FOOTNOTES:

FOOTNOTES:[96]Frank A. Vanderlip,Modern Banking, Three Addresses delivered at Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. New York. 1911 [?].[97]E. W. Kemmerer,Seasonal Variations in the Relative Demand for Money and Capital in the United States. Publication of the National Monetary Commission, Senate Document No. 588, 61st Congress,2d Session, pp. 96-100.[98][Owing to the growth of deposit banking among the farming classes, the increasing diversification of industry in the agricultural States,Sub-treasury operations, and the offer of remunerative rates of interest on loans in New York during the fall, the net autumnal currency movement since 1907 has frequently been to New York. See E. M. Patterson,Certain Changes in New York's Position as a Financial Center,Journal of Political Economy. Vol. XXI, June, 1913, pp. 523-539.][99]E. W. Kemmerer,op. cit., pp. 101-105.[100]Ibid., pp. 118-121.[101]Ibid., 54. 55.[102]O. M. W. Sprague,History of Crises under the National Banking System, Publications of the National Monetary Commission, Senate Document No. 538, 61st Congress,2d Session, pp. 293-297.

[96]Frank A. Vanderlip,Modern Banking, Three Addresses delivered at Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. New York. 1911 [?].

[97]E. W. Kemmerer,Seasonal Variations in the Relative Demand for Money and Capital in the United States. Publication of the National Monetary Commission, Senate Document No. 588, 61st Congress,2d Session, pp. 96-100.

[98][Owing to the growth of deposit banking among the farming classes, the increasing diversification of industry in the agricultural States,Sub-treasury operations, and the offer of remunerative rates of interest on loans in New York during the fall, the net autumnal currency movement since 1907 has frequently been to New York. See E. M. Patterson,Certain Changes in New York's Position as a Financial Center,Journal of Political Economy. Vol. XXI, June, 1913, pp. 523-539.]

[99]E. W. Kemmerer,op. cit., pp. 101-105.

[100]Ibid., pp. 118-121.

[101]Ibid., 54. 55.

[102]O. M. W. Sprague,History of Crises under the National Banking System, Publications of the National Monetary Commission, Senate Document No. 538, 61st Congress,2d Session, pp. 293-297.

[103]The bill, or order to pay money in a foreign centre, is the commodity that is actually bought and sold by dealers in foreign exchange, but it is better for the moment to leave bills out of consideration. They are only the tangible expression of the claim for money in another centre, and at this early stage of our inquiry it is better to keep our minds fixed on what is at the back of the bill, namely, the money in a foreign centre to which it gives its holder a claim. The French buyer of a bill on London buys it, as a rule, because by sending it to his English correspondent he can discharge a debt to him in English money. What he really buys with his francs is so many English pounds, and the labyrinth of the foreign exchanges is much easier to thread if, before we complicate the question by talking about bills, we keep our eye on the comparatively simple problem which is the key to the puzzle, namely, the exchange of one country's money for another's.

Thus stripped to its naked simplicity, the problem begins to look as if it were not a problem at all, and a critical inquirer may be excused for thinking that at least in the case of countries that use currencies based on the same metal, there ought to be no need for daily quotations of rates of exchange, because the relative value of their moneys ought to be constant. It is a natural question to ask, why should there be these daily fluctuations, and, since they are evidently there, what is the sense or purport of them? The answer is, that money in France and money in England are two different things, and the relative value of two different things is almostcertain to fluctuate. Quite apart from any differences in the fineness of gold coined by two different countries, or the ease or difficulty with which a credit instrument can be turned into gold, mere distance is quite enough to make the difference that will create fluctuation in price. New York and Chicago use exactly the same currencies, but money in New York differs from money in Chicago by being nearly a thousand miles away, and consequently there are frequent variations in their relative value. The English and Australian sovereigns are identical in weight and fineness, but there is constant fluctuation in the buying power of the English sovereign as expressed in its brother that is circulating in the Antipodes.

These fluctuations are based on the same influence that sways the movements in the prices of all goods and services that are bought and sold, that is, the influence of supply and demand. Just as the price of boots, Consols, medical advice, football professionals, or anything else that can be the subject of a bargain, will depend in the end upon the number of people who want to buy them compared with that of those who want to sell them, at or near a certain figure, so the price of English pounds, when expressed in francs, guilders, milreis, or Australian sovereigns, depends on the number of people abroad who have to buy money in England as compared with the number of those who have money in England to sell. People abroad have to buy money in England when they owe money to Englishmen and want to pay it; and they have money in England to sell when Englishmen owe them money.

Jacques Bonhomme in Paris has been selling shiploads of Christmas kickshaws to John Robinson in London, and so has thousands of English pounds due to him by the said Robinson. But English pounds, as such, are not wanted by M. Bonhomme. He wants to sell them, to turn them into francs, the currency of his own country, with which he makes his daily payments at home. On the other hand, there are always plenty of Frenchmen who have imported English goods or have had services rendered by English bankers, or shipowners, or insurance companies, and so want to buy English money wherewith to pay their English creditors. So it follows that the price that M. Bonhomme will get for his English poundswill depend on the value of goods and services that other Frenchmen have been selling to England, so producing English pounds to be sold in Paris, as compared with the value of the claims that have to be met in London, for the satisfaction of which English pounds have to be bought. If the amount of English money on offer is bigger than the amount wanted, down will go the price of the English pound as expressed in francs, and the seller in francs will get less in francs for his pound. If the amount of English money wanted is the bigger, the price will go up, and the seller will get more for his pound. When the price goes down, the exchange is said to move against London, because there is a depreciation in the value of the sovereign as expressed in francs. When it goes up the exchange moves in favour of London, because the buying power of the sovereign is enhanced.

The process is exactly the same, and is even more simple and easy to understand when we take away the complication of the exchange of the moneys of two different nations, and look at it at work between two distant towns of the same country. If in the course of trade New York has large payments to make in Chicago, money in Chicago will be wanted in New York, and competition there will send up the price of it, so that a dollar in Chicago will be worth more for the time being to New Yorkers than a dollar in New York, and any New York bank or firm that has a balance or a credit in Chicago will be able to dispose of it at a premium. The extent of this premium, however, will obviously be limited by the expense involved in sending lawful money, as the Americans call it, from New York to Chicago. If we suppose, for the sake of simplicity, that the cost of sending a dollar and insuring it is covered by a cent, no one in New York will pay much more than one dollar and a cent for a dollar in Chicago. Rather than do so he will send his dollar. He will probably pay a small fraction more to save himself the trouble and time involved by sending and insuring money, and this minute fraction that he will sacrifice is the opportunity of the exchange dealer, who will send money to Chicago, and put himself in funds there, and so be able to supply money in Chicago to any one in New York who will pay for it at the rate of one dollarand one cent plus any profit that the exchange dealer can squeeze out of him.

Viewed in this simple example the problem of exchange has few terrors. It is merely a question of the price of money in one place, as expressed in the same money in another, with fluctuations governed by supply and demand and limited by the cost of sending money from place to place. This limitation does not mean that supply and demand cease to govern the market, but merely that at a point supply can be increased to meet any demand by the despatch of currency.

[104]The general feeling with regard to the function of the exchanges, as giving evidence of the mercantile (or rather monetary) situation of any country, is indicated by the usual phrase of a "favourable or unfavourable state of the exchanges." A phrase which occurs so frequently in all banking discussions that it cannot be passed over without remark. It may originally have implied the erroneous theory that the object of commerce is to attract gold, and that that country towards which the tide of bullion sets with the greatest force isipso factothe most prosperous. Political economists, from their point of view, are correct in their statement that, as regards the country at large and the interchange of commodities, exports and imports are always balanced, and that both the words "unfavourable balance of trade" and "unfavourable exchanges" involve fallacy. But merchants and bankers are influenced by the feeling, that at any given moment they may be under greater liabilities for imports than they can temporarily meet, owing to the system of credit which disturbs the coincidence of payments for exports and imports, though their value may actually be equal; and further, by the anxiety as to the possibility of meeting these liabilities in that specific mode of payment to which they are pledged, namely, in gold or convertible notes. When, therefore, in banking treatises, it is said that the exchanges are favourable to any particularcountry, it should be understood that the intention is simply to state the fact that bills of that country upon foreign cities are difficult of sale, whilst bills drawn upon it from abroad are at a premium, indicating an eventual influx of specie. So, when it is said that the exchanges are unfavorable, a situation is described in which foreign bills are in great demand, and when, consequently, their value seems likely to be so enhanced as to render the export of bullion an unavoidable alternative.

[105]Underlying the whole business of foreign exchange is the way in which obligations between creditors in one country and debtors in another have come to be settled—by having the creditor draw a draft directly upon the debtor or upon some bank designated by him. John Smith in London owes me money. I draw on him for 100 pounds, take the draft around to my bank and sell it at, say, 4.86, getting for it a check for $486.00. I have my money, and I am out of the transaction.

The fact that the gold in a new British sovereign (or pound sterling) is worth $4.8665 in our money by no means proves, however, that drafts payable in pounds in London can always be bought or sold for $4.8665 per pound. To reduce the case to a unit basis, suppose that you owed one pound in London, and that, finding it difficult to buy a draft to send in payment, you elected to send actual gold. The amount of gold necessary to settle your debt would cost $4.8665, in addition to which you would have to pay all the expenses of remitting. It would be cheaper, therefore, to pay considerably more than $4.8665 for a one-pound draft, and you would probably bid up until somebody consented to sell you the draft you wanted.

Which goes to show that the mint par is not what governs the price at which drafts in pounds sterling can be bought, but that demand and supply are the controlling factors. There are exporters who have been shipping merchandise and selling foreign exchange against the shipments all their liveswho have never even heard of a mint par of exchange. All they know is, that when exports are running large and bills in great quantity are being offered, bankers are willing to pay them only low rates—$4.83 or $4.84, perhaps, for the commercial bills they want to sell for dollars. Conversely, when exports are running light and bills drawn against shipments are scarce, bankers may be willing to pay 4.87 or 4.88 for them.

For a clear understanding of the mechanics of the exchange market there is necessary a clear understanding of what the various forms of obligations are which bring foreign exchange into existence. Practically all bills originate from one of the following causes:

1. Merchandise has been shipped and the shipper draws his draft on the buyer or on a bank abroad designated by him.2. Securities have been sold abroad and the seller is drawing on the buyer for the purchase price.3. Foreign money is being loaned in this market, the operation necessitating the drawing of drafts on the lender.4. Finance-bills are being drawn,i. e., a banker abroad is allowing a banker here to draw on him in pounds sterling at 60 or 90 days' sight in order that the drawer of the drafts may sell them (for dollars) and use the proceeds until the drafts come due and have to be paid.

1. Merchandise has been shipped and the shipper draws his draft on the buyer or on a bank abroad designated by him.

2. Securities have been sold abroad and the seller is drawing on the buyer for the purchase price.

3. Foreign money is being loaned in this market, the operation necessitating the drawing of drafts on the lender.

4. Finance-bills are being drawn,i. e., a banker abroad is allowing a banker here to draw on him in pounds sterling at 60 or 90 days' sight in order that the drawer of the drafts may sell them (for dollars) and use the proceeds until the drafts come due and have to be paid.

1. Looking at these sources of supply in the order in which they are given, it is apparent, first, that a vast amount of foreign exchange originates from the direct export of merchandise from this country.

Not all merchandise is drawn against; in some cases the buyer abroad chooses rather to secure a dollar draft on some American bank and to send that in payment. But in the vast majority of cases the regular course is followed and the seller here draws on the buyer there.

2. The second source of supply is in the sale abroad of stocks and bonds.

Origin of bills from this source is apt to exert an important influence on rates, in that it is often sudden and often concentrated on a comparatively short period of time. The announcement of a single big bond issue, often, where it is an assured fact that a large part of it will be placed abroad, isenough to seriously depress the exchange market. Bankers know that when the shipping abroad of the bonds begins, large amounts of bills drawn against them will be offered and that rates will in all probability be driven down.

3. The third great source of supply is in the draft which bankers in one country draw upon bankers in another in the operation of making international loans. The mechanism of such transactions will be treated in greater detail later on, but without any knowledge of the subject whatever, it is plain that the transfer of banking capital, say from England to the United States, can best be effected by having the American house draw upon the English bank which wants to lend the money. The arranging of these loans means the continuous creation of very large amounts of foreign exchange.

4. Drawing of so-called "finance-bills," is the fourth source whence foreign exchange originates. Whenever money rates become decidedly higher in one of the great markets than in the others, bankers at that point who have the requisite facilities and credit, arrange with bankers in other markets to allow them (the bankers at the point where money is high) to draw 60 or 90 days' sight bills. These bills can then be disposed of in the exchange market, dollars being realized on them, which can then be loaned out during the whole life of the bills.

These are the principal sources from which foreign exchange originates—shipments of merchandise, sales abroad of securities, transfer of foreign banking capital to this side, sale of finance-bills. Other causes of less importance—interest and profits on American capital invested in Europe, for instance—are responsible for the existence of some quantity of exchange, but the great bulk of it originates from one of the four sources above set forth.

Turning now to consideration of the various sources from which spring the demand for foreign exchange, it appears that they can be divided about as follows:

1. The need for exchange with which to pay for imports of merchandise.2. The need for exchange with which to pay for securities (American or foreign) purchased by us in Europe.3. The necessity of remitting abroad the interest and dividends on the huge sums of foreign capital invested here, and the money which foreigners domiciled in this country are continually sending home.4. The necessity of remitting abroad freight and insurance money earned here by foreign companies.5. Money to cover American tourists' disbursements and expenses of wealthy Americans living abroad.6. The need of exchange with which to pay off maturing foreign short-loans and finance-bills.

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 of exchange with which to pay off maturing foreign short-loans and finance-bills.

1. Payment for merchandise imported constitutes probably the most important source of demand for foreign exchange. Practically the whole amount of our huge importations has had to be paid for with bills of exchange. Whether the merchandise in question is cutlery manufactured in England or coffee grown in Brazil, the chances are it will be paid for by a bill of exchange drawn on London or some other great European financial centre.

2. The second great source of demand originates out of the necessity of making payment for securities purchased abroad. So far as the American participation in foreign bond issues is concerned, the past few years have seen very great developments.

Security operations involving a demand for foreign exchange are, however, by no means confined to American participation in foreign bond issues. Accumulated during the course of the past half century, there is a perfectly immense amount of American securities held all over Europe. The greater part of this investment is in bonds and remains untouched for years at a stretch. But then there come times when, for one reason or another, waves of selling pass over the European holdings of "Americans," and we are required to take back millions of dollars' worth of our stock and bonds. Such selling movements do not really get very far below the surface—they do not, for instance, disturb the great blocks of American bonds in which so large a proportion of many of the big foreign fortunes are invested. The same thing is truewith stocks, though in that case the selling movements are more frequent and less important.

3. So great is the foreign investment of capital in this country that the necessity of remitting the interest and dividends alone means another continuous demand for very large amounts of foreign exchange. Estimates of how much European money is invested here are little better than guesses. The only sure thing about it is that the figures run well up into the billions and that several hundred millions of dollars' worth of interest and dividends must be sent across the water each year. At the interest periods at the beginning and middle of each year it becomes apparent how large a proportion of our bonds are held in Europe and how great is the demand for exchange with which to make the remittances of accrued interest. At such times the incoming mails of the international banking houses bulge with great quantities of coupons sent over here for collection. For several weeks on either side of the two important interest periods, the exchange market feels the stimulus of the demand for exchange with which the proceeds of these masses of coupons are to be sent abroad.

4. Freights and insurance are responsible for a fourth important source of demand for foreign exchange. A walk along William Street in New York is all that is necessary to give a good idea of the number and importance of the foreign companies doing business in the United States. In some form or other all the premiums paid have to be sent to the other side. Times come, of course, like the year of the Baltimore fire, when losses by these foreign companies greatly outbalance premiums received, the business they do thus resulting in the actual creation of great amounts of foreign exchange, but in the long run—year in, year out—the remitting abroad of the premiums earned means a steady demand for exchange.

With freights it is the same proposition, except that the proportion of American shipping business done by foreign companies is much greater than the proportion of insurance business done by foreign companies. An estimate that the yearly freight bill amounts to $150,000,000 is probably not too high. That means that in the course of every year there isa demand for that amount of exchange with which to remit back what has been earned from us.

5. Tourists' expenditures abroad are responsible for a further heavy demand for exchange. The sums spent by American tourists in foreign lands annually aggregate a very large amount—possibly as much as $175,000,000—all of which has eventually to be covered by remittances of exchange from this side.

Then again there must be considered the expenditures of wealthy Americans who either live abroad entirely or else spend a large part of their time on the other side. By these expatriates money is spent extremely freely, their drafts on London and Paris requiring the frequent replenishment, by remittances of exchange from this side, of their bank balances at those points. Furthermore, there must be considered the great amounts of American capital transferred abroad by the marriage of wealthy American women with titled foreigners. Such alliances mean not only the transfer of large amounts of capitalen bloc, but mean as well, usually, an annual remittance of a very large sum of money. No account of the money drained out of the country in this way is kept, of course, but it is an item which certainly runs up into the tens of millions.

6. Lastly, there is the demand for exchange originating from the paying off of the short-term loans which European bankers so continuously make in the American market.

These loaning operations, it must be understood, both originate exchange and create a demand for it. They were mentioned as one of the sources from which exchange originates, and now as one of the sources from which, during the course of every year, springs a demand for a very great quantity of exchange.

In a general way, it may be pointed out, the sources of demand for exchange conform with influences which cause exchange to go up, and the sources of supply of exchange constitute causes which make for low rates.

It is to be noted, however, that money rates are a great factor influencing foreign exchange. Whenever money is cheap at any given centre, and borrowers are bidding onlylow rates for its use, lenders seek a more profitable field for the employment of their capital.

Money rates in the New York market are not often less attractive than those in London, so that American floating capital is not generally employed in the English market, but it does occasionally come about that rates become abnormally low here and that bankers send away their balances to be loaned out at other points. Such a time was the long period of stagnant money conditions following the 1907 panic. Trust companies and banks who were paying interest on large deposits at that time sent very large amounts of money to the other side and kept big balances running with their correspondents at such points as Amsterdam, Copenhagen, St. Petersburg, etc.—anywhere, in fact, where some little demand for money actually existed. Demand for exchange with which to send this money abroad was a big factor in keeping exchange rates at their high level during all that long period.

High money rates at some given foreign point as a factor in elevating exchange rates on that point might almost be considered as a corollary of low money here, but special considerations often govern such a condition and make it worth while to note its effect. Suppose, for instance, that at a time when money market conditions all over the world are about normal, rates, for any given reason, begin to rise at some point, say London. Instantly a flow of capital begins in that direction. In New York, Paris, Berlin, and other centres it is realized that London is bidding better rates for money than are obtainable locally, and bankers forthwith make preparations to increase the sterling balances they are employing in London. Exchange on that particular point being in such demand, rates begin to rise, and continue to rise, according to the urgency of the demand.

The international money markets are a most decidedly complex proposition, and there is literally never a time when several influences tending to put exchange rates up are not conflicting with several influences tending to put rates down. The actual movement of the rate represents the relative strength of the two sets of influences. To be able to "size up" the influences present and to gauge what movement ofrates they will result in, is an operation requiring, first, knowledge, then judgment. The former qualification can perhaps be derived, in small degree, from study of the foregoing pages. The latter is a matter of mental calibre and experience.

The foreign trade of the United States has increased during the last forty years about 370 per cent.... This increase ... reflected not alone our own marvellous development, but as well the wonderful growth of trade throughout the world. The United States stands third among the countries of the world, its foreign trade being exceeded only by that of the United Kingdom ... and Germany....

Our imports and exports[108]are being financed more and more by means of what are known as commercial letters of credit.... An explanation of the operation of the commercial letter of credit will ... disclose the methods and conditions under which our imports are financed.

The commercial letter of credit is an authorization, say of an American bank to its London correspondent, to honor drafts for its account drawn at various tenors by foreign shippers or others against shipments of merchandise to this country. These credits are of two kinds, documentary and clean. Under the documentary credit the London bank is authorized to accept drafts for the account of the American bank only when the bill of exchange is accompanied by certain documents described in the letter of credit. These documents may be the bills of lading for the goods, consular invoices, insurance certificates and possibly other papers. Probably a large proportion of such credits requires that drafts be drawn at sixty or ninety days' sight. So many elements of danger are involved in financing commodities under commercialletters of credit, even where the control of the goods is given to the bank issuing the credit or its agents, that the financial standing of those asking for credits must be the first consideration in their issuance. Dishonesty on the part of the shipper, resulting in a drawing under the credit against forged documents or against shipments of inferior merchandise, is always possible, and the financial responsibility of the buyer of the credit is all that stands between the banker issuing the credit and a loss in such cases.

In order to obtain a clear understanding of the working of a commercial letter of credit, we will take a concrete example and follow its every transaction. An importer of coffee (A) in New York purchases a certain number of bags of coffee from an exporter (B) in Brazil. A agrees to furnish B with a commercial letter of credit. B is not in position, we will say, to await the arrival of the coffee in New York and the return of a remittance before receiving his pay. A on the other hand is unable to remit B for the coffee before its receipt and sale to his customers. A goes to his banker in New York and requests him to authorize B to draw upon the New York banker's London correspondent at ninety days' sight with bills of lading for coffee to the amount of the purchase attached to the draft, consular invoice and insurance certificate, if B is to furnish insurance. If A's banker is willing to extend the credit he writes a letter (or uses a printed form), requesting his London banker to accept B's drafts upon presentation under the conditions already mentioned and others of minor importance. This letter is issued in duplicate, one copy going to the London banker, the other being delivered to A. A then mails the copy received by him to B. B thereupon arranges to ship the coffee, obtains the bill of lading, invoice, etc., and takes them with the copy of the credit to his banker in Brazil. A draft is then drawn on the London bank under the terms of the credit at ninety days' sight and is discounted by the Brazilian banker, the proceeds being placed to the credit of B's account or given to him in the form of a check or cash. The Brazilian banker then forwards the draft and documents, except such documents as the instructions may require to be forwarded direct to New York, to his Londonbanker. He may secure discount of the bill at once by cable or await its arrival in London before doing so, or he may request his London banker to have the bill accepted and hold it for maturity. If the bill is discounted the Brazilian banker may draw against it immediately and thus put himself in funds to purchase other coffee bills. Upon receipt of the bill by the London correspondent it is presented to the London banker on whom it is drawn for acceptance. The acceptor bank examines the documents and if they are drawn according to the terms of the credit accepts the draft and returns it to the correspondent of the Brazilian bank, retaining the documents, which it then forwards to the New York bank which opened the credit. In accepting the draft the London bank has in effect agreed to pay it at the end of ninety days, or, figuring grace, ninety-three days. Upon maturity payment is made and the amount is charged to the account of the issuing New York bank. Upon receipt of the documents the New York bank delivers them to its customer under a trust receipt or against collateral, and the latter is then in position to obtain the goods. Ten days before the bill of exchange is due in London the New York bank collects the amount from A, together with the commission agreed upon when the credit was opened, and remits the amount to its London banker to meet the draft. On all such transactions the London banker, while not himself advancing any money, is extending a credit for which he charges the New York bank a commission. The result is that we are paying tribute to European bankers amounting to an immense sum annually for the purpose of financing our imports.

The fact that London exchange is more marketable generally throughout the world than New York exchange is one of the principal reasons why it is necessary for us to issue credits upon London instead of upon New York.

Our imports are distributed generally throughout the United States. The importers, however, are mostly situated at the ports of entry. A very large proportion of them obtain their credits through New York institutions, although some of them deal direct with foreign bankers.

Probably a smaller proportion of our exports is financed bymeans of commercial letters of credit than of our imports. Different commodities are handled in accordance with special customs which have grown up around them, due partly to trade conditions and partly to the nature of the products. Sellers of grain usually draw at sixty days' sight upon the foreign buyer instead of under a bank credit. These bills, under the customs prevailing in most foreign countries, may be rebated by the foreign buyer whenever he desires to obtain the goods at the "bank rate" or 1 per cent. under the bank rate, or such other rate as custom in the country on which the drafts are drawn requires. Such drafts, with bills of lading and such other documents as are necessary, are purchased by American banks and are forwarded by them to their European correspondents. The American banker is obliged to advance the money on such paper, unless he draws his own time bills against them, until such time as they are rebated. In the case of grain bills the average time rebated is probably around fifty-six days, which places the American bank in possession of demand foreign exchange, against which it can draw in order to reimburse itself with the loss of a very few days' interest.

Flour bills, which are financed in the same manner as grain bills, usually run nearly to maturity before they are rebated, although the condition of the discount market sometimes influences the purchaser, and causes him to take the bills up more promptly. Many foreign shipments are made under three-day sight bills, which uses the money of the American banks making the advance from four to seven days or more, depending upon whether the laws of the country on which the bills are drawn allow grace or not and whether the bills are purchased with intervening days before the sailing of steamers. Other classes of bills are drawn at sight. This includes a portion of our lumber shipments and miscellaneous articles. Where shipments are made on sailing vessels, drafts are frequently drawn at four or six months' sight, and many other transactions go through against cable payments.

As nearly 40 per cent. of our exports consist of cotton, the method under which it is financed is worthy of special consideration. Cotton bills are ordinarily of two kinds: documentarypayment bills and bills drawn upon bankers. Documentary payment bills, which are drawn upon cotton merchants or spinners at sixty or ninety days' sight or other tenors, are handled in the same manner as flour bills. The cotton merchant accepts the draft upon presentation and rebates it when the goods arrive, or when he desires to obtain the cotton. A small percentage of cotton is handled in this way. Most of the commodity is financed by means of credits opened by the foreign buyer through his banker. Various abuses have developed under this system, which have caused losses running into millions of dollars to all of the various parties engaged in carrying the transactions to their close. These losses have only been possible because of the turning over of credits by the foreign buyers to irresponsible concerns in America in their endeavor to obtain cotton at lower prices than their competitors. A foreign buyer makes arrangements with certain American concerns to cable him offers of cotton. The American firms whose offers are accepted receive cablegrams from the buyer advising them of the acceptance of their offers and giving them the names of the foreign bankers on whom the drafts in payment of the cotton are to be drawn. The American sellers thereupon ship the cotton to the buyer under bills of lading drawn to the shipper's order and endorsed in blank. The bills of lading are then attached to drafts drawn upon the bankers designated by the buyer at the given tenor, which is usually sixty or ninety days. This exchange is then sold in the market to the highest bidder or it is forwarded to New York to be sold in the same manner upon arrival. The American exchange buyers have no means whatever of designating whose bills shall be upon the market, as the sellers are all agents of the European buyers. The American exchange houses in their need for exchange to meet the demands of their importers have accepted the bills offered in the market, each exchange man endeavoring to keep his "water line" on weak names as low as possible. If the European buyers only dealt with first-class houses only first-class bills would be offered, but when they deal with second- or third-rate houses, or houses with no standing whatever, suchbills drawn upon prime European banks come upon the market.

The American exchange buyers having the cotton as collateral while the drafts are on the water, and then having the acceptance of a prime European bank for the sixty or ninety days following before maturity of the draft, have accepted these risks, although unwillingly, for want of better bills. They endeavor to protect themselves as far as possible by trying to buy bills only of those in whose honesty they have reason to believe, whether they have any capital back of them or not. If the cotton were actually shipped under a bona fide order, any fluctuation in the value of the cotton which they accepted as collateral, although taken entirely without margin, would probably cause them neither loss nor friction. They have run the risk, however, of having forged documents forced upon them which did not represent goods, or exchange that was drawn without authority. Lines which exchange buyers are willing to take from each cotton shipper before acceptance, and before the name of a prime European banker is added to the paper, have to be based upon this consideration.

The old form of the cotton bill of lading which has been signed by freight agents or their assistants or others has been an instrument not possible to authenticate. This was particularly dangerous, due to the manner in which bills of lading were issued. They were formerly given out to the shippers, who filled them in and returned them to the railroad agent, who in turn often signed them without having any knowledge as to whether the goods called for by the bill of lading were in his possession or not. Under a new system bills of lading are not to be given up until the goods are actually in possession of the railroads. This system, which calls for validation certificates, numbered and printed upon a specially protected water-mark paper, to be attached to the bills of lading in such manner as to make it practically impossible to remove them without detection, went into effect September 1, 1910, and it is confidently hoped that it will give sufficient added safety to the bills of lading of American railroads to satisfy the foreign bankers.

The very act of guaranteeing such bills is recognized by foreign bankers as being wrong in principle, and while they are requesting that American exchange buyers guarantee bills of lading for exports yet on the other hand they particularly call attention to the fact that no bills of lading which pass through their hands for imports to the United States are guaranteed by them in any way, shape, or manner.

[109]Many American manufacturers do not realize the essential "credit" element of transactions on the basis of drafts drawn onforeign customers.... The exporter has received an order; he purchases the goods covered by this order from the manufacturer, and should the customer change his mind the exporter may suffer a loss. Or the customer refuses to accept the goods, and the exporter may again suffer a loss. Or the customer may accept the goods and the draft, but fail to pay, and the exporter once more is the loser....

... The turning over of the bill of lading vests the property right to the goods in the customer. The customer either pays the value of the draft in cash ("documents against payment," abbreviated d/p) or accepts the draft for payment at some future date, which is the more customary course ("documents against acceptance," d/a). Even in the case of d/p drafts, payment by the customer may be postponed; instead of paying cash he accepts the draft at one to three months, but neither the documents nor the goods are turned over to him. He may want to wait until he has sold the goods, on the basis of samples, perhaps, and the goods are warehoused until he can pay the amount of the draft into the bank or to the forwarding agency. This is frequently done in the Far East. Here the banks maintain so-called "godowns" for this purpose. The goods are occasionally turned over to the customer for warehousing purposes against the so-called "trust receipt." One important feature of "acceptance" of the draft by the customer is the fact that it forms an acknowledgment of indebtedness,which it is then unnecessary to prove item by item in case of litigation. In most countries acceptances are far simpler to collect judicially than open accounts. When an accepted draft is unpaid it is "protested," and the debtors may be proceeded against without further trouble.

Frequently open accounts may be neglected by a customer who may find himself for some reason short of immediately available funds, but to neglect the payment of an accepted draft is regarded in the trade and by banks as so serious a matter that the drawee would lose caste with the banks; oversea buyers endeavor in most cases to honor accepted drafts....

[110]It has been shown that, if two countries buy of each other to the same amount, their transactions need not give rise to two separate sets of bills, but that on the contrary, if the foreigner draws on us to the full value of his exports, the bills so created will be sent as remittances to the exporter on this side and will pay him for his sales. Conversely, if the British exporter draws, there is no necessity for the other side to do so.

What, then, are the facts? Does the United Kingdom, generally speaking, draw on abroad, or does the foreigner take the initiative by drawing on London?

As a matter of fact, both sides draw; but, as all who are acquainted with the customs of trade are well aware, the bills drawn by Great Britain on abroad are vastly outnumbered by those drawn from abroad on London.

Owing chiefly to the magnitude of our trade, but also to several contributory causes—such as the stability of our currency; the certainty that a bill on London means gold and nothing but gold; the facility with which those who deserve credit can obtain it here; our freedom from invasion, etc.—London has become to a great extent the settling-place ofEurope and the world, and the seller, wherever he may be, of a good bill on London can always be sure of finding a buyer and of realizing a fair price. As the sale of a bill, moreover, carries the valuable advantage of ready money and a speedy turnover of capital, it is invariably preferred by the foreign exporter, who has consigned or sold produce to us, to the alternative plan of awaiting remittances from this side. The foreign importer, too, who has to pay for the goods he has bought, would rather do so by remitting to London than by allowing us to draw upon him. In the former case, the rate he has to pay depends upon his own success in higgling; in the latter, it is fixed by a London bill-broker, who has not the same interest in the matter.

If the same considerations held good on this side also, our merchants and manufacturers might perhaps object to letting the foreigner have it all his own way; but, on the contrary, it appears to suit both buyers and sellers very well—the former, because in the majority of cases they would scarcely know how or where to buy suitable bills, and the latter, because the drawing and negotiation of a foreign bill requires a certain amount of knowledge of the exchanges, which they do not always possess, and entails a certain amount of trouble, which they would gladly be spared. There is also more risk of loss in drawing. In the latter case they have only their correspondent to look to, while on a London remittance they have the additional security of the other parties to the bill.

Practically speaking, therefore, the settlement of our foreign trade is effected by means of bills of exchange which are drawn and negotiated abroad, and are accepted and paid in London.

To the student of the exchanges this fact is of considerable importance, for, as the rate of exchange between two countries—the price at which bills on the one are sold in the other—must befixed by the one that draws and negotiates the bill, it follows that the exchanges between England and most other countries are controlled from the other side, and that we in London have scarcely part or say in the matter. The rate of exchange, for example, between England and the United States is fixed in New York; between England and Brazil,in Rio; between England and Turkey, in Constantinople; and so on. There may be exceptions, of which the Indian exchange is the most notable, but that is the general rule, and it is one that should be carefully borne in mind.

The same fact also supplies a reason for the solicitude with which the foreign trader watches the fluctuations of the exchange, and for the utter indifference with which they are regarded by the British trader. To the former, who intends maybe to draw a few hundred pounds on London in a day or two against the shipment he is preparing, the difference between selling his draft next week instead of this may mean, if the rate should move in his favor, the gain of an additional half per cent.; but to our home manufacturers, who sell their wares in sterling and stipulate for payment in bills on London, the see-saw of rates is but of academic interest. They pay attention to thecourse of discount, because they may have to melt some of their paper before pay-day comes round; but the course of the exchange—the question of the rate rising or falling—hardly concerns them at all.

It is not sought to detract from the influence of the English-drawn foreign bill, or, as might be imagined, to explain it away altogether. On the contrary, paper to a considerable amount is, and will continue to be, negotiated on the Royal Exchange (though the total, if compared with that of the paper on London negotiated abroad, would appear quite insignificant).[111]The object in view is merely to bring into prominence, and to impress on the reader, the essential principle that, while the position of every rate of exchange is the outcome of the market conditionsin the two countries combined, the predominant mass of the dealings take place on the other side, so that, as a consequence, the real significance of the fluctuations can only be grasped by viewing them from the foreign [e. g., American] standpoint.

[112]Probably the most important effect at this time [1915] of the Federal Reserve Act is the establishment of the American acceptance market. It may well be said that heretofore America has had no real money market. The only semblance of a money market previously existing in this country was the call loan market of New York City. That, however, did not truly reflect money conditions in this country, as it has more often reflected the secondary effect of some movement of the stock market.

The development of a real money market in this country was greatly hampered by the lack of a standardized credit instrument. In every other country the bank acceptance in which the element of credit risk has been practically eliminated is the standard instrument of credit, and the discount rate of such paper marks the level of the money market.

Bank acceptances were not known in this country prior to the operation of the Federal Reserve Act. For the benefit of those who may not be familiar with bank acceptances, I will briefly describe an operation giving rise to such acceptances. Jones, an importer of coffee in New York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes to his bank in New York and arranges with them to finance the deal. Smith, the grower of the coffee in Brazil, makes the shipment to New York and draws a ninety days' sight draft on the New York bank for the amount of his invoice. This draft he then sells to some Brazilian bank.... The Brazilian bank then sends the draft to New York. It is there presented to the New York bank for acceptance. The New York bank accepts the draft by writing the word "accepted" across the face of the draft and affixing its official signature thereto. The draft now becomes the primary obligation of the New York bank. Of course, Jones, for whose account the New York bank accepted the draft, has obligated himself to providethe New York bank with funds to meet the draft, but if he should fail to do so the New York bank must pay the acceptance nevertheless. It is, therefore, the direct obligation of the New York bank, and as such it commands the best discount rates current. This briefly is what is known as a bank acceptance,i. e., a draft drawn on and accepted by a prime bank or banker.

Although this business is still in its infancy, it has reached important proportions and there is an active market for them in New York City. A number of brokers have taken up the business of buying and selling acceptances. Every morning they make the rounds of the various banks with the list of the acceptances they have for sale and the rates at which they are willing to sell them. Incidentally, they also learn whether the banks have any acceptances for sale and at what rates. As the credit risk is practically eliminated, acceptances are a very attractive form of secondary reserve; they are, as a London banker once expressed it, a means of enabling the banker to eat his cake and have it too—the banker by investing his money in acceptances earns the discount and at the same time he knows that his money is instantly available in case of need, so that they are almost as available as cash. This explains why the discount rate on acceptances ranges so low. Ninety days' sight acceptances sold in New York City at one time as low as 2 per cent. per annum and to-day prime acceptances command the excellent rate of 2-3/8 per cent.

Many radical changes in the mechanism of international finance have occurred during the past fifteen months, since the beginning of the European war. Not the least important among these changes, viewed from the standpoint of the American importer, is the evolution in the methods of financing our importations.

Our imports in the way of commodities such as hides, coffee,rubber, wool, etc., etc., run into hundreds of millions of dollars annually, and these are financed generally through the medium of commercial credits established by the purchaser in favor of the vendor of the merchandise. Commercial credits, so called, are in effect a bank guarantee to the seller that his drafts covering certain merchandise, when drawn in accordance with the conditions prescribed in the credit, will meet with due honor on presentation to the accepting bank named in the credit instrument.

In order merely to gain an idea as to the importance and volume of such transactions, it is only necessary to glance at the totals of a few of our principal imports. In the year 1914 we imported, among other commodities, the following:

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