The Theory of the Foreign Exchanges/Chapter I

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order to clear the ground for the consideration of the more interesting theories connected with the Foreign Exchanges, it is desirable in the first instance to define as clearly as possible the general meaning of the term. The phrase "Foreign Exchanges" is in itself vague and ambiguous, being more frequently used to express the rates at which the exchanges in question are effected than the exchanges themselves-the prices rather than the transactions. When it is said in technical phraseology that the exchanges are effected than the exchanges themselves - the prices rather than the transactions. When it is said in technical phraseology that the exchanges are rising or falling, or that the exchanges are at specie point, allusion is made to the fluctuations in the terms on which bargains are made between the buyers and sellers of Foreign Bills. However, before we treat the subject in this sense of the phrase, -that is to say, as denoting the rates at which exchanges take place, -it is necessary to examine the subject-matter of the exchange itself and to realize distinctly what it is that is bought or sold, transferred or given in exchange. When the transaction takes a practical form, Foreign Bills, -that is to say, bills on foreign countries, -constitute this subject-matter; but a less technical explanation can be given. That which forms the subject of exchange is a debt owing by a foreigner and payable in his own country, which is transferred by the creditor or claimant for a certain sum of money to a third person, who desires to receive money in that foreign country, probably in order to assign it over to a fourth person in the same place, to whom he in his turn may be indebted. The operation which takes place is put very clearly by Mr. Mill in the following passage:-

"A merchant in England, A, has exported English commodities, consigning them to his correspondent B in France. Another merchant in France, C, has exported French commodities, suppose of equivalent value, to a merchant D in England.  It is evidently unnecessary that B in France should send money to A in England, and that D in England should send an equal sum of money to C in France.  The one debt may be applied to the payment of the other, and the double cost and risk of carriage be thus saved.  A draws a bill on B for the amount which B owes to him; D having an equal amount to pay in France buys this bill from A and send it to C, who, at the expiration of the number of days which the bill has to run, presents it to B for payment.  Thus the debt due from France to England, and debt due from England to France, are both paid without sending an ounce of gold or silver from one country to the other."*

This explanation, however, involves the idea of the transaction being carried out by the intrumentality of an actual bill of exchange, which, at the present stage of the inquiry, it is better to ignore altogether. It will be found more convenient to treat the transaction, in the first instance, as a simple exchange of debts and claims without considering the instruments by which it is accomplished. IN its most general form, the case may be stated as follows:-

As the result of international commerce, a certain portion of the community has become indebted to

merchants in foreign countries; and in order to save the trouble, risk, and expense of sending coin, they seek out another portion of the community to whom a similar amount is owing by the identical foreign countries in question, and buys up these debts, assign them over in payment to their own foreign creditors. And if the aggregate sums owing by any two countries to each other were absolutely equal, -that is to say, equal in amount, equal in security, equal in the time when the debts become due, and equal in the proportion which the coin in which these debts are payable bears to the circulation of the respective country, -there would be no difficulty of any kind in determining the equivalent which the purchasers of such claims would pay to the sellers. It would simple be a sum equal to that which is payable abroad under the transferred claims. The amount required by the purchasers would be exactly equal to the amount held by the sellers; thus there would be no cause in operation to vary the price, and there would be no fluctuations in the rates of Foreign Exchanges. In technical language, they would always remain at par. But, conversely, we arrive at the point which forms the essence of the present discussion: the fluctuations which actually take place in the Foreign Exchanges are in the first instance the result, and in the second, the manifestation, of the inequalities which exist in the debts of different countries to each other, in the amount of such debts, in the time within which these debts must be paid, and in the relation of the currency of one country to that of another.

It might have seemed easier to have explained the exchanges in question as the exchanges between different currencies, as of sovereigns against francs, or of florins against dollars; the more so, as practically this is the shape which actual transactions almost invariably assume. But by confining the definition to these cases, a most important, and indeed essential, feature would have been overlooked; that is to say, that though one system of coinage were adopted for all countries, claims on foreign countries would nevertheless vary in price, and would still be either at a premium or at a discount, according as there happened to be at any moment more persons desiring to transmit funds abroad than such as had outstandings abroad which they were entitled to draw in. For this is the first cause of what is generally spoken of as the rise and fall of Foreign Exchanges. On the particular day, or through a given season, a large amount is required to be sent abroad in payment of debts; England, let us say, is heavily indebted to France, and the time has arrived for payment. At this time, however, it happens that in the opposite branch of trade, that which results in France being indebted to England, fewer transactions have taken place, and thus there are comparatively few who have accounts standing to their credit in Paris which they might transfer to those who have to remit; in other words, adopting the language of merchants, there are few who have bills upon France. The consequence is, that there is great competition for these few bills; those who do not bid high enough for them will either have to go through all the trouble of packing, insuring, and despatching gold, or else will not punctually meet their engagements. Thus those who have the bills to sell are able to obtain more than the actual par value for them; for, in consideration of their having a given sum already at a spot where another wishes to have it, and whither he will have to convey it himself at some expense if they do not cede it to him, they are able to secure for themselves the whole of the benefit, which, if the exchanges were at par (that is to say, if the indebtedness of the two countries were equal), would be divided between the buyer and the seller. Instead of the arrangement being a mutual convenience, the seller is able, by the competition of the buyers, to secure the whole convenience to himself.

Supply and demand, in their usual form, determine this part of the transaction. Bills on France would in this case be at a premium. It is needless to draw out the opposite case, in which, there being more person who had money to claim from France than those who required to send funds thither, bills on France would be at a discount. This is the first and most elementary phase in which the Foreign Exchanges can appear; and for the purpose of appreciating the most important lessons which can be derived from their study, it is better to discard the idea of the exchange taken place between different sorts of money, and to hold fast to the general principle that what is really given in exchange in the natural and simple transactions from which all others are derived, is a sum of money at one place for an equivalent sum of money at another. By way of anticipation it might, however, be stated here, that in contradistinction to this simples transaction, the most complicated would be one in which the sum of money given would be payable immediately, the equivalent recoverable three months later; the sum given be in gold, the equivalent in silver; the sum given be perfectly undoubted, being paid down at once, the equivalent be of doubtful character, because involving a lengthened credit. To establish the equality between the two sums, it would accordingly be necessary to take into consideration the relative value at the time of gold to silver, the amount of interest which would be lost by waiting three months, and the amount of risk which would be run by receiving a piece of paper representing a promise to pay three months hence in exchange for cash paid down. These are all considerations which affect the exchanges, and which indeed render the subject so complicated that the groundwork may easily be lost sight of. Discussions are sometimes held on the state of the Foreign Exchanges in which attention is paid mainly to the value of money in different countries, to the amount of bullion held by each, and to the relative position of their paper currency, -points, no doubt, of the highest moment in determining the fluctuations in the exchanges, but not entitled to exclude the first and leading feature, their relative indebtedness. In studying the subject as a whole it is above all things necessary to form a clear view of what is meant by international indebtedness, of the elements of which it is constituted, and the various phenomena which it presents. As soon as this elementary question which underlies the whole theory of the Foreign Exchanges is properly understood, and an idea has been gained of the various modes in which countries become indebted to one another, we shall proceed to consider the form which this indebtedness assumes when the time of settlement arrives and when the floating debt is fixed in bills of exchange. The course of the discussion will then naturally lead to the nature and form of these bills of exchange, to their purchase and sale, to the various influences which determine their price, to their frequent fluctuations, to the meaning and force of the term that the Foreign Exchanges are favourable or adverse, and to the value of the state of the exchanges as an index of international transactions. We shall first consider the debts themselves, and shall find them finally represented by, and embodied in, a constant mass of bill of exchange; it will then be necessary to inquire whether these bills are payable at once, or at fixed future terms, whether they represent a final transaction or whether a portion only of a commercial operation, and how the rate of interest, the credit of the debtors, the indulgence of the creditors, the depreciation of the currency in which the bills are payable, affect their exchange-ability. We shall examine what circumstances lead to a demand for bills on foreign countries, and how it is possible to check or intensify that demand. Thus, at the close of our investigation, we shall light on many of the most important questions which have lately been ventilated in monetary circles, -as to the possibility of checking the efflux of gold by a high rate of interest as to the power which foreign capitalists, holders of bills of exchange on England, may exert over our money-market, as to the effect of these bills being all forced upon the money-market for discount at once instead of being gradually encashed as they mature, and other matters of this nature; questions which are by no means theoretical or abstract, but of vital and practical importance to every one engaged in mercantile pursuits.