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
Full2
U. S. "subsidiary silver" coin
Up to $10 3
U. S. "minor coin" (5c, lc)
Up to 25c3
U. S. gold certificates
None
Money
U. S. silver certificates
U. S. treasury notes (green-
None
backs)
Full2
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-
wajrs 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 71/4%.
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 6eAoo%, 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= XA 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 y4th 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 °y305 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
V2 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 l1/4%
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 present1) 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 countrj7.2
(2) The importer remits3 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 491/6 (approximately) signifying 491/& 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 XA 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 5.17y2d. @ 5.17V2 for short. Ger-
many bankers' marks were 94716 @ 94%c for long and 95yi6 @
951/4d. for short. Amsterdam bankers' guilders 40.12 @ 40.14
for short.
Exchange at Paris on London, 25f. 221/2C. ; week's range, 25f.
22y2c. high and 25f. 2iy2c. 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% 5.16y4d @ 5.161,4
Low 5.20a @ 5.20d 5.17y2d @ 5.17V2 5.16%d @ 5.16%
Germany Bankers' Marks:
High 947/iex @ 94 95i/4d @ 9514 95^ @ 95%d
.Low 94% @ 94%6d 95%6d @ 95?/I6 95y4x @ 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 y32 of 1% h %2 of 1%
Plus k yi6 of 1% x y32 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"/i6 4.75% 4.75«A6 — 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 New7 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.
y2%
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 wrill 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 him 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 @ 4.831/4
Grain for payment 4.831/4 @ 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 123171/^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 5.171/! 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 lAo 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.
17 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}rs' 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 twro 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 412% and the deposit allowance rate of
the joint stock banks therefore to be 3%, the retirement |
rate will be 31/£%. 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%esX3^% 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 4.801/2. 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 cost3 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 wrere 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 wThich 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 Jf 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 merelj7- 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 y2
% to Vi
Drafts at 30 days
% to %
V* to %
Drafts at 60 days
y2 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 3A% 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 197t1oo 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}Ts 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.0
'•> 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 da3rs 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 tin1 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 £33-75
= £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 67/&% 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 0 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
0
2
14
7
3
10
3
9
6
1
16
7
1
12
11
3
0
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 31/4%. 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 39<Kooo%.
The Englishman will on occasion write a rate of 31/£% 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 51/4% 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
«1VS6
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?i6 %
4W1B %
41%6 %
4l%e %
4% %
Loans: — Day to day.
4
%
3% 414
3 4
3V2 4%
4V4 4%
4%
3% 4^
Short
4%
u.
Wi %
4% %
4% %
4% y2
4y* y2
4V4 %
Fortnight (at last
5%
5y2
5%
5y2
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
4y4
4Vi
4y4
414
Comparison with previous weeks :
ll
Trade Bills
Rank Bills
"2
0
2
.3
0
0
3
5
a
0
3
c
0
2
BO
a
0
2
1
0
«
«*
«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% %
4y4
1%6
5y* %
5'/2
r,i, :r,
16...
4*4 %
4V2 n/i<i
4y2 %
4%
%
5
5 %
5 %
23...
4y4 %
4%
4>/2
4y2
5
5 %
5 %
30...
4% y
4%8
ma
4%a
5
b y
r> y
April
4...
4% y2
4y °An
4%a
5
5 y
5 y,
13...
4 y
4%
4V2 %
4%
4%
5
5 y
20...
4>i y2
4i-"K» %
m %
4%
5
5
5 y
5 %
27...
4% y2
4%
i
^lO
5
B
b y
May
4...
41/* %
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) 0
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%65 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 maturitjr 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 72%2 pence (November 11th) and the low-
est (i.e., cheapest) rate was lO11/^ 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 3rear 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 = 21,£%
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%%
21/&% 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 wli3r 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
days16), 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 da3Ts' 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 £2T4 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 £21/4 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. ACCEPTANCE28 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.
3r' 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 wrhich 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 liability2 (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
sale9) 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. LTntil 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 rate13 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 31/£% £ 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}7s 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
wrhich 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 .... 31/6%
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 Yrork, 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 hedging1. — 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, wre shall call the
operation an outright speculation. But if the assumption
of risk is only secondary or incidental to some main piece
of business wThich 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 enjo3r 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 205yioo
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 money4 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 = 109i23 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, 491/4d. 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 4866Jftoooo+ 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 (8Hoo 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" 5tioo 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. 41/6d. 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 dollars5) 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 XV\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 1H2. 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 striking1 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 Hit1 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
wTould 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 1869ioo dollars. There are 480 grains in an
1 M FOREIGN EXCHANGE
oum-c and 25.8 is contained 186(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
gold9 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 72%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 wTill make
l292%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 3711/4 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 price2) 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.0 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 luA~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 12317%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 8997/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. 0 110
$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
ifJ 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 *£ cent 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.
lSS1/^ 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 0
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 knowrs 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. 10y2d., 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 xV\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.
3a/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
(niii 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 21/6 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 kilograms32), 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 1EKiooo
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 = 5.182%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 par33), 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.
*6The 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 21i-(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.
5See 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 l9ioo
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 £205,4597/8
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 52,7722%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 52,7722%o oz. of
standard gold (.916% fine) @ £3 17s. 10V2d.)
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. 0V2d.
PROCEEDS
52,7722%o oz. @ £3 18s. Oy2d £205,923.57
Less minor expense 2.00
£205,921.00
"no-profit gold-point"
1,002,835 -t- 205,921 = 4.8699 or $4.8700
This gives us the extreme minimum point of normal times,
and if a shipment incurs an interest charge the point can-
not fall quite so low as this. On October 24, 1904, the
New York Financier reported as a matter of interest that
owing to the exceptionally high price then being offered
in London for gold bars, the export point lay between
4.87 and 4.871/4.8 A comparison of the five preceding ex-
amples gives us the following :
Comparative Table of No-Profit Gold Export Points
(In the rate for demand sterling)
1. Export of coin (M.5 of 1% short weight) price of
eagles at £3 16s. 4d 4.8897
2. Export of bars, price £3 16s. 4d. per ounce, .916% fine. 4.8882
3 Export of bars, price £3 17s. 10y2d 4.8804
4. Export of coin {V15 of 1% short weight) price of
eagles at £3 16s. 6d 4.8790
5. Export of bars, price £3 18s. 0y2d 4.8700
As already said, we should assume that banks must or-
dinarily obtain a profit of Vs& of 1% before they will un-
dertake specie shipments, and therefore without regard
to possible interest charges we should add ^oo of 1$ 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 (lAo 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.0]
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
gratuitous15 (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 British government debt,
with this object, it is understood it sells them for cash
and buys them back "for the account" or for future de-
livery, the operation having the effect of draining a certain
amount of cash out of the market temporarily into the bank.
■Such proceedings are spoken of as "making the Bank Rate
effective. ' '
When it is said the Bank of England by the agency of
its discount rate "corrects the exchange" and regulates,
or at any rate, influences the gold flow in and out of Eng-
land, it must be understood thai such results as arc ac-
complished follow only from the effects which the Bank
is From "Interviews on Banking and Currency Systems," pub
lished for the National Monetary Commission, 1910 (Senate docU"
rnent No. 405, 61st Congress, 2d session), p. 29.
548 FOREIGN EXCHANGE
is able to produce in the open market for money. For
it is the open market rate, or group of rates, that reacts
on the rates of foreign exchange, and not the Bank rate
in and of itself. A rise in London discount rates tends
to attract gold to London or to restrain its outflow. It
exerts, so to say, an attractive influence upon gold. If the
exchange rates, in some other country, or countries, upon
England are almost in position to cause a gold flow to
England, a rise in the London discount rates serve to pre-
cipitate or superinduce the movement, this being brought
about by the tendency of the higher charge for discounting
to raise the rates of exchange in the other country or coun-
tries. The elevation of the British discount rates operates
to pull the exchange rate in the other country up to its
gold-export point. If the rates of exchange are moving
toward the point where a gold outflow from England is
imminent, an elevation of the discount rates serves to re-
strain the movement by restraining the exchange rates
from falling to the gold-import point in the other country.
When we say an elevation of the discount rate serves to
produce these effects, we should be understood as meaning
that it tends to produce them, or operates as one force in
the direction of producing them. In fine, it tends to bring
in gold or restrain its outflow according to the circum-
stances, and does so through the effect it tends to produce
on the exchanges.
The information respecting the bank rate, contained in
"Interviews on Banking and Currency Systems," cited
a moment ago, is of much interest in this connection and
has the advantage of possessing a semi-official character.
From the "Report of Answers to questions addressed to the
Governor and Directors of the Bank of England," we take
the following queries and replies.
Q. How and by whom is the bank rate fixed?
A. The bank rate is fixed at the weekly meeting of the court of
SPECIE SHIPMENTS 549
directors, but the governor has power to raise the rate at any
intermediate time, should circumstances in his opinion render
such a course necessary.
Q. When and under what conditions is the bank rate changed?
A. The bank rate is raised with the object either of preventing
gold from leaving the country, or of attracting gold to the coun-
try, and lowered when it is completely out of touch with the mar-
ket rate and circumstances do not render it necessary to induce
the import of gold.
Q. Do you regard prompt and adequate increase in the bank
rate as the most effective measure to protect the bank's reserves?
A. Yes.
Q. Does the raising of the bank rate ever fail to attract gold
and change the course of the exchanges?
A. Experience seems to prove that the raising of the bank rate
to a sufficient level never fails to attract gold, provided the higher
rate is kept effective.
Q. What effect did raising the rate in the period from October,
1907, to January, 1908, have upon the bank's gold supply?
A. On the 15th August, 1907, the bank rate was raised to 4J/£%
and so continued until the 31st October, when it was further
raised to 5%%. On the latter date the total bullion held by the
bank was £31,700,000 and the proportion of reserve to deposits
39.9%. On the 4th November, owing to further withdrawals of
gold, the governor, acting on his powers, raised the rate to 6%.
On the 7th November the court of directors raised the rate to !'.'< ,
the total bullion being £28,700,000 and the proportion |<>f the
reserve] 35.2%. Thence forward the inflow of gold was greater
than the outflow, thus demonstrating the power of an effective in-
crease of rate.19 On the 11th December the total bullion was
£34,100,000 and the proportion 47%. At the end of January, by
which time the rate had been gradually reduced to 4%, the total
bullion was £38,500,0(10 and the proportion 56.6%.
i» An "effective" increase of rate here means o ffective in bring-
ing up the market rate of discount.
550 FOREIGN EXCHANGE
Q. From how many countries did the bank receive gold as a
result of the increase at thai time?
A. Twenty-four, including British colonies.20
During November and December of 1907 the net ex-
ports of gold to the United States from the United Kingdom
were $85,000,000. 21 It was while London was withstanding
this drain that it succeeded in gathering in the metal from
24 different countries.
NET IMPORTS (U. S.)
Nov., 1907 Dec, 1907
Total from all countries $62,959,000 $43,444,000
From United Kingdom 53,311,000 31,244,000
From Canada 4,835,000 3,388,000
From France 1,414,000 2,900,000
From Germany 1,250,000 10,000
From Monthly Summary of Commerce and Finance (Department of
Commerce and Labor) for Nov., 1907, p. 855, and Dec, p. 1053.
It devolves upon us next to examine the mechanism
through which an elevation of the discount rate works out
its effects on the gold movement. In the course of this
examination we shall discover why, heretofore at any rate,
England alone has been in a position to utilize this remedy
systematically and with striking success. It may be said
in a general way that for London to raise its money rates,
or charges for short-term advances of various descriptions,
will necessarily tend to quicken repayments by foreigners
of funds borrowed there and restrict the demands of these
same people for further accommodation. Thus it tends
to augment the inward and decrease the outward flow of
money funds,22 and exerts an influence in the direction of
bringing in gold. But such a statement does not serve as
20 From "Interviews," etc., as cited, pp. 20-7.
21 Beneath are given some further details of the imports of gold
into the United States during these months.
22 Or of "monev" as some would say.
SPECIE SHIPMENTS 551
an adequate explanation. To obtain this it will be in-
cumbent on us to enter into the subject more technically.
The ordinary gold movement depends on the rates of
exchange.23 The very first effect of an elevation of the
discount rate, is an increase of the spread between the sight
and long rates of exchange in other cities upon the city
where the discount rate is raised. Thus if discounts are
advanced in London the first effect on the exchanges will
be an increase in the spreads between sight and long ster-
ling in the various money capitals of the world. If the
London market discounts the 60 days' acceptances of Lon-
don bankers at 3%, the spread between the sight and 60
days' rates24 in New York, would normally be 2.90 cents
per pound. But if this rate rises to 5%, the spread would
increase to 4.25 cents.25 But the gold movement does not
depend on this or any other spread but upon the position
of the sight rate itself. If the sight rate is not at one
of the gold points, but lies between, resting for instance
at 4.85 or 4.86, there can be no ordinary gold flows what-
ever be the spreads between it and the 60 and 90 days'
rates. Thus if a change of the discount rate is by its re-
action on the exchanges to work some influence upon the
gold flows, it will have to do so by way of its effect on
the rate for sight exchange.
Now in fact an elevation of the discount rate in London
puts a strong upward pull on the sight sterling rate in
23 it is admitted gold can be moved when the exchanges do not
favor it, for it is always possible to move it even at a loss. Con-
ceivably a central bank might come to a position where import of
gold at a loss would be reasonable.
24 That is, between the rates for bankers' checks and bankers 60
days bills on London.
25 If we compute according to the practical method, employed
commonly before the war began, the Bpread is the same whether
the sight rate is high or low. For illustration (and discussion of
the slight error involved) see § G4.
552 FOREIGN EXCHANGE
New York, or in any other foreign money center: this is
because it operates to restrict the supply of and increase
the demand for sight sterling. To develop the reasons
let us analyze the case of New York. (1) In ordinary
limes London is continually discounting a great stream
of long sterling bills drawn by American exporters, many
under sterling credits against sales of goods all over the
world.26 We are already familiar with the ordinary pro-
cedure of our banks. On taking these bills they forward
them forthwith to London for discount and immediate ster-
ling credit and against the credits so created sell their
own sight drafts. The latter constitute a very important
element indeed in the supply of sight sterling in New York.
The supplies of sterling exchange flowing from our exports
consist in the first instance mostly of long bills because in
the greater number of cases the arrangements of exporters
with their importers permit only of the drawing of such
bills. But the unceasing flow of long sterling converts into
sight sterling by the process just remarked. This con-
version depends however on the prompt and continual dis-
counting in London of long bills drawn on that city.
Now then if London raises sufficiently the charges which
it levies for this discounting, our banks will be induced
to invest in the commercial long sterling coming daily to
their counters. The moment they take this line they post-
pone its conversion into immediate London credit and thus
perforce postpone the offer on the market of their sight
drafts which originate in this conversion. Thus while ordi-
narily London not only permits but practically encourages,
the immediate conversion, it has the power through raising
its discount rates to induce the postponement, and it has
26 We write of the system as it was at the time of the beginning
of the great war. The present tense is used on the theory that when
financial conditions become settled we shall find that the same sys-
tem is in good part enduring.
SPECIE SHIPMENTS 553
the power, through positively refusing to discount, to force
postponement. Therefore it has the power to switch off
from our market, for the time being, a large element of
the supply of sight sterling bills. Meanwhile the demand
for this same exchange to cover maturing sterling accept-
ances created under commercial credits issued by our
banks in the immediate past, and to cover maturing finance
bills, and to pay off travelers' checks, will continue for the
time being unabated. All this operates to raise the rate in
New York for sight sterling.
(2) We have already seen that if the London money
rates are enough under those of New York there is a motive
to draw and sell bankers' long sterling in New York (com-
pare Chapter XII). These so-called "finance bills" con-
vert into a supply of sight sterling. Sight sterling to the
amount of the proceeds of the discount of these bills in
London is regularly drawn and sold in New York. A suffi-
cient elevation of the London discount rates will put a
stop to the drawing of finance bills and thus cut off from
our market any element in the supply of sight sterling that
flows from them. So far as this influence goes, then, and
when it is operative, it tends to raise the rate for sight
sterling or to prevent its falling, this by restricting
supply.
Finance bills falling due in London are sometimes met
by the drawing and sale of new ones on this side. A rise
in the London discount rate tends to check such renewals,
and thus once again operates to raise or to sustain the sight
rate. AVhen a finance bill falls due and is not renewed
(replaced would be the more accurate word) the company
drawing it will have to go into the market on this side to
purchase sight bills for cover. But if the renewal lakes
place this purchase is either avoided or flic clement of
demand which it constitutes is offset by a new and equal
element of supply. If the elevation of discounts in London
FOREIGN EXCHANGE
prevents those renewals it has the effect of precipitating
these elements of demand in our exchange market and thus
works in the direction of a high rate for sight sterling.
In fact, if London has recallahle funds placed out in any
manner in the New York money market, high money rates
in London tend to produce the return of them to England,
and this return will engender an extra demand for sight
sterling as a means of transfer of the funds home.27
(3) If London money rates are high enough, more par-
ticularly if they are higher fhan our own, they tend to
produce the lending of funds in England hy American
hanking institutions. Any transfer of funds thither for
this purpose requires purchases of sight sterling (or its
equivalent) and thus an added element of demand for this
kind of exchange is brought into heing, which tends to
raise or sustain the rate.
In sum then, for London to elevate its discount rates
tends at the time to restrict the supply of and increase
the demand for sight sterling in our market. If the rate
for this kind of exchange is already high, standing let us
say at 4.87, this influence may be enough to draw it up over
the gold export point and produce a flow of the metal to
England. If the rate is low and falling towards the import
point, the influence may work to prevent it reaching this
point and thus save London from a gold outflow. If this
outflow would prove embarrassing at the moment, the
weapon might be used to prevent it.
It is not possible to lay down a very significant general
rule regarding the strength or potency of the remedy.
If the commercial and financial forces or tendencies resi-
dent in what we may call the natural situation are work-
ing in the direction of drawing gold from London, resist-
st If cables or long bills should be bought as a means of transfer,
the same effect upon the sight rates will be worked indirectly as if
sight bills themselves were asked for.
SPECIE SHIPMENTS 555
ance may be put up by the manipulation of the discount
rates of that city. The effectiveness of the resistance de-
pends on the strength of the natural pull and there is no
particular way open to us to define this quantitatively or
to measure it. It will be enough to say that the remedy
is really in practice a very potent one. That it has much
greater force when employed by England than by any
other country at present depends sinipty on the fact that
it is London alone which discounts long bills drawn upon
itself in vast quantities from all over the world and which
therefore has the power by checking this accommodation
to precipitate a demand for sight exchange upon itself
which may send gold hurrying to it. In short London
is in the position of a money lender with an immense
short-term loan fund placed in other countries, which is
in large part virtually though not literally out on call.
London is a short-term international creditor. It has been
for years the only exemplar of a city holding such a posi-
tion. Cities not holding a similar position cannot use
London's remedy for a gold drain with the same effect.
Take Berlin before the war. It could not precipitate an
immense demand for sight marks in other countries by
raising its discount rates. To save itself from embarrass-
ment it (or more particularly the Eeichsbank) made a prac-
tice of holding a good quantity of foreign bills, that is
bills maturing in and payable in money capitals foreign
to Germany. By realizing upon these in the cities where
they were payable and using the proceeds to buy mark
exchange, the price of sight exchange on Germany could
be favorably influenced on occasion. To the extent to
which the German bank held these foreign bills if was a
creditor at short term of other countries and could use
its position as such to defend itself from a gold drain.
But Berlin did not have technically quite the same weapon
hs London and its strength was small as compared with
556 FOREIGN EXCHANGE
London's. London does not operate by holding bills drawn
on ami payable in other money capitals.
The foregoing statement might prove misleading if we
should fail to couple with it the admission that other mone-
tary capitals than London can assuredly exert a certain
degree of influence upon the exchanges by the elevation of
their discount rates. The weapon is probably more effec-
tive, under their circumstances, for defensive than for of-
fensive purposes. They can use it to better advantage to
resist withdrawals of gold than to induce its inflow. When
any other city develops the business of discounting foreign-
drawn long bills to something like the colossal proportions
to which London has driven it, it will be able to use Lon-
don's remedy with something like London's results. The
following answers for the Reichsbank express the opinion
of leading German bankers.28
Q. What steps do you take to increase your gold reserve or to
protect it?
A. We always have a large amount of bills of exchange payable
in foreign countries, payable in gold.
Q. What amount of foreign bills did you have on December 31 ?
A. It was very small at the end of the year, but before it was
much greater.
Q. You must have taken some steps to add to your gold at that
time. What steps did you take?
A. We increased the rate of discount. We consider that this
measure is the only effective one.
Q. How high was the rate at that time?
A. Seven and one-half per cent.
Q. If this increase had not been sufficient, you would have
further increased the rate?
A. Yes.
§ 145. Manipulation of the price of gold. — It is on occa-
sion open to the central bank of a European country to
28 "Interviews," etc., pp. 356-7.
SPECIE SHIPMENTS 557
make use of that certain limited control it has over the
price of gold, to influence the national gold movement.
Except in a country on the limping gold-standard (for
example France), this is necessarily a less potent remedy
than manipulation of the discount rate, and as already
intimated, contrasts with the latter in that it affects
not the rates of exchange but rather the gold-points
in these rates. By the price of gold we mean of course
the quantity of the money of any given country that can
be procured in exchange for an ounce or other physical
unit of gold metal.29 "We have alreadj^ seen that, even in
a gold-standard country, this price may undergo slight
variations, owing principally to the effects of the two tech-
nical factors (1) the charge for converting bullion into
coin and (2) tolerance (whether for error in minting or
for abrasion in circulation).
Further explanations can be given most conveniently in
the form of a discussion of the management of the price of
gold by the Bank of England. It is not only a matter
of common knowledge that this institution does at times
change its buying as well as its selling price for gold, but
we have its semi-official statement to this effect in "Inter-
views," etc. (already cited) as follows:
Q. What are the provisions of law with reference to the pur-
chase of gold by the bank?
A. Under the act of 1844 all persons are entitled to demand
notes in exchange for bar gold at the rate of £3 17s. 9d. per ounce
standard, subject to such gold being melted and assayed at the
expense of the seller by persons approved by flic hank.
Q. What is the usual price paid by the bank for gold purchases?
A. (See answer to previous question.)
Q. Does the hank under some conditions advance its rate Eoi
gold purchases?
20 Such as the £3 17s. Od. for an ounce of ni:j,ns lin'" alwayB pro
curable at the Bank of Entrland as a minimum. Compare Chapter
XVI, and also § 131.
558 FOREIGN EXCHANGE
A. Yes.
Q. Under what circumstances and to what extent does the bank
charge a premium for gold bullion or foreign coin?
A. When there is a demand for either gold bullion or foreign
coin for export to another country the bank follows the same
rule as t he seller of any ordinary commodity.
The German Reiehsbank has also made it a practice. at
times to raise its buying price for foreign coin as an auxil-
iary measure to attract gold. The following is from "Inter-
views," page 357. A vice-president and a director of the
Reiehsbank are responsible for the answers given.
Q. Are there any other steps taken to increase the import [of
gold] ?
A. Well, besides granting loans without interest on gold im-
ports, we may raise . . . our tariff for the purchase of foreign
gold coins, as the Bank of England does.
Q. Pay a higher price?
A. Yes; but this is not important. The real remedy is to
raise the rate of discount, besides selling a certain amount of
foreign bills.30
The Bank of France has customarily placed a greater
reliance in raising the price of gold than any other central
bank. Section 146 will deal in particular with this subject.
Let us now suppose that the Bank of England wishes to
restrain an actual or an impending outflow of gold to New
York, by the method of raising its asking price for gold
bars or American or other foreign gold coin which it may
hold. Disregarding the defense it ma}r make by means of
its discount rate, we are to consider the nature and limita-
tions of this distinct and secondary remedy. In the first
place when England's gold standard is truly operative and
when banking conditions are normal, any one having a valid
check on or a deposit in a bank may procure therefor
so The foreign bills referred to are those payable and discountable
in foreign gold standard countries, in which the Reiehsbank made
it a policy to keep a revolving fund invested. Cf. p. 556 above.
SPECIE SHIPMENTS 559
British legal tender. For any sizable amount this will
have to be Bank of England Notes or British gold coin
(to which we must add since the war began, the National
Currency Notes which are redeemable in gold coin). The
Bank of England notes as well being redeemable in gold
coin, it is under normal conditions possible to convert
"money" in hand or in a bank into gold, at the rate of
one sovereign (the one pound coin) to the pound sterling
of "money" of any other kind.
In practice the maximum cost of gold obtained in this
manner will be something in the neighborhood of £3 18s.
0%d. per ounce % fine, and the mini mum cost will be
about £3. 17s. 10/£d. If the sovereigns procured averaged
the exact weight and fineness provided by law for a new
sovereign, the cost would 'necessarily be £3 17s. I01/£d. and
no more: this for reasons already explained (cf. page
496). But because of the tolerance by law, as a prac-
tical necessity, of small deficiencies in the gold contents of
sovereigns, whether caused by error in minting or by abra-
sion in circulation, it is possible that the coin actually ob-
tained may be on the average .2 or .3 of 1% short in weight,
so that the cost of the metal they contain would amount
to about £3 18s. 0%d. of currency.31 When any one de-
mands sovereigns from the Bank of England, that institu-
tion owes him the duty of paying in coin that retain its
legal tender power. It can readily discharge this duty by
delivering sovereigns on the average say % of 1% short
in weight. The person in question would probably not
fare enough better by collecting sovereigns from the gen-
31 A sovereign may weigh so little as 1 J ii . ."> grains gross and retain
its full legal tender power. This, compared with the statutory Eull
weight of 123.27 + grains gross, Bhows a shortage of more than
.6 of 1%. The British mint (acting on the rule followed bj all
mints) exchanges new sovereigns for bullion at a rate Bel on the
theory that the sovereigns are exactly of full weight, thus at tho
rate of £3 17s. 10^ d. per ounce ' > [^the line. Compare § 131.
560 FOKKKJN KX CHANGE
era] circulation to pay for the trouble, to say nothing of
the difficulty in getting together in this manner enough
gold for a shipment.
Gold bars may usually be had in the London market for
less than £3 18s. 0!kl., being in fact often procurable at
£3 17s. 9d., the Bank's minimum buying price, but the
fact that England is on the gold standard32 is of itself
not a guaranty that they can be obtained cheaper than
£3 18s. plus. Thus at times, when the market is not well
supplied with bars, the Bank may easily force the intend-
ing exporter of the metal to pay this higher figure.
The gold reserve held by the issue department of the
Bank of England to redeem its notes consists not only in
legal tender sovereigns but also in large quantities of bars
and foreign coin. If necessary, the latter could be taken
to the mint for conversion into sovereigns, but often an
exporter of gold who presents notes for redemption will
be glad to take bars or foreign coin, especially coin of
the country to which he proposes to make a shipment. This
gold is not legal tender money of England. Its delivery to
the person offering notes is not strictly speaking redemption
of these notes but is really a sale of a commodity for them.
Legally the price of this commodity is purely a matter of
bargain between the bank and this person, though of course
if the latter accepts the bank's figure and surrenders the
notes, these instruments may then be treated as redeemed
and may be cancelled. What we have been concerned to
show is that there is an economic rather than a legal upper
limit upon the bank's asking price. This is the £3 18s.
O^d. just mentioned. If the bank demands more than
this per ounce of bars 11/i2 fine, the note holder will imme-
diately exercise his option to demand legal tender sovereigns
by way of a genuine and technical redemption, and so
secure gold at about this cost.
32 Speaking as if the return to pre-war conditions were assured.
SPECIE SHIPMENTS 561
Assume that the rate for sterling exchange has fallen
in New York to the ordinary gold-import point, and that
London agents of American bankers are making inquiry at
the Bank of England. This institution may now, if it
chooses, exercise its right to demand better than the mint
price for the purpose of restraining or delaying the export,
and perhaps bars cannot be had in the market any cheaper
than from it. If the influences depressing sterling in New
York are strong enough, the rate may continue on down-
ward until the obstruction set up by the Bank is overcome.
For this obstruction consists merely in the establishment
at New York of a lower gold-import point than the ordi-
nary one. Should the rate of exchange actually descend
to this lower point shipments at a profit become as feasible
as ever. This is only to say that the higher the cost of
gold metal in London in exchange for British currency,
the lower must be the price (in U. S. money) at which
the shipper can buy a pound of sterling sight draft in
New York in order to engineer the transfer of gold at a
profit.
To illustrate, suppose a New York bank arranged for a
.shipment from London of bars with a content of 50,000
ounces of British standard gold. The bars may actually
be ''mint fine," that is perhaps .9995 fine. If so they will
not weigh 50,000 ounces but the pure gold in them will
be enough to make that weight of bullion n/i2 fine. Assum-
ing incidental costs at rates prevailing some time before
the war, the following account of the operation may be
made up.33
Price Paid in London
Per Ounce n/i2ths Fine
£3 17s. 9d. £3 18s. 0%d.
Cost of gold in London £194,275 £195,104%
(50,000 X the price)
33 For explanation of the principles of this computation sec § 139.
562 FOREIGN EXCHANGE
Price Paid in London
Per Ounce 11/i2ths Fine
Incidentals paid in London : £3 17s. 9d. £3 18s. OV&d.
Packing and cartage 10 10.
Freight (%'e of 1% of value) . 364 365.
Insurance (%o of 1% of value) 97 97.
Total Sterling Outlay £194,846 £195,576.
Proceeds in New York:
45,833% ounces fine gold sold
to Assay office @ $20.671834947,458.87 $947,458.87
Less charge for copper 34 41.40 41.40
Net worth on arrival in N. Y.. $947,417.47 $947,417.47
Present worth of same say 20
days prior, interest at say
4% 945,317.00 945,317.00
No-profit gold import point in
sight rate.
(1) 945,317-^194,846 4.8516
(2) 945,317-^195,576 4.8335
Summary :
N. Y. gold-import point at extreme low price of
gold in London 4.8515
Same, at extreme high price 4.8335
Difference 0180
Gold cannot always be procured in London at the legal
minimum price. Again ti±e buyer will not often have to
pay the maximum. But the foregoing reckoning shows
that a rise in the London quotations from extreme low to
extreme high will drive down the American gold-import
point almost 2^ per pound sterling.
Conditions may easily arise under which the Bank of
34 For method of computing compare § 130.
SPECIE SHIPMENTS 563
England would have the power through management of
the price of gold to depress our gold-import point by 1^
or more. As a remedy for a gold outflow such a measure
cannot be very far-reaching, since the influences which drive
the sight sterling rate in New York down to our higher
import-point might well continue to be operative until the
lower point is reached and gold actually pours in. But
the Bank of England always has the chance that these in-
fluences will exhaust or partly exhaust themselves mean-
while. There is a chance to postpone the gold flow and
even some chance to prevent it altogether. As the rate for
sight bills on London falls toward the lower point, 4.8315
(or 4.83, allowing 15 points for profit) the demand for
this form of exchange is likely to expand. This expansion
of demand, coming from various sources, might have suffi-
cient force to prevent the rate's actually reaching 4.83.
So much for management of the price of gold to restrict
or prevent the outflow of the metal from London. Similar
tactics may be employed to stimulate inflow. By raising
its buying price for bars or foreign coin the bank has the
power to lower the gold-export point at New York. If
sterling has approached the ordinary gold-export point on
our side but seems unable to rise quite to it, the Bank of
England may, if it desires especially to secure the metal,
contrive to bring the gold-point down to the rate of ex-
change. Compare the table of export-points presented on
page 530. The Bank of England appears never itself
to have offered better than £3 17s. I01/£d. per British stand-
ard ounce, at least prior to the war.35 But the price in
the open market has been known to go 2d. higher than
this.30
35 Cf. p. 504. This is the full mint price, and is l%d. above the
Bank's legal minimum buying price.
as The influences determining the upper and lower limits of the
price of gold in London were discussed in §§ 131 and 132, as well af.
in the present section.
564 FOREIGN EXCHANGE
§ 146. The gold-premium policy of the Bank of France. —
What has long been known as the "gold-premium policy
of the Bank of France" is but the policy of charging a
high price for gold, under a different name. There are,
however, certain special features in the practice of the
French central bank which call for discussion. These arise
out of the fact that France is on the limping gold-stand-
ard (compare § 124). Neither the United States which
also remains on this standard, nor Germany which
was on it until 1907, have made use of the special
opportunities which it affords for charging a premium
for gold. There have been times in New York since the
resumption of specie payments (1878) when gold was
for a brief period at a premium, but these have not
been cases where it was at a premium as compared with
silver coin or any other forms of money issued by or un-
der the authority of our government, but cases where
all kinds of money were equally at a premium com-
pared with bank credit. These were times of temporary
suspension of full and free cash payments by the banks
generally.
Under the law the Bank of France may redeem its notes
either in French gold coin, or in silver 5 franc pieces, which
also possess unlimited legal tender power. There is no
provision of French law requiring the redemption of the
latter in gold, whether at government offices or at the
Bank of France itself. It is, as we have already learned,
the combination of these two features in a monetary sys-
tem that gives rise to what has been dubbed the "limping
gold standard." When now some operator in possession
of notes of the Bank of France, the common currency of
larger denomination in the country, presents them to the
Bank with the purpose of procuring gold for export, this
institution may, if it chooses, exercise its lawful option to
redeem in 5 franc pieces of silver. If it does so, it simply
SPECIE SHIPMENTS 565
refuses to let the note-holder have French gold coin which
he might export with or without melting it into bars. So
far this is evidentty a Yery effective resistance to an export
which would take place at the expense of the gold reserve
of the Bank of France. But so far we have not encountered
a premium on gold.
Having been refused gold coin of France in redemption,
our note-holder may attempt to bargain with the bank with
a view to procuring gold bars or foreign coin in return
for notes, at some figure above the mint price. In other
words he may offer a premium for gold, and the Bank may
let him have it at a premium. If so it puts its gold-
premium policy into effect. From certain briefer expla-
nations of this matter to be found in various texts on money,
it is left open to a reader to infer that the Bank will pay
over French gold coin at a premium when encashing its
notes, and thus redeem these instruments at a discount
in one of the legal tender moneys of France. Such an
inference would be a mistake. The Bank avoids this tech-
nical offense. The gold which it offers to exchange at a
premium for notes, is always bar-gold or foreign coin, and
thus commodity gold. Any person or bank in any country
may ask what he or it please for the gold commodity.
Outright refusal to give up French gold coin in redemp-
tion of notes or payment of deposits, when the gold is
to be exported, in itself constitutes a very effective remedy
indeed against a gold drain. But the Bank has not liked
to let the matter rest at this point, because to do so would
put France definitively and clearly off the gold standard.
At least this is a fair inference as to its state of mind.
Therefore it offers the gold commodity at a premium. This
premium has been characteristically slight, say from .4
to .8 of 1%. It has served to restrain gold outflow while
hardly being equivalent to an abandonmenl of the gold
standard.
566 FOREIGN EXCHANGE
Ft is difficult to ascertain much respecting the extent to
which tlic Bank of France has made use of this measure.
There is a flotsam and jetsam of information on the subject
in the literature which touches on it, but little or nothing
official or authoritative. Professor Arnaune of L'Ecole des
Sciences Politiques, in his "La Monnaie, Le Credit et Le
Change" (Paris, 1909) gives a brief history of the policy
of the Bank in managing its discount rate and premium
on gold (pp. 490--494). He states that this premium stood
as high as .6 of 1% in December, 1899 (p. 492) and tells
us also that under the second empire the "premium on
the precious metals" reached an elevation of from 1.2 to
1.5% (p. 490). In a long and careful article on the sub-
ject written in 1901,37 Dr. R. Rosendorff states that the
Bank of France pursues its polic3r in a manner almost
capricious, letting different applicants have gold at differ-
ent premiums. To quote: "It is never easy to make out
the objective of the Bank's policy at any given time, and
the correspondents of German papers in Paris have often
been at a loss to report this policy correctly."33 After
stating that the premium varies from .4 to .8 of 1%, he
goes on, "Exact data concerning its height cannot be se-
cured, since the official rate of premium is never made
known. The items in the newspapers concerning it can lay
no claim to credibility."30 The following is an excerpt
given by Rosendorff from a letter from a French banker
made public in a report of the president of the German
Imperial Bank to the Reichstag (1899): "When it [the
Bank of France] pays in Napoleons [gold 20 franc pieces]
37 In Conrad's "Jahrbucher fur Xationalokonomie und Statistik,"
III Folge, 21 Band, pp. 632-GG3. This is an article directly against
the position of certain German publicists who recommended the
adoption of the French premium-policy in Germany.
wlbid., p. 634.
39 7 bid., p. 635.
SPECIE SHIPMENTS 567
it never demands a premium and could not lawfully do
so. In latter years it has given up Napoleons in impor-
tant sums only for the payment for cotton in Egypt. Here
again it has not demanded a premium. . . . The Bank sells
foreign gold moneys and gold bars for a premium over its
buying price, taking as a basis the price of fine gold at
London.40 . . . The Bank decides each day the sum to be
released, and apportions it pro rata among the bankers
according to their demands.41
The following from Hartley Withers' "Meaning of
Money" (page 87) is an example of an English statement
regarding the French system. "The Bank of France does
not attempt to do the business that we regard as [interna-
tional] banking, which includes readiness to meet all de-
mands in gold. Its notes are convertible, but convertible
at its option into either gold or silver, and it frequently
takes advantage of this option, when it considers it undesir-
able to part with its gold. So that one who has a credit
in Paris has a credit of no international value [sic], except
in so far as he can make use of it, by means of the ma-
chinery of exchange, to bujr a credit in London, which is
convertible [into gold] as a matter of course." Much
along the same line is the declaration in Swoboda's "Die
Arbitrage" (p. 423) that "the undependableness of the
bill on France has as a consequence that the Austria-Hun-
garian Bank does not regard bills on Paris as cover for
its notes although it does so regard those on London or
Berlin."
In "Interviews" etc., as already cited, page 216, we find
the question and answer set forth beneath. The interview
was in this case with M. Pallain, the governor of the Bank
of France in office at the time (1009).
40 This means presumably that the Bank alters its premium in ac-
cordance with the variations in the London price for gold,
4i P. 03511,
568 FOREIGN EXCHANGE
Q. Tn order to discourage the exportation of gold does the
Bank of France sometimes exercise the right it possesses to re-
fuse payment in gold and to offer to pay its notes in silver?
A. The Bank of France can not, of course, renounce its right
to redeem its notes in gold or in silver, since gold pieces and
silver coins of 5 francs are equally legal tender in France. But
it only uses this right with discretion and to the extent that it
appears necessary in order to prevent an unjustitiahle weakening
of its reserves. In no case, however, whatever may have been
said, have we ever charged any premium on French gold 42 in
redemption of notes.
This statement does little to clear up our uncertainty
regarding the extent to which the Bank of France follows
the plan of charging a premium on gold. Prior to
the Avar L'Eeononiists Francais published an item entitled
"premium on gold" in one of its weekly summary tables
in its partie financiere. According to these tables there
was but one period of three months during the years 1909
to 1913 inclusive, when there was any premium. These
were the months of November and December, 1912, and
January, 1913, and the maximum premium recorded was
one of .2 of 1%. But we have already been warned that
these published figures are purely nominal.
So far as one can tell, European bankers and publicists
are agreed that some measures of control of the foreign
gold movement are necessa^ to a central bank, that what
wre have here called artificial as distinguished from natural
remedies must be employed. The two chief defensive sys-
tems are recognized as being (1) the discount and (2) the
gold premium policies.43 The withholding of bar gold and
foreign gold coin from sale except at a relatively high price
42 I.e., French legal tender gold coin as distinguished from gold
bars and foreign gold coin.
<3 See § 147 for certain other minor plans of influencing the gold
movement.
SPECIE SHIPMENTS 5(30
by the Bank of England is but a limited application of
the gold premium policy. The Bank of England can go
only to a certain point in raising its asking prices for these
forms of the gold commodity. If it goes too far sovereigns
will be demanded for notes and it will lose the gold any-
way. But when the outside public would resort to the
similar alternative at the Bank of France the latter presents
them with the full legal tender silver coin, so that its con-
trol of gold withdrawals will remain unimpaired. The
one great advantage claimed for the gold-premium polic}'
is that through it the Bank of France manages to defend
its gold stock without making frequent or great changes
in its discount rate. There have been times when the Bank
of France has had to raise its discount rate in addition to
placing a premium on gold. The gold-premium policy
cannot be regarded in the light of history as all-sufficient.
On the other hand those who would treat it as a failure be-
cause forsooth the Bank of France has sometimes been
forced to raise its rate of discount are manifesting an
extraordinary prejudice. In point of fact the discount rate
of the Bank of France has exhibited a stability unrivaled
by that of any other central bank and has stood at an av-
erage below that of the German or the English central bank.
The exhaustive statistical studies of European bank rates
published by K. H. Inglis Palgrave in his "Bank Rate and
the Money Market" come down to the year 1900 inclusive.
A table on page 196 of this book shows that the total num-
ber of changes in the discount rate of the central banks
were as follows:
1881-1900 1844-1900
In England 129 400
In Germany 63 116
In Belgium 57 173
In Holland 45 173
In France 21 Ill
570 FOREKJN EXCII.WCE
Nut only have variations in the rate of the Bank of France
been less numerous but they have not been so wide as in
the ease of other central banks.44 The rate of the Bank
of France has maintained its lead with respect to stability
on a generally low level from 1900 to the present time.
It is not surprising that there have been German writers
who have wondered whether German industry and com-
merce could not secure benefits of the same character by
having the same system adopted.45
It is of course impossible to tell just how much more
variable the discount rate of the Bank of France would
have had to be if the gold-premium policy had never been
followed. It would hardly seem possible to estimate with
any precision what its results would be if transferred to
German}'. But it is safe to state that it would be unsuit-
able for employment in a country with the position which
England holds in international commerce and banking.
Its employment would in the first place tend rapidly to
undermine the very position which England has gained,
and secondly it would bej-ond a doubt prove totally inade-
quate to withstand such drains as England is subjected
to while in that position. Propositions of this character
are not susceptible of a rigid and unanswerable demonstra-
tion, but as a matter of judgment there can be little doubt
of these particular statements.
While the gold-premium policy is doubtless in large part
responsible for the stability of the discount rate in France,
and is to be credited with its share of this benefit, it is
not without its drawback. When put in force it operates
to raise the gold-export point thus permitting the rates of
exchange on other gold countries to ascend to greater
•t* See numerous tables in Chapters XIX and XX of Palgrave's
work.
*5 It was against the notions of these men that the article by
Rosendorff, previously cited, was directed.
SPECIE SHIPMENTS 571
heights than they would otherwise. Thus the higher the
price in francs of a check for an English pound or an
American dollar, the greater the cost in francs to the French
of articles imported from these countries. The premium
policy saves the French business world from certain fluctua-
tions in the discount rate, but whenever it is actually ef-
fective, that is, actually operative to restrain gold export,
it results in a greater depreciation in the purchasing power
of the franc over foreign moneys, and thus over foreign
commodities, than would otherwise be experienced. In
general a premium of Wfo, if effective in the sense just
explained, would presumably add ^ of 1% to the cost of
goods imported during the time of its sway. Though there
are French critics of the policy, probably it is well thought
of by the majority of publicists and financiers of the coun-
try. It would seem difficult to prove that the losses which
it involves are more important than the gains. It would
be unsuitable for England (waiving the fact that it would
be impossible under present English law) and it would
be unwise for the United States to adopt it — not that it
has ever been proposed in this country. Some critics have
made the point against the French system that while it
protects the gold reserve of the central bank, it often forces
exporters of the metal to gather it from the general circu-
lation (at a cost of course). Some seem to think that in
some fundamental manner this is very harmful. In the
judgment of the present writer there is little in this point.
§ 147. Further methods of influencing the gold movement.
— A measure which has on occasion been employed by
European central banks to expedite gold import is the mak-
ing of interest-free advances against the metal at the time
when it is shipped from another Country. This practice
has often been remarked by financial writers, but it is
most satisfactory to quote the evidence of its existence
from the semi-official statements made in the National Mone-
672 FOREIGN EXCHANGE
fcary Commissions Interviews etc., which has been men-
tioned a number of times before in these pages. At page
28 of this publication, the following occurs.
Q. [To representatives of the Bank of England.] It is cus-
tomary at such times [times of crisis] to advance money without
interest to importers of gold to cover the time required in trans-
portation .'
A. At such times facilities for bringing gold have been given
in the shape of free advances during transit, adequate security
having been lodged.
In the interview with the governor of the Bank of France
we find this (page 214).
Q. "What measures are taken by the Bank of France if it wishes
to increase its stock of gold or to stimulate the importation of
gold?
A. The importation of gold does not need to be stimulated in
France. It takes place naturally under the influence of the posi-
tion of a creditor which France always holds toward the principal
foreign markets. Certain intermediaries have sometimes asked
us to facilitate their operations of arbitrage in precious metals
by advancing money without interest for the time required in
transportation. We have done so several times by crediting the
importers from the day of shipment, but this operation, which
has its limits in its own conditions, can not be considered as a
premium for importation. Such premiums, we repeat, would be
useless, in consideration of the current importation which nor-
mally overabundantly supplies the French market.
In certain respects the foregoing seems a trifle disin-
genuous. The question below was directed to the repre-
sentatives of the German Eeichsbank (see page 357).
Q. Do you also loan money without interest to people who
are importing gold?
A. Yes, that is done. We make advances without interest to
importers for the time the gold is in transit; we do that even in
times when the ordinary gold import point is not reached.
SPECIE SHIPMENTS 573
If the exchange rates are close to the point of bringing
about an inflow of gold into one of these countries, it is
evident that an interest-free advance upon a consignment
of the metal might well superinduce the movement. Take
as an illustration a shipment from New York to Paris.
The effect of the advance is to give the shipper his full
proceeds in Paris on the day the gold leaves New York,
without interest cost. If the shipment is made by a New
York house, the latter might realize upon this special benefit
by selling cables on Paris on the day of export instead of
sight drafts, thus making the extra dollars that come from
selling this higher priced form of exchange. Without the
advance this would entail an overdraft in Paris. If on the
other hand the fund to be produced in Paris is designed for
employment there, the gain will take the shape of an extra
week's interest upon the same. If the shipment is engi-
neered in Paris and is made against a purchase of New
York exchange, the gain takes the form simply of a
week's earlier return of the francs laid out for that ex-
change.
The interest-free advance on gold shipments does not di-
rectly affect the rate of exchange but affects the point in the
rate at which gold will move. Another policy — which may
in brief be called "the foreign bill policy" — should be
mentioned in its proper order at this place. This is the
plan adopted by some central banks of carrying among
their assets a substantial volume of bills of exchange pay-
able in and discountable in a foreign gold-standard coun-
try, or in a number of such countries. So fast as these
bills mature the proceeds which they yield may be rein-
vested in similar paper, and thus a revolving fund may be
kept employed, though its quantity or value may naturally
be permitted to vary with circumstances. The interest
earnings of such a fund depend primarily upon the rates
of discount prevailing in the countries upon which the
574 FOREIGN EXCHANGE
bills carried in it are drawn, and if these earnings are
below those procurable in purchases of equally secure do-
mestic paper, the fund is carried at a greater or less sacri-
fice. Its advantage lies in its availability as an instru-
ment for regulating or "correcting" the exchanges. The
fund's adequacy as a weapon will vary with its size. Not
to go into historical or statistical detail, we may obtain
an illustration if (disregarding the war) we suppose the
German Reichsbank to be carrying £2,000,000 of bills on
England. The rates of exchange between Germany and
England are approaching the point where gold will be
sought in Germany for export to England. If the Reichs-
bank desires to avert this, it is possible it will be able to do
so by drawing on its reservoir of sterling bills, though this
depends on the strength of the underlying influences which
work towards making the exchanges "unfavorable" to
Germany. The modus operandi is simple. The bank dis-
counts in the course of several days enough of these bills
to yield it a credit of say £500,000 in London. Viewed
from the Berlin end, it is because sterling exchange is
getting too dear in Germany that gold export threatens.
The remedy may be applied in Berlin by selling sight
sterling there against the London credit which has just
been made available. If these sales are in sufficient volume
they prevent the exchange rate from reaching the gold-
export point. Viewed from the London end, the threat
to Germany's gold stock comes from exchange on Berlin
being too cheap. The Reichsbank can if it chooses operate
as well in London, by using some of the released sterling
credit to purchase bills on Berlin and sustain the rate, or
prevent its reaching England's gold-import point. Arbi-
trage being possible, the two methods are virtually equiva-
lent, but insomuch as Berlin deals in exchange on London
much more extensively than does London in exchange on
Berlin, it is more plausible to suppose the Reichsbank to
SPECIE SHIPMENTS 575
operate by selling extra sterling in Germany. By draw-
ing on its reserve of sterling bills it may merely retard
gold withdrawals or may avoid them altogether. Subse-
quently when exchange has righted itself, the bank may
begin buying long sterling again to replenish its store.
This in and of itself tends to produce gold export from
Germany but this result is avoidable if the underlying con-
ditions of the exchanges are favorable at the time when
the replenishment is accomplished.
In case it is the exchange rate between Germany and
France that threatens a gold flow from Berlin, the Reicks-
bank's drawing upon its reservoir of sterling bills will
still serve as a remedy. It might sell sterling in Paris.
This would give it surplus credits in that center and enable
it to better the exchanges between Paris and Berlin either
(1) by purchasing mark-exchange in Paris, or (2) by sell-
ing franc-exchange in Berlin. The Reichsbank could get
its results even by the method of selling sterling in Berlin.
This would lower the value of sterling in terms of marks,
and by reason of arbitrage would necessarily work in the
direction of lowering the value of francs in terms of marks
as well. It is to be supposed however that the Bank would
not leave much to arbitrage, since it would obtain the maxi-
mum for itself from selling out its sterling in that manner
which would forestall the arbitrage operations by reason
of virtually including them.46
Under the conditions prevailing before the great war,
the institution placing the greatest reliance in the foreign
bill policy was the Austro-Hungarian Bank.47
40 For instance, if following a sale of sterling in Berlin by the
Reichsbank there should be a buying of this sterling there by an
arbitrager and sale of it by him in Paris, the Reichsbank could better
sell sterling in Paris itself.
*? The Economic Journal (English) for 190!) contains an article by
Ludwig v. Misea on "the foreign exchange policy of the Austro-
Hungarian Bank." Vol. 19, pp. 201-11.
576 FOREIGN EXCHANGE
It remains to speak of what may be called mere moral
.suasion as a check upon gold export. What follows is
quoted from .Mr. Hartley Withers' "Money Changing"
beginning on page 37).
* • * the point [in the rate of exchange] at which it pays to
send gold to London [from Berlin] is theoretically 20 marks 48
pfennigs. But in November, 1912, London ought to have been
drawing gold freely from Austria and Russia also, but not a
shillingsworth arrived. The Statist of November 16 made the
following observations : —
"As a matter of course, the exchanges continue to be as un-
favorable to Germany, Austria-Hungary, and Russia as they have
been for a considerable time now. And equally as a matter of
course, gold is not withdrawn from the State banks and shipped
abroad. . . . All this shows what remarkable power the State
banks exercise each in its own country. And it shows, likewise,
how very inadequate is the treatment of financial subjects by
economists in general. If men always acted in accordance with
their pecuniary interests gold would be pouring out from Russia,
Germany, and Austria-Hungary at present. But the Govern-
ments of the three States have set their faces against such ex-
ports. The State banks in each case support the policy of the
Government, and the subjects are all afraid to incur the dis-
pleasure of the great Governments and powerful institutions.
What is still more to the point, foreign bankers and merchants
do not dare to take gold from any of the three States. They,
likewise, could make a profit if they knew how to get gold out of
the State banks. But either they are incapable of inventing any
method that would force the banks to give the metal, or they are
in too much dread of the Governments to incur their displeas-
ure."
Thus it appears that the theoretical doctrine, which lays it
down that the rates of exchange cannot move beyond the point
at which it pays better to ship gold than buy a draft, is only
borne out where there is a free market in gold, and a claim for
money carries with it an unquestionable right to immediate pay-
ment in gold.
SPECIE SHIPMENTS 577
In "Interviews," etc., as before cited, the question and
answer given below, appear on pages 413 and 414.
Q. [To the Dresdner Bank.] In times of trouble do the large
banks, like your own, the Deutsche Bank, and Diseonto, co-
operate with the Reichsbank in an endeavor to prevent the ex-
portation of gold?
A. Yes. Opinions are divided as to whether it is for the good
of our country to do so or not. Last year, for instance, many
people asked for gold. It was refused at first in some quarters;
later we shipped freely.
In the same publication there appears also the following
(at page 358), which is reproduced as a matter of interest:
Q. Do you take any steps to prevent exports of gold? We
have been told that it is the habit of the Reichsbank, in case of
large exports of gold from German}7, to suggest to other banks
that it is not agreeable to have the gold exported.
A. It has never been the ease and never will be the case that
such suggestion has been made by the Reichsbank to anybody.
If it happened during the last crisis that some of the banks re-
fused to export gold, that was done for wrongly understood
patriotic reasons. The Reichsbank is not in favor of such meas-
ures and it is very sure that such a thing will not happen again.
We consider this measure absolutely wrong. It was done in
spite of the Reichsbank. After it happened the Reichsbank
approached the other banks, expressing the wish that it should
not happen again.
It must be conceded there are times in practical life
when gold does not flow out of certain lands regarded as
gold-standard countries, even when its export would pay
as an exchange operation. We conclude that the theory
of the gold-points explain what happens, and why it hap-
pens when exchange operations are freely conducted on
a gold basis. Usually gold tlows from leading gold coun-
tries when the gold exporl points are reached. This obser-
vation holds especially of England and the United States.
CHAPTER XXI
THE THEORY OF EXCHANGE RATES
§ 148. Supply and demand and the rate. — By a "theory"
of a rate or value we mean in economics merely a general
explanation of the influences or factors which govern that
rate or value. The law of supply and demand will be found
to play some role in all theories of economic values or rates,
but commonly other elements as well are present, such as
principles of utility and of cost. In the case of exchange,
however, the explanation from supply and demand consti-
tutes the whole theory of rates, for an exchange rate is
merely a sum of money laid down to buy a claim to another
sum of money (payable it is true as a regular thing at an-
other time or in another place). The demand for exchange
does not come from any "subjective" value possessed by
that article explicable, for instance, in accordance with
the principles of marginal utility, and the supply of ex-
change is not checked or determined in any way either by
a subjective or an entrepreneur's cost of production. The
theory of the exchange rate based on supply and demand
is, however, not without its complexities.
The word supply is to be taken as meaning simply the
quantity of a thing offered for sale on the market. When
the thing is a material good, its supply is measured in
physical units, as, for instance, bushels of wheat. But
when the thing is, instead, a claim to money, as in the case
of investment bonds and ordinary negotiable instruments,
the quantity of supply is measured in terms of value, that
is to say, of "nominal" or "face" value. The nominal
value of any contractual claim for money is the quantity
578
THE THEORY OF EXCHANGE KATES 579
of money into which it is convertible at maturity accord-
ing to its terms. This nominal value is, of course, a dis-
tinct thing from its actual market price. A sixty-day
bill of exchange (which is physically, by the way, say
32 square inches of paper), may have a nominal value
of £1,000, and a market price of $4,830 in New York and
of £990 later on in London. It constitutes, however, a
supply of £1,000 of sixty-day exchange. In our discus-
sion we shall take the demayid for an article to signify the
desire to obtain it existing on the part of persons with the
means to purchase it.1
One form in which the principle of supply and demand
is sometimes stated is that, other things remaining the
same, the greater the supply of a thing offered upon the
market the lower its price (and vice versa), and the greater
the demand for a thing the higher its price (and vice
versa). But the relations existing between supply and
demand and price can be stated in a more definite formula,
giving us what is known as the principle of the "equilib-
rium of supply and demand." This principle is that the
market price of an article seeks the point which will make
the volume of the article supplied and the volume demanded
come to an equality. To illustrate, suppose the rate for
bankers' sight drafts in the New York market remained
about 4.85 during a day, and that in the day £1,000.000
of these drafts were offered for sale and accepted by pur-
chasers. If the price had been 4.86 instead of 4.85, with-
out there being any other changes in the underlying con-
ditions of exchange supply and demand than those caused
by this price change, we know perfectly well the volume
i And thus we do not use the term to designate the different,
though related thing, the quantity of the article which will be taken
o(T the market at a given price by the body of purchasers. The
latter is, however, the set definition of "demand" often giyen in
modern treatises on economics.
580 FOREIGN EXCHANGE
offi red on the market would have exceeded the volume de-
manded. Thus, with a rate of 4.86 perhaps £1,500,000
of drafts might be seeking sale while there might be bids
for only £750,000. For, other things remaining the same
. no other original cause of change entering in), a rise
in price calls out a greater volume of supply (and vice
versa), and a rise of price decreases the volume demanded
(and vice versa).- If market price chances to get
to a figure so high that it makes the volume of bills
seeking sale exceed the volume which is demanded at that
figure, the price tends to fall. On the other hand, if the
price happens to be at a point so low that it makes the
requests for bills exceed the offers, the price tends to rise.
But if the price is at the figure which just equalizes the
volume supplied and demanded, it has no tendency to move
one way or the other until a change in underlying condi-
tions takes place. Thus we consider the price which equal-
izes bids and offers to be in a state of "equilibrium" for
the time being. We also speak of it as just "clearing"
the market.
To illustrate our meaning further, suppose that at a
time when the market rate for bankers' demand drafts is
4.85, the volumes of drafts which would be supplied and
demanded at other rates (if these other rates should hap-
pen to be made), would be as indicated below:
Volume
Volume
Supplied
Price
Demanded
£1,300,000
4.86
£ 825,000
1,150,000
4.8550
900,000
1,000,000
4.85
1,000,000
900,000
4.8450
1,100,000
800,000
4.84
1,250,000
2 The volumes supplied and demanded are, speaking with precision,
rates of inflow and offtake in the market; that is, they are such and
such quantities per day, per week, or for some other unit of time.
THE THEORY OF EXCHANGE RATES 581
We are assuming that what actually happens on this given
day is that £1,000,000 of drafts change hands at a rate
of 4.85. There would never be a way of knowing what
the volume of offers or of inquiries would actually have
been on the same day, under the same underlying condi-
tions, if other market rates had prevailed. And so the
figures given are by very nature supposititious. But some
figures would necessarily hold good on a given day, and the
point is that the direction of their changes would be as
indicated in our table. That is, the higher the rate, the
greater the volume of offers would be, and the less the
volume of inquiries (and vice versa). The table of the
volume that would be supplied at each given rate or price
is called a "supply schedule," the table of the volume that
would be demanded, a "demand schedule." What these
schedules actually are at any time, is determined by what
we have designated the "underlying conditions" of supply
and demand, that is, primarily the conditions of interna-
tional trade in merchandise and securities and the condi-
tions of short term international borrowing and lending.
A change of underlying conditions will, of course, shift
the supply and demand schedules. Thus a given change
might shift the demand schedule from the position shown
above to another one, as indicated beneath:
Demand Schedule
Demand Schedule
Under First Set
Under Second Set
Price
of Conditions
of Conditions
4.86
£ 825,000
£1,000,000
4.8550
900,000
1,150,000
4.85
1,000,000
1,300,000
4.8450
1,100,000
1,500,000
4.84
1,250,000
1,750,000
The principle of supply and demand is the affirmation
that the supply and demand schedules being what they arc,
C>*2 FOREIGN EXCHANGE
the market price lends to reach that figure which will make
equal the volume supplied and the volume demanded, or
the volume of the offers and the bids. If, for instance,
the supply and demand schedules for bankers' sight sterling
were to-day those first given (see page 580), then the center
of oscillation of the market rate would be 4.85, or the
market rate would tend to rest at 4.85. For if it main-
tained itself at a higher figure, as at 4.86, the offers would,
as indicated in the tables, come in the course of the day
to exceed the requests by £475,000 of bills. There will
always be some sellers who would rather cut a price than
be unable to make a sale, and as long as the price is such
that there is bound to be a body of unsatisfied sellers, there
is an insistent tendency for that price to fall. At 4.84, on
the other hand, there would be an unsatisfied inquiry for
£450,000 of bills. So the price would be bid up from this
figure because some buyers will always be in a position
to pay more rather than go without the article sought.
But if the actual market price reaches the figure of 4.85,
namely the figure which will at the time make the volumes
supplied and demanded come to an equality, the price then
neither tends to be bid upward nor downward. At 4.85
the amounts supplied and demanded would both be £1,000,-
000, and the price would tend to rest here until a change
in underlying conditions alters the supply and demand
schedules. In point of fact, some change in underlying
conditions, or some change in the speculative forecast of
these conditions, is practically always at work making
alterations in these schedules. Consequently, the mar-
ket price for any given class of bills is generally on the
move. It is forever seeking and following the moving
point which will clear the market under shifting con-
ditions.
§ 149. The manner in which "supply and demand regu-
lates" a rate. — The explanation from supply and demand
THE THEORY OF EXCHANGE RATES 583
just given has the appearance of being circular. The gen-
eral law is that price depends on supply and demand, and
yet has it not been argued that the volume supplied and
demanded depends on price? There is, however, no real
circle in the reasoning. It is true, both the volume sup-
plied and the volume demanded depend on price, but they
depend only in part on price. What the volume supplied
will be at each single price in the schedule or in the
range of variation of price, depends wholly on the inde-
pendent underlying conditions of the supply. And the
volume demanded at any price within the entire range de-
pends wholly on the underlying conditions of demand.
Thus, although price changes affect the volume supplied
and demanded, what the volume is that they affect depends
wholly on underlying conditions. Under one set of condi-
tions, 4.87 might make the volume of the offers and of the
requests equal, and under another, 4.84 might accomplish
this result. Whether it is 4.87 or 4.84 is determined by
the underlying conditions of supply and demand together,
and by them alone. To summarize : when we say that
"supply and demand regulates" price, we mean that price
is governed by the underlying conditions of supply and
demand, and in the following manner: Price movements
react upon the volume of bids and offers, and price neces-
sarily seeks the point that will make these two equal, or
the point which will clear the market, but what this point
is depends wholly on the underlying conditions of supply
and demand.
§ 150. Interpretation of apparent contradictions. — It
would take more space than can be devoted to this subject
to consider and guard against all the possible misinterpre-
tations to which the explanation just given is open. It is
important, however, to consider one or two points in this
connection. Take such a market phenomenon as a rise in
an exchange rate accompanied by an increase of the volume
584 FOREIGN EXCHANGE
of drillings on the way up. Since sales and purchases
must always be in exactly equal quantities,8 we have here
an instance where there is an expansion of the volume
of exchange demanded at the very time when the rate for
exchange is rising. This seems to contradict the law that
iht' volume demanded falls off as the rate rises. It must
be kept in mind, however, that this law holds only when
no independent change takes place in the underlying con-
ditions, and it was stated with this proviso. Now in point
of fact every consequential movement of the exchange rate
is due to a change in underlying conditions. The striking
case of a sharp rise on expanded dealings is due to such
a change and is consistent with the law. A sudden and
great increase in the demand for exchange, in the sense
of the general desire or need for it, might be caused, for
example, by any events tending to increase our imports
of securities or merchandise. Our importers as a body
would come to need more exchange than before to settle
their indebtedness abroad. This increase of demand would
mean that the volume of bills which would be asked for
in the open market at each and every rate of exchange
would rise sharply. It would mean that a new and higher
point of equalization of bids and offers, or of clearance of
the market, would be established, and that the actual rise
of the rate is merely a case of following up its moving
"equilibrium" or equalization point under a change of
underlying conditions.
To illustrate, we may suppose a change takes place in
the underlying conditions of the demand but not of the
supply. Making use of the supply and demand schedules
already given as examples in § 148, we may construct the
following table :
a When the stock-market reporter speaks of ''heavy selling," he
gives us, curiously enough, a half-suggestion that sales may exceed
purchases.
THE THEOKY OF EXCHANGE RATES
585
Volume Supplied
Volume Demanded
Volume Demanded
Under Both
Price
Under the First
Under the Second
Sets of
or
Set of
Set of
Conditions
Rate
Conditions
Conditions
£1,300,000
4.86
£ 825,000
£1,000,000
1,150,000
48550
900,000
1,150,000
1,000,000
485
1,000,000
1,300,000
900,000
4.8450
1,100,000
1,500,000
800,000
4.84
1,250,000
1,750,000
Under the first set of conditions the market rate would
tend to settle at 4.85, at which point the volumes offered
and asked for would be equal, namely £1,000,000 per day,
and actual transfer would take place at the rate of £1,000,-
000 per day. A change in the conditions of demand inter-
venes and the second "demand schedule" replaces the first,
the original "supply schedule" being assumed, for sim-
plicity's sake, to remain unaltered. Putting the second
demand schedule together with the original supply sched-
ule, we see that the new equalization point in the rate for
exchange will be 4.8550. At this point offers and bids will
be equal, appearing in the amount of £1,150,000 per day.
"What will happen then under the conditions of this illus-
tration will be an ascent of the market rate from 4.85 to
4.8550, with an increase of dealings (an increase of "ac-
tivity") from the amount of £1,000,000 per day to that
of £1,150,000 per day. Under changed conditions the
volume demanded becomes greater at 4.8550 (namely
£1,150,000) than it was formerly at 4.85 (namely £1,000,-
000). Meanwhile it remains always true that the higher
the rate of exchange, under given conditions of the demand,
the less will be the volume demanded. Thus under the
second conditions of the demand, a rate of 4.86 would make
the volume demanded fall to £1,000,000 instead of £1,150,-
000, as it would be at the rate of 4.8550.
In the foregoing illustration we have supposed the /ate
686 FOREKJX EXCHANGE
of exchange to rise to an accompaniment of expanding
dealings, appearing to refute the "law of demand," but
in fact refuting a misconstruction of this law. On the
other hand, the rate may fall to an accompaniment of
contracting dealings. This shows the same kind of ap-
parent contradiction, for it seems to refute the principle
that the lower the rate goes the greater will be the volume
of exchange demanded. The explanation here is the same
in character as before. This movement will be due to a
change in underlying conditions, and is not incompatible
with a principle which states how the volume demanded
will behave when no change originates in the underlying
conditions themselves. If a rate rises on expanding deal-
ings, it is a sign that the underlying cause is an increase
in the demand, in the sense of the general need for ex-
change. If it rises with contracting dealings, the cause is
seme change in underlying conditions which restricts sup-
ply, such as a falling off of exports. The cause is one
which operates to reduce the amount of exchange which
would be offered on the market at any given price, and
which thus brings about a decline of the whole "supply
schedule.4 It should not be assumed that these explana-
tions take away the force of the principles of the equal-
ization of bids and offers. It remains true under station-
ary, slowly changing, or rapidly changing conditions, that
too high a price will make offers exceed inquiries (and
vice versa) and price actually seeks to reach the point
which will lead to an excess neither one way nor the other.
Speculation generally has the effect of bringing the force
4 When the rate of exchange rises or falls in the market, dealings
may (1) expand or (2) contractor (3) remain the same. Curiously
enough, no matter whether the volume of transactions behaves in
the first or second or third way, the "law of supply" or the "law
of demand," or both, appear to be refuted! That is, a misconstruc-
tion of them is always refuted by any actual movement of price.
THE THEORY OF EXCHANGE RATES 587
of anticipated changes in underlying conditions to bear
upon the market before they actually transpire. In all
cases of this character the change in rates receives its
ultimate explanation in the change of conditions. It is,
however, not to be denied that speculative anticipations
are often mistaken. With regard to rate changes caused
by mistaken speculation, it would seem that one can go
no further than to make the not altogether illuminating
affirmation that they are caused by mistaken speculation.
However, this much may be added: when the rate is driven
in a given direction by a supply of or demand for bills
coming from mistaken or excessive speculative operations,
the discovery of the mistake or excess when the conditions
of the future actually materialize, will lead to operations
which tend to correct the aberration of the rate first oc-
casioned by the misguided speculation. We see these
things in the liquidation of misguided "longs" and the
covering of misguided "shorts." Sometimes the volume
of the demand in a market increases as price rises, be-
cause as the thing proceeds the imitative speculators pres-
ent detect, or think they detect, the evidence of "good
buying" by big men and leaders. If the leaders are, in
fact, buying because of correct anticipation of future con-
ditions which will work for higher prices, we have in this
instance merely an early concentration of the effects of
these conditions.
We may regard the doctrine that price seeks the figure
which will equalize bids and offers as the scientific ex-
planation of the behavior of price, but it does not follow
that knowledge of this principle is what is needed for
shrewd dealing in foreign exchange. Quite the contrary.
Ability to forecast coming changes in underlying condi-
tions is the great requisite. For example, in the fall of the
year 1912, an exchange banker must have been deeply
concerned with the chances of a general European war
588 FOREIGN EXCHANGE
arising out of the crisis in the Balkan states, and in
the probable effects of such war upon the securities and
merchandise traffic of the United States, and through
these upon the exchange market. A certain New York
newspaper argued at the time for instance, that a war of
this character would not be likely to cause Europeans to
dump American securities upon the New York market,
because Europeans would recognize that our securities are
especially safe, owing to the freedom of this country from
entanglement in the war. Another paper made the reply
that on the contrary we should have to expect dumping
in great volume, just because Europeans could get cash
out of our securities. This is an example of a question
concerning the future course of underlying conditions. A
great discharge of foreign-held securities into the New
York market would raise up a strong demand for ex-
change to pay for them, and thus would tend powerfully
to elevate exchange rates. All the time while any great
influence such as this may be working out its effect, the
exchange rate, for each class of bills, would be keeping
to the figure which would clear the market, but it is not
this principle that is so important to the practical dealer.
What he needs to know is the time when the influence of
new conditions will hit the market, and the direction,
duration and strength of the influence.
§ 151. The sources of exchange supply and demand. — The
total supply of and inquiry for exchange comes from
numerous and varied sources, a conspectus of which is
shown in the tables on pages 589-591 inclusive.
The ordinary transactions that give rise to exchange sup-
ply and demand fall readily into two main groups, that is,
(1) commercial and (2) banking transactions. In nam-
ing the first, we use the word "commercial in its broader
sense covering trade, traffic, and travel in general, and
not merely the export and import of merchandise. The
THE THEORY OF EXCHANGE RATES
5S9
O
o>
fc
u
<
cd
o
y,
W
od
a
K
O
l=i
«H
o
n
'A
-t
o
M
b/rj
Q
.^
73 r£ S* tO t-<
II
cd -=
»H fl
ft <x
03 ns
d C
.*P d
cd
-E d »H fl
id J) B (H
-h ~ o
c ^X
>> O vr.fC
o
be "7
.9 S
03 «-
>» p
X ^
-73 n3
d d
eg Cd
x> n3 03
^ a 9
•w o Si
.2 *
a S 2
ft O rG
-S °
*» o *
'fe S
S » ^
o ^ o
=S .£ ©
g ^3 In
1
0)
■r.
3D
o
>
-
3
03
a
X>
fH
03
S
in
<X
>
o
2
—
>>
,0
>j
od
ft
od
cd
ft
'53
o
-t-j
o
(H
O
-*->
+a
d
t3
0
-d
o
X
(X
T3
T) 1
r/3
0)
M
u
a
x
X
a
H
fl
O)
s
03
d
03
X
p
a
u
d
v{
7-.
~
a
t.j
o
x
+3
W
c^
CO be
d
d 9
X o
>s B
o
03 —
o p
cd «h
o
d tn
* 9, 85
8S _=3
=4H 2
be &
s s
o 2
o d
o
d o
g ^
ft^
^3 t3
5tt
O
be
d
"3 -2 ^
oj "^3
2 t«
d -m
Od
d «
w -2 a; A d cj
O c+h h bX) § ~
y sh
'3
—
c3 -O
d
be <rf
9J
3
« rn
M
Q
d
o
if
X
te
^
o
cu
«M
,d
cd G
be 2
<^ d
03 (X 03 O)
a
o
r 1
O
H
S
r*i
O
H
'/3
/
r-—
Q
5
O
o
O
-
C3
«
M
pq
:-
X
d
H
Ui
^J
'_
3
o
X
H
O
o
<x
>-<
*
w
od
a
3
OS
3
3
H
r-
?!
>5
H w
^
H
cs
C/J
o
^
QQ
W
Q
«
5
W
o
H
n
O
&
o
w
w
Q
5|
5?
".
W
o
r/3
Cm
H
3 S
/5
a ^
>
B co
TOO
FOREIGN i:\CMANGE
h
« f
o
O
* p
<! O
Q -5
-'
i
ai
in
r
U
(V
a
P
o
-^
o
M
o
&
CD
a
ca
3
o
w
m
P
W
A
a>
■•"■
-M
• -
>J
to
a
-P
fl
;-£=
nd
r-t
— <
pE]
P
~
CO l>
p, O
a) "P
P
n
CO
^ -2
p a
° <»
CL, to
O g
■** o
12 "VI
2 -p «« rr
5P CO
,0 cj
P
ft So
P
P
II
o ~
Q
.3 3
5 w
.2 JD
>»
Td
."P, W
-■ p p
,„ JD es -m co
P ?H -i-h -4-3 CO
a; cij ja c<_( ^
> & c i! ^
ca O S " .
S ° S J ~
°£ ft^ |
m ^H o o> _2
be
p
1
P
o
en-
S ■
w
f-i
CD
rt
O
Fh
fc
«<
o
C3
CM
W
P
CM
o
O
o
H
+3
W
ca
P
0)
CO
ca
o
=H
"3
(H
O
P
M
A
Pm
p
Ph
o
>-,
tut)
-Q
03
.2
'53
P
crt
•fi
m3
P
X p
a> o
rp
P P
ca --1
ai --; ,3
C3
-P
a>
o
w
CD
co
K
a>
P
#bp
'3
-~
o
CM
O
H
CD
>
o
u
s
a
u
'I
o
h
^
T3
O
•.
£
-
CO
a>
CO
P
03
ft
co
T.
P =M CD O
2 M u
5f> tc
^ -p £
£ °
o ft »
-^
"o
H
o
A
p
-M
P
V
H
a
l>
P
o
u
%
o
co
o
_P
0)
ft
3
'P
p
aj
a>
-
P
bC
u
5h ^ «
o -p ,rt
CM ^ S3
C co S3
i2 ^ p
« c^ a
0
o
p^
^
H
u
T
H
T3
!<
q
o
■*i
01
r^
o
, |
^3
PS
93
es
pq
:-
0)
i=i
ce
3
<<
a>
O
!zi
H
o
o
M
0)
fc
K
T3
n
as
^<
M
H
H
l
w
rt
.-
^
D
•^
3 P
5
THE THEORY OF EXCHANGE RATES
591
W a
S-J
m o
9 •*>
Z d
be
P -2
>> ^
ft
oj
FH
o
oj
d
o
-•3
O
■a
bo
0
o
R
—
Tr.
pa
0
CD
r3
>.
3
03
•rf
09
*Q
<H 5 tH
1
i
■tt
X*
o
o3
3
«
ft
.9
CD
d
a
3
CO
o
eH
o3
-4-J
o
«H
-4-3
o
T3
5
o3
fi
o
A
03
ft
CD
_d
ts bought as
ge operation.
03
"So
b£
n
2
"S
m
cu
co
03
d
o
cd
H
d
ft
co
d
CO T3
q_| 03
3h
o
sh
Q
Q
Q
«
d
T3
o
t3
Sh
0
4-3
!-H
K
,fi
aj
c3
p*
a)
ft
cu
r>
TS
+■>
,d
tt.
C3
d
a
3
,a
s
m
OJ
-u
p*
CI
Li
0
bQ
pQ 03
03 CO
""d F-|
OJ O
£ «H
O
H n3
?H m
o u
Xl CD
£ o
oj
d _£
O cj_i
3 2
5 ^ rH
^ g S
oj o
d d
03 CO 03
OS
09
en
G .0
o a
■a o o3 +a
d
03
-t-i
a]
O
CM
O
o
ft
-4^>
X
-t-i
fH
OJ
?H
o3
03
ft
CO
03
a |
2
be
^ -
0J 03
CO
03 o
03 "S
co r^
d
CO .d
M
"o3
f-i o3
t, 0)
bD
=H OJ
oj d
03
OJ
H O
CO
^ 03
U
o
° "75
=4-1
co ."d
CO o
co
'*— ' OJ
=4—1 ?:
eH
2 ^
03
p
Q
Q
be
d
T3
o
ca
u
8S
O
03
-»-"
X
ca
T3
09
d
OJ
03
r-
hn
+J
03
d
QJ
ca
2
=H
d
^ fe
g o
2 3
2 r
-
fc
Eh
fc
h
c
w
"J
u^
g
M
CO
-<i
V)
1
y,
o
H
H
P-.
c
fi
h
H
Ph
Hn
0
o5
w
CO*
CO
<
u
CO
<
o
H
tt
CJ
s
u^
Ph
a
k
iv
M
H
•-
c
H
<
H
z'.
H
592 FOREIGN EXCHANGE
distinction between the commercial and banking sources
gains force from the fact that the operations of commerce
are in a very true sense the fundamental governing in-
fluences in the exchange market, while the banking op-
erations are secondary or derived.
§ 152. How national credits and debits affect the market.
— A national credit may be defined as a right possessed
by a resident (or by the government) of a given country
to receive money from abroad. The right may be to re-
ceive a designated quantity of home money as is the case
where an American sells merchandise or securities abroad
for a p»ice stated in dollars ; or it may be a right to re-
ceive a specified sum of foreign money, as when any such
merchandise is sold for a price stated in sterling. In the
latter case the holder of the right to foreign money usually
converts it into home money simply by selling foreign
exchange at the existing rate in the home market. A
national debit is an obligation imposed upon a resident
(or the government) of a given country to pay money
abroad, whether, of course, a specified amount of foreign
or of home money. It should be noted a "national" credit
or debit does not here signify merely a governmental or
state right or obligation.
The great body of national credits and debits of a given
country are produced by the commercial and banking
transactions of private houses and firms. It is the simplest
matter imaginable to tell whether a given transaction
brings into being a national credit or a national debit,
for we can always tell whether because of this transaction
one of our residents stands to receive or stands to pay
money. In fact, calling a right to receive money a na-
tional credit adds nothing to our information regarding
the tendencies of a given commercial or banking trans-
action, but merely gives us a convenient name for this right.
There is a definite rule or law of the effect of national
THE THEORY OF EXCHANGE RATES 593
credits and debits upon the foreign exchange market. A
national credit always works out its effect on the foreign
exchanges in one of the three following ways:
(1) It increases the supply of foreign exchange for
sale in the home market (without exerting a direct
influence upon the supply of or demand for bills in
the exchange market of the other country).
(2) Or it exerts no direct effect upon the home market
but instead increases the demand for bills in the
market of the foreign country, acting in the capacity
of a national debit there (the national credit of one
country being, of course, always the national debit
of some other).
(3) Or a national credit may act both to increase the
supply of foreign exchange in the home market
and to increase the demand for foreign exchange
in the other country's market. (A national credit
has both these effects whenever settlement is ar-
ranged for under a commercial letter of credit au-
thorizing drafts on a third country; or whenever the
exporter draws on the importer for money of a third
country.) (Compare §§39 and 71.)
It appears then that an increase of the supply of foreign
exchange in the home market, and an increase of the de-
mand for foreign exchange in the market of the other
country, are in some regards equivalents. Either may be
the product of a like or common cause. In point of fact
also, both are alike fundamentally in the further effects
which they themselves produce or tend to produce upon
the gold movements and discount rates. Thus an increase
of the supply of sterling exchange in New York tends
to drive down the rate for sterling toward the gold-import
point and to produce a gold import into New York from
594 FOREIGN EXCHANGE
London, and an increase of the demand for New York
exchange in London lends to drive np the rate for this
exchange there toward the London gold-export point, and
to produce a gold export from London to New York. And
these two gold movements are, of course, the same.
In a similar manner a national debit always works out
its effect upon the foreign exchanges in one of three ways :
(1) It may increase the demand for foreign exchange
in the home market (without directly influencing
the supply of or demand for bills in the market
of the other country).
(2) Or it may increase the supply of bills in the mar-
ket of the other country (without directly affecting
the home market for foreign exchange).
(3) Or a national debit may act both to increase the de-
mand for foreign exchange in the home market
and to increase the supply of foreign exchange in
the foreign market. (This is the converse of case 3
under national credits.)
In sum : If a national credit directly affects the home mar-
ket for foreign exchange in any way, it serves always as
a source of supply of exchange, and its existence tends to
lower exchange rates and works in the direction of oc-
casioning gold inflow. If a national debit directly affects
the home market for foreign exchange in any way, it serves
always as a source of exchange demand, and its existence,
therefore, tends to raise exchange rates and works hi the
direction of producing a gold outflow.
When we explain that an operation of commerce be-
tween two cities may be so settled that in one of the two
there will be no effect produced upon exchange supply
and demand, we must be careful to state only that there will
be no "direct" effect. This implies, of course, that there
THE THEORY OF EXCHANGE RATES 595
may be an indirect effect on the exchanges in the city
where there is no direct effect. If New York exports
goods to Paris and if settlement is accomplished by New
York's drawing exchange on Paris, it is true that while
this operation works no direct effect upon the Parisian
foreign exchange market, it does tend to produce an in-
direct effect in that market, especially upon the Parisian
rates of exchange on New York. For the New York oper-
ation takes part in producing a general exchange situation
which, through arbitrage tends to react upon the exchange
market of Paris itself. That is to say, in the interest of
accuracy we must restrict certain preceding assertions to
the ''direct" effects of the given commercial operation upon
the given exchange market.
Returning now to the table giving the classification of
sources of exchange supply and demand, we find the first
source listed is "commerce in merchandise." This has
reference to the commerce in merchandise of any given
country. The second column of the table indicates that the
country's exports of goods create a supply of drafts in its
own exchange market. This is true, provided the export is
settled for in any way that has a direct effect upon the
home market for exchange. If settled in some other way,
this same export will, acting as the other country's im-
port, create a demand for exchange in that other country.
Such a demand for exchange is what is indicated in the
third column of the table by the item "drafts needed to
pay for imports of merchandise." Similarly the given
country's imports either directly affect its own exchange
market and produce a demand for bills, or they act as the
exports of the other country and produce a supply of ex-
change in it, serving as its national credit.
Special features of the securities traffic. — The initial
effect of an export of securities is precisely the same as
that of an export of merchandise, namely, to produce a
596 FOREIGN EXCHANGE
national credit. But most bonds and stocks that attain
the dignity of international purchase and sale, pay inter-
est and dividends. Thus while the sale of our securities
abroad creates a national credit in the first instance, the
interest charges due the foreign holder produce a stream
of lesser national debits. Supposing these national
credits and debits to be settled for by sales or purchases
of exchange in our own market, as is the dominant prac-
tice in fact, instead of by the buying and selling of ex-
change abroad, the sale of a security to a foreigner pro-
duces a supply of exchange, while the necessity of paying
him interest produces thereafter an intermittent and in
general regularly recurring lesser demand for exchange.
' The repurchase, or the discharge of foreign-held securities
at maturity, occasions of course a large single item of de-
mand for exchange, but has the further effect of terminat-
ing the intermittent demand for bills to pay interest
charges, j
§ 153. The several spreads in the group of rates on a
given country. — As we pursue the theory of exchange
rates from this point forward we run into matter of in-
creasing technicality and difficulty. It will not be the at-
tempt of this book to carry investigation or analysis to
the farthermost regions which the purely scientific spirit
might seek to explore. And what remains to be stated
will have to be laid down, at least in places, in a manner
somewhat arbitrary and without a full showing of reasons.
The following are actual quotations for bankers' draw-
ings on an ordinary day some time before the abnormali-
ties of the war injected themselves into the exchanges.
Sterling
Cables 4.8765
Demand 4.8715
Sixty Days 4.83
Ninety Days 4.8160
THE THEORY OF EXCHANGE RATES 597
The group of rates in one given country (e.g. the United
States) on some other given country (e.g. England) rise
and fall together in a general way — acting to a degree
like a constellation — but the gaps or spacings between the
members of the group are not in truth unchangeable. It
is our next problem to make a summary of the causes or
influences which govern these spacings or "spreads."
There are three primary or true spreads existing be-
tween the rates given in the last preceding table. These
are (1) the spread between the cable and the sight rate, (2)
that between the sixty-days' rate and the sight rate, and
(3) that between the ninety-days' rate and the sight rate.
All other spaces or gaps such as that between the ninety-
days' and the cable rates, or between the ninety and the
sixty-days' rates, are what we may call secondary or false
spreads. To explain this discrimination, certain factors
govern more or less rigidly the relative positions of the
rates in any one national group, such as the sterling group.
Now, taking the process of rate-making as it actually goes
on in the real market, these factors govern or determine
only those spreads which we have just designated as
primary or true. It is true the fixing of these spreads de-
termines the configuration of the whole group. The point
is that the group configuration is determined by the fix-
ation of these particular spreads and no others, and that
the other gaps or false spreads become what they are sec-
ondarily and merely in consequence of this fixation.
Every primary spread is one between the sight rate on
the one hand and some other rate on the other hand. Each
of the other rates of a group is tied directly (whether in a
loose or tight relation) to the sight rate, and there are no
other tics. The bids and offers of other rates are com-
puted from the sight rate as a basis, but the sight rate
itself is not computed from any oilier r;itc but is deter-
mined independently in the market by the conditions of
598 FOREIGN EXCHANGE
supply and demand. As will be shown later, a supply of
or demand for telegraphic transfers or long exchange con-
verts sooner or later in regular course into a supply of
or demand for sight exchange, and thus the sight rate be-
comes what might be called the focal rate of exchange as
well as the common basis of reference for the other rates.
The notion that the telegraphic transfer rate is in some
sense the fundamental or pure rate of exchange has a
certain plausibility. Without attempting to analyze this
notion exactly, we perceive that it carries the suggestion
that other rates of exchange, including the sight rate, hang
or depend from the telegraphic transfer rate, each being
lower by an amount governed by discount or interest.
Taking actual determinations or adjustments of rates as
they take place in the real market, this suggestion is in-
correct and will always remain incorrect. Sight bills are
never discounted in any real sense. They are not in fact
bought and sold under a quoted discount rate and never
will be. Again, the rates for long bills are not computed
from the telegraphic transfer rate and it seems safe to say
they never will be.5 The truth of the matter is the long
rates are (times of financial turmoil apart) rather pre-
cisely determined in reference to the sight rate, while the
cable rate is to one side being related more loosely to the
sight rate, and being related to the others only through
the sight rate. The claim of the sight rate to be basic in
the group is further substantiated by the fact that it is
the only rate in which both gold-export and gold-import
points can be located. There can be a gold-import point
in the rate for telegraphic transfers, but there can be no
gold-export point in it. Telegraphic transfers on London
cannot be sold in New York to-day against a gold export
5 Except possibly in an undiscriminating manner in cases where,
owing to a short distance between the two countries concerned, the
sight and telegraphic transfer rate are nearly the same.
THE THEORY OF EXCHANGE RATES 590
of to-day,G and it is not the cable rate of to-day, but the
sight rate which determines the feasibility of the shipment.
Thus when we say that the exchange rate is usually con-
fined between the gold points, it is the sight rate of which
we speak.
§ 154. The spreads for the long rates. — On earlier pages
we have considered the methods of computing the buying
rates for long bills and have also discussed the factors
governing investment in these instruments. It remains to
bring these matters together and summarize them. The
spread between the sight and a given long sterling rate
depends upon the contemporary discount rate as major
factor and upon stamp tax, commission, and profit, as
minor factors. In an ordinary case perhaps 94 o of the
spread will be due to discount. The question arises,
which discount rate is it that governs, that in the drawing
city (e.g. New York) or that in the domicile city (e.g. Lon-
don). The answer may be formulated in the following
rule. When the discount rate in the domicile city is the
lower of the two, it alone governs that part of the spread
due to discount. When the discount rate in the drawing
city is the lower, it may affect, though it will not fully
govern the spread. Stating this in a slightly different
form, the spread can never be greater than the figure
proportionate to the discount rate in the domicile city
but it may be less than this when the discount rate in the
drawing city is lower, though it will not become much
less.
Continuing with illustrations drawn from the New York
market for sterling exchange, if the London money rate
(applicable to the type of long sterling in question) is
3% and the New York rate is higher, the London rate will
govern exclusively, whether the New York rate is 4, 5,
o The case of gold export with an interest-free advance on the
other side is an exception to this statement.
600 FOREIGN EXCHANGE
or 6%, and it makes positively no difference which of
these is the New York rate. When the rate for sight
sterling is 4.85 and the London discount rate for a certain
class of merchants' ninety days' bills is 3%, the buying
rate for these bills would be 4.8070 to yield the purchasing
banker a profit of nearly Vnf; per pound.7 The full spread
is then 4.30^. Money rates in New York being higher
than in London, the best use the banker can make of these
bills is immediate discount on arrival in London. In this
use they are worth 4.8070 per pound and would be worth
no less whatever be the height to which New York money
rates ascend. Nothing is changed so long as demand ster-
ling can be sold at 4.85 and London will discount (for
arrival) at 3%.
Let us suppose that the money rate in New York be-
comes the lower. To obtain a strong case suppose that no
more than 2% can be had in our market for short-term
employment of money in ways equally good with invest-
ment in sterling bills of the kind we are considering. As-
sume further that the London discount rate for these bills
is now 4%. Under these conditions it is quite possible
that the spread will no longer follow the London discount
rate. On the other hand, however, it is very unlikely it
will be governed rigidly by the New York money rate of
2%. To explain: if the spread continued to be propor-
tionate to the London money rate, our bankers would be
able to make about 4% by investing in long sterling, pro-
vided the rate for sight sterling should remain as high at
the termination as at the beginning of the investment.8
Therefore if the indications for the course of sight sterling
seem favorable it is probable the banks will compete for
these sterling bills. If they yield 4% while corresponding
domestic investments give but 2%, bidding is likely to be
7 Compare the computation on p. 266.
s Compare §§ 80 and 81.
THE THEORY OF EXCHANGE RATES 601
sufficiently spirited to drive the rate for them up at least
a little distance, and so decrease the spread. It is safe
to say this rise will never go so far as to make the spread
correspond to the 2% money rate of New York, and in
fact it is improbable it will go more than a small propor-
tion of this distance. The reason is the risk of exchange.
Thus we say that when the money rate is lower in the
drawing than in the domicile city, it affects but does not
fully govern the spread.9
§ 155. The telegraphic transfer spread. — The rate for
telegraphic transfers moves at a variable distance above
the sight rate owing to the fact that the order by wire
results in an earlier payment of funds abroad than does
the demand draft. The cost of the telegram does not en-
ter into the cable rate proper. Thus the cable spread is
a phenomenon of discount or interest. It cannot, how-
ever, be explained in quite the same manner as the other
spreads, though the latter are also based primarily upon
discount, and it does not in practice follow the dictates of
any one distinguishable money rate with anything like
the fidelity with which the other spreads obey the money
rates that control them.
Prior to the present war, the greatest and the smallest
cable spreads in the rates for sterling recorded in New
o The rule formulated in this section was stated by the eminent
Dutch economist, N. G. Pierson, in his "Principles of Economies''
(translation), London, 1902, pp. 527-9 of vol. 1.
At times when the money rates are lower in the drawing city
(e.g. New York) it is possible there will be few or no finance bills
being offered, but long bills drawn by merchants on foreign bankers
and merchants will continue to come forth in the usual volume.
It is to be kept in mind that up to the time of the outbreak of the
war, it was as a matter of fact a rare occasion for money rates to be
lower in New York than in London, and thus as far as experience
goes, the spreads for long sterling in New York have been governed
by the London discount rate. For a time during the panic of 1907,
it must be said, they seemed to be governed by nothing in particular.
602 FOREIGN EXCHANGE
York, at least within the last decade of the period, were
experienced at the time of the panic of 1907 and in the
weeks of financial stagnation immediately following. It is
doubtful if we can tell from newspaper reports precisely
what the extreme spread was on days of great fluctuations.
Some reports quote only one sight rate and one cable rate
for each day, but the better ones give the highest and
lowest, or perhaps the opening and closing rates. Each
of the monthly issues of the Bank and Quotation Supple-
ment of the Commercial and Financial Chronicle (New
York) has a table showing the high and low rates for the
chief classes of sterling exchange for each business day
of the preceding month. The following data are from the
Chronicle's table for November, 1917 : 10
Nov. 7. Sight, 4.86 -4.86*4 Cables, 4.89^4-4.90.
Nov. 13. Sight, 4.86i/4-i.86y2. Cables, 4.90 -4.90y4.
Nov. 16. Sight, 4.87%-4.88. Cables, 4.903/4-4.9iy2.
Examination of the reports of such papers as the New
York Times or the Wall Street Journal shows they are
likely to differ from the Chronicle and from each other
with respect to the exact figures which have been quoted
on a given day, especially if the market has been change-
able. Taking, howrever, the figures copied above from the
Chronicle, and assuming that the highest recorded cable
rate was made at the same time of day as the highest sight
rate, we discover the following spreads :
Nov. 7. Sight, 4.86%. Cables, 4.90. Spread .0375, or 3^ per £
Nov. 13. Sight, 4.86%. Cables, 4.90%. Spread .0375, or 3VJ per £
Nov. 16. Sight, 4.88. Cables, 4.91%. Spread .0350, or 3y2tf per £
The rates for November 16th are of interest as showing
the highest price for cables reached during the period of
the panic. The Chronicle's table for August, 1908, a
10 Bank and Quotation Supplement, December, 1907, p. 22.
THE THEORY OF EXCHANGE RATES 603
month in the ensuing period of stagnation, contains these
quotations :
Aug. 17. Sight, 4.8650— 4.8660, Cables, 4.8660— 4.8665.
This shows a spread of .0005, but perhaps it was never
actually below .0010, which is a figure found in a num-
ber of published reports for various days in this period.
From these data it would appear that the cable spread has
within a period of ten months varied from 375 points to
10 points, or from 3%^ to Mo of 1^ per pound. The great-
est spread was 37^ times the smallest.
On August 1st, 1914, just after the outbreak of the great
war, the rate in New York for sterling cables touched the
astonishing figure of $7.00 per pound. Extensive trans-
actions did not take place at this rate, but it is reported
as one actually reached. For the same day, the Com-
mercial and Financial Chronicle reports the sight rate as
having been at $5.50 to $6.00 per pound. No doubt some
sales actually took place at these figures. If so, there ap-
pears to have been a cable spread of from $1.00 to $1.50
per pound, the abnormality of which is easily appreciated
by comparing it with an ordinary spread of about Vi§. On
August 1st and for several days thereafter the exchange
market, or exchange mechanism if one prefers, was really
not functioning. Later it began to operate somewhat more
smoothly, but it has not been running normally since, from
that day to the present.11 Since August, 1914 there have
been no cable spreads as great as those of the autumn of
1907, though they have averaged greater than those of
ordinary times, having been at or near 1Y much of the
time during the last three years. While it is not difficult
to point out the circumstances which made possible the
colossal spread of August 1st, 1914, it would be absurd
to try to relate it to any existing discount or interesl rate,
ii The spring of 1919.
004 FOREIGN EXCHANGE
and we shall not attempt to bring it under any set rule
or law. A spread of $1 above a sight rate of $6, would
correspond to an interest rate of about 1,000% per annum,
if sight bills were payable in London a week later than
cables. In this condition mails were not in fact getting
over.
Rates for call and short term money have undoubtedly
much influence on cable spreads, but statistical studies, at
least of extraordinary times, will show a very low degree
of correlation between the two. On October 24th, 1907,
the call loan rate reached 100% per annum in New York,
while the cable spread of the day was about 145 points.
On November 7, 1907, the cable spread appears to have
climbed to 375 points, while call money was at the high-
est at 20% in New York and at 5% in London. Dear
call money of course is associated in a general way with
a great spread, but only in a general way. On August
17, 1908, when the spread was 10 points, the call rate was
at 1% in New York and at %% in London.
If we attempt now to construct a theory of the cable
spread, by which we mean nothing more or less than a
general explanation of it, we find that the subject is best
treated under three headings, namely: (1) the theoretical
minimum (or lowest possible rational) spread, (2) the nor-
mal spread, and (3) the spread under the influence of
necessitous buying.
(1) The muiiiiuon spread. — If we arbitrarily assume
that sellers of cables have surplus funds both at home
and in the foreign balance and are willing to sell this
form of exchange so cheap that they merely make no losses
from the operation, and that there are no buyers whose
commitments abroad force them to procure cables, in other
words, that all buyers could make demand drafts serve,
we have the conditions under which the spread might fall
to its very minimum. This minimum would be governed
THE THEORY OF EXCHANGE RATES 605
by the foreign city's deposit allowance rate or rate of in-
terest paid on bankers' balances.
Treating as usual of the New York market for sterling,
let us assume the following:
Sight rate 4.85
London deposit allowance rate 1%
Mail time, New York to London 6 days
A banker buying a sterling cable instead of a demand
draft would at the least make a gain (in sterling in Lon-
don) of 6 days' interest at the deposit allowance rate.
Taking 6 days as about Yeo of a year, a pound remitted
by cable would become £1 plus %0 of 1% of £1, by the day
when a sight draft for £1 could arrive and produce merely
£1. Thus £1 of cable transfer is as a purchase worth at a
minimum Veo of 1% more than £1 of sight draft. %o of
1% of 4.85 is .0008, and therefore when a sight draft can
be bought for 4.85 a cable is as good a purchase at 4.8508,
the spread being 8 points. The spread could hardly then
fall below 8 points, for if it did cables would become bet-
ter purchases than sight drafts even for those who had no
special need for cables as such, and all the demand for
sight sterling ought to shift entirely to cables. Hence
the sight rate could not get closer in to the cable rate
than 8 points.
On the other side the supply of cables would neces-
sarily disappear if the spread should fall below 8 points,
because the seller of this form of exchange would be-
gin actually to lose money if he sold at a rate lower than
within 8 points of the sight rate. This gives us a second
sufficient reason why the spread could not fall below 8
points.
Since rates commonly move only in intervals of 5 points
at a time, the theoretically indicated cable spread of 8
points would probably become 10 points, and with the
606 FOREIGN7 EXCHANGE
siprlit rate at 4.85 and the London deposit allowance rate
at 1% the theoretical minimum cable rate would be 4.8510.
These speculations do not appear altogether idle when we
look at the cable spreads of August, 1908. During that
entire month the Bank rate stood at 2&% in London and
the deposit allowance rate, commonly paid, at 1%, and
according to the Commercial and Financial Chronicle's
table 12 there was one day when the spread was 10 points
(if it was not lower) and there were eight days when it
was but 15 points. Throughout July of the same year,
the deposit allowance rate was likewise at 1%, and there
were four days when the spread was 10 points and four
when it was 15.
(2) The normal spread. — An exchange bank may make
it a regular department of its business to supply the mar-
ket with cables, though only larger banks and exchange
houses are likely to do this. The supply of cables is
usually competitive, but it is to be supposed that sellers
ordinarily should be able to secure from this line of busi-
ness returns covering interest on any funds especially
employed in it and also a remuneration for placing facili-
ties at the disposal of others, substantially equal to the
similar remunerations procurable under competition in
other lines of foreign and domestic banking. The latter
remuneration is likely to go by the name of "profits" and
no objection to this use of words is raised here. In other
words, selling cables must be expected usually to yield in-
terest and profits as great as those obtainable in alternative
lines of employment of money funds and banking-house
facilities.
The seller of a cable who covers his sale with the pur-
chase of another cable is of course not adding to the sup-
ply on the market, but is really acting as an intermediary
for the convenience of some customer. Examination of
12 Bank and Quotation Supplement for September, 1908, p. 22.
THE THEORY OF EXCHANGE RATES 607
this operation will lead us to no conclusions regarding the
cable spread, and so we set it aside. The bank which con-
tributes to the original supply must ultimately cover its
sales of cables by purchases of sight drafts (or their
equivalent in discountable long bills). But if a given lot
of sight drafts are to serve as cover for cables sold to-daj'
they must have been bought and forwarded about six days
ago (from New York). Any lot forwarded at a later time
than this cannot be in London to-day.
If then a New Y'ork bank sells £10,000 of cables to-day
it should charge the operation with the cost of £10,000 of
sight drafts bought six days ago. Dollars were expended
six days ago and a return of the fund in dollars is re-
ceived to-day from the sale of the cables. The return
must exceed the outlay if it is to afford interest and profit.
In the present connection we shall count "profit" as con-
taining everything in the way of gain above the interest,
so that profit contains a contribution to the overhead costs
of banking. The operation is chargeable with six days
interest at the rate which can be had by some alternative
employment of the bank 's funds, substantially equivalent in
point of security and liquidness. Unless it yields this it
is not worth undertaking,13 and only when it yields some-
thing in excess of this can it be said to afford a profit. Per.
haps the nearest alternative employment of funds is in call
loans on good collateral.
Suppose then first that the call loan rate is 4%, or more
fully, that this rate lias averaged 4% during the last six
days, and suppose further that £10,000 of demand drafts
were bought six days ago at 4.85, costing thus $48,500.
Suppose also that a profit of 15 points is required. The
is Except on the theory licit while it dues nol pay all its own
costs it may be justified as attracting other business to the bank
which is self-remunerative. This appears a questionable justifi-
cation.
608 FOREIGN EXCHANGE
£10,000 of cables ought then to sell at a rate determined
as follows :
Sight rate of 6 days ago 4.85
Outlay $48,500.00
}6oth of 1 year's interest on this at 4% 32.33
Xo-profit selling price $48,532.33
No-profit rate 4.8532
Profit required (15 points) .0015
Required selling rate 4.8547
Nearest standard rate above 4.8550
Theoretical normal spread (call money at 4%) . 50 points
This spread is one between the cable rate of a given da}*
and the sight rate 6 days earlier. But the cable spread
as ordinarily understood is the gap between the cable
and sight rates of the same day or moment. Assuming
that the sight rate moves far enough during the six days,
the preservation of a natural spread between the cable
and past sight rate will mean the establishment of an un-
natural one between it and the contemporary sight rate.
Thus if the sight rate were 4.85 six days ago and 4.86
to-day, and if the cable rate of to-day were 50 points above
the past sight rate, it w^ould be 50 points below the pres-
ent sight rate, which would indeed be absurd. If, on the
other hand, cables were raised to 50 points above the pres-
ent sight rate, they would be 150 points above the past
one. As a point of fact, the cable rate is related primarily
to the contemporary rather than the week-old sight rate,
and only a slight study of market reports will be required
to show this. What happens in practice would seem to
be that the spread which, as a matter of cost accounting
in the individual instance, should be added to the past
sight rate, is added to the contemporary sight rate in-
stead. The adoption of this policy means a loss to sellers
THE THEORY OF EXCHANGE RATES 609
of cables on days when the sight rate is lower than a week
earlier and a counterbalancing gain on days when it is
higher. It allows the seller the required interest and
profits on the average or in the long run, and has the great
advantage of making the relation between contemporary
cable and sight rates more stable. A regular and con-
tinuing business in cables could hardly be conducted on
any other plan, for buyers of this form of exchange would
avoid it to the utmost if the rate for it were to have too
capricious a relation with the contemporary demand rate.
The foregoing seems as satisfactory a theory of the nor-
mal cable spread as can be constructed. It makes this
spread depend chiefly upon the rate for call or very short-
term money in the place where the cables are sold. But
only a very rough correlation between the two will be
found in fact. The correlation might be greater if the
call rate were itself a stabler quantum. It must be kept
in mind that a call rate of 3% is twice as high as one of
V/2%, and the call rate may at times be doubled or cut
in half in the course of an hour. The economic theorist
who maintains that cost of production sets the normal
value of freely producible goods does not mean to assert
that the market value will always in fact rest at normal
value. The claims of the theoretical norm here advanced
must be put even more modestly than the claims of the
normal value of goods. The more stable the sight ex-
change rate and the call money rate and the less necessitous
the demand for cables, the more nearly we should expect
the actual cable spread to conform to the normal indicated.
(3) We have attempted to describe the factors which
set the very minimum cable spread and also what we have
assumed the right to call the normal spread. It remains
to discuss the maximum. Concerning this it seems im-
possible to advance any very definite theory. Naturally
maximum spreads will be experienced under the pressure
610 FOKKKIN KXCllAXGE
of necessitous buying. Even under ordinary conditions
it is probable most buyers of cables must procure them,
because of having allowed the time to run by when they
could discharge their foreign commitments by means of
drafts forwarded by mail. Nevertheless the cable spread
ordinarily represents or corresponds to a moderate rate of
interest. The very fact that experienced mercantile,
brokerage, and banking houses will under usual conditions
permit themselves to get into a position where they must
find cables, shows that they feel safe in counting upon
reasonable rates. But the present question is, what fac-
tor or factors will set the upper limit to the cable spread
in case some unusual financial condition precipitates an
extraordinar}- and helpless demand for them. It would
seem that there is nothing more to be said than that as
the spread increases, or the cable rate climbs upward from
the sight rate, the less necessitous elements in the demand
will fall away and certain extraordinary supplies will be
brought forth. Some of the intending buyers may be able
to arrange by wire for a postponement of their foreign
commitments, or may be able to effect a foreign loan by
wire to take care of them. Some sellers may begin to
offer cables at the expense of overdraft in their accounts
in London. Some may make arrangements by wire for
extraordinary credits against which to make sales. Very
likely a considerable fresh supply will come from the
arbitragers. But the question remains, between the neces-
sitous demand and the forced supplies what maximum rate
can come forth? The general principle may be laid down
that the ascent of the spread will be stopped at the point
where the increasing offers of cables become equal to the
declining bids, or where the increasing amount seeking
sale becomes equal to the declining amount sought by
buyers. But this principle, that of the "equalization of
supply and demand" can be of very little utility to the
THE THEORY OF EXCHANGE RATES 611
dealer who desires to estimate the actual figure to which
cables will in some instance probably ascend, though it
has a place in the theoretical explanation of the phenom-
enon. To tell one that when a weight is suspended by a
coil spring the spring will be extended until its upward
pull becomes equal to the downward "pull of gravity" on
the weight (unless the spring breaks meanwhile), will not
of itself enable him to prophesy as to the actual length
to be attained by the spring. That is, this mere principle
of the equalization of stresses without concrete data yield
no concrete results, and a similar observation holds of the
principle of the "equalization of supply and demand."
§ 156. Arbitrage and the interrelation of rates. — We turn
now from the interrelation of rates within a single na-
tional group, such as the group of sterling rates in New
York, to the interrelations among rates in or on different
countries, as determined by arbitrage in exchange.
Consider first the relations between mutual or reciprocal
telegraphic transfer rates, or a pair of rates such as the
rate in Paris on London and the rate in London on Paris,
or again the rate in New York on London and the rate
in London on New York. It being assumed that the es-
sential conditions precedent, namely uninterrupted com-
munication, legal freedom of dealing and continuous and
active markets, are realized, the effect of arbitrage is to
force the pair of mutual rates to a position of parity.
This is any position at which the two express or record
the same value-ratio between the two national currencies.
Thus if according to New York's rate for cables on Lon-
don, pounds are to dollars as 4.8620 to 1, the London rate
for cables on New York will be in a position of parity
when it records this identical ratio. English quotations on
New York are now being published by the Economist (of
London,; in the form of I lie number of dollars of exchange
procurable for one pound. Thus to be at a parity with
612 FOREIGN EXCHANGE
our rate, their rate must be identical with ours, even with
respect to the exact figures which express it, and must in
the case in hand be 4.8620. But London quotations on
New York have also been put in the form of the number
of pence payable for one dollar of exchange, as for ex-
ample say 4911 The position of parity for a rate quoted
in this manner would be 49.362 or close to 49%.
If the rates deviate from parity, even to a very slight
extent, two-point arbitrage springs into action and forces
them to parity or to a negligible distance from parity.14
It should be understood there are an indefinite number
of positions of parity. The following extraordinary pairs
are all at perfect parity, in the sense of the term as used
in connection with arbitrage.
New York on London London on New York
4.60 52.174 d.
1.50 160. d.
7.00 31.286 d.
45.20 5.309 d.
4.8665 mint par 49.317 d.
The first four rates in New York on London are so far
away from the mint par that they look, as one might say,
unnatural. Nevertheless the rates of $4.60 and $7.00 were
actually reached during the great war. In ordinary times
the pair of rates will be confined between the gold-points,
but it is not in the least arbitrage that acts so to restrict
them, but the shipment of gold. Arbitrage as an economic
force is satisfied, so to say, whenever the rates reach a
position of parity, whatever be the tilt of the pair.
It is only the cable rates that arbitrage tends to bring
to an absolute parity. London's sight rate on New York
Will be lower (in the sense of cheaper) than London's
cable rate on New York. New York's sight rate on Lon-
i* This operation is explained in § 97.
THE THEORY OF EXCHANGE RATES 613
don will be lower than its cable rate on London. A mo-
ment's reflection, or work with a pencil, will make it clear
that if the mutual cable rates are at a parity the mutual
sight rates cannot be.
Next to be considered is the wider problem of the in-
terrelation of rates, or their interrelations in three or
more countries. By reason of arbitrage again, the rates
in all countries are bound together in a certain curious
manner, with the result that in some respects their move-
ments are constrained or conditioned while in other re-
spects left free. These wider effects do not flow from the
two-point but from the three-point and more complex
forms of arbitrage. It must be said however, that two-
point and three-point arbitrage, carried out wherever the
movements of rates present opportunities, are together
competent to produce all the effects on the world's rate-
structure that it lies in arbitrage to produce. If four-
point or more complex operations were unknown or im-
possible, arbitrage would be lacking nothing as an economic
force.
Let us now take the case of three cities each of which is
assumed to deal in telegraphic transfers on the other two.
London, Paris and New York will serve, though we know
London's market in exchange on the other two capitals
is not as active as their markets for sterling. Three na-
tional currencies are involved in the problem. There are
likewise three value-ratios between currencies and three
only. These ratios are those
(1) between francs and pounds
(2) between dollars and pounds
(3) between dollars and francs
Two-point arbitrage is sufficient to make each pair of
mutual rates agree as to the value-ratio to which they per-
tain. If the London cable rate on New York makes £1 =
(ill FOREIGN EXCHANGE
$4.86, to be at parity the New York cable rate would have
to make the ratio just the same. Also the mutual tele-
graphic transfer rates between London and Paris would
have to agree on some figure, let us say £1 = 25.20 francs.
With these two ratios determined there is only one posi-
tion left for the ratio between New York and Paris,
namely $1 = 5.185+ francs. For if £1 = $4.86 and
£1 = 25.20 francs, $4.86 ought to equal 25.20 francs, which
would mean that $1 would equal 5.185 -|- francs. But so
far as mere two-point arbitrage goes, the New York and
Paris mutual rates might agree on a ratio of $1 = 4 francs
or any other ratio. When it is said that $1 "ought to"
equal 5 francs, the meaning is that if the other two ratios
maintain themselves as given, buying and selling of ex-
change would force the New York and Paris mutual cable
rates to the ratio of $1 = 5.185 francs. It is not, however,
two-point but only three-point arbitrage that is capable
of forcing this result. Why it should necessarily act in
this manner should be clear in view of the explanations
that have already been offered in Chapter XIV and
especially in § 99. In the problem of three currencies
any two of the value-ratios imply the third, just as the
first two given above, namely,
£1 = $4.86
and £1 = 25.20 francs
imply £1 = 5.185 francs
Now whenever the third ratio is, as actually recorded
in the exchanges, the one required by the other two, we
may speak of it as being consonant with them. When
this position is attained, any two value-ratios may be taken
first and the remaining one, as third, will be consonant
with them, so that all three are consonant. There are an
indefinite number of positions of consonance. For example
the following is one :
THE THEORY OF EXCHANGE RATES 615
£1 = 50 francs
£1= 2 dollars
$1 = 25 francs
The fact that these ratios are very much further away
from the mint pars than any known to actual experience
even in the great war, does not mean that they are not
perfectly consonant. Once established, there would be
nothing in arbitrage to change them. The influence which
would prevent their establishment is not arbitrage.
To summarize : it appears that in any three countries,
having active exchange dealings with one another, arbitrage
tends ever to produce a certain condition of equilibrium
among rates. Complete parity is producible only among
the rates for telegraphic transfers.
I. The condition of perfect equilibrium among cable
rates in the triangle of the three countries, A, B, and C,
involves
1. the parity of each mutual pair of rates,
2. the parity of either rate between any two of the
countries, as A and B, with the opposite pair con-
sisting of (1) either rate between C and A, coupled
with (2) either rate between C and B,1"' and finally
as a consequence,
3. the perfect consonance of the three exchange-ratios
between the three currencies.
is For example, the N. Y. rate on London will be at a parity with
the following four pairs:
(1) N. Y. on Paris — Paris on London,
(2) X. Y. on Paris — London on Paris,
(3) Paris on N. Y. — Paris on London,
(4) Paris on N. Y. — London on Paris.
Taking number (3) from among these at random: if Paris on
N. Y. is at 5.17% francs per dollar, and Paris on London is at 25. 10
francs per pound, the N. Y. rate on London is at parity if it stands
at 4.85024+ (nearest standard quotation, 4.8500). If this rate
616 FOREIGN EXCHANGE
II. There are an indefinite number of positions of per-
fect equilibrium or perfect consonance of value ratios.16
III. Except for cases of complete or partial failure of
arbitrage by reason of inactivity of markets for certain
classes of exchange and inadequacy of communications,
triangles of countries such as the one just considered would
form themselves to connect each single country in the
world with every other possible pair of countries. An ap-
proximation to this result is obtained in actuality.
If we suppose there are four countries in a system,
namely A, B, C, and D, and suppose that after the rate
structure of A, B, and C has reached the position of con-
sonance of value-ratios, D is added, and its rates with B
and C form another perfect triangle, then the rates of
the whole four as a system will have reached the position
of consonance, without further adjustments, and the rates
for any three out of the four will be in the position of
consonance. By successive additions in this manner of
one country after another we can in imagination build up
the rate structure for the principal commercial countries
of the world.
goes appreciably above or below this parity an arbitrage operation
becomes possible. For one example, suppose it goes to 4.8525, the
operation will be to sell sterling in X. Y. This requires us to pro-
duce a fund, or create a credit, in London by way of Paris. This
can be done under the "opposite pairs" of rates given in this problem,
by selling a cable on N. Y. in Paris and buying a telegraphic transfer
on London in Paris. This will produce £1 in London at the cost of
$4.85024 -f- (excluding incidentals) and will yield a gross profit of
2yiooth of lc. per pound.
is The sum of the angles of a triangle equals two right-angles
(except in non-Euclidean geometry) but there are an infinite number
of shapes of triangles. Arbitrage imposes certain restrictions upon
the configuration of the rate structure of three countries, but there
are theoretically an infinite number, and practically an indefinite
number of positions still open to this structure even under these re-
strictions.
THE THEORY OF EXCHANGE RATES 617
If, in conclusion, we examine the significance which the
interrelation of rates due to arbitrage has for the foreign
exchange market in some one country, we find that the
value of the currency unit of that country in terms of the
moneys of other countries is free to rise or fall to any ex-
tent whatsoever. That is, arbitrage will not set any limits
on the duration or extent of such a movement as a whole.
It will merely impose one condition upon its manifestation
in the market for foreign exchange. As the value of the
local money (in terms of other moneys) rises, the local
rates for exchange on other countries fall, and vice versa.
The effect of arbitrage is merely to make it necessary that
the separate rates on all the other different countries
should fall or rise in just the same proportion, unless their
relative values change meanwhile. Thus suppose our dol-
lar appreciates in terms of sterling, insomuch as the rate
for sterling in New York falls 5%.17 Arbitrage will
necessitate that the rate on Paris should also fall ls just
5%, unless the rates of exchange between England and
France make a shift meanwhile. If in the interim sterling
falls perhaps 2%, in Paris, then arbitrage will determine
just how far francs must fall in New York 19 to keep a
position of parity with sterling if the latter falls 5%.
Except, then, as the rates of exchange between foreign
countries, or the relative value of the currencies of these
countries, change inter se, the rates of exchange in our
country must ascend or decline together. Often of course
the relations among foreign currencies change quite as
much, as do their relations with our currency, and it is
it This is a greater movement than can take place when England
maintains the gold standard with the gold contents of the pound
unchanged.
is Fall, in the sense of making francs cheaper. As the rate ia
quoted, the actual figures — francs obtainable per dollar — would rise.
is Virtually but not precisely 3%.
618 FOREIGN EXCHANGE
therefore nothing in the least unusual for some of our
exchange rates to rise while others at the same time are
falling. When several countries maintain the gold stand-
ard, in external as well as internal relations, and keep the
weight of their gold money -units unchanged, the fluctuation
of rates among these countries will be quite closely con-
fined, not in the least through the influence of arbitrage
but through that of gold shipments. The fluctuations of
the value of an inconvertible paper currency against the
background of the other moneys of the world generally,
will depend in part on the course of the values of these
other moneys in terms of commodities and in part on the
variations of the value of the inconvertible paper measured
in the same manner. The fate of the money at home de-
pends of course on the policy pursued by the government
issuing it. The one great and significant principle is that
the greater the quantity of it kept in circulation, the less
its purchasing power over goods tends to be. Increase its
quantity enough and its purchasing power fades towards
the vanishing point. Arbitrage is, of course, possible in
a country with inconvertible paper money.
§ 157. The international distribution of gold. — (A century
ago the economist Kicardo laid down the doctrine that gold
money tends to distribute itself among the different coun-
tries of the world in such proportions as to attain every-
where an equality of value-in-exchange or purchasing
power over commodities. Silver money, in those days a
standard money in many parts of the world, was, of course,
conceived to come under the same rule."\ Each country
was thought of as having a natural share of the world's
specie, a sort of national quota, to which its actual stock
ever tended to conform. If the latter should, through ex-
cessive imports of goods and exports of specie in payment
therefor, be brought below the national quota, specie would
(owing to its very scarcity in the country) ascend in value
THE THEORY OF EXCHANGE RaTES 619
or gain in purchasing power over goods, or, what is the
same thing, prices of goods or their values in terms of
specie would fall. This fall of prices, making the country
a good market in which to buy, would operate to increase
its exports of goods, and, making it a poor place to sell,
would tend to decrease its imports, until the change in
the relation of these two, constituting a reversal in the
balance of trade, would restore the national stock of
money by causing specie to flow back again. Excessive
imports of specie (i.e., those making the actual stock rise
above the natural share) would correct themselves by pro-
ducing just the opposite effects on the balance of trade.
Since Ricardo's day the world has given much thought
to the methods of measuring the general purchasing power
of money over goods, that is, to the problems of index
numbers, and has come to regard the subject as not with-
out its difficulties. ( Since Ricardo's day the banking and
credit systems of the nations have grown enormously in
size and complexity, the machinery for international short-
term borrowing and lending has been much developed, and
discount rates and prices of gold have come to be mani-
pulated with a view to the regulation of the gold move-
ment. Thus under modern conditions the fundamental
forces affirmed in Ricardo's theory are covered over and
obscured by such a number of proximate causes affecting
the How of gold that the truth of the theory is not always
clearly perceived. ^
^The conception is that the geographical distribution of
gold money reaches a condition of equilibrium when this
money has attained equal commodity values in the differenl
parts or countries of the worlds (Until we can agree upon
some method of measurement whereby we shall be able to
determine in fact whether or not gold has precisely the
same general purchasing power in one country as in an-
other, we had better restrict our claim to the proposition
620 FOREIGN EXCHANGE
that gold seeks to distribute itself in such proportions as
to arrive at a rough equality of general purchasing power
in different countries.20^ It is believed then that any gross
inequality in value as thus defined, any inequality so great
as to be indisputable despite the problem of the measure-
ment of fine differences, will tend to correct itself, it being
assumed of course that governments permit the free move-
ment of the metal (an assumption which did not hold dur-
ing the period of the great war).21
It is safe to assert that Kicardo's theory — as a theory
of the fundamental or underlying factors governing gold
movements — is acceptable to the great majority of political
economists to-day. It has been attacked by some who dis-
believe in the so-called "quantity theory" of the value
of money, even in the mild form in which this doctrine is
implied in Ricardo's theory. It will not be the attempt
here to argue the case exhaustively, as this would involve
a very lengthy discussion and force this book beyond the
confines expediency has set upon it. But let us give the
matter a little more consideration.
Suppose, owing to technical business developments Eng-
land begins to sell us so much merchandise and we come
to sell England so little, that (whatever be the national
credits and debits arising from interest, insurance, and
shipping charges and the like) a chronic condition of great
demand and slight supply of sterling exchange arises in
our market. The exchange rate on England stays per-
sistently at the gold-export point. Steadily and in large
volume the metal flows from us to England. The first
effects will probably be rising money rates here and a
20 As a matter of theory it would seem that it seeks to equalize
its general purchasing power, not over all commodities in the several
countries, but only over those as a group, that are capable of export
and import between countries.
21 The effects of foreign trade tariffs are not taken into account
in this brief statement.
THE THEORY OF EXCHANGE RATES 621
falling away of them in England. This will tend tQ<
remedy the difficulty. It will probably lead to our draw-
ing finance bills which will immediately add to the supply
of demand sterling exchange in our market in the manner
already explained in Chapter XII. English banking
houses will be inclined to place short-term loans with us,
in order to gain the higher interest procurable here. This
will also mean a supply of demand sterling at the time
of the making of the loans. Our stiff money rates will
tend to lower the prices of interest-bearing securities in
our market, while the reverse conditions will tend to raise
them in England, so that in consequence we may sell quan-
tities of them to England, and against all such sales sterling
exchange will be drawn and sold in this country.
Perhaps all this will break the exchange market and
pull the sterling rate away from the gold-export point.
Perhaps the rate will be driven even to the import point
so that we shall begin to recover specie. But suppose —
merely suppose — the perverse tendencies in our merchan-
dise commerce remain unabated. If we keep on buying
foreign goods in sufficient excess, the system of holding
our gold by borrowing abroad and selling bonds and stocks
will in time reach the point of exhaustion. What then?
Is there some fundamental remedy which will go to the
seat of the trouble? Assuredly. As the quantity of
money and credit in the country undergoes further and
further contraction, the prices of goods must begin to drop,
if not absolutely, at least relatively to prices in England.
The plethora of money and credit in England will tend
to raise prices there. The consequence will be that many
things formerly importable from England will cease to be
import able, by reason of increased dearness there and in-
creased cheapness here, and many things not exported by
us before will become exportable for precisely the same
reason. Thus if the preliminary remedies fail, the later
622 FOREIGN EXCHANGE
and more fundamental one is bound to be generated. Let
exports of specie be supposed to go far enough, and no
fair-minded and informed thinker can deny the inevitable-
ness of the events that have been pictured. The funda-
mental natural remedy is, or at least may become, pretty
drastic.22 As stated on an earlier page, its existence is
no reason for failing to employ consciously and under
central banking management, the less severe "artificial"
remedies.23 If we admit the existence of this fundamental
"natural" remedy, we admit the essential point in the
Ricardian theory of the international distribution of specie.
We speak of "excessive" exports or imports of gold,
meaning, of course, such movements as will make a coun-
try's stock of the metal either excessively small or exces-
sively great. ( The "natural" share of gold belonging to
the country, as conceived by Ricardo, is the amount which
is neither too great nor too small in comparison with the
amounts held by the rest of the world. This, the national
quota, is the quantity which will make the general price
level of the group of internationally movable commodities
the same here as abroad.) Each gold standard country
will have its quota when the general price level of this
group of commodities is equalized in all the countries.24
k Making a summary statement without proofs, it may be
said a given country's quota or share of specie is a greater
one, the greater its volume of trade, and a lesser one the
22 By reason of leading to a slowing down of industry and inducing
"hard times."
23 Compare §§ 143-147.
24 The function of commerce is constantly to move goods from
where they are most readily produced and cheap to the places where
they are dear. If commerce performed this function with perfect
continuity and smoothness the various national stocks of money
might maintain themselves in a continuous state of equilibrium.
But there is too much that is new arising in commerce all the tims
for this condition to be realized.
THE THEORY OF EXCHANGE RATES 623
greater the extent to which it uses substitutes for gold as
a means of payment such as other forms of money — gov-
ernment and bank notes — and checks on deposits with
banks. The greater the rapidity of circulation of gold
money, other forms of money, and bank deposit "cur-
rency," the less the national quota.25 )
In view of the gigantic superstructure of credit reared
in more modern times upon the foundation of gold — which
has so often been likened to an inverted pyramid — we
should in conclusion state quite explicitly the reservations
that ought to be made as to the adequacy of the so-called
"natural" remedy for gold drains. The operation of this
remedy is always dependent upon the maintenance of the
gold standard. It is this which will necessitate a contrac-
tion of credit as gold drains take place, and thus bring
into operation the corrective of falling (or relatively fall-
ing) prices of goods and commodities. For any untoward
development of commerce, leading to a chronic excess of
imports, a development which by reason of its very na-
ture would have to come somewhat gradually, the "nat-
ural" remedy is not only adequate but is the only real
cure. This, however, does not signify that it is all-suffi-
cient, and that the practices of European central banks
in supplementing, or better, in anticipating it are works
of supererogation. Measures must be taken to meet gold
drains, which under the somewhat hectic conditions of
modern credit may inflict themselves on a country as a
"run" inflicts itself on a bank. In fact, the tendency
of the times is to concentrate a country's gold in its cen-
tral bank, and a foreign drain of sufficient proportions
(like that of 11)07 from England) is virtually nothing but
a great run on this central bank.
25 Further explanations would lead into the theory of the purchas
in<; power of money. The besl work on this Bubject is [rving Fisher's
"Purchasing Power of Money,*' Macmillan & Company, New York.
ADDENDUM
THE QUESTION OF DOLLAR EXCHANGE
In recent times attention has been attracted to the
question of dollar exchange, or the question as to the fu-
ture of the draft drawn payable in dollars, as an instru-
ment of international trade. Bills of exchange employed
in internal trade, being always of course drawn in dollars,
might be included under "dollar exchange" in a broad
sense, but the question being mooted to-day does not con-
cern domestic paper. However, both bills drawn for the
acceptance of bankers' and merchants' bills on merchants
are coming into greater use in the home trade, and this
tends to further a like development in our foreign com-
merce by making for an acquaintanceship with accept-
ances and by aiding in the building up of a broad and ac-
tive discount market for such instruments.
The importance of dollar exchange in foreign trade has
indeed grown considerably during the latter years of the
war, but what many hope for is that it may come to hold
something of the position that sterling exchange has had.
Whether or not we care to make predictions in this field,
we can set forth what the realization of this expectation
would signify. In the first place, dollar exchange might
come to fulfill the same functions in our own foreign com-
merce that sterling exchange has fulfilled in the foreign
commerce of the United Kingdom. But in the second place,
and beyond this, it might come to function in commerce
which does not touch our shores but which goes direct
between two foreign countries, in the way sterling exchange
624
ADDENDUM 625
has for years functioned for commerce not entering the
United Kingdom.1
If dollar exchange comes to occupy the field in connec-
tion with our own foreign commerce it would mean that
some of the exporters who ship to the United States would
draw long bills on our importers, payable here and in dol-
lars. For these "trade" bills there would have to be a
market in the exporters' countries. In this country they
would be discountable after acceptance, except possibly
documentary payment bills. Documentary instructions
would sometimes run "documents for acceptance," some-
times "documents for payment." We should have an
open or public ' ' retirement rate of discount. ' ' 2 Our banks
might or might not develop a custom of discounting docu-
mentary payment bills. If an exporter to this country
demanded a bank credit, he would, under the conditions
we are discussing, be willing to take a credit established
by our importer with an American bank, instead of as
formerly one with a London bank, established through the
intermediation of an American bank.3 His dollar draft
on our bank would have to be readily salable in the country
of export, and would be discountable here as a banker's
acceptance.
Coming to the draft of our exporter on his foreign buyer,
unless he drew in a sum of the money of the foreign
country itself (which would be uncommon), he would draw
for a return draft on New York in dollars. With the
system fully developed this might be one at 60 or 90 days'
sight as well as one payable on demand.4 And if our
exporter demanded a bank credit what he would be offered
i Compare § 39 for an illustration.
2 Compare § 35.
3 Compare §§ 37, 38, and 39.
* On certain countries we have been drawing for return demand
drafts on New York for some time hack.
626 FOREIGN EXCHANGE
and would take would be one with an American bank,
authorizing him to draw upon it a bill (usually a term
bill) in dollars. This credit would be established by the
foreign importer through the intermediation of some bank-
in his country, possibly an American branch, or a bank
managed by American capital.
If these conditions are realized dollar exchange replaces
sterling in the field of our own foreign commerce. But
going further, if it is to play the role in the world at large
which has fallen usually to sterling, it will come to pass
that the importer in some foreign country A will provide
the exporter in some other foreign country B with a dollar
credit at a New York bank, and settlement will proceed
on exactly the same lines as those described in Chapter
VII of this book, New York being substituted for London
and dollars for pounds.
Now, as for predictions, New York will probably not
displace London for years and years to come. Our re-
sources, actual and potential, are greater than those of the
United Kingdom, our foreign trade will probably grow
to huge proportions, but New York will not soon displace
London, The British have a tremendous going concern
in this business of banking for foreign trade. New York
may come to share the business with London, taking a
place similar to London's with respect to some foreign
countries, perhaps in Latin America and the near Orient.
But the one great factor upon which the development of
New York as a foreign trade financing center depends
is the maintenance there of a discount market capable of
absorbing (that is, buying) the great volume of bills im-
plied in this development, AT DISCOUNT RATES
WHICH WILL AVERAGE AS LOW AS THOSE OF
THE OTHER CENTER PREPARED TO OFFER SUCH
A SERVICE, NAMELY, LONDON. Otherwise the ad-
vantage will remain with the sterling long bill, because
ADDENDUM 627
exporters will get more out of these bills for their ship-
ments in the long run. The quotation beneath, from the
Federal Reserve Bulletin for January, 1918, pages 21 and
22, offered by way of conclusion, speaks for itself.
BANKERS' ACCEPTANCES IN LONDON AND NEW
YORK
The following computation prepared by Mr. Leopold Fredrick,
of the American Smelting & Refining Co., furnishes data con-
cerning the estimated amount of acceptances outstanding in
London and New York at a date approximate the end of
November :
London
Acceptances of all London clearing-house banks,
colonial banks, foreign agencies, and private bank-
ers outstanding in the neighborhood of $500,000,000
New York
Acceptances of New York national and State banks
and trust companies 270,000,000
Acceptances of foreign trade corporations and for-
eign agencies established in New York 55,000,000
Acceptances of private bankers 40,000,000
Total $365,000,000
Deduct acceptances issued for the purpose of financ-
ing domestic trade 155,000,000
Total of acceptances representing the financ-
ing of imports and exports through New
York $210,000,000
In commenting upon these figures Mr. Frederick says :
"The foregoing figures show that London is far ahead,
and I believe that even with the much-needed improvement
of the machinery for financing international trade London
will still, for many years to come, outdistance New York.
628 F0KK1CN EXCHANGE
We are lacking here the large number of merehants-
bankers' old-established accepting houses with business
ramifications all over the globe. "We here will be satisfied
if we can hold the Central and South American and Far
Eastern business. Although dollar exchange has made
great strides since the war, the New York discount market
is- still in its infancy. For the present there is little
likelihood that we will get, except occasionally, the financing
of the continental trade of Europe. It is hardly likely
that, say, an Amsterdam merchant importing goods from
France will seek accommodation in New York ; he will go
as heretofore to London. It may be possible, I think, that
this handicap of location will be partly overcome in the
future with the aeroplane development, which would nar-
row down the time consumed by the mail in transit."
THE END
SUBJECT INDEX
(See Index of authorities on page 647)
Abrasion of coin, in relation to
the price of gold, 449.
See also, Tolerance.
Acceptance, 15-7, conditional,
109, 114-16; presentment
for, 31-2; same, withheld
for inspection of goods,
333^4.
Acceptance, bank; bank grant-
ing, not a true lender of
money, 363-4; as a loan
of credit, 371; compensa-
tion for, commission and
not interest, 324; profit
for, instead of commission,
in case of dollar loan by
foreign bank, 362-3.
Acceptance, banker's, against
exporter's bill, 321-5 ;
illustration of same, 323-4.
Acceptance account, 144 et seq.
Acceptances houses, London,
208.
Acceptances; in English bank
statement, 212, 215-6; for
whom granted, 216; in
New York and London
compared, 627.
Advance, burden of, in case
of dollar loan, 363-4.
Advances against collection, 99,
321-5.
Advances, interest-free, by Eu-
ropean banks to facilitate
gold import, 571-3.
62f)
Allonge, 26.
Alloy, 440-1.
American Bankers' Association,
traveler's cheque, 187.
Arbitrage of exchange, 397 et
seq.; preliminary illustra-
tion of, 397-9 ; formal def-
inition of, 399; distin-
guished from certain other
technical operations, 423;
as a computation, 400-1;
two-point, 408-16 ; same,
cases of, 409; three-point
and more complex, 418-23 ;
sixteen fundamental cases
of three-point arbitrage,
419-20; four-point, 421-2;
for future delivery, 424-5;
pure, without speculation,
423 ; rapid work in, 425-6.
Arbitrage and rates; general
theory of interrelation of
rates, 611-18; parity of
pair of mutual rates, 611-
13; rates in three countries,
general theory, 613-16 ;
world's exchange rate
structure, 616-18.
Arbitrage in stocks, 426 et xcq.;
same, illustrated, 427-8.
Arbitrated parities, 397-404;
same and direct and indi-
rect methods of rate quota-
tion, 108n.
A ihil rated par of exchange, dis-
030
SUBJECT INDEX
tinguisbed from mint par,
401-2; use of, illustrated,
403-4.
Arbitrated prices, 397—404.
Arbitrated rates, 397-404.
Arbitrager, arbitrageur, 399.
Arbitration of excbange. See
Arbitrage.
Arrival discount rate, 255.
Assignment of book-accounts,
161n.
'Authority to purchase," 171
et seq.; contrasted with
bank credit, 171.
Australasia; bills on, with
"colonial clause," 310;
London rates on, 312.
Balance; the foreign, 190; in-
terest-free, 204; dealing in
bills on places -where no
balance is kept, 337-42.
See Deposit.
Bank credit, 131 et seq.; as
means of financing a ship-
ment, 160 ; confirmed
credit, 169; and terms
"cash against documents,"
332.
See also Commercial credit.
Bank discount, 53.
Bank of England, 231 et seq.;
specimen statements of,
235-6 ; issue department
and notes, 232-3.
See also Bank rate and
Bank price of gold.
Bank of England discount rate,
237 et seq.; bank's dis-
count policy, 240 et seq.;
character of rediscount
business, 242; "bill brokers
in the bank," 246; redis-
counting at, 244; reserve
and discount rate, 247;
rate to Clearing Banks,
243; bank rate and open
market rates, 252; manipu-
lation of bank rate to in-
fluence gold movement,
546-56; making bank rate
effective, 546-7.
Bank of England note, 492-4;
resemblance to gold-certifi-
cate, 233, 493^.
Bank of England's price for
gold, 504; terms of pur-
chase of gold, 504-5; sys-
tem of manipulation of, to
influence gold movement,
558-60.
Bank of England, cash at, of
other banks, 214.
Bank of England, special war-
time credits, 249-50.
Bank of England, relation of,
with Federal Reserve Bank
of New York, 243-4.
Bank of France; price of gold
at, 509-13; terms on which
buys gold, 512-3; gold-
premium policy of, 563-
71; extent of employment
of latter, 566-7; excep-
tional stability of discount
rate of, 569-70.
Bank price of gold, in England,
502-7; in France, 509-13;
in Germany, 513-16.
Bank rate; in England, 237-
50; in France, exceptional
stability of, 569-70.
See Bank of England dis-
count rate.
SUBJECT INDEX
631
Bankers' acceptances. See Ac-
ceptances.
Banking, meaning of, 56.
Bill of exchange, 11 et seq.;
legal definition of, 11-12;
parties to, 13; usually non-
interest bearing contract,
43; uses of, 13-4; use of,
in settlement illustrated,
69 et seq.; settlement with-
out bill by exporter, 318-
21.
Bills taken by bankers; bankers'
buying rates for bills, 256
et seq.; outright purchase
and receipt for collection,
321-2.
Bills discounted, as asset of
London bank, 214-15.
Bills in sets, 101-2.
Bills on South America, instruc-
tions for drawing, 304-6.
Bills of a more technical char-
acter; drawn on foreign
country in home money,
275 et seq.; same, banker's
buying rate for, 282 et
seq.; same, manner of dis-
charge of, 277-9; same,
computing amount drawn
for, 276-7; bills on a for-
eign country in money of a
third country, 284 et seq.;
same, settlement involving
three currencies, 286; same,
method of settlement with,
287; same, the risks of ex-
change, 288; same, deter-
mining the amount drawn
for, 280 et seq.; same, use
of explained, 202-3; same,
outcome to the purchasing
banker, 293-5; same, spe-
cial agreements covering
risk of exchange, 295-6;
same, taken under a dis-
count rate, 297-8; the bill
with an interest clause,
306-10; the bill with the
"colonial clause," 310-18.
Bill-brokers of London, 218 et
seq.; profit of, illustrated,
219-20; guarantee of bills
by, 220-1 ; relation to great,
banks, 221-2; "in the Bank
of England," 246.
Bill of lading, 102 et seq.;
"order," 103; "straight,"
103; "through," 105; as
collateral, legal nature of
holders interest, 154n;
handling of, in connection
with commercial credit,
138-9, 155-6.
Bimetallic standard, definition
of, 430.
Bolivar, of Venezuela, 484.
Book-accounts, assignment of,
161n.
Borrowing by means of ex-
change, * 359-80, 343-7;
distinguished from ordi-
nary international borrow-
ing, 343-4, 359; and in-
vestments in exchange, con-
trasted, 344 ; possible with
domestic exchange, 359-60.
Branch banks, American, in
London, 230.
Brassage, 434.
Brazilian currency, comment on,
280-1.
Broker, see Bill-broker.
Bullion, see Standard bullion
632
SUBJECT INDEX
and Standard money, and
Mint price.
Bullion value; full, of standard
coin, 456; bullion and
nominal values of token
coin, 465-8; coining and
market value of token bul-
lions, 468-71.
Buying rates, bankers', for bills,
256 et seq.; for banker's
long bill, computed by the-
oretically correct method,
260-1; same, by practical
method, 263; error in
latter, 265; for merchants'
bills on bankers, 266 et
seq.; for documentary ac-
ceptance trade bills, 267;
for documentary payment
bills, a special problem,
268-70, 391 et seq.; for
bill on a foreign country in
home money, 282 et seq.;
same, in money of a third
country, 293-5, 297-8; for
bills bearing the "colonial
clause," 315.
Cable, as form of exchange, 89.
Cable rate, reason for height of,
90 ; general theory of cable
spread, 601-11; cable rate
not basis of long rate,
273— 1 ; certain extraordi-
nary' cable spreads, 601-4.
C.A.F., 335-6.
Call loans of London banks,
214.
Capital, callable and reserved,
of London joint-stock
banks, 210.
"Cash against documents,"
330-3; settlement under
these terms, 318-9; and
methods of settlement,
327-8; bank credit should
niL'et these terms, 332.
"Cash with order," 329-30.
Certificates, gold and silver,
465.
Certified invoice, 116-17.
C.F., 335-6.
Check, 20; traveler's, 181 et
seq.
C.I.F., 335-6.
Classification of exchange, 84
et seq.
Clean bills, 100, 270 ; why Lon-
don discounts clean bills
only, 270-1.
Codes, used for telegraphic
transfers, 89.
Coin, prices of foreign, and the
mint par, 435-6.
Coins ; of England, 492 ; of the
United States, 486-7.
Coinage; laws of, and exchange
rates, 429-42; on govern-
ment and private account,
439; free and gratuitous,
437-40.
Coining value; and market
value of token bullions,
468-71; of gold and silver
in the United States, his-
tory of, 469n; two coining
values of silver in the
United States, 470 ; coining
value of silver in different
countries, 471.
Collateral security, 85-6 ;
banker's legal interest in
merchandise as, 152 et
seq.; plans for surrender
SUBJECT INDEX
633
of goods to importer, 156
et seq.
Collection of bills, 99, 322.
Colonial banks, British,
branches in London, 227
et seq.
"Colonial clause," 310-18; ef-
fect to make bill sell at rate
for sight bill on London,
315; confusion of discount
and premium in connection
with, 316; not common in
bills drawn in England on
colonies, 317; customary
methods of handling bills
bearing, 317-18; compared
with interest clause, 318n.
Commercial credit, 131-89 ; na-
ture and uses of, 131-3;
same, illustrated, 136-40 ;
specimen letter of credit,
136-7; provisions of letter
of credit analyzed, 137-8;
handling of bills of lading
under, 138-9, 155-6; bank-
ing operations involved in
use of, 141-7; risk of
goods under, 149-50; revo-
cation of, 150; specimen
contract for letter of
credit, 151-2; as means of
financing a shipment,
160-3; risk of exchange
under, 164-66; nature of
banker's risk under, 177;
commissions for, 179; ad-
vantages of, summarized,
167; confirmed, 169.
Commereial letter of credit, see
Commercial credit.
"Commercial on banks," 88.
Commercial paper, 1-21, 9 et
seq.; not money, 5; defini-
tion, 10; utility of, 11; im-
portance of negotiability
of, 26.
Commissions ; for commercial
credits, 179 et seq.; same,
contrasted with interest,
180-1 ; correspondents',
205; London banks' usual,
206-7.
Commission houses, activity of
illustrated, 332.
Commodity standard-money,
456-8 ; exportability of,
463-4.
Conditional acceptance, 109,
114 et seq.
Confirmed credit, 169.
Consignee, consignor, consign-
ment, 102.
Consignee, real, notification of,
104.
Consular certificates and certi-
fied invoices, 116-7.
Continentals, defined, 80.
Copper, charge for, in standard
bullion in United States,
441-2.
"Correcting the exchanges,"
546.
Correspondent banks, services
and compensation of, 199
et seq.
"Cotton for payment," 88.
Current and deposit accounts,
of English banks, 211-12.
Dealers in exchange, classes of,
63^.
Defenses against payment on
negotiable instruments, 24
et seq.
634
SUBJECT INDEX
Delegation, 318-21; letter of,
320-1.
Deposit and current accounts of
English banks, 211-12.
Deposits and reserve, 57.
Deposit allowance rate, London,
206; and bank rate, 250-1.
Discount, 39-55 ; contrasted
with interest, 43; reason
for existence as distinct
from interest, 51-2; illus-
trative problems, 45-51 ;
usage of verb "to discount,"
52; rediscount defined, 52;
bank discount and true dis-
count, 53; as interest in
advance, 53-55.
Discount house, 53; discount
houses of London, 218 et
seq., 222; margins of dis-
count, 223; specimen bal-
ance sheet, 225 ; borro wings
by, 225-6; London, com-
pared with joint-stock
bank, 227.
Discount rate, defined, 51; of
Bank of France, excep-
tional stability of, 569-70 ;
and spread between long
and sight exchange rates,
599-601.
Discount rate, manipulation of
to influence the gold move-
ment, 546-56 ; mechanism
of action of same, 551-6;
why particularly a London
remedy, 551-6; by Ger-
many and other countries
than England, 556.
Discount for cash, less common
in foreign than domestic
commerce, 306-7.
Discounts, defined, 52-3; as as-
sets of bank, 58.
Discounting bills. See Buying
rates.
Dinar, of Servia, 484.
Dishonor of negotiable instru-
ments, 33 et seq.
Distribution of gold, interna-
tional, theory of, 618-23.
Documents, reasons for attach-
ing to bills, 99-100; kinds
of attached, 101.
"Documents, cash against," and
methods of settlement,
327-8.
Documentary instructions,
117-8; and terms of sale,
328-9; documents for ac-
ceptance, IIS; for pay-
ment, 88, 118.
Documentary trade bill, 98-130.
Documentary acceptance bill,
118.
Documentary payment bill, 118 ;
not discounted in London,
268-9; recovery of funds
laid out in, 391-6; difficult}'
in determining buying
price for, 391-2; specula-
tion and investment in,
392-3; bankers' own long
bill drawn against, 393-4;
selling futures against,
394-5.
Dollar of United States, history
of various weights of, 482.
Dollar credits, 134-5.
Dollar exchange, the question
of, 624; extent of develop-
ment of, dependent on New
York discount market,
626-7.
SUBJECT INDEX
635
Dollar loan, by foreign bank in
New York, 359-64; same
illustrated, 360 et seq.; risk
of exchange in, 361-3;
character of gain of accept-
ing bank, 362-3; true
lender not the accepting
bank, 363-4; choice be-
tween dollar and sterling
loan, 371-2.
Domestic exchange, methods of
quoting, 73.
Domicile of exchange, 84.
Drachma, Greek, 483.
Draft, 20; definition of term,
20-1.
Drawer's liability, 29.
Endorsement. See Indorse-
ment.
England ; coins of, 492 ; govern-
ment Currency Notes, 495;
legal tender in, 495-6; mint
and bank price of gold in,
502-7; mint pars of, 485;
money notation of, 90;
paper money in, 492-5;
"tolerance" in, 496. See
London.
England, Bank of. See Bank
of England.
Exchange, 20; denned, 1, 21; as
discount on a bill on an-
other place, 313; in the
"colonial clause," 313;
added to invoice, 317.
Exchange supply and demand,
in relation to commerce,
67.
Exchange dealings, general
character of, 62 et seq.J
classes of dealers in ex-
change, 63-4 ; facilities
necessary for, 191-2.
Exchange, methods of quoting,
62 et seq.
Exchange rates, theory of, 578-
623.
Explicit interest, 53.
Export, the special art of,
325-6.
Export of gold, excessive, natu-
ral remedy for, 620-3.
Exportability of commodity
money, 463-4.
»
Facilities required for exchange
business, 191-2.
Farthing, 483.
F.A.S., 335.
Federal Bills of Lading Act,
103.
Federal Reserve Banks, 354;
relations with Bank of
England, 243-4.
Federal Reserve Board, 459n.
Fiat money, 455, 456-8; for-
mal definition of, 456; na-
ture of considered, 457-8;
contrasted with commodity
money, 458-60; propensity
to depreciate, 459-60; non-
exportability of, 464.
Finance; meaning of "to
finance," 161-2, 379-80;
financing shipments by
bant or commercial credit,
160 et seq.; financing by
means of banker's long
bill, 379-80.
Finance bill, 367—9; definition,
380; distinguished from
commercial hill. 359; ac-
count of operation with
636
SUBJECT INDEX
banker's own long bill,
368 -9; interest cost of loan
by, 369 71 ; drawn to carry
borne securities, 373-5;
same, computing profii
gained, 374-5; banker's
long bill, when not a
finance bill, 394.
Fine bullion, mint price of,
440-7; in the United
States, 498.
-Floaters," 221.
"Floating money," 254.
Florin, of Holland, 97.
F.O.B., 335.
Foreign balance, 190 et seq.
Foreign-bill policy, to influence
the gold movement, 573-4.
Foreign coin, sale of to United
States mint, illustrated,
500-1.
Foreign exchange, defined, 1.
Foreign moneys, direct pur-
chase and sale of, 472-3.
Forward or arrival discount
rate, 255 et seq.
France. See Bank of France.
France, mint and bank price of
gold in. 509-13; mint pars
of, 485-6; rates on, in
United States, 92.
Franc, weight of gold, 483; sil-
ver 5 franc piece and gold-
premium policy of Bank of
France, 564-5.
Franco Domicile, 335-6.
Free coinage, 437-40, 456;
right of, defined, 438; and
quantity of money, 458-9.
Fund, formal definition of term,
404 ; methods of transfer
of funds, 405; direct trans-
fer of, 404-8; indirect
transfer of, 416-18; direct
transfer of, illustrated,
407; choice between meth-
ods of direct transfer,
406-8.
Future delivery, exchange for;
dealings in, 381-2; opera-
tions in for a hedge, 382-4;
buying, when a pure specu-
lation on long side, 386;
sale of, when a pure specu-
lation on short side, 389-
90; selling, against pur-
chased documentary pay-
ment bills, 394-5; sources
of supply and demand,
395-6 ; arbitrage in, 424-5.
Future sum and present price,
39-42.
Germany, mint and bank price
of gold in, 513-16; mint
pars of, 486; rates on, in
the United States, 95.
Gold; international distribution
of, theory of, 618-23; pro-
duction and consumption
of, 450 ; purchasing power
of, fluctuations in, 451,
462-3.
Gold bullion, not money, 5.
Gold coins; of England, 492;
of United States, 486-7;
same, least current weight
of, 491.
Gold export and import; inter-
est charge in connection
with exports, 526-7; ex-
port, New York to London,
practical computations of
SUBJECT INDEX
637
costs and proceeds, 423-30 ;
harmfulness of export dis-
cussed, 544-5 ; excessive
export, artificial and natu-
ral remedies for, 545-6,
620-3; import by New-
York from London, prac-
tical computations of costs
and proceeds.
See also Gold movement
and Gold shipments.
Gold movement ; classification
of gold movements, 517;
special banking methods of
influencing, 544-6 ; ma-
nipulation of the discount
rate to influence, 546-
56; mechanism of the ef-
fect .of changes in the dis-
count rate. 551-6 ; manipu-
lation of the price of gold
to influence the, 556-63;
moral suasion to prevent
gold export, 576-7; Eng-
lish and American, during
the panic of 1007.
See aho Gold shipments.
Gold-points, 522-3, 438; vari-
ability of, 522-3; same,
illustrated, 530, 535; rela-
tion to mint par, 542-4;
and foreign price of gold,
526-3.
Gold-premium policy of the
Bank of France, 563-71;
benefits and disadvantages
of, discussed, 570-1.
Gold, price of; mint and mar-
ket price, 443-52; market,
448-50; stability of latter.
443-5; contrasted with
purchasing power, 452;
mint and bank price in
England, 502-7; in Lon-
don market, 507-9; mint
and bank price in France,
509-13; terms of payment
for gold by the Bank of
France, 512-13; mint and
bank price in Germany,
513-16; sale of bars by
Bank of England illus-
trated, 561-2; sale and ex-
change of bars by the
United States mints, 502;
sale of United States gold
coin to the Bank of France
illustrated, 512.
Gold shipments, 517-77; for a
profit, 518-22; at a loss,
551n, 576; regularly made
by bankers only, 518-19;
general relation to ex-
change rates, 519-22; in-
terest cost in, discussed,
536-9; same, variant meth-
ods of computing, 539-41.
See also Gold movement
and Gold export.
Gold standard ; what is requi-
site to be on the. 431-2;
quantity of standard
money determined by free
play of private interests,
458-9.
Gold-exchange standard, 430;
in India, 457.
Gold standard, the "limping,"
432, 476-8.
Grace, days of, 85.
"drain for payment," 88.
Gratuitous coinage, -137—10.
Great Britain. See England
and London.
SUBJECT INDEX
Greenback, legal tender power
of, !n.
Guilder of Holland, 97.
Gulden of Holland, 97.
Hedge, defined, 382; compared
with speculation, 381-2.
Holder in due course, 24.
Home money, bill on foreign
country in, 275 et seq.
Hypothecation ; certificate of,
107 et seq.; general letter
of, 108.
Implicit interest, 53.
Incidental costs, allocation of
in cases of export, 334 et
seq.
India, British, monetary experi-
ence of 1893-99, 456-7.
Indirect rate quotations, 74.
Indorsement, 26; of order bill
of lading, effect of, 103-4.
Indorsements, kinds of, 27; as
liability in English bank
statement.
Indorser's liability, 29.
See also Recourse.
Interest, 39-55 ; rate of defined,
51 ; illustrative problems,
45 et seq.; contrasted with
discount, 43; explicit and
implicit, 53; as "yield,"
53; nominal rate of, 53.
Interest, exporter's charge for,
when entered into bill of
exchange, 306-10 ; added
to invoice, 307.
Interest cost; in sterling loan,
366, 368-9; further dis-
cussed, 369-71; in gold
shipments explained,
536-9; same, methods of
computing, 539^11.
Interest realized, in investment
in exchange, computing
rate of, 347-50; same,
356-8.
Interest on bank balances, 204.
Interest-free balances, 204.
Interest-free advances, to facili-
tate gold import, 571-3.
Interior banks, exchange busi-
ness of through jobbers,
341-2.
Investment in exchange, 343-
58; contrasted with bor-
rowing by means of ex-
change, 344; method of
making, 344-7 ; distin-
guished from making of
ordinary foreign loan, 345 ;
technique of, 346-7 ;
prompt presentment for
acceptance still necessary,
347; computing rate of in-
terest received in, 347-50;
speculation on sight rate
involved in, 350-3; effect
of variations of sight rate
on rate of interest realized,
351, 356-8 ; conditions
favorable and unfavorable
to, 352-3; termination of,
prior to maturity, 353-8;
foreign bill as liquid asset,
354-5 ; combined with
speculation on the long
side, 387-9; in documen-
tary payment bills, 392-3.
Invoice; with documentary bill,
116 ; consular certified,
116-17.
SUBJECT INDEX
639
Inspection of goods, before ac-
ceptance of bill, 333^i.
Insurance certificate, 106; open
policies, 107.
International distribution of
gold, theory of, 618-23.
Irredeemable paper, quantity
and value of, 457-8.
Jevons' definition of standard
money criticised, 455.
Jobbing, exchange, 341-2.
Joint-account, in a loan by
means of exchange, 373-7.
Joint-stock bank, London, 207
et seq.; specimen statement
of, 210 ; functions summar-
ized, 216-17; dealings of
in foreign exchange, 217.
Lading. See Bill of lading.
Latin monetary union, 483.
Lawful money, definition of, 6n.
Legal tender, 3, 6; effect of re-
jection of, 6-7; reasons for
law of, 8; special tender
powers, 8; gold coin clause
in money contracts, 8, 9n;
legal tender power of
standard money, 456 ; same,
of representative moneys,
476; legal tender in the
United States, 4, 8, 487-8 ;
in England, 495-6; least
current weight of gold coin
in the United States, 491.
Letter of credit, commercial,
131 et seq.; specimen,
13G-7; provisions analyzed,
137-8; recording of drafts
under, 139; contract for,
148 et seq.; advantages of
summarized, 167.
See also Commercial credit.
Letter of credit, traveler's,
181-4.
Letter of delegation, 318-21.
Leva, of Bulgaria, 484.
Liability of parties to negotia-
ble instruments, 29 et seq.;
classification of parties lia-
ble on bills and notes, 38n.
Limping gold standard, 432,
476-8; in France, Ger-
many, and the United
States, 477; and gold-pre-
mium policy of the Bank
of France, 564.
Liquid asset, foreign bill as,
354-5.
Lire, of Italy, 483.
Literature of exchange, note on,
191n.
Loan by means of foreign ex-
change; general nature of,
371-2; dollar loan by for-
eign bank in New York,
359-64; foreign, in local
money, 365-7; Ameriean,
in foreign monev capital,
377.
See also Borrowing by
means of exchange.
Loans by bank; their limits,
58-61; as assets, 58;
proper marshaling of, 61.
London money market ; dealers
in, 207 et seq.; interna
tional character of, 230;
group of money rates in,
252; money rates that are
based on the bank rate,
250; financing of non-Eng-
640
SUBJECT INDEX
lish commerce by, 103,
303-4, 379-80; method of
quoting American securi-
ties, 427; exchange rates
for bills on the colonies,
311-12.
See also England.
London, banking in ; acceptance
houses, 208; joint-stock
banks, 207 ; specimen state-
ment of joint-stock bank,
210; functions of same
summarized, 216-17; deal-
ings of in foreign ex-
change, 217; bill brokers
and discount houses, 218;
forei.un and colonial banks
in, 227; American branch
banks in London, 230 ; five
great banks of London,
231n.
Long; going long of exchange,
384—9 ; outcome of opera-
tion illustrated, 387-8 ;
long operation involving
investment or lending,
387-9.
Long bills, bankers'; buying
rates for, 258-65; as
finance bills, 379-80; when
not finance bills, 394; sale
of, and speculation on the
short side, 390-1; drawing
of against documentary
payment bills, 393^4.
Long rates, spread between and
sight rate, theory of, 599-
601.
Mark, of Finland, 484; of Ger-
many, 484.
Market and coining values of
token bullions, 468-71.
Market price of gold, 443-52,
4 18-50; stability of,
443-5; relation to mint
price, 448-50.
See also Price of gold and
Mint price.
Means of payment, 1-21, 2-5;
chief in the United States,
4.
Melting gold coin, and market
price of gold, 449 ; lawful-
ness of melting, 448n.
Metric and troy weight, 479-81.
Minor coin, legal tender power
of, 4n.
Mint (U. S.) ; charges levied by,
498-9 ; computation of
charge for copper illus-
trated, 500-1; terms of
payment by, for bullion,
501-2; sale and exchange
of gold bars by, 502; pur-
chase of foreign coin by,
illustrated, 500-1.
See also Coinage, Price of
gold, Tolerance.
Mint price of gold, 443-52,
445-6; how fixed by stat-
ute, 445-6; basis price of
fine bullion, 446-7; in the
United States, 497-502; in
England, 502-7; in France,
509-13; in Germany, 513-
16.
See also Price of gold and
Market price of gold.
Mint par of exchange, 432-5;
defined, 77, 432; chief
propositions concerning,
432-5; tolerance and, 433;
SUBJECT INDEX
641
seigiiorage and brassage
and, 434 ; distinguished
from an actual value,
435-7; distinguished from
an arbitrated par, 401-2;
and price of foreign coin,
435-6 ; and exchange rates,
436-7; legally fixed char-
acter of, 437; tables of
mint pars, 485-6; relation
to gold points, 542-4.
Money, 2; definition, 3; forms
of, in the United States, 4;
forms of in a modern coun-
try, 454; standard money,
452-64; quantity and value
of money, 460-2; repre-
sentative money, 465-78 ;
token money, 465.
See also Fiat and Com-
modity money.
Money dealers in London, 207.
Money rates, group of in Lon-
don, 252.
Monetary standards, the sev-
eral, 429-32.
Monetary systems of the lead-
ing countries, 479-516.
Moral suasion to prevent gold
export, 576-7.
Morgan-Belmont syndicate of
1896, 519.
Negotiability, 22 et seq.
Negotiable instruments; de-
fenses against payment on,
24 ; liability of parties, 29-
38; classification of parties
liable, 30, 38n; vendor's
warranties, 36; conditions
of recourse, 32 et seq.; pro-
test, 35.
Negotiable instruments, Uni-
form Law of, cited, 12n,
16n, 18n, 20n, 24n, 30n,
32n, 33n, 128n.
Negotiation, 26-8.
Nominal interest, 53.
Nominal rates, 82-4:.
Nominal, bullion, and actual
values of token moneys,
465-8.
Note, the promissory, 17-19;
legal definition of, 18; uses
of, 18-19; interest-bearing
and non-interest-bearing
contrasted, 41-2.
See also Bill and Negotia-
ble instruments.
Notification of real consignee,
104.
Open account, sales on, and re-
mittance by importer, 320.
"Order" bill of lading, 103.
Overdraft rate, London, and
bank rate, 251.
Par of exchange. See Mint
par.
Parity of a pair of mutual
rates, and arbitrage, 611-
13.
Parity of representative money,
467.
Partial deliveries and payments
on D. P. bills, 109; same,
illustrated, 126.
Peel Act, and Bank of England
note, 232-3.
Pence, 483.
Percentages, English method of
writing, 223-4.
Peseta, of Spain, 484.
042
SUBJECT INDEX
Peso, of Argentine, 484.
Philippine silver certificate,
405 and note.
Point, in the exchange market,
80.
Post-remittance, bank, 188.
Posted rates, 82-4.
Pound sterling, 90, 482. See
Sterling.
Power of sale, over collateral,
110, 153.
Premium and discount method
of quoting exchange rates,
73.
Premium on gold, in France,
technical nature of, misun-
derstood, 505.
See Gold-premium policy,
etc.
Prepayment of D. P. bills un-
der rebate, 111, 119 et seq.;
prepayment rate of dis-
count, 111; reasons for
prepayment, 120; prepay-
ment illustrated, 123 et
seq.; prepayment on com-
mercial credit, 160.
Present price and future sum,
69.
Presentment, of negotiable in-
struments, 31-2.
Presentment for acceptance
withheld for inspection of
goods, 333-4.
Price of gold; defined and dis-
cussed, 443-4 ; maximum
range of variation of, in
London, 443, 558-9; inde-
pendence of gold produc-
tion, 444-5; abrasion of
coin in relation to, 449;
mint price in the United
States, 497 ; mint and bank
price in England, 502-7;
and gold-points, 502-3;
manipulation of to influ-
ence the gold movement,
550-03 ; gold-premium pol-
icy of the Bank of France,
563-71.
See also Mint price of gold
and Market price of gold.
Private banks, international,
231.
Protest, of bill of exchange or
note, 35.
Purchasing power of gold, his-
tory of fluctuations of,
462-3.
Quantity of money; and free
coinage, 458-9; and its
value, 460-2.
Quantity theory of the value of
money, 460-2; significance
of, 461-2; involved in the
received theory of interna-
tional distribution of spe-
cie, 620.
Quotation of rates, methods of,
73 et seq.; quotation of
sterling in New York, 91.
Rate of discount, defined, 44,
51 ; rebate rate of discount,
111, 119.
See also Discount and Dis-
count rate.
Rate of interest, defined, 45,
51.
See also Interest.
Rate on bankers' balances in
London and Bank of Eng-
land rate, 251.
SUBJECT INDEX
643
Rates of exchange, 62-97;
methods of quoting, 73;
specimen market reports,
74; posted and nominal,
82-4.
Rebate; of "interest," 121; the
rebate rate, 119-22.
See Prepayment.
Rebate on bills, as item in Eng-
lish bank statement, 213.
Recourse, on parties secondar-
ily liable, conditions of,
32 et seq.; indorsement
without, 28-9; right of,
and conditional acceptance,
114-16 ; practical nature of
right of recourse, 176-9,
332; right of recourse on
draft under commercial
credit, 177-8.
Redemption rights of moneys
in the United States, 489.
Redeemable money, 453.
Rediscount, defined, 52.
See Discount.
Rediscount at Bank of Eng-
land in times of stringency,
244-9.
"Refinancing" in foreign trade,
321-5; illustration of, and
outcome to exporter, 323-4.
Reichsbank, German ; price of
gold at, 513-16 ; discount
rate of, and gold movement,
556; foreign-bill policy of,
to influence the gold move-
ment, 574.
Remittance by buyer, 320.
Representative money, 465-78,
also 453-5; generally non-
exportable character of,
471-4; need of limiting
bullion contents of, 473^;
system of indirect redemp-
tion of, 475-6; limitation
of legal tender power of,
476.
Reserve, bank, 57; effects of
lending upon, 59-60; in
English sense, 211.
Reserved capital, of London
joint-stock banks, 210-11.
"Rest" of the Bank of England,
211.
Retirement rate of discount,
111, 119, 122; customary
retirement rates in various
countries, 122-3; London,
and bank rate, 251.
See Prepayment.
Retirement, effect of privilege
of, on selling price of bill,
391-2.
Risk of exchange, defined, 164;
illustration of, 340 ; in con-
nection with commercial
credit, 164; and the draft
for home money, 276, 279-
80; and draft in money of
a third country, 288; spe-
cial agreements covering,
295-6 ; losses of Americans
on sterling after outbreak
of war, 289; risks of ex-
change and investment in
exchange, 350-3; and the
dollar loan, 361-3; and the
sterling loan, 366-7.
Risk, banker's, nature of under
the commercial credit, 177.
Risk of goods, under the com-
mercial credit, 149-50.
Rule of equal sales and pur-
chases, 198, 260, 271.
(ill
SUBJECT INDEX
Rupee, of British India, as fiat
and as representative
money, 456-7.
Sale, power of, over collateral,
110, 153; terms of, and
methods of settlement,
326-9.
Sales and purchases, rule of
equal, 198, 260, 271.
Security, personal and collat-
eral, 85-6.
Seigniorage, 439; from coinage
on government account,
469; seigniorage and bras-
sage and the mint par, 434.
Sets, bills in, 101-2.
Settlement, international, use of
bill in, illustrated, 69 et
seq.; services of banker in,
71-2; methods of, sum-
marized, 325-36 ; same,
conspectus of, 327-9.
Shilling, 90, 483.
Short of exchange, going,
385-6, 389-91.
Sight rate, as basis of other
rates, 259, 274.
Silver, two coining values of,
in the United States, 470;
coining values of in differ-
ent countries, 471.
Silver dollar, American, legal
tender power of, 4n; sys-
tem of indirect redemption
of, 476n.
Silver, subsidiary, in the United
States, legal tender powers
of, 4n.
South Africa, bills on with the
"colonial clause," 310 ;
London rates on, 311-12.
South and Central America, in-
structions for drawing on,
304-6, 334n.
Specie shipments, 517-77.
See Gold movement and
Gold shipments.
Speculation; definition of, 381;
outright and incidental,
382 ; avoidance of, through
arrival discount rates,
255-6; involved in invest-
ments in exchange, 350-3;
in connection with D. P.
bills, 392-3 ; purposeful
speculation in exchange,
381-96; going long on ex-
change, 384-9 ; going short,
385-6.
"Spread"; theory of the sev-
eral spreads, 596-9; be-
tween local and foreign
money rate, and finance
bills/ 369-72.
Stamp taxes on bills, 256.
Standard bullion, 440-2; charge
for standardizing, 441 ;
mint price of, 445-6; same,
in the United States, 497-8.
See Bullion value.
Standard money, 452-64; defi-
nition of, 429, 454-5; ap-
proved characteristics of,
455-6 ; commodity and fiat,
456-8; in what sense value
of, is determined by law,
459.
Standard units of value, in four
chief countries, 481^4.
Standards, monetary, the sev-
eral, 429-32.
Sterling bill ; schedule of stamp
taxes on sterling bills, 257 ;
SUBJECT INDEX
645
drawn from the United
States on outlying coun-
tries, reasons for the past
use of, 299-300; drawn in
United States on Latin
America and the Far East,
285; on Latin America,
customary method of de-
termining face value,
296-7 ; reasons for long re-
turn bill, 300-2; losses of
Americans on, after out-
break of war, 289.
Sterling credit, 134; American
bank's issue of, 135; risk
of exchange in connection
with, illustrated, 165; how
London finances commerce
under, 163; traveler's ster-
ling credits, 182-3.
Sterling loan, 365-7; in New
York illustrated, 365-6 ; in-
terest cost of, to borrower,
366; risk of exchange in,
366-7; character of gain
of accepting bank, 367 ;
variant form of, 367-9;
choice between and dollar
loan, 371-2.
Sterling mint pars, 485.
Sterling money notation, 90.
Sterling, pound, 482.
Sterling rates in United States,
90; ordinary range of fluc-
tuation of, 92.
"Straight" bill of lading, 103.
Subsidiary silver, legal tender
power of in the United
States, 4n.
Supplemental fractions, in cer-
tain New York foreign
rates, 94, 96.
Supply and demand, exchange;
in relation to commerce,
67 ; sources of, 588-96 ;
general theory of, and
rates, 578-88.
Surrender of goods by banker
to importer, various plans
for, 156 et seq.
Telegraphic transfer. See Ca-
ble and Cable rate.
Terms of sale, 326-7 ; and meth-
ods of settlement summar-
ized, 325-36 ; conspectus
of terms of sale, 327-9.
"Through" bill of lading, 105.
Token bullions, coining and
market values of, 468-71.
Token coin, need of limiting
bullion contents of, 473-5.
Token money, 465; system of
indirect redemption of,
475-6; features of a per-
fected system of, 474-6.
Tolerance ; defined, 489-91 ; in
the United States, 489-91 ;
in gross weight of new gold
coin, 491 ; in England, 496 ;
and the mint par, 433; re-
lation to market price of
gold, 509.
Trade bill, 98 et seq.
Trade paper, definition of, lOn.
Transfer of funds, methods of
direct, 404-8 ; indirect,
416-18.
Traveler's cheque, 185 et seq.;
letter of credit, 181.
Troy and metric weight, 479-81.
True discount, 53.
Trust receipt, 154; use of illus-
R46
SUBJECT INDEX
trated, 157-8 ; specimen,
158-9.
Uniform Negotiable Instru-
ments Law, cited, in notes,
12, 16, 18, 20, 24, 30, 32,
33, 128.
United States; coins of, 486-7;
least current weight of gold
coin, 491; legal tender in,
487-8; mint pars of, 485,
77-8; mint price of gold
in, 497-502; redemption
rights of money in, 489;
"tolerance" in, 489-91.
Units of value, in four leading
countries, 481-4.
Usance, 156n.
Value of gold, in economic
sense, 451.
Value of money, fluctuations of
in history, 462-3.
Value of money, in what sense
determined by law, 459.
Value of money and its quan-
tity, 460-2.
"Value on," 137n.
Vendor's warranties, on bills
and notes, 36.
Warehousing by banker, 112-
13.
Yield, in sense of investment
rate of interest, 53.
AUTHORITIES MENTIONED OR CITED
Andrew, A. P., 3n.
Arnaune, Aug., 566.
Arnold, John J., 119n.
Avebury, Lord, 237.
Brooks, H. K., 135, 151n, 158n,
184n, 187n, 191n.
Brown, H. G., 192n.
Clare, George, 68n, 190n, 191n,
207n, 221n, 232n, 281n,
353n.
Clark, W. A., Graham, 336n.
Deutsch, H., 191n, 496n.
Duguid, Charles, 208n.
Easton, H. T., 191n, 207n, 480n.
Escher, F., 158, 191n, 380n.
Fisher, Irving, 53n, 452n, 461n,
462, 623.
Fredrick, Leopold, 627.
Fuerst, Max., 510n.
Goschen, George J., 192n.
Gow, Charles, 147, 237, 242.
Gregory, G. E., 527n.
Harding, Fred C, 297.
Haupt, 0., 191n.
Jevons, W. S., 455.
Johnson, J. F., 456n, 461n.
Kaufmann, E., 191n, 511n.
Kemmerer, E. W., 452n.
Knapp, G. F., 457n.
Laughlin, J. L., 462n, 474,
476n.
Margraff, Anthony, 116n, 117n,
150n, 158n, 183n, 184n,
191n, 251n, 346n, 353, 394.
Mises, L. van, 575n.
Mitchell, W. C, 452n.
Norman, J. H., 191n.
Norton, C. P., on Bills and
Notes, 38n.
Noyes, A. D., 476n.
Odell, Ralph M., 337n.
Palgrave, R, H., Inglis, 238n,
248n, 569.
Pallain, M. (Governor of Bank
of France), 567.
Pierson, N. G., 601n.
Ricardo, David, 618 et seq.
Roberts, Geo. E., 502n.
Rosendorff, R., 566, 570n.
Schuster, Sir Felix, 146, 218n,
238n, 244n, 250n.
Spaulding, W. F., 192n, 325n.
Straker, F., 207n, 222n.
Swoboda, Otto, 190n, 510n, 513,
567.
Tate, Win, 418n, 496n.
Walker, Francis A., 3n.
Walsh, C. M., 452n.
Withers, Hartley, 192n, 207n,
218n, 567, 576.
Wolff, Archibald J., 123n, 30 In
(7)
• *5 8 I!
UNIVERSITY OF CALIFORNIA AT LOS ANGELES
THE UNIVERSITY LIBRARY
This book is DTCE on the last date stamped below
LD-U
MAY 18 1965
&P* 29 19» am
7
&3 lW
9HC6 1948
APR 1 1 \m
; - l NAYl*'
Form L-9~20wi-8,'37
NOV*
4-9
0 19871
PM
t,. to
03 1981
tf£
omf KRsrrr of califokkia
AT
La;
LIBRARY
3 1
58 01218 6432
.
HG
3851
W58f
CO
r\
AA 001 145 950 o
Live Music Archive
Librivox Free Audio
Metropolitan Museum
Cleveland Museum of Art
Internet Arcade
Console Living Room
Books to Borrow
Open Library
TV News
Understanding 9/11