Money and the Mechanism of Exchange
Foreign Bills of Exchange
In early times foreign trade consisted in the direct exchange of commodities. A caravan set out with a variety of manufactured articles, across the deserts of Arabia or Sahara, and came back with the ivory, spices, and other valuable raw produce obtained by barter. In later times the merchant loaded his own ship and sent her forth on an adventure, trusting that his shipmaster would sell the cargo to advantage, and, with the proceeds, bring back another cargo to be sold to great profit at home. Trade was thus evidently reciprocal, and what was sent out paid for what was brought back, so that little or no money was kept idle in the mean time.
Wherever this direct reciprocal exchange did not exist it was necessary either to transmit metallic money, or to devise some mode of transferring debts. Now the transmission of money not only causes the loss of interest during the interval of transit, but leads to the expense of guarding it, and the liability of total loss. Many centuries ago accordingly, it was discovered that the use of paper documents would economize, if not altogether render needless, the use of metallic money in foreign trade.
Origin and Nature of Bills of Exchange.
Even the Romans appear to have been acquainted in a slight degree with the system of foreign bills of exchange; but it is to the early Italian, and especially the Jewish merchants, that we owe the development of the practice. The history of the subject is buried in much obscurity, but there is evidence that, as early as the fourteenth century, the use of bills of exchange was fully established. The forms of the bills, and the laws and customs relating to them, were then much the same as in the present day.
A bill is nothing but an order to pay money addressed by the drawer to the drawee, or person on whom it is drawn, specifying the amount to be paid, the time of payment, and the person to whom it is to be paid. Whenever a bill is drawn, it is to be presumed that a debt is due from the drawee to the drawer. When presented to the drawee and accepted by him, this acceptance is an acknowledgment of the existence of the debt. The bill, although drawn in favour of a particular person, is transferable by endorsement, and thus represents a negotiable claim to receive money at a future date in a distant country. Hence it is capable of being transmitted in discharge of another debt of equal amount.
England buys every year from America a great quantity of cotton, corn, pork, and many other articles. America at the same time buys from England iron, linen, silk, and other manufactured goods. It would be obviously absurd that a double current of specie should be passing across the Atlantic Ocean in payment for these goods, when the intervention of a few paper acknowledgments of debt will enable the goods passing in one direction to pay for those going in the opposite direction. The American merchant who has shipped cotton to England can draw a bill upon the consignee to an amount not exceeding the value of the cotton. Selling this bill in New York to a party who has imported iron from England to an equivalent amount, it will be transmitted by post to the English creditor, presented for acceptance to the English debtor, and one payment of cash on maturity will close the whole circle of transactions. Money intervenes twice over, indeed, once when the bill is sold in New York, once when it is finally cancelled in England; but it is evident that payment between two parties in one town is substituted for payment across the whole breadth of the Atlantic. Moreover, the payments may be effected by the use of cheques, or the bills when due may themselves be presented through the Clearing House, and balanced off against other bills and cheques. Thus the use of metallic money seems to be rendered almost superfluous, and, so long as there is no great disturbance in the balance of exports and imports, foreign trade is restored to a system of perfected barter.
Trade in Foreign Bills.
It is an unnatural supposition that every importer of goods will meet with an exporter of goods to the same amount, so that two transactions will exactly balance each other. But there are many merchants in Liverpool indebted to American merchants, and many American merchants indebted to others in Liverpool. Hence there will be a continual supply of bills of various amounts, and a continual demand, and it becomes a profitable business for certain houses to deal in the bills, purchasing bills from those who can draw and selling to those who wish to remit.
Large firms of merchants often have houses both in America and in England, or a firm in one country has agents or correspondents in the other with whom they keep a running account. Not uncommonly, the very same firm may be both importing and exporting, so that a direct balancing of their accounts will be so far effected. The remaining balance need only be paid from time to time as opportunity offers. Thus, in foreign as in home trade, book credit serves in a great degree to economize the use of money. Only when there is a derangement of the balance of trade, and one country owes to another a preponderating debt of large amount, need specie be transmitted.
It is out of the question that I should, in this small treatise, attempt to enter into the intricacies of the Foreign Exchanges, which have been so admirably treated by Mr. Goschen, in his "Theory of the Foreign Exchanges." The general principle of the subject is, that bills of exchange drawn on any particular place constitute a new kind of article, subject to the laws of supply and demand. Any circumstance diminishing the supply, or increasing the demand, raises the price of such bills, and vice versâ. The price being raised, there is additional profit on any transaction which allows a new supply of bills to be drawn. The export of any kind of goods in greater quantities tends to restore the balance, but, if requisite, coin or bullion can be sent at a certain cost, and bills drawn against it. Thus the cost of transmitting specie is the limit to the premium on bills. Gold and silver being everywhere considered a desirable possession, and being also very portable, form, as remarked at the outset, the natural currency between nation and nation. If a country were to be absolutely denuded of specie, and had foreign debts to pay, forced exportation and sale of the next most generally desirable and portable commodity would be the only resource, and the premium on bills might vary to almost any extent from par. Thus it is seen that, in an economical point of view, gold and silver differ from other merchandise not in kind but in degree.
The World's Clearing House.
It might seem that in the use of cheques internally, and of bills of exchange in foreign trade, we have reached the climax in the economy of metallic money but there is yet one further step to make. We found that so long as all the merchants of a town keep their cash with the same banker, they have no need to handle the money at all, but can make payments by transfers in the books of their banker. Let us imagine, then, that merchants all over the world agreed to keep their principal accounts with the bankers of any one great commercial town. All their mutual transactions could then be settled among those bankers. An approximation to such a state of things exists in the tendency to make London the monetary head-quarters of the commercial world, and the general clearing house of international transactions.
All that is needed to secure economy of money is centralization of transactions, so that there may be the wider scope for the balancing of claims. Before the elaborate system of English provincial banking grew up, considerable economy was effected by the practice of "drawing upon London." In every country town many persons wanted to transmit money to London, and others wanted to draw money from the same place. To vast private trading transactions with the capital and principal commercial towns was added the whole of the payments connected with the collection and expenditure of the public revenue. In each country town some prominent trader discovered that profit was to be made by selling bills on London to those who wished to remit, and buying with the proceeds the bills of those who had claims upon banks or firms in London. The capital thus becoming the monetary centre, it was often convenient to make payments to other towns by bills upon London. Each person wanting to remit was more likely to get a bill upon London with ease than upon any other place, and it was likely that the creditor would prefer such a bill to one upon a town with which he had no relations. It is obvious that if every important trader in England kept his principal cash with a city banker, the use of bills on London would have enabled all the commercial transactions of England to be centred in, and cleared through the books of these bankers and the Clearing House.
Centralization of Financial Transactions in London.
There is a similar advantage in centralizing foreign transactions in London. In the absence of any general centre each two commercial towns must settle their transactions directly and separately. A merchant will be receiving bills upon the bankers and merchants of many other towns. There is a double inconvenience in this. The supply and demand for bills upon comparatively small places must be comparatively small and variable, and the bills will be drawn upon minor firms, of the soundness of which it will not be easy to get satisfactory information. Many firms, too, in the, present day have houses in several parts of the world, and it would be more convenient that their mutual transactions should be brought to a centre somewhere, just as the transactions of branch banks are brought to a centre in the head office. Thus there arises a tendency to prefer bills drawn upon well-known London banks, or other great London firms, whose credit is known all over the world, and ceteris paribus, such bills will command a readier acceptance in the exchange market. Persons having to draw bills will get a better price if they can draw upon London, which they can do by opening an account with a London firm, and arranging that remittances due to them shall be deposited to their credit in London. It comes to pass that a merchant in America, Australia, or India, will prefer to receive money in London rather than anywhere else. Everyone wishing to remit money can then do so in the form of a bill upon the holders of these funds in London, and the fund will be recruited from time to time by similar bills received and transmitted to London for collection.
This tendency to the centralization of financial business in London is much promoted by the fact that the largest mass of cheap loanable capital exists there. The general rate of interest in New York is at least 2 per cent. higher than in London, so that a trader who has credit enough to obtain loans in London, will make a profit by borrowing there rather than in New York. Thus, instead of first depositing money in London, and afterwards drawing against it, the more usual and profitable form of the transaction is to get a credit there, that is, leave to draw against a banker, making subsequent remittances to recoup the banker accepting and paying the bills. As regards continental trade, Paris, Berlin, Vienna, Hamburg, and Amsterdam are of course highly important centres, but recent wars have occasioned a considerable transfer of financial business to London. Moreover, the great foreign trade of England, reaching into every quarter of the globe, and the distant colonies and dependencies which naturally have financial relations with the capital of the an empire, tend to give London a unique position.
Representation of Foreign Bankers in London.
The result of this centralization of banking transactions in London, is that colonial and foreign bankers find it very desirable to have agents, or even head offices in London. At the present time there are no less than 60 important colonial and foreign banks which have their own London offices or houses. These include the principal Australian, New Zealand, and Indian banks, and a number of minor banks, established by English capitalists to cultivate the trade of the minor states of Europe, South America, China, and the East. In addition to the above 60 banks, there are fully 1000 foreign and colonial banking houses in correspondence with London bankers, so that almost every town in the world which can maintain a bank at all, has the means of correspondence with some member of the London banking system. The foreign bankers vary greatly in the importance of their transactions, and some of them would, according to English ideas, be considered merchants rather than bankers; but, in the aggregate, their transactions must be exceedingly large. It must almost inevitably follow that transfers of money will be more and more made through London. Just as this city is the link of connection between each English country banker and each other one, so it may, and probably will by degrees, become the link between the most distant parts of the world. But the greater becomes the profitable burden of financial business thrown upon Lombard Street and Threadneedle Street, the more it behoves us to take care that our currency system is maintained upon the soundest possible basis. It is requisite, too, that our bankers, financiers, and merchants should regulate their operations with a thorough comprehension of the immense system in which they play a part, and the risks of derangement and failure which they encounter by over-severe competition. No one doubts that alarming symptoms have during recent years presented themselves in the London money market. There is a tendency to frequent severe scarcities of loanable capital, causing sudden variations of the rate of interest almost unknown thirty years ago. I will therefore in the next chapter offer a few remarks intended to show that this is an evil naturally resulting from the excessive economy of the precious metals, which the increasing perfection of our banking system allows to be practised, but which may be carried too far and lead to extreme disaster.
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