XV. THE NATURE AND FUNCTIONS OF TRUST COMPANIES
[91]The trust company supplements the bank. Through a long process of evolution the bank has developed as a means of facilitating the exchange of commodities. The trust company is a still further step in the same process, and, in a highly organized society, it meets needs which the bank is not able to supply.
In a new community the general store forms the centre of the business life of the place. With growth and increasing trade, the private banker sees room for the profitable employment of his funds. The state or national bank meets the needs of further growth. Success and the accumulation of wealth pave the way for the trust company. The bank is organized primarily to serve the needs of active commercial life; the trust company handles funds in less active circulation.
It is customary for the courts to designate or approve certain trust companies as depositories for funds paid into court, and the effect of such designation or approval would be to relieve executors, trustees, or others acting in a fiduciary capacity and depositing with these companies from liability for loss through their failure. A person charged with due care in the selection of a depository could not be held to have been wanting in such care in choosing as a depository a trust company which the court has itself approved.
The powers of trust companies vary in different states, and when they are created by special legislation, local companies are found with different charter privileges. The capital and surplus of these institutions are liable for their acts in fiduciary capacities, and in some states they are required to deposit with one of the state departments a fund as a special guarantee. The liability assumed is generally accepted by the courts in lieu of the bonds which individuals acting in similar capacities are required to give.
The development of trust companies in the United States has been remarkably rapid. Since 1882, when the first legal authority was given for the exercise by corporations of fiduciary powers, they have steadily grown in number until there are now more than fifteen hundred, distributed as follows:
Alabama 30 Arizona 9 Arkansas 38 California 24 Colorado 16 Connecticut 31 Delaware 12 District of Columbia 5 Florida 9 Georgia 25 Idaho 10 Illinois 75 Indiana 108 Iowa 29 Kansas 4 Kentucky 42 Louisiana 22 Maine 39 Maryland 21 Massachusetts 56 Michigan 6 Minnesota 4 Mississippi 19 Missouri 49 Montana 7 Nebraska 13 Nevada 1 New Hampshire 4 New Jersey 86 New Mexico 10 New York 78 North Carolina 38 North Dakota 5 Ohio 60 Oklahoma 10 Oregon 20 Pennsylvania 260 Rhode Island 11 South Carolina 17 South Dakota 12 Tennessee 73 Texas 52 Utah 9 Vermont 26 Virginia 19 Washington 20 West Virginia 22 Wisconsin 9 Wyoming 5 Hawaii 5 ---- Total 1555
Their business in all departments has shown a steady increase, and the trust companies of the United States to-day carry deposits amounting to over $3,858,300,000. Net deposits in the 7397 national banks aggregate $5,891,670,000.
In some states commercial banking and trust powers are exercised by the same companies. In such cases, separate departments are maintained for the various classes of business. Another method is for the same individuals to organize a national bank and a trust company, the former under national and the latter under state laws.
The securities company or trust company organized under state laws and controlled by a national bank with the stock interest in the former distributed among the owners of the stock of the bank and evidenced by indorsement on its certificates is still another expedient which has been resorted to in order to enable a closely affiliated and controlled organization to exercise legitimate functions which are, however, outside the province of a national bank.
The earning power of trust companies has equalled and even exceeded that of the banks, and the stock of those companies which are well established and doing a flourishing business sells at such a premium that investment in it at its market value gives a very low return.
Trust company failures have been few and far between, and where they have occurred they can be traced to a disregard of sound banking principles and to the assumption of unwarranted risks. Even in the case of companies which have failed there is no record of any impairment of trust funds, whatever loss there was having been borne by the stockholders and, to a less degree, by the depositors. This fact, the result of the absolute separation of trust assets from assets belonging to the company, is the strongest argument for the employment of trust companies in fiduciary capacities, and explains their rapid growth in popular favor.
The literature put out by these institutions invariably recites the advantages to be gained by dealing with them instead of with individuals. The following is a good example of such reasoning:
THE ADVANTAGES OF A TRUST COMPANY AS TRUSTEE
A trust company is preferable to individual trustees, because it possesses every quality of desirability which the individual lacks, to wit:--
(1) Its permanency: it does not die.
(2) It does not go abroad.
(3) It does not become insane.
(4) It does not imperil the trust by failure or dishonesty.
(5) Its experience and judgment in trust matters are beyond dispute.
(6) It never neglects its work or hands it over to untrustworthy people.
(7) It does not refuse to act from caprice or on the ground of inexperience.
(8) It is invariably on hand during business hours and can be consulted at all times.
(9) Its wide experience of trust business and trust securities is invaluable to the estate.
(10) It is absolutely confidential.
(11) It has no sympathies or antipathies and no politics.
(12) It can be relied upon to act up to its instructions.
(13) It does not resign.
(14) All new investments of value suitable for trust estates are offered in the first instance to trust companies, and in that way it has a choice of valuable security; and as its purchases are on a scale of magnitude, it can usually buy at a rate which is lower than that at which the individual trustee can purchase.
The most common objection to the appointment of corporate trustees is thus stated by Augustus Peabody Loring, Esq.:
The trust companies, which have of late years become so numerous, to a considerable extent do away with the element of personal risk attaching to an individual trustee; but they lack the advantages of personal management. These companies sometimes fail from improper management as utterly as individuals do, and as a rule the lack of personal management results in securing the minimum return only on the amount invested, and lacks the great advantages often secured by the able personal oversight of individual trustees.
The question, after all, comes back to the personal qualifications of corporate officers and individuals. If the former are less capable than the latter, the fault is with the particular company--not the system, and if interest returns are sometimes less under corporate management, this fact is more than equalized by the added safety to the corpus of the estate.
A "Trustee Company" has been suggested as a proper title for the company doing a legitimate trust business, and is the name used in Australia and in New Zealand. In some states the use of the word "trust" in corporate titles is now regulated by law. Confusion has arisen in the popular mind between the trust company and the trusts or industrial combinations.
The usual functions of a trust company are: banking in a more or less limited form, execution of corporate trusts, execution of individual trusts, care of securities and valuables. In addition, other functions are sometimes exercised, such as life, title, and fidelity insurance, and the business of becoming surety. The earlier companies in the United States were chartered to manage individual estates only and to act in certain fiduciary capacities; the recent development of the trust company has been in the direction of banking functions and corporate trust business.
It is worthy to note that the life insurance companies which originally secured trust powers have, with but few exceptions, given up their life insurance business, and that most of the fidelity insurance and surety business is given over to companies which now make a specialty of such risks. The fact is being recognized that the assumption of vast risks contingent on future occurrences is not compatible with the absolute security which is essential in the transaction of legitimate trust business.
BANKING
The banking functions of trust companies may include any or all of the following:
The receipt of money deposits payable on demand and subject to check, or payable at a fixed date, or according to special agreement. Interest is usually allowed on all deposits above a fixed maximum amount or on the total sum.
Money advances secured by the hypothecation of stocks, bonds, life insurance policies, bonds and mortgages, or other personal property.
Real estate loans, secured by bond and mortgage. It is customary to loan not over two-thirds of the value of improved property; when the property is unimproved, not more than half.
Discounting paper is engaged in principally by companies transacting a commercial banking business. The purchase of unsecured paper is permitted in some states where discounting is not allowed.
The purchase and sale of securities.
Trust companies sometimes guarantee issues of bonds, or at least set their stamp of approval upon them.
The issue or guarantee of letters of credit, and the transaction of a foreign exchange business.
The care of savings deposits. For this purpose a separate department is usually maintained.
CORPORATE TRUSTS
Among the most important functions of a trust company are those relative to the business of other corporations:
Of late years the trust companies in the Eastern cities have been selected as trustees instead of individuals whenever the law of the State where the property was situated allowed such selection. Trust companies have manifold advantages over individuals in such a relationship; they do not die; the large amount of financial business which they daily transact provides them with the machinery for such purposes; while their well-known names stand as evidence to the purchasing public that at least the necessary formalities have been complied with. Beyond that responsibility the trustees of corporation mortgages usually assume none.
In recent years the trust companies have shown a tendency, when acting as mortgage trustees, to recognize a greater moral responsibility than they at first were willing to bear. Trust companies did not, of course, intend to appear as in any way guaranteeing the bonds to which they certified, though that seems often to have been the erroneous opinion of the unthinking; but trustees now acknowledge themselves bound within the limits of the mortgage to use their influence to protect the interest of the bondholders. A trust company which should now allow the issue of unsecured bonds because of some glaring defect in the language of the mortgage, would not longer be morally excused by financial opinion, though perhaps held technically innocent.[92]
As trustee under corporate mortgages and trust deeds, the trust company acts for the bondholders. It is customary for it to authenticate each bond issued subject to the provisions of the mortgage, to represent the bondholders in case of default, and to exercise such other functions as may be provided in the mortgage.
A generation ago it was customary for a railroad to name one or more individuals as trustees of the mortgages executed to secure bond issues. The development of trust companies and their manifest advantages over individuals in such a capacity has resulted in their absorbing almost all this business. Trust companies are now generally appointed as trustees in corporation mortgages, and are also often named to succeed individuals who have died or resigned. The appointment is one of the most important and far reaching which the trust company can accept. Its name and reputation serve as an assurance that the transaction is a regular one, and entered into in good faith. Although the modern corporation mortgage is usually explicit in its terms to the effect that the trustee in no way guarantees the value of the security and assumes no liability except for its own negligence, yet the intimate connection between the trustee and the borrowing corporation in the minds of investors makes it necessary that care be taken not to assume trusteeships which may lead to a wrong use of the name and credit of the trust company.
As trustee under mortgages securing bond issues, the title to the mortgaged property is vested in the trust company for the benefit of the security holders. The corporation owning the mortgaged property retains physical possession of it so long as the terms of the obligation are complied with, except in the case of securities pledged, which are usually lodged with the trustee. In case of default, however, it devolves upon the trustee to protect the interests of the bondholders, and this may necessitate the foreclosure of the mortgage and sale of the property.
As fiscal agent it dispenses coupon and interest payments on bond issues, and dividends on stock. It receives sums set aside as sinking funds to provide for the retirement of obligations at maturity, or when bonds are subject to redemption, draws the specified amount by lot and pays the principal.
As registrar the trust company authenticates certificates of stock and bonds in order to prevent an over-issue, and to reduce the chance of loss or theft. As transfer agent, the company attends to perfecting transfers of ownership for stock and bond issues or parts thereof.
The New York Stock Exchange, like most other stock exchanges, in its constitution requires that all active listed stocks must be registered. This Exchange also requires that a trust company or other agency shall not at the same time act as registrar and transfer agent of the same corporation. In the popular mind, and even in the minds of some trust company officers, the difference between the duties of the two positions has been more or less confused. Both have been created to safeguard and facilitate the passing of title to shares of stock, but the duties of a transfer agent and a registrar are not synonymous; they are distinctive. One is called upon to examine and give clear titles to property transfers, and the other is merely to record such transfers.
As manager of underwriting syndicates, the trust company issues the prospectus and markets the securities of corporations which are being launched, or of established companies which are putting out new securities.
In railroad and other reorganizations, the trust company takes a prominent part, acting both as a depositary for, and as a representative of, the committees which formulate and execute the plans of reorganization. Its officers often have a large share in the preparation of such plans.
As assignee and receiver, the trust company acts in the same capacity for corporations as for individuals and firms or partnerships, assisting in winding up insolvent businesses and in conducting embarrassed ones.
INDIVIDUAL TRUSTS
The execution of individual trusts is the function originally assumed by trust companies. The various other forms of business which are now engaged in, have, with the exception of life insurance, been later developments of the trust company idea. The earliest power granted these companies was to receive moneys or other property, real or personal, in trust. The trust company now also acts as executor and administrator of the estates of decedents.
As executor appointed by the will of a decedent, it takes out letters testamentary upon probate of the will, advertises, files inventory and appraisement, pays debts, collects claims, makes the requisite accounting to the probate or orphans' court, and makes distribution of the estate in accordance with the terms of the will and the court's decree.
As administrator acting under appointment of the register of wills or probate court, it performs similar duties, distributing the estate in accordance with decedent's will if there is one, or if there is none, in accordance with the intestate laws of the state, which specify the order of succession and distributive shares in the case of estates of decedents leaving no wills. There are different kinds of administrators, in any of which capacities a trust company may be called upon to act.
As trustee under will, the trust company carries out the provisions of the will, investing and managing the estate or particular fund in accordance with the directions of the testator. As such it may hold real and personal property.
As trustee under deed or private agreement, a contract is entered into between the company and the owner of the property, by which the title to the property is vested in the corporation subject to the terms recited in the instrument. Such deeds of trust may be revocable or irrevocable. Marriage settlements are frequently made in this way.
The trustee's duty in investing the funds is a double one; namely, to invest them securely so that the principal shall be preserved intact, and to invest them as productively as possible under his powers, so that they shall yield the best rate of interest obtainable for the benefit of the person or persons entitled to the income. He must hold the scales evenly, regarding scrupulously his duties to all beneficiaries. The popular idea that security is the only consideration is erroneous, as the trustee is equally bound to invest the funds as profitably as possible and cannot neglect one duty more than the other. The mistaken impression that the corporate trustee, even more than the individual, is mindful only of the safety of the principal and entirely loses sight of the question of income, has arisen from the restrictions as to investments imposed by law, and frequently also by the will or trust deed, and from the fact that the individual executor or trustee, rightly or wrongly, sometimes assumes risks and personal liability which the proper rules of a trust company would not permit it to assume.
The executor or trustee is governed, as to the kinds of investments, by the directions of the will or deed of trust. This may require the purchase of "legal investments" only, or state that the trustee is not to be confined to securities prescribed by law, or give specific directions as to the classes of securities which are to be bought. The terms of such documents are always strictly construed by the courts; if no directions are given, the trustee is expected to buy only "legal" securities, and when he exceeds his powers he is held responsible for any loss. Administrators and guardians without broader powers given by will are obliged to invest, except at their personal risk, in such securities as are sanctioned by law or directed by the court.
Some states prescribe by statute the securities in which a trustee may invest. "Where there is no statute or decision of the highest court fixing the class of securities in which a trustee may invest, he can safely follow the rule prescribed for the investment of the funds of savings banks." In general, city, State, and United States bonds, first mortgages secured on improved real estate with ample margin, are among the investments sanctioned by law. As to real estate, stocks, and first mortgage bonds of railroad, manufacturing, and other corporations, the practice varies in the different states. Loans on personal property, second mortgages, and other investments subject to prior liens or of a speculative character are excluded. All investments must possess "intrinsic" value; the courts hold trustees liable for any losses from speculative risks--but any gains accrue to the trust estate.
OTHER FUNCTIONS
The trust company acts as guardian, curator, or committee of the estates, and in some states, of the persons of minors, those who are insane or mentally incompetent, spendthrifts, drunkards, and any other persons not legally qualified to take charge of their own affairs. In the case of a minor, the trust terminates on the ward's becoming of age; in other cases, when the disability is removed, or in accordance with a decree of court. These appointments are frequently made by order of court, and to it accounting must be made. In some states the company is styled "conservator" when caring for the estates of persons of unsound mind.
When acting as attorney in fact, the company obtains its authority by virtue of a letter of attorney which usually is or can be recorded, conveying certain definitely specified powers. This may be either to perform a single act--such as to satisfy a mortgage--or may be broader and continuing, granting authority to sell and transfer securities and collect income. A general power of attorney, as the term indicates, is a delegation to another of the general powers of the person appointing--as to payments, collections, transfers of property, and all transactions of a business nature.
As agent merely, the company takes charge of property, real or personal, for its owner, but such agency does not imply nor ordinarily include authority to sell or convey title. Moreover, trust companies as agent often take up lines of business which they either cannot or would not engage in on their own account. Thus, a trust company can act as agent for fire or life insurance companies, for water, gas, and other public service corporations. In new communities and where it is difficult to find responsible representatives, the trust company can often render efficient service and secure a steady income without risk by assuming agencies of various sorts.
As assignee the trust company takes possession of the property assigned for the purpose of carrying out the terms of the deed of assignment in the interest both of the assignor and the creditors of the assignor. The deed of assignment is an acknowledgment of an embarrassed or insolvent condition, and the efforts of the assignee are directed to realizing as much as possible from the assets intrusted to its management.
As receiver, the duties may be very similar to those of assignee, although they are usually broader in scope. The business may not be insolvent, and the application for the appointment of a receiver may be due to temporary difficulties only. By such an appointment the property is preserved intact and equal treatment is afforded creditors. An able receivership often results in the adjustment of difficulties and the return of the property to its owners on a paying basis. While in the case of assignee the appointment is by the individual, partnership, or corporation executing the deed of assignment which specifies the powers and duties of the assignee, in the case of receiver the appointment is by a court and the company so appointed acts as an appointee or ministerial officer of the court, and as such is directly subject to the court's orders.
A trust company acting as receiver is better able than an individual to furnish additional capital, if amply secured, and thus successfully to meet the difficulties which withdrawal of credit and restricted capital have temporarily brought upon an otherwise prosperous business. The courts authorize the issue of receivers' certificates to provide funds for purchase of equipment and the proper maintenance of the property and conduct of the business when the creditors are benefited by such expenditures. Such certificates may be made a first lien on all assets, taking precedence even of mortgages and other secured obligations. The receiver thus secures the capital necessary to make the property more productive and to secure the largest return from the business.
As custodian or depositary, the trust company sometimes holds property the title to which is in dispute, delivering the same when the ownership is legally determined.
In taking charge of escrows or conditional instruments or deeds delivered to a third party until the condition is performed, the trust company acts in a similar capacity, as the joint representative of both parties.
The trust company acts as the representative of both the living and the dead in practically every legal relation in which an individual is qualified to act. Its function is not only to keep intact the estate of which it has charge, but to look to and safeguard the interest of every beneficiary.
CARE OF SECURITIES AND VALUABLES
The functions already recited have resulted in the assumption of the duty of caring for property other than that of the estates held in the trust department. In the safe deposit department, individual safes are rented, bulky packages--not containing stocks or bonds--are received on storage, certificates of deposit covering securities are issued, and provision is made for access to, and examination of, the property so deposited. For personal property received on storage, the charges are either according to bulk or value. Wills are usually receipted for and kept without charge.
INSURANCE
The examination and insurance of real estate titles is a later development often found in connection with the usual trust functions.
Fidelity insurance and suretyship providing against loss by reason of the dishonesty of individuals and the non-performance of obligations, contracts, etc., have often been combined with the various forms of trust company activity. They are, however, largely passing into the hands of corporations especially organized for the transaction of such business.
COMPENSATION
When acting as trustee under corporation mortgages, a definite charge may be made for accepting the trust, and a fixed amount per annum thereafter for paying coupons and performing other duties. For the certification of bonds it is usual to charge fifty cents per bond in the case of large issues, and one dollar for small issues. The figures, however, vary in different places. The charge for certifying the bonds may be the only one, although an additional charge is usually made for counsel fees. In case of default and consequent foreclosure of the mortgage, extra payment is made to the trustee covering all services incident to the foreclosure.
For the disbursement of sinking funds, interest, or coupons, the temporary use of the money may be considered adequate compensation, if the amount involved is large. A commission on the sum distributed or a fixed amount is charged when acting as fiscal agent, apart from duties in other capacities. For acting as registrar or as transfer agent it is usual to make a fixed charge per annum, based on the amount of labor involved. The transfer agent is usually paid about twice as much as the registrar. Compensation for acting as manager of an underwriting syndicate may be a fixed sum or a commission, according to the provisions of the underwriting agreement. For acting as depositary under plans of reorganization, assignee, or receiver, a lump sum is usually paid covering all services. Agency work of various sorts is paid for in accordance with the usual practice in the business which is undertaken; a fixed sum, or a fixed sum and a commission, or a commission only, may be received.
The trust company is in a position to render valuable, and often indispensable, aid to its corporate clients. Large amounts being involved, the great railroad and industrial corporations are willing to pay well for such services. Corporate trust business has, consequently, been a profitable field for the trust companies.
GOVERNMENT REGULATION
An examination of the laws of the various states is interesting as showing the attempts which are being made at regulation. Most of these laws have been enacted within recent years and to-day there are but few States which do not have such statutes on their books.
The step which Massachusetts first took in requiring a legal reserve to secure deposits has been followed by similar action in other states. In general, the wisdom of prohibiting companies which engage in the care of estates from assuming excessive risks is becoming better recognized. The promotion and underwriting of commercial ventures and the assumption of unknown risks are functions not compatible with the proper exercise of the duties of trustee or executor.
The supervision of trust companies by the separate states provides an elastic system to supplement the rigidly guarded powers of the national banks, and can adapt itself to changing conditions and enlarging needs, leaving for solution according to the requirements of each section of the country such questions as proper functions, reserves, and the authority to establish branch offices.
FOOTNOTES:
[91] Adapted from Kirkbride and Sterrett, The Modern Trust Company, pp. 1-13, 113, 114, 127, 143-146, 204, 205, 208. The Macmillan Company. 1913.
[92] Thomas L. Greene, Corporation Finance, p. 59.
XVI. SAVINGS BANKS
[93]The savings bank works with those unacquainted with the ways of business and who could not single handed take good care of their money, or invest it safely or profitably. The bank of discount is generally managed by business men versed in the ways of business, acquainted with monetary affairs, and able to conduct financial operations with intelligence. They combine their capital in order to make it effective; the savings bank combines savings in order to make them capital, and as such to acquire a power impossible to the scattered savings.
The savings bank is for the saver; its funds are invested permanently, while the business bank opens its doors to business men and loans rather than invests its funds, and for a short time only. The latter deals with borrowers rather than savers, and serves for hire. The one serves best by keeping--the other by lending. One aims at profit, while the other never makes (or should make) profit an end. The savings bank is the receiving reservoir for the little springs, the bank of discount is the distributing reservoir for accumulated capital.
We must get the last idea clearly in mind or we get a misconception of the savings bank. However much the element of interest may figure in the management, and whether we pay depositors 4 per cent. or 3 per cent., or no interest at all, the accumulation of interest is not to be compared in importance with the accumulation of principal.
No man ever acquired riches at 4 per cent. In fact, 4 per cent. upon small deposits is so trifling a matter that it may be ignored in considering the greater value of the increase of capital. However desirable the accumulation of interest may be (and this in the course of years is considerable), the chief end and aim of the savings bank should be the accumulation of principal.
CLASSIFICATION OF SAVINGS BANKS
We may roughly classify savings institutions into: First, mutual (trustee), or philanthropic; second, stock (including "savings and trust companies"); third, co-operative, or democratic, as exemplified in the co-operative banks of Europe. The first are usually managed by a self-perpetuating body of trustees, who do not share the earnings; the second are managed by the directors elected by the stockholders; the third are managed by officials elected by the members.
A second classification may be made into public and private institutions; the first includes the postal and municipal banks; the private embraces the mutual, stock, and co-operative. A third classification may still be made into the "unit" and the chain system. In the unit system the bank is an independent entity and has no connection (aside from a managerial standpoint) with any other bank. The banks of the United States are all, excepting the Postal Savings Banks and a few branch savings banks, of this character. In the second, the bank is but a part of a chain, as in the postal system, the municipal banks of Germany, and the co-operative credit banks of Europe. We shall briefly review each system.
TRUSTEE SAVINGS BANKS
The original savings bank is the trustee bank. As Hamilton says, "It stands for the attempt on the part of the well-to-do to improve the condition of the poorer classes, and involves a self-sacrificing service on the part of a few in the interest of the many." While many of the early savings banks partook of this character, others were organised from purely selfish motives and were characterised by bad management and bad faith from the start. A study of savings bank frauds will amply bear out this statement.
The "spirit of commercialism" hereafter spoken of has invaded the domain of the mutual savings bank and it cannot in truth be said that some of the newer banks were organised from any spirit of philanthropy, although the management as a whole may be above suspicion and honorable in the highest degree.
But, however this may be, the mutual savings bank is a product of the East and promises to remain so in spite of the fact that some of the Western states have very good, if not excellent, savings bank laws.
The distinguishing characteristic of the trustee savings bank is mutuality. All the earnings of the bank, less reasonable administrative expenses and the apportionment to surplus or guaranty fund, are divided among the depositors in the form of interest.
One or two features of the mutual bank may be mentioned. First, the investments of such institutions are usually carefully restricted, looking primarily to the element of safety; and as long as the trustees keep their funds so invested they cannot be held, either in law or morals, responsible for losses. Second, the predominancy of the mortgage loan. The nature of the deposits being more or less permanent, investments of a permanent character may be made without fear of a sudden demand for their return on the part of depositors; and to safeguard the banks from such unexpected calls, quite generally trustee banks are permitted by law to require notice, the usual time being either sixty or ninety days. The third distinguishing feature is the self-perpetuation of the board of managers. No amount of money can buy a man's way into a mutual savings bank. He cannot, as in stock concerns, buy enough stock to vote himself into office--he can only gain office as the other men advocate his cause. And, on the contrary, he cannot be voted out of office. Only an act, such as bankruptcy (which voids his office), can affect him, and, like a Supreme Court judge, he is appointed during good behavior.
The greatest weakness of the trustee bank is this: Lacking the "essential element" that prompts men to undertake such ventures (profit), it does not appeal to the average man of means unless he is sentimentally inclined; and not being indispensable to trade and commerce, like a bank of discount, it does not come to be a commercial necessity. Even in a great State like New York we find twenty-eight counties with no savings banks. And in many of these counties there are large and thriving towns and cities. Thus the city of Jamestown, with over 30,000 population, has no savings banks; while Elmira, with over 35,000 population, has but one, and that with but half a million assets.
From the viewpoint of intensive results, as tested by the volume of patronage accorded these institutions, a perusal of the statistics will demonstrate that in some places the trustee bank has had a remarkable record. For instance, in Maine, a sparsely-settled State, and largely of a rural nature, we find one savings account to every 3 of the population. More remarkable is Vermont, the "Green Mountain State," where natural conditions would seem to be much more hostile to such development, we find 30 per cent. of the population having savings bank accounts. New Hampshire has an account for every 2-1/2 of the population, while Massachusetts heads the list, with seventy-five out of every hundred. New York has one to every three.
"In seeking an explanation of this remarkable success of the trustee system," says Hamilton, "we are reminded that New England is singularly separate and distinct in its customs, habits and ideals from the rest of the country. Notwithstanding the large foreign population, the dominant type is more homogeneous and more Anglo-Saxon than it is in any other section, and therefore fixed customs have been more rigid and controlling. Among the ideals behind the customs and institutions must be noted a stern, Puritanical sense of simple living, industry and providence, and this spirit is so strong as to be well calculated to give color and direction to the philanthropic impulse. There is also an unusual amount of public spirit, of collective rather than a neighborly character, as seen in the institution of the town meeting."
STOCK SAVINGS BANKS
The stock savings bank, where it is a savings bank, and not a bank of discount under a savings title, differs in no essential degree from the mutual institution. The mutual bank belongs to the depositors; the stock bank to the stockholders. The mutual bank pays dividends to depositors only; the stock bank pays dividends to both stockholders and depositors. The stock bank does not pretend to be philanthropic in its management. It is purely a business proposition, and where the investments are of the accepted savings bank type, it can justly claim to be on a par with its mutual friends, provided, of course, that it measures up to the standard in its management.
As is implied in the term "stock," it issues capital shares and pays dividends thereon. It has, therefore, the added protection of the stockholder's liability, which, together with the accumulated surplus, affords the element of strength so necessary in all financial concerns. It usually pays the depositors a stipulated rate of interest, and the profits beyond this belong to and are distributed to the stockholders as dividends. The partnership idea is entirely lacking, and the depositors get what they bargain for, while the surplus goes to those who invest, not necessarily their savings, but their capital, and assume all risks of the business. It could not in law or equity "scale down" its deposits to make good any losses--a feature peculiar to the mutual institution.
In this respect one thing is certain: In so far as safety is concerned, especially in a young bank, the stock bank with the stockholders' liability is surely superior to the mutual, unless the trustees of the latter are of such high order and of such financial worth as to be able and willing to assume the burden of any losses that may accrue until the surplus or guaranty fund affords ample protection. This was the trouble in the early days of the mutual savings banks in England.
GUARANTY SAVINGS BANKS
New Hampshire is the only state in which "guaranty savings banks" are found. These are a combination of mutual and stock--a cross between the two. They do not transact a commercial business, being strictly savings banks in their functions, yet having "special deposits," which to all intents and purposes are capital stock. "The guaranty savings bank differs from the ordinary mutual savings bank in that it has capital stock or special deposits, as they are called. It pays a certain stipulated rate of interest to its general depositors and any surplus of earnings above this dividend is available for dividends on the capital stock or special deposits. These special deposits constitute a guaranty fund for the general depositors, and the charter ordinarily stipulates that the special deposits shall always equal 10 per cent. of the deposits."
Such institutions are savings banks in every sense of the word, but the strictly mutual feature is lacking in the specialising of part of the deposits and paying a higher rate of interest on these deposits. In New York State savings banks cannot take a "special deposit," but in New Hampshire, in return for the higher interest rate, the special depositors assume all the risk of loss or depreciation, and, as in the case of stock concerns, they would be the first to suffer in the event of insolvency.
MUNICIPAL SAVINGS BANKS
This form of savings banks properly belongs to a strong class of municipalities. They can only thrive in places where the local spirit is strong, the local government pure, and where the local officials are accustomed to wield a large measure of authority. Accordingly, they have come into being and met with success in those countries where the early history of the town made a large measure of local autonomy a necessity. Towns of this class possess the public spirit and the intelligent administration required for the success of such a public venture. They also possess a fund of gratuitous public service among the citizens which may be drawn upon when occasion requires.
Such banks are found in Austria, France, Italy, Denmark, Sweden, and Japan. The best examples are to be found in Germany, where they have been in operation for a long period of years. Savings institutions exist here at present in great variety and number, including State or Province Savings Banks, City Savings Banks, Township Savings Banks, County Savings Banks, Bezirk (District) Savings Banks, Private Savings Banks, and Co-operative Savings Banks.
These banks have some 19,000,000 pass books out and their deposits amount to 13,500,000,000 marks ($3,213,000,000). These deposits are practically all guaranteed by the various municipalities of the Empire, which condition forms a bulwark of confidence in the security of private wealth and earnings that cannot be shaken by hard times, panics, bank failures, etc.
PEOPLE'S BANKS
The co-operative banks of Europe, otherwise called "People's Banks," are essentially savings banks, in that they depend for their working capital upon the accumulated savings of their members. The aims of these banks are first economic, to enable the economically weak to make themselves financially strong by the power of combination; second, moral, to bring the members together in a unity of interests and to develop character by making thrift and good habits the groundwork of their operations; third, educational, to train in business methods and in the handling of money those whose scope has been narrow and whose experiences have been few in this regard.
In the establishment of these banks, the cardinal rules have been: Maximum of responsibility, minimum of risk, maximum of publicity. To secure the maximum of responsibility, unlimited liability has been accepted by the members in many cases; that is, each one pledging his all for the good of all; and, second, to secure the minimum of risk, character is made the basis of membership and good habits the prime requisite for membership. No investments are made in speculative enterprises, and the purposes for which the money is borrowed are closely inquired into and due care taken that the funds shall be applied for such purposes only. To secure the maximum of publicity the action of the bank in all matters is given the widest publicity possible in order that the work may have public inspection.
The result of these simple rules has been that the poor have proven as good, if not better, creditors than the rich; for once losing credit they can never regain it except by the slow process of years of good behavior.
The great pioneers in the "People's Banks" were Raiffeisen and Schulze-Delitzsch. They fully appreciated that any system that would succeed must descend to the level of its beneficiaries and they have admirably adapted the co-operative idea of banking.
THE LOCALIZATION OF SAVINGS BANKS IN THE UNITED STATES
The home of the mutual savings bank is in the East, where it began operations in 1816, and may even be said to be in the Eastern States; for west of Buffalo and south of Baltimore, we find only 21 savings banks of the mutual character. Out of 647 savings banks of the mutual type found in the United States, 593 are found in New England, New York, and New Jersey; and over one-half, or 334, are found in the two States of New York and Massachusetts. Maine, Vermont, Connecticut and New Hampshire have 215, the total of which accounts for all but 100 of the mutual savings banks in this country.
The dearth of savings banks in Pennsylvania is notable. It would seem strange that in a state of such character, where the mutual savings bank had its first test, and where in individual instances it has been extremely popular and successful, the failure of such an institution has been so pronounced; but Pennsylvania is the home of the building and loan association (there are over 1,400 in operation), which seems in a measure at least, to fulfill the same purpose. From a pamphlet issued by the Dollar Savings Bank of Pittsburgh in 1905, the striking sentence is gathered, that to-day at the end of half a century the Dollar Savings Bank stands as the only institution of its kind in Western Pennsylvania.
As we go south and west the banks take on a more commercial aspect, and the savings bank as we know it in the East is a rarity, and the word "savings" in their title is a misnomer. This is particularly true of Iowa, where we find practically all state banks using this word, and yet very few of them are other than banks of discount. The reason for the large number may be in the economic conditions of that State, and also the fact that banks may organise with as low as $10,000 in capital, making it possible to establish a bank in even the smallest place.
In Illinois, for instance, we find no distinctively savings banks, and in a city like Chicago, where if the same success had attended the savings banks as it has in New York, upwards of a billion dollars would be on deposit, we find no strictly savings institution other than banks of discount and trust companies operating savings departments.
The reasons for the absence of mutual savings banks in the West and South lie, no doubt, as Hamilton suggests, in the fact that these sections were not settled from religious, but commercial motives; and the "spirit of New England" being lacking, the savings bank which requires a peculiar spirit of philanthropy, and age, as well, has not become a factor in the development of the country. In fact, the eleemosynary institution, such as the college, the hospital, or the savings bank, the former requiring endowments of money to become successful, and the latter the endowment of gratuitous management to become possible, is last to follow in the economic development of a community. Another reason may be in the pre-ponderance of agriculture among the employments, which does not, until the country becomes highly prosperous, afford much in the way of idle funds which would go into the savings banks. The mutual savings bank is a product of the East and promises to remain so in spite of the fact that some of the Western states have very good, if not excellent, savings banks laws.
The dearth of savings banks in the South is, no doubt, due to the prostration following the Civil War, which left the country drained of its resources; the general ignorance of banking functions, and the improvidence of the Negro.
POSTAL SAVINGS BANKS
The postal savings bank is not a bank, or a banking system, so much as it is an adjunct of the Government; for the fundamental idea is that through the post office the Government holds itself out as willing to accept the savings deposits of the people, invest them in its own securities and become absolutely responsible for the safe return of the funds when called for, with a nominal rate of interest. All the leading countries of the world except Germany and Switzerland now operate the postal savings banks. While the rules may differ in the details, the general scheme is the same, and a review in brief of the system of Great Britain will serve to illustrate the methods of operation of such an institution.
The present system was established in England in 1861. The deposits, at whatever office they may be made, can be withdrawn from any other office which transacts a savings bank business. The accounts are kept in London and all moneys are remitted to the headquarters, where it is handed over to the Commissioners for the Reduction of the National Debt, who invest the funds in public securities.
Deposits may be made as low as one shilling or multiples thereof, and the limit of deposits for an individual is $150 during one year or $650 in all. Charitable societies may deposit without limit. For the benefit of youthful depositors, who have not a shilling to deposit, cards are issued upon which stamps are placed as purchased, and when filled represent one shilling, and may be turned in as cash. School managers are urged to bring this plan to the attention of the pupils, and it has been productive of good results, over 5,000 schools having adopted this system. The interest rate is fixed at 2-1/2 per cent. and never varies.
AMERICAN POSTAL SAVINGS BANKS
ARGUMENTS FOR AND AGAINST THE ESTABLISHMENT OF POSTAL SAVINGS BANKS IN THE UNITED STATES.
[94]In spite of the numerous differences in the postal savings bank system of the forty-odd countries possessing them, there are certain fundamental features common to all. Whatever else a postal savings bank may be, it is without exception an institution working principally through the post offices, and its primary object is the encouragement of thrift among the poorer classes by providing safe and convenient places for the deposit of savings at a comparatively low rate of interest. In the discussion of the postal savings bank proposition in this country, no one questioned the desirability of encouraging habits of economy and thrift on the part of the public, nor was there any question that adequate savings bank facilities should be provided for this purpose; the debate hinged very largely upon the question whether adequate facilities of this character were not already provided by private initiative.
The advocates of a postal savings bank claimed that adequate savings facilities were not and could not be provided by private enterprise, because of the expense of conducting savings banks in small communities, and also in larger communities where the people were not yet educated to the saving habit; and they pointed particularly to the lack of savings facilities in the southern and western states....
... The country is not nearly so well provided with banks receiving savings accounts as with post offices. In the United States there are 270 square miles of territory to each bank carrying savings accounts and 50 square miles to each post office; there is a population of 8,370 to each such bank and of 1,542 to each post office; and there are 5.4 post offices to each bank carrying savings accounts. A comparison of the figures for the different sections and states shows that it is in the southern, western, and Pacific states that savings bank facilities are most lacking.... The New England, eastern, and middle western states are much better provided with banking facilities than are the other sections; but even in these states post office facilities are much more ample than savings bank facilities....
An objection repeatedly urged against the establishment of a postal savings bank was that it would prove a competitor to existing banks. The fear of such competition appears to have been the chief cause of the opposition of most members of the banking fraternity to all postal savings banks proposals. Senator Cummins of Iowa said in the Senate:
The banks of the United States are opposed unanimously to the institution of a postal savings system.... I venture the assertion that during the nearly two years that I have been a member of this body ... I have received the protests of nearly every bank in my state against any such scheme, and those protests have usually been accompanied by a very large number of petitions, secured, I have no doubt, through the industry and energy of the bank officers.
It was argued that postal savings banks would have an undue advantage over private institutions because of the great confidence in the Government entertained by working people; and it was asserted that funds would be withdrawn from existing banks and deposited in the postal savings banks.... In reply, the advocates of postal savings banks claimed that existing banks had nothing to fear from governmental competition; that they had the advantages of an established clientele, higher interest rates, higher limits, if any, in the amounts that could be kept on deposit, and of the close personal and advisory relation which so often exists between a bank and its customers. They further argued that postal savings banks would be a help rather than a hindrance to other banks. They would educate the people to habits of thrift and would draw money out of hoards; and the deposits which they received would for the most part be transferred to other banks as soon as the limit fixed for postal savings banks deposits should be reached, or even before, as the depositor began to appreciate the safety of other banks and the advantage of their higher rate of interest....
The immediate occasion of the last active movement for a postal savings bank system in the United States was ... the losses and inconveniences arising from bank failures and from the suspension of cash payments in the panic of 1907. Naturally, therefore, the demand for great safety of savings deposits played an important part in the discussion.
The advocates of postal savings banks cited figures showing the number of national bank failures and the losses involved, and similar figures for savings bank failures in certain states. They made much of the large amounts involved and of the hardships in individual cases. On the other hand, the opponents of the postal savings bank scheme quite generally dealt with percentage figures rather than with absolute amounts and showed that for recent years the average losses, in terms of percentage of the amounts on deposit, were almost infinitesimal.
The figures cited for bank failures, so far as they relate to savings deposits, are so incomplete as to be of doubtful value in measuring the extent of the losses....
After all, such figures give us no adequate measure for losses of this kind. "Among the experiences of working people none is more demoralizing and few are more cruel than loss of savings through failure of banks or absconding of individuals intrusted with funds." To such people there is cold comfort in the assurance that the average loss of savings bank depositors over a long period of years is but a fraction of a mill on a dollar. The loss is theirs: it is not distributed among all depositors.
In urging that a postal savings bank would draw money from hoards into circulation, the advocates of the scheme claimed also that such a bank would keep in the United States money that would otherwise be sent abroad by foreigners.... Much was made of the fact that every year many millions of dollars in money orders payable to self are bought for savings purposes.... In such cases the purchaser not only failed to receive any interest on his savings but was required to pay the money order fee. Many immigrants, moreover, distrust American banks, and, being familiar with postal savings banks in their home countries and having great confidence in government institutions, remit their savings to these home banks. How extensively this is done we have no figures to show....
THE MAIN FEATURES OF THE SYSTEM
[95]The Postal Savings Bank System of the United States, which began operations January 3, 1911, by the opening of a postal savings bank in each state, is under the control of a board of trustees, consisting of the Postmaster-General, the Secretary of the Treasury, and the Attorney-General.
Depositories for the receipt of such moneys are designated by the Board. An initial appropriation of $100,000 was made to cover the cost of putting the law in operation, which was supplemented by another appropriation of $500,000 in the session of 1911.
Any person over ten years of age may deposit, but no person shall have more than one postal savings bank account in his or her own right. Upon making the first deposit, a certificate of deposit is issued, which is to be surrendered when paid, and cancelled; or in the event of making a subsequent deposit is to be surrendered for one calling for a higher amount. The lowest deposit permitted is one dollar, the limit being $100 in a calendar month; but to provide for small deposits, a postal savings card is issued for ten cents, to which may be attached postal savings stamps, which when filled will be accepted in lieu of one dollar.
The interest rate allowed is 2 per cent., credited once a year, and the highest balance permitted is $500 to one person. Withdrawals may be made on demand.
The funds so received are to be deposited in national and state banks at 2-1/4 per cent. interest. Five per cent. of these deposits may be withdrawn and kept in the Treasury of the United States as reserve. Before becoming a depository, the bank must furnish as security government, state, or municipal bonds, the limit of deposits being an amount equal to the paid-up capital and one-half the surplus.... Not over 30 per cent. of the amount of such funds may be withdrawn by the trustees for investment in United States bonds, and it is the intent of the act that the residue of such funds amounting to 65 per cent., shall remain on deposit in the banks in each state and territory willing to receive the same under the terms of the act, but may be withdrawn for investment in bonds under the direction of the President, "when in his judgment, the general welfare and interests of the United States so require." Provision is also made for the conversion of savings bank deposits into United States bonds, at the request of depositors.
"POSTAL SAVINGS BEHIND THE SCENES"
Speech of Hon. Carter B. Keene, Director of the United States Postal Savings System at the Banquet of the Investment Bankers Association of America at Denver, Colorado, Tuesday evening, September 21, 1915.
Mr. Toastmaster and Gentlemen:
I appreciate very highly your invitation to speak here to-night, also the words of commendation from your presiding officer. I have often wondered whether the fact that I am the only director of a big savings institution has anything to do with the ability of that institution to pay every depositor his money on demand. (Laughter and applause.)...
The toastmaster was wrong when he said that postal savings has nothing to do with investment bankers. We have a great deal to do with them. Indirectly, we are one of their best customers. More than ninety-four million dollars in bonds are now with the Treasurer of the United States as security for postal savings funds, and you gentlemen have largely supplied the banks with these bonds. Sixteen million dollars are in State and Territory bonds; city, town, and village bonds amount to forty-six millions; county bonds nine; miscellaneous bonds ten; and bonds of the United States Government and its dependencies thirteen....
Since I have been here this week I have heard billions and billions talked about.... I can hardly comprehend what a million is. But I want to tell you that in four and a half years the postal savings system of the United States has become custodian of sixty-eight million dollars, in cash, of the people's savings. Let me lay emphasis on the cash, because big figures do not always mean cash. Sixty-five million dollars of this money is on deposit in six thousand banks scattered throughout the country. In other words, practically all of the money we have collected has been released through the banks to channels of trade in the very localities where it originated. I am sure you will agree with me that this is a very creditable showing so far as dollars and cents are concerned.
The Federal Reserve Act, which went into effect on the 16th of November last, provided that postal savings funds should not be deposited in non-member banks. The Attorney General for the United States has held that the prohibition relates to funds received on and after November 16th. Therefore, postal savings on deposit in state institutions when the act became effective have been allowed to remain, except as it has been necessary to withdraw it to pay depositors.
The Post Office Department has made frequent investigations to determine where postal savings deposits come from; with the invariable result that they are found to come from chimney corners, mattresses, bootlegs, etc., but until very recently no effort has been made to ascertain where postal savings go when withdrawn. And this recent inquiry has been both gratifying and entertaining. It was found that in a vast majority of cases savings were withdrawn for very substantial reasons, prominent among them being payments on homes and the launching of small business enterprises. Occasionally a hospital bill was paid. Some depositors sent money to the old country to bring over a parent or a brother; a wedding trousseau here and there; and in Colorado we have record of a withdrawal to buy an automobile. (Laughter.)
I am glad to say that there has been a very great change in the attitude of the banks toward postal savings in the last few years. At the outset, many bankers thought that postal savings was an unwarranted invasion of the domain of private enterprise and that the service would prove a severe drain on their established business. The opposite has been the result. The tarnished coins and soiled currency that come into our postal depositories represent hidden savings--money that is beyond the reach of any corporate banking institution no matter how sound it may be or how conservatively managed. This newly discovered money has been made available for commercial purposes in the very cities and localities from which it was withdrawn, so instead of being a drain on corporate banking institutions postal savings has added to the deposits of some six thousand banks more than sixty-five millions. The bankers now freely admit that postal savings has been a help to them, and it is no uncommon thing for banks, especially in the mining regions of the West, to urge the Post Office Department to extend postal savings facilities in order that more money may be made available for local uses.
Among our 540,000 depositors every nation on the face of the earth is represented, also every conceivable occupation. The fisherman, the miner, the shoemaker, the preacher, the bank teller, the butcher, the baker, the candle-stick maker, all have accounts, but the great bulk of our deposits come from the men and women who work with their hands for a daily wage.
The foreign born are our most numerous and liberal patrons. An interesting poll of depositors has just been made by the Post Office Department and it was found that 59 per cent. of all postal savings depositors were born outside the United States, while the American born comprise 41 per cent. A still more surprising fact is that the foreign born own 72 per cent. of all the deposits. The Russians lead with $14,000,000 to their credit, or 20.7 per cent. Then follow the Italians with $9,650,000, or 14.2 per cent.; natives of Great Britain and her colonies with $6,000,000, or 8.8 per cent.; the Austrians with $5,900,000, or 8.7 per cent.; Hungarians, $2,900,000, or 4.3 per cent.; Germans, $2,800,000, or 4.1 per cent.; Swedes, $1,500,000, or 2.2 per cent.; and Greeks, $1,200,000, or 1.8 per cent.
What a splendid vote of confidence on the part of our foreign-born citizens in the good faith of the United States. And in these figures also is a high testimonial to the industry and frugality of our newly acquired citizens. That they should take most kindly to postal savings is not remarkable when we consider that they were accustomed to a similar service in their native countries....
Another thing that has induced foreigners to become postal savings depositors is the disastrous experiences many of them have had with so-called "private banks," usually operated by people of their own tongue. It is difficult to conceive of a more heinous crime than some of these so-called "bankers"--slick and persuasive--have committed in alluring credulous, hard-working men and women, to entrust their humble savings with them for the deliberate purpose of theft. I am glad to see that prosecuting officers have recently been aroused to the "private bank swindle" and that their promoters are getting the punishment they deserve.
When Europe got on fire last year, our postal savings receipts began to increase by leaps and bounds. During the fiscal year 1915, the deposits jumped from $43,440,000 to $65,680,000 and more than 140,000 new accounts were opened. The war still has an influence upon postal savings deposits, but the more immediate cause of large deposits at this time is the remarkable revival of commercial activities. Seven cities now have more than a million dollars on deposit, namely. New York, Brooklyn, Chicago, Boston, Detroit, San Francisco, and Portland, Oregon. Greater New York, including Brooklyn and several other offices in the municipality, now have over one-fourth of all the money in the Postal Savings System. During the past fiscal year New York City gained 200 per cent.; Bridgeport, Connecticut, 188 per cent.; Brooklyn, New York, 167 per cent.; Paterson, New Jersey, 162 per cent.; Jersey City, New Jersey, 122 per cent.; Detroit, Michigan, 112 per cent.; Newark, New Jersey, 100 per cent.; Akron, Ohio, 77 per cent.; Gary, Indiana, 66 per cent.; Pueblo, Colorado, 52 per cent.
Now, my friends, I come to a point that I hope will make an impression on your minds--a lasting impression--and that point is that the Postal Savings System from the first has been seriously handicapped by statutory restrictions on the amount that may be accepted. The law permits the acceptance of only one hundred dollars a month and five hundred dollars in all from a depositor. It has been shown that the foreign born are the largest patrons of our savings service and if this service is to reach its full measure of success we must recognize and respect the habits of the foreigner, and one of his habits is to save his money until he gets several hundred dollars together and then take the entire amount to the post office, just as he did in the old country. Because the postmaster cannot accept all that is offered, the intending depositor very frequently goes away in resentment and disappointment without depositing a dollar....
It is the testimony of postmasters from all over the country that they are rejecting about as much money as they are taking in. The Postmaster General last year recommended to Congress that one thousand dollars be accepted with interest and that another thousand dollars be accepted without interest, but for safekeeping. That was a practical and reasonable recommendation--one which would meet all requirements in ninety-five per cent. of the cases. Unfortunately the recommendation failed.... The Postmaster General has indicated that he will repeat the recommendation in his forthcoming annual report and I sincerely hope that Congress will promptly recognize the urgent need of the legislation. Millions of dollars, my friends, are spent every year by uplift societies for the betterment of the foreigners. These foreigners, these begrimed, hard-working foreigners, come to our post offices and ask us to take their humble savings. How unfortunate that we cannot accept what they offer, within reasonable bounds. What an effective agency this would be in bettering in a most practical and permanent way the conditions of the very people we want to Americanize as speedily as possible.
... We have five hundred and forty thousand depositors in the United States to-day and postal savings has a new and different story for each of them. It is not always the big things in life that change or fix our course. Can't you remember when a few dollars or the want of a few dollars tipped you one way or the other in some important matter. Who can estimate the happiness and prosperity that the starting of a postal savings account may lead to. It is a step, and an important one, in the right direction. Some one has well said that the immigrant who opens a postal savings account steps unconsciously on a moving platform; one thing leads to another, and his deposit might lead him into local investment and investment into business and into citizenship.
There is a very interesting human-interest side to postal savings in which every phase of good fortune and disaster is reflected. An aged couple at Norfolk without the knowledge of each other had been carrying $100 on their persons as a guaranty of respectable burial. They are now postal savings depositors. Two sisters died in each other's arms in the Eastland disaster in Chicago a few weeks ago--two working girls--and they had postal savings accounts for like amounts. Their savings went to pay for their burial. One of Uncle Sam's bluejackets who went down on the ill-fated submarine F-4 was the owner of a substantial postal savings account. Gentlemen, the Postal Savings System means something more than a cold array of assets and liabilities, a balance sheet. Way off in an isolated spot in Russia a money order went not long ago to the home of a humble peasant. That money order represented the savings of a son who was drowned in the Susquehanna River. A few weeks back, a thrifty Mexican girl withdrew her savings from the post office at San Diego, California, to buy a trousseau. After the honeymoon she returned to the office with her new husband and both opened postal savings accounts.
Last year Leadville, Colorado, struck a thrift note that was new in this country, so far as I know, and reference to it is particularly timely as Christmas is approaching. A mining company in that city struck the note and I hope it will be heard from one end of this country to the other. It was this: Last December an officer of the company went to the post office and opened a postal savings account for every employee--ninety in all--as a Christmas present. He placed to the credit of each 2 per cent. of what he had earned during the year. These Christmas remembrances amounted to over fifteen hundred dollars. Out of the ninety employees only five had previously opened postal savings accounts. Now, I count that substantial charity; I call that well-directed charity. We have kept track of these particular deposits and the workmen who get their start through that Christmas bounty are adding to their savings weekly by their own personal efforts. (Applause.)
Gentlemen, as a rule, we in official life swing back and forth in a measured arc, and the little one can do is so small when compared with the mass of Government activity that we feel insignificant and lost. But I feel, my friends, that in the Postal Savings System my associates and I are doing a positive good for humanity. I believe that we are making people better and happier because postal savings points the way from the sweat shop to the school--it stands for clean homes and empty alleys. Each of you is a stockholder in the Postal Savings System and its success is your success. Your dividends are in the better and happier American citizenship which it encourages and promotes. (Applause.)
FOOTNOTES:
[93] Adapted from W. H. Kniffin, The Savings Bank and Its Practical Work, pp. 54-75. The Bankers Publishing Company. New York, 1912.
[94] E. W. Kemmerer, The United States Postal Savings Bank, Political Science Quarterly, Vol. XXVI, No. 3, September, 1911, pp. 465-77.
[95] W. H. Kniffin, The Savings Bank and Its Practical Work, pp. 75, 76. The Bankers Publishing Company, New York. 1912.
XVII. DOMESTIC EXCHANGE
[96]The banker has become the bookkeeper and settling agent of the business world. The products of a locality, let us say the State of Georgia, move out to the markets of the world and create credits in favor of that locality on the books of banking institutions in the commercial centers, while at the same time a counter movement of commodities is under way from other localities into Georgia, in like manner creating credits for those localities which are debits against Georgia. The practical effect is that the commodities moving between these communities are exchanged and pay for themselves, the running accounts being kept and settlements effected in the banks.
To illustrate the details: A dealer in cotton in Atlanta makes a sale to a mill in Fall River and receives in payment a check or draft drawn on a New York bank, which he deposits for the credit of his account in an Atlanta bank, and which the latter forwards for the credit of its bank account in New York. Meanwhile an Atlanta merchant has bought goods in New York and in order to pay for them buys from the Atlanta bank an order for the New York credit, and this when forwarded completes the circle of payments for cotton and goods.
If we would extend the investigation to include the bank accounts of the Fall River mill and the Atlanta dealer we would find, first, that the mill account was built up constantly by deposits of checks and drafts received in payment for goods sold in all parts of the country and perhaps all over the world, with almost no deposits of cash, and that it was drawn down by checks for raw cotton, and supplies and large amounts of cash for the pay-rolls; second, that the cotton dealer's account was built up entirely by deposits of checks or drafts received for cotton shipments and drawn down by checks and cash payments to farmers for cotton.
For payments at a distance bank credit in the form of a check or draft is [commonly] used....
The foregoing illustrates the movement of the exchanges constantly proceeding ... between ... different communities.... There is a network of relationship between banks through which each local community and market is connected with all other communities and markets.... No locality is so remote as to be outside of the circle and no community's sales and purchases are so scattered but that they can be brought together in the settlements. Each bank is the center of a circle of which it is the clearing agent; all payments between its own customers may be made by a transfer of credit upon its books. If there are two banks or more banks in a town, all payments between their customers are resolved into offsets between these banks, and in like manner all payments between localities are resolved into offsets between banks, and if not settled in local centers are passed up to larger and larger clearing centers....
But while the cross-payments of trade may be depended upon in the long run to balance and settle themselves, it does not follow that they will do so from day to day, or that they coincide so closely that payments in money are never required. An individual's sales and purchases are seldom made at the same time, and the sales and purchases of communities are not constantly balanced. The trade of a one-crop farming district will not be so evenly balanced as one of a district in which mixed farming prevails, and in every industry there are periods, usually recurring every year, when the payments exceed the current income, and corresponding periods when income exceeds outgo....
A region like the cotton states, whose products move quickly to market, may have large credit balances at one season and at another be wanting to borrow....
The banker is an equalizing agency in the situation. He stands in the breach: he must either supply the missing offsets of credit, or, as a last resort, make the payments in money....
The entire system of settlements, with transfers and offsets and advances and interchange of capital and credit, is exceedingly interesting and wonderfully simple and effective, but depends for its effectiveness upon a scrupulous observance of the principle upon which it is based. That principle is the natural reciprocity of trade....
While there are balances from time to time in the exchanges ... between different localities ... which cannot be settled without shipments of money, they are usually met without inconvenience unless there is a disturbance of credit.
EXCHANGE RELATIONS BETWEEN CHICAGO AND NEW YORK
[97]... It should always be borne in mind that the fact that New York City is the country's dominating financial market results in making New York funds acceptable everywhere as a means of payment, and in making a ready market for New York exchange throughout the country for a large part of the year.
Throughout January money in Chicago relative to that in New York City is cheap. Exchange rates on New York are high and there is a considerable movement of cash from Chicago to the Eastern States--particularly to New York City....
Just prior to January 1 there is normally a large demand in Chicago for New York exchange with which to meet dividend and interest payments due in New York, and the high rates thus created continue somewhat into the new year. The crop-moving and holiday demand, however, being over, money becomes relatively cheap in Chicago and flows to New York City, where it can at least earn the 2 per cent. paid by banks on bankers' balances, and where it is absorbed somewhat in speculative activity and in the higher security prices, which normally rule the latter part of January and the fore part of February.
From the last of January to the fore part of March the demand for money in Chicago relative to that in New York rapidly rises. Exchange rates on New York fall to a low point, and shipments of cash to the Eastern States are very small....
... There is, however, no evidence of a movement of cash from the East to Chicago in February, although there is something of a westward movement in March.
During this period the relative demand for money in Chicago is increased by the anticipated opening of navigation on the Great Lakes, for the opening of navigation gives rise to a large amount of New York exchange received in payment of grain bills. There is also a demand on the part of western bankers for currency to meet the spring needs of the western farmers. The first of March in many sections of the Middle West is the commonest time for making settlements of interest and principal on farm mortgages. It is also a common date for paying farm rents.
This spring advance in the value of money in Chicago as compared with New York reaches its maximum early in March. The demand then falls off rapidly and with only temporary interruptions (the most noteworthy being about the first of May) until it reaches the low level of the early summer, the latter part of May. It continues at a low level until early in July, when the crop-moving advance begins....
About the first of July the relative demand for money in Chicago and vicinity begins to increase, advancing rapidly, with minor interruptions, until early in September, and then maintaining a high level until the fore part of November. During this period exchange rates rule low and money moves in large quantities from the Eastern States to Chicago....
The primary cause for this increasing and large demand for money in Chicago is of course the anticipated and actual crop-moving demand, there being no sufficiently strong Eastern demand for money at the time to hold it back....
It has been found ... that during the last six to eight weeks of the year, after the crop-moving demand has to a large extent subsided, the relative demand for moneyed capital in both New York City and Chicago is maintained until the time of January settlements at nearly the high level of the crop-moving period. A study of domestic exchange rates and of currency shipments shows that the relative demand for money is stronger during this period in New York City than in Chicago, that exchange rates in Chicago on New York rise, and that cash moves eastward....
Money becomes relatively cheap in Chicago and vicinity during these last six to eight weeks of the year, principally because of the return flow of currency previously shipped to the country districts for crop-moving purposes. There is also considerable demand at this time for New York exchange to meet payments in certain lines of goods, such as hardware and dry goods, that are due New York and New England houses by Western establishments, and to make purchases for the holiday trade.... Comparatively high exchange rates... [near] the end of the year are largely due to preparations for the January disbursements, which Western concerns are called upon to make in New York City....[98]
EXCHANGE RELATIONS BETWEEN ST. LOUIS AND NEW YORK
[99]... General seasonal movements in the relative demand for money in St. Louis (as compared with New York City), ... are fairly regular in their occurrence.
From the beginning of the year until the fore part of May the demand appears to be moderate, exchange rates rule near par, and there is a moderate tendency for cash to move from St. Louis to the Eastern States, with almost no tendency to move in the opposite direction....
The first eighteen weeks of the year, St. Louis bankers say, are a period of comparative inactivity in the local money market. Concerning this period, a prominent St. Louis banker writes: "For the first eighteen weeks in the year... there is comparatively no New York exchange making and also a nominal demand for it, and likewise an easy, quiet money market."...
The second noticeable movement in the St. Louis money market is the sharp decline in the relative demand for money from the fore part of May to about the first of June. Exchange on New York rises rapidly at this time, and May is the month of heaviest shipments of cash to the East....
The high exchange rates in May, and the resulting eastward movement of money, are due largely to the fact that at about this time in St. Louis the bills of boot, shoe, hardware, and dry goods merchants mature, and as their paper is held largely in the East, exchange is required in large amounts. The result is large payments to St. Louis banks, the building up of their reserves, and resulting reduction of their credit balances in New York City.
From the first of June to the first of November the demand for money in St. Louis relative to that in New York City increases rapidly, advancing from the cheapest money in the year (twenty-first week) to the dearest money (forty-fourth week)....
This greatly increasing relative demand for money in St. Louis is, of course, attributable to the crop-moving requirements.... The cashier of a St. Louis bank writes: "New York exchange... always goes to a discount here in the fall of the year, and this is caused by the large cotton drafts drawn in payment of cotton shipped out from the Southwest. The banks down there either send us drafts drawn on New England points or New York, or else they send drafts drawn on the two large cotton buyers here, who, in turn, draw their drafts on Eastern points. The result is a great deal of exchange comes in, for which there is a demand for currency." The resulting low rates of exchange continue as long as the cotton season lasts. During this crop-moving season there are heavy shipments of cash from St. Louis to the Southern States....
After about the first week in November the relative demand for money in St. Louis falls off rapidly until about the first of December, and then fluctuates at a moderate level until the end of the year....
The rise in exchange and easing up of the St. Louis money market in the latter part of November and in December is due to the decline in the crop-moving demand for cash, particularly in the South, and the return movement of cash from that section,... which begins the latter part of November. Southern banks in settling their St. Louis bills first use their eastern exchange and then ship currency. The upward movement of exchange is hastened shortly after the first of November by heavy purchases, for about four weeks, of New York exchange by dry goods, hardware, and boot-and-shoe houses for the purpose of settling their eastern accounts....
DOMESTIC EXCHANGE IN SAN FRANCISCO ON NEW YORK CITY
[100]... Before taking up the subject of seasonal variations in San Francisco domestic exchange rates on New York City, it may be well to observe that in a number of respects the San Francisco domestic exchange market is a peculiar one.
In the first place the principal kind of money in circulation is gold coin and this fact materially influences the range of domestic exchange fluctuations, i. e., the shipping points. Concerning this matter I can do no better than quote from letters of Mr. F. L. Lipman of the Wells Fargo Nevada National Bank. Mr. Lipman writes (under date of February 7, 1908): "In the East the medium of exchange is paper or new gold by weight. In California it is current gold coin by tale, with a mingling of paper and new gold. The first effect of an upward movement of exchange, there, is that at about 40 cents per $1,000 the currency shipping point is reached, which in due course, drains off our paper money. At approximately $1.10 per $1,000 the gold shipping point is reached. Of course the only gold that can be economically shipped is new gold. Now it not infrequently happens that the demand for remittance will be so great as to exhaust (1st) the currency and (2d) the new gold, leaving only our current gold, for which there is practically no shipping point, the discount on worn coin being practically prohibitory."
A second peculiarity of the San Francisco exchange market arises from the fact that San Francisco, being the chief port city of the Pacific coast and the seat of one of the United States mints and subtreasury offices, is the recipient of large quantities of gold from gold-producing regions, i. e., California, Alaska, and Australia. The United States mint will issue without any charge its transfer drafts on the subtreasury in New York in return for deposits of gold, the new product of mines, or for deposits of imported gold. "Frequently," writes Mr. Lipman, "this usage is without influence on our local market, as when large importations of Australian gold are received for New York on London account. At other times this practice of the Treasury has a decided effect on our exchange market as, for instance, when the early gold shipments come down from Alaska. These shipments command the service of the Treasury Department to the full amount thereof, while a portion at least of the proceeds is used in payment of local bills for supplies to Alaska from this city. This throws on the market an additional supply of exchange when such exchange is desired. The owners of the gold, however, have the privilege of taking gold coin instead of eastern exchange from the Treasury, and this alternative tends to bring exchange to about par. The Government also influences exchange from the other side, by its willingness to transmit money by telegraph from New York and Chicago to this city."...
Professor Carl C. Plehn of the University of California, suggests three other characteristics of the San Francisco domestic exchange market, i. e., (1) the close exchange relations with the Orient, (2) the fact that in San Francisco, New York bills very frequently represent merely steps in a general arbitrage transaction, and (3) the appreciable interest element involved in demand transactions because of the distance between San Francisco and New York....
From the beginning of January to about the first of March there is a rapid decline in the relative demand for money in San Francisco, resulting in the lowest level of the year during February.
The average rate of exchange rose from 30 cents discount in the first week to $1.05 premium in the seventh....
... Among the principal factors cheapening money in San Francisco at this time and forcing up exchange may be mentioned: (1) the fact that advances which have been made for the movement of general crops up and down the Pacific coast are being repaid very rapidly; (2) the demand for eastern exchange with which to pay bills incurred for holiday purchases; and, finally (3), the latter part of February, the desire of taxpayers to discharge eastern obligations and get movable funds out of the State before the tax returns of the first Monday in March are made to the assessor.
From the fore part of March to the fore part of June the demand for money in San Francisco relative to New York City tends to increase....
Among the causes at work in reducing exchange rates at this time may be mentioned: (1) the readjustment after the heavy demands for exchange which were made anticipatory of assessment day: (2) preparation for the second installment of taxes which become delinquent the last Monday in April; (3) demand for funds by the large fruit canneries with which to buy sugar and tin in preparation for the annual fruit pack which begins in May; (4) by May the shipping trade in green fruits has begun, giving rise to many eastern bills; (5) demand for funds for equipping fishing companies going on long trips....
From about the 1st of July to the fore part of September there is an almost continuous increase in the relative demand for money in San Francisco....
... During August and September, particularly the latter month, substantial transfers of cash [are made] to San Francisco by the United States subtreasury at New York.
This decline in exchange is principally due to the large amount of eastern credits available locally at this time from the shipment of California products, especially green fruits, to eastern points; the returns for such shipments being usually available in either Chicago or New York exchange.... The California hay and grain harvests cause considerable demand for funds by the middle of July, while the ships returning from the fisheries in August and September require large sums with which to pay their crews.
From about the middle of September (thirty-fourth week) to the latter part of October (thirty-ninth week) New York exchange tends to rule at near par....
During these weeks the outward movements of grain, green fruit, and fish tend to force exchange down, while the fact that this is the quarter of large receipts of gold ... from Alaska, making it a period of large receipts of gold bullion at the Mint, and that the San Francisco Mint makes returns for this gold in gold coin or New York exchange, at the option of the owner of the bullion, tends to keep New York exchange at par.
The demand for money in San Francisco relative to New York City increases rapidly from the latter part of October to about the 1st of December when it reaches its highest point in the year.... November and December are the months of largest transfers of cash to San Francisco by the United States subtreasury in New York. The fall in exchange during this period appears to be due primarily to the outward movement of dried fruits, such as raisins, prunes, and apricots. The banks pay out large amounts of actual coin which goes to the country, and receive in return drafts on eastern points which build up their eastern balances. This also represents the most active part of the northern grain season. The low point of the year for exchange is about the last week in November when the tax collector for the city and county of San Francisco withdraws large sums of actual coin from circulation and locks much of it up in the vaults of the city hall.
December is a month in which the relative demand for money in San Francisco lightens considerably as the result of the rapid falling off of the crop-moving demand.... The demand for remittances to the East for January 1st settlements tends to force up exchange rates at the end of the year....
CURRENCY MOVEMENTS BETWEEN NEW ENGLAND AND THE EASTERN STATES
[101]... The distance between New York City and the principal New England cities is very small, and there is a great community of financial interest among these cities and New York. Between New York City and Boston the currency shipping points are only about 25 cents premium and 25 cents discount. Single financial deals between New York City and Boston are frequently of sufficient moment to lead to considerable shipments of currency, although exchange rates previously were only moderate. The relations among the clearing-house banks of Boston and among those of other New England cities are close, so that when one bank is in need of New York funds it is liable to obtain them from another which may have more than it needs. For this reason, it is said, much less money is now received from New York City and shipped there than was the case a few years ago....
THE DOMESTIC EXCHANGES DURING THE CRISIS OF 1907[102]
There is no part of our banking machinery which has received so little elucidation as that of the domestic exchanges. Even for normal times the subject is obscure, and the writer therefore ventures upon an explanation of its course during a period of crisis with hesitation, and he is by no means confident that important considerations may not have been overlooked.
As in the case of foreign exchange, domestic exchange rates fluctuate within limits fixed by the cost of shipping money, and also, in the case of cities distant from New York, by the loss of interest while currency is in transit. The quoted rates apply principally to business between banks, the rates being determined by demand and supply. A Boston bank, for example, receives from its customers New York drafts and also checks drawn on banks in New York and its vicinity. All these items will serve to build up its balances in that city. On the other hand, its depositors have been sending out checks, many of which will in the course of time reach New York and reduce its balances there. The Boston bank will also have received from banks of New York and from banks elsewhere items for collection in its vicinity, and remittance in ordinary course will be made by it in New York funds. Similarly it has sent away items for collection to banks in other cities upon which it expects a like remittance. As a result of all these various influences the balances of the Boston bank may either increase or decrease. If they increase it may be ready to sell exchange to other Boston banks whose balances are running low. It may also happen that the bank is desirous of reducing its New York balances, and in that case it will also appear as a seller of exchange in the market.
Now, if in the course of a crisis clearing-house loan certificates become the principal or sole medium of payment between banks, it may well happen that a bank will be unwilling to sell exchange unless it is unusually well supplied with New York funds. By the sale of exchange it can at best only secure a favorable clearing-house balance, which will be settled in loan certificates, and if this balance should be unfavorable it can meet it by taking out certificates on its own account. Each bank, therefore, to a greater extent than in normal times, is obliged to rely upon itself for means of payment in New York. The loan certificate does indeed yield a return or involve an expense of 6 or 7 per cent., while the return on New York balances is only 2 per cent. This advantage does not, however, seem to have induced the banks to sell exchange as freely as in normal times.
This is, however, not the only disturbing influence. The Boston bank may have remitted to New York upon items collected by it for other banks--let us say those of Philadelphia--but it may happen that the Philadelphia banks delay or even discontinue remitting to New York upon items sent to them for collection by banks of Boston and other cities. The Boston bank can then no longer rely upon what would normally serve to build up its own New York balances. It will be simply acquiring a mass of unavailable credits at scattered points throughout the country. The supply of New York exchange which it might have been willing to sell is consequently diminished, and the premium on exchange must rise to a point at which it will tempt some of the banks to sell exchange, even though it intrenches upon their balances with agents which are available for reserve.
The premium would naturally be especially high in those cities where the banks were most unwilling to reduce their New York balances. Philadelphia seems a case in point, as its deposits with reserve agents, which were $30,995,000 on August 22, were reduced to only $29,389,000 on December 3. At that time the premium on currency in Philadelphia ranged from $1.50 to $3 per $1,000. It is, therefore, a reasonable conclusion that the banks were strongly disinclined to make use of their New York balances. In a few cities it is probable that the premium reached a high level because the banks had exhausted their New York balances. St. Louis may be mentioned as a probable example. Being a central reserve city, its banks would naturally have only such balances in New York as normal business requirements made necessary. The dislocation of exchange elsewhere or the course of payments between New York and St. Louis may have combined to produce such a balance of payments as would have required currency shipments if the St. Louis banks had remitted promptly to New York.
The extent to which banks in different cities delayed or refused to remit to New York on items collected by them for other banks cannot be determined. Banks in one city, very naturally and honestly, were inclined to lay the blame upon banks elsewhere. The banks in other places, however, may not have been able to secure payment of the items sent to them for collection from other banks in their locality with the usual promptness. When every allowance has been made, however, there can be no question that banks in certain cities, in these as well as in other matters, adopted a policy wholly designed to strengthen themselves regardless of consequences.
The general prevalence of the premium on New York exchange is, as we have seen, accounted for in part by the use of clearing-house loan certificates in settling balances between banks and by the delay in remitting in New York funds upon items collected for other banks. It seems probable, however, that, taking the country as a whole, the course of payments was favorable to the New York banks. At the beginning of November withdrawals for crop-moving purposes have in recent years begun to diminish, except to the South, and movements of money from eastern centers are distinctly in favor of New York at that season of the year. If this were indeed the case in 1907, it affords still another reason for thinking that the New York banks might have met the crisis successfully without restricting payments. They would probably have been obliged to meet only withdrawals arising from lack of confidence and not real needs for crop-moving purposes, such as would have increased the difficulties of the situation had the crisis begun at the beginning of September.
Finally, it should be noted that the restriction of cash payments to depositors and the currency premium seem to have increased the demand for New York exchange. Only in that city was it possible to buy any considerable quantity of money. Many banks in various parts of the country purchased gold and currency at a premium in New York and, instead of drawing on their own balances, then entered their home market as purchasers of exchange which was remitted in payment.
In the few instances where exchange was below par the currency premium was a more direct influence; but exchange could not have dropped to the low figures recorded in 1893 in the case of Chicago [$30 discount per $1,000], because the Chicago banks in 1907 did not maintain payments among themselves as they had done on previous occasions. Exchange was at a discount only in those cities where the course of payments was so strongly against New York that practically all the banks found their balances in that city increasing. Chicago might have been expected to belong to this group, but its banks made extensive use of bills derived from grain exports to secure gold which was shipped directly to them. In general, exchange was at a discount, or at par only, in the Southern States, the banks of which, by means of cotton sales, are normally in position to draw money from the northeastern part of the country during the late autumn.
In conclusion, it should perhaps be pointed out that the quoted rates of exchange were often without much significance. The ordinary course of dealings was so completely disorganized in many places that the rates were purely nominal, representing little or no actual transactions.
FOOTNOTES:
[96] Frank A. Vanderlip, Modern Banking, Three Addresses delivered at Chautauqua, New York, August, 1911, pp. 17-29. The National City Bank. New York. 1911 [?].
[97] E. W. Kemmerer, Seasonal Variations in the Relative Demand for Money and Capital in the United States. Publication of the National Monetary Commission, Senate Document No. 588, 61st Congress, 2d Session, pp. 96-100.
[98] [Owing to the growth of deposit banking among the farming classes, the increasing diversification of industry in the agricultural States, Sub-treasury operations, and the offer of remunerative rates of interest on loans in New York during the fall, the net autumnal currency movement since 1907 has frequently been to New York. See E. M. Patterson, Certain Changes in New York's Position as a Financial Center, Journal of Political Economy. Vol. XXI, June, 1913, pp. 523-539.]
[99] E. W. Kemmerer, op. cit., pp. 101-105.
[100] Ibid., pp. 118-121.
[101] Ibid., 54. 55.
[102] O. M. W. Sprague, History of Crises under the National Banking System, Publications of the National Monetary Commission, Senate Document No. 538, 61st Congress, 2d Session, pp. 293-297.
XVIII. FOREIGN EXCHANGE
THE NATURE OF FOREIGN EXCHANGE
[103]The bill, or order to pay money in a foreign centre, is the commodity that is actually bought and sold by dealers in foreign exchange, but it is better for the moment to leave bills out of consideration. They are only the tangible expression of the claim for money in another centre, and at this early stage of our inquiry it is better to keep our minds fixed on what is at the back of the bill, namely, the money in a foreign centre to which it gives its holder a claim. The French buyer of a bill on London buys it, as a rule, because by sending it to his English correspondent he can discharge a debt to him in English money. What he really buys with his francs is so many English pounds, and the labyrinth of the foreign exchanges is much easier to thread if, before we complicate the question by talking about bills, we keep our eye on the comparatively simple problem which is the key to the puzzle, namely, the exchange of one country's money for another's.
Thus stripped to its naked simplicity, the problem begins to look as if it were not a problem at all, and a critical inquirer may be excused for thinking that at least in the case of countries that use currencies based on the same metal, there ought to be no need for daily quotations of rates of exchange, because the relative value of their moneys ought to be constant. It is a natural question to ask, why should there be these daily fluctuations, and, since they are evidently there, what is the sense or purport of them? The answer is, that money in France and money in England are two different things, and the relative value of two different things is almost certain to fluctuate. Quite apart from any differences in the fineness of gold coined by two different countries, or the ease or difficulty with which a credit instrument can be turned into gold, mere distance is quite enough to make the difference that will create fluctuation in price. New York and Chicago use exactly the same currencies, but money in New York differs from money in Chicago by being nearly a thousand miles away, and consequently there are frequent variations in their relative value. The English and Australian sovereigns are identical in weight and fineness, but there is constant fluctuation in the buying power of the English sovereign as expressed in its brother that is circulating in the Antipodes.
These fluctuations are based on the same influence that sways the movements in the prices of all goods and services that are bought and sold, that is, the influence of supply and demand. Just as the price of boots, Consols, medical advice, football professionals, or anything else that can be the subject of a bargain, will depend in the end upon the number of people who want to buy them compared with that of those who want to sell them, at or near a certain figure, so the price of English pounds, when expressed in francs, guilders, milreis, or Australian sovereigns, depends on the number of people abroad who have to buy money in England as compared with the number of those who have money in England to sell. People abroad have to buy money in England when they owe money to Englishmen and want to pay it; and they have money in England to sell when Englishmen owe them money.
Jacques Bonhomme in Paris has been selling shiploads of Christmas kickshaws to John Robinson in London, and so has thousands of English pounds due to him by the said Robinson. But English pounds, as such, are not wanted by M. Bonhomme. He wants to sell them, to turn them into francs, the currency of his own country, with which he makes his daily payments at home. On the other hand, there are always plenty of Frenchmen who have imported English goods or have had services rendered by English bankers, or shipowners, or insurance companies, and so want to buy English money wherewith to pay their English creditors. So it follows that the price that M. Bonhomme will get for his English pounds will depend on the value of goods and services that other Frenchmen have been selling to England, so producing English pounds to be sold in Paris, as compared with the value of the claims that have to be met in London, for the satisfaction of which English pounds have to be bought. If the amount of English money on offer is bigger than the amount wanted, down will go the price of the English pound as expressed in francs, and the seller in francs will get less in francs for his pound. If the amount of English money wanted is the bigger, the price will go up, and the seller will get more for his pound. When the price goes down, the exchange is said to move against London, because there is a depreciation in the value of the sovereign as expressed in francs. When it goes up the exchange moves in favour of London, because the buying power of the sovereign is enhanced.
The process is exactly the same, and is even more simple and easy to understand when we take away the complication of the exchange of the moneys of two different nations, and look at it at work between two distant towns of the same country. If in the course of trade New York has large payments to make in Chicago, money in Chicago will be wanted in New York, and competition there will send up the price of it, so that a dollar in Chicago will be worth more for the time being to New Yorkers than a dollar in New York, and any New York bank or firm that has a balance or a credit in Chicago will be able to dispose of it at a premium. The extent of this premium, however, will obviously be limited by the expense involved in sending lawful money, as the Americans call it, from New York to Chicago. If we suppose, for the sake of simplicity, that the cost of sending a dollar and insuring it is covered by a cent, no one in New York will pay much more than one dollar and a cent for a dollar in Chicago. Rather than do so he will send his dollar. He will probably pay a small fraction more to save himself the trouble and time involved by sending and insuring money, and this minute fraction that he will sacrifice is the opportunity of the exchange dealer, who will send money to Chicago, and put himself in funds there, and so be able to supply money in Chicago to any one in New York who will pay for it at the rate of one dollar and one cent plus any profit that the exchange dealer can squeeze out of him.
Viewed in this simple example the problem of exchange has few terrors. It is merely a question of the price of money in one place, as expressed in the same money in another, with fluctuations governed by supply and demand and limited by the cost of sending money from place to place. This limitation does not mean that supply and demand cease to govern the market, but merely that at a point supply can be increased to meet any demand by the despatch of currency.
"FAVOURABLE" AND "UNFAVOURABLE" EXCHANGES
[104]The general feeling with regard to the function of the exchanges, as giving evidence of the mercantile (or rather monetary) situation of any country, is indicated by the usual phrase of a "favourable or unfavourable state of the exchanges." A phrase which occurs so frequently in all banking discussions that it cannot be passed over without remark. It may originally have implied the erroneous theory that the object of commerce is to attract gold, and that that country towards which the tide of bullion sets with the greatest force is ipso facto the most prosperous. Political economists, from their point of view, are correct in their statement that, as regards the country at large and the interchange of commodities, exports and imports are always balanced, and that both the words "unfavourable balance of trade" and "unfavourable exchanges" involve fallacy. But merchants and bankers are influenced by the feeling, that at any given moment they may be under greater liabilities for imports than they can temporarily meet, owing to the system of credit which disturbs the coincidence of payments for exports and imports, though their value may actually be equal; and further, by the anxiety as to the possibility of meeting these liabilities in that specific mode of payment to which they are pledged, namely, in gold or convertible notes. When, therefore, in banking treatises, it is said that the exchanges are favourable to any particular country, it should be understood that the intention is simply to state the fact that bills of that country upon foreign cities are difficult of sale, whilst bills drawn upon it from abroad are at a premium, indicating an eventual influx of specie. So, when it is said that the exchanges are unfavorable, a situation is described in which foreign bills are in great demand, and when, consequently, their value seems likely to be so enhanced as to render the export of bullion an unavoidable alternative.
THE ORIGIN AND SUPPLY OF FOREIGN EXCHANGE
[105]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. John Smith in London owes me money. I draw on him for 100 pounds, 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.
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, that a vast amount of foreign exchange originates from the direct export of merchandise from this country.
Not all 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.
2. The second source of supply is in the sale abroad of stocks and bonds.
Origin of bills from this source 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.
3. The third great source of supply is in the draft 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. The arranging of these loans means the continuous creation of very large amounts of foreign exchange.
4. Drawing of so-called "finance-bills," 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.
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.
THE SOURCES OF THE DEMAND FOR FOREIGN EXCHANGE[106]
Turning now to consideration of the various sources from which spring 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 merchandise.
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 of 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. Practically the whole amount of our 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 by a bill of exchange drawn on London or some other great European financial centre.
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.
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 stock 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. The same thing is true with stocks, though in that case the selling movements are more frequent and less important.
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. At the interest periods at the beginning and middle of each year it becomes 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. 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. 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. 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.
These loaning operations, it must be understood, both originate exchange and create a demand for it. They were mentioned 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.
In a general way, it may be pointed out, the sources of demand for exchange conform with influences which cause exchange to go up, and the sources of supply of exchange constitute causes which make for low rates.
It is to be noted, however, that money rates are a great factor influencing foreign exchange. Whenever money is cheap at any given centre, and borrowers are bidding only low rates for its use, lenders seek a more profitable field for the employment of their capital.
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. 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.
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 centres 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.
The international money markets are a most decidedly complex proposition, and there is literally never a time when several influences tending to put exchange 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.
METHODS OF FINANCING IMPORTS AND EXPORTS[107]
The foreign trade of the United States has increased during the last forty years about 370 per cent.... This increase ... reflected not alone our own marvellous development, but as well the wonderful growth of trade throughout the world. The United States stands third among the countries of the world, its foreign trade being exceeded only by that of the United Kingdom ... and Germany....
Our imports and exports[108] are being financed more and more by means of what are known as commercial letters of credit.... An explanation of the operation of the commercial letter of credit will ... disclose the methods and conditions under which our imports are financed.
The commercial letter of credit is an authorization, say of an American bank to its London correspondent, to honor drafts for its account drawn at various tenors by foreign shippers or others against shipments of merchandise to this country. These credits are of two kinds, documentary and clean. Under the documentary credit the London bank is authorized to accept drafts for the account of the American bank only when the bill of exchange is accompanied by certain documents described in the letter of credit. These documents may be the bills of lading for the goods, consular invoices, insurance certificates and possibly other papers. Probably a large proportion of such credits requires that drafts be drawn at sixty or ninety days' sight. So many elements of danger are involved in financing commodities under commercial letters of credit, even where the control of the goods is given to the bank issuing the credit or its agents, that the financial standing of those asking for credits must be the first consideration in their issuance. Dishonesty on the part of the shipper, resulting in a drawing under the credit against forged documents or against shipments of inferior merchandise, is always possible, and the financial responsibility of the buyer of the credit is all that stands between the banker issuing the credit and a loss in such cases.
In order to obtain a clear understanding of the working of a commercial letter of credit, we will take a concrete example and follow its every transaction. An importer of coffee (A) in New York purchases a certain number of bags of coffee from an exporter (B) in Brazil. A agrees to furnish B with a commercial letter of credit. B is not in position, we will say, to await the arrival of the coffee in New York and the return of a remittance before receiving his pay. A on the other hand is unable to remit B for the coffee before its receipt and sale to his customers. A goes to his banker in New York and requests him to authorize B to draw upon the New York banker's London correspondent at ninety days' sight with bills of lading for coffee to the amount of the purchase attached to the draft, consular invoice and insurance certificate, if B is to furnish insurance. If A's banker is willing to extend the credit he writes a letter (or uses a printed form), requesting his London banker to accept B's drafts upon presentation under the conditions already mentioned and others of minor importance. This letter is issued in duplicate, one copy going to the London banker, the other being delivered to A. A then mails the copy received by him to B. B thereupon arranges to ship the coffee, obtains the bill of lading, invoice, etc., and takes them with the copy of the credit to his banker in Brazil. A draft is then drawn on the London bank under the terms of the credit at ninety days' sight and is discounted by the Brazilian banker, the proceeds being placed to the credit of B's account or given to him in the form of a check or cash. The Brazilian banker then forwards the draft and documents, except such documents as the instructions may require to be forwarded direct to New York, to his London banker. He may secure discount of the bill at once by cable or await its arrival in London before doing so, or he may request his London banker to have the bill accepted and hold it for maturity. If the bill is discounted the Brazilian banker may draw against it immediately and thus put himself in funds to purchase other coffee bills. Upon receipt of the bill by the London correspondent it is presented to the London banker on whom it is drawn for acceptance. The acceptor bank examines the documents and if they are drawn according to the terms of the credit accepts the draft and returns it to the correspondent of the Brazilian bank, retaining the documents, which it then forwards to the New York bank which opened the credit. In accepting the draft the London bank has in effect agreed to pay it at the end of ninety days, or, figuring grace, ninety-three days. Upon maturity payment is made and the amount is charged to the account of the issuing New York bank. Upon receipt of the documents the New York bank delivers them to its customer under a trust receipt or against collateral, and the latter is then in position to obtain the goods. Ten days before the bill of exchange is due in London the New York bank collects the amount from A, together with the commission agreed upon when the credit was opened, and remits the amount to its London banker to meet the draft. On all such transactions the London banker, while not himself advancing any money, is extending a credit for which he charges the New York bank a commission. The result is that we are paying tribute to European bankers amounting to an immense sum annually for the purpose of financing our imports.
The fact that London exchange is more marketable generally throughout the world than New York exchange is one of the principal reasons why it is necessary for us to issue credits upon London instead of upon New York.
Our imports are distributed generally throughout the United States. The importers, however, are mostly situated at the ports of entry. A very large proportion of them obtain their credits through New York institutions, although some of them deal direct with foreign bankers.
Probably a smaller proportion of our exports is financed by means of commercial letters of credit than of our imports. Different commodities are handled in accordance with special customs which have grown up around them, due partly to trade conditions and partly to the nature of the products. Sellers of grain usually draw at sixty days' sight upon the foreign buyer instead of under a bank credit. These bills, under the customs prevailing in most foreign countries, may be rebated by the foreign buyer whenever he desires to obtain the goods at the "bank rate" or 1 per cent. under the bank rate, or such other rate as custom in the country on which the drafts are drawn requires. Such drafts, with bills of lading and such other documents as are necessary, are purchased by American banks and are forwarded by them to their European correspondents. The American banker is obliged to advance the money on such paper, unless he draws his own time bills against them, until such time as they are rebated. In the case of grain bills the average time rebated is probably around fifty-six days, which places the American bank in possession of demand foreign exchange, against which it can draw in order to reimburse itself with the loss of a very few days' interest.
Flour bills, which are financed in the same manner as grain bills, usually run nearly to maturity before they are rebated, although the condition of the discount market sometimes influences the purchaser, and causes him to take the bills up more promptly. Many foreign shipments are made under three-day sight bills, which uses the money of the American banks making the advance from four to seven days or more, depending upon whether the laws of the country on which the bills are drawn allow grace or not and whether the bills are purchased with intervening days before the sailing of steamers. Other classes of bills are drawn at sight. This includes a portion of our lumber shipments and miscellaneous articles. Where shipments are made on sailing vessels, drafts are frequently drawn at four or six months' sight, and many other transactions go through against cable payments.
As nearly 40 per cent. of our exports consist of cotton, the method under which it is financed is worthy of special consideration. Cotton bills are ordinarily of two kinds: documentary payment bills and bills drawn upon bankers. Documentary payment bills, which are drawn upon cotton merchants or spinners at sixty or ninety days' sight or other tenors, are handled in the same manner as flour bills. The cotton merchant accepts the draft upon presentation and rebates it when the goods arrive, or when he desires to obtain the cotton. A small percentage of cotton is handled in this way. Most of the commodity is financed by means of credits opened by the foreign buyer through his banker. Various abuses have developed under this system, which have caused losses running into millions of dollars to all of the various parties engaged in carrying the transactions to their close. These losses have only been possible because of the turning over of credits by the foreign buyers to irresponsible concerns in America in their endeavor to obtain cotton at lower prices than their competitors. A foreign buyer makes arrangements with certain American concerns to cable him offers of cotton. The American firms whose offers are accepted receive cablegrams from the buyer advising them of the acceptance of their offers and giving them the names of the foreign bankers on whom the drafts in payment of the cotton are to be drawn. The American sellers thereupon ship the cotton to the buyer under bills of lading drawn to the shipper's order and endorsed in blank. The bills of lading are then attached to drafts drawn upon the bankers designated by the buyer at the given tenor, which is usually sixty or ninety days. This exchange is then sold in the market to the highest bidder or it is forwarded to New York to be sold in the same manner upon arrival. The American exchange buyers have no means whatever of designating whose bills shall be upon the market, as the sellers are all agents of the European buyers. The American exchange houses in their need for exchange to meet the demands of their importers have accepted the bills offered in the market, each exchange man endeavoring to keep his "water line" on weak names as low as possible. If the European buyers only dealt with first-class houses only first-class bills would be offered, but when they deal with second- or third-rate houses, or houses with no standing whatever, such bills drawn upon prime European banks come upon the market.
The American exchange buyers having the cotton as collateral while the drafts are on the water, and then having the acceptance of a prime European bank for the sixty or ninety days following before maturity of the draft, have accepted these risks, although unwillingly, for want of better bills. They endeavor to protect themselves as far as possible by trying to buy bills only of those in whose honesty they have reason to believe, whether they have any capital back of them or not. If the cotton were actually shipped under a bona fide order, any fluctuation in the value of the cotton which they accepted as collateral, although taken entirely without margin, would probably cause them neither loss nor friction. They have run the risk, however, of having forged documents forced upon them which did not represent goods, or exchange that was drawn without authority. Lines which exchange buyers are willing to take from each cotton shipper before acceptance, and before the name of a prime European banker is added to the paper, have to be based upon this consideration.
The old form of the cotton bill of lading which has been signed by freight agents or their assistants or others has been an instrument not possible to authenticate. This was particularly dangerous, due to the manner in which bills of lading were issued. They were formerly given out to the shippers, who filled them in and returned them to the railroad agent, who in turn often signed them without having any knowledge as to whether the goods called for by the bill of lading were in his possession or not. Under a new system bills of lading are not to be given up until the goods are actually in possession of the railroads. This system, which calls for validation certificates, numbered and printed upon a specially protected water-mark paper, to be attached to the bills of lading in such manner as to make it practically impossible to remove them without detection, went into effect September 1, 1910, and it is confidently hoped that it will give sufficient added safety to the bills of lading of American railroads to satisfy the foreign bankers.
The very act of guaranteeing such bills is recognized by foreign bankers as being wrong in principle, and while they are requesting that American exchange buyers guarantee bills of lading for exports yet on the other hand they particularly call attention to the fact that no bills of lading which pass through their hands for imports to the United States are guaranteed by them in any way, shape, or manner.
CREDIT RISKS OF DRAFTS DRAWN ON BUYERS ABROAD
[109]Many American manufacturers do not realize the essential "credit" element of transactions on the basis of drafts drawn on foreign customers.... The exporter has received an order; he purchases the goods covered by this order from the manufacturer, and should the customer change his mind the exporter may suffer a loss. Or the customer refuses to accept the goods, and the exporter may again suffer a loss. Or the customer may accept the goods and the draft, but fail to pay, and the exporter once more is the loser....
... The turning over of the bill of lading vests the property right to the goods in the customer. The customer either pays the value of the draft in cash ("documents against payment," abbreviated d/p) or accepts the draft for payment at some future date, which is the more customary course ("documents against acceptance," d/a). Even in the case of d/p drafts, payment by the customer may be postponed; instead of paying cash he accepts the draft at one to three months, but neither the documents nor the goods are turned over to him. He may want to wait until he has sold the goods, on the basis of samples, perhaps, and the goods are warehoused until he can pay the amount of the draft into the bank or to the forwarding agency. This is frequently done in the Far East. Here the banks maintain so-called "godowns" for this purpose. The goods are occasionally turned over to the customer for warehousing purposes against the so-called "trust receipt." One important feature of "acceptance" of the draft by the customer is the fact that it forms an acknowledgment of indebtedness, which it is then unnecessary to prove item by item in case of litigation. In most countries acceptances are far simpler to collect judicially than open accounts. When an accepted draft is unpaid it is "protested," and the debtors may be proceeded against without further trouble.
Frequently open accounts may be neglected by a customer who may find himself for some reason short of immediately available funds, but to neglect the payment of an accepted draft is regarded in the trade and by banks as so serious a matter that the drawee would lose caste with the banks; oversea buyers endeavor in most cases to honor accepted drafts....
ENGLAND DRAWS FEW BILLS, BUT ACCEPTS MANY--THE REASON AND THE RESULT
[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 shipment 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 mass 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 shipment 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 principal 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 assume that fully 95 per cent. of the credits issued to cover these importations were passed 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 principal 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 quantity, 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 2-1/8@2-1/4 per cent. per annum, and a broad, well-developed discount market now exists, with an ever-increasing demand in evidence for this class 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 2-1/2@2-5/8 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 3@3-1/8 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 shipped direct to our own shores, 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 class who engage in the trade.
The middlemen may be divided roughly into three classes. 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 principal 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 assist 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 L1,000, on London, at the rate of 4.86, and that he can sell his own draft for L1,000 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 L1,000 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 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 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.
III. 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 make up the bulk of foreign exchange traded in, and its disposal naturally is the most important phase of foreign exchange business. What the foreign exchange business really is grounded on is the existence of commercial bills called into existence by exports of merchandise.
Buying and remitting commercial long bills is 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.
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.
The successive steps in an actual transaction are 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 L1,000 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 L1,000, but after commissions, bill-stamps, and ninety-three days' discount have been taken out of it, the amount is reduced well below L1,000. The net proceeds going to make up the balance on which the American banker can draw his draft are, perhaps, not over L990. He paid so-and-so many dollars for the L1,000 ninety-day bill, originally. If he can realize that many dollars by selling a demand draft for L990 he is even on the transaction.
IV. 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. 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. All through the past ten years London has at various times opened her reservoirs of capital and literally poured money into the American market.
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 L100,000 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 6 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, L100,000 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 L100,000, 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 4, 5, or 6 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 L100,000 in the New York market. The New York Bank draws L100,000 of ninety days' sight bills, and, satisfactory collateral having been deposited, turns them over to the brokerage house of Smith & Jones, the borrowers. Smith & Jones at once sell the L100,000, 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 L100,000, plus 3/8 per cent. commission, making L375 additional. This L100,375 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 L100,000 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 3/8 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 L100,000. 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 L100,000 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 L100,000, 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 6 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 L100,000 needed to pay off the maturing nineties such a demand draft amounted to, would be the London Bank, Ltd.'s profit.
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 expected.
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 foreign lender 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.
V. 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 a 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. 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.
VI. 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.
Between such cities rates are not apt to be wide enough apart to afford a wide margin of 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. 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.
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.
GOLD MOVEMENTS
[117]When there is a heavy demand for exchange and little supply, the price of exchange gradually advances. The banker, called on by his customers to draw exchange for them, finding few bills in the market that he can remit to cover his drafts, sends gold and directs its equivalent in foreign coin to be placed to his credit, and against this credit he draws. There may be no market abroad for our crops or manufactures; but gold need not be sold in order to produce money; it need only be coined. As this process can be carried on indefinitely, the cost of sending gold is obviously the limit beyond which the price of demand bills cannot advance. Let us follow this transaction in detail. The pure gold contained in one English sovereign is exactly equal to the pure gold contained in $4.8665 of our gold coins; so that, apart from charges and expenses, $4.8665 of our gold will, when sent abroad, produce a credit of L1; to this cost must be added freight, insurance, and other expenses, amounting to about one-fourth of 1 per cent. This brings the cost of L1 through shipment of gold to about $4.88, which is, roughly, the gold export point for full weight coin. The exporting banker obtains his gold either by drawing gold coin from his bank or else by drawing suitable currency from his bank, and obtaining gold coin for it at the subtreasury. In either case, he obtains coin that has suffered more or less abrasion by handling, and this loss of weight by abrasion, amounting to perhaps one-tenth of 1 per cent., increases the cost of his remittance. Generally, however, the banker can obtain gold bars from the United States Assay Office at the nominal charge of one twenty-fifth of 1 per cent., although at times a larger charge is made. The banker prefers bars, because on these there is no loss by abrasion; the Government can afford to give bars, because their export prevents the export of coin, and so saves the cost of coining new money to replace that shipped.
Now for gold import. When there is a large volume of bills offered to bankers, perhaps by grain and cotton exporters, and but little demand from buyers of exchange, the market gradually declines in price, while New York bankers, sending abroad the bills they buy, with little occasion to draw against them, accumulate large sums to their credit in London, with no way of getting the money back to New York through operations in the exchange market. They are not, however, helpless; they can order gold sovereigns sent here, and, once here, can have them melted down at the United States Assay Office and coined into eagles and double eagles, which they can deposit with their banks. Obviously, the amount received in dollars for each melted sovereign will mark the price the banker can afford to pay for sterling bills, and competition among bankers will prevent the rate of exchange from declining below this point by more than a fair margin of profit. The British sovereign, if full weight, will, when sent here and melted down, yield gold for which the United States Assay Office will pay $4.8665; the expense of sending the sovereign, freight, insurance, cartage, and kegs, will amount to about one quarter of 1 per cent., so that the net yield of the full weight sovereign in dollars will be $4.85-3/8. But between the day on which the banker buys the bill of exchange in New York and the day on which he receives in New York the gold which the bill entitled him to collect in London, there must elapse the time needed to send the bill to London, plus the time needed to send the gold back (roughly fifteen days), during which period the banker loses the use of the money. This loss of interest must be deducted from the net yield of the imported sovereign, and thus, if money is worth 6 per cent. per annum, the net yield of full weight sovereigns is brought down to about $4.84-1/4, which is the gold import point for demand exchange, when money is worth 6 per cent. per annum. Losses by abrasion will bring down this point by perhaps one-tenth of 1 per cent., to about $4.83-3/4. When money is higher, the import point will be lower, and vice versa. There is therefore a margin of profit in buying demand bills and importing gold sovereigns against the purchase, whenever the rate for demand bills falls below the gold import point. Active exchange bankers take advantage of this profit whenever exchange prices decline to the proper point, and their competition in buying bills to cover their gold importations stops further decline in exchange rates. It is interesting to note that during the recent crisis, when gold and currency were at a premium, bankers could sell the imported gold at a premium, and this constituted an additional and very large profit; gold importers could therefore pay higher prices than ordinarily for exchange bought to cover the importations, and the stress of competition so drove up the rate of exchange that gold was being imported at a profit, though exchange rates stood at what, under ordinary circumstances, would have been the gold export point.
Gold is, however, not always imported from England in the form of sovereigns. The Bank of England has in its vaults large quantities of American eagles and double eagles exported to England in the past and held without melting. The bank also holds foreign coin and bar gold. Any holder of Bank of England notes can get sovereigns on demand--other gold he can get only as the result of a special bargain. When gold is wanted for export, the bank is often glad to sell bar gold or double eagles at rates somewhat more advantageous to the exporter than would be the export of sovereigns; this the bank can afford to do, for the expense of coining sovereigns to replace those exported is thus saved, while the exporter, if he can get bar gold on the same basis as sovereigns, avoids the losses of abrasion. Eagles are even more advantageous to the exporter, for they are bought in England by weight and used in America by count; the banker therefore gets an advantage if they are light, so long as that lightness is not so great as to make them uncurrent--practically he buys them as light and uses them as full weight....
The mechanism of gold import to, and export from, Germany is practically the same as with England, the Reichsbank being required to give gold coin in exchange for its circulating notes. At times, however, German exchange has fallen below the theoretical gold import point, owing, not to the refusal of the Reichsbank to give gold, but to the practical obstacles that at times are somehow placed in the way of free export of gold. The Reichsbank does not refuse gold for its bank-notes, but German bankers say to their correspondents: "Don't ask us to get gold for you, or we shall lose caste," and on such occasions German exchange rates drop to a point that is theoretically impossible. I do not mean to criticise them: German banks, when they refuse to demand gold of the Reichsbank, do no more than our own banks and bankers did recently, when asked by foreign correspondents to collect in gold the maturing obligations of railroads and other corporations. As will be remembered, clearing-house funds rather than cash were at that time current here, and New York banks and bankers sent to their foreign correspondents the same answer as the Germans have at times sent us. I cite the German instance in partial mitigation of censure of our own course rather than as a reproach to them.
The Bank of France is not compelled to give gold in exchange for its circulating notes; it may at its option give silver. Thus, when it is inconvenient to give gold, the bank can refuse, or, if it prefers, it can exact a premium. This power has been very moderately and very wisely used by the bank to modify foreign demands on the one hand, and, on the other, to keep interest rates low for the requirements of internal trade. Of course, when a premium is exacted, the French gold import point drops accordingly.
Between the gold export point and the gold import point, exchange fluctuates under the sway of conflicting currents and tendencies--I had almost said emotions, for these currents and tendencies have their rise in emotions, needs, and passions as varied as life itself, whether they be hunger as expressed in the grain bill, or love of elegance in the importation of silk, or forethought in the profitable investment of capital.
This brief review will have made clear what is meant by a free gold market--a market in which current money can at all times be exchanged for gold without delay and without premium. Such a market has great commercial advantages; its stability draws business to it. London is such a market, and its commercial and financial pre-eminence is in great measure due to that fact. Paris is not such a market and does not pretend to be; Berlin pretends to be, but cannot always be counted on; New York was believed to be before our recent panic.
I have spoken of the exchange market as an economical mechanism, automatically making delicate international adjustments. In justification of that observation, let me direct attention to the manner in which gold, in moving from financial centre to financial centre, always travels by the most direct route, and that, too, not because some public official is charged with the duty of preventing waste, but because a private trader is trying to make a profit, and is incidentally serving the community; serving it perhaps better than if he had consciously determined to serve it.
Useful acts springing from self-interest have one very comforting aspect--we need have no misgivings as to their continuance. Charity may grow weary or disgusted, but self-interest, once enlisted, may be counted on to continue in operation, whether it be the business man's self-interest in a profit or the professional man's self-interest in advancement and fame. Of course, both the business man and the professional man, in addition to seeking the direct rewards of their labor, take an interest in their work as work and make it yield them pleasure.
It is therefore satisfactory to know that, so long as the banker looks after his profits, gold will move by the most direct route. Let us suppose the United States to be exporting a large quantity of cotton to England at a time when little merchandise is being imported here from England, but when much is being imported from France. If the volume of exports to England and of imports from France were large enough, we might conceivably be importing gold from England in payment of our produce, and exporting it to France in payment for her luxuries; but, in practice, gold does not move that way. Every morning, the New York exchange banker learns by cable the Paris market rate for demand bills on London. When, therefore, he finds a large volume of bills on London offered for sale, and little demand for such bills, while there is large demand for bills on Paris and little supply, he determines, instead of drawing from New York against his purchases of London bills, to let his Paris agent draw against these purchases, placing the proceeds to his credit in Paris; against this credit in Paris, the New York banker draws his bill in francs, having thus supplied via London the New York demand for bills on Paris. He knows how many dollars each pound sterling costs him in New York, and the Paris rate for bills on London tells him how many francs each pound sterling will net him in Paris, and so he can calculate how many cents each franc will cost him. Moreover, he is not the only banker in New York that receives cable quotations; and so with a large volume of London bills offered and little direct demand for such bills, and large demand for Paris bills with little direct supply, we get a situation where New York bankers, competing with each other to buy the London bills for use via Paris, prevent the price of sterling from falling to the gold import point; and then, as a result, these same bankers, competing with each other to supply the demand for Paris bills, by their competition prevent the Paris rate from rising to gold export point. Lastly, they compete with each other in Paris, where all are sellers of bills on London against their New York purchases of London bills, and by that competition they reduce the rate for London bills in Paris to the point, at which, other things being equal, gold will go from London to Paris. What has happened, therefore, is that instead of our importing gold from London, and then exporting it to Paris, it has gone direct from London to Paris.
COMPLICATIONS IN THE DETERMINATION OF GOLD POINTS
[118]It is safe to assert that when the exchanges go down to the point at which it pays better to ship gold from London than to buy a bill, gold will go. But in the first place, experts always differ as to where that point begins; and in the second, gold often leaves London long before there is any question of its being the more profitable form of remittance. In fact, it may be asserted that the foreign exchanges very seldom go down to the export gold point, because gold begins to go before they can get there.
It has often happened to me, when I was a financial journalist and had to try to find out the how and why of gold movements, to ask several of the most experienced and well-informed cambists in the city whether a gold shipment which had taken place had been made as a genuine exchange transaction or was done for some other reason, and to hear from one that there was a reasonable exchange profit on it, from another that there might be just a shade of a turn to be got out of it if you scraped it very hard with a knife, and from another that you could not find a particle of profit in it if you put it under a microscope for a week. So many complications have to be considered that the most eminent doctors may be pardoned for disagreeing.
It may be objected that dealers in exchange, and the comparatively few firms that make a special study of gold shipping, are not in the business for their health, and that shipments would not happen if there were not some profit in them. This is perfectly true, but the profit need not be got from the exchange. As an exchange transaction it only pays to ship gold to America when bills on London can only be sold in New York at a lower price than gold would fetch if brought from London and exchanged into dollars in New York. If bills on London are selling at 4.83-3/4, and gold can be bought and shipped and turned into dollars at the rate of 4.83-7/8, after allowing for all charges and commissions and the loss of interest during transit, then the operation pays as an exchange transaction. If the dollars realized by the gold were at the rate of only 4.83-3/4 the importer would be no better off than if he had sold a bill; if they were at the rate of 4.83-5/8 he would be out of pocket on the business, viewed strictly as an exchange transaction. But this is by no means the only consideration. Gold has such a magical fascination for moneyed mankind, and its movements are so eagerly discussed in their markets and newspapers, that it is often handled and shipped at a loss, especially in America, for the sake of the advertisement that the importing firm thereby gains for itself.
Moreover, imports of gold have a very stimulating effect on speculative stock markets, because an increase in the amount of gold available means a roughly corresponding increase in the amount of credit that bankers can give, so that when gold is known to be coming speculators know that credit will be cheaper for carrying their commitments, and will come in and buy, with a light heart, stock that they could not possibly pay for, but hope to pawn with their bankers until they can sell it at a higher price. And so unless the loss on the exchange side of the business is too great, it often pays the leaders of a bull campaign to import gold, having first laid in a line of stock, and make their profit by unloading during the fit of exhilaration produced by the news that the gold is on the way.
Or, again, quite apart from any speculative and spectacular motives behind gold shipments, it may pay bankers, in a country where rates for money are ruling high, to import gold at an apparent loss, because of the high rates that they get for the credit that they are thereby enabled to give. They thus, in effect, borrow gold, and recoup themselves by being able to lend, on profitable terms, larger amounts than they borrow, since they can always create credit to larger amounts than that of the gold in their vaults. Sometimes, in fact, in times of pressure banks find themselves obliged to import gold so as to strengthen their position, whatever the loss on exchange may be.
For instance, last September, when the Berlin exchange was at the point at which, if theory ruled in these matters, Berlin ought to have been thinking of packing up some gold to send to London, Berlin was buying gold in London and shipping it to the Fatherland, because there is always great pressure for currency in Germany at the end of September when the interest on mortgages falls due and has to be paid in cash, with the result that the Reichsbank's note circulation expands very rapidly and the backing of gold behind it has to be increased. Sometimes, again, in order to attract gold, a central bank will give importers credit for gold that is on the way, so that they may be saved from loss of interest while the metal is afloat. Thus the actual importer may make a profit on the shipment, not as a genuine exchange transaction, but at the expense of the central bank.
In these cases two of the many functions performed by gold have to be considered. As a means of international remittance, it may not be as cheap as a bill, but it may have to be sent, not as a means of remittance, but because it is urgently wanted in the importing country as a make-weight for the balloon of credit.
So we see that the grumbling bill broker who ... [said] that these confounded exchanges only work one way, was actually understating his case. Not only do we [Englishmen] always lose gold when the exchanges go against us, and often get none when they go in our favour, but we also often lose gold long before the exchanges are sufficiently against us to justify its going, and sometimes even when they are strongly in our favour.
The effect on the exchange of an import or export of gold is, of course, just the same as that of the import or export of any other commodity--an import turns the exchange against us and an export turns it in our favour. If we send gold, for example, to Germany we thereby meet a German claim on us or create a claim for ourselves on Germany; in the former case the bills drawn on us will be less by the amount of the gold shipped, and the supply in Berlin of bills on London will be less in relation to the demand, so that the tendency will be for the price of sovereigns, as expressed in marks, to rise. In the latter case some one in Berlin will have a claim to meet in London and will have to bid there for a bill on London, and his bidding will have the same beneficent effect on the exchange. When we import gold, whether brought out of bankers' vaults, or dug out of the bowels of the earth, the country that sends it to us meets claims of ours on it or establishes claims on us. In either case the tendency is for the exchange to move against us.
THE HANDLING OF GOLD SHIPMENTS
[119]Whether in coined pieces or bars (bullion), the gold is packed in strong kegs or boxes, securely strapped with hoop iron, and carefully sealed with private seals; the latter to discover if tampered with en route. Space is chartered from the steamship company, as in the case of merchandise, although nearly all large fast steamers have rooms especially constructed for such valuable cargo.... As an extra safeguard in case of large shipments, the steamship company details special armed men to guard the room day and night, and sometimes the shipper employs special detectives in citizens' clothes to watch the passengers on the trip, since it is generally known several days in advance when large shipments of gold are to be made.
THE SILVER EXCHANGES
[120]... It is acknowledged that commerce between gold standard countries is satisfactory to all classes of traders, for both importers and exporters know exactly the return they may expect, but in trade between a silver-using country and one on a gold basis, a large measure of uncertainty invariably exists. Whenever there is a fall in the gold value of silver, either the exporter in the gold standard country or the importer in the silver country must suffer.
Let us take the case of the exporter. We will suppose that A. Blank & Company, of Manchester, calico printers, send goods to Shanghai, which they hope to sell there for a total sum of, say, L1,000. The price of silver when the shipment was despatched was, we will say, 25_d._ per standard ounce, and on this basis A. Blank & Company have calculated the selling price which is to yield them L1,000. By the time the calico arrives in Shanghai, the gold price of silver has dropped, we will suppose, to 20_d._ per standard ounce, and this obviously indicates that the manufacturers will receive one-fifth less for their wares, since they are paid in the currency of the province (taels in this instance), and when Blank & Company's money comes to be converted back into British gold pieces, they are face to face with the fact that the outturn is L200 less than they had calculated: they have lost one-fifth, and receive L800 only. This is, of course, an extreme case, as in the ordinary course silver would be unlikely to drop 5_d._ in the period between shipment and arrival of the goods in Shanghai; but whatever the fall, the principle is the same, and the illustration serves to show exactly what happens.
It is not only the British exporters who stand to lose in the lottery of trade with countries which have an unstable silver exchange; the capitalist also, and every class of investor, is liable to be adversely affected in operations with silver standard countries. The rate of exchange between such countries and gold standard countries is plainly the exchange between gold and silver; therefore, if a person has invested in undertakings in the silver country, when he receives his dividends in the currency of that country, he will obtain less for his dividend warrant on the London market in proportion to the fall in the price of silver--assuming that it does fall. Conversely, he may reap a higher return on his investment if silver has gone up before the encashment of his dividend.
Finally, the principal is affected in the same way, whenever it is desired to convert it back into gold. A further example will show how this works out in practice.
We may assume that an investor, encouraged by the chance of earning 6 per cent. on his money, remits to China L1,000. The price of silver on the 1st January, 1914, was 26-7/16_d._ per ounce standard; on the 31st December, 1914, 22-11/16_d._ For the sake of argument, we will imagine our investor sent the money out to the Eastern country on the 1st January, 1914, but circumstances made it advisable for him to recall his money at the end of December in the same year, when the metal had depreciated to 22-11/16_d._; in converting his principal back to British currency he will find himself faced with a sharp loss. Silver, in which the investment stood, has dropped 3-3/4_d._ of its gold equivalent, roughly, one-seventh; consequently on conversion the gold value of his original L1,000 has fallen to about L857....
... The exchanges of these silver standard countries ... [are] quoted in shillings and pence to the dollar, tael, or rupee, as the case may be, that is, the gold value of the respective silver coins. Hong-Kong, for instance, is quoted 1_s._ 10-3/8_d._ to the dollar, and Shanghai, 2_s._ 5-5/8_d._ to the tael. The rates from these centres ... indicate the price for telegraphic transfers on London: the unit of exchange in the centres named being by general consent the rate for telegraphic transfers on London.
Let us take the Shanghai rate as an example: 2_s._ 5-5/8_d._ per tael, means that for every silver tael the remitter hands over to the exchange bank in Shanghai, 2_s._ 5-5/8_d._, or, to give it its real significance, a little less than one-eighth of a sovereign in gold, will be paid to the person in whose favour the remittance is made, as soon as a telegram can reach the bank's London branch....
... Besides the T. T. rate, as it is called for the sake of brevity, we have the four months' sight and six months' sight rates, which are the quotations for first-class bank bills. Both quotations are higher than for the telegraphic transfers, that is to say, for every silver tael paid in Shanghai the bank will allow more shillings and pence where it is a question of paying the gold value in London four or six months hence, than it would if the payment is to be made on demand or by wire. The reason is, that if a bill drawn on London, payable four months after sight, is sent, the remitter is bound to place the receiver in such a position that if the latter chooses to turn the bill into cash after it has been "sighted" and accepted, he will not be worse off than if the money had been sent by cable....
As may be gathered, therefore, the discount rates ruling on the London market are of great importance to the Eastern bankers and exchange dealers: so important are they in fact, that it is necessary for each side to keep in direct telegraphic communication regarding the existing discount quotations and the probable trend of the markets....
... The rate at which they are able to cover their drawing operations ... governs the price at which they will sell bills. If a banker has funds deposited with his correspondent upon which he can draw, well and good: if he has no balance with the agent, he must either provide the wherewithal to meet the bills which he has drawn, or, alternatively, he can instruct the agent to draw on him in reimbursement. Finally, there comes a time,... when, as all other means of placing his correspondent in funds have been exhausted, the banker will be obliged to ship ... silver to be sold for what it will fetch....
It is fairly clear that the real trouble in Eastern exchange lies in the fact that we have three main factors to deal with instead of two. In the gold exchanges we have simply the demand for and supply of bills and telegraphic transfers; in the silver exchanges the matter is complicated by the way in which we also have to depend upon the fluctuations in the price of silver on the London market....
Shanghai draws on London for the cost of her exports and remits to London for the value of her imports, and the principal reason for this procedure is that the manufacturer in Great Britain does not wish to be bothered with the variations in exchange, although as the reader has seen, he may be pretty severely affected if silver has depreciated before his goods are sold. Leaving that out of the question, however, we may take it that as all his expenses are payable in gold, he naturally prefers to deal in terms of that metal. Consequently, goods shipped to China are nearly always paid for by remittances, or drawn for in sterling, which comes to the same thing. The Chinese producer is on rather a different footing. His expenses are in silver, and in silver he wishes to be paid. His produce, however, he has sold to Great Britain for a gold price, and either he cannot afford to, or does not want to wait until a remittance can be sent by mail from London. The one way open to him is to draw in sterling and settle the rate of exchange on the spot, which he does and so makes an end of the matter....
FOOTNOTES:
[103] Hartley Withers, Money Changing, pp. 30-35. E. P. Dutton and Company. New York. 1914.
[104] Adapted from the Rt. Hon. Viscount Goschen, The Theory of the Foreign Exchanges, pp. 85-88. Effingham Wilson. London. 1913.
[105] Adapted from Franklin Escher, The Elements of Foreign Exchange, pp. 3-14. Bankers Publishing Company. New York. 1913.
[106] Ibid., pp. 15-24, 26, 31-33, 44.
[107] Adapted from Frederick I. Kent, Financing Our Foreign Trade, The Annals of the American Academy of Political and Social Science, Vol. XXXVI, No. 3, November, 1910, pp. 492-500.
[108] [The method explained would apply without qualification to our imports generally prior to 1914, whether coffee from Brazil, hides from the Levant or textiles from France. The recent and growing practice of drawing on New York rather than on London is discussed later in this chapter.]
[109] Adapted from Archibald J. Wolfe, Foreign Credits, pp. 22, 23, Special Agents Series--No. 62. Department of Commerce and Labor. Washington. 1913.
[110] George Clare, The A B C of the Foreign Exchanges, pp. 11-15. Macmillan and Company. London. 1911.
[111] [English bills drawn on our banks have increased in volume since 1914, through the operation of the Federal Reserve Act and the amended New York State Bank Law which make provision for the acceptance of time drafts by National and New York State banks, respectively.]
[112] John E. Rovensky, How the War Affects Practical Operations in International Exchange, Journal of the American Bankers Association, Vol. 7, No. 12, June, 1915, pp. 1008, 1009.
[113] Joseph T. Cosby, The Economies and Advantages of "Dollar Credits." The National City Bank. New York. 1915.
[114] Harry G. Brown, International Trade and Exchange, pp. 65-66. The Macmillan Company. New York. 1914.
[115] Anthony W. Margraff, International Exchange, pp. 104-105. Fergus Printing Company. Chicago. 1903.
[116] Adapted from Franklin Escher, Elements of Foreign Exchange, pp. 68-101. Bankers Publishing Company. 1910.
[117] Albert Strauss, Gold Movements and the Foreign Exchanges, The Currency Problem and the Present Financial Situation. A Series of Addresses Delivered at Columbia University, 1907-1908, pp. 65-72. The Columbia University Press. 1908.
[118] Hartley Withers, Money Changing, pp. 159-164. E. P. Dutton and Company. New York. 1914.
[119] Address by H. K. Brooks. Lectures on Commerce, Edited by Henry Rand Hatfield, University of Chicago Publications of the College of Commerce and Administration, Vol. I., pp. 283-4. The University of Chicago Press. Chicago. 1904.
[120] William F. Spalding, Foreign Exchange and Foreign Bills in Theory and in Practice, pp. 133-140. Sir Isaac Pitman & Sons, Ltd., Bath, New York and Melbourne. 1915.