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Updated: 2017-12-06 00:03

It is quite in order that we should follow lessons on the clearing-house and commercial drafts with a lesson on foreign exchange.

We learned in the last lesson that commercial drafts are made use of to facilitate the collection of accounts. They are simply formal demands for the payment of legitimate debts. When these formal demands are made upon foreign debtors they are called bills of exchange; and the process of buying and selling these drafts, the drafts themselves, and the fluctuations in price, all are included in the general name exchange.

Foreign exchange.

To illustrate the principles of exchange let us suppose that the following transactions have occurred:

C of Boston has sold goods, £2000, to H of Hamburg.

D of Chicago has sold goods, £5000, to F of Glasgow.

M of Chicago has sold goods, £3000, to K of London.

E of Philadelphia has sold goods, £6000, to R of Paris.

P of New York has sold goods, £1000, to G of Paris.

C draws on H for £2000, sells the draft to a banking-house in Boston; they send to Bank A of New York, and the New York bank to their London correspondent, say Bank B, with instructions to collect from Hamburg.

D draws in a similar way on F. E draws on R, and P on G. Suppose that M instead of drawing on K receives a draft drawn by Bank B of London on Bank A of New York, payable to M's order.

America has sold goods worth £17,000 to Europe.

Europe . . . . . . owes £17,000 to . . . . . America

But B has paid A £3000.


B . . . . . . therefore owes £14,000 to . . . . . . A

Now it will cost B a considerable sum of money to ship £14,000 in gold to A, for all exchanges between Europe and America are payable in gold. Suppose that S of New York owes T of London £14,000, and T draws on S and takes the draft to Bank B in London and offers it for sale. Will B offer more or less than £14,000 for the bill of exchange or draft? He will offer more. It will be cheaper for him to pay a premium for the draft than to ship gold, for he can send this draft to Bank A to pay his indebtedness, and A can collect from S.

In the money market in New York there is a constant supply of exchanges (drafts) on London, and in London a constant supply of exchanges on New York.

Experience has shown that at all times the number of persons in Europe indebted to American business houses is about (though of course not actually) the same as the number of persons in America indebted to European houses. Hence when A of New York wishes to make a payment to B of London he does not send the actual money, but goes into the market-that is, to a banker doing a foreign business-and buys a draft, called a bill of exchange, which is in reality the banker's order on his London correspondent, asking the latter to pay the money to the person named. It may be that about the same time some London merchant who owes money in New York goes to the very same London banker and buys a draft on the New York bank. In this way the one draft cancels the other, and when there is a difference at the end of the week or month the actual gold is sent across to balance the account.

These exchanges have a sort of commodity value, and like all commodities, depend upon the law of supply and demand. When gold is being shipped abroad we say that the balance of trade is against us-that is, we are buying more from Europe than Europe is buying from us, and t

he gold is shipped to pay the balance or difference.

The par of the currency of any two countries means, among merchants, the equivalency of a certain amount of the (coin) currency of the one in the (coin) currency of the other, supposing the currencies of both to be of the precise weight and purity fixed by the respective mints. The par of exchange between Great Britain and the United States is 4.862?3; that is, £1 sterling is worth $4.862?3. Exchange is quoted daily in New York and other city papers at 4.87, 4.88, 4.88?, etc., for sight bills and at a higher rate for sixty-day bills. Business men who are accustomed to watching fluctuations in exchange rates use the quotations as a sort of barometer to foretell trade conditions. The imports and exports of bullion (uncoined gold) are the real test of exchange. If bullion is stationary, flowing neither into nor out of a country, its exchanges may be truly said to be at par; and on the other hand, if bullion is being exported from a country, it is a proof that the exchange is against it; and conversely if there be large importations.

The cost of conveying bullion from one country to another forms the limit within which the rise and fall of the real exchange between them must be confined. If, for illustration, a New York merchant owes a debt in London and exchange costs him, say, two per cent., and the cost of shipping the gold is only one per cent., it will be to his advantage to pay the debt by sending the actual coin across. A favourable real exchange operates as a duty on exportation and as a bounty on importation.

A bill of exchange (private).

It is to the interest of merchants or bankers who deal in foreign bills to buy them where they are the cheapest and to sell them where they are the dearest. For this reason it might often be an advantage for a New York merchant to buy a bill on London to pay a debt in Paris.

A bill of exchange (banker's).

Two illustrations of bills of exchange are given in this lesson. Each is drawn in duplicate. The original is sold or sent abroad, while the duplicate is preserved as a safeguard against the loss of the original. When one is paid the other is of no value. Notice the similarity between bills of exchange as shown here and commercial drafts as shown in our last lesson.

The first form shows a draft made by a coal company upon a steamship company to pay for coal supplied to a particular steamer. Suppose that the steamship company has a contract with Robert Hare Powel & Co. of Philadelphia to supply coal to their steamers. The steamer Cardiff, when in port at Philadelphia, is supplied; the bill is certified to by the engineer; the master (captain) of the vessel signs Powel & Co.'s draft (and in doing this really makes it the captain's draft); the bill is receipted. Now Powel & Co. sell this exchange (draft) on London to a broker or banker doing a foreign business. It is forwarded to London and presented in due time at the office of the Wales Navigation Company for payment.

The second form shows a bill of exchange drawn by a Philadelphia banking house upon a London banking house and payable to the order of the firm buying the draft. C. H. Bannerman & Co. will send this bill (the original) to pay an account in Europe. The first form bears the same relation to a commercial draft that the second does to a cashier's cheque.

First page of a letter of credit.

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