Readings in Money and Banking Part 32

[110]It has been shown that, if two countries buy of each other to the same amount, their transactions need not give rise to two separate sets of bills, but that on the contrary, if the foreigner draws on us to the full value of his exports, the bills so created will be sent as remittances to the exporter on this side and will pay him for his sales.

Conversely, if the British exporter draws, there is no necessity for the other side to do so.

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

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

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

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

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

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

The same fact also supplies a reason for the solicitude with which the foreign trader watches the fluctuations of the exchange, and for the utter indifference with which they are regarded by the British trader.

To the former, who intends maybe to draw a few hundred pounds on London in a day or two against the s.h.i.+pment he is preparing, the difference between selling his draft next week instead of this may mean, if the rate should move in his favor, the gain of an additional half per cent.; but to our home manufacturers, who sell their wares in sterling and stipulate for payment in bills on London, the see-saw of rates is but of academic interest. They pay attention to the _course of discount_, because they may have to melt some of their paper before pay-day comes round; but the course of the exchange--the question of the rate rising or falling--hardly concerns them at all.

It is not sought to detract from the influence of the English-drawn foreign bill, or, as might be imagined, to explain it away altogether.

On the contrary, paper to a considerable amount is, and will continue to be, negotiated on the Royal Exchange (though the total, if compared with that of the paper on London negotiated abroad, would appear quite insignificant).[111] The object in view is merely to bring into prominence, and to impress on the reader, the essential principle that, while the position of every rate of exchange is the outcome of the market conditions _in the two countries combined_, the predominant ma.s.s of the dealings take place on the other side, so that, as a consequence, the real significance of the fluctuations can only be grasped by viewing them from the foreign [_e. g._, American] standpoint.

THE RECENT RISE OF THE AMERICAN ACCEPTANCE MARKET

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

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

Bank acceptances were not known in this country prior to the operation of the Federal Reserve Act. For the benefit of those who may not be familiar with bank acceptances, I will briefly describe an operation giving rise to such acceptances. Jones, an importer of coffee in New York, desires to purchase a cargo of coffee in Rio de Janeiro. He goes to his bank in New York and arranges with them to finance the deal.

Smith, the grower of the coffee in Brazil, makes the s.h.i.+pment to New York and draws a ninety days' sight draft on the New York bank for the amount of his invoice. This draft he then sells to some Brazilian bank.... The Brazilian bank then sends the draft to New York. It is there presented to the New York bank for acceptance. The New York bank accepts the draft by writing the word "accepted" across the face of the draft and affixing its official signature thereto. The draft now becomes the primary obligation of the New York bank. Of course, Jones, for whose account the New York bank accepted the draft, has obligated himself to provide the New York bank with funds to meet the draft, but if he should fail to do so the New York bank must pay the acceptance nevertheless. It is, therefore, the direct obligation of the New York bank, and as such it commands the best discount rates current. This briefly is what is known as a bank acceptance, _i. e._, a draft drawn on and accepted by a prime bank or banker.

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

THE ECONOMIES AND ADVANTAGES OF "DOLLAR CREDITS"[113]

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

Our imports in the way of commodities such as hides, coffee, rubber, wool, etc., etc., run into hundreds of millions of dollars annually, and these are financed generally through the medium of commercial credits established by the purchaser in favor of the vendor of the merchandise.

Commercial credits, so called, are in effect a bank guarantee to the seller that his drafts covering certain merchandise, when drawn in accordance with the conditions prescribed in the credit, will meet with due honor on presentation to the accepting bank named in the credit instrument.

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

Hides and skins $120,289,781.00 Coffee 110,725,392.00 Rubber 131,995,742.00 Wool (unmanufactured) 53,190,767.00

Prior to the outbreak of the war in Europe, it is safe to a.s.sume that fully 95 per cent. of the credits issued to cover these importations were pa.s.sed through London in the form of sterling credits; that is to say, credits available by drafts drawn in pounds sterling on London.

Requests for the issuance of credits available by drafts drawn in United States dollars on New York were extremely rare, and they were issued only in exceptional cases.

Conditions have changed materially in this respect. The Federal Reserve Act grants to national banks the privilege of accepting drafts or bills of exchange growing out of transactions involving the importation or exportation of goods. This acceptance privilege was accorded to national banks only a short time before the commencement of hostilities abroad, and this fact in conjunction with the resulting dislocation in the delicate machinery of international credit brought about by the war, together with the coincidental establishment of American branch banks in South America, has contributed in a large measure to bring about the use of what is known now as "Dollar Credits."

As a factor in creating the existing demand for Dollar Credits, the establishment of American branch banks abroad cannot be emphasized too strongly. Through these branch banks, a new and adequate medium for the liquidation of transactions as between the United States and certain South American countries, especially the Argentine, Brazil, and Uruguay, has been placed at the disposal of our merchants. A direct channel is now open to the ebb and flow of credit transfer between the United States and the countries mentioned, and, as a natural sequence, the former disparity existing against the dollar, as compared with pounds sterling and the princ.i.p.al continental exchanges, has disappeared. The resulting equalization in the rates of exchange benefits the American merchant to the extent of relieving him of the tribute formerly paid to the indirect channels of liquidation, or, in other words, to the foreign banker.

The Dollar Credit is of capital importance to every American merchant who is interested either directly or indirectly in the importation of commodities of any character. A study of the advantages accruing from this form of credit will demonstrate the desirability of its general employment as the vehicle for financing not only our own imports but also those of other countries. Primarily, it is more economical than the Sterling or Continental Credit, for the initial commission cost of issuance is lower. Secondly, it is based on a known quant.i.ty, the dollar, a factor of supreme importance in these days of extreme and violent fluctuations in the exchange rates, and therefore all exchange risk is eliminated from the operation as far as the importer is concerned. Maturities drawn under Dollar Credits are due and payable in dollars on a given date, and no question arises as to what the exchange rate on London may be ninety days after acceptance of the bill.

Under existing conditions in the New York money market, and considering the present low rates of interest actually in effect, the use of Dollar Credits is proving to be particularly attractive to the American importer as the medium for financing his importations. The rate of discount in New York for prime bank acceptances is [email protected]/4 per cent.

per annum, and a broad, well-developed discount market now exists, with an ever-increasing demand in evidence for this cla.s.s of paper. On the other hand, the rate of discount in London for prime ninety-day bills is 4-3/4 per cent. per annum, with operations restricted in a far from normal market. A comparison of these two discount rates will show a difference in favor of New York of [email protected]/8 per cent. per annum. In addition to this difference in interest, there is also a difference in the initial cost in the form of commission for issuance, as between credits available by ninety-day drafts drawn on New York in dollars and those available by ninety-day drafts drawn on London in pounds sterling.

This difference in commission in favor of New York will average 1/2 per cent. per annum, and when added to the saving in discount or interest already noted, will show a net saving on the Dollar Credit of /8 per cent. per annum, which accrues to the importer through the use of Dollar Credits in his operations.

Quite apart from the direct economy to the individual resulting from the use of Dollar Credits, is the broader question of the economic value accruing to the nation as a whole through the designation of the dollar as the basis of value in our credit transactions with the rest of the world. Since 1903, when the total of our imports amounted to $1,025,719,237, the volume of our imports has increased rapidly, and in 1914, the total imports reached the enormous sum of $1,893,925,657.

These figures cover products from all parts of the world s.h.i.+pped direct to our own sh.o.r.es, and while no nation enjoys higher international credit than the United States, yet it is a fact that in order to finance the movement of our imports we have been compelled to have recourse to indirect channels and call on foreign money centers to furnish us with the necessary credit facilities to take care of a large part of our importations. Naturally, we have been obliged to pay for this accommodation, and the service has cost us millions of dollars annually in interest, commissions, etc.

These charges can be saved and an important economy effected, thus benefiting our commerce as a whole by the general designation of dollars in our foreign credit transactions. The purchasing power of the dollar in foreign markets is much greater to-day than it is in normal times because of the varying premium which the dollar commands at present practically throughout the world. The time is unquestionably opportune to increase the prestige of the dollar and to standardize its use in the liquidation of our direct purchases abroad. Co-operation and concerted action on the part of our merchants to the end of generalizing the use of Dollar Credits is therefore a duty, which will bring about lasting benefit to the economic fabric of our commerce.

THE NEW YORK FOREIGN EXCHANGE MARKET[114]

A market may be defined as the coming together of buyers and sellers. It therefore involves all the mechanism necessary to facilitate their intercourse. One may speak of a general market or of a local market, of a market in one or in another place. Thus, there is the New York market for the buying and selling of exchange on London. A bank in New Haven, Connecticut, may be a part of that market if it buys from and sells to it. That market includes, besides the commercial and industrial organizations which buy or sell drafts, all middlemen of whatever cla.s.s who engage in the trade.

The middlemen may be divided roughly into three cla.s.ses. First may be mentioned banks which do a regular foreign exchange business, buying bills from those who have them to sell and selling their own drafts on foreign correspondents to persons desiring to remit. Much of this business is done by foreign exchange banks which carry on little or no other business. Some of it is done by ordinary commercial banks, such as United States National Banks, in addition to their other banking business. Second, we may call attention to those exchange dealers whose princ.i.p.al business is to buy commercial and bankers' bills, and to resell them, chiefly to banks. Third are the independent brokers who make small commissions by bringing buyers and sellers together. These do not invest their own capital, do not, that is, buy bills of exchange in the market, but a.s.sist those desiring to sell bills to find buyers, and _vice versa_....

NEW YORK CITY PRACTICALLY ABSORBS BY PURCHASE ALL AMERICAN FOREIGN EXCHANGE

[115]There is, perhaps, no feature pertaining to banking throughout the country so dependent upon New York financiers, as foreign exchange. The very foundation of this branch of banking is constructed by the New York bankers, and from their banking houses emanate the basic prices and quotations upon which foreign bills are bought and sold throughout the United States.

It is the custom of New York foreign exchange brokers to furnish their Western clients, direct, or through their local representatives, daily market quotations, and to promptly advise them of fluctuations throughout the day. So closely is the West allied to the East, in this respect, that any interruption caused by delayed or suspended telegraphic service, immediately superinduces a practical standstill of exchange transactions, and operations thereafter must necessarily be made in the "dark" until free communication is again renewed between the cities....

The absorptive power of the New York market, to digest not only the surplus foreign exchange of the Chicago market, but that of the entire United States as well, has been demonstrated for many years. The reason for this can be attributed to the fact that international trade balances are at the present day, and always will be, adjusted by the financiers of New York City.

HOW MONEY IS MADE IN FOREIGN EXCHANGE--THE OPERATIONS OF THE FOREIGN DEPARTMENT

[116]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.

I. 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 ill.u.s.trates the principle. For whether the banker sends over in every mail a bewildering a.s.sortment of every conceivable form of foreign exchange to be credited to his account abroad, or whether he confines himself to remittances of the simplest kind 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 centres on which deposit account the bank here is in a position to draw according to the wants and needs of its customers.

II. SELLING CABLES AGAINST DEMAND EXCHANGE

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."

Under ordinary circ.u.mstances foreign exchange dealers who engage in the business of selling cables carry adequate balances on the other side, balances which they keep replenis.h.i.+ng by continuous remittances of demand exchange.

III. SELLING "DEMAND" BILLS AGAINST REMITTANCES OF LONG BILLS