Front Page Titles (by Subject) XIII.: foreign exchanges. - Political Economy
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XIII.: foreign exchanges. - Francis Amasa Walker, Political Economy 
Political Economy (London: Macmillan, 1892) 3rd revised and enlarged edition.
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541. Meaning of Exchange.—Formerly, when debts were paid by the merchants of one country to those of another, it was almost always necessary actually to change the money of the debtor country into that of the creditor country. Thus, if a merchant in Paris had occasion to pay a debt to a merchant in Antwerp, it was necessary first to compute the quantity of “fine“ (i. e. pure) silver contained in the amount of Antwerp money due under the contract; then to find out how many French coins (their weight and fineness being known) would be required to make up that amount of pure silver. This being ascertained, the Paris merchant paid down the French money (plus the premium, or minus the discount, of which we shall speak later) and received the Paris banker's order upon some Antwerp banker to pay the Antwerp merchant the amount of Antwerp money due him. It was with reference to this changing of one kind of money into another, that the term exchange was first applied to this class of transactions. It came in time, however, to be equally applied to transactions between cities under the same government, having the same kinds of money, where, hence, no actual changing of money pieces was required.
At the present time, this changing of money pieces plays a very much less important part in exchange. Instead of many states having independent authority to coin money, there is now but one coining authority in all Italy. The money of Germany is now uniform in weight and fineness. France, Italy, Belgium, Switzerland, Greece and Austria have certain money coins which may be said to be in common, i. e., they contain the same amount of pure metal, though under different denominations and with different inscriptions. The vast extension of the British empire has made the “sovereign” current money over a large part of the globe.
542. What is Exchange?—In essence, where a man buys exchange—he buys the right to have paid to him, or his agent, or his creditor, a certain amount of fine gold or silver, to be delivered in some other place mentioned in the contract. If I buy in New York “exchange on London,” some one who has gold in London, or who has a right to demand gold there, sells me his claim to receive a definite amount of that metal, in London, at a definite time, or at my convenience if we so agree. I may then, either go to London and get the metal, as, for instance, if I am starting out on a European tour, or I may send an order, by post or telegraph, for some one else to get it there, as, for instance, if I have bought cotton goods or pictures in London, and have agreed to pay for them in this way.
543. Par of Exchange.—Now, we may suppose that, in order to induce some person to sell me “exchange on London,” I have to pay him, not in goods, but in a certain amount of gold in New York, where we both live. How much gold shall I pay him in New York to induce him to give me the right to receive a certain amount, say 1,000 ounces, of gold in London? Shall I have to pay him 1,000 ounces, or more, or less? That depends on whether exchange is at par (equality), or above par, or below par.
Exchange between two places is at par, when, by paying a certain amount of money metal, or its equivalent, in one place, you can purchase the right to receive an equal amount of the same metal in the other. I say, the same metal, for there can be no par of exchange between countries having gold money and countries having silver money, unless, indeed, the bi-metallists (par. 563) shall make good the claim that their system will establish and maintain a certain definite ratio between the values of the two metals.
Exchange is above par or below par, when the right to receive elsewhere a given amount of gold or silver, is to be purchased by paying, in the one case, a larger, and, in the other case, a smaller amount of the same money metal, in the place where the transaction is effected.
Exchange will be at par when the sums of the payments to be made to and from any two places, within a given time, exactly balance each other. If the sum of the payments to be made within a limited period by the merchants of one place, say New York, to the merchants of another place, say London, is greater than the sum of the payments to be made in New York by the merchants of London, then exchange on London will be above par in New York; that is, a New York merchant having to pay a debt, within that period, in London, will have to pay down more than 1,000 ounces of gold in New York to buy the right to have paid to him, or to his creditor, 1,000 ounces of gold in London.
544. The upward limit of the premium∗ on bills of exchange is the cost of remitting specie. The New York merchant, in the case supposed, will not pay more, in addition to 1,000 ounces, than the cost of sending 1,000 ounces from New York to London, interest, freight, insurance, and commissions being taken into account. If the holders of bills demand a premium above this, the New York merchant will send the metal, and in that way pay his debt. Within the limit thus assigned, the premium on bills rises or falls with the fluctuations of the market, according to the law of supply and demand.
While, thus, exchange on London is at a premium in New York, exchange on New York will, conversely, be at a corresponding discount in London. If a New York merchant, owing 1,000 ounces of gold in London, has to pay somewhat more than that amount, a London merchant, owing 1,000 ounces in New York, will be able to purchase the right to receive that amount there for something less than 1,000 ounces. The downward limit† of the discount on bills of exchange is, again, fixed by the cost of remitting specie.
545. The Balance of Trade.—We have said that exchange between two places will be at par when the sum of the payments falling due on the one side is equal to the sum of the payments falling due at the same time on the other side. It may happen—it frequently does happen—in the trade between countries A and B, that country A may at one season of the year have the larger payments to make, while in another season the relations will be reversed. The exports from the United States, for example, tend to take place predominantly in the few months following the harvest. At that time the United States becomes chiefly a creditor country. The merchants of other countries have large amounts to pay in New York, on account of produce received; and consequently exchange on New York is at a premium in London, Paris, Amsterdam, etc. Conversely, exchange on London, Paris, Amsterdam, etc., is at a corresponding discount in New York. During the other half of the year, the United States generally import more largely than they export, and the course of exchange is reversed. Bills on London are at a premium in New York, on account of large payments to be made abroad; bills on New York are at a discount in London. The discrepancy thus arising from the nature of the industry of any given country, between the times at which its payments are chiefly to be made and those at which it is to receive the bulk of the amounts due to it, on account of its own exports, is, in a degree, often very largely, removed by bills drawn, as the phrase is, in blank. These are bills which do not discharge a debt, but create a debt. Exporters often draw such bills, generally with permission obtained in advance, upon those to whom they habitually sell or consign their shipments, in anticipation of the goods being actually dispatched. Such a course is liable to very grave abuses, being often resorted to, not merely in promotion of reckless and outrageous speculation, but even for the purposes of downright swindling; and the courts and newspapers are much given to reflecting severely upon this practice, in general, whenever some case of its perversion is brought to light. Yet this system of credits, when kept within bounds, confined to proper parties, and, as Mr. Goschen says, “jealously and even suspiciously watched,” serves a very important purpose in equalizing the income and outgo of nations and in diminishing the extent to which shipments of specie require to be made.
The point we have now reached introduces the vexed question of the Balance of Trade. Few subjects are more complicated or more generally misunderstood. The question, whether a year's commercial transactions have, in the net result, brought a nation more in debt to other nations than they, in the aggregate, have come to owe to it, is commonly decided, offhand, by simple reference to the custom-house statistics of the values of exports from and imports into that country. Such a test is altogether fallacious. The statistics of exports and imports, if fairly well collected and compiled, are of great value; but it is necessary, first, to make correction for their internal errors, and, secondly, to take into account several elements which the custom-house statistics do not undertake to include.
546. Errors in Commercial Statistics.—The official statements of imports and exports are more or less disturbed by errors from two exactly opposite sources. If the goods imported or exported are subject to duties at the custom house, the importer or exporter comes under a very strong temptation to misrepresent their value or amount. If, on the other hand, the goods are free of duty, both the custom-house officials and the merchants are liable to become very careless in making the required statements as to the quantity of such goods, and still more careless regarding statements of value.
How far these two causes together may result in vitiating the official statistics of imports and exports, will, of course, depend greatly upon the organization of the civil service, upon the general morality of the trading and official classes, and upon the integrity and severity with which the laws are enforced; but it is not possible under any organization or administration wholly to eliminate errors of importance, from one or both of these sources. Imported goods subject to duty will be largely undervalued, in spite of all the vigilance of honest officials. Exports are probably even more grossly undervalued, because being, by the fiscal system of most nations, free of duty, even the most honest officials are likely to attach little importance to the statements of value, since they are aware that no revenue interest of the government is concerned therein.
In addition to these general causes, affecting, though in very different degrees, the commercial statistics of all nations, there are apt to be special liabilities to error affecting the commercial statistics of any given country. Thus, with regard to the United States, it is found that while a reasonable degree of care and pains is taken to ascertain the values of goods exported by ocean-going vessels, the statement of our exports by rail, by ferry-boat, or by small river and lake vessels to Canada and Mexico, are exceedingly defective, so much so as to be almost wholly worthless. It is notorious that many millions are omitted yearly from our statistics on these accounts.
547. Elements not included in Custom House Statistics.—Passing now to elements, other than internal errors in custom-house statistics, which require to be taken into account, in order to reach the true balance of trade, I will briefly mention the most important. The reader who desires to pursue the subject, will find it treated in a most interesting and instructive manner in Mr. Goschen's work on Foreign Exchanges.
The principal elements to be considered are, first, the exportation or importation of government securities, shares and bonds of corporations, titles to property, etc. This is an element, which, at times, may rise to an enormous importance; at other times, it may sink into insignificance. It may be considerable as between certain countries, while as between either of those countries and any other, it may amount to little or nothing.
During the war of secession the United States sold its bonds in Europe∗ to the amount of hundreds of millions of dollars, bringing back arms, ammunition, clothing and other supplies. The latter went into the statistics of imports; while the statistics of exports took no account of the former. As these bonds had many years to run, the value of the goods so imported did not enter into the amount to be paid for abroad in those years. In the same way, many of our great railroads have been built mainly or wholly with foreign capital, shares in the stock of those railroads, or more commonly, first-mortgage bonds, being sent abroad without passing through our custom-houses, while rails and other supplies were brought back through the custom-house, thus swelling our tables of imports. In like manner, large quantities of foreign goods, of all sorts, have been sent to us year after year, in consideration of which foreigners have received from us, not our corn, cotton or petroleum, but the titles to mines, to agricultural and grazing lands, mortgages on western farms, the bonds of cities and counties, etc.
The aggregate amount of such securities and titles exported from the United States has been enormous, though the movement has been very irregular from year to year. Nor has the current been all one way. When our government began to refund its debt at a lower rate of interest—at three and a half or three per cent., instead of six or seven per cent., nearly all our national bonds which had been held in Europe were returned. Now and then some large mass of railroad or city bonds are sent back, at maturity, for redemption,—the proceeds to be reinvested in other securities, of which the custom-house would not take notice, or to be “drawn against” in payment for corn or cotton, of which the custom-house would take notice.
While the element which we have been considering is of enormous importance to the United States, as affecting the balance of trade within any given year, England is the nation whose commercial statistics need most to be supplemented from this source. Hers has been the greater part of the capital which has come to us from Europe, for loan or investment; and for the last forty years she has been doing a similar work in every part of the world, building railroads in Canada, Australia, Mexico, South America, India and Persia, even in France, Germany and Russia, providing capital, out of her superabundance, for every species of enterprise in any land that promised a profit, and even furnishing the means with which half the wars of the present generation have been waged.
548. Interest on Government Securities.—But while, as we have said, it is true that in these modern times, enormous amounts of imports or of exports of merchandise are, in the case of any given country, set off, not against equal amounts of exports or of imports of merchandise, but against shares, stocks, bonds, or mortgages, sent abroad or brought home, as the case may be, it is also true, that dividends or interest on such shares, bonds, etc., become due annually, semi-annually, or quarterly, immediately thereafter, and require, therefore, to be added to the amounts which the debtor nations have to pay; which the creditor nations have to receive, thus affecting at once the course of exchange. Some nations have to pay millions annually, others, tens of millions, on this account. Those nations, which, in some past period have spent vast sums in great wars or on costly public improvements, without paying for them at the time through taxation, now find a certain portion of their exports of merchandise going every year to pay the interest on their debts. Against this is set nothing of which the custom-house takes notice. No goods come back to pay for these exports: only some packages of canceled coupons.
549. Expenses of Fleets on Foreign Stations, etc.—Another item which should be added to the imports of a country, in making up its current accounts with other nations, consists of the expenses of its fleets on foreign stations, or of its armies, if in occupation of other countries. In the case of great naval nations, this item is not of small importance. For a little while after vessels of war leave the home ports, their petty expenses may be met with gold taken from home, which may or may not have passed the custom-house; but subsequently, the expenses of the fleet will be met by bills of exchange, which will be just so much added to the volume of bills which represent the commercial imports of the home country.
The expenses of foreign embassies and legations and of the consular service stand in the same relation to the imports of the country represented.
550. Expenses of Foreign Travel.—In like manner the sums expended by tourists and travelers abroad constitute a very considerable item in those accounts which go to determine the balance of trade. The good things eaten or drunk by our citizens abroad are as much a part of our imports, for the purposes of such a computation, as if they had been brought to the United States in vessels and had been consumed here. Every year, many millions are expended by our citizens abroad, out of the proceeds of bills of exchange. Mr. Goschen states that several millions sterling are annually expended by the rich Russian nobility in traveling or in foreign residence.
551. Tributes, War Indemnities, Etc.—From whatever motive an independent country, a colony or a province may have occasion to make payments to another power, or to the sovereign or mother country, whether that motive be found in protection extended, in privileges conceded, in fear of hostility, or as a fine for past conduct, such payments affect exchanges in all respects as if they were on account of foreign goods imported. Yet, here, again, we have an element of which the statistics of commerce take no account. Whenever these payments are regular, they affect the course of exchange no more, if not less, than ordinary commercial payments. Thus, trade and exchange adjust themselves to the tribute paid by Java to Holland with perhaps even more of exactness and certainty than as if the payments were on account of goods imported into Java for the improvement of its agriculture, or for starting manufactures. On the other hand, an extraordinary payment of this character, is likely to produce great and far reaching, and it may be long enduring effects upon the market of exchange. The gigantic war indemnity paid by France to Germany, in 1871,∗ notwithstanding the transcendent financial skill with which the negotiations were conducted, set in motion forces which were felt by trade and industry to the remotest parts of the earth.
552. Freight, Insurance, Profits, Commissions, Etc.—But we have not yet reached the largest of the elements which determine the balance of trade, of which ordinary commercial statistics take no account. Let us suppose, for illustration, that country A imports from country B goods, whose value, at the ports of B, is one hundred and fifty millions of dollars, and exports to B goods, whose value, at its own ports, is correctly stated at one hundred millions. Now, here is an apparent difference of fifty millions of dollars. If, however, we can reach the facts regarding the carriage, insurance, etc., of these goods, amounting in the aggregate to two hundred and fifty millions of dollars, we may find the apparent balance greatly modified, in the way either of increase or reduction. Suppose, for example, that country A owns all the shipping engaged in this traffic; the charges for freight on its own exports might easily reach ten or fifteen millions of dollars, which would require to be added to the custom-house valuation, in order to make up the true balance between the two countries. On the other hand, the ten or fifteen per cent. charged for carriage on its imports would be paid to its own citizens. In the same way country A might do all the insurance business relating to both sides of the traffic; and its merchants and factors might conduct all, or nearly all, the commercial operations involved. In such a case the premiums for insurance, the commissions and profits of trade would go still further to reduce the apparent balance between the two countries. On the other hand that apparent balance might have been greatly extended by the fact that all the shipping merchants and most of the importers, factors and insurers engaged in the traffic belonged to country B.
The suppositions above made are not in themselves unreasonable. It generally happens that, in the commerce between two nations, one or the other does by far the larger part, often, practically, the whole carrying business,∗ as well as obtains an altogether disproportionate share of the premiums of insurance, and of the profits and commissions of traffic.
553. It is not necessary to extend our enumeration to minor items of the accounts between trading nations, in order to show the reader how greatly the ordinary statistics of imports and exports must be corrected and supplemented before we can reach a decision as to the amounts by which the payments to be made in any given period by one country to any other country or to all other countries, exceed the payments due to itself. Mr. Goschen states that Russia has more than once, in times of peace, as I understand it, so far fallen behind in her dealings with other countries, as to be obliged to contract a foreign loan, exporting public securities made for the purpose, as a means of restoring the balance. Of course, such a temporary expedient in the end serves to increase the commercial and financial difficulties of a country.
554. Our illustrations have thus far been drawn mainly from the commercial transactions of two countries, real or supposed. We have perhaps sufficiently shown that, of the amount of payments falling due on one side or the other in a given period, only the balance will require to be discharged in money, the principle of cancellation being applied to all but that excess.
Even this, however, would involve a very much larger use of money in the adjustment of national balances than actually takes place. Although the total exports of a country will always tend to approach its total imports, yet its exports to and imports from any single country may be very unequal. Thus, the United States import tea, silk, etc., to an enormous value, from China, while exporting very little to China. Again, our imports from England are very large, but our exports to that country are vastly greater still. If the United States adjusted its accounts with each foreign country separately, the balances requiring to be paid in money during a year would rise into hundreds of millions of dollars.
555. To further reduce the balances to be paid in money; to still further extend the principle of the cancellation of indebtedness, resort is had to a common market of exchange for all the nations. If, for example, the United States imports from Great Britain manufactured goods to the value of one hundred millions, and exports to Great Britain two hundred and fifty millions, it uses its favorable balance of one hundred and fifty millions in London as a sort of bank on which to draw for the payment of its indebtedness to many other countries from which it imports more than it exports to them. For example, it pays its Chinese creditors in accepted bills drawn on London importers of American wheat, cotton or petroleum. These bills Chinese merchants, having to pay for large amounts of English manufactures, are glad to get possession of; and thus an additional body of indebtedness is canceled. The operation of this force is greatly accelerated by the course of events which have made London the great settling place for the transactions of international commerce.∗ Prof. Jevons, in his work on “Money and the Mechanism of Exchange,” stated that there were then (1875) no less than sixty important colonial and foreign banks which had their own London offices or houses; and that there were, in addition, fully one thousand foreign and colonial houses in correspondence with London bankers. Here, then, in this Exchange of the World, as Edmund Burke called it, a hundred years ago, meet all the claims of all the creditors in the world, and all the acknowledgments of all the debtors in the world, which have not been adjusted nearer home. In the portfolios of the London banker or exchange broker are found bills representing the shipment of every kind of agricultural produce, of every class of manufactured goods, not to or from England merely, but from the country of production, however distant, to every other country known to commerce. And these bills are of all amounts, from the pettiest sums up to thousands of pounds sterling, falling due at all dates from to-morrow up to this day six months. From this varied mass to pick out accepted bills, recognized obligations which, in amount and time of maturity, shall cancel each other, is a work to which the highest intelligence is applied. Although the aggregate profits are large, the amount of exchanges thus effected is so enormous that the percentage charged for the negotiation is very small.
556. It is by this complicated agency that the balance of payments between nations, requiring to be made in money, is reduced to a minimum. Out of hundreds or thousands of millions of “exchange” negotiated, the bodies of indebtedness which bankers or brokers can not find means to offset amount to but a few millions. Except for the continuous production of the precious metals in certain countries which thereby become gold or silver-exporting countries, and except for the acts of government in replacing metal money by paper money, or, conversely, in resuming specie payments after periods of suspension, or, again, in changing “the standard,” from silver to gold or gold to silver, the amount of metal money which would be required to go, now here and now there, to make up for local and temporary failures of coincidence between the amounts to be received and the amounts to be paid, in international trade, would be almost inconsiderable, in comparison either with the aggregate of commercial transactions or with the total body of the precious metals in use.
557. Operating Upon the Exchanges.—The peculiarly important and responsible position which London occupies, as the center of the exchange transactions of the world, has led to the establishment of a well-recognized policy of dealing with the outflow of gold from that point, whenever such a movement is caused by what is called “an unfavorable turn of the exchanges.”
In spite of the great perfection to which the cancellation of international indebtedness is there carried, it will at times happen that a “drain” of bullion continues so long as to cause acute alarm as to the integrity of the financial system of the kingdom. When the act of 1844 was passed, it was believed that the provisions of this law, to the effect that no bank note (beyond the fixed amount of fifteen million pounds) should be issued except on the actual deposit of an equivalent amount of specie, and that, conversely, no specie should be withdrawn except upon the surrender of an equivalent amount of notes, would have the effect, automatically, to check a drain, from whatever cause proceeding. Inasmuch however, as the painful experiences of several commercial crises showed that this force could not always be relied upon as sufficient,∗ the directors of the Bank of England have adopted the policy of raising the rate of discount, sharply and rapidly, whenever signs of a considerable export of gold shall appear. Of course, the decree of the directors can absolutely control the rate of discount only upon the capital which the Bank itself has to loan; but the moral influence of such an act upon the joint-stock and private banks and upon individual capitalists is naturally very great, and the general rate of interest is at once appreciably affected.
In doing this, the object of the directors of the Bank, who deem themselves, by the force of tradition, though not of law,∗ largely responsible for the financial integrity of the kingdom, is so to raise the rate of interest, or of discount, as to induce foreign creditors, who have the right, at the time, to demand gold from England, to leave that gold for a while in England, thus checking a “drain” which is considered dangerous. By raising the rate of interest at once, from three or four to six or eight† per cent., the profit on the investment of funds in England is made so great that any foreign creditor, who is not absolutely required by his financial circumstances to draw his money away to his own country, feels a strong inducement to leave it still longer in England.
It is in this way that the financial authorities of the kingdom seek to “tide over” a highly unfavorable state of the exchanges; and it may be said that the policy, although involving a resort to means which are altogether artificial and highly exceptional in finance, uniformly proves successful. “The fact,” said Mr. Goschen, “has been that almost every advance in the bank rate of discount is followed by a turn of the exchanges in favor of England. Foreign creditors give their English debtors a respite, and prefer to wait longer for remittances, gaining interest meanwhile at the profitable English rate.”
558. The Special Case of England and the United States.—We have said all that the limits of our space will allow concerning foreign exchange in general. A word may, however, be added regarding the exchange between England and the United States. The valuation, in American money, of the English pound sterling, has been several times changed. Prior to 1792, the pound sterling was valued at %4.44 4-9, according to the bullion standard of the Spanish dollar, then universally current among us. From that date down to 1834, the American dollar was worth
cents in gold, at which rate a pound sterling was worth %4.56 ½ cents. By the coinage act of 1834 our standard was so reduced that the bullion contained in the American dollar was worth only 91 ¼ cents, so that the pound sterling became worth about %4.87. The United States custom-house valuation of the “sovereign,” that is, the coin representing the English pound sterling, was, however, fixed at %4.84. By this difference in bullion value between our dollar and the English standard money, a fictitious par of exchange was created between England and the United States, so that an American stock or bond worth %100 in New York, would be quoted in London at about %109, whenever the amounts respectively to be paid and received between the two countries were equal.
By an act of Congress of January, 1874, the custom-house valuation of the English sovereign was again changed, this time to %4.87
, at which point it now remains. The London stock exchange responded to this action, the same year, by valuing the American dollar at four English shillings, equivalent to about
cents of our money, from which it results that American stocks or bonds worth %100 are quoted in London at about %102.75, subject to variations on account of the fluctuations in commercial transactions.
[∗]Except, of course, in great and sudden emergencies, like the outbreak of a war, or the occurrence of a commercial crisis.
[†]Except in great and sudden emergencies, as indicated in a previous note.
[∗]“To contract a foreign loan is [with regard to the Balance of Trade] equivalent to an increase of exportation.”—Goschen.
[∗]A study of the methods used in the payment of this indemnity, and of its financial and industrial effects, will constitute an admirable exercise for a pupil well-grounded in economic principles.
[∗]“An exclusively maritime country could discharge its obligations to other countries which supply it with necessaries, simply by becoming their carrier, without exporting any produce or manufactures to them in return.”—Goschen.
[∗]Of this Mr. Goschen says the “primary cause is to be found in the stupendous and never-ceasing exports of England, which have for effect that every country in the world, being in constant receipt of English manufactures, is under the necessity of making remittance to pay for them, either in bullion, in produce, or in bills.”
[∗]Bagehot's “Lombard Street” will be found most interesting and instructive to an advanced student in economics and finance.
[∗]Walker: Money, Trade and Industry, pages 292–98.
[†]The Bank has, in pursuance of this policy, more than once raised the rate of discount as high as eleven per cent.