W(rker.s Educational Association, Pulilir.i]cis. IBnohscllcis. :utii ^t;Uioiii'V5. FROM Branch at the London School of Economics l/'f' / Ifii^ ^ ^*^^^-l<-^ MONEY-CHANGING WORKS BY HARTLEY WITHERS Editor of "Thk Economist." " Numerous instances of the Wisdom of Withers, culled from a ripe experience and put into literary shape by a trenchaat, and occasionally caustic, pen." Th* Financial Ntwt. Uniform with this volume WAR-TIME FINANCIAL PROBLEMS Stccnd Imprtaitn. THE BUSINESS OF FINANCE Third Imfrtsiion. THE MEANING OF MONEY Ttuenty-ste0nd Itnprtstitn. STOCKS AND SHARES Eighth lmprtion. MONEY CHANGING Sixth Impretiien. WAR AND LOMBARD STREET Fourth Imfri-tsioH. INTERNATIONAL FINANCE Third Impression, POVERTY AND WASTE Third l,nfir,ssion. BAGEHOT'S LOMBARD STREET Fourteenth Edition, OUR MONEY AND THE STATE Second Impression, LONDON : JOHN MURRAY. THE CASE FOR CAPITALISM LONDON : EVELEIGH NASH CO., LTD. MONEY-CHANGING AN INTRODUCTION TO FOREIGN EXCHANGE BY HARTLEY WITHERS ACTHOR OF " THB MEANING OP MONBY," "STOCKS AND SHAKES," ETC. " I^ science est infaillible ; mala les savants se trompent toujours." Anatolb Fbancb, LONDON JOHN MURRAY, ALBEMARLE STREET, W. 1921 First Emtion . . , April, 1913 Reprinted AprU, 19 14 Second Edition , . . July, 19 16 Reprinted y^ru, 1918 Reprinted January, 1920 Reprinted March, 1921 All rights reserved PREFACE TO NEW EDITION It seems at first sight that war, on its present scale, puts the laws of exchange in the dustbin. Rates have gone skyrocketing and diving with an almost indecent disregard for precedent, and the old "gold points" are a half-forgotten memory. And yet above the war flood which has drowned so many of the landmarks by which the students of exchange were taught to steer, there still rise, serene and stronger than ever, the pillars on which the chief laws of this science are engraved. The war has shown more clearly than ever that claims on account of goods, services, and securities (in the widest sense of the term) are the foundation on which rates of exchange are built, and that variations in the amount of these claims are the chief causes of the movements in these rates. The violence of these movements, under war conditions, makes their meaning all the plainer; and if the details of text-books are belied for the time being, that is only because the main principles that they set forth are now freed from many of the modifica- tions which veil their working in time of peace. HARTLEY WITHERa 6, LiNDEX Gardens, W. July, 1916, PREFACE TO FIRST EDITION A BOOK on Foreign Exchange is a venture that I should never have attempted had I not been invited to lecture on the subject to members of the Institute of Bankers. In preparing my lectures, I was able to draw freely on the ripe experience of the President of the Institute and others, without whose help neither the lectures nor this book could have come into being. HARTLEY WITHERS. Ftbruary, 1913. CONTENTS CHAPTER I MONEY AT HOME AND ABROAD PAGB Foreign exchange : the business of international money-changing English money French, German, and American money Money of the gold exchange standard countries Silver money Paper money The essential and distinctive feature of English money, its unquestioned convertibility i CHAPTER II RATES OF EXCHANGE The daily table of exchange rates : its meaning, difficulties and inconsistencies The course of exchange The causes and meaning of fluctuations in rates of exchange Their theoretical limitation by gold points The theory modified in practice Fluctuations regulated by the gold exchange standard countries Silver exchanges Paper exchanges . . , . .16 CHAPTER III TRADE AND. SERVICES How one nation acquires claims to the money of another Its income from, and outlay on, international trade and services of all kinds The so-called adverse balance of trade How it arises A common complaint Transport charges The import and export of securities and coupons 47 CHAPTER IV INTERNATIONAL PAYMENTS The influence of imports and exports on the movements of rates of exchange Temporary transfers of money from one centre to another, caused by variation in rates of interest or in rates of exchange Travellers' payments Brokers' commissions Emigrants' remittances The ' dowry drain " Salaries of officials Acceptance commissions England's commercial and financial balance sheet ..... 70 viii CONTENTS CHAPTER V COMMERCIAL BILLS FAGB The bill of exchange As a form of remittance As a bridge orer the gap between the arrival and sale of goods As an ideal investment A concrete example Bills drawn on London against goods going from one foreign country to another Documentary bills . . . . , , , 91 CHAPTER VI FINANCE BILLS Based on mutual confidence Historical example of finance bills drawn without knowledge or consent of drawees The simplicity and safety of finance bills The limit on their production The causes of their creation Domicile bills . . ,120 CHAPTER Vn DISCOUNT AND EXCHANGE The distinction between commercial and finance bills The latter much more easily influenced by fluctuations in rates of exchange The influence of discount rates The discount market The Bank of England's interventions . . . . . 132 CHAPTER Vni BULLION AND EXCHANGE Gold points and gold movements Gold movements often caused by reasons quite apart from exchange The bullion market . ^55 CHAPTER IX CONCLUSION The broad lesson to be learnt from a study of the problems of foreign exchange 1 . . . , . , ''75 Index 181 MONEY-CHANGING CHAPTER I MONEY AT HOME AND ABROAD " It is awful to read on the currency," says Walter Bagehot in his "Literary Studies," and to read on the currencies of the nations, and their prices as expressed in one another, is awful with an awesomeness that is worldwide and appalling. Nevertheless the subject has a certain fascination when one reaches the root of the matter, after digging through the heavy ground that has to be broken in the opening chapters. It was a proud moment in my life when, in lecturing on Foreign Exchange, I was rewarded with hearty laughter from my audience, and I mention the fact as an encouragement to any reader who may be shivering on the brink of this treatise. The lectures were a series delivered, in London and B 2 MONEY AT HOME AND ABROAD Manchester, before members of the Institute of Bankers, and out of them this book has grown. Foreign Exchange means the buying and selling of the money of other countries, and is handled in the same way as the buying and selling of most other things. If there is a strong demand for foreign money its price goes up, and that of the local money goes down, and if there is a great supply of foreign money coming to be sold, the movement is the other way. If a number of people in Paris have debts to pay in England, they will bid in francs for sovereigns. Their bidding will raise the price of sovereigns, as expressed in francs. The price of sovereigns as measured against francs will rise ; that of francs as measured against sovereigns, will fall. Buying and selling means the exchanging of anything for money, so when it is said that Foreign Exchange means the buying and selling of the money of other coun- tries, that is another way of saying that Foreign Exchange, from the English point of view, is the business of exchanging foreign money into English money. In other words, Foreign Exchange is the Science and Art of international money-changing. The Science teaches us to think about it, to know WHAT MONEY MEANS 3 about it, and to talk about it, and the Art is concerned with the much more difficult problem of going into the market and dealing in it. This being so, we have first to consider what we mean when we speak of money, and to see whether there is any essential difference between English money and foreign. Money has several meanings. If we say colloquially that Mr. Croesus has heaps of money, we mean that he has great possessions in land or mortgages, or stocks and shares, or factories or businesses, from which he draws a big income. Or, if the newspapers say that money in the City is scarce and dear, they mean that bankers are not lending freely, and are charging high prices for loans. But more usually money means a piece of paper or metal with which we pay for what we want, and for which we workers sell our labour ; and this is the sense in which I use the word when I say that Foreign Exchange is the business of money-changing. These pieces of metal or paper are taken in payment, either because they are "legal tender," or because those who take them do so of their own free will. When a coin or note is legal tender, that means to say that if you have a debt to pay, your 4 MONEY AT HOME AND ABROAD creditor cannot refuse to take it in due dis- charge. In this country sovereigns are legal tender up to any amount, and likewise Bank of England notes. But it should be observed that the Bank of England note is not legal tender if tendered by the Bank of England. If a note is presented to the Bank it cannot meet it v^ith another note, but has to pay sovereigns against it. Silver and copper are only legal tender for small amounts silver up to forty shillings and copper up to one shilling and the cheques, with which the majority of commercial transactions are settled, are not legal tender at all. They could not be made legal tender, for it would be most unfair to make a creditor accept, in payment of a debt, a piece of paper which might, or might not, be honoured by the bank on which it is drawn. In practice, how- ever, a dishonoured cheque is so rare an event in comparison with the huge number of them that is drawn and passed through the Clearing House every day, that a cheque on an English bank drawn by a solvent person is generally considered as good as so many sovereigns. Anyone who has such a cheque in his pocket can turn it either directly into sovereigns, or into Bank of England ENGLAND'S MONEY CONVERTIBLE 5 notes and so into sovereigns. If the cheque has been " crossed," by two lines drawn across its face, he can only do so by paying it in through his own bank ; if not, he can go to the bank on which it is drawn and turn it directly into legal tender money. The bank on which it is drawn may, if it chooses, meet it in Bank of England notes ; then the holder of the notes can go across to the Bank of England, which has to meet its notes in sovereigns. In England, then, all the money that we use, except the small change of retail traffic, consists either of gold, or of paper that can unquestionably and immediately be turned into gold. As soon as we cross the sea we find that other people's money does not carry with it the same unquestioned right of being forthwith turned into gold that is borne by our English currency. Not one of the other leading commercial countries undertakes this task of giving everybody, who carries a piece of paper conferring the right to a certain amount of money, the choice of turning it into gold if he wants to do so. In France the Bank of France can meet its notes in five franc pieces, and it often does meet demands on its gold store by the simple method of 6 MONEY AT HOME AND ABROAD charging such a premium for gold that it does not pay to take it for export* In Germany the right to gold is established in theory, but does not exist in practice except when it is convenient to Germany. On paper, the notes of the Reichsbank can be turned into gold on demand. What devices the Reichsbank uses in order to check demands on its gold, when it does not want to meet them, is a question that can only be answered by those who have made the experiment. That some devices are used is very practically and definitely proved by the fact that the rate of exchange in Berlin sometimes rises well above the point at which it would pay to send gold from Berlin to London if it could be got, without any gold coming.* The inference is irresistible that the gold was not to be had, or at least that the quick and skilful German bullion dealers thought it more prudent to forego the profit that was to be earned by taking it. The same system is found in most of the European countries. They have a gold standard, more or less, on paper, but they do not part with gold in payment of their notes unless they are so minded. The meaning of these dark sayings is made clear later on. It is impossible, in the early pages of a treatise of this kind, to avoid expressions that have not yet been explained. AMERICA'S MONEY 7 In the United States convertibility of legal tender currency is established by legal enactment, though the laws that deal with the subject are so complicated that many American bankers and business men have assured me at various times that this is not so. The hitherto exist- ing law of the matter, however, is not a very practical question, in the first place because the United States have in the past been subject to periodical panics, the latest example of which occurred in 1907, in which the American banks took the law into their own hands and refused to meet the demands of their depositors for cash, except in the shape of a curious form of currency called " clearing - house certificates ; " and in the second place, because a new order of things is now established, and new currency arrangements have been made, the effect of which in actual practice has yet to be seen. Those who have instituted these new arrange- ments hope that thereby these panics will be made impossible, and the rest of the financial world devoutly prays that this hope may be fulfilled. There is also a large class of countries whicli have arrived at what may be called the half-way 8 MONEY AT HOME AND ABROAD house in the matter of currency, and have estab- lished a sort of one-sided system, with an option in their own favour. Chief among these are India, Japan, Mexico, Argentina and Brazil. These countries have what is called a gold exchange standard, because a certain exchange value for their currencies is fixed by law as the price at which they are to be maintained. They will all, if gold is brought to them, issue currency, whether silver or paper, in exchange for it, but they do not undertake to turn all their legal tender currency into gold. They do, however, maintain some steady relation between their money and gold, since they take measures for holding up the price of their currencies at a certain exchange value as compared with English sovereigns or American dollars. This system was discovered by Holland, which used it in Java, and was adopted by the Indian Government, which in 1893 closed its mints to the free coinage of silver and set about the task of raising the exchange value of the rupee. It was a bold and hazardous enterprise which caused much head-shaking among the economic pundits of the period. The advisers of the Indian Government assumed that, if it left off coining new rupees, the natural growth of the country's trade, and THE INDIAN RUPEE g consequent need for currency, would give the rupee a scarcity value and so raise its price as expressed in English money. Hence they hoped that, whatever might happen to the price of silver in the outside world, the rupee would circulate, as a token coin, at an exchange value which would gradually advance. And they were right, after a year or two of doubt and anxiety during which the laugh seemed to be on the side of their critics. In 1894-5, the exchange value of the rupee was I3'ijd. 2S. O^jd. Pi. 97i. i6J^. 9li II II = marks and pfennigs tOj^l >i II If = kronen and heller tO;^i = florins and cents. tOj^i = lire II 11 = francs = pesetas to ^"1 = pence to i milreis = roubles and kopeks to ;^I0 II II II = kronor and ore to jCi pence to i rupee II II II ,, ,, dollar tael ,, ,, dollar II I. yen ; piastres to 1 pence to i milreis dollar These rates are telegraphed on the day preceding their receipt. Student, because it is contrary to the method in which the prices have been expressed of every- thing that he has hitherto been used to think of as having a price. Having always thought of an umbrella as worth half a sovereign upwards, according to quality, and pricing a hat according c i8 RATES OF EXCHANGE to the number of shillings that are wanted to purchase it, it gives his mental digestion a very uncomfortable twist when he is suddenly asked to turn the process the other way round, as if umbrellas were to be quoted at 2 and hats at 2|. And this is not the worst of it, for a still more confusing consequence of this reversal of the usual method of quotation is the fact that it makes movements in prices go the wrong way round, or seem to do so. For instance, since the Paris exchange expresses the value of a sove- reign in francs, anyone who wants to buy francs will buy them cheaper the higher the price is. It is clear enough as soon as you think it out, because you want your sovereign to buy as many francs and fractions thereof as possible, so that you deal on better terms when you get 25 francs 30 centimes than when you only get 25 francs 29 centimes; but it is very difficult at first to avoid the confusion caused by the ingrained habit of thinking that a low figure means a cheap bargain. If the system were applied all round it would soon be clear. If umbrellas were quoted at so many to the sovereign, we should quickly learn that they were cheaper at 2 than at i|. But as it is, this contrariwise MENTAL GYMNASTICS 19 method of quoting exchanges remains a pitfall, not only to beginners, but to many who might have been expected to have mastered it. If the rates of exchange were all quoted in the same way, it would be easy enough, with a little practice, to accustom one's mind to giving itself the necessary twist in approaching them, and to remaining twisted throughout one's study of the table. But, as we look down the list, we find that it has a plentiful lack of consistency in this respect. When we come down to Lisbon we have to untwist our minds and adapt them to a rate which is quoted in English pence so many pence to the Portuguese milreis so that here the whole process is turned round, and the lower the quotation the more favourable it is to the English buyer of Portuguese currency, because a smaller number of pence buys him money in Lisbon. Then we have to twist ourselves back again for the rest of the European currencies, but when we get to the Oriental monies Indian, Chinese and Japanese, and Straits Settlements they are quoted in pence again; then comes Egypt, with the Alexandrian rate in piastres and back again to pence for the South American rates. 20 RATES OF EXCHANGE Two more difficulties lurk in this table of rates, which almost looks as if it had been specially designed to confuse the beginner, but has, in fact, merely adapted itself to business convenience and the needs of those who want information, in the shape most useful to them- selves, about the subject matter of their daily trade. The first difficulty is a small one because it only affects one rate. All the rates, save one, quoted in foreign money, give the amount of that money that will buy one English sovereign. That one is the St. Petersburg rate, which gives the number of roubles that will buy ten English pounds. The quotations given in English currency in all cases show the number of shillings and pence that one local coin or piece of paper will fetch one rupee for sixteen pence and a fraction in Calcutta, one yen for two shillings and nearly a halfpenny in Yokohama, and so on. Our second difficulty is a question of time. Most of the rates quoted state the time when the money is due, and these times vary. We begin with the Paris cheque, which is quoted at 25 francs 22| centimes. The meaning of this quotation is, that on the day on which it was current, a cheque on a London bank or firm for 1 was priced in CHEQUES AND SIGHT DRAFTS 21 Paris at 25 francs and 22| centimes. Now a cheque as everyone knows, is payable at once or on demand, so that any one who buys this cheque and sends it to London for collection enables the person to whom he sends it to get his money at once. Consequently when we go on to Berlin and find a " sight " rate quoted, it is natural to suppose that there is some slight shade of difference between a cheque and a draft payable at sight. This, however, is not the case. The quotation first of a Paris cheque and then of a Berlin sight rate is merely a variation introduced by the uncon- scious practical jokers who have in the course of years composed the medley of confusion repre- sented by the table of exchanges. The sight draft is payable at sight, that is to say on demand, and so is exactly the same thing, in practical effect, as a cheque. The next item in the list is the Berlin eight days' rate, and here the element of time comes into the price. The Berlin sight rate is 20 marks 48I pfennigs, which is to say that a* sight draft on London for a sovereign will fetch in Berlin 20 marks and 48I pfennigs, while the eight days' rate is 20 marks 45 pfennigs, this being the price in Berlin of a draft on London payable eight days after sight, that is to say eleven days after it has been 22 RATES OF EXCHANGE presented to the party drawn on, and "accepted" by him. When a draft is accepted, it means that the company or firm whom it orders to pay intimates by its signature across the face of the draft that it will pay the amount named on the due date. The eight days have grown into eleven by the addition of the three " days of grace " which are always allowed in England for the payment of a draft that is payable after an interval. In the case of a cheque or a sight draft payment is immediate, and there are no days of grace ; in that of a draft payable one day or six months after sight, the days of grace have to be allowed for.* It is thus clearly natural that the price of a draft on London payable eight daj^s after sight should be lower in Berlin or anywhere else than that of a draft payable at sight, since the former only gives the holder the right to his money eleven days after its receipt and is, therefore, less valuable than one which carries the right to immediate payment. This difference is expressed in the quotations here given by 3f pfennigs to the pound, but it varies, of course, in accordance with the rate for money * The question of the bill stamp has also to be considered, since it is id. on drafts for any amount payable within three days afterdate or sight, but \ per mille ad valorem on drafts with longer currency. TELEGRAPHIC TRANSFERS 23 current in the city on which the draft is drawn. It naturally follows that the longer the time that has to run before the draft is payable, the bigger the difference will be between its value and that of the sight draft. When we get down to St. Peters- burg again, we find the three months' rate quoted at 93 roubles 85, and the sight rate more than a rouble higher at 95 roubles 27, this difference being clearly due to the greater value of a draft entitling the holder to cash on demand as compared with one which gives him the right to cash three months later. Yet another variety of rate is found when we come to the gorgeous East and find ourselves handling rupees and taels and yen. Owing to the length of time that a mailed remittance takes to arrive, the commonest monetary dealings between the East and London are in the form of telegraphic transfers, "T.T.'s" as they are usually called, so that rates for these show the price at which a pound in London, to be paid as soon as a telegram can be flashed along a wire, can be bought or sold in Calcutta or Shanghai or Yokohama, or wherever the rate may be quoted. Alexandria, like the Scandinavian places, does not specify time with its rate, but both of these 24 RATES OF EXCHANGE are in fact sight rates. When we come to South America, we find Rio, Valparaiso, Buenos Ayres and Montevideo all quoting 90 days* rates, showing the number of pence that will be given for the Brazilian milreis or the Chilian, Argentine or Uruguayan dollar, ninety-three days, including the days of grace, after the draft has been pre- sented for acceptance in London. On a separate table, which is printed apart from the others in the newspapers because it is To-day. Prev. day. Exchange on London, sight ... ... 4-84-5S 4-HAS Cable Transfers 60 days' sight Berlin, short sight Paris, ditto 4.85.05 4.84.9s 4.80.50 4.80.40 94^ less ^ 94| 5.20 less ^ 5.20 Ies5 iV received at a much later hour, we find the New York rates. This table gives us a considerable variety, because business between New York and London is on so great a scale that it is necessary to quote drafts with different periods to run. Here then we have the sight rate, the cable transfer, corresponding to the Oriental T.T., and the sixty days' sight rate. Their meaning ought to be already clear, but perhaps it is safer to repeat that the cable transfer expresses the amount in dollars that will be paid for a pound NEW YORK RATES 25 in London, payable by telegram; the sight rate is the amount in dollars payable for a pound in London, payable when the draft has been sent across the ocean and presented ; and the sixty days' sight rate is the amount in dollars payable for a pound in London payable sixty-three days throwing in the days of grace after the draft has been received in England, presented and accepted. As we should expect, we find the cable transfer is most expensive because it confers the right to prompt cash, while the sixty days* draft costs least, because its holder has to wait longest for his money. The New York table also quotes Berlin short sight; this rate means the number of American cents that will be given in New York, for 4 marks in Berlin, payable eight days after sight. The American cent is a hundredth part of a dollar, the American dollar is worth rather more than four English shillings, and the German mark is worth rather less than an English shilling. Consequently we find that it takes about 94^ hundredths of a dollar to buy 4 marks. The Paris rate in the New York table gives the number of francs in Paris that the dollar in New York will fetch. 26 RATES OF EXCHANGE It has already been noted that these daily tables of rates of exchange quoted in the London papers are composed of quotations sent by telegraph from the various foreign centres, and express the prices there current for English money. Twice a week only we get the other side of the picture, when on Wednesdays and Fridays we find a table printed of the Course of Exchange, giving the rates quoted on the pre- ceding days for foreign currencies in London. Dealers in foreign bills, that is to say in bills payable in foreign countries, meet and traffic in the Royal Exchange on Tuesdays and Thursdays, and the list that appears next day is a record of their business. The specimen on the opposite page is taken from the Times. It should be noted that in this list the Dutch rate is in florins and stivers (a stiver = 5 cents), whereas in the daily list given above it was in florins and cents. The Spanish rate is here in pence to five pesetas, the Russian rate is in pence to the rouble, while the New York rate is in pence to the dollar. It should also be noted that in this table, which looks at the exchanges the other way round, the longer dated draft, being less valuable, has the higher rate, because from THE "COURSE OF EXCHANGE" 27 Thursday, Nov. 28th. Amsterdam, &c. cheques 12 I| 12 2j florins and stivers to ^l >i >i 3 months 12 4j 12 5i i> )i i> Antwerp and Brussels . >i 25 67| 25 72J francs and cents ,, Hamburg >i 20 79 20 83 marks and pfennigs to/"! Berlin, &c. >) 20 79 20 83 II i> I* Paris cheques 25 21} 25 23J francs and cents ,, 3 months 25 46} 25 5ii i> 11 II Marseilles j> 25 47i 25 52J i> i i Switzerland 1) 2563! 25 68| n u Austria 24 59 24 63 kronen and heller ,, St. Petersburg i and Moscow ; II 242 24| pence to one rouble Genoa >> 2588J 25 93 lire and cents tO;fl New York 60 days 4SI 48I pence to one dollar Madrid 3 mouths 431 44| ,, five pesetas Lisbon > 461V 465^5 one milreis Oporto n 46A 46A 11 }> Copenhagen >> 18 51 18 55 kronor and ore to^l Christiania ,, 18 52 18 56 II 1) >i Stockholm 18 52 18 56 i> i 11 London's point of view the higher rate is the lower price. London gives a sovereign for 12 fl 2 stivers when it is a question of an Amsterdam cheque, but wants 12 fl. 5 stivers for its sovereign when the draft is for three months. This list is much less important and is scanned much less carefully, than the daily table of rates cabled from abroad, because most of the business of which the foreign exchange rates are the record and expression is done, not in London, but in the 28 RATES OF EXCHANGE foreign commercial centres. This is so, because many more bills are drawn on London by merchants and others abroad, than are drawn by London on its foreign trade connexions, a fact which will be explained later when we come to close quarters with the mechanism of exchange. So far I have said as little as possible about bills and drafts, because I wanted to make it as clear as possible that the subject matter of the ex- changes is the traffic in foreign monies and the prices at which they are changed into English sovereigns. Now that this leading principle of the business has been made clear, we can go a step further and explain that the actual exchange of dollars into sovereigns, for example, is carried out by the purchase in New York of a claim to so many sovereigns in London, and that this claim is contained in a bill of exchange or draft, which, if payable at sight, that is on presentation, may be called a cheque or sight draft. A bill of exchange is legally defined as "an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a certain sum in money to, or to the BILLS OF EXCHANGE 29 order of, a specified person, or to bearer." There is nothing like a legal definition for obscuring the meaning of things to the lay mind. A bill of exchange may be described in plain language as an order to pay. The cheque that I draw on my bank telling it to pay two pounds nine and six to my butoher is a bill of exchange. The draft by which a foreign Government that has just raised a loan in London orders its bankers to pay half a million to a ship-building firm towards the cost of a Dreadnought on the stocks is a bill of ex- change. Bills of exchange in the form of cheques which are bills payable on demand and drawn on a bank are the kind of money most used in home trade, and bills of exchange payable at sight or at any date up to six months after sight, are the form of currency almost exclusively used in trade between nation and nation. At home we use coined cash to a certain extent, chiefly for small transactions. In international trade we use metal, in bars or coin, only on the comparatively rare occasions when it is not possible to square the account between one people and another by any other means, or when some foreign centre finds it necessary to take gold, when it would have been cheaper to settle by bills, because gold is 30 RATES OF EXCHANGE needed to underpin its credit fabric, or, perhaps, for spectacular effect on the local stock market. The bill, or order to pay money in a foreign centre, is thus 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 con- sideration. 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 WHY RATES FLUCTUATE 31 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 monies 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 any two different things is almost certain 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. 32 RATES OF EXCHANGE 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 on 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 Robin- son 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 SUPPLY AND DEMAND 33 which he makes his daily payments at home. On the other hand, there are always plenty of French- men who have imported English goods or have had services rendered by English bankers, or ship- owners, 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 pounds will 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 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. D 34 RATES OF EXCHANGE 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 monies 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 competi- tion 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 of 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 PRACTICE AND THEORY 35 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 dollar and 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. When we go back to the question of Foreign Exchange there are several complications to be considered. If practice would only be kind enough to conform to theory, these complications would be merely superficial and easily calculable items, as long as the exchanges under discussion were between two countries with gold standards. In theory, we should only have to allow for the dif- ference in weight and fineness between the standard gold coins of the two countries, and the 36 RATES OF EXCHANGE length of time that it takes to send the metal from one to the other so that we might add the loss of interest during this period to the cost of ship- ment and we should then have reduced the problem to the simplicity of our American example, and find the fluctuations in exchange limited by the same influence, namely the cost of sending gold from one centre to the other. In theory, the exact gold equivalent of an English sovereign is 25 francs 22 centimes and the cost of shipping is about 8 centimes, so that if the price of English money rose above 25 francs 30 centimes in Paris, the exchange dealers would immediately ship gold to London, and sell in Paris the English money which they would get for their gold. So the Paris cheque could not rise above 25 francs 30 centimes plus the minute fraction that the exchange dealers could extract as their profit. It is often assumed by economic writers that this is actually the case, and we generally find them laying down a law that the cost of sending gold from one gold- using centre to another results in the establish- ment of what are called gold points, above and below which the rates of exchange cannot rise or fall. In actual practice, however, the working of the THEORY AND PRACTICE 37 foreign exchanges is not attended with this sweet simplicity. In fact, the theoretical gold point is only the point at which it pays better to send gold than buy a bill, if you can get the gold. And it has already been shown that England is the only country in which the possession of a claim to a certain amount of money carries with it the certainty of immediately turning it into gold. And so we find that it is quite possible for the exchange on London to rise in other centres to a point at which it would be much cheaper for those who have payments in London to send gold instead of buying drafts, without any gold coming to London, because no gold is to be got. For instance, the mint par, as it is called, between Germany and England is, according to a table drawn up by Mr. George Clare,* the well-known expert in exchange, 20 marks 43 pfennigs, that is, this is the point at which the gold in the German coin is exactly equivalent to the gold in the sovereign ; and the expense of sending gold to London is calculated at about 5 pfennigs; so that the point at which it pays to send gold to London is theoreti- cally 20 marks 48 pfennigs. But in November, 1912, His " A B C of the Foreign Exchanges" should be studied by all who wish to master the technical intricacies of exchange. 38 RATES OF EXCHANGE the Berlin exchange stood for some weeks at or above 20 marks 53 pfennigs without any gold being shipped to London, and in 1907 the Berlin exchange touched 20 marks 60 pfennigs. According to theory, in November, 19 12, London ought to have been drawing gold freely from Austria and Russia also, but not a shillingsworth arrived. The Statist of November 16 made the following'observations : " As a matter of course, the exchanges continue to be as unfavourable to Germany, Austria- Hungary, and Russia as they have been for a considerable time now. And equally as a matter of course, gold is not withdrawn from the State banks and shipped abroad. . . . All this shows what remarkable power the State banks exercise each in its own country. And it shows, likewise, how very inadequate is the treatment of financial subjects by economists in general. If men always acted in accordance with their pecuniary interests gold would be pouring out from Russia, Germany, and Austria-Hungary at present. But the Govern- ments of the three States have set their faces against such exports. The State banks in each case support the policy of the Government, and the subjects are all afraid to incur the displeasure of the great Governments and powerful institutions. "THESE CONFOUNDED EXCHANGES" 39 What is still more to the point, foreign bankers and merchants do not dare to take gold from any of the three States. They, likewise, could make a profit if they knew how to get the gold out of the State banks. But either they are incapable of inventing any method that would force the banks to give the metal, or they are in too much dread of the Governments to incur their displeasure." Thus it appears that the theoretical doctrine, which lays it down that the rates of exchange cannot move beyond the point at which it pays better to ship gold than buy a draft, is only borne out where there is a free market in gold, and a claim for money carries with it an unquestionable right to immediate payment in gold. And these conditions exist only in England. As a bill broker once ruefully remarked at a time of international monetary stress, "These confounded exchanges only seem to work the wrong way. When they go against us, we lose gold. When they go in our favour, we don't get an ounce of it." This is certainly a true statement of the facts of the case, as they sometimes happen. When the foreign exchanges move against us down to gold point gold leaves London as a matter of course. When the exchanges move in our favour up to gold point. 40 RATES OF EXCHANGE it is quite possible that no gold will come, and that unfortunate foreign merchants who have pay- ments to make in London will have to pay a steadily rising premium in order to buy English money. Ultimately this state of things will correct itself, because anyone who can procure English money by selling goods, services or securities to England, or by raising credits in England, will be encouraged to do so as fast as he can, so as to secure the high price that is current for English money in his home market. And at the same time the depreciation of the foreign money will act as a check on English traders and cause less English goods to be sent to the country thus af^icted. So the supply of English money will be increased and the demand for it will be lessened. Countries with a semi-gold standard, like Brazil and India, which will take gold and issue currency against it, but do not even pretend to be ready to turn currency into gold, are officially committed to the maintenance of their currencies at or near a certain exchange level. Both in Brazil and India this level is iCd., in the former for the milreis, in the latter for the rupee. When India or Brazil owes so much on balance to England that the demand there for English money becomes so keen GOVERNMENT REGULATION 41 that a rupee or a milreis will no longer exchange for IS. 4