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17: Of Exchange - Étienne Bonnot, Abbé de Condillac, Commerce and Government Considered in their Mutual Relationship [1776]

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Commerce and Government Considered in their Mutual Relationship, translated by Shelagh Eltis, with an Introduction to His Life and Contribution to Economics by Shelagh Eltis and Walter Eltis (Indianapolis: Liberty Fund, 2008).

About Liberty Fund:

Liberty Fund, Inc. is a private, educational foundation established to encourage the study of the ideal of a society of free and responsible individuals.


17

Of Exchange

Why have the operations of exchange which are simple in themselves become matters so difficult to understand in every language? Was it impossible then for bankers to explain themselves more clearly? I have not studied their language at all: but in my intention to cast some light on this branch of commerce, I only need to study the exchange market: it will explain itself, if I make precise enough notions of it.

I want to send a hundred thousand francs to Bordeaux. If I were obliged to send them by road, it would cost me expenses, and I should have to run some risks. But in Paris there are some Bordeaux people who themselves need to bring money from Bordeaux; and there are businessmen to whom this city owes money, because they have sent it merchandise.

I search for and find a man from Bordeaux who has fifty thousand francs in Bordeaux which he would like to have at Paris. There is no more involved than to exchange the fifty thousand francs which are in Paris against the fifty thousand francs which are at Bordeaux. Now there we both have the same advantage, because both of us avoid all expenses and all risks. And so I count out for him fifty thousand francs in Paris, and he gives me a letter, drawn on the person who has his funds at Bordeaux, by which he says to pay the bearer fifty thousand francs to my order. So there you have half my sum which I have arranged to send to Bordeaux. The other half will go there in the same fashion, because I find businessmen who are owed that amount in Bordeaux, and who will give me similar letters for fifty thousand francs that I disburse to them.

By means of these letters, we thus exchange sums which are remote from each other. That is why we have called them bills [lit. letters] of exchange.

In all the towns of the kingdom there are people who are in the same position as I, and in all of them there is also the facility of bills of exchange, because the business, which they carry out among themselves, is always putting them in a state of debt with regard to each other. One must just note that this facility is more often found in mercantile towns or in those of easy access.

But if every time one needed a bill of exchange one had to go from door to door to find the businessman who could give it, this would certainly be a great nuisance. So here we have something which has summoned up the energy of some individuals, and gradually produced a class of men whom one calls exchange brokers, because with the bills they give, one exchanges two sums that are at a distance from each other.

I imagine one from among many ways in which this class of men could have formed. I postulate a rich individual who has lands in different provinces, and who, not knowing how to gather his revenue, gives his agent the task of seeing to it. The latter seeks in Paris for merchants who bring various goods from these provinces, and who, in consequence, need to make money go there. He gives them bills of exchange drawn on these provinces: the merchants pay him in person in Paris; and once he has established a connection with them, his master’s revenues arrive each year with the same ease.

The master, who has no idea how this is done, admires the genius of his agent. He never ceases praising him to his acquaintances. So all the rich men apply to this man, and he amazes them all equally.

Here he is an exchange broker: with a connection that is constantly extending, he is in a position to find money everywhere, and people come to him from all parts. So he no longer needs to serve a master. He takes a house in which he sets up his exchange office, and from the table on which he counts out the money, which one calls banque, he takes the name banker [banquier]. If he were alone, he would be able to raise his wage to the skies, but, happily for the public, his fortune, which is a proof of what he earns, gives him rivals, and bankers multiply.

The profit that a banker made in his business was originally called agio, a term which has become odious, and which today marks an excessive, usurious profit made in a bank.

A profit is doubtless due to bankers. Sometimes they are forced to transport money on the roads; they run up expenses in maintaining their connections; in a word, they give their time and their attention.

We imagine their wage will adjust, like all others, through competition. But one finds in exchange a multitude of circumstances of which the public is ignorant; and a banker, who has acquired the art of winning trust, can abuse it all the more because he carries out banking in some sense exclusively. Let us observe exchange between the different towns of a kingdom: we shall afterwards look at it from nation to nation.

In commerce, the person who accepts goods on the understanding that he will pay for them in an agreed period, recognises in writing that he will pay such a sum; and this recognizance, in the hands of the person to whom he has made it, is called credit [créance: lit. belief], because it is a title on which one must believe one will be paid. Thus credit is opposed to debt [dette], as creditor [créancier] is to debtor [débiteur].

I assume that the merchants of Paris have a hundred thousand francs of credits on Bordeaux, and that the merchants of Bordeaux have credits on Paris for the same amount: all these credits would disappear by a simple reversal of the sides; that is to say, when at Bordeaux the merchants who owe in Paris pay those whom Paris owes; and in Paris the merchants who owe in Bordeaux pay those whom Bordeaux owes.

If Paris owes a hundred thousand francs at Nantes, Nantes a hundred thousand francs at Bordeaux, Bordeaux a hundred thousand francs at Lyons, and Lyons a hundred thousand francs at Paris; it will be enough to wipe out all these debts if Paris sends to Nantes a hundred thousand francs of bills of exchange on Lyons; because with these bills Nantes will pay Bordeaux, and Bordeaux will pay Lyons. In such a case the merchants can effect the exchange among themselves, without the intervention of any banker, and the operation is simplicity itself.

But I, who am not involved in business and who am not at all conversant with what goes on in commercial centres, I am obliged to apply to a banker when I want to send money to a province. Now this banker might only have to pay the cost of travelling from his home to the residences of some Paris merchants, and yet it would be open to him to take advantage of my ignorance, and to demand far too great a payment from me. This abuse could happen if there were only one banker in Paris. But there are many, many honest ones, and competition forces them all to be honest.

Every bill of exchange assumes a debt on the part of the person on whom it is drawn. Bordeaux, for instance, can only give one on Paris, because Paris owes at Bordeaux. Now it is these reciprocal debts or credits between towns which regulate all the operations of exchange.

The debts between two towns can be equal on either side: Lyons can owe a hundred thousand francs in Paris, and Paris can owe the same sum at Lyons.

The debts can also be unequal: Lyons can owe three hundred thousand francs in Paris, and Paris can owe four hundred thousand at Lyons.

In the case of equality of debts on the one hand and on the other, if we only look at that consideration, it is certain that two merchants, one in Paris needing a hundred thousand francs in Lyons, and the other, who is at Lyons, needing a hundred thousand francs at Paris, must make that exchange, equal sum for equal sum. For both of them find like benefit in giving a hundred thousand francs for a hundred thousand francs; and since this exchange does not put the one to more expense than the other, neither of the two has the right to demand more than the hundred thousand francs.

When the exchange is made from one town to another, equal sum for equal sum, one says that it is at par.

Take note that I say sum and not value: because the two words are not synonymous. When in Paris I give you a hundred thousand francs to receive a hundred thousand francs at Lyons, the sums are equal; and yet, so far as I am concerned, I give a lesser value for a greater one if it is more advantageous for me to have a hundred thousand francs at Lyons than at Paris. It is the same for you: you give me a lesser value for a greater one if you find an advantage in having this money in Paris rather than at Lyons. We must recapitulate what we have said about exchanges.

In the case where the debts between two towns are unequal: when Paris, for example, owes four hundred thousand livres at Lyons, and Lyons only owes three hundred thousand in Paris, one will be able to settle three hundred thousand with bills of exchange, but there will remain a hundred thousand francs [sic] which will have to be transported from Paris to Lyons.

In settling the three hundred thousand francs of respective debt with bills of exchange, the merchants can make the exchange at par between themselves, that is to say, equal sum for equal sum.

A hundred thousand francs remain to be paid. The merchants of Paris apply to a banker who, having no funds at Lyons, is obliged to have the sum transported there, and to whom, consequently, one will owe the costs of transport in addition to a payment. Now I assume that one has agreed to give him 4 per cent for the whole transaction; one will thus pay out to him one hundred and four thousand francs in Paris and he will give bills on Lyons for a hundred thousand.

In this example, the exchange rises above par, because the merchants give in Paris a larger sum than the one that they can receive at Lyons.

The merchants of Lyons have credits on Paris. They are therefore not in the position of sending money there: rather they need it to come back to them.

If in this situation someone offers to give them ninety-eight thousand francs for a hundred thousand francs of bills of exchange on Paris, they will accept the offer; because it will only cost them two thousand livres to have their money at Lyons, instead of the four thousand their correspondents would have paid the banker.

When one gives a smaller sum to receive a greater one, it is said that the exchange is below par.

From these explanations we can see that exchange, like trade, is no more on one side than a purchase, and on the other than a sale; that in this transaction money is the sole good that is being bought and is on sale, and that the bankers are only money merchants. It is essential that we only see in things what is there, if we wish to speak with clarity and precision.

As soon as money exchange is a purchase, we can consider, as the price of the exchange, the sum that I give in Paris for a sum that must be given to me at Lyons. So it is called the rate [lit.: price] of exchange.

The exchange would regulate itself, as I have just explained, if one always knew exactly the state of the reciprocal debts between two towns: but that is not possible, especially when the exchange is made between two towns which, like Paris and Lyons, carry on a substantial trade with each other.

If, for example, one knows that Paris is in debt, one does not know by how much, either because the amount may vary from one day to the next; or because the dealers, who gather at the place of exchange, cannot be informed at once of the variations; or finally, because some have an interest in exaggerating the debt, whereas others have an interest in reducing it.

The one set of people exaggerate it because, as they want to sell bills of exchange on Lyons, they would like to take the rate of exchange to 4 per cent above par; the other group talks it down, as they want to buy bills of exchange on Lyons, and do not want to pay more than 2 per cent above par.

So here we have haggling: but in the end the parties will come together, and the rate of exchange will be fixed, for that day and subsequent ones until the first assembly, at 3 per cent.

There are thus three ways to consider the rate of exchange. It is at par, it is above par, it is below par.

When it is at par one gives like sum for like sum, and you will perhaps be astonished to hear that one identical sum is the price of an equal sum; that a hundred francs is the price of a hundred francs. You will say, there is no price at all, since one is adding nothing to one side or the other.

But one must remember that the price of a thing is relative to the need of the person who receives it in exchange: it is according to this need that he estimates it; and in proportion as his need is greater or smaller, he will give a higher or a lower price. That being so, the hundred francs you receive in Paris are for you the price of the hundred francs you enable me to draw at Lyons; because you yourself reckon that this money has a greater value for you in Paris, where you can use it, than at Lyons, where you do not need it. If the sums are equal, the values are not; and as we have remarked, one must not confuse sum and value.

For the same reason, when the exchange is below par and I give you, for example, ninety-six livres in Paris to receive a hundred at Lyons, these ninety-six livres are for you in Paris the price of a hundred at Lyons. They form the price, I say, just as much as the one hundred and four when the exchange is above par.

So you can conceive how in exchange you and I each give a lesser value for a greater one, whatever relationship the sums otherwise have to each other. Let me repeat again that value is uniquely based on the utility which things have with regard to those who exchange them.

But if, to make our money pass from Paris to Lyons or from Lyons to Paris, we had to deal with a man for whom it was a matter of indifference whether he had his money in the one or the other of these towns, it is clear that then these values would be, with regard to this man, like sums of money: a hundred and four livres would have for him a greater value than a hundred, and a hundred a greater value than ninety-six. There you have precisely the situation in which the bankers are placed, and that is why they gain doubly in practising exchange dealings. They gain from you, who wish to send money from Paris to Lyons, and they gain from me, who wishes to bring it from Lyons to Paris.

Whether the exchange rises above par or drops below it, there can always be profit for the banker, to whom it is a matter of indifference whether his money is in one town rather than another. As he does not find himself in the same circumstances as the merchants, he has no other interest than to acquire a greater sum of money for a lesser one, and this greater sum always has a greater value for him.

But, you will say, if in exchange deals a dealer always gave a smaller value for a greater value, he would always gain, and yet he would end up ruining himself if he always gave a larger sum of money for a smaller one.

That is true: but that objection is a sophistry which causes me to say that a dealer always gives in exchange a larger sum of money for a smaller one, and that this larger sum always represents a smaller value.

I say then that he gives a sum of money, sometimes larger, sometimes smaller, and that this sum, whatever it is, is always a smaller value for him, because he himself judges that what he is given in exchange has more utility for him. That is a truth which everyone may have experienced.

For the rest, since, in its course, exchange necessarily experiences alternate rises and falls, it is clear that merchants, turn by turn, will give sometimes a larger sum of money for a smaller, sometimes a smaller one for a larger: and it might be that after a certain time the result was the same for both parties, or near enough, as if they had always made the exchanges at par.

We have noticed that one cannot know exactly the state of reciprocal debts between several towns. One can only see that they owe more than they are owed when the exchange is above par; and that when it is below, they are owed more than they owe. Yet this rule is not absolutely without exception: because many circumstances can cause the rate of exchange to vary independently of the state of the debts.

If, when at Lyons the exchange is below par, and one only pays ninety-eight livres to receive a hundred in Paris, several people ask at the same time for five to six hundred thousand francs of bills of exchange on Paris, this demand would raise the price of exchange, so that to buy a hundred francs which are in Paris, you would have to pay a hundred instead of ninety-eight in Lyons, or even a hundred and two, a hundred and three. What is happening is something we have already noticed in markets, where prices rise and fall following the proportion in which the goods for sale relates to the demand for them. If, in the place of exchange, one offers more bills of exchange than are wanted, they will be at a lower price; and they will be at a higher one if one asks for more of them than are on offer.

The bankers’ rivalry can sometimes alone make the rate of exchange vary.

I postulate that in a town a rich banker, who has won trust, wishes to be the sole banker; he has a certain way to elbow aside every rival. He only needs suddenly to lower the rate of exchange and sell his bills of exchange at a loss. He will lose, if necessary, fifteen to twenty thousand francs, but he will have put off those who wanted to carry on this business with him; and when he is the only one, he will know for certain how to recover what he lost and more. If in that town there were several accredited bankers, they would be able to get together at their common expense to carry out what I had one person doing. It is certain that in general dealers think of reducing, as far as possible, the number of their rivals. Now bankers have all the more room to do this, as they have persuaded people that banking is a very arcane matter, because indeed their jargon is very difficult to understand. In the very commercial centres, the greatest praise one can think of giving a merchant is to say, “He understands the exchange market.” One can see that ignorance delivers the merchants into the bankers’ discretion.

Many factors, such as those I have just pointed out, can cause the price of exchange to vary, but as they are all chance, it is pointless to linger on them. It is enough to remember that, outside the case where they operate, the exchange, according to whether it is above or below par, causes one to judge whether a town owes or whether it is owed money.

Exchange rates rise and fall in turn in all the towns which have some mutual commerce. Now these successive rises and falls in which it manifests itself in turn from town to town is what I call the course of exchange, and here we now have all the mystery of this type of business.

A banker watches the course of exchange himself and through his correspondents. He knows not only that it is rising in such and such a town and falling in another; he also knows by how much it is rising above par and by how much it is falling below par.

Given the actual state of exchange, he can foresee, from what his experience teaches him about the ebb and flow of trade, that where the exchange is high, it will not take long to fall; while where it is low, it will soon rise.

I even add that he will often be able to judge it with certainty: because if he is well informed by his correspondents, he will know which are the towns which must make large dispatches of merchandise within a few months. He will thus work out that in such a place, where the exchange is high now because it is indebted, the exchange will be low in some months’ time, because it will have acquired credits. That if Lyons, for example, is owing in Paris, the exchange will be high there, and you will have to pay a hundred and three livres to have a bill for a hundred on Paris. But within six months it will be low if Lyons acquires credits on Paris.

Now, once a banker knows in advance the rises and falls of exchange in the chief trading towns, it will be easy for him to make his arrangements from far away to turn these to his advantage. He will seize the opportunity and, making his money or his credit move swiftly from place to place, he will gain in each in a short time, 2, 3 or 4 per cent, or more. Let me give one example.

I postulate two bankers who have credit, the one established in Paris, the other at Lyons.

The Lyons banker, who sees that the exchange is at 3 per cent above par because Lyons owes Paris more than five hundred thousand francs, knows that a great dispatch of goods is being prepared for that capital, and that, in three months, Paris itself will owe more than five hundred thousand francs at Lyons.

In this situation, this banker will take every opportunity to draw on his correspondent in Paris; and to have the advantage, he will be satisfied, if need be, to gain on each bill of exchange 2½ per cent.

Three months later, when Paris owes at Lyons, and the exchange there has risen to 3 per cent above par, his correspondent will carry out the same manoeuvre. So it is that, in a few months, they will each have made a gain of 2½ or 3 per cent by drawing bills on each other.

Note that to have drawn these bills of exchange they did not run down their assets; because, when the Paris banker paid a hundred thousand francs, the Lyons banker received them; and in his turn the Paris banker received them when the Lyons banker paid them. Beyond the gain on exchange, they therefore also have the product of these hundred thousand francs which they continue to put to use.

The fact is that a bill of exchange is bought with ready money and is paid on account. You give a hundred thousand francs today to have access to a hundred thousand in a month. The Lyons banker thus has the enjoyment for a month of the product of the hundred thousand francs you have counted out to him; and the Paris banker has the enjoyment at the same time of the product of the hundred thousand which he will only pay you in a month’s time.

Such are the great speculations we admire because we are drawn to admiration when we understand nothing of what is occurring. We all resemble that master I mentioned who was amazed at his agent’s intelligence.

The principles which we have given for exchange between the different towns of a kingdom are the same for exchange from nation to nation. But one uses a different language, because the monies have neither the same values, nor the same denominations. A banker will say to you: “The rate of exchange in Paris for London is sixty sous for twenty-nine, thirty-one, thirty-two pence sterling,” and in this language you cannot judge at all if the exchange is at par, above or below, because you do not know what a penny sterling is worth.

Yet again he will say to you that the rate of exchange in Paris for Amsterdam is three livres for fifty-four guilders of Holland, or for sixty. In a word, he will always speak to you in a language you do not understand. You would understand him if he said to you: “The sum which you want to send to London contains so many ounces of silver. Today the exchange is at par. Here is a bill with which you will receive the same quantity of ounces at London in English coin, and they will count out to you so many pounds sterling.” That is how he himself evaluates the different countries’ monies. Because he well knows that from Paris to London or to Amsterdam, as from Paris to Lyons, the exchange is at par when one gives a hundred ounces for a hundred ounces, that it is above par when one gives more, and that it is below when one gives less.

I do not know why bankers affect an obscure language. But it is certain that this language prevents us seeing clearly into their operations; and that it cuts down the number of their rivals, because it leads one to believe that banking is a very difficult science. In my powerlessness to know all the means they deploy to make huge profits, I shall only speak of those which I perceive in the nature of the business.

Let us say that in Paris I am asked to transfer a thousand ounces of silver to Amsterdam, when the exchange is 6 per cent above par; and then let us suppose it is at 4 per cent above par in Paris for London, and at 2 per cent below par in London for Amsterdam. In such a situation one can see that there is a much greater profit in drawing first of all on London, in order to draw next from London on Amsterdam, rather than to draw directly from Paris on Amsterdam.

A banker’s skill therefore sometimes consists in taking a roundabout rather than a direct route.

A person brings to my establishment a thousand ounces of silver that Paris owes in London, and only 4 per cent is paid for the transfer. But because I have credit in England, instead of sending this sum there, I send bills of exchange. So I gain, at one and the same time, both the 4 per cent the person has initially paid me and the interest that a thousand ounces of silver brings in France. As long as my credit can make this debt last, I shall repeat the same operation, and I shall be able to make it worth two, three, four thousand ounces of silver profit or more to me.

Interest in Holland is lower than in France, and the dealers of that republic have often much more silver than they can use in trade. If I am accredited among them, people will seek me out to have bills of exchange on Amsterdam. I will draw as many as I am requested: the money I have received will stay in my hands more or less long term: I shall pay interest in Holland at 2½ or 3 per cent, and I shall draw it in France at 5 to 6 per cent. In that way, I shall continually draw profit from sums that are not mine. The richer I become, the more I shall be trusted and the more I shall find profit in my business. I shall carry on banking almost on my own.

There you have a slight idea of the profits that one can make in exchange dealing. You can see that if the art of drawing profit from the land had made as much progress as that of putting money to use, our cultivators would not be as poor as they are.