Elements of Foreign Exchange

A FOREIGN EXCHANGE PRIMER

By FRANKLIN ESCHERSpecial Lecturer on Foreign Exchange at New York University

_Fifth Edition_

NEW YORKTHE BANKERS PUBLISHING COMPANY1915

LONDONEFFINGHAM WILSON, 54 THREADNEEDLE ST. 

Copyright 1910By 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 andmerchants of one country and the bankers and merchants ofanother, 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 forthe 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 exchangerise as opposed to the five main influences tending to makeexchange fall. 

CHAPTER IV. THE VARIOUS KINDS OF EXCHANGE 45

A detailed description of: Commercial "Long" Bills--CleanBills--Commercial "Short" Bills--Drafts drawn against securitiessold abroad--Bankers' demand drafts--Bankers' "long" drafts. 

CHAPTER V. THE FOREIGN EXCHANGE MARKET 59

How the exchange market is constituted. The bankers, dealers andbrokers who make it up. How exchange rates are established. Therelative importance of different kinds of exchange. 

CHAPTER VI. HOW MONEY IS MADE IN FOREIGN EXCHANGE. THE OPERATIONSOF THE FOREIGN DEPARTMENT 68

An intimate description of: Selling demand bills againstremittances of demand bills--Selling cables against remittancesof demand bills--Selling demand drafts against remittances of"long" exchange--The operation of lending foreign moneyhere--The drawing of finance bills--Arbitraging in ForeignExchange--Dealing in exchange "futures. "

CHAPTER VII. GOLD EXPORTS AND IMPORTS 106

The primary movement of gold from the mines to the markets, andits subsequent distribution along the lines of favorable exchangerates. Description (with presentation of actual figures) of: Theexport of gold bars from New York to London--Import of gold barsfrom London--Export of gold bars to Paris under the "triangularoperation. " Shipments to Argentina. 

London as a "free" gold market and the ability of the CentralBanks in Europe to control the movement of gold. 

CHAPTER VIII. FOREIGN EXCHANGE IN ITS RELATION TO INTERNATIONALSECURITY TRADING 130

Europe's "fixed" and "floating" investment in American bondsand stocks a constant source of international security trading. Consequent foreign exchange business. Financing foreignspeculation in "Americans. " Description of the various kinds ofbond and stock "arbitrage. "

CHAPTER IX. THE FINANCING OF EXPORTS AND IMPORTS 141

A complete description of the international banking system bywhich merchandise is imported into and exported from the UnitedStates. An actual operation followed through its successivesteps. 

PREFACE

"Where can I find a little book from which I can get a clear idea ofhow foreign exchange works, without going too deeply into it?"--thatquestion, put to the author dozens of times and by many different kindsof people, is responsible for the existence of this little work. There_are_ one or two well-written textbooks on foreign exchange, but neveryet has the author come across a book which covered this subject insuch a way that the man who knew little or nothing about it could pickup the book and within a few hours get a clear idea of how foreignexchange works, --the causes which bear upon its movement, its influenceon the money and security markets, etc. 

That is the object of this little book--to cover the ground of foreignexchange, but in such a way as to make the subject interesting and itstreatment readable and comprehensible to the man without technicalknowledge. Foreign exchange is no easy subject to understand; there arefew important subjects which are. But, on the other hand, neither is itthe complicated and abstruse subject which so many people seem toconsider it--an idea only too often born of a look into some of thetextbooks on exchange, with their formidable pages of tabulations, formulas, and calculations of all descriptions. For the average manthere is little of interest in these intricacies of the subject. Manyof the shrewdest and most successful exchange bankers in New York City, indeed, know less about them than do some of their clerks. What isneeded is rather a clear and definite knowledge of the movement ofexchange--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 thehope that something may be added to the general understanding of theseimportant 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 whichobligations between creditors in one country and debtors in anotherhave come to be settled--by having the creditor draw a draft directlyupon the debtor or upon some bank designated by him. A merchant in NewYork has sold a bill of goods to a merchant in London, having thusbecome his creditor, say, for $5, 000. To get his money, the merchant inNew York will, in the great majority of cases, draw a sterling draftupon the debtor in London for a little over £1, 000. This draft hisbanker will readily enough convert for him into dollars. The buying andselling and discounting of countless such bills of exchange constitutethe very foundation of the foreign exchange business. 

Not all international obligations are settled by having the creditordraw direct on the debtor. Sometimes gold is actually sent in payment. Sometimes the debtor goes to a banker engaged in selling drafts on thecity where the obligation exists, gets such a draft from him and sendsthat. But in the vast majority of cases payment is effected asstated--by a draft drawn directly on the buyer of the goods. John Smithin London owes me money. I draw on him for £100, take the draft aroundto 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 financebetween firms in New York and firms in London, it follows that everyday in New York there will be merchants with sterling drafts on Londonwhich they are anxious to sell for dollars, and vice versa. The supplyof exchange, therefore, varies with the obligations of one country toanother. If merchants in New York, for instance, have sold goods inquantity in London, a great many drafts on London will be drawn andoffered for sale in the New York exchange market. The supply, it willof course be apparent, varies. Sometimes there are many drafts forsale; sometimes very few. When there are a great many drafts offering, their makers will naturally have to accept a lower rate of exchangethan when the supply is light. 

The par of exchange between any two countries is the price of the goldunit of one expressed in the money of the other. Take England and theUnited States. The gold unit of England is the pound sterling. What isthe price of as much gold as there is in a new pound sterling, expressed in American money? $4. 8665. That amount of dollars and centsat any United States assay office will buy exactly as much gold asthere is contained in a new British pound sterling, or sovereign, asthe actual coin itself is called. 4. 8665 is the mint par of exchangebetween 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 draftspayable in pounds in London can always be bought or sold for $4. 8665per pound. To reduce the case to a unit basis, suppose that you owedone pound in London, and that, finding it difficult to buy a draft tosend in payment, you elected to send actual gold. The amount of goldnecessary to settle your debt would cost $4. 8665, in addition to whichyou would have to pay all the expenses of remitting. It would becheaper, therefore, to pay considerably more than $4. 8665 for aone-pound draft, and you would probably bid up until somebody consentedto sell you the draft you wanted. 

Which goes to show that the mint par is not what governs the price atwhich drafts in pounds sterling can be bought, but that demand andsupply are the controlling factors. There are exporters who have beenshipping merchandise and selling foreign exchange against the shipmentsall 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 ingreat quantity are being offered, bankers are willing to pay them onlylow rates--$4. 83 or $4. 84, perhaps, for the commercial bills they wantto sell for dollars. Conversely, when exports are running light andbills drawn against shipments are scarce, bankers may be willing to pay4. 87 or 4. 88 for them. 

For a clear understanding of the mechanics of the exchange market thereis necessary a clear understanding of what the various forms ofobligations 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 aregiven, it is apparent, first, what a vast amount of foreign exchangeoriginates 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 buyerabroad chooses rather to secure a dollar draft on some American bankand to send that in payment. But in the vast majority of cases theregular course is followed and the seller here draws on the buyerthere. 

There are times, therefore, when exchange originating from this sourceis much more plentiful than at others. During the last quarter of eachyear, for instance, when the cereal and cotton crop exports are attheir height, exchange comes flooding into the New York market from allover the country, literally by the hundreds of millions of dollars. Thenatural effect is to depress rates--sometimes to a point where itbecomes possible to use the cheaply obtainable exchange to buy gold onthe other side. 

In a following chapter a more detailed description of the New Yorkexchange market is given, but in passing, it is well to note how thewhole country's supply of commercial exchange, with certain exceptions, is focussed on New York. Chicago, Philadelphia, and one or two otherlarge cities carry on a pretty large business in exchange, independentof New York, but by far the greater part of the commercial exchangeoriginating throughout the country finds its way to the metropolis. Forin New York are situated so many banks and bankers dealing in bills ofexchange that a close market is always assured. The cotton exporter inMemphis can send the bills he has drawn on London or Liverpool to hisbroker in New York with the fullest assurance that they will be sold tothe bankers at the highest possible rate of exchange anywhereobtainable. 

2. The second source of supply is in the sale abroad of stocks andbonds. 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 withEurope participating largely, at which times the exchange drawn againstthe securities placed abroad mounts up enormously in volume. Then againthere are times when London and Paris and Berlin buy heavily into ourlisted shares and when every mail finds the stock exchange houses heredrawing millions of pounds, marks, and francs upon their correspondentsabroad. 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 importantinfluence on rates, in that it is often sudden and often concentratedon a comparatively short period of time. The announcement of a singlebig bond issue, often, where it is an assured fact that a large part ofit will be placed abroad, is enough to seriously depress the exchangemarket. Bankers know that when the shipping abroad of the bonds begins, large amounts of bills drawn against them will be offered and thatrates will in all probability be driven down. 

Announcements of such issues, as well as announcements that a block ofthis or that kind of bonds has been placed abroad with some foreignsyndicate, are apt to come suddenly and often find the exchange marketunprepared. For the supply of exchange originated thereby, it must beremembered, is not confined to the amount actually drawn against bondssold but includes also all the exchange which other bankers, in theiranticipation of lower rates, hasten to draw. The exchange market is, indeed, a sensitive barometer, from which those who understand it canread all sorts of coming developments. It often happens that buying orselling movements in our securities by the foreigners are so clearlyforecasted by the action of the exchange market that bankers here areable to gain great advantage from what they are able to foresee. 

3. The third great source of supply is in the drafts which bankers inone country draw upon bankers in another in the operation of makinginternational loans. The mechanism of such transactions will be treatedin greater detail later on, but without any knowledge of the subjectwhatever, it is plain that the transfer of banking capital, say fromEngland to the United States, can best be effected by having theAmerican house draw upon the English bank which wants to lend themoney. In the finely adjusted state of the foreign exchanges nowadays, loans are continually being made by bankers in one country to bankersand merchants in another. Very little of the capital so transferredgoes in the form of gold. A London house decides to loan, say, $100, 000in the American market. The terms having been arranged, the Londonhouse cables its New York correspondent to draw for £20, 000, at 60 or90 days' sight, as the case may be. The New York house, having drawnthe 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 continuouscreation of very large amounts of foreign exchange. As the financialrelationships between our bankers and those of the Old World have beendeveloped, it has come about that European money is being put out inthis market in increasing volume. Conditions of money, discount, andexchange are constantly being watched for the opportunity to make loanson favorable terms, and the aggregate of foreign money loaned out hereat times reaches very large figures. In 1901 Europe had big amounts ofmoney outstanding in the New York market, and again in 1906 very largesums of English and French capital were temporarily placed at ourdisposal. But in the summer of 1909 all records were surpassed, American borrowings in London and Paris footing up to at least half abillion dollars. Such loans, running only a couple of months on theaverage and then being sometimes paid off, but more often shifted aboutor renewed, give rise to the drawing of immense amounts of foreignexchange. 

4. Drawing of so-called "finance-bills, " of which a completedescription will be found in chapters IV and VI, is the fourth sourcewhence foreign exchange originates. Whenever money rates becomedecidedly 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 thepoint where money is high) to draw 60 or 90 days' sight bills. Thesebills can then be disposed of in the exchange market, dollars beingrealized on them, which can then be loaned out during the whole life ofthe bills. The advantages or dangers of such an operation will not betouched upon here, the purpose of this chapter being merely to setforth clearly the sources from which foreign exchange originates. 

And when money is decidedly higher in New York than in London animmense volume of foreign exchange does originate from this source. Anumber of firms and banks, with either their own branches in London orwith correspondents there to whom they stand very close, are in aposition where they can draw very large amounts of finance billswhenever they deem it profitable and expedient to do so. Eventually, ofcourse, these 60 and 90 day bills come due and have to be settled byremittances of demand exchange, but in the meantime the house whichdrew them will have had the unrestricted use of the money. In a marketlike New York this is only too often a prime consideration. With moneyrates soaring as they do so frequently here, a banker can pay almostany commission his correspondent abroad demands and still come outahead on the transaction. 

These are the principal sources from which foreign exchangeoriginates--shipments of merchandise, sales abroad of securities, transfer of foreign banking capital to this side, sale offinance-bills. Other causes of less importance--interest and profits onAmerican capital invested in Europe, for instance--are responsible forthe existence of some quantity of exchange, but the great bulk of itoriginates from one of the four sources above set forth. In the nextchapter effort will be made to show whence arises the demand whichpretty effectually absorbs all the supply of exchange produced eachyear. 

CHAPTER II

THE DEMAND FOR BILLS OF EXCHANGE

Turning now to consideration of the various sources from which springsthe demand for foreign exchange, it appears that they can be dividedabout 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 mostimportant source of demand for foreign exchange. Merchandise broughtinto the country for the period given herewith has been valued asfollows:

 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 bepaid for with bills of exchange. Whether the merchandise in question iscutlery manufactured in England or coffee grown in Brazil, the chancesare it will be paid for (under a system to be described hereafter) by abill of exchange drawn on London or some other great European financialcenter. From one year's end to the other there is constantly thisdemand for bills with which to pay for merchandise brought into thecountry. 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 forimports at certain times of the year than at others, but at all timesmerchandise in quantity is coming into the country and must be paid forwith bills of exchange. 

2. The second great source of demand originates out of the necessity ofmaking payment for securities purchased abroad. So far as the Americanparticipation in foreign bond issues is concerned, the past few yearshave seen very great developments. We are not yet a people, as are theEnglish or the French, who invest a large proportion of their accumulatedsavings outside of their own country, but as our investment surplus hasincreased in size, it _has_ come about that American investors havebeen going in more and more extensively for foreign bonds. There havebeen times, indeed, as when the Japanese loans were being floated, whenvery large amounts of foreign exchange were required to pay for thebonds 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 bondissues. Accumulated during the course of the past half century, thereis a perfectly immense amount of American securities held all overEurope. The greater part of this investment is in bonds and remainsuntouched for years at a stretch. But then there come times when, forone reason or another, waves of selling pass over the European holdingsof "Americans, " and we are required to take back millions of dollars'worth of our stocks and bonds. Such selling movements do not really getvery far below the surface--they do not, for instance, disturb thegreat blocks of American bonds in which so large a proportion of manyof the big foreign fortunes are invested, but they are apt to be, nevertheless, on a scale which requires large amounts of exchange topay for what we have had to buy back. 

The same thing is true with stocks, though in that case the sellingmovements are more frequent and less important. Europe is alwaysinterested heavily in American stocks, there being, as in the case ofbonds, a big fixed investment of capital, beside a continuallyfluctuating "floating-investment. " In other words, aside from theirfixed investments in our stocks, the foreigners are continuallyspeculating in them and continually changing their position as buyersand sellers. Selling movements such as these do not materially affectEurope's set position on our stocks, but they do result at times invery large amounts of our stocks being dumped back upon us--sometimeswhen we are ready for them, sometimes when the operation is decidedlypainful, as in the Fall of 1907. In any case, when Europe sells, webuy. And when we buy, and at the rate of millions of dollars' worth aday, there is a big demand for exchange with which to pay for what wehave bought. 

3. So great is the foreign investment of capital in this country thatthe necessity of remitting the interest and dividends alone meansanother continuous demand for very large amounts of foreign exchange. Estimates of how much European money is invested here are little betterthan guesses. The only sure thing about it is that the figures run wellup into the billions and that several hundred millions of dollars'worth of interest and dividends must be sent across the water eachyear. There are, in the first place, all the foreign investments inwhat might be called private enterprise--the English money, forinstance, invested in fruit orchards, gold and copper mines, etc. , inthe western states. Profits on this money are practically all remittedback to England, but no way exists of even estimating what they amountto. Aside from that there are all the foreign holdings of bonds andstocks in our great public corporations, holdings whose ownership it isimpossible to trace. Only at the interest periods at the beginning andmiddle of each year does it become apparent how large a proportion ofour bonds are held in Europe and how great is the demand for exchangewith which to make the remittances of accrued interest. At such timesthe incoming mails of the international banking houses bulge with greatquantities of coupons sent over here for collection. For several weekson either side of the two important interest periods, the exchangemarket feels the stimulus of the demand for exchange with which theproceeds of these masses of coupons are to be sent abroad. 

4. Freights and insurance are responsible for a fourth important sourceof demand for foreign exchange. A walk along William Street in New Yorkis all that is necessary to give a good idea of the number andimportance of the foreign companies doing business in the UnitedStates. In some form or other all the premiums paid have to be sent tothe other side. Times come, of course, like the year of the Baltimorefire, when losses by these foreign companies greatly outbalancepremiums received, the business they do thus resulting in the actual_creation_ of great amounts of foreign exchange, but in the longrun--year in, year out--the remitting abroad of the premiums earnedmeans a steady demand for exchange. 

With freights it is the same proposition, except that the proportion ofAmerican shipping business done by foreign companies is much greaterthan the proportion of insurance business done by foreign companies. Since the Civil War the American mercantile marine instead of growingwith the country has gone steadily backward, until now the greater partof our shipping is done in foreign bottoms. Aside from the otherdisadvantages of such a condition, the payment of such great sums forfreight to foreign companies is a direct economic drain. An estimatethat the yearly freight bill amounts to $150, 000, 000 is probably nottoo high. That means that in the course of every year there is a demandfor that amount of exchange with which to remit back what has beenearned from us. 

5. Tourists' expenditures abroad are responsible for a further heavydemand for exchange. Whether it is because Americans are fonder oftravel than the people of other countries or whether it is because ofour more or less isolated position on the map, it is a fact that thereare far more Americans traveling about in Europe than people belongingto any other nation. And the sums spent by American tourists in foreignlands annually aggregate a very large amount--possibly as much as$175, 000, 000--all of which has eventually to be covered by remittancesof exchange from this side. 

Then again there must be considered the expenditures of wealthyAmericans who either live abroad entirely or else spend a large part oftheir time on the other side. During the past decade it has come aboutthat every European city of any consequence has its "American Colony, "a society no longer composed of poor art students or those whoseresidence abroad is not a matter of volition, but consisting now ofmany of the wealthiest Americans. By these expatriates money is spentextremely freely, their drafts on London and Paris requiring thefrequent replenishment, by remittances of exchange from this side, oftheir bank balances at those points. Furthermore, there must beconsidered the great amounts of American capital transferred abroad bythe marriage of wealthy American women with titled foreigners. Suchalliances mean not only the transfer of large amounts of capital _enbloc_, but mean as well, usually, an annual remittance of a very largesum of money. No account of the money drained out of the country inthis way is kept, of course, but it is an item which certainly runs upinto the tens of millions. 

6. Lastly, there is the demand for exchange originating from the payingoff of the short-term loans which European bankers so continuously makein the American market. There is never a time nowadays when London andParis are lending American bankers less than $100, 000, 000 on 60 or 90day bills, while the total frequently runs up to three or four timesthat amount. The sum of these floating loans is, indeed, changing allthe time, a circumstance which in itself is responsible for a demandfor very great amounts of foreign exchange. 

Take, for instance, the amount of French and English capital employedin this market in the form of short-term loans; $250, 000, 000 isprobably a fair estimate of the average amount, and 90 days a fairestimate of the average time the loans run before being paid off orrenewed. That means that the quarter of a billion dollars of floatingindebtedness is "turned over" four times a year and _that_ means thatevery year the rearrangement of these loans gives rise to a demand fora billion dollars' worth of foreign exchange. These loaning operations, it must be understood, both originate exchange and create a demand forit. They are mentioned, therefore, in the preceding chapter, as one ofthe sources from which exchange originates, and now as one of thesources from which, during the course of every year, springs a demandfor a very great quantity of exchange. 

The six sources of demand for exchange, then, are for the payment forimports; for securities purchased abroad; for the remitting abroad ofinterest on foreign capital invested here and the money whichforeigners in this country send home; for remitting freight andinsurance profits earned by foreign companies here; for tourists'expenses abroad; and lastly, for the paying off of foreign loans. Fromthese sources spring practically all the demand for exchange. In thelast chapter there were set forth the principal sources of supply. Witha clear understanding of where exchange comes from and of where itgoes, it ought now to be possible for the student of the subject tograsp the causes which bear on the movement of exchange rates. Thatsubject 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 countriesfoot up to the same amount, it is evident that the rate of exchangewill 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 goldcontained in the sovereign. But between no two countries does such acondition exist--take any two, and the amount of the obligation of oneto the other changes every day, which causes a continuous fluctuationin the exchange rate--sometimes up from the mint par, sometimes down. 

Before going on to discuss the various causes influencing the movementof exchange rates, there is one point which should be very clearlyunderstood. _Two_ countries, at least, are concerned in the fluctuationof 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 influencestending to raise and lower exchange rates, New York is chosen as thepoint at which these influences are operative. Consideration will begiven first to the influences which cause exchange to go up. In ageneral way, it will be noticed, they conform with the sources ofdemand for exchange given in the previous chapter. They may beclassified 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 ofexchange rates. Under whatever financial arrangement or from whateverpoint merchandise is imported into the United States, payment is almostinvariably made by draft on London, Paris, or Berlin. At times whenimports run especially heavy, demand from importers for exchange oftenoutweighs every other consideration, forcing rates up to high levels. Apractical illustration is to be found in the inpour of merchandisewhich took place just before the tariff legislation in 1909. Convincedthat duties were to be raised, importers rushed millions of dollars'worth of merchandise of every description into the country. The resultwas that the demand for exchange became so great that in spite of thefact 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 theother side, are the second great influence making for high exchange. There come times when, for one reason or another, the movement ofsecurities is all one way, and when it happens that for any cause weare the ones who are doing the buying, the exchange market is likely tobe sharply influenced upward by the demand for bills with which to makepayments. Such movements on a greater or less scale go on all the timeand constitute one of the principal factors which exchange managerstake into consideration in making their estimate of possible exchangemarket fluctuations. 

It is interesting, for instance, to note the movement of foreignexchange at times when a heavy selling movement of American stocks bythe foreigners is under way. Origin of security-selling on the StockExchange is by no means easy to trace, but there are times when thecharacter of the brokers doing the selling and the very nature of thestocks being disposed of mean much to the experienced eye. Take, forinstance, a day when half a dozen brokers usually identified with theoperations of the international houses are consistently selling suchstocks as Missouri, Kansas & Texas, Baltimore & Ohio, or CanadianPacific--whether or not the inference that the selling is for foreignaccount is correct can very probably be read from the movement of theexchange market. If it is the case that the selling comes from abroadand that _we_ are buying, large orders for foreign exchange are almostcertain to make their appearance and to give the market a very strongtone if not actually to urge it sharply upward. Such orders are notlikely to be handled in a way which makes them apparent to everybody, but as a rule it is impossible to execute them without creating acondition in the exchange market apparent to every shrewd observer. And, as a matter of fact, many an operation in the international stocksis based upon judgment as to what the action of the exchange marketportends. Similarly--the other way around--exchange managers veryfrequently operate in exchange on the strength of what they judge orknow is going to happen in the market for the international stocks. With the exchange market sensitive to developments, knowledge thatthere is to be heavy selling in some quarter of the stock market, fromabroad, is almost equivalent to knowledge of a coming sharp rise inexchange on London. 

Perhaps the best illustration of how exchange can be affected byforeign selling of our securities occurred just after the beginning ofthe panic period in October of 1907. Under continuous withdrawals ofNew York capital from the foreign markets, exchange had sold down to avery low point. Suddenly came the memorable selling movement of"Americans" by English and German investors. Within two or three daysperhaps a million shares of American stocks were jettisoned in thismarket by the foreigners, while exchange rose by leaps and boundsnearly 10 cents to the pound, to the unheard-of price of 4. 91. Nobodyhad exchange to sell and almost overnight there had been created ademand for tens of millions of dollars' worth. 

3. The coming to maturity of American bonds held abroad is anotherinfluencing factor closely kept track of by dealers in exchange. Soextensive is the total foreign investment in American bonds that issuesare coming due all the time. Where some especially large issue runs offwithout being funded with new bonds, demand for exchange often becomesvery strong. Especially is this the case with the short-term issues ofthe railroads and most especially with New York City revenue warrantswhich have become so exceedingly popular a form of investment among theforeign bankers. In spite of its mammoth debt, New York City iscontinually putting out revenue warrants, the operation amounting, infact, to the issue of its notes. Of late years Paris bankers, especially, have found the discounting of these "notes" a profitableoperation and have at times taken them in big blocks. 

Whenever one of these blocks of revenue warrants matures and has to bepaid off, the exchange market is likely to be strongly affected. Accumulation of exchange in preparation is likely to be carried on forsome weeks ahead, but even at that the resulting steady demand forbills often exerts a decidedly stimulating influence. Experiencedexchange managers know at all times just what short-term issues arecoming due, about what proportion of the bonds or notes have foundtheir way to the other side, just how far ahead the exchange is likelyto be accumulated. Repayment operations of this kind are often almost adominant, though usually temporary, influence on the price of exchange. 

4. Low money rates are the fourth great factor influencing foreignexchange upward. Whenever money is cheap at any given center, andborrowers are bidding only low rates for its use, lenders seek a moreprofitable field for the employment of their capital. It has come aboutduring the past few years that so far as the operation of loaning moneyis concerned, the whole financial world is one great market, New Yorkbankers nowadays loaning out their money in London with the samefacility with which they used to loan it out in Boston or Philadelphia. So close have become the financial relationships between leadingbanking houses in New York and London that the slightest opportunityfor profitable loaning operations is immediately availed of. 

Money rates in the New York market are not often less attractive thanthose in London, so that American floating capital is not generallyemployed in the English market, but it does occasionally come aboutthat rates become abnormally low here and that bankers send away theirbalances to be loaned out at other points. During long periods of lowmoney, indeed, it often happens that large lending institutions heresend away a considerable part of their deposits, to be steadilyemployed for loaning out and discounting bills in some foreign market. Such a time was the long period of stagnant money conditions followingthe 1907 panic. Trust companies and banks who were paying interest onlarge deposits at that time sent very large amounts of money to theother side and kept big balances running with their correspondents atsuch points as Amsterdam, Copenhagen, St. Petersburg, etc. , --anywhere, in fact, where some little demand for money actually existed. Demandfor exchange with which to send this money abroad was a big factor inkeeping exchange rates at their high level during all that long period. 

5. High money rates at some given foreign point as a factor inelevating exchange rates on that point might almost be considered as acorollary of low money here, but special considerations often governsuch a condition and make it worth while to note its effect. Suppose, for instance, that at a time when money market conditions all over theworld are about normal, rates, for any given reason, begin to rise atsome point, say London. Instantly a flow of capital begins in thatdirection. In New York, Paris, Berlin and other centers it is realizedthat London is bidding better rates for money than are obtainablelocally, and bankers forthwith make preparations to increase thesterling balances they are employing in London. Exchange on thatparticular point being in such demand, rates begin to rise, andcontinue to rise, according to the urgency of the demand. 

Particular attention will be given later on to the way in which theBank of England and the other great foreign banks manipulate the moneymarket 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 interestrate at any given point begins to go up, foreign exchange drawn uponthat point begins to go up, too. Remittances to the point where thebetter bid for money is being made, are the very simple explanation. Bankers want to send money there, and to do it they need bills ofexchange. An urgent enough demand inevitably means a rise in thequotation at which the bills are obtainable. Which suggests veryplainly why it is that when the Directors of the Bank of England wantto raise the rate of exchange upon London, at New York or Paris orBerlin, they go about it by tightening up the English money market. 

The foregoing are the principal causes making for high exchange. Thecauses which make up for low rates must necessarily be to a certainextent merely the converse, but for the sake of clearness they are setdown. 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 demandfor exchange with which to pay for them, unusually large exports mean abig supply of bills. In a previous chapter it has been explained how, when merchandise is shipped out of the country, the shipper draws hisdraft upon the buyer, in the currency of the country to which themerchandise goes. When exports are heavy, therefore, a great volume ofbills of exchange drawn in various kinds of currency comes on themarket for sale, naturally depressing rates. 

Exports continue on a certain scale all through the year, but, likeimports, are heavier at some times than others. In the Fall, forinstance, when the year's crops are being exported, shipments out ofthe country invariably reach their zenith, the export nadir beingapproached in midsummer, when the crop has been mostly exported andshipments of manufactured goods are running light. 

From the middle of August, when the first of the new cotton crop beginsto find its way to the seaport, until the middle of December, when thebulk of the corn and wheat crop exports have been completed, exchangein very great volume finds its way into the New York market. Normallythis is the season of low rates, for which reason many shippers ofcotton and grain, who know months in advance approximately how muchthey will ship, contract ahead of time with exchange dealers in NewYork 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 thenprotect themselves, at least, from the extremely low rates which theymay be forced to take if they wait and accept going rates at a timewhen shippers all over the country are trying to sell their bills atthe same time. 

How great is the rush of exchange into market may be seen from thestatistics of cotton exports during the period given below. Not all ofthis cotton goes out during the last four months of the year, but thegreater part of it does and, furthermore, cotton, while the mostimportant, is only _one_ of the domestic products exported in theautumn. 

 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 allwith the buyer of foreign exchange. By every mail huge packages ofbills, drawn against shipments of cotton, wheat and corn, come pouringinto the New York market. Bankers' portfolios become crowded withbills; remittances by each steamer, in the case of some of the bigbankers, run up, literally, into the millions of dollars. Naturally, any one wanting bankers' exchange is usually able to secure it at a lowprice. 

2. With regard to the second influence making for low exchange, sale ofAmerican bonds or stocks abroad, no season can be set when theinfluence 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 andbond issues larger than at any other time of the year. No time, however, can be definitely set--there are years when the bulk of thenew issues are brought out in the Spring and other years when the Fallseason sees most of the new financing. But whatever the time of theyear, one thing is certain--the issue of any amount of American bondswith Europe participating largely means a full supply of foreignexchange not only during the time the issues are actually being broughtout, but for long afterward. 

There used to be a saying among exchange dealers that cotton exportsmake exchange faster than anything, but nowadays bond sales abroad havecome to take first place. For foreign participation in syndicatesformed to underwrite new issues almost invariably means the drawing ofbills representing the full amount of the foreign participation. Asyndicate is formed, for instance, to take off the hands of the X Y Zrailroad $30, 000, 000 of new bonds, the arrangement being that therailroad is to receive its money at once and that the syndicate is totake its own time about working off the bonds. Half the amount, say, has been allotted to foreign houses. Immediately, the drawing of£3, 000, 000, or francs 75, 000, 000, as the case may be, begins. Theforeign 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 tolet them draw long drafts, against the deposit of securities on thisside. These drafts, in pounds or francs, at sixty to ninety days'sight, they can sell in the exchange market for dollars, thus securingthe money they have agreed to turn over to the railroad. In themeantime, during the life of the drafts they have set afloat and beforethey come due and have to be paid off, the bankers here can go aboutselling the bonds and getting back their money. Perhaps before thesixty or ninety days, as the case may be, are over, the syndicate mayhave sold out all its bonds and its foreign members have been put in aposition where they can pay off all the drafts they set afloatoriginally in order to raise the money. 

Very often, however, it will happen that on account of one reason oranother, sixty days pass or ninety days pass without the syndicatehaving been able to dispose of its bonds. In that case the long billsdrawn on the foreign bankers have to be "renewed"--that being a processfor which ample provision has, of course, been made. In a succeedingchapter, full description of how long bills of exchange coming due arerenewed will be made. Just here it is only necessary to say that mostor all of the money necessary to pay off the maturing bills is raisedby selling another batch of "sixties" or "nineties, " an operation whichthrows the maturity two or three months further ahead. 

From this outline of the way foreign participation in American bondissues is financed, it can be seen that every time a big issue of bondsof a railroad or industrial in which European investors are activelyinterested, is brought out, it means a large supply of foreign exchangecreated and suddenly thrown on the exchange market for sale. Not anymore suddenly or publicly than the bankers concerned can help, butstill necessarily so to a great degree, because big bond issues canonly be made with the full knowledge and coöperation of a large part ofthe public. Bankers who know in advance of large issues likely to bemade and in which they know they will be asked to participate, oftensell "futures" covering the exchange they foresee their participationwill bring into existence, but as a general rule it may be set downthat heavy issues, involving the sale abroad of large amounts of bonds, are a most depressing factor on the foreign exchange market. Especiallyso, as the participants who have agreed to turn over the money to therailroad, must sell bills to raise it, even if the horde of speculatorsand "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 situationat some point abroad where American bankers usually carry largebalances is another circumstance which often depresses the exchangemarket sharply. "Trouble in the Balkans" and "trouble over the Moroccansituation" are two bugbears which have for years back furnished thekeynote for many swoops downward in the exchange market, and for yearsafter this book is published will probably continue to do so. Money ondeposit at a point several thousand miles away is naturally verysensitive, and the least suspicion of financial trouble is sufficientto cause its withdrawal. Withdrawal of bankers' balances from a foreigncity means offerings of exchange drawn on that point with resultantdecline in rates. 

In the everyday life of the exchange market, political developments ofan unfavorable character and war rumors are about the most frequent andpotent influences toward the condition of uneasiness above referred to. Few war rumors ever come to anything, but there are times when theycirculate with astonishing frequency and persistence and cause decideduneasiness concerning financial conditions at important points. At suchtimes bankers having money on deposit at those points are apt to becomeinfluenced by the drift of sentiment and to draw down their balances. Here, again, operators in exchange, keenly on the alert for suchchances, will very likely begin to sell the exchange market short andoften succeed in breaking it to a degree entirely unwarranted by theknown facts. 

4. But of all the sure depressing influences on exchange, none is moresure than a rise in the money market. More gradual usually than adecline caused by such an influence as the sale of American bondsabroad, the influence of a rising level of money rates is neverthelessfar more certain. 

The theory of this "counter" movement in money rates and exchange issimply that when money rates rise, say at a point like New York, American bankers find it profitable to draw in their deposits from allover Europe for the purpose of using the money in New York. Such aprocess means a wholesale drawing of bills of exchange on all theleading European cities, with consequent offering of the bills andprice-depression in the leading American exchange markets. 

The number of banks scattered all over the United States which keeprunning deposit accounts in the leading European cities has becomesurprisingly great during the past ten years, and a movement to bringhome this capital has to go only a little way before it reaches verylarge proportions. That is exactly what happens when money rates at apoint like New York become decidedly more attractive than they are overon the other side. Arrangements with foreign correspondents usuallycall for a minimum balance of considerable size, which must be leftintact, 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 bedrawn and sold in this market. Especially is this the case when thecause of the higher money level appears to be deep-rooted and theoutlook is for a continuance of the condition for some time to come. 

5. Lastly, as a depressing factor, there is to be considered thecondition which arises when money at some important foreign center, such as London or Paris, begins to ease decidedly. Large receipts ofgold from the mines, a bettering political outlook--these or many othercauses may bring it about that money in London, for instance, after aperiod of high rates, may ease off faster than in Berlin or Hamburg. Asa result, American bankers having large balances in London and findingit difficult to employ them profitably there, any longer, eitherwithdraw them entirely or have the money transferred to some otherpoint. In either case the operation will result in depressing the rateof exchange on London, for the American banker will either draw onLondon himself or, if he wants to transfer the money to Berlin orHamburg, will instruct the German bankers by cable to draw for hisaccount on London. In whatever way it is accomplished, the withdrawalof capital from any banking point tends to lower the rate of foreignexchange 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, asset forth. The international money markets are a most decidedly complexproposition, and there is literally never a time when severalinfluences tending to put rates up are not conflicting with severalinfluences tending to put rates down. The actual movement of the raterepresents the relative strength of the two sets of influences. To beable to "size up" the influences present and to gauge what movement ofrates they will result in, is an operation requiring, first, knowledge, then judgment. The former qualification can perhaps be derived, insmall degree, from study of the foregoing pages. The latter is a matterof mental calibre and experience. 

CHAPTER IV

THE VARIOUS KINDS OF EXCHANGE

Before taking up the question of the activities of the foreign exchangedepartment and the question of how bankers make money dealing inexchange, it may be well to fix in mind clearly what the various formsof foreign exchange are. Following is a description of the mostimportant 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 thebanking representatives of the buyers abroad, at thirty days' sight ormore. The drafts may be accompanied by shipping documents or may be"clean. " The former kind of bill making up the greater part of thewhole amount of foreign exchange dealt in in the New York market, willbe described first. 

Suppose a cotton dealer in Memphis to have sold one hundred bales ofcotton to a spinner in Liverpool, the arrangement being that theEnglish buyer is to be drawn on at sixty days' sight. The first thingthe Memphis merchant does is to ship the cotton on its way toLiverpool, receiving from the railroad company a receipt known as a"bill of lading. " At the same time he arranges for the insurance of thecotton, receiving from the insurance company a little certificatestating that the insurance has been effected. 

The next step is for the Memphis shipper to draw the draft on theLiverpool buyer--or upon some bank abroad designated by the buyer. Thisdraft is drawn in pounds sterling for the equivalent of the dollarvalue of the cotton and made payable sixty days after the party abroadon whom it is drawn has seen it and written "accepted" across its face. This draft, the bill of lading received from the shipping company, andthe insurance certificate received from the insurance company are thenpinned together and constitute a complete "commercial long bill withdocuments attached. "

Other less important documents go with such a bill. Sometimes invoicesshowing the weight and price of the cotton go along with it andsometimes there is also attached a "hypothecation slip" which formallyturns over the right to the goods to the Memphis or New York banker whobuys the draft and accompanying documents from the Memphis cottonshipper. Sometimes, too, insurance is effected by the buyer abroad, inwhich case there may be no insurance certificate. But in the main, oneof 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 cottonshipper is in possession of an instrument which he can dispose of fordollars. This he does either by selling it to his bank in Memphis or bysending it to New York, in order that it may be sold there in theexchange market at the current rate of exchange. Say, the bill ofexchange is drawn on London at sixty days' sight, for £1, 000. Thebuying price for such a draft will be, perhaps, 4. 84. The Memphisshipper gets his check for $4, 840, and is out of the transaction. Thebill has passed into a banker's hands, who will send it abroad--depositit 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 thathad the bill been drawn at less than sixty days' sight, he would havereceived more dollars for it, while if it had been drawn at more thansixty days' sight, he would have received less for it. The longer thebanker who takes the draft off the shipper's hands has to wait until hecan get his money back on it, the lower, naturally, the rate ofexchange he is willing to pay. On the same day that demand drafts areselling at 4. 87, sixty-day drafts may be selling at 4. 84 and ninety-daydrafts at 4. 83. 

Assume, in this particular case, that the draft has been taken off theshipper's hands by some foreign exchange banker in New York. By thevery first steamer the latter will forward it to his bankingcorrespondent abroad, with instructions to present it at once to theparties on whom it is drawn, in order that they may mark it"accepted--payable such-and-such-a-date. " After that the bill is adouble obligation of the drawer and the drawee, and may be discountedin the open market, for cash. 

Just here it is necessary to digress and state that documentarycommercial bills are of two kinds--"acceptance" bills and "payment"bills. In the case of the first-named, the documents are delivered tothe 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 atonce. In the case of a "payment" bill, the credit of the man on whom itis drawn is not good enough to entitle him to such a privilege, and theonly way he can get actual possession of the goods is to actually paythe draft under a rebate-of-interest arrangement. All bills drawn onbanks are naturally "acceptance" bills; and being discountable and thusimmediately convertible into cash abroad, command a better rate ofexchange in the New York market than "payment" bills, which may beallowed to run all the way to maturity before a single pound sterlingis paid on them. 

Except in the case of the shipment of perishable merchandise--grainshipped in bulk, for instance. In that case the buyer on the other sidecannot afford to let the draft run, because the merchandise wouldspoil. He is simply forced to pay it under rebate, in order to getpossession of the grain. And the rebate being always less than thediscount rate, less pounds sterling come off the face of the bill inthe process of _rebating_ than of _discounting_. For which reasonsixty-day bills drawn against shipments of grain--documents deliverableonly on payment under rebate--command a better rate of exchange eventhan 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 themerchants or bankers of another are unaccompanied by shipping documentsthey are said to be "clean. " Bills of this kind may originate from thetransfer of capital from one country to another or may representdrawings against shipments of merchandise previously made. It is notunusual, indeed, where the relationship between some foreign merchantand some American merchant is very close, for the one to shipmerchandise to the other without drawing drafts against the shipmentuntil some little time afterward. It might happen, for instance, that acotton manufacturing firm in France wanted to import a lot of rawcotton from the United States, but did not want to be drawn upon at thetime. Under such circumstances the American house might ship the goodsand send over the documents to the buyer, postponing its drawing forsome time. Eventually, of course, the American house would reimburseitself 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 theforeign department, the risk in buying various kinds of bills will befully explained, but in passing it may be mentioned that "clean" billsare of such a nature that bankers will touch them only when drawn bythe very best houses. With a documentary bill, the banker holds thebill of lading, and if there is any trouble about the acceptance orpayment of a draft, can simply seize the goods and sell them. But inthe case of a "clean" bill, he has absolutely no security. The standingof the maker of the bill and what he knows about the maker's right todraw the bill is all he has to go by in determining whether to buy itor 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 thedraft drawn is at less than thirty days' sight, but there are a goodmany small bills of this kind continually coming into the market. Drafts drawn against manufactured articles and against such products ascheese, butter, dried fruits, etc. , are apt to be drawn for, withshipping documents attached, at anywhere from three to thirty days'sight, but there is no rule about it. Where the "usance"--the time thebill has to run--is only a few days, documents are apt to bedeliverable 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 orbonds against which it is drawn being almost always attached to thebill of exchange. In the case of syndicate participations by largehouses, the bonds may be shipped abroad privately and exchange againstthem drawn and sold independently, in which case, of course, nosecurity is attached, but as a rule the bonds or stocks go with thedraft. A, in New York, executes an order to buy for B in London, onehundred Union Pacific preferred shares on the New York Stock Exchange. The stock comes into A's office, and he pays for it with the proceedsof a sterling draft he draws on B. The stock itself he attaches to thissterling draft. Whoever buys the draft of him gets the stock with itand keeps possession of it till the draft is presented and paid inLondon. 

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 inseveral European centers, are continually drawing and selling theirdemand drafts--"checks, " they are called, or "demand"--upon theseforeign balances. Such checks are always to be had in great volume inthe exchange market, the banker's business being to draw and sellexchange, and his degree of willingness being merely a matter of rate. There come times, of course, when bankers have every reason to leavetheir foreign balances undisturbed, but even at such times the bid of ahigh 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 caremust be taken to differentiate between the _different kinds_ of longbills being bought and sold in the exchange market. A finance billlooks exactly the same as a long bill drawn by a banker for acommercial customer who wants to anticipate the payment abroad for anincoming shipment of wool or shellac, but the nature and origin of thetwo 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 init are continually drawing their sixty and ninety days' sight bills inresponse to their own and their customers' needs. One example whichmight be cited is that of the importer who has a payment to make on theother side, sixty days from now, but who, having the money on hand, wants to make it at once. Under some circumstances such an importermight remit a demand draft on the basis of receiving a rebate ofinterest for the unexpired sixty days, but more likely he would go to abanker and buy from him a sixty days' sight draft for the exact amountof pounds he owed. The cost of such a draft--which would mature at thetime the debt became due--would be less than the cost of a demanddraft, the importer getting his rebate of interest out of the cheaperprice he pays for the pounds he needs. Prepayments of this sort areresponsible 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 anenormous amount of floating capital loaned out in this market, in themaking and renewing of which loans long bills are created as follows:

A banker on the other side decides to loan out, say, £100, 000 in theNew York market. Arrangements having been made, he cables his New Yorkrepresentative to draw ninety days' sight drafts on him for £100, 000, the proceeds of which drafts are then loaned out for account of theforeign house. The matter of collateral, risk of exchange and, indeed, all the other detail, will be fully described in the succeedingchapters on how bankers make money out of exchange. For the time beingit is merely necessary to note that every time a loan of foreigncapital is made here--and there are days when millions of pounds are soloaned out--bankers' long bills for the full amount of the loans arecreated 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. Inthis case, again, detailed discussion must be put off until the chapteron foreign-exchange-bankers' operations, but the fact that bills ofthis kind constitute so important a part of the bankers' long bills tobe had in the market, necessitates their classification in this place. Every time a banker here starts to use his credit abroad for thepurpose of raising money--and there are times when the privilege ispretty freely availed of--he does it by drawing sixty or ninety days'sight drafts on his correspondents abroad. Finance bills, it may besaid without question, are one of the most interesting forms of foreignexchange banking--at the same time one of the most useful and one ofthe most abused of privileges coming to the domestic banker by reasonof his having strong banking connections abroad. 

CHAPTER V

THE FOREIGN EXCHANGE MARKET

The foreign exchange market is in every sense "open"--anyone with billsto buy or sell and whose credit is all right can enter it and dobusiness on a par with anyone else. There is no place where the tradingis done, no membership, license or anything of the kind. The "market, "in fact, exists in name only; it is really constituted of a number ofbanks, dealers and brokers, with offices in the same section of thecity, and who do business indiscriminately among themselves--sometimespersonally, sometimes by telephone, by messenger, or by the aid of thecontinuously circulating exchange brokers. 

The system is about as follows: The larger banks and banking houseshave a foreign exchange manager, or partner, taking care of that partof the business, whose office is usually so situated as to make himaccessible to the brokers who come in from the outside, and whosetelephoning and wiring facilities are very complete. These largerhouses have no brokers or "outside" men in their employ. The managerknows very well that plenty of chance to do business, buying orselling, will be brought in to him by the brokers and that his wireskeep him constantly in touch with his fellow bankers. 

Next come the big dealers in exchange, some of whom do a regularexchange business of their own, the same as the bankers, but who alsohave men out on the street "trading" between large buyers and sellersof bills. Such houses are necessarily closely in touch with banks, bankers, exporters, and importers all over the country, and have alwayslarge orders on hand to buy and sell exchange. Some of the bills theyhandle they buy and use for the conduct of their own business withbanks abroad, but the more important part of what they do is to deal inforeign exchange among the banks. They are known as always having onhand for sale large lines of commercial and bankers' bills, while onthe other hand they are always ready to buy, at the right price. 

After this class of houses come the regular brokers--the independentand unattached individuals who spend their time trying to bring buyerand seller together, and make a commission out of doing it. In a marketlike New York the number of exchange brokers is very large. Likebond-brokerage, the business requires little in the way of officefacilities or capital, and is attractive to a good many persons who arewilling to accept the small income to be made out of it in return forbeing 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 itis now, exchange brokers made their quarter-cent in the poundcommission, and could depend on a respectable income. But nowadaysbrokers swarm among the foreign exchange bankers and dealers, doingbusiness on any commission they can get, which is not infrequently aslittle as 1/128 of one per cent. , say, $1. 50, for buying or sellingfrancs 100, 000. In handling sterling, the broker is lucky if he makeshis five points (5/100 of a cent per pound), which means that forturning over £10, 000 he would be rewarded with the sum of $5. Undersuch conditions it is not difficult to see how hard it is to make anymoney to speak of out of foreign exchange brokerage. 

The dealers, of course, fare much better. Handling commercial billswhere the question of credit affects the price, they have a chance tomake more of a profit, and buying and selling bills for their ownaccount they naturally are entitled to make more than the man withoutcapital, who simply tries to get in between the buyer and the seller. Dealing in exchange, especially for out-of-town clients, is a highlyprofitable business, but one which takes time, brains, experience andmoney to build up. Dealers representing large out-of-town sellers ofexchange are very much in the position of the New York agents ofmanufacturing 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 thecourse of each day will be according to the supply and demand forbills. On any given morning by ten o'clock the bankers will all havereceived their cables quoting money and exchange rates in the foreigncenters, and will all have pretty well made up their minds as to whatthe rate for demand bills on London ought to be. A banker, forinstance, has £10, 000 he wants to sell as early in the morning aspossible, and from his foreign cables figures that 4. 86 is about theright price. He offers it at that, but learns that another banker isoffering exchange at 4. 8595. He offers his own at that price, andsomebody comes along, taking both lots and bidding 4. 86 for £50, 000more. 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 bankerto bid 4. 8605 or 4. 8610, or it may cause him to throw on the marketsuch 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 minuteto minute. Yet so complete is the system of telephones and brokers thatany exchange manager can tell just about what is taking place in anyother part of the market. Not infrequently, of course, sales are madesimultaneously at slightly different rates, but, as a rule, if a tradeis made at 4. 86 on Cedar Street, 4. 86 will be the rate on ExchangePlace. It is remarkable how closely each manager keeps in touch withwhat is going on in every part of the market. And the great number ofbrokers continually circulating around and trying to "get in between"for five points is in itself a powerful influence toward keeping ratesexactly the same in all parts of the market at once. 

"Posted rates" mean little with regard to current conditions, beingsimply the bankers' public notice of the rate at which he will sellbills for trifling amounts. Exchange bankers dislike to draw smalldrafts and usually can be induced to do so only by the offer of a muchhigher rate than that current for a large amount. A banker might offerto sell you £10, 000 at 4. 87, but if you said you wanted only £10, hewould be likely to point to his posted rate and charge you 4. 88. Considering that in transactions based on the best bills the bankeronly figures on making from $10 to $20 profit on each £10, 000, it mayreadily be seen why he is not anxious to sell a £10 draft. 

As to the actual fluctuation of exchange, while it is true that ratesat times rise and fall with all the violence so often displayed in thesecurity markets, most of the time they move within a comparativelynarrow range. On an ordinary business day, for instance, the change isnot apt to run over fifteen points (15/100 of a cent per pound). In themorning, demand sterling may be at, say, 4. 86; at noon a moderatedemand 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 themarket might then recede to, say, 4. 8605, ending the day five pointsup. And that would be an ordinary day--by no means the kind of a daythe exchange market always sees, but a day corresponding to a stockmarket session in which the market leaders rise or fall a point or so. 

There are times, of course, when very different conditions prevail. Anunexpected rise in the bank rate in London, the announcement of a bigloan or any one of many different happenings, are apt to cause areduction in the exchange market and a bewildering movement of rates upand down. At such times a rise or fall of fifty points in sterlingwithin half an hour is not at all out of the ordinary, while in timesof panic, or when great crises impend, the fluctuations will be threeor four times as great. During the latter part of October, 1907, and inNovember, the exchange market fluctuated with greater violence than, perhaps, at any other time since the gold standard was firmlyestablished. Thrown completely out of gear by the premium of 3-1/2 percent. A day for currency during the panic time, the exchange marketsfor some time would rise and fall several cents in the pound on thesame day. Completely baffled by this erratic movement, many bankerstemporarily withdrew entirely from the market. 

As to the relative importance of the different kinds of exchange, sterling, of course, occupies the most prominent position. Whatproportion of the total of exchange dealt in in the New York marketconsists of sterling it is impossible to determine, but that it is asgreat as the volume of all the other kinds of exchange put together cansafely 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 smallscale. As to whether francs or marks come next in volume, there is adifference of opinion. With Germany our direct financial transactionsare probably considerably larger than with France, but the position ofParis as a banking centre makes the French capital figure prominentlyin many operations where the French market is not directly concerned. Despite the fact that sterling easily predominates, the volume of francand mark bills, too, is enormous. Drafts on Paris for from three tofive million francs and on Berlin for as many marks are not at allinfrequently traded in in the exchange market, and at times bills forvery much larger amounts have been drawn and offered for sale. 

Bills drawn in other kinds of currency--guilders on Holland, forinstance, form an important part of the foreign exchange dealt in in amarket like New York, but are subservient in their rate fluctuations tothe movement of sterling, marks, and francs. The latter are, indeed, the three great classes of exchange, and are the basis of at leastnine-tenths of all foreign exchange operations. 

In the following chapter will be taken up the various forms of activityof the foreign exchange department. No attempt is made to state out ofwhich kind of business bankers make most money, but before looking intothe more detailed description of how exchange business is conducted, itmay 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. Highlycomplicated operations are indulged in by some managers with moretheoretical than practical sense, and money is at times made out ofthem, but on the whole the real money is made out of the kinds ofbusiness about to be described. To the author's certain knowledge, theexchange business of one of the largest houses in New York was foryears thus limited to what might be called "straight" operations. Whilethe profits might at times have been materially increased by theintroduction of a little more of a speculative element into thebusiness, the house made money on a large scale and avoided the lossesinevitable 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 foreignexchange department of an important firm would fill a large volume, butthere are certain stock operations in foreign exchange which are thebasis of most of the transactions carried out and the understanding ofwhich ought to go a long way toward making clear what the nature of theforeign exchange department's business really is. 

1. _Selling "Demand" Against "Demand"_

The first and most elementary form of activity is, of course, thebuying of demand bills at a certain price and the selling of thebanker's own demand drafts against them at a higher price. A bankerfinds, for instance, that he can buy John Smith & Co. 's sight draft for£1, 000, on London, at the rate of 4. 86, and that he can sell his owndraft for £1, 000 on his London banking correspondent at 4. 87. All hehas to do, therefore, is to buy John Smith's draft for $4, 860, send itto London for credit of his account there, and then draw his own draftfor £1, 000 on the newly created balance, selling it for $4, 870. It costhim $4, 860 to buy the commercial draft, and he has sold his own draftagainst 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 exactlyof this kind--the one cited is taken only because it illustrates theprinciple. For whether the banker sends over in every mail abewildering assortment of every conceivable form of foreign exchange tobe credited to his account abroad, or whether he confines himself toremittances of the simplest kinds of bills, the idea remains exactlythe same--he is depositing money to the credit of his account in orderthat he may have a balance on which he can draw. That is, indeed, thesum and substance of the exchange business of the foreign department ofmost banking houses--the maintaining of deposit accounts in banks atforeign centers on which deposit account the bank here is in a positionto draw according to the wants and needs of its customers. 

To analyze the underlying transaction a little more closely, it isevident that the banker, in order to make a profit, must be able to buythe commercial bill at a lower rate of exchange than he can realize onhis own draft. Which suggests at once that the extent of the banker'sprofit is dependent largely upon the amount of risk he is willing totake. For the rate on commercial bills is purely a matter of thedrawer's credit. The best documentary commercial exchange, drawn atsight on banks abroad or houses of the highest standing will command arate of exchange in the open market only a little less than thebanker's own draft. From which point the rate realizable on commercialbills tapers off with the credit of the house in question, some billsregularly selling a cent or a cent and a half per pound sterling belowthe 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 forbankers to make widely varying profits out of the same kind ofbusiness. Everything depends upon the amount of risk the banker iswilling to take. The exchange market is a merciless critic of credit, and if a commercial firm's bills always sell at low rates, thepresumption is strongly against its financial strength. Cases veryfrequently occur, however, where the exchange market misjudges thegoodness of a bill, placing too low a valuation upon it. In that casethe banker who, individually, knows that the house in question is allright, can make considerable sums of money buying its bills at thelow-going rates and selling his own exchange against them. This, evidently, is purely a matter of the exchange manager's judgment. Withcomparatively little risk there are banking houses which are making afull cent a pound out of a good part of the commercial exchange theyhandle. 

2. _Selling Cables Against Demand Exchange_

No description of a cable transfer having been given in the precedingdescription of different kinds of exchange, it may be explained brieflythat a "cable, " so-called, differs from a sight draft only in that thebanker abroad who is to pay out the money is advised to do so by meansof a telegraphic message instead of by a bit of paper instructing himto "pay to the order of so and so. " A, in New York, wants to transfermoney to B, in London. He goes to his banker in New York and depositsthe amount, in dollars, with him, requesting that he (the New Yorkbanker) instruct his correspondent in London, by cable, to pay to B theequivalent in pounds. The transfer is immediate, the cable being sentas soon as the American banker receives the money on this end. 

To be able to instruct its correspondent in London by cable to pay outlarge sums at any given time, a bank here must necessarily carry asubstantial credit balance abroad. It would be possible, of course, fora banker to instruct his London agent by cable to pay out a sum ofmoney, at the same time cabling him the money to pay out, but thisoperation of selling cables against cables is not much indulgedin--there is too little chance of profit in it. Under specialcircumstances, however, it can be seen that a house anxious to sell alarge cable and not having the balance abroad to do it, might easilyprovide its correspondent abroad with the funds by going out and buyinga cable itself. 

But under ordinary circumstances foreign exchange dealers who engage inthe business of selling cables carry adequate balances on the otherside, balances which they keep replenishing by continuous remittancesof demand exchange. Which in itself constitutes an important form offoreign exchange activity and an operation out of which many largehouses make a good deal of money. 

All the parties involved being bankers there is little risk in businessof 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 verylarge amounts of money be turned over. The average profit, forinstance, realized in the New York exchange market from straight salesof cables against remittances of checks is fifteen points (15/100 of acent per pound sterling). That means that on every £10, 000, the grossprofit would be $15. 00. A daily turnover of £50, 000, therefore, wouldresult in a gross profit of $75 a day. 

It may seem strange that bankers should be willing to turn over solarge an amount of money for so small a profit, even where the risk hasbeen reduced to a minimum, but that is the case. Very often cables aresold against balances which have been accumulated by remittance of allsorts of bills other than demand, but there are several large Americaninstitutions whose foreign exchange business consists principally ofthe regulation selling of cables against remittances of demand bills. By reason of their large deposits they are in a position to carry fullbalances abroad, while in the course of their regular business a gooddeal of sight exchange of high class comes across their counters. Allthe necessary elements for doing the business being there, it onlyremains for such an institution to employ a man capable of directingthe actual transactions. The risk is trifling, the advertisement isworld-wide, the accommodation of customers is being attended to, andthere is considerable actual money profit to be made. The business inmany 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 exchangebusiness it is the selling by bankers of their demand bills of exchangeagainst remittances of commercial and bankers' long paper. Bills of thelatter class, as has been pointed out, make up the bulk of foreignexchange traded in, and its disposal naturally is the most importantphase of foreign exchange business. For after all, all cabling, arbitraging in exchange, drawing of finance bills, etc. , is onlyincidental. What the foreign exchange business really is grounded on isthe existence of commercial bills called into existence by exports ofmerchandise. 

There are houses doing an extensive exchange business who never buycommercial long bills, but the operations they carry on are madepossible only by the fact that most other houses do. A foreign exchangedepartment which does not handle this kind of exchange is necessarilyon the "outside" of the real business--is like a bond broker who doesnot carry bonds with his own money but merely trades in and out onother people's operations. 

Buying and remitting commercial long bills is, however, no pastime foran inexperienced man. Entirely aside from the question of rate, andprofit on the exchange end of the transaction, there must be taken intoconsideration the matter of the credit of the drawer and the drawee, the salability of the merchandise specified in the bill of lading, anda number of other important points. This question of credit, underlyingto so great a degree the whole business of buying commercial longpaper, will be considered first. 

The completely equipped exchange department has at its disposal all themachinery necessary for investigating expeditiously the standing andfinancial strength of any firm whose bills are likely to be offered inthe exchange market. Such facilities are afforded by subscription tothe two leading mercantile agencies, but in addition to this, theexperienced exchange manager has at his command private sources ofinformation which can be applied to practically every firm engaged inthe export business. The larger banks, of course, all have a regularcredit man, one of whose chief duties nowadays is to assist in thehandling of the bank's foreign exchange business. So perfect does theorganization become after a few years of the actual transaction of aforeign exchange business that the standing of practically any billtaken by a broker into a bank, for sale, can be passed upon instantly. New firms come into existence, of course, and have to be fullyinvestigated, but the experienced manager of a foreign department cantell almost offhand whether he wants a bill of any given name or not. 

Where documents accompany the draft and the merchandise is formallyhypothecated to the buyer of the draft, it might not be thought thatthe standing of the drawer would be of such great importance. Possession of the merchandise, it is true, gives the banker a certainform of security in case acceptance of the bill is refused by theparties on whom it is drawn or in case they refuse to pay it when itcomes due, but the disposal of such collateral is a burdensome andoften expensive operation. The banker in New York who buys a sixty-daydraft drawn against a shipment of butter is presumably not an expert onthe butter market and if he should be forced to sell the butter, mightnot be able to do so to the fullest possible advantage. Employment ofan expert agent is an expensive operation, and, moreover, there isalways the danger of legal complication arising out of the banker'shaving sold the collateral. It is desirable in every way that if thereis to be any trouble about the acceptance or payment of a draft, thebanker should keep himself out of it. 

A concrete illustration of the dangers attendant upon the purchase ofcommercial long bills from irresponsible parties is to be found in whathappened 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 littletime, and everything had gone well. But one day acceptance of a billfor £2, 000 was refused by the party abroad, and the news cabled thatthe bill of lading was a forgery and that no such shipment had everbeen made. Wiring hurriedly to the inland city in which was located thefirm which drew the bill, the New York bank received the reply thatboth partners had decamped. What had happened was that, about to breakup, the "firm" had drawn and sold several large bills of exchange, withforged documents attached, received their money for them, and thendisappeared. Neither of them was ever apprehended, and the variousbankers 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 comparativelyeasy matter, the shipment purporting to have been made from an obscurelittle cotton town in the South, the signature of whose railroad agentwas not at all known. 

This forgery is only one example of the trickery possible and theextreme care which is necessary in the purchase of bills of this kind. And not only must the standing of the drawer be taken intoconsideration, but the standing of the drawee is a matter of almostequal importance--after the "acceptance" of the bill, the partiesaccepting it being equally liable with its maker. The nature of themerchandise, furthermore, and its marketability are furtherconsiderations of great importance. Cotton, it will readily appear, isan entirely different sort of collateral from clocks, or some specialtyin which the market may vary widely. The banker who holds a bill oflading for cotton shipped to Liverpool can at any moment tell exactlywhat 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, hemight have to do so at a big loss. 

Returning to the actual operation of selling bankers' demand againstremittances of long bills, it appears that the successive steps in anactual transaction are about as follows:

The banker in New York having ascertained by cable the rate at whichbills "to arrive" in London by a certain steamer will be discounted, buys the bills here and sends them over, with instructions that they beimmediately discounted and the proceeds placed to his credit. On thisresulting balance he will at once draw his demand draft and sell it inthe open market. If, from selling this demand draft, he can realizemore 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 £1, 000ninety days' sight prime draft, on London, documents deliverable onacceptance. This he has remitted to his foreign correspondent, and hisforeign correspondent has had it stamped with the required "bill-stamp, "has had it discounted, and after having taken his commission out of theproceeds, has had them placed to the credit of the American bank. Inall this process the bill has lost weight. It arrived in London as£1, 000, but after commissions, bill-stamps and ninety-three days'discount have been taken out of it, the amount is reduced well below£1, 000. The _net_ proceeds going to make up the balance on which theAmerican banker can draw his draft are, perhaps, not over £990. He paidso-and-so many dollars for the £1, 000 ninety-day bill, originally. Ifhe can realize that many dollars by selling a demand draft for £990 heis even on the transaction. 

No attempt will be made in this little book to present the tables bywhich foreign exchange bankers figure out profit possibilities inoperations of this kind. The terms obtainable from foreigncorrespondents vary so widely according to the standing and credit ofthe house on this side and are governed by so many different influencesthat a manager must work out each transaction he enters according tothe conditions by which he, particularly, and his operations aregoverned. Such calculations, moreover, are all built up along thegeneral 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 £100. 

 _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 £100 bill amount to $4. 74. Onone pound, therefore, the charge would be $. 0474. From which it isevident that each pound of a ninety-day bill, under the conditionsgiven, 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 weresold at 4. 85 against a ninety-day bill bought at 4. 8026 (found bysubtracting 4. 74 cents from 485 cents) the remitting banker would comeout even in the transaction. 

The foregoing has been introduced at the risk of confusing the layreader, on the idea that all the various calculations regarding thedrawing of "demand" against the remitting of long bills are founded onthe same general principle, and that where it is desired to go moredeeply into the matter the correct conditions can be substituted. Discount, of course, varies from day to day, "payment" bills do not gothrough the discount market at all, but are "rebated, " the commissionscharged different bankers and by different bankers vary widely. Underthe circumstances the value of presenting a lot of hard-and-fastcalculations worked out under any given set of conditions is extremelydoubtful. 

As to the profit on business of this kind it can be said that theaverage, where the best bills are used, runs not much over twentypoints (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 perpound, according to the amount of risk involved. The buying of cheapbills is, however, a most precarious operation. One single mistake, andthe whole profit of months may be completely wiped out. The propositionis a good deal like lending money on insecure collateral, or likelending to doubtful firms. There are banking houses which do it, havebeen doing it for years, and by reason of an intuitive feeling whenthere is trouble ahead have been able to avoid heavy losses. Suchbusiness, 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 moreimportant phase of foreign exchange than the making of foreign loans inthe American market. How great is the amount of foreign capitalcontinually loaned out in this country has been several times suggestedin previous pages. The mechanics of these foreign loaning operations, the way in which the money is transferred to this side, etc. , will nowbe taken up. 

To begin at the very beginning, consider how favorable a field is theAmerican market for the employment of Europe's spare banking capital. Almost invariably loaning rates in New York are higher than they are inLondon or Paris. This is due, perhaps, to the fact that industry hereruns on at a much faster pace than in England or France, or it may bedue to the fact that we are a newer country, that there is no suchaccumulated fund of capital here as there is abroad. Such a hypothesisfor our own higher interest rates would seem to be supported by thefact that in Germany, too, interest is consistently on a higher levelthan in London or Paris, Germany, like ourselves, being a vigorousindustrial nation without any very great accumulated fund of capitalsaved by the people. But whatever the reason, the fact remains that inNew York money rates are generally on so much more attractive a basisthan they are abroad that there is practically never a time when thereare not hundreds of millions of dollars of English and French moneyloaned out in this market. 

To go back no further than the present decade, it will be recalled howgreat a part foreign floating capital played in financing theill-starred speculation here which culminated in the panic of May 9, 1901. Europe in the end of 1900 had gone mad over our industrialcombinations and had shovelled her millions into this market for theuse of our promoters. What use was made of the money is well known. Theinstance is mentioned here, with others which follow, only to show thatall through the past ten years London has at various times opened herreservoirs of capital and literally poured money into the Americanmarket. 

Even the experience of 1901 did not daunt the foreign lenders, and in1902 fresh amounts of foreign capital, this time mostly German, weresecured by our speculators to push along the famous "Gates boom. " Thattime, however, the lenders' experience seemed to discourage them, anduntil 1906 there was not a great deal of foreign money, relativelyspeaking, loaned out here. In the summer of that year, chiefly throughMr. Harriman's efforts, English and French capital began to comelargely into the New York market--made possible, indeed, the "HarrimanMarket of 1906. " This was the money the terror-stricken withdrawal ofwhich during most of 1907 made the panic as bad as it was. After thepanic, most of what was left was withdrawn by foreign lenders, so thatin the middle of 1908 the market here was as bare of foreign money asit has been in years. Returning American prosperity, however, combinedwith complete stagnation abroad, set up another hitherward movement offoreign capital which, during the spring and summer of 1909, attainedamazing proportions. By the end of the summer, indeed, more foreigncapital was employed in the American market than ever before in thecountry's financial history. 

To take up the actual operation of loaning foreign money in theAmerican market, suppose conditions to be such that an English bank'smanagers have made up their minds to loan out £100, 000 in New York--noton joint account with the American correspondent, as is often done, butentirely independently. Included in the arrangements for thetransaction will be a stipulation as to whether the foreign bankloaning the money wants to loan it on the basis of receiving acommission and letting the borrower take the risk of how demandexchange may fluctuate during the life of the loan, or whether thelender 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 isrealized that in the first case the American agent of the foreignlender draws a ninety days' sight sterling bill for, say, £100, 000 onthe lender, and hands the actual bill over to the parties here who wantthe money. Upon the latter falls the task of selling the bill, and, ninety days later, when the time of repayment comes, the duty ofreturning a _demand_ bill for £100, 000, plus the stipulated commission. In the second kind of a loan the borrower has nothing to do with theexchange part of the transaction, the American banking agent of theforeign lender turning over to the borrower not a sterling draft butthe dollar proceeds of a sterling draft. How the exchange marketfluctuates in the meantime--what rate may have to be paid at the end ofninety days for the necessary demand draft--concerns the borrower notat all. He received dollars in the first place, and when the loan comesdue he pays back dollars, plus four, five or six per cent. , as the casemay be. What rate has to be paid for the demand exchange affects thebanker only, not the borrower. 

Loans made under the first conditions are known as sterling, mark, orfranc loans; the other kind are usually called "currency loans. " At therisk of repetition, it is to be said that in the case of sterling loansthe borrower pays a flat commission and takes the risk of what rate hemay have to pay for demand exchange when the loan comes due. In thecase of a currency loan the borrower knows nothing about the foreignexchange transaction. He receives dollars, and pays them back with afixed rate of interest, leaving the whole question and risk of exchangeto the lending banker. 

To illustrate the mechanism of one of these sterling loans. Suppose theLondon Bank, Ltd. , to have arranged with the New York Bank to have thelatter loan out £100, 000 in the New York market. The New York Bankdraws £100, 000 of ninety days' sight bills, and, satisfactorycollateral having been deposited, turns them over to the brokeragehouse of Smith & Jones. Smith & Jones at once sell the £100, 000, receiving therefor, say, $484, 000. 

The bills sold by Smith & Jones find their way to London by the firststeamer, are accepted and discounted. Ninety days later they will comedue and have to be paid, and ten days prior to their maturity the NewYork Bank will be expecting Smith & Jones to send in a _demand_ draftfor £100, 000, plus three-eighths per cent. Commission, making £375additional. This £100, 375, less its commission for having handled theloan, the New York Bank will send to London, where it will arrive acouple of days before the £100, 000 of ninety days' sight billsoriginally drawn on the London Bank, Ltd. , mature. 

What each of the bankers concerned makes out of the transaction isplain enough. As to what Smith & Jones' ninety-day loan cost them, inaddition to the flat three-eighths per cent. They had to pay, thatdepends upon what they realize from the sale of the ninety days' sightbills in the first place and secondly on what rate they had to pay forthe demand bill for £100, 000. Exchange may have gone up during the lifeof the loan, making the loan expensive, or it may have gone down, making the cost very little. Plainly stated, unless they securedthemselves by buying a "future" for the delivery of a £100, 000 demandbill in ninety days at a fixed rate, Messrs. Smith & Jones have beenmaking a mild speculation in foreign exchange. 

If the same loan had been made on the other basis, the New York Bankwould have turned over to Smith & Jones not a _sterling bill_ for£100, 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 payback $484, 000, plus ninety days' interest at six per cent, $7, 260, allof which cash, less commission, the New York Bank would have investedin a demand bill of exchange and sent over to the London Bank, Ltd. Whatever more than the £100, 000 needed to pay off the maturing ninetiessuch 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 bankersare willing to lend money here and figure that the exchange market ison 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 tobe on the upturn, lenders will do their best to put their money out inthe form of "sterling loans. " Bankers are not always right in theirviews, by any means, but as a general principle it can be said thatwhen big amounts of foreign money offered in this market are alloffered on the "sterling loan" basis, a rising exchange market is to beexpected. 

As to the collateral on these foreign loans, it is evident that thereis as much chance for different ways of looking at different stocks asthere is in regular domestic loaning operations. Not only does thestanding of the borrower here make a difference, but there are certainsecurities which certain banks abroad favor, and others, perhaps justas good, with which they will have nothing to do. 

Excepting the case of special negotiation, however, it may be said thatthe collateral put up the case of foreign loans in this market is of avery high order. Three years ago this could hardly have been said, butone of the many beneficial effects of the panic was to greatly raisethe standard of the collateral required by foreign lenders in thismarket. It used formerly to be more a case of the standing of theborrower. Nowadays the collateral is usually deposited here in care ofa banker or trust company. 

From what has been said about the mechanism of making these foreignloans, it is evident that no transfer of cash actually takes place, andthat what really happens is that the foreign banking institution lendsout its credit instead of its cash. For in no case is the lenderrequired to put up any money. The drafts drawn upon him are at ninetydays' sight, and all he has to do is to write the word "accepted, " withhis signature, across their face. Later they will be presented foractual payment, but by that time the "cover" will have reached Londonfrom the banker in America who drew the "nineties, " and the maturingbills will be paid out of that. The foreign lender, in other words, isat 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 theNew York market? On one consideration only does that depend--the amountof accepted long bills which the London discount market will stand. Forall the ninety days' sight bills drawn in the course of these transfersof credit must eventually be discounted in the London discount market, and when the London discount market refuses to absorb bills of thiskind a material check is naturally administered to their creation. 

Too great drawings of loan-bills, as the long bills drawn to makeforeign loans are called, are quickly reflected in a squeamish Londondiscount market. It needs only the refusal of the Bank of England tore-discount the paper of a few London banks suspected of having"accepted" too great a quantity of American loan-bills, to make itimpossible to go on loaning profitably in the New York market. In orderto make loans, long bills have to be drawn and sold to somebody, and ifthe discount market in London will take no more American paper, buyersfor freshly-created American paper will be hard to find. 

To get back to the part foreign loaning operations play in the foreignexchange market here, it is plain that as no actual money is put up, the business is attractive and profitable to the bank having therequisite facilities and the right foreign connection. It means theputting of the bank's name on a good deal of paper, it is true, butonly on the deposit of entirely satisfactory collateral and only inconnection with the assuming of the same obligation by a foreigninstitution of high standing. There are few instances where loss intransacting this form of business has been sustained, while the profitsderived from it are very large. 

As to what the foreign department of an American bank makes out of thebusiness, it may be said that that depends very largely upon whetherthe bank here acts merely as a lending agent or whether the operationis for "joint account, " both as to risk and commission. In the formercase (and more and more this seems to be becoming the basis on whichthe business is done) both the American and the European bank stands tomake a very fair return--always considering that neither is called uponto put up one real dollar or pound sterling. Take, for instance, theaverage sterling loan made on the basis of the borrower taking all therisk of exchange and paying a flat commission of three-eighths of oneper cent. For each ninety days. That means that each bank makesthree-sixteenths of one per cent. For every ninety days the loanruns--the American bank for simply drawing its ninety-day bills ofexchange and the English bank for merely accepting them. Naturally, competition is keen, American banking houses vying with each other bothfor the privilege of acting as agents of the foreign banks having moneyto lend, and of going into joint-account loaning operations with them. Three-sixteenths or perhaps one-quarter of one per cent. For ninetydays (three-quarters of one per cent. And one per cent. Annually) maynot seem much of an inducement, but considering the fact that no realcash is involved, this percentage is enough to make the biggest andbest 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 thatconcerning this phase of the foreign exchange business there is widedifference of opinion. Finance bills make money, but they make trouble, too. Their existence is one of the chief points of contact between theforeign exchange and the other markets, and one of the principalreasons why a knowledge of foreign exchange is necessary to anywell-rounded understanding of banking conditions. 

Strictly speaking, a finance-bill is a long draft drawn by a banker ofone country on a banker in another, sometimes secured by collateral, but more often not, and issued by the drawing banker for the purpose ofraising money. Such bills are not always distinguishable from the billsa banker in New York may draw on a banker in London in the operation oflending money for him, but in nature they are essentially different. The drawing of finance-bills was recently described by the foreignexchange manager of one of the biggest houses in New York, during thecourse of a public address, as a "scheme to raise the wind. " Whether ornot any collateral is put up, the whole purpose of the drawing offinance-bills is to provide an easy way of raising money without thebanker here having to go to some other bank to do it. 

The origin of the ordinary finance-bill is about as follows: A bankhere in New York carries a good balance in London and works asubstantial foreign exchange business in connection with the Londonbank where this balance is carried. A time comes when the New Yorkbanking house could advantageously use more money. Arrangements aretherefore made with the London bank whereby the London bank agrees to"accept" a certain amount of the American banker's long bills, for acommission. In the course of his regular business, then, the Americanbanker simply draws that many more pounds sterling in long bills, sellsthem, and for the time being has the use of the money. In the greatmajority of cases no extra collateral is put up, nor is the London bankespecially secured in any way. The American banker's credit is goodenough to make the English banker willing, for a commission, to"accept" his drafts and obligate himself that the drafts will be paidat maturity. Naturally, a house has to be in good standing and enjoyhigh credit not only here but on the other side before any reputableLondon bank can be induced to "accept" its finance paper. 

The ability to draw finance-bills of this kind often puts a housedisposed to take chances with the movement of the exchange market intoline for very considerable profit possibilities. Suppose, for instance, that the manager of a house here figures that there is going to be asharp break in foreign exchange. He, therefore, sells a line ofninety-day bills, putting himself technically short of the exchangemarket 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 theuse of the money he derived from the sale of the "nineties" to do withas he pleases, and if he has figured the market aright, it may not costhim any more per pound to buy his "cover" than he realized from thesale of the long bills. In which case he would have had the use of themoney 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 anopportunity to the exchange manager shrewd enough to read the situationaright to make money, that many of the big houses go in for it to alarge extent. During the summer, for instance, if the outlook is forbig crops, the situation is apt to commend itself to this kind ofoperation. Money in the summer months is apt to be low and exchangehigh, affording a good basis on which to sell exchange. Then, if theexpected crops materialize, large amounts of exchange drawn againstexports will come into the market, forcing down rates and giving theoperator who has previously sold his long bills an excellent chance tocover them profitably as they come due. 

About the best example of how exchange managers can be deceived intheir forecasts is afforded by the movement of exchange during thesummer and fall of 1909. Impelled thereto by the brilliant cropprospects of early summer, foreign exchange houses in New York drew andsold finance-bills in enormous volume. The corn crop was to run overthree billion bushels, affording an unprecedented exportablesurplus--wheat and cotton were both to show record-breaking yields. Butinstead of these promises being fulfilled, wheat and corn showed onlyaverage yields, while the cotton crop turned out decidedly short. Theexpected flood of exchange never materialized. On the contrary, rise inmoney rates abroad caused such a paying off of foreign loans andmaturing finance bills that foreign exchange rose to the gold exportpoint and "covering" operations were conducted with extreme difficulty. In the foreign exchange market the autumn of 1909 will long beremembered as a time when the finance-bill sellers had administered tothem 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, isanother broad and profitable field for the operations of the expertforeign exchange manager. Take, for example, a time when exchange onParis is more plentiful in London than in New York--a shrewd New Yorkexchange manager needing a draft on Paris might well secure it inLondon rather than in his home city. The following operation is onlyone of ten thousand in which exchange men are continually engaged, butis a representative transaction and one on which a good deal of thebusiness in the arbitration of exchange is based. 

Suppose, for instance, that in New York, demand exchange on Paris isquoted 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-fivecentimes 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 adraft on London for £1, 000, at 4. 84, costing him $4, 840. Instructionsby the American banker to his London correspondent to buy a check onParis for francs 25, 250 in London, and to send it over to Paris for thecredit of his (the American banker's account). Such a draft, at 25. 25would cost just £1, 000. 

The circle would then be complete. The American banker who originallydrew the francs 25, 250 on his Paris balance would have replaced thatamount in his Paris balance through the aid of his Londoncorrespondent. The London correspondent would have paid out £1, 000 fromthe American banker's balance with him, a draft for which amount wouldcome in the next mail. All parties to the transaction would besatisfied--especially the banker who started it, for whereas he paidout $4, 840 for the £1, 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 illustrationsrates are not apt to be wide enough apart to afford any such actualprofit, but the chance for arbitraging does exist and is beingcontinuously taken advantage of. So keenly, indeed, are the variousrates in their possible relation to one another watched by the exchangemen that it is next to impossible for them to "open up" to anyappreciable extent. The chance to make even a slight profit by shiftingbalances is so quickly availed of that in the constant demand forexchange wherever any relative weakness is shown, there exists a forcewhich keeps the whole structure at parity. The ability to buy drafts onParis relatively much cheaper at London than at New York, for instance, would be so quickly taken advantage of by half a dozen watchfulexchange men that the London rate on Paris would quickly enough bedriven up to its right relative position. 

It is impossible in this brief treatise to give more than a suggestionof the various kinds of exchange arbitration being carried on all thetime. Experts do not confine their operations to the main centers, noris three necessarily the largest number of points which figure intransactions of this sort. Elaborate cable codes and a constant use ofthe wires keep the up-to-date exchange manager in touch with themovement of rates in every part of Europe. If a chance exists to sell adraft on London and then to put the requisite balance there through anarbitration involving Paris, Brussels, and Amsterdam, the chances arethat there will be some shrewd manager who will find it out and putthrough the transaction. Some of the larger banking houses employ menwho do little but look for just such opportunities. When times arenormal, the margin of profit is small, but in disturbed markets theparities are not nearly so closely maintained and substantial profitsare occasionally made. The business, however, is of the most difficultcharacter, requiring not only great shrewdness and judgment butexceptional mechanical facilities. 

7. _Dealing in "Futures_"

As a means of making--or of losing--money, in the foreign exchangebusiness, the dealing in contracts for the future delivery of exchangehas, perhaps, no equal. And yet trading in futures is by no meansnecessarily speculation. There are at least two broad classes oflegitimate operation in which the buying and selling of contracts ofexchange for future delivery plays a vital part. 

Take the case of a banker who has bought and remitted to his foreigncorrespondent a miscellaneous lot of foreign exchange made up to theextent of one-half, perhaps, of commercial long bills with documentsdeliverable only on "payment" of the draft. That means that if thewhole batch of exchange amounted to £50, 000, £25, 000 of it might notbecome an available balance on the other side for a good while after ithad arrived there--not until the parties on whom the "payment" billswere drawn chose to pay them off under rebate. The exchange rate, inthe meantime, might do almost anything, and the remitting banker mightat the end of thirty or forty-five days find himself with a balanceabroad 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 sentover the commercial exchange, sell his own demand drafts for futuredelivery. Suppose that he had sent over £25, 000 of commercial "payment"bills. Unable to tell exactly when the proceeds would become available, the banker buying the bills would nevertheless presumably have hadexperience with bills of the same name before and would be able to forma 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: £5, 000 deliverable infifteen days; £10, 000 deliverable in thirty days, £10, 000 deliverablein from forty-five to sixty days. Such drafts on being presented couldin all probability be taken care of out of the prepayments on thecommercial bills. 

By figuring with judgment, foreign exchange bankers are often able tomake substantial profits on operations of this kind. An exchange brokercomes in and offers a banker here a lot of good "payment" commercialbills. The banker finds that he can sell his own draft for delivery atabout the time the commercial drafts are apt to be paid under rebate, at a price which means a good net profit. The operation ties upcapital, it is true, but is without risk. Not infrequently goodcommercial "payment" bills can be bought at such a price and bankers'futures sold against them at such a price that there is a substantialprofit to be made. 

The other operation is the sale of bankers' futures, not againstremittances of actual commercial exchange but against exporters'futures. Exporters of merchandise frequently quote prices to customersabroad for shipment to be made in some following month, to establishwhich fixed price the exporter has to fix a rate of exchange definitelywith some banker. "I am going to ship so-and-so so many tubs of lardnext May, " says the exporter to the banker, "the drafts against themwill amount to so-and-so-much. What rate will you pay me forthem--delivery next May?" The banker knows he can sell his own draftfor May delivery for, say, 4. 87. He bids the exporter 4. 86-1/2 for hislard bills, and gets the contract. Without any risk and without tyingup a dollar of capital the banker has made one-half cent per poundsterling on the whole amount of the shipment. In May, the lard billswill 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 foreignexchange business to put through, but when a house has a large numberof commercial exporters among its clients there are generally to befound among them some who want to sell their exchange for futuredelivery. As to the buyer of the banker's "future, " such a buyer mightbe, for instance, another banker who had sold finance-bills and wantsto limit the cost of "covering" them. 

The foregoing examples of dealing in futures are merely examples of howfutures may figure in every-day exchange transactions. Like operationsin exchange arbitrage, there is no limit to the number of kinds ofbusiness in which "futures" may figure. They are a much abusedinstitution, but are a vital factor in modern methods of transactingforeign exchange business. 

The foregoing are the main forms of activity of the average foreigndepartment, though there are, of course, many other ways of makingmoney out of foreign exchange. The business of granting commercialcredits, the exporting and importing of gold and the business ofinternational trading in securities will be taken up separately infollowing chapters. 

CHAPTER VII

GOLD EXPORTS AND IMPORTS

Gold exports and imports, while not constituting any great part of theactivity of the average foreign department, are nevertheless a factorof vital importance in determining the movement of exchange. The lossof gold, in quantity, by some market may bring about money conditionsresulting in very violent movements of exchange; or, on the other hand, such movements may be caused by the efforts of the controllingfinancial interests in some market to attract gold. The movement ofexchange and the movement of gold are absolutely dependent one on theother. 

Considering broadly this question of the movement of gold, it is to beborne in mind that by far the greater part of the world's production ofthe precious metal takes place in countries ranking very low as tobanking importance. The United States, is indeed, the only first-classfinancial power in which any very considerable proportion of theworld's gold is produced. Excepting the ninety million dollars of goldproduced in the United States in 1908, nearly all of the totalproduction of 430 million dollars for that year was taken out of theground in places where there exists but the slightest demand for it foruse 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 movementfrom the mines to the great financial centers. 

Considering that over half the gold taken out of the ground each yearis mined in British possessions, it is only natural that London shouldbe the greatest distributive point. Such is the case. Ownership of themines which produce most of the world's gold is held in London, and soit is to the British capital that most of the world's gold comes afterit has been taken out of the ground. By every steamer arriving fromAustralia and South Africa great quantities of the metal are carried toLondon, there to be disposed of at the best price available. 

For raw gold, like raw copper or raw iron, has a price. Under theEnglish banking law, it is true, the Bank of England _must_ buy at therate of seventy-seven shillings nine pence per ounce all the gold ofstandard (. 916-2/3) fineness which may be offered it, but thatestablishes merely a minimum--there is no limit the other way to whichthe price of the metal may not be driven under sufficiently urgentbidding. 

The distribution of the raw gold is effected as follows: Each Mondaymorning there is held an auction at which are present all therepresentatives of home or foreign banks who may be in the market forgold. These representatives, fully apprised of the amount of the metalwhich 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 thebest possible price, and finds its way to that point where the greatesturgency of demand exists. It may be Paris or Berlin, or it may be theBank of England. According as the representatives present at theauction 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 nomeans proves that the gold is going to remain for any length of time inBerlin. For some reason, in that particular case, the representativesof the German banks had been instructed to bid a price for the goldwhich would bring it to Berlin, but the conditions furnishing themotive for such a move may remain operative only a short time and theneed for the metal pass away with them. Quarterly settlements in Berlinor the flotation of a Russian loan in Paris, for instance, might beenough to make the German and French banks' representatives go in andbid high enough to get the new gold, but with the passing of thequarter's end or the successful launching of the loan would pass thenecessity for the gold, and its _re_-distribution would begin. 

In other words, both the primary movement of gold from the mines andthe secondary movement from the distributive centers are merelytemporary and show little as to the final lodgment of the preciousmetal. What really counts is exchange conditions; it is along the linesof the favorable exchange that the great currents of gold willinevitably flow. 

For example, if a draft for pounds sterling drawn on London can bebought here at a low rate of exchange, anything in London that theAmerican consumer may want to possess himself of can be bought cheaperthan when exchange on London is high. The price of a hat in London is, say, £1. 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 theoutside markets to buy cheaply at that point. 

And a very little difference in the price of exchange makes a verygreat difference so far as the price of gold is concerned. As stated ina previous chapter, a new gold sovereign at any United States assayoffice can be converted into $4. 8665, so that if it cost nothing tobring a new sovereign over here, no one holding a draft for a pound (asovereign is a gold pound) would sell it for less than $4. 8665, butwould simply order the sovereign sent over here and cash it in for$4. 8665 himself. Always assuming that it cost nothing to bring over theactual 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 £1 as the amount of the draft and the assumption ofno charge for importing the gold, is, of course, mentioned merely forpurposes of illustration. From it should, however, become clear thewhole idea underlying gold imports. A new sovereign laid down in NewYork is worth, at any time, $4. 8665. If it is possible to get thesovereign over here for less than that--by paying $4. 83 for a £1 drafton London, for instance, and three cents for charges, $4. 86 in all--itis possible to bring the sovereign in and make money doing it. 

Whether the gold imported is in the form of sovereigns or whether itconsists of bars makes not the slightest difference so far as theprinciple of the thing is concerned. A sovereign is at all times worthjust so and so much at any United States assay office, and an ounce ofgold of any given fineness is worth just so and so much, too, regardless of where it comes from. So that in importing gold, whetherthe metal be in the form of coin or bars, the great thing is thecheapness with which it can be secured in some foreign market. If itcan be secured so cheaply in London, for example, that the price paidfor each pound (sovereign) of the draft, plus the charge of bringing ineach sovereign, is less than what the sovereign can be sold for when itgets here, it will pay to buy English gold and bring it in. 

Exactly the same principle applies where the question is of importinggold bars instead of sovereigns, except that bars cannot be bought inLondon at a fixed rate. That, however, in no way affects the underlyingprinciple that in importing gold the profit is made by selling the goldhere for more dollars than the combined dollar-cost of the draft onLondon with which the gold is bought and the charges incurred inimporting the metal. To illustrate, if the draft cost $997, 000 and thecharges amounted to $3, 000, the gold (whether in the form ofsovereigns, 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, pluscharges, to meet the draft. As will be seen from the figures of anactual shipment, given further on, the banker who ships gold gets themoney to buy the gold from the Treasury here, by selling a sterlingdraft on London. Suppose, for example, a New York banker wants tocreate a £200, 000 balance in London. Figuring how many ounces of gold(at the buying price in London) will give him the £200, 000 credit, hebuys that much gold and sends it over. Suppose the combined cost of thegold and the charge for shipping it amounts to $976, 000. If the bankerhere can sell a £200, 000 draft against it at 4. 88, he will just getback the $976, 000 he laid out originally and be even on thetransaction. 

Before passing from the theory to the practice of gold exports andimports, there is to be considered the fact that bar gold sells inLondon at a constantly varying price, while in New York it sells at adefinitely fixed price. In New York an ounce of gold of any givenfineness can always be sold for the same amount of dollars and cents, but in London the amount of shillings and pence into which it isconvertible varies constantly. So that a New York banker figuring onbringing in bar gold from London has to take carefully into accountwhat the price per ounce of bar gold over there is. Sovereigns areseldom imported because they are secured in London not by weight but byface value, --even if the sovereigns have lost weight they cost just asmany pounds sterling to secure. Where the New York banker is exportinggold, on the other hand, the price at which bar gold is selling inLondon is just as important as where he is importing. For the price atwhich the gold can be disposed of when it gets to London determinesinto how many pounds sterling it can be converted. 

These matters of the cost of gold in one market and the crediting ofthe gold in some other market are not the easiest thing to grasp atfirst thought, but will perhaps become quite clear by reference to theaccompanying calculation of actual gold export and gold importtransactions. All the way through it must be remembered that thefigures of such calculations can never be absolute--that insurance andfreight charges vary and that different operations are conducted alongdifferent lines. The two operations described embody, however, theprinciple of both the outward and inward movement of bar gold at NewYork. 

_Export of Bars to London_

In the transaction described below about a quarter of a milliondollars' worth of bar gold is shipped to London, the money to pay forthe gold being raised by the drawing and selling of a demand draft onLondon. Assuming that the draft is drawn and the gold shipped at thesame time, the draft will be presented fully three days before the goldis 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 theoperation. 

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 £51, 380

 Draft on London for £51, 380, sold by shipper of the gold, at 487. 96 $250, 718

In the transaction described above, the "overdraft" caused by theinevitable delay in assaying and weighing the gold on its arrival inLondon lasted for three days, the American banker being chargedinterest at the rate of four per cent. 487. 96 being the rate at whichthe banker exporting the gold was able to sell his demand draft at thetime, was, under those conditions, the "gold export point. "

In this particular operation, which was undertaken purely foradvertising purposes, the shipper of the gold came out exactly even. Suppose, however, that he had been able to sell his draft, against thegold shipped, at 4. 88 instead of 4. 87-3/4. That would have meanttwenty-five points (one-quarter cent per pound) more, which, on£51, 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 ornot to ship gold, important. No rule can be laid down as to what profitbankers expect to make on shipments. If, for instance, a banker owes£200, 000 abroad himself and finds it cheaper to send gold than to buy abill, the question of profit does not enter at all. Then, again, manyand many an export transaction is induced by ulterior motives--it maybe for the sake of advertising, or for stock market purposes, orbecause some correspondent abroad needs the gold and is willing to payfor it. Any one of these or many like reasons may explain thephenomenon, occasionally seen, of gold exports at a time whenconditions plainly indicate that the exporter is shipping at a loss. 

As a rule, however, when exchange is scarce and the demand so greatthat bankers who do not themselves owe money abroad see a chance tosupply the demand for exchange by shipping gold and drawing draftsagainst it, the profit amounts to anywhere from $400 to $1, 000 on eachmillion dollars shipped--for less than the first amount named it ishardly worth while to go into the transaction at all; on the otherhand, conditions have to be pretty much disordered to force exchange toa 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 isimported, it will appear from the following calculation that interestplays a much more important part in the case of gold imports than inthe case of exports. With exports, as has been shown, the interestcharge is merely on a three days' overdraft, but in the case of importsthe banker who brings in the gold loses interest on it for the wholetime it is in transit and for a day or two on each end, besides. A NewYork banker, carrying a large balance in London, for instance, ordershis London correspondent to buy and ship him a certain amount of bargold. This the London banker does, charging the cost of the metal, andall shipping charges, to the account of the New York banker. On thewhole amount thus charged, therefore, the New York banker losesinterest while the gold is afloat. Even after the gold arrives in NewYork, of course, the depleted balance abroad continues to draw lessinterest than formerly, but to make up for that the gold begins to earninterest as soon as it gets here. 

The transaction given below is one which was made under the aboveconditions--the importer in New York had a good balance in London andordered his London correspondent to buy and ship about $1, 000, 000 ofgold, 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 sixper 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 £205, 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 ---------- £206, 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 £206, 595

In the above calculation it will be seen that the proceeds of the goldimported were exactly enough to buy a cable on London sufficientlylarge to cancel the original outlay for the gold and the expensesincurred in shipping it over here. On the whole transaction the bankerimporting 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 importoperations is less than where gold is exported. Banking houses bigenough and strong enough to engage in business of this character aremore apt to be on the constructive side of the market than on theother, and will frequently bring in gold at no profit to themselves, oreven at a loss, in order to further their plans. It does happen, ofcourse, that gold is sometimes shipped out for stock market effect, butthe effect of gold exports is growing less and less. Gold imports, onthe other hand, are always a stimulating factor and are good live stockmarket ammunition as well as a constructive argument regarding theprice of investments in general. 

_Exports of Gold Bars to Paris--the "Triangular Operation"_

Calculations have been given regarding the movement of bar gold betweenLondon and New York--what is ordinarily known as the "direct" movement. "Indirect" movements, however, have figured so prominently of recentyears in the exchange market that at least one example ought perhaps tobe 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 sakeof creating a credit balance in London. 

Before examining the actual figures of such an operation it may be wellto glance at the theory of the thing. A New York banker, say, for anyone of many different reasons, wants to create a credit balance inLondon. Examining exchange conditions, he finds that sterling draftsdrawn on London are to be had relatively cheaper _in Paris_ than in NewYork. In the natural course of exchange arbitrage the New York bankerwould therefore buy a draft on Paris and send it to his Frenchcorrespondent with instruction to use it to buy a draft on London andto 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 sendanything to Paris he will have to send gold. Assume, then, that hefinds conditions favorable and decides to thus transfer a couple ofhundred thousand pounds to London by sending gold to Paris. Theoperation 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 £ £205, 536

 New York banker sells his draft on London for £205, 536 at 4. 86832 $1, 000, 615

Conditions principally affecting the shipment of gold by the triangularoperation, it will be seen from the above calculation, are the rate ofexchange on London at New York, and the rate of exchange on London atParis. The higher the rate at which the New York banker can sell hisbills on London after the gold has been shipped, the more money he willmake. The lower the rate at which his Paris agent can secure the draftsdrawn on London, the greater the amount of pounds sterling which thegold will buy. High sterling exchange in New York and low sterlingexchange in Paris are therefore the main features of the combination ofcircumstances which result in these "triangular operations. "

_Gold Shipments to Argentina_

Of the many other ways in which gold moves, one way seems to bebecoming so increasingly important that it is well worthy of attention. Reference is made to the shipment of gold from New York to theArgentine for account of English bankers who have debts to dischargethere. 

Owing to Argentine loans placed in the English market and to heavyexports of wheat, hides, and meat from Buenos Aires to London, thereexists almost a chronic condition of indebtedness on the part of theLondon bankers to the bankers in the Argentine. Not offset by anycorresponding imports, these conditions are putting Buenos Aires eachyear in a better and better condition to make heavy demands upon Londonfor gold, demands which have recently grown to such an extent as tomake serious inroads on the British banks' reserves. Unwilling tocomply with this demand for gold, the powers in charge of the Londonmarket have on several occasions deliberately produced money conditionsin London resulting in a shifting of the Argentine demand for gold uponNew York. The means by which this has been accomplished has been theraising of the Bank of England rate to a point sufficiently high tomake the dollar-exchange on New York fall. Able, then, to buydollar-drafts on New York very cheaply, the London bankers send to NewYork large amounts of such drafts, with instructions that they be usedto buy gold for shipment to the Argentine. 

The very general confusion of mind regarding these operations in goldcomes perhaps from the fact that they are constantly referred to asbeing a result of _high exchange on London_, at New York. Which istrue, but a most misleading way of expressing the fact that _lowexchange_ on _New York_, at London, is the reason of the shipments. High sterling exchange at New York and low dollar-exchange at Londonare, of course, one and the same thing. But in this case, what countsis that dollar-exchange can be cheaply bought in London. 

No attempt is made in this little work to cover the whole field ofoperations in gold, infinite in scope as they are and of everyconceivable variety. But from the examples given above it ought to bepossible to work out a fairly clear idea as to why gold exports andimports take place and as to what the conditions are which bring themabout. 

While not failing to realize the importance to the markets of themovement back and forth of great amounts of gold, it may neverthelessbe said that from the standpoint of the foreign exchange business theimportance of transactions in gold is very generally overestimated. Most dealers in foreign exchange steer clear of exporting or importinggold whenever they can, the business being practically all done byhalf-a-dozen firms and banks. As has been seen, the profit to be madeis miserably small as a rule, while the trouble and risk are veryconsiderable. Import operations, especially, tie up large amounts ofready capital and often throw the regular working of a foreigndepartment out of gear for days and even weeks. There is considerablenewspaper advertising to be had by being always among the first to shipor bring in gold, but there are a good many houses who do not want orneed that kind of advertising. Some of the best and strongest bankinghouses in New York, indeed, make it a rule to have nothing to do withoperations in gold one way or the other. Should they need drafts on theother side at a time when there are no drafts to be had, such housesprefer to let some one else do the gold-shipping and are willing to letthe shipping house make its one-sixteenth of one per cent. Orone-thirty-second of one per cent. In the rate of exchange it chargesfor the bills drawn against the gold. 

Particular attention has been paid all through the foregoing chapter tothe gold movement in its relation to the New York markets, the movementbetween foreign points being too big a subject to describe in a work ofthis kind. In general, however, it can be said that of the three greatgold markets abroad, London is the only one which can in any sense becalled "free. " In Paris, the ability of the Bank of France to pay itsnotes in silver instead of gold makes it possible for the Bank ofFrance to control the gold movement absolutely, while in Germany thepaternalistic attitude of the government is so insistent that goldexports are rarely undertaken by bankers except with the full sanctionof the governors of the Reichsbank. 

It is a question, even, whether London makes good its boast ofmaintaining Europe's only "free" gold market. The new gold coming fromthe mines does, it is true, find its way to London, for the purpose ofbeing auctioned off to the highest bidder, but as the kind of bidswhich can be made are governed so largely by arbitrary action on thepart of the Bank of England, it is a question whether the gold auctioncan be said to be "free. " Suppose, for instance, that the "Old Lady ofThreadneedle Street" decides that enough gold has been taken by foreignbidders and that exports had better be checked. Instantly the bank rategoes up, making it harder for the representatives of the foreign banksto bid. Should the rise in the rate not be sufficient to affect theoutside exchange on London, the Bank will probably resort to thefurther expedient of entering the auction for its own account andoutbidding all others. Not having any shipping charges to pay on thisgold it buys, the Bank is usually able to secure all the gold itwants--or, rather, to keep anybody else from securing it. The auctionis open to all, it is true, but being at times conducted under suchcircumstances, is hardly a market which can be called "free. "

If there is any "free" gold market in the world, indeed, it is to befound in the United States. All anybody who wants gold, in thiscountry, has to do, is to go around to the nearest sub-treasury and getit. If the supply of bars is exhausted, the buyer may be disappointed, but that has nothing to do with any restriction on the market. Themarket for gold bars in the United States is at the Treasury and thevarious sub-treasuries, and as long as the prospective buyer has thelegal 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, whohe 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 losinggold is concerned, can be seen from the following table, introducedhere for the purpose of giving a clear idea as to just where the UnitedStates has stood in the international movement of gold during thefive-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 internationalfinancial relationships between banks are drawn closer, gold movementswill tend to decrease, seem hardly to be borne out by the figures ofthe table given above. Banks here and banks abroad are working togetherin a way unknown ten or even five years ago, but as yet there are nosigns of any lessening in the inward or outward movement of specie. More liberal granting of international credits, increased internationalloaning operations, far from putting an end to the physical movement ofgold in large quantities, --these are influences tending to make goldmove 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 beshifted from one point to another with safety and ease. Gold movementsseem as though they were to play an important part in the markets for agood 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 UnitedStates, on account of Europe's continuous speculative interest in ourmarkets, and the activity of the "arbitrageurs" in both bonds andshares, dealings in securities between ourselves and the Old World arealways on a very great scale. Not infrequently, indeed, Europe'sposition on American securities is an influence of dominatingimportance. 

From the maturities, refunding operations, and interest remittancesalone, growing out of the permanent investment of foreign money in oursecurities, there results a very great amount of international securityand exchange business. Whether Europe's investment here amounts tothree billions or four billions or five billions, it is impossible tosay; the fact remains that it is so large that every year a very greatamount of foreign-held bonds come due and have to be paid off orrefunded, and, further, that the remitting abroad of coupon anddividend money each year calls for upward of $150, 000, 000. 

This matter of maturing investments, alone, calls for continuousinternational security trading and on a large scale. Each year therecomes due in this country an amount of railroad and other bonds runningwell up into the hundreds of millions, of which a large proportion areheld on the other side. Some of these maturities are paid off incash--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 moneyplaced in this country, and the running off to maturity of aforeign-held American bond is nearly sure to be followed up byreplacement with some other American security. 

Bond houses doing an international business are therefore keenlywatchful of the maturity of issues largely held abroad, and are everready with offers of new and attractive investments. Knowledge of thelocation of American investments in Europe is thus a business asset ofthe greatest importance, and records are carefully kept. The fact thata dealer here knows that some bank in London has a wealthy client whoholds a big block of certain bonds about to mature, may very possiblymean that the house here may be able to make a very profitable trade. Information of this character is carefully gathered wherever possibleand as carefully guarded. The longer a house has been in business, naturally, and the closer its financial relationship with investmentinterests abroad, the more of this sort of information it is bound topossess. 

Foreign exchange growing out of these renewals and refundings is on avery large scale. Sometimes the placing of a new issue abroad meanssuch immediate drawing of drafts on foreign buyers of the securities asto depress the exchange market sharply. Sometimes, as in the case ofnew issues of railroad stock, where payments are usually made ininstalments covering a year or more, the drawing of exchange isdistributed in such a way that its influence, if felt at all, is feltmerely as an underlying element of weakness. 

Of a somewhat different character are the foreign exchange transactionsoriginating from what might be called Europe's "floating" investment inAmerican securities and from the out-and-out speculations carried on inthis market by the foreigners. 

There is never a time, probably, when the floating foreign investmentin American stocks and bonds does not run up with the hundreds ofmillions of dollars. "Speculation, " such operations would probably becalled by many people, but whether speculation or not, a form ofactivity which is continually giving rise to big dealings in foreignexchange. For this "floating" investment is very largely for account ofbankers whose international connections and credit make it possible forthem to carry stocks and bonds through the agency of the exchangemarket, and without having to put up any actual money. The ingeniousmethod by which this is accomplished is about as follows:

A banker here, for instance, decides that a certain low-priced bond ischeap and that if purchased it will show a substantial profit withinsix months or a year. Not wanting to buy the bonds and borrow on themhere, he invites his foreign correspondent into the deal on jointaccount, arranging to raise the money with which to buy the bonds bydrawing a ninety-day sight draft on the foreign correspondent. This hedoes, drawing, say, a £50, 000 draft at ninety days' sight, and sellingit in the exchange market at, let us say, $4. 83. 

The $241, 500 received from the sale of the draft, the American bankeruses to buy the bonds. Ninety days later the draft will come due inLondon, and have to be covered (or renewed) from this side, but in themeantime, a profitable chance to sell the bonds may present itself. Ifnot, the draft can be "renewed" at the end of the ninety days, andagain and again if necessary, until the bankers are willing to closeout the bonds. 

This operation of "renewing" long drafts drawn for the purpose ofcarrying securities is one of the most interesting phases of foreignexchange business in connection with international security dealings. The draft has been drawn, say, for £50, 000. The end of the ninety-dayperiod comes, the draft is due, is presented, and has to be paid. Butthe bankers do not choose to sell out the bonds and close the deal. They arrange instead to renew the maturing draft. This they do bypaying the original ninety-day draft out of the proceeds of a newninety-day draft. 

The original draft for £50, 000 comes due let us say on October 19, sothat about October 10th the New York banker will be under the necessityof sending over to London a demand draft for £50, 000. The raterealizable for ninety-day drafts being always considerably lower thanthe price of demand drafts, it follows that if the banker proposes tobuy £50, 000 of demand out of the proceeds of a fresh ninety-day bill hewill have to draw his fresh bill for more than £50, 000. If the demandrate happened to be 4. 86, the £50, 000 he needs would cost him $243, 000. In order to raise $243, 000 by selling a ninety-days' sight draft (sayat 4. 83) he would have to make the new draft for £50, 310. The extra£310 would constitute the interest. Each time he renewed the draft hewould 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 onon a large scale. Where the relationships between the foreign and theAmerican houses are close, there is almost no limit to the number oftimes an original bill may be renewed. As for the constantly increasingamount of the drafts which have to be drawn, that is taken care of bythe interest on the investment carried. 

Not all the floating investment in American securities is carried inthis way, but in whatever form the financing is done it is bound toinvolve foreign exchange operations and to necessitate the drawing ofdrafts by banking houses in this country on their correspondentsabroad. Quiet conditions may result in long periods when investments ofthis kind are left undisturbed, but even then, the constant remittingand renewing of drafts originates a good deal of exchange marketactivity. And with considerable frequency occur periods when thefloating investment is strongly affected by immediate conditions, andwhen purchases, sales, and transfers of securities stir the exchangemarket 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 activitycaused by international security transactions. There are times, as hasbeen said, when individuals and banking houses abroad speculate heavilyand continuously in this market, at which times the exchange market isstrongly affected by the buying and selling of exchange whichnecessarily takes place. Such periods may last for weeks or evenmonths, and during all of the time, London's immediate attitude towardthe market is apt to be the controlling influence on the movement ofexchange rates. 

Concerning arbitraging in stocks, operations of this kind will be foundto divide themselves readily into two classes--trades which are closedoff at both ends at once, and trades which are allowed to run overnight or even for a day or two. The former is a class of business outof which a dozen or twenty well-equipped houses in New York are makinga great deal of money. With an expert "at the rail" on the floor of theNew York Stock Exchange, and continuous quotations as to prices on thevarious stock exchanges in Europe coming in, these houses are in aposition to take advantage of the slightest disparity in prices. Thechance 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 orone-quarter more, is what the arbitrageurs are constantly on thelookout for. With the proper facilities, an expert, in the course ofthe hour during which the London and New York Stock Exchanges aresimultaneously in session, is often able to put through a number ofprofitable trades. 

Such operations are possible, primarily, because of the fact that thesame influences affect different markets in different ways. A piece ofnews which might cause a little selling of some stock in London, forinstance, might have exactly the opposite effect in New York. With thewires continually hot between the two markets and a number of expertson the watch for the chance to make a fraction, quotations here andabroad can hardly get very far apart, at least in the active issues, but occasionally, it does happen that the arbitrageur is able to takeadvantage of a substantial difference. Always without risk, the bid inone market being in hand before the stock is bought in the othermarket. 

But not so in the case of the other kind of arbitrage, where stocksbought in one market are carried over night for the sake of sellingthem out in some other market the next morning. There a decided risk istaken, the success of the operation depending absolutely upon thejudgment of the operator. Under the stimulus of some favorabledevelopment, for instance, which becomes known here only after theStock Exchanges abroad are closed for the day, the New York marketcloses buoyant. The chances are that the receipt of the news abroadover 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 ofselling it out next morning in London at the opening is an operationnot without risk, but one which is likely to make money. A loweropening abroad would, of course, spoil the whole plan, and force aloss, but just there comes in the ability and judgment of the man whois handling the business. His judgment need by no means be infalliblefor the house to make a great deal of money. 

Concerning arbitraging in bonds, practically everything depends notonly on the judgment and skill, but on the facilities and connectionsof the man in charge. In the great "open" market in New York and in thegreat "open" market in London, American bonds are being continually bidfor and offered in a way which gives an expert in touch with bothmarkets a chance to buy here and sell there, or vice versa, at aprofit. Such men are employed by bond houses with internationalconnections, and spend their time doing practically nothing else butkeeping in close touch with open market bids and offers for stocks andbonds and trying to buy in one market and sell in another. Such tradesare frequently put through on a very profitable basis, profits of aclear point or more being not at all uncommon. 

As for the degree of risk to be taken in business of this kind, that isentirely at the discretion of the arbitrageur. Where a firm bid ofninety-nine, good for the day, for instance, is given, there is no riskin cabling a bid of ninety-eight to London, but where the bid is notfirm at all, or where it is only firm for five minutes, or in manyother cases, the man who cables his own bid of ninety-eight is taking acertain amount of risk. Often enough he gets the bonds in London atninety-eight, only to find that the ninety-nine bid in New York hasbeen withdrawn. 

Knowledge of what risks to take and of what risks to leave aloneconstitutes expertness in this line of business. Seldom can thetransaction be absolutely closed at both ends and any substantialprofit be made. Most of the time the correctness of the bond expert'sjudgment as to how he can sell somewhere else what he has bought, iswhat 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 marketsmay be, it is in its application to the every-day importing andexporting of merchandise that foreign exchange has its greatestinterest for the greatest number of people. Every bale of cottonexported from the country, every pound of coffee brought in, is thebasis of an operation in foreign exchange, such operations involvingusually the issue of what is known as "commercial credits. "

Broadly speaking, commercial credits are of two classes, those issuedto facilitate the import of merchandise and those issued to facilitateits export. Considering the question from the standpoint of New York, import credits are so much more important than export credits andissued in so much larger volume, they will be taken up first. 

Not all the merchandise imported into the United States is brought inunder commercial letters of credit, but that is coming to be more andmore the way in which payment for imports is being arranged. Formerlyan importer who had bought silk or white-goods in France went around tohis banker, bought a draft on Paris for the required amount of francsand sent that over in payment. In some cases that is still the methodby which payment is made, but in the very great majority of cases wherethe business is being run on an up-to-date basis, a commercial letterof credit is arranged for before the importation is made. Of how greatadvantage such an arrangement is to the merchant importing goods thefollowing 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 inconnection with the commercial credit business, the case of a shipmentof raw silk from China will, perhaps, serve best. A silk manufacturerin Paterson, New Jersey, we will assume, has purchased by cable tenbales of raw silk in Canton, China. Understanding of the successivesteps in the financing of such a transaction will mean a prettysatisfactory understanding of the general principles under which thefinancing of most of our imports is arranged. 

The purchase of the silk having been consummated by cable, the firstthing 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 thepurchase was made, and get him (the banker) to open a commercial letterof credit covering those terms. Such a credit, of which a reprint isgiven herewith, would be in the form of a letter to the issuingbanker's London correspondent, requesting him to "accept" the drafts ofthe sellers of the silk in Canton up to a certain amount and undercertain conditions. These conditions, having to do with the "usance" ofthe drafts (whether they were to be drawn at three, four, or sixmonths' sight) and with the shipping documents to accompany the drafts, are all very fully set forth in the letter of credit itself. If thesilk has been bought on the basis of four months, for instance, thecredit 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 bemade, as to where the insurance is to be effected, etc. , etc. 

The silk importer having received this letter of credit from the bankerin New York, sends it by first mail (or, if the case be urgent, cablesits contents) to the seller of the silk out in Canton. The latter, having received it, is then in a position to go ahead with hisshipment. The first thing he does is to put the silk aboard ship, receiving from the steamship company a receipt (bill of lading) statingthat the ten bales have been put aboard, and making them deliverable_to the order of the banker in New York_, who issues the credit. Thebill 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 NewYork. 

The shipper in Canton having received this bill of lading from thesteamship company and having properly insured the goods and received acertificate stating that he has done so, is then in a position to goahead and draw his draft for the cost of the silk. The Londoncorrespondent of the New York banker, to whom the letter of credit isaddressed, is, say, the Guaranty Trust Company of London. Upon thatinstitution the Canton silk firm, therefore, draws his draft in poundssterling for the cost of the silk, attaching to the draft the bill oflading, an invoice, and the insurance certificate. 

A pertinent inquiry at this point is as to why the letter of credit forsilk shipped from a city in China directs that drafts be drawn onLondon--as to why London figures in the transaction at all? The answeris that drafts on London are always readily negotiable, and that Londonis the only city in the whole world drafts on which _are_ readilynegotiable in all places and at all times. A draft on New York or onBerlin _might_ be negotiated at a point like Canton, but to be surethat the exporter of the silk will get the best rate of exchange forhis drafts, the drafts must be drawn on London, the financial center ofthe world. One of the chief points to the whole business of taking outa credit, in fact, is to provide a point on which the shipper can drawsatisfactorily. 

Assume now that the silk has been put aboard ship bound for the UnitedStates, that the shipper has drawn, say, a draft for £1, 000 at fourmonths' sight on the Guaranty Trust Co. , London, and has attachedthereto the bill of lading and the insurance certificate. Taking thisdraft around to his bank the shipper sells it for local currency at thethen prevailing rate for four months' sight drafts drawn on London. Thefact that it is drawn at four months' sight means that he will get alower 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 thedrafts against the silk were to have four months to run. 

Having sold this draft to his bank in Canton and received localcurrency therefor, the shipper of the silk is out of the transaction. He has shipped the goods and he has his money. What becomes of thedraft he drew is the next important point to consider. But so far asthe exporter is concerned, the transaction is closed, and he is readyfor the next operation. 

The silk has now been set afloat for New York, and the draft purchasedby the Canton banker is on its way to London for acceptance. Longbefore the silk gets to New York the draft will have reached London andwill have been presented to the cashier of the Guaranty Trust Co. , there, who, of course, was apprised of the credit opened on his bank atthe time such credit was originally issued in New York. Examining thedraft and the documents carefully to see that they conform with theterms of the credit, the cashier of the Guaranty Trust Co. , London, formally "accepts" the draft, marking it payable four months from thedate it was presented to him. The accepted draft he hands back to themessenger of the bank who brought it in; the bill of lading, insurancecertificate, and invoice he keeps. By the next mail steamer hedispatches these papers to the banker in New York who issued thecredit. 

For the time being, at least, that is to say, till the accepted draftcomes due, the London banker is out of the transaction, which is nownarrowed down to the importer of the silk in Paterson and the banker inNew York who issued him the credit. 

Assume now that a week has passed and that the New York banker findshimself in possession of a bill of lading for ten bales of silk, merchandise deliverable to his order. A few days later, perhaps, thegoods arrive overland by fast freight from Seattle. The Paterson silkmanufacturer, who is eagerly awaiting their arrival, comes around tothe banker: "Endorse over the bill of lading to me, " he says, "so thatI can get the silk and start manufacturing it. "

If the banker does it, he will be giving over the only security he hasfor the payment at maturity of the draft his London correspondentaccepted, and for which he himself is responsible. Still, themanufacturer has to have his silk. 

A number of different agreements exist between bankers and importers towhom the bankers issue credits, as to the terms on which the importersare to be allowed to take possession of the merchandise when it arriveshere. Sometimes the goods are put into store and handed over to themerchant only when he shows that he has sold them and needs them tomake delivery. Sometimes they are warehoused at once, and parcelled outto the importer only in small lots, as he needs them. But more oftenthe goods are delivered over to the importer on his signing one form orother 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 thegoodness of the trust receipt system that the author refrains frommaking comment on it, confining himself strictly to description of whatthe system is. As will be seen from the accompanying reprint of thetrust receipt used by one of the largest issuers of commercial creditsin the country, the document is simply a pledge on the part of theimporter to hold the merchandise in trust for the banker, and, as themerchandise is sold, to hand over the proceeds to apply against thedraft drawn by the shipper of the goods. The theory of the thing isthat by the time all the merchandise has been sold more than enoughmoney will have been handed over to the New York banker to take care ofthe draft accepted by his London correspondent, the excess constitutingthe importer's profit. 

The kind of trust receipt under which bankers are willing to give overthe merchandise (the only collateral they have) naturally variesaccording to the standing of the house in question. In the case of someimporters the bankers would be willing to let the bill of lading passout of their hands on almost any kind of a receipt; in the case ofothers a very strict and binding contract is invariably signed. Butwhatever the form of the contract, it is to be borne in mind that whenthe banker issuing the credit hands over the bill of lading to theimporter on trust receipt, he is allowing the only security he has topass out of his hands, and is putting himself in the position of havingmade an unsecured loan to the importer. 

Returning now to the particular transaction in question, the point hasbeen reached where the silk is in the importer's hands, that resulthaving been accomplished without the importer having put up a cent ofmoney. Moreover, for nearly four months to come there will be nonecessity of the importer's putting up any money (unless he should sellsome of the silk, in which case he is bound to turn over the money tothe New York banker as a "prepayment"). But in the ordinary course ofevents the importer of the silk has nearly the four full months inwhich to fabricate the goods and sell them. At the end of that time thedraft drawn by the firm in Canton and accepted by the Guaranty TrustCo. , London, will be coming due, and the silk importer will be underthe necessity of remitting funds to meet it. Twelve days before theactual maturity of the £1, 000 draft in London, the New York banker willsend to the manufacturer in Paterson a memorandum for £1, 000 at, say, 4. 86 (whatever is the current rate) plus commission. The silk firm paysin dollars; the New York banker uses the dollars to buy a demand draftfor £1, 000; a day or two before the four months' sight draft comes duein London this demand draft ("cover") is received in London from NewYork, and the whole operation is closed. 

It has been deemed advisable to set forth the whole course of one ofthese import-financing transactions, in order that each successive stepmay be clearly understood. The question of just _why_ this creditbusiness is worked as it is will now be taken up. 

The whole purpose of the business, it is plain enough, is to give theimporter here a chance to bring in goods without putting up any actualmoney--in other words, of letting him use a larger capital than he isactually possessed of. There are persons so conservative as to considerthis in itself a wrong idea, but with business carried on along thelines on which it is actually done nowadays, bank credits play soimportant 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 usesafely a credit of as much more than that, the standing and credit ofthe firm being always the prime consideration. Granted that amanufacturer stands well and is doing a safe, non-speculative businesson the basis of $100, 000 capital, there is no reason why he should notbe able to secure an import credit for an additional £20, 000. Not onlyis there no reason why he should not get it, but there are any numberof good banking concerns only too glad to furnish it to him. 

So much for the transaction from the importer's standpoint--what doesthe seller of the goods get out of it? Payment for his goods as soon ashe is ready to ship them. No waiting for a remittance, no drawing of adollar-draft on an obscure firm in Paterson, N. J. , which no Cantonbank will be willing to buy at any price. The credit constitutesauthority for the shipper to draw in pounds sterling on London--the onekind of draft which he can always be sure of turning at once into localcurrency and at the most favorable rate of exchange. He ships thegoods, he draws the draft, he sells the draft, he has his money, and heis out of it. From the shipper's standpoint, surely a most satisfactoryarrangement and one which will induce him to quote the very best pricefor merchandise. 

As to the banker's part in the transaction, the whole question is oneof commission. The London banker on whom the credit is issued gets acommission from the American banker for "accepting" the drafts, and theAmerican banker, of course, gets a substantial commission from theparty to whom the credit is issued. Sometimes the banker in New Yorkand the banker in London work on joint-account, in which case both riskand commissions are equally divided. But more often, perhaps, theLondon bank gets such-and-such a fixed commission for accepting draftsdrawn under credits, and the New York banker keeps the rest of what hemakes out of the importer. 

Before proceeding with discussion of what commissions amount to, it iswell to note the fact that in those commercial credit transactionsneither banker is ever under the necessity of putting up a cent ofactual money. As in the case of foreign loans previously described, thebanker's credit and the banker's credit only is the basis of the wholeoperation. The London bank never pays out any actual cash--it merely"_accepts_" a four months' sight draft, knowing that before the draftcomes due and is presented at its wicket for payment, "cover" will havebeen provided from New York. The New York banker, on the other hand, merely sends over on account of the maturing draft in London the moneyhe receives from the importer. He is under an obligation to the Londonbanker to see that the whole £1, 000 is paid off before the four monthsare over, but he knows the party to whom he issued the credit, andknows that before that time all the silk will have been manufacturedand sold and the proceeds turned over to him. At no time is he out ofany actual cash. 

That being the case, the amount of commission he charges is really verymoderate--one-quarter of one per cent. For each thirty days of the lifeof drafts drawn under credits being the "full rate. " Under such anarrangement an importer taking a credit stipulating that the drafts areto be drawn at thirty days' sight would have to pay one-quarter of oneper cent. ; at sixty days' sight, one-half of one per cent. ; at ninetydays' sight, three-quarters of one per cent. , etc. Such commission tobe collected at the time the drafts drawn under the credits fall due. 

These are the "full rates"--naturally, few importers are required topay them, _actual_ rates being largely a matter of individualnegotiation and standing. Where the drafts under the credits run forninety days, for instance, as in the case of coffee imported fromBrazil, the full rate would be three-quarters of one per cent. , butvery few firms actually pay over three-eighths of one per cent. Similarly with credits issued for the importation of merchandise ofalmost every other kind. Silk credits, with drafts running four months, ought at the regular rate to cost one per cent. ; but as a matter offact there are any number of good houses willing to do the business forfive-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 draftsrun _six_ months for a commission of five-eighths of one per cent. Such a commission is entirely inadequate and no fair compensation forthe trouble and risk the banker takes. It means little more than thatthe bank is willing to take business at any price for advertising orother purposes. 

Assume that an importer has taken out a ninety-day credit and is to paythree-eighths of one per cent. On all drafts drawn thereunder, whatrate of interest is he actually paying, figured on an annual basis? Thelife of the draft is ninety days, and he pays three-eighths of one percent. ; in each year there are four ninety-day periods; figured on anannual basis, therefore, the importer is paying four multiplied bythree-eighths of one per cent. , equalling one and one-half per cent. Interest. Not a very high charge, and made possible only because thebanker lends his credit and not his cash. 

For purposes of illustration, the financing of the import of silk fromChina was chosen because the operation embodied perhaps more points ofinterest in connection with commercial credit business than any otherone operation. Commercial credit operations, however, are of greatvariety and scope. They may involve, for instance, the import ofmatting shipped from Japan on slow sailing ships and where the draftsdrawn run for six months or more, or they may involve the import ofdress goods from France, in which case the drafts are often at sight. Furthermore, all credits are by no means issued on London. In the FarEast, where tea or shellac or silk is being exported to the UnitedStates, London is known as the one great commercial and financialcenter, but in the case of dress goods shipped from Marseilles orLyons, for instance, the credits would invariably stipulate that thedrafts be drawn in francs on Paris. 

But whether the material imported be dress goods from France or teafrom China, the principle of the commercial credits under which thegoods are brought in remains identically the same. In every case thereis a buyer on this end who wants to get possession of the goods withouthaving to put up any money, and in every case there is a seller on theother end who wants to receive payment as soon as he lets themerchandise get out of his hands. The banker issuing the credit ismerely the intermediary, and the naming of some foreign point on whichthe drafts are to be drawn is merely incidental to the conduct of theoperation. 

One last point remains to be cleared up. The seller of the goods in thesilk-importing operation described gets actual money for the goods assoon as he ships them--where does this actual money come from? In thelast analysis, from the discount market in London, from the man inLondon who discounts the draft after it has been "accepted". Theexporter in Canton gets the money direct from his banker in Canton, butthe latter is willing to let him have the money in exchange for thedraft only because he (the banker) knows that he can send the draft toLondon and that some one there will eagerly discount it. In that waythe Canton banker gets his money back. The only party who is out of anymoney during the time the silk is being manufactured and sold inPaterson, N. J. , is the party in London who has discounted theshipper's draft. 

The real function of the banker, then, in these Commercial Credittransactions is to open up the international loaning market to theimporter. Through the system now in force this is accomplished by abanker in New York issuing a credit and by a banker in London puttinghis "acceptance" on drafts drawn under that credit. The combinationmakes the drafts _good_; makes the great discount market in Londonwilling to take them, and absorb them, and advance real money on them. And for the opening up of this great reservoir of capital the importerhere has to pay an interest rate of but from one to two per cent. Per