Readings in Money and Banking Part 31

These are the princ.i.p.al 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 quant.i.ty 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' disburs.e.m.e.nts 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 const.i.tutes 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 partic.i.p.ation 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 partic.i.p.ation in foreign bond issues. Acc.u.mulated 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 pa.s.s 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 quant.i.ties 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 ma.s.ses 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 t.i.tled 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 quant.i.ty 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 const.i.tute 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, doc.u.mentary and clean. Under the doc.u.mentary 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 doc.u.ments described in the letter of credit. These doc.u.ments 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 doc.u.ments 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 doc.u.ments, except such doc.u.ments 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 doc.u.ments 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 doc.u.ments, 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 doc.u.ments 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 princ.i.p.al 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 inst.i.tutions, 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 doc.u.ments 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 cla.s.ses 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: doc.u.mentary payment bills and bills drawn upon bankers. Doc.u.mentary 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 compet.i.tors. 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-cla.s.s houses only first-cla.s.s 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 doc.u.ments 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 a.s.sistants 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 pa.s.s 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 ("doc.u.ments against payment," abbreviated d/p) or accepts the draft for payment at some future date, which is the more customary course ("doc.u.ments 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 doc.u.ments 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 "G.o.downs" 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