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Title: Elements of Foreign Exchange - A Foreign Exchange Primer
Author: Escher, Franklin, 1881-
Language: English
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Copyright Status: Not copyrighted in the United States. If you live elsewhere check the laws of your country before downloading this ebook. See comments about copyright issues at end of book.

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Elements of Foreign Exchange


Special Lecturer on Foreign Exchange at New York University

_Fifth Edition_



Copyright 1910
By the Bankers Publishing Co.
New York




The various forms of obligation between the bankers and
merchants of one country and the bankers and merchants of
another, which result in the drawing of bills of exchange.


A discussion of the six sources from which spring the demand for
the various kinds of bills of exchange.


Operation of the five main influences tending to make exchange
rise as opposed to the five main influences tending to make
exchange fall.

CHAPTER IV. THE VARIOUS KINDS OF EXCHANGE                          45

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

CHAPTER V. THE FOREIGN EXCHANGE MARKET                             59

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

OF THE FOREIGN DEPARTMENT                                          68

An intimate description of: Selling demand bills against
remittances of demand bills--Selling cables against remittances
of demand bills--Selling demand drafts against remittances of
"long" exchange--The operation of lending foreign money
here--The drawing of finance bills--Arbitraging in Foreign
Exchange--Dealing in exchange "futures."

CHAPTER VII. GOLD EXPORTS AND IMPORTS                             106

The primary movement of gold from the mines to the markets, and
its subsequent distribution along the lines of favorable exchange
rates. Description (with presentation of actual figures) of: The
export of gold bars from New York to London--Import of gold bars
from London--Export of gold bars to Paris under the "triangular
operation." Shipments to Argentina.

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

SECURITY TRADING                                                  130

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


A complete description of the international banking system by
which merchandise is imported into and exported from the United
States. An actual operation followed through its successive


"Where can I find a little book from which I can get a clear idea of
how foreign exchange works, without going too deeply into it?"--that
question, put to the author dozens of times and by many different kinds
of people, is responsible for the existence of this little work. There
_are_ one or two well-written textbooks on foreign exchange, but never
yet has the author come across a book which covered this subject in
such a way that the man who knew little or nothing about it could pick
up the book and within a few hours get a clear idea of how foreign
exchange works,--the causes which bear upon its movement, its influence
on the money and security markets, etc.

That is the object of this little book--to cover the ground of foreign
exchange, but in such a way as to make the subject interesting and its
treatment readable and comprehensible to the man without technical
knowledge. Foreign exchange is no easy subject to understand; there are
few important subjects which are. But, on the other hand, neither is it
the complicated and abstruse subject which so many people seem to
consider it--an idea only too often born of a look into some of the
textbooks on exchange, with their formidable pages of tabulations,
formulas, and calculations of all descriptions. For the average man
there is little of interest in these intricacies of the subject. Many
of the shrewdest and most successful exchange bankers in New York City,
indeed, know less about them than do some of their clerks. What is
needed is rather a clear and definite knowledge of the movement of
exchange--why it moves as it does, what can be read from its movements,
what effects its movements exert on the other markets. It is in the
hope that something may be added to the general understanding of these
important matters that this little book is offered to the public.




Underlying the whole business of foreign exchange is the way in which
obligations between creditors in one country and debtors in another
have come to be settled--by having the creditor draw a draft directly
upon the debtor or upon some bank designated by him. A merchant in New
York has sold a bill of goods to a merchant in London, having thus
become his creditor, say, for $5,000. To get his money, the merchant in
New York will, in the great majority of cases, draw a sterling draft
upon the debtor in London for a little over £1,000. This draft his
banker will readily enough convert for him into dollars. The buying and
selling and discounting of countless such bills of exchange constitute
the very foundation of the foreign exchange business.

Not all international obligations are settled by having the creditor
draw direct on the debtor. Sometimes gold is actually sent in payment.
Sometimes the debtor goes to a banker engaged in selling drafts on the
city where the obligation exists, gets such a draft from him and sends
that. But in the vast majority of cases payment is effected as
stated--by a draft drawn directly on the buyer of the goods. John Smith
in London owes me money. I draw on him for £100, take the draft around
to my bank and sell it at, say, 4.86, getting for it a check for
$486.00. I have my money, and I am out of the transaction.

Obligations continually arising in the course of trade and finance
between firms in New York and firms in London, it follows that every
day in New York there will be merchants with sterling drafts on London
which they are anxious to sell for dollars, and vice versa. The supply
of exchange, therefore, varies with the obligations of one country to
another. If merchants in New York, for instance, have sold goods in
quantity in London, a great many drafts on London will be drawn and
offered for sale in the New York exchange market. The supply, it will
of course be apparent, varies. Sometimes there are many drafts for
sale; sometimes very few. When there are a great many drafts offering,
their makers will naturally have to accept a lower rate of exchange
than when the supply is light.

The par of exchange between any two countries is the price of the gold
unit of one expressed in the money of the other. Take England and the
United States. The gold unit of England is the pound sterling. What is
the price of as much gold as there is in a new pound sterling,
expressed in American money? $4.8665. That amount of dollars and cents
at any United States assay office will buy exactly as much gold as
there is contained in a new British pound sterling, or sovereign, as
the actual coin itself is called. 4.8665 is the mint par of exchange
between Great Britain and the United States.

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

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

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

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

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

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

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

1. Looking at these sources of supply in the order in which they are
given, it is apparent, first, what a vast amount of foreign exchange
originates from the direct export of merchandise from this country.
Exports for the period given below have been as follows:

    1913      $2,465,884,000
    1912       2,204,322,000
    1911       2,049,320,000
    1910       1,744,984,000
    1909       1,663,011,000

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

There are times, therefore, when exchange originating from this source
is much more plentiful than at others. During the last quarter of each
year, for instance, when the cereal and cotton crop exports are at
their height, exchange comes flooding into the New York market from all
over the country, literally by the hundreds of millions of dollars. The
natural effect is to depress rates--sometimes to a point where it
becomes possible to use the cheaply obtainable exchange to buy gold on
the other side.

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

2. The second source of supply is in the sale abroad of stocks and
bonds. Here again it will be evident how the supply of bills must vary.
There are times when heavy flotations of bonds are being made here with
Europe participating largely, at which times the exchange drawn against
the securities placed abroad mounts up enormously in volume. Then again
there are times when London and Paris and Berlin buy heavily into our
listed shares and when every mail finds the stock exchange houses here
drawing millions of pounds, marks, and francs upon their correspondents
abroad. At such times the supply of bills is apt to become very great.

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

Announcements of such issues, as well as announcements that a block of
this or that kind of bonds has been placed abroad with some foreign
syndicate, are apt to come suddenly and often find the exchange market
unprepared. For the supply of exchange originated thereby, it must be
remembered, is not confined to the amount actually drawn against bonds
sold but includes also all the exchange which other bankers, in their
anticipation of lower rates, hasten to draw. The exchange market is,
indeed, a sensitive barometer, from which those who understand it can
read all sorts of coming developments. It often happens that buying or
selling movements in our securities by the foreigners are so clearly
forecasted by the action of the exchange market that bankers here are
able to gain great advantage from what they are able to foresee.

3. The third great source of supply is in the drafts which bankers in
one country draw upon bankers in another in the operation of making
international loans. The mechanism of such transactions will be treated
in greater detail later on, but without any knowledge of the subject
whatever, it is plain that the transfer of banking capital, say from
England to the United States, can best be effected by having the
American house draw upon the English bank which wants to lend the
money. In the finely adjusted state of the foreign exchanges nowadays,
loans are continually being made by bankers in one country to bankers
and merchants in another. Very little of the capital so transferred
goes in the form of gold. A London house decides to loan, say, $100,000
in the American market. The terms having been arranged, the London
house cables its New York correspondent to draw for £20,000, at 60 or
90 days' sight, as the case may be. The New York house, having drawn
the draft, sells it in the exchange market, realizing on it the
$100,000, which it then proceeds to loan out according to instructions.

The arranging of these loans, it will be seen, means the continuous
creation of very large amounts of foreign exchange. As the financial
relationships between our bankers and those of the Old World have been
developed, it has come about that European money is being put out in
this market in increasing volume. Conditions of money, discount, and
exchange are constantly being watched for the opportunity to make loans
on favorable terms, and the aggregate of foreign money loaned out here
at times reaches very large figures. In 1901 Europe had big amounts of
money outstanding in the New York market, and again in 1906 very large
sums of English and French capital were temporarily placed at our
disposal. But in the summer of 1909 all records were surpassed,
American borrowings in London and Paris footing up to at least half a
billion dollars. Such loans, running only a couple of months on the
average and then being sometimes paid off, but more often shifted about
or renewed, give rise to the drawing of immense amounts of foreign

4. Drawing of so-called "finance-bills," of which a complete
description will be found in chapters IV and VI, is the fourth source
whence foreign exchange originates. Whenever money rates become
decidedly higher in one of the great markets than in the others,
bankers at that point who have the requisite facilities and credit,
arrange with bankers in other markets to allow them (the bankers at the
point where money is high) to draw 60 or 90 days' sight bills. These
bills can then be disposed of in the exchange market, dollars being
realized on them, which can then be loaned out during the whole life of
the bills. The advantages or dangers of such an operation will not be
touched upon here, the purpose of this chapter being merely to set
forth clearly the sources from which foreign exchange originates.

And when money is decidedly higher in New York than in London an
immense volume of foreign exchange does originate from this source. A
number of firms and banks, with either their own branches in London or
with correspondents there to whom they stand very close, are in a
position where they can draw very large amounts of finance bills
whenever they deem it profitable and expedient to do so. Eventually, of
course, these 60 and 90 day bills come due and have to be settled by
remittances of demand exchange, but in the meantime the house which
drew them will have had the unrestricted use of the money. In a market
like New York this is only too often a prime consideration. With money
rates soaring as they do so frequently here, a banker can pay almost
any commission his correspondent abroad demands and still come out
ahead on the transaction.

These are the principal sources from which foreign exchange
originates--shipments of merchandise, sales abroad of securities,
transfer of foreign banking capital to this side, sale of
finance-bills. Other causes of less importance--interest and profits on
American capital invested in Europe, for instance--are responsible for
the existence of some quantity of exchange, but the great bulk of it
originates from one of the four sources above set forth. In the next
chapter effort will be made to show whence arises the demand which
pretty effectually absorbs all the supply of exchange produced each



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

    1. The need for exchange with which to pay for imports of

    2. The need for exchange with which to pay for securities (American
    or foreign) purchased by us in Europe.

    3. The necessity of remitting abroad the interest and dividends on
    the huge sums of foreign capital invested here, and the money which
    foreigners domiciled in this country are continually sending home.

    4. The necessity of remitting abroad freight and insurance money
    earned here by foreign companies.

    5. Money to cover American tourists' disbursements and expenses of
    wealthy Americans living abroad.

    6. The need for exchange with which to pay off maturing foreign
    short-loans and finance-bills.

1. Payment for merchandise imported constitutes probably the most
important source of demand for foreign exchange. Merchandise brought
into the country for the period given herewith has been valued as

    1913      $1,813,008,000
    1912       1,653,264,000
    1911       1,527,226,000
    1910       1,556,947,000
    1909       1,311,920,000

Practically the whole amount of these huge importations has had to be
paid for with bills of exchange. Whether the merchandise in question is
cutlery manufactured in England or coffee grown in Brazil, the chances
are it will be paid for (under a system to be described hereafter) by a
bill of exchange drawn on London or some other great European financial
center. From one year's end to the other there is constantly this
demand for bills with which to pay for merchandise brought into the
country. As in the case of exports, which are largest in the Fall,
there is much more of a demand for exchange with which to pay for
imports at certain times of the year than at others, but at all times
merchandise in quantity is coming into the country and must be paid for
with bills of exchange.

2. The second great source of demand originates out of the necessity of
making payment for securities purchased abroad. So far as the American
participation in foreign bond issues is concerned, the past few years
have seen very great developments. We are not yet a people, as are the
English or the French, who invest a large proportion of their accumulated
savings outside of their own country, but as our investment surplus has
increased in size, it _has_ come about that American investors have
been going in more and more extensively for foreign bonds. There have
been times, indeed, as when the Japanese loans were being floated, when
very large amounts of foreign exchange were required to pay for the
bonds taken by American individuals and syndicates.

Security operations involving a demand for foreign exchange are,
however, by no means confined to American participation in foreign bond
issues. Accumulated during the course of the past half century, there
is a perfectly immense amount of American securities held all over
Europe. The greater part of this investment is in bonds and remains
untouched for years at a stretch. But then there come times when, for
one reason or another, waves of selling pass over the European holdings
of "Americans," and we are required to take back millions of dollars'
worth of our stocks and bonds. Such selling movements do not really get
very far below the surface--they do not, for instance, disturb the
great blocks of American bonds in which so large a proportion of many
of the big foreign fortunes are invested, but they are apt to be,
nevertheless, on a scale which requires large amounts of exchange to
pay for what we have had to buy back.

The same thing is true with stocks, though in that case the selling
movements are more frequent and less important. Europe is always
interested heavily in American stocks, there being, as in the case of
bonds, a big fixed investment of capital, beside a continually
fluctuating "floating-investment." In other words, aside from their
fixed investments in our stocks, the foreigners are continually
speculating in them and continually changing their position as buyers
and sellers. Selling movements such as these do not materially affect
Europe's set position on our stocks, but they do result at times in
very large amounts of our stocks being dumped back upon us--sometimes
when we are ready for them, sometimes when the operation is decidedly
painful, as in the Fall of 1907. In any case, when Europe sells, we
buy. And when we buy, and at the rate of millions of dollars' worth a
day, there is a big demand for exchange with which to pay for what we
have bought.

3. So great is the foreign investment of capital in this country that
the necessity of remitting the interest and dividends alone means
another continuous demand for very large amounts of foreign exchange.
Estimates of how much European money is invested here are little better
than guesses. The only sure thing about it is that the figures run well
up into the billions and that several hundred millions of dollars'
worth of interest and dividends must be sent across the water each
year. There are, in the first place, all the foreign investments in
what might be called private enterprise--the English money, for
instance, invested in fruit orchards, gold and copper mines, etc., in
the western states. Profits on this money are practically all remitted
back to England, but no way exists of even estimating what they amount
to. Aside from that there are all the foreign holdings of bonds and
stocks in our great public corporations, holdings whose ownership it is
impossible to trace. Only at the interest periods at the beginning and
middle of each year does it become apparent how large a proportion of
our bonds are held in Europe and how great is the demand for exchange
with which to make the remittances of accrued interest. At such times
the incoming mails of the international banking houses bulge with great
quantities of coupons sent over here for collection. For several weeks
on either side of the two important interest periods, the exchange
market feels the stimulus of the demand for exchange with which the
proceeds of these masses of coupons are to be sent abroad.

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

With freights it is the same proposition, except that the proportion of
American shipping business done by foreign companies is much greater
than the proportion of insurance business done by foreign companies.
Since the Civil War the American mercantile marine instead of growing
with the country has gone steadily backward, until now the greater part
of our shipping is done in foreign bottoms. Aside from the other
disadvantages of such a condition, the payment of such great sums for
freight to foreign companies is a direct economic drain. An estimate
that the yearly freight bill amounts to $150,000,000 is probably not
too high. That means that in the course of every year there is a demand
for that amount of exchange with which to remit back what has been
earned from us.

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

Then again there must be considered the expenditures of wealthy
Americans who either live abroad entirely or else spend a large part of
their time on the other side. During the past decade it has come about
that every European city of any consequence has its "American Colony,"
a society no longer composed of poor art students or those whose
residence abroad is not a matter of volition, but consisting now of
many of the wealthiest Americans. By these expatriates money is spent
extremely freely, their drafts on London and Paris requiring the
frequent replenishment, by remittances of exchange from this side, of
their bank balances at those points. Furthermore, there must be
considered the great amounts of American capital transferred abroad by
the marriage of wealthy American women with titled foreigners. Such
alliances mean not only the transfer of large amounts of capital _en
bloc_, but mean as well, usually, an annual remittance of a very large
sum of money. No account of the money drained out of the country in
this way is kept, of course, but it is an item which certainly runs up
into the tens of millions.

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

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

The six sources of demand for exchange, then, are for the payment for
imports; for securities purchased abroad; for the remitting abroad of
interest on foreign capital invested here and the money which
foreigners in this country send home; for remitting freight and
insurance profits earned by foreign companies here; for tourists'
expenses abroad; and lastly, for the paying off of foreign loans. From
these sources spring practically all the demand for exchange. In the
last chapter there were set forth the principal sources of supply. With
a clear understanding of where exchange comes from and of where it
goes, it ought now to be possible for the student of the subject to
grasp the causes which bear on the movement of exchange rates. That
subject will accordingly be taken up in the next chapter.



Granted that the obligations to each other of any two given countries
foot up to the same amount, it is evident that the rate of exchange
will remain exactly at the gold par--that in New York, for instance,
the price of the sovereign will be simply the mint value of the gold
contained in the sovereign. But between no two countries does such a
condition exist--take any two, and the amount of the obligation of one
to the other changes every day, which causes a continuous fluctuation
in the exchange rate--sometimes up from the mint par, sometimes down.

Before going on to discuss the various causes influencing the movement
of exchange rates, there is one point which should be very clearly
understood. _Two_ countries, at least, are concerned in the fluctuation
of every rate. Take, for example, London and New York, and assume that,
at New York, exchange on London is falling. That in itself means that,
in London, exchange on New York is rising.

For the sake of clearness, in the ensuing discussion of the influences
tending to raise and lower exchange rates, New York is chosen as the
point at which these influences are operative. Consideration will be
given first to the influences which cause exchange to go up. In a
general way, it will be noticed, they conform with the sources of
demand for exchange given in the previous chapter. They may be
classified about as follows:

    1. Large imports, calling for large amounts of exchange with which
    to make the necessary payments.

    2. Large purchases of foreign securities by us, or repurchase of
    our own securities abroad, calling for large amounts of exchange
    with which to make payment.

    3. Coming to maturity of issues of American bonds held abroad.

    4. Low money rates here, which result in a demand for exchange with
    which to send banking capital out of the country.

    5. High money rates at some foreign centre which create a great
    demand for exchange drawn on that centre.

1. Heavy imports are always a potent factor in raising the level of
exchange rates. Under whatever financial arrangement or from whatever
point merchandise is imported into the United States, payment is almost
invariably made by draft on London, Paris, or Berlin. At times when
imports run especially heavy, demand from importers for exchange often
outweighs every other consideration, forcing rates up to high levels. A
practical illustration is to be found in the inpour of merchandise
which took place just before the tariff legislation in 1909. Convinced
that duties were to be raised, importers rushed millions of dollars'
worth of merchandise of every description into the country. The result
was that the demand for exchange became so great that in spite of the
fact that it was the season when exports normally meant low exchange,
rates were pushed up to the gold export point.

2. Heavy purchasing movements of our own or foreign securities, on the
other side, are the second great influence making for high exchange.
There come times when, for one reason or another, the movement of
securities is all one way, and when it happens that for any cause we
are the ones who are doing the buying, the exchange market is likely to
be sharply influenced upward by the demand for bills with which to make
payments. Such movements on a greater or less scale go on all the time
and constitute one of the principal factors which exchange managers
take into consideration in making their estimate of possible exchange
market fluctuations.

It is interesting, for instance, to note the movement of foreign
exchange at times when a heavy selling movement of American stocks by
the foreigners is under way. Origin of security-selling on the Stock
Exchange is by no means easy to trace, but there are times when the
character of the brokers doing the selling and the very nature of the
stocks being disposed of mean much to the experienced eye. Take, for
instance, a day when half a dozen brokers usually identified with the
operations of the international houses are consistently selling such
stocks as Missouri, Kansas & Texas, Baltimore & Ohio, or Canadian
Pacific--whether or not the inference that the selling is for foreign
account is correct can very probably be read from the movement of the
exchange market. If it is the case that the selling comes from abroad
and that _we_ are buying, large orders for foreign exchange are almost
certain to make their appearance and to give the market a very strong
tone if not actually to urge it sharply upward. Such orders are not
likely to be handled in a way which makes them apparent to everybody,
but as a rule it is impossible to execute them without creating a
condition in the exchange market apparent to every shrewd observer.
And, as a matter of fact, many an operation in the international stocks
is based upon judgment as to what the action of the exchange market
portends. Similarly--the other way around--exchange managers very
frequently operate in exchange on the strength of what they judge or
know is going to happen in the market for the international stocks.
With the exchange market sensitive to developments, knowledge that
there is to be heavy selling in some quarter of the stock market, from
abroad, is almost equivalent to knowledge of a coming sharp rise in
exchange on London.

Perhaps the best illustration of how exchange can be affected by
foreign selling of our securities occurred just after the beginning of
the panic period in October of 1907. Under continuous withdrawals of
New York capital from the foreign markets, exchange had sold down to a
very low point. Suddenly came the memorable selling movement of
"Americans" by English and German investors. Within two or three days
perhaps a million shares of American stocks were jettisoned in this
market by the foreigners, while exchange rose by leaps and bounds
nearly 10 cents to the pound, to the unheard-of price of 4.91. Nobody
had exchange to sell and almost overnight there had been created a
demand for tens of millions of dollars' worth.

3. The coming to maturity of American bonds held abroad is another
influencing factor closely kept track of by dealers in exchange. So
extensive is the total foreign investment in American bonds that issues
are coming due all the time. Where some especially large issue runs off
without being funded with new bonds, demand for exchange often becomes
very strong. Especially is this the case with the short-term issues of
the railroads and most especially with New York City revenue warrants
which have become so exceedingly popular a form of investment among the
foreign bankers. In spite of its mammoth debt, New York City is
continually putting out revenue warrants, the operation amounting, in
fact, to the issue of its notes. Of late years Paris bankers,
especially, have found the discounting of these "notes" a profitable
operation and have at times taken them in big blocks.

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

4. Low money rates are the fourth great factor influencing foreign
exchange upward. Whenever money is cheap at any given center, and
borrowers are bidding only low rates for its use, lenders seek a more
profitable field for the employment of their capital. It has come about
during the past few years that so far as the operation of loaning money
is concerned, the whole financial world is one great market, New York
bankers nowadays loaning out their money in London with the same
facility with which they used to loan it out in Boston or Philadelphia.
So close have become the financial relationships between leading
banking houses in New York and London that the slightest opportunity
for profitable loaning operations is immediately availed of.

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

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

Particular attention will be given later on to the way in which the
Bank of England and the other great foreign banks manipulate the money
market and so control the course of foreign exchange upon themselves,
but in passing it is well to note just why it is that when the interest
rate at any given point begins to go up, foreign exchange drawn upon
that point begins to go up, too. Remittances to the point where the
better bid for money is being made, are the very simple explanation.
Bankers want to send money there, and to do it they need bills of
exchange. An urgent enough demand inevitably means a rise in the
quotation at which the bills are obtainable. Which suggests very
plainly why it is that when the Directors of the Bank of England want
to raise the rate of exchange upon London, at New York or Paris or
Berlin, they go about it by tightening up the English money market.

The foregoing are the principal causes making for high exchange. The
causes which make up for low rates must necessarily be to a certain
extent merely the converse, but for the sake of clearness they are set
down. The division is about as follows:

    1. Especially heavy exports of merchandise.

    2. Large purchases of our stocks by the foreigners and the placing
    abroad of blocks of American bonds.

    3. Distrust on our part of financial conditions existing at some
    point abroad where there are carried large deposits of American

    4. High money rates here.

    5. Unprofitably low loaning rates at some important foreign centre
    where American bankers ordinarily carry large balances on deposit.

1. Just as unusually large imports of commodities mean a sharp demand
for exchange with which to pay for them, unusually large exports mean a
big supply of bills. In a previous chapter it has been explained how,
when merchandise is shipped out of the country, the shipper draws his
draft upon the buyer, in the currency of the country to which the
merchandise goes. When exports are heavy, therefore, a great volume of
bills of exchange drawn in various kinds of currency comes on the
market for sale, naturally depressing rates.

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

From the middle of August, when the first of the new cotton crop begins
to find its way to the seaport, until the middle of December, when the
bulk of the corn and wheat crop exports have been completed, exchange
in very great volume finds its way into the New York market. Normally
this is the season of low rates, for which reason many shippers of
cotton and grain, who know months in advance approximately how much
they will ship, contract ahead of time with exchange dealers in New
York for the sale of the bills they know they will have. By so doing,
shippers are often able to obtain very much better rates. They can then
protect themselves, at least, from the extremely low rates which they
may be forced to take if they wait and accept going rates at a time
when shippers all over the country are trying to sell their bills at
the same time.

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


    1913                  $547,357,000
    1912                   565,849,000
    1911                   585,318,000
    1910                   450,447,000
    1909                   417,390,000

During the autumn months, under normal conditions, the advantage is all
with the buyer of foreign exchange. By every mail huge packages of
bills, drawn against shipments of cotton, wheat and corn, come pouring
into the New York market. Bankers' portfolios become crowded with
bills; remittances by each steamer, in the case of some of the big
bankers, run up, literally, into the millions of dollars. Naturally,
any one wanting bankers' exchange is usually able to secure it at a low

2. With regard to the second influence making for low exchange, sale of
American bonds or stocks abroad, no season can be set when the
influence is more likely to be operative than at any other, unless,
possibly, it be the Spring, when money rates are more apt to be low and
bond issues larger than at any other time of the year. No time,
however, can be definitely set--there are years when the bulk of the
new issues are brought out in the Spring and other years when the Fall
season sees most of the new financing. But whatever the time of the
year, one thing is certain--the issue of any amount of American bonds
with Europe participating largely means a full supply of foreign
exchange not only during the time the issues are actually being brought
out, but for long afterward.

There used to be a saying among exchange dealers that cotton exports
make exchange faster than anything, but nowadays bond sales abroad have
come to take first place. For foreign participation in syndicates
formed to underwrite new issues almost invariably means the drawing of
bills representing the full amount of the foreign participation. A
syndicate is formed, for instance, to take off the hands of the X Y Z
railroad $30,000,000 of new bonds, the arrangement being that the
railroad is to receive its money at once and that the syndicate is to
take its own time about working off the bonds. Half the amount, say,
has been allotted to foreign houses. Immediately, the drawing of
£3,000,000, or francs 75,000,000, as the case may be, begins. The
foreign houses have to raise the money, and in nine cases out of ten,
their way of doing it is to arrange with some representative abroad to
let them draw long drafts, against the deposit of securities on this
side. These drafts, in pounds or francs, at sixty to ninety days'
sight, they can sell in the exchange market for dollars, thus securing
the money they have agreed to turn over to the railroad. In the
meantime, during the life of the drafts they have set afloat and before
they come due and have to be paid off, the bankers here can go about
selling the bonds and getting back their money. Perhaps before the
sixty or ninety days, as the case may be, are over, the syndicate may
have sold out all its bonds and its foreign members have been put in a
position where they can pay off all the drafts they set afloat
originally in order to raise the money.

Very often, however, it will happen that on account of one reason or
another, sixty days pass or ninety days pass without the syndicate
having been able to dispose of its bonds. In that case the long bills
drawn on the foreign bankers have to be "renewed"--that being a process
for which ample provision has, of course, been made. In a succeeding
chapter, full description of how long bills of exchange coming due are
renewed will be made. Just here it is only necessary to say that most
or all of the money necessary to pay off the maturing bills is raised
by selling another batch of "sixties" or "nineties," an operation which
throws the maturity two or three months further ahead.

From this outline of the way foreign participation in American bond
issues is financed, it can be seen that every time a big issue of bonds
of a railroad or industrial in which European investors are actively
interested, is brought out, it means a large supply of foreign exchange
created and suddenly thrown on the exchange market for sale. Not any
more suddenly or publicly than the bankers concerned can help, but
still necessarily so to a great degree, because big bond issues can
only be made with the full knowledge and coöperation of a large part of
the public. Bankers who know in advance of large issues likely to be
made and in which they know they will be asked to participate, often
sell "futures" covering the exchange they foresee their participation
will bring into existence, but as a general rule it may be set down
that heavy issues, involving the sale abroad of large amounts of bonds,
are a most depressing factor on the foreign exchange market. Especially
so, as the participants who have agreed to turn over the money to the
railroad, must sell bills to raise it, even if the horde of speculators
and "trailers" who are always on the lookout for such opportunities,
make every effort to sell the market out from under their feet.

3. Uneasiness with regard to the stability of the financial situation
at some point abroad where American bankers usually carry large
balances is another circumstance which often depresses the exchange
market sharply. "Trouble in the Balkans" and "trouble over the Moroccan
situation" are two bugbears which have for years back furnished the
keynote for many swoops downward in the exchange market, and for years
after this book is published will probably continue to do so. Money on
deposit at a point several thousand miles away is naturally very
sensitive, and the least suspicion of financial trouble is sufficient
to cause its withdrawal. Withdrawal of bankers' balances from a foreign
city means offerings of exchange drawn on that point with resultant
decline in rates.

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

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

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

The number of banks scattered all over the United States which keep
running deposit accounts in the leading European cities has become
surprisingly great during the past ten years, and a movement to bring
home this capital has to go only a little way before it reaches very
large proportions. That is exactly what happens when money rates at a
point like New York become decidedly more attractive than they are over
on the other side. Arrangements with foreign correspondents usually
call for a minimum balance of considerable size, which must be left
intact, but under ordinary circumstances there is considerable leeway,
and when the better opportunity for loaning presents itself here,
drafts on balances abroad, in large aggregate amount, are apt to be
drawn and sold in this market. Especially is this the case when the
cause of the higher money level appears to be deep-rooted and the
outlook is for a continuance of the condition for some time to come.

5. Lastly, as a depressing factor, there is to be considered the
condition which arises when money at some important foreign center,
such as London or Paris, begins to ease decidedly. Large receipts of
gold from the mines, a bettering political outlook--these or many other
causes may bring it about that money in London, for instance, after a
period of high rates, may ease off faster than in Berlin or Hamburg. As
a result, American bankers having large balances in London and finding
it difficult to employ them profitably there, any longer, either
withdraw them entirely or have the money transferred to some other
point. In either case the operation will result in depressing the rate
of exchange on London, for the American banker will either draw on
London himself or, if he wants to transfer the money to Berlin or
Hamburg, will instruct the German bankers by cable to draw for his
account on London. In whatever way it is accomplished, the withdrawal
of capital from any banking point tends to lower the rate of foreign
exchange on that point.

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



Before taking up the question of the activities of the foreign exchange
department and the question of how bankers make money dealing in
exchange, it may be well to fix in mind clearly what the various forms
of foreign exchange are. Following is a description of the most
important classes of bills bought and sold in the New York market:

1. _Commercial Long Bills_

[Illustration: Form of Commercial Long Bill]

Drafts drawn by shippers of merchandise upon buyers abroad, or upon the
banking representatives of the buyers abroad, at thirty days' sight or
more. The drafts may be accompanied by shipping documents or may be
"clean." The former kind of bill making up the greater part of the
whole amount of foreign exchange dealt in in the New York market, will
be described first.

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

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

Other less important documents go with such a bill. Sometimes invoices
showing the weight and price of the cotton go along with it and
sometimes there is also attached a "hypothecation slip" which formally
turns over the right to the goods to the Memphis or New York banker who
buys the draft and accompanying documents from the Memphis cotton
shipper. Sometimes, too, insurance is effected by the buyer abroad, in
which case there may be no insurance certificate. But in the main, one
of these "documentary" commercial bills consists of the draft itself,
the bill of lading, and an insurance certificate.

Having pinned the document and the draft together, the Memphis cotton
shipper is in possession of an instrument which he can dispose of for
dollars. This he does either by selling it to his bank in Memphis or by
sending it to New York, in order that it may be sold there in the
exchange market at the current rate of exchange. Say, the bill of
exchange is drawn on London at sixty days' sight, for £1,000. The
buying price for such a draft will be, perhaps, 4.84. The Memphis
shipper gets his check for $4,840, and is out of the transaction. The
bill has passed into a banker's hands, who will send it abroad--deposit
it in some foreign bank where he keeps a balance.

As to the rate of 4.84 received by the shipper, it is to be noted that
had the bill been drawn at less than sixty days' sight, he would have
received more dollars for it, while if it had been drawn at more than
sixty days' sight, he would have received less for it. The longer the
banker who takes the draft off the shipper's hands has to wait until he
can get his money back on it, the lower, naturally, the rate of
exchange he is willing to pay. On the same day that demand drafts are
selling at 4.87, sixty-day drafts may be selling at 4.84 and ninety-day
drafts at 4.83.

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

Just here it is necessary to digress and state that documentary
commercial bills are of two kinds--"acceptance" bills and "payment"
bills. In the case of the first-named, the documents are delivered to
the party on whom the bill is drawn as soon as he "accepts" the bill,
which puts him in a position to get possession of the merchandise at
once. In the case of a "payment" bill, the credit of the man on whom it
is drawn is not good enough to entitle him to such a privilege, and the
only way he can get actual possession of the goods is to actually pay
the draft under a rebate-of-interest arrangement. All bills drawn on
banks are naturally "acceptance" bills; and being discountable and thus
immediately convertible into cash abroad, command a better rate of
exchange in the New York market than "payment" bills, which may be
allowed to run all the way to maturity before a single pound sterling
is paid on them.

Except in the case of the shipment of perishable merchandise--grain
shipped in bulk, for instance. In that case the buyer on the other side
cannot afford to let the draft run, because the merchandise would
spoil. He is simply forced to pay it under rebate, in order to get
possession of the grain. And the rebate being always less than the
discount rate, less pounds sterling come off the face of the bill in
the process of _rebating_ than of _discounting_. For which reason
sixty-day bills drawn against shipments of grain--documents deliverable
only on payment under rebate--command a better rate of exchange even
than the very best of cotton "acceptance" bills drawn on banks.

2. _Clean Bills_

[Illustration: Form of Clean Bill]

Where the drafts of the merchants of one country drawn upon the
merchants or bankers of another are unaccompanied by shipping documents
they are said to be "clean." Bills of this kind may originate from the
transfer of capital from one country to another or may represent
drawings against shipments of merchandise previously made. It is not
unusual, indeed, where the relationship between some foreign merchant
and some American merchant is very close, for the one to ship
merchandise to the other without drawing drafts against the shipment
until some little time afterward. It might happen, for instance, that a
cotton manufacturing firm in France wanted to import a lot of raw
cotton from the United States, but did not want to be drawn upon at the
time. Under such circumstances the American house might ship the goods
and send over the documents to the buyer, postponing its drawing for
some time. Eventually, of course, the American house would reimburse
itself by drawing, but the documents having gone forward long before,
the drafts would be what is known as "clean."

Later on, in the chapter on the actual money-making operations of the
foreign department, the risk in buying various kinds of bills will be
fully explained, but in passing it may be mentioned that "clean" bills
are of such a nature that bankers will touch them only when drawn by
the very best houses. With a documentary bill, the banker holds the
bill of lading, and if there is any trouble about the acceptance or
payment of a draft, can simply seize the goods and sell them. But in
the case of a "clean" bill, he has absolutely no security. The standing
of the maker of the bill and what he knows about the maker's right to
draw the bill is all he has to go by in determining whether to buy it
or not.

3. _Documentary Commercial Bills Drawn at Short Sight_

[Illustration: Form of Documentary Commercial Sight Bill]

A comparatively small part of our exports are sold on a basis where the
draft drawn is at less than thirty days' sight, but there are a good
many small bills of this kind continually coming into the market.
Drafts drawn against manufactured articles and against such products as
cheese, butter, dried fruits, etc., are apt to be drawn for, with
shipping documents attached, at anywhere from three to thirty days'
sight, but there is no rule about it. Where the "usance"--the time the
bill has to run--is only a few days, documents are apt to be
deliverable only on payment of the bills.

4. _Drafts Drawn Against Securities_

[Illustration: Form of Draft Drawn Against Securities]

Exchange of this kind is naturally of the highest class, the stocks or
bonds against which it is drawn being almost always attached to the
bill of exchange. In the case of syndicate participations by large
houses, the bonds may be shipped abroad privately and exchange against
them drawn and sold independently, in which case, of course, no
security is attached, but as a rule the bonds or stocks go with the
draft. A, in New York, executes an order to buy for B in London, one
hundred Union Pacific preferred shares on the New York Stock Exchange.
The stock comes into A's office, and he pays for it with the proceeds
of a sterling draft he draws on B. The stock itself he attaches to this
sterling draft. Whoever buys the draft of him gets the stock with it
and keeps possession of it till the draft is presented and paid in

5. _Bankers' Checks or Demand Drafts on Their Correspondents Abroad_

[Illustration: Form of Bankers' Check]

Bankers who do a foreign exchange business, keeping large balances in
several European centers, are continually drawing and selling their
demand drafts--"checks," they are called, or "demand"--upon these
foreign balances. Such checks are always to be had in great volume in
the exchange market, the banker's business being to draw and sell
exchange, and his degree of willingness being merely a matter of rate.
There come times, of course, when bankers have every reason to leave
their foreign balances undisturbed, but even at such times the bid of a
high enough rate will usually bring about the drawing of bills.

6. _Bankers' Long Drafts_

[Illustration: Form of Bankers' Long Draft]

In describing the nature of bankers' drawings of long bills, great care
must be taken to differentiate between the _different kinds_ of long
bills being bought and sold in the exchange market. A finance bill
looks exactly the same as a long bill drawn by a banker for a
commercial customer who wants to anticipate the payment abroad for an
incoming shipment of wool or shellac, but the nature and origin of the
two bills are radically different. The three main kinds of bankers'
long bills will thus be taken up in the following order:

A. _Bills Drawn in the Regular Course of Business_

Such is the nature of foreign exchange business that bankers engaged in
it are continually drawing their sixty and ninety days' sight bills in
response to their own and their customers' needs. One example which
might be cited is that of the importer who has a payment to make on the
other side, sixty days from now, but who, having the money on hand,
wants to make it at once. Under some circumstances such an importer
might remit a demand draft on the basis of receiving a rebate of
interest for the unexpired sixty days, but more likely he would go to a
banker and buy from him a sixty days' sight draft for the exact amount
of pounds he owed. The cost of such a draft--which would mature at the
time the debt became due--would be less than the cost of a demand
draft, the importer getting his rebate of interest out of the cheaper
price he pays for the pounds he needs. Prepayments of this sort are
responsible every day for very large drawings of bankers' long bills.

B. _Long Bills Issued in the Operation of Lending Foreign Money_

Bills of this kind represent by far the greater proportion of bankers'
long bills sold in the exchange market. European bankers keep an
enormous amount of floating capital loaned out in this market, in the
making and renewing of which loans long bills are created as follows:

A banker on the other side decides to loan out, say, £100,000 in the
New York market. Arrangements having been made, he cables his New York
representative to draw ninety days' sight drafts on him for £100,000,
the proceeds of which drafts are then loaned out for account of the
foreign house. The matter of collateral, risk of exchange and, indeed,
all the other detail, will be fully described in the succeeding
chapters on how bankers make money out of exchange. For the time being
it is merely necessary to note that every time a loan of foreign
capital is made here--and there are days when millions of pounds are so
loaned out--bankers' long bills for the full amount of the loans are
created and find their way into the exchange market.

C. _Bankers' Long Bills Drawn for the Purpose of Raising Money_

Finance bills constitute the third kind of bankers' long exchange. In
this case, again, detailed discussion must be put off until the chapter
on foreign-exchange-bankers' operations, but the fact that bills of
this kind constitute so important a part of the bankers' long bills to
be had in the market, necessitates their classification in this place.
Every time a banker here starts to use his credit abroad for the
purpose of raising money--and there are times when the privilege is
pretty freely availed of--he does it by drawing sixty or ninety days'
sight drafts on his correspondents abroad. Finance bills, it may be
said without question, are one of the most interesting forms of foreign
exchange banking--at the same time one of the most useful and one of
the most abused of privileges coming to the domestic banker by reason
of his having strong banking connections abroad.



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

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

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

After this class of houses come the regular brokers--the independent
and unattached individuals who spend their time trying to bring buyer
and seller together, and make a commission out of doing it. In a market
like New York the number of exchange brokers is very large. Like
bond-brokerage, the business requires little in the way of office
facilities or capital, and is attractive to a good many persons who are
willing to accept the small income to be made out of it in return for
being in a business where they are independent.

Foreign exchange brokerage, like all other employment of the middleman,
is not what it used to be. Before the business became overcrowded as it
is now, exchange brokers made their quarter-cent in the pound
commission, and could depend on a respectable income. But nowadays
brokers swarm among the foreign exchange bankers and dealers, doing
business on any commission they can get, which is not infrequently as
little as 1/128 of one per cent., say, $1.50, for buying or selling
francs 100,000. In handling sterling, the broker is lucky if he makes
his five points (5/100 of a cent per pound), which means that for
turning over £10,000 he would be rewarded with the sum of $5. Under
such conditions it is not difficult to see how hard it is to make any
money to speak of out of foreign exchange brokerage.

The dealers, of course, fare much better. Handling commercial bills
where the question of credit affects the price, they have a chance to
make more of a profit, and buying and selling bills for their own
account they naturally are entitled to make more than the man without
capital, who simply tries to get in between the buyer and the seller.
Dealing in exchange, especially for out-of-town clients, is a highly
profitable business, but one which takes time, brains, experience and
money to build up. Dealers representing large out-of-town sellers of
exchange are very much in the position of the New York agents of
manufacturing companies who sell goods on commission.

There being no regular market in which foreign exchange rates are made,
it follows that the establishment of rates each morning and during the
course of each day will be according to the supply and demand for
bills. On any given morning by ten o'clock the bankers will all have
received their cables quoting money and exchange rates in the foreign
centers, and will all have pretty well made up their minds as to what
the rate for demand bills on London ought to be. A banker, for
instance, has £10,000 he wants to sell as early in the morning as
possible, and from his foreign cables figures that 4.86 is about the
right price. He offers it at that, but learns that another banker is
offering exchange at 4.8595. He offers his own at that price, and
somebody comes along, taking both lots and bidding 4.86 for £50,000
more. Somebody else bids 4.86 for other large lots, refusing, however,
to pay 4.8605. The market is established at that point.

For the time being. A cable message from abroad may induce some banker
to bid 4.8605 or 4.8610, or it may cause him to throw on the market
such an amount of exchange as may break the price down to 4.85-3/4.
Rates are constantly changing, and changing at times almost from minute
to minute. Yet so complete is the system of telephones and brokers that
any exchange manager can tell just about what is taking place in any
other part of the market. Not infrequently, of course, sales are made
simultaneously at slightly different rates, but, as a rule, if a trade
is made at 4.86 on Cedar Street, 4.86 will be the rate on Exchange
Place. It is remarkable how closely each manager keeps in touch with
what is going on in every part of the market. And the great number of
brokers continually circulating around and trying to "get in between"
for five points is in itself a powerful influence toward keeping rates
exactly the same in all parts of the market at once.

"Posted rates" mean little with regard to current conditions, being
simply the bankers' public notice of the rate at which he will sell
bills for trifling amounts. Exchange bankers dislike to draw small
drafts and usually can be induced to do so only by the offer of a much
higher rate than that current for a large amount. A banker might offer
to sell you £10,000 at 4.87, but if you said you wanted only £10, he
would be likely to point to his posted rate and charge you 4.88.
Considering that in transactions based on the best bills the banker
only figures on making from $10 to $20 profit on each £10,000, it may
readily be seen why he is not anxious to sell a £10 draft.

As to the actual fluctuation of exchange, while it is true that rates
at times rise and fall with all the violence so often displayed in the
security markets, most of the time they move within a comparatively
narrow range. On an ordinary business day, for instance, the change is
not apt to run over fifteen points (15/100 of a cent per pound). In the
morning, demand sterling may be at, say, 4.86; at noon a moderate
demand for bills may carry the rate, first, to 4.8605, then to 4.8610;
and finally, perhaps, to 4.8615. On fairly large offerings of bills the
market might then recede to, say, 4.8605, ending the day five points
up. And that would be an ordinary day--by no means the kind of a day
the exchange market always sees, but a day corresponding to a stock
market session in which the market leaders rise or fall a point or so.

There are times, of course, when very different conditions prevail. An
unexpected rise in the bank rate in London, the announcement of a big
loan or any one of many different happenings, are apt to cause a
reduction in the exchange market and a bewildering movement of rates up
and down. At such times a rise or fall of fifty points in sterling
within half an hour is not at all out of the ordinary, while in times
of panic, or when great crises impend, the fluctuations will be three
or four times as great. During the latter part of October, 1907, and in
November, the exchange market fluctuated with greater violence than,
perhaps, at any other time since the gold standard was firmly
established. Thrown completely out of gear by the premium of 3-1/2 per
cent. a day for currency during the panic time, the exchange markets
for some time would rise and fall several cents in the pound on the
same day. Completely baffled by this erratic movement, many bankers
temporarily withdrew entirely from the market.

As to the relative importance of the different kinds of exchange,
sterling, of course, occupies the most prominent position. What
proportion of the total of exchange dealt in in the New York market
consists of sterling it is impossible to determine, but that it is as
great as the volume of all the other kinds of exchange put together can
safely be said. Many big dealers, indeed, make a specialty of sterling,
and if they handle any other bills at all, do so only on a very small
scale. As to whether francs or marks come next in volume, there is a
difference of opinion. With Germany our direct financial transactions
are probably considerably larger than with France, but the position of
Paris as a banking centre makes the French capital figure prominently
in many operations where the French market is not directly concerned.
Despite the fact that sterling easily predominates, the volume of franc
and mark bills, too, is enormous. Drafts on Paris for from three to
five million francs and on Berlin for as many marks are not at all
infrequently traded in in the exchange market, and at times bills for
very much larger amounts have been drawn and offered for sale.

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

In the following chapter will be taken up the various forms of activity
of the foreign exchange department. No attempt is made to state out of
which kind of business bankers make most money, but before looking into
the more detailed description of how exchange business is conducted, it
may be well to fix in mind the fact that it is out of the "straight"
forms of foreign exchange business that the most profit is made. Highly
complicated operations are indulged in by some managers with more
theoretical than practical sense, and money is at times made out of
them, but on the whole the real money is made out of the kinds of
business about to be described. To the author's certain knowledge, the
exchange business of one of the largest houses in New York was for
years thus limited to what might be called "straight" operations. While
the profits might at times have been materially increased by the
introduction of a little more of a speculative element into the
business, the house made money on a large scale and avoided the losses
inevitable where business is conducted along speculative lines.



Complete description of the various forms of activity of the foreign
exchange department of an important firm would fill a large volume, but
there are certain stock operations in foreign exchange which are the
basis of most of the transactions carried out and the understanding of
which ought to go a long way toward making clear what the nature of the
foreign exchange department's business really is.

1. _Selling "Demand" Against "Demand"_

The first and most elementary form of activity is, of course, the
buying of demand bills at a certain price and the selling of the
banker's own demand drafts against them at a higher price. A banker
finds, for instance, that he can buy John Smith & Co.'s sight draft for
£1,000, on London, at the rate of 4.86, and that he can sell his own
draft for £1,000 on his London banking correspondent at 4.87. All he
has to do, therefore, is to buy John Smith's draft for $4,860, send it
to London for credit of his account there, and then draw his own draft
for £1,000 on the newly created balance, selling it for $4,870. It cost
him $4,860 to buy the commercial draft, and he has sold his own draft
against it for $4,870. His gross profit on the transaction, therefore,
is $10.

As may be imagined, not very much money is made in transactions exactly
of this kind--the one cited is taken only because it illustrates the
principle. For whether the banker sends over in every mail a
bewildering assortment of every conceivable form of foreign exchange to
be credited to his account abroad, or whether he confines himself to
remittances of the simplest kinds of bills, the idea remains exactly
the same--he is depositing money to the credit of his account in order
that he may have a balance on which he can draw. That is, indeed, the
sum and substance of the exchange business of the foreign department of
most banking houses--the maintaining of deposit accounts in banks at
foreign centers on which deposit account the bank here is in a position
to draw according to the wants and needs of its customers.

To analyze the underlying transaction a little more closely, it is
evident that the banker, in order to make a profit, must be able to buy
the commercial bill at a lower rate of exchange than he can realize on
his own draft. Which suggests at once that the extent of the banker's
profit is dependent largely upon the amount of risk he is willing to
take. For the rate on commercial bills is purely a matter of the
drawer's credit. The best documentary commercial exchange, drawn at
sight on banks abroad or houses of the highest standing will command a
rate of exchange in the open market only a little less than the
banker's own draft. From which point the rate realizable on commercial
bills tapers off with the credit of the house in question, some bills
regularly selling a cent or a cent and a half per pound sterling below
the best bills of their class.

Without the introduction, therefore, of the element of speculation,
except as to the soundness of the bills' makers, it is possible for
bankers to make widely varying profits out of the same kind of
business. Everything depends upon the amount of risk the banker is
willing to take. The exchange market is a merciless critic of credit,
and if a commercial firm's bills always sell at low rates, the
presumption is strongly against its financial strength. Cases very
frequently occur, however, where the exchange market misjudges the
goodness of a bill, placing too low a valuation upon it. In that case
the banker who, individually, knows that the house in question is all
right, can make considerable sums of money buying its bills at the
low-going rates and selling his own exchange against them. This,
evidently, is purely a matter of the exchange manager's judgment. With
comparatively little risk there are banking houses which are making a
full cent a pound out of a good part of the commercial exchange they

2. _Selling Cables Against Demand Exchange_

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

To be able to instruct its correspondent in London by cable to pay out
large sums at any given time, a bank here must necessarily carry a
substantial credit balance abroad. It would be possible, of course, for
a banker to instruct his London agent by cable to pay out a sum of
money, at the same time cabling him the money to pay out, but this
operation of selling cables against cables is not much indulged
in--there is too little chance of profit in it. Under special
circumstances, however, it can be seen that a house anxious to sell a
large cable and not having the balance abroad to do it, might easily
provide its correspondent abroad with the funds by going out and buying
a cable itself.

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

All the parties involved being bankers there is little risk in business
of this kind; but, on the other hand, the margin of profit is small,
and in order to make any money out of it, it is necessary that very
large amounts of money be turned over. The average profit, for
instance, realized in the New York exchange market from straight sales
of cables against remittances of checks is fifteen points (15/100 of a
cent per pound sterling). That means that on every £10,000, the gross
profit would be $15.00. A daily turnover of £50,000, therefore, would
result in a gross profit of $75 a day.

It may seem strange that bankers should be willing to turn over so
large an amount of money for so small a profit, even where the risk has
been reduced to a minimum, but that is the case. Very often cables are
sold against balances which have been accumulated by remittance of all
sorts of bills other than demand, but there are several large American
institutions whose foreign exchange business consists principally of
the regulation selling of cables against remittances of demand bills.
By reason of their large deposits they are in a position to carry full
balances abroad, while in the course of their regular business a good
deal of sight exchange of high class comes across their counters. All
the necessary elements for doing the business being there, it only
remains for such an institution to employ a man capable of directing
the actual transactions. The risk is trifling, the advertisement is
world-wide, the accommodation of customers is being attended to, and
there is considerable actual money profit to be made. The business in
many respects is thus highly desirable.

3. _Selling "Demand" Bills Against Remittances of Long Bills_

If there is a stock operation in the conduct of a foreign exchange
business it is the selling by bankers of their demand bills of exchange
against remittances of commercial and bankers' long paper. Bills of the
latter class, as has been pointed out, make up the bulk of foreign
exchange traded in, and its disposal naturally is the most important
phase of foreign exchange business. For after all, all cabling,
arbitraging in exchange, drawing of finance bills, etc., is only
incidental. What the foreign exchange business really is grounded on is
the existence of commercial bills called into existence by exports of

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

Buying and remitting commercial long bills is, however, no pastime for
an inexperienced man. Entirely aside from the question of rate, and
profit on the exchange end of the transaction, there must be taken into
consideration the matter of the credit of the drawer and the drawee,
the salability of the merchandise specified in the bill of lading, and
a number of other important points. This question of credit, underlying
to so great a degree the whole business of buying commercial long
paper, will be considered first.

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

Where documents accompany the draft and the merchandise is formally
hypothecated to the buyer of the draft, it might not be thought that
the standing of the drawer would be of such great importance.
Possession of the merchandise, it is true, gives the banker a certain
form of security in case acceptance of the bill is refused by the
parties on whom it is drawn or in case they refuse to pay it when it
comes due, but the disposal of such collateral is a burdensome and
often expensive operation. The banker in New York who buys a sixty-day
draft drawn against a shipment of butter is presumably not an expert on
the butter market and if he should be forced to sell the butter, might
not be able to do so to the fullest possible advantage. Employment of
an expert agent is an expensive operation, and, moreover, there is
always the danger of legal complication arising out of the banker's
having sold the collateral. It is desirable in every way that if there
is to be any trouble about the acceptance or payment of a draft, the
banker should keep himself out of it.

A concrete illustration of the dangers attendant upon the purchase of
commercial long bills from irresponsible parties is to be found in what
happened a few years ago to a prominent exchange house in New York.
This house had been buying the bills of a certain firm for some little
time, and everything had gone well. But one day acceptance of a bill
for £2,000 was refused by the party abroad, and the news cabled that
the bill of lading was a forgery and that no such shipment had ever
been made. Wiring hurriedly to the inland city in which was located the
firm which drew the bill, the New York bank received the reply that
both partners had decamped. What had happened was that, about to break
up, the "firm" had drawn and sold several large bills of exchange, with
forged documents attached, received their money for them, and then
disappeared. Neither of them was ever apprehended, and the various
bankers who had taken the exchange lost the money they had paid for it.
Forgery of the bill of lading in this case had been a comparatively
easy matter, the shipment purporting to have been made from an obscure
little cotton town in the South, the signature of whose railroad agent
was not at all known.

This forgery is only one example of the trickery possible and the
extreme care which is necessary in the purchase of bills of this kind.
And not only must the standing of the drawer be taken into
consideration, but the standing of the drawee is a matter of almost
equal importance--after the "acceptance" of the bill, the parties
accepting it being equally liable with its maker. The nature of the
merchandise, furthermore, and its marketability are further
considerations of great importance. Cotton, it will readily appear, is
an entirely different sort of collateral from clocks, or some specialty
in which the market may vary widely. The banker who holds a bill of
lading for cotton shipped to Liverpool can at any moment tell exactly
what he can realize on it. In the case of many kinds of articles,
however, the invoice value may differ widely from the realizable value,
and if the banker should ever be forced to sell the merchandise, he
might have to do so at a big loss.

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

The banker in New York having ascertained by cable the rate at which
bills "to arrive" in London by a certain steamer will be discounted,
buys the bills here and sends them over, with instructions that they be
immediately discounted and the proceeds placed to his credit. On this
resulting balance he will at once draw his demand draft and sell it in
the open market. If, from selling this demand draft, he can realize
more dollars than it cost him in dollars to put the balance over there,
he has made a gross profit of the difference.

To illustrate more specifically: A banker has bought, say, a £1,000
ninety days' sight prime draft, on London, documents deliverable on
acceptance. This he has remitted to his foreign correspondent, and his
foreign correspondent has had it stamped with the required "bill-stamp,"
has had it discounted, and after having taken his commission out of the
proceeds, has had them placed to the credit of the American bank. In
all this process the bill has lost weight. It arrived in London as
£1,000, but after commissions, bill-stamps and ninety-three days'
discount have been taken out of it, the amount is reduced well below
£1,000. The _net_ proceeds going to make up the balance on which the
American banker can draw his draft are, perhaps, not over £990. He paid
so-and-so many dollars for the £1,000 ninety-day bill, originally. If
he can realize that many dollars by selling a demand draft for £990 he
is even on the transaction.

No attempt will be made in this little book to present the tables by
which foreign exchange bankers figure out profit possibilities in
operations of this kind. The terms obtainable from foreign
correspondents vary so widely according to the standing and credit of
the house on this side and are governed by so many different influences
that a manager must work out each transaction he enters according to
the conditions by which he, particularly, and his operations are
governed. Such calculations, moreover, are all built up along the
general line of the scheme presented below:

    Assume that the rate for demand bills is 4.85, that discount in
    London is 3-1/2 per cent, and that the amount of the long bill
    remitted for discount and credit of proceeds is £100.

    _The various expenses are as follows:_

    Commission charged by the banker in
    London                             1/40 per cent. $0.12

    Discount, 93 days (3 days of grace)
    at 3-1/2 per cent.                                 4.38

    English Government bill stamp      1/20 per cent.  0.24

Total charges on the ninety days' sight £100 bill amount to $4.74. On
one pound, therefore, the charge would be $.0474. From which it is
evident that each pound of a ninety-day bill, under the conditions
given, is worth $.0474 (=4.74 cents) less than each pound in a bankers'
demand bill. From which it is evident that if such a demand bill were
sold at 4.85 against a ninety-day bill bought at 4.8026 (found by
subtracting 4.74 cents from 485 cents) the remitting banker would come
out even in the transaction.

The foregoing has been introduced at the risk of confusing the lay
reader, on the idea that all the various calculations regarding the
drawing of "demand" against the remitting of long bills are founded on
the same general principle, and that where it is desired to go more
deeply into the matter the correct conditions can be substituted.
Discount, of course, varies from day to day, "payment" bills do not go
through the discount market at all, but are "rebated," the commissions
charged different bankers and by different bankers vary widely. Under
the circumstances the value of presenting a lot of hard-and-fast
calculations worked out under any given set of conditions is extremely

As to the profit on business of this kind it can be said that the
average, where the best bills are used, runs not much over twenty
points (one-fifth of a cent per pound sterling). From that, of course,
profits actually made run up as high as one cent or even two cents per
pound, according to the amount of risk involved. The buying of cheap
bills is, however, a most precarious operation. One single mistake, and
the whole profit of months may be completely wiped out. The proposition
is a good deal like lending money on insecure collateral, or like
lending to doubtful firms. There are banking houses which do it, have
been doing it for years, and by reason of an intuitive feeling when
there is trouble ahead have been able to avoid heavy losses. Such
business, however, can hardly be called high-class banking practice.

4. _The Operation of Making Foreign Loans_

In its influence upon the other markets, there is perhaps no more
important phase of foreign exchange than the making of foreign loans in
the American market. How great is the amount of foreign capital
continually loaned out in this country has been several times suggested
in previous pages. The mechanics of these foreign loaning operations,
the way in which the money is transferred to this side, etc., will now
be taken up.

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

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

Even the experience of 1901 did not daunt the foreign lenders, and in
1902 fresh amounts of foreign capital, this time mostly German, were
secured by our speculators to push along the famous "Gates boom." That
time, however, the lenders' experience seemed to discourage them, and
until 1906 there was not a great deal of foreign money, relatively
speaking, loaned out here. In the summer of that year, chiefly through
Mr. Harriman's efforts, English and French capital began to come
largely into the New York market--made possible, indeed, the "Harriman
Market of 1906." This was the money the terror-stricken withdrawal of
which during most of 1907 made the panic as bad as it was. After the
panic, most of what was left was withdrawn by foreign lenders, so that
in the middle of 1908 the market here was as bare of foreign money as
it has been in years. Returning American prosperity, however, combined
with complete stagnation abroad, set up another hitherward movement of
foreign capital which, during the spring and summer of 1909, attained
amazing proportions. By the end of the summer, indeed, more foreign
capital was employed in the American market than ever before in the
country's financial history.

To take up the actual operation of loaning foreign money in the
American market, suppose conditions to be such that an English bank's
managers have made up their minds to loan out £100,000 in New York--not
on joint account with the American correspondent, as is often done, but
entirely independently. Included in the arrangements for the
transaction will be a stipulation as to whether the foreign bank
loaning the money wants to loan it on the basis of receiving a
commission and letting the borrower take the risk of how demand
exchange may fluctuate during the life of the loan, or whether the
lender prefers to lend at a fixed rate of interest, say six per cent.,
and himself accept the risk of exchange.

What the foregoing means will perhaps become more clear if it is
realized that in the first case the American agent of the foreign
lender draws a ninety days' sight sterling bill for, say, £100,000 on
the lender, and hands the actual bill over to the parties here who want
the money. Upon the latter falls the task of selling the bill, and,
ninety days later, when the time of repayment comes, the duty of
returning a _demand_ bill for £100,000, plus the stipulated commission.
In the second kind of a loan the borrower has nothing to do with the
exchange part of the transaction, the American banking agent of the
foreign lender turning over to the borrower not a sterling draft but
the dollar proceeds of a sterling draft. How the exchange market
fluctuates in the meantime--what rate may have to be paid at the end of
ninety days for the necessary demand draft--concerns the borrower not
at all. He received dollars in the first place, and when the loan comes
due he pays back dollars, plus four, five or six per cent., as the case
may be. What rate has to be paid for the demand exchange affects the
banker only, not the borrower.

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

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

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

What each of the bankers concerned makes out of the transaction is
plain enough. As to what Smith & Jones' ninety-day loan cost them, in
addition to the flat three-eighths per cent. they had to pay, that
depends upon what they realize from the sale of the ninety days' sight
bills in the first place and secondly on what rate they had to pay for
the demand bill for £100,000. Exchange may have gone up during the life
of the loan, making the loan expensive, or it may have gone down,
making the cost very little. Plainly stated, unless they secured
themselves by buying a "future" for the delivery of a £100,000 demand
bill in ninety days at a fixed rate, Messrs. Smith & Jones have been
making a mild speculation in foreign exchange.

If the same loan had been made on the other basis, the New York Bank
would have turned over to Smith & Jones not a _sterling bill_ for
£100,000, but the _dollar proceeds_ of such a bill, say a check for
$484,000. At the end of ninety days Smith & Jones would have had to pay
back $484,000, plus ninety days' interest at six per cent, $7,260, all
of which cash, less commission, the New York Bank would have invested
in a demand bill of exchange and sent over to the London Bank, Ltd.
Whatever more than the £100,000 needed to pay off the maturing nineties
such a demand draft amounted to, would be the London Bank, Ltd.'s,

From all of which it is plainly to be seen that when the London bankers
are willing to lend money here and figure that the exchange market is
on the down track, they will insist upon doing their lending on the
"currency loan" basis--taking the risk of exchange themselves.
Conversely, when loaning operations seem profitable but rates seem to
be on the upturn, lenders will do their best to put their money out in
the form of "sterling loans." Bankers are not always right in their
views, by any means, but as a general principle it can be said that
when big amounts of foreign money offered in this market are all
offered on the "sterling loan" basis, a rising exchange market is to be

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

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

From what has been said about the mechanism of making these foreign
loans, it is evident that no transfer of cash actually takes place, and
that what really happens is that the foreign banking institution lends
out its credit instead of its cash. For in no case is the lender
required to put up any money. The drafts drawn upon him are at ninety
days' sight, and all he has to do is to write the word "accepted," with
his signature, across their face. Later they will be presented for
actual payment, but by that time the "cover" will have reached London
from the banker in America who drew the "nineties," and the maturing
bills will be paid out of that. The foreign lender, in other words, is
at no stage out of any actual capital, although it is true, of course,
that he has obligated himself to pay the drafts on maturity, by
"accepting" them.

Where, then, is the limit of what the foreign bankers can lend in the
New York market? On one consideration only does that depend--the amount
of accepted long bills which the London discount market will stand. For
all the ninety days' sight bills drawn in the course of these transfers
of credit must eventually be discounted in the London discount market,
and when the London discount market refuses to absorb bills of this
kind a material check is naturally administered to their creation.

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

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

As to what the foreign department of an American bank makes out of the
business, it may be said that that depends very largely upon whether
the bank here acts merely as a lending agent or whether the operation
is for "joint account," both as to risk and commission. In the former
case (and more and more this seems to be becoming the basis on which
the business is done) both the American and the European bank stands to
make a very fair return--always considering that neither is called upon
to put up one real dollar or pound sterling. Take, for instance, the
average sterling loan made on the basis of the borrower taking all the
risk of exchange and paying a flat commission of three-eighths of one
per cent. for each ninety days. That means that each bank makes
three-sixteenths of one per cent. for every ninety days the loan
runs--the American bank for simply drawing its ninety-day bills of
exchange and the English bank for merely accepting them. Naturally,
competition is keen, American banking houses vying with each other both
for the privilege of acting as agents of the foreign banks having money
to lend, and of going into joint-account loaning operations with them.
Three-sixteenths or perhaps one-quarter of one per cent. for ninety
days (three-quarters of one per cent. and one per cent. annually) may
not seem much of an inducement, but considering the fact that no real
cash is involved, this percentage is enough to make the biggest and
best banking houses in the country go eagerly after the business.

5. _The Drawing of Finance-Bills_

Approaching the subject of finance-bills, the author is well aware that
concerning this phase of the foreign exchange business there is wide
difference of opinion. Finance bills make money, but they make trouble,
too. Their existence is one of the chief points of contact between the
foreign exchange and the other markets, and one of the principal
reasons why a knowledge of foreign exchange is necessary to any
well-rounded understanding of banking conditions.

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

The origin of the ordinary finance-bill is about as follows: A bank
here in New York carries a good balance in London and works a
substantial foreign exchange business in connection with the London
bank where this balance is carried. A time comes when the New York
banking house could advantageously use more money. Arrangements are
therefore made with the London bank whereby the London bank agrees to
"accept" a certain amount of the American banker's long bills, for a
commission. In the course of his regular business, then, the American
banker simply draws that many more pounds sterling in long bills, sells
them, and for the time being has the use of the money. In the great
majority of cases no extra collateral is put up, nor is the London bank
especially secured in any way. The American banker's credit is good
enough to make the English banker willing, for a commission, to
"accept" his drafts and obligate himself that the drafts will be paid
at maturity. Naturally, a house has to be in good standing and enjoy
high credit not only here but on the other side before any reputable
London bank can be induced to "accept" its finance paper.

The ability to draw finance-bills of this kind often puts a house
disposed to take chances with the movement of the exchange market into
line for very considerable profit possibilities. Suppose, for instance,
that the manager of a house here figures that there is going to be a
sharp break in foreign exchange. He, therefore, sells a line of
ninety-day bills, putting himself technically short of the exchange
market and banking on the chance of being able to buy in his "cover"
cheaply when it comes time for him to cover. In the meantime he has the
use of the money he derived from the sale of the "nineties" to do with
as he pleases, and if he has figured the market aright, it may not cost
him any more per pound to buy his "cover" than he realized from the
sale of the long bills. In which case he would have had the use of the
money for the whole three months practically free of interest.

It is plain speculating in exchange--there is no getting away from it,
and yet this practice of selling finance-bills gives such an
opportunity to the exchange manager shrewd enough to read the situation
aright to make money, that many of the big houses go in for it to a
large extent. During the summer, for instance, if the outlook is for
big crops, the situation is apt to commend itself to this kind of
operation. Money in the summer months is apt to be low and exchange
high, affording a good basis on which to sell exchange. Then, if the
expected crops materialize, large amounts of exchange drawn against
exports will come into the market, forcing down rates and giving the
operator who has previously sold his long bills an excellent chance to
cover them profitably as they come due.

About the best example of how exchange managers can be deceived in
their forecasts is afforded by the movement of exchange during the
summer and fall of 1909. Impelled thereto by the brilliant crop
prospects of early summer, foreign exchange houses in New York drew and
sold finance-bills in enormous volume. The corn crop was to run over
three billion bushels, affording an unprecedented exportable
surplus--wheat and cotton were both to show record-breaking yields. But
instead of these promises being fulfilled, wheat and corn showed only
average yields, while the cotton crop turned out decidedly short. The
expected flood of exchange never materialized. On the contrary, rise in
money rates abroad caused such a paying off of foreign loans and
maturing finance bills that foreign exchange rose to the gold export
point and "covering" operations were conducted with extreme difficulty.
In the foreign exchange market the autumn of 1909 will long be
remembered as a time when the finance-bill sellers had administered to
them a lesson which they will be a good while in forgetting.

6. _Arbitraging in Exchange_

Arbitraging in exchange--the buying by a New York banker, for instance,
through the medium of the London market, of exchange drawn on Paris, is
another broad and profitable field for the operations of the expert
foreign exchange manager. Take, for example, a time when exchange on
Paris is more plentiful in London than in New York--a shrewd New York
exchange manager needing a draft on Paris might well secure it in
London rather than in his home city. The following operation is only
one of ten thousand in which exchange men are continually engaged, but
is a representative transaction and one on which a good deal of the
business in the arbitration of exchange is based.

Suppose, for instance, that in New York, demand exchange on Paris is
quoted at five francs seventeen and one-half centimes per dollar,
demand exchange on London at $4.84 per pound, and that, _in London_,
exchange on Paris is obtainable at twenty-five francs twenty-five
centimes per pound. The following operation would be possible:

Sale by a New York banker of a draft on Paris, say, for francs 25,250,
at 5.17-1/2, bringing him in $4,879.23. Purchase by same banker of a
draft on London for £1,000, at 4.84, costing him $4,840. Instructions
by the American banker to his London correspondent to buy a check on
Paris for francs 25,250 in London, and to send it over to Paris for the
credit of his (the American banker's account). Such a draft, at 25.25
would cost just £1,000.

The circle would then be complete. The American banker who originally
drew the francs 25,250 on his Paris balance would have replaced that
amount in his Paris balance through the aid of his London
correspondent. The London correspondent would have paid out £1,000 from
the American banker's balance with him, a draft for which amount would
come in the next mail. All parties to the transaction would be
satisfied--especially the banker who started it, for whereas he paid
out $4,840 for the £1,000 draft on London, he originally took in
$4,879.23 for the draft he sold on Paris.

Between such cities as have been used in the foregoing illustrations
rates are not apt to be wide enough apart to afford any such actual
profit, but the chance for arbitraging does exist and is being
continuously taken advantage of. So keenly, indeed, are the various
rates in their possible relation to one another watched by the exchange
men that it is next to impossible for them to "open up" to any
appreciable extent. The chance to make even a slight profit by shifting
balances is so quickly availed of that in the constant demand for
exchange wherever any relative weakness is shown, there exists a force
which keeps the whole structure at parity. The ability to buy drafts on
Paris relatively much cheaper at London than at New York, for instance,
would be so quickly taken advantage of by half a dozen watchful
exchange men that the London rate on Paris would quickly enough be
driven up to its right relative position.

It is impossible in this brief treatise to give more than a suggestion
of the various kinds of exchange arbitration being carried on all the
time. Experts do not confine their operations to the main centers, nor
is three necessarily the largest number of points which figure in
transactions of this sort. Elaborate cable codes and a constant use of
the wires keep the up-to-date exchange manager in touch with the
movement of rates in every part of Europe. If a chance exists to sell a
draft on London and then to put the requisite balance there through an
arbitration involving Paris, Brussels, and Amsterdam, the chances are
that there will be some shrewd manager who will find it out and put
through the transaction. Some of the larger banking houses employ men
who do little but look for just such opportunities. When times are
normal, the margin of profit is small, but in disturbed markets the
parities are not nearly so closely maintained and substantial profits
are occasionally made. The business, however, is of the most difficult
character, requiring not only great shrewdness and judgment but
exceptional mechanical facilities.

7. _Dealing in "Futures_"

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

Take the case of a banker who has bought and remitted to his foreign
correspondent a miscellaneous lot of foreign exchange made up to the
extent of one-half, perhaps, of commercial long bills with documents
deliverable only on "payment" of the draft. That means that if the
whole batch of exchange amounted to £50,000, £25,000 of it might not
become an available balance on the other side for a good while after it
had arrived there--not until the parties on whom the "payment" bills
were drawn chose to pay them off under rebate. The exchange rate, in
the meantime, might do almost anything, and the remitting banker might
at the end of thirty or forty-five days find himself with a balance
abroad on which he could sell his checks only at very low rates.

To protect himself in such case the banker would, at the time he sent
over the commercial exchange, sell his own demand drafts for future
delivery. Suppose that he had sent over £25,000 of commercial "payment"
bills. Unable to tell exactly when the proceeds would become available,
the banker buying the bills would nevertheless presumably have had
experience with bills of the same name before and would be able to form
a pretty accurate estimate as to when the drawees would be likely to
"take them up" under rebate. It would be reasonably safe, for instance,
for the banker to sell futures as follows: £5,000 deliverable in
fifteen days; £10,000 deliverable in thirty days, £10,000 deliverable
in from forty-five to sixty days. Such drafts on being presented could
in all probability be taken care of out of the prepayments on the
commercial bills.

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

The other operation is the sale of bankers' futures, not against
remittances of actual commercial exchange but against exporters'
futures. Exporters of merchandise frequently quote prices to customers
abroad for shipment to be made in some following month, to establish
which fixed price the exporter has to fix a rate of exchange definitely
with some banker. "I am going to ship so-and-so so many tubs of lard
next May," says the exporter to the banker, "the drafts against them
will amount to so-and-so-much. What rate will you pay me for
them--delivery next May?" The banker knows he can sell his own draft
for May delivery for, say, 4.87. He bids the exporter 4.86-1/2 for his
lard bills, and gets the contract. Without any risk and without tying
up a dollar of capital the banker has made one-half cent per pound
sterling on the whole amount of the shipment. In May, the lard bills
will come in to him, and he will pay for them at a rate of 4.86-1/2,
turning around and delivering his own draft against them at 4.87.

Selling futures against futures is not the easiest form of foreign
exchange business to put through, but when a house has a large number
of commercial exporters among its clients there are generally to be
found among them some who want to sell their exchange for future
delivery. As to the buyer of the banker's "future," such a buyer might
be, for instance, another banker who had sold finance-bills and wants
to limit the cost of "covering" them.

The foregoing examples of dealing in futures are merely examples of how
futures may figure in every-day exchange transactions. Like operations
in exchange arbitrage, there is no limit to the number of kinds of
business in which "futures" may figure. They are a much abused
institution, but are a vital factor in modern methods of transacting
foreign exchange business.

The foregoing are the main forms of activity of the average foreign
department, though there are, of course, many other ways of making
money out of foreign exchange. The business of granting commercial
credits, the exporting and importing of gold and the business of
international trading in securities will be taken up separately in
following chapters.



Gold exports and imports, while not constituting any great part of the
activity of the average foreign department, are nevertheless a factor
of vital importance in determining the movement of exchange. The loss
of gold, in quantity, by some market may bring about money conditions
resulting in very violent movements of exchange; or, on the other hand,
such movements may be caused by the efforts of the controlling
financial interests in some market to attract gold. The movement of
exchange and the movement of gold are absolutely dependent one on the

Considering broadly this question of the movement of gold, it is to be
borne in mind that by far the greater part of the world's production of
the precious metal takes place in countries ranking very low as to
banking importance. The United States, is indeed, the only first-class
financial power in which any very considerable proportion of the
world's gold is produced. Excepting the ninety million dollars of gold
produced in the United States in 1908, nearly all of the total
production of 430 million dollars for that year was taken out of the
ground in places where there exists but the slightest demand for it for
use in banking or the arts.

That being the case, it follows that there is to be considered, first,
the _primary_ movement of nearly all the gold produced--the movement
from the mines to the great financial centers.

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

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

The distribution of the raw gold is effected as follows: Each Monday
morning there is held an auction at which are present all the
representatives of home or foreign banks who may be in the market for
gold. These representatives, fully apprised of the amount of the metal
which has arrived during the preceding week and which is to be sold,
know exactly how much they can bid. The gold, therefore, is sold at the
best possible price, and finds its way to that point where the greatest
urgency of demand exists. It may be Paris or Berlin, or it may be the
Bank of England. According as the representatives present at the
auction may bid, the disposition of the gold is determined.

The _primary_ disposition. For the fact that Berlin, for instance,
obtains the bulk of the gold auctioned off on any given Monday by no
means proves that the gold is going to remain for any length of time in
Berlin. For some reason, in that particular case, the representatives
of the German banks had been instructed to bid a price for the gold
which would bring it to Berlin, but the conditions furnishing the
motive for such a move may remain operative only a short time and the
need for the metal pass away with them. Quarterly settlements in Berlin
or the flotation of a Russian loan in Paris, for instance, might be
enough to make the German and French banks' representatives go in and
bid high enough to get the new gold, but with the passing of the
quarter's end or the successful launching of the loan would pass the
necessity for the gold, and its _re_-distribution would begin.

In other words, both the primary movement of gold from the mines and
the secondary movement from the distributive centers are merely
temporary and show little as to the final lodgment of the precious
metal. What really counts is exchange conditions; it is along the lines
of the favorable exchange that the great currents of gold will
inevitably flow.

For example, if a draft for pounds sterling drawn on London can be
bought here at a low rate of exchange, anything in London that the
American consumer may want to possess himself of can be bought cheaper
than when exchange on London is high. The price of a hat in London is,
say, £1. With exchange at 4.83 it will cost a buyer in New York only
$4.83 to buy that hat; if exchange were at 4.88, it would cost him
$4.88. Similarly with raw copper or raw gold or any other commodity.
Given a low rate of exchange on any point and it is possible for the
outside markets to buy cheaply at that point.

And a very little difference in the price of exchange makes a very
great difference so far as the price of gold is concerned. As stated in
a previous chapter, a new gold sovereign at any United States assay
office can be converted into $4.8665, so that if it cost nothing to
bring a new sovereign over here, no one holding a draft for a pound (a
sovereign is a gold pound) would sell it for less than $4.8665, but
would simply order the sovereign sent over here and cash it in for
$4.8665 himself. Always assuming that it cost nothing to bring over the
actual gold, every time it became possible to buy a draft for less than
$4.8665, some buyer would snatch at the chance.

Such a case, with £1 as the amount of the draft and the assumption of
no charge for importing the gold, is, of course, mentioned merely for
purposes of illustration. From it should, however, become clear the
whole idea underlying gold imports. A new sovereign laid down in New
York is worth, at any time, $4.8665. If it is possible to get the
sovereign over here for less than that--by paying $4.83 for a £1 draft
on London, for instance, and three cents for charges, $4.86 in all--it
is possible to bring the sovereign in and make money doing it.

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

Exactly the same principle applies where the question is of importing
gold bars instead of sovereigns, except that bars cannot be bought in
London at a fixed rate. That, however, in no way affects the underlying
principle that in importing gold the profit is made by selling the gold
here for more dollars than the combined dollar-cost of the draft on
London with which the gold is bought and the charges incurred in
importing the metal. To illustrate, if the draft cost $997,000 and the
charges amounted to $3,000, the gold (whether in the form of
sovereigns, eagles or bars) would have to be sold here for at least
$1,000,000, to have the importer come out even.

With exports, the theory of the thing is to sell a draft on, say,
London, for more dollars than the dollar-cost of enough gold, plus
charges, to meet the draft. As will be seen from the figures of an
actual shipment, given further on, the banker who ships gold gets the
money to buy the gold from the Treasury here, by selling a sterling
draft on London. Suppose, for example, a New York banker wants to
create a £200,000 balance in London. Figuring how many ounces of gold
(at the buying price in London) will give him the £200,000 credit, he
buys that much gold and sends it over. Suppose the combined cost of the
gold and the charge for shipping it amounts to $976,000. If the banker
here can sell a £200,000 draft against it at 4.88, he will just get
back the $976,000 he laid out originally and be even on the

Before passing from the theory to the practice of gold exports and
imports, there is to be considered the fact that bar gold sells in
London at a constantly varying price, while in New York it sells at a
definitely fixed price. In New York an ounce of gold of any given
fineness can always be sold for the same amount of dollars and cents,
but in London the amount of shillings and pence into which it is
convertible varies constantly. So that a New York banker figuring on
bringing in bar gold from London has to take carefully into account
what the price per ounce of bar gold over there is. Sovereigns are
seldom imported because they are secured in London not by weight but by
face value,--even if the sovereigns have lost weight they cost just as
many pounds sterling to secure. Where the New York banker is exporting
gold, on the other hand, the price at which bar gold is selling in
London is just as important as where he is importing. For the price at
which the gold can be disposed of when it gets to London determines
into how many pounds sterling it can be converted.

These matters of the cost of gold in one market and the crediting of
the gold in some other market are not the easiest thing to grasp at
first thought, but will perhaps become quite clear by reference to the
accompanying calculation of actual gold export and gold import
transactions. All the way through it must be remembered that the
figures of such calculations can never be absolute--that insurance and
freight charges vary and that different operations are conducted along
different lines. The two operations described embody, however, the
principle of both the outward and inward movement of bar gold at New

_Export of Bars to London_

In the transaction described below about a quarter of a million
dollars' worth of bar gold is shipped to London, the money to pay for
the gold being raised by the drawing and selling of a demand draft on
London. Assuming that the draft is drawn and the gold shipped at the
same time, the draft will be presented fully three days before the gold
is credited, that being the time necessary for assaying, weighing, etc.
In other words, there will be an "overdraft" for at least three days,
interest on which will have to be figured as a part of the cost of the

Following is the detailed statement:

    13,195-1/2 ounces bar gold (.9166 fine) purchased
    from U.S. Treasury or Sub-Treasury at
    $18.9459 per ounce                               $250,000

    Assay office charge (4 cents per $100)                100

    Cartage and packing                                    20

    Freight (5/32 per cent.)                              390

    Insurance (1/20 per cent.)                            125

    Interest on overdraft in London (from time draft
    has to be paid until the gold is credited) 3
    days at 4 per cent.                                    83
    Total expense of buying and shipping the
    gold                                             $250,718

    13,195-1/2 ounces of gold credited in London at 77
    shillings 10-1/2 pence                     £51,380

    Draft on London for £51,380, sold by shipper
    of the gold, at 487.96                           $250,718

In the transaction described above, the "overdraft" caused by the
inevitable delay in assaying and weighing the gold on its arrival in
London lasted for three days, the American banker being charged
interest at the rate of four per cent. 487.96 being the rate at which
the banker exporting the gold was able to sell his demand draft at the
time, was, under those conditions, the "gold export point."

In this particular operation, which was undertaken purely for
advertising purposes, the shipper of the gold came out exactly even.
Suppose, however, that he had been able to sell his draft, against the
gold shipped, at 4.88 instead of 4.87-3/4. That would have meant
twenty-five points (one-quarter cent per pound) more, which, on
£51,380, would have amounted to $128.25.

This question of the profit on gold exports is both interesting and,
because it has a strong bearing at times on the question of whether or
not to ship gold, important. No rule can be laid down as to what profit
bankers expect to make on shipments. If, for instance, a banker owes
£200,000 abroad himself and finds it cheaper to send gold than to buy a
bill, the question of profit does not enter at all. Then, again, many
and many an export transaction is induced by ulterior motives--it may
be for the sake of advertising, or for stock market purposes, or
because some correspondent abroad needs the gold and is willing to pay
for it. Any one of these or many like reasons may explain the
phenomenon, occasionally seen, of gold exports at a time when
conditions plainly indicate that the exporter is shipping at a loss.

As a rule, however, when exchange is scarce and the demand so great
that bankers who do not themselves owe money abroad see a chance to
supply the demand for exchange by shipping gold and drawing drafts
against it, the profit amounts to anywhere from $400 to $1,000 on each
million dollars shipped--for less than the first amount named it is
hardly worth while to go into the transaction at all; on the other
hand, conditions have to be pretty much disordered to force exchange to
a point where the larger amount named can be earned.

_Import of Bars from London_

Turning now to the discussion of the conditions under which gold is
imported, it will appear from the following calculation that interest
plays a much more important part in the case of gold imports than in
the case of exports. With exports, as has been shown, the interest
charge is merely on a three days' overdraft, but in the case of imports
the banker who brings in the gold loses interest on it for the whole
time it is in transit and for a day or two on each end, besides. A New
York banker, carrying a large balance in London, for instance, orders
his London correspondent to buy and ship him a certain amount of bar
gold. This the London banker does, charging the cost of the metal, and
all shipping charges, to the account of the New York banker. On the
whole amount thus charged, therefore, the New York banker loses
interest while the gold is afloat. Even after the gold arrives in New
York, of course, the depleted balance abroad continues to draw less
interest than formerly, but to make up for that the gold begins to earn
interest as soon as it gets here.

The transaction given below is one which was made under the above
conditions--the importer in New York had a good balance in London and
ordered his London correspondent to buy and ship about $1,000,000 of
gold, charging the cost and all expenses to his (the New York banker's)
account. In this particular case the interest lost in London was at six
per cent. and lasted for ten days.

    Cost in the London market of 52,782 ounces of
    gold (.9166 fine) at 77 shillings, 11-3/4 pence
    per ounce                                      £205,795

    Freight (5/32 per cent.)                            320

    Insurance                                           102

    Boxing and carting                                    9

    Commission for buying the gold                       26

    Interest on cost of gold and on charges, while
    gold is in transit, 10 days at 6 per cent.          343

    Proceeds, at U.S. Sub-Treasury in New York,
    of the 52,782 ounces of gold at $18.9459 per
    ounce                             $1,000,000

    $1,000,000 invested in a cable on London at
    $484.04                                        £206,595

In the above calculation it will be seen that the proceeds of the gold
imported were exactly enough to buy a cable on London sufficiently
large to cancel the original outlay for the gold and the expenses
incurred in shipping it over here. On the whole transaction the banker
importing the gold came out exactly even; a trifle over 4.84 was the
"gold import point" at the time.

In a general way it can be said that the profit made on gold import
operations is less than where gold is exported. Banking houses big
enough and strong enough to engage in business of this character are
more apt to be on the constructive side of the market than on the
other, and will frequently bring in gold at no profit to themselves, or
even at a loss, in order to further their plans. It does happen, of
course, that gold is sometimes shipped out for stock market effect, but
the effect of gold exports is growing less and less. Gold imports, on
the other hand, are always a stimulating factor and are good live stock
market ammunition as well as a constructive argument regarding the
price of investments in general.

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

Calculations have been given regarding the movement of bar gold between
London and New York--what is ordinarily known as the "direct" movement.
"Indirect" movements, however, have figured so prominently of recent
years in the exchange market that at least one example ought perhaps to
be given. Far and away the most important of such "indirect movements"
are those in which gold is shipped from New York to Paris for the sake
of creating a credit balance in London.

Before examining the actual figures of such an operation it may be well
to glance at the theory of the thing. A New York banker, say, for any
one of many different reasons, wants to create a credit balance in
London. Examining exchange conditions, he finds that sterling drafts
drawn on London are to be had relatively cheaper _in Paris_ than in New
York. In the natural course of exchange arbitrage the New York banker
would therefore buy a draft on Paris and send it to his French
correspondent with instruction to use it to buy a draft on London and
to remit such draft to London for credit of his (the American banker's)

But exchange on Paris is not always plentiful in the New York market,
and very likely the New York banker will find that if he wants to send
anything to Paris he will have to send gold. Assume, then, that he
finds conditions favorable and decides to thus transfer a couple of
hundred thousand pounds to London by sending gold to Paris. The
operation might work out as follows:

    Cost of 48,500 ounces of bar gold (.995 fine) at
    U.S. Sub-Treasury, New York, at $20.5684 per ounce   $997,567

    Insurance (4-1/2 cents per $100)                          450

    Freight (5/32 per cent.)                                1,555

    Assay office charges (4 cents per $100)                   400

    Cartage and packing                                        60

    Commission in Paris                                       250

    Interest from time gold is shipped from New York until
    draft on new credit in London can be safely drawn and
    sold, 6 daysat 2 per cent.                                333

    The gold arrives in Paris and is bought by the Bank of

    48,500 ounces at fcs. 106.3705 per ounce, equals
    fcs.                                                5,158,969

    That amount of francs then invested in a check on
    London, and the check sent to London for credit of the
    American banker, fcs. 5,158,969 at 25 francs 10
    centimes per £                                       £205,536

    New York banker sells his draft on London for
    £205,536 at 4.86832                                $1,000,615

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

_Gold Shipments to Argentina_

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

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

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

No attempt is made in this little work to cover the whole field of
operations in gold, infinite in scope as they are and of every
conceivable variety. But from the examples given above it ought to be
possible to work out a fairly clear idea as to why gold exports and
imports take place and as to what the conditions are which bring them

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

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

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

If there is any "free" gold market in the world, indeed, it is to be
found in the United States. All anybody who wants gold, in this
country, has to do, is to go around to the nearest sub-treasury and get
it. If the supply of bars is exhausted, the buyer may be disappointed,
but that has nothing to do with any restriction on the market. The
market for gold bars in the United States is at the Treasury and the
various sub-treasuries, and as long as the prospective buyer has the
legal tender to offer, he can buy the gold bars which may be on hand.
And at a fixed price, regardless of how urgent the demand may be, who
he is, or who else may be bidding. First come first served is the rule,
and a rule which is observed as long as the bars hold out. After that,
whoever still wants gold can take it in the form of coin.

How such conditions have worked out, so far as our gaining or losing
gold is concerned, can be seen from the following table, introduced
here for the purpose of giving a clear idea as to just where the United
States has stood in the international movement of gold during the
five-year period given below:

           Exports of                    Excess of
         Gold from U.S.     Imports       Imports

    1913   $77,762,622    $69,194,025  [1]$8,568,597
    1912    57,328,348     48,936,500   [1]8,391,848
    1911    22,509,653     73,607,013     51,097,360
    1910   118,563,215     43,339,905  [1]75,223,310
    1909    91,531,818     44,003,989  [1]47,527,829

          [1] Excess of exports

In conclusion, it may be said that the prediction that as international
financial relationships between banks are drawn closer, gold movements
will tend to decrease, seem hardly to be borne out by the figures of
the table given above. Banks here and banks abroad are working together
in a way unknown ten or even five years ago, but as yet there are no
signs of any lessening in the inward or outward movement of specie.
More liberal granting of international credits, increased international
loaning operations, far from putting an end to the physical movement of
gold in large quantities,--these are influences tending to make gold
move more freely than ever. The day of the treasure galleons is over,
but in their place we have swift-moving steamers by which gold can be
shifted from one point to another with safety and ease. Gold movements
seem as though they were to play an important part in the markets for a
good many years to come.



On account of the huge fixed investment of foreign money in the United
States, on account of Europe's continuous speculative interest in our
markets, and the activity of the "arbitrageurs" in both bonds and
shares, dealings in securities between ourselves and the Old World are
always on a very great scale. Not infrequently, indeed, Europe's
position on American securities is an influence of dominating

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

This matter of maturing investments, alone, calls for continuous
international security trading and on a large scale. Each year there
comes due in this country an amount of railroad and other bonds running
well up into the hundreds of millions, of which a large proportion are
held on the other side. Some of these maturities are paid off in
cash--more often, refunding bonds are offered in exchange; seldom,
indeed, are the maturing investments allowed to remain unreplaced.
European investors, especially, have consistently done well with money
placed in this country, and the running off to maturity of a
foreign-held American bond is nearly sure to be followed up by
replacement with some other American security.

Bond houses doing an international business are therefore keenly
watchful of the maturity of issues largely held abroad, and are ever
ready with offers of new and attractive investments. Knowledge of the
location of American investments in Europe is thus a business asset of
the greatest importance, and records are carefully kept. The fact that
a dealer here knows that some bank in London has a wealthy client who
holds a big block of certain bonds about to mature, may very possibly
mean that the house here may be able to make a very profitable trade.
Information of this character is carefully gathered wherever possible
and as carefully guarded. The longer a house has been in business,
naturally, and the closer its financial relationship with investment
interests abroad, the more of this sort of information it is bound to

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

Of a somewhat different character are the foreign exchange transactions
originating from what might be called Europe's "floating" investment in
American securities and from the out-and-out speculations carried on in
this market by the foreigners.

There is never a time, probably, when the floating foreign investment
in American stocks and bonds does not run up with the hundreds of
millions of dollars. "Speculation," such operations would probably be
called by many people, but whether speculation or not, a form of
activity which is continually giving rise to big dealings in foreign
exchange. For this "floating" investment is very largely for account of
bankers whose international connections and credit make it possible for
them to carry stocks and bonds through the agency of the exchange
market, and without having to put up any actual money. The ingenious
method by which this is accomplished is about as follows:

A banker here, for instance, decides that a certain low-priced bond is
cheap and that if purchased it will show a substantial profit within
six months or a year. Not wanting to buy the bonds and borrow on them
here, he invites his foreign correspondent into the deal on joint
account, arranging to raise the money with which to buy the bonds by
drawing a ninety-day sight draft on the foreign correspondent. This he
does, drawing, say, a £50,000 draft at ninety days' sight, and selling
it in the exchange market at, let us say, $4.83.

The $241,500 received from the sale of the draft, the American banker
uses to buy the bonds. Ninety days later the draft will come due in
London, and have to be covered (or renewed) from this side, but in the
meantime, a profitable chance to sell the bonds may present itself. If
not, the draft can be "renewed" at the end of the ninety days, and
again and again if necessary, until the bankers are willing to close
out the bonds.

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

The original draft for £50,000 comes due let us say on October 19, so
that about October 10th the New York banker will be under the necessity
of sending over to London a demand draft for £50,000. The rate
realizable for ninety-day drafts being always considerably lower than
the price of demand drafts, it follows that if the banker proposes to
buy £50,000 of demand out of the proceeds of a fresh ninety-day bill he
will have to draw his fresh bill for more than £50,000. If the demand
rate happened to be 4.86, the £50,000 he needs would cost him $243,000.
In order to raise $243,000 by selling a ninety-days' sight draft (say
at 4.83) he would have to make the new draft for £50,310. The extra
£310 would constitute the interest. Each time he renewed the draft he
would have to draw for more and more.

Requiring the tying up of no actual capital, this form of financing
"floating investments" has become exceedingly popular and is carried on
on a large scale. Where the relationships between the foreign and the
American houses are close, there is almost no limit to the number of
times an original bill may be renewed. As for the constantly increasing
amount of the drafts which have to be drawn, that is taken care of by
the interest on the investment carried.

Not all the floating investment in American securities is carried in
this way, but in whatever form the financing is done it is bound to
involve foreign exchange operations and to necessitate the drawing of
drafts by banking houses in this country on their correspondents
abroad. Quiet conditions may result in long periods when investments of
this kind are left undisturbed, but even then, the constant remitting
and renewing of drafts originates a good deal of exchange market
activity. And with considerable frequency occur periods when the
floating investment is strongly affected by immediate conditions, and
when purchases, sales, and transfers of securities stir the exchange
market to a high pitch of excitement.

Speculative operations in this market for foreign account, are,
however, the cause of the greatest amount of exchange market activity
caused by international security transactions. There are times, as has
been said, when individuals and banking houses abroad speculate heavily
and continuously in this market, at which times the exchange market is
strongly affected by the buying and selling of exchange which
necessarily takes place. Such periods may last for weeks or even
months, and during all of the time, London's immediate attitude toward
the market is apt to be the controlling influence on the movement of
exchange rates.

Concerning arbitraging in stocks, operations of this kind will be found
to divide themselves readily into two classes--trades which are closed
off at both ends at once, and trades which are allowed to run over
night or even for a day or two. The former is a class of business out
of which a dozen or twenty well-equipped houses in New York are making
a great deal of money. With an expert "at the rail" on the floor of the
New York Stock Exchange, and continuous quotations as to prices on the
various stock exchanges in Europe coming in, these houses are in a
position to take advantage of the slightest disparity in prices. The
chance to buy a hundred shares of some stock, in London, for instance,
and to sell it out at the same time in New York, at one-eighth or
one-quarter more, is what the arbitrageurs are constantly on the
lookout for. With the proper facilities, an expert, in the course of
the hour during which the London and New York Stock Exchanges are
simultaneously in session, is often able to put through a number of
profitable trades.

Such operations are possible, primarily, because of the fact that the
same influences affect different markets in different ways. A piece of
news which might cause a little selling of some stock in London, for
instance, might have exactly the opposite effect in New York. With the
wires continually hot between the two markets and a number of experts
on the watch for the chance to make a fraction, quotations here and
abroad can hardly get very far apart, at least in the active issues,
but occasionally, it does happen that the arbitrageur is able to take
advantage of a substantial difference. Always without risk, the bid in
one market being in hand before the stock is bought in the other

But not so in the case of the other kind of arbitrage, where stocks
bought in one market are carried over night for the sake of selling
them out in some other market the next morning. There a decided risk is
taken, the success of the operation depending absolutely upon the
judgment of the operator. Under the stimulus of some favorable
development, for instance, which becomes known here only after the
Stock Exchanges abroad are closed for the day, the New York market
closes buoyant. The chances are that the receipt of the news abroad
over night will make the London market open up strong in the morning.
To buy stock right at the closing of the market here for the purpose of
selling it out next morning in London at the opening is an operation
not without risk, but one which is likely to make money. A lower
opening abroad would, of course, spoil the whole plan, and force a
loss, but just there comes in the ability and judgment of the man who
is handling the business. His judgment need by no means be infallible
for the house to make a great deal of money.

Concerning arbitraging in bonds, practically everything depends not
only on the judgment and skill, but on the facilities and connections
of the man in charge. In the great "open" market in New York and in the
great "open" market in London, American bonds are being continually bid
for and offered in a way which gives an expert in touch with both
markets a chance to buy here and sell there, or vice versa, at a
profit. Such men are employed by bond houses with international
connections, and spend their time doing practically nothing else but
keeping in close touch with open market bids and offers for stocks and
bonds and trying to buy in one market and sell in another. Such trades
are frequently put through on a very profitable basis, profits of a
clear point or more being not at all uncommon.

As for the degree of risk to be taken in business of this kind, that is
entirely at the discretion of the arbitrageur. Where a firm bid of
ninety-nine, good for the day, for instance, is given, there is no risk
in cabling a bid of ninety-eight to London, but where the bid is not
firm at all, or where it is only firm for five minutes, or in many
other cases, the man who cables his own bid of ninety-eight is taking a
certain amount of risk. Often enough he gets the bonds in London at
ninety-eight, only to find that the ninety-nine bid in New York has
been withdrawn.

Knowledge of what risks to take and of what risks to leave alone
constitutes expertness in this line of business. Seldom can the
transaction be absolutely closed at both ends and any substantial
profit be made. Most of the time the correctness of the bond expert's
judgment as to how he can sell somewhere else what he has bought, is
what determines the amount of money he will make or lose.



Interesting as the movement of gold and the international money markets
may be, it is in its application to the every-day importing and
exporting of merchandise that foreign exchange has its greatest
interest for the greatest number of people. Every bale of cotton
exported from the country, every pound of coffee brought in, is the
basis of an operation in foreign exchange, such operations involving
usually the issue of what is known as "commercial credits."

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

Not all the merchandise imported into the United States is brought in
under commercial letters of credit, but that is coming to be more and
more the way in which payment for imports is being arranged. Formerly
an importer who had bought silk or white-goods in France went around to
his banker, bought a draft on Paris for the required amount of francs
and sent that over in payment. In some cases that is still the method
by which payment is made, but in the very great majority of cases where
the business is being run on an up-to-date basis, a commercial letter
of credit is arranged for before the importation is made. Of how great
advantage such an arrangement is to the merchant importing goods the
following practical illustration of how a "credit" works will show.

[Illustration: Form of Commercial Letter of Credit]

To exemplify the greatest number of points of importance possible in
connection with the commercial credit business, the case of a shipment
of raw silk from China will, perhaps, serve best. A silk manufacturer
in Paterson, New Jersey, we will assume, has purchased by cable ten
bales of raw silk in Canton, China. Understanding of the successive
steps in the financing of such a transaction will mean a pretty
satisfactory understanding of the general principles under which the
financing of most of our imports is arranged.

The purchase of the silk having been consummated by cable, the first
thing the purchaser would do would be to go to his banker in New York,
lay before him an exact statement of the conditions under which the
purchase was made, and get him (the banker) to open a commercial letter
of credit covering those terms. Such a credit, of which a reprint is
given herewith, would be in the form of a letter to the issuing
banker's London correspondent, requesting him to "accept" the drafts of
the sellers of the silk in Canton up to a certain amount and under
certain conditions. These conditions, having to do with the "usance" of
the drafts (whether they were to be drawn at three, four, or six
months' sight) and with the shipping documents to accompany the drafts,
are all very fully set forth in the letter of credit itself. If the
silk has been bought on the basis of four months, for instance, the
credit would read that drafts are to be drawn at four months' sight.
Mention is also made as to whose order the bills of lading are to be
made, as to where the insurance is to be effected, etc., etc.

The silk importer having received this letter of credit from the banker
in New York, sends it by first mail (or, if the case be urgent, cables
its contents) to the seller of the silk out in Canton. The latter,
having received it, is then in a position to go ahead with his
shipment. The first thing he does is to put the silk aboard ship,
receiving from the steamship company a receipt (bill of lading) stating
that the ten bales have been put aboard, and making them deliverable
_to the order of the banker in New York_, who issues the credit. The
bill of lading being made out to his order is useless to anybody else.
He and he only can get the silk out of the ship when it arrives in New

The shipper in Canton having received this bill of lading from the
steamship company and having properly insured the goods and received a
certificate stating that he has done so, is then in a position to go
ahead and draw his draft for the cost of the silk. The London
correspondent of the New York banker, to whom the letter of credit is
addressed, is, say, the Guaranty Trust Company of London. Upon that
institution the Canton silk firm, therefore, draws his draft in pounds
sterling for the cost of the silk, attaching to the draft the bill of
lading, an invoice, and the insurance certificate.

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

Assume now that the silk has been put aboard ship bound for the United
States, that the shipper has drawn, say, a draft for £1,000 at four
months' sight on the Guaranty Trust Co., London, and has attached
thereto the bill of lading and the insurance certificate. Taking this
draft around to his bank the shipper sells it for local currency at the
then prevailing rate for four months' sight drafts drawn on London. The
fact that it is drawn at four months' sight means that he will get a
lower rate of exchange for it than if it were drawn payable on demand,
but that was the arrangement with the buyer in New York--that the
drafts against the silk were to have four months to run.

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

The silk has now been set afloat for New York, and the draft purchased
by the Canton banker is on its way to London for acceptance. Long
before the silk gets to New York the draft will have reached London and
will have been presented to the cashier of the Guaranty Trust Co.,
there, who, of course, was apprised of the credit opened on his bank at
the time such credit was originally issued in New York. Examining the
draft and the documents carefully to see that they conform with the
terms of the credit, the cashier of the Guaranty Trust Co., London,
formally "accepts" the draft, marking it payable four months from the
date it was presented to him. The accepted draft he hands back to the
messenger of the bank who brought it in; the bill of lading, insurance
certificate, and invoice he keeps. By the next mail steamer he
dispatches these papers to the banker in New York who issued the

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

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

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

A number of different agreements exist between bankers and importers to
whom the bankers issue credits, as to the terms on which the importers
are to be allowed to take possession of the merchandise when it arrives
here. Sometimes the goods are put into store and handed over to the
merchant only when he shows that he has sold them and needs them to
make delivery. Sometimes they are warehoused at once, and parcelled out
to the importer only in small lots, as he needs them. But more often
the goods are delivered over to the importer on his signing one form or
other of what is known as a "trust receipt."

[Illustration: Form of Trust Receipt]

[Illustration: Form of Bailee Receipt]

Such difference of opinion exists among foreign exchange men as to the
goodness of the trust receipt system that the author refrains from
making comment on it, confining himself strictly to description of what
the system is. As will be seen from the accompanying reprint of the
trust receipt used by one of the largest issuers of commercial credits
in the country, the document is simply a pledge on the part of the
importer to hold the merchandise in trust for the banker, and, as the
merchandise is sold, to hand over the proceeds to apply against the
draft drawn by the shipper of the goods. The theory of the thing is
that by the time all the merchandise has been sold more than enough
money will have been handed over to the New York banker to take care of
the draft accepted by his London correspondent, the excess constituting
the importer's profit.

The kind of trust receipt under which bankers are willing to give over
the merchandise (the only collateral they have) naturally varies
according to the standing of the house in question. In the case of some
importers the bankers would be willing to let the bill of lading pass
out of their hands on almost any kind of a receipt; in the case of
others a very strict and binding contract is invariably signed. But
whatever the form of the contract, it is to be borne in mind that when
the banker issuing the credit hands over the bill of lading to the
importer on trust receipt, he is allowing the only security he has to
pass out of his hands, and is putting himself in the position of having
made an unsecured loan to the importer.

Returning now to the particular transaction in question, the point has
been reached where the silk is in the importer's hands, that result
having been accomplished without the importer having put up a cent of
money. Moreover, for nearly four months to come there will be no
necessity of the importer's putting up any money (unless he should sell
some of the silk, in which case he is bound to turn over the money to
the New York banker as a "prepayment"). But in the ordinary course of
events the importer of the silk has nearly the four full months in
which to fabricate the goods and sell them. At the end of that time the
draft drawn by the firm in Canton and accepted by the Guaranty Trust
Co., London, will be coming due, and the silk importer will be under
the necessity of remitting funds to meet it. Twelve days before the
actual maturity of the £1,000 draft in London, the New York banker will
send to the manufacturer in Paterson a memorandum for £1,000 at, say,
4.86 (whatever is the current rate) plus commission. The silk firm pays
in dollars; the New York banker uses the dollars to buy a demand draft
for £1,000; a day or two before the four months' sight draft comes due
in London this demand draft ("cover") is received in London from New
York, and the whole operation is closed.

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

The whole purpose of the business, it is plain enough, is to give the
importer here a chance to bring in goods without putting up any actual
money--in other words, of letting him use a larger capital than he is
actually possessed of. There are persons so conservative as to consider
this in itself a wrong idea, but with business carried on along the
lines on which it is actually done nowadays, bank credits play so
important a part that conservatism of this order has little place.
Theory and practice prove that there is no reason why a silk importer,
for instance, with a capital of $100,000 should not be able to use
safely a credit of as much more than that, the standing and credit of
the firm being always the prime consideration. Granted that a
manufacturer stands well and is doing a safe, non-speculative business
on the basis of $100,000 capital, there is no reason why he should not
be able to secure an import credit for an additional £20,000. Not only
is there no reason why he should not get it, but there are any number
of good banking concerns only too glad to furnish it to him.

So much for the transaction from the importer's standpoint--what does
the seller of the goods get out of it? Payment for his goods as soon as
he is ready to ship them. No waiting for a remittance, no drawing of a
dollar-draft on an obscure firm in Paterson, N.J., which no Canton
bank will be willing to buy at any price. The credit constitutes
authority for the shipper to draw in pounds sterling on London--the one
kind of draft which he can always be sure of turning at once into local
currency and at the most favorable rate of exchange. He ships the
goods, he draws the draft, he sells the draft, he has his money, and he
is out of it. From the shipper's standpoint, surely a most satisfactory
arrangement and one which will induce him to quote the very best price
for merchandise.

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

Before proceeding with discussion of what commissions amount to, it is
well to note the fact that in those commercial credit transactions
neither banker is ever under the necessity of putting up a cent of
actual money. As in the case of foreign loans previously described, the
banker's credit and the banker's credit only is the basis of the whole
operation. The London bank never pays out any actual cash--it merely
"_accepts_" a four months' sight draft, knowing that before the draft
comes due and is presented at its wicket for payment, "cover" will have
been provided from New York. The New York banker, on the other hand,
merely sends over on account of the maturing draft in London the money
he receives from the importer. He is under an obligation to the London
banker to see that the whole £1,000 is paid off before the four months
are over, but he knows the party to whom he issued the credit, and
knows that before that time all the silk will have been manufactured
and sold and the proceeds turned over to him. At no time is he out of
any actual cash.

That being the case, the amount of commission he charges is really very
moderate--one-quarter of one per cent. for each thirty days of the life
of drafts drawn under credits being the "full rate." Under such an
arrangement an importer taking a credit stipulating that the drafts are
to be drawn at thirty days' sight would have to pay one-quarter of one
per cent.; at sixty days' sight, one-half of one per cent.; at ninety
days' sight, three-quarters of one per cent., etc. Such commission to
be collected at the time the drafts drawn under the credits fall due.

These are the "full rates"--naturally, few importers are required to
pay them, _actual_ rates being largely a matter of individual
negotiation and standing. Where the drafts under the credits run for
ninety days, for instance, as in the case of coffee imported from
Brazil, the full rate would be three-quarters of one per cent., but
very few firms actually pay over three-eighths of one per cent.
Similarly with credits issued for the importation of merchandise of
almost every other kind. Silk credits, with drafts running four months,
ought at the regular rate to cost one per cent.; but as a matter of
fact there are any number of good houses willing to do the business for
five-eighths of one per cent. One large international bank in New York,
indeed, is going so far as to offer to issue credits under which drafts
run _six_ months for a commission of five-eighths of one per cent.
Such a commission is entirely inadequate and no fair compensation for
the trouble and risk the banker takes. It means little more than that
the bank is willing to take business at any price for advertising or
other purposes.

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

For purposes of illustration, the financing of the import of silk from
China was chosen because the operation embodied perhaps more points of
interest in connection with commercial credit business than any other
one operation. Commercial credit operations, however, are of great
variety and scope. They may involve, for instance, the import of
matting shipped from Japan on slow sailing ships and where the drafts
drawn run for six months or more, or they may involve the import of
dress goods from France, in which case the drafts are often at sight.
Furthermore, all credits are by no means issued on London. In the Far
East, where tea or shellac or silk is being exported to the United
States, London is known as the one great commercial and financial
center, but in the case of dress goods shipped from Marseilles or
Lyons, for instance, the credits would invariably stipulate that the
drafts be drawn in francs on Paris.

But whether the material imported be dress goods from France or tea
from China, the principle of the commercial credits under which the
goods are brought in remains identically the same. In every case there
is a buyer on this end who wants to get possession of the goods without
having to put up any money, and in every case there is a seller on the
other end who wants to receive payment as soon as he lets the
merchandise get out of his hands. The banker issuing the credit is
merely the intermediary, and the naming of some foreign point on which
the drafts are to be drawn is merely incidental to the conduct of the

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

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

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