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diff --git a/29364.txt b/29364.txt new file mode 100644 index 0000000..a9a50a3 --- /dev/null +++ b/29364.txt @@ -0,0 +1,3781 @@ +Project Gutenberg's Elements of Foreign Exchange, by Franklin Escher + +This eBook is for the use of anyone anywhere at no cost and with +almost no restrictions whatsoever. You may copy it, give it away or +re-use it under the terms of the Project Gutenberg License included +with this eBook or online at www.gutenberg.org + + +Title: Elements of Foreign Exchange + A Foreign Exchange Primer + +Author: Franklin Escher + +Release Date: July 10, 2009 [EBook #29364] + +Language: English + +Character set encoding: ASCII + +*** START OF THIS PROJECT GUTENBERG EBOOK ELEMENTS OF FOREIGN EXCHANGE *** + + + + +Produced by The Online Distributed Proofreading Team at +http://www.pgdp.net (This file was produced from images +generously made available by The Internet Archive/Canadian +Libraries) + + + + + + +Elements of Foreign Exchange + +A FOREIGN EXCHANGE PRIMER + + + +By FRANKLIN ESCHER +Special Lecturer on Foreign Exchange at New York University + + + +_Fifth Edition_ + +NEW YORK +THE BANKERS PUBLISHING COMPANY +1915 + +LONDON +EFFINGHAM WILSON, 54 THREADNEEDLE ST. + +Copyright 1910 +By the Bankers Publishing Co. +New York + + + + +CONTENTS + + + PAGE + +CHAPTER I. WHAT FOREIGN EXCHANGE IS AND WHAT BRINGS IT INTO EXIST 3 + +The various forms of obligation between the bankers and +merchants of one country and the bankers and merchants of +another, which result in the drawing of bills of exchange. + +CHAPTER II. THE DEMAND FOR BILLS OF EXCHANGE 15 + +A discussion of the six sources from which spring the demand for +the various kinds of bills of exchange. + +CHAPTER III. THE RISE AND FALL OF EXCHANGE RATES 25 + +Operation of the five main influences tending to make exchange +rise as opposed to the five main influences tending to make +exchange fall. + +CHAPTER IV. THE VARIOUS KINDS OF EXCHANGE 45 + +A detailed description of: Commercial "Long" Bills--Clean +Bills--Commercial "Short" Bills--Drafts drawn against securities +sold abroad--Bankers' demand drafts--Bankers' "long" drafts. + +CHAPTER V. THE FOREIGN EXCHANGE MARKET 59 + +How the exchange market is constituted. The bankers, dealers and +brokers who make it up. How exchange rates are established. The +relative importance of different kinds of exchange. + +CHAPTER VI. HOW MONEY IS MADE IN FOREIGN EXCHANGE. THE OPERATIONS +OF THE FOREIGN DEPARTMENT 68 + +An intimate description of: Selling demand bills against +remittances of demand bills--Selling cables against remittances +of demand bills--Selling demand drafts against remittances of +"long" exchange--The operation of lending foreign money +here--The drawing of finance bills--Arbitraging in Foreign +Exchange--Dealing in exchange "futures." + +CHAPTER VII. GOLD EXPORTS AND IMPORTS 106 + +The primary movement of gold from the mines to the markets, and +its subsequent distribution along the lines of favorable exchange +rates. Description (with presentation of actual figures) of: The +export of gold bars from New York to London--Import of gold bars +from London--Export of gold bars to Paris under the "triangular +operation." Shipments to Argentina. + +London as a "free" gold market and the ability of the Central +Banks in Europe to control the movement of gold. + +CHAPTER VIII. FOREIGN EXCHANGE IN ITS RELATION TO INTERNATIONAL +SECURITY TRADING 130 + +Europe's "fixed" and "floating" investment in American bonds +and stocks a constant source of international security trading. +Consequent foreign exchange business. Financing foreign +speculation in "Americans." Description of the various kinds of +bond and stock "arbitrage." + +CHAPTER IX. THE FINANCING OF EXPORTS AND IMPORTS 141 + +A complete description of the international banking system by +which merchandise is imported into and exported from the United +States. An actual operation followed through its successive +steps. + + + + +PREFACE + + +"Where can I find a little book from which I can get a clear idea of +how foreign exchange works, without going too deeply into it?"--that +question, put to the author dozens of times and by many different kinds +of people, is responsible for the existence of this little work. There +_are_ one or two well-written textbooks on foreign exchange, but never +yet has the author come across a book which covered this subject in +such a way that the man who knew little or nothing about it could pick +up the book and within a few hours get a clear idea of how foreign +exchange works,--the causes which bear upon its movement, its influence +on the money and security markets, etc. + +That is the object of this little book--to cover the ground of foreign +exchange, but in such a way as to make the subject interesting and its +treatment readable and comprehensible to the man without technical +knowledge. Foreign exchange is no easy subject to understand; there are +few important subjects which are. But, on the other hand, neither is it +the complicated and abstruse subject which so many people seem to +consider it--an idea only too often born of a look into some of the +textbooks on exchange, with their formidable pages of tabulations, +formulas, and calculations of all descriptions. For the average man +there is little of interest in these intricacies of the subject. Many +of the shrewdest and most successful exchange bankers in New York City, +indeed, know less about them than do some of their clerks. What is +needed is rather a clear and definite knowledge of the movement of +exchange--why it moves as it does, what can be read from its movements, +what effects its movements exert on the other markets. It is in the +hope that something may be added to the general understanding of these +important matters that this little book is offered to the public. + + + + +THE ELEMENTS OF FOREIGN EXCHANGE + + + + +CHAPTER I + +WHAT FOREIGN EXCHANGE IS AND WHAT BRINGS IT INTO EXISTENCE + + +Underlying the whole business of foreign exchange is the way in which +obligations between creditors in one country and debtors in another +have come to be settled--by having the creditor draw a draft directly +upon the debtor or upon some bank designated by him. A merchant in New +York has sold a bill of goods to a merchant in London, having thus +become his creditor, say, for $5,000. To get his money, the merchant in +New York will, in the great majority of cases, draw a sterling draft +upon the debtor in London for a little over L1,000. This draft his +banker will readily enough convert for him into dollars. The buying and +selling and discounting of countless such bills of exchange constitute +the very foundation of the foreign exchange business. + +Not all international obligations are settled by having the creditor +draw direct on the debtor. Sometimes gold is actually sent in payment. +Sometimes the debtor goes to a banker engaged in selling drafts on the +city where the obligation exists, gets such a draft from him and sends +that. But in the vast majority of cases payment is effected as +stated--by a draft drawn directly on the buyer of the goods. John Smith +in London owes me money. I draw on him for L100, take the draft around +to my bank and sell it at, say, 4.86, getting for it a check for +$486.00. I have my money, and I am out of the transaction. + +Obligations continually arising in the course of trade and finance +between firms in New York and firms in London, it follows that every +day in New York there will be merchants with sterling drafts on London +which they are anxious to sell for dollars, and vice versa. The supply +of exchange, therefore, varies with the obligations of one country to +another. If merchants in New York, for instance, have sold goods in +quantity in London, a great many drafts on London will be drawn and +offered for sale in the New York exchange market. The supply, it will +of course be apparent, varies. Sometimes there are many drafts for +sale; sometimes very few. When there are a great many drafts offering, +their makers will naturally have to accept a lower rate of exchange +than when the supply is light. + +The par of exchange between any two countries is the price of the gold +unit of one expressed in the money of the other. Take England and the +United States. The gold unit of England is the pound sterling. What is +the price of as much gold as there is in a new pound sterling, +expressed in American money? $4.8665. That amount of dollars and cents +at any United States assay office will buy exactly as much gold as +there is contained in a new British pound sterling, or sovereign, as +the actual coin itself is called. 4.8665 is the mint par of exchange +between Great Britain and the United States. + +The fact that the gold in a new British sovereign (or pound sterling) +is worth $4.8665 in our money by no means proves, however, that drafts +payable in pounds in London can always be bought or sold for $4.8665 +per pound. To reduce the case to a unit basis, suppose that you owed +one pound in London, and that, finding it difficult to buy a draft to +send in payment, you elected to send actual gold. The amount of gold +necessary to settle your debt would cost $4.8665, in addition to which +you would have to pay all the expenses of remitting. It would be +cheaper, therefore, to pay considerably more than $4.8665 for a +one-pound draft, and you would probably bid up until somebody consented +to sell you the draft you wanted. + +Which goes to show that the mint par is not what governs the price at +which drafts in pounds sterling can be bought, but that demand and +supply are the controlling factors. There are exporters who have been +shipping merchandise and selling foreign exchange against the shipments +all their lives who have never even heard of a mint par of exchange. +All they know is, that when exports are running large and bills in +great quantity are being offered, bankers are willing to pay them only +low rates--$4.83 or $4.84, perhaps, for the commercial bills they want +to sell for dollars. Conversely, when exports are running light and +bills drawn against shipments are scarce, bankers may be willing to pay +4.87 or 4.88 for them. + +For a clear understanding of the mechanics of the exchange market there +is necessary a clear understanding of what the various forms of +obligations are which bring foreign exchange into existence. +Practically all bills originate from one of the following causes: + + 1. Merchandise has been shipped and the shipper draws his draft on + the buyer or on a bank abroad designated by him. + + 2. Securities have been sold abroad and the seller is drawing on + the buyer for the purchase price. + + 3. Foreign money is being loaned in this market, the operation + necessitating the drawing of drafts on the lender. + + 4. Finance-bills are being drawn, _i.e._, a banker abroad is + allowing a banker here to draw on him in pounds sterling at 60 or + 90 days' sight in order that the drawer of the drafts may sell them + (for dollars) and use the proceeds until the drafts come due and + have to be paid. + +1. Looking at these sources of supply in the order in which they are +given, it is apparent, first, what a vast amount of foreign exchange +originates from the direct export of merchandise from this country. +Exports for the period given below have been as follows: + + 1913 $2,465,884,000 + 1912 2,204,322,000 + 1911 2,049,320,000 + 1910 1,744,984,000 + 1909 1,663,011,000 + +Not all of this merchandise is drawn against; in some cases the buyer +abroad chooses rather to secure a dollar draft on some American bank +and to send that in payment. But in the vast majority of cases the +regular course is followed and the seller here draws on the buyer +there. + +There are times, therefore, when exchange originating from this source +is much more plentiful than at others. During the last quarter of each +year, for instance, when the cereal and cotton crop exports are at +their height, exchange comes flooding into the New York market from all +over the country, literally by the hundreds of millions of dollars. The +natural effect is to depress rates--sometimes to a point where it +becomes possible to use the cheaply obtainable exchange to buy gold on +the other side. + +In a following chapter a more detailed description of the New York +exchange market is given, but in passing, it is well to note how the +whole country's supply of commercial exchange, with certain exceptions, +is focussed on New York. Chicago, Philadelphia, and one or two other +large cities carry on a pretty large business in exchange, independent +of New York, but by far the greater part of the commercial exchange +originating throughout the country finds its way to the metropolis. For +in New York are situated so many banks and bankers dealing in bills of +exchange that a close market is always assured. The cotton exporter in +Memphis can send the bills he has drawn on London or Liverpool to his +broker in New York with the fullest assurance that they will be sold to +the bankers at the highest possible rate of exchange anywhere +obtainable. + +2. The second source of supply is in the sale abroad of stocks and +bonds. Here again it will be evident how the supply of bills must vary. +There are times when heavy flotations of bonds are being made here with +Europe participating largely, at which times the exchange drawn against +the securities placed abroad mounts up enormously in volume. Then again +there are times when London and Paris and Berlin buy heavily into our +listed shares and when every mail finds the stock exchange houses here +drawing millions of pounds, marks, and francs upon their correspondents +abroad. At such times the supply of bills is apt to become very great. + +Origin of bills from this source, too, is apt to exert an important +influence on rates, in that it is often sudden and often concentrated +on a comparatively short period of time. The announcement of a single +big bond issue, often, where it is an assured fact that a large part of +it will be placed abroad, is enough to seriously depress the exchange +market. Bankers know that when the shipping abroad of the bonds begins, +large amounts of bills drawn against them will be offered and that +rates will in all probability be driven down. + +Announcements of such issues, as well as announcements that a block of +this or that kind of bonds has been placed abroad with some foreign +syndicate, are apt to come suddenly and often find the exchange market +unprepared. For the supply of exchange originated thereby, it must be +remembered, is not confined to the amount actually drawn against bonds +sold but includes also all the exchange which other bankers, in their +anticipation of lower rates, hasten to draw. The exchange market is, +indeed, a sensitive barometer, from which those who understand it can +read all sorts of coming developments. It often happens that buying or +selling movements in our securities by the foreigners are so clearly +forecasted by the action of the exchange market that bankers here are +able to gain great advantage from what they are able to foresee. + +3. The third great source of supply is in the drafts which bankers in +one country draw upon bankers in another in the operation of making +international loans. The mechanism of such transactions will be treated +in greater detail later on, but without any knowledge of the subject +whatever, it is plain that the transfer of banking capital, say from +England to the United States, can best be effected by having the +American house draw upon the English bank which wants to lend the +money. In the finely adjusted state of the foreign exchanges nowadays, +loans are continually being made by bankers in one country to bankers +and merchants in another. Very little of the capital so transferred +goes in the form of gold. A London house decides to loan, say, $100,000 +in the American market. The terms having been arranged, the London +house cables its New York correspondent to draw for L20,000, at 60 or +90 days' sight, as the case may be. The New York house, having drawn +the draft, sells it in the exchange market, realizing on it the +$100,000, which it then proceeds to loan out according to instructions. + +The arranging of these loans, it will be seen, means the continuous +creation of very large amounts of foreign exchange. As the financial +relationships between our bankers and those of the Old World have been +developed, it has come about that European money is being put out in +this market in increasing volume. Conditions of money, discount, and +exchange are constantly being watched for the opportunity to make loans +on favorable terms, and the aggregate of foreign money loaned out here +at times reaches very large figures. In 1901 Europe had big amounts of +money outstanding in the New York market, and again in 1906 very large +sums of English and French capital were temporarily placed at our +disposal. But in the summer of 1909 all records were surpassed, +American borrowings in London and Paris footing up to at least half a +billion dollars. Such loans, running only a couple of months on the +average and then being sometimes paid off, but more often shifted about +or renewed, give rise to the drawing of immense amounts of foreign +exchange. + +4. Drawing of so-called "finance-bills," of which a complete +description will be found in chapters IV and VI, is the fourth source +whence foreign exchange originates. Whenever money rates become +decidedly higher in one of the great markets than in the others, +bankers at that point who have the requisite facilities and credit, +arrange with bankers in other markets to allow them (the bankers at the +point where money is high) to draw 60 or 90 days' sight bills. These +bills can then be disposed of in the exchange market, dollars being +realized on them, which can then be loaned out during the whole life of +the bills. The advantages or dangers of such an operation will not be +touched upon here, the purpose of this chapter being merely to set +forth clearly the sources from which foreign exchange originates. + +And when money is decidedly higher in New York than in London an +immense volume of foreign exchange does originate from this source. A +number of firms and banks, with either their own branches in London or +with correspondents there to whom they stand very close, are in a +position where they can draw very large amounts of finance bills +whenever they deem it profitable and expedient to do so. Eventually, of +course, these 60 and 90 day bills come due and have to be settled by +remittances of demand exchange, but in the meantime the house which +drew them will have had the unrestricted use of the money. In a market +like New York this is only too often a prime consideration. With money +rates soaring as they do so frequently here, a banker can pay almost +any commission his correspondent abroad demands and still come out +ahead on the transaction. + +These are the principal sources from which foreign exchange +originates--shipments of merchandise, sales abroad of securities, +transfer of foreign banking capital to this side, sale of +finance-bills. Other causes of less importance--interest and profits on +American capital invested in Europe, for instance--are responsible for +the existence of some quantity of exchange, but the great bulk of it +originates from one of the four sources above set forth. In the next +chapter effort will be made to show whence arises the demand which +pretty effectually absorbs all the supply of exchange produced each +year. + + + + +CHAPTER II + +THE DEMAND FOR BILLS OF EXCHANGE + + +Turning now to consideration of the various sources from which springs +the demand for foreign exchange, it appears that they can be divided +about as follows: + + 1. The need for exchange with which to pay for imports of + merchandise. + + 2. The need for exchange with which to pay for securities (American + or foreign) purchased by us in Europe. + + 3. The necessity of remitting abroad the interest and dividends on + the huge sums of foreign capital invested here, and the money which + foreigners domiciled in this country are continually sending home. + + 4. The necessity of remitting abroad freight and insurance money + earned here by foreign companies. + + 5. Money to cover American tourists' disbursements and expenses of + wealthy Americans living abroad. + + 6. The need for exchange with which to pay off maturing foreign + short-loans and finance-bills. + +1. Payment for merchandise imported constitutes probably the most +important source of demand for foreign exchange. Merchandise brought +into the country for the period given herewith has been valued as +follows: + + 1913 $1,813,008,000 + 1912 1,653,264,000 + 1911 1,527,226,000 + 1910 1,556,947,000 + 1909 1,311,920,000 + +Practically the whole amount of these huge importations has had to be +paid for with bills of exchange. Whether the merchandise in question is +cutlery manufactured in England or coffee grown in Brazil, the chances +are it will be paid for (under a system to be described hereafter) by a +bill of exchange drawn on London or some other great European financial +center. From one year's end to the other there is constantly this +demand for bills with which to pay for merchandise brought into the +country. As in the case of exports, which are largest in the Fall, +there is much more of a demand for exchange with which to pay for +imports at certain times of the year than at others, but at all times +merchandise in quantity is coming into the country and must be paid for +with bills of exchange. + +2. The second great source of demand originates out of the necessity of +making payment for securities purchased abroad. So far as the American +participation in foreign bond issues is concerned, the past few years +have seen very great developments. We are not yet a people, as are the +English or the French, who invest a large proportion of their accumulated +savings outside of their own country, but as our investment surplus has +increased in size, it _has_ come about that American investors have +been going in more and more extensively for foreign bonds. There have +been times, indeed, as when the Japanese loans were being floated, when +very large amounts of foreign exchange were required to pay for the +bonds taken by American individuals and syndicates. + +Security operations involving a demand for foreign exchange are, +however, by no means confined to American participation in foreign bond +issues. Accumulated during the course of the past half century, there +is a perfectly immense amount of American securities held all over +Europe. The greater part of this investment is in bonds and remains +untouched for years at a stretch. But then there come times when, for +one reason or another, waves of selling pass over the European holdings +of "Americans," and we are required to take back millions of dollars' +worth of our stocks and bonds. Such selling movements do not really get +very far below the surface--they do not, for instance, disturb the +great blocks of American bonds in which so large a proportion of many +of the big foreign fortunes are invested, but they are apt to be, +nevertheless, on a scale which requires large amounts of exchange to +pay for what we have had to buy back. + +The same thing is true with stocks, though in that case the selling +movements are more frequent and less important. Europe is always +interested heavily in American stocks, there being, as in the case of +bonds, a big fixed investment of capital, beside a continually +fluctuating "floating-investment." In other words, aside from their +fixed investments in our stocks, the foreigners are continually +speculating in them and continually changing their position as buyers +and sellers. Selling movements such as these do not materially affect +Europe's set position on our stocks, but they do result at times in +very large amounts of our stocks being dumped back upon us--sometimes +when we are ready for them, sometimes when the operation is decidedly +painful, as in the Fall of 1907. In any case, when Europe sells, we +buy. And when we buy, and at the rate of millions of dollars' worth a +day, there is a big demand for exchange with which to pay for what we +have bought. + +3. So great is the foreign investment of capital in this country that +the necessity of remitting the interest and dividends alone means +another continuous demand for very large amounts of foreign exchange. +Estimates of how much European money is invested here are little better +than guesses. The only sure thing about it is that the figures run well +up into the billions and that several hundred millions of dollars' +worth of interest and dividends must be sent across the water each +year. There are, in the first place, all the foreign investments in +what might be called private enterprise--the English money, for +instance, invested in fruit orchards, gold and copper mines, etc., in +the western states. Profits on this money are practically all remitted +back to England, but no way exists of even estimating what they amount +to. Aside from that there are all the foreign holdings of bonds and +stocks in our great public corporations, holdings whose ownership it is +impossible to trace. Only at the interest periods at the beginning and +middle of each year does it become apparent how large a proportion of +our bonds are held in Europe and how great is the demand for exchange +with which to make the remittances of accrued interest. At such times +the incoming mails of the international banking houses bulge with great +quantities of coupons sent over here for collection. For several weeks +on either side of the two important interest periods, the exchange +market feels the stimulus of the demand for exchange with which the +proceeds of these masses of coupons are to be sent abroad. + +4. Freights and insurance are responsible for a fourth important source +of demand for foreign exchange. A walk along William Street in New York +is all that is necessary to give a good idea of the number and +importance of the foreign companies doing business in the United +States. In some form or other all the premiums paid have to be sent to +the other side. Times come, of course, like the year of the Baltimore +fire, when losses by these foreign companies greatly outbalance +premiums received, the business they do thus resulting in the actual +_creation_ of great amounts of foreign exchange, but in the long +run--year in, year out--the remitting abroad of the premiums earned +means a steady demand for exchange. + +With freights it is the same proposition, except that the proportion of +American shipping business done by foreign companies is much greater +than the proportion of insurance business done by foreign companies. +Since the Civil War the American mercantile marine instead of growing +with the country has gone steadily backward, until now the greater part +of our shipping is done in foreign bottoms. Aside from the other +disadvantages of such a condition, the payment of such great sums for +freight to foreign companies is a direct economic drain. An estimate +that the yearly freight bill amounts to $150,000,000 is probably not +too high. That means that in the course of every year there is a demand +for that amount of exchange with which to remit back what has been +earned from us. + +5. Tourists' expenditures abroad are responsible for a further heavy +demand for exchange. Whether it is because Americans are fonder of +travel than the people of other countries or whether it is because of +our more or less isolated position on the map, it is a fact that there +are far more Americans traveling about in Europe than people belonging +to any other nation. And the sums spent by American tourists in foreign +lands annually aggregate a very large amount--possibly as much as +$175,000,000--all of which has eventually to be covered by remittances +of exchange from this side. + +Then again there must be considered the expenditures of wealthy +Americans who either live abroad entirely or else spend a large part of +their time on the other side. During the past decade it has come about +that every European city of any consequence has its "American Colony," +a society no longer composed of poor art students or those whose +residence abroad is not a matter of volition, but consisting now of +many of the wealthiest Americans. By these expatriates money is spent +extremely freely, their drafts on London and Paris requiring the +frequent replenishment, by remittances of exchange from this side, of +their bank balances at those points. Furthermore, there must be +considered the great amounts of American capital transferred abroad by +the marriage of wealthy American women with titled foreigners. Such +alliances mean not only the transfer of large amounts of capital _en +bloc_, but mean as well, usually, an annual remittance of a very large +sum of money. No account of the money drained out of the country in +this way is kept, of course, but it is an item which certainly runs up +into the tens of millions. + +6. Lastly, there is the demand for exchange originating from the paying +off of the short-term loans which European bankers so continuously make +in the American market. There is never a time nowadays when London and +Paris are lending American bankers less than $100,000,000 on 60 or 90 +day bills, while the total frequently runs up to three or four times +that amount. The sum of these floating loans is, indeed, changing all +the time, a circumstance which in itself is responsible for a demand +for very great amounts of foreign exchange. + +Take, for instance, the amount of French and English capital employed +in this market in the form of short-term loans; $250,000,000 is +probably a fair estimate of the average amount, and 90 days a fair +estimate of the average time the loans run before being paid off or +renewed. That means that the quarter of a billion dollars of floating +indebtedness is "turned over" four times a year and _that_ means that +every year the rearrangement of these loans gives rise to a demand for +a billion dollars' worth of foreign exchange. These loaning operations, +it must be understood, both originate exchange and create a demand for +it. They are mentioned, therefore, in the preceding chapter, as one of +the sources from which exchange originates, and now as one of the +sources from which, during the course of every year, springs a demand +for a very great quantity of exchange. + +The six sources of demand for exchange, then, are for the payment for +imports; for securities purchased abroad; for the remitting abroad of +interest on foreign capital invested here and the money which +foreigners in this country send home; for remitting freight and +insurance profits earned by foreign companies here; for tourists' +expenses abroad; and lastly, for the paying off of foreign loans. From +these sources spring practically all the demand for exchange. In the +last chapter there were set forth the principal sources of supply. With +a clear understanding of where exchange comes from and of where it +goes, it ought now to be possible for the student of the subject to +grasp the causes which bear on the movement of exchange rates. That +subject will accordingly be taken up in the next chapter. + + + + +CHAPTER III + +THE RISE AND FALL OF EXCHANGE RATES + + +Granted that the obligations to each other of any two given countries +foot up to the same amount, it is evident that the rate of exchange +will remain exactly at the gold par--that in New York, for instance, +the price of the sovereign will be simply the mint value of the gold +contained in the sovereign. But between no two countries does such a +condition exist--take any two, and the amount of the obligation of one +to the other changes every day, which causes a continuous fluctuation +in the exchange rate--sometimes up from the mint par, sometimes down. + +Before going on to discuss the various causes influencing the movement +of exchange rates, there is one point which should be very clearly +understood. _Two_ countries, at least, are concerned in the fluctuation +of every rate. Take, for example, London and New York, and assume that, +at New York, exchange on London is falling. That in itself means that, +in London, exchange on New York is rising. + +For the sake of clearness, in the ensuing discussion of the influences +tending to raise and lower exchange rates, New York is chosen as the +point at which these influences are operative. Consideration will be +given first to the influences which cause exchange to go up. In a +general way, it will be noticed, they conform with the sources of +demand for exchange given in the previous chapter. They may be +classified about as follows: + + 1. Large imports, calling for large amounts of exchange with which + to make the necessary payments. + + 2. Large purchases of foreign securities by us, or repurchase of + our own securities abroad, calling for large amounts of exchange + with which to make payment. + + 3. Coming to maturity of issues of American bonds held abroad. + + 4. Low money rates here, which result in a demand for exchange with + which to send banking capital out of the country. + + 5. High money rates at some foreign centre which create a great + demand for exchange drawn on that centre. + +1. Heavy imports are always a potent factor in raising the level of +exchange rates. Under whatever financial arrangement or from whatever +point merchandise is imported into the United States, payment is almost +invariably made by draft on London, Paris, or Berlin. At times when +imports run especially heavy, demand from importers for exchange often +outweighs every other consideration, forcing rates up to high levels. A +practical illustration is to be found in the inpour of merchandise +which took place just before the tariff legislation in 1909. Convinced +that duties were to be raised, importers rushed millions of dollars' +worth of merchandise of every description into the country. The result +was that the demand for exchange became so great that in spite of the +fact that it was the season when exports normally meant low exchange, +rates were pushed up to the gold export point. + +2. Heavy purchasing movements of our own or foreign securities, on the +other side, are the second great influence making for high exchange. +There come times when, for one reason or another, the movement of +securities is all one way, and when it happens that for any cause we +are the ones who are doing the buying, the exchange market is likely to +be sharply influenced upward by the demand for bills with which to make +payments. Such movements on a greater or less scale go on all the time +and constitute one of the principal factors which exchange managers +take into consideration in making their estimate of possible exchange +market fluctuations. + +It is interesting, for instance, to note the movement of foreign +exchange at times when a heavy selling movement of American stocks by +the foreigners is under way. Origin of security-selling on the Stock +Exchange is by no means easy to trace, but there are times when the +character of the brokers doing the selling and the very nature of the +stocks being disposed of mean much to the experienced eye. Take, for +instance, a day when half a dozen brokers usually identified with the +operations of the international houses are consistently selling such +stocks as Missouri, Kansas & Texas, Baltimore & Ohio, or Canadian +Pacific--whether or not the inference that the selling is for foreign +account is correct can very probably be read from the movement of the +exchange market. If it is the case that the selling comes from abroad +and that _we_ are buying, large orders for foreign exchange are almost +certain to make their appearance and to give the market a very strong +tone if not actually to urge it sharply upward. Such orders are not +likely to be handled in a way which makes them apparent to everybody, +but as a rule it is impossible to execute them without creating a +condition in the exchange market apparent to every shrewd observer. +And, as a matter of fact, many an operation in the international stocks +is based upon judgment as to what the action of the exchange market +portends. Similarly--the other way around--exchange managers very +frequently operate in exchange on the strength of what they judge or +know is going to happen in the market for the international stocks. +With the exchange market sensitive to developments, knowledge that +there is to be heavy selling in some quarter of the stock market, from +abroad, is almost equivalent to knowledge of a coming sharp rise in +exchange on London. + +Perhaps the best illustration of how exchange can be affected by +foreign selling of our securities occurred just after the beginning of +the panic period in October of 1907. Under continuous withdrawals of +New York capital from the foreign markets, exchange had sold down to a +very low point. Suddenly came the memorable selling movement of +"Americans" by English and German investors. Within two or three days +perhaps a million shares of American stocks were jettisoned in this +market by the foreigners, while exchange rose by leaps and bounds +nearly 10 cents to the pound, to the unheard-of price of 4.91. Nobody +had exchange to sell and almost overnight there had been created a +demand for tens of millions of dollars' worth. + +3. The coming to maturity of American bonds held abroad is another +influencing factor closely kept track of by dealers in exchange. So +extensive is the total foreign investment in American bonds that issues +are coming due all the time. Where some especially large issue runs off +without being funded with new bonds, demand for exchange often becomes +very strong. Especially is this the case with the short-term issues of +the railroads and most especially with New York City revenue warrants +which have become so exceedingly popular a form of investment among the +foreign bankers. In spite of its mammoth debt, New York City is +continually putting out revenue warrants, the operation amounting, in +fact, to the issue of its notes. Of late years Paris bankers, +especially, have found the discounting of these "notes" a profitable +operation and have at times taken them in big blocks. + +Whenever one of these blocks of revenue warrants matures and has to be +paid off, the exchange market is likely to be strongly affected. +Accumulation of exchange in preparation is likely to be carried on for +some weeks ahead, but even at that the resulting steady demand for +bills often exerts a decidedly stimulating influence. Experienced +exchange managers know at all times just what short-term issues are +coming due, about what proportion of the bonds or notes have found +their way to the other side, just how far ahead the exchange is likely +to be accumulated. Repayment operations of this kind are often almost a +dominant, though usually temporary, influence on the price of exchange. + +4. Low money rates are the fourth great factor influencing foreign +exchange upward. Whenever money is cheap at any given center, and +borrowers are bidding only low rates for its use, lenders seek a more +profitable field for the employment of their capital. It has come about +during the past few years that so far as the operation of loaning money +is concerned, the whole financial world is one great market, New York +bankers nowadays loaning out their money in London with the same +facility with which they used to loan it out in Boston or Philadelphia. +So close have become the financial relationships between leading +banking houses in New York and London that the slightest opportunity +for profitable loaning operations is immediately availed of. + +Money rates in the New York market are not often less attractive than +those in London, so that American floating capital is not generally +employed in the English market, but it does occasionally come about +that rates become abnormally low here and that bankers send away their +balances to be loaned out at other points. During long periods of low +money, indeed, it often happens that large lending institutions here +send away a considerable part of their deposits, to be steadily +employed for loaning out and discounting bills in some foreign market. +Such a time was the long period of stagnant money conditions following +the 1907 panic. Trust companies and banks who were paying interest on +large deposits at that time sent very large amounts of money to the +other side and kept big balances running with their correspondents at +such points as Amsterdam, Copenhagen, St. Petersburg, etc.,--anywhere, +in fact, where some little demand for money actually existed. Demand +for exchange with which to send this money abroad was a big factor in +keeping exchange rates at their high level during all that long period. + +5. High money rates at some given foreign point as a factor in +elevating exchange rates on that point might almost be considered as a +corollary of low money here, but special considerations often govern +such a condition and make it worth while to note its effect. Suppose, +for instance, that at a time when money market conditions all over the +world are about normal, rates, for any given reason, begin to rise at +some point, say London. Instantly a flow of capital begins in that +direction. In New York, Paris, Berlin and other centers it is realized +that London is bidding better rates for money than are obtainable +locally, and bankers forthwith make preparations to increase the +sterling balances they are employing in London. Exchange on that +particular point being in such demand, rates begin to rise, and +continue to rise, according to the urgency of the demand. + +Particular attention will be given later on to the way in which the +Bank of England and the other great foreign banks manipulate the money +market and so control the course of foreign exchange upon themselves, +but in passing it is well to note just why it is that when the interest +rate at any given point begins to go up, foreign exchange drawn upon +that point begins to go up, too. Remittances to the point where the +better bid for money is being made, are the very simple explanation. +Bankers want to send money there, and to do it they need bills of +exchange. An urgent enough demand inevitably means a rise in the +quotation at which the bills are obtainable. Which suggests very +plainly why it is that when the Directors of the Bank of England want +to raise the rate of exchange upon London, at New York or Paris or +Berlin, they go about it by tightening up the English money market. + +The foregoing are the principal causes making for high exchange. The +causes which make up for low rates must necessarily be to a certain +extent merely the converse, but for the sake of clearness they are set +down. The division is about as follows: + + 1. Especially heavy exports of merchandise. + + 2. Large purchases of our stocks by the foreigners and the placing + abroad of blocks of American bonds. + + 3. Distrust on our part of financial conditions existing at some + point abroad where there are carried large deposits of American + capital. + + 4. High money rates here. + + 5. Unprofitably low loaning rates at some important foreign centre + where American bankers ordinarily carry large balances on deposit. + +1. Just as unusually large imports of commodities mean a sharp demand +for exchange with which to pay for them, unusually large exports mean a +big supply of bills. In a previous chapter it has been explained how, +when merchandise is shipped out of the country, the shipper draws his +draft upon the buyer, in the currency of the country to which the +merchandise goes. When exports are heavy, therefore, a great volume of +bills of exchange drawn in various kinds of currency comes on the +market for sale, naturally depressing rates. + +Exports continue on a certain scale all through the year, but, like +imports, are heavier at some times than others. In the Fall, for +instance, when the year's crops are being exported, shipments out of +the country invariably reach their zenith, the export nadir being +approached in midsummer, when the crop has been mostly exported and +shipments of manufactured goods are running light. + +From the middle of August, when the first of the new cotton crop begins +to find its way to the seaport, until the middle of December, when the +bulk of the corn and wheat crop exports have been completed, exchange +in very great volume finds its way into the New York market. Normally +this is the season of low rates, for which reason many shippers of +cotton and grain, who know months in advance approximately how much +they will ship, contract ahead of time with exchange dealers in New +York for the sale of the bills they know they will have. By so doing, +shippers are often able to obtain very much better rates. They can then +protect themselves, at least, from the extremely low rates which they +may be forced to take if they wait and accept going rates at a time +when shippers all over the country are trying to sell their bills at +the same time. + +How great is the rush of exchange into market may be seen from the +statistics of cotton exports during the period given below. Not all of +this cotton goes out during the last four months of the year, but the +greater part of it does and, furthermore, cotton, while the most +important, is only _one_ of the domestic products exported in the +autumn. + + MONEY VALUE OF COTTON EXPORTED + + 1913 $547,357,000 + 1912 565,849,000 + 1911 585,318,000 + 1910 450,447,000 + 1909 417,390,000 + +During the autumn months, under normal conditions, the advantage is all +with the buyer of foreign exchange. By every mail huge packages of +bills, drawn against shipments of cotton, wheat and corn, come pouring +into the New York market. Bankers' portfolios become crowded with +bills; remittances by each steamer, in the case of some of the big +bankers, run up, literally, into the millions of dollars. Naturally, +any one wanting bankers' exchange is usually able to secure it at a low +price. + +2. With regard to the second influence making for low exchange, sale of +American bonds or stocks abroad, no season can be set when the +influence is more likely to be operative than at any other, unless, +possibly, it be the Spring, when money rates are more apt to be low and +bond issues larger than at any other time of the year. No time, +however, can be definitely set--there are years when the bulk of the +new issues are brought out in the Spring and other years when the Fall +season sees most of the new financing. But whatever the time of the +year, one thing is certain--the issue of any amount of American bonds +with Europe participating largely means a full supply of foreign +exchange not only during the time the issues are actually being brought +out, but for long afterward. + +There used to be a saying among exchange dealers that cotton exports +make exchange faster than anything, but nowadays bond sales abroad have +come to take first place. For foreign participation in syndicates +formed to underwrite new issues almost invariably means the drawing of +bills representing the full amount of the foreign participation. A +syndicate is formed, for instance, to take off the hands of the X Y Z +railroad $30,000,000 of new bonds, the arrangement being that the +railroad is to receive its money at once and that the syndicate is to +take its own time about working off the bonds. Half the amount, say, +has been allotted to foreign houses. Immediately, the drawing of +L3,000,000, or francs 75,000,000, as the case may be, begins. The +foreign houses have to raise the money, and in nine cases out of ten, +their way of doing it is to arrange with some representative abroad to +let them draw long drafts, against the deposit of securities on this +side. These drafts, in pounds or francs, at sixty to ninety days' +sight, they can sell in the exchange market for dollars, thus securing +the money they have agreed to turn over to the railroad. In the +meantime, during the life of the drafts they have set afloat and before +they come due and have to be paid off, the bankers here can go about +selling the bonds and getting back their money. Perhaps before the +sixty or ninety days, as the case may be, are over, the syndicate may +have sold out all its bonds and its foreign members have been put in a +position where they can pay off all the drafts they set afloat +originally in order to raise the money. + +Very often, however, it will happen that on account of one reason or +another, sixty days pass or ninety days pass without the syndicate +having been able to dispose of its bonds. In that case the long bills +drawn on the foreign bankers have to be "renewed"--that being a process +for which ample provision has, of course, been made. In a succeeding +chapter, full description of how long bills of exchange coming due are +renewed will be made. Just here it is only necessary to say that most +or all of the money necessary to pay off the maturing bills is raised +by selling another batch of "sixties" or "nineties," an operation which +throws the maturity two or three months further ahead. + +From this outline of the way foreign participation in American bond +issues is financed, it can be seen that every time a big issue of bonds +of a railroad or industrial in which European investors are actively +interested, is brought out, it means a large supply of foreign exchange +created and suddenly thrown on the exchange market for sale. Not any +more suddenly or publicly than the bankers concerned can help, but +still necessarily so to a great degree, because big bond issues can +only be made with the full knowledge and cooeperation of a large part of +the public. Bankers who know in advance of large issues likely to be +made and in which they know they will be asked to participate, often +sell "futures" covering the exchange they foresee their participation +will bring into existence, but as a general rule it may be set down +that heavy issues, involving the sale abroad of large amounts of bonds, +are a most depressing factor on the foreign exchange market. Especially +so, as the participants who have agreed to turn over the money to the +railroad, must sell bills to raise it, even if the horde of speculators +and "trailers" who are always on the lookout for such opportunities, +make every effort to sell the market out from under their feet. + +3. Uneasiness with regard to the stability of the financial situation +at some point abroad where American bankers usually carry large +balances is another circumstance which often depresses the exchange +market sharply. "Trouble in the Balkans" and "trouble over the Moroccan +situation" are two bugbears which have for years back furnished the +keynote for many swoops downward in the exchange market, and for years +after this book is published will probably continue to do so. Money on +deposit at a point several thousand miles away is naturally very +sensitive, and the least suspicion of financial trouble is sufficient +to cause its withdrawal. Withdrawal of bankers' balances from a foreign +city means offerings of exchange drawn on that point with resultant +decline in rates. + +In the everyday life of the exchange market, political developments of +an unfavorable character and war rumors are about the most frequent and +potent influences toward the condition of uneasiness above referred to. +Few war rumors ever come to anything, but there are times when they +circulate with astonishing frequency and persistence and cause decided +uneasiness concerning financial conditions at important points. At such +times bankers having money on deposit at those points are apt to become +influenced by the drift of sentiment and to draw down their balances. +Here, again, operators in exchange, keenly on the alert for such +chances, will very likely begin to sell the exchange market short and +often succeed in breaking it to a degree entirely unwarranted by the +known facts. + +4. But of all the sure depressing influences on exchange, none is more +sure than a rise in the money market. More gradual usually than a +decline caused by such an influence as the sale of American bonds +abroad, the influence of a rising level of money rates is nevertheless +far more certain. + +The theory of this "counter" movement in money rates and exchange is +simply that when money rates rise, say at a point like New York, +American bankers find it profitable to draw in their deposits from all +over Europe for the purpose of using the money in New York. Such a +process means a wholesale drawing of bills of exchange on all the +leading European cities, with consequent offering of the bills and +price-depression in the leading American exchange markets. + +The number of banks scattered all over the United States which keep +running deposit accounts in the leading European cities has become +surprisingly great during the past ten years, and a movement to bring +home this capital has to go only a little way before it reaches very +large proportions. That is exactly what happens when money rates at a +point like New York become decidedly more attractive than they are over +on the other side. Arrangements with foreign correspondents usually +call for a minimum balance of considerable size, which must be left +intact, but under ordinary circumstances there is considerable leeway, +and when the better opportunity for loaning presents itself here, +drafts on balances abroad, in large aggregate amount, are apt to be +drawn and sold in this market. Especially is this the case when the +cause of the higher money level appears to be deep-rooted and the +outlook is for a continuance of the condition for some time to come. + +5. Lastly, as a depressing factor, there is to be considered the +condition which arises when money at some important foreign center, +such as London or Paris, begins to ease decidedly. Large receipts of +gold from the mines, a bettering political outlook--these or many other +causes may bring it about that money in London, for instance, after a +period of high rates, may ease off faster than in Berlin or Hamburg. As +a result, American bankers having large balances in London and finding +it difficult to employ them profitably there, any longer, either +withdraw them entirely or have the money transferred to some other +point. In either case the operation will result in depressing the rate +of exchange on London, for the American banker will either draw on +London himself or, if he wants to transfer the money to Berlin or +Hamburg, will instruct the German bankers by cable to draw for his +account on London. In whatever way it is accomplished, the withdrawal +of capital from any banking point tends to lower the rate of foreign +exchange on that point. + +These are the main influences bearing on the fluctuation of exchange. +Needless to say they are not exerted all one way, or one at a time, as +set forth. The international money markets are a most decidedly complex +proposition, and there is literally never a time when several +influences tending to put rates up are not conflicting with several +influences tending to put rates down. The actual movement of the rate +represents the relative strength of the two sets of influences. To be +able to "size up" the influences present and to gauge what movement of +rates they will result in, is an operation requiring, first, knowledge, +then judgment. The former qualification can perhaps be derived, in +small degree, from study of the foregoing pages. The latter is a matter +of mental calibre and experience. + + + + +CHAPTER IV + +THE VARIOUS KINDS OF EXCHANGE + + +Before taking up the question of the activities of the foreign exchange +department and the question of how bankers make money dealing in +exchange, it may be well to fix in mind clearly what the various forms +of foreign exchange are. Following is a description of the most +important classes of bills bought and sold in the New York market: + +1. _Commercial Long Bills_ + +[Illustration: Form of Commercial Long Bill] + +Drafts drawn by shippers of merchandise upon buyers abroad, or upon the +banking representatives of the buyers abroad, at thirty days' sight or +more. The drafts may be accompanied by shipping documents or may be +"clean." The former kind of bill making up the greater part of the +whole amount of foreign exchange dealt in in the New York market, will +be described first. + +Suppose a cotton dealer in Memphis to have sold one hundred bales of +cotton to a spinner in Liverpool, the arrangement being that the +English buyer is to be drawn on at sixty days' sight. The first thing +the Memphis merchant does is to ship the cotton on its way to +Liverpool, receiving from the railroad company a receipt known as a +"bill of lading." At the same time he arranges for the insurance of the +cotton, receiving from the insurance company a little certificate +stating that the insurance has been effected. + +The next step is for the Memphis shipper to draw the draft on the +Liverpool buyer--or upon some bank abroad designated by the buyer. This +draft is drawn in pounds sterling for the equivalent of the dollar +value of the cotton and made payable sixty days after the party abroad +on whom it is drawn has seen it and written "accepted" across its face. +This draft, the bill of lading received from the shipping company, and +the insurance certificate received from the insurance company are then +pinned together and constitute a complete "commercial long bill with +documents attached." + +Other less important documents go with such a bill. Sometimes invoices +showing the weight and price of the cotton go along with it and +sometimes there is also attached a "hypothecation slip" which formally +turns over the right to the goods to the Memphis or New York banker who +buys the draft and accompanying documents from the Memphis cotton +shipper. Sometimes, too, insurance is effected by the buyer abroad, in +which case there may be no insurance certificate. But in the main, one +of these "documentary" commercial bills consists of the draft itself, +the bill of lading, and an insurance certificate. + +Having pinned the document and the draft together, the Memphis cotton +shipper is in possession of an instrument which he can dispose of for +dollars. This he does either by selling it to his bank in Memphis or by +sending it to New York, in order that it may be sold there in the +exchange market at the current rate of exchange. Say, the bill of +exchange is drawn on London at sixty days' sight, for L1,000. The +buying price for such a draft will be, perhaps, 4.84. The Memphis +shipper gets his check for $4,840, and is out of the transaction. The +bill has passed into a banker's hands, who will send it abroad--deposit +it in some foreign bank where he keeps a balance. + +As to the rate of 4.84 received by the shipper, it is to be noted that +had the bill been drawn at less than sixty days' sight, he would have +received more dollars for it, while if it had been drawn at more than +sixty days' sight, he would have received less for it. The longer the +banker who takes the draft off the shipper's hands has to wait until he +can get his money back on it, the lower, naturally, the rate of +exchange he is willing to pay. On the same day that demand drafts are +selling at 4.87, sixty-day drafts may be selling at 4.84 and ninety-day +drafts at 4.83. + +Assume, in this particular case, that the draft has been taken off the +shipper's hands by some foreign exchange banker in New York. By the +very first steamer the latter will forward it to his banking +correspondent abroad, with instructions to present it at once to the +parties on whom it is drawn, in order that they may mark it +"accepted--payable such-and-such-a-date." After that the bill is a +double obligation of the drawer and the drawee, and may be discounted +in the open market, for cash. + +Just here it is necessary to digress and state that documentary +commercial bills are of two kinds--"acceptance" bills and "payment" +bills. In the case of the first-named, the documents are delivered to +the party on whom the bill is drawn as soon as he "accepts" the bill, +which puts him in a position to get possession of the merchandise at +once. In the case of a "payment" bill, the credit of the man on whom it +is drawn is not good enough to entitle him to such a privilege, and the +only way he can get actual possession of the goods is to actually pay +the draft under a rebate-of-interest arrangement. All bills drawn on +banks are naturally "acceptance" bills; and being discountable and thus +immediately convertible into cash abroad, command a better rate of +exchange in the New York market than "payment" bills, which may be +allowed to run all the way to maturity before a single pound sterling +is paid on them. + +Except in the case of the shipment of perishable merchandise--grain +shipped in bulk, for instance. In that case the buyer on the other side +cannot afford to let the draft run, because the merchandise would +spoil. He is simply forced to pay it under rebate, in order to get +possession of the grain. And the rebate being always less than the +discount rate, less pounds sterling come off the face of the bill in +the process of _rebating_ than of _discounting_. For which reason +sixty-day bills drawn against shipments of grain--documents deliverable +only on payment under rebate--command a better rate of exchange even +than the very best of cotton "acceptance" bills drawn on banks. + + +2. _Clean Bills_ + +[Illustration: Form of Clean Bill] + +Where the drafts of the merchants of one country drawn upon the +merchants or bankers of another are unaccompanied by shipping documents +they are said to be "clean." Bills of this kind may originate from the +transfer of capital from one country to another or may represent +drawings against shipments of merchandise previously made. It is not +unusual, indeed, where the relationship between some foreign merchant +and some American merchant is very close, for the one to ship +merchandise to the other without drawing drafts against the shipment +until some little time afterward. It might happen, for instance, that a +cotton manufacturing firm in France wanted to import a lot of raw +cotton from the United States, but did not want to be drawn upon at the +time. Under such circumstances the American house might ship the goods +and send over the documents to the buyer, postponing its drawing for +some time. Eventually, of course, the American house would reimburse +itself by drawing, but the documents having gone forward long before, +the drafts would be what is known as "clean." + +Later on, in the chapter on the actual money-making operations of the +foreign department, the risk in buying various kinds of bills will be +fully explained, but in passing it may be mentioned that "clean" bills +are of such a nature that bankers will touch them only when drawn by +the very best houses. With a documentary bill, the banker holds the +bill of lading, and if there is any trouble about the acceptance or +payment of a draft, can simply seize the goods and sell them. But in +the case of a "clean" bill, he has absolutely no security. The standing +of the maker of the bill and what he knows about the maker's right to +draw the bill is all he has to go by in determining whether to buy it +or not. + + +3. _Documentary Commercial Bills Drawn at Short Sight_ + +[Illustration: Form of Documentary Commercial Sight Bill] + +A comparatively small part of our exports are sold on a basis where the +draft drawn is at less than thirty days' sight, but there are a good +many small bills of this kind continually coming into the market. +Drafts drawn against manufactured articles and against such products as +cheese, butter, dried fruits, etc., are apt to be drawn for, with +shipping documents attached, at anywhere from three to thirty days' +sight, but there is no rule about it. Where the "usance"--the time the +bill has to run--is only a few days, documents are apt to be +deliverable only on payment of the bills. + + +4. _Drafts Drawn Against Securities_ + +[Illustration: Form of Draft Drawn Against Securities] + +Exchange of this kind is naturally of the highest class, the stocks or +bonds against which it is drawn being almost always attached to the +bill of exchange. In the case of syndicate participations by large +houses, the bonds may be shipped abroad privately and exchange against +them drawn and sold independently, in which case, of course, no +security is attached, but as a rule the bonds or stocks go with the +draft. A, in New York, executes an order to buy for B in London, one +hundred Union Pacific preferred shares on the New York Stock Exchange. +The stock comes into A's office, and he pays for it with the proceeds +of a sterling draft he draws on B. The stock itself he attaches to this +sterling draft. Whoever buys the draft of him gets the stock with it +and keeps possession of it till the draft is presented and paid in +London. + + +5. _Bankers' Checks or Demand Drafts on Their Correspondents Abroad_ + +[Illustration: Form of Bankers' Check] + +Bankers who do a foreign exchange business, keeping large balances in +several European centers, are continually drawing and selling their +demand drafts--"checks," they are called, or "demand"--upon these +foreign balances. Such checks are always to be had in great volume in +the exchange market, the banker's business being to draw and sell +exchange, and his degree of willingness being merely a matter of rate. +There come times, of course, when bankers have every reason to leave +their foreign balances undisturbed, but even at such times the bid of a +high enough rate will usually bring about the drawing of bills. + + +6. _Bankers' Long Drafts_ + +[Illustration: Form of Bankers' Long Draft] + +In describing the nature of bankers' drawings of long bills, great care +must be taken to differentiate between the _different kinds_ of long +bills being bought and sold in the exchange market. A finance bill +looks exactly the same as a long bill drawn by a banker for a +commercial customer who wants to anticipate the payment abroad for an +incoming shipment of wool or shellac, but the nature and origin of the +two bills are radically different. The three main kinds of bankers' +long bills will thus be taken up in the following order: + + +A. _Bills Drawn in the Regular Course of Business_ + +Such is the nature of foreign exchange business that bankers engaged in +it are continually drawing their sixty and ninety days' sight bills in +response to their own and their customers' needs. One example which +might be cited is that of the importer who has a payment to make on the +other side, sixty days from now, but who, having the money on hand, +wants to make it at once. Under some circumstances such an importer +might remit a demand draft on the basis of receiving a rebate of +interest for the unexpired sixty days, but more likely he would go to a +banker and buy from him a sixty days' sight draft for the exact amount +of pounds he owed. The cost of such a draft--which would mature at the +time the debt became due--would be less than the cost of a demand +draft, the importer getting his rebate of interest out of the cheaper +price he pays for the pounds he needs. Prepayments of this sort are +responsible every day for very large drawings of bankers' long bills. + + +B. _Long Bills Issued in the Operation of Lending Foreign Money_ + +Bills of this kind represent by far the greater proportion of bankers' +long bills sold in the exchange market. European bankers keep an +enormous amount of floating capital loaned out in this market, in the +making and renewing of which loans long bills are created as follows: + +A banker on the other side decides to loan out, say, L100,000 in the +New York market. Arrangements having been made, he cables his New York +representative to draw ninety days' sight drafts on him for L100,000, +the proceeds of which drafts are then loaned out for account of the +foreign house. The matter of collateral, risk of exchange and, indeed, +all the other detail, will be fully described in the succeeding +chapters on how bankers make money out of exchange. For the time being +it is merely necessary to note that every time a loan of foreign +capital is made here--and there are days when millions of pounds are so +loaned out--bankers' long bills for the full amount of the loans are +created and find their way into the exchange market. + + +C. _Bankers' Long Bills Drawn for the Purpose of Raising Money_ + +Finance bills constitute the third kind of bankers' long exchange. In +this case, again, detailed discussion must be put off until the chapter +on foreign-exchange-bankers' operations, but the fact that bills of +this kind constitute so important a part of the bankers' long bills to +be had in the market, necessitates their classification in this place. +Every time a banker here starts to use his credit abroad for the +purpose of raising money--and there are times when the privilege is +pretty freely availed of--he does it by drawing sixty or ninety days' +sight drafts on his correspondents abroad. Finance bills, it may be +said without question, are one of the most interesting forms of foreign +exchange banking--at the same time one of the most useful and one of +the most abused of privileges coming to the domestic banker by reason +of his having strong banking connections abroad. + + + + +CHAPTER V + +THE FOREIGN EXCHANGE MARKET + + +The foreign exchange market is in every sense "open"--anyone with bills +to buy or sell and whose credit is all right can enter it and do +business on a par with anyone else. There is no place where the trading +is done, no membership, license or anything of the kind. The "market," +in fact, exists in name only; it is really constituted of a number of +banks, dealers and brokers, with offices in the same section of the +city, and who do business indiscriminately among themselves--sometimes +personally, sometimes by telephone, by messenger, or by the aid of the +continuously circulating exchange brokers. + +The system is about as follows: The larger banks and banking houses +have a foreign exchange manager, or partner, taking care of that part +of the business, whose office is usually so situated as to make him +accessible to the brokers who come in from the outside, and whose +telephoning and wiring facilities are very complete. These larger +houses have no brokers or "outside" men in their employ. The manager +knows very well that plenty of chance to do business, buying or +selling, will be brought in to him by the brokers and that his wires +keep him constantly in touch with his fellow bankers. + +Next come the big dealers in exchange, some of whom do a regular +exchange business of their own, the same as the bankers, but who also +have men out on the street "trading" between large buyers and sellers +of bills. Such houses are necessarily closely in touch with banks, +bankers, exporters, and importers all over the country, and have always +large orders on hand to buy and sell exchange. Some of the bills they +handle they buy and use for the conduct of their own business with +banks abroad, but the more important part of what they do is to deal in +foreign exchange among the banks. They are known as always having on +hand for sale large lines of commercial and bankers' bills, while on +the other hand they are always ready to buy, at the right price. + +After this class of houses come the regular brokers--the independent +and unattached individuals who spend their time trying to bring buyer +and seller together, and make a commission out of doing it. In a market +like New York the number of exchange brokers is very large. Like +bond-brokerage, the business requires little in the way of office +facilities or capital, and is attractive to a good many persons who are +willing to accept the small income to be made out of it in return for +being in a business where they are independent. + +Foreign exchange brokerage, like all other employment of the middleman, +is not what it used to be. Before the business became overcrowded as it +is now, exchange brokers made their quarter-cent in the pound +commission, and could depend on a respectable income. But nowadays +brokers swarm among the foreign exchange bankers and dealers, doing +business on any commission they can get, which is not infrequently as +little as 1/128 of one per cent., say, $1.50, for buying or selling +francs 100,000. In handling sterling, the broker is lucky if he makes +his five points (5/100 of a cent per pound), which means that for +turning over L10,000 he would be rewarded with the sum of $5. Under +such conditions it is not difficult to see how hard it is to make any +money to speak of out of foreign exchange brokerage. + +The dealers, of course, fare much better. Handling commercial bills +where the question of credit affects the price, they have a chance to +make more of a profit, and buying and selling bills for their own +account they naturally are entitled to make more than the man without +capital, who simply tries to get in between the buyer and the seller. +Dealing in exchange, especially for out-of-town clients, is a highly +profitable business, but one which takes time, brains, experience and +money to build up. Dealers representing large out-of-town sellers of +exchange are very much in the position of the New York agents of +manufacturing companies who sell goods on commission. + +There being no regular market in which foreign exchange rates are made, +it follows that the establishment of rates each morning and during the +course of each day will be according to the supply and demand for +bills. On any given morning by ten o'clock the bankers will all have +received their cables quoting money and exchange rates in the foreign +centers, and will all have pretty well made up their minds as to what +the rate for demand bills on London ought to be. A banker, for +instance, has L10,000 he wants to sell as early in the morning as +possible, and from his foreign cables figures that 4.86 is about the +right price. He offers it at that, but learns that another banker is +offering exchange at 4.8595. He offers his own at that price, and +somebody comes along, taking both lots and bidding 4.86 for L50,000 +more. Somebody else bids 4.86 for other large lots, refusing, however, +to pay 4.8605. The market is established at that point. + +For the time being. A cable message from abroad may induce some banker +to bid 4.8605 or 4.8610, or it may cause him to throw on the market +such an amount of exchange as may break the price down to 4.85-3/4. +Rates are constantly changing, and changing at times almost from minute +to minute. Yet so complete is the system of telephones and brokers that +any exchange manager can tell just about what is taking place in any +other part of the market. Not infrequently, of course, sales are made +simultaneously at slightly different rates, but, as a rule, if a trade +is made at 4.86 on Cedar Street, 4.86 will be the rate on Exchange +Place. It is remarkable how closely each manager keeps in touch with +what is going on in every part of the market. And the great number of +brokers continually circulating around and trying to "get in between" +for five points is in itself a powerful influence toward keeping rates +exactly the same in all parts of the market at once. + +"Posted rates" mean little with regard to current conditions, being +simply the bankers' public notice of the rate at which he will sell +bills for trifling amounts. Exchange bankers dislike to draw small +drafts and usually can be induced to do so only by the offer of a much +higher rate than that current for a large amount. A banker might offer +to sell you L10,000 at 4.87, but if you said you wanted only L10, he +would be likely to point to his posted rate and charge you 4.88. +Considering that in transactions based on the best bills the banker +only figures on making from $10 to $20 profit on each L10,000, it may +readily be seen why he is not anxious to sell a L10 draft. + +As to the actual fluctuation of exchange, while it is true that rates +at times rise and fall with all the violence so often displayed in the +security markets, most of the time they move within a comparatively +narrow range. On an ordinary business day, for instance, the change is +not apt to run over fifteen points (15/100 of a cent per pound). In the +morning, demand sterling may be at, say, 4.86; at noon a moderate +demand for bills may carry the rate, first, to 4.8605, then to 4.8610; +and finally, perhaps, to 4.8615. On fairly large offerings of bills the +market might then recede to, say, 4.8605, ending the day five points +up. And that would be an ordinary day--by no means the kind of a day +the exchange market always sees, but a day corresponding to a stock +market session in which the market leaders rise or fall a point or so. + +There are times, of course, when very different conditions prevail. An +unexpected rise in the bank rate in London, the announcement of a big +loan or any one of many different happenings, are apt to cause a +reduction in the exchange market and a bewildering movement of rates up +and down. At such times a rise or fall of fifty points in sterling +within half an hour is not at all out of the ordinary, while in times +of panic, or when great crises impend, the fluctuations will be three +or four times as great. During the latter part of October, 1907, and in +November, the exchange market fluctuated with greater violence than, +perhaps, at any other time since the gold standard was firmly +established. Thrown completely out of gear by the premium of 3-1/2 per +cent. a day for currency during the panic time, the exchange markets +for some time would rise and fall several cents in the pound on the +same day. Completely baffled by this erratic movement, many bankers +temporarily withdrew entirely from the market. + +As to the relative importance of the different kinds of exchange, +sterling, of course, occupies the most prominent position. What +proportion of the total of exchange dealt in in the New York market +consists of sterling it is impossible to determine, but that it is as +great as the volume of all the other kinds of exchange put together can +safely be said. Many big dealers, indeed, make a specialty of sterling, +and if they handle any other bills at all, do so only on a very small +scale. As to whether francs or marks come next in volume, there is a +difference of opinion. With Germany our direct financial transactions +are probably considerably larger than with France, but the position of +Paris as a banking centre makes the French capital figure prominently +in many operations where the French market is not directly concerned. +Despite the fact that sterling easily predominates, the volume of franc +and mark bills, too, is enormous. Drafts on Paris for from three to +five million francs and on Berlin for as many marks are not at all +infrequently traded in in the exchange market, and at times bills for +very much larger amounts have been drawn and offered for sale. + +Bills drawn in other kinds of currency--guilders on Holland, for +instance, form an important part of the foreign exchange dealt in in a +market like New York, but are subservient in their rate fluctuations to +the movement of sterling, marks, and francs. The latter are, indeed, +the three great classes of exchange, and are the basis of at least +nine-tenths of all foreign exchange operations. + +In the following chapter will be taken up the various forms of activity +of the foreign exchange department. No attempt is made to state out of +which kind of business bankers make most money, but before looking into +the more detailed description of how exchange business is conducted, it +may be well to fix in mind the fact that it is out of the "straight" +forms of foreign exchange business that the most profit is made. Highly +complicated operations are indulged in by some managers with more +theoretical than practical sense, and money is at times made out of +them, but on the whole the real money is made out of the kinds of +business about to be described. To the author's certain knowledge, the +exchange business of one of the largest houses in New York was for +years thus limited to what might be called "straight" operations. While +the profits might at times have been materially increased by the +introduction of a little more of a speculative element into the +business, the house made money on a large scale and avoided the losses +inevitable where business is conducted along speculative lines. + + + + +CHAPTER VI + +HOW MONEY IS MADE IN FOREIGN EXCHANGE. +THE OPERATIONS OF THE FOREIGN DEPARTMENT + + +Complete description of the various forms of activity of the foreign +exchange department of an important firm would fill a large volume, but +there are certain stock operations in foreign exchange which are the +basis of most of the transactions carried out and the understanding of +which ought to go a long way toward making clear what the nature of the +foreign exchange department's business really is. + + +1. _Selling "Demand" Against "Demand"_ + +The first and most elementary form of activity is, of course, the +buying of demand bills at a certain price and the selling of the +banker's own demand drafts against them at a higher price. A banker +finds, for instance, that he can buy John Smith & Co.'s sight draft for +L1,000, on London, at the rate of 4.86, and that he can sell his own +draft for L1,000 on his London banking correspondent at 4.87. All he +has to do, therefore, is to buy John Smith's draft for $4,860, send it +to London for credit of his account there, and then draw his own draft +for L1,000 on the newly created balance, selling it for $4,870. It cost +him $4,860 to buy the commercial draft, and he has sold his own draft +against it for $4,870. His gross profit on the transaction, therefore, +is $10. + +As may be imagined, not very much money is made in transactions exactly +of this kind--the one cited is taken only because it illustrates the +principle. For whether the banker sends over in every mail a +bewildering assortment of every conceivable form of foreign exchange to +be credited to his account abroad, or whether he confines himself to +remittances of the simplest kinds of bills, the idea remains exactly +the same--he is depositing money to the credit of his account in order +that he may have a balance on which he can draw. That is, indeed, the +sum and substance of the exchange business of the foreign department of +most banking houses--the maintaining of deposit accounts in banks at +foreign centers on which deposit account the bank here is in a position +to draw according to the wants and needs of its customers. + +To analyze the underlying transaction a little more closely, it is +evident that the banker, in order to make a profit, must be able to buy +the commercial bill at a lower rate of exchange than he can realize on +his own draft. Which suggests at once that the extent of the banker's +profit is dependent largely upon the amount of risk he is willing to +take. For the rate on commercial bills is purely a matter of the +drawer's credit. The best documentary commercial exchange, drawn at +sight on banks abroad or houses of the highest standing will command a +rate of exchange in the open market only a little less than the +banker's own draft. From which point the rate realizable on commercial +bills tapers off with the credit of the house in question, some bills +regularly selling a cent or a cent and a half per pound sterling below +the best bills of their class. + +Without the introduction, therefore, of the element of speculation, +except as to the soundness of the bills' makers, it is possible for +bankers to make widely varying profits out of the same kind of +business. Everything depends upon the amount of risk the banker is +willing to take. The exchange market is a merciless critic of credit, +and if a commercial firm's bills always sell at low rates, the +presumption is strongly against its financial strength. Cases very +frequently occur, however, where the exchange market misjudges the +goodness of a bill, placing too low a valuation upon it. In that case +the banker who, individually, knows that the house in question is all +right, can make considerable sums of money buying its bills at the +low-going rates and selling his own exchange against them. This, +evidently, is purely a matter of the exchange manager's judgment. With +comparatively little risk there are banking houses which are making a +full cent a pound out of a good part of the commercial exchange they +handle. + + +2. _Selling Cables Against Demand Exchange_ + +No description of a cable transfer having been given in the preceding +description of different kinds of exchange, it may be explained briefly +that a "cable," so-called, differs from a sight draft only in that the +banker abroad who is to pay out the money is advised to do so by means +of a telegraphic message instead of by a bit of paper instructing him +to "pay to the order of so and so." A, in New York, wants to transfer +money to B, in London. He goes to his banker in New York and deposits +the amount, in dollars, with him, requesting that he (the New York +banker) instruct his correspondent in London, by cable, to pay to B the +equivalent in pounds. The transfer is immediate, the cable being sent +as soon as the American banker receives the money on this end. + +To be able to instruct its correspondent in London by cable to pay out +large sums at any given time, a bank here must necessarily carry a +substantial credit balance abroad. It would be possible, of course, for +a banker to instruct his London agent by cable to pay out a sum of +money, at the same time cabling him the money to pay out, but this +operation of selling cables against cables is not much indulged +in--there is too little chance of profit in it. Under special +circumstances, however, it can be seen that a house anxious to sell a +large cable and not having the balance abroad to do it, might easily +provide its correspondent abroad with the funds by going out and buying +a cable itself. + +But under ordinary circumstances foreign exchange dealers who engage in +the business of selling cables carry adequate balances on the other +side, balances which they keep replenishing by continuous remittances +of demand exchange. Which in itself constitutes an important form of +foreign exchange activity and an operation out of which many large +houses make a good deal of money. + +All the parties involved being bankers there is little risk in business +of this kind; but, on the other hand, the margin of profit is small, +and in order to make any money out of it, it is necessary that very +large amounts of money be turned over. The average profit, for +instance, realized in the New York exchange market from straight sales +of cables against remittances of checks is fifteen points (15/100 of a +cent per pound sterling). That means that on every L10,000, the gross +profit would be $15.00. A daily turnover of L50,000, therefore, would +result in a gross profit of $75 a day. + +It may seem strange that bankers should be willing to turn over so +large an amount of money for so small a profit, even where the risk has +been reduced to a minimum, but that is the case. Very often cables are +sold against balances which have been accumulated by remittance of all +sorts of bills other than demand, but there are several large American +institutions whose foreign exchange business consists principally of +the regulation selling of cables against remittances of demand bills. +By reason of their large deposits they are in a position to carry full +balances abroad, while in the course of their regular business a good +deal of sight exchange of high class comes across their counters. All +the necessary elements for doing the business being there, it only +remains for such an institution to employ a man capable of directing +the actual transactions. The risk is trifling, the advertisement is +world-wide, the accommodation of customers is being attended to, and +there is considerable actual money profit to be made. The business in +many respects is thus highly desirable. + + +3. _Selling "Demand" Bills Against Remittances of Long Bills_ + +If there is a stock operation in the conduct of a foreign exchange +business it is the selling by bankers of their demand bills of exchange +against remittances of commercial and bankers' long paper. Bills of the +latter class, as has been pointed out, make up the bulk of foreign +exchange traded in, and its disposal naturally is the most important +phase of foreign exchange business. For after all, all cabling, +arbitraging in exchange, drawing of finance bills, etc., is only +incidental. What the foreign exchange business really is grounded on is +the existence of commercial bills called into existence by exports of +merchandise. + +There are houses doing an extensive exchange business who never buy +commercial long bills, but the operations they carry on are made +possible only by the fact that most other houses do. A foreign exchange +department which does not handle this kind of exchange is necessarily +on the "outside" of the real business--is like a bond broker who does +not carry bonds with his own money but merely trades in and out on +other people's operations. + +Buying and remitting commercial long bills is, however, no pastime for +an inexperienced man. Entirely aside from the question of rate, and +profit on the exchange end of the transaction, there must be taken into +consideration the matter of the credit of the drawer and the drawee, +the salability of the merchandise specified in the bill of lading, and +a number of other important points. This question of credit, underlying +to so great a degree the whole business of buying commercial long +paper, will be considered first. + +The completely equipped exchange department has at its disposal all the +machinery necessary for investigating expeditiously the standing and +financial strength of any firm whose bills are likely to be offered in +the exchange market. Such facilities are afforded by subscription to +the two leading mercantile agencies, but in addition to this, the +experienced exchange manager has at his command private sources of +information which can be applied to practically every firm engaged in +the export business. The larger banks, of course, all have a regular +credit man, one of whose chief duties nowadays is to assist in the +handling of the bank's foreign exchange business. So perfect does the +organization become after a few years of the actual transaction of a +foreign exchange business that the standing of practically any bill +taken by a broker into a bank, for sale, can be passed upon instantly. +New firms come into existence, of course, and have to be fully +investigated, but the experienced manager of a foreign department can +tell almost offhand whether he wants a bill of any given name or not. + +Where documents accompany the draft and the merchandise is formally +hypothecated to the buyer of the draft, it might not be thought that +the standing of the drawer would be of such great importance. +Possession of the merchandise, it is true, gives the banker a certain +form of security in case acceptance of the bill is refused by the +parties on whom it is drawn or in case they refuse to pay it when it +comes due, but the disposal of such collateral is a burdensome and +often expensive operation. The banker in New York who buys a sixty-day +draft drawn against a shipment of butter is presumably not an expert on +the butter market and if he should be forced to sell the butter, might +not be able to do so to the fullest possible advantage. Employment of +an expert agent is an expensive operation, and, moreover, there is +always the danger of legal complication arising out of the banker's +having sold the collateral. It is desirable in every way that if there +is to be any trouble about the acceptance or payment of a draft, the +banker should keep himself out of it. + +A concrete illustration of the dangers attendant upon the purchase of +commercial long bills from irresponsible parties is to be found in what +happened a few years ago to a prominent exchange house in New York. +This house had been buying the bills of a certain firm for some little +time, and everything had gone well. But one day acceptance of a bill +for L2,000 was refused by the party abroad, and the news cabled that +the bill of lading was a forgery and that no such shipment had ever +been made. Wiring hurriedly to the inland city in which was located the +firm which drew the bill, the New York bank received the reply that +both partners had decamped. What had happened was that, about to break +up, the "firm" had drawn and sold several large bills of exchange, with +forged documents attached, received their money for them, and then +disappeared. Neither of them was ever apprehended, and the various +bankers who had taken the exchange lost the money they had paid for it. +Forgery of the bill of lading in this case had been a comparatively +easy matter, the shipment purporting to have been made from an obscure +little cotton town in the South, the signature of whose railroad agent +was not at all known. + +This forgery is only one example of the trickery possible and the +extreme care which is necessary in the purchase of bills of this kind. +And not only must the standing of the drawer be taken into +consideration, but the standing of the drawee is a matter of almost +equal importance--after the "acceptance" of the bill, the parties +accepting it being equally liable with its maker. The nature of the +merchandise, furthermore, and its marketability are further +considerations of great importance. Cotton, it will readily appear, is +an entirely different sort of collateral from clocks, or some specialty +in which the market may vary widely. The banker who holds a bill of +lading for cotton shipped to Liverpool can at any moment tell exactly +what he can realize on it. In the case of many kinds of articles, +however, the invoice value may differ widely from the realizable value, +and if the banker should ever be forced to sell the merchandise, he +might have to do so at a big loss. + +Returning to the actual operation of selling bankers' demand against +remittances of long bills, it appears that the successive steps in an +actual transaction are about as follows: + +The banker in New York having ascertained by cable the rate at which +bills "to arrive" in London by a certain steamer will be discounted, +buys the bills here and sends them over, with instructions that they be +immediately discounted and the proceeds placed to his credit. On this +resulting balance he will at once draw his demand draft and sell it in +the open market. If, from selling this demand draft, he can realize +more dollars than it cost him in dollars to put the balance over there, +he has made a gross profit of the difference. + +To illustrate more specifically: A banker has bought, say, a L1,000 +ninety days' sight prime draft, on London, documents deliverable on +acceptance. This he has remitted to his foreign correspondent, and his +foreign correspondent has had it stamped with the required "bill-stamp," +has had it discounted, and after having taken his commission out of the +proceeds, has had them placed to the credit of the American bank. In +all this process the bill has lost weight. It arrived in London as +L1,000, but after commissions, bill-stamps and ninety-three days' +discount have been taken out of it, the amount is reduced well below +L1,000. The _net_ proceeds going to make up the balance on which the +American banker can draw his draft are, perhaps, not over L990. He paid +so-and-so many dollars for the L1,000 ninety-day bill, originally. If +he can realize that many dollars by selling a demand draft for L990 he +is even on the transaction. + +No attempt will be made in this little book to present the tables by +which foreign exchange bankers figure out profit possibilities in +operations of this kind. The terms obtainable from foreign +correspondents vary so widely according to the standing and credit of +the house on this side and are governed by so many different influences +that a manager must work out each transaction he enters according to +the conditions by which he, particularly, and his operations are +governed. Such calculations, moreover, are all built up along the +general line of the scheme presented below: + + Assume that the rate for demand bills is 4.85, that discount in + London is 3-1/2 per cent, and that the amount of the long bill + remitted for discount and credit of proceeds is L100. + + _The various expenses are as follows:_ + + Commission charged by the banker in + London 1/40 per cent. $0.12 + + Discount, 93 days (3 days of grace) + at 3-1/2 per cent. 4.38 + + English Government bill stamp 1/20 per cent. 0.24 + ------ + $4.74 + +Total charges on the ninety days' sight L100 bill amount to $4.74. On +one pound, therefore, the charge would be $.0474. From which it is +evident that each pound of a ninety-day bill, under the conditions +given, is worth $.0474 (=4.74 cents) less than each pound in a bankers' +demand bill. From which it is evident that if such a demand bill were +sold at 4.85 against a ninety-day bill bought at 4.8026 (found by +subtracting 4.74 cents from 485 cents) the remitting banker would come +out even in the transaction. + +The foregoing has been introduced at the risk of confusing the lay +reader, on the idea that all the various calculations regarding the +drawing of "demand" against the remitting of long bills are founded on +the same general principle, and that where it is desired to go more +deeply into the matter the correct conditions can be substituted. +Discount, of course, varies from day to day, "payment" bills do not go +through the discount market at all, but are "rebated," the commissions +charged different bankers and by different bankers vary widely. Under +the circumstances the value of presenting a lot of hard-and-fast +calculations worked out under any given set of conditions is extremely +doubtful. + +As to the profit on business of this kind it can be said that the +average, where the best bills are used, runs not much over twenty +points (one-fifth of a cent per pound sterling). From that, of course, +profits actually made run up as high as one cent or even two cents per +pound, according to the amount of risk involved. The buying of cheap +bills is, however, a most precarious operation. One single mistake, and +the whole profit of months may be completely wiped out. The proposition +is a good deal like lending money on insecure collateral, or like +lending to doubtful firms. There are banking houses which do it, have +been doing it for years, and by reason of an intuitive feeling when +there is trouble ahead have been able to avoid heavy losses. Such +business, however, can hardly be called high-class banking practice. + + +4. _The Operation of Making Foreign Loans_ + +In its influence upon the other markets, there is perhaps no more +important phase of foreign exchange than the making of foreign loans in +the American market. How great is the amount of foreign capital +continually loaned out in this country has been several times suggested +in previous pages. The mechanics of these foreign loaning operations, +the way in which the money is transferred to this side, etc., will now +be taken up. + +To begin at the very beginning, consider how favorable a field is the +American market for the employment of Europe's spare banking capital. +Almost invariably loaning rates in New York are higher than they are in +London or Paris. This is due, perhaps, to the fact that industry here +runs on at a much faster pace than in England or France, or it may be +due to the fact that we are a newer country, that there is no such +accumulated fund of capital here as there is abroad. Such a hypothesis +for our own higher interest rates would seem to be supported by the +fact that in Germany, too, interest is consistently on a higher level +than in London or Paris, Germany, like ourselves, being a vigorous +industrial nation without any very great accumulated fund of capital +saved by the people. But whatever the reason, the fact remains that in +New York money rates are generally on so much more attractive a basis +than they are abroad that there is practically never a time when there +are not hundreds of millions of dollars of English and French money +loaned out in this market. + +To go back no further than the present decade, it will be recalled how +great a part foreign floating capital played in financing the +ill-starred speculation here which culminated in the panic of May 9, +1901. Europe in the end of 1900 had gone mad over our industrial +combinations and had shovelled her millions into this market for the +use of our promoters. What use was made of the money is well known. The +instance is mentioned here, with others which follow, only to show that +all through the past ten years London has at various times opened her +reservoirs of capital and literally poured money into the American +market. + +Even the experience of 1901 did not daunt the foreign lenders, and in +1902 fresh amounts of foreign capital, this time mostly German, were +secured by our speculators to push along the famous "Gates boom." That +time, however, the lenders' experience seemed to discourage them, and +until 1906 there was not a great deal of foreign money, relatively +speaking, loaned out here. In the summer of that year, chiefly through +Mr. Harriman's efforts, English and French capital began to come +largely into the New York market--made possible, indeed, the "Harriman +Market of 1906." This was the money the terror-stricken withdrawal of +which during most of 1907 made the panic as bad as it was. After the +panic, most of what was left was withdrawn by foreign lenders, so that +in the middle of 1908 the market here was as bare of foreign money as +it has been in years. Returning American prosperity, however, combined +with complete stagnation abroad, set up another hitherward movement of +foreign capital which, during the spring and summer of 1909, attained +amazing proportions. By the end of the summer, indeed, more foreign +capital was employed in the American market than ever before in the +country's financial history. + +To take up the actual operation of loaning foreign money in the +American market, suppose conditions to be such that an English bank's +managers have made up their minds to loan out L100,000 in New York--not +on joint account with the American correspondent, as is often done, but +entirely independently. Included in the arrangements for the +transaction will be a stipulation as to whether the foreign bank +loaning the money wants to loan it on the basis of receiving a +commission and letting the borrower take the risk of how demand +exchange may fluctuate during the life of the loan, or whether the +lender prefers to lend at a fixed rate of interest, say six per cent., +and himself accept the risk of exchange. + +What the foregoing means will perhaps become more clear if it is +realized that in the first case the American agent of the foreign +lender draws a ninety days' sight sterling bill for, say, L100,000 on +the lender, and hands the actual bill over to the parties here who want +the money. Upon the latter falls the task of selling the bill, and, +ninety days later, when the time of repayment comes, the duty of +returning a _demand_ bill for L100,000, plus the stipulated commission. +In the second kind of a loan the borrower has nothing to do with the +exchange part of the transaction, the American banking agent of the +foreign lender turning over to the borrower not a sterling draft but +the dollar proceeds of a sterling draft. How the exchange market +fluctuates in the meantime--what rate may have to be paid at the end of +ninety days for the necessary demand draft--concerns the borrower not +at all. He received dollars in the first place, and when the loan comes +due he pays back dollars, plus four, five or six per cent., as the case +may be. What rate has to be paid for the demand exchange affects the +banker only, not the borrower. + +Loans made under the first conditions are known as sterling, mark, or +franc loans; the other kind are usually called "currency loans." At the +risk of repetition, it is to be said that in the case of sterling loans +the borrower pays a flat commission and takes the risk of what rate he +may have to pay for demand exchange when the loan comes due. In the +case of a currency loan the borrower knows nothing about the foreign +exchange transaction. He receives dollars, and pays them back with a +fixed rate of interest, leaving the whole question and risk of exchange +to the lending banker. + +To illustrate the mechanism of one of these sterling loans. Suppose the +London Bank, Ltd., to have arranged with the New York Bank to have the +latter loan out L100,000 in the New York market. The New York Bank +draws L100,000 of ninety days' sight bills, and, satisfactory +collateral having been deposited, turns them over to the brokerage +house of Smith & Jones. Smith & Jones at once sell the L100,000, +receiving therefor, say, $484,000. + +The bills sold by Smith & Jones find their way to London by the first +steamer, are accepted and discounted. Ninety days later they will come +due and have to be paid, and ten days prior to their maturity the New +York Bank will be expecting Smith & Jones to send in a _demand_ draft +for L100,000, plus three-eighths per cent. commission, making L375 +additional. This L100,375, less its commission for having handled the +loan, the New York Bank will send to London, where it will arrive a +couple of days before the L100,000 of ninety days' sight bills +originally drawn on the London Bank, Ltd., mature. + +What each of the bankers concerned makes out of the transaction is +plain enough. As to what Smith & Jones' ninety-day loan cost them, in +addition to the flat three-eighths per cent. they had to pay, that +depends upon what they realize from the sale of the ninety days' sight +bills in the first place and secondly on what rate they had to pay for +the demand bill for L100,000. Exchange may have gone up during the life +of the loan, making the loan expensive, or it may have gone down, +making the cost very little. Plainly stated, unless they secured +themselves by buying a "future" for the delivery of a L100,000 demand +bill in ninety days at a fixed rate, Messrs. Smith & Jones have been +making a mild speculation in foreign exchange. + +If the same loan had been made on the other basis, the New York Bank +would have turned over to Smith & Jones not a _sterling bill_ for +L100,000, but the _dollar proceeds_ of such a bill, say a check for +$484,000. At the end of ninety days Smith & Jones would have had to pay +back $484,000, plus ninety days' interest at six per cent, $7,260, all +of which cash, less commission, the New York Bank would have invested +in a demand bill of exchange and sent over to the London Bank, Ltd. +Whatever more than the L100,000 needed to pay off the maturing nineties +such a demand draft amounted to, would be the London Bank, Ltd.'s, +profit. + +From all of which it is plainly to be seen that when the London bankers +are willing to lend money here and figure that the exchange market is +on the down track, they will insist upon doing their lending on the +"currency loan" basis--taking the risk of exchange themselves. +Conversely, when loaning operations seem profitable but rates seem to +be on the upturn, lenders will do their best to put their money out in +the form of "sterling loans." Bankers are not always right in their +views, by any means, but as a general principle it can be said that +when big amounts of foreign money offered in this market are all +offered on the "sterling loan" basis, a rising exchange market is to be +expected. + +As to the collateral on these foreign loans, it is evident that there +is as much chance for different ways of looking at different stocks as +there is in regular domestic loaning operations. Not only does the +standing of the borrower here make a difference, but there are certain +securities which certain banks abroad favor, and others, perhaps just +as good, with which they will have nothing to do. + +Excepting the case of special negotiation, however, it may be said that +the collateral put up the case of foreign loans in this market is of a +very high order. Three years ago this could hardly have been said, but +one of the many beneficial effects of the panic was to greatly raise +the standard of the collateral required by foreign lenders in this +market. It used formerly to be more a case of the standing of the +borrower. Nowadays the collateral is usually deposited here in care of +a banker or trust company. + +From what has been said about the mechanism of making these foreign +loans, it is evident that no transfer of cash actually takes place, and +that what really happens is that the foreign banking institution lends +out its credit instead of its cash. For in no case is the lender +required to put up any money. The drafts drawn upon him are at ninety +days' sight, and all he has to do is to write the word "accepted," with +his signature, across their face. Later they will be presented for +actual payment, but by that time the "cover" will have reached London +from the banker in America who drew the "nineties," and the maturing +bills will be paid out of that. The foreign lender, in other words, is +at no stage out of any actual capital, although it is true, of course, +that he has obligated himself to pay the drafts on maturity, by +"accepting" them. + +Where, then, is the limit of what the foreign bankers can lend in the +New York market? On one consideration only does that depend--the amount +of accepted long bills which the London discount market will stand. For +all the ninety days' sight bills drawn in the course of these transfers +of credit must eventually be discounted in the London discount market, +and when the London discount market refuses to absorb bills of this +kind a material check is naturally administered to their creation. + +Too great drawings of loan-bills, as the long bills drawn to make +foreign loans are called, are quickly reflected in a squeamish London +discount market. It needs only the refusal of the Bank of England to +re-discount the paper of a few London banks suspected of having +"accepted" too great a quantity of American loan-bills, to make it +impossible to go on loaning profitably in the New York market. In order +to make loans, long bills have to be drawn and sold to somebody, and if +the discount market in London will take no more American paper, buyers +for freshly-created American paper will be hard to find. + +To get back to the part foreign loaning operations play in the foreign +exchange market here, it is plain that as no actual money is put up, +the business is attractive and profitable to the bank having the +requisite facilities and the right foreign connection. It means the +putting of the bank's name on a good deal of paper, it is true, but +only on the deposit of entirely satisfactory collateral and only in +connection with the assuming of the same obligation by a foreign +institution of high standing. There are few instances where loss in +transacting this form of business has been sustained, while the profits +derived from it are very large. + +As to what the foreign department of an American bank makes out of the +business, it may be said that that depends very largely upon whether +the bank here acts merely as a lending agent or whether the operation +is for "joint account," both as to risk and commission. In the former +case (and more and more this seems to be becoming the basis on which +the business is done) both the American and the European bank stands to +make a very fair return--always considering that neither is called upon +to put up one real dollar or pound sterling. Take, for instance, the +average sterling loan made on the basis of the borrower taking all the +risk of exchange and paying a flat commission of three-eighths of one +per cent. for each ninety days. That means that each bank makes +three-sixteenths of one per cent. for every ninety days the loan +runs--the American bank for simply drawing its ninety-day bills of +exchange and the English bank for merely accepting them. Naturally, +competition is keen, American banking houses vying with each other both +for the privilege of acting as agents of the foreign banks having money +to lend, and of going into joint-account loaning operations with them. +Three-sixteenths or perhaps one-quarter of one per cent. for ninety +days (three-quarters of one per cent. and one per cent. annually) may +not seem much of an inducement, but considering the fact that no real +cash is involved, this percentage is enough to make the biggest and +best banking houses in the country go eagerly after the business. + + +5. _The Drawing of Finance-Bills_ + +Approaching the subject of finance-bills, the author is well aware that +concerning this phase of the foreign exchange business there is wide +difference of opinion. Finance bills make money, but they make trouble, +too. Their existence is one of the chief points of contact between the +foreign exchange and the other markets, and one of the principal +reasons why a knowledge of foreign exchange is necessary to any +well-rounded understanding of banking conditions. + +Strictly speaking, a finance-bill is a long draft drawn by a banker of +one country on a banker in another, sometimes secured by collateral, +but more often not, and issued by the drawing banker for the purpose of +raising money. Such bills are not always distinguishable from the bills +a banker in New York may draw on a banker in London in the operation of +lending money for him, but in nature they are essentially different. +The drawing of finance-bills was recently described by the foreign +exchange manager of one of the biggest houses in New York, during the +course of a public address, as a "scheme to raise the wind." Whether or +not any collateral is put up, the whole purpose of the drawing of +finance-bills is to provide an easy way of raising money without the +banker here having to go to some other bank to do it. + +The origin of the ordinary finance-bill is about as follows: A bank +here in New York carries a good balance in London and works a +substantial foreign exchange business in connection with the London +bank where this balance is carried. A time comes when the New York +banking house could advantageously use more money. Arrangements are +therefore made with the London bank whereby the London bank agrees to +"accept" a certain amount of the American banker's long bills, for a +commission. In the course of his regular business, then, the American +banker simply draws that many more pounds sterling in long bills, sells +them, and for the time being has the use of the money. In the great +majority of cases no extra collateral is put up, nor is the London bank +especially secured in any way. The American banker's credit is good +enough to make the English banker willing, for a commission, to +"accept" his drafts and obligate himself that the drafts will be paid +at maturity. Naturally, a house has to be in good standing and enjoy +high credit not only here but on the other side before any reputable +London bank can be induced to "accept" its finance paper. + +The ability to draw finance-bills of this kind often puts a house +disposed to take chances with the movement of the exchange market into +line for very considerable profit possibilities. Suppose, for instance, +that the manager of a house here figures that there is going to be a +sharp break in foreign exchange. He, therefore, sells a line of +ninety-day bills, putting himself technically short of the exchange +market and banking on the chance of being able to buy in his "cover" +cheaply when it comes time for him to cover. In the meantime he has the +use of the money he derived from the sale of the "nineties" to do with +as he pleases, and if he has figured the market aright, it may not cost +him any more per pound to buy his "cover" than he realized from the +sale of the long bills. In which case he would have had the use of the +money for the whole three months practically free of interest. + +It is plain speculating in exchange--there is no getting away from it, +and yet this practice of selling finance-bills gives such an +opportunity to the exchange manager shrewd enough to read the situation +aright to make money, that many of the big houses go in for it to a +large extent. During the summer, for instance, if the outlook is for +big crops, the situation is apt to commend itself to this kind of +operation. Money in the summer months is apt to be low and exchange +high, affording a good basis on which to sell exchange. Then, if the +expected crops materialize, large amounts of exchange drawn against +exports will come into the market, forcing down rates and giving the +operator who has previously sold his long bills an excellent chance to +cover them profitably as they come due. + +About the best example of how exchange managers can be deceived in +their forecasts is afforded by the movement of exchange during the +summer and fall of 1909. Impelled thereto by the brilliant crop +prospects of early summer, foreign exchange houses in New York drew and +sold finance-bills in enormous volume. The corn crop was to run over +three billion bushels, affording an unprecedented exportable +surplus--wheat and cotton were both to show record-breaking yields. But +instead of these promises being fulfilled, wheat and corn showed only +average yields, while the cotton crop turned out decidedly short. The +expected flood of exchange never materialized. On the contrary, rise in +money rates abroad caused such a paying off of foreign loans and +maturing finance bills that foreign exchange rose to the gold export +point and "covering" operations were conducted with extreme difficulty. +In the foreign exchange market the autumn of 1909 will long be +remembered as a time when the finance-bill sellers had administered to +them a lesson which they will be a good while in forgetting. + + +6. _Arbitraging in Exchange_ + +Arbitraging in exchange--the buying by a New York banker, for instance, +through the medium of the London market, of exchange drawn on Paris, is +another broad and profitable field for the operations of the expert +foreign exchange manager. Take, for example, a time when exchange on +Paris is more plentiful in London than in New York--a shrewd New York +exchange manager needing a draft on Paris might well secure it in +London rather than in his home city. The following operation is only +one of ten thousand in which exchange men are continually engaged, but +is a representative transaction and one on which a good deal of the +business in the arbitration of exchange is based. + +Suppose, for instance, that in New York, demand exchange on Paris is +quoted at five francs seventeen and one-half centimes per dollar, +demand exchange on London at $4.84 per pound, and that, _in London_, +exchange on Paris is obtainable at twenty-five francs twenty-five +centimes per pound. The following operation would be possible: + +Sale by a New York banker of a draft on Paris, say, for francs 25,250, +at 5.17-1/2, bringing him in $4,879.23. Purchase by same banker of a +draft on London for L1,000, at 4.84, costing him $4,840. Instructions +by the American banker to his London correspondent to buy a check on +Paris for francs 25,250 in London, and to send it over to Paris for the +credit of his (the American banker's account). Such a draft, at 25.25 +would cost just L1,000. + +The circle would then be complete. The American banker who originally +drew the francs 25,250 on his Paris balance would have replaced that +amount in his Paris balance through the aid of his London +correspondent. The London correspondent would have paid out L1,000 from +the American banker's balance with him, a draft for which amount would +come in the next mail. All parties to the transaction would be +satisfied--especially the banker who started it, for whereas he paid +out $4,840 for the L1,000 draft on London, he originally took in +$4,879.23 for the draft he sold on Paris. + +Between such cities as have been used in the foregoing illustrations +rates are not apt to be wide enough apart to afford any such actual +profit, but the chance for arbitraging does exist and is being +continuously taken advantage of. So keenly, indeed, are the various +rates in their possible relation to one another watched by the exchange +men that it is next to impossible for them to "open up" to any +appreciable extent. The chance to make even a slight profit by shifting +balances is so quickly availed of that in the constant demand for +exchange wherever any relative weakness is shown, there exists a force +which keeps the whole structure at parity. The ability to buy drafts on +Paris relatively much cheaper at London than at New York, for instance, +would be so quickly taken advantage of by half a dozen watchful +exchange men that the London rate on Paris would quickly enough be +driven up to its right relative position. + +It is impossible in this brief treatise to give more than a suggestion +of the various kinds of exchange arbitration being carried on all the +time. Experts do not confine their operations to the main centers, nor +is three necessarily the largest number of points which figure in +transactions of this sort. Elaborate cable codes and a constant use of +the wires keep the up-to-date exchange manager in touch with the +movement of rates in every part of Europe. If a chance exists to sell a +draft on London and then to put the requisite balance there through an +arbitration involving Paris, Brussels, and Amsterdam, the chances are +that there will be some shrewd manager who will find it out and put +through the transaction. Some of the larger banking houses employ men +who do little but look for just such opportunities. When times are +normal, the margin of profit is small, but in disturbed markets the +parities are not nearly so closely maintained and substantial profits +are occasionally made. The business, however, is of the most difficult +character, requiring not only great shrewdness and judgment but +exceptional mechanical facilities. + + +7. _Dealing in "Futures_" + +As a means of making--or of losing--money, in the foreign exchange +business, the dealing in contracts for the future delivery of exchange +has, perhaps, no equal. And yet trading in futures is by no means +necessarily speculation. There are at least two broad classes of +legitimate operation in which the buying and selling of contracts of +exchange for future delivery plays a vital part. + +Take the case of a banker who has bought and remitted to his foreign +correspondent a miscellaneous lot of foreign exchange made up to the +extent of one-half, perhaps, of commercial long bills with documents +deliverable only on "payment" of the draft. That means that if the +whole batch of exchange amounted to L50,000, L25,000 of it might not +become an available balance on the other side for a good while after it +had arrived there--not until the parties on whom the "payment" bills +were drawn chose to pay them off under rebate. The exchange rate, in +the meantime, might do almost anything, and the remitting banker might +at the end of thirty or forty-five days find himself with a balance +abroad on which he could sell his checks only at very low rates. + +To protect himself in such case the banker would, at the time he sent +over the commercial exchange, sell his own demand drafts for future +delivery. Suppose that he had sent over L25,000 of commercial "payment" +bills. Unable to tell exactly when the proceeds would become available, +the banker buying the bills would nevertheless presumably have had +experience with bills of the same name before and would be able to form +a pretty accurate estimate as to when the drawees would be likely to +"take them up" under rebate. It would be reasonably safe, for instance, +for the banker to sell futures as follows: L5,000 deliverable in +fifteen days; L10,000 deliverable in thirty days, L10,000 deliverable +in from forty-five to sixty days. Such drafts on being presented could +in all probability be taken care of out of the prepayments on the +commercial bills. + +By figuring with judgment, foreign exchange bankers are often able to +make substantial profits on operations of this kind. An exchange broker +comes in and offers a banker here a lot of good "payment" commercial +bills. The banker finds that he can sell his own draft for delivery at +about the time the commercial drafts are apt to be paid under rebate, +at a price which means a good net profit. The operation ties up +capital, it is true, but is without risk. Not infrequently good +commercial "payment" bills can be bought at such a price and bankers' +futures sold against them at such a price that there is a substantial +profit to be made. + +The other operation is the sale of bankers' futures, not against +remittances of actual commercial exchange but against exporters' +futures. Exporters of merchandise frequently quote prices to customers +abroad for shipment to be made in some following month, to establish +which fixed price the exporter has to fix a rate of exchange definitely +with some banker. "I am going to ship so-and-so so many tubs of lard +next May," says the exporter to the banker, "the drafts against them +will amount to so-and-so-much. What rate will you pay me for +them--delivery next May?" The banker knows he can sell his own draft +for May delivery for, say, 4.87. He bids the exporter 4.86-1/2 for his +lard bills, and gets the contract. Without any risk and without tying +up a dollar of capital the banker has made one-half cent per pound +sterling on the whole amount of the shipment. In May, the lard bills +will come in to him, and he will pay for them at a rate of 4.86-1/2, +turning around and delivering his own draft against them at 4.87. + +Selling futures against futures is not the easiest form of foreign +exchange business to put through, but when a house has a large number +of commercial exporters among its clients there are generally to be +found among them some who want to sell their exchange for future +delivery. As to the buyer of the banker's "future," such a buyer might +be, for instance, another banker who had sold finance-bills and wants +to limit the cost of "covering" them. + +The foregoing examples of dealing in futures are merely examples of how +futures may figure in every-day exchange transactions. Like operations +in exchange arbitrage, there is no limit to the number of kinds of +business in which "futures" may figure. They are a much abused +institution, but are a vital factor in modern methods of transacting +foreign exchange business. + +The foregoing are the main forms of activity of the average foreign +department, though there are, of course, many other ways of making +money out of foreign exchange. The business of granting commercial +credits, the exporting and importing of gold and the business of +international trading in securities will be taken up separately in +following chapters. + + + + +CHAPTER VII + +GOLD EXPORTS AND IMPORTS + + +Gold exports and imports, while not constituting any great part of the +activity of the average foreign department, are nevertheless a factor +of vital importance in determining the movement of exchange. The loss +of gold, in quantity, by some market may bring about money conditions +resulting in very violent movements of exchange; or, on the other hand, +such movements may be caused by the efforts of the controlling +financial interests in some market to attract gold. The movement of +exchange and the movement of gold are absolutely dependent one on the +other. + +Considering broadly this question of the movement of gold, it is to be +borne in mind that by far the greater part of the world's production of +the precious metal takes place in countries ranking very low as to +banking importance. The United States, is indeed, the only first-class +financial power in which any very considerable proportion of the +world's gold is produced. Excepting the ninety million dollars of gold +produced in the United States in 1908, nearly all of the total +production of 430 million dollars for that year was taken out of the +ground in places where there exists but the slightest demand for it for +use in banking or the arts. + +That being the case, it follows that there is to be considered, first, +the _primary_ movement of nearly all the gold produced--the movement +from the mines to the great financial centers. + +Considering that over half the gold taken out of the ground each year +is mined in British possessions, it is only natural that London should +be the greatest distributive point. Such is the case. Ownership of the +mines which produce most of the world's gold is held in London, and so +it is to the British capital that most of the world's gold comes after +it has been taken out of the ground. By every steamer arriving from +Australia and South Africa great quantities of the metal are carried to +London, there to be disposed of at the best price available. + +For raw gold, like raw copper or raw iron, has a price. Under the +English banking law, it is true, the Bank of England _must_ buy at the +rate of seventy-seven shillings nine pence per ounce all the gold of +standard (.916-2/3) fineness which may be offered it, but that +establishes merely a minimum--there is no limit the other way to which +the price of the metal may not be driven under sufficiently urgent +bidding. + +The distribution of the raw gold is effected as follows: Each Monday +morning there is held an auction at which are present all the +representatives of home or foreign banks who may be in the market for +gold. These representatives, fully apprised of the amount of the metal +which has arrived during the preceding week and which is to be sold, +know exactly how much they can bid. The gold, therefore, is sold at the +best possible price, and finds its way to that point where the greatest +urgency of demand exists. It may be Paris or Berlin, or it may be the +Bank of England. According as the representatives present at the +auction may bid, the disposition of the gold is determined. + +The _primary_ disposition. For the fact that Berlin, for instance, +obtains the bulk of the gold auctioned off on any given Monday by no +means proves that the gold is going to remain for any length of time in +Berlin. For some reason, in that particular case, the representatives +of the German banks had been instructed to bid a price for the gold +which would bring it to Berlin, but the conditions furnishing the +motive for such a move may remain operative only a short time and the +need for the metal pass away with them. Quarterly settlements in Berlin +or the flotation of a Russian loan in Paris, for instance, might be +enough to make the German and French banks' representatives go in and +bid high enough to get the new gold, but with the passing of the +quarter's end or the successful launching of the loan would pass the +necessity for the gold, and its _re_-distribution would begin. + +In other words, both the primary movement of gold from the mines and +the secondary movement from the distributive centers are merely +temporary and show little as to the final lodgment of the precious +metal. What really counts is exchange conditions; it is along the lines +of the favorable exchange that the great currents of gold will +inevitably flow. + +For example, if a draft for pounds sterling drawn on London can be +bought here at a low rate of exchange, anything in London that the +American consumer may want to possess himself of can be bought cheaper +than when exchange on London is high. The price of a hat in London is, +say, L1. With exchange at 4.83 it will cost a buyer in New York only +$4.83 to buy that hat; if exchange were at 4.88, it would cost him +$4.88. Similarly with raw copper or raw gold or any other commodity. +Given a low rate of exchange on any point and it is possible for the +outside markets to buy cheaply at that point. + +And a very little difference in the price of exchange makes a very +great difference so far as the price of gold is concerned. As stated in +a previous chapter, a new gold sovereign at any United States assay +office can be converted into $4.8665, so that if it cost nothing to +bring a new sovereign over here, no one holding a draft for a pound (a +sovereign is a gold pound) would sell it for less than $4.8665, but +would simply order the sovereign sent over here and cash it in for +$4.8665 himself. Always assuming that it cost nothing to bring over the +actual gold, every time it became possible to buy a draft for less than +$4.8665, some buyer would snatch at the chance. + +Such a case, with L1 as the amount of the draft and the assumption of +no charge for importing the gold, is, of course, mentioned merely for +purposes of illustration. From it should, however, become clear the +whole idea underlying gold imports. A new sovereign laid down in New +York is worth, at any time, $4.8665. If it is possible to get the +sovereign over here for less than that--by paying $4.83 for a L1 draft +on London, for instance, and three cents for charges, $4.86 in all--it +is possible to bring the sovereign in and make money doing it. + +Whether the gold imported is in the form of sovereigns or whether it +consists of bars makes not the slightest difference so far as the +principle of the thing is concerned. A sovereign is at all times worth +just so and so much at any United States assay office, and an ounce of +gold of any given fineness is worth just so and so much, too, +regardless of where it comes from. So that in importing gold, whether +the metal be in the form of coin or bars, the great thing is the +cheapness with which it can be secured in some foreign market. If it +can be secured so cheaply in London, for example, that the price paid +for each pound (sovereign) of the draft, plus the charge of bringing in +each sovereign, is less than what the sovereign can be sold for when it +gets here, it will pay to buy English gold and bring it in. + +Exactly the same principle applies where the question is of importing +gold bars instead of sovereigns, except that bars cannot be bought in +London at a fixed rate. That, however, in no way affects the underlying +principle that in importing gold the profit is made by selling the gold +here for more dollars than the combined dollar-cost of the draft on +London with which the gold is bought and the charges incurred in +importing the metal. To illustrate, if the draft cost $997,000 and the +charges amounted to $3,000, the gold (whether in the form of +sovereigns, eagles or bars) would have to be sold here for at least +$1,000,000, to have the importer come out even. + +With exports, the theory of the thing is to sell a draft on, say, +London, for more dollars than the dollar-cost of enough gold, plus +charges, to meet the draft. As will be seen from the figures of an +actual shipment, given further on, the banker who ships gold gets the +money to buy the gold from the Treasury here, by selling a sterling +draft on London. Suppose, for example, a New York banker wants to +create a L200,000 balance in London. Figuring how many ounces of gold +(at the buying price in London) will give him the L200,000 credit, he +buys that much gold and sends it over. Suppose the combined cost of the +gold and the charge for shipping it amounts to $976,000. If the banker +here can sell a L200,000 draft against it at 4.88, he will just get +back the $976,000 he laid out originally and be even on the +transaction. + +Before passing from the theory to the practice of gold exports and +imports, there is to be considered the fact that bar gold sells in +London at a constantly varying price, while in New York it sells at a +definitely fixed price. In New York an ounce of gold of any given +fineness can always be sold for the same amount of dollars and cents, +but in London the amount of shillings and pence into which it is +convertible varies constantly. So that a New York banker figuring on +bringing in bar gold from London has to take carefully into account +what the price per ounce of bar gold over there is. Sovereigns are +seldom imported because they are secured in London not by weight but by +face value,--even if the sovereigns have lost weight they cost just as +many pounds sterling to secure. Where the New York banker is exporting +gold, on the other hand, the price at which bar gold is selling in +London is just as important as where he is importing. For the price at +which the gold can be disposed of when it gets to London determines +into how many pounds sterling it can be converted. + +These matters of the cost of gold in one market and the crediting of +the gold in some other market are not the easiest thing to grasp at +first thought, but will perhaps become quite clear by reference to the +accompanying calculation of actual gold export and gold import +transactions. All the way through it must be remembered that the +figures of such calculations can never be absolute--that insurance and +freight charges vary and that different operations are conducted along +different lines. The two operations described embody, however, the +principle of both the outward and inward movement of bar gold at New +York. + + +_Export of Bars to London_ + +In the transaction described below about a quarter of a million +dollars' worth of bar gold is shipped to London, the money to pay for +the gold being raised by the drawing and selling of a demand draft on +London. Assuming that the draft is drawn and the gold shipped at the +same time, the draft will be presented fully three days before the gold +is credited, that being the time necessary for assaying, weighing, etc. +In other words, there will be an "overdraft" for at least three days, +interest on which will have to be figured as a part of the cost of the +operation. + +Following is the detailed statement: + + 13,195-1/2 ounces bar gold (.9166 fine) purchased + from U.S. Treasury or Sub-Treasury at + $18.9459 per ounce $250,000 + + Assay office charge (4 cents per $100) 100 + + Cartage and packing 20 + + Freight (5/32 per cent.) 390 + + Insurance (1/20 per cent.) 125 + + Interest on overdraft in London (from time draft + has to be paid until the gold is credited) 3 + days at 4 per cent. 83 + --------- + Total expense of buying and shipping the + gold $250,718 + + 13,195-1/2 ounces of gold credited in London at 77 + shillings 10-1/2 pence L51,380 + + Draft on London for L51,380, sold by shipper + of the gold, at 487.96 $250,718 + +In the transaction described above, the "overdraft" caused by the +inevitable delay in assaying and weighing the gold on its arrival in +London lasted for three days, the American banker being charged +interest at the rate of four per cent. 487.96 being the rate at which +the banker exporting the gold was able to sell his demand draft at the +time, was, under those conditions, the "gold export point." + +In this particular operation, which was undertaken purely for +advertising purposes, the shipper of the gold came out exactly even. +Suppose, however, that he had been able to sell his draft, against the +gold shipped, at 4.88 instead of 4.87-3/4. That would have meant +twenty-five points (one-quarter cent per pound) more, which, on +L51,380, would have amounted to $128.25. + +This question of the profit on gold exports is both interesting and, +because it has a strong bearing at times on the question of whether or +not to ship gold, important. No rule can be laid down as to what profit +bankers expect to make on shipments. If, for instance, a banker owes +L200,000 abroad himself and finds it cheaper to send gold than to buy a +bill, the question of profit does not enter at all. Then, again, many +and many an export transaction is induced by ulterior motives--it may +be for the sake of advertising, or for stock market purposes, or +because some correspondent abroad needs the gold and is willing to pay +for it. Any one of these or many like reasons may explain the +phenomenon, occasionally seen, of gold exports at a time when +conditions plainly indicate that the exporter is shipping at a loss. + +As a rule, however, when exchange is scarce and the demand so great +that bankers who do not themselves owe money abroad see a chance to +supply the demand for exchange by shipping gold and drawing drafts +against it, the profit amounts to anywhere from $400 to $1,000 on each +million dollars shipped--for less than the first amount named it is +hardly worth while to go into the transaction at all; on the other +hand, conditions have to be pretty much disordered to force exchange to +a point where the larger amount named can be earned. + + +_Import of Bars from London_ + +Turning now to the discussion of the conditions under which gold is +imported, it will appear from the following calculation that interest +plays a much more important part in the case of gold imports than in +the case of exports. With exports, as has been shown, the interest +charge is merely on a three days' overdraft, but in the case of imports +the banker who brings in the gold loses interest on it for the whole +time it is in transit and for a day or two on each end, besides. A New +York banker, carrying a large balance in London, for instance, orders +his London correspondent to buy and ship him a certain amount of bar +gold. This the London banker does, charging the cost of the metal, and +all shipping charges, to the account of the New York banker. On the +whole amount thus charged, therefore, the New York banker loses +interest while the gold is afloat. Even after the gold arrives in New +York, of course, the depleted balance abroad continues to draw less +interest than formerly, but to make up for that the gold begins to earn +interest as soon as it gets here. + +The transaction given below is one which was made under the above +conditions--the importer in New York had a good balance in London and +ordered his London correspondent to buy and ship about $1,000,000 of +gold, charging the cost and all expenses to his (the New York banker's) +account. In this particular case the interest lost in London was at six +per cent. and lasted for ten days. + + Cost in the London market of 52,782 ounces of + gold (.9166 fine) at 77 shillings, 11-3/4 pence + per ounce L205,795 + + Freight (5/32 per cent.) 320 + + Insurance 102 + + Boxing and carting 9 + + Commission for buying the gold 26 + + Interest on cost of gold and on charges, while + gold is in transit, 10 days at 6 per cent. 343 + ---------- + L206,595 + + Proceeds, at U.S. Sub-Treasury in New York, + of the 52,782 ounces of gold at $18.9459 per + ounce $1,000,000 + + $1,000,000 invested in a cable on London at + $484.04 L206,595 + +In the above calculation it will be seen that the proceeds of the gold +imported were exactly enough to buy a cable on London sufficiently +large to cancel the original outlay for the gold and the expenses +incurred in shipping it over here. On the whole transaction the banker +importing the gold came out exactly even; a trifle over 4.84 was the +"gold import point" at the time. + +In a general way it can be said that the profit made on gold import +operations is less than where gold is exported. Banking houses big +enough and strong enough to engage in business of this character are +more apt to be on the constructive side of the market than on the +other, and will frequently bring in gold at no profit to themselves, or +even at a loss, in order to further their plans. It does happen, of +course, that gold is sometimes shipped out for stock market effect, but +the effect of gold exports is growing less and less. Gold imports, on +the other hand, are always a stimulating factor and are good live stock +market ammunition as well as a constructive argument regarding the +price of investments in general. + + +_Exports of Gold Bars to Paris--the "Triangular Operation"_ + +Calculations have been given regarding the movement of bar gold between +London and New York--what is ordinarily known as the "direct" movement. +"Indirect" movements, however, have figured so prominently of recent +years in the exchange market that at least one example ought perhaps to +be given. Far and away the most important of such "indirect movements" +are those in which gold is shipped from New York to Paris for the sake +of creating a credit balance in London. + +Before examining the actual figures of such an operation it may be well +to glance at the theory of the thing. A New York banker, say, for any +one of many different reasons, wants to create a credit balance in +London. Examining exchange conditions, he finds that sterling drafts +drawn on London are to be had relatively cheaper _in Paris_ than in New +York. In the natural course of exchange arbitrage the New York banker +would therefore buy a draft on Paris and send it to his French +correspondent with instruction to use it to buy a draft on London and +to remit such draft to London for credit of his (the American banker's) +account. + +But exchange on Paris is not always plentiful in the New York market, +and very likely the New York banker will find that if he wants to send +anything to Paris he will have to send gold. Assume, then, that he +finds conditions favorable and decides to thus transfer a couple of +hundred thousand pounds to London by sending gold to Paris. The +operation might work out as follows: + + Cost of 48,500 ounces of bar gold (.995 fine) at + U.S. Sub-Treasury, New York, at $20.5684 per ounce $997,567 + + Insurance (4-1/2 cents per $100) 450 + + Freight (5/32 per cent.) 1,555 + + Assay office charges (4 cents per $100) 400 + + Cartage and packing 60 + + Commission in Paris 250 + + Interest from time gold is shipped from New York until + draft on new credit in London can be safely drawn and + sold, 6 daysat 2 per cent. 333 + ----------- + $1,000,615 + + The gold arrives in Paris and is bought by the Bank of + France-- + + 48,500 ounces at fcs. 106.3705 per ounce, equals + fcs. 5,158,969 + + That amount of francs then invested in a check on + London, and the check sent to London for credit of the + American banker, fcs. 5,158,969 at 25 francs 10 + centimes per L L205,536 + + New York banker sells his draft on London for + L205,536 at 4.86832 $1,000,615 + +Conditions principally affecting the shipment of gold by the triangular +operation, it will be seen from the above calculation, are the rate of +exchange on London at New York, and the rate of exchange on London at +Paris. The higher the rate at which the New York banker can sell his +bills on London after the gold has been shipped, the more money he will +make. The lower the rate at which his Paris agent can secure the drafts +drawn on London, the greater the amount of pounds sterling which the +gold will buy. High sterling exchange in New York and low sterling +exchange in Paris are therefore the main features of the combination of +circumstances which result in these "triangular operations." + + +_Gold Shipments to Argentina_ + +Of the many other ways in which gold moves, one way seems to be +becoming so increasingly important that it is well worthy of attention. +Reference is made to the shipment of gold from New York to the +Argentine for account of English bankers who have debts to discharge +there. + +Owing to Argentine loans placed in the English market and to heavy +exports of wheat, hides, and meat from Buenos Aires to London, there +exists almost a chronic condition of indebtedness on the part of the +London bankers to the bankers in the Argentine. Not offset by any +corresponding imports, these conditions are putting Buenos Aires each +year in a better and better condition to make heavy demands upon London +for gold, demands which have recently grown to such an extent as to +make serious inroads on the British banks' reserves. Unwilling to +comply with this demand for gold, the powers in charge of the London +market have on several occasions deliberately produced money conditions +in London resulting in a shifting of the Argentine demand for gold upon +New York. The means by which this has been accomplished has been the +raising of the Bank of England rate to a point sufficiently high to +make the dollar-exchange on New York fall. Able, then, to buy +dollar-drafts on New York very cheaply, the London bankers send to New +York large amounts of such drafts, with instructions that they be used +to buy gold for shipment to the Argentine. + +The very general confusion of mind regarding these operations in gold +comes perhaps from the fact that they are constantly referred to as +being a result of _high exchange on London_, at New York. Which is +true, but a most misleading way of expressing the fact that _low +exchange_ on _New York_, at London, is the reason of the shipments. +High sterling exchange at New York and low dollar-exchange at London +are, of course, one and the same thing. But in this case, what counts +is that dollar-exchange can be cheaply bought in London. + +No attempt is made in this little work to cover the whole field of +operations in gold, infinite in scope as they are and of every +conceivable variety. But from the examples given above it ought to be +possible to work out a fairly clear idea as to why gold exports and +imports take place and as to what the conditions are which bring them +about. + +While not failing to realize the importance to the markets of the +movement back and forth of great amounts of gold, it may nevertheless +be said that from the standpoint of the foreign exchange business the +importance of transactions in gold is very generally overestimated. +Most dealers in foreign exchange steer clear of exporting or importing +gold whenever they can, the business being practically all done by +half-a-dozen firms and banks. As has been seen, the profit to be made +is miserably small as a rule, while the trouble and risk are very +considerable. Import operations, especially, tie up large amounts of +ready capital and often throw the regular working of a foreign +department out of gear for days and even weeks. There is considerable +newspaper advertising to be had by being always among the first to ship +or bring in gold, but there are a good many houses who do not want or +need that kind of advertising. Some of the best and strongest banking +houses in New York, indeed, make it a rule to have nothing to do with +operations in gold one way or the other. Should they need drafts on the +other side at a time when there are no drafts to be had, such houses +prefer to let some one else do the gold-shipping and are willing to let +the shipping house make its one-sixteenth of one per cent. or +one-thirty-second of one per cent. in the rate of exchange it charges +for the bills drawn against the gold. + +Particular attention has been paid all through the foregoing chapter to +the gold movement in its relation to the New York markets, the movement +between foreign points being too big a subject to describe in a work of +this kind. In general, however, it can be said that of the three great +gold markets abroad, London is the only one which can in any sense be +called "free." In Paris, the ability of the Bank of France to pay its +notes in silver instead of gold makes it possible for the Bank of +France to control the gold movement absolutely, while in Germany the +paternalistic attitude of the government is so insistent that gold +exports are rarely undertaken by bankers except with the full sanction +of the governors of the Reichsbank. + +It is a question, even, whether London makes good its boast of +maintaining Europe's only "free" gold market. The new gold coming from +the mines does, it is true, find its way to London, for the purpose of +being auctioned off to the highest bidder, but as the kind of bids +which can be made are governed so largely by arbitrary action on the +part of the Bank of England, it is a question whether the gold auction +can be said to be "free." Suppose, for instance, that the "Old Lady of +Threadneedle Street" decides that enough gold has been taken by foreign +bidders and that exports had better be checked. Instantly the bank rate +goes up, making it harder for the representatives of the foreign banks +to bid. Should the rise in the rate not be sufficient to affect the +outside exchange on London, the Bank will probably resort to the +further expedient of entering the auction for its own account and +outbidding all others. Not having any shipping charges to pay on this +gold it buys, the Bank is usually able to secure all the gold it +wants--or, rather, to keep anybody else from securing it. The auction +is open to all, it is true, but being at times conducted under such +circumstances, is hardly a market which can be called "free." + +If there is any "free" gold market in the world, indeed, it is to be +found in the United States. All anybody who wants gold, in this +country, has to do, is to go around to the nearest sub-treasury and get +it. If the supply of bars is exhausted, the buyer may be disappointed, +but that has nothing to do with any restriction on the market. The +market for gold bars in the United States is at the Treasury and the +various sub-treasuries, and as long as the prospective buyer has the +legal tender to offer, he can buy the gold bars which may be on hand. +And at a fixed price, regardless of how urgent the demand may be, who +he is, or who else may be bidding. First come first served is the rule, +and a rule which is observed as long as the bars hold out. After that, +whoever still wants gold can take it in the form of coin. + +How such conditions have worked out, so far as our gaining or losing +gold is concerned, can be seen from the following table, introduced +here for the purpose of giving a clear idea as to just where the United +States has stood in the international movement of gold during the +five-year period given below: + + Exports of Excess of + Gold from U.S. Imports Imports + + 1913 $77,762,622 $69,194,025 [1]$8,568,597 + 1912 57,328,348 48,936,500 [1]8,391,848 + 1911 22,509,653 73,607,013 51,097,360 + 1910 118,563,215 43,339,905 [1]75,223,310 + 1909 91,531,818 44,003,989 [1]47,527,829 + + [1] Excess of exports + +In conclusion, it may be said that the prediction that as international +financial relationships between banks are drawn closer, gold movements +will tend to decrease, seem hardly to be borne out by the figures of +the table given above. Banks here and banks abroad are working together +in a way unknown ten or even five years ago, but as yet there are no +signs of any lessening in the inward or outward movement of specie. +More liberal granting of international credits, increased international +loaning operations, far from putting an end to the physical movement of +gold in large quantities,--these are influences tending to make gold +move more freely than ever. The day of the treasure galleons is over, +but in their place we have swift-moving steamers by which gold can be +shifted from one point to another with safety and ease. Gold movements +seem as though they were to play an important part in the markets for a +good many years to come. + + + + +CHAPTER VIII + +FOREIGN EXCHANGE IN ITS RELATION TO INTERNATIONAL SECURITY TRADING + + +On account of the huge fixed investment of foreign money in the United +States, on account of Europe's continuous speculative interest in our +markets, and the activity of the "arbitrageurs" in both bonds and +shares, dealings in securities between ourselves and the Old World are +always on a very great scale. Not infrequently, indeed, Europe's +position on American securities is an influence of dominating +importance. + +From the maturities, refunding operations, and interest remittances +alone, growing out of the permanent investment of foreign money in our +securities, there results a very great amount of international security +and exchange business. Whether Europe's investment here amounts to +three billions or four billions or five billions, it is impossible to +say; the fact remains that it is so large that every year a very great +amount of foreign-held bonds come due and have to be paid off or +refunded, and, further, that the remitting abroad of coupon and +dividend money each year calls for upward of $150,000,000. + +This matter of maturing investments, alone, calls for continuous +international security trading and on a large scale. Each year there +comes due in this country an amount of railroad and other bonds running +well up into the hundreds of millions, of which a large proportion are +held on the other side. Some of these maturities are paid off in +cash--more often, refunding bonds are offered in exchange; seldom, +indeed, are the maturing investments allowed to remain unreplaced. +European investors, especially, have consistently done well with money +placed in this country, and the running off to maturity of a +foreign-held American bond is nearly sure to be followed up by +replacement with some other American security. + +Bond houses doing an international business are therefore keenly +watchful of the maturity of issues largely held abroad, and are ever +ready with offers of new and attractive investments. Knowledge of the +location of American investments in Europe is thus a business asset of +the greatest importance, and records are carefully kept. The fact that +a dealer here knows that some bank in London has a wealthy client who +holds a big block of certain bonds about to mature, may very possibly +mean that the house here may be able to make a very profitable trade. +Information of this character is carefully gathered wherever possible +and as carefully guarded. The longer a house has been in business, +naturally, and the closer its financial relationship with investment +interests abroad, the more of this sort of information it is bound to +possess. + +Foreign exchange growing out of these renewals and refundings is on a +very large scale. Sometimes the placing of a new issue abroad means +such immediate drawing of drafts on foreign buyers of the securities as +to depress the exchange market sharply. Sometimes, as in the case of +new issues of railroad stock, where payments are usually made in +instalments covering a year or more, the drawing of exchange is +distributed in such a way that its influence, if felt at all, is felt +merely as an underlying element of weakness. + +Of a somewhat different character are the foreign exchange transactions +originating from what might be called Europe's "floating" investment in +American securities and from the out-and-out speculations carried on in +this market by the foreigners. + +There is never a time, probably, when the floating foreign investment +in American stocks and bonds does not run up with the hundreds of +millions of dollars. "Speculation," such operations would probably be +called by many people, but whether speculation or not, a form of +activity which is continually giving rise to big dealings in foreign +exchange. For this "floating" investment is very largely for account of +bankers whose international connections and credit make it possible for +them to carry stocks and bonds through the agency of the exchange +market, and without having to put up any actual money. The ingenious +method by which this is accomplished is about as follows: + +A banker here, for instance, decides that a certain low-priced bond is +cheap and that if purchased it will show a substantial profit within +six months or a year. Not wanting to buy the bonds and borrow on them +here, he invites his foreign correspondent into the deal on joint +account, arranging to raise the money with which to buy the bonds by +drawing a ninety-day sight draft on the foreign correspondent. This he +does, drawing, say, a L50,000 draft at ninety days' sight, and selling +it in the exchange market at, let us say, $4.83. + +The $241,500 received from the sale of the draft, the American banker +uses to buy the bonds. Ninety days later the draft will come due in +London, and have to be covered (or renewed) from this side, but in the +meantime, a profitable chance to sell the bonds may present itself. If +not, the draft can be "renewed" at the end of the ninety days, and +again and again if necessary, until the bankers are willing to close +out the bonds. + +This operation of "renewing" long drafts drawn for the purpose of +carrying securities is one of the most interesting phases of foreign +exchange business in connection with international security dealings. +The draft has been drawn, say, for L50,000. The end of the ninety-day +period comes, the draft is due, is presented, and has to be paid. But +the bankers do not choose to sell out the bonds and close the deal. +They arrange instead to renew the maturing draft. This they do by +paying the original ninety-day draft out of the proceeds of a new +ninety-day draft. + +The original draft for L50,000 comes due let us say on October 19, so +that about October 10th the New York banker will be under the necessity +of sending over to London a demand draft for L50,000. The rate +realizable for ninety-day drafts being always considerably lower than +the price of demand drafts, it follows that if the banker proposes to +buy L50,000 of demand out of the proceeds of a fresh ninety-day bill he +will have to draw his fresh bill for more than L50,000. If the demand +rate happened to be 4.86, the L50,000 he needs would cost him $243,000. +In order to raise $243,000 by selling a ninety-days' sight draft (say +at 4.83) he would have to make the new draft for L50,310. The extra +L310 would constitute the interest. Each time he renewed the draft he +would have to draw for more and more. + +Requiring the tying up of no actual capital, this form of financing +"floating investments" has become exceedingly popular and is carried on +on a large scale. Where the relationships between the foreign and the +American houses are close, there is almost no limit to the number of +times an original bill may be renewed. As for the constantly increasing +amount of the drafts which have to be drawn, that is taken care of by +the interest on the investment carried. + +Not all the floating investment in American securities is carried in +this way, but in whatever form the financing is done it is bound to +involve foreign exchange operations and to necessitate the drawing of +drafts by banking houses in this country on their correspondents +abroad. Quiet conditions may result in long periods when investments of +this kind are left undisturbed, but even then, the constant remitting +and renewing of drafts originates a good deal of exchange market +activity. And with considerable frequency occur periods when the +floating investment is strongly affected by immediate conditions, and +when purchases, sales, and transfers of securities stir the exchange +market to a high pitch of excitement. + +Speculative operations in this market for foreign account, are, +however, the cause of the greatest amount of exchange market activity +caused by international security transactions. There are times, as has +been said, when individuals and banking houses abroad speculate heavily +and continuously in this market, at which times the exchange market is +strongly affected by the buying and selling of exchange which +necessarily takes place. Such periods may last for weeks or even +months, and during all of the time, London's immediate attitude toward +the market is apt to be the controlling influence on the movement of +exchange rates. + +Concerning arbitraging in stocks, operations of this kind will be found +to divide themselves readily into two classes--trades which are closed +off at both ends at once, and trades which are allowed to run over +night or even for a day or two. The former is a class of business out +of which a dozen or twenty well-equipped houses in New York are making +a great deal of money. With an expert "at the rail" on the floor of the +New York Stock Exchange, and continuous quotations as to prices on the +various stock exchanges in Europe coming in, these houses are in a +position to take advantage of the slightest disparity in prices. The +chance to buy a hundred shares of some stock, in London, for instance, +and to sell it out at the same time in New York, at one-eighth or +one-quarter more, is what the arbitrageurs are constantly on the +lookout for. With the proper facilities, an expert, in the course of +the hour during which the London and New York Stock Exchanges are +simultaneously in session, is often able to put through a number of +profitable trades. + +Such operations are possible, primarily, because of the fact that the +same influences affect different markets in different ways. A piece of +news which might cause a little selling of some stock in London, for +instance, might have exactly the opposite effect in New York. With the +wires continually hot between the two markets and a number of experts +on the watch for the chance to make a fraction, quotations here and +abroad can hardly get very far apart, at least in the active issues, +but occasionally, it does happen that the arbitrageur is able to take +advantage of a substantial difference. Always without risk, the bid in +one market being in hand before the stock is bought in the other +market. + +But not so in the case of the other kind of arbitrage, where stocks +bought in one market are carried over night for the sake of selling +them out in some other market the next morning. There a decided risk is +taken, the success of the operation depending absolutely upon the +judgment of the operator. Under the stimulus of some favorable +development, for instance, which becomes known here only after the +Stock Exchanges abroad are closed for the day, the New York market +closes buoyant. The chances are that the receipt of the news abroad +over night will make the London market open up strong in the morning. +To buy stock right at the closing of the market here for the purpose of +selling it out next morning in London at the opening is an operation +not without risk, but one which is likely to make money. A lower +opening abroad would, of course, spoil the whole plan, and force a +loss, but just there comes in the ability and judgment of the man who +is handling the business. His judgment need by no means be infallible +for the house to make a great deal of money. + +Concerning arbitraging in bonds, practically everything depends not +only on the judgment and skill, but on the facilities and connections +of the man in charge. In the great "open" market in New York and in the +great "open" market in London, American bonds are being continually bid +for and offered in a way which gives an expert in touch with both +markets a chance to buy here and sell there, or vice versa, at a +profit. Such men are employed by bond houses with international +connections, and spend their time doing practically nothing else but +keeping in close touch with open market bids and offers for stocks and +bonds and trying to buy in one market and sell in another. Such trades +are frequently put through on a very profitable basis, profits of a +clear point or more being not at all uncommon. + +As for the degree of risk to be taken in business of this kind, that is +entirely at the discretion of the arbitrageur. Where a firm bid of +ninety-nine, good for the day, for instance, is given, there is no risk +in cabling a bid of ninety-eight to London, but where the bid is not +firm at all, or where it is only firm for five minutes, or in many +other cases, the man who cables his own bid of ninety-eight is taking a +certain amount of risk. Often enough he gets the bonds in London at +ninety-eight, only to find that the ninety-nine bid in New York has +been withdrawn. + +Knowledge of what risks to take and of what risks to leave alone +constitutes expertness in this line of business. Seldom can the +transaction be absolutely closed at both ends and any substantial +profit be made. Most of the time the correctness of the bond expert's +judgment as to how he can sell somewhere else what he has bought, is +what determines the amount of money he will make or lose. + + + + +CHAPTER IX + +THE FINANCING OF EXPORTS AND IMPORTS + + +Interesting as the movement of gold and the international money markets +may be, it is in its application to the every-day importing and +exporting of merchandise that foreign exchange has its greatest +interest for the greatest number of people. Every bale of cotton +exported from the country, every pound of coffee brought in, is the +basis of an operation in foreign exchange, such operations involving +usually the issue of what is known as "commercial credits." + +Broadly speaking, commercial credits are of two classes, those issued +to facilitate the import of merchandise and those issued to facilitate +its export. Considering the question from the standpoint of New York, +import credits are so much more important than export credits and +issued in so much larger volume, they will be taken up first. + +Not all the merchandise imported into the United States is brought in +under commercial letters of credit, but that is coming to be more and +more the way in which payment for imports is being arranged. Formerly +an importer who had bought silk or white-goods in France went around to +his banker, bought a draft on Paris for the required amount of francs +and sent that over in payment. In some cases that is still the method +by which payment is made, but in the very great majority of cases where +the business is being run on an up-to-date basis, a commercial letter +of credit is arranged for before the importation is made. Of how great +advantage such an arrangement is to the merchant importing goods the +following practical illustration of how a "credit" works will show. + +[Illustration: Form of Commercial Letter of Credit] + +To exemplify the greatest number of points of importance possible in +connection with the commercial credit business, the case of a shipment +of raw silk from China will, perhaps, serve best. A silk manufacturer +in Paterson, New Jersey, we will assume, has purchased by cable ten +bales of raw silk in Canton, China. Understanding of the successive +steps in the financing of such a transaction will mean a pretty +satisfactory understanding of the general principles under which the +financing of most of our imports is arranged. + +The purchase of the silk having been consummated by cable, the first +thing the purchaser would do would be to go to his banker in New York, +lay before him an exact statement of the conditions under which the +purchase was made, and get him (the banker) to open a commercial letter +of credit covering those terms. Such a credit, of which a reprint is +given herewith, would be in the form of a letter to the issuing +banker's London correspondent, requesting him to "accept" the drafts of +the sellers of the silk in Canton up to a certain amount and under +certain conditions. These conditions, having to do with the "usance" of +the drafts (whether they were to be drawn at three, four, or six +months' sight) and with the shipping documents to accompany the drafts, +are all very fully set forth in the letter of credit itself. If the +silk has been bought on the basis of four months, for instance, the +credit would read that drafts are to be drawn at four months' sight. +Mention is also made as to whose order the bills of lading are to be +made, as to where the insurance is to be effected, etc., etc. + +The silk importer having received this letter of credit from the banker +in New York, sends it by first mail (or, if the case be urgent, cables +its contents) to the seller of the silk out in Canton. The latter, +having received it, is then in a position to go ahead with his +shipment. The first thing he does is to put the silk aboard ship, +receiving from the steamship company a receipt (bill of lading) stating +that the ten bales have been put aboard, and making them deliverable +_to the order of the banker in New York_, who issues the credit. The +bill of lading being made out to his order is useless to anybody else. +He and he only can get the silk out of the ship when it arrives in New +York. + +The shipper in Canton having received this bill of lading from the +steamship company and having properly insured the goods and received a +certificate stating that he has done so, is then in a position to go +ahead and draw his draft for the cost of the silk. The London +correspondent of the New York banker, to whom the letter of credit is +addressed, is, say, the Guaranty Trust Company of London. Upon that +institution the Canton silk firm, therefore, draws his draft in pounds +sterling for the cost of the silk, attaching to the draft the bill of +lading, an invoice, and the insurance certificate. + +A pertinent inquiry at this point is as to why the letter of credit for +silk shipped from a city in China directs that drafts be drawn on +London--as to why London figures in the transaction at all? The answer +is that drafts on London are always readily negotiable, and that London +is the only city in the whole world drafts on which _are_ readily +negotiable in all places and at all times. A draft on New York or on +Berlin _might_ be negotiated at a point like Canton, but to be sure +that the exporter of the silk will get the best rate of exchange for +his drafts, the drafts must be drawn on London, the financial center of +the world. One of the chief points to the whole business of taking out +a credit, in fact, is to provide a point on which the shipper can draw +satisfactorily. + +Assume now that the silk has been put aboard ship bound for the United +States, that the shipper has drawn, say, a draft for L1,000 at four +months' sight on the Guaranty Trust Co., London, and has attached +thereto the bill of lading and the insurance certificate. Taking this +draft around to his bank the shipper sells it for local currency at the +then prevailing rate for four months' sight drafts drawn on London. The +fact that it is drawn at four months' sight means that he will get a +lower rate of exchange for it than if it were drawn payable on demand, +but that was the arrangement with the buyer in New York--that the +drafts against the silk were to have four months to run. + +Having sold this draft to his bank in Canton and received local +currency therefor, the shipper of the silk is out of the transaction. +He has shipped the goods and he has his money. What becomes of the +draft he drew is the next important point to consider. But so far as +the exporter is concerned, the transaction is closed, and he is ready +for the next operation. + +The silk has now been set afloat for New York, and the draft purchased +by the Canton banker is on its way to London for acceptance. Long +before the silk gets to New York the draft will have reached London and +will have been presented to the cashier of the Guaranty Trust Co., +there, who, of course, was apprised of the credit opened on his bank at +the time such credit was originally issued in New York. Examining the +draft and the documents carefully to see that they conform with the +terms of the credit, the cashier of the Guaranty Trust Co., London, +formally "accepts" the draft, marking it payable four months from the +date it was presented to him. The accepted draft he hands back to the +messenger of the bank who brought it in; the bill of lading, insurance +certificate, and invoice he keeps. By the next mail steamer he +dispatches these papers to the banker in New York who issued the +credit. + +For the time being, at least, that is to say, till the accepted draft +comes due, the London banker is out of the transaction, which is now +narrowed down to the importer of the silk in Paterson and the banker in +New York who issued him the credit. + +Assume now that a week has passed and that the New York banker finds +himself in possession of a bill of lading for ten bales of silk, +merchandise deliverable to his order. A few days later, perhaps, the +goods arrive overland by fast freight from Seattle. The Paterson silk +manufacturer, who is eagerly awaiting their arrival, comes around to +the banker: "Endorse over the bill of lading to me," he says, "so that +I can get the silk and start manufacturing it." + +If the banker does it, he will be giving over the only security he has +for the payment at maturity of the draft his London correspondent +accepted, and for which he himself is responsible. Still, the +manufacturer has to have his silk. + +A number of different agreements exist between bankers and importers to +whom the bankers issue credits, as to the terms on which the importers +are to be allowed to take possession of the merchandise when it arrives +here. Sometimes the goods are put into store and handed over to the +merchant only when he shows that he has sold them and needs them to +make delivery. Sometimes they are warehoused at once, and parcelled out +to the importer only in small lots, as he needs them. But more often +the goods are delivered over to the importer on his signing one form or +other of what is known as a "trust receipt." + +[Illustration: Form of Trust Receipt] + +[Illustration: Form of Bailee Receipt] + +Such difference of opinion exists among foreign exchange men as to the +goodness of the trust receipt system that the author refrains from +making comment on it, confining himself strictly to description of what +the system is. As will be seen from the accompanying reprint of the +trust receipt used by one of the largest issuers of commercial credits +in the country, the document is simply a pledge on the part of the +importer to hold the merchandise in trust for the banker, and, as the +merchandise is sold, to hand over the proceeds to apply against the +draft drawn by the shipper of the goods. The theory of the thing is +that by the time all the merchandise has been sold more than enough +money will have been handed over to the New York banker to take care of +the draft accepted by his London correspondent, the excess constituting +the importer's profit. + +The kind of trust receipt under which bankers are willing to give over +the merchandise (the only collateral they have) naturally varies +according to the standing of the house in question. In the case of some +importers the bankers would be willing to let the bill of lading pass +out of their hands on almost any kind of a receipt; in the case of +others a very strict and binding contract is invariably signed. But +whatever the form of the contract, it is to be borne in mind that when +the banker issuing the credit hands over the bill of lading to the +importer on trust receipt, he is allowing the only security he has to +pass out of his hands, and is putting himself in the position of having +made an unsecured loan to the importer. + +Returning now to the particular transaction in question, the point has +been reached where the silk is in the importer's hands, that result +having been accomplished without the importer having put up a cent of +money. Moreover, for nearly four months to come there will be no +necessity of the importer's putting up any money (unless he should sell +some of the silk, in which case he is bound to turn over the money to +the New York banker as a "prepayment"). But in the ordinary course of +events the importer of the silk has nearly the four full months in +which to fabricate the goods and sell them. At the end of that time the +draft drawn by the firm in Canton and accepted by the Guaranty Trust +Co., London, will be coming due, and the silk importer will be under +the necessity of remitting funds to meet it. Twelve days before the +actual maturity of the L1,000 draft in London, the New York banker will +send to the manufacturer in Paterson a memorandum for L1,000 at, say, +4.86 (whatever is the current rate) plus commission. The silk firm pays +in dollars; the New York banker uses the dollars to buy a demand draft +for L1,000; a day or two before the four months' sight draft comes due +in London this demand draft ("cover") is received in London from New +York, and the whole operation is closed. + +It has been deemed advisable to set forth the whole course of one of +these import-financing transactions, in order that each successive step +may be clearly understood. The question of just _why_ this credit +business is worked as it is will now be taken up. + +The whole purpose of the business, it is plain enough, is to give the +importer here a chance to bring in goods without putting up any actual +money--in other words, of letting him use a larger capital than he is +actually possessed of. There are persons so conservative as to consider +this in itself a wrong idea, but with business carried on along the +lines on which it is actually done nowadays, bank credits play so +important a part that conservatism of this order has little place. +Theory and practice prove that there is no reason why a silk importer, +for instance, with a capital of $100,000 should not be able to use +safely a credit of as much more than that, the standing and credit of +the firm being always the prime consideration. Granted that a +manufacturer stands well and is doing a safe, non-speculative business +on the basis of $100,000 capital, there is no reason why he should not +be able to secure an import credit for an additional L20,000. Not only +is there no reason why he should not get it, but there are any number +of good banking concerns only too glad to furnish it to him. + +So much for the transaction from the importer's standpoint--what does +the seller of the goods get out of it? Payment for his goods as soon as +he is ready to ship them. No waiting for a remittance, no drawing of a +dollar-draft on an obscure firm in Paterson, N.J., which no Canton +bank will be willing to buy at any price. The credit constitutes +authority for the shipper to draw in pounds sterling on London--the one +kind of draft which he can always be sure of turning at once into local +currency and at the most favorable rate of exchange. He ships the +goods, he draws the draft, he sells the draft, he has his money, and he +is out of it. From the shipper's standpoint, surely a most satisfactory +arrangement and one which will induce him to quote the very best price +for merchandise. + +As to the banker's part in the transaction, the whole question is one +of commission. The London banker on whom the credit is issued gets a +commission from the American banker for "accepting" the drafts, and the +American banker, of course, gets a substantial commission from the +party to whom the credit is issued. Sometimes the banker in New York +and the banker in London work on joint-account, in which case both risk +and commissions are equally divided. But more often, perhaps, the +London bank gets such-and-such a fixed commission for accepting drafts +drawn under credits, and the New York banker keeps the rest of what he +makes out of the importer. + +Before proceeding with discussion of what commissions amount to, it is +well to note the fact that in those commercial credit transactions +neither banker is ever under the necessity of putting up a cent of +actual money. As in the case of foreign loans previously described, the +banker's credit and the banker's credit only is the basis of the whole +operation. The London bank never pays out any actual cash--it merely +"_accepts_" a four months' sight draft, knowing that before the draft +comes due and is presented at its wicket for payment, "cover" will have +been provided from New York. The New York banker, on the other hand, +merely sends over on account of the maturing draft in London the money +he receives from the importer. He is under an obligation to the London +banker to see that the whole L1,000 is paid off before the four months +are over, but he knows the party to whom he issued the credit, and +knows that before that time all the silk will have been manufactured +and sold and the proceeds turned over to him. At no time is he out of +any actual cash. + +That being the case, the amount of commission he charges is really very +moderate--one-quarter of one per cent. for each thirty days of the life +of drafts drawn under credits being the "full rate." Under such an +arrangement an importer taking a credit stipulating that the drafts are +to be drawn at thirty days' sight would have to pay one-quarter of one +per cent.; at sixty days' sight, one-half of one per cent.; at ninety +days' sight, three-quarters of one per cent., etc. Such commission to +be collected at the time the drafts drawn under the credits fall due. + +These are the "full rates"--naturally, few importers are required to +pay them, _actual_ rates being largely a matter of individual +negotiation and standing. Where the drafts under the credits run for +ninety days, for instance, as in the case of coffee imported from +Brazil, the full rate would be three-quarters of one per cent., but +very few firms actually pay over three-eighths of one per cent. +Similarly with credits issued for the importation of merchandise of +almost every other kind. Silk credits, with drafts running four months, +ought at the regular rate to cost one per cent.; but as a matter of +fact there are any number of good houses willing to do the business for +five-eighths of one per cent. One large international bank in New York, +indeed, is going so far as to offer to issue credits under which drafts +run _six_ months for a commission of five-eighths of one per cent. +Such a commission is entirely inadequate and no fair compensation for +the trouble and risk the banker takes. It means little more than that +the bank is willing to take business at any price for advertising or +other purposes. + +Assume that an importer has taken out a ninety-day credit and is to pay +three-eighths of one per cent. on all drafts drawn thereunder, what +rate of interest is he actually paying, figured on an annual basis? The +life of the draft is ninety days, and he pays three-eighths of one per +cent.; in each year there are four ninety-day periods; figured on an +annual basis, therefore, the importer is paying four multiplied by +three-eighths of one per cent., equalling one and one-half per cent. +interest. Not a very high charge, and made possible only because the +banker lends his credit and not his cash. + +For purposes of illustration, the financing of the import of silk from +China was chosen because the operation embodied perhaps more points of +interest in connection with commercial credit business than any other +one operation. Commercial credit operations, however, are of great +variety and scope. They may involve, for instance, the import of +matting shipped from Japan on slow sailing ships and where the drafts +drawn run for six months or more, or they may involve the import of +dress goods from France, in which case the drafts are often at sight. +Furthermore, all credits are by no means issued on London. In the Far +East, where tea or shellac or silk is being exported to the United +States, London is known as the one great commercial and financial +center, but in the case of dress goods shipped from Marseilles or +Lyons, for instance, the credits would invariably stipulate that the +drafts be drawn in francs on Paris. + +But whether the material imported be dress goods from France or tea +from China, the principle of the commercial credits under which the +goods are brought in remains identically the same. In every case there +is a buyer on this end who wants to get possession of the goods without +having to put up any money, and in every case there is a seller on the +other end who wants to receive payment as soon as he lets the +merchandise get out of his hands. The banker issuing the credit is +merely the intermediary, and the naming of some foreign point on which +the drafts are to be drawn is merely incidental to the conduct of the +operation. + +One last point remains to be cleared up. The seller of the goods in the +silk-importing operation described gets actual money for the goods as +soon as he ships them--where does this actual money come from? In the +last analysis, from the discount market in London, from the man in +London who discounts the draft after it has been "accepted". The +exporter in Canton gets the money direct from his banker in Canton, but +the latter is willing to let him have the money in exchange for the +draft only because he (the banker) knows that he can send the draft to +London and that some one there will eagerly discount it. In that way +the Canton banker gets his money back. The only party who is out of any +money during the time the silk is being manufactured and sold in +Paterson, N.J., is the party in London who has discounted the +shipper's draft. + +The real function of the banker, then, in these Commercial Credit +transactions is to open up the international loaning market to the +importer. Through the system now in force this is accomplished by a +banker in New York issuing a credit and by a banker in London putting +his "acceptance" on drafts drawn under that credit. The combination +makes the drafts _good_; makes the great discount market in London +willing to take them, and absorb them, and advance real money on them. +And for the opening up of this great reservoir of capital the importer +here has to pay an interest rate of but from one to two per cent. per + + + + + +End of Project Gutenberg's Elements of Foreign Exchange, by Franklin Escher + +*** END OF THIS PROJECT GUTENBERG EBOOK ELEMENTS OF FOREIGN EXCHANGE *** + +***** This file should be named 29364.txt or 29364.zip ***** +This and all associated files of various formats will be found in: + http://www.gutenberg.org/2/9/3/6/29364/ + +Produced by The Online Distributed Proofreading Team at +http://www.pgdp.net (This file was produced from images +generously made available by The Internet Archive/Canadian +Libraries) + + +Updated editions will replace the previous one--the old editions +will be renamed. + +Creating the works from public domain print editions means that no +one owns a United States copyright in these works, so the Foundation +(and you!) can copy and distribute it in the United States without +permission and without paying copyright royalties. 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