upon the volume of business. But in the case of 
a fiat system the government controls the supply of stand- 
ard money, while in the case of a commodity money this 
supply is made to take care of itself. 

§ 118. The fluctuations of the value of gold commodity 
money. — The course of the value of gold commodity money 
from 1789 to 1897 has been summarized by Irving Fisher 
as follows: 

(1) Between 1789 and 1809 the exchange value of gold 
against commodities in general fell to just about one-half 
of what it was at the beginning of the period. 

(2) From 1809 to 1849 the value of gold ascended to 
about two and one-half times what it was at the com- 
mencement of this period. 

(3) From 1849 to 1873, with two notable interruptions, 
gold's value fell to something less than three-quarters of 
what it was in 1849. 

(4) From 1873 to 1897 (a noteworthy period of falling 
prices accompanied by much political agitation on money 
questions) the value of gold ascended to about one-fourth 
higher than in 1873. 9 



a "The Purchasing Power of Money," pp. 240-46. Fisher sum- 
marizes the rise and fall of prices. In our text his figures have 



STANDARD MONEY 463 

From 1897 to 1914 there was a great rise of prices. 
According to the index numbers of wholesale prices pub- \t 
lished by the United States Bureau of Labor, 10 amounted 
to about 50%, indicating a fall in the purchasing power of 
gold to about % of what it was in 1897. 

§ 119. The exportability of commodity money. — The sec- 
ond principal difference in operation between the com- 
modity and fiat standards, lies in the fact that com- 
modity money is regularly exportable as bullion. The 
rates of exchange between two countries possessing the 
same commodity standard are, by reason of this fact, 
confined within relatively very narrow limits of fluctua- 
tion. To-day the only commodity standard of consequence 
which is common to a group of countries is gold. China 
and Persia alone remain with a silver commodity standard. 
As already indicated, the exchange rates in any given gold 
country upon any other gold country, cannot rise (in 
the sense of becoming dearer) more than a certain dis- 
tance above the mint par without causing a gold export 
which checks further rise. Likewise they cannot fall more 
than a certain distance below this point without occa- 
sioning a gold import, which checks further fall, and in 
normal times the full range of fluctuation in the Ameri- 
can sight rate on England is, for example, about 1% of 
the average between the extremes. 11 To give but one in- 
stance of the fluctuation in a rate of a fiat country upon 
a gold country, in the year 1896 the rate in Rio Janeiro 
upon England varied from the high point of 7 2 %2 English 
pence for one Brazilian milreis to the low point of 10%>d. 
per milreis. The range of variation here amounts to 22.8% 
of the average of these two rates! The fact has already 

been inverted ho as t<> give the fall or rise; in the purchasing power 
of gold. 

io Bulletin of the Bureau of Labor, No. 200, July, l!)l(i, p. 13. 

ii That is. in times of peace, when both countries are truly on the 



4(>4 FOREIGN EXCHANGE 

boon mentioned that the Brazilian government is now tak- 
ing measures to confine the rate on England within rela- 
tively narrow limits, but the example given shows that 
fiat exchanges may do when not controlled. The price 
of exchange in one fiat country upon another fiat coun- 
try may naturally enough run over a greater range of 
variation than that found for any other kind of exchange. 
The fundamental point is that neither of such countries 
can by export convert its standard money into that of 
the other, and the steadying influence, of such movements 
as gold export and import between gold countries, is en- 
tirely lacking. The fluctuations of the exchanges between 
a gold and a silver country are confined within certain 
limits set by the export and import of specie, these limits 
having the relative value of gold and silver as their approxi- 
mate center. 12 Since the relative value of gold and silver 
is changeable, the limits which confine the movements of 
gold-silver exchanges are changeable. In the gold stand- 
ard countries the relative value of gold and silver is shown 
in the price of silver. Especially during the last forty 
years, the price of silver has been exceedingly variable 
in terms of gold and the gold-silver exchanges have shown 
corresponding instability. 

gold standard, and when there is competition between foreign ex- 
change houses and when banks are paying legal tender on demand. 

12 This center corresponds in many respects to the mint par of 
the gold-gold exchanges, but it is not a mint par, and differs from 
the mint par in that it is movable. 



CHAPTER XVIII 

REPRESENTATIVE MONEY 

§ 120. The nominal and bullion values of token moneys. — 
Representative money falls into the two subclasses of coin 
and paper. The term "token money" usually means 
coined representative money, and is usually restricted to 
this meaning, though occasionally it is extended to include 
all representative money. Paper representative money ir 
of two kinds, (1) the circulating promissory note, and (2) 
the money certificate. The latter, though resembling a 
circulating demand note in many essentials, is distinguished 
by the fact that it can be issued only against the deposit, 
by the person receiving it, of its full amount in some 
specified kind of money, and by the fact that any such 
money must be held as a special trust fund to be used solely 
for the purpose of redeeming the certificate, so that the 
outstanding certificates are always secured by a 100% 
reserve. The gold and silver certificates, and the former 
"currency" certificates of the United States, and the 
Philippine "silver" certificates issued under the authority 
of the United States, are examples. 1 So far as the writer's 
knowledge extends, this type of representative money is 
issued only by the government of the United States, but 

i During the lir.st three years of its existence the Philippine silver 
certificate was exactly what its name implies, but hy act of June 23, 
1906, Congress provided that gold coin of the United Slates might 
be used to discharge these instruments at the rate of $1 for 2 pesos 
and that such gold coin might be substituted for silver in the trust 
fund though not to exceed G0% of this fund. The Philippine cer- 
tificate is now a gold and silver coin certificate. 

4G5 



466 FOREIGN EXCHANGE 

it should be said the Bank of England note, while not a 
literal gold certificate, comes very close to being one, so 

that it might be called a virtual gold certificate. (Cf. 
§ 129.) 

The circulating promissory note may issue in a diversity 
of ways either from governmental treasures or from bank- 
ing institutions. The reason for including this instru- 
ment in the category of money was discussed in § 2 of 
this book. In present day practice these notes are pay- 
able on demand and do not bear interest. They are se- 
cured by cash reserves and other assets under the very 
greatest variety of rules throughout the world. 

In dealing with metallic representative moneys, we often 
have occasion to distinguish between their nominal and 
their bullion values. Thus the nominal value of the larg- 
est silver coin of the United States is $1.00, and when 
silver sells at 60^ per fine ounce its bullion value is about 
46^. Paper representative money has a nominal value 
of precisely the same nature as that which belongs to token 
coin, but it has corresponding to the bullion value of the 
latter only the value of the paper on which the notes or 
certificates are printed, which is wholly negligible. Thus 
in representative moneys generally, we may distinguish 
(1) nominal value, and (2) material value, or the value 
of the material of which the money is made. 

But this class of money possesses still another kind of 
value which makes itself distinct in times of monetary 
derangement. This we may call actual or circulation value. 
Suppose that a silver dollar were capable of buying only 
% as much in trade as a standard or gold dollar at a time 
when the price of silver is 65^ per fine ounce. Under these 
assumptions this money piece would have (1) a nominal 
value of $1, (2) an actual value of 75^ and (2) a material 
or bullion value of 50^. It is the design of the state to 
maintain the actual value of its representative money at 



REPRESENTATIVE MONEY 467 

its nominal value. When its actual value is held exactly 
at its nominal value, a representative money is said to be 
"at a parity." But when a state fails to maintain such 
money at a parity, it does not of necessity follow that its 
actual value should drop to the level of its bullion or 
material value. Were this a necessary consequence, the 
moment paper money should fall below par it would have to 
drop all the way to zero ! And thus there is nothing 
absurd in supposing that a silver dollar might have a nom- 
inal value of $1, an actual value of 75^, and a third 
or distinct value as bullion of 50^. When everything is 
as it should be, the nominal values and actual values of 
representative moneys are the same. 

"Nominal" value is an appropriate term, because the 
value of a piece of representative money depends on the 
words which it bears, or on its legal name. It is in this 
sense the value is nominal. This is really no more difficult 
to understand than that the value of a promissory note 
depends upon the words it contains and not upon the 
amount of the paper on which it is written. The value 
of the promissory note is, of course, nominal in precisely 
the same sense. In fact, when representative money is 
expressly redeemable in standard money, it amounts to a 
promise or order to pay the latter. When the govern- 
ment manages by indirect redemption rather than by di- 
rect, to support its value, the same thing remains virtually 
true. 

It is to be kept in mind that all three of the values which 
we have distinguished as belonging to representative moneys 
are measured in standard money. When we supposed that 
in the United States the silver dollar might have at a 
given time a nominal value of 100^, an actual value of 75^, 
and a bullion value of 50^, all three of these figures signify 
cents in gold. Thus the supposition is that though the 
dollar is by name designed to represent 100^ gold, it shows 



468 FOREIGN EXCHANGE 

a purchasing power in trade the equivalent of 75^ of sold, 
while it melted down into bullion the ingot which it would 
make would sell for 50$ gold. 

§ 121. The coining value and market value of token 
bullions. — It is characteristic of metallic representative 
money that its nominal (and thus normally what we have 
called its "actual" value) exceeds its bullion value. Fur- 
thermore its bullion value, in contrast with that of "com- 
modity" standard money, fluctuates freely, because the 
metals of which representative moneys are made (silver, 
nickel, and copper) have variable market prices. This 
brings us to the distinction between the coining value and 
the market value of token bullion. This distinction is 
the same for copper and nickel as it is for silver, but we 
need consider it only in connection with silver. The 
coining value of silver is the amount of silver coin which 
can in accordance with the legal definition of this coin, 
be made from an ounce (or other physical unit) of silver 
bullion. In the United States the coining value of silver 
is quoted per fine ounce troy, and it is $1.2929+, for the 
reason that one ounce of fine silver with alloy w T ill make 
l 292 %oooo+ silver dollars. This figure is calculated as fol- 
lows: 

The legal weight of the silver dollar = 412.5 grains .900 fine. 
The fine silver in the dollar =371% grains (412.5 X -900). 
And if 371 1 /4 grains make one dollar, 480 grains (or 1 ounce) 
will make 480 -r- 371%, or 1.2929 + dollars. 

The coining value of an ounce of fine gold is $20.67+. 
Under the right of free coinage this also becomes, as we 
have seen, the mint price (or speaking with greater ac- 
curacy, the mint's basic price 2 ) for fine gold. If we 
had free coinage of silver, $1.29+ would, of course, be- 
come in the same way the mint price of silver. In point 

2 Cf. § 109. 



REPRESENTATIVE MONEY 469 

of fact, prior to 1873 the United States did have free 
coinage of silver, and the mint price of silver was $1.2929-}- 
per fine ounce and $1.1636-)- per "standard" ounce .900 
fine. 3 But to-day silver is coined on government account 
only. The government buys so much of the metal as it 
needs for coinage upon the open market at the fluctuating 
market price. The difference between this price and the 
bullion's coining value, constitutes the gross profit or 
seigniorage gained by the government in the manufacture 
of silver coin. 

Curiously, silver has two coining values in the United 

s From 1792 to 1873 the United States had a system of legal 
bimetallism. The coining value of gold per ounce was set at 
(almost) 1G times that of silver, giving the now famous "ratio" 
of 16:1. It happened that during a great part of the period from 
1792 to 1873 silver bullion had in the open market of the world 
a price in gold above $1.29 per fine ounce. Thus in 1851 an ounce 
of silver .925 fine (i.e. — British "standard" silver — called "standard" 
silver although since 1817 a token bullion in England) sold in Lon- 
don for an average price of 6 Id. This price was payable in gold 
coin of England. If the sight rate of New York on London were at 
4.86'/^, a New York dealer could ship silver from New York to 
London, sell it at the rate of 61d. per standard ounce, draw his 
sight exchange (payable in gold in England) and realize $1,337 
less expenses, per fine ounce by the sale of this exchange for gold 
coin in New York. In 1859 the London price of silver rose to the 
point which gave a New York equivalent of $1.36 per fine ounce. 
Thus the mint price of $1.29+ failed to govern the market price in 
the United States. There is nothing in this contradictory to the 
principles explained in §§ 108-110 concerning the relation of the mint 
price to the market price of standard bullion under free coinage, 
for those principles apply only to the case of monometallism. The 
principles of bimetallism (we might say, of successful and unsuc- 
cessful bimetallism) make a subject so large we cannot enter upon 
it, but by way of summary we may state that under bimetallic stat- 
utes the market price, payable in local legal lender coin, of neither 
standard metal can fall below its mint price, although the price of 
either one or the other (though not of both at once) may rise in- 
definitely above the mint price. 



•17i) FOREIGN EXCHANGE 

States. The one heretofore discussed is its coining value 
for the making of silver dollars. It has a different rating 
for manufacture into "subsidiary silver," or pieces of 
5(V, 25^, and 10^, because a dollar's worth of these coins 
does not contain the same weight of bullion as the one- 
dollar piece of silver. The law provides that two halves, 
four quarters, or ten dimes shall contain 25 grams (metric) 
of silver .900 fine. Twenty-five grams is the weight of the 
French silver 5 franc piece. The United States mint adopts 
385.8 grains troy as the official equivalent of 25 grams, 
and thus a dollar's worth of subsidiary silver coins con- 
tains as near as possible to 385.8 grains of silver .900 fine. 
The table below is self-explanatory. 

COINING VALUE OF SILVER IN THE UNITED STATES 

Gross Fine Coining Value of Silver 

Weight Contents Per ounce Per ounce 

Grains Grains 1.000 fine .900 fine 

The silver dollar 412.5 371.25 $1.2929* $1.1636* 

A dollar of subsidiary 

silver 385.8 347.22 $1,382** $1,244** 

* I.e. — coining value for manufacture into silver dollar pieces. 
** I.e. — coining value for manufacture into subsidiary silver 
pieces. 

$1.29+ is the figure which is commonly given as the coin- 
ing value of silver in the United States. But it is in fact 
the figure of $1.38-)- which indicates the seigniorage en- 
joyed by the mint as manufacturer of subsidiary silver, 
and at present this is the only form of silver which our 
mints coin regularly. In statistics the value of silver may 
be given either as its "commercial value" (price per ounce 
in gold) or its coining value. When the coining value 
is the one given it is always calculated at the rating of 
$1,294- per ounce, and not at $1,384-. This is because 
the former figure was once a mint price of silver in the 



REPRESENTATIVE MONEY 471 

United States, while the latter never possessed that distinc- 
tion. 

In each of the different countries where silver is used as 
token money, it has its particular local coining value, as 
7.45 francs per fine ounce in France, or 6.22 marks in 
Germany. 4 These several coining values have no relation 
to the present day market price of silver, though all 
have historical relations with the former price of silver 
bullion in the days when silver was a standard instead 
of a token money. This is the place to call to mind the 
fact that the comparative silver contents of the token 
coins of different countries have no relevancy to their 
comparative values as moneys. For the silver in the 
mark, the franc, the shilling, or the dollar, has, as we 
have seen, no bearing upon the normal money value of 
these pieces. 

§ 122. The non-exportable character of representative 
moneys. — Under normal conditions a representative money 
is commercially non-exportable. In this respect it is in 
sharp contrast with commodity standard money. We can- 
not say that a representative money is absolutely non- 
exportable, because it is generally possible for individuals 
to send or take any form of representative money abroad 
and, if it is in appreciable quantities, to obtain for it 
something approaching its full nominal converted value 
in foreign money. But when such a money does go abroad, 
the only economical use to which it can be put by the 
dealer who gives foreign money for it, is to send it back to 
its home country. Thus as we may express it, represen- 
tative money is not finally exportable. And for the very 
reason that when it is sent away from home, some one 
must bear the expense of sending it back, it can rarely be 
employed commercially as a means of remittance. In any 

* Converted from the metric system in which the French and Ger- 
man money units are legally defined. 



172 FOKEIUX EXCIIAXGE 

event it is clear it cannot be used as a final means of dis- 
charging: a national balance of indebtedness. Thus, when 
it comes to pass that the United States, 5 having become 
indebted abroad in a greater sum than its credits against 
foreign places, needs to export say $1,000,000 of money 
on balance, if gold is sent it may be converted into foreign 
standard money and thus finally liquidate the indebtedness. 
But if $1,000,000 of United States Notes or gold certifi- 
cates should be sent, since they could neither enter directly 
into circulation abroad nor be manufactured over into 
foreign money, they would merely come back home and 
only by paying for them in something that can stay abroad 
could the United States permanently liquidate its bal- 
ance of indebtedness. 

The Bank of England note is preeminent among repre- 
sentative moneys for having a general acceptability in parts 
of the world foreign to the home country. Just as New 
York exchange is readily salable in almost any part of the 
United States, so London exchange has a good market in al- 
most any part of the civilized world. The Bank of Eng- 
land note is, of course, a very superior form of sight sterling 
exchange. In large lots, these notes could naturally be 
sold for the very highest exchange prices. In small quan- 
tities thej* bring a reasonable price in any commercial 
capital of the world. Without taking the trouble to make 
a statistical study of the average price of foreign bank 
notes in relation to the rates for bankers' sight drafts, 
we may give the following quotations for a single day as 
being of interest. The prices given for bank notes are 
those offered in New York on February 17, 1912, by 
Zimmerman and Forshay for such currency in small 
lots. 

5 Meaning, of course, simply the entire group of persons in the 
United States who have entered into business engagements with for- 
eigner?. 



REPRESENTATIVE MONEY 473 

PRICE OF FOREIGN MONEY ON DIRECT SALE IN 
NEW YORK 



(1) 


(2) 


(3) 

This con- 


(4) 




N. Y. Rate 


verted to 


Percent- 


Price 


for Bank- 


dollars per 


age 


of Bank 


ers' Sight 


1 foreign 


which (1) 


Notes 


Drafts 


unit 


is of (3) 


Bank of England notes, per £ $4,865 


4.8725 


4.8725 


99.8% 


Notes of Bank of France per 








franc 1925 


5.18% less Vie 


.1929 


99.7% 


Notes of Reichsbank, per mark.. .2370 


■95Ve 


.2378 


99.67o 



On the same date this firm offered 95<? for the French 5 franc 
piece of silver (i.e., at the rate of 19? per franc) and $4.84 per £ 
for English silver coin. The following quotations also may be 
noted: gold sovereigns, $4,865; gold 20 mark pieces, $4.74 ($.237 
per mark) ; gold 20 franc pieces, $3,875 ($.19375 per franc). 

In the Paris market, Jan. 27, 1912, Bank of England notes 
were quoted at 25.24 @ 25.26 francs per £, when sight exchange 
was 25.25 @ 25.28. 

The New York house purchasing these foreign moneys 
must as a regular thing realize upon them by the simple 
expedient of using them as a substitute for exchange, 
namely by remitting them abroad and selling drafts 
against the proceeds. 

To summarize: a commodity standard money (in a word, 
gold money) is exportable and importable as a part of 
the regular course of things. Representative moneys of 
paper can never be, as we chose to express it, the subjects 
or final export. Representative moneys of metal come un- 
der the same rule, unless the foreign market price of the 
bullion of which they are composed should rise so high that 
export would become profitable. Such a contingency would 
have to be met by the reduction of the bullion contents 
of the representative money by the home government. 6 

o Compare §123. If the price of silver should pass above 59d. 
in London (the quotation being per <>/.. British standard silver, 
that is, silver .925 fine) it would pay commercially to export United 



171 FOREIGN EXCHANGE 

But even if this action were not taken, the export possi- 
bilities of the representative money would by no means 
make it a substitute for the regular standard money as a 
means of adjustment of international balances. In the 
first place, it would probably have a strong tendency to flow 
in one direction only, and in the second place, its avail- 
ability for export would depend upon the position of the 
fluctuating price of the bullion of which it is made. The 
conclusion is that it is no part of the regular function of 
representative moneys to serve as articles of export and 
import, and as means of discharging international balances 
of indebtedness. 

§ 123. The features of a perfected system of token money. 
— Xot all countries have brought the administration of 
their token moneys into entire conformity with correct 
principles, but the drift of modern practice makes unmis- 
takable what the requirements are of a perfected system 
of token money. The four essentials about to be indi- 
cated are those given by Professor J. L. Laughlin in his 
"Principles of Money." 7 

(1) Token money may be coined only on government 
account. (We hardly need pause to show that a system 
of free coinage of token money with a variable seigniorage 
would be impracticable.) 

(2) Token coin must be made with a bullion content 
sufficiently small to preclude the possibility of its being 

States silver dollars to be sold on the London market as bullion. 
Though silver was often above this price in the middle of the nine- 
teenth century, it has not reached such a height since. The sale of 
the silver would be for gold money of England, against which ster- 
ling exchange would be drawn and sold in New York for American 
money. At a price of 59d. per oz., more than a dollar of U. S. 
legal tender would thus be realized on every silver dollar shipped 
abroad, it being assumed that sterling exchange stands at par 
(4.8665) in New York. 
7 Chapter XV. 



REPRESENTATIVE MONEYS 475 

melted down for sale as metal at home or abroad. Some 
of the noteworthy tokens of the leading nations were once 
standard money, and retained the weight and fineness they 
had in the days of their higher standing. But since the 
pronounced fall in the price of silver which began in 1872, 
none of them has been in great danger of the melting pot. 
Still the war-time ascent of the white metal to a dollar a 
fine ounce brings the bullion value of the silver dollar of 
the United States up to 77^. Beneath are some statis- 
tics for this country. 



Average Price 



Selected Years 


fine ounce) 


1872 


$1.32 


1875 


1.24 


1885 


1.06 


1895 


.65 


1905 


.61 


1909 


.52 


1910 


.54 


March 1919 


1.01 





Bullion Value 


lion Value 


of a Dollar 


J. S. Silver 


of Subsidiary 


Dollar 


Silver * 


1.022 


$ .954 


.96 


.896 


.82 


.766 


.50 


.47 


.47 


.44 


.40 


.376 


.418 


.39 


.78 


.73 



* As two half-dollars, four "quarters," or ten dimes. 

(3) A token money ought to be directly redeemable 
at its nominal value in standard money on demand. Like- 
wise all forms of token money should be issuable on de- 
mand to any applicant who offers standard money in ex- 
change. The method of direct redemption is the simplest 
and most certain for supporting parities. It provides 
automatically for the maintenance of the proper quantity 
of token moneys in circulation, for the supply of a de- 
ficiency or the withdrawal of a surplus. The government 
needs only to manufacture enough tokens to keep its ex- 
change offices in a position to meet the demands made upon 
them by the general public. It is true, as historical evi- 



476 FOREIGN EXCHANGE 

deuce shows, that a sufficient limitation placed upon the 
supply of tokens, which have once been established in com- 
merce, will sustain their parity without the express legal 
right of redemption at government offices on demand. 
Furthermore, if a government receives its tokens freely in 
payments due it, and pays out standard mone}' freely on 
request in payments due its creditors, this furnishes a kind 
of indirect redemption which unaided may serve in prac- 
tice to sustain parity. 8 But the method of direct redemp- 
tion is the only clear-cut and entirely safe method of man- 
aging the token (and also other representative) elements 
in the circulation. 

(4) In the fourth place token moneys or some of them 
should be given a limited legal tender power to enable the 
technical legal discharge of debts involving fractional sums 
— such as a debt for $7.83. One reason for restricting 
their legal tender power to small amounts in a single pay- 
ment is to prevent their employment by a spiteful debtor 
to pay off a large account with a great weight and bulk 
of metal. Another is the negative reason that there is no 
necessity for money serving as change to be legal tender 
in large sums. Again in case a token money should lose 
its parity it would be inecniitable if any substantial debt 
should be dischargeable in it. 

§124. The limping gold standard. — The "limping gold 
standard" (French "etalon boiteux") is a term of fairly 
recent origin applied to the monetary system of a country 

s The history of the American silver dollar since 1878 is espe- 
cially instructive in this connection. It has been maintained at a 
parity by the method of indirect redemption. This method works 
provided the government does not manufacture and, through its ex- 
penditures, discharge into circulation too great a quantity of tokens. 
See A. D. Noyes, "Forty Years of American Finance," or J. L. 
Laughlin, "History of Bimetallism in the United States," (appro- 
priate chapters). Not even to-day does the silver dollar of the 
United States have the legal right of redemption in gold. 



REPRESENTATIVE MONEY 477 

which has associated with a gold standard money, token 
currency possessing unlimited legal tender power without 
being by express declaration of law redeemable in gold. 
France and the United States have been on this standard 
since 1873. Germany was on it from 1871 until 1907 in 
which year a law was passed (October 1) taking the legal 
tender power away from the silver thaler (or piece of three 
marks). The limping standard arose out of the suspension 
of the free coinage of silver by the three countries named 
(in 1871 by Germany, and in 1873 by France and the 
United States) without the removal, from the formerly 
standard silver coins, of their earlier attributes of irre- 
deemability and full legal tender power. The essential 
point in the monetary system thus developed which has 
earned for it the appellation, "limping" standard, is that 
in the strict letter of the law contracts for money, includ- 
ing bank deposits and commercial paper, can be discharged 
in silver coin, and the government is not explicitly bound 
to redeem this coin in gold. Hence Englishmen, for in- 
stance, living in a country which had before the war a 
standard without a limp, a fact of which they were well 
aware, were inclined to say a person could not be sure 
that credit claims in France or the United States are 
just as good as gold. The French silver five-franc piece 
and the United States silver dollar are the coins which 
possess full tender power without explicit legal authority 
for redemption in standard gold money. France alone 
utilizes the possibilities contained in the limping standard 
for hampering gold export. In the United States 
absolutely no use in made of these possibilities. And de- 
spite the tradition dominating all London "financial" 
writers, New York has been for years the freest gold market 
in the world — when New York banks have not suspended 

b Bee Chapter XX, § 140, on the gold premium policy of the Bank 
of Frame. 



FOREIGN EXCHANGE 

payments for a period. Their occasional suspensions have 
had nothing to do with the limping standard in the United 
States. 

While from 1890 to 1896 there was much fear at home 
and abroad lest our silver dollar should lose its parity 
with gold, this event has never happened. Still the only 
legal protection existing for the parity of this coin is the 
statutory declaration (see § 1, Act of March 14, 1900) 
that it is the policy of the United States to maintain all 
forms of money at parity with gold and that it shall be 
the duty of the Secretary of the Treasury to maintain these 
parities. It seems at present writing quite out of the ques- 
tion to develop any great alarm about the limp in the 
American gold standard. As already explained (§ 3), con- 
tracts calling specifically for gold cannot be discharged in 
silver or paper money in the United States except by 
consent of the creditor. A bank deposit, however, is a 
contract for plain "dollars" and not specifically for gold 
coin, and is therefore dischargeable in U. S. Treasury Notes 
and silver dollars as well as in gold. 



CHAPTER XIX 

MONETARY SYSTEMS OF THE LEADING NATIONS 

§ 125. Troy and metric weight. — The legal specifications 
of the "standard unit of value" are laid down in troy 
weight in the United States and England, and in metric 
weight in France and Germany and the majority of other 
gold standard countries. According to the received histori- 
cal account, the original troy pound was the weight of 7,680 
grains of wheat, all taken from the middle of the ears and 
well dried. But the unit of weight known to-day as the 
troy pound is, in the United States, simply the weight of 
a certain piece of brass kept by the Philadelphia mint. 
Whatever balances exactly against this in the scales has 
a weight of one troy pound. This brass weight-unit is 
itself a copy, procured in 1827 by the minister of the United 
States, of a certain piece of brass formerly kept by the 
English government as its official troy pound. The pres- 
ent standard of weight in England is a certain block of 
platinum called the British imperial pound. This is the 
legal avoirdupois pound, and in England an official troy 
pound weight does not exist. Legally a troy pound is 
any weight B76 %ooo or lu A~r, as great as the imperial pound. 
In the destruction of the Houses of Parliament a number 
of older British standards of measurement were destroyed 
or made useless and a new se1 was prepared. 

The unit of weight under the metric system is the kilo- 
gram. This is the weight of a certain block of platinum 
and iridium kept by the International Bureau of Weights 
and Measures near Paris. This block was established as 

479 



ISO FOREIGN EXCHANGE 

Hie standard metric kilogram weight by the concurrent 
action of the chief governments of the world. Although 
the kilogram was in the first instance derived from the 
meter, or metrical unit of length, 1 the ultimate scientific 
definition of the kilogram is now simply the weight of 
this particular official block of metal. Between the troy 
pound and the kilogram, there is no ratio depending upon 
mathematical or physical law. From the standpoint of 
physical science the two units of weight are simply two 
arbitrarily selected blocks of metal, and the ratio between 
them can be obtained only by actual weighing of one against 
the other in the balance. According to the appraisal 
adopted by the Bank of England and by the United States 
mints, the kilogram has a troy equivalent of 15,432 grains 
(or 2 lbs. 8 oz. 3 dwt.). 2 Comparative weighing of the 
two standards has, however, been carried out to further 
decimals, giving such results as 

1 kilogram = 15,432.349 grains, or again, 
1 kilogram = 15,432.35639 grains. 

The tables following show the fractions of units in the 
troy and metric systems of weight. 

i The one-hundredth part of the meter is the centimeter. The 
gram (the original unit of weight, but now merely the one-thou- 
sandth part of the official kilogram) was first defined as the weight 
of 1 cubic centimeter of water at its maximum density under a 
pressure of one atmosphere. 

2 In connection with its bullion dealings, the Bank of England 
converts kilograms into troy weight at this rate. Tate's "Modern 
Cambist," 24th ed., 1908, by H. T. Easton, p. 59, note. For the 
purpose of translating the legal metric definition of United States 
subsidiary silver coin (see § 121, p. 470) into troy, the mints of this 
country have adopted 15.432 grains as the equivalent of a gram (the 
same ratio as 15,432 grains equal to one kilogram). The mint ac- 
tually manufactures the subsidiary silver pieces in accordance with 
their translated troy weights. See "Instructions and Regulations 
for Mints and Assay Offices," 1908, Treas. Department Doc. No. 2,494. 



MONETARY SYSTEMS OF LEADING NATIONS 481 

Troy 

Abbreviations : lb. = pound, oz. = ounce, dwt. = pennyweight, 
and gr. = grain. 

1 lb. = 12 oz. == 240 dwts. = 5,760 grains. 

1 oz. = 20 dwts. = 480 grains. 

1 dwt. = 24 grains. 

Metric 

1 kilogram = 10 hectograms = 100 decagrams = 1,000 grams. 

1 gram = 10 decigrams = 100 centigrams = 1,000 milligrams. 

Approximate Equivalents 

1 kilogram = 2.2 lbs. avoirdupois = 2.67 lbs. troy. 
1 lb. avoirdupois = 1.21 lbs. troy. 3 
Official ratio in England and the United States, 
1 kilogram = 15,432 grains. 

§ 126. The standard units of value. — 

United States 

A statute of the United States of March 14, 1900, de- 
clares (§1) 

That the dollar consisting of twenty-five and eight-tenths grains 
of gold nine-tenths fine * * * shall be the standard unit of value, 
and all forms of money issued or coined by the United States shall 
be maintained at a parity of value with this standard, and it shall 
be the duty of the Secretary of the Treasury to maintain such 
parity. 

The statement that the dollar of 25.8 grains shall be the 
standard unit of value, means that such gold coins as are 
Struck shall contain this number of grains per dollar of 
their nominal or legal-tender value, and does not necessarily 

3 Troy and avoirdupois are not independent systems, as are troy 
and metric, or avoirdupois and metric. 1 lb. troy = 5,760 grains, 
and 1 lb. avoirdupois = 7,000 of the same grains, and therefore 144 
lbs. avoirdupois equals exactly 17. r > lbs. troy. 



482 FOREIGN EXCHANGE 

signify thai a one-dollar piece of gold shall actually be 
coined, hi l'acl the one-dollar gold piece was first author- 
ized in 1849 and discontinued in 1890. The statutor} r his- 
tory of the gold contents of the standard unit is as follows: 

Weight of the 1'nited States Gold Dollar (not always coined) 







Gross 


Fine- 


Fine 






Weight 


ness 


Contents 


Act of April 2, 


1792. . 


27 grains 


.916% 


24.75 grains 


Act of June 28, 


1834.. 


25.8 grains 


.899225 


23.2 grains 


Act of Jan. 18, 


1837.. 


25.8 grains 


.900 


23.22 grains 



Present metric weight of the dollar 1.6718 grams (gross), 
1.5046 grams (fine). 

The Act of Feb. 12, 1873, dropped the silver dollar from 
the list of coins of the United States. The silver dollar 
was theretofore legally a standard coin, coordinate in this 
respect with the gold money of the country, and before 
1873 the United States possessed a system of legal though 
not of actual bimetallism. In a somewhat uncertain man- 
ner, the act of 1873 put the country upon a basis of legal 
gold monometallism, with the same gold dollar as that pro- 
vided by the act of 1837. It remained for the act of 1900 
to make the adoption of the gold standard definitive. 4 

Great Britain 

The pound sterling of England is a unit of 123 17 %23 (or 
123.27447) grains troy of gold %s fine, with a pure con- 
tents of 113%23 grains. 

* This would seem to be a fair description of the effect of the act 
of 1900, in spite of the fact that it could have been made stronger 
if sections had been inserted providing expressly for the redemption 
in gold of all forms of representative money, including the silver 
dollar, and providing that this dollar should have only those legal 
tender powers which are given the "subsidiary" silver. The Sec- 
retary of the Treasury is charged with the duty of maintaining the 






MONETARY SYSTEMS OF LEADING NATIONS 483 
The English money notation is shown below. 

1 pound = 20 shillings = 240 pence = 960 farthings. 

1 shilling = 12 pence = 48 farthings. 

1 penny = 4 farthings. 

A sum of English money is commonly written in figures in the 
following fashion: £3. 17s. 9d. or £3. 17/9 (i.e., three pounds, 
seventeen shillings, and nine pence, a sum which happens to be the 
Bank of England's legal minimum buying price for gold). 
£, s, and d, are abbreviations for the Latin words, libra, solidus, 
and denarius. Shillings may also be abbreviated as "sh." 

France 

The standard unit of value of France is the franc with 
a contents of 0.32258 grams of gold .900 fine. A number 
of countries in different parts of the world have adopted 
laws providing standard units of gold with the same weight 
and fineness as the French franc. But not all these coun- 
tries have been so fortunate as to possess a gold standard 
in point of fact. A list follows. 

Countries with the Same Legal Gold Unit as France 

Name And its one- 

I Of Unit hundredth part 

Members of the 
Latin Monetary Union 

France franc centime 

Belgium franc centime 

Switzerland franc centime 

Italy lire centesimi 

Greece drachma lepta 

parity of all representative moneys, but this is not quite the equiva- 
lent of such a provision as the one just mentioned. That is, the 
act might have taken the country off the "limping gold standard." 
See § 124. 



FOREIGN KXCIIANGE 

Countries with fix Sarin Legal Gold Unit as France 
(Continued) 

Name And its one- 

II Of Unit hundredth part 

Other Countries 

Spain peseta centimo 

Finland mark penni 

Bulgaria leva statinki 

Servia dinar paras 

Venezuela bolivar centimes 

Argentine Republic . . 1 peso of 100 centavos has exact gold 

contents of 5 francs (i.e., 1.6129 grams 

.900 fine). 



Germany 

The standard unit of value of the German Empire was 
established by the law of December -1, 1871, which provides 
that "there shall be coined an Imperial gold piece, of 
which 139^ shall be made from one pound of fine 
gold. The tenth part of this piece shall be known as 
the mark and shall be divided into 100 pfennigs. . . . 
The composition of imperial gold coin shall be 900 
thousandths of gold and 100 thousandths of copper. 
Accordingly 125.55 ten-mark pieces shall weigh one 
pound. ..." The German pound (pfund) is exactly 
500 grams or one-half kilogram. Consequently 279 (i.e., 
2 times 139a->) pieces of ten-marks, or 2,790 marks are 
coined from one kilogram of fine gold. This gives the 
mark the following weight: 

Gross "Weight Fineness Fine Contents 

Mark (gold) 398274 grams .900 .358422 grams 



MONETARY SYSTEMS OF LEADING NATIONS 485 

The Germans use a comma where we use a decimal point. 
Thus the sum written by us as 2505.32 marks appears in 
German as 2505,32 marks. 

§ 127. Tables of mint pars. — The chief mint pars of the 
world are indicated in the tables beneath. 



MINT PARS OF THE UNITED STATES 

One Foreign Unit One U. S. Dollar 

Dollars as below equals Foreign 

equals U. S. Units as below 

England pound $4.86656 49.316 pence* 

France f franc .19295 5.1826 francs 

Germany mark .23821 4.1979 marks 

Netherlands florin § .40195 2.4878 florins 

Austria crown .20262 4.9351 crowns 

Russia ruble .51456 1.9433 rubles 

Japan yen .49845 2.0061 yens 

* Or $1 equals £.20504 -f. 

f The figures are also good for the franc of Belgium and 
Switzerland, lire of Italy, drachma of Greece (not in circulation 
and at a premium), peseta of Spain, mark of Finland, lei of Ron- 
mania, and certain other coin with the same definition as the 
French franc. 

§ The florin is also called the "guilder" and the "gulden." 

MINT PARS OF GREAT BRITAIN 

One Foreign Unit One English Pound 
Equals English Equals Foreign 

Pence as below Units as below 

United States dollar 49.316 d. 4.8665 dollars 

France franc 9.5157d. 25.22155 francs 

Germany mark 11.7477d. 20.429 155 marks 

Netherlands florin 19.823Dd. 12.1071186 florins 

Austria crown 9.9927d. 24.017427 crowns 

Russia ruble 25.3764d. 9,157582 rubles 

Japan yen 24.5819d. 8.763278 yens 



tsei 



FOREIGN EXCHANGE 



MINT PARS OF FRANCE 

One Foreign One Franc 

Unit Equals Equals Foreign 

Francs as below Units as below 

United States dollar 5.1826 f. 0.192952 dollars 

England pound 25.22155f. 9.5157 pence 

Germany mark 1.23456f. 0.81 marks 

Netherlands florin 2.0832 f . 0.48003 florins 

Austria crown 1.0501 f. 0.9522 crowns 

Russia ruble 2.6668 f. 0.3749 rubles 

Japan yen 2.5833 f . 0.3871 yens 

Other countries possessing the same gold unit at law as France 
are listed on page 483. 

MINT PARS OF GERMANY 

One Foreign One Mark 

Unit Equals Equals Foreign 

Marks as below Units as below 

United States dollar 4.19792M 0.23821 dollars 

England pound 20.42945M 11.74774 pence 

France franc 0.81 M 1.23456 francs 

Netherlands florin 1.68739M 0.59263 florins 

Austria crown 0.85061M 1.17562 crowns 

Russia ruble 2.16011M 0.46293 rubles 

Japan yen 2.09247M 0.47790 yens 



The mark is to the franc exactly as 100 to 81. 

The data for the tables of this section may be found in the Re- 
port of the Commission on International Exchange (U. S.) on 
The Gold Standard in International Trade (1904), page 512. 



MONETARY SYSTEMS OF LEADING NATIONS 487 

§ 128. Technical detail. The United States. — 

THE COINS OF THE UNITED STATES 
(at present authorized to be struck, 1919) 

Gold 

Gross Fine Fine 

Nominal "Weight Fine- Contents Contents 

Name Value (grains) ness (grains) (grams) 

Double-eagle .. $20 516 .900 464.4 30.0926 

Eagle 10 258 .900 232.2 15.0463 

Half-eagle .... 5 129 .900 116.1 7.5231 

Quarter-eagle .. 2.50 64.5 .900 58.05 3.7615 

Silver 

Half-dollar 50 192.9 .900 173.61 

Quarter-dollar . .25 96.45 .900 86.805 

Dime 10 38.58 .900 34.722 

Nickel 

"Nickel" 05 77.16 75% copper, 25% nickel. 

Bronze 
Cent 01 48 95% copper, 5% tin and zinc. 

The Silver Dollar 
Dollar 1.00 412.5 .900 371.25 grains. 

Legal tender in the United States. — In the discussion 
of the general nature of legal tender given in § 3, we drew 
our illustrations from the legal tender law of the United 
States, and we need add little to the latter subject in the 
present section. The several forms of money in circula- 
tion in the United States possess a variety of special tender 
powers, which are explained brie% in the quotation below. 

"Gold coin is legal tender at its nominal or face value for all 
debts, public and private, when not below the standard weight 
and limit of tolerance prescribed by law; and when below such 

standard and limit of tolerance it is legal tender in proportion to 
its weight. 

"Standard' silver dollars are legal fender al their nominal or 
face value in payment of all debls, public and privale, without 



FOKEIGN EXCHANGE 

regard to the amount, except where otherwise expressly stipulated 
in the contract. 

"Subsidiary silver is legal tender for amounts not exceeding 

#10 in any one payment. 

'• I r< asury notes of the Act of July 11, 1890, are legal tender for 
all debts, public and private, except where otherwise expressly 
stipulated in the contract. 

"United States notes are legal tender for all debts, public and 
private, except duties on imports and interest on the public debt. 
United States notes, upon resumption of specie payments, Janu- 
ary 1, 1879, became acceptable in payment of duties on imports 
and have been freely received on that account since the above date, 
but the law has not been changed. 

"Gold certificates, silver certificates, and national-bank notes 
are not legal tender, but both classes of certificates are receivable 
for all public dues, while national-bank notes are receivable for 
public dues except duties on imports, and may be paid out by 
the Government for all salaries and other debts and demands 
owing by the United States to individuals, corporations, and asso- 
ciations within the United States, except interest on the public 
debt and in redemption of the national currency. All national 
banks are required by law to receive the notes of other national 
banks at par. 

"The minor coins of nickel and copper are legal tender to the 
extent of 25 cents." 5 

Federal Reserve Bank Notes have the same special tender 
powers as National Bank Notes, it being added that Federal 
Reserve Banks are required to receive them in payment at 
par (this under the statutory provision that they shall be 
to the "same tenor and effect as national-bank notes," § 18, 
Federal Reserve Act of Dec. 23, 1913). 

Federal Reserve Notes "shall be receivable by all na- 
tional and member banks [i.e., members of the Federal 
Reserve banking system] and Federal reserve banks and 

5 From United States Treasury Department Circular, No. 62, '"In- 
formation Respecting United States Bonds, Paper Currency," etc., 
July 1, 1908, p. 15. 



MONETARY SYSTEMS OF LEADING NATIONS 489 

for all taxes, customs, and other public dues. " ( § 16, 
Federal Reserve Act of Dec. 23, 1913.) 

The redemption rights of United States moneys. — The 
following rules governing the redemption of the several 
forms of money in this country are taken from "Circular 
No. 62" issued by the Treasury Department. 6 

"Gold coins and standard silver dollars, being standard coins 
of the United States, are not 'redeemable.' 

"Subsidiary coins and minor coins may be presented, in sums or 
multiples of $20, to the Treasurer of the United States or to an as- 
sistant treasurer for redemption or exchange into lawful money. 

"United States notes are redeemable in United States gold coin 
in any amount by the Treasurer and all the assistant treasurers 
of the United States. 

"Treasury notes of 1890 are redeemable in the United States 
gold coin in any amount by the Treasurer and all the assistant 
treasurers of the United States. 

"National-bank notes are redeemable in lawful money of the 
United States by the Treasurer, but not by the assistant treas- 
urers. They are also redeemable at the bank of issue. In order 
to provide for the redemption of its notes when presented, every 
national bank is required by law to keep on deposit with the 
Treasurer a sum equal to 5% of its circulation. 

"Gold certificates being receipts for gold coin, are redeemable 
in such coin by the Treasurer and all assistant treasurers of the 
United States. 

"Silver certificates are receipts for standard silver dollars de- 
posited, and are redeemable in such dollars only. 

" '(Join' obligations of the Government are redeemed in gold coin 
when gold is demanded and in silver when silver is demanded." 

The treasury offices make a practice, however, of paying 
out gold on requesl in redeeming any form of money. 

Tolerance. — Tolerance is an allowance made by law for 
the deviation of actual coin from its exact legal specifica- 
tions. The different kinds of tolerance are here shown. 

8 As cited immediately above, p. 488. 



190 FOWEIGN EXCHANGE 

f Error in fineness 



Tolerance 



For error in minting , T , 

LError in gross weight 

For abrasion (or loss of weight in circulation). 



* The tolerance for error in minting is also known as the 
"remedy." 

The tolerance for error in fineness is in this country one- 
thousandth for gold coin, and three-thousandths for silver. 7 
That is, a gold coin might come from the mint either .901 
or .899 fine and be a good coin at law. However, the in- 
structions of the Director of the Mint state that in practice 
bullion should not be coined which varies outside of the 
limits of 899 7 /io and .9001io. s Thus the mints are directed 
to take advantage of not more than three-tenths of the 
maximum legal tolerance for error in fineness. 

The tolerance for error in the gross weight of newly 
minted coin is defined in two w'aj's. (1) When a coin is 
weighed by itself: For the double-eagle and the eagle the 
tolerance is one-half grain, and for smaller gold coins one- 
quarter grain. 9 (For all silver coin it is one and one-half 
grains for each coin.) (2) "When a number of coins are 
weighed together : ' ' And in weighing a number of pieces 
together, the deviation from the standard weight shall not 
exceed one-hundredth of an ounce in five thousand dollars 
in double-eagles, eagles, half-eagles, or quarter-eagles, in 
one thousand three-dollar pieces, and in one thousand one- 
dollar pieces. ' ' 10 The following table of tolerances is self- 
explanatory. 

7 Revised Statutes of the U. S., § 3533. 

8 "General Instructions and Regulations," etc. (before cited), Art. 
22, § 2. p. 25. 

o Revised Statutes of the U. S., § 3,535. 

io R. S., § 3535. The three-dollar and one-dollar pieces are no 
longer coined, 



MONETARY SYSTEMS OF LEADING NATIONS 491 
TOLERANCE IN GROSS WEIGHT OF NEW GOLD COIN " 







Tolerance 






Standard 


allowed by 


Minimum 


Denominations 


or legal 


law on in- 


legal weight 


of coins 


weight 


vidual pieces 


of new coins 




Grains 


Grains 


Grains 


Double-eagle 


51C.0 


0.50 


515.50 


Eagle 


258.0 


.50 


257.50 


Half -eagle 


129.0 


.25 


128.75 


Quarter-eagle 


64.5 


.25 


64.25 



The tolerance for abrasion in circulation. — The law pro- 
vide.? that a gold coin may suffer a loss of weight by natural 
abrasion at the rate of one-half per cent, in twenty years, 
the total abrasion not to exceed one-half per cent. Thus 
a coin one year old must not show an abrasion in excess 
of one-fortieth per cent., one five years old not in excess 
of one-eighth per cent., and so on. The effect of excessive 
abrasion is to make a coin cease to be legal tender at its 
"full" or "nominal" value, although it retains legal tender 
power in proportion to its actual weight. 12 The "least 
current weights" of our present gold coins are indicated 
in the following table. 



LEAST CURRENT WEIGHTS U. S. GOLD COINS 13 







One-half 






Actual 






per cent. 


Least cur- 


Annual 


coefficient 


Denomina- 


Standard 


abrasion 


rent weight 


abrasion 


of annual 


tions 


or legal 


after 20 


after 20 


within 


abrasion from 


of coins 


weight 


years' wear 


years' wear 


legal limit 


experiments 




Grains 


Grains 


Grains 


Grains 


Grains 


Double-eagle 


516.0 


2.58 


513.42 


0.129 


0.0860 


Eagle 


258.0 


1.29 


256.71 


.0645 


.0430 


Half-eagle 


129.0 


.643 


128.355 


.0322 


.0215 


Quarter-eagle 


64.5 


.322 


64.178 


.0161 


.0107 



ii From "General Instructions and Regulations," etc. (before 
cited), p. 22. 

"Revised Statutes, 8 3585. 

"From "General Instructions and Regulations," etc. (before 
cited), p. 22. 



492 



FOREKiX EXCHANGE 



§ 129. Technical detail. England.— 

THE COINS OF ENGLAND 
Gold 













Mint 




Gross 


Fineness 


Fine 


Fine Gold 


Parity 




Weight 


in thou- 


Gold 


(metric 


in U. S. 


Denomination 


(grains) 


sandths 


(grains) 


grams ) 


Dollars 


Five-pound 


616.37239 


.910% 


565.0079 


36. 110 


$24.3328 


Two-pound 


246.54895 


.916% 


220.0031 


14.0447 


9.7331 


Sovereign (£1) 


123.27447 


.916% 


113.0015 


7.3223 


4.8665 


Half-sovereign 












(10s.) 


G1.G3723 


.916% 


50.5007 


3.GG11 


2.4332 



(There are virtually no £5 and £2 coins in circulation.) 

Silver 

Fine 

Gross weight Contents 

Denominations (grains) Fineness (grains) 

Crown (5s.) 430.36 .925 403.03 

Half-crown (2Vjs.) 218. IS .925 201.81 

Florin (2s.) 174.54 .925 161.45 

Shilling 87.27 .925 80.72 

Sixpence 43.03 .925 40.36 

Threepence 21.81 .925 20.18 

Bronze 

Gross Weight (grains) Alloy 

Penny 145.83 f 95% copper 

Half-penny 87.50 J 4% tin 

Farthing 43.75 1% zinc 



PAPER MONEY IN GREAT BRITAIN 

Bank of England Notes (in denominations of £5, 10, 20, 50, 100, 
200, 500, and 1,000) were prior to the war the only legal tender 
paper money of England. The Bank of England is divided 
into two distinct parts known as the Banking Department and 
the Issue Department. The latter has sole charge of the issue 
and redemption of Bank of England notes, and this is its only 
function. On March 6, 1912, there were £56,092,145 of notes 



MONETARY SYSTEMS OF LEADING NATIONS 493 

outstanding and the Issue Department possessed exactly 
£56,092,145 of assets to cover them. It is generally assumed 
that these assets are specially pledged for the payment of 
notes alone, but the law is not really explicit on this point, 
and Mr. George Clare states, "good authority" has held that 
should the bank fail, the assets of the Issue Department would 
become a part of the general fund of resources against which 
depositors and note-holders would have merely equal claims. 11 
The assets held by the Issue Department fall into two parts: 
(1) gold coin and bullion (amounting to £37,642,145 on 
March 6, 1912) and (2) British government debt and other 
securities (amounting to £18,450,000). In consequence the 
entire circulation of the Bank is thought of as divided into the 
two parts known as the "covered" and the "uncovered issue." 
Thus on Feb. 12, 1919, the issue was constituted as follows: 

Covered Issue £80,570,795 

Uncovered Issue 18,450,000 



Entire circulation £99,020,795 

The uncovered issue is not without backing but is "uncovered" 
so far as specie is concerned. Under the law, the uncovered 
issue of the Bank cannot be increased except by the addition 
to it of two-thirds of any issue rights which may in the future 
be surrendered by those "country banks" which still possess 
a circulation. (See "Notes of Other Banks" hereunder.) 
The maximum to which the uncovered issue can ever attain 
under this provision is £19,616,000. 

Except for this, the uncovered issue of the Bank is an un- 
changing quantity. The fluctuations in the total outstanding 
circulation take place solely in the shape of the expansion of 
contraction of the covered part of the issue. Notes are regu- 
larly paid out by the Issue Department only in exchange for 
gold, and they are retired only upon redemption in gold. 
Since the covered notes to-day constitute two-thirds of the 

14 "A Money Market Primer," 2d. ed. 1903, }>■ 17. .Mr. (hire Bays 
by way of comfort, "though interesting in theory, the question is, of 
course, of no practical importance." 



494 FOREIGN EXCHANGE 

whole issue, and since the retirement of notes by the public 
in such volume as to reach the uncovered part is almost un- 
thinkable. 1 r ' the Bank of England note is in its practical aspects 
a gold certificate. Suppose the United States government had 
$800,000,000 of gold certificates outstanding, and should with 
the consent of their holders remove about $300,000,000 of the 
gold carried in the special reserve, and substitute an equal 
amount of its own bonds payable in gold. This would make 
the gold certificate very similar to the Bank of England note 
as it is to-day. The law permits the Issue Department to 
include in the specie held to cover notes, a one-fifth propor- 
tion of silver coin, but the Bank has long since ceased to avail 
itself of this privilege. The Banking Department keeps its 
own separate cash reserve chiefly in the shape of the notes of 
the Issue Department. It has to give up gold to obtain these 
notes and holds them instead of gold only as a matter of con- 
venience. On March 6, 1912, the Banking Department held 
£27,839,000 of notes as cash, and there were therefore but 
£28,253,000 of notes held by the outside public. In many 
eases the figure given by statisticians as "the circulation" of 
the Bank is merely the figure for the notes held by the outside 
public. 
Notes of Other English Banks. — A number of banks located in 
England and Wales have the right to issue circulating notes, 
but the total of their issue is at present subject to an absolute 
maximum limit of £1,166,000. These notes have no legal 
tender power and have, in fact, only local currency. When- 
ever one of these so-called "country banks" goes out of exist- 
ence or otherwise gives up its issue rights, these rights disap- 
pear never to be revived as such. The law provides that % of 
such lapsed rights may be added to the Bank of England's 
"uncovered" issue, that is, issue to be covered by securities. 
The present law (the Peel Act) governing the circulation of 

isAt none of the times when the Bank of England has been in 
difficulties, since the separation of the Issue and Banking Depart- 
ments, has there been the slightest suspicion of the notes on the 
part of the public. There has never been such a thing as a run on 
the Issue Department. 






MONETARY SYSTEMS OF LEADING NATIONS 495 

notes in England and Wales was passed in 1844. Since 1844 
the uncovered issue of the Bank of England has grown from 
£14,000,000 to £18,450,000. The law was designed with a 
view to the ultimate extinguishment of the country bank 
issues. 

Scotch and Irish Baoik Notes. — Several banks in Scotland and 
several in Ireland issue notes which circulate freely in their 
respective countries, but which are at a discount of Id. per 
pound in dealings between banks in London. These notes 
have no legal tender power. 

English Government Currency Notes. — The act of the 6th of 
August, 1914, authorized the English Treasury to issue circu- 
lating notes (in denominations of £1 and of 10s.) known as 
Currency Notes, which have unlimited legal tender power and 
are redeemable in gold coin on demand at the Bank of Eng- 
land, where the Treasury is to keep funds for the purpose. 
This new element of English paper money was created just 
after the country entered the great war, obviously under the 
stress of that event. Probably it will be done away with in 
time, but in February, 1919, there were outstanding over 
£300,000,000 of these notes (and certificates representing 
them). The purpose of the issue was to enable the govern- 
ment to make advances to the banks. The government was 
secured by taking a floating prior lien on all the assets of the 
banks receiving the advances. It charged for the accommoda- 
tion at the Bank of England rate. The conferring of the 
full legal tender power upon the notes made them so much 
the more appropriate as an emergency currency for the dis- 
charge of debts throughout the frightened business community. 

LEGAL TENDER IN ENGLAND ia 

Standard gold coin has unlimited legal tender power in the entire 
United Kingdom. 

i6 "For the purpose of meeting immediate exigencies" postal orders 
were made legal tender in the United Kingdom by the acl of August 
6th, 1914, until the removal of this power by proclamation. In a 
similar manner the acl made bank notes issued in Scut land and Ire- 



496 FOREIGN EXCHANGE 

Silver coin is lopral tender in the United Kingdom up to the 
amount of 40 shillings in a single payment. 

Bronze coin. Pence and half-pence are legal tender in single 
payments not to exceed 1 shilling, and farthings in payments 
not to exceed 6d. 

Ba>ik of England Notes are legal tender in unlimited amounts in 
England and Wales but not legal tender in Scotland or Ireland. 
These notes are not legal tender "at the Bank of England it- 
self," which means practically, not legal tender when offered 
by this institution to its creditors. 

Currency Notes have unlimited legal tender power throughout 
the United Kingdom. 

TOLERANCE 

The tolerance for error in fineness, allowed the mint 
for gold coin, is %ooo- That is, gold coin may vary 
from .914% to .918%. For error in gross weight it 
is 1( Koo of 1%- For loss of weight in circulation, the 
sovereign, having a legal weight of 123.27447 grains, may 
in consequence of abrasion fall to 122.5 grains without 
losing its legal tender power. Sovereigns below this weight 
are not legal currency, but light gold coins are now re- 
ceivable by the Bank of England for the account of the 
Mint, at their full nominal value, 17 the cost of supplying 
the losses due to abrasion being shifted to the government, 
with whom it belongs. (The half-sovereign with a legal 
weight of 61.63723 grains has a least current weight of 
61.5 grains.) The permissible abrasion in the sovereign is 
then about % of a grain (a loss of 6% parts in 1,000). 
The Bank of England rarely delivers sovereigns which have 
a deficiency of more than 2% parts in 1,000, weighed in 
bulk. 18 

land legal tender in Scotland and Ireland respectively until revoca- 
tion by proclamation. The text of this act may be found in one of 
the appendices to Hartley Withers' "War and Lombard Street." 

i^Deutsch, "Arbitrage," London (1904), p. 18. 

is Tates,, "Modern Cambist" (as already cited), p. 14. 






MONETARY SYSTEMS OF LEADING NATIONS 497 
§ 130. The Mint price of gold in the United States. — 

Standard Bullion 

The standard bullion of the United States is 900 parts 
of fine gold to the 1,000. The 100 parts not gold, called 
in this connection the alloy, may consist wholly of copper, 
but a proportion of silver equal to Vio of the alloy is per- 
mitted by law. Silver will be left in only in cases where it 
is present in such small quantities that it does not pay to 
refine it out. Such silver as remains in the bullion, though 
by nature a valuable metal, has no effect upon the value 
of the bullion, except that its presence saves the use of 
an equal weight of copper which is a negligible matter. 
This silver is like silver in the moon, or too far under 
ground to be worth anything. 19 

The price of standard gold bullion in the United States is 

$18.60465 per ounce troy, without deduction or charge. 
This is computed in the following manner: 

Data. The statutes provide 

1. That 25.8 grains of standard gold shall constitute a 

dollar, and 

2. That the depositor of such metal at the mint shall 

be entitled to receive back all the coin it will make, 
without charge. 

An ounce, or 480 grains, of standard gold will make 
18.60465 dollars. 

480 -h 25.8 = 18.60465 

i f J In practice the presence of very small quantities of impurities 
in standard bullion lias i<> lie tolerated by (lie mint, if they arc nol 
injurious to the coining machinery, Imt the line "old, to which copper 
is added to produce standard bullion, is usually run up above ,999 
in fineness. 



498 FOREIGN EXCHANGE 

Iho mint price for standard gold bullion is also some- 
times expressed as 

$800 for 43 ounces. 

If the mint gives $1 for 25.8 grains, it will give $800 for 
800 X 25.8, or 20,640 grains, and this happens to be exactly 
43 ounces troy. 

Non-Standard Bullion 

The mint price for non-standard gold bullion is in the 
United States 

$20.67183 per ounce of fine contents, less charges. 

This is best expressed by saying that the basic price for 
non-standard gold bullion is $20.67183 per ounce of pure 
gold contents. The computation of this price was explained 
in § 109. In no case does the depositor of non-standard 
bullion receive payment for its fine contents at the full 
rate of $20.67183 per ounce, because there is always some 
charge to cover the cost of standardizing. This statement 
applies even to bars of fine gold, or of "mint fine" gold, 
the latter signifying gold containing such trifling impuri- 
ties that the mint does not demand their elimination. 
These impurities count of course only as an unavoidable 
evil. They go along with the gold but do not count as 
gold in the weighing. 

The charges to which non-standard bullion may be sub- 
ject are four in number, as follows. 

(1) A melting charge of the exceedingly small amount of $1 
per 1,000 ounces of bullion. Deposits of uncurrent U. S. gold 
coin and of "mint-fine" bars are exempt from this charge. 

(2) A parting and refining charge varying from *£ cen t to 
4 cents per ounce gross weight of the deposited bullion. The 
mints accept bullion not below .200 fineness in gold, if suf- 



MONETARY SYSTEMS OF LEADING NATIONS 499 

ficiently homogeneous for assay, except that bullion containing 
arsenic or other elements objectionable in treatment may be re- 
jected. The parting and refining charges vary according to the 
percentage of gold in the bullion and according to the character 
of its other constituents. These charges are fixed by the Director 
of the Mint. 20 Exempt from the parting and refining charges 
are (1) foreign coin of our standard of fineness or above, and 
(2) bullion containing .992 thousandths of gold and upwards, 
which does not contain substances (such as iron, lead, tin, etc.) 
which must be refined out before coining. The latter bullion 
may contain silver or copper. Silver contained in gold deposits 
is paid for by the government at a rate fixed from time to time 
by the Director of the Mint, with the approval of the Secretary 
of the Treasury. This rate follows the current market quota- 
tions. But where the silver constitutes no more than .008 of 
the bullion no accounting is made for it, since it is in practice 
utilized simply as a part of the alloy. 21 

(3) A toughening charge equal to the cost to the government 
of the necessary treatment of the bullion, is exacted whenever 
the deposited bullion contains certain elements which must come 
out in order to make assay and coining feasible. 

(4) A charge for copper alloy is levied upon all bullion to 
which copper must be added to bring it to the standard. This 
charge of 2£ per ounce of copper actually required. 

The mints of the United States receive for coinage bul- 
lion of a great variety of degrees of fineness. It is not 

20 At present writing the latest schedule of the mint's charges was 
the one published March 27, 1911, to take effect May 1, 1911. 
(Leaflet, U. S. Mint Service, Form 92.) 

2i If it paid to refine out (or make a "parting" of) so small a 
proportion of silver, this would of course be done. The silver could 
be replaced by copper. But silver appearing in quantities too small 
for profitable extraction is commercially unavailable. It has no 
value and does not affect the value of the bullion otherwise than by 
saving a little of the charge for copper. It is like good silver, say, 
so deep under the ground as to be worthless. 



500 FOREIGN EXCHANGE 

our endeavor to go exhaustively into the technical subject 
of the appraisal of the coining value and purchase price 
of such metal, but it will be well to consider an example 
or two. Suppose that 10,000 ounces of British sovereigns 
(coins of £1 each) are offered an American mint. How 
will the amount payable to the depositor of this gold be 
computed ? 

SALE OF 10,000 OUNCES OF BRITISH SOVEREIGNS TO 
THE UNITED STATES MINT 22 

When melted and assayed this gold shows, say, a fineness of .9165 
(which is just a shade under the legal fineness and well within 
the limit of tolerance allowed the English mint). 

10,000 ounces contain therefore 9,165 oz. fine gold. 

9,165 ounces at the basic price of $20.67183 are 

valued at $189,457.32 

(i.e., 9,165 X 20.67183) 

The following charges are levied: 

Melting charge. (1 per 1,000 oz.) $10.00 

Parting and refining 

(none for this kind of deposit) 
Toughening (none) 
Charge for extra copper at 2c an ounce. . . 3.67 

Total charge $13.67 

Mint's net price for the 10,000 oz $189,443.65 

CALCULATION' OP THE CHARGE FOR COPPER 

British coin has M2th alloy as against ^oth alloy in the United 
States standard gold, therefore copper must be added to Brit- 
ish standard gold to bring it to the U. S. standard. 

The copper in U. S. standard gold weighs 10 %ooths or %th as 
much as fine gold. 

22 10,000 ounces would be £38,038 of coin extremely close to full 
weight. 



MONETARY SYSTEMS OF LEADING NATIONS 501 

Therefore 9,165 oz. of fine gold 
will make 9,165 + %th of 

9,165 or 10,lS3]-6 ounces of standard gold. 
The British gold weighs 10,000 ounces 
It lacks of copper 18316 ounces to make it 9iotks fine. 
lSS 1 /^ ounces @ 2ti = $3.67 the charge for additional alloy. 

Consider for a second example a 

SALE OF 10,000 OUNCES OF MINT FINE BARS 
ASSAYING AT .9995 

Fine contents 9,995 oz. 

Basic price, 9,995 X 20.67183 $206,614.94 

Charge for copper 22.1 

Paid by mint $206,592.84 

THE CHARGE FOR COPPER 

Standard gold being 9 parts gold and 1 part alloy, 

the alloy equals M>th in weight of the fine gold. 

The alloy must be %th of 9,995 ounces or 1,110.55 oz. 

Of this the 5 ounces of impurity form a part, leaving 

copper to be added 1,105.55 oz. 

This will cost, at 2? an ounce $22.10 

The law does not require the mints to accept deposits 
of gold bullion of less than $100 in value, but in actual 
practice they buy all offered that is sufficiently homogene- 
ous to allow the value to be readily ascertained. Bullion 
is sometimes rejected for containing arsenic and other 
objectionable elements, but the American mints will receive 
bullion containing iridium. The mint must take this metal 
out to avoid damage to dies. It does so but makes no 
allowance to the depositor for the value of the iridium 
itself. 

Bullion is paid for in full as soon as its value is deter- 
mined. The Superintendent of the Mini may, in bis dis- 
cretion, make immediate advances on deposits by well known 



502 FOREIGN EXCHANGE 

firms before the determination of the precise value, such 
advances not to exceed 90% of the estimated value. Pay- 
ments to depositors are made in various ways. The New 
York Assay Office always pays by draft on the Assistant 
Treasurer in New York, whose office is next door. The 
Philadelphia mint pays in gold coin over the counter. The 
San Francisco mint pays in coin over the counter, or by 
draft on the San Francisco Assistant Treasurer, or by 
draft on the New York Assistant Treasurer. 23 

The sale and, exchange of gold bars by the mints. — 
Under the authority of the Act of March 3, 1891, the Phila- 
delphia and San Francisco mints and the New York Assay 
Office sell mint fine bars to the public for gold coin at the 
price of $20.67183 per ounce of fine contents, plus a charge 
of 40^ to the $1,000 worth, to cover the immediate cost 
of manufacture. These bars are a favorite form of gold 
for export, but large quantities are also bought for use in 
the industrial arts within the country. Under the statute 
the mints are not bound to make these sales, but are per- 
mitted to do so with the approval of the Secretary of the 
Treasury. The smallest sale permitted is one for $5,000. 

§ 131. The mint and bank price of gold in England. — 
The mint price of gold in England is 

£3 17s. lOHd. per ounce .916% fine. 

The English law provides for gratuitous coinage of stand- 
ard bullion. According to the legal weight of the sovereign, 
934/£ of these coins can be made from 20 pounds troy of 
standard bullion, 24 or 1,869 can be made from 40 pounds. 
The consequence is that the mint price for standard gold 



23 For many points in thk section the writer is indebted to the 
kindness of Mr. George E. Roberts, former Pirector of the Mint of 
the United States. 

24 The earlier English monetary statutes defined the sovereign 
merely by providing that 934V2 should be coined from 20 Jbs. Trov of 
standard gold. 



MONETARY SYSTEMS OF LEADING NATIONS 503 

is £3 17s. 103-^d. per ounce. This figure results from the 
calculation given below. 

40 pounds troy =480 ounces 
480 ounces =£1,869 (i.e. — makes 1,869 sovereigns). 

1 ounce =*sff of £1,869. 

Divide 480 into £1,869 

This may be done so as to yield pounds and a decimal 
fraction of a pound, and the latter converted into s. and d.; 
or the following method may be pursued. 

480 ) 1,869 pounds ( 3 pounds 
1,440 



429 pounds left over 

20 (number of shillings to a pound) 



480 ) 8,580 shillings left over ( 17 shillings 
480 



3,780 
3,360 



420 shillings left over 
12 (pence to a shilling) 



840 
420 



480 ) 5,040 pence left over ( 10.5 pence 
480 



2,400 
2,400 



Answer £3 17s. lO^d. 

The terms on which the mint will pay this price to the de- 
positors of gold bullion, are (1) the coin is returnable to the 
depositor only after the period required for actual coinage, 
two to three weeks, and (2) no deposit is received of a value 
of less than £10,000. 



504 FOREIGN K.M'll AXtiK 

The Bank of England's Buying Price for (lold. — In 
practice all gold bullion which the owners desire to convert 
into British legal tender is sold to the Bank of England 
instead of the mint. The Bank then has coin struck from 
time to time according to its needs. In practice the Bank 
of England has become the sole depositor at the mint proper. 

The minimum buying price of the Bank of England 
for an ounce of gold n btha fine is £3 17s. 9d. 

The Act of 1844 compels the Bank to exchange its notes 
for standard gold bullion at the rate of £3-17-9 per stand- 
ard ounce. Since notes are redeemable in gold coin on 
demand at the Bank itself, any one can procure coin for 
bullion at the Batik without resort to the mint. Uncoined 
bars in the possession of the Bank count as legal reserve 
against its outstanding notes, and it is for this reason that 
the institution does not need to have all the bars which 
it buys converted into actual coin. 

AVhile the Bank may raise its buying price for gold as 
far above £3 17s. 9d. as it sees fit, in point of fact for 
reasons to be explained presently, it could never while 
itself maintaining specie payments have a motive for of- 
fering at the utmost more than £3 18s. OMid. According 
to information kindly furnished the writer by Mr. J. E. 
Nairne, Chief Cashier of the Bank, the highest recorded 
price paid by this institution for bars is £3 17s. lO^d. 
The letter containing this information was written before 
the war, but so far as the writer know r s the Bank has not 
in later times made offers above this figure. 

Terms upon which the Bank buys gold bullion. 25 — (1) 
The metal must be melted into bars of approximately 400 
ounces in weight and of a designated shape. A charge at 
the rate of /4d. per ounce is made for the services of the 

25 According to Tate's "Modern Cambist," 24th edition, 1908, pp. 
15 and 16. 



MONETARY SYSTEMS OF LEADING NATIONS 505 

melters officially recognized by the Bank. The Bank does 
not buy a smaller quantity than 400 ounces. (2) The 
Bank makes no stipulation as to the fineness of the bars 
but it is rare for gold under the British standard of .916% 
to be offered. The detection in a bar of iridium or any 
other substance making it unsuitable for coinage, would 
lead to its rejection. The private refineries charge Md. 
per ounce for taking iridium out, and its presence in gold 
usually leads to the sale of the latter to some refiner at a 
price reduced by *4d. per ounce. (3) The gold must be 
subjected to a triple test by the Bank's official assayers, 
at an expense to the seller of about 4s. 6d. per bar. The 
amount of standard gold contained in a bar, and hence its 
price, is determined on the basis of these assays. American 
and other foreign bars, the fineness of which has already 
been determined abroad, may be taken by the Bank without 
further assay from sellers of recognized standing. The 
seller is in such cases, however, required to give a kind of 
bond of indemnity against the possible discovery of error 
in the indicated fineness. (4) The Bank weighs gold in 
ounces and decimal fractions of ounces (instead of in 
grains) and does not take into account smaller fractions 
than .025 (or }4o of an ounce). (5) The Bank price is 
(unlike the mint price) payable cash down, as soon as the 
value of the deposited gold is established. A comparison 
shows that 

the Mint price is £3 17s. 10y 2 d., and 

the Bank minimum price is £3 17s. 9 



the difference is 1 ' -<1. per oz. 

When going to the mint, the Bank will, as already ex- 
plained, have to wail for the coining to l>e finished before 
receiving back sovereigns. The difference between its legal 
minimum price and the mini price is usually accounted for 



506 FOREIGN EXCHANGE 

as being an allowance of interest to the Bank as com- 
pensation for tlic average period of this delay. l%d. is 
almost exactly 3% interest on £3 17s. 9d. for 20 days. 

In contrast with the American mints, the British mint 
bears the cost of any copper alloy which may need to be 
added to a bar to bring it to standard fineness for coinage. 
Therefore when bullion with a fineness above the stand- 
ard contains no impurities that must be removed and dif- 
fers from the standard only by the lack of a certain amount 
of copper, it is evaluated by the Bank as being worth the 
same as the amount of standard bullion which can be made 
from it. Thus a bar weighing 399.5 ounces .998 fine, would 
be worth £1,690 17s. 0.6s. computed as follows: 

399.5 ounces .998 fine (contain 399.5 X -998 ounces of 

pure gold) =398.701 ounces pure. 
The alloy in standard bullion, being Y12 of the whole, 

is Ml of the pure gold contents (i.e., Vx2 is Mi of x V\3l). 

Therefore 1 ounce of fine gold will make lMi ounces 

of standard gold. 
398.701 X 1%1 = 434.946 standard ounces. 
434.946 ounces @ £3 17s. 9d. per ounce = £1,690 17s 6 /iod. 

The Bank's price for foreign gold coin. — Without legal 
compulsion, the Bank both buys and sells foreign gold 
coin. A price quoted for coin is one payable for the ounce 
of gross weight without melting and assay. The Bank 
alters its prices for this form of gold as it sees fit, but 
there are certain fairly obvious limits beyond which neither 
its buying nor selling prices may go. Those who sell gold 
coin to the Bank always possess the option of melting it, 
refining it if under .916%, paying certain minor expenses, 
and selling it at least at the minimum rate of £3 17s. 9d. 
per ounce of standard contents. Consequently no one 
would be likely to take much less than £3 16s. 3Md. per 
ounce for American, German, French or other gold coin 



MONETARY SYSTEMS OF LEADING NATIONS 507 

which is supposed to be .900 fine. For, disregarding minor 
expenses, when bullion .916% fine is worth £3 17s. 9d., that 
which is exactly .900 fine is worth just £3 16s. -iT^d. Coin 
of the United States, Germany, or France, will show an 
average actual fineness very little under .900, and the 
Bank's lowest buying price for such gold is in fact £3 16s. 
3 a /4d. The Bank no longer publishes a fixed buying or 
selling price for foreign coin but it is open to offers the 
acceptance of which depends upon the circumstances of 
the moment. Unofficial information indicates that the 
bm'ing price ranges between the lower limit just stated 
and an upper limit of about £3 16s. 7d., the latter figure 
corresponding closely to a price for standard bars of 
£3 18s. 

In selling foreign coin .900 fine (generally of course 
for export), it is supposed the Bank usually asks about 
£3 16s. 7d. per ounce. It is also prepared to sell bars, 
but in ordinary times the amount sold is small. The price 
is a matter of adjustment, but the Bank has sold bars 
as high as £3 18s. Id. per standard ounce. The last occa- 
sion on which bars were sold in any considerable quantity 
was during the American crisis of 1907. 

132. The London market price for bar gold and its limits. — 

Lower limit £3 17s. 9d. 

Upper limit, about £3 18s. Id. 

Much of the newly mined gold of the world finds its way 
directly or almost directly to London, which lias had for 
many years past the greatest of all markets for the yellow 
metal. Often the fresh supply goes to the Bank of Eng- 
land at the latter 's Legal iiiininmm buying price. In these 
eases there has been nothing better to do with it than to 
convert it into English sovereigns. But in many instances' 
buyers in the open market, as the savin- goes, bid higher 
for it and carry it off. These are mainly foreign buyers, 



508 FOREIGN EXCHANGE 

many of them acting for continental European banks. 26 
There is then an open market for gold metal, and in this 
market demand is sometimes brisk, sometimes dull, and the 
price is a variable. But it varies only to a trifling extent, 
ami we have already learned enough to realize that gold 
is no ordinary market commodity. The lower limit of 
the price in London is £3 17s. 9d. per standard ounce 
( n iii fine), this being the Bank's minimum buying price, 
and the very topmost limit appears to be about £3 18s. Id. 
Meanwhile the mint price proper is £3 17s. 1014d. 

"We must keep clearly in mind that an offer to buy gold 
bullion at a price is an offer of money for the metal, and 
that so long as England is on the gold standard it is an 
offer of gold money for gold metal. Doubtless payments 
for gold metal are made by check quite as payments for 
tin or zinc, but a check on a London bank is convertible 
into British legal tender on demand and under the assump- 
tion stated this will be either gold coin itself or paper 
moneys convertible into gold coin. 

Now if the British mint paid the full coining value for 
gold on the moment of its deposit, or at least on the moment 
when this value is determined, and if all gold coin procur- 
able for bank credit and paper money were of absolutely 
full legal weight, there could be no variation in the mar- 
ket price for gold metal. An ounce of metal, standard 
metal, of course, and £3 17s. lO^d. would be interchange- 
able things. No seller would take less than this, the mint 
price, and no buyer would give better than a shade more, 
because the very £3 17s. l(B£d. of coin that he offers con- 
tains an ounce of standard gold. It is understood we are 
speaking of wholesale dealings. 

The lower limit of the market price is underneath the 
mint price for the primary reason that the price at the 

26 It goes without saying these observations do not apply to the 
period of the war. 



MONETARY SYSTEMS OF LEADING NATIONS 509 

mint cannot be obtained without waiting about three weeks 
after making the deposit of the metal. The Bank's legal 
minimum spot-cash price is therefore attractive as com- 
pared with the mint price and thus comes to set the prac- 
tical minimum for the market. 

The upper limit exceeds the mint price for the reason 
that the average weight of actual sovereigns which still 
have the legal tender power at their full nominal rating is 
something under the full legal weight. At this point we 
see the relation of "tolerance" 27 to the open market price 
for gold bars. So far as the tolerance laws are effective 
in setting the limits below which the pure contents of 
the gold coin of actual circulation will not fall, they serve 
to set a limit beyond which the price of bullion cannot 
rise. It is however the average actual deficiency in the 
weight of coin which in fact establishes the upper limit 
for the price of bullion. If, for instance, the sovereigns 
delivered by the Bank of England in the redemption of 
notes should never show a deficiency in pure contents 
greater than 2 1 /6 parts in 1,000, or V± of 1%, the market 
price for bullion could not ascend to an appreciable extent 
above £3 18s. O^d. If sovereigns are of full weight, they 
weigh 1 ounce to each £3 17s. 10%d. of nominal value. If 
they are short in weight by Vi of 1%, it will take (a little 
more than) M of 1% more nominal value of sovereigns 
to weigh an ounce. Vi of 1% of £3 17s. lOM. is a little 
over 2d., and £3 17s. lOVid. plus 2d. makes £3 18s. 
Olfcd. This is, in fact, within ] /kl. of the highest price for 
bar gold ever experienced in the London market. 

133. The mint and bank price of gold in France. — The 
weight of the franc has already been given as 0.32258 grams 
of gold .900 fine. This, however, is not the precise legal 
definition of the franc, but is a consequence of it. The law 
of March 28, 1803, laid down the specifications of the 

27 Compare § 129, p. 406. 



510 FOREIGN EXCHANGE 

gold franc by providing that 3,100 francs should be coined 
from 1 kilogram of gold .900 fine. 28 Therefore the mint 
price of 1 kilogram of standard gold would be 3,100 francs 
were it not for the fact that the mint makes a seigniorage 
or brassage charge of G.70 francs per kilogram. (This is a 
charge of a little more than ^ of 1%.) 

1 kilogram of gold .900 fine will make, or has a coining 

value of 3,100. francs. 

The mint's charge for coining 1 kilogram is 6.79 francs. 

The mint price (per kg. standard gold) is 3,093.30 francs. 

"When fine gold is sold the mint, the latter makes no charge 
for the copper which must be added to bring the gold to 
the legal standard, or rather, + he charge of 6.70 francs 
per kilogram for coining also includes the charge for 
standardizing refined gold. Sin<?e ^ °f a kilogram of fine 
gold makes (with copper) 1 kilogram of standard gold, the 
coining value and mint price for 1 standard kilogram, as 
given above, are the coining value and mint price of ■£■$ 
of a kilogram of fine gold. Thus the following figures 
result: 

1 kilogram of fine gold has 

' a coining value of 3,444.44 francs (VX3.100) 

a mint price of 3,437. francs (tf X3,093.30) 

The price of gold at, the Bank of France.— The Bank 
of France buys gold bullion through its main office in 
Paris, at the mint price. The following conditions gov- 
ern its purchases. 29 First with respect to gold bars: These 

» This law also provided that 200 francs of silver coin should be 
struck from 1 kilogram of silver .900 fine. The ratio of 3100:200 or 
15^:1, thus established between gold and silver, became known as 
the "French bimetallic ratio," since from 1801 to 1873 both gold and 
silver possessed the right of free coinage. 

*>As given in Swoboda's "Die Arbitrage," 13th ed., 1909, edited 
by Max Ftirst, pp. 418-21. 



MONETARY SYSTEMS OF LEADING NATIONS 511 

must be at least .996 fine (unless they are legal standard 
bullion 30 ) and must contain no iridium, platinum, arsenic, 
or other impurity which renders the bullion unsuitable 
for coinage. 31 Each bar must weigh at least 6 kilograms 
(but must not exceed 13 kilograms 32 ), and must be ac- 
companied by certificates of weight and fineness, one from 
one of the two official assayers of the Bank and one from 
some outside assayer. The former certificate costs 1E Kiooo 
of 1% of the value of the bar, the latter 1 franc per bar. 
With respect to foreign gold coin: The Bank buys gold in 
this form without requiring it to be cast into bars and 
assayed. The gross weight of the deposit of coin is first 
ascertained, and then the fine contents are calculated ac- 
cording to a tariff of fineness which the Bank publishes 
and alters as it desires. For example, according to this 
tariff, 32 

20-Mark pieces are reckoned as .8992 fine 

Sovereigns .9164 

Eagles .8992 

Gold coin of Austria, Holland, Scandinavia, 
and Japan .8992 

Thus the Bank counts foreign coin as being of a some- 
what lower fineness than its exact legal standard. If the 
Bank should go too far in making this tariff unfavorable, 
the owner of the coin could pay the expenses of the 
melting and refining, and then could sell his gold as lino 
bars at the fixed legal price. The following is self-ex- 
planatory: 

•'io Cf. E. Kaufl'niann, "Banknotes, Monnaies et Arbitrages," p. ::"> s . 

-I The chief forms in which gold appears in regular international 
shipments to-day are coin and "tine" liars. The latter are usually 
as high or higher than .9!)!) in fineness, and free from injurious 
impurities. 

32 Given at p. 41!) in Swoboda (as already eited). 



512 FOREIGN EXCHANGE 

SALE OF 10.000 EAGLES TO THE BANK 

10,000 Eagles should weigh at 25.8 grains per 

dollar 2,580,000 grains 

2,580,000 grains, at 15,432 grains per kilo- 
gram, equal 167.185 kilograms 

Allowing say Mo of 1% weight shortage, this 

lot of eagles should weigh 167.018 kilograms 

167.018 kilograms reckoned as .8992 fine would 

have a fine contents of 150.183 kilograms 

150.183 kilograms at 3,437 francs per kilogram, 

are wortli 516,178.97 Francs 

10,000 eagles are $100,000. If $100,000 of American gold 
coin produces 516,178.97 francs, $1 produces S.lG^ioo 
francs. By referring to the table on page 485 we see that 
the mint par between the United States and France is 
$l = 5.18 2 %oo francs. Therefore in case of actual ship- 
ment and sale of American gold coin for French money, 
the proceeds per dollar turn out to be about 2 centimes 
under the mint par. This loss is accounted for by three 
factors, namely, (1) the charge of 6.70 francs per standard 
kilogram levied by the French mint for converting any 
gold into French coin, (2) the reduction of the rated fine- 
ness of American coin to .8992 in the tariff of the Bank 
of France, (this signifying a loss of §4o of one one-thou- 
sandth from the .900 of fineness assumed in calculating 
a mint par 33 ), and (3) the loss in the weight of gold con- 
sequent (chiefly) upon taking abraded coin from circula- 
tion. 

The Bank's Terms of Payment for Gold. — The Bank 
of France buys gold only in large lots. As soon as the value 
of a lot, bars, or foreign coin, has been determined, and 
the gold is delivered over the counters of the Bank, the 
institution will make an immediate payment of 95% of 

33 See the definition of mint part. p. 432. 



MONETARY SYSTEMS OF LEADING NATIONS 513 

the value of the deposit on account. The Bank treats 
this partial payment as an "advance" inasmuch as it 
itself will have to wait until the bullion has been coined 
at the mint before it receives back the coin which the 
metal will make. On the actual date when the mint de- 
livers up this coin the advance is regarded as terminating, 
and the remaining 5% due the original depositors of the 
bullion or foreign coin is then paid him. But the Bank 
charges the latter interest for the advance it has made him, 
practically always at the very low rate of 1% per annum. 
This interest is collected under the following rules. At 
the time of the prepayment of the 95%, the Bank with- 
holds interest on this sum for 36 days, or Mo of a year, 
making the deduction thus regularly Mo of 1%. Then 
when the advance terminates and the remaining 5% of 
the principal amount is paid, an adjustment is made so 
that the depositor's real interest payment will be only for 
the period that has turned out to be the actual time of the 
advance. 34 

§ 134. The mint and bank price of gold in Germany. 35 — 
Since the German law provides that 139/6 ten-mark pieces 
shall be coined from 1 pound (i.e. — one-half kilogram) 
of fine gold, the coining value of the kilogram becomes 
2,790 Marks. The German law fixes a charge for coining, 
of 3 Marks per pound of fine gold, or 6 Marks per kilo- 
gram. Consequently we obtain the following: 

Coining value of 1 kilogram fine gold 2,790 Marks 

Seigniorage or brassage charge per kilogram G 

Mint Price of Gold, per fine kilogram 2,784 Marks 

The mint price for standard gold is simply 9io of 2,784, 

3* Compare Swoboda, "Die Arbitrage" (as already cited) p. 421, 
and Kauffmann's, "Banknotes," etc., p. 359. 

* 6 The information given in this section applies to conditions in 
Germany prior to the great war. 



514 FOREIGN EXCHANGE 

or 2505. GO per kilogram. 88 The mint does not pay the 
depositor the value of his bullion in money until the time 
actually required for coinage elapses. To be receivable 
by the mint, bars must have a minimum weight of 5 pounds 
(2% kilograms) and be of a minimum fineness of .900, 
except that when a number of bars are offered in a single 
deposit it suffices for them to have an average fineness of 
.900. The charge for assaying is 3 Marks per bar. When 
non-standard bars can be made suitable for coining by 
the mere addition of copper, the mint price for the pure 
gold contents of these bars is calculated at the full rate 
of 2,784 M per kilogram. (That is, no charge is made 
for copper, outside of the "coining charge" of 6 Marks 
per kilogram.) 

The price of gold at the Reichsbank. 37 Gold Bars. — 
The Reichsbank buys gold bars on the following terms. 
(1) The bars must weigh at least 2% kilograms each, and 
must possess an average fineness of at least .900. (2) The 
fineness must be tested two times at an official assay office ; 
charges 3 M. per bar for the two tests. (3) When the 
value of the gold is thus established, the Bank pays for it 
cash down the price of 2,784 M. per fine kilogram. (4) Bars 
with a fineness certified to by foreign mints or official as- 
saj'ers are sent to a regular German assay office for test, 
but the Bank advances %o of the value calculated on the 
basis of the foreign certification, without waiting for the 
returns from the home assay. The balance in full is paid 
at the time of the receipt of these returns calculated ac- 
cording to them. (5) The seller of bars must agree to 

36 The German law is peculiar in that it specifies how many money 
units are to be made from a given weight of fine gold. France, 
England, and the United States define their money units, in the 
statutory law, by specifying the number to be made from a given 
weight of standard gold, or else by giving their weight in standard 
gold. 

37 From Swoboda (as already cited), p. 200. 



MONETARY SYSTEMS OF LEADING NATIONS 515 

take back any that are subsequently discovered to be brittle 
or to contain iridium, and to return the price paid for 
them. 

Foreign Gold Coin. — The Reichsbank buys foreign gold 
coin as a special article, without the requirement that it 
shall be melted and assayed, paying for the different kinds 
prices which it sets forth in a schedule or tariff. The fol- 
lowing items are selected from one of these tariffs. 38 

REICHSBANK'S BUYING PRICE FOR FOREIGN COIN 
PER KILOGRAM OF GROSS WEIGHT 
(A few of the items given as examples) 
Eagles 2,505.60 M. (.900) 

20 Franc pieces of the Latin Union 
countries, and certain other franc- 
coining countries (except Greece) 2,504.208 M. (.8995) 
10 and 5 Franc pieces of France, 
Belgium, and Italy, at the same price 
with a deduction of %oooo from the 
gross weight as an allowance for dirt. 
Sovereigns 2,551.536 M. (.9165) 

The last column shows the fineness of the respective 
pieces implied in the price offered by the Reichsbank. To 
explain: the legal standard of fineness of the sovereign is 
.916%, but on account of the "remedy" or tolerance for 
error in minting, a given lot of sovereigns might show say 
an average fineness of .9165. If this lot were melted into 
a bar which assayed at .9165, and this bar were sold at 
the regular mint or bank price of 2,784 M. per fine kilo- 
gram, it would fetch 2,551.536 M. per gross kilogram. 
Since the Bank offers just 2,551.536 M. per gross kilogram 
for sovereigns, we may say it buys sovereigns on the basis 
of a fineness of .9165. 89 It is a point of interesl thai in the 

88 Ab given by Swoboda (as already cited), p. 204. 
■""> In making this calculation the assay charges incidental to (he 
sale of bar gold are ignored. 



516 FOREIGN EX CHANGE 

tariff from which the above excerpts were made, United 
States eagles were complimented by being the only foreign 
coins bought on the basis of possessing the precise degree 
of fineness established for them by law. Dutch, Austrian, 
and Japanese gold coin were close seconds, since with a 
legal fineness of .900 they were priced as if .8999 fine. 



CHAPTER XX 

SPECIE SHIPMENTS 

§ 135. The classification of gold movements. — Four types 
of international gold movements may be distinguished. 
(1) First there is the export and import of gold contained 
in manufactured articles, jewelry, and like objects made 
partly of this metal. This may be called the movement 
of manufactured gold. This movement has no special re- 
lation with exchange rates, that is, it has just the same 
connections with these rates as has the movement of all 
ordinary commodities. (2) Second there is the flow of 
new gold from the mines to the general market of the 
world. This is in large part an international movement 
because it happens to-day that the greater portion of new 
gold is found outside the main zone of commerce which 
contains the principal gold-standard countries. And most 
of this gold is shipped into these countries as fast as pro- 
duced. This flow, the movement of new gold, in part takes 
place without reference to the position of the international 
exchanges. And where it is influenced by the exchanges, 
and in turn exercises an influence upon them, the char- 
acter of this influence or the general relation of this gold 
movement to the "balance of international indebtedness," 
is different from what it is in the case of the ordinary or 
"commercial" gold movement. (3) In the third place we 
distinguish gold shipments which have for their function 
the mere discharge of previously created indebtedness be- 
tween one gold-standard country and another. These 
shipments are due to the condition of commerce (using the 

517 



518 FOREIGN EXCHANGE 

term in its broadest sense) as it works out its effects 
through its influence upon the market for foreign exchange. 
This class of gold we may call the commercial movenu nt 
of gold between gold-standard countries. It is with this 
movement that the present chapter has to deal. (4) 
Fourthly we have the commercial movement of gold be- 
tween a gold-standard and a non-gold-standard country, 
or between two non-gold-standard countries. For even 
countries which lack a gold-standard ship the metal in and 
out, at least as one means of settling international indebted- 
ness. This class of shipments resembles the third in cer- 
tain respects but also lias its peculiar features. 

§ 136. Gold shipments for a profit. — If it were not for 
the intervention of bankers and exchange dealers as mid- 
dlemen, 1 merchants and other foreign debtors and creditors 
would have to buy and sell exchange among themselves, 
and they would also find it necessary from time to time 
to make international shipments of gold on their private 
and individual accounts. For when, under the influence 
of supply and demand, the price of exchange should mount 
above a certain point, those owing money abroad would 
find it cheaper to send gold than to buy exchange; and 
when exchange should fall below a certain point, those 
having it would not sell but would obtain better returns 
by sending it abroad for encashment in gold to be brought 
back and converted into home money. Thus there would 
be specie shipments without bankers. But in point of 
fact virtually all the shipments of gold that answer to 
the ascent and descent of the rates of exchange, are en- 
gineered by bankers alone. Bankers can operate at a 
lower incidental expense than mere merchants, and thus 
as a regular thing they intervene to move the metal be- 
fore the rates of exchange have risen or fallen far enough 
to make it a business possibility for a merchant to ship it. 

i Compare §21. 



SPECIE SHIPMENTS 519 

Gold shipment amounts to a species of relief from too 
high or too low a swing of the exchange rates, and the ac- 
tion of bankers affords this relief. Nevertheless if the 
bankers should fail to supply the remedy, merchants them- 
selves would find it necessary to act. To illustrate, in 
New York in 1896, a pool of the foreign-exchange firms 
of the country was formed to aid in carrying out part of 
the program of the famous Morgan-Belmont syndicate to 
sustain the gold reserves in the United States Treasury. 
The bankers undertook to prevent gold exports. In the 
course of events the rate for sight sterling rose to $4.91 
per pound. Whereupon a coffee importing house of New 
York began to export gold, sending out enough in fact 
not only to satisfy its own commitments, but to establish 
a foreign credit against which it sold exchange to others 
at a profit. In this case the merchant went into the ex- 
change business. The bankers' pool soon dissolved. 2 

Those gold movements then which take place in answer 
to the fluctuations- of the exchanges are engineered by the 
bankers. And when they occur they are governed in the 
first instance or proximately by the position of the rate 
for bankers' sight drafts. The supply of and demand for 
commercial bills, or the market rates for the same, are 
the ch'ief factors governing gold movements fundamentally 
and in the long run, but are operative only through their 
effect upon the bankers' sight rate. Assume that $4.8665 
of United States gold coin exported to England will yield 
just £1 of British money after arrival, and conversely thai 
£1 shipped from England will produce $-4.8665 in America. 
Assume also that the total of incidental expenses for gold 
export as conducted by a New York bank will be V^ and 
for an import 2 1 i-( i per pound sterling. Tt would then 

2 This remarkable as ociation was partly successful in effecting its 
chief objects. Its monopolistic high rules for exchanges were rather 
an incident to its main program of checking gold export. 



520 FOREIGN EXCHANGE 

cosl a hanking house $4.8815 to produce a pound of credit 
in London by the method of gold export. The pound 
would cost 

$4.8665 initial outlay in U. S. money. 
.0150 total incidental expenses. 



$4.8815 entire cost. 

The consequence of this would be that in times of un- 
hampered gold movement the rate for bankers' sight drafts 
could not rise to anj^ great distance above 4.8815. Two 
distinct, though related, reasons explain this. (1) The 
demand for bankers' sight sterling at ordinary rates comes 
in part from banks which possess the facilities for gold 
export. This demand would simply cease to exist at any 
rate appreciably above 4.8815. No such bank, acting as 
an individual institution in the pursuit of its own profit, 3 
could be expected to pay say 4.8830 per £ for sight bills 
to create a fund in London when the same result can be 
accomplished by gold shipment, all expenses paid, at 
4.8815 per £. Thus the disappearance of one element in 
the demand for bills as soon as the rate passes above a 
certain point is one influence which tends to check further 
rise. However the demand from banks which do not 
usually ship specie and the demand especially from non- 
banking sources would continue for a time. (2) But in 
the second place the ascent of the rate an appreciable 
distance above 4.8815 opens up a practically inexhaustible 
supply of bankers' sight exchange, and this serves, in and 
of itself, to put a complete check upon further rise. This 
supply originates in the export of gold by the banks for 
the purpose of selling exchange at a profit. Suppose the 

3 Concerning the cases where gold movements seem to be or are 
independent of the mere private profits of the shipping banks, 
see §§ 143-7. 



SPECIE SHIPMENTS 521 

non-banking demand drives the rate up to 4.8825. Then 
bankers generally will begin to export gold and produce 
a pound sterling of credit abroad at a cost of 4.8815, and 
at the same time sell drafts on this credit at 4.8825, mak- 
ing a profit of 10 "points" or Ko cent to the pound. Per- 
haps not all banks will begin at precisely the same point, 
but there will soon come forth a supply sufficient to check 
further rise of exchange. It may be necessary for the 
shipments to continue more or less steadily through weeks 
or even months before the forces which tend to drive rates 
higher exhaust themselves. Such an outpouring of gold- 
export bills would be stopped by the breakdown or sus- 
pension of the gold standard, but in the case of the lead- 
ing countries, before the war, the yielding of a small frac- 
tion of the entire stock of gold would always suffice. Dur- 
ing hostilities the governments of all the belligerent and 
of most if not all neutral states of consequence, took con- 
trol of the outshipment of gold. 

Turning now to the relation of gold imports to the rate 
for bankers' sight drafts, our present assumption is that 
a pound of English gold coin transported to the United 
States, at an expense to any of our banks of 2li><^, will 
produce $4.8665. The net proceeds of the import of a 
pound will then be $4.8415 (that is, 4.8665- .025). From 
this it follows that in ordinary times the price for bank- 
ers' sight drafts on London cannot fall very far below 
$4.8415. The great influence acting to check further de- 
cline will be the emergence of an indefinitely large demand 
for these bills, a demand coming from banks with facilities 
for gold import. If the rate falls to 4.84 for instance, 
a bank will make 1 ^ / ioo of 1^ on every pound of bill that it 
purchases on this side and uses as a means of importing 
gold. It is true the specie cannot arrive until from 12 
to 20 days after the purchase of the bills, and there is 
therefore an interest loss or cost in the transaction of gold 



FOREIGN EXCHANGE 

importation, but this interest charge is included in the 
L'^.r which we have assumed for the presenl to be the costs 
of the import of £1 of gold. The account of the venture 
would therefore stand as follows: 

U. S. money realized on each £ of imported gold. .$4.8665 
Expenses per £ (including interest) 0250 

Net proceeds from each £ 4.8415 

Cost of each £ in purchase of bill 4.8400 

Profit per £ (about % 2 %) $ .0015 

The foregoing explanation as a whole should make it clear 
why gold export and import under normal and competi- 
tive conditions make it impossible for the bankers' sight 
rate to swing beyond certain very definite limits. As a 
general thing before the war, these limits stood in the 
case of the New York rate for sterling exchange, at about 
4.88 and 4.84, and the range of fluctuation between them 
was something less than 1% of the mint par. 

§ 137. The gold points. — The rates of exchange at which 
gold movements take place are known as the "gold points." 
The terms "export point" and "import point" are self- 
explanatory. But it is not to be understood that these are 
really invariable or precise points. "When under given 
conditions sight sterling reaches say 4.8770 gold exports 
may begin to move without at first taking place in great 
volume. The influences which are making for dear ex- 
change may perhaps force the rate on up to 4.8790 be- 
fore the full flow of gold appears which is sufficient wholly 
to check further rise. Thus it would be more accurate to 
say that at this time there is a gold export region in the 
rate, namely 4.8770 to 4.8790, rather than a precise 
"point." The exact cost of shipment is perhaps slightly 
different for different banks. The disposition of banks 
to move gold probably is influenced to an extent by their 



SPECIE SHIPMENTS 523 

estimates of the ulterior effects of the movement upon 
money market conditions, or upon sentiment. It is sup- 
posed that the stock market effect of a gold movement is 
sometimes taken into view as a matter of considerable 
consequence. Thus at times part of the banks or all of 
them may refrain from moving gold unless a considerable 
gain will appear in the transaction, whereas at other 
times they might be content with an exceedingly small 
profit. 

In the month of April, 1906, gold imports into New 
York were delayed to such an extent that sight sterling 
reached on the eleventh so low a point as 4.8290. Again 
on December 7, 1903, it fell to 4.8275. The latter was 
the lowest rate experienced in New York in thirteen 
years. 4 Yet on September 12, 1905, New York engaged 
$1,250,000 worth of gold in London for import with sight 
sterling as high as 4.85. 5 Among the causes for the dif- 
ference in location of the gold points at different times 
we may mention the following. (1) Changes in the price 
of gold. These changes may affect both the initial out- 
lay and the proceeds in a gold shipment. It should be 
stated, however, that so far as American gold movements 
are concerned, there is almost no fluctuation in the pur- 
chase or sale price of gold on this side of the water. But 
in the European countries these prices change enough to 
work a considerable effect upon the gold movement. (2) 
The incidental expenses of moving gold also vary some- 
what as between different times. Interest is one element 
in these charges which is always a variable. Freighl and 
insurance costs also change sometimes, but war-times aside, 
not so often nor to so great an extent. 

§ 138. Gold export, New York to London : practical com- 

■i Sir the Commercial and Financial Chronicle for April 14, 1906, 
p. 833. 

5 See the Wall Street Journal for Sept. It. 1905, p. 8. 



524 FOREIGN EXCHANGE 

putations. — Coming now to the practical calculation of 
the costs and proceeds of gold shipments, we shall con- 
sider first an export of coin from New York to London. 

Example 1 
An Export of U. S. Coin from New York to London 
(Bank of England buying Eagles at 76s. 4d. per oz.) 

INITIAL OUTLAY 

$1,000,000 of current gold coin $1,000,000 

Full legal weight (1,000,000X25.8 grains) = 

25,800,000 grains, or 53,750 ounces, .900 fine. 

Actual weight on arrival is say 53,715 

ounces, showing a shortage due to all causes 

of 35 oz. or nearly %5 of 1%. 

INCIDENTAL EXPENSES 

Packing and cartage 60 

20 kegs of $50,000 each 
(Packing $2 per keg) 
(Cartage $1 per keg) 
Freight (at rate of %6 of 1% of the value) in- 
cluding delivery to designated party in London . . . 1,875 

Insurance (Y20 of 1% of value) 500 

Interest (none charged in this case, but see text 

below) 

Total outlay $1,002,435 

PROCEEDS 

53,715 oz. of U. S. gold coin, 
sold as such to Bank of England at 76s. 4d. 
per oz. gross weight. 76s. 4d. = 916d. 

(916d. X 53,715 = 49,202,940d.) or £205,012 

Commissions or Expenses Abroad. 

A gratuity of £2 to Bank of England messenger. 2 

Between regular correspondents no commissions 
are asked. 



Net proceeds £205,010 



SPECIE SHIPMENTS 525 

COST IN DOLLARS OP £1 OF CREDIT PRODUCED ABROAD. 

If £205,010 cost $1,002,435 

£1 costs (1,002,435 -r- 205,010) $4.8897 

or 

NO-PROFIT GOLD-EXPORT POINT 4.8897 

A comparison of the net proceeds abroad in pounds, with 
the total outlay at home in dollars, shows that the cost 
of each £1 of foreign credit is $4.8897. As indicated we 
may call this, under the conditions, the "no-profit gold- 
export point." A gold point is a point or figure in the 
exchange rate at which we may expect a gold movement 
to be induced. By a no-profit gold point we mean the rate 
at which gold might be moved without the shipper mak- 
ing either profit or loss. Thus under the conditions of 
our present example, if a banker exported $1,000,000 of 
American coin, at an incidental expense of $2,435, and in 
this manner produced a credit in London of £205,010, and 
sold £205,010 of his demand drafts against this credit at 
the rate of $4.8897 ; he would come out exactly even. His 
total outlay in the venture would be $1,002,435, and his 
Total return would be 205,010 X 4.8897 or $1,002,435. Of 
course it is not at this so-called no-profit point that we 
would expect shipment actually to take place. If the 
bank should defer export until it could make certain of 
selling its drafts at a higher figure, as say 4.8915, it would 
then make a profit of $.0018 per pound, or a total profit 
of $369.01 or (205,010 X .0018). As we shall see, it is 
possible also to calculate no-profit import points. The 
reason for distinguishing the no-profit from the actual 
points, is that under given conditions and with a given 
sort of gold to ship, the former are precise and definite 
figures, whereas the actual gold points, differing as they 
do from the no-profit points by the margin of gain re- 
quired to induce banks to make shipments, are a little less 
definite. Special circumstances apart, it may be said 



:>-2C> FOREIGN EXCHANGE 

banks do not care to move gold for a profit of less than 
M-2 of 1%, which means almost exactly 15 points, or l 9ioo 
of 1(* per pound. This signifies then that the actual or 
ordinary-profit gold export point should stand about 15 
points above the calculated no-profit export point, and the 
actual import point about 15 points below the no-profit 
import point. 

In the foregoing calculation we made an allowance of 
Ms of 1% for deficiency in the weight of the gold coin 
exported. It will of course pay an exporter to obtain 
as heavy coin as possible, but the precise percentage of 
deficiency in weight is naturally as variable as between 
different shipments. The less this deficiency the lower the 
no-profit export point will be, because the greater will 
be the sterling proceeds of the export. And the greater 
these proceeds for a given outlay at home in dollars, the 
less the number of the dollars of outlay will be per pound 
of proceeds. Thus the 4.8897 no-profit point of our ex- 
ample would become 4.8865 if the coin were absolutely 
full weight. 

A gold export is a business transaction involving a 
money outlay and a money return. The main outlay is 
made on the day when the gold is withdrawn from the 
general resources of the bank while the return is realized 
on the day when payment is received for the exchange 
which is sold against the export. If outlay and return oc- 
cur on the same day, the transaction is not chargeable 
with an expense for interest. If on the other hand three 
days, say, should intervene between outlay and return, a 
charge of three days interest — at the home market rate 
of interest — is to be reckoned against the operation. In 
the example under consideration three days interest at 
4.-% would amount to $334.15. The interest charge is 
omitted in our calculation not on the grounds that it is 
negligible when it exists, but because it is a variable de- 



SPECIE SHIPMENTS 527 

pendent upon minor circumstances attending the ship- 
ment. It readily appears an allowance for an interest 
cost will raise the "no-profit gold export point." When 
circumstances favor the transaction loss of interest may 
be avoided. Quoting a letter from a gentleman in the bank- 
ing business, "In actual business there is usually from 
one to three days loss of interest. For example, if a 
steamer sails Saturday at 10 a. m., the gold must be taken 
out and paid for on Friday, while the bill of exchange 
is sold under contract for Saturday's steamer and paid 
for on that day. Now if this latter transaction is settled 
for in gold, there would be a loss in interest of one day; 
but according to custom the bill of exchange is paid for 
by a draft on some Clearing House institution, which 
must be presented for payment through the Clearing 
House on Monday; so actually you would get payment 
for the bill of exchange in gold three days after you 
made the payment for the shipment. On the other 
hand, should the steamer sail at 4 o'clock in the after- 
noon and dock on the other side before 10 a. m. there 
would be time to clear the transaction during banking 
hours, both here and abroad, which would cause no loss 
of interest. We always take into consideration the ac- 
tual conditions at the time the shipment is made." 6 

Example 2 
Another Export of Coin — with a Higher Price for Eagles 

(If the Bank of England should raise its price for U. S. gold 
coin to 76s. 6'd. per ounce, the following calculation would 
hold) : 

initial outlay (as before) 

incidental bxpenses (as before) 

Total $1,002,435 

''•This information the author owes to the kindness "f Mr. <;. E. 
Gregory of the National City Bank tA New 5Tork. The freight, In 



528 FOREIGN EXCHANGE 

PROrEEDS 

53,715 oz. of U. S. gold coin sold to Bank of 
England (3 76s. 6d. per ounce gross weight 

(918d. X 53,715 = 49,310,370d.) or £205,459 7 / 8 

Less sterling expense 2 

Net proceeds £205,458 

NO-PROFIT GOLD EXPORT POINT 4.8790 

(1,002,435 -r- 205,458) 

This example illustrates the fact that the higher the price 
of eagles abroad, the greater are the sterling proceeds of 
export per dollar of outlay, and the lower is the export 
point. If the English price of eagles ascends from 76s. 4d. 
(first example) to 76s. 7d. per ounce (second example), 
the gold point descends from 4.8897 to 4.8790, or more 
than 1^. 

The "fine bars" which the New York Assay Office sells 
at a premium of 40^ per $1,000, or %s of 1%, are the 
cheapest and best form of gold for export from New York. 7 
They are always used in preference to coin to export to 
Europe when a supply of them is available. At times the 
demand for gold for export will temporarily outrun the 
New York supply of bars and in these cases coin may be 
shipped to Europe, even in large quantities. 

Example 3 
An Export of Fine Bars from New York to London. 
(Bars sold to Bank of England at its minimum price of 
£3 17s. 9d. per oz. .916% fine.) 

surance, and cartage rates used in the calculations in the text, are 
those given by Mr. Gregory as being in force shortly before the war 
began. Mr. Gregory states that a bank would hardly expect to 
move gold for a profit of less than Vz2 of 1%. 
i Compare § 130. 



i 



SPECIE SHIPMENTS 529 

INITIAL OUTLAY 

Invested in assay bars, say, .999 fine with a con- 
tents of 48,375 oz. of fine gold, at $20.67183 per 
oz. fine $1,000,000 

Plus premium of 40tf per $1,000 400 

$1,000,400 

INCIDENTAL EXPENSES 

Packing and carting 60 

Freight (9io of 1%) 1,875 

Insurance (%o of 1% ) 500 

Total outlay $1,002,835 

PROCEEDS 

48,375 oz. of fine gold make 52,772.727 (% of 
48,375) oz. of gold x ¥\2 fine; counted to nearest 
Moth oz. below as 52,772.725 or 52,772 2 %o oz. 
at the Bank, 

bought @ £3 17s. 9d. per oz £205,153.96% 

Less minor expense 2. 

£205,152. 

NO-PROFIT EXPORT POINT $4.8882 

(1,002,835 -^205,152) 

Example 4 

the same — with a higher price for bars. 

(Bars sold to the Bank of England at the relatively high 

[though not the highest] price of £3 17s. lOV-jd.) 
total outlay, the same as before $1,002,835 

PROCEEDS 

48,375 oz. of fine gold, making 52,772 2 %o oz. of 
standard gold (.916% fine) @ £3 17s. 10V 2 d.) 

per oz £205,483.89 

Less minor expense 2. 

£205,482. 

no-profit export point $ 1.880-1 

(1,002.835 -h 205,482) 



o30 FOREIGN EXCHANGE 

Example 5 

the same — With Bars Sold in the Market at the Extreme 
price of £3 18s. 0V 2 d. 

PROCEEDS 

52,772 2 %o oz. @ £3 18s. Oy 2 d £205,923.57 

Less minor expense 2.00 

£205,921.00 
"no-profit gold-point" 
1,002,835 -t- 205,921 = 4.8699 or $4.8700 

This gives us the extreme minimum point of normal times, 
and if a shipment incurs an interest charge the point can- 
not fall quite so low as this. On October 24, 1904, the 
New York Financier reported as a matter of interest that 
owing to the exceptionally high price then being offered 
in London for gold bars, the export point lay between 
4.87 and 4.87 1 /4. 8 A comparison of the five preceding ex- 
amples gives us the following : 

Comparative Table of No-Profit Gold Export Points 
(In the rate for demand sterling) 

1. Export of coin (M.5 of 1% short weight) price of 

eagles at £3 16s. 4d 4.8897 

2. Export of bars, price £3 16s. 4d. per ounce, .916% fine. 4.8882 
3 Export of bars, price £3 17s. 10y 2 d 4.8804 

4. Export of coin {V15 of 1% short weight) price of 

eagles at £3 16s. 6d 4.8790 

5. Export of bars, price £3 18s. 0y 2 d 4.8700 

As already said, we should assume that banks must or- 
dinarily obtain a profit of Vs& of 1% before they will un- 
dertake specie shipments, and therefore without regard 
to possible interest charges we should add ^oo of 1$ to 
each of the above rates to find the actual rates at which 
export may be expected to take place. 

*The number for October 24, 1904, p. 2,002. 



SPECIE SHIPMENTS 531 

§ 139. Gold import by New York from London. — Our 

next task is to calculate the " no-profit gold import point" 
in the rate for bankers' sight sterling. We treated the 
complete transaction of gold export as consisting in two 
parts, (1) the shipment of the specie itself and (2) the 
sale of bankers' sight exchange as a means of realizing 
on the shipment. It is true a gold export might take 
place without an accompanying sale of exchange but what 
we may well call the standard operation of gold export 
is completed in these two steps. In a similar way, the 
standard operation of gold import consists in two parts, 
(1) the purchase of exchange as a means of obtaining the 
gold abroad, and (2) the inshipment of the specie itself. 
In the illustration to follow of gold import by New 
York, we shall assume that "fine" bars can be procured 
in the London market at the price of £3 17s. lOd. The 
reader will understand, of course, that besides bars, Brit- 
ish gold coin can always and American gold coin can 
generally be obtained. We shall suppose the importer to 
deal with approximately $1,000,000 of bars. 

Example 6 

An Import of Gold Bars by New York from London Against a 
Purchase of Sight Drafts 

(Bars being procurable in the London market @ £3 17s. lOd.) 

INITIAL OUTLAY IN LONDON 

Purchase of "fine" bars (say .999) which have a 
contents of 48,400 oz. of pure gold, at a rate of 
£3 17s. lOd. per standard-oz. of contents £205,480. 

INCIDENTAL EXPENSES PAID IN LONDON 

Packing and cartage 10. 

Freight (Wo of 1% of value) 385. 

Insurance ( l Ao of 1% of value) 102. 

Total sterling outlay £205,977. 



532 FOKKIGN EXCHANGE 

PROCEEDS ON ARRIVAL IN NEW YORK 

48,400 oz. fine gold sold N. Y. Assay Office @ 

$20.67183 per fine oz $1,000,516.57 

Less charge for copper 106.57 

[There are no other charges for this kind of 
gold. ] 

Net proceeds on arrival $1,000,410.00 

THE INTEREST COST 

Deduct 20 days' interest at N. Y. market rate, 
say 4% 2,218. 

PRESENT WORTH OP THE PROCEEDS $998,192. 

That is, present worth at the time when the sight 
exchange was bought, or 20 days before gold 
arrives and proceeds are obtained. 

NO-PROFIT PURCHASE PRICE FOR SIGHT DRAFTS, OR NO-PROFIT IM- 
PORT POINT 

$998,192 obtained for £205,977 of drafts bought, which 
means $4.8461 {i.e., 998,192-^205,977) obtained 
for £1 of draft bought $4.8461 

Before proceeding to the necessary explanations of the items 
in this calculation, we had best give two more examples. 

Example 7 
The Same Import — Except against a Purchase of Cables 

NET PROCEEDS ON ARRIVAL IN NEW YORK $1,000,410 

[The same as in Example 6.] 

THE INTEREST COST 

10 days' interest @ 4%. 

[10 instead of 20 days] 1,110 

PRESENT WORTH OF THE PROCEEDS $999,300 

» Compare § 130. 



SPECIE SHIPMENTS 533 

That is, at the time when the cable transfer was 
bought, 10 days before gold arrives and proceeds 
are obtained. 

NO-PROFIT PURCHASE PRICE FOR CABLES, OR NO-PKOFIT IMPORT 
POINT IN CABLE RATE 

(999,300-^205,977) $4.8515 

Example 8 
An Import of U. S. Gold Coin by New York from London 
(Bank of England selling Eagles at say 76s. 7d. per oz.) 

INITIAL OUTLAY IN LONDON 

$1,000,000 of U. S. gold coin bought from Bank 

of England for 76s. 7d. per oz., actual weight, 

say, 53,715 oz. (i.e., Viz of 1% under legal 

weight) 

53,715 oz. @ 76s. 7d £205,683.+ 

INCIDENTAL EXPENSES PAID IN LONDON 

Packing and cartage 10. 

Freight (Mb of 1% of value) 385. 

Insurance (%o of 1% ) 102. 

Total sterling outlay £206,180. 

PROCEEDS ON ARRIVAL IN NEW YORK 

$1,000,000 of home coin $1,000,000. 

THE INTEREST COST 

20 days' interest at 4% 2,217. 

PRESENT WORTH OF THE PROCEEDS $ 997,783. 

As explained in Example 6. 

NO-PROFIT PURCHASE PRICE FOR SIGHT DRAFTS $4.8394 

(997,783 -=-206,180.) 



THE NO-PROFIT PRICE FOR CABLES WOULD BE $4.8447 

(Taking 10 clays' interest, c£. Example 7) 
(998,891-^206,180) 



534 FOREIGN EXCHANGE 

An export of gold against a sale of cables is not a simple 
or standard operation because it would either involve an 
overdraft or loan in London for the period which must 
elapse between the arrival of the cable draft and the sub- 
sequent arrival of the gold credit, or would necessitate a 
delay of say 5 to 10 days before the cables could be sold. 
If the sale of cables were withheld until the gold credit 
should be established abroad, a speculation on the course 
of cables would be involved. Since there would have to 
be some special reason for selling cables later rather than 
selling demand bills immediately, an export of gold against 
a sale of cables should not be considered a standard op- 
eration. But the operation of an import of gold against a 
purchase of cables (as a means of procuring the foreign 
gold) is simple or standard. If cable transfers for 
£206,180 are bought in New York to-day, they establish 
a credit in London to-day or to-morrow and this credit 
may be converted into gold forthwith which is due to 
arrive in New York in 10 days or less from to-day. If 
sight drafts for £206,180 are bought to-day, we must al- 
low say 10 days for the drafts to reach London and 10 
days more for the gold to get back to New York, or a 
total of 20 days. Ten days is a liberal allowance for the 
transatlantic mail and express, and frequently the cable 
and sight draft operations of our illustration can be 
brought to conclusion in shorter periods than we have 
assumed. 

A banker will of course figure the interest costs on 
the basis of the actual time elapsed between investment in 
exchange and realization on the gold, a period depending 
on circumstances. 

Before giving further attention to the interest cost 
chargeable against gold movements, we may put together 
from the foregoing tables a summary of gold import 
points. 



SPECIE SHIPMENTS 535 

Summary of Gold Import Points as Shown in the Particular 
Examples Preceding 10 

No-Profit Ordinary Profit 
Demand Drafts Point Point 

Import of bars costing £3 17s. lOd. . . 4.8461 4.8445 

Import of U. S. coin costing 

76s. 6d. per oz 4.8394 4.8380 

Cables 

Import of bars as above 4.8515 4.8500 

Import of coin as above 4.8447 4.8430 

To show how an importing bank makes a profit, let us 
assume that under the conditions of Example 6, a bank 
is able to buy £205,977 of sight drafts in New York at 
4.8445, 16 points under the "no-profit" import point. 
The drafts will cost a total of $997,855. Mailing these 
drafts abroad, the bank engages gold for import. It thus 
procures 48,400 ounces of fine gold expenses of delivery 
in New York prepaid. This bullion arrives 20 days after 
the purchase of the £205,977 of drafts, and yields net pro- 
ceeds of $1,000,410 by sale to the New York Assay Office. 
The net proceeds exceed the outlay by $2,555 (1,000,410- 
997,855). From these gross profits substantially $2,218 
must be deducted for interest lost (that is, foregone) at 
the New York market rate of 4%. This leaves a profit of 
$337, which is a little more than %2 of 1% on the original 
outlay. 

In engaging gold in London for import, the decision 
whether bars or coin should be obtained depends simply 
upon the relative prices existing at the time for these 
forms of gold. Wbeilier demand sterling or cables should 
be purchased on this side as the means of procuring the 

io With the particular rate of interest assumed in these examples 
the difference between 11i<' cable and the Bight rate import points will 
be affected by a change in the interest rate. 



53(i FOREIGN EXCHANGE 

gold abroad, depends upon the space or "spread" between 
the demand and cable rates. The cable operation involves 
roughly about half as much loss of interest as the oper- 
ation with demand drafts, but cables will ordinarily cost 
about enough more to compensate for this. It is generally 
understood that in practice the greater part of New York's 
gold imports are provided for by the purchase of demand 
drafts rather than cables. 

§ 140. The place of interest in the cost of gold movements. 
— Any kind of business transactions involving an outlay 
of money (or its equivalent) and a subsequent return, is 
chargeable with interest for the time running between 
the outlay and return. If the return exceeds the outlay 
merely by an amount equal to interest, the transaction 
results neither in profit nor loss. This is but another way 
of saying that the return just equals the "costs." Gold 
export against a sale of demand drafts involves no interest 
cost if incidental circumstances are the most favorable 
possible, because the return from the sale of drafts may be 
had on the same day with the outlay for gold. But, as 
already explained, more frequently from one to three days 
elapse between the payment for the gold and the receipt 
of money for the drafts. The true interest charge depends 
simply on the actual loss of time experienced. As far as 
the time consumed in the transatlantic passage is con- 
cerned, the gold, which will be credited to the account of 
the New York exporting bank, travels just as fast as the 
drafts which will be debited. Gold import against a pur- 
chase of exchange in the home market always involves an 
interest cost. In what we have called the "standard" op- 
eration of gold import, as considered in the preceding 
pages, the exchange is first purchased and remitted abroad 
for conversion into gold. The latter is then shipped home. 
Thus a time must always elapse between outlay and re- 
turn. 



SPECIE SHIPMENTS 537 

The problem of the interest charge against gold move- 
ments presents certain curious aspects that require ex- 
amination to safeguard us against confusion. A gold ship- 
ment from London to New York may show at least three 
different interest costs, depending upon the manner in 
which the shipment is engineered. 

The practical interest charge on a gold shipment from London to 

New York 

(1) On the basis of N. Y. rates for sterling. 

(a) Against purchase of demand drafts. .12-20 days' interest 

(b) Against purchase of cables 7-10 days' interest 

(2) On the basis of London rates for New 

York exchange u 

(c) Against a sale of N. Y. drafts 0-3 days' interest 

In all three cases, is not the gold locked up in the steam- 
er's express room for the same length of time? Since 
during a period of, say, 10 days the gold can serve as 
bank reserve on neither side of the water, is not the real 
interest loss necessarily one for just 10 days in all three 
cases? 

"We might have knowledge that a consignment of 20 
kegs of gold is upon a transatlantic steamer westward 
bound, and that this metal will be locked up 10 days, but 
we could not tell whether the bank making the shipment 
is charging its venture with an interest cost of 0, 10, or 

ii In this case the shipment is an export by a London bank, a 
transaction which is less common than the N. Y. import. but nut 
unknown. The London hank simply exports gold to a New fork 
correspondent and immediately sells drafts in London upon that 
correspondent. The operation is undertaken upon the basis of the 
London price for New York exchange and has no reference whatever 
to the New York price for London exchange. However when the 
London rate on New York is in position for a gold export, the New 
York rate on London will neees-arilv be about in position for a gold 
import, that is, the same movement. 



538 FOREIGN EXCHANGE 

20 days. This, because we do not know the full terms of 
the bank's transaction. The gold is, nevertheless, locked 
up just 10 days in all three cases, and there is in all cases 
a final interest loss of just 10 days, which would show as 
such if the three calculations were reduced to final and 
equivalent terms. To avoid devoting too much space to 
this incidental though curious point of theory, we will not 
extend our discussion beyond giving an answer to one 
question. When a New York bank exports gold and sells 
demand sterling, and makes no interest charge against its 
transaction, what has become of the real interest cost which 
we nevertheless know must exist for the time consumed in 
passage ? Suppose the bank is an office of an international 
house, and makes the export simply to the London branch 
of the same house. The interest loss must be borne by 
this international house. The truth is, it will fall upon 
the New York branch. It lies in the discount which re- 
sides in the price of demand exchange as compared with 
cables. Suppose a good fairy should wish this particular 
gold over to London for the bank instanter — or some of 
its spiritualistic friends should "levitate" it over — thus 
saving the time required for ordinary passage. In what 
form would the consequent saving of interest to the bank 
appear? The answer is, in the shape of the excess pro- 
ceeds which it could now obtain by selling cables instead 
of sight drafts. The good fairy might enable it to sell 
say £205,458 (see Example 2) of cables at perhaps 4.8850 
instead of the same sum of demand exchange at 4.8790. 
Thus it would make an extra gain of $1,232.75 which in 
fact it fails to get because it really takes as much time 
for the gold to get across the sea as for demand drafts. 
This sum is the hidden interest lost. Doubtless this sub- 
ject should be further explained to be wholly clear, but 
we cannot afford to develop it at greater length. The 
calculations of interest costs as given in the examples in 



SPECIE SHIPMENTS 539 

the text are the correct ones to show the no-profit gold 
points in the particular rates of exchange with which each 
example is concerned. In no case is the time spent by 
the gold in transit to be taken in and of itself as the basis 
for the interest charge to be made against a gold ship- 
ment in calculating the gold point in any given exchange 
rate. It is true this time has much to do with the period 
which must elapse between the actual outlay and actual 
return to the shipper, but the latter period alone governs 
the interest charge. 

§ 141. Variant methods of calculating the interest charge. 
— By condensing Example 6 as given on pages 531-2, we 
obtain the following: 

Initial outlay in London for gold bars containing 

48,400 ounces of fine gold £205,480. 

Incidental expenses paid in London 497. 12 

£205,977. 

Net proceeds from bars on arrival in N. Y $1,000,410. 

20 days' interest deducted, @ 4% 2,218. 

$ 998,191'. 

No-profit purchase price for sight drafts $4.8461 

(998,192 -=-205,977) 

This table exhibits the method which we have employed 
thus far in calculating the interest charge in gold import. 
It shows that (the price of gold and the costs for packing, 
cartage, freight and insurance being given) demand bills 
to the amount of £205,977, purchased in New York for tin- 
purpose of importing gold, will produce proceeds from 
the metal on arrival of just $1,000,410. But these returns 
are received at home 20 days after the investmenl of home 

12 it is assumed that the incidental expenses of £497 are payable 
in advance of the shipment, bo that the operation is chargeable with 
interest upon them aa well as upon the "initial outlay." 



540 FOREIGN EXCHANGE 

money in the £205,977 of exchange. The sum of $1,000,- 
410 receivable in 20 days, with interest calculated at 4%, 
has a present worth of $998,192, the interest itself coming 
to $2,218. Thus, if 4% is the market rate of interest for 
funds employed at home in ways involving about the same 
degree of risk as an investment in the operation of gold 
import, the banker who ventures $998,192 in the latter 
business for a return of $1,000,410, makes just market in- 
terest. That is, he makes no profit, in that narrow and 
proper sense of the term which excludes interest. If then 
the banker is to pay just $998,192 for £205,977 of ex- 
change, the rate of exchange will have to be 998,192-=- 
205,977, or 4.8461. This figure is therefore the no-profit 
gold-import point in the sight rate. If the operator were 
to pay more than this figure per pound sterling for the 
bills, he would fail to make full market interest in his 
venture. If, however, he could buy bills for less, he would 
make something more than interest. 

A variant method of reaching the same result is shown 
as follows: 

Total sterling outlay £205,977. 

Net proceeds from gold on arrival $1,000,410. 

Dollars of proceeds per pound of outlay 

(1,000,410 -^ 205,977) $4.8569 

20 days' interest @ 4%, deducted from 4.8569. . . .0108 

No-profit gold import point $4.8461 

To explain : the third item of the table shows that for each 
£1 of exchange purchased, the banker receives a return 
of $4.8569 worth of gold laid down in New York. Now 
$4.8461 is the sum of money which, if put out at 4% 
interest for twenty days, will earn $.0108 and will amount 
to $4.8569 at the end of the 20 days. It follows if the 
banker pays $4.8461 for £1 of exchange which through the 
importation of gold converts into $4.8569 of home mone«y 



SPECIE SHIPMENTS 541 

at the end of 20 days, he makes just 4% in his venture, 
and consequently makes neither profit nor loss. 

In the third place, the calculation may take the following 
form: 

Initial outlay for gold in London £205,480. 

Incidental shipping expenses (see Example 6) . . 497. 

£205,977. 
Interest on £205,977 for 20 days @ 4% 

(calculated in sterling) 457.9 

"Total costs" £206,434.9 

Receipts from gold in New York $1,000,410. 

Receipts per £, or no-profit gold point 

(1,000,410 -T- 206,434.9) $4.8461 

This calculation will always give a correct result, not 
however because it gives a correct representation of the 
actual stages in the import transaction. In fact it is quite 
misleading in at least one point, and if given alone, tends 
to confuse the reader. For instance it would seem to in- 
dicate that the banker actually invests £205,977 of sterling 
for 20 days. But this, of course, is not precisely what he 
does. Furthermore it reckons, or ought to reckon, the 
interest on the principal sum of sterling at the New York 
market rate of interest. And this again would seem con- 
fusing. The reason why the method followed in this 
calculation works, is simply that it happens to be a precise 
arithmetical, though merely arithmetical, equivalent of the 
true method. We had best consign the explanation of 
this to a footnote. 13 

is 20 days' interest, taking a year as 3G0 days, is 2 %«o X 4%, or 
2 %oo X *ioo, or %oo. The rate of 4.8461 is, in the first and third 
calculations given just above, the result of the division of ;i Bum of 
dollars by a sum of pounds. The divisor and dividend are indicated 
in each instance. In the first and correct calculation, the result of 



542 FOREIGN EXCHANGE 

§ 142. The gold points and the mint par. — A mint par is 
tlir figure which expresses the relative contents in pure 
gold of the monetary units of any two gold-standard coun- 
tries. 14 So long as two given countries have free and 
gratuitous 15 (or virtually gratuitous) coinage of gold, the 
mint par between them will serve as the fundamental 
regulator of the "gold points" in the exchange rates of 
either country on the other. The gold points will lie at 
approximately equal distances to either side of the mint 
par, and therefore the latter will serve as the approximate 
center of oscillation of the exchange rates. If we examine 
the practical calculations of the costs and proceeds of gold 
shipments we see that what the mint par does is to govern 
the ratio between the initial outlay for gold in the money 
of the one country and the proceeds received for the same 
gold in the money of the other country. Thus if £10,000 
of English money is spent for gold in London, this same 
gold when brought to New York is bound to yield very 
close to 4.8665 times as many American money units, or 
$48,665. If sovereigns were the form of gold shipped 
out of England, the only factors which would make the 
ratio of pounds sterling given up to dollars obtained vary 
from 1:4.8665, would be deficiency in the weight of the 

making an allowance of 20 days' interest is to reduce the dollar, or 
dividend number, from 1,000,410 to 998,192, or to reduce it to just 
90 %02 of itself. In the third or last calculation, the effect of the 
interest allowance as erroneously introduced, is simply to increase 
the pound, or divisor number, from 205,977 to 206,434.9 or to in- 
crease it by %oo of itself, or make it 90 %oo of itself. It is a fortu- 
nate circumstance that an increase of a divisor to 90 %oo of itself has 
iust the same effect as the decrease of a dividend to 90 %o2 of itself, 
otherwise the common practical method of figuring the interest cost 
on a gold import would not yield a correct result. For it does not 
follow the facts of the transaction. 

i* Taking these units as defined by law: see formal definition of 
the mint par, § 103. 

is Free and gratuitous coinage are distinct. See § 105. 



SPECIE SHIPMENTS 543 

actual sovereigns and the very small charges of the U. 
S. mint exacted in the purchase of sovereigns. If bar 
gold is the form of metal shipped from England, the mar- 
ket price per ounce payable in sovereigns must be to the 
price per ounce received in dollars very nearly as 1 :4.8665. 
This is true because these two prices must, as we know, 
lie very close to the mint prices for gold in the respective 
countries, and except for the very small coinage or stand- 
ardizing charges made by mints, the mint prices for fine 
gold are one to the other exactly in the ratio of the mint 
par. / 

Thus it takes 4.8665 dollars to contain as much pure 
gold as one sovereign, and therefore of course, under the 
system of free and gratuitous coinage (ignoring small 
charges for standardizing) the United States mints are 
bound to give 4.8665 times as many dollars for an ounce 
of pure gold as the British mint gives sovereigns for an 
ounce of pure gold. 16 We know that the total of the in- 
cidental expenses and interest costs of a gold shipment 
(between places as distant as New York from London) 
varies from something less than Vi to something less than 
% of 1% of the value of the shipment. If there were 
no incidental costs at all, the ratio between outlay for gold 
in one money (as pounds sterling) and proceeds for the 
same gold in the other money (as dollars) — namely the 
ratio governed by the mint par — would be the sole factor 
governing the gold points. Considering how small the in- 
cidental costs are, this ratio remains 1 lie one great influence 

is The British mint price for standard gold, ''^ths line, is £3 17s. 
10M;d., or £3.89375, per ounce. The U. 8. mint price for gold Vint lis 
fine is $18.60405 per ounce. 1:4.8005 is not the ratio between these 
two mint prices, but the ratio between the mint prices for fine gold 
deducible from them. The "basis" price (see § H>!>) for line gold i« 
in England tilths times £3.89376 or £4.24772. 'Hie U. 8. baBic mint 
price for fine gold is $20.67183 (that is, "%ths times $18.60465). 
Now 4.24772 is to 20.6718.'} as I is to 4.8665. 



544 FOREIGN EXCHANGE 

determining the gold-points and thus the limits which con- 
fine the fluctuations of exchange rates. 

Roughly speaking, the gold-export point is the mint par 
plus incidental costs of export, and the gold-import point 
is the same figure minus the incidental costs of import. 
But a striking fact in this connection is that, in the case 
of exchange between somewhat distant places, the under, 
or import, point in the sight rate of exchange is further 
away from the mint par than the upper or export point. 
The reason is that in gold import interest is lost for a 
period of at least double the time required for the mail 
and express transit between the places; while in gold ex- 
port there is either no interest loss or else a very slight 
one. 

If one or both of two given countries were to suspend 
the free coinage of gold, or were to continue its coinage 
at a substantial seigniorage, the mint par would cease 
to bear its ordinary relation to their mutual exchange 
rates. For the imposition of a seigniorage would affect 
the mint price, and consequently the market price of gold, 
and so would affect the relation of outlay to proceeds in 
gold shipments. Even the slight seigniorage of about Va 
of 1% charged by the mint of France, exercises a certain 
effect upon the relation of the French mint pars to the 
gold points of the exchanges in and on France. 

§ 143. Special banking methods of influencing the gold 
movement. — Speaking with especial reference to countries 
having the gold standard, it may be said exportation of 
gold has a tendency to raise money rates and lower the 
prices of securities, and if long continued also to lower 
the prices of commodities. Importation of gold has a 
tendency to produce the opposite results. It is for these 
reasons that the trading and enterprising classes, who are 
usually interested in an immediate future of lower money 
rates and high prices, are prone to regard gold import 



SPECIE SHIPMENTS 545 

as a favorable and gold export as an unfavorable event. 
Since the beginnings of writing and speaking on the sub- 
ject, there have always been those to maintain, whether 
expressly or by implication, that the national object in 
engaging in foreign trade is, or ought to be, to get gold 
or specie away from other countries. This delusion which 
has been repeatedly exposed in the most workmanlike 
manner, seems fated to persist as something impervious to 
reason. Akin to it is the notion that unless something is 
done to prevent foreigners selling us their wares too freely, 
we are likelj* to have to export so much gold as to under- 
mine or destroy our gold-standard. The reason why it is 
not absolutely essential to do something about this is that 
there is a natural and automatic remedy for excessive ex- 
ports of specie. To call this remedy "natural" does not 
signify that it is necessarily wholly good and absolutely all- 
sufficient, but merely that it becomes operative without 
calculated action to affect the specie movement being taken 
by a government or by a great central bank. It works 
by changing the course of trade or business, and so depends 
on human motivation, but it is automatic in the sense that 
no authority plans and executes it with a purpose of mak- 
ing it effective. It consists in a fall (whether absolute 
or relative) of the prices of commodities within the coun- 
try suffering the excessive exports of gold. This natural 
fall of prices will be preceded by a rise of money rates, 
but it is the fall of the prices of goods that is the funda- 
mental remedy. The fall of prices (or relative fall of 
prices 17 ) operates to check imports and increase exports of 
goods and thus to reverse the flow of specie. 

It has not been the practice of all countries to rely ex- 
clusively upon the natural or automatic remedy. In time 
of war the government or central bank of a country is apt 

17 A rise of prices less rapid in the one country than abroad may 
relative fall. 



be called a relative fall. 



546 FOREIGN EXCHANGE 

to assume a more or less complete control of the gold 
movement. In truth during the great war just closed this 
action was taken in practically all countries, belligerent 
and neutral, which possessed any gold put to monetary 
use. However war-times aside, it has been the policy of 
some central banks to employ certain special devices to 
influence the gold flow in the interest of local financial com- 
fort. It is to these expedients our attention is next to be 
directed. Resort to them is not founded on the supposi- 
tion that the natural reinecty will fail but rather on the 
notion that the artificial ones may serve until the turn of 
the tide, and make the experience less severe. 

The measures in question fall into two classes according 
as an effect is worked (1) on the rates of foreign exchange, 
or (2) on the points in these rates at which gold shipment 
will take place. The chief exemplar of the first class is 
manipulation of the discount rate. The institution which 
has, up to the present juncture in the world's financial 
history, most successfully and most regularly employed 
this remedy is the Bank of England, England having been 
the county whose position has made possible a very ef- 
fective use of it. With the British the proceeding has 
often been known as "correcting the exchanges," because 
it acts to bring the exchange rates to a more favorable 
position. 

§ 144. Manipulation of the discount rate. — As indicated 
on earlier pages, the official discount rate of the Bank of 
England is ordinarily non-operative or non-effective. 
When this is the condition it stands above the market rate 
— that is, above the particular market rate which applies 
to the same class of bills as the bank rate — and no actual 
discounting goes on at the bank rate. If now it chances 
that the demand for accommodation increases so as to drive 
the rate in the market up to or above the Bank rate, the 
latter becomes operative or effective in the sense that dis- 



SPECIE SHIPMENTS 547 

counting begins to take place under it. When this hap- 
pens the Bank's reserved discounting power is brought to 
the aid of the market. Now of course the Bank has in 
these times the power of determining, with limitations, the 
point at which the rising market will overtake the bank 
rate. In other words in times of very active demand for 
accommodation in the money market the Bank may exert 
a decided control over market rates of discount. Some- 
times when these rates do not rise so high as the Bank 
thinks they ought to under the circumstances or in view 
of the position of the exchanges, it takes measures to further 
their ascent. The following is evidence on this point, from 
the interview granted the National Monetary Commission 
(U. S.) by the Bank of England. 18 

Q. Does the bank sometimes borrow money in the open market 
for the purpose of raising the market rate? 
A. Yes. 

Q. Do you sometimes sell consols for the same purpose ? 
A. Yes ; on rare occasions. 

"When the bank sells consols, or Brit