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DOMESTIC AND FOREIGN EXCHANGE

The
THE MACMILLAN COMPANY
NEW YORK BOSTON • CHICAGO • DALLAS
ATLANTA SAN FRANCISCO
MACMILLAN & CO., LIMITED
LONDON • BOMBAY CALCUTTA
MELBOURNE
THE MACMILLAN CO. OF CANADA, LTD.
TORONTO

DOMESTIC AND FOREIGN

EXCHANGE

THEORY

AND

PRACTICE

BY
IRA B. CROSS , PH.D.
PROFESSOR OF ECONOMICS , UNIVERSITY OF CALIFORNIA

New York
THE MACMILLAN COMPANY

1923
All rights reserved

COPYRIGHT, 1923
BY THE MACMILLAN COMPANY
Set up and electrotyped. Published January, 1923.

Printed in the United States of America

3

TO THE MEMORY OF A WONDERFUL
FRIEND AND COLLEAGUE
CARLETON HUBBELL PARKER

Bus.At.Lib .
Wohr
4-12-47
13067

PREFACE
In writing this volume I have sought to prepare a book on the
exchanges which would be simple and adequate in its treatment of
the subject, and suited to the needs alike of college students and the
younger men engaged in actual exchange operations.

In my class

room work I have used practically all the volumes thus far published
and have felt the need of a book that would be neither a banker's
manual nor a brief and inadequate treatment of the more complicated
phases of exchange operations.

I appreciate the difficulties of others

who, as beginners, delve into the intricacies of the field , and have
tried to keep their interests continually in mind, even to the extent
of being guilty at times of obvious repetition.

It is also partly, but

not solely, because of them that I preface the discussion of foreign
exchange with a survey of the practices and forms commonly found
in the domestic field .
There has been much needless mystery about the workings of the
exchanges, especially of foreign exchange , due undoubtedly to the
stress laid by early writers on the theoretical aspects of the subject.
In the chapters that follow, I have interwoven the more important
parts of the theoretical with the practical so as to present as complete
a treatment as is possible within the limits of one volume.

I have

frequently questioned the validity of certain commonly accepted
theories as tested out in practice, and have urged the advisability of
avoiding the customary rigid and dogmatic application thereof to
the field of the exchanges.

Much still remains to be done not only

in this connection but also in the realm of general economic theory.
It is my sincere hope that the economists of the future will completely
shake off the influence of the past and formulate a group of theories
that will be more fully in accord with Twentieth Century conditions.
vii

viii

PREFACE

Some progress is already being made in this direction by our younger
writers.
Throughout the volume I have not only dealt with the exchanges
as they are supposed to function normally, but have continually
referred to those abnormal developments occurring both in times of
peace and war which call for a closer and more searching examination
of exchange practices and rate fluctuations and necessitate the adoption of unusual methods to meet unusual circumstances.
Many of the details of the practical side of exchange transactions
cannot be dealt with in writing, but must be learned solely " on the
job" behind the exchange counter.

I have, however, given con-

siderable space to the more important features of the technique of
exchange operations so as to place before the student the fundamentals
of, and the reasons for, some of the more customary practices of the
business.
In preparing this work, I have incurred many obligations.

I am

deeply indebted to those banks and exchange dealers which have so
graciously allowed me to reprint their exchange forms and documents,
viz. , The Guaranty Trust Company, the Irving National Bank, the
American Express Company, all of New York City ; the Anglo and
London Paris National Bank, the First National Bank, the International Banking Corporation , the Crocker National Bank, and the
American National Bank, all of San Francisco ; and the Merchants
National Bank of Los Angeles .

The Guaranty Trust Company has

also permitted me to reprint some of the forms appearing in its pamphlet, " How Business with Foreign Countries is Financed ," and also a
photograph of its trader's room, while the Irving National Bank has
granted me a similar courtesy in connection with certain forms relating to export credits appearing in its monograph " Trading with
the Far East."

I am especially eager to make acknowledgment of

the aid given me by those good friends and co-workers who have read
all or parts of the manuscript and who have made numerous helpful
suggestions, viz . , Mr. Harry Coe, Vice President of the Anglo and

PREFACE

ix

London Paris National Bank and Manager of its Foreign Department; Mr. C. S. Reuter, Assistant Manager of the Foreign Exchange
Department of the Merchants National Bank of Los Angeles ; Dr.
H. H. Preston of the Department of Economics of the University
of Washington ; Dr. F. Fluegel and Mr. W. R. Robinson of the Department of Economics of the University of California ; Dr. M. W.
Dobrzensky of the School of Jurisprudence of the University of
California, and Mrs. E. D. Wilkie of the University of California
Press.

Mr. J. G. Schaffer, Teaching Fellow in the Department of

Economics of the University of California, has assisted me in checking many of the exchange calculations appearing in the volume.

My

greatest debt of gratitude is to Mr. Max Rosenberg, a dear good friend,
without whose sincere interest and encouragement this volume would
not have been written.
IRA B. CROSS.
Berkeley, California,

January, 1923.

CONTENTS
CHAPTER

PAGE
I
6
22

I. Introductory ..
II. Inter-Bank Relations .
III. Domestic Exchange.
IV. Indorsement, Acceptance, and Liability.
V. Exchange Dealers ...
VI. Principles of Foreign Exchange .
VII.
VIII.
IX.
X.
XI.

Fundamentals of Foreign Bills of Exchange .
Types of Foreign Bills of Exchange .
Import and Export Credits .
Rates of Exchange ...
Gold and Gold Movements .

79
94
116

137
171
234
300
370

XII. Exchange Relations with Silver Standard, Gold Exchange, and
Paper Standard Countries .
427
487
XIII. Investment, Speculation, Arbitrage ..
XIV. The World War and the Exchanges .

527

APPENDICES :
I. A Typical Correspondent Relations Agreement . .
II. Values of Foreign Coins ..
III. Methods of Conversion .

INDEX ...

555
557
559

567

xi

FORMS

~
w
∞
~

FIGURE
PAGE
1. Application for domestic money order .
23
2. Domestic postoffice money order .
24
3. Domestic express money order ..
27
28
4. Application for domestic telegraphic transfer .
29
5. Notice to payee of telegraphic transfer . .
6. Application for bank telegraphic transfer .
30
7. Bank's receipt for telegraphic transfer .
8. Bank check ...
38
9. Availability schedule for Seattle branch Federal Reserve Bank of
San Francisco ..
42
10. Bank draft ...
46
II. Book of traveler's checks .
50
12. Front page domestic circular letter of credit .
52
13. Second page domestic circular letter of credit .
53
14. Letter of indication ..
54
15. Part of correspondent list .
55
16. First page of bank's signature sheet .
56
17. Second page of bank's signature sheet .
57
60
18. Sight draft ..
61
19. Ninety day sight draft .
61
20. Date draft ...
68
21. Trade acceptance .
22. Domestic commercial letter of credit ...
71
76
23. Certificate of elegibility of banker's acceptance .
24. Crossed check ..
87
25. Protest blank .
91
26. Notice of protest ..
92
ΙΟΙ
27. List of offerings of bankers' acceptances by discount house
124
28. Diagram showing theory of foreign payments .
124
29. Diagram showing theory of foreign payments .
30. Diagram showing theory of foreign payments .
125
129
31. Typical list of foreign money prices .
141
32. Instructions accompanying a foreign bill of exchange .
142
33. Instructions accompanying a foreign bill of exchange.
34. Instructions accompanying several bills of exchange .
143
35. General letter of hypothecation .
153
36. Draft drawn by exporter on importer.
156
37. Steamship bill of lading .
159
38. Insurance certificate .
164
166
39. Invoice ...
xiii

xiv

FORMS

8t

FIGURE
PAGE
40. Consular invoice ...
167
41. American Express Company limited check .
175
176
42. Foreign exchange rate list of American Express Company
43. American Express Company postal remittance ...
177
44. Postal remittance issued by bank through American Express Company ..
178
180
45. Postal remittance issued by bank .
46. Advice to foreign correspondent in connection with bank post
180
money order ....
47. Advice to jobbing bank in connection with bank post money order 181
183
48. Original and duplicate bank drafts on foreign account .
184
49. Application for bank draft on foreign account .
185
50. Advice of issuing bank to foreign bank ..
186
51. Advice to correspondent of foreign correspondent .
187
52. Advice to issuing bank by foreign correspondent .
53. Exchange rate sheet ...
189
54. Type of four-part form of bank draft .
190
55. Type of four-part form of bank draft .
192
193
56. Advice to correspondent of foreign correspondent .
57. Type of five-part form of bank draft .
194
195
58. Receipt for letter of delegation .
59. Application for cable transfer .
197
219
60. Old form of foreign traveler's check ..
220
61. New form of foreign traveler's check .
221
62. American Express Company's franc traveler's check .
225
63. Foreign circular letter of credit agreement .
226
64. First page foreign circular letter of credit .
65. Second page foreign circular letter of credit .
227
228
66. Advice of letter of credit ...
67. Application for commercial letter of credit .
237
68. Agreement signed by applicant for commercial letter of credit .
238
240
69. Dollar import letter of credit . . . . . .
245
70. Trust receipt (documents for warehousing) .
246
71. Trust receipt (goods to be held or sold by importer) .
247
72. Trust receipt (for delivery to purchaser).
248
73. Bailee receipt . .
256
74. Sterling import letter of credit .
267
75. Draft with interest clause .
76. Draft with colonial clause .
271
281
77. Confirmed export credit .
282
78. Unconfirmed export credit .
294
79. Authority to purchase (letter of guarantee) ..
295
80. Authority to draw or advice of authority to purchase.
522
81. Weekly statement of foreign accounts .

CHARTS
CHART
PAGE
I. Highest and lowest quotations for sight sterling per month, 1907,
1910, 1913 ...
320
II. Spread of sterling rates, 1907 .
362
III . Spread of sterling rates, 1913 ..
363
IV. Relation between cable spread and deposit allowance rate in
London ..
364
V. Maximum and minimum spread of sixty day D/A commercial
bills and bankers' bills at varying rates of discount in London,
365
1913 ...
VI. Gold movements and wholesale prices, United States, 1890-1921 . 422
VII. Price of silver in the United States and wholesale price index,
November , 1918-April, 1922 ....
437
VIII. London quotations of telegraphic transfers, Shanghai, Hongkong,
and Calcutta, and of price for spot silver, 1914-1921 ..
443
IX. High rate for sight drafts on Argentina, Brazil and Chile in New
York, 1914-1921 ...
471
X. Wholesale commodity prices in the United States, England,
France, and Italy ...
477
XI. Commodity price indices and New York exchange rates on Eng483
land, France, Italy, and Germany .
XII. Purchasing power parity of sterling, francs, lire and marks, 19171921 ...
484
XIII. Exchange rates in New York on belligerent countries, June, 1914–
July, 1918 .
540
XIV. Exchange rates in New York on neutral countries, June, 1914July, 1918 ....
541
XV. Exchange rates in New York on England , France, Germany,
Italy, Netherlands, Argentina, and Japan, November, 1918December, 1921 ..
544

ILLUSTRATIONS

Gold shipment from China being received at San Francisco ..
An exchange trader's room ..

XV

385
524

DOMESTIC AND FOREIGN EXCHANGE

DOMESTIC AND

FOREIGN

EXCHANGE

CHAPTER I
INTRODUCTORY
To the layman and to the student enrolled in university classes in
finance, the field of Domestic and Foreign Exchange appears at first
sight to be but a mass of incomprehensible details , complicated and
therefore meaningless documents, mystical and magical practices
concerned with creating funds out of "the wind " and shifting such
funds, figuratively speaking, almost by wave of hand from one place
to another for the purpose of making a profit thereon, and last, but
by no means least, endless columns of figures and tables of mathematical computations which further serve to heighten the foreboding
character of the subject.
Up to within very recent years there has been good reason for the
extent of ignorance and the lack of interest which has existed among
us Americans regarding exchange matters, especially as to that part
of the subject which deals with the principles and practices of foreign
exchange. Prior to the World War we were not vitally concerned
with foreign trade ; our national task appeared rather to be the caring
for our domestic requirements. Trafficking with other nations was
carried on only by fits and spells and as the occasion or the situation
required. A very small number of American banks had exchange
departments, and in the few which did, the work of such departments
was practically a closed book even to the rest of the staff of the bank.
Our federal and state banking laws were not adapted to the financing
of foreign trade, indeed, they were none too satisfactory even for
the needs of domestic trade. Practically all of the small amount of
foreign trade that we had was financed through our banking connections in European countries, chiefly in England. Few articles and
governmental reports and still fewer American books on foreign trade
and foreign exchange were available to those desirous of learning the
technique and the practices involved .
I

Foreigners, mostly of English

DOMESTIC AND FOREIGN EXCHANGE
or German birth and training, dominated the field in the United States.
Both England and Germany were competing for the mastery of the
seas. Their exporting and importing firms and their banking houses
had connections and branches in all parts of the world. Goods had
to be paid for, credits had to be established, gold and silver had to be
shipped about from one country to another ;-in short, trade had to
be financed in the most profitable and easy manner, so that it was
to be expected that expertness in the handling of exchange transactions would characterize English and German bankers. The World
War, however, literally forced us into the field, and our expanding
foreign trade, coupled with our more extended international relations,
compelled our bankers, import and export managers, investors and
speculators, to learn something of the intricacies of foreign exchange
methods. Today increasing numbers of American young men are
training for a career in the realm of foreign trade and its financing ;
universities are offering courses in various phases of the subject ; books¹
1 For many years the only outstanding volume on foreign exchange was "The Theory
of Foreign Exchanges, " by Viscount George J. Goschen, published in 1861. It has run
through many editions and has been widely translated . It is still the classic treatise on
the subject, especially on the theory of the exchanges. Another standard English volume,
likewise of many editions, is "The A B C of the Foreign Exchanges," by George Clare
(London, 1892) . Mr. Clare is also the author of "A Money Market Primer and Key to
the Exchanges " (London, 1891 ) . Both of these volumes are excellent though brief. "Money
Changing" (London, 1913 ) and "War and Lombard Street " (London, 1915) by Hartley
Withers are undoubtedly the best available popular discussions of the field by an Englishman. "Foreign Exchange and Foreign Bills " (London , 1915 ) , by W. F. Spalding presents
a most complete and satisfactory treatment of the subject. Mr. Spalding's " Eastern Exchange, Currency and Finance " (2d edition, London, 1920) is also to be highly recommended as is also T E. Gregory's volume on " Foreign Exchange before, during, and
after the War" (London, 1921).
American publications have been much later in appearing. In 1902 the Financier Company of New York issued a small volume entitled " Foreign Exchange." It was not a very
successful attempt to cover the fundamentals of the subject. "International Exchange,"
by A. W. Margraff (Chicago, 1903) and "Foreign Exchange Textbook," by Howard K.
Brooks (Chicago, 1906) long remained the standard American volumes. "The Elements
of Foreign Exchange," by Franklin Escher (New York, 1910) was the first satisfactory
attempt with us to popularize the subject. In 1917 Mr. Escher published another small
volume, " Foreign Exchange Explained " (New York). Both of these discussions are excellent, but naturally, being popular in character, they do not go deeply into the subject.
Approximately one-half of "International Trade and Exchange," by H. G. Brown (New
York, 1914) is devoted to foreign exchange, and has been subsequently reprinted under
the title of "Foreign Exchange" (New York, 1915 ) . The treatment is scholarly but extremely brief for the student or layman . A much more satisfactory textbook is " Domestic
and Foreign Exchange," by E. L. S. Patterson (New York, 1917 ) , although again the treatment is necessarily too brief. By far the best volume on the subject is " Foreign Exchange,"
by A. C. Whitaker (New York, 1919) . It is scholarly, practical, and clearly written . Other
volumes that may be mentioned are " Foreign Exchange, Theory and Practice," by T. York
(New York 1920), " Problems in Foreign Exchange," by J. M. Shugrue (New York, 1920),
and " Modern Foreign Exchange," by V. Gonzales (New York, 1914, revised, 1920) . Tables
which may be used for figuring foreign exchange rates, may be found in Brooks, " Foreign

INTRODUCTORY

3

and articles are being published , lectures delivered, and governmental documents issued as never before, so that to the observer
foreign trade and foreign exchange appear to be riding on the crest of
a wave of popularity. American exporting firms have added exchange experts to their staffs. Banks that never before thought of
foreign exchange transactions now advertise in their local papers that
they are able to furnish exchange on almost any part of the world.
The larger metropolitan banks have established branches abroad or
have arranged a far-flung system of correspondents, so that they are
able to reach practically all corners of the globe for the purpose of
putting through almost any sort of moneyed transaction. Local newspapers carry exchange quotations while the more important and
serious financial journals publish columns of exchange rates with
complete analyses of the exchange market. National and state banking laws have been modified so as to enable both domestic and foreign
trade to be financed in an up-to-date and much more satisfactory
manner than was formerly possible. We hear much of the United
States becoming a creditor nation. The balance of trade, the payment of international debts , the importation of gold, the development
of a discount market in the United States, and many similar subjects
have become topics of current comment, even in circles outside of
the banking and trading worlds. Because of these things there has
arisen a real and sincere demand for the diffusion of information concerning exchange matters. Therein alone lies the justification for the
publication of this volume.
Foreign exchange has always seemed to be shrouded in mystery.
The possible reasons are two. One is that the average student or
man of affairs who strays into the field is ignorant of ordinary credit
transactions and knows nothing or practically nothing as to how claims
are settled between creditor and debtor without the use of money.
Exchange Textbook "; Margraff, "International Exchange " ; Gonzales, "Modern Foreign
Exchange"; E. D. Davis, "Foreign Exchange Tables " (Minneapolis, 1912) ; J. H. Norman,
"Norman's Universal Cambist " (London, 1897) ; C. A. Stern, " Arbitration and Parities of
Foreign Exchange " (New York, 1902) ; and Tate's " Modern Cambist " (there are several
editions of this, one by H. Schmidt, London, 1903 , still another by H. T. Easton, 24th
edition, London, 1908) . No mention need be made of the large number of volumes issued
in foreign languages.
Many American banks have published pamphlets and shorter studies dealing with the
financing of foreign trade. These are for the most part fleeting documents and need not
be listed.
The Commercial and Financial Chronicle and the Annalist, both of New York, contain
weekly summaries and analyses of the exchange markets.

DOMESTIC AND FOREIGN EXCHANGE
The other is that foreign exchange implies a knowledge of the
monies of foreign nations, for one no longer talks of dollars and
cents but of pounds sterling, francs, yen, marks, etc. If one first
becomes acquainted with the practices and devices employed in
paying bills at home by means of credit transactions, and then
applies those same principles to the foreign field, and if at the
same time he merely translates dollars into the money of the foreign
country concerned, he will have no serious difficulty in treading the
devious trails of the field of foreign exchange. The principles that
underlie both domestic and foreign exchange are the same, although
at times the practices followed and the instruments employed are
decidedly different in character.
In line with the suggestions just outlined, I shall first discuss in a
general manner the fundamentals or bases of credit transactions as
they facilitate the payment of bills between individuals, business
firms, or banks located in different communities in one country. I
shall then take up in greater detail the numerous practices and principles involved in settling such obligations. When a man pays a
grocery bill or buys a new suit of clothes from his local dealer, he is
not concerned with the practices of domestic exchange. But when a
man in San Francisco wishes to pay a bill in New York, or when a
bank in Seattle desires to pay a debt in New Orleans, or to collect
money owing it by a Boston firm, or to establish a deposit or credit with
a Baltimore bank, then the question arises " How shall it be done? "
It is this sort of financial transaction, involving the use of credit
arrangements or the shipment of gold or money , with which domestic
exchange is concerned.

After a discussion of domestic exchange I shall pass on to the question of how creditors in one country and debtors in another settle
their financial obligations. Suppose that an American owes a bill
in England, or desires to get funds with which to travel in France ,
or wishes to speculate in the exchanges of foreign countries, or plans
to import goods from abroad, or to collect money owing him by a
resident of Brazil, or suppose that a bank wishes to engage in financial
deals of various sorts in other countries or with citizens or banks of
those countries , -how are all of these and similar transactions carried
through? What are the mechanism, the practices, the underlying
principles, and the theories involved? These are matters lying within
the province of foreign exchange. By approaching the discussion of

INTRODUCTORY

5

foreign exchange in this manner I hope to make it possible for the
reader to understand the fundamentals of the subject more easily
than is usually the case.
The details of the technique of domestic and foreign exchange are
so numerous, and in some connections so complicated, that it is
practically impossible at times to discuss certain phases of the subject
without using terms that have not previously been defined or mentioned in the text. It will frequently be necessary to state that certain
matters will be more fully discussed in a later portion of the volume.
An effort has been made, however, to develop the subject logically
and in such a manner that a minimum of confusion may arise in the
mind of the reader.

CHAPTER II
INTER-BANK RELATIONS
Ordinarily Jones in Chicago who owes $ 1,000 to Smith in Los
Angeles will not ship actual money, either paper or metallic, to meet
his obligation. Once in a while a person paying a small domestic
debt will place paper money or a still smaller sum of metallic money
in an envelope and mail it to his creditor. As a rule, however, a credit
instrument of some sort will be used. Again, if Jones in Chicago owes
£50 to Pratt in London , he will not ship fifty pounds sterling of gold
to Pratt , nor will he send him fifty pounds sterling's worth of American
money. He will be compelled to resort to some kind of credit instrument with which to make the payment . It is not surprising, therefore, to learn that we finance or pay for about ninety per cent of our
domestic trade by means of credit instruments, while practically all
of our international payments are so made . The first matter therefore that has to be clearly understood concerns the arrangements that
exist by means of which Jones may be supplied with or make use of
such credit instruments.
The bulk of domestic and foreign payments could not be made
were it not for the accommodations provided, and for the services
rendered, by our banking and other financial institutions. These
services are made possible by extensive and sometimes very complete
and detailed relationships which banks and exchange dealers of all
kinds establish with one another . Banks in Minneapolis must have
representatives in New York to handle New York deals for them.
Likewise banks in New York or Seattle must have representatives in
Chicago, San Francisco, and other important centers to do many
things for them. American banks must make arrangements with
banks abroad so that their foreign financial interests and operations
may be satisfactorily handled and cared for. Sometimes these relationships are of a purely reciprocal character, i. e ., what one bank agrees
to do for another without charge, the latter agrees to do for the former
without charge. More frequently, however, slight charges are made
for services rendered . These bank inter-relationships constitute what
6

INTER-BANK RELATIONS

7

is known as a system of " bank correspondents. " The details of such
correspondent relationships and their effect on exchange transactions
will be discussed in detail in subsequent pages.
Thus it is that our large banks and financial houses have correspondents in practically every city of consequence in the United States
and also in foreign countries. Some also have their own foreign
branches. At this writing (May, 1922 ) the American Express Company, besides having about 75,000 agencies and offices in the United
States, has thirty-five foreign branch offices and subsidiaries as well
as more than 10,000 banking and shipping correspondents elsewhere
throughout the world. The National City Bank of New York, with
its subsidiary, the International Banking Corporation, has 83 foreign
branches and more than 3,000 foreign correspondents. Other large
financial concerns such as The Guaranty Trust, The Bankers Trust
Company, The American Foreign Banking Corporation, J. P. Morgan
and Company, The Equitable Trust Company, The Asia Banking
Corporation, The Mercantile Bank of the Americas, and many others
have branches in foreign countries, ¹ to say nothing of their hundreds
or even thousands of correspondents, which form a network of relationships reaching the more important countries and facilitating transactions of all sorts concerned with foreign financing. Likewise,
European banks have their branches and correspondents in various
places.

English and German owned banks have been especially active

in this regard, some having as many as a thousand or more branches
in addition to several thousand correspondents.2 It is this system
of branch banking that has been of such vital importance in obtaining
for England her control over foreign trade. And in passing, it may
not be out of place to remark that if the United States wishes to make
real progress in building up its foreign trade, it must make it both
possible and profitable for American banks to establish branches
abroad. Some steps have already been taken in this direction through
the revision of our state and federal banking laws.³
1 Quite a number of these branches were discontinued in 1920-21 .
2 Cf. footnote 1 , p. 112 ; footnotes 3 and 4, p. 113.
> The revision of state and federal banking laws since 1913 has made possible the use of
the bank acceptance in the financing of foreign trade. The establishment of the Federal
Reserve system enabled an open discount market of growing proportions to be brought
into existence. The Federal Reserve Law also permits national banks under certain
conditions to establish foreign branches. The passage of the Edge Act by Congress (December 24, 1919) provided for the organization of corporations which may engage in foreign
trade and undertake the long-time financing thereof through the issuance of securities
based upon acceptances, collateral trust notes, etc. Other changes in state and national

8

DOMESTIC AND FOREIGN EXCHANGE

Banks in our smaller cities arrange with banks in the more important
financial centers to make use of the latter's correspondents to a limited,
sometimes to an unlimited, extent in connection with either domestic
or foreign transactions. The usual requirement is that the former
must keep an account or deposit with the latter, either large or small
as the case may be. Ordinarily an interest rate of about two per cent
is paid on the average balance so maintained . The interest rate on the
balances kept by American banks with European correspondents
varies, usually in accordance with the discount rate of the central
bank of the foreign country.
A bank in St. Louis, for example, wishing to have the facilities
which come from a system of domestic and foreign correspondents,
makes arrangements to that end with a bank in New York. It agrees
to keep an account or deposit with the latter and to notify the latter
by means of " advices " of all transactions which it puts through.
An " advice " is merely a printed or written statement showing what
has been done, which is sent to the correspondent bank as a notice
or notification of the transaction . Advices are widely used in connection with all sorts of domestic and foreign exchange operations.
Copies of typical advices will appear in subsequent pages. The relationship entered into gives the St. Louis bank exchange connections
with a large group of American and foreign banks, but always through
the agency of the New York bank. The New York bank, in its turn,
keeps accounts with certain banks in the more important cities in the
United States and in foreign countries, and when it draws on its
accounts for exchange purposes it likewise uses advices to notify the
bank drawn on as to the details of the transaction.
The question that immediately arises is, " How are such accounts
established , and how are they replenished from time to time so as to
enable banks to make use of their correspondent relations in transacting their exchange business? "
It would, of course, be expensive and risky for banks to send actual
money or gold to each other in order to create or replenish their exchange accounts, although this is sometimes done, as will be noted
later. It is not customary , however, and occurs only when banks find
it cheaper to ship gold or money than to use various forms of credit
instruments .
banking legislation have made it possible for banks to take a much more active part in
the financing of foreign trade in various ways that were formerly prohibited.

INTER-BANK RELATIONS

9

Today, if a buyer wishes to pay a bill of ordinary amount to a party
located in another section of the country, he will as a rule merely
draw a personal check on his bank account and forward it to his
creditor. The latter cashes it or deposits it to the credit of his account
with his local bank. In order that the check may be collected and the
amount actually deducted from the bank account of the buyer, it is
necessary that the check find its way back to the bank upon which it
has been drawn. Thus, if Jones of Chicago draws a check for $ 1,000
on his account with the Chicago State Bank and sends it to Smith
in Los Angeles, Smith may deposit it with the Los Angeles National
Bank and be credited with that sum or be given the $ 1,000 in actual
cash. The Los Angeles National Bank, let us say, has an account
with the San Francisco Commercial Bank, which it desires to replenish.
It forwards the check to the latter with the request that it be credited
with that sum. The San Francisco Commercial Bank then credits
the Los Angeles National Bank with $ 1,000, making it possible for
the latter to draw drafts on the account or to use it in any manner
that the Los Angeles bank may desire. In its turn the San Francisco
Commercial Bank may send the check to the Continental Bank of
Chicago. The Continental Bank of Chicago will collect the $1,000
from the Chicago State Bank and credit the San Francisco Commercial Bank with that sum. Finally the Chicago State Bank will deduct
$1,000 from the account of Mr. Jones and return the canceled check
to him. Thus it is that the Los Angeles National Bank has added
$1,000 to its account with the San Francisco Commercial Bank, and
the San Francisco Commercial Bank has added $1,000 to its account
with the Chicago Continental Bank. Both of these banks may use
their accounts built up in this manner for the benefit of themselves
or to satisfy the needs of customers who may at any time desire to
obtain any of a number of different kinds of exchange instruments.
Another typical method of creating or replenishing such accounts
is the following :-Let us say that Andrews of Los Angeles has sold
a bill of goods to Sargent in Boston. He draws a draft on Sargent,
attaches his shipping documents, ¹ and sells the bill of exchange to the
Los Angeles National Bank . The Los Angeles National Bank may
then send the draft and documents to the Boston State Bank for
collection and credit. The Boston State Bank collects the amount
1 Draft and shipping documents constitute what is known as a documentary bill of exchange.

ΙΟ

DOMESTIC AND FOREIGN EXCHANGE

of the draft from Sargent and credits the sum to the account of the
Los Angeles National Bank which may use it as desired. The employment of drafts in such connections will be more fully explained
later.
It is by such simple means that funds are shifted about from place
to place, and accounts are created for exchange and other purposes.
The same principles apply in building up foreign accounts. Let us
say that the Old Colonial Bank of New York desires to create or to
build up an account with Barclay's Bank of London so that it may
have the use of the latter in accordance with the terms of the correspondent agreement entered into by the two banks. Suppose that
Mr. Andrews of New York has sold a bill of goods to Mr. George in
London amounting to £500 and has drawn a demand draft (a draft
payable at sight) on him for that sum. Andrews may sell that draft
and the accompanying shipping documents to the Old Colonial Bank
of New York, which in its turn transmits them to Barclay's Bank
of London for collection and credit. The draft will be collected by
Barclay's Bank from Mr. George and the sum placed to the credit
of the Old Colonial Bank of New York. The latter may then use the
account thus built up by selling exchange against it.
In foreign exchange, as well as in domestic exchange, the most
customary method of creating and replenishing accounts is through
the forwarding of checks, drafts, and other bills of exchange for collection or discount.¹ Other methods are employed, but they are of
minor importance and will be discussed incidentally in subsequent
chapters. If at any time a bank finds that it can shift its funds or
build up its accounts by cheaper methods than the ones usually employed, it does so. It must be remembered that in all exchange transactions, both domestic and foreign, the bank is in business to make
profits for its stockholders. It is this fact that accounts for many of
the practices followed by means of which a slight saving of interest
or of funds may be accomplished . It is this fact also which accounts
for the continued improvement in exchange methods and the development of new ways of handling the various operations.
Having briefly reviewed some of the practices followed in building
1 "Thus an active bank at any given date may have hundreds or even thousands of
outstanding loans on foreign trade transactions, some of which are due and paid every
day, and, in consequence, afford a renewed supply of funds for new transactions." F. H.
Sisson, Annals of the American Academy of Social and Political Science, March, 1921
(vol. XCIV) , p. 150.

INTER-BANK RELATIONS

II

up accounts and in establishing correspondent relations, we may
now sketch the fundamental methods employed in making use of
such relations. Reverting again to our example of the St. Louis
and New York banks, let us say that the St. Louis National
Bank is approached by a customer who desires to obtain a draft on
a New York bank with which to pay a bill in that city. The St. Louis
bank merely draws a draft on its account with the New York bank,
say the Guaranty Trust Company, and hands the draft to its customer,
who mails it to his creditor in New York. The creditor presents it
to the Guaranty Trust Company or cashes it at his own New York
bank, which in its turn presents it to the Guaranty Trust Company,
and the account of the St. Louis National Bank is debited with the
amount of the draft, the canceled draft thereupon being returned to
the St. Louis National Bank.
Let us now say that the Guaranty Trust Company has established
correspondent relations with Barclay's Bank in London, and that a
customer desires to pay a bill of £500 in London . The Guaranty
Trust Company will draw a draft in pounds sterling, not in dollars,
for £500 and sell it to the customer for a certain sum of American
dollars. If the price of the pound in New York (the sterling rate of
exchange) on that day happens to be $4.86, the customer will have to
pay the Guaranty Trust Company the sum of $2,430 (4.86 X 500).
The draft will be made payable to the London creditor, who, when he
receives it from the American debtor, will cash it at his own bank or
at Barclay's and receive £500 therefor. The London account of the
Guaranty Trust Company will thereupon be debited with that
sum .
Thus far the procedure appears to be fairly simple ; but let us go
a step farther and have a customer ask the St. Louis National Bank
for a draft for £100 with which to pay a bill in London . Suppose that
the St. Louis bank has no account in London, but that it has arranged
with the Guaranty Trust Company to use the London account of the
latter, which is on deposit with Barclay's Bank, London, for all sterling
exchange purposes. The Guaranty Trust Company will have furnished
the St. Louis bank with the required printed forms. It also keeps the
St. Louis bank advised daily as to the rates it will charge the latter
for all exchange drawn. Thus daily either by mail or by wire it sends
to the St. Louis bank a list of the different rates of exchange at which
it is authorized to draw against the foreign accounts of the Guaranty

12

DOMESTIC AND FOREIGN EXCHANGE

Trust Company.

Suppose that the rate on the list for sight drafts on
London happens to be 4.87 . The St. Louis bank may charge the customer $4.88 for every pound purchased or a total of $488 for the £100
draft. The customer will mail the draft to his creditor in London,
who will cash it at his bank and receive his £ 100. When the draft

reaches Barclay's Bank, it will be paid out of the account of the
Guaranty Trust Co. When the St. Louis bank hands the £100 draft
to the customer, it sends an " advice " to the Guaranty Trust Company stating that on the day in question it sold a £100 draft on Barclay's Bank, payable to a certain party , whose name is given, and that
the rate at which the draft had been drawn , as per the rate list furnished by the Guaranty Trust Company, was 4.87 . The Guaranty
Trust Company is not interested in the rate that the St. Louis bank
charges the customer-but only in the fact that the St. Louis bank
draws on it at the rate of 4.87 . When the advice reaches the Guaranty
Trust Company, the account of the St. Louis bank is debited to the
extent of $487 (100 X 4.87) . The rate of exchange quoted the St.
Louis bank includes a profit for the Guaranty Trust Company, so that
the New York account of the St. Louis bank is debited only to the
extent of $487. The Guaranty Trust Company then sends an advice
to Barclay's Bank that the draft in question has been drawn, that it
will soon appear for payment, and that Barclay's is to pay it and debit
the London account of the Guaranty Trust Company with the sum
of £100. This is the more customary procedure, although sometimes
the New York bank authorizes the drawing bank (in this case the St.
Louis bank) to notify the foreign bank directly as well as to send a
copy of the advice on to New York.
The above pages briefly describe in a general manner the methods

employed in building up and in making use of correspondent relations
in exchange transactions. Many details remain to be explained but
they will be taken up as the discussion proceeds. For our immediate
purposes this birdseye view of the situation is sufficient.
The exact terms of the agreements under which the correspondent
relations are carried on are sometimes embodied in a several page,
printed or typewritten, document which holds until amended or
changed by subsequent instructions.

Especially in the field of foreign

dealings does such a document play an important part because of the
distances separating the correspondents and the time that it takes to
get in touch with one another concerning any financial matter.

The

INTER-BANK RELATIONS

13

following is typical of such agreements between American and foreign
correspondents :-

CONDITIONS FOR THE ACCOUNT OF THE
BOSTON STATE BANK, BOSTON, MASS.
with the
PROVINCIAL BANK, ANTWERP, BELGIUM
ACCOUNT.
INTEREST .
COLLECTIONS.

DRAWINGS.
PAYMENTS.

Commission Franco.
Credit : until further notice 3%.
Debit : 1% over the National Bank Rate. Min . 5%.
Clean Bills :
Antwerp
Brussels
Franco. Value day of payment.
Ostend
Other towns in Belgium : fr. 0.50 per bill.
Value 3 days after payment.
Documentary Bills:
Antwerp
1/4 0/00. Min. frs. 2.50.
Brussels
Value day of payment.
Ostend
Other towns in Belgium : ½ 0/00. Min. frs. 2.50.
Value 3 days after payment .
A special commission may be charged on bills on out-of-theway places.
On our offices or on our agents : Franco. Value date of receipt of advice. See list of correspondents attached .
Clean:
Antwerp
At our offices.
Brussels
Ostend
To banks or large mercantile houses : Franco.
To private parties at their domiciles : ½ 0/00.
Documentary :
Antwerp
½ 0/00. Min. frs . 2.00.
Brussels
Ostend
Under travelers' letters of credit :
Expressed in currencies other than Belgian francs :
Franco .
Expressed in Belgian francs: 1/8 % . Min. fr. 1 .

14

DOMESTIC AND FOREIGN EXCHANGE

CREDITS .

Sight : See clean payments.
Documentary: See documentary payments.
Confirmed: ½ 0/00. Min . frs. 2.00, additional .
ACCEPTANCES . For your account :
14 % for 3 months . (Subject to arrangements.) .
VALUE DATES . Payments to your account :
Same day if effected before noon.
Monies paid to the debit of your account :
Same day.
The above agreement covers the conditions of an account which
the Boston State Bank has opened with the Provincial Bank of
Antwerp, Belgian .
The account is in terms of the money of that
country, i. e., Belgian francs. The Boston bank is to receive an interest rate of 3 per cent until further notice on its balance or account with
the Antwerp bank. This interest rate varies with the official discount
rate of the central bank (the National Bank of Belgium) . If perchance the Boston bank overdraws its account, it will be compelled
to pay a minimum charge of 5 per cent on such overdrafts, but a
charge of at least one per cent over the central bank's ( the National
Bank of Belgium) official rate of discount.
In choosing a correspondent abroad, bankers deem it advisable to
select a bank that has a large number of branches and whose correspondents make the least charges, not a bank that allows the greater
rate of interest on credit balances .
If the Boston bank send bills of any sort to be collected by the
Provincial Bank, they will either be clean bills, i. e. , having no documents attached 2 or documentary bills, i . e. , having documents attached.
For example, the Boston bank may have a customer who
has presented to it a bank draft, received from a Belgian debtor, for
1,000 francs drawn on a bank in Brussels. The Boston bank may have
paid the customer a certain number of American dollars for that
franc draft. It forwards the draft to the Provincial Bank of Antwerp,
which collects from the Brussels bank and credits the Boston bank's
account with the amount of the draft. The Boston bank may receive a
number of similar bills to be collected from Belgian banks. For all
clean bills drawn in francs to be collected from banks in Antwerp,
1 Cf. pp. 402-406 for discussion of official discount rate of the Bank of England.
2 Cf. pp. 63 , 139 for discussion of clean bills.
Cf. pp. 61-62 , 140 for discussion of documentary bills.

INTER-BANK RELATIONS

15

Brussels, and Ostend, the Provincial Bank makes no charge for
collection and credits the account of the Boston bank as soon as the
bills are collected, i . e. , " value day of payment." On other towns,
clean bills are collected at the charge of a half franc per bill and credit
given the Boston bank three days after payment. Documentary
bills are collected on the three cities mentioned at a charge of 1/40 per
cent of the face value of the bill (1/4 per mille), with a minimum charge
of 2 1/2 francs, and credit given on day of payment. On other towns
the charge is 1/20 per cent with the same minimum charge and with
credit three days after payment. In the case of out-of-the-way places,
a higher charge may be imposed.
The Boston bank is authorized to draw franc drafts on any of the
offices of the Provincial Bank of Antwerp or its agents, and its (the
Boston bank's) account is debited upon the receipt of the advice
relating to the transaction.
If the Boston bank draws clean bills on the Provincial Bank, they
will be paid in Antwerp, Brussels, or Ostend and to banks or large
mercantile houses without the deduction of exchange charges, but
if made payable to private parties in cities where the bank has no
branches, an exchange charge of 1/20 per cent is made to the Boston
bank for the service rendered . Documentary bills drawn against
the Provincial Bank will also be charged against the account of the
Boston bank at the rate of 1/20 per cent with a minimum charge of 2
francs. There is no charge for travelers' letters of credit ¹ issued by
the Boston bank on the Provincial Bank, provided they are issued in
terms of foreign currency because the Provincial Bank in those cases
will make a profit in cashing the drafts drawn in foreign monies. But
if travelers' letters of credit are drawn in Belgian francs, the Provincial Bank is compelled to pay the full amount of the drafts and will
therefore get its commission or profit by charging the account of the
Boston bank 1/8 of 1 per cent (minimum charge of 1 franc) on the face
value of each draft cashed. For " confirming" a commercial letter of
credit 2 a charge of 1/20 per cent is made plus a minimum additional
charge of 2 francs . For assuming the responsibility of accepting drafts
drawn against it under commercial letters of credit , it will charge the
Boston bank, on the average, 1/4 per cent on three months' drafts.
This rate may be modified under certain conditions. Some of these

1 Cf. pp. 223-233 for discussion of foreign travelers' letters of credit.
2 Cf. pp. 257, 284-287 for discussion of confirmed letter of credit.

16

DOMESTIC AND FOREIGN EXCHANGE

terms may be confusing to the beginner but all of them will be more
fully defined and described in later pages.
Finally, when items come to the Provincial Bank to be credited
to the account of the Boston bank, the latter is given credit on the
same day if they arrive before noon ; if not , on the next day . In the
case of items being presented for payment from the account of the
Boston bank, the Provincial Bank debits the account of the Boston
bank with those amounts on the day when paid.¹
The commissions charged American banks by foreign correspondents
are a matter of negotiation, the rate usually varying " with the volume
and the nature of the transactions-the larger the account the cheaper
the rates." The customary scale of charges imposed by London banks
will approximate the following : handling documentary bills, about
1/40 of 1 per cent; cashing drafts drawn under travelers' letters of
credit, about 1/40 of 1 per cent ; accepting drafts drawn under commercial letters of credit, about 1/16 of 1 per cen per month of usance ; confirmation of commercial letters of credit, from 1/8 to 1/20
of 1 per cent ; accepting long bills drawn by the American bank, about
1/16 of 1 per cent per month of usance. Instead of a commission
being charged on each item handled for the American bank, a flat
commission may be levied on all items credited or debited to the account of the latter, excluding only acceptances. Such flat rates vary
from 1/40 to 14 of 1 per cent. Or still another form of " arrangement
is for the American bank to pay a lump sum periodically for the total
service; this arrangement makes for simplicity , frees the business
from special commission charges , eliminates the clerical work of
recording in detail the different commission charges, gives the American bank interest on its full balance, and saves correspondence over
petty details. This lump charge varies, of course, with the average
volume of business that the account occasions, and is accordingly
readjusted from time to time by contract." 2
Agreements covering correspondent relations between domestic
banks contain clauses of the same general nature as those that are

found in the foreign field .
planation:

The following is typical and needs no ex-

1 Cf. Appendix I for another form of correspondent relations agreement.
2 Westerfield, R. B., “ Banking Principles and Practice," New York, 1921 , p. 1138.

INTER-BANK RELATIONS

17

CONDITIONS OF ACCOUNT
WITH
THE MERCHANTS NATIONAL BANK OF LOS ANGELES
LOS ANGELES, CALIFORNIA

WE DEBIT You:
ACCOUNT :
INTEREST :
DRAWINGS :

Free of commission.
1% above Federal Reserve Bank rate, minimum 6%.
On Us and Our Correspondents by you and your friends :
In Dollars: Free of commission, value date of payment.
In Other Currencies : Free of commission. In reimbursement will draw on you or as you may instruct
otherwise, with canceled vouchers attached.
Drafts must bear the clause: " At drawee's buying
""
rate for bankers checks on.

PAYMENTS :

COLLECTIONS:

Under Telegraphic or Mail Advices: To Banks, Mercantile Houses and Private Parties throughout the
United States, free of commission, value date of
payment, plus actual costs.
Against Documents or under Unconfirmed Credits: 1/16%
And Acceptances under Confirmed Credits: Sight 1/16%
30 days 1/8%
60 & 90 days 1/4%
Under Travelers' Letters of Credit: Both Dollars and
Other Currencies, free of commission.
Clean and Documentary:
On Los Angeles, free of commission.
On Other Cities, at actual cost to us.

TRANSFERS
ON BOOK:
WE CREDIT YOU:
INTEREST :

REMITTANCES:

Free of commission.

22% per annum, on average daily balances, credited
monthly, until further notice. (Excepting items
under deferred credits.)
Clean and Documentary: Items payable in Los Angeles
if received before 3 P. M. will be credited the same,
otherwise the next day.
Items drawn on other places will be credited on a deferred basis ranging from two to ten days (San
Francisco 2 days, Seattle 3 days, Chicago 4 days,
New York 5 days, etc. )

18

DOMESTIC AND FOREIGN EXCHANGE

SPECIAL CONDITIONS AND REMARKS :
INTEREST ON TERM ACCOUNTS : 3% if left for three months, 4% if left six
months.
DISCOUNT:
Of fine long bills payable in the United States at best
rate.
FOREIGN EXCHANGE TRANSACTIONS : We are constant buyers and sellers of
foreign exchanges at best rate obtainable.
INFORMATION :
Regarding the credit standing of firms and individuals ,
free of charge.
ACKNOWLEDGMENT: Of remittances is made each time by letter and statement of account is furnished at the close of each
month.

The larger metropolitan bank or exchange dealer, whose domestic
or foreign accounts are used by correspondent banks for exchange
purposes, usually issues a set of instructions to the latter as to just
how drawings are to be made. These instructions are frequently of a
very detailed character, being necessarily of that nature because of
the lack of information and training concerning exchange matters
which characterizes bankers and bank employees in our smaller towns.
The following is typical of such documents :
THE MERCHANTS NATIONAL BANK
of Los Angeles
GENERAL INSTRUCTIONS
FOR DRAWINGS UNDER OUR PROTECTION

Draft Form

1. The Merchants National Bank of Los Angeles will furnish
you upon application books containing drafts and bank post
remittance forms with your own title printed upon them.
Checks are to be drawn by you over your own signature and
for your own account , as we simply act as agents in transmitting
funds abroad.
On account of the still existing inefficient postal service
abroad and in order to insure prompt payment, our foreign

Drawing
Places

drafts are in duplicate form, either of the instruments being
negotiable, which enables the sender to dispatch duplicate by
next mail boat or upon advice that the original has not been
received by the payee, without further inconveniencing the
issuing bank for the issuance of a duplicate.
2. We urgently request that drawings be confined to the
principal cities of the country on which drawn unless the pur-

INTER-BANK RELATIONS

19

chaser insists upon having a check drawn direct upon one of
the smaller places , in which case you are at liberty to draw
on any one of the banks mentioned in this book.

Foreign
Currency

3. Drafts should be issued only in the currency of the respective foreign country and in a manner indicated at the head
of the various countries.

Post Remittance

4. We recommend the use of bank post remittance in all
cases where a remittance is desired payable at a place in Europe
without proper banking facilities. Under this system the
payee's name, address, and amount advised is forwarded to

our correspondent, who, in turn, remits the money in banknotes by registered and insured mail. When sending a bank
post remittance to Italy it is necessary to indicate also the
father's name of the payee with the prefix " DI " if living and
"FU" if dead . Example : " Luigi Angello di Abbateccola " or
"Luigi Angello fu Abbateccola."
Rate Sheets
5. Quotations are mailed daily on numbered rate sheets.
Always use the last rate sheet on hand. For all drafts in
excess of our rate sheet limits , special rates will be supplied
by us by phone or wire.
Advice
6. Advice stubs must be mailed to us on the same day the
drafts are issued, as our correspondents abroad will honor
drafts only upon receipt of our advice.
We acknowledge all advices received . If acknowledgment
is not received say within 10 days of date of mailing, inquiries
should be made.
Settlement
7. Indicate on the advice whether you are enclosing check
or wish to have amount charged to your account.
Spoiled
8. Drafts spoiled should be returned to us marked " Cancelled ."
Drafts
9. In case a draft is to be cancelled or refunded after payRepurchase
ment has been made to us, refund will be made only upon surof Drafts
render of both the original and duplicate at the prevailing
rate of exchange and not at the rate issued . All drafts sent us
for purchase must bear your guaranteed endorsement signed
in ink by an officer duly authorized to sign.
Dollar
10. All drafts drawn in Dollars on points outside of the
United States, or in Pound Sterling on points outside of EngDrafts
land, Ireland, and Scotland, or in Francs on points outside of
France, are to be marked on their face " PAYABLE AT THE
DRAWEE'S BUYING RATE FOR DEMAND DRAFTS
(ON NEW YORK) (ON LONDON) (ON PARIS) " as the
case might be.

20

20

Cable
Transfers

Foreign
Deposits

DOMESTIC AND FOREIGN EXCHANGE
In remitting us for Dollar drafts , please include a charge of
Minimum twentyone-quarter of one per cent commission.
five cents.
12. Our facilities to effect quick payment by cable in all
parts of the world and especially Europe are equal to those of
any of the great financial institutions in this country . Whenever the matter is urgent or when transferring large sums of
money, we recommend the use of cable (use Special Foreign
Money Transfer Blanks).
In selling cable transfers, be governed by the following:
(a) Send us order by telegraph or mail .
(b) Remit cover at the cable rate quoted on your last rate
sheet, plus cable charges which we will assume to
be on the average of $4.50 for England , France,
Belgium, Holland, and $5.50 for other European
countries ; $7.50 for countries in South America, and
$10.00 for oriental points.
(c) All cable orders reaching us before 4 p.m. Los Angeles
time will be attended to the same day.
13. In the past two years we have opened accounts in foreign
currencies abroad for thousands of our clients to the entire

satisfaction of every one of them. You are at liberty to call
upon us for similar services in behalf of your clients, enclosing
in each case three specimen signature cards. Usually it takes
about two months to receive a receipt or pass-book from
abroad. When the depositor chooses to open an account
with our correspondent abroad , then make checks payable to :
"Drawee Bank, Account Mr. X. X." If he chooses some
other bank, say for instance Hypotheken Bank, München,
then make drafts read, " Pay to Hypotheken Bank, München,
Account Mr. X. X. " If the draft is already made out in the
individual's name, have him make a special endorsement reading: " Pay to Société Genérale, Paris for credit of my account.
Signed X. X. " In case a check is lost in the mails, unauthorized
individuals are not able to cash it if made out in the above
described manner.
Withdrawal of such accounts can be effected in the following
manner:
(a) A personal check may be drawn against the account
abroad.
We shall forward such check for collection abroad and
make settlement at the current rate of exchange on
day advice of credit reaches us.

INTER-BANK RELATIONS

21

(b) We will purchase same outright if same bears the endorsement of the bank, at the prevailing market.
It is prudent but not essential that the drawer
present some evidence that he maintains sufficient
funds abroad to cover the withdrawal.

Letters of
Credit

14. Our Commercial and Travelers' Letters of Credit are well
known throughout the world. We will gladly furnish your
clients upon request with such Letters of Credit upon cash
payment or under your guarantee, in Dollars, for a nominal
charge of 1/8 of 1 %, or in other currencies at a fixed rate, or
at the current rate of exchange upon receipt of payment advice.
15. All correspondence relative to foreign exchange service
Correspondence
should be addressed to the Foreign Exchange Department.
Facilities
16. Owing to the fact that our sphere of activity is confined
only to some 250 banks located in the great Southwest, we
are in position to render to country friends, using our facilities,
prompt and efficient service.
Our connections are very extensive, our operations complete,
and you may safely entrust us with any foreign exchange
transaction that may come up .
THE MERCHANTS NATIONAL BANK
OF LOS ANGELES
FOREIGN DEPARTMENT
The terms of the above agreement are self-explanatory. If it becomes necessary at any time to modify the terms of either domestic
or foreign agreements, notices of the changes are sent by mail or by
wire.
Naturally it is impossible for a bank to have a correspondent in
every city in which it may have to put through some sort of financial
transaction or on which it may have to provide exchange . Banks
have correspondents only in those cities with which they have the
greater part of their outside business relations. But if a bank does
not have a correspondent in a certain town, either at home or abroad,
and finds it inconvenient or impossible to use one of its already authorized correspondents, it is customary to wire or write a bank
located in the city in question, and ask it to act in the desired capacity.
In this way it is possible for a bank to arrange financial connections
in practically every country and important city of the world.

CHAPTER III
DOMESTIC EXCHANGE
Domestic exchange concerns itself with the instruments, practices,
and principles involved in making payments between creditors and
debtors in different communities of the same country. It is sometimes known as " inland " exchange, and the instruments with which
it is concerned are frequently called " inland bills of exchange."
Legally, however, an inland bill of exchange is one that is drawn and
payable within the same state. Under our " Uniform Negotiable
Instruments Law," a bill drawn in New York and payable in New
York is an inland bill of exchange ; if it is drawn in New York and
made payable in St. Louis, it is a " foreign " bill . In this volume,
however, I shall use the terms " domestic exchange " and " domestic
bills " in the sense employed in the opening statement of this chapter,
and the terms " foreign exchange " and " foreign bills " as referring
to exchange relations between parties in different countries.
Suppose that Jones of Chicago buys $ 100 worth of toys from Smith
in New York. How will he pay for the goods? He may use one of a
number of methods. He may place $ 100 of paper, silver, or gold money
in a package and send it to Smith by registered mail or by express.
This is very unsatisfactory , unsafe, unnecessarily expensive to the
sender, and is seldom employed. Usually a credit instrument of some
Credit instruments are commonly known as
kind will be used .
"bills of exchange. " A bill of exchange is defined by the Uniform Negotiable Instruments Law
as being " an unconditional
order in writing addressed by one person to another, signed by the
¹ Negotiable instruments, such as checks, drafts, acceptances, etc., play an important
part in our commercial and financial activities. The laws of the forty-eight states of our
nation dealing therewith were so confusing and diverse, that the American Bar Association
drew up a Uniform Negotiable Instruments Law, somewhat similar to that of England,
and presented it for adoption to the various state legislatures. It has been adopted, with
but slight modification, by all divisions of our country except Georgia, Hawaii, the District of Columbia, and the Philippine Islands. It establishes uniform regulations regarding
the use of negotiable instruments and has been an invaluable aid in facilitating credit transactions in all parts of our commonwealth. More detailed reference is made to it in Chapter IV.
22

DOMESTIC EXCHANGE

23

person giving it, requiring the person to whom it is addressed to pay
on demand or at a fixed or determinable future time a sum certain in
money to order or to bearer."
The means of creating domestic (as well as foreign) exchange may

be divided into two general groups : ( 1 ) those in which a third party,
such as the postoffice, banks, express companies, telegraph companies,
etc., supplies the debtor thereby enabling him to satisfy his obligations
Form No. 6001

No.
Post Office Department
THIRD ASSISTANT POSTMASTER GENERAL Stamp of Issuing Office
DIVISION OF MONEY ORDERS
The Postmaster,
will insert

here
the office drawn on, when the office named by the
remitter in the body ofthis application is not a Money Order Office.
Spaces above this line are for the Postmaster's record, to be filled in by him
Application for Domesti Money Order
Spaces below to be filled in by purchaser, or, necessary,
by another person for him
Amount

Pollars .

Cents

Pay to
Order of
of }
(Name ofperson firm for who order is intended)

Whose
Address
is
No.....
Post
Office }

Street

State
Sent by.

(Name of Bender)

Address
of
Street
sender No..---PURCHASER MUST SEND ORDER AND COUPON TO PAYER
05-7156
FIGURE I
Application for domestic money order

DOMESTIC AND FOREIGN EXCHANGE

STARPRESS
HERB
STARP

THIS
GOOD
NOT
IS
ORDER
MONEY
FOR
AMOUNT
LARGEST
THAN
MORE
INDICATED
LEFT
MARGIN
-HON
AND
AND
ORDER
THE
OF
ALTERAANY
RENDERS
ERASURE
OR
TION
VOID
IT
POSTMASTER

sells it to an exchange dealer. If
sold to an exchange dealer, it will
be forwarded and collected by the

:
PAYMENT
RECEIVED

struments as postoffice and express money orders ; telegraphic
transfers made available by telegraph companies, banks, and Federal Reserve banks ; checks, bank
drafts, and certificates of deposit

19

STUB
DOLLARS
CENTS
AMOUNT
ISSUED
WHICH
FOR
RETAINED
BE
TO
BYTHE
WHO
POSTMASTER
ISSUING
SHOULD
ORDER
THE
DETACH
ONSHALL
LEFT
AMOUNT
MAR
THE
ORDER
THE
OF
GIN
BE
THE
WHICH
FOR
AMOUNT
ORDER
DRAWN
ISTHE
OF
AMOUNT
LARGER
NEXT
THE
IFTHE
ISDRAWNORDER
POR
JUST
CUT
LESS
OR
CUT
63OR
AS
FUSY
SS.ETC.BELOW
ELOW

OFFICE
PAYING

AT
POSTMASTER
THE

company, or telegraph office, or

latter or his agent from the debtor.
Under the first group come such
kinds of domestic exchange in-

HERS
STAND

DOLLARS
IME CENTO
C
E
ISSUED
WHICH
FOR
AMOUNT
SP

United
States
Postal
Money
Order

972
,lowa
.Brainard

the buyer or debtor remits or sends
a bill of exchange of some kind to
the creditor which the latter may
cash at a bank, postoffice, express

the debtor or his agent and either
sends it forward for collection or

PAYING POSTMASTER DETACH COUPON ON THISLINE
64560

existence by the creditor himself
by which he satisfies his claims
upon the debtor. In the first case,

case, the seller or the creditor
draws a draft or an order upon

181

97.
UNDED 2

to his creditor, and (2) those
Iwhich are created or brought into

which he may sell to another
person for money. In the second

REMITTER
STATED
AMOUNT
PAY
WILL
ABOVE
PAYEE
OF
ORDER
TO
NAMED
COUPON
INATTACHED
SAME
F
.ITHE
NUMBER
ISSUED
WITHIN
CONTINENTAL
UNITED
LASKA
,ATLASKA
STATES
HE
CONTINENTAL
THE
IN
OFFICE
ORDER
DIY
, EXCEPTED
ASTATES
UNITED
WITHIN
PRESENTED
IF
PAY
WILL
ISSUE
OF
DATE
FROM
DAYS
THIRTY

972
Brainard
Iowa
,.
Office
Paying
for
Coupon
NOT
BYHOLDER
BEDETACHED
TO
.
S CENTS
DOLLAR
DOLLARS
FOR
CENTS
FOR
FIGURES
WORDS
WPAYEE
, ATE
SP
EC
IM
E

BRAND
CHERO

64560

As

9
NDC72

AVIAONI
BWVW
SH,

RECEIPT
DOLLARS
CENTS
ISSUED
WHICH
FOR
AMOUNT
BE
TO
DETACHED
THE
BY
PUR
N
ITAT
IF
ISSUE
OF
OFFICE
THE
ORDER
THE
REGARDING

24

provided by banks ; and finally
travelers' checks and travelers ' or
circular letters of credit issued both
by banks and by express companies.

Under the second group

comes the ordinary or individual
draft, as distinguished from the
bank draft, drawn by the creditor
upon the debtor or upon the finan-

FIGURE 2
Domestic postoffice money order

cial agent of the latter, usually a
bank, with which the debtor has

DOMESTIC EXCHANGE

25

made the necessary arrangements. All these kinds of domestic
exchange will be described in this chapter.
Postoffice Money Order. A commonly used type of domestic bill
of exchange is the postoffice money order. Jones of San Francisco,
wishing to send $100 to Smith in New York, goes to his local postoffice
and writes out an " Application for Domestic Money Order " (Fig. 1 ) .
The postoffice clerk thereupon fills out the regulation money order
form which is of three parts (Fig. 2) , (a) the stub of the agent of the
selling office, kept for record, (b) the receipt which Jones may keep
for future reference, and (c) the order itself which directs the New
York postoffice to pay $100 to Smith upon identification. Jones
sends the order to Smith who presents it at the postoffice and gets
his money, or indorses it and cashes it at his local bank. He may not
indorse it to another person. Only his own indorsement and that of a
bank are permitted by the rules of the postoffice money order department. In fact, the indorsement of the bank is not legally an indorsement, but is looked upon as being the identification of the signature
of the payee. This naturally limits the negotiability of the order
and makes it far from satisfactory under many conditions. The order
may be cashed at any postoffice within thirty days after being issued,
but after that time it is necessary for Smith to cash it only at the office
upon which it was issued, i. e. , the New York office . Postoffice money
orders are used primarily for small sums because of their expense.¹
They are seldom used by business men and are usually employed
only by those who do not have banking accounts. They are bothersome because the sender has to go to the postoffice and personally
fill out the application blank.

If the recipient of the order cashes it

at the postoffice, he has to be identified, which is frequently no easy
matter because usually he is not acquainted with the clerk in charge
of the money order department . The maximum amount for which
an order may be issued is $100, so that if one desires to send more
than that sum he must obtain additional orders.
The order itself, as may be noted from Fig. 2 , is made up of two
parts. Once a week the various postoffices cut their cashed orders
1 The costs are as follows:
From $0.01 to $2.50 ....... 3 cents
(6
5 cents
$2.51 to $5.00 .
66
8 cents
to $10.00.
$5.01
(C $10.01 to $20.00 .
IO Cents
66 $20.01 to $30.00.
12 cents

15 cents
From $30.01 to $40.00 ..
18 cents
$40.01
to
$50.00
..
66
.... 20 cents
$50.01
to
$60.00
..
66
25 cents
to $75.00 ..
66 $60.01
.30 cents
$75.01 to $100.00 .

26

DOMESTIC AND FOREIGN EXCHANGE

in two, keep one part for record, and send the other to Washington
where the receipts and expenditures of the various postoffices are
checked up and balanced . England inaugurated her postal money
order business as early as 1839, but it was not until 1864 that the
United States put its system into operation.¹ During the first year
our postoffice department sold $ 1,360,122.52 worth of domestic orders.
2
By 1920 this sum had grown to $ 1,333,045,947.73 . For the year 1914
the excess of revenues over cost of operation amounted to $ 10,296.05,
which, when added to the proceeds obtained from the cancellation
of unclaimed orders more than a year old ($ 580,888.85) , netted a total
profit to the government from the sale of domestic money orders of
$591,184.90.
Express Money Order. A much more satisfactory and commonly
used form of domestic exchange is the express money order issued by
the offices of the American Railway Express Company and by banks,
business firms, etc. , acting as agents of the American Express Company. This form of money order was introduced in 1882 by the
American Express Company. It consists of an agent's stub, a receipt
for the sender, and the order itself which is sent to the creditor (Fig. 3 ) .
The rates for an express money order are slightly higher for smaller
sums and slightly lower for larger sums than those charged for a postoffice order.
An express money order is much easier to obtain than
a postoffice order because the company's office or branch office is
usually more conveniently located than is the postoffice. In applying
for an express money order, it is necessary to tell the agent only the
name and address of the party to whom you wish to send the money
and the amount to be sent. There is no application blank to be made
out by the sender. The order will be handed to the customer as quickly
as the agent can fill in the blank spaces . Single orders may be issued
for any sum up to $50 . If a customer wishes to send a larger sum he
must purchase two or more orders. Express money orders may be
cashed on the usual identification in any place and at any time, and
do not have to be cashed at the office upon which drawn. They may
1 The practice of issuing foreign or international money orders, to be discussed later in
detail, was begun September 1 , 1869 .
2 No later data appear available.
3 Rates for Express Money Orders:
Not over 50.00.
5 cts .
Not over $2.50 ...
15 cts.
66
66
66 66
66
18 66
75.00 .
5.00
.
66
66
66
66 66 10.00 .
100.00
.
ΤΟ
. 20
66
12 66
Over $ 100 at above rates.
25.00 .

1

DOMESTIC EXCHANGE

27

11-

WHEN
COUNTERSIGNED
BY
AGENT
ISSUE
POINT
OFAT

TO
OF
PAY
THE
ORDER

DOLLARS.
EXCEED
FIFTY
CASETONOIN

NAMEER.OF
REMITT

11-

TREASURER,

DOLLARS
TOO

Jones of San Francisco desires to wire

ORDER
EXPRESS
MONEY

American
TRANSMIT
AGREES
TOExpress Compug
AN

AGENT

telegraphic exchange transaction, first of
an express company and second of a bank.

CENTE

$500 to Smith in New York. He goes to
the telegraph company's office and fills out

Order
Agent's
Money
Stub
of.
DOLLARS

CENTS

STATE
OF

principle involved is merely the sending
of a telegram to an agent or correspondent
requesting him to pay over to a designated
party a certain sum of money. The details of the procedure will be brought out
in connection with the description of a

AMOUNT
PAYABLE
TO

THE
SUM
OF
GOOD
FOR
MORE
THAN
THE
HIGHEST
PRINT
COUNTERSIONED
ISSUED
AT

be purchased either through the regular
telegraph offices or through banks. The

RENDERS
ORDER
VOID
DEFACEMENT
ALTERATION,
MUTILATION
ERASURE,
THIS
ANY
OROFIT

send a message by wire. Practically any
part of the United States may be reached
in this manner. Telegraphic exchange may

NOT PAYABLE MY FIFTY DOLLARS
NOT PAYABLE
FORTY DOLLARS
NOT PAYABLE
THANTHIRTYDOLLARS.
***NTWENTY DOLLARS.&
NOT PAYABLE
NOT PAYABLE ON TEN DOLLARS 5
HAN FIVE DOLLARS U
NOT PAYABLE

DATE

money orders.
Recourse may then be
had to a telegraphic order. It is as easy
to send money by telegraph as it is to

NAME
OF
REMITTER

Telegraphic Transfers. At times a need
arises for a more rapid transference of
funds or payment of money than is afforded by the use of postal or express

SOLD
DATE

be indorsed any number of times and
passed from person to person or deposited with a bank. In case of loss or theft,
the receipt, as in the case of the postoffice
money order, guarantees the sender against
monetary loss.

to whom the money is to be paid or he
may waive that formality. In the latter
case the company will have to use due
diligence and precaution to see that the

19.to
Bent

IF
AMERICAN
EXPRESS
CO.
GRGER.
MONEY
REMITTER'S
RECEIPT
KEEPIT
ORDEROF .
AMOUNT

an application for a domestic money transfer order (Fig. 4) . He may require positive
evidence of identification from the person

payee (the one to whom the money is to
be paid) is the proper party. If it uses
such diligence it cannot be held liable for

FIGURE 3
Domestic express money
order

28

DOMESTIC AND FOREIGN EXCHANGE

Form 72 A
THE WESTERN UNION TELEGRAPH COMPANY
INCORPORATED
NEWCOMB CARLTON, PRESIDENT
DOMESTIC MONEY TRANSFER ORDER
If after the receipt of this domestic order at the paying office
(Ellis Island, N. Y., excepted), payment cannot be made within 72 hours
(exclusive of Sundays and holidays), the order will be canceled and
refund made to the sender. Transfers to Ellis Island, if unpaid, will be
canceled at the expiration of 5 days (exclusive of Sundays and holidays).
No.
191.

THE WESTERN UNION TELEGRAPH COMPANY:
SUBJECT TO THE CONDITIONS BELOW,
PAY TO

wrong payment. If the
company has no office
in the town of the
payee, it agrees to act
merely as an agent of
the sender and to be
held liable only for any
default that may occur
in connection with its
having acted as the
sender of the message .
Upon filling out the

(The address should be full and clear. If to a woman give prefix Mrs. or

required application
blank, the sender is

Miss, if practicable )
given a receipt. The
cost of the telegraphic
transfer includes the

Dollars
cost of the telegram
(known as "the tele-

Signature

Address.
When the Company has no office al destination authorized to pay money, it shall
not be liablefor any default beyond its own lines, but shall be the agent of the sender.
without liability, and without further notice, to contract on the sender's behalf with any
other telegraph or cable line, bank or other medium, for the further transmission and
final payment of this order.
(c) As the above-named payee may not be able to produce positive
evidence ofpersonal identity, I hereby authorize and direct The Western
Union Telegraph Company to pay the sum named in this order, at my
risk, tosuch person as the Telegraph Company's Agent believes to be the
above-named payce.
Signature
NOTE-Should the sender, of the transfer prefer that the payee be
required to produce the necessary evidence of his identity, he should
sign the following:
(v) The undersigned directs that the above amount be paid only on the
production by the payee ofpositive evidence of his personal
Identity.
Signature
Principal, $
Premium,

graphic toll " and varying according to the
distance the telegram
is to be sent), and the
premium costs. The
percentage charge for
the amount remitted
becomes less as the sum
sent becomes

larger.

The premium costs are
the same for all offices
and range somewhat
as shown on opposite

Time Filed
a. m.

Teleg. tolls,
Total, $

p. m.

page.
In sending telegraphic transfers, codes are
used in order to pre-

FIGURE 4

vent the message being
intercepted and pay-

Application for domestic telegraphic transfer

ment being made to

DOMESTIC EXCHANGE

29

the wrong party. The sum that may be sent by one order is usually
limited, depending upon he classification of the city. Offices located
in large cities are allowed to handle larger amounts than offices in
smaller cities. As a rule orders addressed to cities of minor importance
are sent through a larger city nearby ( " transfer cities ") , thus minimizing the confusion that would result from having too many sending
and receiv ng offices with thousands of sending codes.
TELEGRAPHIC TRANSFER PREMIUM COSTS
Up to $25.00 ..
$26.00 to $50.00 .

51.00 to 75.00 .
76.00 to 100.00 .

.$.25
35
.60

.85
For each additional $ 100 up to and including $3,000 ....... $. 25
.20
For each additional $ 100 ov r $3,000 ..

When the telegram reaches the receiving office, the latter sends out
a notice (Fig. 5) to the payee, asking him to appear at the company's
Form75
THE WESTERN UNION
TELEGRAPH COMPANY
INCORPORATED
CABLE SERVICE TO ALL THE WORLD
25,000 OFFICES IN AMERICA
NEWCOMB CARLTON, PRESIDENT
GEORGE W. E. ATKINS, VICE-PRESIDENT
BELVIDERE BROOKS, VICE-PRESIDENT
MONEY TRANSFERRED BY TELEGRAPH
NOTICE TO PAYEE OF MONEY TRANSFER
191

To

A telegraphic order to pay you a sum of money has just been received and we shall be glad to
make the payment if you will call at the office No..
If not paid within 72 hours (exclusive of Sundays and Holidays), the order will necessarily be
canceled and the amount thereof returned to the sender.
Satisfactory evidence of identity will be required.
MONEY TRANSFER AGENT
BRING THIS NOTICE WITH YOU

FIGURE 5
Notice to payee of telegraphic transfer
office to identify himself positively or to the satisfaction of the company's official, depending upon whether or not the sender has demanded positive identification, and to receive the sum remitted.
It is frequently necessary for banks to forward sums of money to

DOMESTIC AND FOREIGN EXCHANGE

30

¦
their correspondents without loss of time. They also send telegraphic
orders for their patrons. Let us say that Jones of San Francisco wants
to telegraph $ 1000 to
Smith in Boston. He
The Anglo &London ParisNational Bank
of SanFrancisco
TELEGRAPHIC TRANSFER

goes to his bank and
makes his request . The
bank clerk hands him
an application blank
(Fig. 6) , or the clerk

To be placed to the Order of

may write out the application for the customer as the latter dic-

Address
At.

tates the required data.
The clerk gives the cus-

For Acc't of

tomer a receipt (Fig. 7) ,
and also keeps a record
of the transaction for
the bank's files. The
bank may , if it desires

Amount
Premium
Telegram

to do so, send the trans-

Total

fer through the telegraph company, which
will take care of it in

San Francisco,

192 ..

the manner described
above. As a rule, however, the transfer will
not be made in that
manner. Almost every

Purchased by...
No....

FIGURE 6

bank has a copy of the

telegraphic code of the
American Banker's Association . The forwarding bank will usually send a message in
code direct to a bank in Boston, with whom it may or may not
Application for bank telegraphic transfer

have an ac ount, requesting it to pay $1000 to Smith.
If it has
an account with the Boston bank, the code message will order
that the account be debited to the extent of $1000 . If it doesn't
have an account with the Boston bank, the message will state that
remittance to cover is being forwarded by wire or by mail. In the
latter case the Boston bank will lose interest on $ 1000 for a few days,

1

Transfer
for
Telegraphic
Receipt

DOMESTIC EXCHANGE

31

The Anglo & London Paris National Bank

No. B 15159
ForValue Received of
we agree to place at the office of
to the credit of.

SanFrancisco,.

192

DOLLARS,
NOT RESPONSIBLE FOR ANY INACCURACIES OR DELAYS IN THE TRANSMISSION BY THE TELEGRAPH COMPANIES
Amount
$
THE ANGLO & LONDON PARIS NATIONAL BANK
$.
Exchange .
Telegram
Cashier

FIGURE 7
Bank's receipt for telegraphic transfer
but such courtesies are usually granted by domestic banks to each other.
The San Francisco bank will also mail an advice to the Boston bank
notifying it of the details of the transaction. This is merely for confirmation and for the purpose of checking up on the transaction to
see that it goes through satisfactorily. The Boston bank will in its
turn forward an advice to the San Francisco bank informing the latter
that it has followed the telegraphic instructions and has paid the sum
of money to the party designated.
The charges for telegraphic transfers between banks vary with
circumstances. In addition to the principal sum sent and the regular
tolls of the telegraph company, the charges will include an " exchange
charge varying with conditions . If the sum sent is large, the rate per
hundred dollars will be less than if it is small. Some banks charge
$.50 per $100, others $.75 . For large amounts it is not unusual for a
bank to charge as low as $.04 a hundred . If the bank is " long "" on
funds in the payee's city and wants to transfer some of its money
to its own vaults at home, it will sell telegraphic exchange, as well as
other kinds of exchange , at lower rates than if the reverse condition
existed. By selling exchange, it gets cash in hand, and loses that
amount from its balance with the bank upon which the exchange
has been sold. Suppose that a bank in Denver is running short of
funds in its own vaults, or suppose that it has a chance to invest its
money at home and receive a larger return upon it than it is receiving
on its balance deposited with the Old Colonial Bank of New York.
It will telephone to other local banks asking them if they are in the

IC

32

DOMEST

N

AND FOREIG

NGE

EXCHA

market for telegraphic exchange on New York, and may find several
which are short of funds in New York, but long on funds at home.
To these, it will sell the necessary amount of telegraphic exchange,
for cash. Then it has only to send a telegram to the Old Colonial Bank
in New York, advising it to turn over to the New York banks designated by the buying Denver banks, the sums of money represented
by the amounts of exchange sold . The Old Colonial of New York
debits the account of the selling bank, and pays the sums requested
to the designated New York banks for the account of the buying
Denver banks.
The rates for telegraphic transfers are always higher than rates
for other kinds of domestic exchange. If the customer sends a sight
draft, the bank has the use of the money until its account with the
bank upon which the draft has been drawn has been debited with
the amount of the draft. But in the case of a telegraphic transfer, it
takes only a few moments for the telegram to reach its destination, so
that the bank gets practically no use of the customer's money, and
consequently has to charge a higher rate for such kind of exchange .
With the introduction and extension of the Federal Reserve System,
the activities of local banks in handling telegraphic transfers for large
amounts have been greatly modified , in fact revolutionized . The
change has come about through the use of the Gold Settlement Fund
of the Reserve System for telegraphic transfer purposes. The Fund
was established at Washington in May, 1915 , by the Federal Reserve
Board, and is operated directly under its supervision and by its
appointees. Each Federal Reserve bank was required to deposit
$1,000,000 gold or gold certificates with the Fund , to be used for the
purpose of clearing obligations and items of one Federal Reserve
bank upon another, thus making it unnecessary to ship gold , exchange,
or money back and forth across the continent in the settlement of
balances between the Federal Reserve banks . The Fund has increased
rapidly since its establishment and on January 19, 1922 , held a balance of $468,174,000 for the twelve Federal Reserve banks and their
branches.¹ The regulations governing the operation of the Fund have
been changed from time to time. At present clearings are made daily
between Federal Reserve banks and sixteen out of their twenty-three
branches by messages that are sent over their own leased wires.
1 It is held by the Treasurer of the United States. It also constitutes part of the gold
reserves of the Federal Reserve banks.

DOMESTIC EXCHANGE

33

Every evening the Federal Reserve banks and their branches wire
to the Fund stating the amounts due them from the other Federal
Reserve banks and their branches. A settlement of obligations is
effected merely by book entries , usually within an hour's time after
the receipt of the information, and a telegram is then sent each Federal
Reserve bank or branch advising it as to the extent of its favorable
or unfavorable balance as a result of the day's clearings, and the
balance which it has in the Fund.

The Federal Reserve Board early saw the possibility of using the
Fund in connection with the telegraphing of money from one section
of the country to another and introduced a system of telegraphic
transfers. As a consequence the whole field of domestic exchange, as
it formerly existed, has been revolutionized, especially in connection
with the transference of large sums of money, even for banks that
are not members of the Federal Reserve System . The plan that was
adopted is based primarily upon the Giro Conto Transfer System of
the Imperial Bank (Reichsbank) of Germany . The Reichsbank has
branches in practically every important city in Germany. If a merchant having a deposit with the Hamburg branch of the Reichsbank
wishes to pay a firm in Berlin, he merely requests the branch to debit
his account for a certain sum and to transfer that amount to the credit
of the Berlin firm on the books of the Berlin branch. This the bank
does by mail free of charge, but if done by telegraph a small fee is
charged. Transfers under the Federal Reserve System are made by
telegraph only and are sent free of charge but only at the request of
banks that are either "member " banks or " non-member clearing "
banks. Member banks are those that are stockholders in the Federal
Reserve bank of their district to whom all privileges of the Federal
Reserve System are accorded. " Non-member clearing" banks are
those that are not stockholders, but that maintain a balance with the
Federal Reserve bank of their district so as to enjoy some of the advantages of the Federal Reserve System. They are allowed to have
such privileges as sharing in the par-collection of checks, ¹ the collection
of non-cash items, the use of the telegraphic transfer system, etc.
Then there are also those banks that are not members of the Federal
Reserve System and that do not keep any balance with the Federal
Reserve bank of their district, but which nevertheless agree to remit
at par for checks on themselves forwarded to them by a Federal Re1 Cf. pp. 39-44.

34

DOMESTIC AND FOREIGN EXCHANGE

serve bank. Finally there are those non-member banks that are not
even on the par-list. Only the first two groups of banks are allowed
to share directly in the use of the Federal Reserve telegraphic transfer
system, although indirectly , as we shall see, the others may use it by
having a bank in either of the first two groups act for them. Inasmuch as the Federal Reserve banks hold only the accounts of banks,
the transfers must be made by and through banks and not by or
through individuals.
Today, if the San Francisco National Bank, a member of the Federal
Reserve System, wishes to telegraph $1,000,000 to the National City
Bank of New York, it may merely notify the Federal Reserve Bank
of San Francisco to send the necessary wire. The Federal Reserve
Bank of San Francisco deducts $ 1,000,000 from the account which
the San Francisco National Bank has with it, making no charge for
the service which it performs for the latter. It then sends a code
message to the Federal Reserve Bank of New York, notifying that
bank to pay $ 1,000,000 to the National City Bank for the credit of
the San Francisco National Bank. The National City Bank, being
a member of the Federal Reserve System, will have an account with
the Federal Reserve Bank of New York and the latter pays the sum
as requested by merely crediting the account of the National City
Bank with that amount, and notifying the National City Bank that
it has done so at the request of the San Francisco National Bank.
The San Francisco National Bank thus has its account at the Federal
Reserve Bank of San Francisco debited $ 1,000,000, while its account
with the National City Bank is credited with a like sum. The claim
of the Federal Reserve Bank of New York for $ 1,000,000 against the
Federal Reserve Bank of San Francisco will b settled through the
Gold Settlement Fund . Possibly on that same day, banks in the New
York Federal Reserve district may telegraph $3,000,000 to banks in the
San Francisco Federal Reserve district through the agency of the Federal Reserve banks, while the latter may forward $5,345,000 to the
former in the same manner. The balance for the day is settled by wire
through the agency of the Gold Settlement Fund at Washington in the
manner already described .

Not only do the Federal Reserve banks supply telegraphic exchange for " member " banks and for " non-member clearing " banks,
but they also afford the same service indirectly to the customers of
those banks. If Stephens in Sacramento, California, desires to send

DOMESTIC EXCHANGE

35

$5,000 to Reilly and Company in New York, whose bank is the National Bank of Commerce, he merely pays his local bank, if a member
or a non-member clearing bank in the Federal Reserve System,
$5,000 and requests it to make the transfer for him. The local
bank then advises the Federal Reserve Bank of San Francisco,
by wire, to debit its (the Sacramento bank's) account with $5,000
and to transfer that sum of money by telegraphic order to Reilly
and Company through the National Bank of Commerce in New
York. The Federal Reserve Bank of San Francisco wires the Federal Reserve Bank of New York to pay the sum to Reilly and
Company through the National Bank of Commerce. The latter bank
will be credited on the books of the Federal Reserve Bank of New
York with the $5,000, and may receive that sum in actual funds or
let it stand to its account. The National Bank of Commerce credits
Reilly and Company with $5,000, and the latter likewise may either
cash against that sum, or let it stand to their credit on the books of
the National Bank of Commerce. If the banks make no charge to
correspondents or customers, the Federal Reserve banks make no.
charge for the service rendered.
Another interesting angle of the situation is the possibility of a
bank that is not a member of the Federal Reserve System, or a "nonmember clearing " bank, or a customer of such a bank, securing this
same service free of charge. This may be accomplished in the following manner: Let us say that the Emporium Department Store of
San Francisco has an account with the Union Trust Company of that
city. The latter is not a member of the Federal Reserve System , but
has as its local agent, or is financially connected with, the Wells Fargo
Nevada National Bank, which is a member of the Federal Reserve
System. If the Emporium wishes to send $500,000 to Reilly and Company in New York and asks the Union Trust Company to do so for
it, the Union Trust Company will request the Wells Fargo Nevada
National Bank to put through the transaction just as though the
Emporium were a customer of the Wells Fargo Nevada National
Bank. The Emporium pays the Union Trust Company $500,000,
by check or cash. The Union Trust Company may send cash, a check,
or a draft for $ 500,000 to the Wells Fargo Nevada National Bank,
either directly or through the clearing house. The Wells Fargo Nevada
National Bank then requests the Federal Reserve Bank of San
Francisco to forward $ 500,000 telegraphic exchange to the National

STIC

36

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AND FOREI

ANGE

EXCH

Bank of Commerce for the account of Reilly and Company.

This

would be done, as in the above example, through the Federal Reserve
Bank of New York.
It is also possible for a member bank to telegraph funds to a nonmember bank by means of this system. Let us say that the Wells
Fargo Nevada National Bank of San Francisco wishes to remit $ 10,000
to the Milwaukee State Bank. It requests the Federal Reserve Bank
of San Francisco to send the telegraphic transfer. The latter wires
the Federal Reserve Bank in Chicago , which in turn notifies a member
bank in Milwaukee, let us say, the First National Bank of Milwaukee,
that $10,000 has been credited to it for the account of the Milwaukee
State Bank. The First National Bank then turns over $ 10,000 to the
Milwaukee State Bank. It should be noted, however, that the Federal
Reserve banks will forward telegraphic transfers directly for member
and " non-member clearing " banks acting either for themselves or
for their customers, when the transfers are to be sent to or through
member or " non-member clearing " banks .
Banks that are neither
members of the Federal Reserve System nor " non-member clearing "
banks cannot transmit funds directly through the Federal Reserve
banks, nor will any Federal Reserve bank accept transfers to be sent
directly to them. They may, however, as we have seen, send transfers through member or " non-member clearing " banks, and on
the other hand transfers may be sent to them only through such
banks.
Thus far the Federal Reserve Board has left to the individual
Federal Reserve bank the decision as to the minimum sum that will
be transferred in the manner above described. One Federal Reserve
bank has fixed the minimum amount for customers' telegraphic transfers at $ 1,000, another at $ 2,500. This rather high limit was decided
upon in order to prevent the already crowded telegraph wires of the
Federal Reserve System being swamped with an unlimited number
of small $ 100 or $200 transfers for customers of member and "nonmember clearing " banks. The Federal Reserve bank that has the
$2,500 limit for customers' transfer, however, permits member and
"non-member clearing " banks to send transfers for themselves, not
for customers, for as low an amount as $ 1,000.
Some banks make use of the telegraphic transfer system of the
Federal Reserve banks for the purpose of earning a day's interest on
funds thus transferred . This is done as follows : Let us say that the

1

DOMESTIC EXCHANGE

37

Fourth National Bank of San Francisco has payments of $1,000,000
to make to various firms in New York, either for its own account or
for the accounts of its customers. It instructs the Federal Reserve
Bank of San Francisco to wire that amount to the Chase National
Bank of New York. The Federal Reserve Bank of San Francisco
does so. At the same time the Fourth National Bank wires the Chase
National Bank that a telegraphic transfer is being sent it through
the Federal Reserve banks of San Francisco and New York, and that
the sum is to be paid out in designated amounts to different parties.
When the Federal Reserve Bank of New York notifies the Chase
National that the latter has been credited with $1,000,000, it is, to the
Chase National Bank, the equivalent of having $ 1,000,000 in its own
vaults. It therefore proceeds to draw checks on itself (cashier's checks)
and mails them to the parties designated by the Fourth National
Bank of San Francisco. Or if the sums are to be paid to banks which
are members of the Clearing House of New York, the checks will be
sent to them that day through the Clearing House. The checks that
are sent out by mail will be received by the customers possibly on that
same day, but will be presented to the Chase National through the
Clearing House the next day. Consequently the Chase National
Bank will have the use of the $ 1,000,000 for a day. The account of the Fourth National Bank of San Francisco with the
Chase National Bank will be credited with that sum and will
receive a day's interest thereon (usually at the rate of about 2 per
cent) .
A bank sending a telegraphic transfer through the Federal Reserve
banks to another bank usually itself wires the " advice " as to the
amount, for whose account , etc. , or it may send such an advice by
mail. This is done for the purpose of confirmation, and to avoid any
possible mistake or error.
Telegraphing money is safe, quick, and a very simple and effective
method of transferring funds or making payments between distant
communities. It is being more and more widely used by all classes
of people and by financial institutions. In 1915 the Western Union
forwarded $ 30,000,000 in this manner. No data are available as to
the extent that banks employ telegraphic transfers either by means
of the service afforded by the Federal Reserve banks or by the telegraph companies themselves.¹
1 Some idea of the extent of the total amount of telegraphic transfers sent in 1920 by

IC

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38

Checks .

E

NG

N

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AN

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C
EX

FOR

A person owing a sum of money to another in a distant

city usually forwards his personal check for the amount.

A check

(Fig. 8) is an order upon a bank by a depositor requesting the bank
to pay a certain sum of money on demand to the depositor himself,
to the bank itself, or to a third party who is sometimes designated as
the "bearer."

Most frequently the check is made out to a third

party " or order." The recipient of a check either deposits it at his
own bank and receives actual cash or an addition to his deposit account, or he indorses it and passes it to another person who in his turn
cashes it, or indorses it and passes it on to another.

Ultimately, it is

90-48
N
E
M

Berkeley Commercial & Savings Bank

I

C
E
P

AY TO
THE ORDER OF

S

BERKELEY, CALIFORNIA 4-3

No 95

192 1
30
$ 105 100

John Jones
100
hu
nd
Une
red five

DOLLARS

W. E. Smith

FIGURE 8
Bank check
presented to the bank upon which it has been drawn, is paid, the sum
deducted from the account of the drawer, and the check cancelled
and returned to the drawer.
The party who draws the check seldom appreciates or knows anything about the complicated machinery of banking relations that lies
behind its collection . Until 1915 there was no system of national
extent nor was there a central directing force or scheme to be found
in connection with the collection of checks . A check might wander
the Federal Reserve banks may be gained from the following data covering only five of
those institutions:
Items
Amount
New York.
$ 17,021,509,734
147,302
9,832
Philadelphia .
625,338,000
Richmond .
21,836
1,246,861,158
St. Louis .
32,068
1,225,250,058
San Francisco .
29,291
3,043,193,000

DOMESTIC EXCHANGE

39

over the greater part of the United States before reaching the bank
upon which it had been drawn . Jones in Chicago, for instance, might
draw a check on the Commercial National Bank of that city and forward it to Smith in Los Angeles. Smith would cash it at his bank, but
66
not at its face value. The bank would make what was called an exchange charge," varying from five cents to twenty-five cents, for its
services in connection with the collection of the check. The Los
Angeles bank might then send the check to the New Orleans State
Bank for the purpose either of building up its account with that bank
or of settling some obligation which it owed that bank. The New
Orleans bank might then forward the check to the Liberty Trust
Company of New York for similar reasons. The Liberty Trust Company might send it to the Plymouth National Bank of Boston, which
in its turn might forward it to a bank in Minneapolis, and so on, the
check passing through a number of other banks until it would be returned finally to the Chicago Commercial National Bank. The check
might be out on the road, in " float " as it is called, for several weeks .
It might crisscross back and forth across its own path several times.
Each bank would make an exchange charge for the costs of bookkeeping, handling, mailing, etc. Any day ten banks in a city might
have a large number of items on the same banks in other cities and
send them out along any number of separate paths for collection.
Merchants were harassed by the collection charges imposed by banks
for the cashing of these so -called " country " or out-of-town checks,
losing from five to twenty-five cents on the face value of each check.
Outside of the establishment of a few " country" or " regional clearing houses " for the more economical and efficient collection of such
items, nothing had been done up to 1915 to remedy the situation .
These regional clearing houses, which had been established at Boston,
Kansas City, and a small number of other cities, had reduced the time
of collection about 25 per cent and had saved their members about
50 per cent in the expense of handling such checks. But most banks
were not willing to join in the organization of regional clearing houses,
and as a consequence the antiquated system of collecting checks, in
spite of its deficiencies and shortcomings, remained practically unchanged until 1915 .
When the Federal Reserve law was passed in 1913 it contained a
provision (Section 16) to the effect that the Federal Reserve banks,
if directed by the Federal Reserve Board, were to act as clearing houses

IC

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for the collection of checks for their members , while the Federal Reserve Board itself was authorized to act as a clearing house for the
Federal Reserve banks or to require one of the Federal Reserve banks
to act for it in that capacity. The Federal Reserve Board considered
this to be one of the most important responsibilities with which it was
charged under the Act and early began to prepare a series of regulations
designed to carry out the provisions of the law. First of all , in May,
1915, it established the " Gold Settlement Fund " as above described.¹
Next, in order to educate the bankers of the country to appreciate the
advantages of the par collection of country checks, the Federal Reserve Board in 1915 authorized the Federal Reserve banks to establish
a voluntary check collection system.

The scheme did not work out

satisfactorily, chiefly because it was a voluntary system and few banks
joined in it, so on July 15 , 1916, the Federal Reserve Board inaugurated
a compulsory par collection system. The essence of the plan was that
all member banks should pay the checks drawn on them, when presented by a Federal Reserve bank, without deducting any exchange
charge, i. e., they were to remit the full face value of the check to the
Federal Reserve bank which presented the check for payment. Member banks were still allowed to send checks through the old channels
if they desired, and to make such charges as they wished, but not to
exceed ten cents on the $ 100 ; but if checks were sent through the
Federal Reserve banks for collection, no such deductions could be
made. To make the system effective it was necessary to induce or
compel the non-member banks to enter the check collection system
either as "non-member clearing " banks or as banks that would agree
to remit at par. As we have seen in the last section , they did not have
to become stockholding members of the Federal Reserve System to be
a part of the par collection system. As " non-member clearing "
banks they kept funds or balances with the Federal Reserve bank of
their district, while as " par list " banks they agreed only to remit at
par, i. e., to make no exchange charge, for all checks presented to them
for payment through the mails or otherwise by the Federal Reserve
bank of their district.
Great opposition was shown by many of the member banks, and
especially by the non-member state banks. However, when a member
bank in a city, compelled as it was by the rules of the Federal Reserve
Board, remitted for its checks at par, other banks who were non-mem1 Cf. pp . 32-33.

DOMESTIC EXCHANGE

41

bers immediately found their checks at a disadvantage in the local
market. Also, again and again, when a non-member bank refused
to remit at par, the Federal Reserve bank presented the check to the
bank through an express company or some other agency and compelled it to pay the same at par over its counter, even though the
costs to the Federal Reserve bank in pursuing this method of collection
were at times greatly in excess of the small collection or exchange
charge that would have been made by the non-member bank. The
par collection system spread rapidly, however, and on January 1 , 1922 ,
included all but about 2,000 banks in the United States.¹ The magnitude of the operations of the Federal Reserve banks in this connection
is shown by the fact that, in 1921 , 522,665,000 items, totalling $ 118,844,391,000, were collected through this agency.
Charges varying from 1 to 1½ ¢ per item, imposed by the Federal
Reserve banks during the first few years, were abolished in 1918, and
all checks and drafts are now collected free of charge when passed
through the par collection system. In June, 1920 , the Federal Reserve banks also established a collection department for the collection
of maturing notes, bills, and other collection items. Credit is given
only when these items have actually been paid. The Federal Reserve
banks impose no charge for the collection of the latter group of items
except to cover any " collection charges made by the collecting bank
and for registration , insurance or express charges on negotiable securities (coupons, etc. ) payable out of the Federal Reserve city. " 2
The Federal Reserve banks and their branches have in this way
become a great collecting agency for the systematic and efficient
handling of the collection of checks, drafts, and other similar items.
By means of the arrangements provided it is possible for banks to
build up their accounts with the Federal Reserve bank of their district, to shift funds about the country as desired, to collect moneys
owing them in a minimum of time, to say nothing of the various other
services provided, and all this is performed free of charge, except in
the case of the collection of maturing notes, bills, and similar collection
items, which is done at cost.
The par collection system gives immediate credit to the depositing
bank on all items deposited, but the proceeds do not become available
for the use of the depositing bank until actually collected or until a

1There were about 31,000 banks in the United States on that date.
2 Circular 101, Federal Reserve Bank of San Francisco.

DOMESTIC AND FOREIGN EXCHANGE

42

certain number of days have elapsed if perchance the item has not
actually been collected by that time. Each Federal Reserve bank or
branch has an " Availability Sehedule " which fixes the number of
AVAILABILITY SCHEDULE FOR DEPOSIT OF CHECKS AND DRAFTS WITH
SEATTLE BRANCH, FEDERAL RESERVE BANK OF SAN FRANCISCO
ForAvailability Schedule of Items "Direct Routed" to other offices of this bank, see their respective schedules.
DEPOSITED IN SEATTLE ON:
12TH DISTRICT

SUBJECT TO
FOLLOWING
AVAILABILITY

OTHER
DISTRICTS

Seattle
Immediate United States Treasury Warrants
Drafts on Federal Reserve Bank of San Francisco- Head Office and
Branches
Portland, Spokane
1 Day...
2 Days... Washington-Seattle Zone, excepting places noted in 3-day division
Salt Lake City, San Francisco
Washington- Seattle Zone, the following places :
Days...
South Bend Wilkeson
Black Diamond Raymond
Langley
Snoqualmie Toledo

4 Days...

Los Angeles
Oregon-Country
Washington-Portland Zone
Washington-Spokane Zone

5 Days...

Idaho

6 Days...

California-Country
Nevada
Utah-Country

7 Days.... Arizona-12th District

8 Days....
9 Days....

Atlanta
Baltimore
Birmingham
Boston
Buffalo
Houston
Jacksonville

1

Chicago
Denver
Kansas City
Minneapolis
Omaha
St. Louis
Little Rock
Memphis
Louisville
Philadelphia
Nashville
Pittsburgh
New York City Richmond
New Orleans
Missouri
Michigan
Minnesota
Wisconsin

Cleveland
Cincinnati
Dallas
Detroit
ElPaso
Illinois
Indiana
Iowa
Arkansas
New MexicoMaryland
Massachusetts 10th District
Colorado
Connecticut Montana
N.Y. State
Nebraska
Delaware
North Dakota
Kansas
New
Hamp- Ohio
shire
Oklahoma
Kentucky
Maine
NewJersey Pennsylvania
Alabama
New MexicoGeorgia
Louisiana
Arizona11th District
11th District Mississippi N. Carolina
Florida

Rhode Island
South Dakota
Tennessee
Vermont
Virginia
Wyoming

S. Carolina.
Texas
WestVirginia.

FIGURE 9
Availability schedule for Seattle branch Federal Reserve Bank of
San Francisco
days that must elapse before the items deposited are available for
use by the depositing bank. The following schedule (Fig. 9) of the
Seattle branch of the Federal Reserve Bank of San Francisco is typical
of lists issued by Federal Reserve banks and their branches.

DOMESTIC EXCHANGE

43

If, for instance, the Tacoma National Bank deposits with the Seattle
branch a check for $500 on a Los Angeles bank, the funds that the
check represents become available for the use of the depositing bank
on the fourth day, no matter whether or not the check has actually
been paid by the Los Angeles bank. If the check is on the First National Bank of Jacksonville, Florida, the funds become available
after nine days have elapsed. In the case of the Florida check, the
method of procedure would be somewhat as follows : The check would
be deposited with the Seattle branch of the Federal Reserve Bank of
San Francisco, which would enter on the account of the Tacoma National Bank a deferred credit of $500 to become available nine days
hence. The Seattle branch would then send the check to the Federal
Reserve Bank of Atlanta, which would credit it with that sum. The
Atlanta institution would then forward the check to the Jacksonville
bank. The Jacksonville bank would remit $500 in gold or paper
money other than National Bank notes to the Federal Reserve Bank
of Atlanta, the costs of the shipment being borne by the Federal Reserve Bank of Atlanta. The Federal Reserve Bank of San Francisco,
being the head office of the Seattle branch, would have $500 coming
to it from the Atlanta Reserve Bank and its claim would be cleared
through the agency of the Gold Settlement Fund without the necessity
of shipping any exchange, gold , or money from Atlanta to San Francisco. All branches of a Federal Reserve bank transact their business
in the name of the head office.
If, in order to save time, banks in the clearing system desire to send
their items for collection direct to a Federal Reserve bank or its branch
located outside of the district in which the banks are located they
may be authorized to do so and may receive credit at the office of the
Federal Reserve bank with which they are affiliated, but ordinarily
they will clear checks and other items directly through the Federal
Reserve bank of their district.
The par collection system, therefore, has made the check a much
more useful means of payment than ever before. It has saved time,
labor, and much expense. Each bank now sorts its items according
to banks and cities and reserve districts . These bundles of checks flow
into the Federal Reserve bank of the district, which gathers all the
checks on one bank into one package, and all the checks on banks in
one district into a still larger package. The checks that are to be
cleared through the Federal Reserve Bank of Chicago go to that

44

DOMESTIC AND FOREIGN EXCHANGE

institution ; those that are to be cleared through the Federal Reserve Bank of New York go there the idea being to collect items
directly and with the least expenditure of time, expense, and energy.
As noted above, the balancing of credits and debits between the
various Federal Reserve banks that arise in this and in other
connections is made through the Gold Settlement Fund at Washington.
The results of the clearings and collections obtained thus far through
the activities of the Fund have been truly surprising, while the costs
have been extremely slight. Combined clearings and transfers through
the Fund during the year 1921 aggregated $ 68,223,882,000 as compared with $92,625,805,000 for 1920, $73,984,252,000 for 1919, $50,251,592,000 in 1918, $27,154,704,000 in 1917 , $5,533,966,000 in 1916,
and $ 1,052,649,000 in 1915 , making a grand total of $318,826,850,000
since the inception of the Fund on May 20, 1915. "When it is considered that these enormous transfers are made almost instantly by
means of the leased wire system without involving the physical movement of a dollar, it will be seen that that arrangement has been of
incalculable value to the Government, the banks and the public." 1
The total expense of operations for 1921 , including the entire cost of
the leased wires and salaries of accountants, was approximately
$485,000. This represents the basic cost of effecting domestic exchanges between the several Federal Reserve districts. A charge of
10 cents per $ 100, if generally imposed, would have involved an expense to the Treasury and the commerce of the country of $68,223,000
for the transfers made during 1921 .
The large sums representing the combined transfers and clearings
effected through the Gold Settlement Fund, averaging about $ 1,500,000,000 weekly , have been due to the heavy movements of funds by
the Government (the Federal Reserve banks now being authorized
to act as the fiscal agents of the Government because the subtreasuries have been abolished) , and to large transfers for the accounts of member banks in connection with telegraphic exchange,
the collection of country checks, and other items.
Bank Drafts. The existence of the Gold Settlement Fund also
makes it possible for the Federal Reserve banks greatly to simplify
the means by which member banks in any part of the country may
provide themselves with "New York exchange," to be availed of by
1 Annual Report of the Federal Reserve Board, 1920, p . 71 .

DOMESTIC EXCHANGE

45

drafts on their accounts with New York banks whenever desired
either for their own needs or for those of their local customers.

Bank drafts on New York still bulk very large in domestic exchange
transactions, although they are by no means so important as before
the introduction of the Federal Reserve System of telegraphic transfers and the par collection of checks . They are still used for small
sums up to $1,000 or more by customers of member banks and of
course for even larger sums by customers of non-member banks unless
the latter have an arrangement with a member bank or a non-member
clearing bank whereby telegraphic transfers may be procured through
a Federal Reserve bank.
It is not strange that New York exchange should still be the most
important kind of domestic exchange remitted by mail. New York is
the financial center of the United States. Banks all over the country
have either direct or indirect connection with financial institutions
in that city. There is also some Chicago, St. Louis, and San Francisco
domestic exchange (bank drafts on those centers) demanded by
customers, but the great bulk of bank draft exchange is on New York.
If a man in Seattle wishes to pay a bill in Chicago, his bank will sell
him a draft on its account with a New York bank. If a man in Denver
wishes to pay a bill in Mobile, or Los Angeles, or Boston, it is more
than likely that his local bank will provide him with a draft on its
account with a New York bank. The reason for this is simply that
all banks have a continual demand for exchange of some sort or other
on New York. They must build up their accounts in that city with
which to meet this demand. When a customer deposits a draft on a
New York bank, the local bank sends it on to be collected and credited
to its New York account. The demand for New York exchange in
connection with domestic financial affairs is as widespread as is the
demand for exchange on London in the field of international financial
operations.
If Baker in San Francisco has purchased $1,000 worth of goods
from Foster in Boston, he goes to his local bank, say, the First National Bank, and asks it for a bank draft for that sum on its New York
correspondent, say, the Chase National Bank. The San Francisco
bank builds up its account by sending various items to the Chase
National Bank for collection . These items may be on New York firms
or banks, or on firms or banks located elsewhere in the East. The
First National Bank is a member of the Federal Reserve System, and

C

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may also at any time replenish its account by having the Federal Reserve Bank of San Francisco telegraph the needed funds to its correspondent in New York in the manner described above.¹
As will be noted from the accompanying bank draft (Fig. 10) , the
name of the remitter does not appear on its face. A bank draft is
merely an order from one bank to another requesting the latter to pay
a certain sum to a third party and to debit or charge the account of
the drawing bank which is on deposit with the paying bank. If the
drawing bank does not have sufficient funds on deposit with the paying bank at the time when it draws the draft, it is necessary for it to
N
E
M
I
No. 387
C
THE FIRSTNATIONALBANK
OF SANFRANCISCO 11-8
E
P
March 5 1921
SAN FRANCISCco, Car
S
PAY TO THE ORDER OF

Charles B. Foster

-----One Thousand and 00/1004

$1.000.00

Lars

CHASE NATIONAL BANK
NEW YORK

CASHIER

FIGURE IO
Bank draft

provide such funds by remitting telegraphic or other exchange to meet
the payment of the draft when it is presented.
The First National Bank will provide Baker with a draft on the
Chase National Bank for $ 1,000. Whether it will charge him more
than $1,000 for the draft, i. e. , whether it will make an " exchange"
charge, depends upon certain circumstances which will be discussed
later.2

Baker mails the draft to Foster, his creditor, in New York.

Foster deposits it to his account in his local bank, let us say, in the
Irving National Bank. The Irving National Bank collects it from
the Chase National Bank through the clearing house or by messenger.
The Chase National Bank deducts the amount of the draft from the
account of the First National Bank on deposit with it and sends an
advice thereof to the latter.
In connection with the issuance of such drafts, several technical

1 Cf. pp. 34-37.

2 Cf. p. 48.

DOMESTIC EXCHANGE

47

terms arise that must be kept clearly in mind throughout our subsequent discussion, because we shall use them constantly. The party
that draws the draft, in the above case the First National Bank, is
known as the " drawer"; the party upon whom the draft is drawn,
in this case the Chase National Bank, is known as the "drawee ";
the party to whom the draft is made payable, in this case Foster of
New York, is the "payee "; the party that pays the draft, i. e. , the
""
Chase National Bank, is the " payer."
The essential difference between a check and a bank draft is that
the former is an order of an individual or firm , not a bank, to a bank
ordering the latter to pay a certain sum of money to a third party from
the account of the party that drew the check. A bank draft is an
order drawn by a bank on another bank ordering the latter to pay a
certain sum of money to a third party out of the account of the drawing bank.
Sometimes banks make arrangements whereby they are permitted
to draw directly upon a New York bank even though they have no
account with the latter, the agreement being that the drawing bank
shall remit immediately to cover the amount of the drafts issued .
Up to the time of the inauguration of the telegraphic transfer
system of the Federal Reserve banks, rates of domestic exchange,
telegraphic and mail, were quoted as commonly as foreign exchange
rates are quoted today. The following is typical of the weekly announcements that formerly appeared in the Annalist of New York:
DOMESTIC EXCHANGE RATES
The week's range of exchange on New York at Chicago last week
was from 25c @ 10c discount, closing at the former ; at Boston it
stood at par all week; at St. Louis it was 25c @ 15c discount , closing at the former, and at San Francisco it was 30c premium all week.
According to this announcement, Chicago banks apparently had
a considerable supply of funds in New York which they were willing
to dispose of by means of New York drafts at from $.10 to $.25
discount on $ 1,000. In Boston the supply of exchange on New York
about balanced the demand for such exchange, so that the Boston
banks were willing to sell it at par, making no charge and taking no
discount. In San Francisco, however, the demand for New York exchange was heavy and the banks were having a hard time to get an
adequate amount , so they were charging $.30 premium, i. e. , a New

STIC

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IGN

AND FORE

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HAN

EXC

York draft for $ 1,000 would cost $ 1,000.30 . Frequently the rates
would be published as " Domestic exchange [ meaning on New York]
2¢ premium regular, " ¹ which would signify that a draft on New York
would be charged at the rate of $.02 per $ 100. It was not unusual
to charge a sliding rate which would decrease with larger amounts,
e. g. , 5 ¢ up to $25 , 10¢ for $25 to $ 100 , 50¢ per $ 1,000, etc.
The basic rates of domestic exchange used to vary from day to day,
and would experience the same general tendencies in their swing upward or downward as foreign exchange rates, depending in general
upon the same factors that influence foreign exchange rates. In the
late summer and fall of the year when the West was shipping the East
a large amount of goods, countless drafts would be drawn on eastern
consignees, thus creating a large supply of exchange and consequently
tending to weaken exchange rates on New York and other eastern
centers . In the spring and early summer the West would be buying
more heavily from the East, and exchange rates would then tend to
rise. As is true also in the field of foreign exchange,2 the limits within
which domestic rates on New York would fluctuate were determined
by the cost of shipping gold . It cost normally about $.50 to ship
$ 1,000 in gold from New York to Chicago, $.60 to St. Louis , $.75 to
New Orleans, and $1.50 to San Francisco. If a banker in Chicago
had to pay more than $1,000.50 for a $ 1,000 draft on New York, he
preferred to ship gold instead of purchasing a bank draft because he
could do so at a profit. Likewise if a shipper in Chicago had to accept
less than $999.50 for his drafts on New York consignees, he preferred
to send his bill to New York for collection and to have gold or currency
sent him. If Chicago banks were forced to sell bank drafts on New
York for less than $999.50, it would pay them to have gold shipped
to them from New York.
The old system and the old methods were revolutionized by the
practices inaugurated by the Federal Reserve System. Today the
applicant for New York drafts is usually not charged any exchange
for the service that is accorded. But if he asks for too large an amount,
or if he is a stranger at the bank, or if he asks daily for a large number
of drafts on New York, the bank may make what it calls a " service
charge," usually rather small in amount. Domestic exchange rates no
1 Drafts on New York banks were called " regular exchange " so as to differentiate them
from "telegraphic exchange."
2 Cf. Chapter XI, Gold and Gold Movements.

DOMESTIC EXCHANGE

49

longer fluctuate as they used to, nor do banks ship gold from one to
another. Gold is transferred through the Federal Reserve banks
without charge. If a San Francisco bank desires to pay $100,000 in
gold to a New York bank, it may send the gold to the Federal Reserve
Bank of San Francisco, charges collect. The latter then wires the
Federal Reserve Bank of New York to pay out that sum in gold to the
designated New York bank. No charges for this sort of service are
made to member banks or to non-member clearing banks.
It is not possible for all banks to keep accounts with correspondents
in New York. Arrangements are therefore made with banks that
do keep such accounts whereby banks without correspondents are
authorized to draw drafts on New York by means of a system of
"advices." If the State Bank of Madison, Wisconsin, has made
arrangements with the Chicago Commercial Bank to draw on the
latter's New York correspondent, say the Chase National Bank, it
can sell a draft to its customer on the Chase National Bank, drawing
the draft on blanks furnished by the Chicago bank. The drafts bear
the monogram or mark of identification of the Chicago bank, so that
the Chase National Bank knows through which one of its correspondents the draft has been drawn . An advice is sent by the Madison
bank to the Chicago bank notifying it of the sale, to whom payable,
the amount, date, etc. The latter then debits the account of the
Madison bank and sends an advice to the Chase National Bank.
When the draft reaches the Chase National Bank either over the
counter or through the clearing house of New York, it is paid and the
amount deducted from the account of the Chicago Commercial Bank.
Traveler's Check. All the forms of domestic exchange discussed in
previous pages deal with a situation in which the debtor stays at home
and forwards exchange with which to meet his obligations. But if
he were traveling from place to place and desired to have available
the wherewithal to pay bills as he goes , it would not be advisable for
him to carry cash. To carry cash, either metal or paper, in large
amounts is bothersome and extremely risky. As long ago as 1891
the American Express Company devised a most satisfactory substitute, viz. , the "traveler's cheque " or the "traveler's check."
Other express companies followed the example of the American Express Company, until with their amalgamation into the American
Railway Express Company all express offices now issue only the
American Express Company's traveler's checks. Somewhat later,

DOMESTIC AND FOREIGN EXCHANGE

50

the Bankers' Trust Company of New York obtained permission from
the American Bankers ' Association to issue what are known as the "A.
B.A. Cheques " to any bank that desired them for the accommodation
of its customers. Subsequently several other large banks in New York
notified their correspondents that they too would issue traveler's
checks under conditions similar to those of the Bankers' Trust Company. At present traveler's checks may be obtained from practically
any bank and from all express company offices in the United States
as well as from many hotels, stores, etc.
Traveler's checks may be issued in terms of dollars or in terms of

O

20

603800
James Williams
Guaranty Trust
Company of NewYork
10 BROADWAY

WILLPAYTOTHES
AN UNITED STATES GA S200
TWENTYDOLLARS

OTHER
ATBANKANSBUY
OuarantyTrustCompanyofNowYa

FIGURE II
Book of traveler's checks

both dollars and the more commonly demanded foreign moneys,
such as sterling, francs, etc. Before 1914 the latter was the more
customary form , and when foreign exchange rates again return to
normal it will undoubtedly come back into general use. The World
War, with its wide fluctuations in the exchange rates on foreign
countries, brought into existence a form of traveler's check payable
in the United States and Canada in dollars and in foreign countries in
terms of foreign money at the banker's selling rate for sight drafts on
New York. In the present section we shall confine ourselves to a
description of the traveler's check as employed in domestic travel.
Say that the traveler goes to his bank or to the express company
office and asks for a book of traveler's checks (Fig. 11) amounting

DOMESTIC EXCHANGE

51

in all to $1,000.

He may have them in various combinations of
denominations, inasmuch as they are issued in denominations of $10 ,

$20, $50, $100, and $200. The printed blanks are supplied the agent
by the main office of the express company, the Bankers' Trust Company, or the issuing New York bank. The clerk fills out the blanks,
each one of which has been numbered before being sent out by the
issuing office. The clerk, or one of the officials of the bank, signs his
name in the lower right-hand corner of the check. The purchaser
signs his name in the upper left-hand corner. The clerk then collects
$1,000 from the purchaser plus a commission of $.75 per $100 or
$1,007.50 in all. The selling bank or hotel retains two-thirds of the
commission ($5.00) and remits the principal ($1,000) plus the remaining one-third of the commission ($2.50) to the issuing company.
The purchaser takes his book of checks and departs. When he wishes
to cash one of the checks, he presents it at a hotel, bank, express
company, or store, and usually has no difficulty in cashing it. To make
the check negotiable, he merely signs his name in the lower left- hand
corner of the check. The party cashing the check compares the signature at the top of the check with the one at the bottom and if they
are the same, the money is paid to the traveler. This method of
identification obtains the world over.
A.B.A. traveler's checks are sold only by banks, but the American
Express Company traveler's checks may be purchased at hotels, stores,
express offices, banks, etc. , under the same conditions and terms as
hold in the case of the A.B.A. checks .

The American Express Com-

pany and the large New York banks that issue traveler's checks give
the selling agent the greater portion of the commission because they
get the use of the principal until the checks are finally paid by them.
In some extreme cases this has meant the use of the principal for ten
or twenty years, but usually for several weeks or months.¹
The advantages of traveler's checks are many.

They are issued in

a neat leather folder convenient to carry. They are easily cashed
and do not require the identification necessary in case of personal
checks or drafts. They are cashed for their face value, no discount
being charged. If lost, the traveler gives due notice to the bank or
express company upon which they have been drawn, and after he signs
1 During the Yukon gold rush in the 90's a large number of the gold seekers took traveler's
checks with them. Many were cashed years afterwards, and some have not yet been
cashed.

52

DOMESTIC AND FOREIGN EXCHANGE

certain protective forms, his money is refunded. Notices are then
sent out cautioning all parties not to cash the lost or stolen traveler's
checks, which can be identified both by their number and by the
signature of the traveler. They cannot be cashed unless properly
countersigned, and few forgers are able to execute another person's signature in the presence of the cashing agent. It is not necessary to cash
them at a bank. This is a decided advantage because banks are open
only during certain hours of the day and only on banking days, while
the traveler sometimes needs funds on a holiday or when in a small
town which has no bank.
Travelers' or Circular Letters of Credit.

Domestic travelers' letters

of credit, frequently known as " circular " letters of credit, are also
used by those who travel, but are more commonly employed where

Setter of
Credit
N
E
M

Ja 563

$50,000

The First National Bank of SanFrancisco

SanFranciscoCul
January 41921
Gentlemen,
Wehavethehinier to introduce toyou
S.
J
where signature appearsbelianandwhom we commendtoyourkindlattention.
Housecash his chufts
atsight
onthisBankoronthe NationalBankofCommerce inNounFork,
forany sumsnotdexvedingthe aggregate amount of
thousand
-Billars
Fly trythe water ofthis.
Fitter and dls amounttranny
wach
entorsed byyouheroon
enquge thatdraft'sdrawn in compliance withtheterms
ofthisCreititshallhaveduehoner
Yourchargesare ofcourse tobepaidby theacreditedparty
.
ThisCreditwillcontinue inforce until
ag 1, 1928 and isto
bereturnedwiththefinalstraft WeSoma
in,
Gentlemen,
Signatureof
I
ent,sowants
Yourmostbutik
C
E
William S.Jones
P
S
Toour Correspondents and
President.
otherBanken
Cashier

//

William

FIGURE 12
Front page domestic circular letter of credit

DOMESTIC EXCHANGE

53

the traveler wishes to carry a large purchasing power which may be
required for needs other than the costs of traveling, such as the purchase of supplies, stocks of goods, etc. They are issued by banks,
exchange dealers, and express companies.
Let us say that Jones of San Francisco is to take a three months'
trip during which time he is to make a number of purchases for his

...
DATE
WHEN
PAID

... •
•BY WHOM
" PAID

·

PAYMENTS
TOWN

AMOUNTINPAID
EXPRESSED
WORDS

Job3,44 ExcondNationalBank Boston

Three thousand to

3/2/21 City Stat Bank

Chings Five hundred fo

AMOUNT
IN
FIGURES
$3000 100
500

FIGURE 13
Second page domestic circular letter of credit
store. He must be provided with a safe and convenient means of
carrying $50,000. His bank, the First National Bank, recommends
a traveler's letter of credit because traveler's checks for that amount
would make a rather bulky package. The bank clerk fills out a
traveler's letter of credit for $50,000, dates it, gives it a number, and
also writes in the date on which it is to expire, say three months hence
(Fig. 12) . Jones signs his name in the lower left-hand corner of the

E
DOMESTIC AND FOREIGN EXCHANG

54

page or on the front page of a small pamphlet known as a " letter of
indication "
(Fig. 14).
The proper officials of the bank sign their names to the letter of

OF
INDICATION
LETTER

credit and Jones is prepared for his trip . A small pamphlet is also
given him containing a list of the correspondents of the issuing bank
located in all parts of the country (and also, frequently, in foreign

The Anglo & London Paris National Bank ofSan Francisco
N
To our Correspondents,
E
Gentlemen:
M
Jones
Webeg to advise having issuedI
to....... William S.
C
... specimen of whose signature appears below,
E
oo
our Circular Letter
of Credit No. 56.3.
P
bearing
S
date of
ask
your
we
ich
kind protection.
of
Jammary 4,192
Your obedient servants,
THE ANGLO & LONDON PARIS NATIONAL BANK.

Vice-President

Cashier

Vice-President

Cashier

Signature of Payee

WilliamS.
Jones

FIGURE 14
Letter of indication
countries) at which Jones may cash drafts drawn under his letter of
credit.
The letter of credit itself is a four page document , usually 8½ x 10½
Printing appears only on the first two pages. The
first page is a printed communication addressed to the correspondents
of the bank, requesting them to honor the drafts of Mr. Jones when
drawn in accordance with the terms of the credit. When Jones is in
need of funds, he looks in the book of correspondents to see what
bank in the city in which he is staying is a correspondent of his home

inches in size.

Banks pursue different policies in connection with this matter. Some banks issue
traveler's letters of credit with the signature of the traveler appearing on the letter itself
Other banks do not have the traveler sign the letter but furnish him with a letter of indication on the first page of which he signs his name. The traveler is advised to carry
the letter of credit and the letter of indication in separate pieces of his luggage so that if
one is lost the other will not be, thus guarding a little more securely against the possibility
of forgery It usually happens, however, that the traveler carries both in the same place,
so that really nothing is gained by the latter method . The letter of indication almost
always is in the form of a pamphlet and, with the exception of the first page upon which
the traveler's signature appears, contains a list of the bank's correspondents.

DOMESTIC EXCHANGE

55

bank (Fig. 15) . He then presents himself and his letter at the exchange window of that bank and states that he desires to draw $3,000
against his letter. The
clerk looks over the letLIST OF CORRESPONDENTS
ter and compares it
UNITED STATES OF AMERICA
with the set of blank
INDIANA
forms which the issuing
EVANSVILLE.
Old State National Bank.
FORT WAYNE...
First and Hamilton National Bank.
INDIANAPOLIS.
.Indiana
National Bank.
bank has furnished his
FAYETTE.
LA
.First-Merchants National Bank.
SOUTH BEND
First National Bank.
TERRE HAUTE...... McKeen National Bank.
bank at the time when
IOWA
correspondent relations
BURLINGTON,
National State Bank.
were established . If the
CEDAR RAPIDS.
Cedar National
Rapids National
DES MOINES.
.Iowa
Bank. Bank.
CITY
SIOUX
.
.Security
National Bank.
letter is in the proper
KANSAS
form , he compares the
LEAVENWORTH .
.Leavenworth National Bank.
TOPEKA..
Bank of Topeka.
signatures of the bank's
WICHITA....
..Kansas National Bank.
officers appearing on
KENTUCKY
COVINGTON.
..First National Bank.
Jones' letter with their
FRANKFORT.
National Branch Bank ofKentucky.
LEXINGTON
First and City National Bank.
LOUISVILLE.
.American
Southeration Bank.
signatures appearing on
LOUI
SIAN
A
a "signature sheet "
BATON ROUGE...... Louisiana National Bank.
CitizensBank & Trust Co. ofLouisiana,
NEW ORLEANS.
which the issuing bank
New Orleans National Bank.
SHREVEPORT;
First National Bank.
has also forwarded to
MAINE
all of its correspondAUGUSTA,
First National Granite Bank.
BAR
First National Bank.
BATHHARBOR.
.First
National
Bank.
ents (Fig. 16) . When
National
PORTLAND..
.Portland
Bank.
new officials of the isMARYLAND
ANNAPOLIS..
.Farmers National Bank:
suing bank are apBALTIMORE .
..Farmers & Merchants NationalBank
pointed, or when a
• new style of form is
FIGURE 15
adopted, new signature
Part of correspondent list
sheets and copies of
the new forms must be sent to all the correspondents. If every-

thing seems to be satisfactory, the clerk draws a draft on the
First National Bank of San Francisco for $3,000 and on the
draft states that it is being " Drawn under Letter of Credit
No. 563 " (the number of the letter of credit which has been
issued to Jones) . He then passes the draft to Jones to sign. Jones
signs the draft and hands it back to the clerk. The clerk compares
Jones ' signature on the draft with his signature on the letter of credit
or in his letter of indication, and if they are identical, cashes the
draft, handing Jones $3,000 minus any charge that the correspondent
bank may make for rendering such service. Frequently no commission

TIC

56

DOMES

GN

AND FOREI

NGE

EXCHA

will be charged, and where charged it is usually of small amount.
When the clerk cashes the draft he enters on the second page of the
letter the amount , the date, by what bank it was cashed, and hands
the letter to Jones. The paying bank then sends the draft to the First
National Bank of San Francisco through the Federal Reserve check

THE FESTNATIONAL BANK OF SAN FRANCISCO

JanFrancisco,California,
Jan. 1041922.

Gentlemen

Your attention iscalle
the accompanying
facsimilesignaturesofthe ofis ofthisBank,whoare
individually empowered
on on itsbehalfDrafts
,andtoend
and Checks
Drafts, Checksand Billsof
Exchange
Creditissued bythisBank,
howevermustbesitbythePresidentora licerPresident,
andbytheCashier oran AssistantCashier
.
Awaitingyour acknowledgment weremain,
Yoursfaithfully
,

Fornali
Cashier

For
Messieurs.
TheBanks andBankersCorrespondentsof
NationalBank of
TheFirst
SanFrancisco.
FIGURE 16
First page of bank's signature sheet
collection system or in any other manner that it may desire. If Jones
uses up all of his $50,000, the letter of credit is attached to the draft
that exhausts the credit and both are returned to the First National
Bank.
Large banks issue their own travelers' letters of credit, while smaller
banks which are not so well known and which cannot afford to establish
a list of correspondents throughout the country make arrangements

DOMESTIC EXCHANGE

57

with the former whereby they may issue letters of credit on them.
The small bank will be furnished with all the necessary blanks , together with a set of regulations and directions governing the issuance
of such letters of credit. The blanks will bear the name of the smaller
bank, but the letter itself will contain instructions to the correspond-

Aurkey
Jo
.
Mr.C. H. McCORMICK, Vice President, willsign :

C
E

E
M
I

Mr.GEORGE A. KENNEDY, Vice President, will sign:

Custom
P

When the

N

ents that the drafts are to be drawn on the larger bank.
N
E
Mr.RUDOLPH SPRECKELS. President, willsign
M
I
C
E
Mr.JOHN P. BROOKE. Vice President, will sign.P
Mr.E.AVENALI, Cashier,will sign:
S
Tornali

S

Mr. ROBERT R. YATES, Vice President, will

Room

Yares
Mr R. A. NEWELL, Assistant Cashier, will sign:

Mr L P. CADOGAN, Assistant Cashier, will sign.

N
E
ейши
M фн
IM. ALVORD, Assistant Cashier, will sign. d
Mr.V
MI. FRANKSEED, Assistant Cashier, will sign:
r
C
a
E
w
P
k
A
n
Fra Je
Srs
Mr.L.E. TOWNSEND, Assistant Cashier, willsign:

DORGELOH, Assistant Cashier, will sign.

JFNorgeleh

FIGURE 17
Second page of bank's signature sheet
smaller bank issues the circular letter of credit, it notifies the larger bank
of that fact and informs it of the amount, the person to whom issued,
the date of expiration , and the number of the credit. As the drafts
are drawn against the letter by the traveler, they are sent to the larger
bank, which deducts the amounts for which they have been drawn
from the account of the smaller bank and advises it to that effect .
The charges made by the issuing bank to the customer vary accord-

IC

EST

58

DOM

ing to circumstances.

GE

N

EIG

AND FOR

HAN

EXC

If the traveler is a depositor of the bank, and

gets a letter of credit for a rather large amount , paying for it in advance, he may obtain it free of charge, because the bank will have
the use of the money, which he pays for it, during the time that the
letter is in effect ; or he may have to pay a commission varying from
1/8 per cent to 1/2 per cent. If he is a stranger, or asks for a small
amount, or if he doesn't pay for it in advance but asks that the drafts
as they come in be deducted from his account on deposit with the
issuing bank, he will usually be charged a commission of from 1/8 per
cent to 1/2 per cent. Where the letter is purchased outright, the larger
the amount for which it is issued and the longer the period for which
it is to run, the lower the commission will be.
This is because the
issuing company will have the use of a larger sum of money or will
have the use of the principal for a longer time. Thus a letter for
$50,000 might be sold at a commission of 1/4 per cent, while one for
$ 100,000 for the same length of time might be sold for 1/8 per cent .
One for $ 100,000 running for 30 days might cost 1/4 per cent , while
if it ran for six months it might cost only 1/8 per cent.
The circular letter of credit is the favorite method of carrying large
sums while traveling. It gives greater distinction to the traveler in
his dealings with banks than do traveler's checks . It serves as an
identification of his credit standing because the correspondent that
cashes his checks knows that if he has received his letter under a
guarantee, his credit at the bank is satisfactory, while if he is a stranger
to the issuing bank he has had sufficient funds to pay for it in cash . It
usually costs less than traveler's checks. The traveler deals with the
correspondents of the issuing bank, with whom the latter has already
established connections, thus making it possible for him to receive
more courteous treatment than is usually the case when one attempts
to cash a traveler's check at any place other than at the office of the
agent of the issuing company. It has the disadvantage, however,
of compelling the traveler to cash his draft at a bank, and banks
keep short office hours and observe legal holidays, thus occasionally
putting the traveler to some inconvenience.
Individual or Ordinary Drafts. Excluding the check and the bank
draft, the individual or ordinary draft undoubtedly plays the most
important part in domestic exchange transactions .
A draft, as noted earlier, is an order by the first party upon a second
party (whether it be a bank, business firm or individual) , to pay a

DOMESTIC EXCHANGE

59

certain sum of money either at sight (on demand) or after a certain
length of time, to a designated party or to his order. This designated
party, the one who is to receive the money or who may order it paid
to still another party, may be a bank, a business firm , or an individual.
It may even be the party who has drawn the draft.
It will be noted from the above and from what was said regarding

a check, that the only differences between a check and a draft are (a)
that a check is always drawn on a bank, while a draft may be drawn
on a bank or on other parties ; (b) that a check is drawn by the debtor
to pay his obligation to a creditor, while a draft may be drawn by the
creditor to collect funds from the debtor; and (c) that a check is
payable always "at sight " (on demand) while a draft may be payable
"at sight" or a certain number of days " after sight " or a certain
number of days "after date."
A draft is drawn for the collection of money already due or to become due at some future date . It may be used in any of a number
of financial transactions and in many different ways, but it is always
drawn by a creditor on a debtor or on the debtor's bank or financial
agent. It is usually drawn with the consent of the debtor, although
at times it is drawn by the creditor without the knowledge or consent
of the debtor and for the purpose of forcing payment from him. In
the latter case, let us say that for many months Robinson has been
waiting for Stockard to pay him for a shipment of goods. He has
written frequently requesting payment but with no results. Finally
he decides to draw a draft on Stockard for the amount in question
and gives it to a bank for collection . The latter sends it to its
correspondent bank in the city where Stockard is located. The correspondent bank presents it to Stockard for payment , who may or may
not pay the draft. He is under no legal obligation to do so. If he does
pay it, the correspondent collecting bank will deduct its collection
charges and forward the remainder to Robinson's bank. The latter
deducts its charges and credits Robinson with the proceeds or pays him
in cash. Thus a draft is sometimes, not frequently, used in domestic
transactions for the purpose of compelling debtors to pay their bills.
The draft is more customarily used, however, with the consent of the
debtor . If Robinson sells a $ 1,000 shipment of goods to Bates in a
distant city, Bates will usually advise Robinson as to how the draft
is to be drawn, or will advise Robinson that he will agree to the draft
being drawn according to the terms already specified by Robinson

DOMESTIC AND FOREIGN EXCHANGE

60

in earlier correspondence. Thus when Bates wrote or wired Robinson
regarding the terms upon which he wished the goods to be forwarded,
he may have specified that the draft was to be drawn on him at thirty
days' sight or thirty days from date ; or he may have sent a commercial
letter of credit¹ authorizing Robinson to draw on Bates' bank or
financial agent at thirty days' sight, or at thirty days from date, or
for any other length of time. In all cases where the draft is drawn
with the consent of the debtor the terms of the sale have been agreed
upon beforehand.
Individual or ordinary drafts are practically always collected
through or handled by a bank or financial agency as will be seen from
our subsequent discussion of trade acceptances and bankers ' acceptances.
Drafts may be sight or time drafts, and clean or documentary
(collateral) drafts. A sight draft is one which is drawn "payable at
sight " or " on demand," i. e. , when presented for payment (Fig. 18) .

Ari 2

of 1,000.00
At wight
order of Nyself
One thousand--

1921

Juy tothe
00 Lollais

I A
bECIMEN
accountof
Valu accrved andcharge to Ro
Wen. Bates

New York

FIGURE 18
Sight draft
A time draft may be made payable at so many days " after sight,"
i. e. , so many days after it has been " accepted " or honored (Fig. 19) ,
or it may be drawn payable so many days " after date," i. e., after the
date appearing on the date line of the draft (Fig. 20) . When the party
upon whom a draft has been drawn payable say thirty days after sight,
desires to honor it and agrees to pay in accordance with the amount
and terms stated on its face, he " accepts " or honors the draft by
writing across its face the word "Accepted," and the date, his name,
and also at times the place at which or the bank by which the draft
will be paid.

The draft then becomes an " acceptance " and the

¹ Cf. pp. 70-73 for discussion of commercial letter of credit in domestic trade.

61

DOMESTIC EXCHANGE

drawee becomes the " acceptor." This type of time draft is far the
more common, in fact it is the usual type employed in financing both
domestic and foreign trade.
Clean drafts, more commonly known , both in domestic and in
foreign exchange transactions, as " clean bills," are those bills or drafts

April 2

of1,000.00

At ninety days sight.
order of myself
One thousand-

1921
Paytothe

-200Lollurs
N
HTE

PEC.
Valvereceived and charge toaccount
3. Batea
A.Robinson
New York
FIGURE 19
Ninety day sight draft
which have no documents attached.

When Robinson drew on Stock-

ard to compel him to pay, Robinson simply drew a draft to
which nothing was attached. This was a "clean" draft or a " clean"
bill . However, when he shipped goods to Bates and drew his draft
on Bates, or on Bates' bank or financial agent, he most likely attached

1000.00

April 2

Binety days from date
Eyself
order of
R
OnethousandLO
SP

1923
Buy tothe
00 llai
20fo
s
Lottais

A Rob FECIMEN
Value received andcharge toaccount
W. Bates
New York
FIGURE 20
Date draft
shipping or other documents which carried title to the goods.

We

shall later discuss this practice and the reasons therefor . The attaching of documents to a draft makes it a "collateral " draft , or, as it
is more commonly known, a " documentary" draft.
act as security or as collateral for the draft.

The documents

Documentary bills of

62

DOMESTIC AND FOREIGN EXCHANGE

exchange play an extremely important part in the financing of domestic
and foreign trade, being the most common form of exchange used in
that connection . We shall henceforth know this class of drafts as
"documentary bills. " When a thirty or sixty day sight draft has
been accepted and the documents have been turned over to the acceptor, the draft will then have no documents attached, and will thus
become a "clean " draft.
An interesting practice has grown up in connection with the use
of the draft in the sale of stocks and bonds, both in domestic and
foreign transactions. A customer in Chicago will instruct a firm
in New York to buy for him a certain amount of stocks or bonds and
to draw on him for the amount covering their cost plus the commission
of the agent. The agent fulfills the engagement and draws on the
buyer as requested. He attaches the draft to the stocks or bonds
with the instructions that they are not to be turned over to the buyer
until the latter has paid the draft. The draft and the securities are
given to a bank for collection, or are sold directly to a bank, the attached stocks or bonds acting as " backing " or security for the draft.
Such a draft, however, is technically known as a " collateral " draft,
not a "documentary " draft. Stocks and bonds are not " documents "
which give possession to property being shipped by another route ;
they are themselves the property involved in the transaction.
The use of the draft in domestic business relations is a most interesting study, and it is regretted that it is not possible in this volume to
enter into a detailed discussion thereof. The most important phases
only will be sketched , in order to show the part which the individual
draft plays in the financing of our domestic trade.
Trade Acceptances. For many years it has been customary for the
American business man to sell goods to his customer and merely enter
the amount of the sale on his books as charged to the account of the
buyer. This is known as the " open book account " method. When
the goods are shipped , the seller sends a bill to the buyer with a statement that if paid at once or within a period of ten days the buyer
will receive a deduction or rebate of one, two, or possibly as high
as five per cent of the amount of the bill, an effort thus being made
to induce the buyer to remit cash upon receipt of the bill. This deduction or rebate is known as a "cash discount. "
On the face of it , it would appear that the buyer would be eager to
remit cash in order to obtain the discount , but in actual practice, on

DOMESTIC EXCHANGE

63

the contrary, it has been customary for the buyer to wait until he is
"good and ready " before remitting for the goods purchased. One
two, or three months, or possibly a longer period may elapse before
payment is made. In reality, the seller finances the business of the
buyer, supplying him with goods to sell and then waiting for him to
remit. Under such conditions the seller at times has been placed in a
very unsatisfactory financial position. It might happen that he would
have on his books a large number of " accounts payable." He might
need funds with which to conduct his own business, and yet find himself unable to collect from his customers. He has received nothing
from them in the shape of a promissory note or an accepted draft to
show just when they would pay. Consequently if he wished to obtain
additional funds for his business he might have to do one of three
things : (a) sell his accounts outright to the bank, which would charge
him a high commission for receiving them because it would have to
assume the risks attendant upon their collection ; (b) use them as security in applying for a loan, assigning them to the party loaning
him the money. This again is unsatisfactory because the margin of
safety required by the lender would be rather large since there is no
way of knowing just what percentage might be realized on the accounts in case the borrower could not meet his loan when it fell due.
(c) Or the seller might place the accounts in the hands of a collection
agency, which would undoubtedly lose him the business of his customers. This system of book accounts has been productive of bad
debts, undue extension of payments, cancellation of orders, slow collections, and losses, all entailing heavy burdens upon business operations. It has, also, naturally resulted in higher prices to the buyer.
Book accounts are not the proper kind of short time investments for
banks. In fact, practically nothing good can be said of the system
of open book accounts.
For a long time there has been a demand that American business
men develop and use the " trade acceptance " for the financing of
domestic trade. The reason why no progress was made in that direction until after the enactment and amendment of the Federal Reserve
law was because there was no open discount market in the United
States. There was no place where banks could take the commercial
paper which they had discounted or bought from their customers and
sell it, i . e., rediscount it.

Such a discount market has existed in the

European countries which for years past have financed their internal

64

DOMESTIC AND FOREIGN EXCHANGE

trade to a very large extent by means of the trade acceptance.¹ But
American banks had not been educated to an appreciation of the
practice and advantages of rediscounting bills. If they got hard
pressed for funds and sold some of their first class discounted commercial paper to a friendly bank, it was felt that such an action was evidence of the financial weakness of the banks resorting to it. The
enactment of the Federal Reserve law, its amendments, and the regulations of the Federal Reserve Board , have done much to remove the
"stigma which may have attached to rediscounting in the past " 2
so that today a very considerable progress has been made in the use
of both trade and bank acceptances in financing domestic business .
In general an acceptance may be defined as a bill of exchange, payable at a fixed or determinable future date, the obligation to pay being
acknowledged in writing on the face of the bill either by the person
to whom it is addressed or by some other party. This is usually done
by writing the word " Accepted ," also the date, followed by the signature of the acceptor, although legally the signature and date only on
the face of the draft are sufficient. Frequently the acceptor will
designate the place at which or the bank by which the acceptance is
to be paid. When the draft is drawn by the seller upon the buyer and
accepted by him (or by some other party " for honor " 3) it is known
as a "trade acceptance. " Bank acceptances will be discussed in the
next section of this chapter. To be eligible for rediscount at a Federal
Reserve bank, the acceptance must bear on its face the words " The
1 The following, from the New York Times of July 27, 1919 , is of interest in connection
with the methods now being followed by English firms in financing their internal trade:
"At a time when so much is being done in the United States to stimulate the use of the
trade acceptance in domestic business it may be of interest to know what British practice
is in this regard .
""The domestic trade acceptance,' explains Trade Commissioner Henry F. Grady, ' was
very generally used thirty or thirty-five years ago, but its use has since been practically
discontinued . The bank acceptance is used universally in foreign business, but in domestic
business the banks make advances and permit overdrafts as the accredited method of
financing trade.
""The five large joint-stock banks which have branches throughout the United Kingdom
and control about 70 per cent of the banking business of the country use the overdraft
very extensively. The overdraft is used particularly in the case of the very large firms.
It does not follow, of course, that advances made in this form are unsecured . The custom
is to keep with the bank as a reserve against which to secure advances, a certain amount
of securities, this being true whether the advance is to be an overdraft or a loan . To obtain an overdraft the firm calls on or writes the bank and advises it that it wishes to overdraw its account for a prescribed amount, and the bank then honors checks against it for
approximately that amount--the sum is never rigid, and the extent of the overdraft is
left to the requirements of the firm .' "
2 Holdsworth, J. T., " Money and Banking," New York, 1917 ed . p. 268.
3 Cf. pp. 86-87.

DOMESTIC EXCHANGE

65

obligation of the acceptor of this bill arises out of the purchase of
goods from the drawer," or it must be accompanied by a certificate
bearing a statement to the same effect . Federal Reserve banks rediscount acceptances only for member banks.¹
Trade acceptances arise in the following manner: Robinson of New
York sells Stockard of New Orleans $5,000 worth of steel. He takes
the steel to the railroad company for shipment and receives a bill of
lading. The bill of lading is a receipt from the carrier stating that it
has received goods from the shipper for transport to a certain point.
If a bill of lading is made out showing that the goods are consigned
"
or destined to a certain party, it is known as a " straight ” bill of lading. If, on the other hand, it is made out showing that the goods
are consigned to the order of a certain party, usually the seller, it is
known as an " order " bill of lading. A straight bill of lading is normally not negotiable , i . e. , not capable of being indorsed and delivered
to another person (as a check would be under ordinary circumstances) ,
thereby transferring title to the goods. Usually the shipper has the
railway company make the bill of lading out to himself " or order,"
which means that the title to the goods rests with him until he transfers it to another person by writing an indorsement across its face.
An " order " bill of lading is negotiable and is the form ordinarily met
with in both domestic and foreign trade. In domestic trade, however,
the straight bill of lading is frequently used in connection with trade
acceptance transactions.
Robinson, having received his order bill of lading from the shipping
company, attaches an invoice, which is simply a statement of the
goods shipped, and draws a draft on Stockard. Let us say that it is
a thirty day sight draft. Robinson pins the three documents together,
thus constituting what is known as a " domestic documentary bill of
exchange." Sometimes, but not frequently, the documents are drawn
in duplicate as a precaution against loss in the mails. If Robinson
has faith in the credit standing of Stockard, he may send the docu1 It is not deemed necessary or advisable to present a discussion of the rules and regulations of the Federal Reserve Board regarding the eligibility of commercial paper for
rediscount or the extent to which member banks may engage in the acceptance business.
Such matters may be easily found by consulting any standard book written since 1917
dealing with the subject of Banking or the Federal Reserve law. Cf. Holdsworth , J. T.,
"Money and Banking "; Willis, H. P. , "The Federal Reserve Act "; Kemmerer, E. W.,
"The A. B. C. of the Federal Reserve System," etc. Cf. also the Federal Reserve Bulletin
and the annual reports of the Federal Reserve Board.
In 1920 the Federal Reserve banks rediscounted $192,157,000 in trade acceptances for
member banks and purchased $74,627,000 worth of them in the open market.

66

DOMESTIC AND FOREIGN EXCHANGE

mentary bill (with a straight bill of lading) direct to him, ask him
to accept the draft, and to return the accepted draft. Robinson may
hold the accepted draft until about the time of its maturity and then
hand it to his bank for collection, or he may sell it to his bank (discount
it) at any time before maturity. During the last few years many firms
have been attempting to induce their customers to adopt the trade
acceptance practice by sending the bill to them in two different forms
accompanied by a straight bill of lading. One form embodies the old
idea of the open book account method , being just a statement of the
amount of money due the seller and a note to the effect that if paid
at any time within ten days a discount of a certain percentage will
be given the purchaser. The other form is in the shape of a trade
acceptance to be accepted by the purchaser, payable, say, at the end
of thirty days. The customer thus has the alternative of resorting to
either the trade acceptance or the open book account method.
In Robinson's case, above, it may be that after preparing his documentary bill of exchange he asks his bank to purchase it (discount it)
before acceptance by Stockard, or to take it for collection. If the
bank discounts it for him , it may pay him immediately, or it may
wait until it has been notified by its New Orleans correspondent of
Stockard's acceptance. When the bank discounts the bill for Robinson it will pay him a sum of money slightly less than the face value
of the draft. The bank has really purchased his claim to $5,000 thirty
days hence, and, having to wait that long for its money, it imposes a
small charge for the accommodation rendered . If the market rate of
discount prevailing at that time is 6 per cent for bills of the kind under
discussion, the bank will charge a sum equal to 6 per cent for thirty
days on $5,000, i . e . , $25 , and will hand Robinson the remaining $4,975 .
If the bank takes the draft for collection, however, Robinson will get
his money after it has been collected, i. e ., thirty days hence, less the
bank's collection charges. Or Robinson may hand the documentary
bill to his bank to be presented to Stockard by the New Orleans correspondent merely to secure Stockard's acceptance. After having been
accepted, the draft in this case will be returned to Robinson for
his keeping, or, if he desires, it may be retained by the New Orleans
bank until paid, or until Robinson orders the New Orleans bank to
discount it, the funds to be remitted to him through the New York
bank or to be credited by the New Orleans bank to his account.

DOMESTIC EXCHANGE

67
440

Among bankers, discounting is commonly looked upon as " taking
out interest ahead of time " or " taking interest in advance ." They
purchase commercial paper which is due and payable at a certain
future date, thus advancing the money prior to the time when it is
actually due. It is necessary for them, therefore, to calculate the
present worth of the future payment. The amount that is deducted
from the face value of the bill is known as the " discount." The "rate
of discount " is the percentage per year relation which the amount
of the discount bears to the sum that is to be collected by the discounting bank at the maturity of the discounted paper. "Re-discounting" is merely discounting again, i . e . , the act of either selling
or buying a bill which has already been discounted . The verbs "to
discount " and " to re-discount " apply to the action of either
the buyer or the seller of the bill. You "',discount " your commercial paper at the bank, and the bank " discounts " it for you.
A bank " rediscounts " its discounted bills at the Federal Reserve
bank, and the Federal Reserve bank "re-discounts " them for the
bank.
If you draw a sixty day draft for $1,000 and present it immediately
to the bank for discounting, and if the bank buys it at a discount rate
of 6 per cent, it pays you $990, which is the present worth of $ 1,000
sixty days hence.

Six per cent on $1,000 for a year is $60 . Sixty days

is one-sixth of a year, taking 360 days to the year, which is the customary American practice. One-sixth of $60 is $ 10, the discount deducted
by the bank. The bank, of course , collects the full sum of $1,000 sixty
days hence when the draft matures . On the other hand , if you were
to borrow $990 from the bank as an ordinary loan, agreeing to pay
six per cent on the loan at the end of sixty days, you would pay back
to the bank the sum of $999.90, or slightly less than the bank would
have received had it discounted a $1,000 commercial bill. Discounting
at the same rate that prevails for the loaning of money at interest
really nets the bank a slightly larger return.
If the bank holds your sixty-day draft for thirty days and then
presents it to a Federal Reserve bank for rediscounting, the latter
will have to carry the unpaid claim for the remaining thirty days.
If, to make our problem simple, the rediscount rate of the Federal
Reserve bank happens to be the same as the discount rate of your
bank (which supposition is seldom true), the Federal Reserve bank
would pay $995 for your draft, thus obtaining $5 on its investment for

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DOMESTIC AND FOREIGN EXCHANGE

thirty days and at the same time giving your bank its discount for
the thirty days during which it had carried the claim.¹
Reverting to our example of Robinson and his documentary bill
of exchange, let us say that he sells it to his New York bank. He indorses the draft on the back ; he also indorses the bill of lading but
by signing his name on its face. He then turns all the documents over
to the bank, thus transferring title and claim to the goods to the buying or discounting bank. The bank indorses the documents and sends
them to its correspondent in New Orleans. The New Orleans bank
presents the draft to Stockard for his acceptance . He accepts the
draft by writing across the face of the draft the word " Accepted,"
and signs his name and the date , or he may omit the word "Accepted "
and merely sign his name and the date. In either case the draft has
become a " trade acceptance " (Fig . 21 ) .

5.000.00

Stockard, after accepting

April 2
At thirty days sight
myself CIN
of
te thousand
SPE

21
Pay tothe

NSais
00 Gell
ME
CI
E
P
received and charge to accountof
J. C. Stockard
A Robins
New Orleans
FIGURE 21
Trade acceptance
the draft, hands it to the bank clerk , and the bank turns over to him
the bill of lading, the invoice, and any other documents that may
have accompanied the draft. The New Orleans bank, acting under
instructions received from the New York bank, may or may not take
from him security in the form of stocks , bonds, mortgages, or any other
1 It is the policy of the European central banks, the most important rediscounting agencies
in their respective countries, to keep their rate of discount (or rediscount) above the market
rate for money, otherwise they would be overwhelmed with offers of bills for rediscount.
The Federal Reserve banks, however "have adopted the policy of keeping their buying
rates more closely in line with the rates at which bills were offered in the open market by
purchasing only at or slightly below those rates." (Sixth Annual Report , Federal Reserve
Board, 1919, p. 23.) In 1921 they even scaled down their discount rates in advance of the
declining market rates. For example, the Federal Reserve Bank of New York adopted
a 4½ per cent rate of discount when the market rates for prime commercial paper, shortdated time paper, and longer dated maturities were respectively 5-5 per cent, 5-5 per
cent and 54-5½ per cent.

DOMESTIC EXCHANGE

69

kind of security so as to protect the New York bank in case of nonpayment. In the absence of instructions , it is required by law to turn
over the documents upon acceptance. The New Orleans bank holds
the draft subject to the orders of the New York institution , and may
hold it until maturity at which time the New Orleans bank will present
it to Stockard for payment . When paid, the funds are credited to
the account of the New York bank or remitted to it, depending upon
the instructions received from the latter.

Let us say that when

Stockard accepted the draft he made it payable at his bank, the
Cotton National of New Orleans. The draft would then be presented
to the Cotton National Bank on the day of its maturity, and would
be paid by that bank out of the deposit account of Stockard without
his giving the bank any further order than that authorized by his
having written the words " Payable at the Cotton National Bank "
on the face of the draft.¹
Let us say that ten days after Stockard accepts the draft, the New
York bank notifies its New Orleans correspondent to take the draft
to the New Orleans branch of the Federal Reserve Bank of Atlanta
and have it rediscounted . The New Orleans branch of the Federal
Reserve Bank of Atlanta rediscounts the draft and credits the discounting bank with the discounted face value of the draft, or, acting
upon orders from the latter, it may transfer the funds to the New York
bank by means of a telegraphic transfer. The discounted bill may
then be used by the Federal Reserve Bank of Atlanta, the parent of the
New Orleans branch, as partial security behind the issuance of Federal
Reserve notes , provided it desires to do so. When the draft falls due,
the New Orleans branch of the Federal Reserve Bank of Atlanta will
1 The report of the Acceptance Committee of the American Bankers Association (May 2 ,
1921 ), comments as follows on this point :
"One of our greatest problems is to bring about a clearer understanding on the part
of bankers as to what the trade acceptance is, its proper use, true method of operation
and particularly its final disposition when made payable at a bank . Judge Thomas B.
Paton, General Counsel of the American Bankers' Association, in a recent decision, the
full text of which appears on page 684 of the April "Journal of the American Bankers'
Association," stated : 'Where the drawee of a trade acceptance makes it payable at a bank,
it is equivalent (except in certain States) to an order to the bank to pay, and there is no
need of express instructions as to prerequisite to payment. A bank which refuses payment
having sufficient funds of its customer would be liable to him for injuring his credit .'
"Section 87 of the Negotiable Instruments Act, as operative in all States except Illinois ,
Kansas, Minnesota , Missouri, Nebraska and South Dakota, provides that when an instrument is made payable at a bank it is equivalent to an order on the bank to pay the sum
for the account of the principal debtor thereon, which in the case of trade acceptances is
the acceptor. If banks would observe this rule of law, the handling of trade acceptances
would be greatly facilitated and many complaints and disputes would be obviated ."

70

DOMESTIC AND FOREIGN EXCHANGE

collect the draft from Stockard just as the New Orleans correspondent
would have done had it held the draft until maturity.
The advantages of a trade acceptance over the old open book account system are evident. Robinson can get his money whenever he
wants it by discounting the draft either before or after acceptance
by Stockard. He can keep his assets in more liquid form and his
business in better condition . Banks are provided with a means of
investing their funds for short time periods and receive therefor the discount at the rates charged. If they are pressed for funds at any time
they may easily rediscount acceptances, if in proper form, at a Federal
Reserve bank or its branch. They can therefore keep themselves in
a much better financial condition than might otherwise be the case.
Stockard by his acceptance definitely agrees to pay the draft when it
falls due and is thereby enabled to obtain better prices from Robinson.
The Federal Reserve banks also are supplied with satisfactory commercial paper to use as partial security for the issuance of Federal
Reserve notes with which to supply the fluctuating needs of business.
From the point of view of all parties concerned, therefore, the trade
acceptance is superior to the open book account system.
It has been very difficult to induce the American merchant to use
the trade acceptance method of financing domestic trade although
there has been much propaganda toward that end. National associations of merchants and bankers have gone on record as favoring
it and have spent much time and money in furthering its cause. A
"National Trade Acceptance Council " has also been established
whose object is to popularize the use of the trade acceptance. State
and national banking laws have been modified to encourage its development. The results thus far obtained have indeed been very
satisfactory.¹
Bank or Bankers' Acceptances. Closely akin to the trade acceptance is the bank or bankers' acceptance. A bank acceptance may be
1 A recent report of the Acceptance Committee of the American Bankers' Association
contains the following statement:
"In 1916 the known users of trade acceptances in America numbered 185. In October,
1921 , the list exceeded 20,000 . The number has grown steadily and now includes practically every line of business that makes sales on the time basis. Where the trade acceptance has been properly and legitimately used , the results have been eminently satisfactory.
It has shortened the credit period , it has made collections more certain ; it has enabled an
equal amount of capital to do a greater amount of service ; it has eliminated many troublesome claims and disputes; it has reduced the expense of operation both for the buyer and
seller; it has stabilized the businesses involved and has produced a character of strictly
liquid paper."

DOMESTIC EXCHANGE

71

defined as a bill of exchange or draft, payable at a fixed or determinable future date, upon the face of which has been acknowledged in

Letter of Credit
DOMESTIC

No. 5871
$ 10,000 00/100

OF SAN ANCISCO

SanFrancisco,California, sebruary 7

1921

Mr. A. Robinson
New York City
DearSir,
Attherequestandforaccountof xx. 3. J. McGraw of San Francisco.
California-----weherebyauthorizeyou tovalue in
The Anglo and London Paria National Bank of San Francisco.
at
ninety days
sighttotheextentof Ten thousand dollars ($10.000)
accompaniedby invoice and bill of lading made out to the order of The inglo
NE
and London Paris National Bank
TI
C
E
SP
representing shipmentof steel
IM
EC
P
S

Itisparticularlyrequestedthateach draftnegotiatedbeendorsedhereon.
Weherebyagree withthebonafideholders thatalldraftsissuedbyvirtue ofthis
Credit, andinaccordancewiththewithin stipulated terms,shallmeetwithdue honor
upon presentation atabove named drawees ifdrawnand negotiatedpriorto
May 1, 1921
ME
N
CI
TheAnglo&LondonParisNationalBank.
HE
E
P
C
S
N.B.ORAFTSDRAWN UNDERTHIS CREDIT
CS SPENCER
MUST BEARTHE CLAUSE DRAWN UNDER
PE
CA
LETTER OFCREDIT
SVICK
No. 5871 DATED Feb.7,1931 "
VICE PRESIDENT CASHIER

FIGURE 22 -Domestic commercial letter of credit

writing the unconditional obligation of the bank or other financial
agent on which it is drawn to pay the same at maturity.¹

In this

1 The Federal Reserve Board has defined a bankers' acceptance as "a draft or bill of
exchange, whether payable in the United States or abroad, and whether payable in dollars

72

DOMESTIC AND FOREIGN EXCHANGE

case the seller draws his draft on a bank, not on the buyer. To do this,
the buyer gets from his bank a document known as a commercial
letter of credit. " This is usually in the form of a printed letter (although sometimes it is typewritten) , with the necessary blanks filled
in on the typewriter or in ink, advising the seller that he is authorized
to draw on the bank for a certain sum of money , the draft to run for
a certain number of days, etc. The letter contains full and complete
instructions to the seller informing him how many and what kind of
bills of lading he must get from the carrier, what documents he must
forward and how they are to be drawn and indorsed , before what date
the draft must be drawn and the shipment made, etc. Let us say
that McGraw of San Francisco desires to have Robinson of New York
ship him $ 10,000 worth of rope.

Robinson doesn't know McGraw

or his credit standing and would hesitate to draw a draft on him or to
give him open unsecured credit . So McGraw goes to his San Francisco
bank, let us say the Anglo and London Paris National Bank, and
obtains from it a commercial letter of credit addressed to Robinson
(Fig. 22) . A commercial letter of credit is usually a four page letter
with printing appearing only on the first page. As will be noted from
the accompanying form , it authorizes Robinson to draw on the Anglo
and London Paris National Bank of San Francisco up to the sum of
$10,000, before a certain date, and advises him as to how the shipment is to be made, what documents must be provided , etc.
McGraw sends this letter to Robinson , or may instruct the bank
to forward it. McGraw also instructs Robinson regarding how the
rope is to be sent, over what transportation lines, etc. Robinson packs
the rope, gets the necessary documents from the shipping company,
and draws his draft not on McGraw but on the Anglo and London
Paris National Bank of San Francisco. He may then sell the draft
to his New York bank or it may be handled by him in any of the
methods mentioned in connection with our description of the trade
acceptance. Let us say that the New York bank discounts the draft.
It pays a little higher amount for such a draft , i. e., it charges a lower
rate of discount, than it would for a trade acceptance , because it is a
draft on a bank, not on an individual , with consequently less risk of
non-payment. The documentary bill is then sent to its San Francisco

or some other money, of which the acceptor is a bank or trust company, or a firm , person,
company, or corporation engaged generally in the business of granting bankers ' acceptance
credits." Regulations A, Series 1920, VI , B.

DOMESTIC EXCHANGE

73

correspondent with the request that it be presented to the Anglo and
London Paris National Bank for acceptance. The latter will accept
the draft and the documents will be turned over to it without its
furnishing any security.

Its acceptance is sufficient.

Instructions

as to just how the transaction is to be handled are always sent to the
correspondent bank by the discounting bank.
Let us say that the
San Francisco correspondent bank, acting on instructions from the
New York bank, discounts the acceptance at the local Federal Reserve bank.
The Anglo and London Paris National Bank notifies McGraw that
it has the documents covering the shipment. He comes to the bank
and receives the documents upon furnishing the proper security, or
if he has excellent credit , he is given the documents without furnishing
any security, although he would normally be required to execute a
trust receipt in favor of the bank.¹ He then gets his goods and pays
nothing until the draft falls due. A day or so before the draft matures,
he " puts the bank in funds, " i . e. , he gives the bank the money with
which to pay the maturing draft plus the commission (usually about
4 of one per cent) charged by the bank for the service rendered. On
the day of the maturity of the draft, the Federal Reserve Bank of
San Francisco presents the draft to the Anglo and London Paris National Bank for payment. The latter will pay the face value of the
draft, McGraw, in the meantime, as has been noted , having "put the
bank in funds ."
The Guaranty Trust Company of New York in one of its pamphlets
on this matter, summarizes the numerous advantages of the bank
acceptance as follows:
( 1 ) Bank customers can ordinarily borrow by this means more cheaply
than by their straight note.
(2) The use of acceptances makes it possible for banks and trust companies to properly and conveniently finance legitimate business transactions of their customers without using any of the bank's funds or the use
of any additional funds .
(3) Banks having surplus money which cannot be readily employed at
the time can invest it in prime acceptances, which can either be held until
maturity or sold in the open market, should such action be found necessary.
It is obvious that prime bank acceptances, backed as they are by wellknown banks or trust companies, and readily rediscountable, can find eager
1 Cf. pp. 245-250 for an extended discussion of the trust receipt.

74

DOMESTIC AND FOREIGN EXCHANGE

purchasers by virtue of their high intrinsic security as the most liquid form
of investment for banking institutions. Aside from cash in the vault nothing is so rapidly liquidated, especially in view of the existing Federal Reserve system.
(4) Acceptances of well-known institutions will more and more be sought
as short-term investments and will be especially valuable for such a pur
pose, principally on account of their ready marketability.
(5) Banks and trust companies can accept for a commission the paper
issued by their best customers and sell it in the open market, thus adding
to their business another feature which can be a source of definite
profit .
(6) The presence of the name of the accepting bank makes prime to the
extent of the credit of the accepting bank the paper on which it appears.
This at once eliminates the necessity and bother of checking the drawer
or several indorsers upon paper, as the primary responsibility rests with
the accepting bank . If this is in good credit all other names on the paper
become proportionately of less interest .
(7) With the development of the use of bank acceptances, the knowledge
of the relations that the borrower has with other institutions, which the .
credit-extending banks will thus have, will create a condition of almost
automatic registration of paper ; thus more than ever protecting the banks
as well as the borrowers from the evil results of the over-extension of credit .
The buyer advances no funds, but finances the transaction through
the credit advanced by the accepting bank. The seller knows that he
is sure of his money , because the draft is drawn on a bank. He does
not know the buyer or his credit standing, but the substitution of
the banks' credit for that of the buyer makes him willing to sell without any hesitancy. The drawer is also able to realize a little higher
amount on a draft drawn under a commercial letter of credit because
the discounting bank will charge a little lower rate of discount for a
bank acceptance than for a trade acceptance . Likewise in the past
the rates of rediscount charged by the Federal Reserve banks have
been slightly lower for bank acceptances than for trade acceptances, ¹
The rates of rediscount charged by the Federal Reserve banks on March 25, 1921,
were as shown on opposite page.
"Note: Rates shown for St. Louis and Kansas City are normal rates, applying to discounts not in excess of basic lines fixed for each member bank by the Federal Reserve Bank.
Rates on discounts in excess of the basic line are subject to a 2 per cent progressive increase for each 25 per cent by which the amount of accommodation extended exceeds the
basic line, except that in the case of Kansas City the maximum rate is 12 per cent."
It will be noted that in the case of eight banks out of the twelve the rate of rediscounting
trade acceptances was higher than that charged for rediscounting bank acceptances.

DOMESTIC EXCHANGE

75

although at the time of this writing (April, 1922) the same rediscount
rates apply to both kinds of paper.¹
Federal Reserve banks are authorized to rediscount bank acceptances of member banks or to purchase them in the open market 2
(with or without their bearing the indorsement of a member bank),
from banks, firms , corporations, or individuals, provided they fulfill
all the requirements for eligibility prescribed by the Federal Reserve
As eligibility for rediscounting at the Federal Reserve banks
has an important bearing on their marketability, we find such bills
classified into three groups : ( 1 ) " Eligible bills of member banks," (2 )
" Eligible bills of non-member banks," and (3 ) " Ineligible bills,”
with different rates of discount applying to each class . Some of the
more important requirements concerning eligibility are to the effect
that the acceptance must have a maturity of not more than three

Board.

months,³ exclusive of days of grace, and must have been drawn to
" DISCOUNT RATES OF THE FEDERAL RESERVE BANKS IN EFFECT MARCH 25, 1921

Trade
acceptances
maturing
within
90 days
7
6
6
6
7
7
6
62

Agricultural and
live-stock
paper
maturing
91 to 180
days
7

676

7767676

66

Boston..
New York.
Philadelphia..
Cleveland .
Richmond
Atlanta..
Chicago
St. Louis .
Minneapolis .
Kansas City..
Dallas .....
San Francisco .

Discounted bills maturing within
90 days (including member banks'
15-day collateral notes) secured by Bankers'
acceptOtherances
Treasury Liberty
disc'ted
wise
certifibonds
for
and
secured
cates of
and
member
Victory
indebtbanks
unsecured
notes
edness
6
7
52
6
6
6
7
6
*6
52
6
6
6
6
7
52
6
6
7
6
52
5/2
6
52
7
52
6
6
7
6
6

"* Discount rate corresponds with interest rate borne by certificates pledged as collateral with minimum of 5 per cent in the case of Kansas City and 5½ per cent in the case of
Philadelphia.
1 On April 1 , 1922 , the rates of rediscount for all kinds of paper were 42 per cent for the
Federal Reserve banks of Boston, New York, Philadelphia, and San Francisco, and
5 per cent for the other Federal Reserve banks.
2 During 1920 the Federal Reserve banks discounted $187,162,000 worth of bankers'
acceptances for member banks and purchased $3,143,737,000 worth in the open market.
3 On May 6, 1921 , the Federal Reserve Board issued what were taken to be temporary
regulations, permitting Federal Reserve banks to purchase bankers' acceptances with six
months maturities growing out of foreign trade transactions. The regulation was to re-

76

DOMESTIC AND FOREIGN EXCHANGE

finance the foreign or domestic shipment of goods, or the storage of
readily marketable staples,

or to create dollar exchange.2

Evi-

At the time of acceptance, this bill was accompanied by shipping documents evidencing the
(name of commodity)
domestic shipment of . . . ..
(point of shipment)

from ..
(place of destination)

to .
No...

$.

ACCEPTED
(date of acceptance)
PAYABLE AT
(name of bank)

(date payable)

(name of accepting bank)

(Vice President)
(Assistant Cashier)

FIGURE 23
Form of statement approved by the Federal Reserve Board to be stamped
or printed on bank acceptances covering domestic shipments, or to
appear on an accompanying certificate. Similar statements are used in
case of warehoused goods.
dence of eligibility indicating the character of the transaction must
appear on the face of the acceptance or on an accompanying certificate (Fig. 23).
main effective "until further notice " and was designed for the purpose of trying "to widen
the acceptance market " and "to provide more ample facilities for financing import and
export trade."
1 "A clothing manufacturer, for example, desires to carry his stock of wool through the
use of bankers' acceptances. He places the wool in a warehouse, draws a draft on his bank

2 Cf. p. 135.

DOMESTIC EXCHANGE

77

The bank acceptances of member banks are classed as " eligible "
provided the requirements of the Federal Reserve Board have been
fulfilled . Non-member banks and bankers may make their acceptances " eligible " and thus purchasable by the Federal Reserve banks
in the open market by filing with the purchasing Federal Reserve
bank a statement of financial condition in the form approved by the
Federal Reserve Board. They must also agree in writing to inform
the Federal Reserve bank upon request concerning any transactions
covered by their acceptances. Other bank acceptances which the
Federal Reserve banks cannot purchase or rediscount are called “ ineligible." The first group commands the best or lowest rates of discount in the open market, while the " ineligible " bills command the
highest or least satisfactory discount rates, as is shown by the following table :
BANK ACCEPTANCE DISCOUNT RATES IN OPEN MARKET, NEW YORK ,
MARCH 21-26 , 1921

Ninety
Days
Eligible bills of member banks ... . . . .6-1/8 @ 6
Eligible bills of nonmember banks.... 6-½ @64
@ 64
Ineligible bills .
.7

Sixty
Days
6

Thirty
Days

@ 5-7/8 5-7/8 @ 5-34

64 @ 6
7 @ 64

6-1 /8 @ 5-7/8
@ 64
7

Delivery
within
30 days
6-4 bid
6-5/8 bid
bid
7

As yet bankers ' acceptances are not used to any extent in domestic
trade because other satisfactory means are provided for its financing.
In Chapter IX we shall discuss in detail their use in foreign trade.
One reason why they have not been more widely used in domestic
circles is that until lately national banks and the banks of practically
all states have not been allowed to accept drafts arising out of either
domestic or foreign trade. The Federal Reserve Act of 1913 aufor the value of the wool , attaching the warehouse receipts as collateral. The draft, after
acceptance, is returned to him to be sold , the warehouse receipts being retained by the
bank. The wool must be stored in a warehouse which is independent of the manufacturer;
that is, the manufacturer must not have any control of the wool as long as the warehouse
receipts are outstanding. It is , of course , possible to secure possession of the original warehouse receipts by substituting other warehouse receipts for wool, but if the manufacturer
desires to take down wool without substitution he should give the bank the cash value
of the wool taken, for the bank should be secured either by warehouse receipts or cash all
the time its acceptance is out." National City Company, Pamphlet on Acceptances,
November, 1920, p. 4.

78

DOMESTIC AND FOREIGN EXCHANGE

thorized national banks to accept drafts only in connection with the
financing of foreign trade. It was not until 1916 that that law was
amended so as to permit national banks to accept drafts arising out
of domestic transactions. During the last few years, however, the
laws of the more progressive states have not only greatly widened
the powers of state banks in this respect, but they have also aided in
the development of the use of both trade and bankers' acceptances
by permitting state banks to invest their funds in such acceptances.
Until 1921 the open discount market in the United States had not
progressed sufficiently to take care of the business that was actually
available, as a consequence of which it was greatly dependent upon
the Federal Reserve banks. This is clearly evident from the following table showing at various dates the percentage of the total bills
outstanding which the Federal Reserve banks had to purchase from
member banks and others unable or unwilling to carry them to maturity:

I
2
3
Estimated
Owned by
Owned by
Reserve Bank All Reserve
Amount
Date
Banks
New York
Outstanding
Dec. 31 , 1916....$ 41,457,000 $ 127,497,000 $ 250,000,000
Dec. 31 , 1917 .... 148,125,000
275,366,000
450,000,000
Dec. 31 , 1918 .... 69,323,000
750,000,000
303,673,000
Dec. 31 , 1919 .... 191,312,000
1,000,000,000
585,212,000
Dec. 31 , 1920.... 109,902,000
1,000,000,000
255,702,000
1,000,000,000
Mar. 25 , 1921 ... 39,386,000
123,056,000

Per Cent of
Column 2
to
Column 3
51.0
61.2

40.5
58.5
25.6
12.3

The Royal Bank of Canada in a pamphlet issued in 1921 entitled
...... the open
"Financing Foreign Trade " (p. 63) states that " .....
market now existing in New York for this class of paper [acceptances]
is probably second only to that of London . " Nevertheless, our bankers
and exchange dealers, as well as our business men, still have much
hesitancy regarding the advantages that would accrue from the use
of trade and bank acceptances in financing domestic and foreign
trade.¹
1 For more detailed discussion of trade and bank acceptances, see the annual reports of
the Federal Reserve Board, the Federal Reserve Bulletin, the publications of the National
Trade Acceptance Council, and "Acceptances, Trade and Bankers," by P. Mathewson
(Appleton and Company, New York, 1921).

CHAPTER IV
INDORSEMENT, ACCEPTANCE , AND LIABILITY ¹
Before going farther into the subject it is advisable that certain
matters relating to the acceptance and indorsement of bills of exchange and the liability of the parties concerned be more fully discussed, because of their great significance in practically all exchange
transactions.
All bills of exchange that are negotiable are made payable either (a)
to a certain party " or order," or (b) to " bearer." In the case of
"order " bills, the party in whose favor they are drawn , or in the case
of “ bearer " bills, the bearer, may indorse them and pass them to another party. Bills of exchange brought into existence by a party
other than the debtor or his creditor, such as bank drafts, express
and postoffice money orders, etc. , are usually drawn payable to the
creditor or to his order. The debtor purchases such kinds of exchange
from a bank, postoffice or express company in order to make payment to his creditor . In the case of bills drawn by the creditor on
his debtor or on the latter's financial agent, the drafts are usually
made payable to the creditor or to his order, in words similar to the
following: "Pay to ourselves or order, the sum of, etc., etc. " In the
first case, when the creditor receives the instrument of payment
through the mails from his debtor he indorses the bill by writing his
name on the back of the document and hands it to another party,
receiving his money therefor or asking the other party to collect it
for him. In the second case, i. e . , where the creditor draws the draft
payable to himself or order and sells it, i. e ., discounts it, at the bank,
he likewise indorses it on the back and receives payment from the
1 While this chapter deals with certain matters that relate in a way to negotiable instruments as a whole, I have felt it advisable to confine the discussion solely to matters affecting
those bills of exchange that are commonly used in domestic and foreign exchange transactions. It must not be overlooked by the reader that the principal kinds of negotiable instruments are bills of exchange, both domestic and foreign ; promissory notes, including
notes and certificates of deposits; checks or orders by depositors on their banks to pay
money to a third party, and bonds or promises to pay in a special form by ""corporations or
the government . (Cf. Huffcut, E. W., "The Elements of Business Law, 1917 ed., pp.
159-160.)
79

80

DOMESTIC AND FOREIGN EXCHANGE

bank. If he has drawn the draft on his debtor and has made it payable to a third party or order, he merely delivers it to the party named
as payee, no indorsement being necessary. In case of indorsement,
the one who indorses is known as the " indorser " and if when indorsing
he makes the bill payable to a certain party, that party is known as
the " indorsee." If under any circumstances the bill should be made
payable to "bearer," it would be possible for the drawer or the holder
of the bill to deliver it to another party without indorsement, provided the other party were willing to accept it without indorsement.
The party who delivers a negotiable instrument without indorsement,
i. e., by delivery, is known as the " vendor," while the person to whom
he delivers the bill is known as the " vendee." The person who transfers the instrument to another by indorsement or delivery is also
known as the " transferor " ; the person to whom the instrument is
transferred is known as the " transferee." As noted in previous
chapters, the party who draws the draft is the " drawer "; the party
upon whom the draft is drawn is the " drawee "; the one who pays
is the " payer," and the one who is paid is the " payee.”
According to the Uniform Negotiable Instruments Law, which
has been adopted with but slight variations by all states except
Georgia,¹ a bill of exchange is negotiated when it is transferred from
one party to another in such a manner as to constitute the transferee
the holder thereof in due course .2
." If the instrument has been drawn
payable to bearer, or indorsed to bearer or "in blank," it may be
negotiated merely by delivery , while if it has been drawn payable to a
certain party or his order it is negotiated by the indorsement of the
party who legally holds it , followed by its delivery to the transferee.

INDORSEMENT
Indorsement is made by the holder of the bill signing his name on
the back of it, with or without additional words which convey instruc1 In the following pages the wording of the Uniform Negotiable Instruments Law has
been very closely followed.
2 "A holder in due course is a holder who has taken the instrument under the following
conditions:
" (1) That it is complete and regular upon its face;
"(2) That he became the holder of it before it was overdue, and without notice that
it had been previously dishonored , if such was the fact;
"(3) That he took it in good faith and for value;
“ (4) That at the time it was negotiated to him he had no notice of any infirmity in
the instrument or defect in the title of the person negotiating it." (Uniform
Negotiable Instruments Law, California Civil Code, Sec. 3133.)

INDORSEMENT, ACCEPTANCE, AND LIABILITY

81

tions or qualify his liability. If the bill has been covered with indorsements a slip of paper, known as an " allonge," may be pasted
on its back, on which extra indorsements may be written.
A commonly accepted rule of law is that a person cannot transfer
any title or right which he does not possess. There are two general
exceptions, however, namely, negotiable paper and money. If I lose
$100 which Smith finds and spends at his grocery store, I have no
action at law against the grocery store to recover my money. The
grocery store receives a title or right to the money which Smith did
not possess. The same exception to the general rule holds true in the
case of negotiable paper. Suppose that Smith steals from Jones a
negotiable instrument made payable to bearer and that Smith indorses it and delivers it to Robinson. If Robinson has received the
instrument before maturity, for value , in good faith, and without
knowledge of the defect in Smith's title to it, Robinson is a " holder
in due course" and Jones cannot defend himself against payment
by claiming that Smith got possession of the instrument by fraud or
without consideration. Thus while Smith's title would not be good
as against Jones, Robinson would receive title to it under the circumstances stated because the instrument is " negotiable. " 1 As
Huffcut says: " Negotiability carries with it the following results :
(a) the transferee gets a legal title and can sue in his own name; (b)
if the transferee is a holder for value and without notice of defenses
and obtains title before maturity of the instrument, he is free from
the defenses that might have been set up against his transferor, except those that operate to destroy the contract altogether.

He is not

subject to the personal defenses of fraud, duress, want of consideration,
want of title in the transferor and the like, but is subject to the absolute
defenses of forgery, alteration, infancy of the maker, that the statute declares the instrument void (as it does in a gambling contract),
etc.'" 2

If the instrument has been drawn in duplicate or triplicate, the
indorser must be careful not to indorse the copies to different parties,
otherwise he will be held liable on each so indorsed .
Indorsements may be " special," " in blank," " restrictive,” “ quali1"A holder in due course holds the instrument free from any defect of title of prior parties, and free from defenses available to prior parties among themselves, and may enforce
payment of the instrument for the full amount thereof against all parties liable thereon."
(Uniform Negotiable Instruments Law, California Civil Code, Sec. 3138.)
2 Op. cit., p. 162.

82

DOMESTIC AND FOREIGN EXCHANGE

fied," or " conditional. " A " special " indorsement (sometimes known
as an indorsement " in full ") specifies the person to whom or to whose
order the bill is payable, and the indorsement of that person is necessary to further negotiate the instrument. The following is an example
of such indorsement :

Pay to John Jones or order
Wm . Smith
In this case the bill could not be passed to another party without the
indorsement of John Jones. An indorsement "in blank " specifies
no party to whom or to whose order the bill is payable. A bill indorsed in blank is really payable to bearer and may be negotiated by
delivery without further indorsement. Such an indorsement is found
in those cases where the indorser merely signs his name, with no
qualifying words of any sort. Thus if William Smith above had
signed his name on the back of a bill of exchange, such an indorsement
would have been an indorsement " in blank. " Bills that bear a special
indorsement or an indorsement in blank may be indorsed by the
holder as he wishes, that is, he may put his indorsement in any form
that he desires. If a bill has been made payable to himself or order
(i. e., a special indorsement) , he may indorse it in blank, or he may make
his indorsement restrictive, qualified , or conditional . Also when he
has been handed a bill which has been indorsed in blank, he may make
66
his own indorsement "special, " "qualified ,' ' "restrictive," or conthe
of
blank
ditional." A holder may convert the indorsement in
previous holder into a special indorsement by writing over the latter's
signature any contract consistent with the character of the indorsement. Thus, if Wm . Brown desires to protect himself from the risks of
carrying a check or draft indorsed to him in blank by Andrew White,
he may write above White's signature the words , "Pay to Wm. Brown
or order." Bills of exchange, as well as the accompanying documents
that require indorsement , are frequently indorsed " in blank. "
An indorsement is restrictive when it limits further negotiation, or
constitutes the indorsee the agent of the indorser, or vests the title
in the indorsee in trust for or to the use of some other person. Thus ,

"Pay to John Jones only" is a restrictive indorsement and prevents
further negotiation . But " Pay to John Jones," the word " only"
being omitted, is not a restrictive but a special indorsement. "Pay
to John Jones or order for collection for my account ," or " Pay to

INDORSEMENT, ACCEPTANCE, AND LIABILITY

83

the First State Bank for the benefit of John Jones," are also forms
of restrictive indorsement. Such form of indorsement confers upon
the indorsee the right to receive payment of the bill, to bring any
action in connection with the same that the indorser could bring, or
to transfer his rights as such indorsee when the form of the indorsement authorizes him to do so, but all later indorsers acquire only the
rights and title of the first indorsee under the restrictive indorsement.
Another form of a restrictive indorsement is found in what is called
a "Restricted in trust indorsement," such as " Pay to the First National Bank for account of William Smith." Such indorsement passes
title to the bank for the benefit of William Smith, and is the form
used when a deposit is made for the account of one who cannot make
proper indorsement in person because of absence, age, incompetence,
etc.
A qualified indorsement is one which is made by adding to the indorser's signature the words " without recourse "" or words to the same
effect.

Such an indorsement does not guarantee the payment of the

bill nor does it impair its negotiability. It merely limits the liability
of the indorser who under such circumstances becomes what is technically known as an assignor, whose liability will be more fully discussed
later.
A conditional indorsement is one where some condition is added to
the indorsement, such as " Pay to John Jones or order on the completion of his contract to build my house. " If such a condition had
appeared in the body of the bill itself it would have made the bill nonnegotiable, because the date of payment is not "determinable," but
its appearance as part of the indorsement has no such effect. Any
bill that is originally negotiable continues to be negotiable until it
is restrictively indorsed or discharged by payment or otherwise.
Only a restrictive indorsement nullifies the negotiability of a bill
that has previously been negotiable.
At times an indorsement is used waiving the right to be notified in
case the instrument is protested either for non-acceptance or for nonpayment. An indorsement " waiving protest " would be as follows:
Protest and notice of protest waived
John Jones
Such an indorsement , however, does not relieve the indorser from any
liability to the holder of the bill. It merely notifies the holder that

84

DOMES

TIC

AND FOREI
E
GN XCHANG

E

the indorser will consider himself liable as an indorser without the
necessity of being notified that the bill has been protested.¹ Some
banks consider such an indorsement as being merely a waiver of
the indorser's right to be notified in case of protest and require
the indorser to indorse in blank before he indorses " waiving protest."

ACCEPTANCES
Indorsements always appear on the back of a bill of exchange. An
acceptance, however, usually appears on the face of the bill, never
on the back, written either directly or diagonally across the bill . In
England the acceptance has to be on the bill itself but in the United
States it may be made on a separate sheet.

The customary form of

acceptance is made by writing the word " Accepted," the date and
the acceptor's name on the face of the bill, although the date and the
acceptor's signature alone are sufficient without the use of the word
"Accepted."

Under the Uniform Negotiable Instruments Law, the

holder of a bill may require that the acceptance be written on the face
of the bill itself and if his request is refused he then has the right to
treat the bill as dishonored . However, if he consents, the acceptance
may be written on a piece of paper other than the bill itself, but in
such cases the acceptor is bound only to the person to whom it is
shown and who, on faith, receives the bill as an accepted document.
An unconditional promise to accept the bill , given even before the
bill has been drawn, is deemed to be an actual acceptance. Bills
drawn payable at sight are presented for payment only. Bills drawn
payable a certain number of days from sight must be presented for
acceptance and run the designated number of days following the
presentment for acceptance. Bills drawn payable a certain number
of days from date run from the date the bill is drawn , and may be
presented for acceptance at any time or not at all. The drawee has
twenty-four hours after the bill is presented to him in which to accept,
but the date of the acceptance is as of the day of presentation. If he
destroys the bill or refuses to return it to the presenter within the
twenty-four hour limit , or within any period that the presenter or
holder may allow, he is deemed to have accepted the bill.
An acceptance is merely the act of acknowledging in writing that

1 The process of protesting and the liability of the parties concerned will be discussed
in a later portion of this chapter. Cf. pp . 88-90 .

INDORSEMENT, ACCEPTANCE, AND LIABILITY

85

the obligation or debt is honored and will be paid at maturity. The
word " acceptance " is also used as referring to the instrument after
it has been accepted, as well as to the words that constitute the
acknowledgment. If a draft has been drawn in duplicate or triplicate,
the drawee should accept but one copy. If he places his acceptance
on more than one copy, and if the copies have by chance been indorsed
to different parties, the acceptor becomes liable on each such acceptance .
According to the Uniform Negotiable Instruments Law an acceptance (the act of accepting) may be either general or qualified . A
general acceptance acknowledges the obligation without any qualification whatsoever. The usual form is as follows:

Jan. 1 , 1921
Accepted
John Jones
It is also possible to designate the place at which the instrument is to
be paid, as :

Jan. 1 , 1921
Accepted
Payable at the First National Bank,
Berkeley , Cal.
John Jones 1

On the other hand, a qualified acceptance varies the effect of the bill
in some particular. It may be conditional, partial, local, qualified
as to time, or it may be the acceptance of one, or some, but not
all of the drawees. A conditional acceptance imposes certain conditions which must be met before the bill will be paid, such as the
following:

Jan. 1 , 1921
Accepted provided shipping documents
are turned over to me
John Jones
A qualified acceptance may be "partial, " i. e., be an acceptance of
only a part of the face value of the bill . Thus if the draft has been
1 Cf. footnote p. 69 as to the legal interpretation of this kind of acceptance.

86

DOMESTIC AND FOREIGN EXCHANGE

drawn for $1,000 and the drawee accepts for only $800, such an acceptance would be " partial. " If the acceptance designates the place
at which and only at which the bill will be paid, it is a " local acceptance."

Jan. 1 , 1921
Accepted
Payable only at the First National Bank,
San Francisco, Cal .
John Jones

If the draft is drawn payable at sixty days sight, and the drawee
accepts but makes the bill payable at a shorter or longer length of
time, then the acceptance is qualified " as to time." It is not unusual
to have a draft drawn against two or more parties. If all of the parties
do not accept the draft when presented to them, the acceptance is
"qualified." The holder of a draft may refuse to receive a qualified
acceptance and may proceed to have the bill protested if he wishes
to do so. Where the holder consents to a qualified acceptance he
releases the drawer and the indorsers of the bill unless they have expressly or impliedly authorized him to take such an acceptance. If
the holder notifies the drawer and the indorsers that he has seen fit
to take a qualified acceptance, they must individually notify him of
their dissent within a reasonable time, otherwise they will be deemed
to have given their consent to the same.
There is also an " acceptance for honor." This occurs where a bill
of exchange that is not overdue has been protested for non-acceptance
or for better security, and some party, other than a person already
liable on the bill, intervenes and accepts the bill "supra protest "
for the honor of any party liable on the bill. He may accept for the
honor of any one of the parties already liable as drawer or indorser,
or for the honor of the drawee himself.¹ In his acceptance he mentions
the party for whose honor he is accepting. The bill under such cir1 In foreign exchange transactions it is not unusual for the drawer to realize that difficulty may be met in connection with the matter of acceptance or payment. To avoid
delays, loss of interest, etc. , he will therefore designate some party in the town of the drawee
to whom the holder of the bill may have recourse in such a case. He will designate such a
party on the face of the bill or on the instructions that accompany the bill. In case the
drawee refuses to accept or to pay, the holder then goes to this party, who is known as a
"referee in case of need," who in his turn may accept the bill for the honor of the drawer,
or who may serve in other ways as the agent of the drawer so as to save the latter any
unnecessary expense.

87

INDORSEMENT, ACCEPTANCE, AND LIABILITY

cumstances runs from the date of presentment to and non-acceptance
by the drawee, and not from the date upon which it is accepted for
honor. The acceptor for honor agrees to pay the bill at maturity
provided that at its maturity it is presented to the drawee for payment, refused payment, i. e., dishonored, formally protested for nonpayment, and a formal notice of such dishonor given to him (the acceptor for honor) . Payment for honor must be made before a notary
""
and attested by him, the attest to be appended to the " protest
or made an extension of it.¹
Crossed Checks.

In handling sterling exchange one frequently runs

across an interesting practice found only in England known as " cross-

No C.2792

AD

HE

MAY 6 1920

19

Guaranty Trust Companyof NewYork.
STREET, E. C.
LONDON OFFICE . 33 LOMBARD
BARDST
REET.
•
Pay
orBearer

One Thousand Sounds

Starligh

Fire None

£ 1000 - 0-0

FIGURE 24
Crossed check

ing" a check. A crossed sterling check is one that is made payable
to bearer or order which has the name of a banker or two parallel
lines and the abbreviation " and Co." written or printed across its
face. (Fig. 24.) The effect is to direct the bank upon which the check
has been drawn to pay it only when it is presented by some other bank.
The purpose of crossing a check is to provide an additional safeguard
against wrong payment. Under the English Bills of Exchange Act
of 1906, a crossed check can only be credited to a customer's account
or paid to another banker.
It cannot be paid in cash to the
customer.

1 Cf. p. 91.

EXCHANGE

FOREIGN

AND

DOMESTIC

888

LIABILITY OF PARTIES 1

In discussing the liability of the parties who are interested in the
kinds of negotiable instruments with which this volume deals , it is
necessary to distinguish between parties primarily or unconditionally
liable and those secondarily or conditionally liable. The Uniform
Negotiable Instruments Law declares that " The person ' primarily'
liable on an instrument is the person who by the terms of the instrument is absolutely required to pay the same. All other parties are
'secondarily' liable." It has often and incorrectly been said that
the drawer of a bill is primarily liable, that he is " absolutely required
to pay the same," but according to the terms of the Uniform Negotiable
Instruments Law he is not bound to pay unless the bill has been presented to the drawee for acceptance or payment, as the case may be,
and has been dishonored by the latter, following which due notice
of such dishonor has been sent to him (the drawer) . Unless these
three things, i . e. , proper presentment , dishonor, and notice of such
dishonor, have been done in accordance with the terms of the law
it is not possible to hold the drawer liable. Even an acceptor "for
honor," as has been noted above, is not liable as an acceptor unless
the bill has been presented for payment to the drawee, dishonored ,
protested, and a notice of such protest sent to him (the acceptor " for
honor "). It should also be made clear that the drawee is not liable
in connection with a bill of exchange before he has accepted it even
though he legally owes the drawer the sum of money in question. A
written promise to accept, appearing on a separate piece of paper,
given even before the bill has been drawn, is looked upon by the courts
as a regular acceptance, even though the drawee when the draft is
presented to him for acceptance refuses to place his acceptance on
the face of the bill. After the drawee has accepted the bill he is the
only person primarily liable and absolutely bound to pay the same
when presented to him for payment at maturity. The situation is
the same as though the acceptor were the maker of a promissory note
and the drawer were the first indorser thereof. The drawer and the
various parties who indorse either before or after the acceptance of
the bill, together with the acceptor for honor, are liable only when
the bill has been presented for payment, dishonored , and a notice
of such dishonor (or protest) sent them . Consequently they (the
1 See Whitaker, op . cit., pp. 29-38 , for an excellent discussion of this matter.

INDORSEMENT, ACCEPTANCE, AND LIABILITY

89

drawer, the indorsers , and the acceptor for honor) are secondarily
liable, that is, liable on condition that a certain legal procedure is
followed for the purpose of holding them liable before the law.
Presentment for acceptance must be made to the drawee, while
presentment for payment at the maturity of a bill must be made to
the "acceptor." Presentment , either for payment or for acceptance,
must be made by the holder of the bill at a reasonable hour of the
business day and at a proper place, otherwise the drawer and the indorsers will be discharged from their liability. When the place is
specified in the bill itself presentment must be there made. For example, if the drawee's acceptance has stated that the bill is to be paid
at a designated bank or address, presentment must be made accordingly. If no place is designated , then it must be made at the place of
business of the drawee or at his residence . Presentment for payment
must be made upon the date of the maturity of the bill, although in
some states and in some European countries the payer is allowed a
few days extra (days of grace) after the presentment of the bill in
which to arrange for payment. In the United States and in European
countries days of grace are not allowed as a rule.¹ Great Britain , however, permits three days of grace ; Canada does likewise . Among
South American countries days of grace vary from six to fifteen . If
the bill is payable at sight there is no need of acceptance because it
must be paid at once inasmuch as days of grace do not ordinarily run
in the case of such bills.
If the drawee refuses to pay a sight bill upon presentment it must
be protested at once. If the bill has been accepted and at maturity
the drawee refuses to pay, then after the allowable days of grace have
run, and payment is still not forthcoming, the bill must be protested .
Protesting arises only in case of failure to accept or failure to pay and
is made for the purpose of protecting the interests of the holder of
the bill by taking certain required legal steps which are necessary in
order to hold the drawer and the indorsers liable for payment. Failure
to protest, however, does not free from liability the party or parties
primarily liable. When the drawer draws the draft he, according to
the law, agrees to pay the amount thereof to the holder or to any
subsequent indorser who may be legally compelled to pay it, provided
presentment, dishonor, and notice of dishonor take place. The
1 Huffcut, op . cit., p . 162 , states that days of grace are allowed in Mississippi, Texas and
Wyoming on all classes of bills ; in Massachusetts and North Carolina on sight bills only,
and in Alaska only on paper payable at a future date.

90

DOMESTIC AND FOREIGN EXCHANGE

drawer, however, may insert a stipulation in the bill negativing or
limiting his own liability to the holder. Unless such stipulation is
inserted the liability of the drawer ceases only with the payment
of the bill, not with its acceptance. When the drawee accepts the bill
he agrees to pay at maturity. An acceptor for honor agrees to pay
at maturity provided pre entment to drawee, dishonor, and notice
of dishonor take place. When a party indorses a draft, either before
or after it has been accepted, he agrees to pay the instrument provided it is not paid by other parties who are liable and also provided
presentment, dishonor, and notice of dishonor occur . Notice of such
protest must be sent to all those who have not by their indorsement
waived the right of demanding such notice by indorsing " Protest
and notice of protest waived " or words to a similar effect. Any
party negotiating a bill merely by delivery or by qualified indorsement warrants that the instrument is genuine and that it is in all
respects what it purports to be, that he has good title to it, that all
prior parties had capacity to contract, and that he has no knowledge
of any fact that would in any way impair the validity of the bill or
render it worthless. In other words, the liability of such a party is
merely that of a seller. His guaranties or warranties extend only
in favor of the immediate transferee, i . e., the person to whom the
instrument is passed by him, and not to subsequent holders of the bill.
Protest is necessary only in the case of " foreign " bills, i. e. , those
that have been drawn upon a party residing in another state or country,
but is not required where the bill has been drawn in one state and
made payable by a party in that state. Protest is usually made by a
notary public, although it may be made by any respectable person
in the presence of two or more creditable witnesses. It must be made
on the day the bill has been dishonored , unless delay be excused, and
must be made at the place where it has been dishonored. The protest
blank or document is a formal notice which is either appended or
attached to the bill itself, specifying the time and place of presentment, stating that the bill has been dishonored by non-acceptance
or by non-payment, and that the parties concerned, mentioned by
name, are therewith notified of such dishonor and will be held liable
in their respective capacities (Fig. 25) .

When a bill has been handed

to a notary for protest , he presents it to the drawee for acceptance or
for payment as the case may be, and upon the refusal of the latter to
accept or pay, makes a notation to that effect in his protest book.

91 215

DOMESTIC EXCHANGE
This is called a "notation of protest."
He must thereupon
promptly notify the
drawer and indorsers
of such dishonor or
the holder will lose
his legal claim against
them. If possible
protest notices (Fig.

United States of America,
State of Californin
County of Alameda
By this Public Instrument of Protest,
Be it Known, that on the furth day of January
at the request of
one thousand nine hundred and twenty-two
Mr. A. U. Anderson
I M. B. Carlran
a Notary Public, duly commissioned
did
and sworn, dwelling in the said County of Alameda
duringthebusiness hours ofsaid day present the original . draft
(a copyof whichis endorsed, at the foot ofthis sheet) to the First National Bank
of Berkeley, California.

26) must be presented
in person to the
parties
concerned,
but if such cannot
be done, they may
be mailed by deposit- .
ing them in the postoffice, in a branch of
the postoffice, or in a
letter box under the
control of the postoffice
department.
Mailing

the said Notary Publix,
Whereupon, H. B. Carlson
at the request of aforesaid, did PROTEST, and bythese presents do publicly PROTEST,
as well against the nsker and eLaorsers
as against all others whom it does or may concern, for exchange, re-exchange and all costs,
damages, charges and interest already incurred, and to be hereafter incurred, for the
non-payment
of the maid
draft
Thus Bone and Protested, in the said County of Alameda
the day and year above written.
19.22
I da Hereby Certify, that onthe fourthday of January
notice of protest, demand and non-payment.
ofthe above mentioned draft
was served by me upon Mr. Jillian Smith (drawer , 1525 cldorado Street.
Berkeley, California and . J. M. Andrews, (endorser ) . 321
Yan Keas Stroet , Berkeley, California.

must take

place on the day following the day of
protest, or, if there is
no mail service at

Form No 1063-

that time, then on
the first mail thereafter.
Notice
is

dayof
And further certify that onthe
notice of poles demand and non-payment of the above.
was served by me upon

deemed to have been

by depositing the same in the Dited States Postoffice inthe
State of
County of
fully paid thereon directed asfollows at theirlast known places of residence

19

postage

given even though
there is a miscarriage
of the mails. If the
notary does not have
the addresses of all
the indorsers and the
drawer, he need only
send the notices of

auchbeing the reported places ofresidence of id respective parties and the post offices nearest
thereto, according to the best information I could oben
In Testimony Whereof, I have hercuntv signed my name and
affired my Official Seal, this fourth
day 1 January
one thousand nine hundred andtwenty-twe
Johfornthe]Jones County of
Notary Public in[ged
Mateof Californ

FIGURE 25-Protest blank

92

DOMESTIC AND FOREIGN EXCHANGE

protest to the party from whom he received the bill, and this party
to protect himself forwards them to the prior indorser, and so on,
until all have been properly notified.
The protest fees of the notary public vary from place to place , and
are usually fixed by the notaries themselves.¹ The fee is added to the
amount of the draft and has to be paid by the party who is finally
liable.
The notice of protest is merely a legal notification that the bill in
question has been dishonored and that the indorsers and drawer are

Notice of Protest
Sir

January 4

Please take notice that a certain draft
dated December 12. 1921
forthe sum of five thousand dollars ( $5,000 )
payable at First National Bank of Berkeley California
drawn by you
in favor of John Jones
was this day presented by me
and
payment
and the said draft

1922

Dattans,

to the above bank

thereof demanded, which was refused,
having been dishonored , the same was

this day protested by me for non- payment
thereof, and the holder looks to you for the payment of the same, together with all
cost, charges, interest, expenses, and damages already accrued, or that may hereafter accrue
thereon, by reason of the non- payment
of said draft
EN
Very respectfully,
CIM
SPE
Mr. William Smith
Ta
Notary Public
Berkeley, California
Iz and forsaid.
County of
State of California

FIGURE 26

Notice of protest
to be held liable for its payment . Indorsers are liable in the order of
their indorsement . To get his money out of the bill the holder may
sue any one of the indorsers that he chooses, but a suit against any
indorser frees all subsequent or later indorsers. The indorser who
has been sued and has paid may in his turn sue the drawer or any of
the prior indorsers . An acceptor for honor is liable to the holder of
the bill and to all parties to the bill subsequent to the party for whose
1 They range from $1.25 to $7.50.

INDORSEMENT, ACCEPTANCE , AND LIABILITY

93

honor he has accepted . When a bill which has been accepted for honor
has been paid, all parties subsequent to the party for whose honor the
bill was accepted and was paid are discharged.
When a bill which has been accepted by the drawee is presented

for payment and is dishonored and then protested for non-payment,
any person may intervene and pay the bill for the honor of any person
liable thereon or for the honor of the person for whose account it was
drawn. This is called " payment for honor supra protest. " Such
payment must be attested by a notary public and the attest appended
to the instrument or made a part of it. The attest must contain the
name of the party for whose honor the payment is made. Payment
for honor frees all parties subsequent to the party for whose honor the
bill has been paid, and gives the payer for honor all the rights and
duties of that party for whose honor he has paid the bill. He can,
therefore, proceed to collect from any indorser prior to the party for
whose honor he has paid the bill, or from the drawer.

CHAPTER V
EXCHANGE DEALERS

A. IN THE UNITED STATES
The exchange market in the United States is unlike the stock and
produce markets in that the exchange dealers of a city are not organized into a central trading body like a Stock Exchange or a Board
of Trade. The exchange market is what is generally known as an
"open " market. There is no designated place or time at which buyers
and sellers come together for trading purposes , and there are no sets
of rules and regulations by which the dealers abide. During the
so-called Greenback period (1862-1878 ) , when our nation had suspended specie payments, gold was bought and sold on the New York
Stock Exchange because of the fluctuating premium which it commanded. During the World War when the price of silver was changing
daily, almost hourly , it also was quoted on the Exchange. In 1921 it
was proposed that foreign exchange should be dealt in on the floor of
the New York Stock Exchange, following the example of some of the
European stock exchanges , but thus far (April , 1922 ) , no action
thereon has been taken by the committee to which it was referred.¹
All transactions in exchange are carried on "over the counter " directly between buyer and seller or thru exchange brokers. The
market is "open " and any person who wishes may enter for trading
purposes. In London until 1920, the situation was slightly different, 2
but even there the market is now an " open" one.
The metropolis of a country is usually the center of the exchange
activities for that country-London for England, Paris for France,
Berlin for Germany, etc. In the United States, New York is the center
for all the exchanges, European, South American, and Oriental.
1 Some of the American writers follow Escher (" Foreign Exchange Explained,” p. 54) , in
stating that "Years ago bills of exchange were traded in on the New York Stock Exchange."
I have carefully checked this matter through various channels, especially through the
Secretary of the New York Stock Exchange, who very kindly interviewed some of the oldest
members about it, but nowhere have I been able to verify the statement as made.
2 See pp. 105-107.
94

EXCHANGE DEALERS

95

Chicago, New Orleans , San Francisco , and other large cities transact a
great deal of foreign exchange business , but for the most part it is not
of an independent character, all of the markets in the United States
being dependent primarily upon the New York market. A large share
of the bills purchased from exporters by banks in cities outside of
New York is handled through New York, and the greater part of the
bills that are sold by them are also drawn upon banks and financial
houses in the latter city. Dealers in all parts of the nation make the
rates for the day almost solely on the basis of the quotations received
from New York. Even in the matter of rates on the Orient, San
Francisco does not independently arrive at its own quotations but
bases them upon telegraphic advices from New York.
In the foreign exchange market, there is a variety of dealers, just as
is the case in the produce or clothing or hardware markets. It may not
be amiss to warn the student of the exchanges that bills of exchange,
both domestic and foreign, so far as the marketing of them is concerned, are very much like any other commodity. Those who are concerned with them may be roughly grouped into buyers and sellers, or
again into manufacturers, wholesalers, jobbers , brokers , retailers, and
customers. A party may be in the market both as a buyer and a seller
at the same time. He may be buying the same sort of exchange that
he is selling or he may be buying a kind of exchange that he may need
a few hours or a few months later. He may also be a wholesaler and
retailer, or a jobber and retailer, at the same time. This analogy will
be made a little clearer as the discussion proceeds.
First of all, we have the very prominent banking and financial
houses of New York, including the head office of the American Express
Company,¹ which are vitally interested in practically every phase of
1 The wide range of activities of some of the large New York houses is surprising. The
American Express Company, for instance, advises the public that it offers the following
services:
"For the importer, the American Express Company: locates foreign dealers in the commodity desired, or sources of raw material ; obtains prices and credit report; procures samples
for examination ; arranges a proper introduction between the foreign dealer and the American purchaser; executes buying orders for account of accredited importers; insures and
ships the goods, advising as to freight rates and steamship routes and sailings; finances
the shipment completely ; arranges for clearance at the seaboard or ships the goods in bond;
warehouses or forwards the shipment wherever desired; makes arrangements with the foreign dealer for payment by cable transfer, foreign draft, commercial letter of credit, acceptance credit, collection of draft or invoice , or any other approved banking method preferred by the importer. Other incidental services of the American Express organization
are at the disposal of the importer as occasion may arise.
"For the exporter, the American Express Company: locates the names of foreign prospects; reports on their financial standing and responsibility; reports on conditions of foreign

TIC

96

DOMES

GN

AND FOREI

NGE

EXCHA

the exchange field, both domestic and foreign . These five or ten
prominent dealers are in the market every day as buyers and sellers
of large amounts of exchange, their daily transactions reaching into
the millions of dollars. These concerns have accounts with correspondents in the more important cities of the world and some have
two or more correspondents in each of the financial centers of Europe,
as well as one or more correspondents in every large city in the United
States. Within the last decade or so several of these dealers have
established their own branches in London , on the continent, and in
the Orient. Other cities like Chicago, New Orleans, Boston , San
Francisco, support three or more large dealers , but none so important
as those of New York, who likewise have their accounts and correspondents abroad although not to the same extent as do the leading
New York houses.
This first group of dealers carry on an ordinary retail business in the
sale of exchange in small amounts to their customers over the counter.
They also do a wholesale business in that they sell millions of dollars
worth of exchange to other banks or to importing firms which have
to meet their commitments abroad. They buy equally large amounts
from exporters and from banks and dealers. They also do what might
be termed a jobbing business. They stand ready to take care of the
requirements of their domestic correspondents for such exchange as
may be requested by the latter or their clients . They are in close touch
with a large number of smaller dealers scattered all over the country
who buy and sell exchange through them.

As has been stated in

Chapter II, banks in small towns, and also frequently banks in large
cities, have no accounts or correspondents abroad, yet their customers
continually demand exchange or have exchange to sell. The needs of
the customers must be taken care of, so these banks make arrangements with the larger dealers whereby they are able to sell exchange
markets as to demand, competition , prices and other details ; advises about the better markets as conditions vary; provides direct introductions and references for prospective customers abroad ; recommends as to packing , marking, invoicing and shipping ; advises as
to steamship lines and freight rates; offers assistance in dealing with foreign languages,
weights and measures, currency and foreign exchange, postal requirements and similar
local problems; explains unfamiliar technicalities ; establishes credit anywhere, provides a
Commercial Letter of Credit, or arranges a foreign checking account, or any other approved
or preferred banking accommodations ; receives the shipment in the United States for export ;
insures and ships the goods by the most advantageous route; finances the shipment while
in transit; arranges for customs house clearances, domestic and foreign ; sees the goods
delivered to the buyer abroad, or, if desired, warehoused or reshipped ; even sells the goods
on the shipper's order, if necessary ; and finally, handles collections completely, not only
of current accounts but of old accounts as well, making returns to the shipper."

1

EXCHANGE DEALERS

97

on foreign countries, or to buy the exchange offered by their customers. The larger banks furnish the needed forms or blanks to the
smaller institutions and advise them , either daily or weekly, as to the
rates at which and for what amounts the latter may draw, and also
as to the rates at which the larger banks will purchase exchange from
them.
Many of the banks in Chicago, New Orleans, San Francisco, etc.,
which have a few accounts abroad, would not be able to traffic in
bills of exchange except on the few countries in which they happen
to have their own foreign accounts, unless they, too, made arrangements with the large New York houses similar to those described
above in the case of small town bankers. This group of banks in
their turn, as has been noted in Chapter II , may likewise become
jobbers in exchange , selling to a large list of small correspondent banks
in their individual territory, handling the business through their own
foreign accounts or through the larger New York banks.
A number of foreign banks have branches in the more important
cities of the United States. These branches conduct a general business
in foreign exchange and also act as agents through which American
banks may purchase or sell exchange on foreign countries.
The exchange dealers have no outside men, i. e. , no employés that
go from bank to bank or from firm to firm, buying and selling exchange.
Their business is transacted over the counter, by mail, by telegraph,
or by telephone . They are constantly in touch with the exchange
developments in the more important financial cities of the world.¹
The next class of exchange dealers is composed of the small banks
above mentioned, which have no foreign accounts abroad but which
are able through their connections with the larger banks to supply
the needs of their customers who desire exchange accommodations.
As a rule, they are able to sell only ordinary sight drafts on foreign
countries and then only for relatively small amounts, unless special
permission be obtained from the jobbing bank. Generally they have
authority to sell only on the more important European , South American , and Oriental cities. If their customers require traveler's letters
of credit, import or export credit, or some more technical form of
exchange, the small local bank cannot provide it, and will have to
act merely as an agent in getting it for the customer from the jobbing

1 The details of the work of the foreign exchange department of a bank will be more
fully discussed in subsequent chapters.

IC

98

DOMEST

N

AND FOREIG

GE

EXCHAN

bank. Jobbing banks usually grant the right to be drawn against
only for a certain length of time, commonly for not more than a year.
In such cases, the arrangement has to be renewed annually and the
amount set for which the small bank may draw. These smaller banks
make a practice of engaging in the exchange business only for the
purpose of taking care of the immediate needs of their depositors .
Ordinarily they do not buy exchange from their customers, but act
only as agents in forwarding it to the larger banks. Their exchange
business is of the regular routine character and requires no special
knowledge of the principles or theories of exchange . They receive
their rates daily or weekly from the jobber , add their profit , and
charge the customer the resulting amount. They then remit to the
jobbing bank at the rate quoted by the latter. They care nothing as
to the forces that move the exchange market or as to its more technical
or theoretical phases.
The next class of firms in the exchange market is technically known
as the " dealers. " As American foreign commerce has developed, an
increasingly large number of bills has come into the market.

Many

of these bills have been drawn by exporting firms in cities far removed
from New York, which, realizing the importance of the New York
market and the fact that they can possibly get a much better rate for
their bills in that city than in their home towns, regularly send them
to that center to be marketed. They have no banking connections in
New York, and consequently make arrangements with exchange
dealers to handle the bills for them. These dealers are usually small
firms made up of men who are experts in the exchange business. When
the bills are drawn by the exporter they are mailed to the dealer, who
takes them from bank to bank and markets them at the best obtainable price. Or it may be that the exporting firm has agreed to sell
certain goods to some foreign company at a future date, say three
months hence. It therefore instructs its New York dealer to get for
it the best possible contract price or rate for the bills which it will have
for sale three months hence. The dealer therefore goes from bank
to bank and secures the best offer that he can for this "future." ¹ It
is possible for the dealer to act as an agent for scores of firms scattered
throughout the country . All sorts of bills may be sent to him by his
clients to be disposed of in the New York market. He may personally
make the rounds of the exchange houses each day , or he may transact

1 Cf. pp. 497-501.

EXCHANGE DEALERS

99

a great deal of his business over the phone. As he usually has a variety
of bills in his portfolio , he is a welcome visitor at the bank's counter.
Each bank is thus enabled to purchase the kind and the amount of
exchange that it wants and to keep its foreign accounts in the desired
condition. The dealer may also have orders to buy exchange and here
again he is able to obtain for his out-of-town clients much better rates
than they could get from their local banks. As a rule, the rates in
New York vary little from bank to bank, sometimes not at all, but,
no matter what the case may be, it is the task of the dealer to take
the best possible care of the interests of his clients. At times the
dealer may actually have foreign accounts himself, and buy from
or sell to his clients just as banks do , but that is not usually the case.
The dealer charges his clients a small commission , but his charges are
more than offset by the better rates which he obtains for them. In addition to acting for a large number of clients who are either exporters or importers, he also frequently acts as the New York representative of a number of the larger banks in other parts of the country in
connection with their purchases and sales of foreign exchange . Often
they commission him to keep them advised as to the fluctuations in
the exchange rates, and he accordingly wires them at the opening of
the day the sight rates for the more important European exchanges.
If during the day the rates change noticeably, he immediately wires
his client banks to that effect. A client bank in Chicago may find
that it needs a certain amount of exchange on London to take care of
its obligations ; it wires him to purchase the same for its account ; or
a San Francisco bank may happen to have more franc exchange on
hand than it needs and it wires him to dispose of it at the best price.
By this means the exchange of the client bank is sold or purchased
at much better rates than it itself could secure by trying to sell to or to
purchase from some bank in its own community.
With the exception of the above paragraph, the word " dealer"
will not be used in this volume in its technical sense. In subsequent
pages, as has been true of the earlier ones, the word will be used as
referring to all firms, banks, trust companies, financial houses , express companies, etc. , which deal in the exchanges.
Among some exchange men and also in the literature on the subject
the "dealers " as described above are sometimes known as "brokers. "
To be strictly technical , however , the broker is a different type of dealer.
He is a man, usually without an office, who comes between the buyer

100

DOMESTIC AND FOREIGN EXCHANGE

and the seller. As a rule, he trades solely with the larger exchange
dealers . Each morning he goes from bank to bank, asking what they
have to sell or what they wish to buy, getting their bids and their
offerings and very carefully inquiring as to their rates. He may find
that one bank wishes to sell some sterling exchange at a slightly lower
rate than some other bank is willing to pay. He acts as the go-between
in making the transaction and his profit may either be the difference
between the purchase price of the one bank and the sale price of the
other, or it may be that he receives a commission . A bank may be
in the market for exchange on some particular center, and may give
him an order to get it at the best possible price. In that case, the
broker gets only a commission for his work. Before the wide use of
the telephone, the broker was a very useful and necessary person in
buying what some banks desired and in selling what other banks wished
to get rid of. Today his lot is far from an easy one, because the banks
themselves for the most part take care of their needs over the telephone. Before the introduction of the Gold Settlement Fund of the
Federal Reserve System the broker was very active in the sale of
domestic exchange. But, as noted earlier, that field has been almost
completely taken away from him. On foreign deals, the competition
among brokers themselves has greatly reduced the commissions .
Formerly the average charge was a commission of 1/20 of 1 per cent
on the pound sterling, or $5.00 on every £ 10,000 , and about 1/64 of
I per cent on Continental exchanges, or on francs, for example, $3.00
on a turnover of 100,000 francs. Since the World War these rates
have declined to about 1/16 to 1/8 of a cent per £, and to about one
point on Continental exchanges, except on marks , where the average
rate is about 1/4 to 1/2 of a point .
Lately there has arisen in the United States a new group of exchange dealers, viz., the acceptance houses. This innovation has
been made possible through the changes already referred to , resulting
in the development of our acceptance market. During the last few
years the practice of using the acceptance for both domestic and foreign.
trade has grown to such an extent as to warrant the establishment
of several acceptance houses with headquarters in New York, Boston
and other eastern cities . Their primary function is to buy and sell
acceptances, i . e . , to discount (buy them ) at one rate and to sell at
another thus making a slight profit. They issue circulars to clients
scattered all over the United States telling what acceptances they

ΙΟΥ

EXCHANGE DEALERS

have for sale , what the accepting bank is and where located, the
amount of the acceptance, the length of time it has to run, and the
rate at which it is for sale (Fig. 27) .

JONES SMITH AND COMPANY
85 Wall Street

New York City
May 17, 1922
Dear Sirs :

པ

We own and take pleasure in offering subject to prior sale and change
in rate all or part of the following acceptances for delivery in New York.
Days
Rate
Amount
Acceptor
to Run
New York
$300,000 Chase National Bank
33/47 31/8%
(6
200,000 Guaranty Trust Co.
48
(6
66
20/54
50,000 Huth & Company
100,000 Bank of New York N. B. A.
85/88 31/8%
66
(6
150,000 BrownBrothers & Co.
77/85
200,000 Central Union Trust Co.
75
66
80
150,000 Chase National Bank
""
60,000 Chemical National Bank
84
66
200,000 Equitable Trust Co.
61/69
200,000 Guaranty Trust Co.
77
66
66
150,000 International Acceptance Bank
61/78
"C
(6
200,000 National Bank of Commerce
76/78
""
66
68
100,000 New York Trust Co.
66
66
200,000 Royal Bank of Canada
51/81
66
al
rd
Bank
200,000 Seaboa Nation
84
Boston
200,000 First National Bank
61/81
6
250,000 First National Bank
Chicago
79
66
82
400,000 Merchants Loan & Trust Co.
(6
165,000 First National Bank
Minneapolis
75/83
66
150,000 Merchants National Bank
St. Paul
64
66
82
250,000 Anglo & London Paris Nat'l Bk. San Francisco
150,000 First National Bank
174
Chicago
34%
66
66
200,000 First Trust & Savings Bank
174

19

པ 15

. པ

36 35

པ

;

135

39

པ༷(

58

19

;

The above bills are eligible for purchase by the Federal Reserve Banks.
Please communicate promptly at our expense, either with us or with our
correspondents listed below, in case you care to avail yourselves of the
above offering .
Very truly yours,
Telephone Rector 70
FIGURE 27-List of offerings of bankers' acceptances by discount house

102

DOMESTIC AND FOREIGN EXCHANGE

Some of these firms also carry on other financial transations of an
international nature, such as the establishment of dollar acceptance
credits in the United States, the opening of foreign credits on all parts
of the world, the negotiating, collecting, and selling of all kinds of
exchange, and, generally, the financing of foreign trade upon a
reasonably short term basis. The acceptance companies are corporations possessed of large amounts of capital. Some are owned jointly
by a number of American banks, others are owned by American banks
and foreign banks, while still others are owned solely by individuals .
Some are incorporated under state laws ; others under the federal
laws.¹ If we are to become an international financial power we must
develop a system of discounting and accepting houses similar in
character and importance to those of London .
About a dozen or more foreign banking corporations have also been
organized under the laws of the various states for the purpose of engaging primarily in banking, exchange, and other financial operations
in foreign countries. Some of the more important of these are the
American Foreign Banking Corporation , the Mercantile Bank of the
Americas, the Asia Banking Corporation, the International Banking
Corporation, the French American Banking Corporation, the First
National Corporation , the Shawmut Corporation , and the Equitable
Eastern Banking Corporation .
The purchase and the sale of bank acceptances have become of such
importance, especially in New York, that in 1920 a number of brokers
began actively dealing in them. Every morning they make the rounds
of the various banks with the list of the acceptances that they have
for sale, inquiring at the same time as to what the banks themselves
have for sale and at what prices. Certain investment houses in the
more important cities have also started carrying an assortment of
acceptances varying as to maturities and denominations, which they
offer to their customers (banks and individuals) as excellent forms of
short time investments.
Behind the entire acceptance market, however, stand the twelve
1Typical examples of such firms are as follows: The Foreign Credit Corporation of New
York City was incorporated under the laws of the State of New York in 1919 with a capital
stock of $5,000,000 . In 1921 it also had a surplus of $ 1,000,000 . It is owned by two national banks and four state banks. The International Acceptance Bank was also incorporated under the laws of the State of New York. Its capital and surplus in 1921 were
respectively $ 10,000,000 and $5,000,000. It is owned jointly by eleven national banks ,
seven state banks, trust companies, and investment firms, eleven foreign banks, and two
foreign private banking companies. There are other acceptance houses of similar character.

EXCHANGE DEALERS

103

Federal Reserve banks, ever ready not only to rediscount acceptances
for member banks, provided such acceptances fulfill the requirements
laid down by the Federal Reserve Board, but also willing to go out
into the market and buy for their member banks indorsed bills of all
kinds and maturities which will be held for such banks, or sold for
them as requested , or collected at maturity. This service has been
rendered free of charge and has made it very easy for the member
banks to keep their excess funds constantly and profitably employed
through the continued or occasional investment in prime bills.¹ This
service has been performed by the Federal Reserve banks solely for
the purpose of acquainting the banks with the advantages of investing
in acceptances, thus popularizing the practice and aiding greatly in
the development of the discount market. The amount of acceptances
bought in the open market by the Federal Reserve banks from 1915 to
1920, inclusive, was as follows : 1915 , $64,845,000 ; 1916 , $386,095,000 ;
1917 , $909,301,000 ; 1918, $ 1,809,539,000 ; 1919, $2,825,177,000 ; 1920,
$3,218,364,000. These data, although covering only the amount purchased in the open market by the Federal Reserve banks, clearly
show the wonderful strides that have been made during the last few
years in the growth of discounting and rediscounting domestic and
foreign bills of exchange in the United States.
The Federal Reserve banks do not provide their member banks
with any of the ordinary exchange facilities in connection with foreign
trade, i. e., they do not issue letters of credit, accept bills, sell drafts
on foreign accounts , etc. A Federal Reserve bank, however, is authorized " with the consent of the Federal Reserve Board to open and
maintain banking accounts in foreign countries, appoint correspondents, and establish agencies in such countries wheresoever it may deem
best for any purpose of purchasing, selling and collecting bills of exchange, and to buy and sell with or without its indorsement through
such correspondents or agencies, bills of exchange arising out of actual
commercial transactions." 2 It may also, "under rules and regulations
prescribed by the Federal Reserve Board, purchase and sell in the
open market, at home or abroad, either from or to domestic or foreign
banks, firms, corporations, or individuals, cable transfers and bankers'
acceptances and bills of exchange of all kinds and maturities by this
Act made eligible for rediscount, with or without the indorsement

1 Annual Report of the Federal Reserve Board, 1920, p . 51 .
2 Section 14, Federal Reserve Law.

104

DOMESTIC AND FOREIGN EXCHANGE

of a member bank. "
It is also authorized to deal in gold coin and
bullion at home or abroad. On December 20, 1916, the Federal Reserve Board approved the request of the Federal Reserve Bank of
New York that it be allowed to appoint the Bank of England as its
agent and correspondent, the relation to be reciprocal in character.
The arrangement finally concluded on May 3 , 1917 , was of " a formal
character, covered by written agreement . . . covering in detail
the basis of the principal operations and making a close, effective and
complete agency. " 2 During 1917 the Federal Reserve Bank of New
York "acting for itself and other Federal Reserve banks, paid for
account of certain English banks a loan of $52,500,000 with interest,
maturing in New York, and accepted in return earmarked 3 sovereigns
of equivalent value in the Bank of England. " During 1918 all but a
small amount of this gold was either shipped to New York or furnished
to the Treasury Department for the use of the United States Government or its allies in Europe. During 1919 the Bank of England handled
for the Federal Reserve banks the $173,000,000 of gold paid by Germany to the United States Grain Corporation for food supplies. The
Bank of England transferred that sum to London from the Belgian
and Dutch banks in which it has been deposited by the German government, and held it subject to the orders of the Federal Reserve
Bank of New York.

A large proportion of this gold, although on

deposit with the Bank of England, was later sold to American banks
by the New York institution for export to the Far East. The remainder was brought to the United States in 1920. Arrangements, although not the same in all cases as that described above, were also
concluded with the Bank of France, the Bank of Japan, the Bank of
Spain, De Javasche Bank (Java) , De Nederlandsche Bank (Holland) ,
the Bank of Italy, the Philippine National Bank, the Sveriges Riksbank (Stockholm ) , the Norges Bank (Christiania) , and with the
governments of Argentina , Bolivia, Peru, and Great Britain. The
greater part of these relations with the foreign central banks and
governments are no longer in effect , owing to the passing of the
critical conditions in the exchange market which had necessitated
their establishment . In all these agency relationships, the other
eleven Federal Reserve banks participated with the Federal Reserve
1 Section 14, Federal Reserve Law.
2 Annual Report of the Federal Reserve Board, 1918, p . 339.
• Earmarked " means that the sovereigns were counted and actually set aside as being
the property of the Federal Reserve Bank of New York.

EXCHANGE DEALERS

105

bank of New York upon the same terms and under the same conditions.
As a result of the situation arising out of our entrance into the
World War, the United States government placed all exchange matters
under the complete control of the Federal Reserve Board . This was
done by Executive Orders issued by the President at various times
following September 7, 1917 , which orders remained effective until
in June, 1919, when practically all of the restrictions were removed.
Such control was purely a war-time measure.¹ In normal times it is
not intended that the Federal Reserve Board shall function directly
as a factor in the foreign exchange market.

Its influence, however ,

can be, and possibly may be, made effective through the various
Federal Reserve banks.
B. FOREIGN EXCHANGE DEALERS IN ENGLAND 2
In England the situation in some respects is different from that
which exists in the United States; in others it is similar. The London
market is centuries old , interwoven with long-standing customs and
traditions, and characterized by practices that have developed as only
they could in what has for centuries been the world's center of finance
and foreign trade . There the actual trading in bills of exchange, or
at least a part of such trading, had, until December 30 , 1920 , a more
formal character than in any other place in the world . Twice a week
(Tuesdays and Thursdays) the bill-brokers who had business to transact in foreign bills gathered at the Royal Exchange , and for about an
hour the buying and selling of bills took place. Clare in his "ABC
of the Foreign Exchanges " 3 describes the Royal Exchange and its
activities as follows :
"There is perhaps no public edifice in the City [London] , which is better
known or less understood than the Royal Exchange. Familiar as its outlines
are to the thousands of Londoners who daily pass by it, there is not one in a
hundred that can tell why it was erected, or what purpose it serves. Nor,
1 This will be more fully discussed in Chapter XIV, War and the Exchanges.
2 The discussion which follows is concerned only with those phases of the London money
market that affect the foreign exchange field, and touches only the part which they play
in that connection. It is not designed to give the reader a complete survey of the English
banking system. For such a survey consult the publications of the United States National
Monetary Commission , F. A. Straker, " The Money Market," G. Clare, "A Money Market
Primer," A. Andreades, " History of the Bank of England, " C. A. Conant, " History of
Modern Banks of Issue, " and similar volumes pertaining to that subject.
3 Pp. 37-40.

106

DOMESTIC AND FOREIGN EXCHANGE

if they should enter it in quest of information would they be much the wiser,
for at times they would find the interior either entirely deserted or only
tenanted by a few loungers . It was not always so, however. The Royal
Exchange was intended as a meeting place for merchants, and up to a quarter of a century or so ago London merchants actually did meet there, each
separate branch of trade collected in its own corner or round its own particular pillar. But, as the various sections grew in numbers, it became more
convenient to make homes for themselves in the localities that they specifically affect, and the coal, wood , corn, produce, and other interests now
possess their own separate Exchanges.
"One important group still remains true to its allegiance. Twice a week,
on Tuesdays and Thursdays, the Royal Exchange wakes up for a brief
space. Immediately after luncheon-time, those who have business to
transact in foreign bills begin to gather at the eastern end of the courtyard
and for about an hour ' Change is held. The assemblage which is not a very
large one-not more than perhaps five or six score at the outside-consists
of a small number of brokers and of the chiefs of all the great foreign banking
houses. Of bankers, in the ordinary acceptation of the term, scarcely one is
to be seen, except on rare occasions ; London being perhaps the only great
capital in the world of which the home-banking interest is not regularly
represented on the ' Change. There is an entire absence of noise or excitement. So quietly is the business transacted that it is difficult for the onlooker to believe that anything is going on. Now and again one observes
a broker draw a likely buyer aside, covertly exhibit a contract-note and
suggest a price in a whisper. A simple nod of the head, almost imperceptible to a bystander, signifies acceptance ; the broker scribbles down.
the rate, passes over the contract, which the banker thrusts unconcernedly
into his pocket, and the bargain is complete. In an hour or so all is over,
and the broker hurries back to his office to write out his course of exchange,
or list of current prices." 2
The London papers the next morning contained the list of prices
or the rates of exchange which had prevailed on the Exchange. This
1 Note by Clare: "Formerly Tuesdays and Fridays were the only days on which foreign
mails were dispatched from London , and on those days alone were foreign bills negotiable
on 'Change. It had always been the custom that bills bought on one ' post day ' should
be paid for on the next; but a notorious case (and not the first) having occurred of a house,
that had bought cheques to a large amount, stopping payment before the following post
day, thereby involving the sellers in heavy loss, it was arranged in 1879 that, for the future
all bargains should be settled the next morning, in order that , if a similar case happened
again, the cheques might be stopped by telegraph. At the same time the second day was
altered to Thursday, as it was not to the convenience of the great Jewish houses to pay on
Saturday ."
2 Cf. Ernest Seyd, "Bullion and Foreign Exchanges, " London, 1868, pp. 434-436 ; Straker,
op. cit., pp. 133-135 .

EXCHANGE DEALERS

107

list was much less important, and was scanned much less carefully,
than the daily table of rates cabled from abroad, because most of the
business in which the foreign exchange dealers are interested concerns
not the bills drawn in London on foreign centers but those drawn in
foreign centers on London. Nevertheless, the list was of importance
as showing the trend of the exchanges.
These semi-weekly meetings of the Royal Exchange were the only
instances of the formal marketing of bills of exchange in London.
Otherwise the market has always been as open and as informal as it
is in the United States.
The reason for the abandonment of the Exchange meetings is nicely
summarized in the London Times under date of December 24, 1920:
“ An institution which has existed in the City for generations is about
to come to an end, owing to the altered conditions existing at the present
day. . . . Originally these dealings were chiefly in the form of bills ; nowadays, with the telephones and telegraphs in operation , dealings in foreign
The necessity
exchange take place at a furious pace all day long. .
for the old post-day meetings has therefore largely disappeared ; hence it
has been decided for the present to discontinue these bi-weekly meetings
after Thursday next."
The agencies that are active in the English exchange market are :
(a) the bill-brokers ; (b) the discount houses ; (c) the merchant
bankers and accepting houses ; (d) the branches of London offices
of foreign and colonial banks and financial houses; (e) the English
private and joint stock banks ; and (f) the Bank of England . Each
plays its part in the daily transactions that arise in connection with
the accepting, negotiating, discounting, and collecting of claims for
untold millions of pounds sterling arising out of both domestic and
foreign trade.
The bill-brokers and discount houses are peculiarly English institutions, only in exceptional cases are they found on the Continent,
and, as we have noted earlier, it is only during the last few years that
they have appeared in the New York market to perform the same
function that they do in London. There are only a few of the “ running " bill brokers, i . e. , those who do not themselves make a practice
of actually purchasing the bills, but who go from bank to bank or from
firm to firm , selling and buying for others on a commission and always
using funds supplied by their clients. There are about twenty dis-

108

DOMESTIC AND FOREIGN EXCHANGE

count houses that are actual dealers in exchange, buying and selling,
and having offices and funds of their own . Three of these discount
houses, viz . , The Union Discount Company, Ltd. , The National Discount Company, Ltd. , and Alexanders Discount Company, Ltd. , are
incorporated ; ¹ the others are private partnerships.

Both groups work
with their own capital and also with funds which they attract in the
shape of deposits from customers (just as in the case of a banking concern) . Interest is paid on these deposits, the rate being based on that
prevailing in the market, usually at the bankers' seven day rate for ordinary commercial checking deposits or accounts (in England known as
"call deposits ") and one-quarter per cent additional for time or savings deposits (known in England as " short notice " deposits) . It is also
the custom of the discount houses to borrow large sums from the
private and joint stock banks, and, in times of need , when all other
sources fail, to have recourse to the Bank of England where they
either borrow for a few days (usually from three to ten days) the sum
which they need to care for their business, or else discount (sell) some
of their bills and thus put themselves in funds . They also make loans
on negotiable securities, buy and sell stocks and bonds, and at times
underwrite new issues of corporation securities, but they do not issue
letters of credit, drafts , or other forms of exchange instruments.
The principal function of the brokers and the discount houses , both
of which are frequently known only as " brokers, " is to provide a
market for bills of exchange . The running brokers intervene between
buyers and sellers and charge a commission for their services, but
the discount houses actually buy the bills that are offered for sale .
The discount houses keep a considerable portion of these bills until
maturity, thus earning the discount thereon . Other bills they sell
to banks and investors at a slightly different rate of discount than
that at which purchased, and make their profit on the difference between their buying and their selling rates . English and continental
1 The National Discount Company, Ltd., was established in 1856. It has a subscribed
capital of £4,233,325 , of which £846,665 is paid up. Its reserve fund is £500,000. In its
balance sheet for December 31 , 1920, it showed a total of £32,406,636 worth of bills discounted, £ 12,114,742 of which it had sold to others.
The Union Discount Company, Ltd., was established in 1885. Its balance sheet of
December 31 , 1920, showed a capital stock of £ 2,000,000, of which £ 1,000,000 was paid
up. Its reserve fund was £1,000,000 . Bills discounted stood at £41,079,452.
Alexanders Discount Company, Ltd., was established in 1810 and incorporated in 1891 .
Its balance sheet for December 31 , 1920, showed a capital stock of £ 1,000,000, of which
£550,000 was paid up; a reserve fund of £270,000, and bills discounted at £18,063,470.

EXCHANGE DEALERS

109

bankers know the advantages of the acceptance as a form of short
time investment. They prefer, however, to purchase them from the
discount houses rather than to deal directly with the acceptors because the discount houses specialize in that particular class of paper,
and know the exact credit status of each acceptor in the London
market, the genuineness of the signatures, the amount of the paper
which each acceptor is likely to have outstanding, and all other related facts. Discount houses have many sources of information on
these matters and keep their data up to date. In the field of foreign
trade and finance the standing of a firm may change almost overnight, so that there is constant need of investors being closely in touch
with the latest developments. Thus far the banks have seen fit to rely
solely upon the discount houses in such matters. Discount houses can
provide the banker with just the kinds of bills that he desires, the
proper amounts and maturities, so that he can keep his portfolio filled
with the right kinds of paper.

Many of the banks on the Continent,

including the central banks of Germany, France, Italy, Belgium, and
Holland, invest heavily in sterling acceptances. They, too, make
their purchases primarily through the discount houses. Also , the
small English banks outside of London, find that it is not possible to
obtain enough, or at times the right kinds, of acceptances from their
customers in which to invest surplus funds , so that they, too, have
need of recourse to the discount houses to fill their portfolios. These
acceptances are looked upon as being the very best kinds of bills for
short time investment.

If an English bank does not wish to hold the

bills until maturity, it may easily sell them again to a discount house,
to one of the private or joint stock banks in London , or to the Bank
of England itself. In actual practice, however, it is not customary
for English banks to rediscount the acceptances which they have
purchased for their own needs .
"The function of the discount house is thus of considerable importance in the London money market, because the terms on which they
do business may have a considerable effect upon the foreign exchanges
and so upon the inward and outward movement of gold . Ultimately
and in the long run it is probable that the discount rates current in
the London money market are decided by the banks themselves since
if the bankers decide that they will not buy below a certain rate that
rate is almost certain to become speedily effective . Nevertheless the
discount houses may have a considerable effect on the rates current ,

IIO

DOMESTIC AND FOREIGN EXCHANGE

since if they take a strong view concerning monetary probabilities
in London their sentiment is almost certain to express itself on the
" 1
rates current for the moment. "

It is not usual for the discount houses to indorse the acceptances
which they sell to others. It is customary, however, for them to have
a standing " guaranty " with the banks to which they sell large
amounts, which guaranty is, practically, the equivalent of an indorsement. "In consideration of the bill-broker's guarantee and of having
the advantages of his knowledge in selecting and collecting bills , a
banker is content to buy bills from a broker at a slightly lower rate
than the ruling market rate , usually 1 /8th or 1 /16th per cent per
annum lower. For instance, if bank or first-class paper is quoted
in the market at 2 3/8ths per cent per annum for bills due in three
months' time, bankers would buy such bills from the broker at 2 4
per cent.
The broker thus makes a turn of about 1 /32nd per cent on
the deal, but in active times this ' turn ' is often divided with the merchant from whom he buys. This profit may seem small, but when the
enormous turnover of a bill-broker is taken into consideration, it is
apparent that the total profits derivable from this business are
very considerable. This is confirmed by the satisfactory dividends
paid by two or three public companies conducting discount business. >> 2
The brokers and discount houses are very heavy borrowers from
the banks, either at call or at short notice rates. The security for
such loans is either " first-class bills or what are known as ' floaters.'
'Floaters' are bearer securities of the highest class, such as Consol
certificates, the debentures of certain Indian
of the Corporation of London , and the London
obtain the name of ' floaters ' from the fact that
to bank, as one bank calls and another lends. ”

railways, the bonds
City Council. They
they float from bank
3 When the money

market gets tight and the brokers and discount houses have to borrow
from the Bank of England (they are then said to be " in the Bank "),
the latter charges them a slightly higher rate, ranging from one-half
1 Withers, Hartley, "The English Banking System," United States National Monetary
Commission Reports, 61st Congress, 2d Session, Senate Document No. 492 , pp. 62–63 .
2 Straker, op . cit ., pp. 108-109. The following dividends were paid for 1920 : Union
Discount Company, Ltd. , 28 per cent; National Discount Company, Ltd., 24 per cent;
Alexanders Discount Company, Ltd., 28 per cent on common shares and 12 per cent on
preferred shares.
3 Straker, op. cit ., pp . 111-112 .

EXCHANGE DEALERS

III

to one per cent higher, than the official Bank rate. Such loans usually
run from three to ten days.
From the above discussion it can be readily appreciated that the
brokers and the discount houses are a very important and influential
factor in the London money market.
The merchant bankers and accepting houses were among the first
to specialize in accepting bills for customers. "The importance of
the acceptor's name on a bill . . . led merchants of first rate standing
to specialize in this form of business. They gradually let off or reduced
the amount of their actual mercantile business and confined themselves to accepting bills, for a commission, for
was less well established . . . . The business of
grown up an important and separate function
the hands of the leaders among the old merchant

others whose credit
acceptance has thus
which is largely in
firms, whose accept-

ance of a bill stamps it at once as a readily negotiable instrument. ...
Other functions of the merchant firms and accepting houses are their
activity in general finance and in exchange business. Both of these
functions arise out of their old business as merchants, which gave
them close connection with the governments and the business communities of foreign countries. Their connection with the governments naturally led to their providing credit facilities for them, and
to their handling loans and other operations which these governments
might have to conduct in the London market . Many of them act as
regular agents of foreign governments, making issues of bonds on their
behalf, paying their coupons, and conducting amortization and other
business in connection with their loans ; and their connections with the
general business community led inevitably to their doing a considerable exchange business with foreign countries, financing drafts on
them for purposes of travel and the innumerable other arrangements
which necessitate the transfer of credit from one country to another." ¹
It is interesting to note that the board of directors of the Bank of England is chosen mainly from the ranks of the merchant bankers and
accepting firms .
There are in London ( 1921 ) sixty- eight offices or branches of foreign
banks, representing practically every country of the world , many of
which act as correspondents for other banks located not only in the
home country of the branch or office itself but in other countries as

1 Withers, H., "The English ' Banking System," pp. 54-57.

112

DOMESTIC AND FOREIGN EXCHANGE

well. These foreign and colonial banks, as can be surmised, are most
actively engaged in and concerned with practically all phases of
foreign exchange. They issue letters of credit, act as accepting houses,
discount bills, and provide exchange facilities for many banks located
in their own and in other countries. It was the fact that they were
so successful in the foreign exchange field and were, as a result, able
to compete with London banks in other lines of banking activities,
that finally compelled the private and joint stock banks of England
to engage in the foreign exchange business. It was as late as 1905
that the first foreign exchange department was organized by an English joint stock bank, which is now the London Joint City and Mid2
land Bank.
At the time this unprecedented action aroused the
hostility of English joint stock and private banks, but it has since been
widely copied by them. Having once entered the field, it was easy
to take the next step, and the private and joint stock banks then
undertook to act as accepting firms. In so doing, however, they
aroused the opposition of the older merchant accepting houses. The
latter claimed that the banks did not have the special training needed
to become acceptors, and also that there was an anomaly in their
being acceptors of bills of exchange and at the same time guardians, as
they necessarily have to be, of the volume of acceptances created by
other accepting firms. It was felt that if they became acceptors they
would tend to discriminate against the acceptances created by the
merchant bankers and the accepting houses. The banks, however,
1 The Economist of London, in its issue of Oct. 22, 1921 , gives the following data concerning colonial and foreign banks with branches or offices in London :
Colonial Joint Stock Banks with London Office:
6 African banks with 979 branches elsewhere.
15 Australian banks with 2,364 branches elsewhere.
8 Canadian and West Indian banks with 2,784 branches elsewhere.
4 Indian banks with 94 branches elsewhere.
Total, 33 Colonial joint stock banks with 6,221 branches.
Foreign Banks with London Offices:
17 Continental banks.
5 Asiatic banks.
6 South American banks.
5 United States banks.
Total, 33.
2 In October, 1907 , the Journal of the Institute of Bankers (English) stated, "For some
time past there have been signs that some of the English joint stock banks favored the
idea of getting into their own hands some of the foreign exchange business which has been
so largely under the control of foreign banks and firms. An important step in this direction
has been taken by the London and County Bank, who announce that they have purchased
the business of Messrs. Fredk. Burt & Co. , of 80 Cornhill , and that they will from October 1st
carry on at that address a Foreign Exchange Branch of the Bank. It will be interesting to
see if this example is followed by other banks."

EXCHANGE DEALERS

113

have not allowed these objections to interfere with the development
of the acceptance phase of their business.
The joint stock banks are undoubtedly the most important factors
in the London money market outside of the Bank of England . Until
lately there have also been a number of private banks in England, but
since 1896 , and especially during and since the Great War, they have
been rapidly absorbed by a few of the more important joint stock
banks until today ( 1922) private banks are almost non-existent.
Banking in England is now dominated by a few of the joint stock
banks (known as "The Big Five ": the London Joint City and Midland; Lloyds ; London County, Westminster and Parr's; Barclays; and
the National Provincial and Union ¹ ) either through their having
combined with or purchased outright a number of other banking institutions, or through control exercised by their owning a large portion of the stock of these latter banks.
The English banks have been very slow to establish branches in
foreign countries 2 although in the British Isles themselves branch
banking has long been an accepted practice.³ It has been the foreign
banks, colonial and others, controlled by English capital and with
their main offices sometimes in London, sometimes not , that have been
so active in spreading a network of branches over the face of the earth.¹
1 The progress made in the absorption of the private banks and the tendency toward
combination of banking resources are shown by the following data:
Private Banks
Joint Stock Banks
Year No. of Banks
Year No. of Banks
1895
123
38
1890
118
19
1900
1895
12
96
1900
1905
79
1910
9
1905
1910
63
7
1915
1920
1915
55
1920
37
The control exercised by the Big Five through stock ownership is not disclosed in the
above table.
2 The situation as it applies to the English joint stock banks is aptly characterized by
an article which appeared in the New York Annalist on March 5 , 1917, written by that
journal's London correspondent . In part it stated that:
"The number of British banks with direct connections abroad are few. Lloyds Bank
has a subsidiary enterprise in France known as Lloyds Bank (France) and the London
County and Westminster Bank has a branch in Paris
but even bolder is a step just
taken by the London County and Westminster Bank. This concern has decided to open a
branch in Spain. . .
No other purely British bank is represented in Spain by branch
offices."
3In 1890, 123 English banks had a total of 3,634 branches. In 1920, 37 banks had a
total of 9,452 branches.
4 As noted above, 33 colonial joint stock banks with London offices controlled a total
of 6,221 branches.

114

DOMESTIC AND FOREIGN EXCHANGE

The private and joint stock banks do a general banking business , receiving deposits and paying interest thereon, holding the accounts
of domestic and foreign correspondents, selling and buying foreign
exchange, accepting and discounting bills, etc. They also loan large
amounts of money to bill-brokers and discount houses. When they
become hard pressed for funds they rediscount some of their bills
with the Bank of England, although it is not the practice of the joint
stock banks to discount freely with the Bank of England. While the
Bank is willing to act as a rediscounting agency, nevertheless, as noted
above, it is the custom of the joint stock banks to hold until maturity
the bills which they purchase. The banks of France and Germany
have much less hesitancy about discounting with the central bank of
their respective countries. In fact, with them it is the customary
thing, as a consequence of which the " intercourse between customer
and bank on the one hand, and the bank and the central bank on the
other, is a pretty direct one.

While a large business is still done by

brokers and consequently in the open market, the majority of the
transactions is carried on directly between customer and bank and
bank and central bank ." 1
"In England, banks and bankers generally avoid accepting long
bills for home customers, whom they prefer to accommodate by cash
advances, but they accept very largely for out-of-town customers.
The joint stock banks in England make it a rule to accept only against
collateral, while important banking firms and banks, which often
make accepting their exclusive business, grant uncovered credits to a
very large extent. In France and Germany no line of demarcation
of this kind exists ; banks, large and small, private bankers as well ,
accept with or without collateral, according to their own best judgment. The aggregate amount that a firm in any of these countries
will accept, must, of course, bear a certain relation to its own resources. But this proportion differs according to the character of
the general business done by such firm. A bank doing an extensive
general banking business will accept to the extent of its capital only,
while banks or bankers devoting themselves exclusively to the business of accepting will accept an aggregate amount representing many
" 2
times their own capital."
1 Warburg, Paul M., "The Discount Market in Europe." Publications of the United
States National Monetary Commission, 61st Congress, 2d session, Senate Document No.
402, p. 18.
2 Ibid, p. 11.

EXCHANGE DEALERS

115

Back of the entire banking and credit structure of the country
stands the Bank of England, known familiarly as " The Old Lady of
Threadneedle Street." It is a mountain of strength to the banking
interests of the British Isles, and while not the largest bank in the world
so far as capitalization, assets, etc. , are concerned, it is nevertheless
the most important financial institution because of its dominating
influence in the world's money market. It deals directly with banks ,
firms, and individuals, holding their deposits, loaning funds , discounting bills, etc. It is not a bankers' bank as are the Federal Reserve
banks. English banks may, but are not required to , keep their reserves with the Bank of England. When these reserves fall low, they
are readily replenished by the individual bank rediscounting some of
Such bills, to be eligible for
its bills with the Bank of England.
rediscounting, must be presented by a party having a deposit account
with the Bank, must not be payable in other countries, and must bear
two British names, one of which must be that of a British acceptor.
The Bank of England does not act as the acceptor of bills of exchange, nor does it provide its customers with any of the ordinary
exchange facilities. It has no list of correspondents scattered over
the world through which to conduct exchange transactions. In connection with the field of foreign exchange it performs three functions.
First, it rediscounts bills for its depositors. We have already discussed
its activities in that regard. Second , it is an active participant in the
gold market, buying and selling that precious metal in large amounts,
and regulating, when necessary, its flow into or out of the country,
primarily by raising or lowering its rate of discount, known popularly
as the " Bank rate. " Third, it practically determines the money
rates in the London market, and thus incidentally influences the money
rates throughout the world, by manipulating its Bank rate. This
rate, published in normal times every Thursday morning by the
directors of the Bank, and immediately cabled to all financial centers,
is the rate at which the Bank will discount prime three months' bills
which are presented to it or advance money against the deposit of approved securities. Interest and discount rates in the English market
go up and down with the fluctuations in the Bank rate, as will be more
fully brought out later. The details of the functioning of the Bank
in the gold market and the influence that it wields through its official
Bank rate will be dealt with at length in Chapters X and XI.

CHAPTER VI
PRINCIPLES OF FOREIGN EXCHANGE
The origin of foreign bills of exchange is lost in antiquity and will
doubtless so remain. We know, however, that they were used during
the heyday of the Roman Empire. Cicero, for example, mentions
bills of exchange as being in common use in his time and the inference
is that they had been in use for many years prior to that date. It is
thought by some writers that they were introduced into the northern
provinces of Europe by the Jews, as a means of transferring their
belongings to foreign countries in a way that would be safe from the
demands of the " robber barons " through whose countries they were
compelled to travel. We know that bills of exchange began to be
rather widely used in France and England during the early part of
the twelfth century. Charters given to various cities during the
twelfth and thirteenth centuries authorized the cities themselves to
Macleod tells us that the growing power and arrodeal in such bills .
gance of the popes had a great deal to do with the extension of their
use. At the "time of the Crusades they [the popes] claimed the right
to tax all Christendom for their support. They had their own money
dealers, termed Cambiatores, who kept tables in the capital cathedrals
to exchange the money of foreigners who came to worship . These
persons sent their own agents into different countries to collect the
Papal tribute . As soon as they had collected a sufficient amount, they
sent the Pope bills upon their principals and correspondents for the
amount. . . . These bills were naturally in the form of an order
upon their principals to pay a certain amount of the money of the
country they were in at a certain rate of exchange in Italian money.
In the 12th century Florence became especially famous for this ' banking business,' as it was called. Lucca, Siena, Milan, Placentia, and
others were also famous. " 1 From that time, primarily as a result
of expanding commerce and the developing need for a satisfactory
1 Macleod, H. D., " Theory and Practice of Banking," 3d ed . , London, 1875, Vol. I,
196. An excellent summary of the early history of bills of exchange, together with examples of such bills, is given on pp. 195-203 of that volume.
116

PRINCIPLES OF FOREIGN EXCHANGE

117

method of handling financial transactions between traders living in
different countries, bills of exchange became increasingly prevalent.
The principles underlying foreign exchanges are practically the
same as those underlying domestic exchange, the most important
of which is the settlement of debts without the shipment of gold or
silver. Credit instruments are used to an even greater extent than
in domestic transactions, although, strangely enough, it more frequently becomes necessary or profitable to engage in the shipment
of the precious metals. Because very few business firms or individuals
have checking or commercial accounts with foreign banks, the bank
check, as we know it in our ordinary domestic business relations, is
seldom employed.¹ There is no international clearing house for
foreign bills of exchange. Bills provided or created either by a third
party or by the creditor play a much more important part in international transactions than do bills created by the debtor. At times
the exigencies of the situation necessitate the use of certain kinds of
credit instruments totally unlike those found in domestic affairs.
A matter which causes the greatest amount of confusion , especially
for the beginner, is the fact that documents and bills of exchange are
drawn usually in terms of the money of a foreign country. At home
when we ship goods to a fellow-countryman , we charge him dollars
and we receive dollars, either in cash or in the form of credit. Our
domestic transactions are carried on in terms of our own unit of value,
the dollar. When we sell goods to an Englishman, however, we ordinarily charge him so many pounds sterling, although lately the practice
has been growing of charging him so many dollars , just as we do with
our domestic customers. In the past our foreign bills have almost
always been drawn in terms of foreign moneys 2 because " in former
years the American Dollar was a pariah among the foreign moneys.
There was no market in American exchange other than an arbitrary
one and the price was dictated absolutely according to the whims and
fancies of the foreign banker . In the event of a merchant desiring
to sell an American draft, he was obliged to suffer a discount of from
one, two and three per cent and if he wanted to buy a draft, the reverse operation would be put into effect and he had to pay an exceedingly high premium." 3

1 Cf. p. 38.
2 Not always, however, in terms of the money of the customer's country.
3 Gardin, J. E., Vice-President, National City Bank of New York, in Number Eight,
August, 1916, p. 3.

118

DOMESTIC AND FOREIGN EXCHANGE

Exchange rates on foreign countries were fairly stable, and we
knew just about what our bills drawn in foreign money would be
worth in the exchange market. Those conditions, however, no longer
exist. With the unsettled conditions caused by the World War it was
and has been impossible for us to know from day to day the value
of any foreign money in terms of the dollar, but we have known that
if we drew our bills in dollars, and compelled the foreign customers
to pay us enough of their money at the prevailing exchange rates to
equal those dollars, we would be fairly certain not to lose on the transaction. At times we have even compelled the foreign buyer to purchase with his own money a draft drawn in terms of dollars and to
remit it to us so that we might have the dollars in hand rather than
to have the dollars' worth of foreign money added to our accounts in
foreign banks. By so doing the American exporter has been able to
shift the risks of exchange to the shoulders of the foreign customer.
Whether or not , after international relations return to normal, we
shall resume our former practice of drawing foreign bills almost solely
in terms of foreign currencies is a matter concerning which definite
prophecy is impossible, although at the present time (April , 1922) it
seems that the pound sterling will, to a considerable extent, regain
its dominancy among the exchanges, with the dollar retaining at
least some of the importance gained during the last few years, especially in the financing of South American trade.
The elements that constitute the content of foreign trade necessitating the use of exchange instruments are of the same character as
those that constitute the content of domestic trade. We have those
"visible " items, such as the exports and imports of raw materials
and manufactured goods. We also have those " invisible " items,
such as the sums remitted or received for the payment of dividends
and interest, insurance premiums, ocean freight charges ; funds for
clients, financial correspondents, friends, and relatives ; expenditures
of travelers , etc.¹
Until within the last few years the United States has been classed as
a debtor nation, its citizens and firms owing abroad more than was
¹ The case of Greece presents an interesting instance of the really important part played
by the invisible items in the foreign trade of some countries. A recent report of the American Consul General at Athens states that remittances (funds sent to Greece) increased
from thirty-three million drachmas in 1914 (a drachma is quoted roughly as having a par
of $.193) to three hundred and fifty million drachmas in 1919, in the latter year amounting
to seven-ninths of the total trade balance against that country.

PRINCIPLES OF FOREIGN EXCHANGE

119

owing to them.¹ The most customary method of paying such an indebtedness is, of course, by the shipment of goods. Before the World
War leading authorities agreed that we were compelled to have an
excess of exports over imports varying from $400,000,000 to $600,000,ooo annually in order to settle our annual foreign indebtedness without
being forced to export gold . This excess of exports was required to
pay interest and dividends of from $200,000,000 to $300,000,000 on
American securities of various kinds held abroad, the expenditures
of tourists varying from $ 150,000,000 to $ 200,000,000, remittances
by Americans to friends and relatives estimated at from $ 100,000,000
to $150,000,000, and payments to foreign shipowners for ocean freight
charges ranging between $ 20,000,000 and $40,000,000.2 As a result
1 In an address delivered before the California Bankers Association in San Francisco,
Cal., May 27, 1915 , Dr. Ewing Pratt, formerly Chief of the U. S. Bureau of Foreign and
Domestic Commerce, stated that at the outbreak of the European War the United States
owed no less than £ 1,500,000,000 (about $6,000,000,000) to Europe, the largest portion
of which was distributed as follows:
England .
France...
Germany..
Holland..

.$ 4,000,000,000
1,000,000,000
1,250,000,000
650,000,000

Part of this indebtedness was offset by loans which we had made to European countries,
and by our holdings of certain European securities, so that it would seem that at the opening of the World War we owed Europe approximately $6,000,000,000. (Proceedings ,
California Bankers Association , 1915 , p . 66.)
2 Dr. Ewing Pratt, in the address cited above, also discussed our balance of trade and
how we met our obligations therefor during what may be called a normal year, the fiscal
year ending July 1 , 1914. He said : " In order to show this balance clearly it might be
worth while to strike a very brief balance-sheet, and to find out exactly where we stood at
the beginning of the European War. Our balance of trade, both visible and invisible,
during the last fiscal year [ 1914] would, therefore, be something as follows:
FOREIGN TRADE OF THE UNITED STATES DURING THE FISCAL YEAR 1914
Remittances
Merchandise
Interest (net) .
.$250,000,000
$2,365,000,000
Exports...
Tourist expenditure
Imports.
1,894,000,000
170,000,000
(net) .
Excess of exports over imports.....$471,000,000 Remittances to friends
Gold
150,000,000
(net) .
112,000,000
25,000,000
Freight.
Exports.
67,000,000
Imports.
Excess of gold exports over imports.. 45,000,000
Silver
55,000,000
Exports .
30,000,000
Imports .

$595,000,000
Excess of silver exports over imports 25,000,000
Total excess . . . . . . .
.$541,000,000

Excess of sum remitted over trade
balance ....

54,000,000
"This balance sheet shows that we had payments to make in Europe over and above
the total amount of merchandise exported , and this fact means that we were still contracting debts in Europe at the outbreak of this war. But the situation has changed since
the 1st of August , 1914."

DOMESTIC AND FOREIGN EXCHANGE

120

of the World War, however, the situation has been reversed, and we
now find ourselves a creditor nation of surprising proportions . The
Federal Reserve Board has estimated that our total unfunded international balance accrued since the Armistice, excluding the war-time
debts of foreign countries to the United States (approximately $ 10,000000,000) amounted to some $3,000,000,000 in August, 1920 , ¹ to $3,408 ,000,000 on October 1 , 1921,2 and to $3,400,000,000 on January 1 , 1922.3
The volume and value of our foreign trade have increased at a rapid
rate since 1914. The maximum expansion in volume was attained
in 1917 although the maximum value was reached during 1920.4
Our excess of exports over imports during the period of the war and
to the end of 1921 approximated $ 20,000,000,000.5 The task of paying
for such large amounts of goods has taxed the minds of the world's
financiers and has placed an enormous burden upon the purchasing
nations. It has naturally involved foreign exchange problems of the
most interesting, complex, and varied sort. But as a prominent
banker has well said :

"Every exchange transaction is reciprocal : you give something and you
get something. You transfer goods or render services to others in return
for goods they transfer or services they render to you. And exchanges
go on so long as they are mutually profitable. It is ' fair exchange ' that
1 Federal Reserve Bulletin, September, 1920, p . 1262 .
2 Ibid, November, 1921 , pp . 1262-1266.
3 Ibid, February, 1922 , pp . 128-129 .
4 The great increase in prices explains the seeming contradiction contained in the above
statement.
5 MERCHANDISE IMPORTS AND EXPORTS OF THE UNITED STATES

1911-1921
(ooo omitted)

1921 .
1920 .
1919 .
1918.
1917 .
1916 .
1915 .
1914.
1913 .
1912 .
1911 .

Exports
. $4,485,000
8,288,016
7,920,425
6,149,087
6,233,512
5,482,641
3,550,915
2,114,257
2,484,018
2,399,217
2,092,526

Imports
$2,509,000
5,278,481
3,904,364
3,031,212
2,952,467
2,391,635
1,778,605
1,789,022
1,792,596
1,818,073
1,582,359

Excess Exports
$1,976,000
2,949,535
4,016,061
3,117,875
3,281,045
3,091,006
1,772,309
325,235
691,421
581,144
560,167

PRINCIPLES OF FOREIGN EXCHANGE

121

'is no robbery.' This means that the goods and services that this country
furnishes to other countries will represent goods and services of equal value
furnished to this country by other countries. Our exports of merchandise
will never exactly balance our imports of merchandise, but our exports of
merchandise plus the services that we render other countries will equal in
value the imports of merchandise plus the services that other countries
render to us. There is no escape from such a conclusion unless men are
to quit exchanging things of equal value and begin giving things away.
We hear a lot about our export trade, but our export trade involves an
import trade. The nation that will not buy, neither shall it sell." 1
Our stupendous favorable balance of trade has been paid for in the
first place by huge importations of gold. From August 1 , 1914, to
December 31 , 1921 , our excess gold imports totaled $ 1,542,119,000.
We have also loaned huge sums to private parties and to foreign
governments. Private loans made by individual citizens through
banking and investment houses to foreign political units have
amounted roughly to $2,000,000,000. Our government has loaned to
foreign nations, both during and after the war, approximately $9,500, 000,000. To enable the United States to purchase the needed supplies
for our army in Europe, England, France and Italy advanced a sum
of their currencies equal to $1,490,557,111 . We have repurchased
from European holders close to $3,000,000,000 of American securities.
We have also invested heavily in ventures of all sorts in various parts
of the world, the extent of which it is not possible to estimate with any
degree of accuracy.2 We have sent money abroad to friends and
relatives, insurance companies, freight carriers, and to the needy of
Europe . The export of American funds in such large amounts and
their use in various ways have aided greatly in the temporary settlement of Europe's indebtedness to us arising out of its huge adverse
balance of trade . Because it is through foreign exchange transactions
that such indebtedness between different countries and the peoples
of those countries is cared for, it is not strange that the subject of the
exchanges has loomed large in all discussions in financial circles since
1914.3
1 Dwight L. Morrow, Commercial and Financial Chronicle , Nov. 6, 1920, p . 1801 .
2 Cf. pp. 332-336.
The following most excellent survey of this unique situation appears in a pamphlet
issued by the Guaranty Trust Company of New York City (1921 ) entitled "Our New
Place in World Trade":
"For convenience, we may now sum up the known items, both visible and invisible, of

122

DOMESTIC AND FOREIGN EXCHANGE

In normal times and even in abnormal times efforts are made by
those dealing in the exchanges to obviate the shipment of precious
metals . Claims of the citizens of one country on those of another
must be paid, if not by the shipment of goods, the rendering of services, etc., then by the shipment of either gold or silver. While gold
cannot correctly be called the " international money, " it is nevertheless the most important metallic medium or basis of exchange in all
foreign relations. In normal times practically all of the countries of
the world are on a gold standard basis, the unit of their monetary
system being some sort of gold coin. Other countries, like India, the
Straits Settlement, the Philippine Islands, etc. , are on what is technically known as a "gold exchange " basis, ¹ which means in brief that
their coins are exchangeable for a certain amount of foreign exchange
payable at a fixed ratio in gold in some designated foreign center.
Only a few countries, China being the most important, still remain
on a silver basis. Some South American nations are on a paper money
basis.

Due to the exigencies of the war even the more important

our foreign trade balance during the six and a half years from July 1 , 1914, to December 31 ,
1920.
"A table showing items in our foreign trade balance between July 1, 1914, and December
31, 1920, of known amounts follows:

CREDIT
Visible
Exports of merchandise and silver.
Exports of gold ..

$39,477,831,159
1,429,262,624
$40,907,093,783

Invisible
Interest received on government loans ..

437,349,431

$41,344,443,214
DEBIT
Visible
Imports of merchandise and silver.
Imports of gold ..

.$20,528,606,984
2,259,323,817

$22,787,930,801
Invisible
Government loans less repayments .
Government purchases of foreign currency .
Private loans .

.$9,466,283,171
1,490,557, III
1,989,717,727
12,946,558,009

$35,734,488,810
Leaving a debit liquidated by other items of..
$5,609,954,404
'The last debit in the table consists of invisible items representing payments for services,
etc., the amounts of which can only be estimated."
1¹ Cf. pp. 451-465.

PRINCIPLES OF FOREIGN EXCHANGE

123

European nations, which are normally on a gold basis, are at present
(April, 1922) on a depreciated paper money standard . In spite of
that fact, however, gold figures solely as the metal that is used in the
settlement of trade balances between us and the latter nations because we will not accept either paper money or silver in payment of
their obligations to us.¹
If, when we sold goods to foreigners there were no bills of exchange,
they would have to ship us precious metals, and when they sold goods
to us we would have to ship precious metals to them, which would
result in a great waste of effort and money. We have therefore devised ways and means through the use of bills of exchange whereby
such shipments are made only when necessary to pay balances, or
to put the exchange machinery back into its normal functioning
condition, or to net a profit to exchange dealers. The fundamental
principle upon which is based the practice of settling debts without
the shipment of the precious metals is as follows :
Let us say that Jones in New York has bought some goods from
Pratt in London equal in value to 1,000 ounces of gold . We will use
ounces of gold in our illustration so as to obviate the necessity of
dealing with pounds sterling and dollars. At the same time Smith
in New York has sold goods, likewise valued at 1,000 ounces of gold,
to Lloyd in London .

Now, if it were possible for all of the parties to

know each other personally, inasmuch as the amount of money that
Jones of New York owes Pratt in London is the same as that which
Smith of New York has coming to him from Lloyd of London, the
whole transaction could be settled without any funds crossing the
Atlantic Ocean by Pratt telling Jones to pay Smith 1,000 ounces of
gold, and by Smith telling Lloyd to pay Pratt the same amount. Each
buyer would thus pay the amount that he owed, and each seller would
receive the amount that was due. Of course, such a situation could
never arise, because the parties could not know each other and also
because the sums to be paid and to be received would never be equal
(Fig. 28).
If the parties knew each other the claims of all parties might also
be settled in the following manner : Smith in New York who has
sold goods to Lloyd in London might draw a draft on Lloyd for the
value of the goods and sell the same for 1,000 ounces of gold to Jones
in New York who has to pay Pratt in London for the goods which
¹ Cf. Chapter XII .

124

DOMESTIC AND FOREIGN EXCHANGE

he has bought from Pratt. Jones might then send the draft to Pratt,
who would collect 1,000 ounces of gold from Lloyd. Thus by means
of one draft, the claims
PRATT
YOWES->
JONES
of all parties against
each other would be

Jones
pays
Smith

SMITH

satisfactorily and completely settled (Fig. 29) .
What actually happens, however, is that a

LLoyd
pays
Pratt

Hours

third party, a bank or
an exchange dealer of
some sort, comes in be-

LLOYD

tween the parties concerned and make the

FIGURE 28
Diagram showing theory of foreign payments

payments

more

easily

possible. Smith of New York has sold goods to Lloyd of London ;
he draws a draft on Lloyd to the value of 1,000 ounces of gold
and sells it to his bank. The bank in New York sends it to its
correspondent in London, which collects it from Lloyd.

To keep

our example as simple as possible , let us say that Jones of New
York, having purchased goods from Pratt of London, goes to
Smith's New York bank and buys a draft from it on its London
correspondent to the value of 1,000 ounces of gold. Jones mails
the draft to Pratt. Pratt receives the draft in the mail and takes
it to the bank upon which it has been drawn, and gets his money.
By this means all parties
concerned have paid their
bills or have received the
money that was due

JONES

Jonessends the draft
draft toPratt
toPratt PRATT

Smith draws
them, and no gold has Draft on LLoyd
andsellsit to Jones
crossed the Atlantic (Fig.
30).
The item of discount
and the use of the terms

SMITH

Pratt collects
the draft
from LLoyd

ས་

LLOYD

"dollars" and "pounds

FIGURE 29
sterling" have been purposely omitted from Diagram showing theory of foreign payments
these preliminary explanations of the fundamental principles that
underlie the workings of our foreign exchanges, so as to present the

PRINCIPLES OF FOREIGN EXCHANGE

situation in as simple a form as possible.

125

As has been previously

stated, American firms are continually exporting to and importing
from various countries. To simplify the discussion somewhat, it is
better to limit our illustration to England and the United States.
American exporters draw drafts on English firms for the value of the
goods that are sent abroad. The drafts are for all sorts of amounts,
and also run for various
JONES
OWESPRATT
Jones sends bankdrafttoPratt |
lengths of time, i. e.,
Jones buys a
Prattcollects
from sight to six months.
draft from
draftfrom
bank
London bank
American banks and
financial houses purchase these bills of exchange and send them
abroad for collection.
As the funds are collected, they are added to
the foreign balances
which the banks and

w
New
York banksends
York
London
BANK
Saroftto BANK
London Correspondent
Smith
London bank
Collects draft
drawsdrafton
from Lloyd
LloydAmerica
and sells
to
n bank
LLOYD
SMITH
・OWES

FIGURE 30
Diagram showing theory of foreign payments

financial houses keep with their English correspondents.

Those who
have bills to pay in England come to these banks and financial
houses and buy drafts with which to make such payments.
These
drafts are also drawn for any sum, and also for various lengths of
time, but are usually payable at sight. They are mailed by the
American purchasers to the English firms to which they owe money
for goods bought, and these firms cash them at their own banks.
The latter then present the drafts to the banks upon which they
have been drawn, and the accounts of the American banks are
debited, or decreased , by the sums which the drafts represent. The
banks and financial houses act as the "go-betweens " that make
such transactions possible .
If we buy from English merchants more than we sell to them, there
is a great demand for drafts on England, which tends to use up the
accounts that the American banks have with their correspondents
in England. This creates a scarcity of exchange on England, which
tends to raise the rate of exchange to levels where it may become
profitable to ship gold to England . On the other hand, if we sell to
English merchants a much larger amount than we buy from them an
over-supply of bills on England is created, which floods the bankers
and exchange dealers with bills, and therefore tends to lower the rate

126

DOMESTIC AND FOREIGN EXCHANGE

of exchange to such a point that it may become profitable to import
gold from that country .
Gold will not be shipped, however, unless
it becomes necessary or profitable to do so.
In any discussion of the exchanges , one must always keep clearly
in mind the fact that banks (and from now on we shall use the word
"banks " as referring to all financial houses that deal in foreign exchange) act as both buyers and sellers of exchange. They buy so as
to build up their foreign accounts against which to sell exchange of
various sorts, and they sell to those who have to make remittances
to foreign parties . Banks, therefore, have their buying and their
selling rates of exchange.

Naturally they aim to buy low and to sell

high, or to put the matter in a slightly different form, they aim to sell
at a slightly higher rate than that at which they have purchased in
order to net a profit. Frequently, however, banks are compelled to
take considerable losses owing to adverse fluctuations in exchange
rates.
Another matter which the beginner must not overlook is the long
standing practice that when we buy goods from Englishmen they expect us to buy a draft and to remit it to them, while when we sell goods
to them they expect us to draw a draft on them and realize our money
thereon by selling the draft to our banks . The result is that drafts
remitted by American buyers and drafts drawn by American sellers
both flow toward London . This is quite the practice in the case of all
countries that trade with firms in England, although of course English exporters at times do draw on the foreign buyer. Even the astounding developments of the World War have not as yet noticeably
affected this long prevailing custom .
There are several reasons for
the origin and retention of this practice.

The American exporter

prefers to draw his draft and to get his money immediately by selling
his draft to the local bank, rather than to wait for a remittance to
come to him from his English customer. American banks readily
purchase these bills because there is always an excellent market for
them in the discount market of England and also because they must
have some means of building up their accounts in England against
which to sell drafts to those who desire to remit funds to England or
to other countries. On the other hand, the American importer much
prefers to remit to his English creditor rather than to allow the latter
1 The details of gold shipments and the reasons therefor will be more fully presented in
Chapter XI.

PRINCIPLES OF FOREIGN EXCHANGE

127

to draw against him for the goods that the Englishman has purchased.
If the American buyer remits, he knows exactly how many pounds
sterling he owes the British firm, and he can get the best possible rate
for sterling exchange from his local bank with which he has had business connections possibly for many years.

Rates charged for ex-

change are always " shaved " or decreased slightly in favor of a bank's
regular customer. Although the English firm has to wait for its
money to arrive (in the form of a remittance) , nevertheless, in making
its prices to the American, it has taken care to include therein an
interest charge that will compensate it for the time lost while waiting
for the arrival of the funds. If the American did not remit, but allowed the English firm to draw on him, he would most likely have the
draft presented to him for payment through a strange bank or broker
who would not give him so favorable a rate as would his own banker.
One very important reason for the development of the custom of our
remitting to England is the fact that before the enactment of the
Federal Reserve Law in 1913 there were no facilities in the United
States for the discounting of drafts that arose out of our foreign trade.
Therefore, if the English firms drew on American firms and sent their
drafts to the United States for collection, the bills had to be held until
maturity and could not be discounted in the open market. English
merchants much preferred to get their money as soon as possible, so
they demanded that we remit to them for goods purchased.
The practices employed between American firms and firms in

countries other than England ordinarily follow the custom of the
exporter drawing a draft against the importer or against some bank
with which the importer has arranged some form of credit. Thus
when we export we usually draw a draft on the foreign importer or
on a bank which he has designated , and when we import, the foreign
exporter usually draws a draft on us or on some bank that we designate.
The bank, in either case, may be in the country of the exporter or in
that of the importer or it may even be in a third country. Paying
for imports and exports through a bank as an intermediary will be
discussed in Chapter IX.
Normally we have in the market at all times large amounts of bills
of various kinds drawn against foreign firms and banks and also
against domestic firms and banks. Foreign exchange dealers daily
traffic in these bills just as other merchants traffic in clothing, farm
produce, raw materials, etc. Their stock in trade is, briefly, " claims

128

DOMESTIC AND FOREIGN EXCHANGE

to money in other countries. " Their customers either have a claim
for money against some foreigner which claim they desire to sell to a
bank in return for dollars, or else they owe some money to a foreigner
and desire to buy from the bank, for dollars, a claim to funds abroad
with which to settle their indebtedness. Only occasionally will a
bank be called upon to buy or to sell the actual money, either paper
or metal, of foreign countries, and only occasionally will even the
very largest banks be in the market as buyers or sellers of gold or
silver. It is " claims to money in other countries," more commonly
called " bills" or " bills of exchange," with which the foreign exchange
houses primarily concern themselves.
These bills of exchange are drawn for the most part in the moneys
of other countries. A small but increasing proportion is being drawn
The foreign exchange dealer, therefore, must
ever be ready to purchase or to sell foreign bills, but always in return
for payment in the money of his own country. In other words , when
an American draws a draft in pounds sterling, or francs , or marks,
and sells it to his bank, the banker must translate the amount of
foreign money, for which it has been drawn, into dollars. How much
in terms of dollars.

are the pounds or francs or marks worth in American money? Likewise when an American goes to his bank and purchases a draft for a
certain number of pounds sterling, francs, or marks, etc. , he pays
dollars for it, and the banker is compelled to translate the value of
that amount of foreign money into dollars and cents. This translating of the value of one nation's money into the money of another is
technically known as " conversion " and will be more fully discussed
when we come to a description of the methods and calculations involved in the actual buying and selling of bills of exchange.¹ In the
early years of foreign trade and travel before the use of credit instruments developed, the money changer played an important part,
sitting in the market place and exchanging the money of his own
country for that of the traveler from foreign lands. Today the exchange department of a bank performs the same service, except that
for the most part it deals in credit instruments, in bills of exchange,
in claims for money, rather than in the actual paper or metallic money
of foreign countries. But the clerks in that department are still compelled, as were the money changers of old, to convert the money of one
At times, travelers
country into terms of the money of another.
1 Cf. Appendix III .

PRINCIPLES OF FOREIGN EXCHANGE

129

do come to the exchange department with small sums of foreign
monies which they desire to sell to the bank, i. e., to have converted
into the money of the United States. It is then that the exchange
department becomes an old-fashioned money changer, and the clerk
looks up his list of rates for foreign monies, supplied weekly by some
large New York dealer, and sets the price at which he will exchange
American money for the foreign (Fig. 31) .

NEW

CABLE
ADDRESS
G
GUTTABRO
GUTTAG BROS.
UTTA BROS
CODES
ABA
FOREIGN MONEYANDFOREIGN EXCHANGE MABENTLE
TE AND LETTER
LIEBER'S
BULLION AND SPECIE
YORK
PETERSON'S
FOREIGN & UNITED STATES GOVERNMENTBONDS
LETTERAND LETTER)"
WESTERNUNION
ISLETTERS
BROKERS IN FOREIGN EXCHANGE
52 WALL STREET,NEW YORK
SELLERS
BUYERS
Rates Subject tofluctuation
COPPER
*NOTES
44GOLD
SILVER
APRIL 21th. 1922 .
#474
Africa So. 4.35
4.75
.11
.000160
.16
Austrian
.1915
.01
.08
Bulgarian
.04
Aigeria
.08%
.35
.35
.20
Czecho
.0210
4.80
Argentine
.1976
.0005
4.46
.0001
Austria
071
English
Finnish
4.82
.16
.11
4.26
.02
Australia
.08
.06
French
.0945
.1915
.0835
Belgium
0
.4
German
.20
8.75
.0039
Bolivia
Brazil
.13
.54
.15
.08
Greek
.0420
.0015
British W. I. .88
Hungarian
.1915
.07
.0060
.0005
5.50
Currency
Italian
Bulgaria
#
1
.85
6.
.981
Canada
.961
Stamps (80 Centesimi
.975
W #1
.45
China
.51
6.
(20
Chile
.08
.05
.0003
.10
.35
Polish
.45
.86
Colombia
.60
.11
4.82
Portuguese
0
.19
.1
Coste Rica
.45
.30
Roumanian
.0082
.98).
.88
.75
500s
Russian
.00075
Juba
.02
.0190
.02
Servian
Czecho
.21
.21
.14
Denmark,
CAMBIALI E CARTA BOLLATA.
.261
.38
.12
Ecuador
.22
4.82
4.90
.12
.12
4.45
FOREIGN BONDS.
Egypt
4.37
.22
4.42
4.84
.19
Austrian Treas 6s
England
.01
Finland
.1915
62.00
.08
1917 4s French Nat.
.01%
73.50
France
1931- 5s Victory
.1920
.08
.07
.0932
.2360
.10
.003
.0036
1920 # 6s French Nat. 87.50
Germany
3.25
Gibraltar 4.30
German
DA141 Gov.
AN #5s
1016
n2$
Arasca

3130
3131
132
PHONES 3133
HANOVER 313
31356
3166
3644
PRIVATE
WIRES

FIGURE 31
Typical list of foreign money prices
The "rate of exchange" is the price that the buyer has to pay for
the particular kind of foreign exchange that he is purchasing. When a
traveler from a foreign country asks the clerk in the exchange department, "How much will you give me for the foreign coins that I
have brought over with me, " the rate is the amount of American
money that the clerk will give him for his foreign coins. The rate
that will be paid for a foreign bill on the traveler's country may be
greatly different from the rate that he will get for his foreign coins or

130

DOMESTIC AND FOREIGN EXCHANGE

paper money. In normal times there is a rather close relationship
between the two, but in abnormal periods they may be widely apart.
In the case of the coins themselves the amount given will be somewhere near the value that we place on their gold or silver content,
i. e., the value of the gold or silver bullion which they contain . This
is because the coins may be melted and sold as so much bullion in
our home markets . Gold coins will be bought usually at a discount
of from I1 to 12 per cent. The value of foreign paper money, naturally,
fluctuates much more widely than the value of foreign coins because
it is of no value to us in our own country unless we can find some person who is willing to buy it, either as a dealer or speculator, or as a
prospective traveler in the country concerned . During the past few
years a considerable amount of foreign bank notes has passed through
the hands of American banks which have purchased them usually at
their buying rates for demand drafts less cost of insurance, which
differs with the country, but which has ranged from 14 per cent to I
per cent.
Inasmuch as there are different monetary systems in different
countries, there must be some basis used upon which to make calculations as to the value of the money of one country in terms of that
of another. The basis of the rate of exchange on foreign countries
(and in the rest of this volume we shall use the term " exchange rate ”
as applying solely to the price paid or charged for foreign bills of exchange) is what is technically known as " the mint par of exchange, "
more commonly as the " par of exchange. " This par of exchange is
obtained by comparing the relative weight and fineness of the precious
metal contained in the standard coin of the respective countries concerned. The standard coin of a country is the unit or basis of its
monetary system, in terms of which all things are valued in that
country. There can be a mint par between countries that have a gold
coin of any sort as their standard coin , but as between a gold standard
country and a silver standard country there can be no mint par because there is no fixed ratio between the value of gold and silver. The
value of silver in terms of gold fluctuates continually, making a fixed
basis of comparison impossible . Nor can there be a mint par of exchange between paper standard countries themselves, nor between
them and gold or silver standard countries, because, again, there is
no fixed relationship between the value of the paper money of one
country in terms of the paper money of another, or in terms of either

PRINCIPLES OF FOREIGN EXCHANGE

131

the gold or silver money of another. Thus a mint par of exchange,
or as we more commonly say, a par of exchange, exists between the
United States and only those countries which have a gold coin as
their standard, or measuring rod, of value, or more technically, as
the basis of their monetary systems. As between the United States
and silver or paper standard countries there can be no par of exchange.
The paper and silver exchanges as well as the exchange relations with
the so-called " gold exchange standard " countries will be discussed
in Chapter XII.
There is considerable difference between the weight of the various
gold coins which have been adopted by the more important countries
of the world as the bases of their monetary standards, although their
fineness is almost universally the same, i . e. , 9/10 fine.

Our own

gold coins are 9/10 fine, i. e. , they contain nine parts of pure gold
to one part of alloy, the alloy being used for the purpose of hardening
the metal and making it more capable of resisting wear and consequent
loss in weight from constant handling.

The same is true of the gold

coins of France, Germany, Italy, Belgium, Switzerland , and practically all of the other trading countries. The one notable exception
is England whose gold coins are 11/12 fine. To obtain the par of exchange as between countries on the same monetary standard, it is only
necessary, therefore, to compare the weight of the pure metal in the
standard coin of one country with the weight of the pure metal in
the standard coin of another. As between the United States and England, we find the following : Our gold dollar, though no longer minted,
is by law decreed to be 23.22 grains of pure gold.¹ The English
sovereign contains 113.0015 grains of pure gold.2 Dividing the latter
by the former we find that the pure gold content of the English sovereign is 4.8665+ times as great as that of the American dollar. Therefore we say that the par of exchange between the United States and
England is $4.8665 + , which is the value of the pure gold in the sovereign as measured in terms of the value of the pure gold in the American dollar.
The smallest French gold coin minted is the five franc piece, which
contains a total of 24.8908 grains 9/10 fine, or a content of 22.4018
grains of pure gold. Thus the pure gold in the five franc piece is
worth $.9647 of our money; a franc being one-fifth of that amount, the
1 Being nine-tenths fine, it has a gross or total weight of 25.8 grains.
2 Being eleven-twelfths fine it has a gross or total weight of 123.2744 grains.

132

DOMESTIC AND FOREIGN EXCHANGE

mint par between the United States and France is $ .19295. Inasmuch
as Italy, Belgium, Spain , Switzerland , Greece, Bulgaria, Serbia, Finland, Venezuela , and certain other countries have as their standard
of value a gold coin of the same weight as the franc (known
respectively as the lira, franc, peseta, franc, drachma, lev, dinar,
markka and bolivar) , the par of exchange between the United
States and those countries is the same as that for France , i . e. ,
$.19295.
The German crown of ten marks contains 61.4588 grains of gold
Valued in terms
9/10 fine, or a pure gold content of 55.3130 grains.
of the American dollar it is worth $2.3821 , which gives a mint par
per mark of $.23821 . The par of exchange in terms of the pound
sterling between England and Germany is 20.429 marks (commonly
known as 20.43 ) , while between England and France it is 25.2215
francs (commonly known as 25.22) . Between England and those
other countries that use the same weight gold standard coin as France,
the par of exchange is naturally the same as that between England
and France, viz. , on Greece , 25.2215 drachmas ; on Belgium, or
Switzerland, 25.2215 francs ; on Italy, 25.2215 lira ; on Spain, 25.2215
pesetas, etc. Between Germany and France, the par of exchange
of the mark is 1.2345 francs. It must not be overlooked that in the
examples just given we have quoted the par of exchange in only one
direction. For example the mint par of the mark in terms of francs
is 1.2345 francs, but the mint par of the franc in terms of the mark
is approximately .81 marks (to be exact, .8099 marks) . The mint
par of the mark, the franc, and the dollar in English money is respectively 11.747 pence, 9.515 pence , and 49.316 pence or 4 shillings
1 5/16 pence.
As between countries that have as their standard a coin of the same
metal, weight, and fineness, the par is found without any calculation
being necessary. The Dominion of Canada has, as its standard coin,
the gold dollar of the same weight and fineness as that of the United
States. The mint par is therefore one American dollar for one CanaIdian dollar or vice versa. Rates of exchange between Canada and
the United States fluctuate above and below par just as do the rates
of exchange between the United States, England, France, or any
other country, depending upon certain factors to be later considered.¹
The pars of exchange for gold standard countries as estimated
1 See Chapter X, Rates of Exchange.

PRINCIPLES OF FOREIGN EXCHANGE

by the Director of the
pendix II.¹

United

States

133

Mint appear in Ap-

The mint par expresses only the ratio between the weights of the
standard coins of two countries as they are supposed to be minted,
not the ratio between their weights as they are found in actual circulation. If a comparison were made between the weight of £10,000
of English gold coin and $48,665 of American gold coin actually in
circulation, the ratio would be different from the mint ratio because
of loss by abrasion, or because the minting had not been perfect as
to weight or as to fineness, or both. As Clare so aptly says, "The
Mint Par depends, in short, not on the coin itself, but on the legal
definition of it ; not on the sovereign de facto, but on the sovereign de
jure; and if every gold coin in this country were debased, and every
gold coin in France sweated and mutilated , the Mint Par would still
remain the same. Unless and until the law is altered the Mint Par
cannot alter." 2

While the market rates of exchange on a country are continually
fluctuating above or below the par of exchange, the par itself never
changes unless the country itself modifies the metallic content of its
standard coin. This has occurred many times in the past as monetary
systems have been revised, and naturally necessitates a change not
only in the mint par of exchange but also at times in the method employed in quoting the exchanges. In the case of our own country
we have from time to time varied the weight and fineness of our standard gold coin and have likewise changed our methods of quoting exchanges on other countries. In our early history the value of foreign
monies was quoted in terms of the Spanish dollar, which was then
the current standard , the par of the pound sterling being fixed at $4.44
by Congress by Act of July 31 , 1789. The law creating our monetary system (April 2, 1792) decreed that the ten dollar gold piece
should have a total or gross weight of 270 grains of gold 11/12 fine.
This made the pound sterling worth about $4.562 . The law of June
28, 1834, reduced the gross weight of the ten dollar gold piece to 258
grains, still 11/12 fine, making the pound sterling worth about $4.78.
On Jan. 18, 1837 , the fineness of our gold coins was reduced to 9/10,
changing the par of the pound to $4.8665 + where it still remains.
1 The Director of the United States Mint estimates quarterly the par of exchange between the United States and all gold standard or gold exchange standard countries so that
the value of foreign merchandise entering the country may be properly estimated.
2 "The A. B. C. of the Foreign Exchanges," p. 21 .

134

DOMESTIC AND FOREIGN EXCHANGE

Up to 1834 the English valued our dollar as being worth almost exactly
4 shillings 6 pence, which they called 100 or par, and we quoted the dollar, as they did, as being either above or below par. However, when it
was above par for England it was below par for us. Thus if the quotation were to appear as " Pound sterling-108 1/8 " in England it would
signify that the pound sterling commanded a premium of 8 1/8 per
cent or that it would purchase 8 1/8 per cent more American money
than if it had remained at par. With us, conversely, it meant that
our dollar was at a discount of 8 1/8 per cent, because at 108 1/8
it would take more American dollars to buy a fixed sum of English
money than if the quotation were at 100. From 1834 to January 1 ,
1874 , during which time we made the change in our monetary system
above referred to, the London Stock Exchange continued to value
the American dollar for trading purposes at 4 shillings 6 pence, which
was from 9 to 9 1/2 per cent too high, so that in the field of exchange
the accepted par was raised to 109.45 5/8, which par was adopted
by the New York bankers. On March 3 , 1873 , however, Congress
fixed the par of exchange of the pound sterling at $4.8665 and in pursuance of that law the method of quoting sterling was altered, the
present system going into effect January 1 , 1874.
We have also changed our methods of quoting other exchanges.
Until 1920 we quoted German exchange on the basis of how much
four marks were worth in American money, while French exchange
was quoted on the basis of how many francs the dollar would buy.
Since 1920, however, we have changed to the basis of quoting what
the mark or the franc is worth in American money, i. e., how many
cents it takes to buy a mark or a franc.¹
The exchanges become " favorable " or " unfavorable," in accordance with the nature of their fluctuation. If our own money becomes
more valuable as measured in terms of the foreign money, or, more
accurately, if our dollar will purchase more pounds, francs, marks,
etc., the exchanges are said to be " for us," or are " favorable. " If

1
our money will buy less foreign money , the exchanges are said to be
"against us," or " unfavorable." When exchanges are " favorable,"
rates have moved toward the point at which gold will tend to be
shipped into our country. This will build up our bank reserves and
will tend to make money " easier " or cheaper in the United States,
1 Our former system of quoting marks and francs will be more fully described in Chapter X.

PRINCIPLES OF FOREIGN EXCHANGE

135

thereby enabling borrowers to secure loans and discounts from their
banks at lower rates. When the exchanges are “ unfavorable,” rates
have moved toward the point at which gold will tend to leave the
country, and if gold does leave it will reduce bank reserves and cause
money to become " tighter " with the result that the rates charged
by banks for loans and discounts will tend to be increased.
Another expression "the commercial par of exchange" is found
at times in text-books and sometimes in our financial journals . The
more customary statement is that " the exchanges are at par," which
signifies that our financial claims on another country are equal to its
claims on us. Of course such a situation could but rarely if ever occur.
As will be noted later it is the inequality of claims that to a very great
extent causes exchange rates to fluctuate above and below par.
In publications and articles dealing with the exchanges and also
in current discussion among exchange dealers themselves, such terms
as " dollar exchange," "sterling " or " sterling exchange," "the Continental exchanges," " neutral exchanges," " Eastern " or "Oriental
exchanges," " South American exchanges," " silver exchanges " and
"paper exchanges " are commonly met with. " Dollar exchange ” is
exchange drawn in terms of dollars . American exporters now draw
a large number of bills on foreign firms in dollars ; importers also
frequently ask that the bills drawn on them by foreigners be drawn
in dollars ; travelers, both for pleasure and for commercial purposes,
take dollar letters of credit abroad , and banks that are members of the
Federal Reserve System are authorized, under restrictions imposed
by the Federal Reserve Board, to establish dollar exchange in the
United States for the use of foreign banks " as required by the usages
of trade in the respective countries." 1
1 The Federal Reserve Law permits " any member bank to accept drafts or bills of exchange drawn upon it having not more than three months' sight to run, exclusive of days
of grace, drawn under regulations " . . . prescribed by the Federal Reserve Board, by
banks or bankers in foreign countries or dependencies or insular possessions of the United
States for the purpose of furnishing dollar exchange as required by the usages of trade in
the respective countries, dependencies, or insular possessions (Sixth Annual Report [ 1919],
Federal Reserve Board , p. 21).
The purpose of the act and the regulations adopted thereunder by the Federal Reserve
Board is to provide dollar exchange in countries where the sight draft or cable " is not the
current means of remittance in payment of foreign debts, but where the three months'
bankers' draft is generally used for that purpose."
The Board has ruled that there is nothing " in the provisions of Section 13 of the Federal
Reserve Act which can be construed to permit the acceptance by member banks of drafts
drawn merely for the purpose of correcting adverse exchange conditions," or "merely
because dollar exchange is at a premium in the country where the drafts are to be drawn."
The countries designated thus far (April, 1922) are : Australia, New Zealand, and other

136

DOMESTIC AND FOREIGN EXCHANGE

"Sterling exchange " means exchange on England . The " Continental exchanges " refer to the exchanges of the countries of the European continent. " Neutral exchanges " is a term that is already
passing out of use, and arose during the World War to designate the
exchanges on the then neutral nations. The term "Eastern " or
"Oriental " exchanges applies to the exchanges on Oriental countries
including India; " South American exchanges " to the exchanges on
South American countries ; " silver exchanges " to the exchanges on
silver standard countries ; and " paper exchanges " to the exchanges
on paper standard countries.
The methods followed in quoting the rates on various countries,
the system by which the rates progress or advance, the factors affecting the actual rates charged or paid, will be considered in detail in
Chapter X. It is sufficient for our present purpose to have learned
the meaning of certain technical terms commonly employed in the
open market and in the discussion of the exchanges.
Australasian dependencies, Argentina, Australia, Bolivia, Brazil, British Guiana, British
Honduras, Chile, Colombia, Costa Rica, Cuba, Dutch Guiana, Ecuador, French Guiana,
Guatemala, Honduras, Nicaragua, Panama, Paraguay, Peru, Porto Rica, San Salvador,
Santo Domingo, Trinidad, Uruguay, Venezuela, and the French West Indies.

CHAPTER VII
FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE
Foreign bills of exchange are very much like domestic bills of exchange, the main differences being that, first, the personal bank check
drawn in dollars as we know it in domestic trade is never used ; second,
the draft drawn by the seller upon the buyer, viz. , the ordinary trade
acceptance, is very seldom found, although now and then it appears
for reasons later to be discussed ; and third, bills of all kinds, even in
spite of the developments during the World War, are still for the most
part drawn in terms of a foreign money, although as has been noted
there appears to be a growing tendency to finance our foreign trade
by means of " dollar exchange. " Foreign exchange stresses the part
played by banks and other financial intermediaries even more than
does domestic exchange.
Practically all foreign trade is financed by means of drafts of some
sort or other and cables, although of late there has been a slight
development in the use of the ordinary bank check drawn by American
importers in terms of foreign money against checking accounts which
they have established with foreign banks. Cables, or telegraphic
transfers (commonly designated as " T. T. " in the foreign exchange
lists), are payable immediately upon receipt by the foreign correspondent to whom the cable is sent. Foreign drafts, however, may
be payable at sight, i . e. , on presentation to the payer or the party
upon whom drawn (commonly called " sight " or " demand " bills) ,
or at so many days after sight, i. e. , so many days after the draft has
been presented for acceptance (commonly called " time " bills), or at
so many days from date, i. e. , so many days from the date on which
the draft was drawn (commonly called " date " bills) . Days of grace
do not run in the case of sight bills or cables, but they do hold in the
case of time bills and date bills, the number of days of grace varying
as between different countries. Days of grace are not allowed by
European countries as a rule ; Great Britain, the most noteworthy
exception, allows three days grace. A sixty days draft on London
reaches maturity and is payable, not at the end of sixty days, but at
137

138

DOMESTIC AND FOREIGN EXCHANGE

the end of sixty-three days. Short time bills may run three, ¹ seven,
ten, or thirty days from sight. Many of the shipments sent to Germany from the United States since the World War have been covered
by three day sight drafts.

Had the drafts been drawn at sight, it

might have been difficult for the German importer to have paid the
draft on demand, but being allowed three days time in which to make
the necessary arrangements with his bank he could much more easily
make provision for the payment. Long time bills usually run sixty
or ninety days from sight, although some run as long as six or nine
months. Date bills drawn in New York on London or nearby European cities frequently run "ten days from date," due to the fact
that it normally takes about ten days for a cargo to reach those centers.
Such drafts arrive a few days before the goods and before date of
payment, but the time that intervenes makes it possible for the importer to get the funds needed for payment.

If the draft were drawn

at sight, it would necessitate payment by the importer before the goods
were received . Importers as a rule do not wish to pay for goods before
they are at hand. Date bills may run for longer periods, i. e. , thirty,
sixty, or ninety days. There has been a growing desire on the part
of the exporters to use the date bill rather than the long sight bill,
because the former enables them to know exactly when the bill will
mature and become payable, while if it is drawn so many days from
sight the exporter cannot know definitely just when it is to mature
unless the foreign correspondent advises him of the date of acceptance
by the drawee. Importers, however, object to the use of the date bill
because they feel that the bill is running against them during the
days that it is in transit, and that consequently they have a shorter
time in which to make payment than would be the case if the draft
were drawn payable a certain number of days after sight.
Drafts drawn payable at sight and date bills do not have to be
accepted by the drawee as do bills drawn payable a certain number
of days after sight. The latter, commonly known as " acceptance
bills " or "acceptances," are used in one form or another for the financing of the greater part of our foreign trade. Acceptances that arise
out of foreign trade may be classified on the basis of whether or not
they are used in paying for exports (" export acceptances ") , in paying
for imports ("import acceptances ") , or in the loaning of money by a
foreign bank to or through a domestic bank by means of the latter
1 In England a three day bill is not classed as a time bill.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

139

drawing drafts against the former (generally known as " finance bills,"
sometimes as dollar, sterling, mark, or franc loans). Acceptances in
the foreign field may also be classified into trade acceptances and
bank, or bankers' , acceptances. Each of the above forms of acceptance bills will be discussed in subsequent pages.
Foreign bills of exchange may be either " clean " or " documentary."
A clean bill has no documents attached relating to the nature of the
transaction that brought it into existence. A foreign postal money
order, a draft drawn by one bank upon another or by one merchant
upon another merchant or by a merchant upon a bank, or a check
drawn by an American upon his account with a foreign bank, are all
instances of clean bills of exchange. They may be sent by the remitter for the purpose of enabling him to pay for goods, services , securities, etc. , already purchased or about to be purchased abroad, or
for the purpose of remitting funds to friends, relatives , etc., or they
may be drawn by an exporting firm in order to obtain payment for
goods that have been, are being, or are about to be, shipped abroad.
Such bills are usually sight bills, although they may run from sight to
sixty or ninety days. When a " clean " bill has been drawn by one
merchant upon another, the bank or exchange dealer purchasing it
takes a greater risk than usual because the dealer has no security
except the credit of the drawer. The goods, payment for which is
represented by the draft, may have been shipped some months before
the draft was drawn. Or it may be that the clean bill is not based
on a shipment of goods but arises in some other connection. The
dealer who purchases a clean bill knows nothing of the details of the
transaction which brought it into being. It is because of these facts
that clean bills drawn by one merchant upon another are either not
bought at all by some banks , or when purchased are paid for at a
slightly lower rate than is given for documentary bills. Drafts drawn
by a domestic bank upon a foreign bank, or by a merchant upon a
bank under proper authorization, do not have to meet the above
mentioned objections because of the unquestioned credit standing
of the parties concerned , although, as we shall see later, when one bank
draws too many drafts on another bank for the purpose of creating
"finance bills, " the market will even in that case question the worth of
the bills and will pay a little lower rate for them.
Documentary bills of exchange, also known as " commercial bills "
or "collateral bills," are those which have negotiable documents

140

DOMESTIC AND FOREIGN EXCHANGE

attached to the draft , which documents cover the goods that are being
shipped.¹ The usual documents are the bill of lading, invoice, and
insurance policy or insurance certificate . The invoice is a statement
of the character and amount of the goods shipped , their prices, and any
additional charges that may be involved . The bill of lading is, briefly,
a receipt from the shipping company, and if made out to order and
indorsed in blank, gives possession of the goods to the party holding it.
The insurance policy or insurance certificate represents insurance
coverage for the goods, and, if in proper form and indorsed in blank,
awards the insurance money in case of loss to the party that has
possession of it . Each of these documents, as well as others that are
used under certain conditions , will be more fully discussed later . The
number and kinds of documents that are to accompany the draft, the
manner in which they are to be drawn and to whom payable, the length
of time for which the draft is to run (its " usance " ) , interest charges,
exchange, and all other matters relating to the shipment of the goods,
are as a rule fully and completely determined between seller and buyer
before the goods are shipped . " In export trade no detail of a transaction should be left vague or undefined . Customers are far distant,
mails are slow, cables are costly, and misunderstandings are exasperating and difficult to straighten out. A clear-cut agreement should
be reached between buyer and seller as to the way the goods are to be
packed and marked , who is to insure them and pay various charges,
such as consular fees and other incidentals . The parties to the transaction should assure themselves that they fully understand each other
when using such trade terms as F. O. B. , F. A. S. and so on, and attach
precisely the same meaning to these commercial formulas." 2 It is
necessary that the exporter abide by the terms of the contract of sale ,
otherwise when the goods and documents arrive at their destination
the drawee may refuse to accept the draft and thus cause serious loss
to the shipper. When a bank buys a bill of exchange, regardless of
whether or not it is clean or documentary, or when it takes a bill for
collection, it must always be careful to note that any instructions that
are attached to the bill accord with the agreement between the drawer
1 " Documentary bills are those to which are attached negotiable shipping documents
which not only constitute the evidence of the shipment but which also carry the right
ultimately to control the goods. Of course the documents must be negotiable, otherwise
the bill is practically a clean bill ." Agger, E. E. , in National City Bank Correspondence
Course in Foreign Exchange.
2" Essentials of Trading with Latin America, " pamphlet issued by Guaranty Trust
Company, N. Y., pp. 9-10.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

141

19 21

January 2,

GUARANTY TRUST COMPANY OF NEW YORK,
140 Broadway, New York City
Dear Sirs:
Discount
We enclose for
the undermentioned draft with documents as enumerated.
Collection
The surrender of documents to drawees is conditional upon fulfillment of instructions as
indicated by cross (x) in margin.
DRAFT

NUMBER
:
co
1123

298
No.
Drawer John Brown & Co.
Drawee Chinese Trading Co.
City Where Payable Shanghai, China
Date
Aug. 7, 1920
Amount U. S. $10,342.10
Drawn at 120 d/d

DOCUMENTS
Commercial Invoice
Consular Invoice
Bills of Lading
Insurance Certificate
Certificate of Origin
Weight Certificate
Declaration of Shipper

-

INSTRUCTIONS

Payment
Acceptance.
Protest for Non-Payment
Non AcceptancePermit Drawee privilege inspecting merchandise before accepting draft.

Documents against

Hold for arrival of goods.

Check
Payable at collecting banks selling Cable rate on New York day of payment.
Payable at Check rate on New York, remitting proceeds by cable, charges for our account.
6
% from date of issue until approximate arrival cover

Interest to be collected at..
in New York.

Allow Drawee interest at.. 6

% per annum for anticipated payment.
Drawer
All charges are for account of Drawee.
Waive charges if refused by Drawee.

Mail
In case of need refer to__American Export Co. Shanghai__and advise immediately by Cable.
SPECIAL INSTRUCTIONS.
Kindly collect this draft through the Asia Banking Corporation, Shanghai.

Yours truly,
J. BROWN & CO.
FIGURE 32- Instructions accompanying a foreign bill of exchange

142

DOMESTIC AND FOREIGN EXCHANGE

and the drawee covering the terms of the transaction , usually to be
found in the commercial letter of credit ¹ or other document which
forms the basis of the transaction.

If it is a documentary bill of ex-

change, the bank must be certain that the correct number of documents accompany the draft, that they are of the designated kind, that
full instructions accompany the bill as to how the documents are to be
handled by its foreign
(3M.sets. 11-6-11)
ORIGINAL
correspondent , i
e.,
whether they are to be
The American National Bank
of San Francisco, Cal.
turned over to the
INSTRUCTIONS
DOCUMENTS ATTACHED
drawee on payment or
PERTAINING TO
REMITTANCE NO.
on acceptance of the
LETTERS OF ADVICE
draft, and that all other
INVOICES
conditions are fully proCONSULAR INVOICE
vided for. In addition

CERTIFICATES
BILLS OF LADING
INSURANCE POLICIES

DELIVER DOCUMENTS AGAINST.
IN CASE OF NEED APPLY TO.

the instructions
which the drawer may

to

give the bank when he
places the bill in its
hands, the bank itself
may impose certain conditions or add other
instructions. These instructions may be a
typewritten set of directions, or a small

FIGURE 33
printed blank with the
accompanying a foreign bill of
spaces properly filled in,
exchange
or they may appear on
the draft itself or on a detachable stub at the left end of the draft.
Instructions

Figures 32-33 are samples of forms commonly used to convey the
necessary instructions to the foreign correspondent.
These instructions are drawn in duplicate, sometimes in greater

number, one copy always accompanying each complete set of documents. When a number of bills are forwarded at the same time it is
customary for the bank to send instructions regarding them on one
blank, rather than to attach a separate list of instructions to each set

1 Cf. Chapter . IX

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

143

of documents. In that case the following form (Fig. 34) may be used,
1
the terms of which will be explained later :
FORM 101-8. § . 6-18-am.
CABLE
ADDRESS:
"AMERICAN
CODESUSED: "UNION
Licuen's.WeaTERN
A.B.C.
8TH
EDITION
AND BROOMHALLO

AMERICAN NATIONAL BANK OF SAN FRANCISCO
SAN FRANCISCO, CAL..
void

WE ENCLOSE HEREWITH FOR.
PROCEEDS TO BE PLACED TO OUR CREDIT
USANCE
DRAWER

IN CASE OF NEED APPLY TO
N.P. D.MEANS PAYMENT
ACCEPTANCE
O.. "NON-ACCEPTANCE
RODOCUMENTO
WINE
OR NON-PAYMENTUNLESS OTHERWISE INSTRUCTED
NON-ACCEPTANCE
DO NOT PROTESTFOR
UNLESS OTHERWIGE INSTRUCTED
NON-PAYMENT
PROTESTFOR
PLEASEADVIDEDUEDATE
PLEASEREPORT BY dumOCA

AMOUNT

Dailver
Dece
Upen

DOCUMENTS

WeForwardDuplicate

RESPECTFULLY.
AMERICAN NATIONAL BANK
OF GAN FRANCISCO
DUPLICATE

FIGURE 34
Instructions accompanying several bills of exchange
The draft accompanying each set of documents may be drawn by
a merchant (the exporter) against another merchant (the importer) ,
or by a merchant (the exporter) against a bank with which the foreign
importer or possibly his bank has made the necessary arrangements.2
Long bills running from sixty to ninety days are usually, though not
always, documentary in character. Documentary bills drawn against
shipments of cotton , wheat, corn, and other staples, constitute the bulk
of the bills dealt in by the New York exchange market. If the documentary bills are demand (sight) bills, there is of course no need of
acceptance by the drawee ; he gets his documents and his goods only
upon the payment of the draft when presented to him. In case the
draft is to run a certain number of days after sight, the documentary
bill must be accepted and thus is classed as an "acceptance " bill. If
drawn by one merchant against another it is a trade acceptance ; if
by a merchant on a foreign bank, it is a bank or banker's acceptance.
Whether or not the documents will be turned over to the drawee upon
his having accepted the draft will depend entirely upon the instructions
which accompany the draft. If the instructions are that the docu1 Cf. pp. 159-169.
2 See discussion of foreign commercial letters of credit, Chapter IX.

144

DOMESTIC AND FOREIGN EXCHANGE

ments are to be turned over to him upon acceptance, the drawee receives them immediately upon acceptance . Whether or not he must
deposit security with the bank or agent who presents the draft to him
for acceptance will also depend upon the instructions which the
foreign correspondent has received and which accompany the documents. In the case just described, the instructions would read " Documents on acceptance," or merely " D. A." Ifthe drawer did not wish
to have the documents turned over to the drawee upon acceptance
but only after he has paid for the goods, the instructions would read
"Documents on payment," or merely " D. P." Acceptance does
not always give possession of the documents or of the goods. In the
latter case, where the instructions are "D. P.", the act of accepting
The acmerely sets the date from which the draft begins to run.
ceptor of a " D. P. " bill is able to obtain his documents and his goods
only after he has paid the draft . He is permitted to pay it any time
between the date of his acceptance and the date of the maturity of the
bill. In England, if the draft runs for sixty days, he may wait until
sixty-three days (three days of grace being allowed) have elapsed before
being compelled to pay the bill and before getting his documents,
but he may pay it any time after acceptance. If he pays before
maturity, he is given a " rebate," i. e., he pays less than the face value
of the draft, the amount of his rebate depending upon the discount
rate in the market and the number of days the bill is paid ahead of
time. " D. P." bills are therefore usually known as " rebatable commercial long bills." The rate of the rebate, sometimes called the " rebate rate," or " the rebate rate of interest," but more correctly the
"retirement rate of discount, " is fixed by custom in England at onehalf of one per cent above the rate of interest that bankers are paying
for deposits (usually two per cent under the Bank of England's official
rate of discount) , or, to put the matter another way, the retirement
rate of discount is usually one and one-half per cent below the Bank
of England's discount rate . In other European centers the retirement
rate of discount is usually fixed at the current rate of discount of the
central bank of the country upon which the draft has been drawn.
It is an unusual thing for an acceptor of a " D. A" bill to be willing to
pay the draft before it is due . If, however, he does pay it before
maturity, he is given a rebate at the same rate as for " D. P" bills.
When a "D. A. " bill has been accepted and the documents have
been handed to the acceptor, the documentary bill becomes a clean

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

145

bill, nothing but the draft remaining in the hands of the correspondent.
This draft may then be indorsed by the holder and discounted in the
open market. There is no need of keeping track of the bill as it passes
from one party to another, because the person who holds it on the
date of maturity will either present it or have his bank present it to
the acceptor for payment. "D. P. " bills are not discounted in England,
for the simple reason that the acceptor may at any time wish to pay the
draft and thereupon obtain his documents so as to have access to his
goods. If the bill were discounted and possibly rediscounted a
number of times, it would be difficult for him to trace it from bank
to bank and locate the person or bank that was holding it. The holder
of a number of " D. P." bills, however, may use them as a pledge for
a loan, with the agreement, however, that the acceptor may have
his documents whenever he is willing to pay the draft and that other
bills may be substituted for those that are taken up by the acceptor before the maturity of the loan. In Germany, however, it is not unusual
for " D. P." bills to be discounted in the open market. In such cases,
the correspondent retains the documents (which give possession to
the goods) , and sells the draft as a clean bill. The bill then runs to
maturity. When the acceptor announces that he is ready to pay the
draft less the rebate, the banker receives the money, turns the documents over to him, and guarantees that the draft will be paid in full
at maturity.
Where the credit standing of the drawee is not well known or is not
considered to be of the very best, or where there is more than ordinary
risk involved, or where the commodities shipped are perishable, it is
customary to have the documents go forward under " D. P." instructions. It is not unusual, therefore, for trade acceptances to be "D. P."
bills . When the draft is drawn against a bank, however, documentary
bills are always " D. A. " bills, because there is no question involved
as to the credit standing of the bank. If definite instructions do not
accompany the bills, documents are delivered only against payment
in India and other eastern countries and occasionally in Europe, but
in some of the South American countries they are turned over to the
drawee only upon acceptance.
The laws of some of the South American countries accord the merchants the right to demand and to obtain
the documents when they accept, regardless of the instructions that
may accompany the bill of exchange . The following letter addressed
to a bank in the United States by a bank of Lima, Peru, depicts the

DOMESTIC AND FOREIGN EXCHANGE

146

attitude of the merchants and banks of that country toward "D. P."
bills:
"Dear Sirs:
We beg to confirm our cable of the 5th instant reading as
follows:
'REFERRING YOUR LETTER 7TH & 8TH ULTIMO YOUR REMITTANCES 48 TO 53 AND 59 TO 60 DRAWEES DEMAND DELIVERY DOCUMENTS AGAINST ACCEPTANCE-TELEGRAPH
INSTRUCTIONS '
which refers to your collections
all drawn at sixty days' sight.
"Regarding the above transactions, we beg to call your attention to
the fact that such drafts, in the form they are issued , i . e. , at sixty days'
sight, with instructions to deliver documents against PAYMENT and not
against ACCEPTANCE cause us a great deal of trouble. The merchants
of this country are accustomed since early years, to have surrendered to
them , corresponding documents against ACCEPTANCE OF TIME
DRAFTS ; which means to them to enjoy the privilege of credit for the time
at which items are drawn. Furthermore, the Law of this country upholds
the merchants in their contentions.
"Time Drafts should come with instructions of delivering documents
against ACCEPTANCE and in case of cash payment being desired (that
is, documents against PAYMENT) SIGHT BILLS should be drawn.
"We shall be obliged if in future you will bear the foregoing in mind and
refrain from forwarding us for collection , TIME DRAFTS with documents
to be surrendered only against PAYMENT.
"We trust the above is quite explanatory and shall appreciate your
usual good attention to the matter which has compelled us to write this
letter.
"Yours faithfully," 1
1 The following letter from a bank in Bolivia to a bank in the United States is likewise
of interest in the above connection:
"Gentlemen :
Collection
"We beg to call your attention to the discrepancy which we note in your instructions
given us in reference to the above collection . The draft is drawn at 120 days' sight and
you tell us that the documents should be handed against payment. We do not know this
way of proceeding and rather believe that this is an error or a ridiculous inconsistency.
It is plain to us in this country, that if a drawing is issued at 120 days' sight, with documents, said documents should be deliverable against acceptance of draft and not against
payment. If it had been the wish of the Drawers to give instructions to hand the documents against payment, why the draft should simply have been drawn at sight . We fail
to understand in this country what benefit a person would enjoy by having drafts drawn
on him at 120 days' sight, as in this case, when he is unable to procure corresponding docu-

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE · 147
The instructions that accompany a documentary bill of exchange
may contain the designation " D. D. , " which means simply that the
documents are to be delivered to the party concerned. Such instructions are employed only when goods have been shipped with the
understanding that the documents are to be forwarded immediately
and that payment may be made at some later date by means of a
draft upon the importer or by the latter forwarding a remittance
to the shipper. In this case the documents are turned over to the
bank as the shipper's forwarding agent.
There often appears on the face of the draft, or more frequently
on the instruction blank accompanying the bill of exchange, the
"" or "In case
phrase "In case of need, with ...
," the name and address
of need, apply to .....
of some business concern, bank, shipping agency, branch office of
the exporter, or individual being inserted . This party, known as a
"referee in case of need," is usually located in the country upon which
the draft has been drawn and may be called upon by the holder of the
bill to straighten out any difficulty that may arise between him and
the importer and thus save the expense of delay, cablegrams, protest
fees, etc. , which would otherwise result. It frequently happens that
the importer's "refusal to accept or pay a draft arises from some
trivial matter which can be adjusted easily by a tactful intermediary ,
but which otherwise would involve expensive cablegrams and negotiations at long range. If the ' case of need ' succeeds in adjusting the
point in dispute so that the drawee becomes willing to complete the
transaction , then the matter is closed without material expense to the
exporter. Or, failing to arrive at any agreement, the local representative (' case of need ') may honor the draft himself or make some arrangement with another importer to take over the goods upon satisfactory
terms. On the other hand, it may be that the ' case of need ' finds it
necessary to make certain concessions to the buyer. The local bank
holding the draft then is in the position to cable a concrete proposal
on behalf of the purchaser to the American bank which originally
ments without payment. In what manner is he to procure the necessary funds if he cannot
take possession and dispose of the relative merchandise and receive the proceeds therefrom?
"With this explanation, we beg to inform you that in future we shall not take upon
ourselves any collections that contain such contradictory instructions, and we must again
inform you that such proceedings are not known here as they are very evidently absurd.
"Expecting that you will find our remarks in order, we remain,
"Yours very truly,"

148

DOMESTIC AND FOREIGN EXCHANGE

started the bill along for collection . If it is desired that the powers
and authority of the ' case of need ' exceed those described above, then
the necessary authorization or power of attorney should be filed both
with the ' case of need ' and with the bank which negotiates the draft
>> 1
in the United States. "
Other terms that appear on the drafts themselves or in the instructions which accompany the documents, such as the " colonial clause,"
the "interest clause," the phrase " exchange as per indorsement,"
etc. , will be explained in later chapters.
Documentary bills, unlike clean bills, are comparatively safe for
the exchange dealer to purchase, because, aside from the liability of
the drawer, which, as has been seen, does not cease until payment of
draft, the documents normally afford practically complete protection
against loss. When prices are falling rapidly, as they did during 19201921 , bankers and others run great risks through the refusal of the
drawee to accept the drafts covering goods contracted for at higher
prices, and also through the failure or bankruptcy of the exporting
firms from which the bills have been purchased. In normal times,
however, documentary bills covering shipments of staple non-perishable products, such as flour, farming implements, canned meats (or
fresh meats and provisions when shipped in refrigerator cars and
vessels) , etc., are comparatively safe because the goods can usually
be sold in the market where consigned, if a forced sale is necessary,
at prices that will reimburse the bank for its outlay. If a small balance remains unpaid, it can usually be collected from the indorsers
or drawer without difficulty, while if a surplus be realized it is returned to the drawer. Cotton bills should be purchased only from
well-known and responsible shippers because there are so many grades
with a different price for each and because it is so easy to substitute
one grade for another. Bills against grain shipments are usually safe
provided the grain inspector at the shipping point is of good repute
and will not certify a higher grade for a lower. Bills covering shipments of perishable fruits, goods, etc. , because of the chance of spoilage,
naturally involve more or less risk, as do those covering live stock,
because any delay at destination necessitates the expense of feed and
attention, or those covering specialties, such as pianos, phonographs,
musical instruments, etc. , because they can rarely be sold at auction
at anywhere near the price at which they have been billed .
1 Foreign Trade Bulletin of the American Express Company, May-June, 1918.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

149

Documentary bills, regardless of the conditions existing, should
be dealt in only by those who are thoroughly trained in that phase
of foreign exchange, because it means , when the transaction is stripped
of all its outward characteristics , the loaning of money upon goods
that the exchange dealer has not seen. "The attachment of documents does not enhance the value of the draft in every case. The
standing of the drawer is what counts in first instance, as documentary
bills are not easily negotiable in the open market and they protect
only while documents are attached. The acceptance of the drawee
adds usually to the value of the paper, especially when the acceptor is
>> 1
a bank, a banker, or merchant of good standing and reputation .
If the drawer and the drawee have excellent financial standing, that
of course eliminates the principal source of loss. But even then, great
care should be exercised by the dealer in purchasing bills so that no
possible difficulty may arise to impair their value . The bank clerk
should note whether all documents are drawn in accordance with the
terms called for in the letter of credit. He should examine the bill
of lading to see that it is correctly dated and corresponds with the
shipment made; that it declares that the goods were received in good
condition ; that it is duly signed by the agent or the proper official of the
railway or steamship company ; that it corresponds with the insurance
certificate or policy in all particulars ; that all negotiable copies of the
bill of lading are in his possession ; and that there are no stamped or
printed conditions on it that might render it valueless in case of an
emergency. He should know the market value of the goods shipped,
so as to be sure that the draft is not drawn for a larger sum than could
normally be realized should the goods have to be sold by the bank
in order to collect its claim . Information concerning the value of
commodities can be obtained from the various trade journals or from
local firms dealing therein. The banker should keep continually
posted as to the financial standing of the drawer, and if possible of the
drawee. If the goods are perishable, he should take care to see that
they are to be sent by fast freight or steamer or in refrigerator cars
and vessels. If sent from some small inland point where it is not
possible to obtain a through bill of lading to the point of destination ,
he should make the necessary arrangements with a broker or the bank's
correspondent at the seaport to have the original bill of lading ex1 Gonzales, V., "Modern Foreign Exchange, " N. Y., 1920, second edition, pp.
41-42.

150

DOMESTIC AND FOREIGN EXCHANGE

changed for a through bill of lading.¹ In every seaport there are a
number of firms that make a business of acting as forwarding agents
for inland customers, exchanging bills of lading, arranging for shipment of goods on the proper lines, etc. He should also note whether
or not the insurance in effect on the shipment is for the proper sum,
whether or not it covers the goods from the time they leave the exporter's hands until they reach the importer, just what length of time
and what route the policy covers, and whether there are any clauses
in the insurance policy or certificate or attached thereto by stickers
that may make it either difficult or impossible for the bank to collect a
claim for damages. And in the case of all documents needing indorsements, he should note that the indorsements are in proper form, in
order that the documents may be easily negotiated and the bank's interests completely protected. Any error or incompleteness may cause
delay and necessitate loss of interest , protest fees, cablegram costs, etc.
Practically all of the important banks (both domestic and foreign)
in the United States that are engaged in buying documentary bills
of exchange have adopted a uniform set of rules governing payments
of commercial credits and the handling or purchasing of documents
drawn thereunder, and have notified their correspondents to the following effect :
TO CORRESPONDENTS :
Payments under Export Commercial Credits advised to the undersigned
are made in conformity with the following regulations, which are in accord
with the standard practice adopted by the New York Bankers Commercial
Credit Conference of 1920:
1. We assume no liability or responsibility for the form, sufficiency,
correctness, genuineness or legal effect of any documents, or for the description, quantity, quality , condition, delivery or value of the merchandise
represented thereby, or for the good faith or acts of the shipper or any
other person whomsoever; but documents will be examined with care
sufficient to ascertain whether on their face they appear to be regular in
general form .
2. We will interpret the terms " documents," "' shipping documents " and
words of similar import, as comprehending only ocean bills of lading (sailor
bill of lading included) and marine and war risk insurance, in negotiable
form, with invoices.
3. Unless specifically otherwise instructed , we will accept " received for
transportation " bills of lading in the form customarily issued in New York.
1 Brooks, op. cit., p. 189.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

151

(The steamship lines constituting the Transatlantic Conference state that
the customary procedure necessitated by American port conditions, is to
issue bills of lading against the receipt of goods into the custody of the
steamship owners or agents, for transportation by a named steamer, and
failing shipment by said steamer , with liberty to ship in and upon a prior
or following steamer. They state that it is not possible here to issue " on
board " bills of lading, but have agreed, after the goods are loaded , so far
as reasonably practicable, to indorse on the bills of lading, if returned for
the purpose by the shippers, a dated clause to the effect that the within
goods have been loaded on board, specifying any portion that has been
"short shipped." They represent , however, that such procedure will not
be reasonably practicable in all trades, nor in any trade at all times, and
where used, on account of the delay involved , may result in the merchandise
arriving at destination in advance of the bills of lading.) When specifically
requested by a correspondent, we will request the "on board " indorsement, and obtain it, where practicable.
4. When the "on board " indorsement is not specifically requested by a
correspondent, or it is impracticable to obtain it, the date of the bill of
lading will be taken to be the date upon which shipment has been effected .
When the "on board " indorsement is obtained, the date of such indorsement will be taken to be the date upon which shipment has been
effected .
5. Instructions shall be interpreted according to our law and customs,
but in any event, in accordance with the following general rules :
A. Forwarders' bills of lading will not be accepted , unless specially
authorized . Railroad through bills of lading will not be accepted,
except on exportations to the Far East via Pacific ports, unless expressly stipulated .
B. Bills of lading shall contain no words qualifying the acceptance
of the merchandise in apparent good order and condition. If "on
board" bills of lading are stipulated, they shall acknowledge receipt
of the goods on board a named vessel. Otherwise, " received for transportation" bills of lading, which acknowledge the receipt of the goods
into the custody of the steamship owners or agents for transportation
by a named steamer, and failing shipment by said steamer with liberty
to ship in and upon a prior or following steamer, will be accepted ;
and insurance certificates, if required, shall cover shipment correspondingly.
C. Documents for partial shipments will be accepted, even if the
pro rata value cannot be verified, unless expressly prohibited.
D. The use of "to," "until "on," and words of similar import,
in indicating expiration, is interpreted to include the date mentioned.

152

DOMESTIC AND FOREIGN EXCHANGE
E. When the indicated expiration date for payment falls upon a
Sunday or legal holiday here, the expiration is extended to the next
succeeding business day.
F. The terms "prompt shipment," " immediate shipment," "shipment as soon as possible" and words of similar import, shall be interpreted as requiring shipment to be effected and (if the credit advice
is without expressed duration) the stipulated documents presented
for payment within thirty days from the date of our credit advice.
G. Our credit advice if without expressed duration , shall not continue in force longer than one year from its date.
H. The stipulated documents must all be presented not later than
3 p. m. (or twelve o'clock, noon, if Saturday) on the indicated expiration date.
I. The terms "approximately," "about," or words of similar import, shall be construed to permit a variation of not to exceed ten
per centum.
J. Definitions of Export Quotations will be those adopted by the
National Foreign Trade Council , Chamber of Commerce of the U. S. A,.
National Association of Manufacturers, American Manufacturers ' Export Association, Philadelphia Commercial Museum, American Exporters' and Importers' Association, Chamber of Commerce of the
State of New York, N. Y., Produce Exchange, and New York Merchants ' Association, at a conference held in India House, N. Y. , on
December 16, 1919 .

6. Correspondents will understand that the above regulations shall govern
in all credit transactions in the absence of other specific agreements. If
the beneficiary shall make representations, or shall offer security, satisfactory to the bank, that no loss shall result to its correspondent or client
by the waiver of any of such regulations or any instruction, the bank reserves the right to make such waiver, and shall recognize no claim in the
premises unless substantial direct damage shall be shown to have
resulted.
In order to protect themselves against possible losses resulting from
their transactions in documentary bills of exchange, bankers take
from exporters, whose bills they purchase, a document known as an
"hypothecation certificate. " In case a large number of bills are to
be purchased, a “ general letter of hypothecation " (Fig. 35) is taken
and retained by the bank, but if only one or a few bills are involved
then a separate certificate of hypothecation is taken and attached
to the draft along with the other documents.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

153

GENERAL LETTER OF HYPOTHECATION
To the Tenth National Bank, New York.
Gentlemen:Having in contemplation transactions with you from time
to time in the sale of Bills of Exchange with Shipping Documents for goods
or produce attached as collateral security, which documents are to be held
by you for the due payment of the same, we hereby declare that upon the
sale by us to you of any such Bills of Exchange our agreement with you
is understood to be as follows:
You may insure any goods forming the collateral security (if not already
insured, and the policy or policies deposited in your hands) , from sea risk,
including loss by capture, and from fire on shore, and add the premiums
and expense thereof to the amount chargeable in respect of the said Bills,
but it shall not be imperative upon you to effect any such insurance.
You may sell any portion of the said goods which you may deem neces-

sary for payment of such premiums and expenses, freight , or duties, and
take such measures generally, and make such charges for commission, and
are to be accountable in such manner, but not further or otherwise as in
ordinary cases between a Merchant and his Correspondent.
You may take conditional acceptance to such Bills to the effect that on
payment thereof at maturity or under discount the documents handed to
you as collateral security shall be delivered to the Acceptors , and this
shall extend to acceptances for honor.
In case default be made in acceptance of the said Bills on presentation,
we agree immediately on receiving notice from you that you have been
advised by telegraph of such non-acceptance, and without waiting for or
requiring the protest of the said Bills, that we will pay to you the amount
thereof, with all charges of every description incurred by you in consequence of the non-acceptance of the said Bills , or give you a margin which
shall be satisfactory to you, either in cash or Securities, and notwithstanding
that the goods or produce against which the said Bill is drawn , or the Documents thereof remain in your possession in the United Kingdom or elsewhere ; and we hereby agree that your account of the disbursements, commission and charges, incurred by you in consequence of the non-acceptance
of the said Bills shall be received by us as sufficient evidence of the amount
of such disbursements, commission and charges, and shall not be open to
objection of any kind.
In case default be made in acceptance or payment of any of the said
Bills, or if the Drawees or Acceptors should suspend payment, or be adjudicated Bankrupt, or execute any Deed of Arrangement, Composition,
or Inspectorship or take any other steps whatsoever towards effecting a
compromise or arrangements with their creditors during the currency of

154

DOMESTIC AND FOREIGN EXCHANGE

the said bills, you may at any time after either of the aforesaid events
taking place, sell the goods or any part thereof without notice to or the
concurrence of any person whomsoever without waiting for the maturity
of the said bills, and either by public auction or private sale, and you may
act in all respects as if you had been the direct consignee of the goods,
charging such commission as is usual between a Merchant and his Correspondent in ordinary cases, and shall apply the net proceeds of any sale,
after deducting any payment made under the powers herein contained,
with interest thereon and the usual commission and charges, in payment
of the Bills with interest, re-exchange and other charges, and may retain
the balance (if any) towards liquidation of any debt or liability of ours to
you whether or not the same be then payable or ascertained , it being hereby
agreed that the goods themselves until sale shall be liable for and be charged
with the payment of all such Bills, with commission, interest , re-exchange,
and other charges, debts, or liabilities, and we agree that all account sales
and accounts current furnished by you in respect of the said goods shall
be received by us as sufficient evidence of the accuracy of the transactions
to which they refer, and shall not be open to objection of any kind .
We further authorize you, in case the net proceeds of the sale of such
goods shall be insufficient to pay the amount of the said Bills, with disbursements, interest, re-exchange and charges, to draw upon us at the exchange of
the day for the amount of such deficiency, and we engage tohonor such drafts
on presentation, or even without such drafts being sent, to pay you the
amount of such deficiency on your informing us of the amount.
In case the aforesaid Power of Sale shall not have arisen during the
currency of the said Bills, you may accept payment from the Drawees or
Acceptors thereof, and on payment deliver the said Bills of Lading and
Shipping Documents to such Drawees or Acceptors.
In case the Drawees or Acceptors should wish to take delivery of any
portion of the Goods held as collateral Security against the said Bills before
maturity thereof, you are authorized (but not so as to be binding on you) to
make such partial deliveries on receiving payment of a proportionate part
of the said Bills.
The delivery to you as aforesaid of the above mentioned collateral securities is not to prejudice any of your rights on the said Bills in case of dishonor, nor shall any proceedings taken thereon prejudicially affect your
title to the said securities.
All rights, powers, and authorities hereinbefore given to you shall extend to and may be exercised by the holders for the time being of the said
Bills and Shipping Documents.
It is understood that in the event of Bills being paid under discount ,
rebate of interest shall be allowed as follows :-

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

155

At one-half per cent per annum above the advertised rate of interest for
short deposits allowed by the leading London Joint Stock Banks, if the
Bills are taken up in the United Kingdom of Great Britain and Ireland .
At the current minimum rate of Discount of the National Banks of
France, Italy, Belgium and Germany respectively if taken up in either of
those Countries.
Signed

FIGURE 35
The letter or certificate of hypothecation is merely a rather detailed
statement given by the exporter, i. e. , the seller of the bill of exchange,
to the purchasing bank, containing an enumeration of the powers
and privileges of the latter as the buyer of the draft. It recites that
the bank has the right to insure the goods against all risks, if such has
not already been done ; that it may sell all or any part of the goods in
order to satisfy its claims for expenses, commission, and principal ;
that if sufficient funds are not provided by the sale of the goods, the
exporter will reimburse the bank for the deficit ; and that the bank
shall have all authority necessary to enable it to handle the transaction in a manner that will protect its interests. In other words, the
letter or certificate of hypothecation represents a rather complete and
detailed bill of sale and , while it gives the bank few if any powers
that it would not otherwise possess before the law, it does nevertheless clearly set forth those powers in the shape of a formal agreement and thus prevents a controversy arising in the future between
the bank and the exporter in case there be non-acceptance or nonpayment of the draft.

It is not possible or necessary for us to enter into a detailed discussion
of the various papers that must be prepared and handled by an exporter in getting his goods ready for shipment. Anyone interested
in the details of clerical work in connection with foreign shipments,
such as export licenses, shipping permits, export declarations, dock
receipts, etc. , will find full explanations of those matters in the many
volumes that deal with the technic of foreign trade.¹ In this volume
only those papers concern us that are related to the financing of the
transaction .
We have seen that a documentary bill of exchange is usually made
1 Cf. Hough, B. O., " Practical Exporting " ; deHaas, A., " Foreign Trade and Shipping,"
etc.

156

DOMESTIC AND FOREIGN EXCHANGE

up of the draft, bill of lading, invoice, and insurance certificate or
policy , although there are other documents that may be required under
certain conditions and as a consequence of the requirements of the
laws of trading countries. We have already referred briefly to some
of the documents that are commonly found in the field of foreign exchange, but it is advisable to describe them in more detail than has
been done in preceding pages.

Exchangefor
200/0/0

San Francisco,Calif. January 15th , /9/9

At sixty

100 )daysaftersight ofthis33355

)
the same tener unddaleunpaid
of&
rchange (
Second
Paytothe order ofThearkeNationalBankof
SanFrancisco
Two Hundred Pounds
Valuereceivedandcharge the Same toaccountof
J. Robinson & Co..
Liverpool, England .

h16
.
Heury Smit.

Exchangefor
SanFrancisco,Calif
, January 15th, 1919

£200/0/0

At sixty
First
of rchange (

1004days aftersight ofthisSECOND
)
sametenoranddate unpaid

Paytotheorder ofTheCerkeNationalBankof
SanFrancisco
Two Hundred Pounds
Talur revivedand charge thesametoaccountof
J. Robinson & Co. ,

Liverpool , England.

HanySmith 13.

FIGURE 36
Draft drawn by exporter on importer
As has been noted above, the draft is drawn either by a merchant
(the exporter) against another merchant (the importer) (Fig. 36)
or by the exporter against a bank or financial agent with which the
importer has made the necessary arrangements (to be described more

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

157

fully in our discussion of commercial letters of credit) .¹ It is usually
drawn in duplicate, although at times in triplicate, occasionally in
greater number. Each of the copies issued bears its number, i . e.,
"original" or "first of exchange," " duplicate" or "second of exchange," "triplicate " or " third of exchange," etc. Duplicate or
triplicate drafts are drawn, as is the case with the other documents,
so that one set of documents may be sent by one steamer, another by
a second steamer, etc., as a precaution against loss in transit. The
drawer will also usually keep a complete set of documents for his own
file ready for future reference. The first complete set of documents
to arrive, regardless of whether or not they are the originals, duplicates, or triplicates, are the ones that are used to carry through the
transaction. The others become void and are filed away by the
correspondent bank or importer.

The usance of the draft is custom-

arily thirty to ninety days, although short time bills, and bills for a
longer term than ninety days, are not unusual.
The usance depends
upon the agreement between the seller and the buyer, but the really
determining factor is the custom of the trade and of the country to
which the goods are shipped.2 The credit standing of the importer,

1 Cf. Chapter IX.
2 A concise and excellent statement of the credit terms in Latin American trade, prepared by the Guaranty Trust Company of New York, is in part as follows :
Custom of many years' standing has made the 90 days sight draft the most generally
used instrument of credit in South America. Probably eighty to ninety per cent of the
foreign business is done on those terms. The banks even carry their sterling accounts in
90 day bills, checks on which read payable in exchange on London at 90 days after sight.
Another good reason for asking terms other than cash in advance or on arrival of goods
is the natural desire of the merchant to get his purchases in his warehouse and examine
and list them. Usually, too, it takes quite some time to put them through the customs.
Then again the importer may be an agent and the goods may have to go back into the
country where transportation is difficult, in which case he himself will have to wait perhaps
six months before receiving his final payment.
It is not, therefore, a desire to be financed by the foreign seller that prompts this request
for credit as much as the necessity arising from the circumstances of the trade.
The following are the usual terms required :
Argentina: The big houses in Buenos Aires do a large amount of business for cash against
delivery of documents, but bills at 60 and 90 days are common. In Rosario and other
outlying districts 90 days after receipt of goods is quite generally the custom , and even 120
days in Mendoza and up-country. For textiles 120 days is the usual time allowed for payment and for machinery 150 days may be demanded. Although interest at six per cent is
added, it should be included in the face of the draft as only the amount of the face of the
draft is legally collectible in Argentina.
Bolivia: Terms are not less than 90 days after sight and range up to 150 days, dry goods
requiring 120 days. The rule is to accept drafts only on arrival of goods at customhouse.
Documents are very seldom held for payment, being delivered almost in every instance

158

DOMESTIC AND FOREIGN EXCHANGE

the length of time that he has been established, the extent of his business, are factors that also enter into the length of time for which
upon acceptance. Transportation is particularly slow and arduous, pack animals being
required very extensively.
Brazil: The best houses secure credits at 90 days sight. In the out ports 120 days is
quite common, especially for textiles, while heavy machinery frequently requires six to
nine months.
Chile: While some business is done on open credit, 90 days after sight is almost universally
the custom at Valparaiso, the principal port, while at Iquique it is 90 to 120 days .
Colombia: Buyers require usually from 30 to 60 days after goods pass through the custom
house, but six to nine months' bills are quite common . Discount cost plus interest at six
per cent is generally added. Discount for cash or prepayment is usually at the rate of five
per cent per annum. The custom among wholesalers in Colombia is to allow retailers and
agriculturists six months' credit.
Costa Rica: Although many will pay cash for a liberal discount, 90 to 180 days is customary .
Cuba: Credit terms are for three, six and twelve months, according to the commodity,
with six per cent interest added . Discounts offered are usually five or six per cent.
Dominican Republic: Generally four to six months credit is granted, plus interest at
six per cent.
Ecuador: The rule is 30, 60 and 90 days sight bills, but the up-country trade requires
seldom less than 90 days and usually six months to a year, plus six per cent interest.
Guatemala: Ninety days to six months are granted, usually the former, but not infrequently six months after arrival of goods is required, with interest at six per cent.
Haiti: General rule is six months from date of invoice, but quite frequently the time
runs from receipt of goods in warehouse, with interest at six per cent.
Honduras: Many leading firms take advantage of discounts for cash, but six months'
credit is usual. At Puerto Cortez the prevailing terms are 30, 60 or 90 days, plus six per
cent interest or five per cent discount.
Nicaragua: Usual terms six or nine months' bills.
Panama: Usual terms six months.
Paraguay: The general rule is six months after clearance through customhouse, but
as officials allow quite long warehousing in bond agreement should be made limiting time
for clearance.
Peru: Usual terms 90 days sight, but 60 days, 120, and even 180 days are quite common.
Interest is usually at six per cent, and eight per cent for extension . Dry goods require 120
days, and machinery, especially sugar machinery, is sold on long credit, sometimes as
much as three years, with a payment of one third in cash on receipt of invoice.
Salvador: Bills at six to nine months, with interest at five to eight per cent, though a
liberal discount for cash is usually taken advantage of by the importing houses.
Uruguay: Open accounts are quite generally allowed to well-established Montevideo
houses. Otherwise 30 to 60 days sight bills are the rule. Up-country trade requires six
months' credit.
Venezuela: Large amount of business is done on open account but usually payment is
by bills of three to six months' time. Discounts for prepayment are availed of by many
firms. As the consignees named in the consular invoice can always obtain goods from the
customhouse without having any papers in his possession , the bills of lading having no
standing in Venezuela as commercial documents, the attaching of such documents to drafts
affords no security. If acceptance or payment should be required before delivery of goods
to purchaser the only way is to invoice the goods to the banking house that is to make the
collection.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

159

credit is given and assist in determining the usuance of the draft . The
shipper usually indorses the draft in blank when he hands the documents to the bank.
The bill of lading (B/L) is without doubt the most valuable and
important of all the documents that accompany the draft (Fig. 37) ,
Received in apparent good order and condition by AGENTS OF RED "D" LINE OF S. s.
from•HenrySmith and Co. of San Francisco,
to be transported by the steamship
now lying in the port ofSan Francisco.
"Ocean Ware"
with
liberty
to
call
at
any
port
or
ports
in
the
Schedule,
without
regard
to
the
order
specified;
and
to
call
at
that
portssteamer.
in the Schedule
to land passengers and mails, and afterwards return to land eargo; or failing shipment by said steamer, in and uponora other
following
J.R. & Co.

Rosin
2250165
Via Panama Canal
$ 60perton
607150
being marked and numbered, as per margin, shipper's weight (quality, quantity, gauge, contents, weight and value unknown), and to be delivered
land
in like good order and condition, at the port of Liverport
anto Order: notify J. Robinson aingLiverpool. or to his or their assigns, he or
they paying
freight, primage
charges
on discharge
the goods,ofwithout
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or measurement
as per and
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same atanyportallowance
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ITin18craft
MUTUALLY
AGREED
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-ALSO,
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the
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Steamer's
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3.
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FIGURE 37
Steamship bill of lading
because it alone gives possession of the goods either to the holder or
to the consignee, depending upon whether it is an " order " or a
"straight " bill of lading.¹

If the goods have been shipped through

to their destination from some interior point, a comparatively large
number of copies must be obtained from the railroad, varying from
1 Cf. p. 65.

160

DOMESTIC AND FOREIGN EXCHANGE

three to eleven, and depending upon the needs of the railroad, the
exporter, his banker, and the steamship company. If the goods have
been shipped from some seaport, the number of copies will be less and
will be obtained from the steamship company. Only those that are
signed by the proper official of the carrier, usually two or three in
number, are " negotiable,” and all the negotiable copies must be turned
over to the shipper. The number of negotiable copies is entered on
the bill itself with the statement that "one of which Bills of Lading
being accomplished , the others to stand void. " The " non-negotiable "
copies are for purpose of record only. The exporter may keep one
of the latter for his office records, may send one to the importer,
together with a copy of the invoice as an " advice " that the goods
have been shipped . One copy goes to the captain of the ship. Some
countries require that the negotiable bills of lading covering goods
that are being imported must be certified by the consul of that country
at the point of export. This is especially true of South American
countries.¹ The consul of some countries requires a non-negotiable
copy for his files.
Bills of lading are usually drawn " to the order " of the exporter and
when indorsed by him, simply by his writing his name across the bill,
become negotiable. Some countries, however, forbid the use of
the " order " bill of lading (Venezuela, Costa Rica, Columbia, and
2
Panama, for example) .
In those cases a " straight " bill of lading is
necessary and very frequently is made out to a party other than the
importer but located in the importer's country, such as the correspondent of the bank negotiating the draft. Order bills of lading
customarily bear the clause " to be delivered unto Order: notify-" (mentioning the name of the consignee). This practice is
followed so that the correspondent bank, when it receives the documents, may know to whom the goods are being shipped and thus
be able to advise the importer of their arrival. Bills with the " notify " clause do not give the party mentioned any control over the
goods until they have presented the properly indorsed bill of lading.3

1 Uruguay, Bolivia, Chile, Costa Rica, Cuba, Peru , Honduras, and San Salvador require
that all negotiable bills of lading shall be certified by the consul, while Paraguay requires
only one to be certified, Haiti five, and Panama four. Cf. deHaas, op. cit ., p. 191 .
2 During the World War the Allies forbade the use of the " order " bills of lading to some
ports because they wished to know to whom the goods were actually being consigned.
In 1921 a Brazilian court held that a dual control was created by a bill of Lading containing the "notify " clause. It should not appear, therefore, on bills of lading covering

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

161

The purchasing bank should make certain that the bill of lading is
((
'clean," i. e., that there is no notation on the bill to the effect that
the goods have been received by the carrier in damaged condition.
In the latter case the carrying company issues what is called a "foul "
bill of lading, which, of course, from the standpoint of the bank, is not
a satisfactory sort of security for its investment .
Insurance on land shipments is practically unknown because of the
liabilities imposed by state and federal laws upon common carriers ,
but on sea shipments it is universal, not only because of the limited
liability of the steamship company, but also because the possibilities
of loss are so much greater. Some of the more important contingencies
are :
"(a) Loss of vessel or cargo or damage sustained from stranding, sinking,
fire or collision, including salvage and other charges.
"(b) Loss or damage by sea water or from risks on shore while in transit,
or awaiting shipment, transshipment or delivery, including those of loading
and discharge .
"(c) Loss or damage from theft or pilferage, leakage and breakage, fresh
water, sweat, etc.
"(d) War risks, including danger from mines as a result of war-time operations, riots and civil commotion. " 1
The liability of the marine carrier is limited practically to its exercising due diligence in seeing that the ship is seaworthy, " free from
all defects, latent or otherwise," 2 and properly manned , equipped,
and supplied. If such is the case, neither the shipowner " nor the
charterers shall be held responsible for damage or loss resulting from
faults or errors in navigation or in the management of the vessel, nor
shall they be held liable for losses arising from dangers of the sea, acts
of God, or public enemies, or the inherent defect, quality or vice of
the thing carried, or from insufficiency of package, or seizure under
legal process, or from loss resulting from any act or omission of the shipper or owner of the goods , or from saving or attempting to save life
or property at sea, or from any deviation in rendering such service.
It is obvious, therefore, that the responsibility for a good many kinds
of losses which may be incurred can with difficulty be brought home
shipments to Brazil. Consignments to that country should be made "to the order" of the
shipper himself or "to the order " of the bank negotiating the draft.
1 "Trading with the Far East," published by the Irving National Bank, N. Y., 2d edition ,
1920, p. 124.
2 Hough, "Practical Exporting, " 3rd ed ., 1919, p. 421 .

162

DOMESTIC AND FOREIGN EXCHANGE

to the carrier. The shipper's protection against other losses must be
secured through marine insurance. " 1
The marine insurance policy usually covers only the loss or damage
resulting directly from the " perils of the sea. " If a person desires
to cover loss from other causes, such as deterioration of the goods in
transit, breakage, pilferage, fire, etc. , it is necessary to include clauses
to that effect and to pay extra premiums therefor. Losses from pilferage were very great during the World War and have continued down
to date.

It has been estimated by one British shipowner that claims

for pilferage have increased about 2000 per cent since 1913 ,² a situation
that has naturally tended to increase the premiums on insurance
against theft and robbery. Where ordinarily these premiums have
been about 5/8 of one per cent on the invoice value of the goods,
they are now from three to four times that amount. At present
(April, 1922 ) British and American steamship companies refuse to
hold themselves responsible for pilferage where the loss can be covered
by insurance, and proof of negligence on the part of the carrier is
necessary to obtain damages. Needless to say such negligence is at
very difficult matter to prove in court . British and Dutch underwriters have also adopted the policy of covering theft risks up to only
seventy-five per cent of the value of the shipment. The ever present
danger from floating mines makes it still advisable to carry war risk
insurance. Newspapers even yet occasionally report ships being blown
up by floating mines in the North Sea and in the Mediterranean.
The insurance policy of today contains many clauses and expressions
which appear old-fashioned and, to the uninitiated, also meaningless.
Some of the policies issued by American marine insurance companies
and by the U. S. War Risk Insurance Bureau 3 during and after the
World War have been couched in somewhat more modern terms . The
reason for the dominance of the British or old-fashioned form of policy
is that, having been in use for centuries, the English courts have established a body of interpretations and decisions covering the various
phases of marine insurance, and to change the form of the policy at
this late date would raise many questions as to the meaning of the
newer statements and necessitate interpretation by the courts .
Prior to the World War, English companies controlled more than
1 Hough, op. cit., p. 436.
2 Foreign Trade Bulletin of the American Express Company, March, 1921 .
3 The U. S. War Risk Insurance Bureau insured only against marine war risks, the cargo
having to be insured against other risks in approved companies.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

163

two-thirds of the marine insurance business of the United States.
There were relatively few American companies operating in the field ¹,
and those which did reinsured a considerable portion of their business
with English companies. In international trade rivalry, marine insurance plays a very prominent part . It is one of the three principal
commercial facilities, the other two being an adequate merchant
marine, and an adequate banking and financial machinery covering
all countries with which we trade. "British commercial interests
have long realized the advantages of coöperation between these three
complementary factors, since each can be made to serve and hasten
the growth of the others. " 2 Dr. Huebner estimated that in 1918
foreign companies in the American market collected approximately
$71,500,000 premiums on marine insurance, to say nothing of premiums
on fire insurance , amounting to approximately $ 144,000,000 and on
casualty, liability, and the various forms of inland insurance, amounting to about $35,000,000, making an annual insurance payment by us
to foreign companies of about $ 250,000,000.3 During the World War,
efforts were made-and met with some success-to increase the amount
of marine insurance written by American companies. Since the conclusion of the war, however, American companies have been unable
to hold their own in competition with foreign companies, and now find
their business slipping away from them . Great changes must come
in our insurance laws, in our banking system, and in our foreign trade
activities before we can expect to compete successfully with foreign
insurance companies .
The marine insurance policy differs from the so-called insurance
certificate. The policy is usually a rather lengthy printed document
describing in detail just what shipment is insured , the amount for
which insured, the length of time the policy is to be in effect, the conditions and circumstances under which the insurer will hold itself
liable for loss, the boat on which the goods are to be shipped, etc. , and
is usually issued in duplicate.

The shipper is given a receipt by the

1 Dr. S. S. Huebner in his Report on the Status of Marine Insurance in the United States,
Washington, 1920 , pp. 27-33 , gives the following reasons for the dominance of the British
companies: A world market of long development ; a broader spread and broader reinsurance
facilities; a close union with banking and shipping interests; freedom to combine or to
form communities of interest; permission to write numerous kinds of insurance; a smaller
tax burden; ease with which American insurance may be exported abroad ; a smaller overhead charge; and support of home merchants and vessel owners.
2 Huebner, op. cit ., p . 10.
3 Ibid, p. 12.

164

DOMESTIC AND FOREIGN EXCHANGE
e
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order of The Assured
jon surrender of this Certificate, which represents and takes the place of the Policy and conveys all the rights of the Original Policyholder, (for the purpose of collecting any claims for loss or damage), as fully as ifthe
property were covered by a special policy direct to the holder hereof, and is free from
any liability for unpaid premiums.

Not valid unless countersigned by
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The

ByAuthorityof theAbove Kamed Insurance Companies
WILLCOX, PECK HUGHES
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FIGURE 38 -Insurance certificate

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE
insurer showing the essential facts of the transaction.

165

In case of

occasional shipments an ordinary policy is issued, but when frequent
shipments are made by the exporting firm, an "open " or " floating"
policy is customarily obtained. These open policies cover risks
amounting to large sums of money and contain clauses which protect
the goods under various circumstances as desired by the shipper.
They do not contain any data relating to any one shipment, but , as
each shipment is made, the insurance company indorses the required
information thereon. An open policy runs for a given length of time
or until the aggregate values of the shipments amount to the total
sum for which the policy has been issued. Open policies are extremely
handy for exporters because they enable the shippers to insure their
goods without the necessity of continually resorting to the insurance
office . When a shipment is ready to go forward, the exporter fills out
the necessary blanks, which have been supplied him, just as though
he were the insurance agent. These blanks are technically known as
"insurance certificates " (Fig. 38) . He makes as many copies as he
needs for his bills of exchange, usually two, in addition to one copy
for his own files and another for the advice of the insurance company.
When the latter receives the "advice " copy it indorses the required
data on the open policy , and enters the amount of the premium
against the account of the exporter . The certificate contains a statement to the effect that a certain specific shipment sent on a certain
designated vessel has been insured under a policy of certain number
and that losses will be paid on such shipment in accordance with the
terms of the original policy . Although much briefer, the certificate
has all the force of the policy on which it is based. Special clauses may
also be stamped on the certificate. Once a month or thereabouts, the
exporter settles with the insurance company and pays the premiums
charged against him.
Such practice avoids delay in making shipments, since the insurance agent does not have to visit the exporter's
plant and write a policy every time a shipment of goods is ready to
go forward.
Marine insurance policies and insurance certificates are made out
to the shipper or order and as a rule are indorsed by him in blank,
just as is done in the case of the other negotiable instruments that
constitute a documentary bill of exchange.
It is customary to insure the cargo for from ten to twenty per
cent more than the actual value of the goods shipped in order to

166

DOMESTIC AND FOREIGN EXCHANGE

cover "the costs of ocean freight, other incidentals, and possibly,
sometimes, loss of the foreign importer in the non-arrival of goods
on which he was depending."
All the various kinds of risks insured
against must be mentioned in the policy in order to secure the desired
coverage. The cost of insurance depends upon the character of the
risks insured , the nature of the goods, the point of destination, the
character of the vessel on which the goods are shipped, etc. In normal
times the rates will vary from one-quarter of one per cent on the invoice value, provided the goods are being sent to one of the main
European ports, to one and one-half or to even two per cent on shipments going to Oriental or tropical ports.
Insurance may be effected by the shipper or by the importer. Very
frequently the importer finds that he can obtain marine insurance
much more cheaply at home than by allowing the exporter to secure
it for him, in which case he notifies the exporter, and the latter, in
place of the insurance certificate or policy , includes a declaration to
the effect that “ Insurance has been effected abroad . ” 2
Another important document is the invoice (Fig. 39) , which is
HENRY SMITH & COMPANY
San Francisco

January 15, 1919

To J. Robinson & Co. ,
Liverpool, England
50 bbls. Rosin 450 lbs . each @ £4 per bbl.
C. I. F. Liverpool ...

£200. o. O

Marked J. R. & Co.
Numbered 1 to 50
Per S. S. "Ocean Wave " via Panama Canal

FIGURE 39
Invoice
usually only a statement of the goods shipped , although good commercial practice demands that it contain the name and address of the
consignee as well as the name and address of the party to whom invoiced, a full description of the goods , a statement of the number of
boxes or packages, the method of packing, the number of articles in
1 Hough, op. cit., p. 445 .
2 Cf. Chapter IX . The technical details of marine insurance may be learned by consulting any of the standard books on that subject. Cf. Huebner, S. S., " Marine Insurance"; Gow, W., " Marine Insurance " ; Winter, W. D., " Marine Insurance," etc.

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

167

each container, the marks on the boxes, the weight and dimensions
of the cases, the price per unit of measurement, the total price of the
shipment, discounts, the name of the steamer and route, the terms
of sale, and such other information as may be necessary for the importer to identify the goods when they arrive.¹ Invoices should always be numbered and signed and should include the cable code which
the exporter is accustomed to use. It is the practice of some firms to
include also a statement of extra charges that the importer is to pay
and which have been included in the sum for which the draft has been
drawn, but sometimes this latter information appears on a separate
form . The number of copies and the language in which the invoice
is made out must coincide with the legal requirements of the country
to which the goods are being sent.
A consular invoice is very generally demanded, especially by Central and South American countries, Cuba, Mexico, etc. (Fig. 40) .
AMERICAN CONSULAR SERVICE
CONSULAR INVOICE

(Place and date.)
-purchased

Invoice of

of9 of-

by
from
to be shipped per-

Marks,
Numbers,
and
Quantities

FULL DESCRIPTION OF
GOODS
(N. B. -Always state the
cost of packing, and all
other costs, charges, and
expenses)

Price
Per Unit

The above invoice is correct and true.
(Signature of purchaser or seller or duly
authorized agent of either signing in the
name of his principal)

1 Cf. deHaas, op. cit., pp. 180-182 .

Total
Amount

Consular
Corrections
or
Remarks

168

DOMESTIC AND FOREIGN EXCHANGE

Declaration of Purchaser or Seller or Duly Authorized Agent of Either

I,
We
of-

-do solemnly and

I am
truly declare that
thewe are
(Purchaser or seller)
of the merchandise in the within invoice mentioned and described ; that
the said invoice is in all respects correct and true, and was made at the
place named therein whence the said merchandise is to be exported to the
United States of America ; that said invoice contains a true and full statement of the time when, the place where, and the person from whom the
same was purchased , or agreed to be purchased and the actual cost thereof,
price actually paid or to be paid therefor ; and all charges thereon ; that no
discounts or commissions are contained in said invoice but such as have
been actually allowed thereon ; that all drawbacks or bounties received or
to be received are shown therein ; that no different invoice of the merchandise has been or will be furnished to anyone, and that the currency
in which the invoice is made out is that which was actually paid or to be
paid for the said merchandise .
I
further declare We

I
We further declare that it is intended to make entry of said merchandise
-in the United States of America.
at the port ofDated at" this
day of
(Date)

The signature to a declaration made by an agent should show the name
of the principal, the name of the agent , and an indication of the authority
by virtue of which the agent acts.

FIGURE 40
Consular invoice

FUNDAMENTALS OF FOREIGN BILLS OF EXCHANGE

169

It is similar in its content to . the ordinary invoice, but at times contains additional information required by the laws of the importing
country. The form is usually obtained from the consular officers.
When the necessary number of copies (varying from one to seven)
have been filled out, they are certified or sworn to before the consul
of the country to which the goods are to be sent . A small fee , either
a definite fixed sum, such as $2.00, $2.50 , etc. , or a percentage fee,
such as one or two per cent of the value of the shipment, is paid the
consul for certification. Such fees are in reality disguised import
taxes. On the other hand, however, consular invoices greatly facilitate the work of the customs officials of the importing country.
A certificate of origin is sometimes met with in handling documentary bills of exchange. It is merely a certified statement showing in
what country the goods originated, and also giving the name of the
exporter and the consignee, and a description of the goods themselves.
In some countries it is necessary for such certificate to be presented
in order that the goods may be admitted to the importer's country
at a reduced tariff rate. The certificate is viséed for a fee by the consul
of the country of destination.
Some countries require an inspection certificate showing that the
goods were in proper condition when they left the shipping point.
This applies especially to meat and meat food products, processed
butter, etc. Some countries (primarily British colonies) also require
anti-dumping certificates, which are sworn statements to the effect
that the goods are not listed at prices lower than those for which they
are selling at home and that no unusual discounts are being given to
the importer.
necessary.

Certificates of weight, analysis, etc. , are also sometimes

A documentary bill of exchange comprises one copy of each of the
required documents. Care must be taken to have each set complete,
free from erasures, corresponding in all details , and properly indorsed .
They carry title to the goods, and consequently the banker who buys
them must be careful that they contain or omit nothing that will impair the bill of exchange as a negotiable instrument in which he has
invested his money .
The above discussion holds true regardless of whether the exporter
sells his documentary bill of exchange to the bank or whether he
turns it over to the bank for collection . Very frequently the latter
practice is followed when the discount rates are unfavorable and the

170

DOMESTIC AND FOREIGN EXCHANGE

exporter prefers to wait for the return of the funds after their collection abroad, or when the consignee is unknown, or when the exporter
is willing to allow the importer to take a portion of the goods from
time to time and to pay for them in pro rata installments, or for some
other reason. The bank then acts as a collection agent, and pays the
money to the exporter as collected , minus its charges . The instructions given by the exporter to the bank in such cases must necessarily
be full and explicit as to just what the bank is to do under any and
all circumstances that may arise.

CHAPTER VIII
TYPES OF FOREIGN BILLS OF EXCHANGE
The means that are employed in paying bills abroad or in financing
foreign trade or foreign travel may be roughly divided into five groups :
A. Mail remittances, i. e . , checks on foreign accounts, postal and
express money orders, bank post or postal remittances, and bank
drafts.
B. Cable remittances , i . e. , cables or telegraphic transfers.
C. Those that arise in connection with the loaning of foreign money

or foreign credit in the United States, i. e. , the greater part of the socalled bankers' long bills, including those used in connection with (a)
currency or dollar loans, (b) loans in terms of a foreign money, and
(c) "finance " bills.
D. Those that are used for traveling purposes , i. e . , the travelers'
check, and the travelers' letter of credit.
E. Those means that enable creditors to draw drafts on debtors
for goods sold or services rendered or to collect some monetary claim,
i. e . , drafts drawn against sales of securities or drawn under a commercial letter of credit, authority to purchase, etc.
A. MAIL REMITTANCES
Checks. The ordinary check drawn by the depositor on his banking
account in terms of dollars, with which all are so familiar in domestic
trade, does not function in foreign transactions. Lately, however,
large American importing and exporting firms have developed a
decided tendency to establish checking accounts, both demand and
time, in foreign countries. This tendency has been encouraged by
the very favorable exchange rates that have prevailed during the last
few years. Today, when one of these firms desires to pay a bill abroad,
it merely draws a check on its foreign account in favor of its creditor,
just as it would on its own local bank account for a domestic payment,
and forwards the check to the foreign party to whom it owes the money.
The check is drawn in terms of the money of the country in which
171

172

DOMESTIC AND FOREIGN EXCHANGE

the firm has its foreign account, and is payable at sight. In the establishment of such foreign accounts, certain of the larger banks and
some express companies have given active assistance by selling sight
drafts drawn on the foreign accounts of the bank or express company.
These drafts the American firm (or the bank or the express company
acting on its behalf) forwards to the foreign correspondent along with
copies of the signature of the firm , whereupon the foreign correspondent
opens the account just as a San Francisco bank under similar conditions
would open an account for a New York firm . More frequently the
American firm deposits a sum of money with the American bank or
express company, together with several copies of the signatures which
are to be honored on the firm's checks . The exchange dealer sends the
signatures to the foreign correspondent with a request that an account
be opened for the American firm and that the stated sum be deducted
from the account of the exchange dealer on deposit with the correspondent and transferred to the account of the American firm . The
exchange dealer is paid for his services by the profit which he makes
in charging the American firm a certain exchange rate for that portion
of his foreign account which he has turned over to it, the rate charged
being the ruling rate for sight drafts on the center in which the account
is established .
International or Foreign Postal Money Order. A method often employed, especially by foreigners, in sending small sums abroad , is the
international postoffice money order sold by the local offices of the
U. S. Postoffice Department. The application blank must be filled
out by the sender or remitter. The clerk takes the application and
from the data thereon fills in the spaces on the money order itself. The
money order is of three parts, one being the stub or receipt kept by
the issuing office , the second being the receipt given to the remitter,
and the third the order itself, which is also given to the remitter. The
remitter sends the order to the foreign party, who presents it at his
postoffice and receives, in money of his own country, the sum designated. Suppose that the remitter wishes to send ten dollars to
his mother in England. He fills out the application , the clerk converts the ten dollars into pounds sterling at the rate fixed by the U. S.
postal authorities, and writes out an order for so many pounds, shilling, and pence . The English postoffice, on presentation of the order
by the sender's mother, pays the amount designated.
The United States Government in 1920 had direct exchange con-

TYPES OF FOREIGN BILLS OF EXCHANGE

173

nections with fifty-three countries and indirect connections with many
others. On some it is authorized to draw in the money of the countries
concerned ; on others it must draw in dollars and cents and the orders
are converted by the local foreign postoffice into the money of the paying country.
The postoffice charges a fee for the issuance of the order varying
in amount from three cents to one dollar for sums ranging from one
cent to 100 dollars, depending upon the amount of the order and also
upon the country to which the order is sent. There is a group of
countries made up mostly of the smaller West Indian islands, Cuba,
Canada, the Philippines, etc. , on which the domestic form of money
order is issued and for which the domestic rates are charged.¹ On all
other countries the international money order form is used and a
different set of rates is charged. A single foreign money order cannot
be drawn for more than $ 100 worth of foreign money, although any
number of such orders may be issued to a person .
Inasmuch as the money order must be drawn on the more important
nations in terms of the money of those countries, dollars must be
converted into terms of that money. The postoffice authorities supply
the local offices with a conversion schedule of rates. The following
rates on the more important European countries were in effect until
August 15, 1920:

Pound Sterling ..
Krona on Sweden, Norway and Denmark ..
Florin on Holland ..
Franc on France, Belgium, Switzerland,
and lire on Italy ..

$4.87
.26 9/10
.40 1/2

1.00 for 5.15 francs or lire

During the early days of the World War, the market rates on the
above countries , especially on England , reached such high levels that
it was possible for bankers, speculators, and others to go to the postoffice and receive, for example, a money order on England at a cost
of $4.87 per pound sterling when the cost in the open market was $5.00
or higher. To have continued the unlimited sale of orders at the then
existing scale of rates would have meant serious financial loss to the
government. Therefore, on August 3 , 1914 , the Postoffice Department instructed the local offices not to send more than $ 100 worth
of foreign money orders to any one payee. This restriction remained

1 Cf. footnote, p. 25.

174

DOMESTIC AND FOREIGN EXCHANGE

effective until January 21 , 1915 , by which time the rates in the market
had returned to normal. The rates of conversion and the practices of
the postoffice then remained unchanged until August 15 , 1920 , when
the following schedule was issued by the Postmaster General, because
the rates in the market had declined so greatly:

Pound Sterling ...
Krona on Sweden .
Krona on Denmark and Norway .
Florin ...
Franc on France, Belgium, and lire
on Italy ......
Franc on Switzerland

.$4.00
.24
.20
.38

1.00 for 10.30 francs or lire
1.00 for 5.15 Swiss francs

A further revision was made on November 15 , 1920 :

Pound Sterling.
Florin on Holland .
Krona on Sweden ..
Krona on Denmark and Norway .
Franc on France and Belgium ...
Lira on Italy ..
Franc on Switzerland .

$3.75
-35
.22
.16
13 francs for 1.00
for 1.00
20 lire
5.15 francs for 1.00

These revisions of the conversion table of the postoffice were necessary because the previous rates had afforded excellent opportunities
for speculation and because also serious complaint was being made
that the government was charging altogether too much for its money
orders. The public until August , 1920, had to pay $4.87 (which rate
had been fixed in 1880) plus a ten cent fee for a £ ı money order at
a time when express companies and banks were charging from $3.20
to $3.50 and were getting the major portion of the business. The
high rates, however, enabled the postoffice department to profit
greatly, so that, in spite of losses arising out of unfavorable purchases
of exchange, ¹ it made a profit of $ 1,242,079.08 on the foreign money
order business during the fiscal year ending June 30, 1920. Approximately $33,000,000 worth of orders were sold during that year.2
The U. S. Postoffice Department sells more money orders on foreign
countries than it is called on to cash against those countries. As a
1 The total loss amounted to $ 1,380,224.94.
2 The extent of the business grew from $22,189.70 in 1870 to a maximum of $97,681,211.85
in 1911. Since 1911 there has been a slight decrease in the amount of orders sold.

CAUTION
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41
FIGURE
check
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The American Ex-

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chased in this way is then sent
abroad to settle the obligations of
our postal department to foreign
governments.

N

does by asking for competitive
bids from the exchange dealers in
New York. The exchange pur-

.THIS Data
AMOUNT
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PRINTED
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amount
thewritten
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ifany
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consequence it has to go into the
open market and purchase exchange to meet its foreign indebtedness thus occasioned.¹ This it

175

Sent
...
to191

.
CO
EXPRESS
AMERICAN
LIMITED
CHECK
REMITTER'S
RECEIPT
.
KEEP
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AMOUNT

TYPES OF FOREIGN BILLS OF EXCHANGE

press Company issues through its
agents what is known as a "limited

M
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order
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with it. The maximum amount
for which the check can be issued

that sum he may purchase as many
orders as may be required to do so.

260
25
50
100
150
200
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to the postoffice

is limited to $ 100, although if a
customer wishes to send more than

160
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KRONER

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press Company in New York City,
where it is finally canceled.
The check is somewhat similar

30
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later finds its way back to the
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142
1086

To

hotel, store, or express office.

,defacement
alteration
hereon
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check " (Fig. 41 ) .

three parts, the customer's receipt,
the order itself, and the agent's
stub. The customer keeps the receipt and mails the order to the

DOMESTIC AND FOREIGN EXCHANGE

176

The checks are sold at the current rates of exchange, according to
quotations supplied the agents (Fig. 42) , so that the customer
AMERICAN EXPRESS COMPANY

Foreign Exchange Rates
SAN FRANCISCO
Good Only for Use

May 24th, 1922
Postage applies only on Foreign M/Os
Checks
England
4.452
Ireland-Scotland 4.45%
France
.0912
Belgium
.0844
Switzerland
. 1912
Italy
.0523
.1840
Norway
Sweden
.2590
Denmark
.2150
Holland
.3895
.0212
Finland

Hongkong
Spain
Greece
Germany
Hungary
Austria
Czecho-Slovakia
Jugo-Slavia
Roumania
Japan

.6035
.1605
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.0038
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£
£
Francs
Francs
Francs
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Kroner
Kroner
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$ Loc. Cy .
Pesetas
Drachmas
Marks
Kronen
Kronen
Crowns
Kronen
Lei
Yen

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.0071
.4875

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25¢
25¢
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30¢
15¢
15¢

15¢
15¢
15¢
25¢
15¢
25¢
25¢
25¢

256
25¢
25¢

FIGURE 42
Foreign exchange rate list of American Express Company
First column of rates applies to express foreign drafts and limited check ;
the second column to postal remittances ; the third column to the
postage charge on postal remittances

is always able to purchase his remittance at a much better rate
than in the case of the postoffice foreign money order.

The offices

TYPES OF FOREIGN BILLS OF EXCHANGE

177

of the express company are usually more conveniently situated
near the business district of the town than is the postoffice. Further, the express company sells not only through its own offices,
but also through branch agents and local exchange dealers, such
as banks, steamship companies, etc. It can also furnish orders on
more foreign countries than the postoffice because it has thousands
of correspondents scattered all over the globe.
Bank Post Money Order or Postal Remittance. Closely akin to the
foreign money order is the " bank post money order," or, " foreign
postal remittance " as it is sometimes called, originated by the American Express Company in 1897.

People in the outlying districts of

foreign countries are unacquainted with the intricacies of checks,
drafts, money orders, indorsements, etc., and much prefer to have
the actual money sent them. Banks and express companies have
developed a very unique device to make this possible. If the remitter
goes to the office of the bank or express company and states that he
(6264, JUNE 1831)

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ADDRESS
FROM
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NAME AND
NOT NEGOTIABLE DATE
SUR-AGENT
NOT EXCEEDING $50
STAMPER HERE

FIGURE 43
American Express Company postal remittance
wishes to put a certain amount of the actual money of a foreign country in the hands of his family or relatives, he will be advised to use a
postal remittance (bank post money order) . This order is usually
of four parts, viz. , the remitter's receipt, the agent's stub, the notification to the payee , and the advice to the correspondent of the exchange
dealer from whom the order is being purchased. To simplify the
description of this interesting foreign exchange device, let us first
consider the method and form issued by the American Express Company for which, as it will be remembered, all express offices now act
as agents in domestic and foreign exchange matters.

DOMESTIC AND FOREIGN EXCHANGE

178

FIGURE
-ostal
remittance
P44
issued
through
bank
by
American
Express
Company

192
CREDIT
BALANCE
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N°
000000

these is the remitter's receipt,
the second, the agent's stub,
and the third, the advice to
the Foreign Order Department
of the American Express Com-

SCRANTON
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The blanks are issued to the
agencies in book form, each
order being in triplicate and
numbered serially.
One of

pany. No notification to payee
is given to the remitter. The
agent fills out the three parts

Spredum

at once by using carbon paper
between the sheets. The same

and Aruo

data thus appear on each, although each contains a printed
heading at its top showing
whether it is the stub, receipt,

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or advice (Fig. 43) . He retains the stub, and gives the re-

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ward it to the payee in the
foreign country so as to advise
him that the money is being
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by the agent to the head office

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ceipt to the remitter. The remitter keeps the receipt, but if
he desires to do So, he may for-

of the American Express Company in New York, which, in
turn notifies its agent or correspondent, located nearest to
the payee, to pay to the latter
the amount of money designated . The correspondent incloses the exact sum of money
in an envelope, registers it, and,
through the postoffice

or a

messenger, sends it to the payee.

TYPES OF FOREIGN BILLS OF EXCHANGE

179

Sometimes a local postoffice money order is inclosed instead of the actual money depending upon whatever method the correspondent considers will best serve the interests of the payee. When the payee
receives the registered letter he signs a receipt which is generally sent
back to the original issuing agent in the United States and through
him turned over to the remitter thus assuring the latter that the
money has reached its destination .
The forms used by exchange dealers that sell exchange through the
American Express Company's service, i. e. , banks, steamship companies, etc. , have the name of the exchange dealer, instead of the name
of the American Express Company, appearing on the blanks (Fig.
44) . They consist of two parts, the dealer filling out both parts at
once by using carbon paper. The first part consists of the order and
the remitter's receipt, while the second part consists of the dealer's
stub and the advice which he sends to the American Express Company.
The costs of a postal remittance are higher by two points on the
exchange rate than for the limited check, plus postage, which ranges
from 10 cents to 30 cents according to the postal rates of the country
to which the order is being sent.¹
If the money is to be forwarded to a country upon which the company quotes exchange rates to its agents and dealers, the sum in
dollars that is to be sent is converted into terms of the foreign money
on the basis of the conversion table furnished the agent or dealer by
the New York office of the company and kept up to date by it.² The
quoted rate includes a slight profit for the express company. But when
exchange rates are not so quoted , the remittance is made out in dollars
and is payable in the foreign country at the current rate of exchange
for dollars in that country on the day that the remittance is paid, the
conversion being effected by the foreign correspondent, who deducts
his charges before paying over the money to the beneficiary.
Of late the American Express Company has had to meet the competition of the larger banks and exchange dealers , who have also
developed their own system of bank post remittances.

The following

is typical of the form commonly used by banks and exchange dealers
(Fig. 45) . It is made out in triplicate and none of the copies is negotiable, just as was the case with the postal remittance of the American
1"The system depends for its life upon a facility provided by continental postoffices .
that of marking the value of the contents of registered letters on the cover, and paying ad
valorem postage which automatically insures it." Guaranty News, September, 1919, p . 216.
2 Cf. p. 176.

DOMESTIC AND FOREIGN EXCHANGE

180

Bank
National
Merchants
The

Express Company. The original is mailed to the payee notifying him
that the money will be forwarded ; the duplicate is the remitter's receipt, while the triplicate is kept by the issuing bank for its files. The

FOR. DEPT.

ED
EL
NC
CA

OF
ANGELES
LOS
California
A.
,U.
S.

Bank Post Remittance a

No.

Los Angeles California, U. S. A..

M
Address

192

will be transmitted the sum of.
for account of
FOREIGN AMOUNT

AMERICAN AMOUNT
$

ORIGINAL

BEE NOTICE ON BACK НЕЯСОР

FIGURE 45
Postal remittance issued by bank
FOON2:0 F M.N.ELA
CABLE ADDRESS MERCHANTS LOSANGELES

16-5
TheMerchants National Bank 16
OF LOS ANGELES
Los Angeles, Cal.,.

192.

Tothe
DearSirs:
Kindly executefollowing payments by registered and insured mail boxshayxagainst debit ofour account.

DATE

No.

IN FAVOR OF AND ADDRESS OF PAYEE

AMOUNT

ED
EL
NC
CA

YOURS TRULY

FIGURE 46
Advice to foreign correspondent in connection with bank post money order

181

TYPES OF FOREIGN BILLS OF EXCHANGE

issuing bank uses the following form of advice in notifying its foreign
correspondent to pay to the designated party, by registered and insured mail, the sum mentioned and to deduct that amount from the
account of the sending bank (Fig. 46) .

When a local country bank

issues a postal remittance through another exchange dealer or jobbing
bank, it employs the same forms in the same manner as above, but
it does not notify the foreign correspondent bank. It notifies the exchange dealer or jobbing bank through which it is issuing the postal
remittance and uses the following form for that purpose (Fig. 47) :
FRCN. DEPT.

USF SEPARATE SHEET FOR EACH COUNTRY-SEND US ORIGINAL AND DUPLICATE

M.N.B.I.A.

FOREIGN POST REMITTANCES
Date.

Bank
To The Merchants National Bank of Los Angeles, California
Gentlemen: Please execute the following payments:
AMOUNT
NO.
NAME AND ADDRESS
OF PAYEE IN FULL
(WritePlainly)

&

Total
Ca
Postage .. Orders (@
TOTAL

$
$
Bank.

FIGURE 47
Advice to jobbing bank in connection with bank post money order
The exchange dealer or jobbing bank uses the same form as above
(Fig. 46) in notifying its foreign correspondent of the issuance of the
post remittance just as though it itself had sold the remittance to the
customer. The larger banks , just as was true of the American Ex-

182

DOMESTIC AND FOREIGN EXCHANGE

press Company, act as wholesalers of exchange, while the local banks
that draw through them act as retailers . The retailer charges what
the traffic will bear, but always buys exchange at the rates sent out
daily or weekly by the bank through which it sells.
Before the upheaval and disarrangements caused by the Great War
this system of forwarding money to foreign countries was " as nearly
perfect as was humanly possible."
In normal times hundreds of
thousands of such payments were transmitted to Europe weekly. The
American Express Company alone in 1919 handled an average of
10,000 such orders per week, while during seasons of heavy business
it has been called upon to handle upward of 4,000 remittances daily.
The Guaranty Trust Company of New York declares that "We have
always felt that the financial regeneration of Italy, which was so noticeable from 1895 onward, was due in no small measure to the continual
pouring in to that country in one unending stream of these small
remittances which represented the savings of her faithful children
who emigrated both to North and South America." 2 It is estimated that at least $100,000,000 was formerly sent annually to
Poland by her emigrants, mostly by means of the bank post remittance.
The breaking up of families, the changing of addresses , and all the
confusion caused by the World War, greatly upset previous conditions,
with the result that it has been difficult and in many cases impossible
for the bank and express post remittances to function as satisfactorily
as before. Undoubtedly, with the return of normal conditions in the
late warring countries, the bank and express post remittances will regain their former usefulness.
Bank Drafts. The two kinds of exchange most commonly purchased by American business firms and others for remitting money

to parties in foreign countries are drafts and cables, both of which are
sold by banks and express companies . In normal times they are
available on any of the important trading countries of the world; war,
of course, naturally interferes with customary practices.
Most foreign drafts are drawn payable at sight, but drafts payable
a certain number of days after sight or after date are not uncommon.
Especially is the latter true of drafts sold by South American banks,
usually drawn on correspondents in England payable 90 days after
sight and sent by South Americans to their creditors even in countries
2 Ibid.
1 Guaranty News, op cit.

TYPES OF FOREIGN BILLS OF EXCHANGE

183

other than England.¹ Foreign drafts are usually drawn payable to
the order of the foreign party to whom payment is to be made, although
they are sometimes drawn to the order of the customer or purchaser
who then must add his indorsement before sending them abroad. It
is customary to draw foreign drafts in duplicate or even in triplicate,
but the former practice is the rule (Fig. 48) . The copies are sent by
NOL 5199
16-5
Chr
The MerchantsNational Bank
LOS ANGELES
UNITEDOFSTATES
OF AMERICA

500

1921

CALI

LES
ANGELOS

FORN

IA

Los Angeles . Cal . March 5

ororder

payla

John Phate INAL

EN
tive hundred poundhang
CIM
SPE
ds
Bank, Ltd.
Lloy
17, CORNHILL, LONDON, E. C..
CASH ER
London, England

NOL 5199
16-5
TheMerchantsNationalBank
LOS ANGELES
UNITEDOFSTATES
OF AMERICA
LosAngeles, Cal.

March 5

1921

500

LES
ANGELOS

E

PLICAT
Pay to John Pratt
Five hundred
Lloyds Bank, Ltd.
17. CORNHILL, LONDON, E. C.
London, England

pound

ororder

sty
SPECMEN
CASHIER

FIGURE 48
Original and duplicate bank drafts on foreign account
separate mails as a precaution against possibilities of loss. The one
that arrives first is paid and voids the remaining copy or copies. Foreign drafts are drawn on the foreign account of the issuing exchange
1 This custom of selling three months drafts instead of drafts payable at sight arose in
the South American countries because of the uncertainties of mail connections and the
limitations of the foreign exchange market. If South American bankers sold sight drafts
they might have great difficulty in finding sufficient cover to forward immediately, while
in selling three months drafts they feel fairly assured of being able to forward cover before
the drafts fall due.

DOMESTIC AND FOREIGN EXCHANGE

184

bank or on the foreign account of some domestic bank which acts as
an intermediary for it in various foreign exchange transactions. The
details of the practices followed in each case, as well as the forms that
are used, differ to such an extent that to avoid confusion , some
of the more commonly
used forms will be de6-7
scribed in detail.

TheAnglo & London Paris National Bank
of San Francisco
STERLING

Considering first the
case of the bank which
issues drafts on its own
foreign account let us
say that a customer of
a San Francisco bank

EXCHANGE ON LONDON

Time

asks for a sight draft
with which to pay his
creditor in London the
The
sum of £1,000 .

Order of

bank may have several
accounts in London,
but on that particular
day it may be draw-

Ainount, £.

Rate.
ing heavily on its account with the banking
firm of Lazard Brothers

Cost
San Francisco, ....

191 .......

in order to reduce its
deposit with that company. The clerk asks

Purchased by.....

the customer to fill out

No.....
a blank (Fig. 49) giving
the name of the party
to whom the draft is to

FIGURE 49
Application for bank draft on foreign account

be made payable, the
amount in American
or in English money

that is to be sent , whether it is to be a demand bill , date bill or payable
a certain number of days after sight, and by whom purchased (the
customer's name) . The clerk then glances at the rate board behind
the counter on which the rates for the day are posted and notes that
the rate on London which his bank is charging at that moment is $4.87

TYPES OF FOREIGN BILLS OF EXCHANGE

185

per pound sterling.

If the customer is an old depositor of the bank,
and because the sum is a rather large one, the rate will be shaved
slightly, and he may get his draft at the rate of 4.862 . He therefore
has to pay the clerk an amount of American money equal to $4.86½ X
1000, or $4865.
E-24
On the other hand,
The Anglo & London Paris National Bank
of San Francisco
if the customer
wishes to send
192 .
San Francisco,...
the equivalent of
$4865 to his creditor in England ,
Dear Sirs:
the clerk would calWe beg to advise that we have drawn the following drafts on you
culate how many which kindly pay and charge to our account:
PAYEE
AMOUNT
No.
pounds
sterling
could be purchased
for that sum at a
rate of, say, 4.86½.
The process would
be one of divi-

SP
sion, i . e. , 4865 ÷
4.865 = £ 1,000.
The customer

EC

IM

EN

would therefore be
able to obtain a
draft for £1,000 in
return for $4,865 if
the rate per pound
were 4.862.¹
The draft

is

drawn on Lazard
Brothers in duplicate, and both

FIGURE 50

Advice of issuing bank to foreign bank
copies are given
to the customer. He sends them by different mails to his creditor,
who cashes at his own bank the one first received. This bank
then forwards it to Lazard Brothers through the clearing house. In
the meantime Lazard Brothers have received a statement or advice
1 The methods followed in converting dollars into English money and vice versa will be
presented in Chapter X and Appendix III .

186

DOMESTIC AND FOREIGN EXCHANGE

(Fig. 50) from the San Francisco bank advising them that it has
drawn the draft in question, and asking them to honor the same and
deduct the amount from its (the San Francisco bank's) account. After
Lazard Brothers have cashed the draft and debited the account of
the San Francisco bank, they notify the latter of that fact.
Sometimes a customer demands a draft on a city in which the
American bank has no correspondent. In that case the bank draws a
draft on a bank in the designated city, which bank is a correspondent

ED

EL

NC

CA

of the American bank's foreign correspondent, and notifies the bank
drawn on to present the draft to the latter for payment . The bank
FORM2-D FEA. M.N.BL.A.
CABLE ADDRESS MERCHANTS LOSANGELES
The Merchants National Bank 16-5
OF LOS ANGELES
192
Los Angeles, Cal.,
To the Banco Mercantil
Santander, Spain.
Dear Sirs:
Wehave drawn upon you undermentioneddrafts to which please give due honor on presentation to the debit ofour account with
The Royal Bank of Canada, Barcelona, Spain
IN FAVOR OF
AMOUNT
DATE
NO.

YOURS TRULY

FIGURE 51
Advice to correspondent of foreign correspondent
in such matters merely uses the correspondents of its foreign correspondent. To make the example a little more concrete, suppose a
customer of the Merchants' National Bank of Los Angeles asks for a
draft on Santander, Spain. The Merchants' National Bank has as
its correspondent in Spain the Barcelona branch of the Royal Bank
of Canada. The Banco Mercantil of Santander is the local correspondent of the Royal Bank of Canada.

The Merchants' National

Bank of Los Angeles draws a draft on the Banco Mercantil and hands
it to the customer. It then fills out an advice in duplicate, similar
to the following (Fig. 51 ) and sends the original to the Banco Mercan-

TYPES OF FOREIGN BILLS OF EXCHANGE

187

til, asking that bank to honor the same and to present it to the Barcelona branch of the Royal Bank of Canada. The duplicate copy of
the advice is sent to the Royal Bank of Canada so that it may be

The Royal Bank of Canada
BARCELONA, SPAIN.
LP/IS

January 11th 1921
THE MERCHANTS NATIONAL BANK
of Los Angeles

LOS ANGELES (California)
Dear Sir:
We have debited your account with the following drafts drawn on
ourselves or on our correspondents:
PLACE DRAWN ON
AMOUNT OF DRAFT
DRAFT NO.
BRANCH DRAWN BY
COMMINBION
PESETAS
PESETAS

Barcelona
"

Yourselves

56.436.65
38.000.93.436.65

DUPL

5000-10-99B187

CA

NC

EL

E

5013

Yours truly,

Sam- Manager .
M.Qwald

FIGURE 52
Advice to issuing bank by foreign correspondent
advised of the transaction . The draft will subsequently be presented
to the Banco Mercantil, which will cash it , and then forward it to

188

DOMESTIC AND FOREIGN EXCHANGE

the Royal Bank of Canada at Barcelona, where the amount, plus
charges if any, will be deducted from the account of the Los Angeles
Bank, and the latter advised to that effect. (Fig. 52) .
There are two other methods by which a bank may issue a draft on
another bank with which it has no account. First : Suppose that Jones
in Chicago goes to his bank and asks it to sell him a draft on Rome.
It may have no account in Rome, but it has one in London with Barclays, and it also knows that the Banca di Italia of Rome has an account at Barclays. It can therefore sell a draft to its customer in lire
drawn on the Banca di Italia of Rome, notify the latter of that fact,
and ask it to reimburse itself by drawing a draft covering the transaction on the Chicago bank's account with Barclays. The Chicago
bank will also notify Barclays to honor such a draft and deduct the
amount from its account. The Chicago bank, however, runs the risk
that the dollars it receives for the lire draft on the Banca di Italia may
be less in amount than the dollars that will be required to replenish
its sterling account at Barclays after Barclays has deducted the reimbursement sterling draft of the Banca di Italia. Second : Say that
the Banca di Italia has an account with the Chicago bank, but that
the latter does not have an account with the Banca di Italia . Suppose
Jones requests that the Chicago bank sell him a draft in lire on Rome.
The Chicago bank issues the draft on the Banca di Italia and advises
it of that fact, suggesting that it reimburse itself either by drawing
a dollar draft on it (the Chicago bank) and selling the draft in the local
(Rome) market, thus getting its funds in Rome, or by merely authorizing the Chicago bank to credit its account, on deposit with the
Chicago bank, for the amount in question.
When local banks that have no foreign banking accounts or correspondents sell foreign bank drafts through the agency of banks that
act as exchange jobbers, the practices followed and the forms used are
quite different from those described above. The jobbing bank supplies the local bank with the needed forms upon which the name of
the retailing local bank is printed. These forms are bound in a book or
pad, are serially numbered, and usually consist of four parts, although
at times of two or of five parts . It also supplies a list of the foreign
banks upon which drafts may be drawn . Daily or weekly the jobbing
bank forwards the issuing bank a rate sheet containing the rates at
which the issuing bank is authorized to cover its drafts, i . e. , remit to
the jobbing bank for drafts which it draws (Fig . 53) .

If the rates

TYPES OF FOREIGN BILLS OF EXCHANGE

189

change noticeably, as has often been the case since 1914, the jobbing

о

The Merchants National Bank
OFLOS ANGELES
FOREIGN EXCHANGE RATES
DATEMay 5 1922.
GOOD ONLY FOR TODAY
No. 104
SELLING RATES FOR
LIMIT +
COUNTRY
CABLE® IN THE
CHECKS ON
PRINCIPAL CITY CURRENCY
TRANSFERS
AGGREGATE
Principal City OtherPlaces AND
B.P.R.
.013
.013
.013 $ 500
.AUSTRIA
Kronen
VIENNA
8.47
ANTWERP
8.46
1000
France 8.45
BELGIUM
.77
.78
.76 .
500
SOFIA
Levs
BULGARIA
1.96
1.97
1.95
800
Kronen
CZECHO-SLOVAKIA PRAGUE
2000
21.33 21.35
COPENHAGEN Kroner 21.28
DENMARK
2.09 2.10
500
HELSINGFORS Finmarke 2.08
FINLAND
2000
9.20
9.21
9.22
PARIS
Francs
FRANCE
.36
800
.361 .361
BERLIN
GERMANY
Marks
4.44% 4.443 8000
LONDON
GREAT BRITAIN
Pounds 4.44
1000
4.55
4.87
ATHENS
Drachmas 4.53
GREECE
5000
AMSTERDAM Guilders 38.35 38.40 38.43
HOLLAND
.134
500
.13k
.13142
BUDAPEST
Kronen
HUNGARY
5.37
5.38 8.39.
2000
ITALY
ROME
Lire
1.49
1.49
1.4.7
800
JUGOSLAVIA
BELGRADE
Dinars
800
.37% .37%
.36%
ZAGREB
Kronen
2000
NORWAY
CHRISTIANIA Kroner 18.65 18.70 18.75
.02%
500
POLAND
.02*
WARSAW
Marks
8.20 8.25
800
LISBON
PORTUGAL
Escudos 8.15
500
.74
.78
.73
ROUMANIA
BUCAREST
Lel
NOT QUOTED
PETROGRAD
RUSSIA
Roubles
2000
SPAIN
BARCELONA
Pesetas 15.60 15.62 15.65
STOCKHOLM
SWEDEN
Kronor 25.90 25.95 26.00 2000
8000
19.40 19.42 19.45
SWITZERLAND
ZURICH
France
8000
MONTREAL
CANADA
Dollars 98.35 98.35 98.60
49.50 50.00 80.50 5000
MEXICO
MEXICO CITY Pesos
57.50 2000
HONGKONG
CHINA
Loc. Cur. 87.00
2000
CALCUTTA
INDIA
Rupees 28.50 28.78 28.75
47.78 48.00 48.25 2000
YOKOHAMA
JAPAN
Yea .
4.45 5000
4.44% 4.45
AUSTRALIA
MELBOURNE Pounds
GERMANY 33
FRANCE 9.08
BUYING RATES; ENGLAND 4.424
CANADA97.78
For other Countries quotations furnished on application.
• ADD TO EACH BANK POST REMIT
FOR RATES ON AMOUNTS IN
EXCESS OF ABOVE LIMITS. INTANCE 25 CENTS FOR POSTAGE,
QUIRE BY PHONE OR TELEGRAPH.
AND IN CASE OF CABLE TRANSFER
THE COST OF CABLE.

FIGURE 53
Exchange rate sheet
bank may see fit to change its quotations by telegraph. The issuing
bank is supposed to draw at the latest quoted rate, although it is not

190

MATE
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WHICH
AT

KONG
CEREMY

7564

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正
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American
The

TYPES OF FOREIGN BILLS OF EXCHANGE

191

unusual for it to disregard instructions and draw at a previous rate
which may be slightly more favorable to it. Disputes frequently arise
between the issuing bank and jobbing bank over this matter. The
issuing bank on its part may charge its customer any rate that the
traffic will bear, merely being certain that the rate charged is above
the rate at which it will have to cover with the jobbing bank. It is
customary for the issuing bank to charge about one per cent more than
the rate quoted by the jobbing bank.
There are a number of different kinds of forms used that are of four
parts. The limits of space preclude our discussing any but those that
are the most typical . In the form above (Fig. 54) the draft is drawn
only on a designated foreign bank and in a designated foreign money.
The original and duplicate drafts constitute the right-hand portion
of the blank. The name of the issuing bank is not printed on the form,
but is stamped in when its officers sign the draft. The lower left-hand
portion of the form is retained by the issuing bank as its record of the
sale. The upper left-hand portion is the advice which the issuing
bank must send to the jobber, notifying it of the amount of the draft,
when drawn, the name of the payee, and also as to what rate of exchange and in what manner the issuing bank is covering (paying the
jobbing bank) , i. e. , whether by check or by asking the jobbing bank
to debit its (the issuing bank's) account. The jobbing bank in its
turn sends an advice to the foreign bank and asks that its (the jobbing
bank's) account be debited accordingly.
In another four-part form (Fig. 55) , the draft is issued in duplicate
and bears on its face the name of the issuing bank and also the emblem or monogram of the jobbing bank. Both of the copies are given
to the customer. The lower left-hand portion is the issuing bank's
stub or record, while the upper left-hand portion is the advice which
the issuing bank forwards to the jobbing bank.

The latter notifies

the foreign bank by means of an advice as in the examples given above.
Sometimes the issuing bank is asked to sell a draft on a correspondent
of the foreign correspondent of the jobbing bank. The practice followed, so far as the issuing bank is concerned , is the same as in the example cited above, ¹ but it becomes necessary for the jobbing bank to
notify not only the foreign correspondent but also the bank on which
the draft has been drawn as to the details of the transaction. To cite
an example: Let us say that the First National Bank of Pasadena,
1 Cf. pp. 188-191 .

No.

SP
E

CI

ME

N

Ordered
h

Rate
remitted
atwhich

sold
which
at
Rate

Ammont
Foreign

Drawn
on

Date

In
of
favor
ofPayee
Name
enclose
We
forCheck
Incover
thereof
with
account
our
charge
Please
@of
above
equivalent
Rate
.
truly
Yours

ofCheck
Awund
Foreign

.
orCountry
City
ofForeign
Name

EN

No.

Bosk
ofForeign
Name

CIM

SPE

192
archange
in
Proft

inUS
Equivalent

asper
.
quotation
your
NATIONAL
OFPASADENA
BANK
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AND
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INTHIS
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Lalifornia
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draft
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ype
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192

BANK 90-76
NATIONAL
CENTRAL
THE

No.

.Cashier
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order
or

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or

C

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No.
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BANK

TYPES OF FOREIGN BILLS OF EXCHANGE

193

California, has sold a draft through the Merchant's National Bank of
Los Angeles on the Banque Fédéral, Vevey, Switzerland . The latter is
a correspondent of the Credit Suisse, of Zurich, which in its turn is a
correspondent of the Merchants ' National Bank of Los Angeles. The
First National Bank of Pasadena will, on selling the draft, notify
the Los Angeles bank to that effect. The latter will fill out the following form (Fig. 56) usually, though not necessarily different in color
FORM2: FUL MNBLA
CABLE ADDRESS MERCHANTS LOSANGELES
Copy to Credit Suisse
Zurich
To the

The Merchants National Bank 16-5
OF LOS ANGELES
Los Angeles, Cal.,.
Banque Federal, Vevey, Switzerland

192----

Our friends
The First National Bank of Pasadena, Calif.
have drawn upon you the undermentioned drafts to which please give due honor or presentation to the debit ofour account with
Credit Suisse, Zurich
No.
IN FAVOR OF
DATE
AMOUNT

03

13

0N

:

YOURS TRULY

FIGURE 56
Advice to correspondent of foreign correspondent
from the form above mentioned (Fig. 51 ) .

This form or advice will

be made out in duplicate, the original being sent to the Banque
Fédéral and the duplicate to the Credit Suisse. The Credit Suisse
will not wait until the arrival of the draft before debiting the account
of the Los Angeles bank, but will debit the latter's account as soon
as the above advice is received.

The draft may be presented several

days or weeks later, so that in the meantime the Credit Suisse has the
use of an amount of money equal to the face value of the draft. This
is the general custom of all European banks, excepting only a few of
the English banks, which debit the correspondent's account only when
payment of drafts is made.
Certain of the above forms do not provide a purchaser's receipt.

Date

Purchaser

Amorot

In
favor
of

Draw
on n

Date

RECEIPT
PURCHASER
THE
FOR
OF
CHECK

AMOUNT
FOREIGN
Remitted
LNB
ACKNOWLEDGED
$ t
Profi

furcorof
In

Draw
on n

Sold
to
Address

$
Paid

Dut

No

For

Na

S

SP

EN

IM

Ten
Nati
Banth
konal
Toledo
Ohio

N

Dra
by wn

in
of
favor

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To

NO

SUM
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SP

protect
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No.

PAY
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THE
ORDER
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N

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EC

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for

at

Date

EC
I

ME

N
SP

Tenth
Bank
National
Ohio
Toledo

At

For

At

DRAWN
UNDER
PROTECTION
OF
NATIONAL
IRVING
BANK
YORK
NEW

Tart
57
-pFIGURE
five
draft
bank
of
form
ype

UNPAID
BEING
DUPLICATE

S

EN
EN
IM
EC
P
S

191

AGAINST
BALANCE
OUR

ORIGINAL
CHEQUE
FOR

BLANK
LEAVE
PLEASE
CHECKED ADVISED
Tenth
National
Bank
ToledoOhia

US
$

IM
SIGNATURE

RATE
QUOTED
For
which
ACCOUNT
OUR
DEBIT
ENCLO
CHECK
SE

NAME
FOREIGN
OF
AND
COUNTRY
CITY

Dale

Toledo
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TENTH
NATIONAL
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by wn

AMOUNT
FOREIGN

favor
In
of
PAYEE
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NAME

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on
FOREIGN
OF
NAME
BANK

No.
Check

ADVICE
TO
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IRVING
NEW
BANK
YORK

PE
C

STUB
ISSUING
OF
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PE
C

ME

EC
I

194
DOMESTIC AND FOREIGN EXCHANGE

TYPES OF FOREIGN BILLS OF EXCHANGE

195

It is the practice of every bank however, to give the customer a receipt,
using a printed form for that purpose, stating the name of the payee,
the amount of the draft, and other necessary data.
In the case of the five-part form, which has but lately come into
use in the foreign exchange field, the form is divided horizontally into
two equal parts (Fig. 57) . The draft itself constitutes the right-hand
portion of the lower half, and the purchaser's receipt the left-hand portion. The draft bears the name of the issuing bank and certain other

RECEIPT
FOR
DELEGATION
OF
LETTER

marks or emblems which enable the foreign bank readily to recognize
the identity of the jobbing bank. The upper half of the form is divided
into three parts; the left-hand portion is the stub or record of the issuing bank, the middle portion is the advice that is mailed to the jobbing
bank, and the right-hand portion is the advice that is mailed by the
THE FIRST NATIONAL BANK OF SAN FRANCISCO
San Francisco,ENCal., No. 180
IM
For value received from
EC
P
S
We agreeto write today to our correspondent intocredit (less expenses)
pay to
the sum of
without responsibility on the part ofthis bank for loss or delay in transmission.
TO
EN
Amount
L
M
A
N
O
I
K
I
I
N
BA OF SEANC
THE FIRST
SAT
Commission
SP
Exchange @
07-83-8-15-16-500
Cashier

FIGURE 58
Receipt for letter of delegation
issuing bank to the foreign bank upon which the draft has been drawn.
In this case the issuing bank itself notifies the foreign bank. A slight
modification of this form, as used by some jobbing banks, lies in the
fact that the issuing bank is required to send both advices to the jobbing bank which in its turn then forwards the advice to the foreign
correspondent .
Letter of Delegation . Under the disturbed conditions brought about
by the World War, one could not be certain that a draft, postal or
express order, or other form of exchange ordinarily exployed in remitting money abroad, would reach its destination, ¹ so that resort was
The real cause for the wide use of the letter of delegation was the announcement of the
British Government in 1916 that it had placed all negotiable instruments destined to enemy
countries on the absolute contraband list, and subject to seizure. A letter of delegation is
not a negotiable instrument and therefore could be safely used.

196

DOMESTIC AND FOREIGN EXCHANGE

had to the " mail transfer " or " letter of delegation , " which became
very popular as a means of sending funds to certain sections of Europe
(Fig. 58) . Instead of issuing a foreign draft, the American exchange
dealer simply writes to its foreign correspondent requesting it to pay a
designated sum of money to a specified person or firm and to inform
the latter that the money is being paid at the request of the sender.
The letter of delegation is sent in duplicate, so that there is reasonable
certainty that at least one copy will reach the foreign correspondent .
A copy of the letter or a receipt is given the purchaser, who may forward it to the payee to advise him of the method and the amount
of payment. The letter of delegation had been used to some extent
before the World War, but primarily in connection with the establishment of bank credits.¹ Not being a negotiable instrument, it is not
subject to the stamp taxes usually imposed by foreign governments
on negotiable instruments.

B. CABLES
Cables. Cables or telegraphic transfers (commonly abbreviated in
foreign countries to "T. T. ") are, technically speaking, not bills of
exchange because they are not negotiable instruments. Nevertheless,
they are a form of exchange because they are a credit means of paying
bills abroad. They have played an increasingly important part in our
exchanges during and since the World War, following the depreciation
in the exchange rates on foreign countries. A cable, as may be surmised, represents the " cabling of money " to a foreign payee when
occasion renders it advisable or profitable to use that means of making
payments. "Cabling money " is a misnomer, because no money is
sent via the route of the cable . Money is paid to the exchange dealer
in the United States, and he cables his foreign agent or correspondent
to pay out a designated sum to a specified party.
The customer who wishes to purchase a cable fills out a short application blank, or the clerk does it for him , giving his name, the amount
in American or foreign money that is to be cabled, and the name and
address of the payee (Fig . 59) . The application is frequently filled
out in duplicate and a copy given to the remitter as a receipt. The
clerk converts the American money into terms of the foreign money,
or vice versa, depending upon whether the customer states the sum
that he wishes to send in terms of foreign money or American money.

1 Cf. pp. 298-299 .

TYPES OF FOREIGN BILLS OF EXCHANGE

197

The conversion will be made at the cable rate for that day. The cable
rate is always higher than the rate for demand or for time drafts.
The reason, as will be explained more fully in Chapter X, is that in
the case of a cable transfer the foreign account of the exchange dealer
is debited within a few E-D

hours after he has sent
the order, and he thus
loses a number of days'
interest that he would

The Anglo & London Paris National Bank
of SanFrancisco.
CABLE TRANSFER

To be placed to the Credit of

otherwise have gained
had the customer purchased a draft and for-

Address

warded it by mail.
The costs of the cable-

At the Office of MESSRS. LAZARD BROTHERS & CO., LONDON

gram message are paid
by the customer. The

For Acc't of

profit to the exchange
dealer comes out of

Amount

the cable rate that he
charges.
The dealer
does not hold himself

Cablegram ·

"responsible for any
delays , mistakes
or
omissions which may
happen in the transmission of the message
or for its misinterpretation when received ."
In a large foreign exchange department, one
clerk will take the or-

$.

Total

San Francisco ,

191..

Signature
Purpose of
Remittance
No.........

FIGURE 59
Application for cable transfer

der, make the conversion, fix the charges, and receive the money from
the customer while another will prepare the message in code form. A
code is always used so as to save cable charges and also to guard
against possibility of loss through wire tapping, etc. Test words at the
beginning or at the end or at both the beginning and the end of the
message are commonly employed for additional safety . During the
World War the exchange operations in New York were greatly upset
because code messages were forbidden by the Allies who were fearful

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DOMESTIC AND FOREIGN EXCHANGE

of German spies . Cables may be " unregistered " or " registered. " If
a firm frequently sends cable exchange, it may register the full name
and address of the payee firm with the exchange dealer, who sets aside
a code word covering these data and forwards it to the paying office
or correspondent abroad. Then when the American firm wishes to
send a cable to that firm , the one code word alone will suffice for the
name and address of the payee. Such "registered " remittance
usually costs about one-half the regular rate charged for the unregistered cables, which, as may be inferred , do not have the name and
address of the payee or correspondent registered with the exchange
1
dealer. Brooks gives the following example as illustrative of a
registered cable transaction :

66
The firm of H. J. Meyerfield and Co. of Chicago wish to have two thousand five hundred pounds sterling paid to Johnson, Gladstone and Co. ,
153 Threadneedle St. , (E. C. ) , London, England, for their account.
"The message given to the telegraph company for transmission would
be as follows (cipher words are fictitious) :
"NETIPROV LONDON MURTIER MYERSON MARDADIE.
"Translated , these cipher words would mean:
"(NATIPROV)-To the National Provincial Bank of England , Ltd.
"(LONDON ) -London, England.
"(MURTIER) -Pay to the person (s) named in this cablegram.
“ (MYERSON) —Johnson, Gladstone and Co. , 153 Threadneedle St. ,
(E. C.) London, for account of H. J. Meyerfield and Co., Chicago, Ill .,
U. S. A. (Registered) .
“ (MARDADIE ) —(£2,500) Two thousand five hundred pounds sterling."
The American Express Company has a combination " Express
Money Order and Cable Money Order " that is unique. An ordinary
foreign money order is issued with the words " By cable " stamped
across the face of the advice which is mailed to the head office of the
company in New York. When the advice has been received in New
York the company immediately executes the cable as requested .
When a cable is sent from an inland point in the United States to an
inland point in a foreign country, the telegraph charges, both here
and abroad, are added to the cable charges.
At various times during the World War the larger part of our foreign

1 " Foreign Exchange Textbook," p. 157 .

TYPES OF FOREIGN BILLS OF EXCHANGE

199

remittances were made by cable because the mails were so uncertain.¹
Since that time, the very low exchange rates which prevailed and
the possibility of their falling even lower, caused many merchants
to resort to cables in the hope of effecting a saving on their foreign
payments. If the merchant in New York buys a draft with which to
pay a bill in Paris, he must send it by mail about nine to twelve days
before the time when payment is due. On the other hand , if he thinks
that the firm can make better use of the money for that length of time
by waiting and then buying a cable , or if he thinks that the rate on
Paris is likely to drop so that he will be able to buy a cable nine or
twelve days hence at about the same rate that he would have to pay
immediately for a sight draft, he will consider it to his advantage to
wait and purchase a cable. Even in normal times circumstances arise
that make it profitable and advisable for a firm to buy cables rather
than sight drafts.2
Exporters who desire to obtain immediate use of funds due them
from foreign merchants will frequently advise the exchange dealer,
to whom they have given their drafts and documents for collection,
to have the funds remitted to them by cable. An exporter may also
instruct the foreign purchaser to place the funds covering the transaction in a foreign bank to his (the exporter's) account. He may then
go to his local bank and sell his foreign account to it , using the cable to
instruct the foreign bank to place the money to the credit of the bank
to which the account has been sold.
1"Because of the uncertainties of the European mails, bankers last week transacted more
business with Amsterdam by cable than by check, customers being willing to meet the
additional expense for the sake of more certain transfer of their funds. The seizure of mail
for Holland in recent weeks by British authorities has been the chief factor in expanding
cable business . . . . Bankers say that complaints of non-delivery of letters containing
drafts caused so much embarrassment to clients that many of them have declined to send
funds through checks to the Netherlands and Switzerland , even though the due date lies
several weeks in the future.
"So difficult have means of communication between this country and Amsterdam become, bankers say, that clients have found recently that it is safest to allow on cabled
remittances nearly as much time for delivery as though a check had been sent through
the mails in ordinary times. Frequently as much as five days elapse in transmission."
Annalist, March 6, 1916.
2 "The continued fluctuation in foreign exchanges during the past year is largely responsible for the increased use of cable transfers for the meeting of obligations maturing
abroad-debtors apparently waiting until the last possible moment to make their remittances, in the hope of getting a better rate.
"Even in the days of more stable exchanges there were many possible situations in which
American firms with obligations abroad would find it to advantage to remit by cable transfer,
and such occasions will still arise when the recovery of the exchanges commences, unless
it is far more rapid than is to be expected at present." Foreign Trade Bulletin of the American Express Company, September-October, 1919.

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DOMESTIC AND FOREIGN EXCHANGE

Not only do banks, express companies, and cable or telegraph
companies sell cables to the public, but they also buy and sell cables
among themselves. Banks buy a large amount of cables from each
other for the purpose of meeting obligations abroad, such as drafts
that are falling due ¹ or to cover cables that they have sold to others
even though with insufficient funds in their foreign accounts to meet
the amount sold . At times they also sell heavily to each other in order
to bring their funds back home when needed for more profitable investment or to meet some pressing financial need.
C. BANKER'S LONG BILLS
Banker's long bills are drafts that are issued by a banker upon a
foreign banker, running usually for ninety days, although drafts of
sixty days usance are not uncommon .

They are issued for a number

of purposes but primarily to enable foreign bankers to loan money or
credit in the United States, either on their own initiative or on that of
the American banker.
Long Bills in Ordinary Course of Business. In our discussion of
2
banker's foreign drafts we stated that it is not unusual for a bank
to sell a sixty or a ninety day draft to a customer who may wish to
pay for goods which have been purchased abroad . If he purchases a
ninety day sight draft on some foreign bank, it will be necessary for
the party receiving it to have it accepted at the foreign bank. The
payee may then hold it until it matures or he may get his money
immediately after its acceptance by discounting it in the open market.
A date bill may also be used in the same manner and for the same purpose. The reason why the customer purchases a long bill instead of a
demand bill is that he may be able thereby to save on the exchange
rate, the rate for long bills always being lower than that for demand bills because the bank has the use of the money during the interim . Although the purchaser, on the other hand , loses interest on
his investment in a long bill, nevertheless he gets back a portion of it
through the lower rate which he pays for the bill . It may also happen
that the customer has to remit to some market upon which there is a
small amount of exchange available, and so, because he cannot always
be sure of getting demand exchange when he needs it , he purchases a
It is not unusual for dealers to sell demand drafts and then within a few days, just
before the sight drafts reach their destination , to cover by going into the market and purchasing cables from other dealers.
2 Cf. p . 182.

TYPES OF FOREIGN BILLS OF EXCHANGE

201

Such long bills may be sold by the bank against its
account already on deposit with the foreign banker or against remittances of commercial " payment " bills which the banker has purchased
but which as yet have not matured . As will be seen later, ¹ the banker
learns from experience just about how many of the " payment " bills
long bill instead.

which he has purchased will be taken up or paid under rebate at approximate future dates. On the basis of his calculations he thinks
that he will have a certain amount on deposit in his foreign account
sixty or ninety days hence, and therefore feels that he can with safety
sell his own long bills against the same. If the "payment" bills are
not taken up by the dates that he has figured on, he will of necessity
have to resort to other means of providing funds out of which to meet
his long bills when they fall due.
Long Bills in Loaning Operations . The sale or purchase of the type
of banker's long bill just described has, as is evident, nothing whatever
to do with the loaning of foreign funds in the United States. Yet it
is in connection with this latter matter that the banker's long bill plays
its most important part. Not only have foreigners , especially the
English, been very heavy investors in American stocks and bonds, which really amounts in the end to their loaning large sums of money
to American industries-but foreign banks, principally the English,
for years previous to 1914 loaned large sums of money for short periods
of time to American banks and also, through them, to American firms
with which many a financial deal of importance was consummated .
These loans were customarily made by means of a banker's long bill
of one kind or another, running usually for ninety days, and at times
renewed for a like period . Since 1914, however, the foreign bankers
have had such pressing needs for funds at home that they have been
borrowing very heavily from us, and the long bill no longer functions
as prominently as of old in our exchange markets.
The initiative in negotiating these foreign loans may be taken
either by the foreign bank, by the American bank, or by both. The
foreign bank may note that the rates of exchange and the money rate
in the American market promise profit on such a venture, and it thereupon notifies the American bank to loan a certain amount of money
for it in the American market. Or it may be that the American bank
surmises that the favorable exchange rates on the foreign country
offer an opportunity to borrow profitably from the foreign bank by
1 Cf. pp. 495-496.

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DOMESTIC AND FOREIGN EXCHANGE

means of an exchange transaction , or it may need the money to bolster
up its legal reserves, or to float some stock and bond deal. Still another possibility is open, i. e. , both institutions may enter into the
transaction on the basis of a "joint account " whereby each party
is to share equally in the profits or losses. Each of these arrangements requires a separate explanation.
Suppose that Barclays of London takes the initiative and decides
to loan £100,000 in the New York market through its correspondent,

the Fifth National Bank. It notifies the latter by cable of its decision
and makes arrangements as to the terms of the loan , i . e . , whether the
Fifth National is to put the money out at a definite rate of interest, in
which case the risk of exchange falls upon the English bank : or whether
it shall charge the firm to which the money is loaned a small commission, the borrowing firm, instead of the English bank, in this case
assuming the risk of exchange. The amount of the commission or fee
which the Fifth National is to receive is also agreed upon. The Fifth
National Bank in either case finds a borrower in the market, possibly
some investment house , or industrial or commercial firm , which deposits collateral security for the loan just as it would for any other
kind of bank loan.
Currency or Dollar Loan.

Let us say that the arrangements are that

Barclays will charge a fixed rate of interest, say 4 per cent, and that
it will assume the risk of exchange. This form of loan is commonly
known as a currency " or " dollar " loan. The Fifth National Bank,
following instructions , draws a draft or drafts on Barclays, running
for 90 days and totalling £ 100,000, and sells the same in the open
market to an exchange dealer, say the United Trust Company, at the
going or current rate of exchange on that day for 90 day bills. If the
rate is 4.83 , the Fifth National Bank receives $483,000 (4.83 X 100,000).
Suppose that it loans this amount to Jones and Smith, who have the
use of the funds for the next ninety days at 4 per cent interest. Note
that dollars are turned over to the borrowing firm . The United Trust
Company, to which the draft is sold, immediately sends it to its correspondent in London , say Lloyds Bank, which presents it to Barclays
for acceptance. After acceptance, Lloyds either has the draft discounted in the open market or holds it until maturity, depending upon
the instructions that it has received from the United Trust Company.
At the end of 90 days, if the loan is not to be renewed , Jones and
Smith, in accordance with their agreement, pay the Fifth National

TYPES OF FOREIGN BILLS OF EXCHANGE

203

Bank $483,000 plus interest at 4 per cent for 90 days, or a total
$487,830. Note that a predetermined number of dollars (principal plus
interest) is paid back by the borrowing firm. It is because of this fact
that this type of transaction is called a " dollar " or " currency " loan.
The Fifth National Bank thereupon takes immediate action to cover
the £100,000 draft falling due in London either by forwarding a demand draft against its own account with Barclays, or by going into
the market and buying a demand draft from some other exchange
Suppose that it does the latter. The amount of the draft
would be for £ 100,000 plus the profit that belongs to Barclays after
the Fifth National Bank has deducted its charges for acting as an

dealer.

intermediary. When the draft reaches Barclays it is immediately
cashed at the bank upon which it was drawn, in order that the money
may be on hand to meet the 90 day draft when presented at maturity.
The profit that Barclays makes on the deal depends entirely on the
New York rate of exchange for demand drafts existing on the day
that the Fifth National Bank goes into the market and buys cover for
the maturing 90 day bill . The English lending bank will usually enter
into a dollar loan when the lookout in the exchange field appears to
be for a falling sterling rate, because it assumes the risk of exchange
and is therefore hoping to have cover purchased at a lower figure than
is prevailing at the time when the loan is made. When dollar loans appear in large amounts, comment on the street is that the market may
expect to experience lower exchange rates in the near future . Suppose
that the rate for demand bills does fall from 4.87 , which prevailed at
the time the loan was made, to 4.85 at the time when cover is purchased by the Fifth National Bank. The full face value of the sum
returned by the borrowing firm, $487,830 (not deducting the commission charges of the New York bank) , converted into sterling at the
demand rate of 4.85 , will purchase £100,583 16s 2d of sterling exchange (487,830 ÷ 4.85 ) , a gain of £583 16s 2d on the transaction.
Figured on a percentage basis this amounts to a return of over 2.3
per cent. If the demand rate drops lower, the return will be larger.
If the demand rate remains high, say at 4.86, the Fifth National Bank
will be able to purchase only £ 100,376 10s 1od, representing a total
gain of £376 10s 1od, or a return of only about 1.7 per cent. The
rate of return received by the lending bank seems to be very small
and it would be small had Barclays actually put up any of its own
funds, but, as has been seen, the bank advances only its credit , i . e. ,

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DOMESTIC AND FOREIGN EXCHANGE

allows its name to be used .

It has merely accepted the draft and

agreed to pay it when it falls due . Who or what it is that actually
furnishes the money with which the deal is financed will be discussed
later.¹
Loans of this kind, so far as the American borrowing firm is concerned, are no different from any other loan that it might procure
from its New York bank. In fact, in practically all cases the borrowing concern has no idea that it is not actually borrowing the
funds from the American bank; it has no knowledge whatsoever that
a London bank is the party primarily interested in the transaction.
Sterling, Franc, Mark, etc. , Loans.
Taking up another angle of
foreign loans negotiated by means of bankers ' long bills , suppose that
Barclays advises the Fifth National Bank that it will accept a commission on a loan and that the borrowing American firm is to assume
the risk of exchange.

This is known as a " sterling " loan.

If marks

were to be loaned by a German bank under the same conditions, it
would be a " mark " loan , or if francs by a French bank, it would be a
"franc " loan. In this case , the borrower knows that the loan is being
engineered at the request of the foreign bank, because, when getting
the loan, the borrower agrees to pay the principal plus the usual commission by furnishing the New York bank with demand exchange or
with sufficient funds to purchase an amount of demand exchange
equal to that which forms the basis of the loan .
The English bank usually charges the small commission of 3/8 of
one per cent for its acceptance of a 90 day draft. This amounts to 1/8
of one per cent per month, or 1 1/2 per cent per year. The commission
may seem to represent a small return to the lending or drawee bank,
but again it must be remembered that the London bank does not advance its own funds ; it simply loans its credit or its name by accepting
the draft, and the American borrowing firm, through the New York
bank, puts it in funds with which to meet the draft when it matures.
The London bank is liable for the full face value of the loan if anything goes wrong, but such possibilities are so slight as to be practically
negligible.2
In tracing the various details of a " sterling" loan, suppose the data

to be the same as those given in the case of the dollar or currency loan
1 Cf. p . 217.
2 By many it is felt that the commission charged by the accepting bank is not commensurate "with the risk involved should a monetary crisis ensue between the date of drawing
and maturity of the bills." Spalding, op. cit., p. 74.

TYPES OF FOREIGN BILLS OF EXCHANGE

205

above described. Barclays advises the Fifth National Bank to find
a borrower for a sterling loan of £ 100,000. The terms are arranged by
cable. A party willing to take such a loan, Jones and Smith, is found
in New York. The commission is to be 3/8 of one per cent and the
borrower is to bear the risk of exchange. The Fifth National Bank
draws a 90 day draft for £100,000 on Barclays and turns it over, against
a deposit of collateral security, to Jones and Smith . Note that a
sterling draft is handed to the borrower. It is not unusual, however,
for the New York bank, at the request of the borrowing firm, to sell
the draft in the open market , because the bank is a keener bargainer
and can secure a higher rate than can Jones and Smith. Say that
the sterling draft is sold at the prevailing rate for 90 day bills, which
happens to be 4.83 , and that the United Trust Company buys it for
$483,000. That amount of money is then turned over to Jones and
Smith to be used by them for the next 90 days . The United Trust
Company forwards the draft immediately to its correspondent in
London, i. e., Lloyds, which presents it to Barclays for acceptance.
Again, Lloyds will discount the bill or hold it until maturity, following
the instructions received from the United Trust Company. At the
end of 90 days, Jones and Smith will furnish the Fifth National Bank
with a sterling demand draft for £ 100,000 plus the 3/8 per cent commission, or will pay it a sum of American money that will purchase
such a draft in the open market. It is because the borrowing firm has
to purchase a sterling draft or has to pay the New York bank a sum
of money, not determinable beforehand, with which to purchase such
a draft, that this type of loan receives its name . Suppose that at the
end of the 90 days the demand rate on London is 4.85 . The principal
of the loan is £100,000, the 3/8 per cent commission amounts to £375.
How much money will Jones and Smith have to pay for a demand
draft for £ 100,375 at the rate of 4.85 ? Multiplying the former by
the latter, we get $486,818.75 , an increase of $3,818.75 over the sum
which Jones and Smith had received 90 days earlier from the sale of the
sterling draft. This would be at the rate of approximately 3.1 per cent
per year. If the demand rate for sterling were 4.86 , the draft would
cost $487,822.50, an increase of $4,822.50 over the sum which Jones
and Smith had borrowed, or at a cost of 3.9 per cent per year. If the
demand rate should fall low enough, the borrower might be able to
get the loan for an extremely small interest rate or possibly for nothing
at all. But no matter what the rate is, the London bank receives its

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DOMESTIC AND FOREIGN EXCHANGE

commission of 3/8 per cent and pays the New York bank its fee for
acting as the intermediary.
When Jones and Smith repay the loan, either in cash or by means
of a sterling draft, the Fifth National forwards the sum to Barclays
(minus its commission of possibly one-half of the 3/8 per cent charged
by Barclays for the loan) , thereby putting the accepting bank in funds
with which to meet the £ 100,000 draft when presented by the holder at
maturity. The transaction has been purely one of credit , no funds having been advanced either by Barclays or by the Fifth National Bank.
"Because of the speculative element which attaches to loans of foreign
money in this market , they are a favorite form of operation with many
houses. Take for instance the case of a borrower of money who figures
out that the exchange market is bound to decline within a few months.
By getting some foreign banker to lend him money on the basis of his,
the borrower, taking the risk of exchange, he can practically get himself
short of the exchange market, and if he is right in his forecast he can get
the use of the money for nothing, or even make a profit on the deal. Similarly with the banker. Frequently it happens that foreign money is pressed
on the market here on the idea that exchange rates are about to go down
and that the lender of the money, by assuming the risk of exchange himself,
can make a big return on the money put out." 1
Finance Bills . Another very important class of banker's long bills
is the so-called " finance bills." Authorities differ as to what sort of
bills this term actually applies.

Escher alone holds that finance bills

are those that arise through the initiative of a bank that desires to
borrow from a foreign institution . In his " Foreign Exchange Explained " 2 he declares :
"Make inquiry, even among those actively engaged in the exchange
business, as to what the finance bill is and what it is used for, and the chances
are that you will be amazed by the divergence of the expression you call
forth. Almost generally you will find a tendency to confuse the finance
bill with the loan bill 3 which has just been described. Now the finance
bill is essentially different from the loan bill in that the loan bill is issued
by bankers who want to lend out the money to third parties, on collateral,
whereas the finance bill represents nothing more than the drawing of long
¹ Escher, Franklin, " Foreign Exchange ", (Part II of "Banking Practice and Foreign
Exchange" with Jefferson, H. M.) , Alexander Hamilton Institute, New York, 1913, pp.
321-322.
2 Pp. 102-103.
He is referring to dollar and sterling loans.

TYPES OF FOREIGN BILLS OF EXCHANGE

207

drafts by one banker on another for the purpose of raising money to be
used by either banker or both. In the case of a loan bill John Smith borrows
from the First National Bank and puts up good and sufficient collateral
for its repayment. In the case of a finance bill, the First National Bank
draws a time draft on the Second National Bank, turns it into ready money,
and uses the money (sometimes alone and sometimes, in connection with
the drawee) for any purpose it sees fit.
"There is, of course, no apparent difference in appearance between a
loan bill and a finance bill. . . The circumstances which bring them
into existence vary greatly, but the bills themselves, after they have been
uttered, are all exactly alike."
Patterson states , ¹ and Whitaker agrees with him ,2 that
"Other authorities are inclined to include [as finance bills] all long bills
originating between bankers, whether secured or not . The latter is
perhaps the more general understanding of the term."
Although opposed by majority opinion , I cannot help but agree with
Escher. In my opinion there are some very essential differences between loan bills and the type that we shall henceforth call "finance
bills." In the case of the former, the initiative is taken by the foreign
bank that wishes to place its funds or credit in the American market.
In the case of finance bills, the initiative is taken by the American
bank that is desirous of borrowing funds for its own personal use, or
on joint account for the profit of itself and the foreign accepting bank.
With loan bills, the American bank receives only its commission as an
intermediary ; with finance bills it gets all the gain minus the small
acceptance commission charged by the foreign bank, unless the deal
is carried through on joint account, in which case the two banks
divide the profits between themselves. With finance bills the risk of
exchange is borne by the New York borrowing bank, or, if the deal
is on joint account, the risk is borne by both banks ; but with sterling
or dollar loan bills the New York bank assumes none of the risk of
exchange. With loan bills, the borrower is a third party; with finance
bills the New York bank is the borrower.
Suppose that the Fifth National Bank of New York sees an opportunity of swinging some big stock and bond deal, -possibly underwriting some large corporation,-which it feels it can handle satisfactorily in three or possibly in six months and "get out from under "
within that time ; or suppose that some large stockbroker in New York
1 "Domestic and Foreign Exchange," p. 144.

2 "Foreign Exchange," p. 380.

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DOMESTIC AND FOREIGN EXCHANGE

desires to borrow so as to invest heavily in stock and bonds ; or suppose
any similar situation arises in which the New York bank needs money
but does not care to invest its own deposits and capital in the transaction; or suppose that the bank itself is getting rather short of funds and
needs to build up its cash temporarily but does not wish to go to some
other New York bank for a loan : any of these or similar circumstances
may cause the New York bank to take the initiative and cable its
London correspondent, say Barclays, to the effect that it wishes to
draw £ 100,000 worth of 90 day bills against the latter.
Will Barclays
accept?

The reply comes back that the arrangement is satisfactory.
The New York bank may or may not be requested to deposit collateral security with some local trust company.
The Fifth National

Bank naturally will not consider entering into such a transaction unless it feels that exchange rates at the time that the bills mature will be
at lower levels.
If the situation looks promising , the Fifth National Bank draws
£100,000 in 90 day bills on Barclays and sells them to some local exchange dealer, say the United Trust Company, at the going rate for
long bills on that day. If the rate is 4.83 , it receives $483,000 , which
it will use for the next 90 days. The United Trust Company forwards
the bills to its correspondent in London, say Lloyds, which presents
them to Barclays for acceptance. When accepted the bills are either
discounted in the London market or held until maturity, as indicated
by the instructions of the United Trust Company. Another method
of handling the deal would be for the Fifth National Bank to send the
90 day bills to another of its correspondents in London , say the London
Joint City and Midland Bank, which would present them for acceptance to Barclays, and when accepted have them discounted immediately in the open market, and the proceeds (£ 100,000 minus the discount) credited to the account of the Fifth National Bank with the
London Joint City and Midland Bank. The Fifth National Bank, in
the latter case, could then sell demand drafts against the account which
it has thus built up, and receive cash in New York for such drafts.
The reason for following this latter method is that the New York bank
is thereby able to take advantage of the position of the discount rate
in the London market and the rate for demand drafts in the New York
market.

Unless these two conditions are satisfactory , it will follow

the procedure first mentioned, i . e . , sell £ 100,000 of 90 day bills in the
New York market.

TYPES OF FOREIGN BILLS OF EXCHANGE

209

For the purpose of making our problem as concrete as possible,
suppose that the Fifth National Bank loans the $483,000 in the New
York market at the short time loan rate of, say, 6 per cent. It receives a total return at the end of the 90 days of $490,245.

When it

goes to buy sight exchange with which to cover the 90 day draft maturing in London, the sight rate on London is 4.85. To meet the £ 100,000
draft plus Barclays' acceptance commission of 3/8 per cent, it must
purchase £100,375 at 4.85 , which costs it $486,818.75. The profit
of the Fifth National Bank on the $483,000 would amount to $3,426.25
($490,245.00- $486,818.75 ) or a gain at the rate of 2.8 per cent per
year. This 2.8 per cent return seems small, but it is placed in a
different light when we remember that in the whole transaction the
Fifth National Bank has not advanced one cent on its own funds.
Let us take the case in which the Fifth National Bank sends its 90
day drafts to London to be discounted immediately and against which
it simultaneously draws drafts in order to take advantage of the discount rate in the London market and the demand rate for sterling in
New York. The Fifth National Bank draws a draft on Barclays for
£100,000 and sends it to the London Joint City and Midland Bank
with instructions to present it to Barclays for acceptance, after which
to discount it in the open market and credit the proceeds to its (the
Fifth National Bank's) account with the London Joint City and Midland Bank. Let us say that on the basis of the rate of discount in
London, the stamp tax which long bills must pay in England, and the
commission of the accepting bank (Barclays) , the Fifth National
Bank is able to get its funds in London at the cost of $.04875 per pound
sterling.¹ If the market rate for demand sterling is $4.8825 , it sells
£ 100,000 worth of demand drafts on its account with the London
Joint City and Midland Bank and receives in return $488,250 . It is
able to sell for the full face value of the £ 100,000 because it has extra
funds on deposit with the latter correspondent. It may then loan
the $488,250 in the New York market at the current rate, say 6 per
cent, and receive therefor $7,323.75 . Suppose that, three months
later, the demand rate for sterling, at which the Fifth National Bank
has to purchase cover to forward to Barclays, is at 4.85 . It will have
to expend $485,000 for demand drafts to mail to Barclays so that the
latter may meet the 90 day finance bills at maturity. The profits of
the Fifth National Bank are figured as follows :

1 Cf. Margraff, op. cit. pp. 38-39.

210

DOMESTIC AND FOREIGN EXCHANGE

Received for £ 100,000 demand drafts @ $4.8825 ..... $488,250.00
Paid for £ 100,000 demand drafts as cover @ 4.85.... 485,000.00
Gain ....

3,250.00

Interest on $488,250 for 90 days at 6 per cent .
Total Gain ...

10,753.75

Cost of discounting, commission, stamps, etc., on
£100,000 90 day drafts @ $.04875 per £..
Net Gain ....

$5,878.75

7,323.75

4,875.00

A profit of $5,878.75 on $488,250 for a period of 90 days amounts to a
gain of approximately 4.8 per cent per year. Out of this gain has to
come the cost to the Fifth National Bank of the extra funds which it
had to draw on in its account with the London Joint City and Midland Bank, the possession of which enabled it to draw demand drafts
for the entire amount of the £ 100,000.
1
Margraff ¹ gives another example of the advantageous employment
of finance bills by the American banker. The banker may have a
large amount of money invested in certain securities which have temporarily depreciated in value just at the moment when there is a demand for money in the local market at very favorable rates. The
banker may either sell the securities at the depreciated quotation
and take his losses, or he may hold them and not make the requested
loans to his customers , or he may resort to the issuance of finance bills.
Let us say that he puts up the securities as collateral for an issue of
finance bills , and loans the money thus secured in the open market .
If the finance bills cost him about three and a half per cent per year,'
and if the securities are yielding him an interest of three per cent, he
has a net cost on the finance bills of about one-half per cent per year,
but at the same time he has the return on the money received from
the sale of the finance bills , which money he is able to loan in the open
market. By subsequent renewals of the finance bills, "the securities
can be carried in this manner until the value of the same has recovered by appreciation in price, and such holding would be advisable,
provided: the securities were ' gilt-edge ,' and there is every reason to
believe that the shrinkage in value is only temporary."
Another method of using finance bills occurs in connection with
the investment of the funds obtained therefrom in issues of corporation securities either by the American bank or by it on joint account

1 op. cit. pp. 40–41 .

2 Ibid, p. 41.

TYPES OF FOREIGN BILLS OF EXCHANGE

211

with the foreign accepting bank. If the American bank wishes to "go
it alone, " it gets the permission of the London bank to draw the required amount of 90 day finance bills, sells them in the market,
and invests the returns in the selected securities. During the 90 days
that the bills have to run, the bank will hope to unload the securities
on the market at a price high enough to yield a profit over the cost of
the demand bills which it must buy to meet the maturing finance bills,
the commission of the accepting bank, and any other expense that it
may have incurred . Very often such deals are arranged and carried
through on joint account. The New York bank may be asked to
join a syndicate of banking houses interested in floating some large
investment proposition. It may not desire to invest its own funds,
but invites the coöperation of its London correspondent , which, because of past profitable experiences, agrees to such an arrangement.
The finance bills are drawn and sold, and the money is invested in the
corporation issues. As the days pass the securities are unloaded onto
the public, and at the end of the 90 days the New York bank goes into
the market and purchases demand exchange to cover the maturing
finance bills. The rate at which the finance bills are sold, the prices at
which the stocks and bonds are disposed of, and the rate at which the
New York bank has to purchase demand sterling, determine the
profit on the transaction, which profit will be shared between the two
banks as stipulated in the agreement. An instance of the issuance
of finance bills to take care of the needs of the security market occurred
in October, 1912, when, owing to the international uncertainties caused
by the Balkan War, a mass of American securities were thrown onto
Wall Street by Europeans. The New York banks immediately issued
large amounts of finance bills in order to satisfy the demands of the
brokers for funds with which to absorb those securities.
It is not unusual for an American bank, when it is buying cover for
its own maturing finance bills, to purchase finance bills that have just
been issued by another bank in the same city, provided the rate is
satisfactory. They are then sent abroad, accepted, discounted immediately, and the sum realized added to the foreign account of the
American bank.

Its foreign correspondent then has the funds on

hand out of which the maturing finance bills are paid.
In the case of loan bills and finance bills it is possible and frequently
necessary for the issuing bank to ask for a renewal for another period
of 90 days. The bond transactions described above may not have

212

DOMESTIC AND FOREIGN EXCHANGE

been pushed to completion, the borrowing American firm may wish
to have the money for a little longer time, the American bank may
feel that the rate for demand drafts has not declined sufficiently to
make the transaction a profitable one and that there is a possibility of
the rate going lower, or there may be some other contingency that
may have to be met. Finance bills may be renewed by issuing a new
lot at the then prevailing rate for 90 day bills and selling them in the
market, the proceeds being used to purchase demand or cable exchange to meet the earlier issues as they mature ; or they may be
exchanged directly, " that is to say, they are swapped for demand or
cable exchange. The swapping operations are tantamount to the discount of the long bills in London and are arranged on the basis of the
prevailing rates for long bills and demand or cable exchange. The
amounts swapped are in each case equal , the holder of the long bill
paying the holder of the demand or cable exchange the difference
between the two prices, which represents the London interest and
bill stamp converted into New York funds. If a £ 10,000 90 day sight
bill is exchanged for the same amount of demand exchange on the
basis of $4.8090 for the long bill and $4.87 for the demand draft, the
owner of the long bill pays the owner of the demand draft the difference between the two rates for every £1 exchanged , or $610 on the
entire swap ."
" 1 If the American bank does not want to swap 90 day
bills for demand or cable exchange, but prefers to issue a new lot of
finance bills and sell them in the New York market , it may find that
the exchange rates have fallen , precisely as it had surmised would be
the case, and that, if it issues only the same amount as before , the sum
received from the sale will not be sufficient to cover the face value of
the maturing bills. Suppose that it had originally issued £ 100,000
worth of finance bills at 4.85 , receiving therefor $485,000, but that
when the second lot is to be put on the market the rate has fallen to
4.82 . If the bank issues only £ 100,000 worth of finance bills, it will
receive $482,000, or $3,000 less than for the first issue. Under such
circumstances, it will probably get the permission of its London correspondent to issue an additional amount to make up the difference, or a
total of approximately £ 100,622 . The same procedure may also be
followed in renewing either sterling or currency loans.
In floating either loan or finance bills the American bank or the
American borrowing firm is really speculating on the probable course
1 York, T., "Foreign Exchange," p. 152.

TYPES OF FOREIGN BILLS OF EXCHANGE

213

of the exchanges . As in the case of stock and bond deals , when a
dealer sells short of the market, i. e. , sells securities that he does not
have on hand but hopes to obtain later at lower prices than those at
which sold, so the American bank or borrowing firm that has to purchase demand exchange with which to cover the maturing long bills
hopes that exchange rates will drop to lower levels. Thus it is that
finance bills and currency loans usually come onto the market during
the summer months when the prospects for large crops and consequently large exports, with accompanying lower exchange rates, appear to be inevitable.¹ Prophets are not infallible, however, and it is
not unusual for the exchange dealers to be deceived in their forecasts.
" 22 states that in 1909
Escher in his " Elements of Foreign Exchange "
"Impelled thereto by the brilliant crop prospects of early summer,
foreign exchange houses in New York drew and sold finance bills in
enormous volume. The corn crop was to run over three billion bushels,
affording an unprecedented exportable surplus-wheat and cotton
were both to show record-breaking yields. But instead of these
promises being fulfilled, wheat and corn showed only average yields ,
while the cotton crop turned out decidedly short. The expected flood
of exchange never materialized . On the contrary, rise in money rates
abroad caused such a paying off of foreign bills that foreign exchange
rates rose to the gold export point and ' covering ' operations were
conducted with extreme difficulty. In the foreign exchange market
the autumn of 1909 will long be remembered as a time when the finance
bill sellers had administered to them a lesson which they will be a good
while in forgetting ."
In order to guard against these unexpected developments in the
foreign exchange field it is customary for the party that has to purchase cover to engage in " forward exchange operations," i. e., to
"hedge" by buying what is known as a "future." This is done by
going to an exchange dealer and obtaining a contract from him to the
effect that he will deliver the required amount of demand exchange
at the designated date and at the rate contracted for .

The dealer

looks over the field, sizes up the possibilities of future developments,
1"There is no doubt, of course, that many finance bills have been drawn in times past
for less legitimate purposes [than those drawn in anticipation of produce shipments], to
provide money that was going into factory building or other forms of fixed capital which
ought to have been provided out of more permanent forms of security, such as bond issues
or creations of shares or debenture stocks." Withers , H., "War and Lombard Street,"
p. 85.
2 Pp. 97-98.

214

DOMESTIC AND FOREIGN EXCHANGE

and estimates approximately what the demand rate will be 90 days
hence. If the rate is satisfactory to the purchaser a contract for future
delivery is signed. If when the 90 days have passed the rate in the
market is higher than the rate contracted for, the purchaser gains and
the dealer loses, but if the market rate happens to be lower than the
rate contracted for, the purchaser loses and the dealer gains. In either
case, however, the purchaser is able to minimize his probable losses
by means of the " future " contract.¹
With the establishment of branches of foreign banks (including
American banks) in London , an interesting development has taken
place through the growth of what is technically " one name " paper, but
what is familiarly known among exchange dealers as " house paper " or
"pig on pork." This practice involves the drawing of loan or finance
bills by a banking institution on its branch or on a financial institution
which it controls . "The drawer and acceptor being virtually identical
concerns, such bills represent but a single financial responsibility. The
two-name class includes bills the drawers and acceptors of which are
strictly separate and mutually independent establishments ; they represent a twofold security. On this account prime two-name bills always
command a lower rate in the London market and a higher price in the
New York market than the best one-name bills." The latter bills are
issued , however, because the loss that is suffered by the banks by
reason of the lower price " is more than compensated for by the saving in acceptance commission they would otherwise be obliged to pay.
" Issuers of one-name bills frequently put them out merely for the
sake of the acceptance commission they thereby obtain . In lieu of
selling the bills themselves, they turn them over to others who lack the
requisite facilities for drawing on London, and receive the customary
fee in return. Those accommodated in this way are generally large
stock brokerage houses or money brokers. They dispose of the drafts
in New York, and either relend or utilize the proceeds in their own business. They procure the bills only upon giving satisfactory guarantee
of furnishing the issuing banks with the exchange the latter will be
obliged to remit to London as cover for the bills. This guarantee consists : (1 ) of immediately placing in the hands of the banks contracts of
other prime institutions promising delivery of demand or cable exchange when the long bills fall due ; and ( 2 ) of engaging to supply the
1 See pp. 497-502 for a more detailed discussion of " futures," " hedging," and " forward
contracts."

TYPES OF FOREIGN BILLS OF EXCHANGE

215

banks with the funds they will be required to pay on the future contracts, and to that end pledging with them stocks and bonds as
collateral security." 1
Loan bills and finance bills have for many years past played an
extremely important part in the foreign exchange market. Before
the World War it was customary for from $300,000,000 to $500,000,000
to be outstanding in the spring and early summer months when exchange rates were usually high with the possibility of a decline in the
fall as the crops began to move toward European countries. Bankers ,
brokers, and large industrial concerns have made wide use of them as
a method of obtaining money at low rates, in many cases as low as
I to 14 per cent per year. London bankers, likewise, have been willing to act as acceptors and to receive their commission or their profits
on joint accounts. They have also looked upon them favorably as a
means of making loans to parties in other countries without as a rule
entailing the exportation of gold.2 Whenever exchange rates show
a tendency to rise to higher levels, the banker immediately appreciates the opportunity of speculating on a possible decline , or it
may be that he wants to build up his accounts abroad so that he may
sell demand exchange against them and profit through the prevailing
high exchange rates , or it may be that he has certain foreign obligations
to meet and objects to paying such high exchange rates. Under these
circumstances he will issue finance bills or loan bills. As Clare says
""
in speaking of the situation between England and France, ... the
bidding need only be raised a centime or two to tap an almost inexhaustible source of supply, that of bankers' drafts." 3 A rising
exchange market will normally bring forth a large supply of bankers'
bills, which, because they increase the supply of exchange available,
normally reduce the rates of exchange. In this way the floating of
finance and loan bills usually keeps exchange rates from going to a
point where it is profitable to export gold, and therefore assists in
4
protecting the gold supply of the drawing country. But it sometimes
happens that the issuance of these bills may be the indirect cause of
gold being drained from the country that has been drawn upon. A
1 York, op. cit., pp. 151-152 .
2 Finance and loan bills " afford the most powerful and cheapest means of raising money
without the actual employment of gold." Gonzales, V., op. cit. p. 42 .
3 "The A. B. C. of the Foreign Exchanges," p. 29.
4"Finance bills of this kind, drawn in anticipation of shipments of produce, thus perform a most useful office by checking fluctuations in exchange, and expensive and clumsy

216

DOMESTIC AND FOREIGN EXCHANGE

situation of this kind occurred in 1906 and 1907 between England,
Germany, and France on the one hand and the United States on the
other. Large amounts of corporation securities had been floated in
the New York market in 1906 , and in order to obtain the needed funds
and also in order to take advantage of the high money rates existing
here (with low discount rates abroad) , enormous amounts of finance
and loan bills were drawn on English, French, and German banking
houses. The issuance of such large sums lowered the exchange rates,
especially those on England, and started the flow of gold to this country. The movement of gold was aided both in the spring and in the
fall by the Secretary of the U. S. Treasury depositing government
funds with the importing exchange dealers, thus making the funds
immediately available and saving the importers the loss of interest on
the gold while it was in transit.¹ The net imports amounted to $103 ,000,000, which with the exception of the year 1898 were the greatest
in the history of our country up to that date. The rates on England
were further weakened by the large number of drafts drawn on London
by insurance companies for the purpose of obtaining funds with which
to pay the losses of the San Francisco earthquake and fire. The
situation became rather critical for the foreign banks, especially for
the Bank of England , the Bank of France, and the Reichsbank of
Germany. The London money market was badly strained, and it
appeared necessary, as an English writer of the time stated, "to restrict the creation of American credits on this [ English] side of the
ocean. For there is no doubt that the stringency in the money market
would never have been so acute if Europe had not given excessive
credits to America , who not only placed large amounts of finance
bills in London, Paris and Berlin , etc. , but began already , in the second
half of the year, to place its railway debentures and railway ' notes '
on the principal European money markets. All of the operations had
to be liquidated by London, which was made responsible for the stringency that took place." 2 Another writer of the time also declared that
"The London banks, by their treatment of New York finance bills ,
will decide whether the wild inflation of credit in the United States is
to go on for another year or to be checked . So long as they accept and
shipments of gold from one side of the ocean to another. If they were abolished, the exchanges would tend to swing violently from one gold point to another, according as the
movement of produce or the payment of other seasonal debts shifted the balance of claims
from one country to another.' Withers, H., "War and Lombard Street," pp. 84-85.
1 Governmental aid ceased on October 23 , 1906 .
2 Rozenraad, C., Journal of the Institute of Bankers, vol . 28, p. 206 , April, 1907.

TYPES OF FOREIGN BILLS OF EXCHANGE

217

discount such bills, so long will the New York banks be able to buy
gold in London, and the moment it is bought four more dollars may be
lent against every dollar of it. " ¹ The Bank of England and the Reichsbank of Germany were forced to raise their discount rates, which made
money dearer in those countries and thus made it unprofitable for
American bankers to issue new bills or to renew the old ones at maturity. Banks in England, France, and Germany discriminated against
the American bills, so that by 1907 there were but $ 25,000,000 to
$30,000,000 outstanding in England with much smaller amounts in
Germany and France. Temporarily the flow of gold toward this
country was checked, and matters became somewhat more normal.
During 1907, however, our exports of crops to England were extremely
heavy, and an oversupply of sterling exchange was again created .
The usual amount of maturing finance bills was not present in the
market.

Normally the demand for exchange with which to retire

finance and loan bills always stiffens exchange rates somewhat during
the fall and winter months. But with only a small amount of such
bills to retire, and with only a slight demand for exchange with which
to cover, the exchange rates on England fell below our gold import
point and gold flowed into the United States in huge sums.
In the discussion of finance bills and loan bills we have continually
stated that neither the American drawing bank nor the foreign accepting bank invests one penny of funds in the transaction. Just where,
then, does the money come from? The answer is simple : It is the
party that holds the bill until maturity that supplies the funds. As
a rule, it is some discount house or bank in London. If the New York
bank that purchases the long bill from the American issuing bank,
gives instructions to its correspondent that the bill is to be presented
for acceptance and held until maturity, the New York purchasing
bank will under those circumstances furnish the funds with which the
transaction is financed . On the other hand, if the New York bank
instructs its London correspondent to have the bill discounted in London immediately upon acceptance, the money is advanced by the
London bank or discount house that buys the bill, or, as we say, " the
London discount market " advances the money. It is willing to do
this, as has been noted earlier, because of the discount that is earned
during the time that the bill is held.
The discount market, especially that of London, is very sensitive
1 Lawson, W. R. , Bankers Magazine (England), vol . 82, p. 468, Oct. , 1906.

218

DOMESTIC AND FOREIGN EXCHANGE

and carefully watches the amount of finance and loan bills that are
issued bearing the acceptance of any one bank. As an English writer
puts it, "Merely as a means of raising the wind temporarily, it [the
issuance of finance and loan bills] is an easy and pleasant device so
long as it does not excite suspicion . "
The market has an uncanny
way of keeping in touch with the amount of such bills that are offered
for discount and, when once its suspicion has been aroused, it has no
hesitancy in refusing to discount those bills that have been accepted
by a London firm which it feels has " accepted " to too great an extent.
Hints may be dropped that " so and so's " bills are too numerous, or
a more unfavorable rate of discount may be asked when they are
offered for sale, or the market may refuse absolutely to discount them ,
or some other action may be taken to show that the market feels that
the accepting firm has exceeded its limit . Very seldom has this practice of issuing loan or finance bills been abused. Bankers and acceptance houses appreciate the fact that they must not arouse the suspicion
of the market if they desire to retain their credit standing with it.
D. TRAVELER'S FUNDS

American travelers, even in Canada, which has a monetary system
practically the same as our own, find , as a rule, that American money
cannot be used in foreign countries in making their purchases or in
supplying their other needs. If they should take American money
with them , it would be necessary to have it exchanged at some money
1 Lawson, op. cit., p. 460 .
2 It is surprising, however, to learn what large amounts of American money are actually
in circulation in foreign countries under the disturbed conditions caused by the World War,
due in part to the great depreciation in the purchasing power of foreign monies. The Federal Reserve Bank of New York circularized banks and private banking houses in New
York as to their shipments of United States paper money to and from foreign countries.
The following tabulation covers the period from January 1 to April 30, 1921 :
Imports
Country
Exports
$ 35,121,251
Europe..
$105,168
Mexico and South America .
1,773,062
1,355,000
Cuba and West Indies ..
12,257,779
9,684,500
Canada .
2,318,662
20,000
Asia ..
687,239
Africa..
86,766
Australia.
3,690
3,405,192
12,000
Country not reported .
Total..
$11,176,668
. $55,653,641
An additional $22,500,082 in United States paper money was forwarded by the Federal
Reserve Bank of New York to Cuba for the account of New York City banks. The actual
total amount of exports of paper money is greatly in excess of the sum stated because of
remittances by individuals and because of the amounts taken out of the country by travelers.

YORK
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TYPES OF FOREIGN BILLS OF EXCHANGE

219

220

DOMESTIC AND FOREIGN EXCHANGE

changer's office or at some bank for the money of the country in
which they were traveling. The rates of conversion in such cases in
normal times are not usually satisfactory, so that the traveler takes
the precaution of providing himself with the money of the country
that he is to visit or with certain kinds of exchange documents that
will furnish him with the needed funds when desired . He will usually
resort either to traveler's checks or to a traveler's, or circular, letter
of credit. We have already discussed the advantages and the methods
of using traveler's checks and traveler's letters of credit in domestic
travel. We may therefore confine our present discussion to their use
in foreign travel.
Traveler's Checks . Before the great depreciation of the foreign
exchanges occurred , the customary form of the traveler's check was
as shown in Fig. 60.

It was issued in denominations of $10 , $20 , $50,
TRAVELERS CHECK

(100

100

HOLDER'S SIGNATURE

No 000000

Company of NewYork
Guaranty Trust
140 ORITS
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THE PERSON WHOSE SIGNATURE APPEARS ANDVE
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BY

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THE HOLDER HUST GIGN HEMS IN PRESENCE OF MENING OFFICER

FIGURE 61
New form of foreign traveler's check

$ 100, and $200, and sold at the rate of face value plus one-half of one
per cent commission , the selling bank or agent retaining the commission for its services as salesman . The express company or bank upon
which the checks were issued received its return or profits through
interest derived from the use of the funds until the checks were cashed.
The old form of traveler's check was convertible into foreign monies
at fixed rates. As shown on the accompanying check, for instance,
a $ 100 check could be cashed abroad for £20 8s 2d in Great Britain,
512 francs and 50 centimes in France, Belgium, and Italy, 416 marks
and 65 pfennigs in Germany, etc. If revenue stamps were required
they had to be affixed by the holder when cashing the check, but other-

upset calculations and policies long followed, and it

traveler's check, and also
the method of conversion.
Fixed rates of conversion

were no longer possible, so
the simplest thing to do
was to issue a traveler's

check payable at home in
a fixed number of dollars,

but payable abroad at the
cashing banker's buying
rate of exchange for sight
drafts on New York (Fig.
61). This meant that the

purchaser bought his traveler's check for $ 100 plus a
one-half or three-fourths
S

FRAN
IN

T

CIPHER

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American
62
FIGURE
traveler's
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PAYAGENCIES
ITS
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With the World War, the
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CIPHER

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TREASURER
.

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ChEQUE
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its face. This arrangement
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LEBS CULLQUES AS YOU WOULD MONEY. WHEN CASHINGFILL
No.
DATE, BUT CHEQUE COMPLETELYANDCOUNTERRIC
BYWHOM
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AT

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AMERICAN
EXPRESS
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TYPES OF FOREIGN BILLS OF EXCHANGE

221

became necessary forbanks

and express companies to
modify the form of their

222

DOMESTIC AND FOREIGN EXCHANGE

per cent commission, and that when he cashed it in England he received
in return $ 100 worth of English money calculated on the basis of the
rate being paid that day for demand drafts on New York by the
banker that cashed the check. If, for example, the English banker were
buying demand drafts on New York at the rate of £1 for every $4.00
of American money, the traveler would receive £25 in return for his
$100 traveler's check. As the exchange rates on the United States
varied from day to day, he would receive varying amounts of foreign
money for his traveler's checks. Another form that has been adopted
has been a traveler's check payable in a fixed amount of money of
one foreign country, but in all other countries made payable at the
banker's rates for demand drafts on New York. Thus in the case of
the above " French franc traveler's check " (Fig. 62) , the American
Express Company issues to the traveler a 200 franc check and charges
him the franc rate for that day plus the usual commission. The traveler's check can be cashed in France for 200 francs , but if the traveler
goes to London, his franc check will be converted by the London
banker into English money at the rate that the banker is that day paying for demand franc drafts on Paris. In the case of a " sterling traveler's check," the check is drawn payable at a fixed amount of sterling,
but if cashed in France or elsewhere it is converted at the banker's buying rate for demand drafts that day on London . If the traveler so desires, he may have a book of checks made up for him containing dollar,
sterling, and franc traveler's checks , and thus save himself the trouble
of having them converted into the money of some other country. A
third variation has been introduced by the Bankers Trust Company of
New York, which, as noted earlier, issues the A. B. A. Traveler's
Checks. The form used by the latter bank and its agents provides
that if a traveler is going to England he can buy a dollar traveler's
check, such as we have described in Chapter III. When he reaches
England he can go to the London office of the Bankers Trust Company and exchange his dollar checks for sterling checks at the banker's
buying rate for demand drafts on New York. If he takes a notion to
go to France, he can visit the Paris office of the Bankers Trust Company and exchange his sterling traveler's checks for franc traveler's
checks at the banker's buying rate for demand drafts on London, and
so on in the various countries in which the Bankers Trust Company
has made similar arrangements with bankers and correspondents.
When any of the above described forms of checks are cashed in any

TYPES OF FOREIGN BILLS OF EXCHANGE

223

country in which conversion is necessary, the rate at which it is converted includes a slight commission for the bank that makes the
conversion.
If the traveler should lose his checks or they should be destroyed,
he wires the nearest agent or the agent from whom they were purchased, and after he has put up an indemnity bond, the bank or express
company will refund the face value of the lost or destroyed checks, or
issue a new supply to him.
Traveler's or Circular Letter of Credit. When travelers plan to take
with them more than $1,000 or its equivalent in foreign money they
universally resort to a traveler's, or circular, letter of credit. A
traveler's letter of credit is the oldest form of instrument used for the
purpose of advancing funds to travelers and is still the one most widely
used. The general form and methods of using such a document have
been fully discussed in Chapter III. Only a few additional details,
referring to its use in foreign travel, need be mentioned .
The general form of a traveler's letter of credit as used in foreign
travel is practically the same as that for domestic purposes. It is
customarily a four-page document, the first page bearing a printed
letter addressed " To our Correspondents and other Bankers," requesting them to honor the drafts drawn against the letter by the
accredited party. If the traveler is to remain in one country, it may
be addressed only to a particular bank. The foreign circular letter is
almost always drawn in terms of a foreign money, although it is sometimes drawn in dollars. The drafts that are drawn under it are almost universally ordered to be drawn against a designated foreign
bank mentioned in the body of the letter, although the letter may
require that they be drawn on the issuing American bank. The second
page, sometimes both inside pages of the letter, contains columns in
which are to be entered the dates on which drafts against the letter
are paid, by whom, where, the amount in figures, and the amount in
words.
Let us say that Mr. Andrews goes to the First National Bank of
San Francisco and applies for a £10,000 traveler's letter of credit . He
may obtain it in return for a cash payment, that is, he may buy it outright by paying the value of £10,000 at the bank's selling rate for
demand sterling exchange on that day. He may or may not have to
pay a commission, but if it is exacted by the issuing bank, it is usually
about 1/8 to 1/2 of one per cent of the face value of the letter. If the

224

DOMESTIC AND FOREIGN EXCHANGE

banker's sight rate on England is 4.85 on that day, and if no commission
is charged, Andrews gets his circular letter for $48,500. The bank gets
the use of that sum of money while the letter is being drawn against ,
the amount available for the bank's use decreasing as drafts are cashed
against the letter. If the traveler does not exhaust his letter, i. e., if
he does not use all of the funds which it represents, the bank will buy
the remainder from him upon his return , paying therefor the bank's
buying rate for demand sterling drafts.
If the applicant is a depositor at the bank, enjoying a satisfactory
credit standing, and also agreeing to keep on deposit an amount of
money sufficient to protect the bank against loss, he may receive the
letter of credit without making any payment at the time he gets it,
or without depositing any security. He merely agrees to provide for
the payment of the drafts together with the bank's charges. In this
case, when the drafts drawn against the letter finally reach the First
National Bank, it debits his account with the face value of the drafts
plus its charges. The bank watches the account of the traveler so as
to be sure that enough remains in it to meet all possible payments
that may have to be made as the letter is drawn against. The bank
may also issue the circular letter to the applicant upon a deposit of
sufficient collateral to protect the bank against loss.

Under these

two methods the bank receives no money in advance, and therefore
cannot count on gaining any interest on the use of the funds involved
as was the case with the first method. Also, when the letter of credit
has been drawn on the issuing bank's foreign account or deposit, say
with Barclays of London, as the drafts drawn by the traveler are
forwarded to Barclays and deducted by Barclays from the account
of the issuing bank, the deposit of the latter with Barclays is to that
extent reduced. It therefore loses interest on the amount involved
from the time that its account is debited until it is reimbursed by
debiting the account of the traveler or until it receives payment from
him or from the guarantor of the letter of credit. As a consequence,
if either of the last two methods is used, the bank will charge the
traveler not only with the face value of the draft converted at the
bank's selling rate on that day for demand sterling drafts together
with its commission of one per cent , but also with an additional charge
for the interest lost.

Some banks charge interest only for the time

that elapses from the debiting of their foreign accounts to the time
that the draft reaches them, while others charge, in addition, interest

TYPES OF FOREIGN BILLS OF EXCHANGE

225

for the length of time that it takes for the " cover " to be sent to replenish their foreign accounts. It takes approximately seven days
for mail to reach London from New York ; some banks charge seven
days' interest ; others, however, make a charge for fifteen days.
Banks located in the western part of the United States frequently
charge fifteen or thirty days' interest.

The majority of traveler's letters are issued against a guarantee
(Fig. 63 ) rather than against a deposit of collateral or for cash payGUARANTEE

San Francisco, Jamary 6

Letter of Credit No. 347-

19_21

Whereas, The First National Bank of San Francisco has given to
its Circular Letter of Credit No.. 347

N
forE £10,000
M

I
say Ten thousand pounds sterling
C
E
hereby guarantee and
nk the amounts drawn against said Letter of
Pagree to pay
Credit, together with the usual charges. "
In case this
hereby authorize the said Bank to send the usual
. credit be either lost or sto
Circular to its Correspondents, noting them of the loss, and to take such precautions as it may deem
advisable for the prevention of fraud agreeing to pay any expenses attending the same, and in case of
the cashing of any drafts by any banker, under the usual precautions, and before the receipt of any circular,
I
agree to indemnify the said Bank for any loss therefrom.

...hereby authorize said Bank to charge to......
account any drafts, plus interest and
commission, that may be drawn under this Credit, also any charges that may be incurred under same.

A.B.Andrews

07-79-2-2-16-1M

FIGURE 63
Foreign circular letter of credit agreement

ment. The letters of guarantee will vary as between banks , but usually
follow a general type, guaranteeing that the issuing bank will be paid
"the amounts drawn against said Letter of Credit, together with the
usual charges," or that the traveler " hereby agrees and binds himself
whenever notified of the payment of any or all drafts under said Credit,
to provide for the payment of the same to you in Dollars, plus ........
days' interest at ........... per cent per annum, at the current rate of Exchange for your Sight Drafts on London, together with a commission

226

DOMESTIC AND FOREIGN EXCHANGE

of........ per cent on the amount of the drafts made by virtue of this
credit." When collateral is deposited the agreement provides that
the bank is authorized to sell at any time, with or without notice, at
public or private sale, any securities that may be held by it as collateral
for the circular letter which it has issued.
When the clerk issues a circular letter he makes several copies. The

Setter Credit
.
CathAddress
"LANOITAN"
10,000
The FirstNational Bank ofSanFranciscoCalifornia
1921
,
Cal January 6,
SanFrancisco
Gentlemen,
Wehavethehonorto
introduce toyou» Mr.A. 3. Andrews
whosesignatureappearsbelowandwhom wewommendtotoyourkindattention:
dra
Please cash ras
Candon, England
.
atsight
on
the
Bank
of
odexceedingthe aggregateamountof
foranysumsnoterro
Ten thousand (£10,000)-tig
BoundsSterling
cachdraftbearing thenumber ofthisLetteranditsamountbeing
endorsedbyyouhercom.
engagethatdraftsdrawnincompliancewiththeterms
ofthisCreditshallhaveduehonor.
Your chargesare ofcourse tobepaidbytheaccreditedparty.
ThisCreditwillcontinue inforevuntil December 20 , 1921 andisto
be returned withthefinaldraft. We remain,

Signature of
AB Andrews

Gentlemen,
Ffourmostobedientservants

Toour Correspondentsand
other Bankers

Presulent
Cashier

FIGURE 64
First page foreign circular letter of credit
original goes to the traveler, one copy to the files of the issuing bank,
and, in case the letter is addressed only to one foreign bank, on which
the traveler will always draw his drafts, a copy is sent to it. When a
business firm obtains a letter of credit for one of its traveling salesmen
and guarantees the payment of drafts in the manner described above,

1

TYPES OF FOREIGN BILLS OF EXCHANGE

a copy may be given to it for its files.
only the first page of the letter.

227

The copies are duplicates of

One type of traveler's letters of credit bears the signature of the
traveler on its face ; the other type has the signature of the traveler
appearing on the letter of indication which makes the first page of the
small pamphlet containing a list of the bank's correspondents.¹ This

NO
OF
DRAFT

PLACE

Sums drawn under within Credit
AMOUNT
DATE
IN WORD'S
IN FICURES

BY WHOM NEGOTIATED

345 Rome 2/2.21 Five hundredSt. + 30 Banca Roma
834 London 3/5/ 2/ One thous andIty. Good - Barclaye
1
SPECIMEN

FIGURE 65
Second page foreign circular letter of credit
list of correspondents contains not only the names and addresses
of the actual correspondents of the issuing bank with which it has an
account abroad, but also, in case the letter is directed only to one
foreign bank, the names of the correspondents of that foreign bank.
Let us say that Mr. Andrews gets his circular letter in sterling from
1 Cf. pp. 54-55.

DOMESTIC AND FOREIGN EXCHANGE

228

the First National Bank of San Francisco with the understanding that
his account with that bank is to be debited with the face value of the
drafts which he draws against his letter, converted at the bank's selling rate for sight sterling, plus commission and interest. The letter
will be in the form on pp. 226-227 (Figs. 64–65) . In this particular
case the letter is issued in pounds sterling on the Bank of Montreal , London. The signature of the traveler appears on the face of the letter.
The First National Bank clerk will also have Mr. Andrews sign a signature blank, which will be forwarded to the Bank of Montreal (Fig. 66) .

ADVICE OF LETTER OF CREDIT

No347

£10,000
The First National Bank of San Francisco

To
Bank of Montreal.
London, England .

San Francisco. January 6, 1921

S
P
E

Gentlemen:
We have issued our Travelers L

C
I
Credit No. 347ME

Dated January 6 , 1921
N

in favor of Mr. A. B. Andrews
authorizing drafts on yourselves to the extent of
This credit will bé in force till December 30, 1921

Ten,thansand pounds

and

Sterling.

hank you to accord due honor to

any drafts drawn thereunder, charging same to our account, when presented in due form
SPECIMEN SIGNATURE OF HOLDER
Yours faithfully,

AB Auchnew
683-4 6-14
FIGURE 66
Advice of letter of credit
When Mr. Andrews arrives in Paris and finds that he is in need of
funds, he leafs through the list of correspondents and notes that the
Crédit Lyonnais is the Paris correspondent of the First National Bank.
He thereupon presents himself at the exchange window of that institution and makes his wants known, handing the clerk the circular letter
of credit. The clerk glances over it to see that the letter is still in
force, i. e . , that the expiry date has not passed, and also that the
amount for which the letter was issued has not been exceeded. If in
doubt concerning the form of the letter, he refers to his files and notes
that the letter is on a form similar to the sample copies which have
been received from the First National Bank when it established corre-

TYPES OF FOREIGN BILLS OF EXCHANGE

229

spondent relations. He may also wish to look up the signatures of
the bank's officials attached to the letter, so he again resorts to his
files and consults the signature sheet which the First National Bank
has also sent to all of its correspondents, which sheet bears the
printed signatures of the officers who are authorized to sign any of the
documents issued by that bank (Figs. 16-17) . Some banks will have
but one sheet of signatures, while the larger banks with many branches
will have a small sized book of fifty or more pages of signatures of the
officials who sign documents for the various branches . If everything
is in order, the clerk asks Mr. Andrews how much money he desires.
The clerk then makes out a draft for, let us say, £50, drawn on the
Bank of Montreal , writes thereon " Drawn under Letter of Credit
No. 347 issued by the First National Bank of San Francisco, " and
passes the draft to Mr. Andrews to sign. The clerk then compares
the signature on the draft with the one that appears on the circular
letter of credit (or in the letter of indication if perchance it is that type
of letter) . If there appears to be no evidence of forgery , the clerk will
pay Mr. Andrews as many francs as the £50 draft will buy at the prevailing rate for demand drafts on London, plus any commission that
the correspondent may charge.
Mr. Andrews will also have to
pay any stamp duties or taxes that may be imposed .

If the rate is

25.22 francs for £1 , Andrews receives 1,261 francs. The clerk enters
the data of the transaction on the second page of the letter and returns
it to Andrews. The Crédit Lyonnais forwards the draft to its London
correspondent which presents it to the Bank of Montreal for payment.
Inasmuch as the Crédit Lyonnais makes its profit on the rate which it
charges Andrews, the Bank of Montreal will have to meet no other
obligation than the payment of the £50 draft. The clerk of the Bank
of Montreal will look up the signature blank of Mr. Andrews, and compare his signature on the draft with the one that appears on the signature blank forwarded to it at the time the First National Bank of San
Francisco issued the circular letter of credit. If everything is satisfactory the draft will be cashed and £50, plus any charges that may be
made, will be deducted from the account of the First National Bank
of San Francisco . The canceled draft or a statement to the same
effect will be forwarded to the First National Bank, which in its turn
will deduct a sum from Andrews' account equal to £50 in American
money converted at the bank's selling rate for sterling sight drafts,
plus commission and interest.

230

DOMESTIC AND FOREIGN EXCHANGE

If the letter has been issued in " dollars" and the drafts are to be
drawn on the First National Bank of San Francisco, the procedure is
the same so far as the general features of the transaction are concerned.
The draft will be drawn in dollars on the First National Bank, the
Crédit Lyonnais will give Mr. Andrews as many francs as his dollars will
buy at the rate charged by the bank, and the draft will be forwarded
to an American correspondent of the French bank, either in New York
or in San Francisco . The latter will present the draft to the First
National for payment, and when paid , will credit the account of the
French bank with the dollars collected . Otherwise the procedure is
the same as in the case of the sterling letter. Some firms in the United
States find it profitable to provide their salesmen with traveler's
checks for small sums and with two letters of credit for large sums,
one being drawn in sterling and the other in dollars, so that the salesman may take advantage of the more favorable rate of exchange.
"Fixed," "advised," or " restricted " letters of credit are frequently
issued to clients who intend residing in a particular town or community. They are addressed to a specified bank, to which the issuing
bank also sends a special " advice " containing the signature of the
client, the amount for which the letter has been issued , the date of
expiry, and other data . The beneficiary is expected to cash his drafts
drawn against the issuing bank or its designated correspondent only
at the bank to which the letter is addressed. The procedure followed
in cashing drafts against the letter is the same as in the example first
given.
Some American banks have lately inaugurated the practice of furnishing books of bank drafts to their clients who have obtained a
circular letter of credit from them. These bank drafts bear the number and date of the circular letter of credit, thus avoiding one source
of confusion, and enable the bank to segregate more easily from the
day's mail those drafts that have been issued under its circular letters.
The smaller banks have no correspondents abroad against whom
they may issue circular letters, so they arrange with exchange dealers
in nearby financial centers either to have such letters issued on blanks
bearing the local bank's name or else the name of the exchange dealer.
For instance, the State Bank of Evanston , Illinois will arrange with
the Continental and Commercial Bank of Chicago to issue such letters
on the Bank of Scotland, London , England . The Evanston bank will
fill out the letter form , bearing its own name and address. Signatures

TYPES OF FOREIGN BILLS OF EXCHANGE

231

will be taken from the applicant and forwarded with the letter to
Chicago. The Chicago bank will make the necessary entries in its
books , send the signatures and required advices to the Bank of Scot1
land, London, and after its own officials have signed the letter ¹ will
return it through the Evanston bank to the applicant. When the
traveler goes abroad, draws and cashes his drafts, they are forwarded
to the Bank of Scotland, which debits the account of the Continental
and Commercial Bank. They are then sent to the Chicago bank which
will figure out its charges and deduct the same from the account of
the Evanston bank, forwarding a statement thereof for the latter's
information. More often , however, exchange dealers do not allow a
local correspondent to issue circular letters in this manner, but require that the applicant obtain the letter direct from them in the same
way as would be done by one of their own customers , the local correspondent merely acting as the agent of the issuing bank, forwarding
the necessary signatures, the funds for cash payment, etc.
Previous to the World War, all traveler's letters were issued only
against foreign banks, usually in terms of pounds sterling. Now, however, an increasingly large number are being issued by American banks
upon themselves, the drafts to be drawn in dollars as above described.2
In 1915 a few of the larger New York banks originated a new form of
traveler's letter which was a combination of the old-fashioned traveler's
check with fixed rates of conversion and the ordinary traveler's letter
of credit. The letter was issued in dollars , but when the traveler drew
his drafts, he drew them in pounds, francs, marks, or in the money
of any country in which he happened to be traveling . The drafts
were then converted at the offices of the foreign correspondents designated by the issuing bank, at fixed rates (like those on the oldfashioned traveler's check ³ ) , which conversion rates were printed
on the second page of the letter. Thus, if he drew a draft on the issuing
1 This is necessary because the foreign correspondent does not have copies of the signatures of the officials of the Evanston bank.
2 "Merchants are coming more and more to use American Express Traveler's Checks
and Circular Letters of Credit drawn in dollars for trading in Central and Eastern Europe,
our European offices report. Both these forms of financial paper are desirable for this
purpose because they are so readily accepted and so widely available, at the same time
combining the advantage of being issued in a stable currency.
"Traders who follow this practice are usually able to obtain considerable concessions
over quoted prices by reason of being ab e to pay cash . Another advantage is that these
forms of paper are so fami iar throughout Europe that it is possible by approaching several
banks to get at all times the best rate of exchange." Foreign Trade Bulletin of the American
Express Company, January-February, 1922.
3 Cf. p. 219 .

232

DOMESTIC AND FOREIGN EXCHANGE

bank for $100 and presented it at the Paris correspondent's office, he
would receive $100 worth of francs at the fixed rate of conversion
thereby avoiding the uncertainties arising from the fluctuating rates
of exchange and also the exorbitant rates frequently charged by certain
classes of foreign exchange dealers. As a result of the extremely wide
variations in the exchanges, which followed shortly after this new
form was adopted, it had to be abandoned , but there is no good reason
why it should not again be used when conditions return to normal,
embodying as it does all the advantages of the traveler's check and
the traveler's letter of credit.

E. MEANS BY WHICH CREDITORS SECURE PAYMENTS DUE THEM
The remaining group of exchange documents comprises those that
enable creditors to obtain payments due them for things sold, services
rendered, money loaned, etc.
Drafts Drawn without Commercial Letters of Credit, etc. An exporter
will often use the trade acceptance as a means of obtaining payment
for goods which have been sold to a foreign customer. This is the case,
however, only where the two parties have had extensive dealings with
each other and where the exporter has faith in the credit standing of
the importer. When the goods are ready to be shipped and all the
documents have been prepared, the exporter draws his draft directly
on the importer, as per agreement, and sells the bill of exchange to
his banker or hands it to him for collection. In either case, the importer accepts the draft when it is presented by the foreign correspondent of the American bank, and pays the draft at maturity or under
rebate, depending upon whether the instructions are D/A or D/P
respectively. As was noted in Chapter VII¹ it is not unusual for an
exporter to sell goods to a foreign customer of excellent standing with
the agreement that three months after the goods have been shipped,
or possibly at the end of thirty days, a draft is to be drawn on the
customer for the amount involved. The draft when drawn is sold to
an exchange dealer or turned over to him for collection. Importers
frequently run open accounts with exporting firms with the understanding that a draft for the amount due shall be drawn on them
2
every month. Such an arrangement is customary between American

1 Cf. p. 139.
2 Or the importer may remit monthly to the exporter.

TYPES OF FOREIGN BILLS OF EXCHANGE

firms and their foreign branches.

233

Parties rendering professional ser-

vices at the request of foreign firms or for individuals residing abroad
usually draw drafts against their clients as per agreement and receive
their fees or salaries in American money through the sale of their drafts
to exchange dealers. American agents of foreign insurance companies,
who desire to obtain funds from their home offices with which to make
payments of losses, salaries, etc. , do not wait for remittances to come
from abroad, but draw drafts against their companies, sell them in
the open market, and thus get the needed funds. In the late spring
and early summer of 1906 foreign exchange rates were rather seriously
weakened by the drawing of such drafts in large amounts in connection
with payments made necessary because of the San Francisco earthquake and fire of that year.
Another very customary use of drafts in this connection is where
they are drawn against securities which American stock and bond
houses have sold to foreign clients. An order will come to a stock and
bond house to buy 100 shares of Southern Pacific stock when the
quotation in the market has reached a certain point. The stock is purchased by the bond house, a draft is drawn against the foreign customer
for the amount of the sale plus the commission, and , with the bonds
attached as collateral security, the draft is sold to an exchange dealer.
Drafts of this sort find a ready market and always command high rates
in the market for the reason that the credit of the drawer and of the
drawee is further enhanced by the attached securities.
Commercial Letters of Credit. Commercial letters of credit, sometimes called " mercantile letters of credit, " and how they function in
domestic trade, have been rather fully discussed in Chapter III. Mention was made of the fact that business men were as yet but slightly
acquainted with their use in that connection , but that they were
commonly employed in foreign trade in the financing of exports and
imports. There are so many types of import and export credits that
it is advisable to devote a separate chapter to a discussion of their
characteristics and varied uses.

CHAPTER IX
IMPORT AND EXPORT CREDITS
Exporters may agree to sell to foreigners, first, only for cash, i. e.,
cash to accompany the order, in which case the importer obtains the
necessary amount of exchange on the exporter's country, usually a
banker's sight draft, and sends it with his order. Or, second, the goods
may be sent on open account, the agreement being that the foreigner
is to remit for the goods when received , or that he is to pay for them
at the end of a stated period, say within thirty or sixty days, or that
the exporter is to draw a sight draft on him at the end of that time.
In either of the last two cases, of course, the importer gets his documents and his goods without having to pay for them and without having to accept any draft before obtaining possession . Or, third, the
exporter may draw a sight draft on the importer at the time the goods
are shipped and thus compel him to pay for the goods before he gets
them. Or, fourth, he may draw a long time D/P bill and send it along
with the documents, which accomplishes the same result, because the
importer cannot get the goods until he pays the draft. Or, fifth , he
may draw a long time D/A bill on the importer, i . e. , a trade acceptance, which is seldom done in foreign trade unless the exporter has
implicit faith in the credit of the importer, or unless the latter has
arranged for an " authority to purchase." Or, sixth, the goods may
be sent to the importer under the terms of a commercial letter of
credit , which of all the practices followed is the most important and
the one most commonly employed.
Under a commercial letter of credit, the importer really substitutes
the credit of a bank or accepting house for his own credit. We shall
use the term " bank" in the subsequent discussion as including all
classes of exchange dealers that are concerned with export or import
credits. The exporter frequently does not know the standing of the
importing firm , or if he does he may be unwilling to assume the
risks involved in connection with shipping solely on that basis. American bankers and exporters have been extremely slow in accumulating
credit information concerning foreign firms. An exporter is not
234

IMPORT AND EXPORT CREDITS

235

desirous of shipping goods to a foreign importing company unless he
is assured of receiving payment. The foreign firm hesitates to send
cash with its order because there have been many instances where exporters have failed in business before the goods have been shipped,
thus causing a loss to the importers. Also, certain abuses of the trade
which we do not need to consider have been fairly common among
exporters when cash has been sent along with the order. Another
reason why the importer does not wish to send cash with his order is
that he does not care to stand the loss of interest on the money invested
in the remittance. If, on the other hand, the goods are sent to him
on any basis that approximates our domestic " C. O. D. , " he does not
particularly enjoy the prospect of having to pay cash for his goods
before having a chance to inspect them. The importer much prefers
to obtain possession of his goods, to have about three months or longer
in which to dispose of part or all of them, and thus to put himself in
funds so that he may meet the payment when due. But as we have
seen, the exporter prefers not to enter into any such arrangement unless he is definitely assured as to the possibility of getting his money.
The greatest advantage arising from the use of such import and export
letters of credit and from the substitution of the bank's credit for that
of the importer or the exporter is that the bank or the discount market
carries the burden of financing the transaction. If the drafts covering
an export of goods are drawn on the importer, the amount of such
bills that a bank will negotiate for the exporter is limited by the
financial standing and credit of the latter. But if the drafts are drawn
under a commercial letter of credit against a foreign bank, the amount
that the exporter's bank will then negotiate for him is practically unlimited . The exporter is able to get his money out of the transaction
as soon as his shipment is ready and his documents have been sold to
the bank. He can , therefore, finance many more export shipments
than would be the case if he had to tie up his capital in them for an
indefinite length of time. The importer also benefits from the use
of a commercial letter of credit. He is not required to advance any
of his own funds in order to import goods or to obtain possession
thereof. He uses the credit of the accepting bank. He can therefore
conduct a business of a much greater extent than if he had to depend
solely upon his own resources. It is because of these reasons that the
importing firm, having corresponded with the exporter as to the cost
of the goods, the terms of sale, etc. , and an agreement having been

236

DOMESTIC AND FOREIGN EXCHANGE

reached between the two contracting parties regarding all details of
the proposed transaction, goes to its bank and asks for what, under
If a
the circumstances, is known as an " import letter of credit. "
commercial letter of credit is requested by an exporter for the purpose
of financing exports, it is known as an " export letter of credit. " 1
Commercial letters of credit are usually for large amounts. Banks
ordinarily refuse to issue them for less than $500, sometimes for less
than $ 1,000, because of the bother involved in handling small sums.
It must be remembered that the commercial letter of credit itself is
not a bill of exchange, but merely a means through which or by means
of which a bill of exchange is brought into existence. Such bills may
be either clean or documentary, demand or time, D/A or D/P.
Commercial letters of credit have been used extensively by American
merchants only since 1914.
Import Letters of Credit. In order to make our problems as simple
as possible, let us first consider the intricacies of a " dollar " import
letter of credit , issued to the American Importing Company of New
York City by the Guaranty Trust Company of New York, covering
the importation of a shipment of silk from the Asaki Silk Company
of Yokahama, Japan. The silks are valued by the exporter at 40,000
yen. When asked by the American importer to quote prices, the Asaki
Silk Company goes to its bank, the Sumitomo Bank Ltd. , and obtains from it a contract in which the bank agrees to buy the exporter's
draft on an American bank covering the shipment at the rate of 2 yen
The exporter is able to obtain this satisfactory rate be-

per dollar.

cause the draft will subsequently become a banker's acceptance , which
involves little or no risk for the Japanese bank that has agreed to buy
the draft. The exporter obtains this " forward" quotation in order
to avoid the possibility of a loss through fluctuations in the exchange
rate which may take place between the time that it advises the importer as to the cost of the goods and the time that the draft is sold to
the Japanese bank. In quoting prices to the American Importing Company the exporter is thus able to advise that the silks will cost $ 20,000
(40,000 yen ÷ 2). It notifies the importer that shipment will be made
only under a commercial letter of credit . All other matters concerning
the shipment and the costs thereof having been definitely settled
between the exporting and the importing firms, the American Importing Company goes to the Guaranty Trust Company of New York
1 Cf. pp. 260-268.

11

IMPORT AND EXPORT CREDITS

237

Guaranty Trust Company of New York
APPLICATION FOR LETTER OF CREDIT

New York,-

Jan. 2, 1981.

BY
PREPARED
CREDIT
CHECKED
......
BY
..CREDIT

GUARANTY TRUST COMPANY OF NEW YORK
FOREIGN DEPARTMENT
Import
Division
New York City
GENTLEMEN;
cable
Please issue an Irrevocable Letter of Credit bý-mailFor account of.
Asaki Silk Company
In favor of

BY
CHECKED
CABLE

TRANSFERRED
.
BY
LETTER
FROM
APPLICATION
CHECKED
BY

CABLE
PREPARED
.
BY

Amount - #20.000.00

available by drafts at.
against documents as follows:
Bills of Lading reading Bills of Lading
"Received for Shipment" or
otherwise worded to same Invoice
effect are acceptable against
this credit.
Consular Invoice

Four/4Months.sight.

other documents

covering Full invoice value of C. I. F., .&F.,F.O. B., F.A.S. Shipments
75%
(cross out allbut one)
Raw Silk
New York City
Yokohama.
.to.
to be shipped from.
Drafts to be negotiated on or beforeInsurance to be effected by-

March 31, 1921.
Shippers
(Shipper or Purchaser)

Partial shipments are to be permitted.
Special InstructionsThe Letter of Credit is subject to your usual terms and conditions, and in
consideration of the issuance thereof we agree to reimburse you on demand, and
we hereby authorize you to charge our account with you with any and all
amounts for which you are liable thereunder, plus your commission and charges,
Neither you nor your correspondents shall be responsible for the description,
quantity, quality or value of the merchandise shipped under this credit, nor for
the correctness, genuineness or validity of the documents, nor for delay or deviation from instructions in regard to shipment, nor for any other cause beyond
your control.
Very truly yours, ~
American Importing Co.
The Guaranty Trust Company ofNew
York does not assume responsibility for
any inaccuracy, interruption, or delay in
New York City
the transmission or delivery of messages
by cable.
FIGURE 67-Application for commercial letter of credit

238

DOMESTIC AND FOREIGN EXCHANGE

and asks for a commercial letter of credit, say for $20,000.

It advises

the bank as to the terms of the letter that is desired , the amount for
which the drafts are to be drawn, by whom the insurance is to be
effected, etc. If the bank is willing to issue the letter it may ask the
importing firm to fill out an "Application for Commercial Credit "
blank (Fig. 67) and a "Letter of Guarantee " (Fig. 68) .
New York,
-19_____
To the
GUARANTY TRUST COMPANY OF NEW YORK
Gentlemen:
-account of
Having received from you the Letter of Credit on.
I
which a true copy is on the other side, we hereby agree to its terms, and in
I
consideration thereof
agree with you to provide in New York, one day
we
previous to the Maturity of the Bills drawn in virtue thereof, sufficient funds
per cent
in cash, to meet the payment of the same with
commission, and I undertake to insure at my expense, for your benefit,
our
we
against risk of Fire or Sea, all property purchased or shipped pursuant to said
Letter of Credit, in Companies satisfactory to you.
I
We agree that the title to all property which shall be purchased or shipped
under the said credit, the bills of lading thereof, the policies of insurance thereon
and the whole of the proceeds thereof, shall be and remain in you until the payment of the bills referred to and of all sums that may be due or that may become
due on said bills or otherwise , and until the payment of any and all other indebtedness and liability now existing or now or hereafter created or incurred by
me to you on any and all other transactions now or hereafter had with you
us
with authority to take possession ofthe same and to dispose thereof at your discretion for your reimbursement as aforesaid , at public or private sale , without demand or notice , and to charge all expenses including commission for
sale and guarantee .
Should the market value of said merchandise in New York, either before or
after its arrival, fall so that the net proceeds thereof (all expenses, freight, duties,
etc., being deducted) would be insufficient to cover your advances thereagainst
I
with commission and interest,
further agree to give you on demand any
we
further security you may require, and in default thereof you shall be entitled to
sell said merchandise forthwith, or to sell " to arrive," irrespective of the maturity of the acceptances under this Credit, we
I being held responsible to you for
I
bind and oblige myself to pay you in cash on demand.
any deficit, which
ourselves
we
In case I should hereafter desire to have this credit confirmed, altered or
we
I
my expense and risk) , we hereby agree to
extended by cable (which will be at our

IMPORT AND EXPORT CREDITS

239

hold you harmless and free from responsibility from errors in cabling, whether
on the part of yourselves or your Agents, here or elsewhere, or on the part ofthe
cable companies .
This obligation is to continue in force, and to be applicable to all transactions,
notwithstanding any change in the composition of the firm or firms, parties to
this contract or in the user of this credit, whether such change shall arise from
the accession of one or more new partners, or from the death or secession of
any partner or partners.
It is understood and agreed that if the documents representing the property
for which the said Credit has been issued are surrendered under a trust receipt,
collateral security satisfactory to the Trust Company, such as stocks, bonds,
warehouse receipts or other security, shall be given to the Trust Company, to
be held until the terms of the credit have been fully satisfied and subject in every
respect to the conditions ofthis agreement.
It is further understood and agreed in the event of any suspension, or failure,
or assignment for the benefit of creditors on my part, or of the nonpayment at
our
maturity of any acceptance made by me
us of the nonfulfillment of any obligation under said credit or under any other credit issued by the Guaranty Trust
my
Company of New York on our account, or of any indebtedness or liability on
my part to you, all obligations, acceptances, indebtedness and liabilities whatour
soever shall thereupon , at your option then or thereafter exercised, without notice,
mature and become due and payable.
It is understood and agreed that you shall not be held responsible for the
correctness or validity of the documents representing shipment or shipments,
nor for the description , quantities, quality or value of the merchandise declared
therein.
(Signature)

FIGURE 68
Agreement signed by applicant for commercial letter of credit
Or the bank may ask the importing firm to fill out a blank
which is both an application and a letter of guarantee.
Most
blanks are of the latter type.

The application , usually printed,

although sometimes typewritten, supplies data concerning the
amount for which the letter is to be issued, the usance of the
drafts, the party by whom they are to be drawn, the duration of the letter, the date before which the drafts must be drawn
and negotiated, by whom the insurance is to be effected , the date before which shipments must be made, and various other details regarding the number and kind of documents that must be provided , to
whom they are to be sent, how indorsed , etc. The " guarantee," as
will be noted from the above form, advises the bank that the appli .

DOMESTIC AND FOREIGN EXCHANGE

240

cant will provide it with funds with which to meet the drafts when
they mature, that all expenses are to be paid by the applicant includ-

Import Letter of Credit (Dollars)
Credit No.. 134567
For $20,000-US.C.

Guaranty Trust Company of New York
Foreign Department
New York,

February 11, 1921

Messrs.Asaki Silk Company,
Yokohama, Japan
Gentlemen;
At the request and for the account of The American Importing Company, New York
we hereby authorize you to value on
Guaranty Trust Company of New York, New York
Four (4) Months sight
for any sum or sums not exceeding a total of
by your drafts at

Twenty thousand dollars ($20,000)
inaccompanied by commercial invoice, consular invoice, bills of lading_Marine
surance certificates
-cost, insurance and freight shipment of Raw Silkfrom Yokohama, Japan, to
representing
New York
Insurance

Marine

insurance to be effected by the shippers

Bills of lading for such shipments must be drawn to the order of THE GUARANTY TRUST
COMPANY OF NEW YORK, unless otherwise specified in this credit.
A COPY OF THE CONSULAR INVOICE AND ONE BILL OF LADING MUST BE SENT BY THE BANK
OR BANKER NEGOTIATING DRAFTS, DIRECT TO THE GUARANTY TRUST COMPANY OF NEW YORK,
NEW YORK .
THE AMOUNT OF EACH DRAFT NEGOTIATED TOGETHER WITH THE DATE OF NEGOTIATION
MUST BE ENDORSED HEREON.
We hereby agree with bona fide holders that all drafts drawn by virtue of this Credit,
and in accordance with the above stipulated terms, shall meet, with due honor upon presentation at the Guaranty Trust Company of New York, NewYork, if drawn and negotiated on
or before May 31 , 1919
Guaranty Trust Company of New York
N. B.- All drafts drawn under this Credit must
bear clause "drawn under G. T. Co. of
N. Y. Letter of Credit No. 184567
dated New York,.
Feb. 11, 1921
to cover shipment of Raw Silk from
Yokohoma to. New York

FIGURE 69
Dollar import letter of credit

I

IMPORT AND EXPORT CREDITS

241

ing the bank's commission , that title to the goods is to rest in the
bank until the applicant has met his obligations, that the bank may
take steps at any time to protect itself against loss, etc. An interesting clause that should not be overlooked declares that if the merchandise should decline in value either before or after its arrival, thereby
possibly causing the bank to suffer a loss, the applicant will either
provide additional security as required or allow the bank immediately to possess itself of the goods and sell the same and also that
the applicant will reimburse the bank for any losses incurred by it.
A copy of this document is given to the applicant for his
files.
After the applicant has filled out the above form or forms, the bank
clerk takes a commercial letter of credit blank (Fig. 69) and fills in the
spaces in accordance with the data supplied on the application. The
importing firm may or may not be required to put up collateral security.
The terms of the letter, the details of which vary from bank to
bank, universally direct the exporter to draw a draft or drafts on the
issuing bank covering the value of the goods which are to be forwarded.¹ The amount of the credit, the date of its expiry, how the
documents are to be prepared, how many and what kinds, possibly
upon what steamer or steamship line the goods are to be sent, these
and all other necessary directions are contained in the body of the
letter of credit. In brief, it is a statement by the issuing bank that it
will accept drafts drawn on it by the exporter and that it will meet
them at maturity provided goods are sent and documents are drawn
.
in accordance with the directions contained in the letter of credit.
The letter of credit seldom alludes to the sales contract between buyer
and seller because the issuing bank has no direct concern in the terms
of such contract or in any controversy that may arise over the merchandise to be imported. " Moreover, the banker negotiating the drafts
under the letter would look with disfavor upon the inclusion of commercial details which he is unable to verify. In fact, a credit burdened
with such stipulations, would prove of little value, as foreign banks
generally would refuse to negotiate the drafts. On the other hand,
some banks feel obliged to protect the interests of their clients, and
this explains the considerable number of institutions reporting that

1 Cf. Federal Reserve Bulletin , April, 1921, pp. 410-415, " Forms of Commercial Letters
of Credit."

242

DOMESTIC AND FOREIGN EXCHANGE

they do refer to the sales contract in their letters of credit. Such mention is made to a varying degree. In some cases the terms of the credit
merely follow the stipulations of the contract in a general way. Other
banks go to the extent of specifying the grade, quantity, and price of the
1
merchandise."
Still others request " a declaration, furnished by
the accredited party, that the goods were shipped in accordance with
the terms of the contract between the buyer and seller." 2 Where the
letter of credit incorporates some or all of the terms of the contract
of sale, such terms become part of the letter of credit and both the
issuing bank and the exporter (seller) are bound by them. The issuing
bank has the right to refuse to accept the draft as drawn by the exporter unless he has completely followed the terms of the letter of
credit. If the terms of the sales contract are not included, the letter of
credit and the sales contract are two separate and distinct documents,
and have been so declared by various courts. In case there is any
breach, dispute, or default of the sales contract, where it is a separate
document, the aggrieved party has a right of action at law to recover
damages, but such breach or default cannot in any way affect the
contract between the bank and the seller, or between the bank and the
buyer as contained in the letter of credit.3
A commercial letter of credit is usually issued in duplicate, one copy

1

for the files of the applicant, the other to be sent to the exporter. The
issuing bank either keeps a carbon copy or makes a record of the transaction for its files. "The importer at whose instance the credit is
opened may choose to have the exporter notified by cable or mail.
If by mail, the bank hands the letter to the importer, who forwards
•
it to the beneficiary . If by cable, the bank usually communicates
with its correspondent nearest the point of shipment .
When it is
definitely known through which bank the exporter will negotiate his
drafts, the letter is then sent to this institution . " 5 The exporter is
ordinarily free to sell his drafts to any bank willing to negotiate them,
although under certain conditions he may be limited by being required by the terms of the letter of credit to negotiate the drafts only
1 Federal Reserve Bulletin , February, 1921 , p. 166 .
2 Ibid . The Federal Reserve Bulletin of February, April, June and October, 1921 , contains the results of a most excellent study of commercial letters of credit made by Mr.
George W. Edwards of the Division of Analysis and Research of the Federal Reserve Board.
A portion of the following discussion is based to some extent upon the data there presented.
3 Cf. American Steel Company vs. Irving National Bank, 233 Fed . 41 .
4 Cable notifications are subsequently confirmed by mail.
5 Federal Reserve Bulletin , February, 1921 , p . 166 .

‫تو‬

IMPORT AND EXPORT CREDITS

243

at the bank so designated in that document. Exporters object to
being restricted in this regard because it compels them to deal with a
strange bank which as a rule will not give them so good a rate on their
drafts as will the bank with which they have long been accustomed
to carry on their financial relations. Sometimes copies of the letter
of credit are sent to the exporter by separate steamers so as to lessen
the possibility of delay in case one of the letters is lost in transit.
"However, duplicate letters offer the opportunity of presenting drafts
and letter to one bank and repeating the same operation with a second
bank. To prevent a fraud of this nature, banks place negotiators on
their guard by indicating clearly in the duplicate form that an original
is in existence." 1
The Asaki Silk Company, upon receiving the letter of credit, prepares the shipment, procures the various sets of documents as required by the terms of the letter of credit , draws a draft, one for each
set of documents, a " first," " second ," etc. , and goes to the Sumitomo
Bank Ltd. to sell its documentary bill of exchange. The draft will
be drawn on the Guaranty Trust Company of New York, (not on the
American Importing Company) , for $20,000 . Notation will be made
on the draft that it is drawn under " Number 134567 letter of
credit issued by the Guaranty Trust Company of New York." If the
letter of credit were to cover two or more shipments, the Sumitomo
Bank Ltd. , when it bought the bills of exchange, would indorse the
amounts and the dates on the back of the letter of credit, so as to avoid
2
the possibility of any fraud arising. The bank clerk looks over the
documents to see that they are in order and in accordance with
the terms of the letter of credit, and if everything is satisfactory
the Asaki Silk Company will receive 40,000 yen for the documentary bill of exchange as per the " forward " contract mentioned
above.
The Sumitomo Bank Ltd. then indorses the documents and forwards
them to its correspondent in New York,³ which in this case happens
1 Federal Reserve Bulletin, February, 1921 , p. 167 .
2 "American banks issuing import letters of credit uniformly require that foreign banks
indorse on the reverse side particulars of all drafts negotiated . This precaution is taken
to prevent an unscrupulous foreign exporter from presenting his letter and shipping documents simultaneously to several banks and thus overdrawing his credit." Federal Reserve
Bulletin, February, 1921 , p. 165 .
It is customary for the foreign purchasing bank to forward the documents to the accepting bank through a correspondent. But in case of banks located in China that are
correspondents of the American accepting bank, it is customary to forward the documents
direct to the accepting bank, which after accepting the draft will as a rule sell its own

244

DOMESTIC AND FOREIGN EXCHANGE

to be its New York branch, with instructions to present the draft to the
Guaranty Trust Company for acceptance and then to discount it in
the open market.¹ Whether or not the letter of credit will accompany
the draft that exhausts the credit will depend entirely upon the practice of the beneficiary, the Asaki Silk Company. The general rule
is that the letter of credit is not attached to the final draft , although
the tendency at present seems to be to return the original credit.²
When the documents have reached New York, the correspondent
of the Sumitomo Bank, Ltd. presents the draft to the Guaranty Trust
Company for acceptance. Under a commercial letter of credit the
documents always go forward under " D/A" instructions, because
of the unquestioned credit of the issuing bank upon which the draft
is drawn. Therefore when the Guaranty Trust Company accepts the
draft, it detaches the documents and returns the accepted draft to the
presenting correspondent which , following instructions, has it discounted immediately in the open market at the prevailing rate for
banker's acceptances, and credits the sum obtained to the account
of the Sumitomo Bank, Ltd. In this manner, the Japanese bank builds
up its account in the United States against which it may sell exchange
in the future . If the draft has been drawn in duplicate, the New York
correspondent does not wait for the second set to appear before presenting the draft for acceptance. The first set to arrive and to be
accepted nullifies all other sets.³ The documents are usually sent by
fast steamers, one set to a boat to guard against possibilities of loss,
while the goods are forwarded by ordinary freighters ; but it sometimes happens that the goods arrive ahead of the documents.
The Guaranty Trust Company, having the shipping documents in
hand, notifies the importing firm to make arrangements for their release. It may turn the documents over to the American Importing
Company without taking any sort of security and without asking it
to sign anything other than just a receipt . This is done only where
the bank has implicit faith in the importer. It is more customary to

acceptance in the open market just as though it were the acceptance of some other bank,
although at times, however, it will hold its accepted draft until maturity.
1 The instructions from the Japanese bank may, however, be to the effect that the draft
is to be presented for acceptance and then held until maturity.
2 Federal Reserve Bulletin , February, 1921 , p. 165.
3 In Holland it is not legal for drafts to be presented for acceptance until the duplicate
has arrived; the banker must have all sets of the documents in his possession before accepting.

IMPORT AND EXPORT CREDITS

245

ask the importer for a trust receipt, ¹ the terms of which will vary
somewhat depending upon just what the importer wishes to do. Many
banks use the same printed form for all purposes, but usually different
forms are used for different conditions. If the importer wishes to
obtain the documents so that the goods may be warehoused upon

TRUST RECEIPT

(DOCUMENTS FOR WAREHOUSING)

Received from THE GUARANTY TRUST CO. OF NEW YORK Bill of Lading perdated
for the following goods and merchandise,
their property, marked and numbered as follows:

imported under the terms of Letter of Credit No.
issued by them for
me
my
account
the
said
Bill
of
Lading
to
be
used
by
for
the
sole
purpose
of entering the
OuOur
{ us
above described property at the United States Custom House at the Port of
and of storing the same in the name, and as the property, of the
said THE GUARANTY TRUST CO. OF NEW YORK, and subject only to their order,
{}
hereby agreeing to so store the said property and to hand the storage receipt for the same to
the said THE GUARANTY TRUST CO. OF NEW YORK, when obtained.
ALSO AGREE to fully insure said property againstfire, the loss, if any, payable
to said THE GUARANTY TRUST CO. OF NEW YORK, and to hand to them the policies of insurance thereon.
192
Dated
(Signed).
£.

FIGURE 70
Trust receipt (documents for warehousing)
arrival, the bank will take from him the above type of trust receipt
(Fig. 70).
1 The practice of using the trust receipt seems to have originated in the United States.
It is not found in any other country. In the early days it was called "the red letter" because it was generally printed in red ink to emphasize its nature and intent. The Federal
Reserve Bulletin, January, 1922, pp. 32-37, contains an excellent discussion of the trust
receipt.

DOMESTIC AND FOREIGN EXCHANGE

246

If he is to have access to the goods for the purpose of selling them
to his customers, the following form of trust receipt will be used
(Fig. 71) :

TRUST RECEIPT

Received from THE GUARANTY TRUST CO. OF NEW YORK the following goods and merchandise, their property, specified in the Bill of Lading per S.S..
Dated
-marked and numbered as follows:
(Space is left here for description of merchandise)
and, in consideration thereof,
we HEREBY AGREE TO HOLD SAID GOODS IN TRUST for them,
and as their property, with liberty to sell the same for their account, and further agree, in case
of sale, to hand the proceeds to them to apply against the acceptances of THE GUARANTY
TRUST CO. OF NEW YORK on ( my) account, under the terms of the Letter of Credit
οιOur}
No..
issued for my account and for the payment of any other indebtedness of
Our
mine
to THE GUARANTY TRUST CO. OF NEW YORK.
ours
THE GUARANTY TRUST CO. OF NEW YORK may at any time cancel this trust and take
possession of said goods, or of the proceeds of such of the same as may then have been sold,
wherever the said goods or proceeds may then be found and in the event of any suspension,
or failure, or assignment for the benefit of creditors, on{m
y} part, or ofthe non-fulfillment
our
me
of any obligation, or of the non-payment at maturity of any acceptance made by us } under
{
said credit, or under any other credit issued by THE GUARANTY TRUST CO. OFNEWYORK ON
my account or of any indebtedness on my
part to them, all obligations , acceptances,
ou }
indebtedness and liabilities whatsoever shall thereupon (with or without notice) mature
my
and become due and payable. The said goods while in our hands shall be fully insured
against loss by fire.
192.
Dated, New York City.

£

(Signed).
Stg.
1

FIGURE 71
Trust receipt (goods to be held or sold by importer)
If he has already sold the goods and wishes to deliver them upon
arrival to the purchasers , the bank will require him to sign the form
of trust receipt appearing on page 247 (Fig. 72) .

7

IMPORT AND EXPORT CREDITS

247

If he is a customer of doubtful standing, the bank may request him
to sign what is known as a " Bailee Receipt " (Fig. 73) . This receipt
is regarded as a little " more stringent than the trust receipt and is
supposed to offer the bank more adequate protection.

The opinion

TRUST RECEIPT
(FOR DELIVERY TO PURCHASER)
Received from THE GUARANTY TRUST CO. OF NEW YORK the following goods and
dated
merchandise, their property, specified in the Bill of Lading per.
marked and numbered as follows:

In trust to deliver the same to.
who have purchased the same for.
payable in.
and to obtain from the purchaser the proceeds of the sale of the same.
In consideration of the delivery of said goods to me iin trust as above
above,, we agree
to deliver them immediately to the said purchasers, and to collect the proceeds of sale, and immediately deliver such proceeds to THE GUARANTY TRUST CO. OF NEW YORK in whatever form collected,
{ my
to beapplied by them against the acceptances of THE Guaranty Trust Co. OF NEW YORK On (our
issued for my
account, under the terms of Letter of Credit No..
Iour account, and
to THE GUARANTY TRUST CO. OF NEW YORK .
to the payment of any other indebtedness of ( mine
ours
It is understood, however, that if such proceeds be in notes or bills receivable, they shall not be
so applied until paid, but with liberty meanwhile to THE GUARANTY TRUST CO. OF NEW YORK
to sell or discount, and so apply net proceeds.
THE GUARANTY TRUST CO. OF NEW YORK may at any time cancel this trust, and they may
take possession of said goods until the same have been delivered to said purchasers and the proceeds
of sale received from them, and thereafter of such proceeds, wherever the said goods and proceeds
may then be found, and in the event of any suspension or failure or assignment for the benefit of
creditors on my part or of the non-fulfillment of any obligation or of the non-payment at
our
me
maturity of any acceptance made by us under said credit, or any other credit issued by
THE GUARANTY TRUST CO. OF NEW YORK on my account, or of any indebtedness on my
our
our
part to them, all obligations, acceptances, indebtedness, and liabilities whatsoever shall thereupon
(with or without notice) mature and become due and payable.
191

Dated

£

FIGURE 72
Trust receipt (for delivery to purchaser)
has been expressed that any trust receipt is a priori a bailee receipt,
and so no legal distinction exists between these two documents . " 1

1Federal Reserve Bulletin , January, 1922 , p . 36.

DOMESTIC AND FOREIGN EXCHANGE

248

If the importer wishes to get the goods so that he may use them in manufacturing other products, the bank may, and often does, object to turning them over to him on a trust receipt because of the impossibility

BAILEE RECEIPT
Received from the Guaranty Trust Company of New York
solelyforthe purpose of selling same for account of said Company:

marked and numbered.
and
hereby undertake to sell the property herein specified, for account of the said

1

Company, and collect the proceeds of the sale or sales thereof, and deliver the same immediately on
receipt thereof to the said Company, to be applied to the credit of-

hereby acknowledging Company, and

to be Bailee of the said property for the said
do hereby assign and transfer to the said

Company the accounts of the purchaser or purchasers of said property to the extent of the purchase
pricethereof, ofwhichfact notice shall be given at the time ofdelivery ofthe said property by
to such purchaser or purchasers and all invoices therefor shall have imprinted, written or stamped
hereon bythefollowing:
"Transferred and payable to GUARANTY TRUST COMPANY OF NEW YORK,
140 Broadway, New York."
Ifthe said property is not sold and the proceeds so deposited within ten days from this date,
-undertake to return all documents at once on demand, or to pay the value of
the goods, atthe Company's option.
The said goods while in Smy
urS hands shall be fully insured against loss byfire.
Oou
The terms of this receipt and agreement shall continue and apply to the merchandise above
referred to whether or not control of the same, or any part thereof, be at any time restored to the
Guaranty Trust Company of New York, and subsequently delivered to us.
Dated at New York City,.

192

FIGURE 73
Bailee receipt
of identifying the goods once they have been transformed into other
products.
The substance of these receipts is that the title to the goods rests in

*

IMPORT AND EXPORT CREDITS

249

the bank, that the importer is warehousing or selling them as the agent
of the bank, and that all monies received from their sale are to be
handed to the bank as soon as received, to pay off the importer's
obligation to the bank. Whether or not the bank will insist "upon the
application of the funds derived from the sale of the goods to the prepayment of the time drafts which the bank has accepted " will depend
in each case upon the credit standing of the importer. As a rule such
prepayment is not demanded , but where it is, a rebate is given, similar
to the rebate on D/P bills above described.¹ The rebate is not fixed
“but is graduated according to such factors as credit standing of
customer, time of maturity, and prevailing value of money. Whether
dollar, sterling, or foreign acceptances , the rebate is actually governed
by the rate of the central bank . It may be determined directly by
placing the rebate at 1 or 2 per cent below the discount rate of the
Federal Reserve Bank in the case of dollar acceptances, or a little
below the rate of the Bank of England for sterling bills. Another
method is to allow a certain per cent below the market rate for prime
bankers' bills. A third way is to grant the customer the same rate of
interest allowed on deposit accounts." 2 The trust receipt also authorizes the bank to cancel the trust at any time and to take actual
possession of the goods in order to protect itself against loss.
Sometimes the goods arrive before the documents, in which event
the bank usually releases the goods to the importer so as to save warehousing charges, and also to save perishable goods from spoiling. The
bank under such circumstances takes a trust receipt from the importer,
also a statement that he accepts the goods even though the shipment
prove to be somewhat irregular. The importer is also required to give
the customs and steamship officials a bond of indemnity before being
allowed to remove the goods without presenting the documents.³
There is considerable difference of opinion among bankers regarding
the value of a trust receipt. By many it is considered a " necessary
evil " that should be replaced by some more satisfactory method of
protecting a bank's right to the property which it surrenders . As
Escher so cogently remarks :
"A large volume could be written on the subject of trust receipts and
the litigation which has grown out of the attempt to enforce them, but the

1 Cf. p. 144.
2 Federal Reserve Bulletin, February, 1921 , p. 168.
3 Ibid, p. 167.

250

DOMESTIC AND FOREIGN EXCHANGE

whole sum and substance of it all would be that the trust receipt is just
about as good as the party who signs it and no more. Bankers who hand
over the documents on trust receipt (and an immense volume of business
is so handled annually) do it almost entirely on the standing and credit of
the party receiving the goods and hardly at all on the idea of being able to
earmark and recover the merchandise or its proceeds in the event of failure.¹
Nor has the rating of the importer as much to do with the banker's being
willing to let him have the documents against trust receipt as might be
imagined. Many a firm of known large resources has trouble getting the
banks to let it have the bills of lading against a straight trust receipt ;
whereas, many a firm whose resources are admittedly nowhere near as
large have no trouble whatsoever. The importer's business and particularly the way he runs his business- that is what counts. What it comes
down to is very much the same as though the importer were going to the
bank and asking for a loan. Just about the same things are taken into
consideration. " 2
To date the legal status of the trust receipt remains undecided .
Federal courts have upheld the rights of the bank under the trust
receipt on the basis of the trust receipt being a commercial necessity.
Very little agreement can be found among the decisions of state courts,
and as a result banks have been seriously limited in their efforts to
maintain their rights over property released on such documents .
To revert to our illustration : The American Importing Company
gets the goods under a trust receipt and either prepays its indebtedness to the Guaranty Trust Company under the rebate system as already discussed , or waits until the maturity of the draft before putting
the Guaranty Trust Company in funds with which to meet the obligation which it (the bank) has incurred on behalf of the importing
company. The latter must also pay the commission of the accepting
bank as well as any extra charges the accepting bank may have to
meet. The commission of the American bank for accepting drafts
drawn on it in terms of dollars will vary as between clients, and also
1 "But whatever the form of the contract, it is to be borne in mind that when the banker
issuing the credit hands over the bill of lading to the importer on trust receipt , he is allowing
the only security he has to pass out of his hands, and is putting himself in the position of
having made an unsecured loan to the importer." Escher, " Elements of Foreign Exchange,"
p. 152.
2 Escher, "Foreign Exchange Explained, " p . 126. The Federal Reserve Board , in its
Regulations C Series of 1920, declares that " A trust receipt which permits the customer
to have access to or control over goods will not be considered by Federal Reserve Banks
to be ' actual security ' within the meaning of Section 13 " of the Federal Reserve Law.
3 Cf. Federal Reserve Bulletin, January, 1922 , p. 33.

1

IMPORT AND EXPORT CREDIT
as to the usance of the drafts.

251

The customary commissions are

sight, 1/8 per cent ; 30 to 60 days, 1/4 per cent ; 90 days, 3/8 per cent
When the draft matures, the holder, whoever that may happen
to be, presents it to the Guaranty Trust Company and receives its
face value. In the example which we have been following, it is readily
seen, as has been true of the other examples of acceptances earlier discussed, that it is the discount market which advances the funds with
which the transaction is financed. The accepting bank uses none of
its funds, it simply advances its credit ; the importing firm uses none
of its funds, it employs the credit of the accepting bank. The exporter
gets his money when he sells his documents to the Japanese bank.
The Japanese bank in the above example, advances the funds only
temporarily because it has the bill discounted as soon as it is accepted.
When it buys the bill from the Asaki Silk Company it does so at a
rate calculated to net it a profit. As soon as the draft has been accepted, the Japanese bank shifts the burden onto the discount market
by selling the draft to some party willing to buy it as a short time
investment. The latter carries the obligation until its maturity, but
receives in return the current rate of discount for a banker's acceptance.
The fact must not be overlooked that the liability of the drawer and
of the indorsers continues until the transaction has been concluded
by the payment of the draft by the Guaranty Trust Company.
When exports from the United States are financed by means of a
commercial letter of credit issued in terms of the money of the foreign
country to which the goods are to be sent, the practices followed are
along the same general lines as those outlined above.¹ To give a
concrete example, let us have the Anglo Automobile Company of
London arrange with the American Truck Company of New York
for a shipment of automobiles. The Anglo Automobile Company
goes to its bank, say Barclays, and secures a sterling letter of credit , and
mails it to the American Truck Company. The latter prepares the
shipment, gets all the documents required , draws its draft in pounds
sterling on the English issuing bank, and sells the draft, i. e. , discounts
it for dollars at a New York bank. The latter sends the documentary
bill to its correspondent in London , which presents it for acceptance
"In these days of restricted exports an increasing number of cases are apparent where
foreign buyers prefer to open credits through their own banks in terms of their own currency. Hesitancy on the part of American exporters in accepting such credits in foreign
currency has, in many instances, resulted in loss of current business." Foreign Trade
Bulletin of the American Express Company, June, 1921 .

252

DOMESTIC AND FOREIGN EXCHANGE

to Barciays. The latter accepts the draft, and retains the documents.
The correspondent bank, acting upon instructions from the New York
bank, either holds the draft until maturity or discounts it in the open
market. Barclays hands the documents to the Anglo Automobile
Company against a trust receipt or other form of security. The Anglo
Automobile Company gets the goods , sells them, and puts the bank
in funds with which to meet the payment of the draft when presented
at maturity by the party holding it at that time. The importing firm
also pays the accepting bank its commission for having advanced its
credit during the period of the transaction . If the American Truck
Company were located in Detroit instead of New York, an additional
step in our story would have to be added provided the Detroit bank
to which the documents had been sold had no direct London connections. The Detroit bank would have to indorse the documents and
discount them with a New York bank, and the documents would then
follow the course outlined above . Or the Detroit exporting company,
having a number of similar shipments to make during the year, might
arrange directly with a New York bank to take all its exchange at the
prevailing market rates. Under such conditions, the exporting company draws a draft in sterling against a shipment, after wiring the
New York bank for the rate which it is willing to pay. The exporting
firm then converts the amount of its sterling draft into dollars at the
quoted rate, and draws a draft for that sum in dollars on the New
York bank. It then hands the sterling draft and documents and also
its dollar draft to its local bank. The latter may credit the exporter
immediately with the value of the dollar draft or may take it for collection. In either case, the local bank sends the shipping documents,
the sterling draft and the dollar draft to the New York bank. The
New York bank pays the dollar draft by crediting the account of the
Detroit bank with that sum. The New York bank sends the sterling
draft and documents to its correspondent in England , and from this
point, the procedure is the same as outlined above. Or it may be
that the Detroit exporter has made arrangements with a New York
exchange dealer through whom it is able to market all of its documentary exchange at better rates than it could if it dealt only with one
New York bank. The exchange dealer will secure the best market
rate for the exporter, and wire a notice of the rate quoted and to what
bank the exchange has been sold . The exporter then draws a dollar
draft on that bank, as in the case just cited, hands the dollar draft

*

IMPORT AND EXPORT CREDITS

253

and the sterling bill with accompanying documents to the local bank
which forwards them to the New York bank, giving the exporter immediate or deferred credit for its dollar draft. From this point, the
New York bank handles the bill as above described. The New York
exchange dealer receives a small commission for marketing the
exporter's bill at the best obtainable sterling rate. The last two
methods are customarily employed where the exporter has to dispose
of a large amount of documentary exchange.
In the cotton trade it is a more or less common practice for the importer not to furnish the exporter with a letter of credit. Trading in
cotton is for the most part in the hands of responsible firms and all
that is necessary is for the importer to wire the exporter the name of
the London bank upon which his drafts are to be drawn. American
bankers, knowing these firms and their excellent reputation , buy the
cotton bills of the exporters without question because they feel that
"their implied word when offering the bills for sale is sufficient guarantee that the London banks will honor the bills with their acceptance."
"> 1
It is not unusual for an American importer to be required to obtain
a commercial letter of credit drawn in terms of a foreign money because of the customs of trade in the exporting country, or because
drafts drawn in terms of a foreign currency command a higher rate in
the foreign market, or because of some other reason . Before 1916
American banks were not permitted to accept drafts drawn on them
in connection with the financing of foreign trade. It therefore followed that they could not issue commercial letters of credit except as
agents of foreign banks. Drafts in all cases had to be drawn against
foreign banks. American banks acted only as the intermediary in
supplying the American importer with his letter of credit. With
England supreme in the trading and financial world and with the
sterling draft more readily discountable than drafts drawn in other
monies, the sterling letter of credit was the type most commonly used,
not only by English importers, but by importers throughout the world.
American firms importing goods from South America, the Orient,
Europe, or Australia employed the sterling letter almost exclusively,
although at times the mark or the franc letter was used. Estimates
of the commissions which we paid annually to English bankers for
their acceptance of our long sterling bills vary from a minimum of
1 York, op. cit ., p. 136.

254

DOMESTIC AND FOREIGN EXCHANGE

1
$ 10,000,000 ¹ to a maximum of $ 150,000,000.2 The practice of paying
for imports by means of sterling drafts drawn on a London bank is
still followed rather universally by all trading countries. Even , for
example, where a Peruvian sells sugar to a Chilean firm , the goods are
paid for by means of a 90 day draft on London. South American firms
frequently remit sterling drafts to exporters in the United States or
send sterling letters of credit to us; and when we export goods to them,
we not uncommonly draw our drafts on London banks and in terms
of sterling.

Since 1916, however, we have made substantial progress

toward popularizing the " dollar " letter of credit, especially among
our exporters. The fluctuating exchanges were primarily responsible
for the rather rapid development of this form of credit. American
houses engaged in shipping goods abroad wanted to be assured of a
definite return on their drafts. With the foreign exchanges fluctuating
so adversely from day to day, our exporters stood to lose on their
shipments. They then began to ask foreign importers either to establish dollar credits in the United States or to forward a dollar letter
of credit issued by the importer's bank on an American correspondent.
Under such letters of credit the draft is drawn in dollars on the American bank, accepted by it, and then discounted in the American market.
At maturity the holder is paid by the American bank out of funds
supplied by the foreign importer and forwarded to the American accepting bank by the foreign bank that had issued the dollar letter of
credit. Such dollar letters of credit, however, have been used only
to finance trade into or out of the United States and have never been
employed, so far as I have been able to ascertain, to finance shipments between other countries, such as from Brazil to Portugal, or
from China to France.
The progress that was made in developing the use of the dollar
acceptance credits is nicely pictured by the following report of the
Acceptance Committee of the American Bankers Association, published in May, 1921 :
“Your committee is pleased to report that marked progress has been
made with the development of certain phases of the American acceptance
method of financing in the past half-year. Hundreds of banks , individuals,
firms and corporations have been converted during that period to the idea
1 Pamphlet on "Acceptances " issued by the American Exchange National Bank of New
York, 1921 , p. II .
2 Statement by Prof. E. E. Agger in the Nationa! City Bank of New York Correspondence
Course in Foreign Exchange .

IMPORT AND EXPORT CREDITS

255

of investing temporarily available funds in bankers' acceptances. Prime
bankers' acceptances are now regarded as a dependable reserve. The open
discount market here has become a reality—every interest in America is
benefitting from its operations. Dollar credits have gained preference
everywhere. Many commercial banks have qualified for the utilization
of their full acceptance powers. New and substantial acceptance houses
have been organized and plans have been perfected under which funds
are now being loaned on call or demand against acceptances as collateral
in preference to stocks, bonds, and other long-term securities.
"Through the use of and investment in acceptances funds heretofore
idle and practically useless are being mobilized and made to serve commerce and industry. Over-night money, spot and forward rates and other
discount market terms so well known abroad are rapidly finding their way
into our business and financial vocabulary • . . The bankers ' acceptance
method has been thoroughly tested here; its merits are established, and,
if it is honestly applied, allowed to develop along natural lines and is not
stifled by over-regulation, its further success is assured. According to
figures compiled by the American Acceptance Council, the volume of
bankers' acceptances outstanding April 1 , 1921, was approximately $665,000,000, while the volume one year ago was $ 800,000,000. Considering
the slump in our exports and the drop in prices, this showing is highly satisfactory. The drawings to create dollar exchange have shown a notable
increase. The discount rates on prime bankers' acceptances for the six
months' period ranged from 5 1/2 to 6 3/8%. Dealers buying rates from
5 5/8 to 6 3/8%. Dealers selling rates from 5 1/2 to 6 1 /4%. Acceptances
call or demand loan rates ranged from 4 1/2 to 6%. The commission
charged by banks on acceptance credits ranged from 1 to 1 1/2 % (4 to
3/8% for ninety days) , varying with the character of the transaction covered and risk involved."
Even as yet, in spite of the opportunities that arose during the
World War, American bankers have not become experienced in the
financing of foreign trade. Our interest and commission charges are
usually higher than those of foreign bankers. Our exchange or discount market is not so thoroughly developed as that of London.
America bankers are but slightly versed in the purchase and sale of
acceptances. All of these matters, however, are of a comparatively
recent growth, and as with the passage of years the rough places are
ironed out, our dollar credits may be able to compete successfully
with sterling credits . In spite of these shortcomings, a large proportion of our exports and imports is being financed at present by
"dollars " as a result of the depreciation and uncertainties of the foreign

256

DOMESTIC AND FOREIGN EXCHANGE

exchanges, but during the last two years sterling credits have been
regaining their former place of supremacy. This is inevitable, of
course, for the long standing tradition of sterling exchange and the

The Anglo & London Paris National Bank
N SAN FRANCISCO
EOF
IM
EC
P
S
CREDIT NO. 3467
£ 5,000
192
San Francisco May 1
TO Franco Exporting Company
Paris, France
We hereby authorize you to value on MESSṚS. LAZARD BROS. & CO., LTD. 11 Old Broad St.
London
for account of
at ninety days sightN
American Lace Company, San Francisco, California…….. IME
up to an aggregate
C
amount of five thousand pounds sterling (£ 5,000)SPE
for invoice cost of1a00

N

ME

SP
EC
I

SP

EC

IM

EN

tobe shipped to... The American Lace Company. 34 Battery Street, San Francisco.
California.
BillsofLadingfor such shipments must be made outtothe order ofThe Anglo & London Paris National
Bank of San Francisco.
Consular Invoice and One Bill of Lading must be sent by the Bank or Banker negotiating the draft
direct toTheAnglo & London Paris National Bank of San Francisco, by mail, attaching to the draft a statement to that effect. The remaining documents must accompany the draft drawn on London
The amount of each draft negotiated, with date of negotiation, must be endorsed on the back hereot
We hereby agree with the bona fide holders that all drafts issued by virtue of this credit and in
accordance with the above stipulated terms shall meet withdue honor upon presentation at the office of MESSRS.
LAZARD BROS. & CO., LTD., if drawn and negotiatedpriorto July 1, 1921 ..
Drafts under this credit must state that they are drawn under Letter of Credit No. 3467 .
ofA. &L. P. N. B. dated May 1, 1921
lasurance to be effected by shipper
THE ANGLO LONDON PARS NATIONAL BANK.

familiarty of foreign
exporters with London
bankers and accepting
houses cannot be easily
overcome.
When an American
bank issues a sterling
letter of credit to an
importer, it customarily issues the letter
either against its own
London
branch or
directly against a correspondent bank in
London with which
it has previously made
arrangements regarding such matters.¹
the
Suppose that
American Lace Company of San Francisco

wishes to import a shipment of laces from the
Franco Exporting
Company of Paris, and
that it has been noti-

FIGURE 74
fied by the exporter to
Sterling import letter of credit

send a £5,000 letter of

credit to cover the costs. The American Lace Company obtains
from the Anglo and London Paris National Bank a commercial letter
of credit on Lazard Brothers of London (Fig. 74) .
The letter may be made out in duplicate or in quadruplicate. If
in duplicate, one copy goes to Lazard Brothers as an advice, notifying
It is possible, though not customary, for an American bank to issue a sterling letter
of credit upon itself. In that case the foreign exporter draws a sterling draft on the American bank, sells it to his local bank ; it is then forwarded to the American bank for acceptance, which pays it at maturity by a draft in pounds sterling drawn on its London account.

IMPORT AND EXPORT CREDITS

257

them of the contents of the letter that has been issued ; the second
copy is given to the purchaser, which forwards it to the Franco Exporting Company. The bank keeps its own record of the transaction
and may also give a receipt to the purchaser for its files. When four
copies of the letter are issued, one goes to Lazard Brothers, one is kept
by the bank for its record, one is sent abroad to the exporter, and the
remaining one is kept by the importer for its files.

Or, of the four

copies issued, two may be sent by separate steamers to Lazard Brothers
and the other two copies in like manner to the Franco Exporting
Company.
If the exporter demands that the letter of credit be actually confirmed by Lazard Brothers in order to make sure that the latter
assumes the obligation placed upon it by the Anglo and London Paris
National Bank, Lazard Brothers will give such a confirmation to the
French exporter, charging therefor from 1/20 to 1/8 of one per
cent of the face value of the letter, to be paid, of course, by the importer.
When the Franco Exporting Company has prepared the shipment
as per agreement with the American Lace Company, and has obtained the various documents as per the requirements of the letter of
credit, it draws a 90 day draft on Lazard Brothers for £5,000, the value
of the shipment . It presents the draft and documents to its banker,
say the Crédit Lyonnais, and receives £5,000 worth of francs at the
rate of the day for that type of sterling bill. If the rate happens to be
25.51 francs per pound sterling, the Franco Exporting Company
receives 127,550 francs (5000 X 25.51 ) . The Crédit Lyonnais in accordance with the directions in the letter sends the consular invoice
and one copy of the bill of lading direct to the Anglo and London
Paris National Bank of San Francisco ¹1 and at the same time attaches
a statement of that fact to the draft, which must be sent with the
remaining documents to its correspondent in London to be presented
to Lazard Brothers for acceptance. The documents which accompany
the draft are sent merely to show that the shipment has been made
in accordance with the terms of the letter. Lazard Brothers accept
the draft, detach the documents, and return the accepted draft to the
correspondent of the Crédit Lyonnais, which holds it until maturity
or has it discounted immediately, depending upon instructions which
1 The French bank is willing to do this because it has no reason to question the solvency
and good faith of the San Francisco bank.

258

DOMESTIC AND FOREIGN EXCHANGE

it has received from the Paris bank.

Lazard Brothers may or may

not send the documents to the San Francisco bank, depending again
upon instructions. There is no need that they be forwarded, for the
San Francisco bank has a copy of the bill of lading which has been
sent to it direct by the exporter's bank, and which will enable the
importer to get the goods off the wharf. When the draft has been
accepted, Lazard Brothers notify the San Francisco bank so that the
latter may know the maturity date of the draft.
When the documents and the goods reach San Francisco, the bank
notifies the importer. The latter gives the bank a trust receipt or
makes some other such arrangements whereby it is enabled to get
possession of the goods. At the end of a certain time, usually about
fifteen days before the accepted draft must be paid in London, the
bank notifies the American Lace Company to deposit with it a sum
in dollars which at the prevailing banker's sight rate for sterling exchange will be sufficient to purchase a £5,000 demand draft plus all
commissions and charges. The commission of the English accepting
firm will vary from nothing to ½ per cent or more , determined by the
usance of the bill, the reputation of the parties concerned, the nature
of the goods shipped, the competition of banks for the business, etc.
American banks fix their commissions so as to include those charged
by the English accepting bank. The total commission will range from
4 per cent for the sight drafts to about 3/8 per cent for 90 day
drafts, the arrangement between the English acceptor and the American bank usually being that the returns shall be divided evenly. If
the face value of the draft plus the commissions and charges amounts
to £5,040, and if the rate for demand drafts in the market is 4.86,
the American Lace Company will have to pay the San Francisco
bank the sum of $ 24,494.40 (5,040 X 4.86) . The bank will then put
Lazard Brothers in funds by sending a demand draft, or by waiting
a few days and sending a cable, or by instructing Lazard Brothers
to debit its account for the amount of the draft plus their commission.
In any event , funds are on hand with which Lazard Brothers pay the
draft when presented at maturity by the holder.
The greater portion of the world's trade is still financed by sterling
bills of this character, and that condition will remain so long as England is dominant in foreign trade through her merchant marine and
her far-flung system of foreign branch banking. A ready market for
sterling drafts always prevails, no matter in what part of the world they

t

IMPORT AND EXPORT CREDITS

259

are drawn, because bankers and others with obligations to meet in
London are continually in the market for sterling exchange. Letters
of credit, handled in the above manner, are also issued in terms of
francs, in which case the drafts would be drawn on a French bank and
accepted by it, or in marks, with the drafts drawn on a German bank
and accepted by it, or in lire, florins, etc.
Revolving Letters of Credit. Occasions sometimes arise which make
it advisable for the importer to obtain a "revolving " letter of credit
rather than the ordinary commercial letter of credit. He may be
importing continually from some foreign house and does not want to
be bothered with getting a letter for each lot of goods imported, or
possibly the bank does not want to issue to him a letter of credit for
an amount large enough, or for a period long enough, to cover his
importations. To meet such contingencies, the banking world had
developed a "revolving " letter of credit which meets such conditions
admirably. Revolving credits are issued under the same terms and
on the same type of form as the ordinary commercial letters of credit
that we have discussed, the only difference being that a description
of the conditions under which the credit is to revolve or be renewed
is incorporated in the letter. Revolving letters of credit may be divided
into four general groups. (a) The credit may be opened for, say,
$50,000 with the agreement that the draft is to be for the total
amount of the credit, and that the credit is to be automatically renewed as soon as the draft is paid. (b) The credit may be opened for,
say $50,000, with the understanding that the total amount of drafts
outstanding at any one time shall not exceed that sum. For example, the exporter may draw any number of drafts against the letter of
credit up to the sum of $50,000 , but no more may be drawn until some
of those outstanding have been paid. As they are paid, the accepting
bank advises the exporter of the payments and he may then draw
additional drafts up to the amount of those that have been paid, but at
no time may there be more than $50,000 worth of drafts outstanding
and unpaid. (c) The credit may be opened on the condition that
when the exporter draws a draft for any amount within the limit set
by the letter, say $50,000, the credit becomes immediately available
for the full sum. Thus if the exporter should draw a draft for $40,000
under the terms of this type of revolving letter, as soon as he had
drawn such a draft, the letter would be automatically renewed for the
entire amount.

In types (a) and (b) the act of paying the draft or

260

DOMESTIC AND FOREIGN EXCHANGE

drafts renews the letter, but in type (c) the act of drawing the draft
renews the letter.
(d) The letter may be drawn authorizing the
exporter to draw for a certain amount weekly, monthly, or annually.
This type of letter may be accumulative or non-accumulative, i. e. , if
the amount specified is not drawn each week, month, or year, the sum
that is not drawn may be allowed to accumulate and become available
for the next period (accumulative) ; or if not drawn, the beneficiary
loses the right to draw for the lapsed amount (non-accumulative) .
The convenience and usefulness of revolving letters of credit are
clearly evident and do not need elaboration. The commission charged
by the issuing bank is based, not on the amount for which the credit
is issued, but on the amount that is availed of thereunder.
Export Letters of Credit. Situations arise at times in which the exporter is compelled to take the initiative in obtaining an export letter
of credit or an export credit that may be known by some other name.
It may be that a South American or Asiatic importer finds himself unable to obtain an import letter of credit because of the lack of banking
facilities, or he may know that he will be unable to obtain dollar exchange when he wishes to remit payment with his order . The exporter always wants to get his money for the goods as soon as they are
shipped. The practice of drawing directly upon the importer is
seldom employed . Various forms of export credits have been devised
for use in foreign trade. Previous to the establishment of the Federal
Reserve System almost all export credits were in terms of sterling.
Lately, however, as a result of the World War and also because American banks since 1916 have been authorized to finance trade by means
of acceptances, an increasingly large amount has been drawn in dollars.
Suppose that Lima and Company of Rio de Janeiro desires to import $10,000 worth of goods from the New York Machinery Company.
The latter is willing to ship the goods with the understanding that
they are to be paid for thirty days after the acceptance of the draft.
The exporter consults with the Chase National Bank of New York
as to the best method of financing the shipment. An arrangement
is entered into whereby the exporter is to hand all documents to the
bank; the draft is to be drawn at thirty days sight ; documents are to
be turned over to the importer on acceptance or on payment, as the
case may be, and the exporter is to receive in return a sterling export
letter of credit. When the documents have been prepared, and the
draft drawn in sterling on Lima and Company payable to the Chase

IMPORT AND EXPORT CREDITS

261

National Bank or order at thirty days sight, the exporter hands his
documentary bill of exchange to the bank, and receives in return his
export letter of credit. By its terms he is authorized to draw a ninety
day draft on the London correspondent of the Chase National Bank,
say Barclays, for ninety per cent of the invoice value of the goods.
He may then sell this draft in the open market and receive dollars for
it, or he may have the bank draw the draft and sell it in the market
and turn the dollars over to him or to his account on deposit with the
Chase National Bank. If the bank draws and sells the draft a larger
return will be obtained because the bank's draft will command a
higher price than will the draft of the exporter.

The New York bank

that purchases the draft, say, the United Trust Company, sends the
draft to its London correspondent, say, Lloyds, which presents it to
Barclays for acceptance. Barclays accepts the draft in accordance
with the " advice " forwarded to it by the Chase National Bank. The
draft then runs to maturity. In the meantime, the Chase National
Bank forwards the documents covering the shipment to its correspondent at Rio de Janeiro, say the Banco do Brasil, with instructions to
present the draft of the New York Machinery Company to Lima and
Company for acceptance . Lima and Company accepts the draft, gets
the goods, and disposes of all or part of them.
Some time elapses
before the goods and the documents reach Rio de Janeiro, perhaps
twenty-five days ; the draft runs for thirty days. At the end of that
time Lima and Company is required to pay the Banco do Brasil
an amount of milreis sufficient to purchase a sterling demand draft
on London, called the " return bill " or " return draft. " The Banco do
Brasil charges a commission for acting as the agent of the Chase National Bank, and includes that charge in the rate which Lima and Company pays for the demand draft on London. The stamp taxes also
have to be paid by the importing firm.2 The Banco do Brasil then
forwards the draft to Barclays in London as per instructions from
the Chase National Bank, thus putting the accepting bank (Barclays)
in funds with which to meet the draft which it (Barclays) had earlier
accepted. It will be noted that the draft drawn by the exporter on
Barclays was a ninety day draft but for only ninety per cent of the
1 If payments are made before maturity of drafts it is customary in South America to
allow a rebate of 6 per cent on such pre-payments.
2 Stamp taxes are imposed on commercial invoices, receipts, bills of lading, indorsements
on the same, and upon practically all documents, legal or otherwise, in all South American
countries.

262

DOMESTIC AND FOREIGN EXCHANGE

value of the goods.

The draft drawn by the exporter on Lima and

Company was a thirty day draft for the full value of the shipment.
The demand sterling draft sent from the Banco do Brasil to Barclays
was for the full value of the shipment. It takes about twenty-five days
for the mail to reach London from Rio de Janeiro, so that the demand
sterling draft has sufficient time to arrive in London and thus put Barclays in funds before the exporter's draft on Barclays matures and has
to be paid. Barclays cashes the demand draft sent it by the Banco do
Brasil, pays its accepted draft at maturity and deducts from the
remainder its usual acceptance commission . It then forwards the
remainder to the Chase National Bank in the form of a dollar draft,
or it may simply credit the Chase National Bank with the amount
in question and send an advice to that effect. The Chase National
Bank deducts its commission for having acted on behalf of the exporter and pays him whatever remains.

Thus it happens that no

bank advances any funds. The transaction throughout is purely
of a credit character. The London discount market again carries the
financial burden, and, as always, at its usual discount rate. The exporter has to pay two commissions , one to the London accepting bank
1
(Barclays) ¹ against which the export letter was issued, and one to the
Chase National Bank, 2 but in return therefor he has the use of the
money for at least ninety per cent of the value of the shipment during
the period covered by the transaction . The exporter is willing to wait
for the remaining ten per cent until the deal has been closed . The
risk of exchange has been borne in this case entirely by the importer,
for it is Lima and Company that has to buy sterling exchange at the
market rate in Rio de Janeiro with which to put Barclays in funds
wherewith to meet the exporter's draft.
With the changes wrought by the Federal Reserve Act, it is now
possible for an exporter to draw the draft on an American bank instead of on an English bank. Taking the data of the above example,
the exporter under this arrangement draws the draft in dollars on Lima
and Company, payable in exchange on New York at the Brazilian
bank's sight rate, and turns the draft and documents over to the
Chase National Bank which forwards them to the Banco do Brazil in
Rio de Janeiro. The draft will be accepted by Lima and Company
and will run for the designated period . The exporter, at the same
1 Possibly from 1/8 to 3/16 of one per cent.
2 Usually 1/2 of one per cent for a ninety day acceptance.

4

IMPORT AND EXPORT CREDITS

263

time, also draws a draft in dollars against the Chase National Bank
for 90 per cent of the invoice value of the shipment. The latter is
accepted by the drawee (the Chase National Bank) and possibly discounted by it, although it is not advisable for a bank to discount its
own acceptances. More often, after the Chase National Bank has
accepted the draft, the exporter discounts it in the New York market,
say with the National City Bank. Before the draft matures, Lima
and Company puts the Banco do Brasil in funds by paying the draft
drawn by the exporter. The Brazilian correspondent bank then puts
the Chase National Bank in funds so that the exporter's second draft,
i. e., the one which he drew on the Chase National Bank itself, may
be paid when presented t maturity by the National City Bank.
There are other methods of financing exports from one country to

another by means of drafts drawn on a third country, but without the
use of a commercial letter of credit. For instance, say the New York
Machinery Company as per instructions sent it , draws a 90 day sterling
draft on Lima and Company for enough sterling at the prevailing
market rate for 90 day bills to yield the dollar value of the goods plus
certain charges for interest and commission that the negotiating bank
imposes. The bank's commission will usually be 14 per cent, and the
1
interest charges ¹ will be figured customarily at 6 per cent and for the
length of time that it will take the draft to reach Rio de Janeiro, be
accepted and run to maturity of 90 days, plus the time that it will
take for the remittance to reach New York (calculated in all at 140
days) . If the rate is 4.81 2 for 90 day sterling drafts, and if the total
1 Sometimes the face value of the draft will be discounted by the bank instead of interest
being charged . The former, even though the same rate be employed, yields the exporter
a slightly smaller sum .
American banks charge a " flat rate of from 12 to 5 7/8 per cent for discounting drafts on
South America, depending upon the tenor of the draft and the time and distance from
New York to the country upon which the item is drawn . These rates are made up in this
manner for general convenience in calculating and are arrived at by charging interest for
the estimated time elapsing between payment of funds by the discounting bank and date
of reimbursement in New York. To illustrate ; if the draft be drawn at 90 days sight on
Buenos Aires, an additional two months' interest is added to the 90 days to cover the
estimated time in transit to and from that point. The bank reserves the right to adjust
the interest charge with the drawer of draft should the elapsed time be longer than the
time estimated .
"To some countries there is also added the foreign bank's collecting charge for drafts,
plus foreign revenue stamp tax on bills of exchange. These charges range from 1/20 to
1/5 of one per cent. Malley, F. O., "Our South American Trade and Its Financing,"
New York, 1920, issued by the National City Bank, p. 29.
2 Speaking of conditions before the Great War, the Americas (vol. 1, No. 3, p. 47 ) states
that "For South American business, it is the custom , generally, to figure a rate of exchange
of $4.80 for all transactions, owing to the fact that this is a well-ingrained usage with which

264

DOMESTIC AND FOREIGN EXCHANGE

yield that the draft is to bring is $ 10,258 ($ 10,000 value of goods plus
$233 interest at 6 per cent for 140 days plus $25 commission of the
negotiating bank at 4 per cent) , the draft will have to be drawn for
£2132 125 8d (10,258 ÷ 4.81 ) . The Chase National Bank gives the
exporter $10,000, takes the draft and documents and forwards them
to the Banco do Brazil. The draft is presented to Lima and Company
for acceptance, and at the end of 90 days is paid by that firm in the
exact amount of milreis required to buy a sight draft for £2132 12s 8d
on London. If the rate is high, Lima and Company has to pay more
milreis; if it is low, the firm has to pay less. The draft is then forwarded to the Chase National Bank, or, if the latter so desires, it may
have the draft sent to its correspondent in London, there to be cashed
and credited to its account. If the draft is forwarded to the Chase
National Bank, instead of to London, the bank can either sell it to
another exchange dealer in New York at the current rate for sight
drafts on London, or it can forward it to London for collection , the
proceeds to be credited to its account. It will follow the course that
seems to promise the greater profit. In either case the Chase National
Bank assumes the possibility of a decline in the rate for sterling exchange, and a corresponding decrease in its profit on the transaction.
In the two instances , where the sterling draft is sent to London to build
up the account of the New York bank so that exchange may be
drawn against it, the rate for sterling may fall so low as to cause a loss
to the Chase National Bank. Likewise, in the other instance where
the draft is returned to New York and the bank sells the draft to
another local dealer, sterling exchange may fall, and entail a loss to the
bank. Of course, conversely, there are chances that the rate for sterling may rise and thus bring larger profits than anticipated.
It is possible for this latter method to be financed in terms of dollars.
As an illustration , say the New York Machinery Company draws
a dollar 90 day draft on Lima and Company, payable to the Chase NaSouth Americans are thoroughly familiar. Naturally, it suits very well in the case of a
shipment of goods against sight drafts because, as a rule, they can always be sold to a better
advantage than $4.80 in this market. However, if the draft were 90 days sight, it would
not at all times bring $4.80 and it would be necessary, in making a price for goods, to bear
that fact in mind. The rate is a matter of custom only. Rate making on the invoices
can be adjusted satisfactorily to both the importer and the exporter. The rate of $4.80
on a sight draft in sterling on South America is favorable to the United States exporter,
as it means about $4.85, if the voyage to and from is counted as 60 days at 6 per cent,
making about five points difference or approximately 1 per cent. The banker purchasing
it takes the risk in exchange."

IMPORT AND EXPORT CREDITS

265

tional Bank or order, and payable (in Brazilian currency) at the rate
being charged on the maturity date by the Brazilian bank for dollar
sight drafts on New York.

The draft is drawn to include the bank's

commission of 4 per cent and interest at 6 per cent for the period of
140 days plus the invoice value of the goods, totalling, say, $ 10,258,
and is sold to the Chase National Bank. The draft and the documents
then take the same course as in the last example, i . e . , they are sent
to the Banco do Brasil, the draft is accepted by Lima and Company
and runs for 90 days , at the end of which time the importing firm pays
the Banco do Brasil a sum of milreis sufficient to purchase a $10,258
demand draft on New York. The commission of the Banco do Brasil
is included in the rate that it charges the importer for the dollar sight
draft on New York, or it is obtained in some manner from the Chase
National Bank. The demand draft for $ 10,258 on a New York bank
is then forwarded to the Chase National Bank and cashed by it at the
bank upon which the draft has been drawn.
In the last two examples, the Chase National Bank of New York
has advanced its own funds during the life of the transaction, and has
therefore charged interest as well as its commission. In the earlier
examples, the Chase National Bank loaned only its credit to the exporting firm , and it was the discount market of London or of New York
that bore the burden of financing the transaction.

Normally, banks

much prefer to follow the latter practice, because to them the loaning
of credit is always more acceptable than the loaning of actual funds.
In all the examples given above, the importer, Lima and Company,
has furnished funds with which to purchase a sterling or a dollar demand draft as cover for the draft drawn by the exporter. Lima and
Company may, instead, resort to a purchase of cables, for by that
means it is possible for the firm to save from twenty to twenty-five
days in time. If Lima and Company wishes to get an extension of time,
permission must be secured from the Rio correspondent of the Chase
National Bank to buy a cable instead of a draft. The importer pays
an extra commission for this privilege and also a higher rate for cable
exchange, because cables are always more expensive than drafts. If
there is a possibility of a decline in exchange rates, it may be that the
importer may secure a cable twenty days hence at about the same rate
that a demand draft would have cost originally.
As was noted above ¹ it is rather customary for exporters in certain
1 Cf. pp. 182-183.

266

DOMESTIC AND FOREIGN EXCHANGE

of the South American and Central American countries to pay their
obligations in 90 day sight bank drafts .

Before the World War these

drafts were drawn almost exclusively on London ; since that time,
however, an ever increasing number has been drawn in dollars. Such

F

drafts mature 90 days from the time that they are accepted by the
bank upon which they have been drawn by the selling bank, and if
they are sterling bills, three days grace additional must be allowed.
In such cases, the draft of the exporter on the importer is drawn payable at "the bank's drawing rate on the day of payment for 90 day
sight drafts on London, " or in the case of dollar drafts, " on New York. "
On the date that the draft of the exporter falls due, the importing
firm has to hand the bank, that presented the original draft, sufficient
funds with which to buy the " return draft " as specified . If the 90
day sight bank draft is drawn in sterling, it is forwarded to the New
York bank that originally purchased the bill of exchange from the
exporter. The New York bank either sells the draft in the New York
market at the rate for 90 day sight bank drafts on London, and thus
gets its money, or forwards it to London for acceptance and, very
probably, for discount . The accepted draft will run for 93 days and
will be paid at maturity. In the meantime the South American or
Central American bank which sold the draft to the importer will put

I
I

the accepting or paying bank in funds with which to meet the draft at
maturity. It may do so by sending a sight draft or a cable, or by
merely advising the London bank to deduct the amount of the draft
from its (the selling bank's) account. When the 90 day sight bank
draft is drawn in dollars and sent to the New York bank, the latter presents it to the American bank upon which it has been drawn, and
upon acceptance the bill may be discounted in the New York market
or held until maturity.
When such 90 day sight bank drafts are to be used as " return drafts "
it is possible for the importer to ask for a postponement of payment
in order to obtain the temporary use of the funds ; later he will purchase a sterling or dollar cable in order to reimburse the New York
bank. It must be remembered that 90 day drafts are always worth
less to the receiving bank than sight drafts, because of the delayed
payment. Both yield the same number of dollars when paid at maturity, but with 90 day drafts the bank has to wait longer for its money
and thus loses interest on the funds represented . If it wishes to get
the immediate use of the money tied up in the transaction and there-

1

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ORIGINAL
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1922

IMPORT AND EXPORT CREDIT
267

268

DOMESTIC AND FOREIGN EXCHANGE

fore discounts the draft immediately upon acceptance, a sum smaller
than the face value of the draft is realized . The bank appreciates
these facts and takes them into consideration in fixing the amount
for which it advises the exporter to draw his draft. A delayed payment
necessitates that the exporter draw the draft for a larger amount than
would be required were payment to be made by means of a sight
draft. Thus the importer really pays for the privilege of enjoying the
delayed payment, but, of course, he has a longer period in which to
speculate on a fall in exchange rates on London or on New York.
In all of the above instances of export credit transactions it is possible
for the New York bank to instruct the foreign bank to accept funds
from the importer and to credit them to the account of the New York
bank, instead of bothering about remitting the exchange as called for
in the wording of the exporter's draft. It will ask that this procedure
be followed if it is desirous of building up its foreign account for exchange purposes or if it feels that more profit can be made by such an
arrangement.
Interest Clause. In the examples given above the interest charged
by the bank has been figured in the amount for which the draft has
been drawn.

The practice in the trade with the Far East and also

with the British West Indies is slightly different and requires that when
the American bank purchases the draft and documents from the exporter it stamp on the face of the draft the so-called " interest clause "
(Fig. 75) , which varies in its wording as between banks. Some banks
print the interest clause on the draft. The following are typical
examples :
"Payable at Bank's selling rate for sight exchange on New York with
interest at 8% per annum from date hereof until estimated date of arrival
of return remittance in New York."
or
“ Payable with exchange, commission, stamps and interest at 6% per
annum from date hereof until estimated date of arrival of return remittance
in New York."
or
"Draft to be paid at current rate for Bank demand draft at date of payment with interest added at 9% per annum from date to approximate date
of returns reaching London."

IMPORT AND EXPORT CREDITS

269

or
"Payable in United States gold coin or its equivalent together with
interest at the rate of 9 per cent per annum from date hereof until approximate date of repayment in San Francisco and all collection charges. "
The foreign correspondent that presents the bill for acceptance and
which later collects its value from the importing firm also computes
the interest and commissions that must be paid.

It knows the ap-

proximate or customarily accepted number of days required for the
original draft to arrive from the purchasing bank and for the remittance to be returned to that bank. It also knows the usance of the
bill, and is therefore able to calculate at the designated rate the amount
of interest that will have to be paid by the importer. This sum will be
added to the face value of the original draft, and will determine the
amount of exchange that the importer must purchase for remittance.
If the clause states that the draft is payable at " the bank's selling rate"
for the kind of exchange designated in the interest clause, then the
importer is compelled to purchase such exchange from the bank holding
the accepted draft. If that phrase is absent, the importer is free to go
to any bank, procure the required exchange at the best obtainable
rate, and turn it over to the correspondent bank to be remitted to the
payee bank.
The commission of the foreign bank depends upon "local custom and
the degree of accessibility or inaccessibility of the point where the
collection is made. " 1 It will be noted that several of the interest
clauses mentioned above do not contain any reference to commissions
or who shall pay them. The reason is that the rate of interest , which
is generally high, is intended to cover the usual commissions. Stamp
taxes are also passed on to the importer.
The rate of interest varies from time to time, but is customarily
fixed for the United States by the rate quoted in the New York exchange market, which in its turn follows closely the rate charged by
the London market. Exchange dealers state that a small group of the
large banks in New York fix the interest rate used in such transactions.
Hough in his excellent volume " Practical Exporting," in discussing
the insertion of the interest clause, concludes that " There is an element
of great uncertainty about it, and a great many foreign houses object
to this practice, in fact object to paying more than the charges specifi1 Irving National Bank, " Trading with the Far East," p. 91.

270

DOMESTIC AND FOREIGN EXCHANGE

cally named by invoices. The clause in question, therefore, should
not be included except by previous agreement with the customers. " ¹
Exporters are urged by bankers to draw their drafts for an amount
that will include interest charges, commission, stamps, etc. , because
importers, especially those in South America, refuse at times to pay
more than the face value of the draft. In Argentina a banker cannot
legally collect more than the face value of the draft.

In the Scandina-

vian countries, notations relating to the payment of interest and other
charges may be placed on the bill of exchange, but they are without
legal effect, the drawer being under no legal obligation to pay them.
It should also be noted that in the Scandinavian countries if drafts
are to be paid at the " bank's selling rate," banks are not permitted
to apply their own rates, but are legally compelled to use the official
rates published by the Stock Exchange Committee of their respective
countries.
Colonial Clause. Another clause requently met with is the " colonial
clause " 2 appearing only on drafts drawn against South African and
Australasian merchants and issued against exports to them. It is
never used on drafts drawn on other countries and seldom on drafts
drawn on banks in the two countries mentioned . This clause may
read, " Payable with exchange and Eng sh Colonial stamps at the
current rate for negotiating this in London on the colonies," or " Payable with exchange (English and Colonial stamps added) at the current
rate in London for negotiating bills on the Colonies " (Fig . 76) .
The importer, i. e. , the drawee , is by this clause compelled to pay all
charges for English and Colonial stamps , collection fees, interest from
the time the draft is drawn until the date of arrival of the proceeds
in London, the difference in exchange rates, etc. , so " that the bank
that finally presents the draft for payment, collects from the drawee
4
not only the face value , but also all these accrued charges. "
South
Africa and the Australasian colonies have the same sovereign for their
unit of value as has England . The rate of exchange in London on
1 P. 493 .
2 Cf. Whitaker, op . cit ., pp. 310-318 for the best available discussion of this clause.
"Bills upon South Africa or Australasia originating in England do not customarily
bear the colonial clause. But a substitution for the clause is in constant use by English
drawers. Instead of enfacing the latter on their bills they simply add the ' exchange ' to
their invoices, and reach the same result. Thus if £ 100 is due the English exporter, he
adds the £2 for exchange to the invoice and (disregarding stamps) draws an ordinary bill
for £102 ." Whitaker, op. cit. , p. 317.
4 "Selling in Foreign Markets," compiled by G. E. Snider, U. S. Bureau of Foreign and
Domestic Commerce, Miscellaneous, Series No. 81 , p. 548 .

ON
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FORMA
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1921

IMPORT AND EXPORT CREDITS
271

272

DOMESTIC AND FOREIGN EXCHANGE

these countries , however, varies just as does the rate of exchange
between the United States and Canada which have the same " dollar "
for their standard of value, or as the rates of domestic exchange between New York and San Francisco formerly fluctuated before the
introduction of the Federal Reserve System. A draft bearing the
Colonial clause is payable by the drawee in the pound sterling of his
own country, not in the pound sterling of London. It is not the rate
of exchange on London in the drawee's country that determines what
the drawee shall pay: it is the rate of exchange in London on the
drawee's country on the date of maturity of the draft that fixes the
cost of the draft to him. Furthermore, it is the rate in London on
that date for bills of the same usance, not for sight bills or for telegraphic transfers. It will be noted by reference to the wording of the
Colonial clause that it requires that the bill be payable " at the current
rate" (meaning the rate existing on the date that the drawee pays the
draft), "for negotiating this in London " (meaning the rate at which
a bill of the same type, same usance, etc. , would be negotiated in
London on the same day that the draft becomes payable by the
drawee).
To illustrate a case where the colonial clause is used, say that the
San Francisco Exporting Company sells goods valued at $48,600 to
the Australian Importing Company of Melbourne. If the sight rate
on London on the day the draft is drawn stands at 4.86, the exporter
will draw against the Australian firm for £10,000, regardless of whether
the usance of the draft be sight, 30, 60 or 90 days.
draws always at the prevailing sight rate on London.

The exporter
The Colonial

clause is stamped on the face of the draft, which is thereupon sold,
along with the documents, usually to a branch of an English or Colonial
bank. The draft is sold at par, sometimes at a premium, because
when the draft is finally paid by the importer it will yield a sum that
is above par for reasons that will be later explained . " It is not necessary for the shipper to concern himself with a calculation of the approximate time that will elapse before his draft is presented, the time
it has to run, and the time required for the return of funds, and to add
interest for all this time to his invoice or provide for it in his price, nor
need he be concerned regarding fluctuations of exchange. He has only
to convert his invoice from dollars into pounds sterling at the sight
rate on London and draw his draft for the resultant amount. This
draft can be sold to any bank having the proper London and Aus-

IMPORT AND EXPORT CREDITS
tralian connections for full face value.

273

The transaction is to all

intents and purposes a cash one for the manufacturer or shipper, although, of course, he still runs the credit risk, as such drafts are not
bought ' without recourse ' unless a confirmed banker's credit has been
opened. In the case of sight drafts this risk is reduced to a minimum,
since the drawee cannot obtain possession of the corresponding goods
until the draft is paid. In other or doubtful cases it is not difficult
for the manufacturer to satisfy himself of the standing or reputation
of the client through the reliable commercial agencies that have
branches in Australia or through the correspondents of the Australian
banks. ” 1

The draft and documents are forwarded to the importer through a
Melbourne bank, the draft is accepted by him, and runs, say, for 90
days. At maturity, the importer comes in and pays the bank the face
value of the draft and the accrued charges, plus the premium that is
being charged in London on that date for 90 day bills on Melbourne.
Exchange rates in London on Australia (and also on South Africa)
normally stand at a premium,2 the amount of the premium varying
from day to day, so that the bank that has purchased a draft bearing
the Colonial clause is always certain of receiving more than the amount
for which the draft has been drawn. American banks always ask
Australian banks to remit directly to London because sterling exchange is cheaper than dollar exchange. Australian banks have
accounts in London and are able to draw drafts on their accounts
when remitting to the London accounts of the American banks.3
The practice is for the Australian banks to forward the original draft
to the designated London bank and the duplicate draft to the American
bank .
Writing on " Exporting to Australia,"
1916 stated that:

Mr. Philip B. Kennedy in

"Since the war a fair number of drafts have been drawn in dollars and
sent to the Australian banks for collection. If the drawer wishes to realize
the face amount of the draft, this should be provided for by a clause stamped
1 Commercial Attaché W. C. Downs of Melbourne in " Export Trade Suggestions,"
Miscellaneous Series No. 35 , U. S. Bureau of Foreign and Domestic Commerce, p. 53.
2 It was not at a premium in 1921 .
•American banks do not have branches or accounts in Australia. The Australian banker
has maintained a closed monopoly of banking in his country.
4 Miscellaneous Series No. 45, Ù. S. Bureau of Foreign and Domestic Commerce, pp.
15-16.

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DOMESTIC AND FOREIGN EXCHANGE

on the draft. The Bank of New South Wales, which does more of this collection than any other Australian bank, advises that the following clause
should be added to enable them to remit the face amount in dollars:
'To be converted into sterling at the Bank of New
South Wales rate on due date, and payable at the current
rate of exchange for purchasing demand drafts on London
with all charges.'
"At this date (June 28, 1916) the Bank of New South Wales will convert
at the rate of $4.75 . This rate is on collections forwarded by an American
bank. Exchange at 1 1/4 per cent is added, together with 3/8 per cent commission. If a draft of a face value of $475 had been sent forward for collection with this clause added , the importer would be called upon to pay
the following amount :

$475 at 4.75.
Exchange ..
Commission .
Duty stamp .
Total .

£100
I

£ IOI

OS.
5
7
O

od.
O
6
I

I2S.

7d.

"If the terms of the sale were on the basis of draft against date drawn
in New York, the Australian bank may also be asked to add interest for
the time taken for the round-trip mail, which is usually reckoned at 72
days. The rate of interest is 6 per cent, and in this case the importer
would also be asked to pay 72 days' interest at 6 per cent.
"The Bank of New South Wales, the largest bank in Australia, will
now forward a draft upon the National City Bank of New York, where an
account is kept, for the full amount in dollars up to £1,000 . For larger
amounts the sum will be forwarded to be converted at the New York sight
rate on London. This limit on dollar exchange is due to the difficulty that
the Australian bank may have in replenishing its funds in New York. It
is not policy to carry large accounts in New York, because New York.
banks pay only 2 per cent interest on bank accounts, whereas at present
4½ per cent is being paid in London for similar accounts.
"The advantage of adding the colonial clause to the draft is that the
full amount may be obtained at once. The London banks that accept and
carry these bills finance the time consumed.
"It is probably fully as cheap for the importer at present to have drafts
drawn upon him directly in dollars, because the Australian exchange on
London is now much higher than normal, 22 per cent. Drafts drawn in
dollars with the above mentioned clause attached and forwarded direct
are entirely feasible at the present time."

IMPORT AND EXPORT CREDITS

275

Exchange as per Indorsement. Another practice, again peculiar to
the English exporter, is the drawing of drafts bearing the clause " Exchange as per indorsement " or " At the rate of exchange as per first
London indorsement." This makes the bill drawn by the English
exporter in sterling eventually payable in a foreign currency at a predetermined rate for each pound sterling. Thus if an English merchant
draws a 90 day draft for £1,000, on a New York firm, and includes
the clause " Exchange as per indorsement," the London banker who
negotiates the bill will pay the exporter the face value of the draft
less the usual commission and charges, will then convert the sterling
into dollars at the 90 day rate on New York and will indorse on the
bill either the total amount of dollars to be paid by the importer or
the rate of sterling exchange at which payment is to be made. The
object of the drawer is to avoid the risk of loss in exchange and at the
same time to satisfy the drawee that the rate of conversion has been
fixed by an impartial referee, viz., the bank. Previously it was customary for the banker to indorse the rate of conversion on the draft
(note that the clause says " rate as per indorsement ") but " owing to
the increased number of cases in which the persons on whom bills of
exchange are drawn refuse to pay the equivalent at the rate of exchange
indorsed on the bills, the custom among some of the bankers is to
quote the seller the rate and insist on his indorsing it on the bill himself. Under this arrangement any dispute which may subsequently
arise when the bill is presented can be referred back to the drawer for
settlement between the drawee and himself. " 1
Domiciled Bills.

A variation of the documentary bill drawn under

a commercial letter of credit and drawn in one country on a second
but payable in a third country, either in the money of the second or
in the money of the third, is found in the " domiciled bills," known
for short as " domiciles. " Suppose that an American exporter draws
a bill on a French bank covering shipments of cotton to a French firm.
The French bank accepts the draft, and by the wording of its acceptance makes it payable at a certain bank in London . The bank that
presented it for acceptance then forwards it to London to its correspondent either for discount or to be held until maturity. The draft
therefore becomes " domiciled " in London . A short time before it
falls due, the French accepting bank forwards funds to the London
1 Spalding, Foreign Exchange and Foreign Bills," (1st ed . ) p. 141. Cf. Bankers' Magazine, (England) , January, 1921 , pp. 65–66.

276

DOMESTIC AND FOREIGN EXCHANGE

bank that is to pay the draft, and with these funds payment is made
at maturity. All charges, of course, are met by the French importing
firm . The London discount market harbors a very great prejudice
against domiciled bills and charges a higher rate of discount, usually
a quarter to one half per cent per annum higher than for bills bearing
the acceptance of a British bank. The bill must bear two stamps,
one for the accepting country and one for England. These facts are
taken into consideration in the New York market when the bill is
offered for sale, and as a consequence a bill that is to become a domicile
commands the lowest price for documentary bills of the same usance.
Another matter that similarly affects the price of the bill is that it is
sent by an indirect route to London, taking much longer than if it
were forwarded directly to London from New York. The New York
bank is out of funds for the additional time, not being able to have the
draft discounted until it reaches London, and therefore has to charge
for the loss of time. " Partly because of these disadvantages attaching
to the domiciled bill, some foreign banks in their eagerness to retain
the financing of native imports by means of sterling bills, have established branches in London for the purpose of giving their bills the status
of London acceptances. But London bill buyers show some discrimination even against the sterling bills of these foreign agencies. As a
rule they reserve the lowest discount rate for bills of purely British
acceptors, the great joint-stock banks, and the world-renowned private
banking firms, whose business is primarily that of accepting bills." 1
The attitude of the discount market in the United States toward
domicile bills closely follows that of London. During the spring of
1920 a plan was submitted to the Federal Reserve Board in connection
with a proposed method of financing cotton shipments whereby the
American exporters would draw six months drafts on foreign spinners,
not on banks ; the spinners after accepting the drafts were to present
them to their local banks for indorsement, giving a chattel mortgage
on the cotton as security. These drafts were to be made payable in
the United States. The question arose as to whether or not such bills
Icould be discounted at the Federal Reserve banks. The General
Counsel of the Federal Reserve Board ruled that " Although a draft
drawn by an American exporter upon a foreign buyer and accepted by
that buyer payable in the United States in dollars may be technically
eligible for discount under the terms of section 13 of the Federal Re-

1 York, op. cit. p. 142.

IMPORT AND EXPORT CREDITS

277

serve Act, nevertheless, a Federal Reserve bank may, in its discretion,
decline to discount such an acceptance on the ground that, inasmuch
as it is a domicile bill, it is not a desirable investment." The Federal
Reserve Bulletin of April, 1920, in commenting upon this ruling added
that "The Federal Reserve Banks have evidenced their unwillingness
to discount acceptances made by foreign banks payable in this country
in dollars unless the accepting bank has an office and assets in this
country. It is also understood that most of the central banks of
Europe have generally declined to afford a market for bills of this
character. With the foreign exchange market in its present unsettled
condition the principles which make domicile bills undesirable even
" 1
in normal times are now all the more pertinent.

As it is possible for local banks which do not have an international
reputation to arrange through other bankers for the sale of certain
kinds of exchange, as has been described, so it is also possible for them
to arrange for the issuance of letters of credit through their correspondents located in either domestic or foreign commercial centers .
In this connection as in all others, state laws govern state banks and
national laws govern national banks. So far as I know there has been
no question raised regarding the powers of state banks to make such
arrangements, but lately (May, 1921 ) the Federal Reserve Board
has handed down a significant ruling affecting the manner in which
national banks have been accustomed to issue letters of credit to their
clients. It has been rather customary for an interior bank to have
its large city correspondent issue the letter for the customer's account
which letter the interior bank would guarantee, i. e ., if the client
should fail to put the issuing bank in funds with which to meet the
drafts at maturity, the interior bank guaranteed that it would do so.
The Federal Reserve Board has ruled that a national bank does not
have the right to act as surety on a letter of credit issued by another
bank; that, while it itself has the right to issue a commercial letter of
credit and to accept drafts drawn under such letters of credit, nevertheless " such powers do not carry with them the power to guarantee,
or act as surety upon, acceptances or letters of credit issued by other
banks." The Board, however, has outlined a plan whereby an interior
bank may still have its large city correspondent issue letters of credit
for local customers without running contrary to the Board's ruling.

1 P. 386.

278

DOMESTIC AND FOREIGN EXCHANGE

It is proposed that the interior bank merely designate the city correspondent as the agent which is authorized to issue letters of credit
to customers of the former. The interior bank's name will not appear
on the letter of credit, but the city correspondent is to look directly
and unconditionally to it for reimbursement, and not conditionally
upon the failure of the client to put the issuing bank in funds. Under
this arrangement the client will pay the sum involved to the interior
bank, and the latter will reimburse the city correspondent. To the
layman this new arrangement seems to be merely a case of " beating
the devil around the bush," but, in so far as banking law is concerned ,
it really represents an entirely new and also a legal practice. And,
while, at first sight, the decision appeared to many to mean the curtailment of the activities of national banks in the financing of foreign
trade through letters of credit, the new plan as suggested by the
Board points to a thoroughly satisfactory and legal way out of the
difficulty .
Collecting Drafts Abroad. It is not an uncommon practice for exporters to hand their drafts and documents to their local banks for
collection rather than to offer them for discount. It may be that
discount rates are unsatisfactory and that the exporter has sufficient
funds to carry him until the collections are made ; or possibly the
consignee is unknown and the shipper is not quite certain as to whether
or not the draft will be accepted, thus possibly involving extra expense in the shape of protest fees , etc.; or the shipper may have agreed
that the consignee is to take the merchandise in part lots, making
pro-rata payments therefor, thus having returns forwarded to him
by the collecting bank as each separate lot is delivered.
If the collection method is adopted, the shipper should be careful to
draw his draft in such a way that he will be sure to receive its full face
value. The directions given by the American Express Company in
this connection , which may advisedly be followed in all cases, are as
follows :
"Drafts to be collected by the American Express Company should be
drawn to shippers' own order, and indorsed to the American Express Co.
"If full face value of dollar drafts is desired, each draft should carry the
following: ' Payable with exchange, all bill stamps and all collection charges
at holding bank's selling rate of exchange for sight drafts on New York.'
“If full face value of drafts, plus interest is desired , each draft should
carry the following:

IMPORT AND EXPORT CREDITS

279

666
" Payable with exchange, all bill stamps and all collection charges plus
interest at the rate of 6 per cent per annum from date of issue to approximate due date of arrival of cover in New York.'
"If collection charges are for account of drawer, the dollar draft should
bear the following phrase: ' Payable at the collection bank's selling rate
on day of payment for sight drafts on New York.'
"In drawing upon Spain and France, the check form instead of the draft
form should be used (on account of resulting economy of bill stamps) , in
other words the phrases referring to the words ' exchange ' and ' value received' should be omitted on the face of the draft. Dates and amounts
must be written in words instead of figures.” 1
Detailed instructions relating to every possible contingency should
accompany the bill of exchange. Are the documents to go D/A or
D/P; what is to be done in case or non-acceptance or non-payment ;
shall the draft be protested ; these and similar questions should be
completely covered by the instructions. If the bank is advised beforehand concerning these matters it is then in a satisfactory position to
care for the interests of the shipper. Furthermore, the bank is " on
the ground," so to speak, and can care for emergencies as they arise.
At times the importer for sundry reasons may be unable to accept
the draft. The shipper, being informed by the collecting bank of that
fact, may order the latter, if possible, to clear the goods pending
their resale to another party. This type of service rendered by the collecting bank " is of great importance in many South American countries, where clearance must be effected within a limited time after
the arrival of the shipment, or else heavy penalties are incurred.

Or,

if non-payment is due to temporary financial difficulties of the purchaser, the collecting bank, upon receipt of new authority, is in position
to obtain full satisfaction by using the installment plan. Allowing
payment of one-third of the draft in 30 , 60 or 90 days has been successfully applied in cases which have appeared to be hopeless at first.
Or again, if the shipment is valuable, instructions may be given to
reforward it to another nearby market or even to return it to the
United States.” 2
There is always the question as to who is to pay the collection
charges. These are nominal sums and are levied at a graduated scale
upon the face value of the draft .

European banks charge from 1/16

1 Foreign Trade Bulletin of the American Express Company, July-August, 1919 .
2 Ibid, October-November, 1917.

280

DOMESTIC AND FOREIGN EXCHANGE

to 1/8 of one per cent. The fees of the American banks are slightly
higher. The seller and buyer usually agree beforehand as to which
party is to pay the collection charges. " In the absence of any previous
agreement as to the payment of such charges, exporters should remember that the laws of many foreign countries, particularly in South
America, make it impossible for the banker to collect more than the
amount for which the bill is drawn. Quite frequently the above clause
[relating to collection charges] is used without the consent of the purchaser, and the collecting bank has the alternative of declining to
receive payment altogether or of waiving all claim to the charges.
If they are waived, the banker does so because he believes it to be
against the exporter's interest to refuse the face amount of the draft
and naturally will look to the exporter to refund him for his services
to the extent that he was entitled to collect from the drawee. ” ¹
Export Credits. There are still other ways by means of which international trade may be financed . For example, the importer may go
to his local bank and arrange to open an account with a bank in the
exporter's country. He can deposit funds with his local bank, which
will then forward exchange or by other means open an account for him
with the designated foreign bank. Instructions will also be forwarded
at the same time asking the foreign bank to receive the documents
and to pay the sight draft of the exporter when presented by the
latter. The exporter is notified by the bank with which the account
has been opened. The exporter prepares his documents and draws
his draft on the local bank. The bank cashes the draft and forwards
the documents to the correspondent bank in the importer's country.
The latter bank then turns the documents over to the importer and
he gets the goods. Both the bank in the exporter's country and the
one in the importer's country will charge a small commission to the
importer for acting in the above capacity. One advantage of this
method is that the importer is saved the risk of forwarding cash with
his order.2 No money is paid out by the foreign bank until the shipment has actually taken place. The importer, however, loses interest
on the funds involved.
Another practice followed at times is to have the importer arrange
to have his bank instruct its foreign correspondent to pay out a specified sum of money to the exporter under certain designated conditions
1 Foreign Trade Bulletin of the American Express Company, October-November, 1917.
2 Cf. p. 235 .

IMPORT AND EXPORT CREDITS

281

and to charge the same to its (the importer's bank's) account. The
importer then has to pay the commission of the foreign bank and also
of his own bank plus interest on the use of the money, but these
charges generally compare favorably with what he would have to

Bank
Irving National
NEW YORK

New York, January 7; 1919
Irrevocable Export Credit No. 627
Expiring June 30,1919
New York Motor Company
New York City.
Centlemen:You are hereby authorized to draw upon us at
sight
tor account of Java Motor Company
to the extent of FOUR THOUSAND AND 00/100 DOLLARS ($4000.00)
covering nine ( 9 ) motors to be shipped to the Dutoh East Indies

Documents (Complete sets unless otherwise stated) comprising:
Steamer
Bills of Lading issued to order of consignee
Invoices
Insurance Policies covering marine and war risk
to be delivered to us against payment
Insurance as above.
Bills of Lading issued by Forwarding Agents will not be accepted unless specifically authorized herein, and any modifications of the terms of the credit must be in
writing over authorized signatures of this Bank.
Drawings must clearly specify the number of this Credit.
Yours very truly.
Entered

PRO FORMA
Vice-President

FIGURE 77
Confirmed export credit

pay for sight drafts should he choose that method of paying the exporter.
Somewhat similar is the method whereby the importer arranges
with his bank for the establishment of a credit in the exporter's
country. A great deal of Asiatic trade with the United States is
The term "letter" is seldom employed in connection with export credits such as are
described in the following pages. The terms " export credit," "credits " or " advice of

282

DOMESTIC AND FOREIGN EXCHANGE

financed in this manner. Such credits may be established in one of
several ways . The importer, say the Java Motor Company of
Batavia, may ask the Netherlands State Bank to issue an " export

Irving National
Bank
NEW YORK

New York, January 7, 1919
Export Credit No. 500

Expiring June 30,1919

New York Motor Company,
New York City.
Gentlemen :-

We are informed that you will draw upon usfor
account of - - Java Motor Company .. at ---- eight ·
tothe extent of FOUR THOUSAND AND 00/100 DOLLARS ($4000.00)
covering nine ( 9 ) motors to be shipped to the Dutch East Indies.

Documents(Complete sets unless otherwise stated) comprising:
Steamer
Bills ofLading issued to order of consignee
Invoices
Insurance Policies covering marine and war risk.
to be delivered to us against payment
Insurance as above.
This letter isfor your guidance in preparing documents and conveys no engage
ment onthe part ofthis Bank as we have no instructions to confirm the Credit.
Bills of Lading issued by Forwarding Agents will not be accepted unless specifically
authorized herein, and any modifications ofthe terms ofthe credit must be in writing over
authorized signatures ofthis Bank.
Drawings must clearly specify the number ofthis Credit.
Yours very truly.
PRO FORMA

Vice-President.
FIGURE 78
An unconfirmed export credit

1
credit " on its New York correspondent in favor of the New York
Motor Company, covering the shipment of nine motor cars. The
Java Motor Company then fills out and signs a letter of guarantee,
credit" are, however, generally used . The reason probably is because the banks in the exporters' country that advise the exporters of the existence of such credits do not assume
any primary obligations, but rather secondary obligations contingent only upon the default
of their correspondents abroad . Cf. Federal Reserve Bulletin, April, 1921 , p. 413 .
1 When an English bank establishes for its client a credit in a foreign country and in the
money of that country, it is called a " currency credit."

IMPORT AND EXPORT CREDITS

283

one of

similar to the one discussed above in connection with commercial

ny of
export

letters of credit.¹ The Java bank then notifies the Irving National
Bank, its New York correspondent, and asks it to act in the desired
capacity. The Irving National Bank sends to the New York Motor
Company either a confirmed (Fig . 77) or an unconfirmed export letter
of credit (Fig. 78) . This form notifies the exporter that he is to draw
upon the Irving National Bank at sight or at so many days sight
for goods to be sent to the Java Motor Company. If the draft is
drawn at sight the Irving National Bank will pay when it is presented
with documents attached , provided the terms of the credit have been
complied with. It may pay directly out of its own funds, or it may
instead be advised to debit the account of the Netherlands State
Bank which it holds.

The Irving National Bank forwards the docu-

ments to the Netherlands State Bank, accompanied by a statement
of its charges. If it pays the draft from its own funds the charges will
include the face value of the draft, the bank's commission, and also
interest on the funds invested from the time the draft has been paid
until a remittance can reach it from the Netherlands State Bank.
On the other hand, if it simply debits the account of the Java bank
for the transaction, the charges cover only its commission for acting
as the representative of the Java bank. All charges are finally passed
on to the importer in accordance with the terms of the letter of guarantee which he signed at the time he asked that the export credit be
opened for him.
If the draft is for 90 days sight the Irving National Bank accepts
the draft and returns it to the exporter, takes the documents and forwards them to the Netherlands State Bank, notifying it at the same
time of the due date of the draft . The Java bank collects the funds
from the Java Motor Company in time to forward them to the Irving
National Bank so that the latter bank may be put in funds wherewith
to meet the payment of the draft at maturity. The exporter may
either hold the accepted draft until maturity or he may have it discounted immediately in the New York open market. The accepting
bank may discount its own acceptance, thus making it unnecessary for the exporter to discount it elsewhere, but this is not generally done. When it is, however, the draft may be canceled as
paid, or it may even be sold to some other bank and later paid at
maturity.

3 Pp. 238-239.

284

DOMESTIC AND FOREIGN EXCHANGE

It should be evident, from our discussion in this chapter, that
bank credits of all kinds used to finance foreign trade may be grouped
into irrevocable, revocable, confirmed, and unconfirmed . When a bank
issues a letter of credit on itself the letter may be revocable or irrevocable, depending upon whether or not it reserves the right to rescind
its engagement to honor drafts drawn on it by the beneficiary.¹ When
it issues a letter of credit on a foreign bank and asks it to notify the
beneficiary that it (the foreign bank) agrees to honor the drafts drawn
on it, or where the beneficiary asks the foreign drawee bank to give
such a guarantee and the foreign bank does so , the letter of credit then
becomes a " confirmed " credit. If such a guarantee is not asked for,
or if it is asked for and not given, it is known as an " unconfirmed "
credit. There has been much confusion in the use of these terms both
by bankers and by traders. The statements of Mr. George W. Edwards in the Federal Reserve Bulletin of February and June, 1921 ,
are so excellent and so authoritative that I take the liberty of quoting
them verbatim.
"If the credit-issuing bank reserves the right to withdraw from the
undertaking, the document is styled a ' revocable ' letter of credit. The
'irrevocable ' letter of credit contains a definite engagement on the part
of the issuing bank to honor drafts drawn by the beneficiary in accordance
with the terms and conditions specified in the letter. This engagement
may not be canceled by the issuing bank prior to the expiration date without the consent of the beneficiary. The ' irrevocable ' letter of credit may
be strengthened further by having the notifying bank in the same country
as the exporter add its unqualified assurance that it will pay or accept the
bills drawn by him even if the foreign bank should refuse to honor them.
It is then called a ' confirmed export letter of credit . Expressing, therefore, both the definite undertaking of the issuer and also of the notifier,
it is actually an ' irrevocable-confirmed ' letter of credit . Where the notifying bank does not add its guaranty, the credit is described as ' unconfirmed,'
since the advising bank maintains that it is merely transmitting the information of the credit to the beneficiary without incurring liability for its continuance. Thus three classes of letters of credit may exist : (1 ) Irrevocable
by the issuer and confirmed by the adviser; ( 2) irrevocable by the issuer
but unconfirmed by the adviser ; (3 ) revocable by the issuer and also unconfirmed by the adviser." 2
1 The beneficiary is always the party who is authorized to draw drafts under the terms
of a letter of credit.
2 Federal Reserve Bulletin, February, 1921 , p. 158.

IMPORT AND EXPORT CREDITS

285

"It is . . . clear that a distinction must be drawn between an irrevocable
and a confirmed letter of credit. The irrevocable letter of credit is a document in which a foreign bank promises to honor the drafts of the beneficiary, provided he complies with certain conditions stated in the letter,
and it is an obligation absolutely binding upon the issuing institution.
This credit may be sent directly by mail to the exporter, or it may be transmitted by cable to a correspondent bank, which in turn informs the favored
party of the credit. This report is conveyed without the assumption of
any liability by the informing bank. However, if the notifier, at the request of the issuer, adds its guarantee or confirmation to the advice addressed to the beneficiary, it then becomes an engagement binding upon
both banks. In other words, one credit is irrevocable by the issuer but
unconfirmed by the notifier, and the other is both irrevocable by the issuer
and further confirmed by the notifier." ¹
Most bank credits are irrevocable and not confirmed.

Some are

irrevocable and also confirmed . A very small number are revocable
because an exporter does not care to ship goods under the terms of a
revocable letter of credit.
Regarding the type that is revocable by the issuer and unconfirmed
by the notifier, Mr. Edwards states that this form " does not constitute
a true letter of credit, for the document is the obligation neither of the
issuing nor of the notifying bank, and hence cannot be described as a
' credit.' This document should be termed rather a ' letter of advice.'
It serves a definite trade purpose especially in financing shipments
from agents, affiliated concerns or firms which, of course, would not
cancel their obligations. Most banks do not issue these revocable
letters of advice. " 2
The above classification " is a departure from the usual precept
that the terms ' confirmed ' and ' irrevocable ' are synonymous as
applied to commercial credits. However, while writings on this subject accept the two-fold grouping of confirmed or irrevocable as against
unconfirmed or revocable credits, actual banking practice operates
on the classification given above. " 3
While it may be said that the exporter is normally protected against
loss by an irrevocable letter of credit , nevertheless it is always advisable for him to examine most carefully the phrases and clauses, terms
and conditions which the letter contains. A letter of credit will lapse
1 Federal Reserve Bulletin, June, 1921 , p. 683.
2 Ibid, p. 683.
3Ibid, February, 1921 , p . 158.

286

DOMESTIC AND FOREIGN EXCHANGE

if not availed of within the designated time ; or it may contain a
"joker" of some sort, hidden away in a mass of verbiage, that may
make it impossible for the exporter to realize on it regardless of how
closely he lives up to its terms ; or it may be so worded that errors,
and subsequently disputes and legal proceedings, may easily arise if
the exporter does not study and understand its various parts. The
beneficiary must ever be on his guard , and should remember, as someone has well said , that “ A letter of credit is just as safe as its wording."
A situation similar to those that exporters have to meet from time to
time is illustrated by the following : An American exporter received
a letter of credit from an Oriental importing firm, the letter containing
a clause to the effect that " Shipments are to be made as per buyer's
shipping instructions. " No additional instructions were given as to
shipping dates. The goods were awaiting shipment in August, the
letter was to expire in October, but prices fell greatly in the meantime
and the importer took advantage of the loophole, refused to give shipping instructions and thus canceled his engagement. Such clauses
enable an unscrupulous importer to assure himself of a supply of goods,
and if prices fall or if he can obtain better terms from some other exporter, he can simply allow the credit to expire by refusing to forward
the necessary shipping instructions.
Statements similar to the following appear in irrevocable letters of
credit :
"We hereby agree with the drawers, indorsers and bona fide holders of
drafts drawn under and in compliance with the terms of this credit that
the same shall be duly honored upon presentation to us."

or
"We hereby engage that drafts in compliance with the terms of this
credit will be duly honored ."
or
"We engage that the bills so drawn shall be accepted on presentation
and paid at maturity."
Banks may confirm credits by stating that :
"We herewith open a confirmed credit in your favor. "
or
"We are informed by-

(the issuing bank) that they

IMPORT AND EXPORT CREDITS

287

have established a credit with us in your favor, which we herewith confirm ."

or
"We hereby confirm the following credit opened at the request of—
-(the issuing bank)."
Bank credits that are revocable contain statements similar to the
following :
"This credit is revocable and subject to cancellation. "
or
"Please note that this credit may be modified or canceled with or without notice to you."
Banks may refuse to confirm credits by using such statements as
the following :
"Please note that this is an unconfirmed credit."

or
"We have no authority from our clients to confirm this credit."

Legal Aspects of Commercial Letters of Credit. During the last halfcentury the commercial letter of credit in one form or another has
been the financial basis for the development of the greater part of the
foreign trade of England.

Questions have arisen from time to time

as to the rights of exporters , importers, issuers, and negotiators , and a
line of decisions has been handed down by the British courts. With
the United States, however, it has been only since 1916 that the
commercial letter of credit issued by American banks in terms of
dollars has played even a small part in our foreign trade. When prices
were rising and while trade was booming, almost no questions arose
among American bankers and traders as to the rights of the parties
under letters of credit. But when in 1920 prices began to tumble in an
incredible manner, and importers found themselves held to pay for
goods contracted for at higher prices, and facing losses of considerable
magnitude, they hastened by every conceivable device to attempt
the cancellation of their contracts and to avoid fulfilling the terms of
confirmed letters of credit which banks had issued at their request.
Not only did cancellation of contracts become a common practice
among our own merchants and importers, but American exporters

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DOMESTIC AND FOREIGN EXCHANGE

also found that foreign merchants likewise availed themselves of every
excuse and form of trickery for the purpose of avoiding their legal
obligations as purchasers of American goods. Injunctions and court
proceedings became matters of common occurrence, but fortunately,
courts both here and abroad maintained their earlier attitude and
held that a bank which has issued a " confirmed credit has no option
but to pay drafts presented against the credit, provided the conditions
specified in the credit are complied with." When a bank issues a
letter of credit it promises to make certain payments to designated
beneficiaries provided the conditions of the credit are fulfilled . Court
decisions have uniformly held that if the shipper has complied with
those conditions the bank has no option but to pay the draft or
drafts that are drawn under the credit. "It has neither the right nor
the power to go behind the transaction in the interest of its client and
endeavor to assist the client in avoiding payment " even though such
payment may "result in a loss to the client. If the routine specifications called for by the letter of credit as to quality of goods , time
of shipment or other details appear to have been complied with, any
breach of contract between the buyer and the seller is a matter for
litigation between them, and concerns the bank in no way. The bank
is bound to pay, and an attempt to abet the efforts of clients who are
seeking by questionable means to avoid losses will inevitably react
against the bank which tries such a thing and the purchaser who instigates the action , and it will inevitably ruin the reputation of the
American business community in foreign countries . . . " Foreign " sellers of goods to this country ship the goods with the understanding that the credits against which their drafts are drawn are
irrevocable, provided shipping documents are in order. They feel an
absolute assurance of acceptance upon presentation. Of course, after
a draft has been accepted by the bank, it is then the obligation of the
bank itself which the bank is bound to pay at maturity. No legal
action can possibly be maintained that would serve to prevent the
bank paying at maturity its acceptance when presented by a holder
in due course. All these attempts to evade the carrying out of contracts have been made with the idea of preventing a bank from accepting under the terms of its irrevocable letter of credit and have not had
to do with drafts previously accepted . It is well to bear in mind that
nothing can transpire which can effect the integrity of the banker's
acceptance after it has in fact become an acceptance. To allow any

IMPORT AND EXPORT CREDITS

289

movement to get started having for its purpose the slightest deviation
from this would be disastrous and would result in the complete disappearance of the dollar acceptance outside of the United States.

If

the integrity of the dollar acceptance becomes impaired , American
importers will be forced to resort to the humiliation of financing their
purchases by means of sterling or other foreign credits. " 1
After giving a most comprehensive and excellent review of British
decisions concerning commercial letters of credit , Mr. George W. Edwards of the Division of Analysis and Research of the Federal Reserve Board 2 concludes that the following principles may be deduced :
"(a) A letter of credit is not a negotiable instrument. (b) It does
not create a trust fund in favor of the beneficiary. (c) An issuer of a
letter of credit may not dishonor drafts presented by a negotiating
bank under a clean irrevocable letter of credit if all the terms of the
credit are fulfilled . (d) An issuer may dishonor bills drawn in violation
of the conditions specified in a documentary letter of credit . The
negotiator is not liable for the genuineness either of goods or documents. (e) The issuer is responsible to the party requesting the credit
for the observance of the conditions by the beneficiary. (f) The
contract between the issuer and the beneficiary is entirely independent
of the contract of sale between the buyer and seller, and the issuer
cannot, because of the seller's breach of contract of sale, refuse to
honor drafts which comply with the terms of the letter of credit." ³
Recent American cases have closely followed the principles laid
down by the British courts in such matters. Mr. Edwards, in the

1 The Americas, December, 1920, p. 2 .
2 Federal Reserve Bulletin, February, 1921 , pp. 159-162.
3 Ibid, p. 162. These conclusions are based on the decisions of British courts in the
following cases : Orr & Barber v. Union Bank of Scotland ( 1854), 24 Law Times, Old
Series, 1 ; Waterson v. Edinburgh and Glasgow Bank ( 1858), 20 Dun. (Ct . of Sess.,
642, Scot.) ; Sovereign Bank v. Bellhouse (1911 ) , Quebec Reports, 23, King's Bench,
413 ; Morgan v. Lariviére ( 1875) , Law Reports, vol . 7, House of Lords, 423 ; Bank of
Toronto v. Ansell (1875) , 7 R. L. Q. B., 262 ; Graham v. Mahony, Irish Law Reports [1st series], 385 ; Agra & Masterman's Bank, ex parte Asiatic Banking Corporation (1867), 36 Law Journal, Chancery, 222 ; Maitland v. Chartered Mercantile Bank of
India, London, and China ( 1869) , 38 Law Journal, 363 ; Oriental Banking Corporation
v. Lippert & Co. ( 1875) , Buchanan's Reports, South Africa , p . 152 ; Brazilian & Portuguese
Bank (Ltd. v. British and American Exchange Banking Corporation, 18 Law Times, p.
823 ; Union Bank of Canada v. Cole, 47 Law Journal, Queen's Bench, p. 100 ; Chartered
Bank of India, Australia & China v. Macfayden & Co., 64 Law Journal, Queen's Bench,
p. 367; Woods v. Thiedemann I. Hurlstone & Coltman , 478; Ulster Bank v. Synnott, Irish
Reports 5, Equity 595; Guaranty Trust Co. of New York v. Hannay, 87 Law Journal,
King's Bench, 1223 ; Basse & Selve v. Bank of Australia (1904) , 90 Law Times, 618; Borthwick v. Bank of New Zealand ( 1900) , 17 Times Law Reports, 2 ; Prehn v . Royal Bank of
Liverpool ( 1870) Law Reports , 5 Court of Exchequer, 92.

290

DOMESTIC AND FOREIGN EXCHANGE

article cited, also presents a brief statement of the three outstanding
decisions handed down by American courts from which statement
the following quotations have been taken:
"The case of American Steel Co. v. Irving National Bank, 266 Fed. 41
(C. C. A. , 2d Circuit , Apr. , 1920) , holds that the beneficiary of an irrevocable
letter of credit has an absolute right to have the drafts honored by the
issuing bank when drawn in accordance with the terms of the letter, and
that the issuing bank cannot decline to honor drafts so drawn , even though
requested to do so by its customer, because the contract of sale between
that customer and the beneficiary has become impossible of performance.
In that case the defendant national bank had issued an irrevocable letter
of credit to the plaintiff steel company authorizing the plaintiff to draw at
sight upon the national bank for account of the defendant MacDonnell
Chow Corporation for $43,000 covering the shipment of tin plate. The
plaintiff steel company had contracted to sell the tin plate to the defendant
MacDonnell Chow Corporation f. o. b. Pittsburgh for export. The plaintiff shipped the tin plate and presented a sight draft to the defendant national bank with certain documents and the defendant national bank declined to honor the draft . The second defense alleged that by reason of
the Federal prohibition against the export from the United States of tin
plate the performance of the contract between the plaintiff and the defendant MacDonnell Chow Corporation became impossible of execution.
The third defense alleged a resale by the plaintiff of the tin plate and claimed
an offset of the amount realized on the resale. As to the second defense,
Circuit Judge Rogers said:
'The second defense, that the contract became impossible of execution, inasmuch as the MacDonnell Corporation was unable to obtain
a license from the United States Government permitting the export
of the tin plate, is wholly inconsequential. The liability of the bank
on the letter of credit as agreed upon between plaintiff and defendant
was absolute from the time it was issued, and it was quite immaterial
whether the defendant could export the tin or not . The law is that
a bank issuing a letter of credit like the one here involved cannot
justify its refusal to honor its obligations by reason of the contract
relations existing between the bank and its depositor.'
"The opinion then cites with approval the case of Sovereign Bank of
Canada v. Bellhouse, Dillon & Co. (Ltd.) (supra) upon the point that the
customer at whose instance a bank has issued an irrevocable letter of credit
cannot compel the bank to cancel that letter, since the letter constitutes
a contract between the issuing bank and the beneficiary. The opinion
concludes :

IMPORT AND EXPORT CREDITS

291

'The defendant in effect seeks to read into the contract a provision
that the plaintiff's rights under the letter of credit should be subject
to the superior right of the MacDonnell Chow Corporation to modify
the contract which the bank had made with the plaintiff. We do not
so understand the law.'
"The case of Frey & Son (Inc.) v. Sherburne Co. and the National City
Bank, 184 New York, Supp . 661 (Appellate Division, N. Y. Supreme Court) ,
expressly holds that the contract between the issuing bank and the beneficiary, as evidenced by the letter of credit, is entirely independent of the
contract of sale between the buyer at whose instance the letter of credit
was issued and the seller who is the beneficiary under the letter of credit,
and that the issuing bank cannot repudiate its contract with the beneficiary
merely because of a breach of the contract of sale. The facts in that case
were that the plaintiff had agreed to buy from the defendant Sherburne
Co. 350 tons of sugar to be shipped from Java ; payment for the sugar to be
made in New York on presentation of warehouse receipt or delivery order
and the plaintiff to furnish an irrevocable letter of credit for the full amount
of the invoice. The contract also provided that the plaintiff, the buyer,
should have the right to cancel the contract in the event that the shipment
was delayed. At the instance of the plaintiff the defendant national bank
issued a letter of credit to the Sherburne Co. authorizing that company to
draw sight drafts upon the bank accompanied by specified documents
covering the shipments of sugar. The letter of credit also contained a
provision whereby the bank agreed with bona fide holders that all drafts
issued in accordance with the letter would be honored upon presentation.
The letter did not, however, refer to the plaintiff's right to cancel the contract of sale if shipment was delayed. The plaintiff alleged that the shipment of 45 tons of the sugar had been delayed and that he had elected to
cancel his contract for the purchase of so much of the sugar and that notwithstanding this the defendant Sherburne Co. threatens to negotiate or
present for payment drafts drawn under the letter of credit and that the
defendant national bank threatens to pay such drafts if so presented or
negotiated. The relief sought by the plaintiff was an injunction restraining
Sherburne Co. from drawing or negotiating drafts under the letter of credit
and enjoining defendant national bank from honoring or paying drafts
which have been or may be so drawn. In the opinion, Mr. Justice Greenbaum says:
'From our view of the case it is not important to discuss the rights
of the plaintiff under the contract with the defendant Sherburne
Co. . . .
'It is equally clear that the bank issuing the letter of credit is in no

292

DOMESTIC AND FOREIGN EXCHANGE
way concerned with any contract existing between the buyer and
seller. The bank is only held liable in case of a violation of any of
the terms of the letter of credit. It therefore would follow that, if
the bank issued any drafts violative of the terms of the letter, the
buyer would have recourse to the bank in an action for damages for
the breach of its contract . Similarly, if the defendant Sherburne
Company violated its contract with the plaintiff, the latter has a
remedy in an action at law for damages against the defendant . It is
not alleged in the complaint that the National City Bank is in financial
difficulties. Nor is it alleged that the Sherburne Company is not
financially able to respond to damages. Our attention has been called
to Higgins v. Steinhardter ( 106 Misc. Rep. 168 ; 175 N. Y. Supp. 279) .
We are of the opinion that the facts appearing in the opinion of that
case did not warrant the granting of an injunction. Interests of innocent parties who may hold drafts upon the letter of credit should
not be made to suffer by reason of rights that may exist between the
parties to the contract of sale in reference to which the letter of credit
was issued. It would be a calamity to the business world engaged in
transactions of the kind mentioned in this complaint, if for every
breach of a contract between buyer and seller a party may come into
a court of equity and enjoin payment on drafts drawn upon a letter
of credit issued by a bank. The parties should be remitted to their
claims for damages in an action at law.'

"To the same effect is the case of El Reno Grocery Co. , etc. v. Lamborn,
et al., reported in the New York Law Journal for December 15 , 1920, in
which Mr. Justice Cohalan of the Supreme Court of New York said :

"There are before the court 24 motions for injunctions pendente lite
in equity cases brought for the cancellation of certain contracts for
the sale of sugar which the plaintiffs have attempted to rescind . The
decision on this application is decisive of the 23 other motions. To
enjoin the defendants from collecting upon a letter of credit established
in their favor, because the plaintiff alleges there is a dispute, default
or breach by the defendants of the contract is for the court to make a
new, different and distinct agreement between the parties herein.
This the court is not prepared to do. In my opinion the plaintiffs have
an adequate remedy at law and there are no substantial reasons shown
for invoking the extraordinary remedy of an injunction order. The
plaintiff's motion is denied and the injunction vacated.””
A recent decision by Judge J. M. Mayer in the United States District Circuit Court in New York City is also of interest as further
supporting the contention that banks deal in documents and not in

IMPORT AND EXPORT CREDITS

293

goods, and that even where the goods themselves conform to the sales
contract the bank that has issued the letter of credit cannot be held
to pay if the documents do not comply with the conditions called
for in the letter of credit. The court held that:
"The mere statement of the arguments pro and con destroys the plaintiff's case. When the bank issued this Letter of Credit , it did not purchase
goods. It agreed to purchase documents in the sense that it would pay
on receipt of certain documents which should conform in every respect
with the requirements of the Letter of Credit. It was, of course, not concerned with the goods, but with the documents. It would gravely impair
the business of issuing Letters of Credit if banks were required to construe
the documents involved and determine arguable questions. The only safe
rule for a bank is to refuse to pay if, by omitting, as here, a distinct and
clearly expressed provision, the documents do not conform with the Letter
of Credit." 1
Authority to Purchase. Authority to Draw. Importers at times have
recourse to what is known as an " Authority to Purchase," sometimes incorrectly called an " Authority to Draw," as a means of
financing their transactions on a credit basis.2 This document is
seldom found outside of banking and trade circles of New York and
the Pacific Coast . It is used primarily, if not solely, in the financing
of Oriental trade, and almost always in facilitating exports from
the United States. The authority to purchase is not a bank credit
involving a banker's acceptance. It involves nothing more than a
trade acceptance, the negotiation of which is facilitated by the services
of a bank in the importer's country, which acts as the issuer of the
authority, and a bank in the exporter's country, which acts as the
purchaser of the exporter's draft.
To make matters somewhat clearer, let us take the transaction
which we have discussed above, involving the shipment of goods to
the Java Motor Company, and see how the shipment can be financed
by means of an authority to purchase. The Java Motor Company,
being desirous of importing a shipment of trucks from the New York
Motor Car Company, goes to the Netherlands State Bank and asks
it to issue an authority to purchase in favor of the latter.

The Java

concern being well known to the issuing bank may or may not have
1 Quoted in Foreign Trade Bulletin of the American Express Company, SeptemberOctober, 1921.
Cf. an excellent article on "The Authority to Purchase " in the Federal Reserve Bulletin, August, 1921 , pp. 926-931.

294

DOMESTIC AND FOREIGN EXCHANGE

to deposit security before the bank will furnish the desired accommodations. If the bank consents, it asks the Java Motor Company
to fill in and sign a " letter of guarantee." The Java bank then fills
in another form, or merely types a letter to the same effect , asking

IN DUPLICATE

4.P.No. 891
Cabled December 1, 198

AUTHORITY
TO PURCHASE
(LETTER OF GUARANTEE)
Singapore..., „December 1

191.8

THE NETHERLANDS STATE BANK
THEGAPORE
We beg to inform you that we have authorized
to draw on us with recourse to
The New York Motor Company
days' sight
at 90 xmonths
the extent of Four thousand dollars ($4.0001
for full-======~~~~~~~~~==.invoice cost against the following documents:
Bill of Lading,
Invoice,
EN
Insurance Certificate,
Consular Invoice,
IM
C
E
SP
w cover shipment of nine (9) motor trucks
from New York
to Singapore
BILL OF LADING TO ORDER and endorsed in blank

by skipper
Freight to be prepaid
paid at destination Marine Insurance covered here
We agree. 1 To acceptuponpresentation all bills drawn pursuant hereto.
2 Toholdthe Netherlands State Bank harmlessbecauseofanydamage tomerchandise shipped or
deɓciency ordefect therein or in thedocuments above described.
• That the said documents, or the merchandise covered thereby, and insurance shall be held as collateral
security
due acceptanceorand
draftstothem
drawn hereunder,
with powerto
the pledgeetosell
in caseandofforafter
non-acceptance
non payment
paymentofany
ofthe commissions
draft
attached, without
notice
sale
therewith,
the atnetpublicorprivate
proceedsto
applied
toward deducting
payment ofallsaidexpenses
drafts. including
The receiptby
you of connected
other collateral,
merchandise
or casb, nowbe
inproceeds
your bands,
orapplied
hereafteron deposited,
shall notbyalter
your
powerdueto orto
sell the
merchandise
pledged and the
may
be
any
indebtedness
asto
the
Bank
become
due.
• Topayyourcommission of--% for negotiating ofdrafts hereunder.
This engagement to commence from date hereof and to apply to allN Bills drawn
within three (3). months
ME
Yours faithfully,
CI
Please advise by mail.
E
SP
To Manager
Jaya Motor Company
IRVING NATIONAL BANK
.PRO PORMA
New York City, H. Y.
EN
N
Theabove is our A. P.No. 891
IM
Please
IMEdotheneedful.
EC
C
E
R
Yours very truly, SP
S

Acet

Agat

FIGURE 79
Authority to purchase (letter of guarantee)
the Irving National Bank to purchase the draft drawn by the exporter and also giving other necessary instructions. This is the
"authority to purchase." Some banks use separate forms for these
two documents ; others combine them into one form (Fig. 79) . In
short, all that the importing firm has done is to go to its local bank
and ask it to arrange for, or to guarantee, a purchaser of the draft
that is to be drawn on it (the Java Motor Company) by the New

IMPORT AND EXPORT CREDITS

295

York exporter. Trade acceptances are not easily marketable, and
especially do those drawn on Oriental firms have to be provided with
assured purchasers in the manner under discussion.
If the Irving National Bank is willing to carry out the transaction
it writes the New York Motor Company, notifying it that it (the exporter) may draw on the Java Motor Company for a definite sum
of money and that it (the bank) will negotiate the same for the Netherlands State Bank (Fig. 80) .

This letter constitutes what is known

IRVING NATIONAL BANK
NEW YORK

Foreign Department
ADVICE # 600/100
New York Motor Co.

Organized 1851
In replying please quote
Export Credit
)

Cable Address
"Irving Bank-New York "

January 2nd, 1919

New York City, N. Y.
Gentlemen:
We are instructed by the Netherlands State Bank to negotiate as offered,
without recourse, your documentary bills at ninety days sight on Java Motor
Company, Singapore, to the extent of FOUR THOUSAND AND 00/100
DOLLARS ($4000.00) at one time outstanding, for invoice cost of goods
shipped to that port.
The bills must be accompanied by a full set of Bills of Lading (Express
Company's Bills of Lading not acceptable) and Insurance Certificates covering
marine insurance and also war risk insurance, made out to order and endorsed
in blank together with invoice covering merchandise shipped from America to
Singapore, and shipping documents to be delivered against payment of the
relative drafts.
The drafts must be drawn to order, endorsed in blank and be marked.
"Drawn under authorization of the Netherlands State Bank, # 100 " and
must bear the following clause:
"Payable with interest added at the rate of 6% per annum from date of
draft until approximate arrival of cover in New York."
This authorization is subject to cancellation and/ or modification by us at
any time.
Kindly hand in this letter with your drafts in order that the amounts of the
same may be endorsed on the back hereof.
Yours very truly,
PRO FORMA
Vice President.
FIGURE 80-Authority to draw or advice of authority to purchase

296

DOMESTIC AND FOREIGN EXCHANGE

as the " authority to draw" or the " advice of authority to purchase."
This advice also contains directions for the guidance of the exporter
in preparing the shipment and in drawing the draft.
The exporter ships the goods, gets the documents, and draws the
draft on the importer in dollars. Practically all drafts drawn under
an authority to purchase are dollar drafts. They usually run for
60, 90, or 120 days. The exporter then takes the documentary bill
of exchange (documents are almost always indorsed in blank under
an A/P) to the Irving National Bank which pays the face value of
the draft. The Irving National Bank immediately debits the account
of the Netherlands State Bank with that sum plus charges. In order
to reimburse the Java bank for interest lost as a consequence of such
debiting, the customary interest clause is inserted in the draft.¹ The
documentary bill is sent to the Netherlands State Bank, which presents it to the Java Motor Company for acceptance. The importer
gets his goods and pays the draft at maturity plus interest and commissions .
Authorities to purchase may be revocable or irrevocable by the
issuing bank, while authorities to draw (advices of authority to purchase) may be revocable, irrevocable , confirmed, or unconfirmed .
When the Java bank sends an authority to purchase to the New York
bank, it may agree to meet all obligations no matter what situations
may arise. This is an irrevocable A/P. If it reserves the right to
revoke the A/P at any time, it is a revocable credit. The New York
bank may be asked by the Java bank to " confirm " the credit, and
if it is willing to do so it includes in the authority to draw, which it
sends the exporter, a statement worded somewhat as follows :
"We herewith open a confirmed credit in your favor "

or
"We hereby confirm the following credit opened at the request of
If a bank confirms the credit, it charges an extra commission,
usually one-eighth of one per cent, because such confirmation adds
the credit of the notifying bank to the transaction and also causes
it to assume the liability as a “ confirmer" or " guarantor."
If the credit is " unconfirmed," the authority to draw will read
somewhat as follows:

1 Cf. pp. 267-270.

IMPORT AND EXPORT CREDITS

297

"Kindly note that this is not a confirmed credit, and is consequently
revocable at any time, either by the parties granting the credit, or by ourselves under certain conditions."
or
"Please note that this is an unconfirmed credit and is consequently subject to modification or cancellation."
It is clear from these statements that an unconfirmed authority to
draw is also revocable by the notifying bank, although not necessarily
When the credit is unconfirmed by
revocable by the issuing bank.
the notifying bank, or revocable by the issuing bank, it is subject to
cancellation at any time prior to the actual payment of the draft.
If the credit is not confirmed by the notifying bank, it will receive its
fee for acting as the representative of the foreign bank, for examining
the shipping documents to see that everything is satisfactory and in
accordance with the terms of the credit, etc.
It will be noted that in the authority to draw given above (Fig. 80),
the credit is revocable and that the draft is to be drawn " without
recourse" on the exporter. Exporters frequently refuse to ship goods
under an authority to draw unless it is confirmed and unless the
drafts are to be drawn " without recourse." " Several exporters of
experience accept orders based on authorities to negotiate, without
recourse, only for shipments of standard material and when billed to
houses of undoubted responsibility and reputation for fair dealing.
In all other cases they require either that an authority without recourse be given, or that some other arrangement be made whereby
they may be assured of their money, in case the importer should
refuse to pay.'" 1
In all of the instances of bank credits , it will be remembered that the
draft was drawn upon a bank, either domestic or foreign, which meant
the almost absolute certainty that the draft would be paid at maturity
regardless of what happened to the importer, unless , of course, the
drawee (accepting) bank should fail.2

In the case of an authority

1 Irving National Bank, "Exporting to the Far East," p. 79.
2 "Under the Law of Negotiable Instruments, any bona fide holder has full recourse
upon the drawer of a draft under a letter of credit if the drawee bank dishonors the bill.
Considering the question not from the strictly legal standpoint but from commercial usage,
the drawer of drafts under a confirmed irrevocable letter of credit, issued by a reputable
bank, may safely regard the transaction as closed upon acceptance by the drawee bank
and he would be liable only in the extreme event of failure of the accepting bank." Federal
Reserve Bulletin, June , 1921 , p. 685.

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DOMESTIC AND FOREIGN EXCHANGE

to draw, which is not technically a bank credit, the draft is drawn
against the importer who may become bankrupt before acceptance,
or after acceptance and before payment. The banks act merely as
agents in handling the transaction and if the exporter is not relieved
from his liability by a " without recourse " clause he may be held
liable by the negotiating banks for the face value of the draft plus
protest charges, etc. , just as in the case of an ordinary trade acceptance.
It is because of this attendant risk that exporters do not favor the
use of an authority to draw as a substitute for the more customary
and reliable forms of bank credit. Most banks when they notify the
exporter of the existence of an authority to draw make it clear to him
that they are acting only as the representative of the foreign bank and
that they are not opening a bank credit in his (the exporter's) favor.
The following clause is frequently used in this connection : " Please
note that this advice [the letter to the exporter] is NOT to be considered as being a ' BANK CREDIT ' and does not relieve you from
the ordinary liability attaching to the ' DRAWER ' of a Bill of Exchange."
In handling export credits, the notifying bank does not insist that
the exporter negotiate his drafts with it. In fact it is quite customary
for the exporter to negotiate his drafts with his own local bank from
which he can undoubtedly receive a much higher rate than from the
notifying bank. His local bank then presents the drafts and documents to the notifying bank, so that the latter as a rule eventually
gets possession of them. In the instance cited above, it would be
possible for the New York Motor Car Company to sell its draft and
documents to its local bank, say the National City Bank, which in
its turn would dispose of them to the notifying bank, i. e. , the Irving
National Bank.
Letter of Delegation . There is still another method that may be
resorted to by the exporter in obtaining payment for his shipments.
In this case he draws no draft, either on the bank or on the importer,
but takes the documents to his local bank and asks it to forward them
to its correspondent in or near the importer's city. The correspondent
1
is advised in a communication, called a " letter of delegation," ¹ of
1 Although the letter of delegation as previously described (pp. 195–196) was used in another connection, i. e., to pay funds to a designated party in a foreign country, in this case it
is used by the exporter to get money for goods shipped . Nevertheless, in both cases it takes
the form merely of a set of instructions or directions to a foreign banker or exchange dealer.

IMPORT AND EXPORT CREDITS

299

the terms under which the documents are to be turned over to the
importer. This letter of delegation is not a bill of exchange ; it is a set
of instructions, and consequently is not negotiable.

Neither does it

have to carry any revenue stamps as negotiable instruments generally
do.

CHAPTER X
RATES OF FOREIGN EXCHANGE
The rates of exchange are the prices charged for the different grades
or kinds of bills of exchange. Bills of exchange are similar to any
other commodity that has a number of different grades and is sold in
a competitive market, such as shoes, for example. There are many
grades and styles of shoes with a different price for each, although
sometimes different styles or grades may sell for the same price ; this
is true of bills of exchange . The prices of shoes may vary from week
to week or from day to day because of certain conditions or factors
in the market ; so may the rates of exchange. The price of a pair of
shoes may be " shaved " a little for the old customer or for a buyer
of large quantities ; so it is with bills of exchange. Continuing our
analogy, we find that the shoe retailer is both a buyer and a seller of
shoes. He has the price at which he buys from the jobber, the wholesaler, or manufacturer, and the price at which he sells to the public.
Likewise in the exchange market we have the price at which various
kinds of exchange are purchased by the dealer and we also have those
prices at which the dealer sells his exchange to the public, or in the
language of the exchange market itself, respectively the rates " bid "
and the rates " asked." Naturally it is the desire, and the practice
wherever possible, of the exchange dealer to buy low and to sell high.
In the exchange market, the public and the exchange dealers are
simultaneously both buyers and sellers , the buying price of the exchange dealers being the selling price of the public, and vice versa.
The public as a seller is made up of exporters desirous of receiving
money for goods shipped abroad, individuals wishing to be paid for
services performed for foreign clients, tourists with traveler's checks
or foreign drafts to be cashed, etc. , etc. Exchange dealers whose
main stock in trade is a supply of foreign funds or credits are the most
active sellers in the market. The public, as a buyer, is composed of
importers who must pay for goods purchased in foreign countries,
prospective travelers who wish funds for travel, customers desirous
of paying foreign debts incurred for any of a number of reasons, etc.
300

RATES OF FOREIGN EXCHANGE

301

Exchange dealers are continually in the market as purchasers of large
amounts of exchange with which to replenish their stock of foreign
funds or credits, of which they must always have an available supply
in order to carry on their business. These two large groups, i . e. , the
buyers and the sellers, are the forces that influence the rates one way
or the other. What their activities or desires may be, how much they
can or are willing to pay or charge, depend upon certain other factors
which will be considered in detail in this chapter. It must be recognized that in the foreign exchange field, as in the commodity markets,
it is much easier for the smaller, better trained and organized group,
viz., the dealers, to act effectively and to exert a predominating influence in the market than it is for the unorganized public. Whether
we consider the latter as being made up of buyers or of sellers, it cannot be so closely in touch with all those matters that determine the
rates of exchange as can the smaller group of exchange dealers. The
public knows nothing of the supply of or the demand for exchange ;
it is unacquainted with the influence of the discount rates of the central banks of Europe ; it is ignorant of fluctuations that may be caused
by foreign political developments, war, abundance or failure of crops,
and othermatters of similar import. Exchange dealers in the important
financial centers watch such matters most carefully and attempt to
gauge their rates both as buyers and as sellers in accordance therewith. Selling rates are fixed by the dealers on the basis of the buying
rates and at a point where a profit is expected on the business as a
whole, and not on any particular bill that they buy or sell. In this
respect the exchange dealers again are similar to the shoe dealers in
that when, for example, the shoe dealer buys his spring stock of goods
he attempts to fix his prices at a point that will net him a profit on
his business as a whole. He may lose on one style of shoes or on a
few sales, but he hopes to gain on his total business.
It is impossible in a discussion of retail prices to go into the details
of why each and every retailer fixes his prices at this or at that point,
and the same holds true in a discussion of exchange rates. It will be
necessary, therefore, for us to confine our discussion to those more
important factors that in general affect exchange rates in normal as
well as in abnormal times.
It is advisable, first, to explain briefly the methods followed in

quoting the exchanges on various countries so that the reader may
be perfectly clear regarding all matters subsequently discussed.

302

DOMESTIC AND FOREIGN EXCHANGE

In Chapter VI it was noted that as between countries actually
on a gold standard basis, i . e. , where all forms of money are readily
redeemable either directly or indirectly in gold, where gold may be
freely obtained for export and for domestic use, and where the mints
are open to its free and unlimited coinage, the rates of exchange in
normal times fluctuate around what is known as the "mint
":
par of
exchange" (more commonly known only as the "par of exchange ") ;
that as between a silver standard country and a gold standard country
the rates of exchange fluctuate on a basis of the purchasing power
of the gold monetary unit of the latter country measured in terms
of the silver monetary unit of the former country, or, in other words,
on the basis of the gold price of silver ; and that as between a gold standard or silver standard country on the one hand and a country having
an irredeemable paper currency on the other, exchange rates vary in
accordance with the purchasing power respectively of the gold or the
silver monetary unit of the former countries as measured in terms of
the paper monetary unit of the latter.¹ A discussion of the exchanges
of silver standard, paper standard , and gold exchange standard countries will be taken up in Chapter XII.
The practice of quoting exchange rates is different in different
countries regardless of whether or not they are on the same monetary
standard. It is needless for us to take up all the different variations ;
therefore only a few of the more important types will be considered.
All of the practices followed , however, may be grouped under the following three methods : (a) fixed exchange, or what Whitaker calls
"direct" exchange ;2 (b) movable exchange, or what Whitaker calls
"indirect" exchange,3 and (c) premium and discount exchange. *
Fixed or direct exchange is where we quote the value of the foreign
unit of currency in terms of the money of the home country In quoting English exchange, for instance, we say that the pound sterling is
worth 4.85, 4.86 , etc. As the pound sterling falls in value we give
less of our money, say 4.82 , for it, and as it rises in value we give more,

1 Cf. pp. 122-123.
2 Op. cit., p. 73.
3Ibid.
4 Mr. C. S. Reuter of the Merchants National Bank of Los Angeles suggests that the
terms "fixed" or " direct quotations" and "movable " or " indirect quotations " be used
so as to avoid confusion inasmuch as banks sometimes use the term 'direct exchange"
as referring to the exchange which they sell on their own foreign accounts, and " indirect
exchange" as referring to the exchange which they sell on the foreign accounts of their
American correspondents.

RATES OF FOREIGN EXCHANGE

303

say 4.90. In other words, we buy it as we would a lead pencil or any
other commodity, i. e. , on the basis of what it is worth in dollars and
cents. Movable or indirect exchange is a little more difficult to comprehend because we then quote how many units of foreign money can
be purchased with one unit of home money, i. e. , London asks how
many francs, marks, dollars, etc. , can be purchased with a pound
sterling. Instead of saying as we do in the case of fixed exchange
that lead pencils are 5 cents each, we say, in quoting movable exchange, that we can get 20 lead pencils for one dollar. If lead pencils
rise to 10 cents each, we say, quoting on the basis of movable exchange,
that we can get only 10 lead pencils for one dollar. The higher the
value of the pencils, the fewer we get ; the lower the value, the more
we get. When London quotes francs at 25.20 per pound sterling, and
later quotes them at 26, it means that more francs are obtainable per
pound sterling, or that francs have fallen in value, even though the
quotation as a numerical quantity is greater. When the London
quotation is 20.35 francs per pound sterling it means that we get
fewer francs at that rate, that they are more valuable, even though
the quotation as a numerical quantity is smaller. As is frequently
said, "The higher the rate, the lower the price ; the lower the rate, the
higher the price. " The rule to follow in dealing in fixed exchange is
to buy at the low quotation and sell at the high, but in dealing in
movable exchange the rule is to buy at the high quotation and sell
at the low.
The discount and premium method of quoting exchange is used
between countries that have the same monetary unit. Taking for
example the United States and Canada , we note that New York on
May 1 , 1921 , quoted the Canadian dollar at 10½ per cent discount,
i. e. , to obtain a Canadian dollar draft would have cost a New Yorker
but 892 cents of American money. If there had been a great demand
for Canadian dollars, a demand much greater than the supply, the
rate might have been quoted at a premium, possibly a 1 per cent premium, which would have meant that for a New Yorker to get a Canadian dollar's worth of exchange he would have had to pay $1.01 in
American money. In some cases in using the premium and discount
method only the rate of the premium or discount itself is given in the
exchange tables, i. e. , 1 per cent premium, 2 per cent discount, etc.; in
others the cost of one unit or 100 units of the foreign money in terms
of the home money is given , i. e. , Canadian exchange may be quoted

DOMESTIC AND FOREIGN EXCHANGE

304

at $.98, or $98.00 ; while in still other quotations, the cost of a unit of
the foreign money is expressed in terms of a percentage of the home
money, e. g., Canadian exchange in New York may be quoted as being
at 98 per cent of par, 102 per cent of par, etc. London quotations of
the pound sterling of South Africa and of Australia offer an interesting example of how in one country two separate types of the premium
and discount method are employed in quoting the value of the same
monetary unit current in two other countries. The following table is
taken from the London Economist of May 21 , 1921 :

TABLE I
SOUTH AFRICAN EXCHANGE RATES

The South African Banks quote the following rates :
Union of South Africa
From May 16, 1921
South Africa on London

Union of South Africa
From May 13, 1921
London on South Africa

Buying
T. T ... ...
Demand .
30 ...
60 ..
90 .
I20 .

I

% dis.
""
.I 3/4%
66
.2 1/2%
66
・3 1/4%
66
.4
%

Selling
1/2 % prem.
66
3/8%

Buying

I
2
3
4
5

1/2 % dis.
66
1/4%
66
1/8%
""
%
%
66
%

Selling

1/2% prem.
66
1/2 to 1/4%
1/8% dis.
66
1/2%
66
7/8%

OVERSEAS DOMINIONS RATES
Commonwealth of Australia and Dominion of New Zealand
London on Aust. & N. Z.
Selling
Buying
Aust. N. Z. Aust. N. Z.
Cable....
99 99 1/2
On demand..96 1/2 96 1/2 par par

30 days .... 95 7/8 95 7/8
60 ...
.95 1/4 95 1/4
.94 5/8 94 5/8
90 ..
I20 .
5 months sight .
6 months sight .

Aust . & N. Z. on London
Buying
Aust. N. Z.
ΙΟΙ
100 3/8
99 3/4
99 1/8
98 1/2
97 7/8
97 1/4
96 5/8

100
99 1/2
99
98
97 1/4

Selling
Aust. N. Z.

102 1/2
IOI 7/8
101 3/8
100 7/8
100 1/2

103
101
101
101
100

7/8
3/8
7/8
1/2

RATES OF FOREIGN EXCHANGE

305

The above tables show that on May 13 , 1921 , London banks were
buying demand exchange on South Africa at one per cent discount
and selling it at 3/8 per cent premium ; in other words, they were buying £100 on South Africa for £99 and selling at £ 100 3/8 (£100 75 6d)
per £100. At the same time, they were buying demand exchange on
Australia at 96½ and selling at par (100 per cent) ; in other words,
they were paying £96½ (£96 10s) for £ 100 worth of demand exchange
on Australia and selling it for £100. The use by London of both of
these methods of quoting discount and premium rates (a person might
think that only one method would be employed) has no rhyme or
reason, and can only be explained on the basis of long standing custom
and tradition. Somehow it got started and somehow it has continued
to date without a demand arising for a change. In the financial world ,
as in all other fields, it is difficult to uproot custom no matter how
foolish and useless the practice may become.
There has been a noticeable tendency among American exchange
dealers to adopt a uniform system of quoting exchange by the fixed
exchange method, as is evident from the following table taken from
the New York Journal of Commerce and Commercial Bulletin of
December 17, 1921 : 1
TABLE II

OPEN MARKET QUOTATIONS
Open market quotations for sterling and Continental exchange yesterday
for large amounts were as follows:
Close
Prev. Close
Range
LONDON-Par $4.8665 per pound
#Bankers' 90 days .
4.13 5/8 a
4.112
4.1134
4.13
4.15 5/8 a
Bankers' 60 days .
4.132
4.1334
4.15
Demand sterling .
534
4.17 5/8 a
5
4.1
4.1 %
4.17
Cable Transfers .
4.172
4.18 1/8 a 4.16
4.164
Bills4.164 a 4.14 1/8
Grain, 7 days ..
4.14 3/8
4.15 5/8
Com'l, sight..
4.16 7/8 a
4.1434
4.15
4.164
Documents for payment0½
a
34
5/8
4.12
4.12
4.1
60 days, against grain .
4.10
a 4.09 3/8
4.10 7/8
Com'l, 90 days ..
4.112
4.09 5/8
a 4.10 3/8
4.122
Com❜l, 60 days ...
4.10 5/8
4.II 7/8
1 Tables of exchange rates similar to the one shown are to be found on the financial pages
of the large metropolitan papers and in the financial and commercial weeklies, such as
the New York Journal of Commerce and Commercial Bulletin, the Commercial and Financial
Chronicle, the Annalist, etc. Monthly surveys of the range of exchange rates are also published in the Monthly Bank and Quotation Section of the Commercial and Financial
Chronicle.

306

IC

DOMEST

N

AND FOREIG

GE

EXCHAN

TABLE II-Continued
OPEN MARKET QUOTATIONS-Continued

Close
Range
CANADIAN EXCHANGE IN N. Y.-Par 100c per Canadian dollar
Checks ......
7 3/8 per cent. discount
PARIS- Par 19.3c per franc
a 7.78
Bankers' checks .
7.78
7.90
a 7.79
Bankers' cables .
7.91
7.79
a 7.76
7.88
Com'l, checks .
7.76
7.82
a 7.70
7.70
Com❜l, 60 days .
ANTWERP-Par 19.3c per franc
a 7.49
Checks..
7.60
7.49
a 7.50
Cables .
7.61
7.50
BERLIN-Par 23.8c per mark
Bankers' checks ..
$ .0049
$.005034 a $ .00482
Cables .
.0049
.0049%
.00514 a
AUSTRIA-Par 20.3c per krone
Checks .
$ .00034
$.00034 a $.00034
Cables .
.000334
.000334 a
.000334
HUNGARY-Par 20.3c per krone
142
a
Checks .
14½
14½
ITALY-Par 19.3c per lira
a 4.50
Bankers' sight ..
4.59
4.50
a 4.51
Bankers' cables .
4.60
4.51
HOLLAND- Par 40.2c per florin
36.41
Bankers' sight ..
36.33
a 36.25
a 36.30
Bankers' cables .
36.38
36.46
a 36.20
36.28
36.36
Com❜l, sight .
Bankers' 60 days .
36.00
35.92
a 35.84
SWITZERLAND-Par 19.3c per franc
a 19.35
Bankers' checks .
19.38
19.38
a 19.40
Bankers' cables .
19.43
19.43
GREECE-Par 19.3c per drachma
a 4.II
Bankers' checks .
4.II
4.II
4.16
a 4.16
Bankers' cables .
4.16
TURKEY-Par $4.40 per Turkish pound
a
Checks ..
59
59
59
DENMARK-Par 26.8c per kronen
a 19.20
Bankers' checks .
19.28
19.20
a 19.25
Bankers' cables .
19.33
19.25
SWEDEN-Par 26.8c per krona
a 24.40
Bankers' checks ..
24.45
24.40
a 24.45
Bankers' cables ..
24.45
24.50
NORWAY-par 26.8c per krone
a 15.39
Banker's checks ..
15.40
15.56
a 15.44
Banker's cables..
15.61
15.45
SPAIN-Par 19.3c per peseta
a 14.54
Checks ...
14.65
14.54
a 14.59
... 14.70
Cables.
14.59
CZECHO-SLOVAKIA-Par 20.3c per crown
a I.22
I.22
I.22
Checks.
ROUMANIA-Par 19.3c per leu
a
Checks ..
.85
.85
.85
POLAND-Par 23.8c per mark
Checks..
.$0325
$.0325 a $ .0325

Prev. Close

7.92
7.93
7.90
7.84
7.62
7.63
.0052
.00522
$.00032
.0004

15
4.52
4.53
36.30
36.35
36.25
35.89
19.35
19.40

4.20
4.25
60

19.30
19.35

24.65
24.70
14.45
15.50

14.85
14.90
I.22

.87%
$.03122

RATES OF FOREIGN EXCHANGE

307

TABLE II-Continued
OPEN MARKET QUOTATIONS-Continued
Close
Prev. Close
Range
SERBIA-Par 19.3c per dinar
a 1.54
Checks ..
1.54
1.54
1.58
FINLAND-Par 23.8c per mark
Checks .
1.85
a 1.85
1.85
1.85
PORTUGAL- Par $1.08 per escuda
Checks .
7.812
a 7.81%
7.81½
7.872
JUGO-SLAVIA-Par 20.3c per crown
Checks ..
38½
a
382
38½
BULGARIA- Par 19.3c per leu
a
Checks ....
70
70
70
75
RUSSIA (exch.) -Par 51.46c per ruble
92c per 100 rubles
Currency..
SOUTH AMERICAARGENTINA-Par 42.45c per paper peso
Checks ..
33 1/8 a
33 1/8
33 1/8
334
Cables .
33 3/8
334 a
334
334
BRAZIL- Par 32.45c per paper milreis
Checks..
12 7/8
1234 a
1234
1234
Cables.
12 7/8 a
12 7/8
12 7/8
13
BOLIVIA- Par 40c per boliviano
Checks.
204
2014
2014 a
2014
COLOMBIA-Par 97.33c per peso .
8934 a
Checks .
8934
8934
894
ECUADOR-Par 48.7c per sucre
a 27.77
(Official 3.60) .
27.77
27.77
Open market .
a 24.10
24.10
24.10
URUGUAY- Par 103.42 per peso
Checks ..
69 7/8
69 7/8 a
69 7/8
70
VENEZUELA-Par 10.3c per bolivar
Checks ..
a 17.50
16.25
17.50
17.50
PERU-Par $4.8665 per pound
a 3.55
Checks ..
3.55
3.55
CHILE-Par 36.50c per paper peso
Checks .
10 5/8c per U. S. money
ASIASHANGHAI ON LONDONFour months' bank credits ...
2s. 8 5/8d.
HONGKONG ON LONDONFour months' bank credits ...
3s. gd.
JAPAN ON LONDONFour months' bank credits ..
2s. 4 5/16d.
FAR EASTERN CHECK RATESHongkong ..
5434 a
55
784
a
782
Shanghai .
Yokohama .
484 a
482
482 a
4834
Manila .
4834 a
49
Singapore .
a
284
28½
Bombay .
a
282
2834
Calcutta..
a
352
3534
Java..
In a general way sterling quotations involved transactions approximating £10,000 or
more. In the case of Continental quotations rates cover amounts representing $ 100,000
Nominal .
or over.

308

DOMESTIC AND FOREIGN EXCHANGE

Without dealing to too great an extent with the details of the table,
it may be well to explain briefly some of its items so that the reader
may be informed as to their meaning. The terms "Check, " " Bankers'
sight," and " Demand bills " all have reference to the same type of
exchange, i . e., bankers' sight drafts on a foreign center. The high
and the low quotations are given, together with the rate at the close
of the day and the rate at the close of the previous day. " Londonpar $4.8665 per pound " of course refers to the mint par of sterling
Mint par is
exchange measured in terms of the American dollar.
given in all cases except for those countries that are on a silver or
paper standard basis. It will be noted that all quotations, except for
Canada, are based on the value of the foreign unit in terms of American
money, i . e. , fixed exchange. Canada is quoted on the basis of premium
and discount.

Under the London quotations the terms " Bankers'

90 days," " Bankers' 60 days, " and " Demand sterling," all refer to
drafts of those usances sold by bankers on their London accounts.
"Cable transfers " needs no explanation . "7 day grain bills " are
bills that are drawn against grain shipments, payable 7 days from date,
which amounts to practically the same thing as a sight draft on the
drawee. "Commercial sight " has reference to sight drafts that are
drawn against shipments other than grain . " Documents for payment,
60 days against grain " refers to 60 day drafts that are drawn against
grain shipments where the documents go forward with instructions
"D/P." "Commercial 60 days " and " Commercial 90 days " refer to
drafts that are drawn against shipments of various sorts where the
instructions are that the documents are to be released on acceptance.
It will be noted that the table also includes three quotations of Oriental
markets on London, namely, Shanghai, Hongkong, and Japan . The
rates refer to the cost in English money of sterling letters of credit
against which four months' drafts are to be drawn. The table concludes with eight quotations dealing with Far Eastern check rates,
giving the cost in New York for sight exchange on those centers per
unit of foreign currency, i. e. , 54 3/4 cents bid and 55 cents asked per
Hongkong dollar, or 78 1/4 cents bid and 78 ½ cents asked per
Shanghai tael, etc. etc.
Under the requirements of the Emergency Tariff Act of May 27,
1921 , the Federal Reserve Bank of New York certifies daily to the
Secretary of the Treasury the buying rate for cable transfers on the
different countries of the world.

The following table which needs

RATES OF FOREIGN EXCHANGE

309

no explanation is taken from the Journal of Commerce and Commercial Bulletin of December 17, 1921 :

TABLE III

Country
Austria .
Belgium .
Bulgaria..
Czecho-Slovakia .
Denmark ..
England ..
Finland ..
France .
Germany .
Greece .
Holland
Hungary .
Italy...
Jugo-Slavia .
Norway .
Poland .
Portugal .
Rumania .

Rate
.$ . 000406
.0780
.007592
.012138
.1935
4.1991
.018921
.0811
.005463
.0420
.3642
.001480
.0462
.003941
.1553
.000303
.0798
.00871

Country

Rate

Serbia .

.$ . 01587
Spain ..
.1504
Sweden .
.2465
Switzerland ..
.1943
Hongkong ..
.5413
Shanghai, tael.
.7483
Shanghai, Mex. dollar .. .5432
India ..
.2767
Japan .
.4788
Java..
.3567
Singapore .
.4742
Canada .
.924375
Cuba .
.996255
Mexico ...
.4919
Newfoundland .
.9225
Argentina.
.7509
Brazil .
.1274
.6911
Uruguay .

In many of the exchange lists, quotations will be found joined with
the sign " @", e. g., 3.73 3/4 @ 3.744 . This does not mean, as one
might surmise, that the selling rates for the particular kind of exchange in question ranged between the two quotations given. The
rate that precedes the sign represents the rate bid by the buyers, while
the rate that follows the sign is the rate asked by the sellers at the opening of the day's market.
The English follow a less uniform practice than the Americans in
their published tables of exchange quotations. They quote about
one-half of their rates as movable exchange; the remainder, with only a
few instances of premium and discount exchange, are quoted as fixed
exchange. The following table is a portion of the daily " Money
1
Market " article appearing in the London Times, December 2 , 1921 :
1 The London Economist (weekly) also devotes considerable space to tables of exchange
quotations.

310

DOMESTIC AND FOREIGN EXCHANGE
TABLE IV

"The outstanding feature in the foreign exchange market was a further
distinct improvement in the value of the mark. The Berlin rate at one
time fell to 700m. , closing at 7372m., against 9572m. on Wednesday.
Vienna fell a further 1,250kr. to 12,250kr . (having been down to 11,500kr .) .
The franc and lira appreciated, Paris closing at 55f. 63½c. , Brussels at
57f. 57½c. , and Rome at 95 lr. 25. Rates on Switzerland ( 21f. 08c .) , and
Holland (11fl. 37c) moved further against those countries . After rising
to 4.05, New York closed at 4.0434 -a rise of 4½c. The following rates
were current yesterday:

Method of
Par of
Exchange
Quoting
New York..
$ to £
4.86 2/3
Montreal..
$ to £
4.86 2/3
Paris .
Fr. to £
25.22 1/2
Brussels..
.Fr. to £
25.22 1/2
.Lire to £
Italy .
25.22 1/2
.Fr. to £
Berne..
25.22 1/2
.Dr. to £
Athens..
25.22 1/2 •
.M . to £
Helsingfors .
25.22 1/2
.Pts. to £
Madrid .
25.22 1/2
.Per escu.
Lisbon.
53 1/4d
Fl to £
Amsterdam..
12.107
M. to £
Berlin ..
20.43
Vienna...
Kr. to £
24.02
Kr. to £
24.02
Budapest..
.Kr. to £
24.02
Prague..
Warsaw.
M. to £
20.43
.Lei to £
Bukarest .
25.22 1/2
ΙΙΟ
.Pst. to £
Constantinople.
.Din. to £
Belgrade .
25.22 1/2
.Lev. to £
Sofia..
25.22 1/2
18.159
.Kr. to £
Christiania .
18.159
.Kr. to £
Stockholm..
18.159
Kr. to £
Copenhagen.
Alexandria .
.Pst. to £
97 1/2
Per rup.
Bombay .
24d.
Per rup.
Calcutta .
24d.
Per rup.
Madras .
24d.
. Per dol.
Hongkong .
.Per yen.
Yokohama .
24.58d .
.Per tael
Shanghai .
.Per dol.
Singapore .
Per dol.
24.066d .
Manila .
Per mil.
Rio de Janeiro .
27d.
.Per dol.
B. Aires, T. T..
47.58d .
Valparaiso, 90 days..$ to £
$ 13 1/3
Montevideo, T. T ... Per dol.
5id.
Lima .
.Eng. to Peru £ Par
.Per dol.
Mexico .
24.58d.
Place

December I

November 30

4.00 1/2-4.05
4.37-4.32
55.50-56.85
57.55-59.30
94.00-96.25
21.00-21.IO
99.50-100.50
225-235
28.80-28.97
4 1/2-5
II.30-11.40
700-825
11,500-13,500
2,500-3,000
360-370
12,000-14,500
*
730-780
275-325
620-700
28.20-28.45
16.86-17.00
21.55-21.70
97 7/16
1/3 15/16-1/4 1/16
1/3 15/16-1/4 1/16
1/3 15/16-1 /4 1/16
2/8-2/8 3/4
2/4 7/16-2/4 9/16
3/10-3/11
2/3 13/16-3 15/16
2/4 1/2
8
431/2-43 7/8
38.90
40-421/2
121/2% Prem.
32 1/4-33 1/4

3.99 1/4-4.00 1/2
4.36-4.38
56.30-57.25
58.90-60.10
95 1/2-97 3/4
20.95-21.IO
99.50-100.50
230-240
82.75-28.88
4 5/8-5 1/8
II.20-11.30
930-1050
13,000-14,000
2,900-3,500
370-380
13,000-14,500
*
735-775
280-320
650-700
28.00-28.20
16.90-17.00
21.45-21.62
97 7/16
1/3 15/16-1/4 1/16
1/3 15/16-1/4 1/16
1/3 15 / 16-1 /4 1/16
2/8-2/9
2/4 11/16-2/4 15/16
3/10-3/11
2/3 13/16-3 15/16
2/4 3/4
7 3/4
43 3/4-43 7/8
39.10
39 3/4-40 1/2

* Nominal. No quotation.

324-331/4

RATES OF FOREIGN EXCHANGE

311

"The price of Gold fell a further 4d . to 102s. 7d. per ounce (fine) . All
available supplies were taken for New York.
"There was a recovery of 1 /8d. to 37 5/8d . per ounce in the cash price
of bar Silver, owing to some bear covering, but the forward price remained
at 37½d. The market closed steady."
With but a few exceptions, the rates quoted are for telegraphic
transfers on London at the foreign points mentioned . Inasmuch as
the greater part of the world's exchange is drawn in foreign centers
on London, and not in London on those centers , it is readily seen why
it is that London customarily quotes the rates existing in other centers
on London rather than the rates in London on those centers. Before
the abandonment of the Royal Exchange, the rates at which its
transactions were handled were published Wednesdays and Fridays
of each week, which were the days following the meeting of the Exchange. Inasmuch as these rates were those prevailing in London
on other centers they were not considered so important as were the
published daily rates of foreign countries on London.
In the London Times table, reproduced above, it will be noted that
the first twenty-three rates, excepting that on Lisbon, are indirect
(movable exchange) quotations, i . e. , how much foreign money can
be purchased with one pound sterling. The Lisbon rate and the rest
of the rates in the table excepting that on Lima and Valparaiso are
direct (fixed exchange) quotations, i. e. , how much does one unit of
foreign money cost in terms of English money, either in pounds sterling
or in pence. Lima alone is quoted on the premium and discount
basis, while the Valparaiso rate is quoted on the indirect basis. The
South African and Australian rates which usually appear in separate
tables have already been discussed.¹
There are one or two items in the above table that may justify
further explanation . In the opening paragraph where the Berlin
rate is dealt with, the letter " m " refers to marks. In the next sentence the abbreviation " kr " has reference to the Vienna kronen. In
the statements concerning Paris, Brussels, and Switzerland the ab""
breviations "f" and " c, mean francs and centimes, while in those
concerning Holland the abbreviations "fl " and " c " refer to florins
and cents. The quotation on New York is given in terms of dollars
and cents. The second column explains the method of quoting the
exchange while the third column gives the par of exchange where a
1 Cf. p. 304.

312

DOMESTIC AND FOREIGN EXCHANGE

par exists . The last two columns contain the buying and selling rates
of exchange on the two days preceding publication . It will be noted
that with Hongkong, Shanghai, and Singapore, there is no par of
exchange, while with Lima the Peruvian pound is the equivalent
of the English pound. The money market article concludes with a
statement concerning the price of gold and silver.

It is stated that

the price of silver rose slightly, "owing to some bear covering, but the
forward price remained at 37½c. " This refers in the first place to the
purchases made by silver dealers who had previously sold silver for
future delivery, hoping to obtain it when needed at a lower price than
that at which they had sold it . On December 1 , they undoubtedly
felt that the price had reached its lowest point, or else they were forced
into the market to buy in order to deliver silver to purchasers , and
their demand, as a consequence, exerted a strengthening influence
on the price of silver. The " forward " price of silver is the price for
delivery two months hence.
Published tables of rates are known as the " posted ” rates and are
by no means the rates at which the greater part of the business is
transacted. As was noted in the case of the table taken from the New
York Journal of Commerce and Commercial Bulletin of December 17,
1921 , the quotations of sterling given were applicable to transactions
of £ 10,000 or more while the Continental quotations were effective
for amounts of $ 100,000 or over. Every dealer has a list of rates
(posted rates) at which exchange is sold to the general public when
ordinary amounts are desired, but these rates are either raised or
lowered respectively for small or large purchases, or for strangers or
old customers. The rates at which sales are made are known as the
"actual" rates. The difference between these two groups of rates is
shown by a comparison of the following tables taken from the Commercial and Financial Chronicle, Bank and Quotation Section , of December, 1911 : 1

TABLE V
POSTED RATES-BANKERS' STERLING BILLS

Nov. 60 days
I
4 84
2
4 84
3 4 84

Demand

Nov. 60 days

4 872
4 872
4 872

4
5
6

Demand

4 872
4 842
Sunday
4 84½
4872
1 Pp. 20-21.

Nov. 60 days Demand

7
8
9

Holiday
4 842 4 872
4 842
4 872

RATES OF FOREIGN EXCHANGE

313

TABLE V -Continued
POSTED RATES-BANKERS' STERLING BILLS -Continued
Nov. 60 days Demand
IO 4 842
4 872
II 4 842
4 872
12
Sunday

13
14
15
16
17
18
19

4 842
4 842
4 842
4 842
4842
4 842

4872
4 872
4 872
4872
4 872
4 872
Sunday

Nov. 60 days Demand
20 4 8412
4872
21. 4842
4872
22 4 842
4872
4·842
23
4872
4 872
24 4 842
4 872
25 4 84
26
Sunday
4872
27 4 84
28 4 84
4872
29 4 84
4 872

Nov. 60 days Demand

Holiday

30

Open 4 84
High 4 842
Low 4 84
Last 4 84

4 872
4872
4 872
4872

TABLE VI
ACTUAL RATES-BANKERS' AND COMMERCIAL BILLS
Bankers' Bills

23456∞

Cable
Νου.
60 Day
Sight
Transfers
I 4 8360-4 8370 4 8680-4 8695 4 8720-4 8725
4 8360-4 8370 4 8675-4 8695 4 8720-4 8730
4 8370-4 8380 4 8690-4 8705 48730-4 8745
4 8365-4 8375 4 8695-4 87
4 8735-4 8740
8
9
ΤΟ
II
12
13
14
15
16
37
18
19
20
21
22
23
24
25
26
27
28
29

Commercial Bills
Documents
On Banks
for Payment
-4 83
482
4 82 3/4-4 83 3/4
4 82 7/8-4 83 7/8
4 82 -4 83
4 82 1/4-4 83 1/4 4 82 3/4-4 84
4 82 -4 83 1/2 4 83 -4 83 3/4

4 8375-4 8380
4 8375-4 8380
4 8370-4 8380
4 8370-4 8280
4 8370-4 8380

4 8690-4 8705
4 8695-4 8705
4 8695-4 87
4 8695-4 8705
4 87 -4 8705

4 8735-4 8740
4 8735-4 8740
4 8735-4 8740
4 8735-4 8745
4 8740-4 8745

482
4 82
4 82
4 82
4 82

-4 83 3/8
1 /8-4 83 1/4
1 /8-4 83 3/8
1/2-4 83 1/2
1 /4-4 83 1/2

4 83 -4 83 7/8
4 83 1 /8-4 84
4 83 -4 84
4 83 -4 84
4 83 -4 84

4 8370-4 8380
4 8375-4 8385
4 8375-4 8385
4 8370-4 8380
4 8370-4 8380
4 8375-4 8385

4 87 -4 8705
4 8695-4 87
4 87 -4 8705
4 87 -4 8705
4 8690-4 87
48690-4 8695

4 8740-4 8745
4 8735-4 8740
4 8745-4 8750
4 8740-4 8745
4 8730-4 8740
4 8725-4 8730

4 82
4 82
4 82
4 82
4 82
4 82

1/8-4 83
1 /8-4 83
1/8-4 83
1 /4-4 83
1/2-4 83
1 /4-4 83

3/8
3/8
1/2
1/2
1/2
1/2

-4 84
4 83
4 83 -4 84
4 83 -4 84
4 83 1/8-4 84 1/8
-4 84
4 83
4 83 1 /4-4 84

4 8365-4 8380
4 8370-4 8380
4 8350-4 8360
4 8340-4 8350
4 8345-4 8360
4 8340-4 8350

4 8685-4 8690
4 8670-4 8685
4 8665-4 8670
4 8660-4 8665
4 8660-4 8665
4 8670-4 8675

4 8710-4 8715
4 8695-4 87
4 87 -4 8705
4 87 -4 8705
4 8695-4 8710
4 87 -4 8705

4 82 1/8-4 83 1/2
4 82 1/8-4 83 1/2
4 82 1/8-4 83 3/8
4 81 3/4-4 83 1/4
4 82 -4 83 1/2
4 81 3/4-4 83

-4 84
483
483 -4 83 7/8
4 82 7/8-4 83 3/4
4 82 7/8-4 83 3/4
4 83 -4 83 3/4
4 83 1/4-4 83 3/4

4 8335-4 8345 4 8655-4 8660 4 8685-4 8690 4 81 3/4-4 83 1/4 483 -4 83 3/4
4 8320-4 8330 4 8635-4 8640 4 8665-4 8675 4 81 3/4-4 83 1/4 4 82 3/4-4 83 1/2
4 83 -4 8310 4 8615-4 8635 4 8655-4 8660 4 81 3/8-4 83
4 82 5/8-4 83 1/4

It will be noted that the actual rates are consistently lower than the
posted rates.

314

DOMESTIC AND FOREIGN EXCHANGE

In reading articles dealing with foreign exchange, one frequently
comes across such terms as "the spot rate, " " spot cables," " spot
sight," "futures," " forward transactions," "forward discount rate,"
"firm rates,” etc. The first three terms refer to the rates of exchange
where immediate delivery is intended . " Future rates," "futures,"
"future delivery," " forward transactions," " forward discount rate,”
and " arrival discount rate," all refer to the practice of the buyer or
seller of exchange guarding himself against a possible unfavorable
trend in the exchange or discount rates. If an importer has engaged
a shipment of goods from abroad and will have to pay by means of a
remittance of exchange three months hence, he can protect himself
against an unexpected rise in the exchange rate by going to his banker
and buying exchange for future delivery, but at a "future rate,"
not at the rate then current in the market. The future rate quoted
by the banker may be higher or lower than the current rate, depending upon which way the banker thinks the market will turn. An
exporter who has goods to ship, say a month hence, is likewise interested in the exchange rates that will then prevail, because the returns
which he gets from the sale of his drafts will depend on where the rates
are at that time. In order to guard against unfavorable developments,
and also to have a fixed or certain basis from which to calculate the
value of his goods and thus more accurately to fix the prices to be
charged the foreign customer, he may go to his banker and get him
to quote a “ future rate ” at which he (the banker) will purchase the
exporter's bills of exchange a month hence . The banker quotes the
exporter a “ forward rate ” or a “ future rate,” and if satisfactory, a
contract for a "future " or a "future delivery " is accordingly entered
into. No matter where the market rate may be, the banker is bound
by the rate quoted in the agreement. The " forward discount rate ”
is slightly different from the " futures " above referred to in that it
concerns the rate of discount at which a bank agrees to discount drafts
when presented by another bank at a future date.

Say that a New

York bank is approached by a large exporter and asked to buy a
large amount of long bills on English banks or firms a month hence,
i. e., the importer wants the New York bank to quote him a rate for
future delivery. In order to be able to arrive at a satisfactory basis
for the rate which it will pay, the New York bank must be assured
of a definite rate of discount by its English correspondent or by an
English discount house .

English rates of discount vary from time

RATES OF FOREIGN EXCHANGE

315

to time, although normally they remain fairly stationary during any
particular week because they are based on the official rate of the Bank
of England, which as a rule is announced every Thursday. The New
York bank cables the London bank and asks it to quote a rate at which
it will discount the bills in question a month hence. This "forward
rate of discount ," or the discount rate at which the bills will be discounted a month hence on " arrival," is cabled to the New York bank,
and the latter is then able, definitely, to enter into a contract with the
exporter as to the exchange rates at which it will purchase the bills for
"future delivery." No matter where the London discount rate is at
the time the bills arrive, provided, of course, they arrive at the time
agreed upon, the London bank is bound by its contract to discount
1
them at the "forward rate " previously stipulated.
The part that
futures play in the exchange market will be more fully discussed in
Chapter XIII.
"Firm rates " are the prices set by a bank which has actually agreed
to buy or to sell exchange at a definite rate, and are supposed to hold
for a definite period . For example, New York bankers quote " firm "
rates to their domestic correspondents at which the latter are authorized to draw bank drafts on foreign correspondents in connection
with their sales of exchange. These "firm " rates are usually for a day
only, although in normal periods, when the exchanges are practically
stationary, they may hold for a week or until changed by subsequent
notice.
In quoting sterling exchange in our markets two methods of progression are used. One, the older, progressses by one-eighth of a cent
and is expressed as a fraction, while the newer, which is the more
widely used, and which makes possible a little closer shading, progresses by 5/100th of a cent and is expressed in the form of a decimal.
Where the first method is employed the rate advances in the following
66
manner: 4.86 , 4.86 1/8 , 4.86 1/4 , 4.86 3/8 , 4.86 1/2 etc., 'one point"
being one cent ; but where the second method is followed the rate advances by half a mill , as 4.8600 , 4.8605 , 4.8610 , 4.8615 , 4.8620, etc. ,
"one point " in this case being not 5/100th but 1/100th of a cent.
At certain points the two scales coincide, as at 4.86 1/4 and 4.8625 ,
or at 4.86 1/2 and 4.865 , etc.
We formerly quoted German exchange on the basis of the value of
four marks in American money. The reason for this was that as the
¹ Federal Reserve banks are permitted to quote forward discount rates.

316

DOMESTIC AND FOREIGN EXCHANGE

mint par of the mark is approximately 25 cents ($.23831 ) , four marks
would equal about $ 1.00 (four marks at par being quoted as $.95284) ..
Thus in exchange books and tables published up to within a few years
ago, mark quotations appear as the following : "M... 95.5 ," which
means that four marks could be purchased for $.95 1/2. Progression
under the old system was made by 1/16th of a cent. The rates would
thus run 95 1/16, 95 1/8, 95 3/16 , etc. In order to shade the quotations more closely the practice was followed of supplementing the main
rate with the slight percentages of 1/16, 1/32 , and sometimes 1/64 ,
meaning 1/16 of one per cent, 1/32 of one per cent, etc. The quotations
would sometimes appear, therefore, as 95 1/8-1/16, or 95 1/4 + 1/16,
etc. Thus if we were desirous of knowing how much M.10,000 would
cost at 95 1/4 + 1/32 per four marks, we would first find out how much
they would cost at 95 1/4 cents per four marks. Then, after taking
1/32 of one per cent of the result, we would add the latter sum to the
total number of dollars first obtained . Thus , 95 1/4
$.9525 for four
marks.

$.9525 divided by 4 equals $.238125 per mark.

M10,000 X

$.238125 per mark equals $ 2381.25 . 1/32 of 1 per cent of $2381.25
equals $.74 . $2381.25 plus $.74 equals $2381.99, which would be the
cost of M10,000 at 95 1/4 + 1/32 . If the supplemental fraction were
minus 1/32 , we would subtract the $.74 instead of adding it. On the
other hand, when dollars were converted into marks at fractional rates,
the sign that appeared before the supplemental quotation was reversed.
For example to convert $ 10,000 into marks at 95 1/4-1/32 we would
find the cost of one mark by dividing 95 1/4 by 4, which would give us
$.2381 (without carrying out the decimal) . Dividing $10,000 by $.2381
would give 41999.16 marks . 1/32 of one per cent of $ 10,000 is $3.125 ,
which converted into marks at $.2381 per mark, would give 13.12
marks. Adding 13.12 marks to 41999.16 marks would give the result
of 42012.28 marks. If the supplemental fraction were a plus 1/32 , we
would subtract the 13.12 marks.
The supplemental percentage
fraction was usually applied to the dollars in the computation, not
to the marks, although, as will be shown in Appendix III, the same
results were obtainable by applying the supplemental percentage
fraction to the marks and not to the dollars.
By means of these confusing supplemental percentage fractions
bankers were able to shave the quotations a little more closely than
would otherwise have been possible. As Escher says :
1 Other methods of conversion will be discussed in Appendix III.

RATES OF FOREIGN EXCHANGE

317

"On small amounts, two rates such, for instance, as 95 1/16 less 1/32
and 95 plus 1/32 are practically the same, but where considerable sums
are involved the difference is appreciable. By giving the arithmetic of
the matter a little thought, it will plainly be seen that a fraction in the
rate (which is less than 100) is a little more than the same fraction expressed as a percentage (reckoned on 100) . For example, convert M100,000
at 95 1/16 less 1/32 and you get $23,758.20 . At 95 plus 1/32 the result
is $23,757.43 . The first rate is higher than the second by 1/16 in the rate,
which is more than the 1/16 per cent which comes off.” 1
All quotations of the mark ceased in the United States on or about
March 28, 1917, and when resumed again in July, 1919, another
practice, the quotation of what one mark is worth in our money, was
adopted by American dealers.2 Thus today rates on Germany are
quoted either as 1.36½ cents (1.365 cents) per mark, or as $.01365 ,
progression in the former case being made by one-eighth of a cent
($.001/8) and in the latter by no fixed amount.³
The story of the franc quotation is somewhat similar to that of the
mark. Until December, 1920, we quoted francs on the basis of the
movable exchange, i. e. , how many francs the dollar would purchase, or
in other words, what was the dollar worth in terms of francs. The
franc at par is worth $.19294, which would enable us at par to purchase 5.182 francs for a dollar. The situation was even further confused, as in the case of marks, by the addition or subtraction of supplemental fractions representing percentages. Thus our quotations on
Paris would run something like this : 5.18 1/2, 5.18 1/8-1/32 , 5.16 1/4 +
1/16, etc. Progression was by 5/8 of a centime (a centime being 1/100th
of a franc) , because 5/8 of a centime equals 1/8 of 1 per cent of a pound
sterling, which made it easier to convert francs into pounds sterling
for arbitrage purposes than if some other method had been employed. It is said that the reason for the latter practice arose from
the fact that in early years practically all franc exchange was covered
or paid for by means of sterling exchange. Brooks ,5 however, assigns
a different reason for this strange method of progression by saying

1 "Foreign Exchange Explained ," p. 35.
2 Cf. Appendix III for examples of conversion on new basis of quoting mark exchange.
Sample quotations of mark exchange illustrating the latter method taken from the
weekly tables of cable rates published by the Federal Reserve Board are as follows : .01605,
.0158, .015825 for May 28, 31 and June 1 , 1921 , respectively. The reader can readily appreciate the fine shading made possible by quoting marks up to the thousandths of a cent.
4 Cf. Ch. XIII for a discussion of Arbitrage.
5 Op. cit., p. 114.

318

DOMESTIC AND FOREIGN EXCHANGE

that " as there are five francs to the United States dollar, 1/8 of 1 per
cent on one franc would call for 5/8 of 1 per cent on five francs ; besides, until recent years, 1/8 of 1 per cent difference in quotation was
regarded sufficiently close for commercial purposes." In the case
of franc exchange, as was also true of mark exchange, the supplemental
fractions represented a small percentage figured usually, though not
always, on the basis of dollars involved in the computation . As will
be shown in Appendix III, the same results could be obtained if the
supplemental fractions were applied to the major franc quotation and
not to the dollars. If we were calculating how many dollars we would
have to pay for 5,000 francs at 5.16 1/4 -1/16, we divided 5000 by
5.16 1/4 which would give us $968.52 , the number of dollars required at
the major rate. We would then take 1/16 of one per cent of $968.52,
or $.61 , and subtract it from $968.52 , which would give us $967.91 . If
on the other hand we were figuring how many francs we could purchase with $ 1000 at the rate of 5.16 1/4 −1/16 , we would multiply 1000
by 5.1625 which would give us 5162.50 francs . We would then take
1/16 of one per cent of $ 1000 (not of 5162.50 francs) , which would give
us $.625 . This then would have to be converted into francs at the
given major rate, i. e . , 5.16 1/4 , and would equal 3.226 francs. This
sum (3.226) would then be added to 5162.50, giving us the result of
5165.726, or 5165 francs and 73 centimes. When converting francs
into dollars we followed the sign by adding or subtracting the amount
obtained in using the supplemental fraction , but when converting
dollars into francs we reversed the sign and if the fraction were
minus we added the amount obtained in using the supplemental fraction, but if the fraction were plus we subtracted the amount. This
reversal of the sign was necessary because the plus sign made the franc
cost more, while the minus sign made it cost less. Thus in changing
1
francs into dollars with a plus fractional quotation (remembering
that francs then cost more), we had to add the supplemental
amount because it would cost more dollars ; but in changing
dollars into francs with a plus fractional quotation (still remembering as before, that the francs cost more under such circumstances) , we had to subtract the supplemental amount because we
would get fewer francs per dollar.¹

Whitaker comments as follows

upon one of the phases of this curious practice of using supplemental
quotations :
1 See Appendix III for a further discussion of franc conversion methods.

RATES OF FOREIGN EXCHANGE

319

"To look a little further into the curiosities of this notation, we may
explain that to place ' minus 1/16 ' after a rate brings that rate a little more
than halfway towards the next cheaper main rate. Thus 5.19 3/8 less 1/16
is a little closer to 5.20 than it is to 5.19 3/8 . On the other hand 5.20 plus
1/16 is a little closer to 5.19 3/8 than to 5.20 ! But the two rates, 5.19 3/8
less 1/16 and 5.20 plus 1/16 are almost identical. The interval of 5/8 centime
between the main rates is an interval of almost exactly 1/8 of 1 %. Consequently an addition or subtraction of 1/16 of 1 % to or from any main rate
takes us almost exactly halfway to the next rate. In point of fact it takes
us a shade beyond the halfway point." 1

To avoid the complexities of the situation, H. K. Brooks unsuccessfully urged the adoption of a plan of quoting francs and similar exchanges with an interval of 1/8 of a centime.2 Instead of progressing
from 5.15 to 5.15 5/8, he suggested that progression be from 5.15 to
5.15 1/8, then to 5.15 1/4, etc. The adoption of such a plan would have
given practically the same results as were secured by the use of the
confusing plus and minus fractional quotations . A change was bound
to occur sooner or later, however , and in July, 1920, a number of New
York banking firms agreed to abandon the old system of quoting
francs, lire, drachmas, etc. , as described above, and to adopt in its place
quotations based on what the franc, lira, drachma, etc. , are worth
in American money, thus putting those exchanges on the same fixed
or direct exchange basis as other foreign exchanges, excepting' only
the Canadian, which still was to be quoted on a premium and discount
basis. As the result of further publicity, an announcement was made
in November, 1920 by practically all the prominent exchange dealers
in the United States that henceforth they likewise would follow the
practice of quoting on the basis of fixed exchange . Progression in
quoting francs is now made by one-eighth of a hundredth of a cent
where fractional quotations are used, but where the decimal method
is followed the shadings may at times reach four decimal places beyond
the cents column.3
Rates of exchange fluctuate slightly in normal times and within
certain well defined limits, but violently in times of panic or under
the stress of war conditions. The accompanying chart (Chart I) and
1Op. cit., p. 95, footnote.
2 Op. cit., p. 115.
3 Rates for cables on Paris for May 27, 28, 31 and for June 1 and 2 , 1921 , respectively,
as published by the Federal Reserve Board , were .08245, .08345 , .0829 , .0847, .082725,
the quotations signifying that franc cables were selling at slightly over eight cents per
franc.

DOMESTIC AND FOREIGN EXCHANGE

320

table (Table VII) show the highest and lowest monthly quotations for
sterling sight exchange for the two normal years, 1910 and 1913 ,
TABLE VII
HIGHEST AND LOWEST QUOTATIONS FOR SIGHT STERLING PER MONTH,
1907 , 1910, 1913

1907
Lowest
Highest

Months

・4.8440
.4.8440
.4.8275
.4.8365
4.8610

January...
February..
March .

April .
May .
June..
July ..
August ..
September..
October...
November..
December.

.4.8655
4.8655
.4.8525

.4.8525
.4.8240
.4.8500
.4.8410

1910
Lowest
Highest

4.8610
4.8480
4.8470
4.8675
4.8700
4.8740
4.8725
4.8800

4.8615
4.8600
4.8665
4.8760
4.8640
4.8585
4.8520
4.8525

4.8625
4.8650
4.8875

4.8595
4.8570
4.8540

4.8670

4.8475

4.8700
4.8715
4.8780
4.8800
4.8780
4.8710
4.8585
4.8685
4.8675
4.8680
4.8620

1913
Lowest Highest

4.8570
4.8720
4.8675
4.8625
4.8595
4.8635
4.8645
4.8575
4.8535
4.8500
4.8480

4.8615 4.8500
STERLING Months
Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec
SIGHT
RATE

4.8780
4.8780
4.8800
4.8725
4.8680

4.8700
4.8710
4.8675
4.8585
4.8615
4.8565
4.8565

499
488
4.87
486
485
484

1913
--

4.83
482

---- 190?
1910

4.81
CHART I

Highest and lowest quotations for sight sterling
monthly, 1907 , 1910, 1913
and for the abnormal year, 1907. The fluctuations of sight rates during the period of the World War and later are shown on Charts XIII ,¹
XIV,2 and XV.3 It will be noted that in normal years the sight rate
fluctuates well within what are generally known as the " gold export
1 P. 540.
2 P. 541 .
3P. 544-

RATES OF FOREIGN EXCHANGE

321

1
point " and the "gold import point, " ¹ although this does not of necessity signify that no gold was being exported from or imported into
During the panicky year of
the United States during those years.
1907 the fluctuations were very great. In any one month in the normal
years of 1910 and 1913 , it was unusual for the lowest and the highest
quotation for sterling sight exchange to be more than one cent per
pound sterling apart, although under conditions of stress and strain
as in 1907 the lowest and the highest quotations of the month were
from three to four cents per pound sterling apart.
It is not only the rates of exchange between countries with different
monetary systems that fluctuate from day to day. If all countries
of the world were on the same monetary basis, rates of exchange would
still vary as greatly as they do today with our multiplicity of monetary
systems. As noted above in the case of Canada and the United States,
and in the case of England, Australia, and South Africa, the countries
in each group have the same coin for their standard unit of value, yet
the rates of exchange fluctuate just as greatly and for the same causes
as do those between countries not on the same monetary basis.
The buying and selling rates of exchange depend primarily upon
the relative bargaining power of the parties concerned although in
the background a large number of factors are always at work influencing the rates in one way or another . The rates charged or paid by
the small local dealers will usually depend in the first instance upon
quotations which they receive by mail or by wire from the larger
dealers. With these rates as a basis, the prices actually paid or charged
will depend upon the amount demanded or offered for sale, the reputation of the customer, what the traffic will bear, etc. In the case of
the larger dealers, their opening rates in the morning will be fixed
upon the basis of the closing rates of the day before, the bids and offerings that come in by mail, wire, or phone before the office opens for
business in the morning, cable advices received from abroad regarding
the trend of rates in foreign centers, etc. The posted rates of the larger
dealers will tend to be fairly uniform as is shown by the table of
sterling rates on page 322 taken from the Commercial and FinanAgain, as is also true with
cial Chronicle of December 31 , 1910.2
the smaller dealers, the rates actually set for each transaction by the
1 Cf. Ch . XI, Gold and Gold Movements.
2 This is the last date on which such tables appear in the Commercial and Financial
Chronicle.

322

DOMESTIC AND FOREIGN EXCHANGE
TABLE VIII
BANKERS' POSTED RATES OF EXCHANGE

Brown Bros & Co.

60 days
Sight
Kidder, Peabody & Co. 60 days
Sight
Bank of British No. A. 60 days
Sight
Bank of Montreal
60 days
Sight
Canadian Bank of Com. 60 days
Sight
60 days
Heidelback, Ickelheimer & Co.
Sight
Lazard Freres.
60 days
Sight
Merchants' Bank
60 days
of Canada
Sight

Mon.
Thurs.
Fri.
Fri.
Tues.
Wed.
Dec. 23 Dec. 26 Dec. 27 Dec. 28 Dec. 29 Dec. 30
83
83
83
83
4 83
862
862
862
862
4 862
83
83
83
83
4 83
86
86
86
86
4 86
83
83
832
4832
83
86
86
86
862
4 862
4 832 HOLIDAY 83
83
83
83
86
86
86
86
4 862
83
83
83
83
4 83
86
86
86
86
4 862
83
83
83
83
4 83
862
862
862
862
4 862
822
822
822
4 83
83
86
4 86
852
852
852
83
83
83
832
4 832
86
86
86
862
4862

large New York houses will depend upon the amount involved, the
reputation of the customer, what other firms are charging, etc.
Behind the actual rates of the day, however, are those forces that
tend to raise or to lower the quotation , which forces may be briefly
summarized as :
1. Supply of exchange.
2. Demand for exchange.
3. Length of time for which exchange is to run before payment , i. e.,
length of life of exchange.
4. The discount rate prevailing in foreign markets.
5. The standing or reputation of drawer and drawee.
6. The nature of the goods against which the drafts have been drawn.
7. The amount of drafts that drawer has outstanding.
8. War or rumors of war , political developments, and other miscellaneous
influences.
It must always be remembered that " foreign exchange rates are
results of forces playing not only in the market where exchange is
being bought, but also in the foreign market upon which it is being
bought."
No market stands alone, uninfluenced by what is going on
in other markets . Developments of all sorts in London , Paris, Berlin,
South America, or the Orient affect the rates in the United States ;
and likewise developments in the United States affect the rates in
1 Agger, op. cit.

RATES OF FOREIGN EXCHANGE
foreign centers.

323

The corners of the foreign exchange market are

knitted together into an unbelievably sensitive network, like the
threads of a spider's web.
The two most important forces mentioned in the summary above
are our old friends " Supply" and " Demand," each exerting a great
influence upon exchange rates but in their turn being influenced by
certain other factors.
I. Supply of Exchange. (a) Considering first the element of supply,
it is easily seen that the greatest source of bills of exchange is foreign
trade transactions. When goods are shipped abroad and the exporter draws his draft on the buyer or on the financial agent of the
latter as authorized by a commercial letter of credit, his draft immediately adds to the supply of exchange in the open market, provided it is sold to some foreign exchange dealer. If, on the other hand,
it is sent abroad for collection it has no influence upon the supply
side of the market until it has been collected and added to the foreign
account of the exporter or to the foreign account of the collecting bank.
Then, to get the funds back home, drafts may be drawn and disposed
of in the home market , or cables may be sold, both of which will increase the supply of exchange in the exporter's country.
According to the statistics of the United States government, there
have been but three years since the Civil War when our exports have
not exceeded our imports.

The value of our merchandise imports

and exports for 1909-1920 has been as shown on page 324.
The statistics compiled by the United States Department of Commerce do not include merchandise exported directly by our government, so that our excess exports have really been larger than as disclosed by the above table. This huge excess of merchandise exports
does not of necessity mean that it was all covered , or that a majority
of it was covered, by the issuance of bills of exchange. A very considerable amount of our exports during the war and since that time
has been sold against dollar credits which foreign countries have established in the United States. Beginning with the Anglo-French
loan of 1915 , it became the customary practice of the European
countries to which we advanced funds, either through governmental
or private loans, to use the monies thus made available in establishing
" dollar credits " in the United States. These funds were deposited
principally in New York for the account of the foreign countries, and
whenever exports were forwarded , drafts were drawn in terms of dol-

324

DOMESTIC AND FOREIGN EXCHANGE
TABLE IX

MERCHANDISE EXPORTS AND IMPORTS, UNITED STATES , 1909-1920¹

Year ended-

June 30:
1909 .
1910 .
1911 .
1912 .
1913 .
1914 .
1915 .
1916 .
1917 .
1918 .
Dec. 31:
1918 (6 mos.)..
1919 ..
1920..

Excess of Exports
over Imports

Total Exports

Imports

.1,663,011,104
1,744,984,720
. 2,049,320, 199
.2,204,322,409
• 2,465,884,149
.2,364,579,148
2,768,589,340
.4,333,482,885
.6,290,048,394

1,311,920,224
1,556,947,430
1,527,226,105
1,653,264,934
1,813,008,234
1,893,925,657
1,674,169,740
2,197,883,510
2,659,355,185
2,945,655,403

351,090,880
188,037,290
522,094,094
551,057,475
652,875,915
470,653,491
I, 094,419,600
2,135,599,375
3,630,693,209
2,974,055,968

1,485,208,776
3,904,364,932
5,278,481,490

1,689,652,159
4,016,061,058
2,949,534,817

5,919,711,371

.3,174,860,935
7,920,425,990
.8,228,016,307

lars against those dollar credits. As a consequence, the foreign exchange market was not affected by the drawing of those drafts any
more than it would have been affected by a Chicago merchant drawing
a draft on a New York bank, although as a result of the drawing of
those dollar drafts the exchanges of the Allies were relieved from the
great weakening pressure of a mass of foreign bills that otherwise
would have been drawn, thereby enabling those exchanges to be
maintained during the war at a level that did not truly represent their
real value. It must not be surmised, however, that this was the only
means that was employed to stabilize the exchange rates of the Allies ;
others will be discussed in subsequent chapters.
During normal times exports from the United States to foreign
countries predominate during the fall and winter months, for it is
then that we ship large amounts of raw materials, such as grain, cotton,
etc. , chiefly to the European countries. During those months, therefore, a large number of drafts are drawn against exports, and exchange
rates normally tend to weaken. Looking at the matter from the standpoint of an Englishman, Clare in his " A. B. C. of the Foreign Ex-

1 Statistical Abstract of the United States, 1920, p. 397.

RATES OF FOREIGN EXCHANGE

325

changes " ¹ states that : "Owing to the magnitude of our imports from
the States, the creation of bills in connection with the shipments of
corn and cotton, &c. , in the Autumn is so great as almost invariably
to turn the exchange against us from about August until December,
but during the rest of the year it is mostly in our favor, and as a rule
attains its maximum about April , that is to say, after the whole of the
old crops have been paid for and before drafts have been offered in
anticipation of the new."
(b) A second source of the supply of exchange has to do with the
sale of American securities to residents of other countries. When we
sell stocks or bonds to foreigners, the ordinary practice is for a draft
to be drawn against the buyer and sold in the New York market,
usually with the securities attached as collateral. Such drafts necessarily add to the supply of exchange. Before the war enormous
amounts of American securities were sold and held abroad. Sir George
Paish in his report to the United States National Monetary Commission in 1908 estimated that the amount permanently invested by
foreigners in United States securities was approximately $6,000,000, ooo , apportioned as follows : Great Britain, $4,500,000,000; France,
2
$500,000,000 ; Germany, $ 1,000,000,000; Holland , $750,000,000.2
Although the floating of new securities in the American market does
not of necessity weaken the exchange rates on those countries whose
citizens are heavy investors therein, nevertheless there is a very
decided tendency in that direction, especially in times of active
financing. For example, in May, 1895 , exchange rates were demoralized during the first half of the month as a result of the offering of a
large supply of drafts which had been drawn in connection with the
foreign purchases of our securities. Inevitably exchange rates declined , although subsequently when foreign purchases eased off considerably the market became firmer. In October, 1913 , the sale of
$5,000,000 Interborough Rapid Transit bonds was one of the important
causes that produced a decline in sterling rates. Hundreds of other
instances might be cited . It sometimes happens that instead of the
securities of a new concern or the new issues of an older firm being
floated only in the United States, a large block of such stocks and
bonds will be sent abroad by the trust company, syndicate, or invest¹ Pp. 135-136.
2 "Trade Balance of the United States," 61st Congress, 2nd Session, Senate Document
579, pp. 174-175.

326

DOMESTIC AND FOREIGN EXCHANGE

ment house that is underwriting the issue, and disposed of in European
markets, the financial returns therefrom being added to the foreign
bank account of this underwriting agency. These increased foreign accounts merely signify that an added amount of foreign exchange is
thereby made available. It is not unusual for the foreign funds thus
accumulated to be brought back to the United States through the drawing of drafts against such deposits, and at times their sale in the American market materially weakens the exchanges. In August, 1908, to
cite one of the many instances, exchange became extremely heavy
(the lowest rates existing on August 25th, when sight sterling sold at
4.8570 and cables at 4.8585) , caused in part by the gradual recall
from Europe, through sight sterling and cable transfers, of bankers'
balances and credits representing the proceeds of securities negotiated
abroad during the preceding months. It was estimated that about
$30,000,000 was availed of in that manner at that time, the funds in
question representing the proceeds from the sale abroad of securities
of the National Railroads of Mexico, the Pennsylvania Railroad , and
certain other corporations, the returns from which had been temporarily loaned in London, Paris, and other financial centers.
(c) A third factor affecting supply has to do with the money rates
at home and abroad. If money rates are high in New York and low

elsewhere, it necessarily implies that American bankers much prefer
to have the use of their money at home rather than abroad.¹ In order
to bring their funds home, they will draw drafts on their foreign accounts and sell such drafts in the open market, thus adding to the
supply of exchange and tending to reduce the rates. Not only do
high money rates at home and low money rates abroad influence the
transactions of American bankers, but they also cause foreign bankers
to place their money in the American market. This is done by their
requesting American correspondents to draw drafts on them, to sell
those drafts, and to loan in the American market the funds thus obtained, so as to receive the prevailing higher money rate.2 At times
the money rate may be higher in one foreign center than in another,
whereupon the American banker withdraws his account from the
1 In August and September, 1906, low discount rates abroad and the demand for funds
in the United States at high rates caused a mass of finance bills to be drawn by American
bankers.
2 For example, in November, 1913 , when the money market abroad stiffened and ease
developed at home, exchange rates advanced, but when firmness in money rates occurred
here, exchange rates declined.

RATES OF FOREIGN EXCHANGE

327

lower money market and forwards it to the higher money market.
The American banker effects this by selling a draft on his own account
in the lower money rate center and buying with the funds thus obtained , a draft or cable on the higher money rate center. The draft
or cable is forwarded abroad and the proceeds credited to his account.
The first draft, or cable , i. e. , the one which he has sold, will add to
the supply of exchange on the low money rate center and, as a result,
other things being equal, will have the effect of tending to weaken
exchange rates on that point. The purchase of the draft or cable by
which he remits to the other country will have the effect of increasing
the demand for exchange on the country to which his funds are being
transferred, and consequently will tend to increase or strengthen the
exchange rates thereon. If, on the other hand, he cables his correspondent in the low rate center to purchase exchange and forward it
to the high rate center, his cable in itself has no effect upon the exchange rate on either center, although the shifting of his account
to the high money center will affect the demand for exchange on that
center in the country from which his account is being shifted . When
his account is finally in the high money rate center, it will add to his
supply of exchange in that center, and will tend to weaken the exchange rate thereon.
The existence of high money rates in the United States and low
money rates abroad, when linked with high exchange rates in the
United States on foreign centers, will induce American bankers to
issue finance bills in order to take advantage of the high exchange
rate and also the high money rate at home. The sale of their finance
bills provides them with the funds which they loan out in the home
market, thus increasing the available money supply and tending to
reduce money rates. Also, strangely enough, the very issuance of
their finance bills creates a supply of exchange which in itself tends to
weaken the exchange rate on the foreign center against which the finance
bills have been drawn, thus enabling cover to be purchased sooner or
later at lower rates, provided no unexpected developments occur to affect the situation adversely. Thus high money rates and high exchange
rates bring forth a flood of finance bills which exert a weakening influence upon the exchange market and also upon the money market,
and so tend to reduce both the rate of exchange and the money rate,
unless other counteracting influences appear in the market.¹
1 Cf. p. 347, for discussion of the effect of the foreign discount rate on rates of exchange.

328

DOMESTIC AND FOREIGN EXCHANGE

(d) Fourthly, we have that group of miscellaneous activities that
bring forth a supply of exchange. Americans render all sorts of services to foreigners and in order to be reimbursed draw drafts on them.
There are also those who have payments due them from abroad in
connection with dividends, interest, maturing loans, brokerage charges,
insurance commissions, repair work on foreign vessels, consular expenses, etc., and who draw drafts on their foreign debtors.
Another matter that must not be overlooked in this connection is
the interest payments on the loans which we have extended to foreign
nations during and after the World War as well as the interest payments on our investments in foreign municipal and corporation bonds.
The total amount of foreign government, state, city, and corporation
loans floated in the United States and outstanding on July 1 , 1920,
aggregated more than $ 12,000,000,000.¹ As 1921 came to a close
the accrued interest owing on that sum totaled over one billion dollars.
When interest payments on such loans are made, it is necessary for
the foreign borrower (private party or government) to build up dollar
credits in the United States. A means to this end is the purchase of
American exchange in the foreign market, which makes the dollar
more valuable in that market , i. e., able to command more of the foreign
money unit, which weakens the value of the foreign money unit in
our market. Another means is the sale of foreign drafts in our markets,
which adds to the supply of exchange available on those countries and
which has the same weakening effect on the exchange rates. The
volume of these forthcoming interest payments is so large as to be
almost unbelievable. Great Britain's annual interest debt to our
government for funds advanced to her during the World War amounts
to $209,840,000. The aggregate annual interest debt of the Allied
Governments to the United States totals $475,000,000.

We have

permitted Great Britain to suspend interest payments until 1922 ,
and it is now proposed that the interest payments of all the Allies be
deferred for a period of at least fifteen years. This proposal in actuality would result in the creation of a loan to them of approximately
$7,000,000,000 in addition to the $9,000,000,000 which we have
already advanced .
When these public and private loans mature, they may be paid off
out of funds made available (a) by means of drafts drawn on the
Allies by their American agents, or (b) by the Allies forwarding us
1 Cf. p. 333 .

RATES OF FOREIGN EXCHANGE

329

dollar exchange, or (c) by gold shipments. Any of these methods
will necessarily result in a weakening of the exchange rates on the
countries concerned and in the strengthening of the position of the
dollar, provided , of course, no other outstanding developments occur
to offset the influence of the great demand for dollar exchange and the
creation of such a large supply of foreign exchange. The most important of the foreign loans paid off thus far has been the outstanding
balance of the Anglo-French loan of $500,000,000, floated in 1915 and
maturing October 15 , 1920. About $200,000,000 was involved in the
payment made on the latter date, being largely the share of the French
government in the loan . The Commercial and Financial Chronicle of
October 16, 1920, stated that the remaining amount of the bonds had
• been retired somewhat earlier through their purchase in the open
market or in other ways, a considerable number being accepted in
payment of subscriptions to the $ 100,000,000 French loan which had
just previously been floated by an American syndicate. The Chronicle
declared that the funds to meet the maturity had been raised by
Great Britain and France by various methods, including operations
in the exchange market, sale of American securities, gold shipments,
and the placement of the above mentioned French loan. The transaction was handled most cautiously so as not to disturb the money
market, most of the required funds as they were accumulated being
loaned on call in the New York market and then very gradually called
in before the day of payment. In July, 1921 , however, as the result
of a similar situation , not so carefully handled , sterling exchange displayed sensational weakness , falling from 3.735 on July 1 to 3.55 3/8
on July 29. While the chief weakening influence was the continued
offering of commercial bills drawn largely against future shipments
of grain and cotton, yet a powerful element in the situation was the
sale of sterling bills by prominent British interests for the purpose
of accumulating dollar credits in anticipation of the payment in the
United States of the maturing British notes.¹
Considering our foreign loans, the interest payments thereon, our
huge excess exports, etc. , it is difficult to see how in the future any
very great strength can be evidenced by the foreign exchanges in our
market, even after the leading nations of the world return to a gold
standard basis. This statement does not mean to imply that the
foreign exchanges will remain for any length of time as greatly de1 Commercial and Financial Chronicle, Bank and Quotation Section, August , 1921 , p 16.

330

DOMESTIC AND FOREIGN EXCHANGE

preciated as they are at present, but that when conditions do return
to normal the exchanges will be very apt to fluctuate between the
gold import point and the par of exchange rather than between the
gold import point and the gold export point.¹
Ordinarily, American offices of foreign insurance companies keep
sufficient funds on hand to meet losses as they occur, but in times of
widespread disaster, such as the Baltimore and San Francisco fires,
they are compelled to get funds from their foreign home offices, which
they do by drawing drafts against the latter and selling them in the
American market, an operation that tends to weaken exchange rates
by greatly increasing the available supply.
Exchange offered for sale in connection with arbitrage operations
and speculative transactions 2 must also be included as " Supply."
Both arbitrage and speculation are common activities in normal
times, but during the World War arbitrage practically ceased, while
speculation became rampant, even among those who were ignorant
of the simplest features of foreign exchange. Again and again speculative interests have been in control of the market. During 1921 when
the mark registered such startling declines, millions of marks were
dumped onto the market by speculators who hoped to avoid greater
losses as a result of a further decline in the mark quotation . This
dumping process helped to force the rate even lower than it would
otherwise have gone.
An increasingly large number of travelers, both for pleasure and
for business, have come to the United States in these later years,
bringing with them travelers' checks or travelers' letters of credit.
Travelers' checks or drafts against travelers' letters of credit, being
payable by the foreign issuing bank or dealer, add to the claims of
American banks on foreign institutions and result in an increase
in the amount of exchange available on foreign countries.
(e) Finally, at times when it pays American bankers to export gold ,
it is the custom, as will be seen in Chapter XI, for drafts to be drawn
or cables to be sold against the gold as soon as shipped. Gold is
usually exported in fairly large sums, and the resulting drafts or cables
necessarily tend to weaken the exchange rate. It is this same weakening influence of gold exports, as will be seen in Chapter XI, that in
normal times tends to bring the exchange rate again below the gold
export point.
1 Cf. Chapter XI .

2 Cf. Chapter XIII.

RATES OF FOREIGN EXCHANGE

331

II. Demand for Exchange. (a) The demand for exchange is influenced by an equally large number of independent factors, the most
important undoubtedly being the need for exchange instruments of
various sorts with which to pay for imports of merchandise. Although ,
as we have seen in earlier pages, our exports have greatly exceeded
our imports for many decades past, it is necessary for us to pay for
imports just as we expect to receive payment for our exports . American firms who import from all parts of the world are continually in
the market for exchange with which to pay their foreign creditors. A
matter frequently overlooked in this connection is that a considerable
amount of our imports coming from all parts of the world has been
and will probably continue to be financed under sterling letters of
credit.
When the foreign exporter draws his drafts on a London
bank under a sterling letter of credit sent to him by an American importer, his drafts create a supply of exchange on London in his country. These drafts have to be met in London when they mature , and
consequently add to our indebtedness to England . We then pay by
remitting sterling drafts to London as " cover," thereby creating a
demand for sterling exchange in the United States.
(b) In earlier pages we have seen that the sale of securities to foreigners creates a supply of exchange ; conversely, when we purchase
securities from them, our payments, being made by means of bills of
exchange, increase the demand for exchange. A serious decline in
the prices of securities often induces foreign holders to unload on the
American market, although it is not unusual for high prices of securities to induce them to sell to us so as to reap the gains. We remit
exchange to pay for the securities that we purchase. During times of
stress and strain in the financial world we have always bought back
large amounts of foreign-held securities . During the panic of 1893 ,
partly as a consequence of the fear aroused at that time by the growing
demand for a bimetallic standard in the United States, foreign holdings of stocks and bonds were dumped onto the American markets.
Rates of exchange ruled high during the first six months of 1893
partly because of that fact and partly because our imports of merchandise were unusually heavy with an accompanying light export
of domestic merchandise. Again, during the early weeks of the panic
of 1907 , millions of dollars worth of foreign-held securities were unloaded on the American stock exchanges, and as a result of the great
In England, frequently called " reimbursement credits."

332

DOMESTIC AND FOREIGN EXCHANGE

demand for exchange with which to remit, rates rose to what were
their record levels, cables selling at one time for 4.91 . During the week
ending February 27, 1909, a demoralizing decline in United States
Steel, Reading Railroad, and other stocks occurred, and a continued
selling by foreigners ensued with a resulting demand for exchange
which exerted a stiffening influence on the exchange market. Again,
at the beginning of the World War we had the same sort of situation
arising, but from other causes. On July 24 , 1914 , Austria forwarded
her ultimatum to Serbia. The stock exchanges of the world closed
between July 27 and July 31. The New York exchanges remained
open until the 31st, while liquidation went on at an amazing rate from
all parts of the world , necessarily producing startling declines in the
prices of securities. New York investment houses had such a heavy
list of orders to sell that had they been able to negotiate all of them
the results would generally have been disastrous. The unprecedented
demand for foreign exchange with which to make remittances caused
sterling demand drafts to rise to 5.50 on July 31 , while cables went
to 6.35. Sterling demand drafts and cables rose to still higher levels
within a few weeks, but for additional causes.
As the war progressed, and partly as a consequence of the methods
pursued by England in stabilizing sterling exchange in the United
States, ¹ it became possible for us to buy back large blocks of American
stocks and bonds. In the latter part of March, 1917 , Mr. L. F. Loree,
President of the Delaware and Hudson Railway Company in announcing the results of an exhaustive study which he had made concerning
the return of European-held securities stated that we had, up to that
time, purchased over 56.15 per cent ($ 1,518,000,000) of the total
amount of American railroad securities which had been held abroad.
It is impossible to estimate accurately the total sum which has been
purchased since 1914, but it is claimed by many authorities that it
is approximately $4,000,000,000 and that a relatively small amount
still remains in foreign hands.
Concomitantly we have been investing heavily in the stocks and
bonds of foreign corporations as well as in the bonds of foreign cities
and foreign countries.

These investments have taken the shape of

1 As will be described more in detail in Chapter XIV, England bought or borrowed
American securities held in England and sold them through Morgan & Co. in New York
at those times when sterling rates fell below the pegged position of 4.76. The money realized
from such sales was used to purchase cables on England, thus artificially strengthening
sterling in our market and causing it to rise again to 4.76.

Mexico
.
Cuba
.
.
Panama
Santo
Domingo
.
.
Argentina
Bolivia
.
Brazil
.
Chile
..
Great
.
Britain
France
.
Germany
.
.
Russia
Belgi
um
.
Italy
.
Greece
.
Roumania
.
Serbia
.
Norway
.
Switzerland
.
Sweden
.
Denmark
.
China
.
.
Japan
Australia
.
Czecho
.-Slovakia
Liberia
..
Total
.

NCanada
. ewfoundland
&

Country

18,500,000
431,000

15,000,000
13,000,000
102,552,000 5,250,000

5,000,000
30,000,000
25,000,000

772,633,000
250,000,000 95,000,000
2,000,000
75,000,000
75,000,000
25,000,000

4,048,000

500,000
10,000,000
2,705,000
10,806,000

State
Government and
Municipal

15,000,000

1,250,000

Public
Utility

128,087,765

Railroad

Corporation

OUTSTANDING
AND
OF
AS
1JULY
, 920

1,000,000

15,000,000

Industrial

5,000,000
30,000,000
25,000,000
15,000,000
13,000,000
107,802,000
1,250,000

2,000,000

, 920
11
)1May
30,425,313
52,500,000
31$8521,328,500
9,899,500
0,095,000
24,248,313
128,587,765
10,000,000
2,705,000
10,806,000
15,000,000
4,048,000
18,500,000
431,000

Total

26,000

187,729,000
75,000,000
76,000,000
338,745,000
1,631,338,000
25,000,000
48,236,000
25,000,000
26,780,000

787,633,0,000
000
4,277,00

1$0,000,000

Cash
Advances
other
and
charges
credits
against
establishe
by
d
United
States
to
(up

5$24,248,313
128,587,765
20,000,000
2,705,000
10,806,000
15,000,000
4,048,000
18,500,000
431,000
5,064,633,000
345,000,000
2,997,477,000
3,342,477,000
2,000,000
262,729,000
414,745,000
1,656,338,000
48,236,000
25,000,000
26,780,000
5,000,000
30,000,000
25,000,000
15,000,000
13,000,000
107,802,000
1,250,000
56,524,000
26,000
,555,744,000
64,416,265
1,345,000
5,899,500
,222,011,078
,598,855,000
1921$58$64,606,313
1,820,866,078

Grand
Total

FLOATED
STATES
UNITED
IN
CORPORATION
LOANS
,A
AND
MUNICIPAL
ND
FOREIGN
SCOUNTRIES
GOVERNMENT
BTATE
OX.
FY
TABLE
SUMMARY

334

DOMESTIC AND FOREIGN EXCHANGE

loans of huge proportions to the Allied Governments made by the
United States government for the purpose of prosecuting the war
against Germany, and investments by individuals and financial houses
in the bonds of foreign cities and nations ¹ and in the stocks and bonds
of corporations of various kinds in all parts of the world, totaling
far in excess of $12,000,000,000 .

The data regarding our loans out-

standing July 1 , 1920 are shown in Table X (page 333) , compiled by
the Guaranty Trust Company of New York.
The above tabulation does not include subscriptions in the United
States to foreign internal loans, as the amounts of such subscriptions
are not available, nor does it include the following issues: " (1) Mexican
loan of $25,000,000 (U. S. ) 4 per cent bonds (of a total issue of $40,000, ooo) , due in 1954 ; (2) two Cuban government loans, one of $35,000,000
gold 5 per cent bonds , dated March, 1904 , and due March 1 , 1944, and
one of $ 16,500,000 external 42 per cent bonds dated August 2, 1909,
and due August 1 , 1949. These issues were placed partly in the United
States and partly abroad, but the amounts placed in this country
are not available.'" 2 From July 1 , 1920 , to December 31 , 1921 , we
floated an additional amount of foreign government, state, and municipal loans totaling $610,579,300.3 No data are available as to the
amount of our investments in foreign corporations since July 1 , 1920.*
The larger part of our loans to foreign cities and nations has been
in the form of cash advances and dollar credits established in the
United States, which could have no immediate effect upon the rate
of exchange except through reducing the supply of exchange on those
countries. Later, however, when the loans are paid off or when interest
payments are made, it is evident that foreign exchange rates will
inevitably be weakened.5 Some of the loans, however, and the greater
part of our investments in corporation and foreign municipal securities
made during and after the World War, have necessitated the remitting
of the funds so invested and have therefore aided in sustaining the
demand for exchange on those countries.

The heavy investment

1 T. W. Lamont of J. P. Morgan and Company stated in March, 1922, that out of a total
of$2,587,399,000 European government obligations floated in this country from August 1st,
1914 to January 1, 1922 , only $818,000,000 remained at that time in private hands. The
amount held by bankers was declared to be negligible. Commercial and Financial Chronicle, March 4, 1922 .
2 Federal Reserve Bulletin, July, 1920, p. 687.
3 New York Journal of Commerce and Commercial Bulletin, January 3 , 1922.
4 The Federal Reserve Bulletin of April, 1922, states that during 1921 and down to
March, 1922 , we had floated foreign loans aggregating $913,303,000.
5 Cf. p. 329.

RATES OF FOREIGN EXCHANGE

335

(speculative in character) of Americans in German municipal bonds
immediately following the war undoubtedly held the mark at a higher
level than would otherwise have been the case. In September, 1921 ,
the floating in the United States of a $25,000,000 loan to Brazil and
one of $50,000,000 to Argentina had the effect of strengthening the
exchanges not only of those two countries, but of practically all of the
South American countries as well.¹
Excluding the large war advances which our government made
to the three important Allies, Great Britain, France, and Italy, our
heaviest investment thus far has been in Canadian loans of various
kinds. Commenting on this matter, the Bankers' Trust Company
of New York, in a statement issued December 6 , 1920, declared :
"Prior to 1914, Canada secured in Great Britain the greater part of the
capital required to develop her natural resources. The war immediately
dried up the wells from which flowed this vivifying supply. In fact the
current was reversed and Canada gave back to the mother country many
millions of capital.
"Then it was that Canada turned to the United States for the capital
no longer to be obtained overseas. The result is that in the past six years
we have loaned Canada nearly a round billion of dollars. This money
has gone to help Canada meet her military expenses, to help her finance
her exports of wheat and other foodstuffs and of munitions of war.
"A large amount has been invested in American owned factories because
on account of Canadian tariff regulations it is more profitable to manufacture certain classes of goods to be sold within her borders rather than to
export them to her. Again we need paper pulp and paper and Canada
has in abundance the raw materials to produce them if we will turn them
into the manufactured product on her side of the boundary line.
"But this is not done at a loss. On the contrary, our interest and profits
received from our Canadian investments are estimated to have been, during
the past six years, around $330 million while Canadians have probably
paid us over $90 million in freight money, insurance and the like. Therefore, of the approximately one billion dollars which we have invested in
Canada in recent years, nearly half represents merely a reinvestment of
payments made to us by our Canadian friends.” 2
Demand for exchange also arises in connection with the payment
of maturing American corporation and municipal loans held abroad.
1 Commercial and Financial Chronicle, Bank and Quotation Section, October 8, 1921,
p. 17.
2 Commercial and Financial Chronical, December 11 , 1920.

336

DOMESTIC AND FOREIGN EXCHANGE

Before the World War a large share of the securities of American corporations was floated abroad.¹

It was not unusual for corporations

to issue bonds, the principal and interest of which were made payable
to foreign holders, either in gold or at a fixed rate of exchange . When
payments are made the corporation goes into the market and purchases exchange with which to make remittance, thus helping to
strengthen the rate. The same holds true in the case of maturing
city loans. To cite a concrete instance :—it had for some years been
1
the practice of New York city to sell its tax warrants ¹ in foreign
countries, principally in France and England, because it could get a
larger return therefor than when sold in the United States. At the
outbreak of the World War, New York City owed about $82,000,000
on foreign-held tax warrants, payable in gold. A syndicate of bankers
was organized to finance the city's demands, and subsequently remitted $80,243,941 in exchange, not to mention certain gold shipments.
The demand for such a large amount of exchange increased the pressure upon the market and aided in raising the rates on England and
France. 3
The part played by the international dealings in stocks and bonds
(both civil and corporation) can hardly be overestimated so far as their
effect on the exchange and financial markets is concerned. The ramifications of such transactions and their importance in the financial affairs
of a country are seldom appreciated by the layman or by the ordinary
exchange dealer.
(c) In the past it has been necessary for us to remit, usually semiannually, large payments of interest and dividends upon stocks and
bonds held abroad . Those payments have been variously estimated
as totaling from $200,000,000 to $300,000,000 per year . Every halfyear the mail sacks coming from foreign countries would be bulging
with clipped coupons being forwarded to us for payment. Since we
had to remit payments to our foreign creditors by means of bills of
exchange, the rates on foreign countries always showed a tendency
at those times to increase. Inasmuch as since the war we have bought
back the greater part of these European-held securities, it may be
years before our payments of interest and dividends will again play
1 It has been estimated
United States in August,
2 Short time obligations
by many cities as a means
3 Cf. p. 530.

that the aggregate amount of British capital invested in the
1914, was about $3,888,000,000.
secured by the forthcoming tax income of the city, and used
of anticipating future revenue from taxes.

RATES OF FOREIGN EXCHANGE

337

such an important part in our foreign exchange market. In fact our
country has within the last few years become a creditor nation and has
invested heavily in loans to European governments, cities, and corporations, not to mention the investment of much American capital
in South America and in the Orient. The Europeans, however, especially in neutral countries, are still active in the market as purchasers of American securities, as is evidenced by a late report from
The Hague, appearing in the New York Times of November 3 , 1920,
to the following effect: " . . . big capitalists are sending enormous
sums to America and steadily buying scores of millions of dollars of
American securities. . . . The Dutch feel that America is the one
place safe from Bolshevism and other social disturbances and are investing largely in American securities. Even the small farmers who
grew wealthy during the war favor those securities. Bankers in small
provincial towns say that they invest millions of dollars monthly.”
The to-be-expected result of such heavy purchases by the Dutch was
a sudden fall in the rate for guilders which had for so long been steadily
maintained in our market. Later, however, as we remit interest and
dividend payments to the Dutch, the increased demand will tend to
raise the rate of exchange on Holland.
(d) Each year large amounts of money are sent abroad by immigrants to relatives and families, remittance almost always being
made by means of some kind of exchange. The extent of such remittances is not definitely known but it has been variously estimated
at from $ 100,000,000 to $ 150,000,000 a year. As showing the extent
to which immigrants are an influence on the demand side of the foreign
exchange market, it is interesting to note that during 1919 the Italians
in the United States sent to their home country 432,692,497 lire ¹ in
addition to the savings which some 75,553 returning immigrants
carried back with them.2 The American Consul General at Athens
estimated that during the same year the Greeks in the United States
remitted approximately 350,000,000 drachmas.3 It has been stated
that English and Irish immigrants remit about $25,000,000 a year to
friends and relatives in Great Britain.
1 Approximately $83,509,651 when computed at 19.3 cents per lira. The lira at par is
19.294 cents.
2 Statement issued by the U. S. Department of Commerce, Commercial and Financial
Chronicle, October 9 , 1920.
This amounts to $67,550,000 when figured at 19.3 cents per drachma. The drachma
at par is 19.294 cents.

338

DOMESTIC AND FOREIGN EXCHANGE

(e) Another element that looms large as a factor in the demand for
exchange concerns itself with the annual remittances which we have
for many years been compelled to make to England and a few of the
Continental countries for insurance premiums and ocean freight
charges. From 1791 to 1820 our imports exceeded our exports by more
than $500,000,000. We paid for that relatively vast importation by
rendering a shipping service to foreign nations. For many years
past, however, our exports have greatly exceeded our imports and in
part payment of the difference foreign countries have rendered us a
shipping service, carrying our ocean freights and exacting a charge
therefor variously estimated at from $20,000,000 to $40,000,000 per
year.¹ During the World War, however, the unusual conditions that
existed made possible the sudden expansion of the American merchant
marine; European-owned ships were being kept busy carrying supplies
and troops for the warring nations. But since the signing of the
Armistice it has been increasingly difficult for American ships to compete successfully with European and Oriental vessels. It is impossible
at this writing to say what the outcome of the present struggle on the
high seas will be. If American capital can make more money on the
water than it can by investing in enterprises on the land, either with
or without a subsidy, our merchant marine will remain an active and
powerful factor in the world's carrying trade ; otherwise not.

Foreign

competition is bound to be severe, especially between the United
States, England, and Japan.
Before the war practically all of our marine risks were insured in
foreign companies, mostly British. A great deal of life, fire, accident,
and liability insurance was and still is carried in English and Continental companies . Dr. S. S. Heubner, Professor of Insurance at the
University of Pennsylvania, estimated that in 1918 the insurance
premiums which Americans paid on policies with foreign companies
amounted to approximately $250,000,000. Although the American
offices of these companies usually keep a large amount of reserve
funds on hand or invested in American securities, nevertheless the
greater share of the premiums is sent abroad by means of exchange
purchased in the open market, which of course increases the demand
for exchange and tends to strengthen the rate. During the war a large
amount of insurance of all kinds, including quite a bit of marine
1 Escher, "Elements of Foreign Exchange," p. 21, approves an estimate of $150,000,000
per year.

RATES OF FOREIGN EXCHANGE

339

insurance, was written by American companies, and since the Armistice
a serious effort has been made to retain the business so lately won.
This state of affairs has naturally resulted in a lighter demand for exchange with which to pay premiums abroad.
(f) Europe has always been a favored land of travel for American
tourists, and many a city on the Continent survives solely or mainly
on the funds which our citizens take into those communities. Before
the World War it was estimated that our tourists were in the American
markets each year for from $ 200,000,000 to $ 500,000,000 in exchange
to carry abroad with them. The effect of this recurring and fairly
steady demand was always evident in the market. During the war,
however, our tourists remained at home, and the lack of demand for
such a large amount of exchange aided in weakening the rates on
European countries.
(g) There are also a number of American families living temporarily
or permanently in foreign countries to whom funds must be sent
occasionally or at regular intervals. Nor must we overlook those
instances in which American heiresses have wedded English and
European husbands, making it incumbent on us to remit millions of
dollars as dowries or as income from American-owned properties. As
Withers facetiously remarks, "We (England) draw on the United
States for the ' dowry drain ' and repay it with affection and social
distinction conferred on American heiresses by their English husbands ."" 1
(h) Before the World War there was also a great demand for exchange with which to meet our maturing currency and sterling loans
and finance bills. These long bills were customarily drawn so as to
fall due in the autumn, at which time exchange rates on foreign countries were usually at their lowest levels.2 Had it not been for the
autumnal demand for exchange with which to pay off the millions
of dollars of such long bills issued during the spring and early summer
months, the rates of exchange every fall would have reached considerably lower levels. To cite an instance of the effect of finance
bills on the rates of exchange : In October, 1912 , a mass of American
securities was thrown onto our markets following the declaration
of the Balkan War. To obtain the funds with which to supply the
stock and bond dealers with the money needed to absorb those securi1"Money Changing," p. 89.
2 Cf. 324-325.

340

DOMESTIC AND FOREIGN EXCHANGE

ties, finance bills were issued maturing in January, 1913. The demand
for cover at that time caused exchange rates to rise to such levels that
large exports of gold became advisable and profitable. During and
since the World War , loan and finance bills have not exerted the influence on either the supply or the demand side of the exchange market
that they did before that time. With the United States at present
a creditor nation (and it is difficult to prophesy just how long we will
be able to retain that position) , it is not expected that loan or finance
bills will in the near future function as actively in the exchange markets as they have in the past.
(i) The money rates at home and abroad also have their effect on

the demand for exchange. If low money rates rule in the United
States with high money rates in some foreign center, banks with funds
to invest for a short period will enter the market as demanders of exchange with which to transfer their accounts abroad so as to take
advantage of the high foreign money rate. Fluid capital, using those
words rather loosely as signifying funds in the hands of bankers available for investment, is extremely mobile and shifts or is shifted from
one center to another by cable or otherwise at a moment's notice for
the purpose of taking advantage of a slightly higher rate of return.
Our international bankers are quick to seize an opportunity of getting
an increase in the yield of their funds.¹ High money rates abroad
also make it unprofitable for us to renew maturing finance and loan
bills, and hence tend to stimulate the demand for exchange with which
to pay such bills when due. Thus it is that we can always expect to
see low money rates at home and high money rates abroad increasing
the demand for exchange and tending to raise the exchange rates,
and vice versa. Low money rates abroad are at times, however,
linked with low money rates at home. This brings about a slackening
in the demand for foreign bills , with a resulting tendency to weaken
the exchange rates on the foreign country. In the first week of June,
1898, a decline in the discount rate of the Bank of England caused
bankers to stop purchasing long sterling bills for investment purposes,
1 The Annalist of New York under date of January 15 , 1917, stated that: " The marked
ease of money rates last week stimulated the investment of banking funds in cotton bills
and other paper drawn against exports. The process enabled the purchaser to draw interest at higher rates on an amount of funds in London equivalent to his investment on
such bills. Before money advanced to the high levels current late in November, it was
estimated that fully $400,000,000 American funds were being loaned in London in this
manner, of which more than $ 100,000,000 was thought to have been drawn back here
when the money market stiffened."

RATES OF FOREIGN EXCHANGE

341

while easy money rates at home tended to prevent the purchase of
sterling for future delivery. The result was a heavy market for sterling
exchange with lower rates prevailing. The student should not overlook the fact that the money rates of a country are inseparably connected with the discount rate of the rediscounting institution or central bank.

The discount rate, however, is so important a factor in

affecting the rates of long bills that we shall devote a separate section
of this chapter to it.¹
(j) There are also those foreign payments which we must make
to those who have rendered services for us, such as lawyers' fees , agents'
commissions , payments to sales agencies, salaries to foreign employees
and consular representatives, bankers' commissions, etc. , etc., all
of which create a demand for exchange. Before the World War we
paid English discount and acceptance houses large sums of money
as commissions on various financial transactions. These commissions,
variously estimated at from $ 10,000,000 to $ 150,000,000 have largely
disappeared as a result of developments during and since the war
and therefore do not figure as prominently on the demand side as
formerly. If the present tendency to return to the use of sterling
letters of credit should continue, it seems safe to predict that in the
future we shall again be in the market for large sums of exchange with
which to pay acceptance commissions to English banking houses.
(k) Exchange is also demanded in connection with arbitrage and
speculative transactions.2 Especially during and since the war has
speculation been an extremely important factor in the exchange market. First it was the demand for Russian rubles ; then for francs and
lire ; later for marks. This speculative demand has been of great
influence in strengthening the market, and at times has raised the
speculative exchanges to higher levels than would otherwise have prevailed . On January 2 , 1921 , sterling exchange opened at 3.53 @ 3.54
and in a month's time (January 31) it had risen to 3.834 @ 3.85 3/4.
One of the strengthening influences was the large outstanding " short "
interest made up of those dealers who had sold futures, counting on
covering later through an expected fall in the rate but who were compelled to purchase at the higher rates for fear of having to cover later
at even higher prices.
(1) We have seen that gold exports tend to create a supply of ex-

1 Cf. p. 347.
2Cf. Chapter XIII.

342

DOMESTIC AND FOREIGN EXCHANGE

change and thereby weaken the rates.

On the other hand, gold im-

ports do not of necessity create a demand for exchange, although
such is usually the case. An importation of gold must be paid for in
one of two ways : first, by the dealer cabling his correspondent to
take a certain portion of his (the importer's) deposit account and to
use the same in purchasing gold. This cable request, in itself, does not
create a demand for exchange in the American market, nor does it, as
a cable, affect the supply; but the procedure does reduce the foreign
account of the dealer and thereby decreases the supply of exchange.
Also, when the importing banker later takes steps to build up his
depleted foreign account, he will have to go into the open market
and buy exchange, thereby increasing the demand for foreign bills.
Second, if when the dealer makes his plans to import gold , he finds that
his foreign account is relatively low, he may be forced to go into the
market and buy a sufficiently large amount of either cables or sight
exchange to send abroad to build up his account in order to be able
to pay for the gold that he wishes to import. This procedure would
create a demand for exchange and so tend to raise the rates.
(m) At times, although rather infrequently, the exchange market
will be disarranged by the payment of an indemnity between nations.
For example, in 1900 the United States government paid Spain a
claim for $20,000,000, arising out of the Spanish-American War, and
for several months our government remained in the market as an
active demander of exchange, thereby materially increasing exchange
rates. On May 17 , 1921 , Germany paid the Reparations Commission
150,000,000 gold marks, the payment consisting of foreign currencies.
Germany secured these funds by drawing drafts on credit balances
which she had accumulated in those countries with which she was
trading. The Reparations Commission found itself possessed of a
miscellaneous volume of drachmas, lei, francs , dollars, guilders , and
every conceivable unit of currency in commercial use in the world, and
requested Germany to convert these foreign funds into dollars. Germany did so by May 31 , with the result that her demand for dollars
strengthened the dollar quotation and weakened practically every
European rate, sterling , for example, falling from 4.00 on May 19 to
3.86 on May 31. The Reparations Commission finally authorized
Germany to pay in any foreign credits which she might possess in
order to prevent the disturbing effects of similar demands for dollar
credits in the future.

RATES OF FOREIGN EXCHANGE

343

Before bringing to a close the discussion of the supply of and the
demand for exchange, several other matters should be briefly referred
to. For example, the reader must always keep in mind that when
we state that increasing the supply of exchange tends to weaken the
rate, or that decreasing the supply tends to stiffen it, we mean that
such statements hold true provided the demand factor remains constant ; and likewise , when we say that increasing the demand stiffens
the rate or that decreasing the demand weakens it, we mean that the
supply factor remains constant. It is not unusual, however, to find
that an increased supply or a decreased demand does not weaken the
rate, or that a decreased supply or an increased demand does not
strengthen it, the reason being that the other factor has not remained
constant and consequently has affected the condition of the market
in a manner that was not anticipated. Also, one must not overlook
the fact that there may be any number of bills drawn on creditors in
a foreign country that are not sold to exchange dealers in the country
of origin, but instead are sent abroad for collection. Such bills do not
affect the supply side of the market until actually collected and the
funds so obtained have been added to the foreign account of the exporter's collecting agency. The funds may then be returned to the
country of origin in one of two ways : (a) the collecting agency may
draw drafts on the foreign account, sell them in open market, and thus
receive funds with which to pay the exporter ; or (b) the collecting
agency may advise its foreign correspondent to remit the account by
means of sight drafts or cables. The first method creates a supply
of exchange on the foreign country; the second method creates a
demand in the foreign country for exchange on the exporter's country.
Both affect the exchange rate in the exporter's country in the same
manner, i. e. , they tend to lower the rate. To illustrate : a demand
in France for dollar exchange raises the rate for dollars, or what
amounts to the same thing, it lowers the value of the franc, because
it then takes more francs to buy a dollar.

A supply of franc ex-

change in the United States lowers the value of the franc, or increases
the value of the dollar because the latter then buys more francs.
In this way, bills that are collected abroad may ultimately result in
(a) a demand in the foreign country for exchange on the country of
origin, or (b) in the creation of a supply of exchange in the country
of origin on the foreign country, both of which in the end, as we have
seen, have the same effect on the market.

344

DOMESTIC AND FOREIGN EXCHANGE

A draft drawn on a party in a foreign country, say France, and disposed of in the country of origin, say the United States, may add to
the supply of franc exchange in the United States, or it may create
a demand for dollar exchange in France, but it cannot affect the supply
side in the United States and the demand side in France at the same
time. When it is offered for sale to an exchange dealer in the United
States, it is clearly a part of our supply of franc exchange. But it
cannot at the moment of sale affect the demand for dollar exchange
in France. When the bill reaches France and is finally paid, say seven
or ninety days later, the French correspondent may then possibly
be requested to purchase dollar exchange and remit it to the American
dealer. Such a proceeding is rather unlikely to occur, ¹ but still it is
practically possible. Thus the existence of a supply of franc exchange
in the United States may ultimately lead to a demand for dollar exchange in France, but where only two countries are concerned it is not
possible for the franc draft to figure simultaneously as a supply factor
here and as a demand factor abroad.
The situation becomes slightly different, however, when we discuss
relations that may arise between merchants and bankers in three
countries. Say, for example, that a German bank issues a commercial
letter of credit to a German importer, under the terms of which the
drafts are to be drawn on an English bank, and that the letter of
credit is forwarded to an American exporting firm. The draft that
the American firm draws on the English bank may be considered as
increasing the supply of sterling exchange in the United States and
also at the same time as resulting in an increased demand for sterling
exchange in Germany. In this case the draft drawn on England by
the American firm will be sold in the New York market , thereby adding
to the supply of sterling exchange in that market. The German bank
that issued the letter of credit upon the London correspondent will
have to reimburse the latter, i. e. , cover the sterling draft drawn by
the American exporter, thus increasing the demand in Germany for
sterling exchange.
Trade relations between three countries may in various ways affect
the demand for, or the supply of, exchange of those countries in a
most interesting manner. Say that American importers owe English
exporters ; that German importers owe American exporters ; and that
1 To get the funds back to the United States, the customary practice is for the American
banker to sell franc drafts against his account.

RATES OF FOREIGN EXCHANGE

345

English importers owe German exporters. The usual method of
handling such a situation would be for the United States firms to
draw on the German firms so as to get the money which was due them ;
the German companies would likewise draw on the English importers ;
and the United States importers would remit to the English exporters.
The American bankers who purchase the drafts drawn against the
German firms may and frequently do send such drafts to their English
correspondents for collection, the amounts collected to be credited
When these drafts reach England they
to their English accounts.
are forwarded to German correspondents who in their turn collect
the amounts due and then purchase sterling exchange with which to
make remittance to the English bankers. Thus it is that the existence
in the United States of mark drafts leads to the creation of a demand
in Germany for sterling drafts.

The German banks that sold the

sterling exchange for remittance in the above connection undoubtedly
had built up their accounts in England by purchasing the drafts that
the German exporters had drawn on the English importers.
To cite another possible situation, say that England buys cotton
from the United States, that Germany buys cloth from England, and
that the United States purchases scientific instruments from Germany.
We would draw drafts on England in order to receive money owing
us by the English importers . These drafts would be purchased by the
American bankers and might be sent to Germany for collection from
England, the idea of the American bankers being to build up their
accounts in Germany. The German bankers would send these drafts
to England and ask that the funds be deposited to their accounts .
They would thus have a supply of sterling exchange available with
which to satisfy the needs of the German importers who require
it for remittance to England to pay for the cloth. A supply of sterling
exchange in the United States has thus led to the creation of a supply of sterling exchange in Germany. Or it might be that the
American importers would send sterling commercial letters of credit
to the German exporters, who would draw drafts on English banks for
goods shipped to the United States.
And in this way a demand for
sterling exchange in the United States would lead to the creation of a
supply of sterling exchange in Germany.
It is not unusual for a debtor in one country to pay a creditor in a
second by means of exchange drawn on a third. An importer in New
York may pay an exporter in Paris by sending him a draft on London.

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DOMESTIC AND FOREIGN EXCHANGE

The Parisian will be compelled to sell his sterling draft in Paris in
order to obtain his money. This adds to the supply of sterling exchange in Paris. The Parisian banker who purchases the draft will
forward it to London for collection, and have the proceeds credited
to his London account. Thus the existence of a demand for sterling
exchange in the New York market has created a supply of sterling
exchange in the Paris market. Or if the Parisian banker asks that the
funds , when collected in London, be remitted to him, franc exchange
will be purchased in London in order that the funds may be returned
to Paris. The existence of a demand for sterling exchange in New
York has therefore led to the creation of a demand for franc exchange
in London. While to the uninitiated this might seem to be a roundabout way of making payments in international transactions, it is not
so uncommon as one might suppose. Sterling drafts have been universally used in such connections.
In 1912, Germany exported about £13,000,000 worth of goods to
Argentina, but imported far less than that amount from her. The
difference was undoubtedly paid for by means of sterling remittances
sent to the German exporters by the Argentine debtors, drawn against
credits which had been built up in England as the result of large
English purchases of foodstuffs from the exporters of Argentina.
Especially has it been customary among South American countries
for payments to be made to each other or to foreign nations by means
of 90 day drafts drawn on London.
Four-cornered transactions similar to the above triangular operation
were frequently engaged in during the World War. The Annalist
of May 7 , 1917 , in describing such a four-cornered operation, stated
that:

"Russia owes Japan for war munitions, ships, steel, etc. , but is forced
by the exigencies of war to borrow in London to pay the bill. London in
turn is a heavy borrower in New York, and so theoretically the burden
is passed along to the New York market. Japan, then, in order to get
her money, draws on New York, and it happens that at the same time she
has a heavy trade balance here, resultant from extraordinary exports to
this country. The addition of this debt to the debt of Russia, which has
been shifted to the American market, acts to depress the value of the dollar
in Tokio and makes more easy the outflow of gold. Last week shipments
were made from San Francisco to a total in excess of $4,000,000, and the
continuance of the flow is expected for some time."

1

I

RATES OF FOREIGN EXCHANGE

III. The Discount Rate.

347

The discount rate prevailing in foreign

markets is an important matter that is kept in mind by every exchange dealer in purchasing acceptance bills. If a New York dealer
purchases a long bill and sends it to London when the discount rate
is high, he will receive less when it is discounted than if the discount
rate had been lower. It is for this reason that the New York dealer
pays less for long bills when the discount rate is high than when it is
low. The discount rate applies only to long bills. Sight bills are never
discounted because they are payable on demand. It is not unusual
to have demand drafts on London sell for 4.86 , and to find that the
American exporter can obtain but 4.81 or 4.82 for his 90 day bills
because of the high discount rate in London.¹ Conversely, if the discount rate abroad is low, the exchange dealer will be able to secure a
greater return on bills discounted abroad and consequently will be
willing to pay a higher exchange rate for them. Thus, in 1908, the
discount rate of the Bank of England was lowered from 7 per cent on
January 2, to 6 per cent on January 3 ; to 5 per cent on January 17 ;
to 4 per cent on January 24 ; to 3½ per cent on March 6 ; to 3 per cent
on March 20 ; and to 24 per cent on May 29. The rates for 60 day
acceptance bills on those dates were respectively : 4.7950 @ 4.7975 ;
4.80 @ 4.8025 ; 4.8210 @ 4.8220 ; 4.8340 @ 4.8350 ; 4.830 @ 4.8325 ;
4.8315 @ 4.8325 ; 4.8520 @ 4.8530 ; a consistent though not a proportionate increase being shown as the discount rate was lowered.
The influence of the discount rate in narrowing the spread between
the quotation for long bills and sight exchange will be discussed in the
following section, while its connection with the flow of gold will be
considered in the next chapter.
IV. Usance of Bills. The length of time for which the bill is to
run before payment is made, i. e. , its length of life , is a factor that also
influences the rates charged or paid on any particular day for the
different kinds of exchange. The sight or demand rate, as Whitaker
so well says, " is forged out in the open market between the hammer
and anvil of bid and offer," 2 (supply and demand) , but the rates for
cables and long bills are always calculated on the basis of the sight
1 On January 3 , 1908, the Bank of England discount rate stood at 6 per cent ; the open
market rate at 5 per cent. The rates of sterling exchange on that day were : 60 day bills,
4.795 @ 480; sight bills, 4.8470 @ 4.8475 ; cables, 4.8575 @ 4.86 . On January 2, 1913, the
Bank of England discount rate stood at 5 per cent, the open market rate between 4 per
cent and 5 per cent. The rates of sterling exchange on that day were : 60 day bills,
4.8155 @ 4.8165 ; sight bills , 4.8570 @ 4.8580 ; cables, 4.8630 @ 4.8640.
2 Op. cit., p. 274.

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GN

AND FOREI

NGE

EXCHA

rate and are not in themselves subject to any great extent to the influences that focus upon the sight rate. There has been some controversy among exchange dealers, as well as among those who have
written on the subject, as to whether or not the sight rate or the cable
rate should be taken as the basis for the calculation of the other exchange rates.
The American Express Company in a late number
of its Foreign Trade Bulletin calls attention to the fact that " It is
interesting to note that the cable rate of exchange is the real rate indicating what the United States dollar is actually worth day by day,
in terms of each foreign currency." Whitaker, on the other hand,
maintains that:
""
. . . it must be confessed the thought that the cable rate is the ' real
exchange rate,' unadulterated by discount or interest, so to speak, is an
attractive idea to both the theorist and the banker. But be this as it may,
the various long rates (and also the rates for merchants' sight bills, which
are sometimes drawn) are tied to the rate for bankers' sight drafts in a
way in which they cannot be connected with the cable rate. The spread
between a long rate and the sight rate can be calculated at the time of the
purchase of the long exchange, from factors which are then all foreknown.
Neither speculation nor investment enters in. But the purchase of any
kind of bill cannot be counterbalanced by a sale of cables without both a
speculation and an investment of funds being involved . And so a banker
cannot base his buying rate for long bills upon the cable rate without putting
into the spread one speculative element, or one factor that is guesswork.
The point remains even if under very quiet conditions the degree of speculation may be slight . . .
"The rates for exchange which takes the form of written instruments
that have to be transmitted by mail to the place where they are payable,
happen then to be more intimately connected with each other than with
the rate for telegraphic transfers. The sight rate is basic among this larger
group. The sight rate and the cable rate are related , but the spread between them contains an ineradicable speculative element. Whether the
cable rate is in some theore tical sense the basic one as between these two,
is a question that it is practically idle to discuss. In point of fact the sight
rate is not determ ined by a calculation from the cable rate. . . . Under
ordinary conditions at least, the market would no more think of calculating
sight rates from cable rates than the tail would think of wagging the dog." 1
In actual practice the sight rate is always the starting point in all
exchange calculations whether they concern the purchase of short or
1 Op . cit. pp. 273-4 .

RATES OF FOREIGN EXCHANGE

349

long bills or the exchange rate at which gold may be profitably imported or exported.
A bank at any particular moment may be selling cables on London
at 4.8715, sight drafts at 4.8675, 60 day drafts at 4.8305 , and 90 day
drafts at 4.815 . In quoting the cable rate, the cost of the message
itself is not included . Cables command a higher rate because they
call for immediate payment. It takes but a few hours from the time
a cable is sent until the sum it represents is deducted from the foreign
account of the selling bank. From the standpoint of the dealer the
sale of a cable allows no opportunity to earn interest on the transaction. If he sells a sight draft he has the use at home of the money
which he receives for it and for the length of time that it takes the
draft to reach London and be paid. In the meantime he also receives
interest on an equal amount of money in his foreign account. Because
he gains no interest on the sale of cables, he charges a higher rate therefor than for other kinds of exchange. From the standpoint of the
purchaser it can be said that the cable enables him to wait until the
last moment before making payment abroad, and so makes it possible
for him to retain the use of his money for that length of time. The
purchaser is willing therefore to pay more for a cable than for other
kinds of exchange. If money rates are high, the purchaser in buying a
sight draft will lose more interest than when money rates are low, and
vice versa .
If he buys a cable when local money rates are high, he
gains more interest on his money at home and is therefore willing to
pay a higher rate for a cable than when money rates are low. Money
rates thus exert an influence upon the spread or difference between
the rates paid or charged for demand bills on the one hand and those
paid or charged for cables and long bills on the other. During 1908-09
a period of cheap money in the United States, the rates for sterling
cables and demand drafts were often less than one-half cent apart.
The rates charged by a bank for 60 and 90 day bills, as well as the
rates at which a bank will purchase such bills, are less than the rates
charged or paid for sight drafts because the bank gains interest on the
funds in the case of long bills sold, and loses it in the case of long bills
purchased . If a bank sells a 60 day draft to a customer, the bank
has the use of the money received therefor, as well as the interest on an
equal sum of money in its foreign account, during the days that
intervene before the draft is cashed and its face value deducted from
the foreign account of the issuing bank. The purchaser of a long bill

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DOMESTIC AND FOREIGN EXCHANGE

invests his money a certain number of days ahead of time with the
result that he loses interest on the amount involved. He will therefore not pay so much for a long bill as he will for a sight draft. Likewise when a bank buys a 60 day draft from an exporter, if it is a D/A
bill, the bank will not be able to obtain the face value of the draft unless it holds the draft until maturity, in which event it will lose interest
on the funds invested for the time involved. If the bank orders its
foreign correspondent to discount the D/A bill immediately upon
acceptance —and the greater part of such bills are immediately discounted-the bank receives the face value of the draft minus the discount. The bank will in the first case lose interest for the time involved, while in the second case it will lose the discount charged .

A

bank cannot afford, therefore, to pay as much for a long bill as it can
for a sight draft. If the long bill that the bank purchases from the
exporter is a D/P bill , it cannot be discounted in the London market ,
and the bank may have to wait until the maturity date before it gets
its money out of the transaction. If the acceptor pays the bill before
maturity the bank is compelled , according to the custom of the trade,
to give him a rebate.¹ The rebate rate, as a rule about 1 per cent less
than the discount rate , causes less pounds sterling to be taken off the
face value of the bill than if the bill is discounted. Because of this
fact, certain types of D/P bills that it is highly probable will be paid
as soon as presented for acceptance command higher rates of exchange
than do some kinds of D/A bills . As Escher says, " . . . bills
for payment drawn against perishable goods which must be paid
under rebate as soon as the goods arrive, command a better rate of
exchange than even the best bills where documents are handed over
to the consignee on acceptance." 2 Sixty day D/P bills against grain
shipments are usually, though not always, purchased by exchange
dealers at higher rates than even the very best D/A cotton bills drawn
on English bankers.3

1 Cf. p. 144.
2 Jefferson and Escher, op. cit., p. 315.
On May 6, 1898, rates for grain payment bills on London were 4.80% @ 4.8034, while
rates on sterling cotton acceptance bills were 4.804 @ 4.80% , and on cotton payment
bills, 4.79 % @ 4.7934 . Again, to cite another instance, on September 5, 1913, the rates
for commercial acceptance bills on London banks, including cotton acceptance bills, were
4.804 @ 4.822 , while grain payment bills were at 4.82 @ 4.824 , and cotton payment
bills at 4.8134 @ 4.82 . As stated above, grain payment bills do not always command higher
rates than cotton acceptance bills. Thus, to cite only one instance out of many: on June 3,
1898, rates for sterling cotton acceptance bills stood at 4.8334 @ 4.84, while rates for sterling
grain payment bills stood at 4.83¼ @ 4.83 1/2.

RATES OF FOREIGN EXCHANGE

351

When a bank purchases a trade acceptance, another element appears that is frequently overlooked by the student of the exchanges,
and that is that the risk of non-payment increases with the usance
of the draft. A firm may be of excellent standing at the time that
it draws or accepts a draft, but before the bill matures the firm
may have become bankrupt. Again, in two or three months'
time the money rates in the market may fluctuate so adversely
as to wipe out the holder's profit. The time element, therefore,
must always be considered by the banker in buying acceptance
paper.
Cables are always higher and long bills are always lower than sight
bills. Their rates will ordinarily roughly parallel the sight rate, the
long rates being at a greater distance below the sight rate than the
cable rates are above it. This again is because the element of time
is involved, the time in the case of long bills being greater than in the
1
case of cables. Referring to Charts II and III, 2 and to Tables XI 3
and XII 4 it will be noted that sterling cable rates are normally from
25 to 50 points higher than sight rates.

Naturally, of course, there

are exceptions to this general statement, as, for example, during the
panic of 1907-08 when at one time cables were 375 points higher than
sight bills 5 although a few months later they were only 10 points
higher.

Again during the first days of August, 1914, a most surprising

spread occurred when sterling cables were quoted at 7.00 with sterling
sight at 6.00, a spread of 10,000 points.

Sterling bankers' 60 day

bills will usually range from 350 to 425 points below sight bills,
while 60 day D/A commercial bills on banks will range from 500 to
650 points below sight bills, a spread of about 150 to 225 points
greater than in the case of bankers' bills.

For example, during the

period of 1907-08, the spread for sterling bankers' 60 day bills ranged

1 P. 362.
2 P. 363.
8 P. 360.
4 P. 361.
5On November 7, 1907, the highest sterling sight rate was 4.865 and the highest cable
rate, 4.90, a spread of 334¢ or 375 points.
• On August 17, 1908, the highest sterling quotation was 4.865 and the highest cable
quotation was 4.866, a spread of 1/10¢ or 10 points.
7 The average spread between the lowest quoted cable rates for sterling and the lowest
quoted sterling sight rates, taking only the closing weekly quotations for the period, October,
1907-September, 1908, was 23 points; and for 1913, 50 points. Cf. Tables XI and XII,
pp. 360-361 .

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DOMESTIC AND FOREIGN EXCHANGE

from 120 to 775 points, and for 60 day D/A commercial bills on banks
from 140 to 1025 points. '
A question that inevitably arises in connection with any discussion
as to the effect of the length of the life of the bill upon the rate is,
what determines the spread, i. e. , the variation between the demand
rate on the one hand and the rates for cables , short bills and long bills
on the other. In considering this question, the student must not overlook the fact that the exchange dealer acts in a dual capacity, i. e.,
he is both buyer and seller. As a buyer he has to consider the value
of his money as it stands, part of it abroad in foreign accounts and
part of it at home in his own vaults or loaned out in the home market.
Are there plenty of satisfactory investment opportunities at home;
are his funds that are invested locally earning as much as they would
if invested in a bill of exchange to be discounted later at the rate existing in the foreign money market ; can he secure a larger return on his
money by investing it in such bills of exchange to be discounted abroad
or paid under rebate or held until maturity, or, on the other hand,
can he make a greater return by keeping his funds loaned out on call
in the home market? As a seller of exchange, he has to keep in mind
whether his money abroad is earning a higher return than it would
if he should bring it home through the sale of exchange and loan it
on call in New York City. If he sells cables he will lose part of his
account in London immediately and at the same time add to his funds
in New York. If he sells sight exchange or long bills he will have the
use of his funds in London until the drafts are paid and at the same
time the use at home of a sum of money equal in amount to the face
value of those drafts. As a buyer of exchange he loses the use of money
in New York and is out of the funds covering the transaction until
he has realized on the exchange in the foreign center. Thus, no matter
in what capacity he acts, and no matter what sort of exchange he buys
or sells, he will be governed primarily, though not necessarily solely,
by the money rates prevailing both at home and in foreign centers.
May we not therefore lay down the general rule that money rates
both at home and in foreign centers are the important, but not the sole,
1 From October, 1907, to September, 1908, the average spread between the lowest quoted
sight rates and the lowest quoted bankers' 60 day bills, using only the closing weekly quotations, was 310 points, and for the year 1913 , 393 points. From October, 1907, to September,
1908, the average spread between the lowest sight rates and the lowest quoted 60 day
D/A commercial bills, again using only the closing weekly quotations, was 356 points, and
for the year 1913, 591 points.

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353

#

factor that determines the spread? There are so many other influences
at work affecting exchange rates-just as in the open market there are
so many influences affecting the price of any commodity-that the
most that can be said of any " law " or " principle " in this connection
is that, " In general, it may be true, " and that " Under all circumstances it must be interpreted and applied in a most general and
liberal manner. " In fact, no law or definite rule can be laid down.
At best one can offer only an " explanation." In the field of commodity
prices, we have no universally accepted law that explains where individual prices are fixed and why. All suggestions are mere theories or
explanations. All that can be said is that out in the market the seller
tries to fix his prices at those levels that will net him a profit, large or
The same general statement
small as the circumstances permit .
applies to the question of the spread between exchange rates. A
grocery storekeeper does not know whether he has made a profit until
he strikes a balance at the end of his business year. He cannot know
whether or not each article that he is selling is bound to yield a profit
in the end. But he tries to watch his expenses and his prices in the
hope that his business will be profitable. The same is true of the exchange dealer. He has funds to invest. He tries to keep them at work
and to the best advantage. He hopes at the end of, say, every six
months, to strike a balance sheet that will show a profit, and it is his
funds, the money rates abroad, and the money rates at home that
are the elements with which he works and from which he hopes to
derive his profits.

21
In considering the spread between sight exchange and long bills
many writers concern themselves solely with the influence of the
foreign (domicile country) rate of discount. Others , quite properly,
also include the discount rate of the home (drawing) country. Practically all writers declare or imply that the discount rates abroad and
at home are the only factors that enter into the calculation of the
spread in the market and that as discount rates rise one per cent the
long bill rate should fall one per cent. , and vice versa ; in other words,
that there is a rather direct or proportionate relation existing between
the rise and fall in the discount rate, especially the foreign discount
rate, and the rates ruling for long bills. Whitaker, more careful than
the rest, remarks that, " In an ordinary case, perhaps 9/10 of the spread
will be due to discount. "
He then raises the question as to " which

1 Op. cit., p. 599.

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DOMESTIC AND FOREIGN EXCHANGE

discount rate is it that governs, that in the drawing city (e. g., New
Let us proceed
York) or that in the domicile city (e. g. , London) ."
to take up the various points involved, first theoretically and then
practically to see whether or not we can discover a " theory " or " law "
that is wholly or partially applicable to actual transactions.
Theoretically an exchange dealer having funds at home and abroad
will always shift his funds back and forth in order to get the greatest
possible returns. If money rates are higher at home than abroad he
will bring his funds home and will refuse to invest money in foreign
bills. Bringing his funds home involves the sale of exchange, primarily
cables and sight, with a resultant increase in the supply of exchange
on the market. His refusal to invest in foreign bills means a decrease
in the demand therefor. An increased supply and a decreased demand
normally cause a lowering of exchange rates. Sight rates cannot fall
lower than the gold import point and remain below it for any length
of time because of the corrective influence of the gold flow.2 The
rate for long bills is not directly affected by the gold flow except as it
(the long rate) is tied to the sight rate. If bankers can purchase long
bills at rates low enough so that they are able to obtain therefrom a return equal to the rate being paid on money in the home market, they
will invest. In other words, they will then purchase the exporter's bills
at the higher home discount rate, which will cause long bills to sell for
a low rate and thus increase the spread between the long rate and
the sight rate. The long bills will then be sent abroad and discounted
at the lower discount rate in the domicile (foreign) country, thus
netting the exchange dealer a nice profit. However, competition
develops among the local exchange dealers who actively bid for the
exporters ' bills in order to make the larger than customary profit,
and as a consequence the rate for long bills rises, and the spread
between it and the sight rate decreases. If competition is strong
enough, the long bill exchange rate may be raised so high that the
home bankers will receive only their discount on the face of the bill
calculated at the lower foreign discount rate. Thus in this case the
maximum spread would be fixed by the lower discount rate abroad.
The day to day spread would fluctuate between these two extremes.
It must always be remembered that the exchange dealer uses the
present or existing sight rate as the basis for his estimate of the value

1 Op. cit., p. 599.
2 Cf. pp. 412-413.

RATES OF FOREIGN EXCHANGE

355

of a long bill of exchange. The other two factors in his calculations are the discount rates at home and abroad existing, again, on
the day of his purchase, although as has been noted earlier, ¹
"forward discount " rates sometimes enter into exchange calculations.
To reverse the process, suppose the foreign discount rate is higher
than the home discount rate. This signifies that bankers ' funds will be
more valuable abroad than at home. The banker will hesitate to sell
sight or cable exchange because he wishes to keep his funds profitably
employed abroad. He will likewise be in the market as a buyer of
sight or cable exchange so as to send his funds abroad in order to obtain the larger return. The decreased supply and the increased demand
will tend to raise the rates for sight bills and for cables. Sight rates
will rise, but they cannot exceed the gold export point for any length
of time because of the corrective influence of gold exportations.2 But
what of the rate for long bills? Long bills if purchased and sent abroad
for discounting will have to be discounted at the higher discount rate,
i. e., more will have to be taken off their face value,-they will not be so
valuable as they would be with a lower foreign discount rate. Hence
the bankers will pay proportionately less for them. This results in a
low price for long bills and a greater spread between the long rate
and the sight rate. Bankers, however, then see the advisability of
investing their funds in the low priced long bills to be held until
maturity, because by so doing they will receive the higher discount
thereon (calculated on the basis of the higher foreign discount rate) ;
and with the low money rates in the local market, such investments
may prove to be more profitable than any other form of paper. Competition for such bills again develops, but this time for investment,
not for discount as was the case in the former example. This causes
the rate for long bills to rise and decreases the spread between the
long and the sight rate. But the long rate cannot rise any higher than
will be permitted by the existing lower discount rate in the home
country. In other words, bankers will not pay a higher exchange rate
for long bills that will yield them a smaller return (calculated on the
low home discount rates) than they can get by investing their funds
in other kinds of paper. Hence, again, the higher discount rate, this
time the foreign discount rate, fixes the maximum spread; and the
lower discount rate, this time the home discount rate, fixes the mini2 Cf. pp. 412-413.
1 Cf. pp. 314-315 .

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mum spread . The spread from day to day will vary between these two
extremes. But in both this and in the former example, the tendency
will be for the lower discount rate to govern , i. e. , to exert a strong influence in decreasing the spread between the sight rate and the long
rate through the competition of the exchange dealers for the more
profitable form of investment. The lower discount rate will not completely govern because there is always a possibility of a fall in the
sight rate which might wipe out profits if the long bills have been
purchased on the basis of the lower discount rate. When sight rates
are high, which is apt to be the case when foreign discount rates are
high, there is always a possibility of their declining somewhat. High
discount rates increase the demand for exchange , raise the sight rate,
and attract funds. Ample funds being thus obtained, the discount
rate falls and demand for exchange eases off, and the sight rate falls.
The dealer always has to take the future trend of exchange rates into
consideration in purchasing long bills, the returns from which are to
be used as the basis for future sales of cables and sight drafts. So the
dealer will not be willing to approach too close to the margin, and
therefore will not calculate his purchase price for long bills on the basis
1
of the lower discount rate, but always somewhat above it.¹
1 Whitaker, who presents an excellent discussion of this entire matter of the spread,
takes a slightly different point of view. He states that, "When the discount rate in the
domicile city is the lower of the two, it alone governs that part of the spread due to discount.
When the discount rate in the drawing city is the lower, it may affect, though it will not fully
govern the spread. Stating this in a slightly different form, the spread can never be greater
than the figure proportionate to the discount rate in the domicile city, but it may be less
than this when the discount rate in the drawing city is lower, though it will not become
much less." The reason assigned for the last statement is that with a high money rate
abroad and a low money rate here, the home bankers will bid actively for foreign long bills,
which they will hold as an investment. This active bidding raises the exchange rate, which
results in a decreased spread , but the spread will not be decreased sufficiently to correspond
to the lower money rate existing in the home market. Whitaker , who follows the rule advanced by Prof. N. G. Pierson (" Principles of Economics," London, 1920, pp. 527-9) ,
would undoubtedly accept Pierson's statement that when the rate is lower in the foreign
country (e. g., London) it governs that part of the spread due to discount because, as Pierson says, "As the London rate of discount is known everywhere , holders of long-term bills
on London will not accept a lower price for them than that for short-term bills, less interest,
at the rate current in London." Theoretically this is correct , for in the field of theory we
go on the basis of all buyers and sellers being supplied with all the available and necessary
information regarding a situation, and being free to act according to their desires in the
matter. Practically, this is not true, because exporters who have bills to sell do not know
the market and are usually not in touch with its trend , possibilities, etc. They have no
correspondents in London to whom they can send their bills if they are not satisfied with
the exchange rate offered by the New York dealer. Of course, if over a long period of time
they become thoroughly dissatisfied with the prices offered for their bills, they may possibly make connections with London correspondents, send their bills abroad, have them
discounted, and the proceeds credited to their account in a foreign bank. But such a state

RATES OF FOREIGN EXCHANGE

357

Looking at the matter from a slightly different angle, one might
think that the difference or the margin between the discount rate at
home and that existing abroad might give a clue to the variation in,
or serve as a sort of gauge in estimating, the spread between sight
1
and long bills. Clare ¹ in following out this idea approaches the problem from a slightly different point of view, suggesting that the variation of the sight rate from the long rate is due to the influence of the
discount margin. He claims that if, because of a better discount rate
existing in the domicile (foreign) country, the dealer bids higher for
long bills on that country so as to invest his funds therein , he will in
turn be compelled to sell sight exchange on the domicile country at a
higher rate. Consequently, there is a close but not an " arithmetical
relationship between an increase in the discount margin and a rise
in the sight-exchange." 2 Clare seemingly attempts to tie the sight
rate to the long rate, rather than the long rate to the sight rate, through
the variations in the discount margin. He presents some interesting
charts with explanations that appear to justify his general conclusions
for the years which he examines. We shall shortly 3 apply his theory
to sterling rates in the United States during a normal and an abnormal
year, and shall then see whether or not his explanation is of any service in helping us to solve the problem we are now discussing.

We have omitted thus far all mention of the varying rate of profits
that a banker expects to get through the purchase of long bills. The
profit usually runs from 1/8 cent to 2 cents. In our theoretical discussion we have been dealing with all bankers as a class, all of them
calculating prospective profits on the same basis, and all being unmoved by any other circumstance than the cold single purpose of buying long bills for the largest possible profit. In actual practice, one
banker might be content with a profit of 1/8 cent, another with nothing
less than one cent, etc. The minimum and maximum spreads in each
case would necessarily be different. Or if no profit were to be made by
any banker, the minimum and maximum spreads would not be the
same as though we had included a varying profit, although they would
be proportionately just as far apart.
of affairs would not normally occur. It is because of this fact that the lower foreign discount rate does not govern so completely as Pierson and Whitaker seem to suggest is the
case.
1 "The A. B. C. of Exchanges," Chapters 14-16.
2Op. cit., p. 92.
Cf. pp. 359-364.

358

DOMESTIC AND FOREIGN EXCHANGE

When we come to a consideration of the spread between cable and
sight bills, we find that theoretically it is supposed to be gauged or
determined, not by the open market discount rate prevailing in the
foreign or home markets, but by the rate of interest allowed dealers
on their foreign accounts, i. e., the deposit allowance rate.

This is

closely tied to the official bank discount rate, being usually one per
cent lower. As we have seen, when an American banker sells a sterling
cable he loses the amount of the cable, within a few hours, from his
London account. Had he sold a sight draft he would have obtained
the interest on the foreign account for at least six days longer (not to
mention the use of an equal sum of money at home during the interim).
Consequently, when he sells a cable he is supposed to charge not less
than the rate for sight bills plus the interest lost on his foreign balance.
If the sterling sight rate is 4.87 , and the London deposit allowance
rate is 3 per cent, he would presumably not be willing to sell a cable
for less than 4.87 plus the loss of six days' interest at 3 per cent, or
4.8724 (4.87+ [6/360 X 3 per cent X 4.87 ]) .

The closest quotation

to 4.8724 would be 4.8725 . This rate would not include a profit, yet it
involves a spread of 25 points. If a profit were to be obtained the rate
would have to be made correspondingly higher and the spread therefore greater.
We saw that too great a spread between sight and long bills proved
to be its own corrective through the heavy purchase of long bills by
bankers, thus raising the rate for the latter and thereby decreasing
the spread. Too small a spread would likewise prove to be its own
corrective because if the spread should perchance become so slight
that the bankers would not be able to make the lower discount rate
on their investment of funds, they would refuse to purchase, thus
reducing the demand for exchange and consequently increasing the
spread. Customers who would purchase bankers ' 60 day bills for
remittance abroad would find it financially worth their while to purchase sight drafts rather than pay the high rate for 60 day bills. This
would increase the demand for sight bills, would tend to raise the
sight rate, and so increase the spread. Likewise in the case of cables
and sight bills too small a spread is normally its own corrective. If
the two rates get too close together, bankers are able to sell demand
bills at high rates as compared to cable rates. This will cause them
to go so far as to sell short, hoping to cover at about the same rate by
means of cables. They will therefore receive the money from their

RATES OF FOREIGN EXCHANGE

359

sale of demand bills and will have the use of it for at least six days
before having to purchase cables to cover. Selling demand bills short
increases the supply of sight exchange and lowers the rate. Covering
with cables means an increased demand for cables and a higher rate
therefor. The increased supply of sight bills and the greater demand
for cables tend to push the rates farther apart and to bring the spread
back more nearly to normal. If the spread between cables and sight
bills becomes too great, bankers will appreciate the extra profits that
can be made from the sale of cables and will take steps immediately
to create or obtain a larger checking account abroad so as to use it
for that purpose. A demand will therefore arise for any kind of exchange that can be sent abroad and realized on . The exchange rates
for long bills and for sight bills will rise and the spread will decrease.
On the other hand, too high a rate for cables as contrasted with sight
bills, i. e., too great a spread, will lead to a decrease in the demand
for cables. Customers will prefer to satisfy their needs where possible
by means of sight bills. This decreased demand for cables will have a
weakening effect on the cable rate and will tend to reduce the spread.
For the time being the demand may be so unusually heavy that the
rates may rise to unheard of levels, as was true during the strenuous
days of August, 1914, but in the long run the supply is increased or
the demand is decreased, and the spread again reverts to normal.
In order to test the theory of spreads outlined above, two typical
years have been taken, 1913 for a normal period and the period , October, 1907-September, 1908, for an abnormal period characterized by
panicky conditions and not by a world war. A study has been made
of sterling rates during those two years. The accompanying charts
(Charts II and III) and tables (Tables XI and XII) present the necessary data upon which to base our discussion. The tables show the
closing weekly sterling rates for 60 day D/A commercial bills on banks,
60 day bankers' drafts , sight bills, and cables ; the spread between
the sight rate and the other three rates; the average call rate for money
in the New York market for each week taken from the Financial
Review (New York) ; the discount rate in the London money market
for three months' bills, taken from the London Economist; the
discount margin calculated weekly by the London Economist, showing how much higher or lower the London open market discount
rate for three months ' bills is than the New York call rate; and, finally,
the deposit allowance rate in London.

Allowance
Deposit

Economiste
Differenc

Call
Y.
N.
Rate

Rate

2

4
Cable

3
Sight

60
Day
CD
/Aom❜l

Mo.

I

Day

SPREAD

STERLING RATES

60
Day
Bank
' ers

DATE

London
Open
Market
Discount
Rate

TABLE XI - OCTOBER, 1907, TO SEPTEMBER, 1908

3-I

3-2

4-3

Oct.

N

5 3 15/16 1/16 below 3 %
54.8190 4.8240 4.8580 4.8680.0390.0340.0100
54 1/8
1 5/8 above 3
| 12 |4.8210 4.8235 4.86254.8685.0415.0390.0060
54 3/8 1 5/8 below 3
194.82 4.82104.86 4.8675.0400.0390.0075
66
3
264.7675 4.7775 4.8225 4.8650.0550.0450.0425 404 5/8 15 3/8
Nov. 24.78 4.79 4.8675 4.885 0875.0775.0210 50 5 11/16 11/16 above||4
66
3/4 66 14
94.765 4.7875 4.8575 4.8825.0925.0700.0250 22 6 3/4
7/8
4
164.785 4.81 4.8775 4.9075.0925.0675.0300 IO 6 7/8
1/8 below 4
23 4.78 4.795 4.87104.9025.0910.0760.0315 ΙΟ 6 7/8
7 6 1/8 3 1/8 above 4
.07 10.0685.0140
30 4.795 4.7975 4.8660 4.88
6 5 3/4
Dec. 74.80 4.8050 4.86 4.87
3/4 66 14
.0600.0550.0100
66
.0610.0585.0140 18 6
2
14 4.795 4.7975 4.8560 4.87
14
4
214.8025 4.810 4.86 4.8830.0575.0500.0230| 12 5 7/8 3 1/8 below
66
2
14
284.785 4.795 4.845 4.8675.0600.0500.0225 20
66
2
14
Jan. 44.80 4.8035 4.85304.8630.0530.0495.0100 ΙΟ 15
4
114.81 4.8115 4.8550 4.8605.0450.0435.0055 6 4 9/16 1/16 above
66
4 4 1/4 I 1/4
32
184.8225 4.8275 4.8670 4.8725.0445.0395.0055
2 3 5/8 I 5/8
22
25 4.8325 4.8365 4.87 4.8775.0375.0335.0075
Feb. 14.8325 4.8370 4.8685 4.8730.0360.0315.0045 1 3/4 3 1/2
I 1/2 66 22
84.8250 4.83 4.8635 4.8665.0385.0335.0030|| 1 7/8 3 3/16 I 13/1666" 22
154.8190 4.8230 4.8585 4.8615.0395.0355.0030 1 7/8 3 3/4
1 3/4 66 22
22
I 3/4
| 22 | 4.8290 4.8340 4.8665 4.8705.0375.0325.00401 3/4 3 1/3
22
294.8325 4.8350 4.8670 4.8720.0345.0320.0050||1 3/4 3 5/16 1 9/1 6 66
I
2
Mch. 7 4.8312 4.8345 4.8635 4.8660.0323.0290.0025 1 7/83
66
2
144.8275 4.8315 4.8590 4.8615.0315.0275.0025||1 7/8||2 15/16|| 15/16 66
1½
214.8312 4.83404.86 4.8630.0288.0260.0030 1 7/8 2 11/16|| 11/16
| 28 | 4.83654.8385 4.8630 4.8655.0265.0245.0025|| 2
2 5/8
7/8 above 12
66
1½
3/4
Apr. 44.84 4.8425 4.8646 4.8675.0246.0221.0029||1 5/8||2 1/2
66
114.84 4.8435 4.8680 4.87
.0280.0245.0020 |1 3/4 2 7/16 15/16
1½
184.8430 4.8475 4.87 10 4.8750.0280.0235.0040 1 1/2 2 5/8 1 1/8 66
1½
254.8445 4.8480 4.8730 4.8760.0285.0250.0030|| 1 3/4||2 11/16|| 15/16 66
1½
5/8
May 24.8420 4.8435 4.8690 4.8715.0270.0255.0025 1 7/8 2 5/8
66
1½
3/8
94.845 4.8490 4.87 20 4.8770.0270.0230.0050|| 1 3/4 ||2 3/8
12
16 | 4.8480 4.8510 4.8705 4.8730.0225.0195.0025||1 3/4||2 1/16 5/16 66
1½
234.8485 4.8525 4.8710 4.8735.0225.0185.0025 1 1/2 1 15/16 3/16
1
30 4.8520 4.8555 4.8715 4.8740.0195.0160.0025 1 5/8 1 9/16 3/16 below
66
I
June 64.8512 4.8545 4.8690 4.8720.0178.0145.0030||1 1/2|| 1 5/16 3/16 66
I
3/16
134.8485 4.85304.8680 4.8705.0195.0150.0025 | 1 5/8 1 1/2
66
I
1/2 66
204.8525 4.85404.8685 4.87
.0160.0145.0015 1 1/2 1 1/4
I
27 4.8535 4.85604.8695 4.8720.0160.0135.0025|1 1/2||1 5/16 3/16
1/8 above 1
July 44.8540 4.8575 4.8690 4.8710.0150.0115.0020 I 1/2 1 1/8
I
114.8540 4.8570 4.8695 4.8715.0155.0125.0020 | 1 1/4 1 3/16 1/16 below
66
I
1/4
184.855 4.8575 4.8695 4.87 10.0145.0120.0015 1 1/4 1 1/4
1/8 above
1
25 4.85 4.8525 4.8675 4.8695.0175.0150.0020 | 1 1/4 || 1 3/8
66
I
1/8
Aug. 14.85 4.8525 4.8685 4.8705.0185.0160.0020|| 1 1/8 1 3/8
I
1/8
1 3/8
84.8465 4.85 4.8645 4.8660.0180.0145.0015 |1
15 4.8485 4.85 4.8640 4.8660.0155.0140.0020| 1 1/8 1 7/1613/16 below 1
1
|22 |4.8425 4.8465 4.86 4.8615.0175.0135.0015 I
1 5/16 5/16 above
66
I
29 4.8375 4.8425 4.8575 4.86
.0200.0150.0025 1 1/8 1 7/16 3/16 66
I
Sept. 54.8425 4.8450 4.86 4.8625.0175.0150.00251
1 7/16 3/16
124.8455 4.8490 4.8645 4.8670.0190.0155.0025 1 1/4 1 9/16 7/16 below I
1/8 below 1
194.8475 4.8505 4.8625 4.8665.0150.0120.0040||1 3/4||1 3/8
3/8 above 1
| 26 ||4.8465 | 4.8490| 4.8635 |4.8655 || .0170| .0145.0020|| 1 1/4 || 1 3/8

Allowance
Deposit

Economiset
Differenc

4

Cables

3
Sight

Rate

2

60
Day
'
Bankers

60
Day
Com'l
DIA

Day

Mo.

H

Jan.

SPREAD

STERLING RATES

Call
Y.
N.
Rate

DATE

Market
Open
London
Discount
Rate

TABLE XII-JANUARY TO DECEMBER, 1913

3-I

3-2

4-3

32 %
3½
3½
3/2
32
3/2
3½
3½
3½
3/2
3½
3½
3½
3/2
3½

333

44.7975 4.82054.8640 4.8685.0665.0435.0045 5 1/8 4 9/16 1 3/16 below
114.8087 4.8290 4.8675 4.8715.0588.0385.0040 2 7/8 |4 7/16 1 11/16 above
66
18 4.81 4.8310 4.8725 4.8770.0625.0415.0045 2 3/44 9/16 || 1 13/16 "6
254.8162 4.8350 4.8760 4.8825 . 0598.0410.0065|| 2 5/8||4 5/8 1 7/8 66
Feb. 14.81 4.8310 4.8730 4.8785.0630.0420.00552 3/4 4 3/4 2
66
84.8137 4.8350 4.8775 4.8835.0638.0425.0060| | 2 5/8||4 3/4 1 7/8
15 4.81 4.8290 4.8725 4.8798.0625.0435.00653 7/84 13/16|| 13/16 66"
214.81 4.8305 4.8745 4.8815.0645.0440.0070|| 3 5/8||4 13/16|| 1 5/16
Mar. 14.8112 4.83104.8750 4.8830.0638.0440.00803 1/8 4 3/4 I 3/4 (6
66
84.815 4.8350 4.8775 4.8850.0625.0425.00803 3/84 3/4 I 3/4
1/8 below
15 4.8025 4.8255 4.8705 4.8785.0680.0450.0080 4 1/2 4 3/4
1/8 above
| 22 | 4.8075 4.8270 4.8720 4.8810.0645.0450.0090||4 1/24 7/8
1/8 66
294.81 4.8315 4.8715 4.8800.0615.0400.0085 4 3/84 5/8
Apr. 54.8125 4.8325 4.8705 4.8760.580.0380.00554 7/8 4 5/16 5/16 "C
12 4.8125 4.8275 4.8645 4.8700.520 .0370.0055 3 3/4 4 1/16 5/16
7/8 "6
3 5/8
194.8112 4.8300 4.86404.8680.0528.0340.00403
0335.0030
/16 "
13
16
4
52
26 4.8175 4.83304.8665 4.8695.0490.
||3
9/
||2
3/
03
8.0370.0
May 3 4.8112 4.8300 4.8670 4.8705.055 0340.0040 3/4 ||3 15/16 || 1 3/16 "
104.8112 4.8260 4.8600 4.8640.0488.0355.0040||2 5/8 3 9/16 13/16 "66
3.
7/8
174.8112 4.8270 4.8625 4.8665.051 5.0340.002522 7/8 3 3/4
24 4.8125 4.8300 4.8640 4.8665.0510.0345.0035 3/4 3 9/16 I 1/16 "
52
.0
25
/16 "
/16
4
314.81 4.8300 4.8645 4.8680
0390.0030 2 3/ 3 11 || 15
5
June 74.81254.828 4.8675 4.8705.0550. 90.0030||2 3/4 ||4 3/16 I 7/16 "
66
70
03
86
2 1/4 66
4.87 10.0595. 0385.0045 ||2 1/24 1/4
14 4.8075 4.82804.
573.
4
4
1/4
2
1/
0
|21 | 4.81124.8300 4.8685 4.8730.057
|2
08
.0
0370
4 1/4 2 1/4 above
28 4.81 4.8300 4.8670 4.8750.0 0. 90.0045| |2
66
8.03
4 1/4 2 1/4 66
July 5 4.8087 4.8315 4.8705 4.8750.0618.
.0050 |2
85
03
58
.0
87
4
1/4
1/4
2
||2
124.80 4.8290 4.8675 4.8725
0
05
66
0355.0
I 3/4 "C
194.81 4.8305 4.8655 4.8705.0560.0355.0050||2 1/4 |4
0.
1/2
I
0
2
26 4.8125 4.8320 4.8675 4.8725.055
04
||
1/
||2
4
.0
(6
560.0345
I 3/4
Aug. 24.81 4.8315 4.8660 4.8700.0 0.0325.0040 2 1/4 4
94.81 4.8325 4.8650 4.8695.0555.0345.0035 2 1/43 7/8 I 1/2
54
16 4.81 4.8300 4.8645 4.8680.0 5.0340.003522 1/43 13/16 1 9/16 "
23 4.81 4.8285 4.8625 4.8660.052 0320.0035 1/4 3 13/16 1 9/16 "66
30 4.805 4.8255 4.8575 4.8610.0525. 25.003522 1/43 5/8
I 1/4 66
03
7/8 66
Sept. 64.805 4.8230 4.8555 4.8590.0505.
35.00302 3/4 |3 5/8
03
8.
52
.0
37
I
134.80 4.8230 4.8565 4.8595
.00353 3/4 3 1/2
75
03
5.
57
3 15/16 15/16 "
20 4.80 4.8200 4.8575 4.8610.0
66
03
0403
.005
55.0
0305
4 1/8
3.04
I 3/8
583.
27 4.7962 4.8190 4.8545 4.8585 .062
.0
2
6
11/16
1
/1
Oct. 44.796 4.8180 4.8585 4.8635
11
4
03
05
.0
66"
0395
7/8 66
114.7912 4.8160 4.8555 4.8605.0643.0420.0050 3/4 4 3/4
5.
64
.0
24
1 3/8 66
18 4.7875 4.8100 4.8520 4.8570
0435.0045 3 1/ 7/8
1 7/8 66
25 4.7875 4.8075 4.8510 4.8555.0635. 0445.005043 1/4 4 7/8
5.
68
.0
5
I 7/8
Nov. 14.782 4.8065 4.8510 4.8560
0450.0045 1/4 |5
84.7825 4.8045 4.8495 4.8540.0670.0445.0045 4 1/4 4 15/16 || 15/16 "
0.
67
.0
15 4.7875 4.8100 4.8545 4.8590
033 3/4 || 4 15/16 || 1 3/16 "66
8.0445.005
2 1/2 66
15
22 4.7937 4.8100 4.8545 4.8595.060
1/8
4 3/4
29 4.7875 4.8085 4.8525 4.8580.0650.0440.00554
4 7/8
5/8 below
Dec. 64.7875 4.8100 4.8535 4.8595.0660.0435.0060||6
66
4 13/16 11/16
134.7887 4.8090 4.8540 4.8590.0653.0450.00507
20 4.7912 4.8090 4.8535 4.8590.0623.0445.0055 3 1/24 15/16 11/16 below
1/5 above
274.7912 4.81004.852014.8605 | 1.06081.04201.00853 5/84 3/4

3

13
3
3
3
3
3
3
3
13

3
3
3
3
3
3
3
3
13
3½
32
32
3½
32
3%
3½
3/2
32
32
3½
3%
3½

DOMESTIC AND FOREIGN EXCHANGE

362

These data are plotted on Charts II and III. A glance at either
of the charts is sufficient to show that no close or proportionate correspondence exists between any of the spreads and the New York call
rate, the London discount rate, the Economist's " difference " or

61

22

σε

SDO

Cables
Sight Drafts
Bankers
88Day Commercial
L
60Day
New YorkCall
MoneyRate
Discount Rate
London Open Market
London Economists Difference
London Deposit Allowance Rote
22
12
୧ 2

11
July

4.88 5
4874
1.86 3
4852
4.941
483 0
4.82-1
49/2
404-3
4774
4765
4776
476 7
4.758

Aug
81
22
Septs

discount-margin, if we may call it such, or the London deposit allowance rate. Any of the latter may rise or decline and the spread may
remain the same or move in a direction opposite to that which the
above theory holds should be the case. There are, of course, a number
of instances in which the spread moves in harmony with the theory

CHART II
Spread of sterling rates, 1907
above outlined ; but is a theory to be justified by only occasional correlations?
Picking out a few instances for the purpose of illustrating how contrariwise the spread may move, and choosing the normal year 1913
in order to avoid the criticism that no rule holds good under abnormal
conditions, let us take February 1 , 1913. The London open market
discount rate was 4 3/4 per cent ; the New York call rate was 2 3/4 per
cent; the Economist's difference was 2 per cent, and the London
deposit allowance rate was 32 per cent. The spread from the sight

RATES OF FOREIGN EXCHANGE

363

rate for cables was 55 points ; for 60 day bankers' bills, 420 points ;
and for 60 day D/A commercial bills, 630 points. A week later the
London open market discount rate was still 4 3/4 per cent ; the New
York call rate had dropped to 2 5/8 per cent; the Economist
"difference " was 1 7/8 per cent, and the London deposit allowance
rate was still 32 per cent. The cable spread had increased to 60
points ; the 60 day bankers' bill spread had increased to 425 , and the

STERLING

60-day D/A commercial bill spread had increased to 638—all contrary
to our theory. A week later, February 15 , with a very slight increase

401-2
484-

473-?

Cables
Sight Drafts
Bankersbill
toDay
Day Comme
69
rcial Bills
-New
York
te
OpelMoneyRo
London
Discount
Rate
London Economists Difference
London Deposit Allowance Rate
t

१

4

CHART III

Spread of sterling rates, 1913
(1/16 per cent) in the London discount rate, an increase of 1 2/8 per
cent in the New York call rate, a decrease of 1 1/16 per cent in the
Economist's "difference," and with no change in the London deposit allowance, there was a slight decrease in the spread of 60 day
D/A commercial bills, an increase in the spread of 60-day bankers'
bills, and an increase in the cable spread.
Considering for a moment only the cable spread and its relation to
the London deposit allowance rate, we note that from April 19, 1913 ,
to September 27 , 1913 , the deposit allowance rate remained at 3 per

364

DOMESTIC AND FOREIGN EXCHANGE

cent yet the cable spread ranged from a maximum of 80 points to a
minimum of 25 points, while from January 4, 1913 , to April 12 , 1913 ,
and from October 4 , 1913 , to December 27 , 1913 , when the London
deposit allowance rate was 3½ per cent, the cable spread ranged from
a maximum of 90 points to a minimum of 40 points. With the deposit
allowance rate at 3 per cent, the spread (25 to 80 points) was twelve
out of a possible twenty-four times within the range of the spread when
the rate was 32 per cent (40 to 90 points) , and with the rate at 3½
per cent, the spread (40 to 90 points) was 22 out of a possible 28 times
within the range of the spread when the rate was 3 per cent (25 to 80
points) . (Chart IV.) If the deposit allowance rate in London is such
Spread
a determining factor in the spread between the
100
sight rate and the cable rate, surely there should
90
be a much closer correlation than the above data
80
70
disclose.
60
A similar conclusion may be arrived at if a
comparison is made between the maximum and
minimum spread from the sight rate in the case

20
10

of the two types of long bills under discussion
and the discount rate for three months' bills in the

3/2
Deposit Allowance London open market. Chart V shows the greatest
Rate
and the smallest spreads at varying rates of disCHART IV
count for the year 1913. The conclusion to be
Relation between drawn is so evident that no discussion is needed.
cable spread and One point of importance is disclosed by this chart,
deposit allowance
however, and that is that as the rate of discount
rate in London
rises the spread tends to increase, but by no
means proportionately.
A glance at Charts II and III is sufficient to show that there is no
apparent correlation between either the New York call money rate or
the Economist's " difference," on the one hand, and the spreads either
of cables or of long bills on the other.
To conclude, and we must reach some conclusion in this attempt to
apply theory to the practical world of the exchanges-all that can be
said is that as the foreign open market discount rate rises there is a
tendency for the spread between sight bills and long bills to become
greater, but by no means proportionately greater. In fact, basing
one's conclusions upon the above discussion , might not one be justified
in disagreeing with Whitaker's statement in connection with long

RATES OF FOREIGN EXCHANGE

365

bills that " In an ordinary case perhaps 9/10 of the spread will be due
to discount" ? Also we may conclude that as the foreign deposit
allowance rate rises there is a very slight tendency for the spread
between sight bills and cables to become greater. This is all that can
be justly claimed in view of the data presented herewith .
In the transactions of the market dealers and the public are not
on a basis of equality when it comes to bargaining. The public knows
nothing of foreign discount rates or of the deposit allowance rate
that is being paid on accounts
When a business
abroad.
man wants a cable with which

Spread

to make a payment, he usually
wants it badly and does not
stop to ask why it is that

640

the banker charges a certain
rate for it. Likewise when an
exporter has exchange to sell,
he does not stop to calculate

560

Spread

680
640

600

440
520
400

480

O

why the banker gives him a
certain rate. The banker will
charge what the market will
bear, unless he himself is in
great need of funds at home

360

320

320
32

42
3%
4
4%
Percent, Discount Rate

4%

CHART V
and is selling exchange for the
purpose of transferring his
Maximum and minimum spread of
foreign account to his own sixty day D/A commercial bills and
bankers' bills at varying rates of disvaults. When he buys excount in London, 1913. Upper portion
change he buys it at what the of chart relates to spread of sixty day
market will stand, paying for D/A commercial bills; lower portion of
it no more than necessary in chart relates to spread of sixty day
bankers' bills.
order to get the exchange with
which to build up his foreign accounts. As was stated above, the
banker has three elements to consider in his money-making activities
as an exchange dealer, viz., his funds, the money rates abroad, including the deposit allowance rate, and the money rates at home. He
will lose on some deals ; he will gain on others. To a great extent he
works by rule of thumb and not with the exacting foresight and
finesse that many exchange writers would have us believe to be the

case.

366

DOMESTIC AND FOREIGN EXCHANGE

V. Financial Standing of Parties. The standing and reputation
of the drawer and also that of the importer, and if the importer and
the acceptor are two different parties then also that of the acceptor,
greatly affect the rate of exchange that bankers will pay for bills of
exchange. If the drawer has a very unsatisfactory commercial or
financial standing the bank will pay a lower rate for his bills than for
those of firms having an excellent reputation. Banks are usually very
careful about ascertaining the financial rating of the drawer or exporter. Not only do they use their own credit files for this purpose,
some of the larger banks having a very complete credit department ,
but they also consult the reports of rating bureaus such as Dun's,
Bradstreet's, etc. The standing of the importer or acceptor is also
of importance because it is the importer or acceptor who is obligated
to pay the draft at maturity. Where the acceptor is a bank, no question regarding the bank's ability to pay will ordinarily arise. But
where the acceptor is an importing foreign firm , as is the case in all
trade acceptances, its financial standing is of course important. Trade
acceptances drawn and accepted by firms of unquestioned standing
are known in England as " fine trade bills " and are discounted at a
lower rate than are other classes of trade acceptances consequently
they command a higher rate when being sold by the drawer to his
bank. Bank acceptances will sell for higher rates than trade acceptances because of the unquestioned financial status of the acceptor
and also because they are discounted abroad at a lower rate of discount.1
We have already dealt with the importance of the standing
of the drawer in connection with our discussion of clean bills of exchange. Banks will ordinarily purchase clean bills only when drawn by
first class reputable exporting firms. Some European banks make
it a practice never to deal in clean bills. The rates paid by banks to
exporters for such bills are always lower than the rates paid for documentary bills, the reason being that the risk is greater because clean
bills have no security other than the reputation of the drawer. Clean
bills issued by banks on their accounts abroad command, as one can
well surmise, the highest rates that are paid for drafts of any sort
and are discounted abroad at the prevailing market rate, while those
drawn against firms of excellent reputation are discounted at a rate
1 To cite an example: on June 3 , 1898, sterling bank acceptance rates were 4.8334 @
4.84: sterling trade acceptance rates were 4.834 @ 4.83 ½.

RATES OF FOREIGN EXCHANGE

367

about 4 per cent higher. Demand drafts drawn by exporters and
others who are not exchange dealers but who possess foreign bank
accounts, are always quoted at lower rates than prime bankers' bills.
It is also interesting to note that the bills of first-class small firms will
sell for a little less than will those of first-class large firms, depending
upon the market's estimate of the drawer's credit.
VI. Character of Goods Drawn Against. If the exporter's drafts
have been drawn against a shipment of staple commodities, such as
grain, cotton, raw materials, etc. , other things being equal his drafts
will sell for more than if drawn against specialties, such as clocks ,
phonographs, musical instruments, etc. The reason is that if any
difficulty should arise in connection with the transaction and make it
necessary for the holder of the bill of exchange to sell the goods at
auction he would be able to realize on a shipment of staple commodities approximately the face value of the draft, while in the case
of specialties nothing like their listed value could be obtained.
VII. Amount of Drafts Outstanding. Just as in the earlier part
of our discussion we have seen that London discount houses watch
very carefully the total amount of bills accepted by any London firm,
and if the firm has assumed too heavy a liability in connection therewith the discount houses charge a higher discount rate than usual,
so we find that in our own market if banks issue too many finance
or loan bills they will be compelled to sell them for a little lower rate,
probably ten to fifteen points less, than that which is being paid for
the bills of other bankers who have issued a smaller amount. The
same policy is followed in connection with the amount of bills drawn
by an exporting firm . The purchasing bank is always desirous of ascertaining the extent of the liability that the exporting firm has assumed. If too heavy a burden has been incurred the bills command
a lower rate. The rate paid for " pig on pork " bills is universally a
little less than that paid for two-name paper, because the former are
actually, as we have seen, only single-name paper.
VIII . Miscellaneous Influences. Finally, war and rumors of war,
political developments of various kinds, the death of international
financiers or rulers, ¹ " sentiment " of one sort or another, and a host
of miscellaneous causes affect exchange rates favorably or unfavorably
as the case may be. For many years past, for example, the Balkan

1 On January 5, 1916, the rumored death of the Kaiser of Germany caused a decline in
the mark quotation in New York.

368

DOMESTIC AND FOREIGN EXCHANGE

situation has been a disturbing factor in the field of the exchanges.
Again, in September, 1908, a great deal of political uncertainty was
caused in Europe by Germany's attitude on the Morocco question
and brought about the extensive selling of securities in the United
States by Europeans who were desirous of calling in their funds in
order to have them handy if war were declared. An instance of another character is found in the case of the return of King Constantine
to the Grecian throne in November, 1920. The Allies refused recognition and did not allow Greece to draw against the balance of unused
credits which had been advanced in connection with her participation
in the World War.

They also levied a sort of financial boycott, with

the result that drachmas, which had been well maintained up to 1919
fell rapidly, reaching 7.50 cents in February, 1921 , 5.60 cents in May,
and about 4 cents in December (par being 19.294 cents) . Large
military operations, the difficulty of absorbing the new territories
added under the peace settlement, together with the issuance of millions of inconvertible paper drachmas, also played their part in weakening the rate. In the latter part of November, 1921 , sterling and continental rates stiffened noticeably, due, so it was claimed, almost
solely " to the sentimental influence of the proposal to grant Germany
a two-year moratorium. Bankers generally expressed approval of the
plan on the ground that Germany must soon default if regular payments are insisted upon. " 1
In brief, it may be said that almost any political or economic development or event that is likely, to affect international relations is
bound to exert some influence on the course of exchange rates. This
is the main reason why every international banker is vitally interested
in all such matters. He must ever be on his guard to take advantage
of favorable situations and to avoid those that are likely to result in
losses. He has to be possessed not only of excellent judgment but
at the same time also of a sense of prophecy. The difficulties and uncertainties which he has to meet in gauging the direction in which
rates may tend in turbulent times are uniquely evidenced by an instance that occurred during the early stages of the World War. Germany declared a war zone around Great Britain, and many dealers
felt that exchange rates would inevitably decline. On the contrary,
however, rates rose slightly on the theory that exports from the United
States to England would be restricted and would result in a reduced
1 Commercial and Financial Chronicle, December 3, 1921 , p. 2350.

RATES OF FOREIGN EXCHANGE
supply of bills of exchange.

369

As a result of wrong guesses, it is said

that many of our international bankers suffered losses amounting
in some cases to millions of dollars when the exchange market went
to pieces following the " unpegging " of sterling exchange in the spring
of 1919 .
The above discussion has had to do with the more important factors
affecting exchange rates under average or normal conditions. In a
period of world war, such as we experienced from 1914 to 1918, those
factors that are normally of great influence recede into the background
and become less important, only to be superseded by other factors
which war conditions make possible and seemingly inevitable. The
World War caused the abandonment of the gold standard by all of
the European countries and resulted in the issuance of huge amounts
of paper money. Gold commanded a premium, and the cost of living
soared to unheard of levels. The exchanges necessarily depreciated
to a startling degree. Artificial methods of stabilization have also
interfered with the normal functioning of the market. These matters
and their various ramifications, as well as the unusual fluctuations
that have characterized the exchanges since 1914, will be more fully
discussed in subsequent chapters.

CHAPTER XI
GOLD AND GOLD MOVEMENTS
Any contact with the field of the exchanges or with foreign trade
reveals the fact that gold and silver are continually shipped back and
forth between the nations of the world, regardless of whether or not
those nations are on a gold, silver, paper, or gold exchange standard
basis.

At times these shipments are made even at a loss because of

the requirements of the financial or trade situation, although they
are usually made only because of the possibility of speculative profits .
Gold is not always exported to pay off foreign indebtedness, as some
might think. Bankers who owe nothing abroad may export gold to a
correspondent in London because, the costs of shipment being low
and the rates at which they can sell their exchange being high, they
see a chance to profit by selling drafts against the gold exported . A
banker may desire to build up his account in London and finds that he
can do it much more cheaply by sending gold to Paris or to some other
center where his correspondent, acting under instructions, will use
the gold to buy exchange on London so that the New York banker
will be able to sell drafts against the London account thus built up.
Such a transaction, of course, will occur only when exchange in New
York on London is fairly high and in Paris on London is fairly
low, and also when at the same time the rate between New York
and Paris is too high to make the purchase of French exchange
advisable.
The financial and business worlds are more particularly concerned
with shipments of gold, although as between some countries the silver
market and shipments of silver bulk large in importance. Gold, however, is the metal in terms of which the value of practically all the
wealth and trade of the world is measured. It forms the basis of
our greatest banking and monetary systems.

Trade balances, obli-

gations of one government to another, private debts, all are paid by
means of it or by credit instruments directly or indirectly based on it.
370

GOLD AND GOLD MOVEMENTS

371

A nation's demand for gold varies from day to day and from week to
week, just as a banker's need of gold for reserves or other purposes
varies from time to time. The total stock of gold in the world, available for monetary purposes, is variously estimated at about $9,500,000,000. This amount is so extremely small compared to the tremendous demands made upon it, and the output each year, estimated before the World War at about $450,000,000 per year, is so limited , that
in normal times the fluctuating demands of the various countries for
the metal , provided no obstacles are placed in its way, cause it to flow
freely from one part of the world to another, apparently seeking its
level and satisfying, at least temporarily, the requirements of the
country that needs it most. Being a non-perishable and constantly
treasured commodity, the same gold may journey back and forth
across the ocean several times a year, just as a National bank note
may be sent back and forth between San Francisco and New York
several times a year in payment of various obligations. As there are
certain forces at work in the United States that cause the bank note
to be sent to and from New York, so in international relations there
are factors that cause gold to flow from one section of the world to
another as occasion demands. If a country has an insufficient supply
of gold, certain economic forces, if allowed to work freely, will bring
it gold from other countries, while if it has too much gold, similar
forces will cause it to be exported.¹ The forces concerned are primarily
those that we have been discussing in connection with our examination
of what it is that goes to make up the supply of and the demand for
exchange.
Just as the rates of exchange in the market are " hinged " onto the
sight rate, so we find that the sight rate is also the basis on which
calculations are made as to the advisability of gold movements. To
lay down then, at the beginning of the chapter, the general thesis or
principle from which our discussion proceeds, we may say in brief that
when the sight rate of exchange rises to too high a level gold will flow
out of the country because it will pay to ship gold rather than to buy
exchange at high rates. On the other hand, when the sight rate falls
to too low a level gold will flow into the country because it will be
profitable first, for foreigners to send gold rather than exchange ;
second, for domestic merchants to have gold sent them rather than
1 Whether or not a country can ever have too much gold will be discussed in subsequent
sections of this chapter.

372

DOMESTIC AND FOREIGN EXCHANGE

to draw on the foreign importer and be compelled to sell their exchange
at such a low figure ; and , third, for domestic bankers to buy exchange
at low rates, send it abroad for discount, get gold , and import it. While
in general, we are correct in saying that in normal times the gold movement is dependent primarily upon the position of the sight rate, nevertheless we must also remember, as we have noted earlier, that the gold
movement in its turn affects the sight rate.
There is as much necessity for providing means whereby gold may
readily and easily flow from one part of the world to another as there
is for the easy and ready flow of gold or funds in any form from one
section of our country to another. Under our national banking system
it was not possible for funds to be shipped with any degree of facility
from East to West or vice versa, although gold and other forms of
money were continually being sent back and forth. As a consequence
of the difficulties, expense, and loss of time attending domestic transfers of gold, money rates in one section of the country were frequently
widely divergent from those existing in another. With the introduction
of the Federal Reserve System and the inauguration of the Gold Settlement Fund the situation was completely revolutionized . Federal
Reserve banks now keep a large portion of their gold holdings with
the Gold Settlement Fund in Washington and shift them, as the
occasion demands, from one Federal Reserve bank to another merely
by means of a book entry. Thus it is, that, figuratively speaking,
gold is shipped instantly from one section of the country to another
as the need arises. Since the inauguration of this practice a great
saving in time and costs has been effected and sectional money rates
have tended more and more to be on a par with one another. In the
field of international dealings, however, transfers of gold and funds
are not so easily and quickly effected . We have not as yet established
an International Gold Settlement Fund, although one has been proposed by some of our prominent financiers. We are therefore compelled to ship gold and silver back and forth across the waters for the
settlement of international obligations, although, as we shall see later,
it sometimes happens that the gold is not shipped but is merely " earmarked," i. e., set aside to the credit of the foreign party and held in
the debtor country until orders are received for its disposal. Normally, however, gold is actually shipped from one part of the world
to another, entailing expenses of freight, insurance, interest, labor,
etc.

GOLD AND GOLD MOVEMENTS

373

For many years London has been considered the great international
market for both gold and silver, but there is some question as to
whether or not it has in times past been the only free gold market. In
fact, some authors question whether or not it has ever been a free gold
1
market. English writers before the World War ¹ universally maintained that it was the only free gold market because the Bank of England stood ready at any time, as the storehouse of the world's gold,
to part with gold sovereigns in return for Bank of England notes, thus
making gold always available for export. They also cited the measures
availed of at times by the Bank of France and the Reichsbank of
Germany to prevent the outflow of gold when such was deemed to be
detrimental to the financial interests of France or Germany respectively. It was claimed that New York was not a free gold market because gold could be obtained from the United States Treasury only
by presenting gold certificates, and that even then the Treasury was
not compelled to sell gold bars in return for gold certificates or anything else unless it wanted to do so. In England, before the war, gold
coins and Bank of England notes were legal tender. Under the Act
of August 6, 1914, however, the government was authorized to issue
£1 and Ios. notes (called " Bradbury's ") redeemable at the Bank of
England in gold.

English writers have urged that a person who de-

sired to obtain gold for export could demand payment from his debtors
in sovereigns, Bank of England notes, or government paper money.
He could take the latter two kinds of money and demand gold from
the Bank of England, and so get gold for export. Up to the time of
the declaration of war in 1914 , it was true that the exporter could
get all the sovereigns, but sovereigns only, that he desired by following
the procedure outlined . But after the outbreak of the war, although
the Bank could not legally refuse to redeem its notes or the government
notes in sovereigns , yet the same end was actually attained by appealing to the patriotism of the citizens, by placing gold exports under
government control, by requiring licenses for gold shipments, and
by various other devices. Down to the present time (April, 1922)
London has not as yet resumed her former position as a gold
market.
In the United States, four kinds of money, viz. , gold coins, gold
certificates, silver dollars, and Treasury (Sherman) notes of 1890,
have full legal tender qualities under all conditions in the absence of
1 Cf. especially Withers, "Money Changing," Chapter VIII.

374

DOMESTIC AND FOREIGN EXCHANGE

contract, whether it be payments by an individual to the government
or vice versa, or payments between individuals, banks, etc. Other
kinds of paper and metallic money possess varying degrees of legal
tender qualities. Legally, the Secretary of the Treasury is required
to maintain all of our money at a par with gold , which in times of a
crisis might mean redemption in gold ; but in normal times the law
specifically requires that only gold certificates, Treasury notes, United
States notes, and Federal Reserve notes ¹ be redeemed in gold, although in practice the Treasury will normally redeem any kind of
United States money in gold. Thus, as the reader can easily appreciate, it is not possible in times of stress or strain for the merchant to demand that his debtor pay his obligations in money that may be redeemed in gold at the United States Treasury or at a Federal Reserve
bank.2 Technically, therefore , we do not now have, and never have
had a free gold market in the sense that the English writers have used
that term ; but for all practical purposes, our market has been as free
as, in fact in many regards. freer than, that of London. Prior to the
establishment of the Federal Reserve System we possessed no means
of controlling the gold flow either into or out of our country. Gold
went or came in response to the conditions prevailing in our own
markets or in response to the policies followed by the central banks of
foreign countries. If conditions were such that gold was expected to
come to us, it might or might not come, depending upon what was
happening abroad-primarily in England. If the financial situation
were such that we would not ordinarily expect gold to flow out of our
country, it still might go-again depending upon what action the
foreign central banks might take to induce its exportation. A "free
gold market," by the very connotation of the term, should imply a
market where the forces of supply and demand work freely and without
artificial restrictions. If the word had not been so greatly abused by
faire economists, one might say that a free market is
our early laissez one in which gold is allowed " naturally" to flow into or out of a
country. We shall see, as the discussion proceeds, that in normal
times the " free" (?) gold market of London has always been under
1 Federal Reserve notes are redeemable in gold at the United States Treasury in Washington, D. C., or in gold or lawful money (any kind of money issued by the United States
government) at any Federal Reserve bank.
The Federal Reserve banks now act as redemption agencies, the sub-treasuries by the
law of May 29, 1920, having been discontinued and their powers and functions assigned to
the Federal Reserve banks.

GOLD AND GOLD MOVEMENTS

375

the complete control of the Bank of England when it desired to assume
that control, and that again and again by artificial means it has prevented or encouraged the gold movement as required by the interests
of the London money market. That statement applies likewise to the
gold markets of other European countries. It goes without saying
that during the topsy-turvy conditions following the declaration of
war in 1914 down to this date of writing (April, 1922) , London has
ceased to be or even to claim that she is a free gold market or the
onlyfree gold market in the world. Needless to say, this statement
is not made with any feeling of malice or exultation , for all American
economists appreciate the wonderful service to the world which London
has performed in her former position of dominance, the assistance
which she has rendered in times of financial strain, and the relative
generosity with which she has shared her gold holdings with other
countries, at times even to the detriment of her own financial interests.
With the introduction of an open discount market in the United
States following the inauguration of the Federal Reserve System and
the adoption of a discount policy by the Federal Reserve banks as a
possible means of controlling the gold flow, it is difficult to say to
what extent our gold market will in the future be similar to that of
London. As yet we have had no opportunity of seeing what possible
effects our proposed methods may have on specie movements, because,
with the exception of the short time during which our foreign exchanges were, as a war measure, completely under the control of the
Federal Reserve Board , we have had no occasion to attempt a manipulation of the gold flow in either direction. The developments of the
future alone will disclose to what extent our gold market is capable
of remaining a really free gold market.
London has been the one important center to which the new gold
of the world, especially that produced in South Africa and Australia,
has been shipped for sale. More than one-half of the annual gold
output is mined in countries that have little or no use of it for monetary
purposes. In 1913 , to take a presumably normal year, Africa produced over 40 per cent of the world's supply, the various provinces
of Australasia more than 12 per cent, and the United States, Canada,
and Mexico about 19 per cent, 4 per cent, and 4 per cent respectively.
In 1913 the total output was $459,941,100; in 1920, because of conditions existing during and after the war, chiefly the increased cost of

DOMESTIC AND FOREIGN EXCHANGE

376

mining, it fell to $337,951,000.¹ The greater part of this gold is shipped
to London where it is auctioned off in the gold market held, in normal
times every Monday morning. The buyers represent a small group
of foreign and domestic banks and bankers. As the various lots of
gold are put up at auction they are bid for in accordance with the
needs of the buyers and the possibility of securing a profit on the
transaction. If there are no bidders, the gold is usually disposed of
by the producer's agent to the Bank of England, which by law is
compelled to purchase it at a minimum price of £3 17s. 9d. (77s. 9d.)
per ounce .916 2/3 (11/12ths) fine. It may pay more than this price
if it desires to do so and, before the war, when sorely in need of the
metal for reserve purposes, it was known to pay as high as 77s. 10½d.
An ounce of gold 11/12ths fine can be coined into £3 17s. 10½d. (77s.
10½d.) . The difference ( 1½d. ) between that sum and the minimum
price of the Bank of England represents a discount or demurrage
charge which goes to the Bank to reimburse it for the loss of interest
which it assumes by advancing cash to the seller and then having to
wait fourteen to twenty days before receiving the minted gold from
the Royal Mint . The Mint is compelled by law to receive gold at the
fixed price of £3 17s. 10½d. per ounce 11/12ths fine, or £4 4s . 11 5/11d.
per ounce for pure gold, but the seller must wait from two to three
weeks while the metal is being coined into sovereigns. Almost all
the gold that is not disposed of to foreign buyers is sold to the Bank
of England rather than to the Royal Mint.
Inasmuch as an ounce of gold 11/12ths fine when minted yields 775.
10½d., it is maintained by some that the market price cannot rise
above that figure. This is not the case, however, for even before the
World War there were times when, as during 1907 , we were drawing
so much gold from the English market that it reached the price of
78s. 2d.

During the war, the English government completely con1 GOLD PRODUCTION OF THE WORLD

United States .
Canada....
Russia.
South Africa .
Australasia .
British India .
All Others ..

1913
.$ 88,884,000
16,599,000
26,508,000
196,160,000
53,113,000
12,178,000
66,499,000

Total ..
. $459,941,000
* Estimates of London Economist, February 19, 1921

1919
$ 60,333,000
15,859,000
12,000,000
184,498,000
26,112,000
10,486,000
55,878,000

1920*
51,098,000
16,011,000
4,867,000
180,065,000
24,401,000
9,194,000
52,315,000

$365,166,000

$337,951,000

GOLD AND GOLD MOVEMENTS

377

trolled the London situation, and no data are available as to what
prices were actually paid for gold ; but it is known that South African
producers were compelled by the government to sell their gold only
in England and at the customarily fixed price of 77s. 10½d. for gold
11/12ths fine. During the war every effort was made by the government to conserve the gold holdings of the nation.

Gold exports were

under its complete control, being made only on its behalf. Strangely
enough, gold imports (either manufactured or non-manufactured gold)
were prohibited by Royal Proclamation on December 5 , 1916, unless
such gold were consigned for delivery and sale to the Bank of England.¹
Sales of gold in the open market were abandoned . Gold disappeared
from circulation , and the Bank of England, though legally compelled
to redeem its notes in gold, resisted most strenuously the demands
of those who made such requests. Lately I have been informed by a
prominent English banker that it has not been possible to get gold in
any amount from the Bank. This party stated that a sovereign or
two might be obtained on the claim that it was to be used as “a gift
to the bride," or for similar purposes, but even then, the recipient
might be followed by detectives to see that the gold was not used for
some other purpose.
We suffered from about the same sort of restrictions in the United
States during the greater part of the war, even before our government
took over the regulation of the exchanges. The Federal Reserve banks
early mobilized our gold holdings, and so effectually was it done that
gold practically disappeared from circulation. Banks, not being required by law to pay out gold, acceded to the request of the Federal
Reserve officials and did not do so. With us, however, the situation
cleared up shortly after the Armistice and restrictions on gold export,
import, or trading ceased with the abandonment of the control of the
exchanges by the Federal Reserve Board on June 25 , 1919.2 In England, however, some war restrictions still (April, 1922) remain. While
it is technically true that the government of England did not legally
prohibit exports of gold during the war, nevertheless all gold that was
It was stated that the reason for this proclamation was the desire of the government
to secure control of all the gold flowing into England in order to be able to use it in financing
its war needs rather than to have it used in the manufacture of jewelry, for which there
was a great demand during the war.
2 Gold, however, was not put back into circulation in the United States until in March,
1922 , when the Secretary of the Treasury notified the Federal Reserve banks that the need
for complete mobilization of our gold holdings had ceased and that the Federal Reserve
banks were at liberty to put as much gold back into circulation as they desired.

C

378

DOMESTI

GE

AND FOREIGN EXCHAN

shipped out went only as the result of government action.

On March

28, 1919, however, an Order in Council was issued under the Exportation Prohibition Act of 1915 , formally prohibiting the export of gold in
any form and to any destination.

In July, 1919, a slight modification

of this order was made, permitting new gold which had been shipped to
the London market to be exported provided a license therefor was
obtained from the government. This was embodied into law on December 23 , 1920, through the enactment of the Gold and Silver Export
Control Act, which not only prohibited, under heavy penalty, the export of gold and silver coin or bullion from the United Kingdom except under a license granted by the Treasury, but also made it unlawful for any person to " melt down, break up, or use otherwise than
as currency, any gold or silver which is for the time being current
in the United Kingdom or in any British possession or foreign coun1
try."
On September 12, 1919 , war time restrictions on gold sales
were lifted and gold trading was again resumed in the open market,
the metal being sold to the highest bidder and exported only under
license from the Treasury. Owing to active bidding, the price advanced rapidly and went to about a 15 per cent premium. On September 18 it rose to 99s . (per fine ounce) , in early November to 100s . , on
November 20 to 103s., on December 4 to 106s . 4d .; and the price at
the close of the year stood at 109s. 8½d . Computing this closing rate
at par ($4.8665) , gold was actually selling in London for $26.67 per
ounce 11/12ths fine as measured in terms of American money.2

With

pure gold procurable in the United States at a price of $20.6718 per
ounce, one might expect that it would have paid an American banker
to ship gold to England and procure in English money the equivalent
of $27.094 per ounce (the price of $26.67 above was for an ounce of
gold 11/12ths fine) ; but it must be remembered that with gold at a
premium, England was not (and still is not) on a gold standard basis.
Her government paper money and the notes of the Bank of England
did not and no longer do bring their face value in gold. They are at a
discount as measured in terms of gold. Hence the American exporter
would have received paper money for his gold , an extra amount it is
true, but it could not be redeemed in gold—and furthermore, owing to
the depreciated value of the paper money it would not have purchased
1 This Act was designed to remain in effect until December 31 , 1925.
In other words, if an American banker had sent an ounce of gold to England, he could
have obtained 109s. 8½d. in paper money for it. Converted into American money at the
par rate of 4.8665 = £, 109s . 8½d. equals $26.67.

GOLD AND GOLD MOVEMENTS

379

in England as much as an equal amount of gold . The premium
on gold continues down to date (April, 1922), the price remaining
almost constantly above 100s. until the closing days of 1921 , when it
fell somewhat below that level.¹ The significance of the premium on
gold as affecting sterling rates will be discussed in a later portion of
this volume.2
The order permitting the re-export of new gold sold in London came
about primarily as a step taken by London to retain its position as the
principal gold market of the world. With New York placing no restrictions whatsoever upon the import or export of gold, London
realized that something had to be done to prevent a flow of gold from
the producers directly to New York, thence to be distributed over the
world-a situation that would enable New York to displace London as
the gold center.

South African gold producers had complained that

they were being compelled to sell in the London market at the pre-war
price in spite of their greatly increased costs of production and threatened to close down their mines unless the government gave them either
a bounty or a free market. The government therefore decided to establish, as far as possible, a free market. The results justified the
decision, and gold has continued to flow to London, and from London
to various parts of the world, but principally to New York and India.
The foreign market in which the gold exporting country's exchange
1 The price of gold per fine ounce at the opening of each month since the resumption of
active trading in 1919 has been as follows:
1919
November I 99s .
September 1 99s.
December 4 10бs. 4d .
October I
99s.
1920
104S.
109s. 8½d.
July 2
January 1
II2S.
February 5 127s. 4d.
August 3
March 2
119s . 6d.
September 1 II5S . Id.
October I
118s. 4d.
April 3
105S.
November I II9s . 2d.
107s . 6d.
May I
December I 117s. 5d.
10бs. 3d.
June 1
1921
II5S . IId.
IIOS. Id.
January 3
July 1
II5S . 2d.
February 1 107S. 2d.
August I
March I
105S. Iod.
September 1 IIOS. 4d.
October I
10бs. Id.
IIIS . od.
April 1
November 1 104S. 4d.
103s . 8d.
May 2
December 1 102S. 3d.
105S. 9d.
June 1
1922
March 1
93s. 3d.
97s. 9d.
January 3
April 1
96s. 3d.
February 1
95s. 3d.

2 Cf. pp. 478-486.

380

DOMESTIC AND FOREIGN EXCHANGE

is at the greatest depreciation gets the gold because it can bid the
highest price for it.¹
Paraphrasing a statement appearing in the Federal Reserve Bulletin
for June, 1921,2 what actually took place under the new arrangement
was that the South African producers sent their gold to London, where
they refined it to a purity of 999/1000. The gold was then sold at
auction and was bid in by the agents of the producers , the price being
determined on the basis of the dollar exchange rate with allowance
made for commissions and expense of shipment. The gold was forwarded to New York where local agents of the producers sold it to
the Federal Reserve Bank of New York through a member bank.
Through this procedure it was possible for the South African producers
to receive in New York $20.6718 for every ounce of pure gold , from
which they had to deduct the cost of shipment from South Africa to
New York via London and the commissions of the London and New
York agents. If the bankers or gold using industries of England or the
Continent required gold, it was necessary for them to bid above the
price offered by the producers ' agents, which price, as noted, was fixed
by the New York exchange rate on London. There have been almost
no other bidders (excepting a few parties who from time to time have
obtained small amounts for use in the arts) , owing to the fact that no
banker can afford to bid more for gold than its price at the dollar rate.
In fact, the quotation on gold prevailing in the London market has
been practically paralleled by our sterling exchange rate.³ The Federal
Reserve Bulletin stated that "A comparison of the two rates shows
that frequently there is a slight margin of less than 2 per cent between the premium on the dollar and the premium on gold. This
margin is sufficient to pay the costs of transportation, insurance and
commissions from London to New York. These charges, not allowing
for interest or commissions, are estimated at approximately two-tenths
The sale of their gold in New York enables the
"
of one per cent .."4
South African producers to obtain American bank accounts (dollar
exchange in New York) , which they can easily dispose of, either in
London, South Africa, or in any other exchange market.
1 It was for this reason that most of our gold exports during the Civil War went to England, while during the Napoleonic wars Hamburg secured the greater portion of England's
gold exports.
2P. 681.
8 Cf. p. 479.
4 Federal Reserve Bulletin, June, 1921 , p. 681.

GOLD AND GOLD MOVEMENTS

381

During the war, few questions were more frequently asked than
why, in the face of war, of suspended gold payments, and of the very
large increase in paper currencies, was no premium quoted on gold
in the London market ? Its absence during the war was due to the fact
that the government completely controlled the market. Gold exports
were prohibited, so there was no object in offering a premium for
gold bullion, because the buyer could do nothing with it but sell it to
the Mint or to the Bank of England, and neither would pay a premium.¹
It is not at all unusual for gold coins, instead of gold bars, to be
shipped from one country to another. Gold coins are not accepted at
their face value (by tale or by count) but at their actual weight. The
Bank of England buys gold coins 9/10 fine in normal times at a rate
of about 76s. 4½d.2 per ounce provided they are full weight. Coins
are seldom full weight, so the Bank of England usually pays about
76s. 3½d. per ounce for coins 9/10 fine. The student of the exchanges
should not conclude that when foreign gold coins flow into the Bank
of England, the Bank immediately turns them into bullion or presents
them at the Mint later to receive English coins in return. The Bank
in normal times has acted (and in the future may possibly continue
to act) as the world's greatest keeper of gold upon which demands are
likely to be made at any time for large quantities of the yellow metal
in coins or in bullion . Rather than ask for bar gold those having payments to make in France may demand French Napoleons , those having
payments to make in the United States may demand eagles, etc., etc. ,
so that the Bank usually stores away the bags or boxes of foreign coins
which it receives and pays them out when they are demanded .*
The easiest method by which foreign bankers obtain gold in England
for export is to purchase bills of exchange in their home countries, send
them to England for discount or payment demanding in return therefor

1Commercial and Financial Chronicle, February 7, 1920, p. 510.
2 Or at the rate of $4.8719 per £1 , which represents a slight discount.
* For an excellent discussion of the regulations and practices of the central banks of
England, France, and Germany and of the United States Mint in connection with specie
shipments, see Whitaker, op. cit. , Chapters 19 and 20.
It is interesting to note that during the war, bags of gold that came to the Bank of
England from Sweden were found to be American eagles which had been sent by France
to Germany at the end of the Franco-Prussian War, and sent by Germany to Sweden in
return for supplies during the World War. Even the original bags were used in shipping
the gold to England. On December 28, 1916, we received $33,000,000 in gold from the
British Government's depository at Ottawa. Over three-fourths of the shipment was in
the form of American eagles, sent to us in the same boxes in which we had forwarded them
to Paris in 1904 to pay the $40,000,000 claim of the old French Panama Canal Company
for its equities in the Canal Zone.

382

DOMESTIC AND FOREIGN EXCHANGE

Bank of England notes, and then to present the notes to the Bank of
England for sovereigns. The Bank of England is compelled by law
to redeem its notes at par in sovereigns (but not in gold bars) . The
Bank had never interposed any objections or hindrances to doing so
until the outbreak of the World War.¹ The sovereigns, while not required by law to be full weight, are within the limits placed by the
tolerance of the Mint.
This results, however, in the exporter of gold
receiving from 2/10 of 1 per cent to 25/100 of 1 per cent less gold than
the par value of the bank notes, making the gold cost him approximately 78s. , instead of 77s. 10½d. In the foreign market, however,
the sovereigns are accepted only by weight and not by tale, so that
the English exporter or the foreign importer takes these facts into
consideration when figuring on the possibility of the profitableness of
a gold shipment.
Foreign gold coins of bar gold, rather than sovereigns, may be desired for export. The Bank of England and the Royal Mint are not
compelled to supply these forms of gold, nor are they by law required
to charge a fixed price for either. The price in all cases varies with the
market. In the fall of 1890, when gold was urgently needed in New
York, the Bank refused to sell gold bars and, although willing to sell
foreign coin, nevertheless charged what was considered the exorbitant
price of 76s. 7d. to 76s. 8d . for it, which was at the rate of approximately 78s. for gold 11/12ths fine.
The gold that is produced in our own country, and not used in the
arts, may be disposed of to the United States Mint. Our government
3
stands ready at any time to take gold in unlimited amounts ³ from
producers or others at the fixed price of $20.67183 per ounce pure, or
at $18.60465 per ounce 9/10ths fine.

The price which our Mint will

pay for gold is fixed and does not vary from day to day as does the
price of the Bank of England . The Mint pays 90 per cent of the estimated value of the metal upon deposit, and the remaining 10 per cent
less a melting charge of 4¢ per $ 100 as soon as the exact value of the
gold has been ascertained . In some cases this requires a wait of only a
few hours. Until the spring of 1921 , all of the gold imports crossing the
1 The Bank of Netherlands is the only bank in Europe besides the Bank of England
where it has been possible in normal times to obtain gold for export without any serious
obstacles being interposed . Its supply of gold, however, has never been large, so that
heavy exports have inevitably led to the Bank's raising its discount rate within a very
short time after exports have begun.
2 Sovereigns may be legal tender if not lighter than full weight by .77447 grains.
Although the law does not compel the mints to take gold in smaller amounts than $ 100.

GOLD AND GOLD MOVEMENTS

383

to
Atlantic were handled by the New York Assay Office of the United
States Mint. Its capacity was about $15,000,000 in gold a day, but
owing to the tremendous influx of the precious metal in 1920, a large

ces to

A

places
KOOTIESI

rket,

ytale
lese f

18. m

eaded

portion of the importations had to be sent to the Philadelphia Mint.
The delay occasioned by the inability of the New York office to handle
the gold resulted in a loss of thousands of dollars a day in interest to the
shippers who were forced to hold the metal idle until it could be assayed
and accepted by the Federal authorities.
Shipments of gold and silver are made only by international bankers
who have equipment and facilities for handling large transactions,
although under unusual circumstances, gold may be shipped by large
mercantile houses. It is said that ordinarily not more than nine or
ten bankers in New York and a few on the Pacific Coast concern themselves with gold shipments.
From what has been said above and in previous chapters, it may be
seen that there are two main movements in specie shipments, one from
the mines or producers to the market, the other arising in connection
with the apportionment of the world's gold supply among the various
countries through the settlement of trade balances or in order to take
advantage of prevailing exchange rates. It is with the latter movement, depending as it does primarily upon fluctuations in exchange
rates, that we are chiefly concerned in this chapter.
As a rule the precious metals are shipped only when it is profitable
to do so, although, as we shall see later, occasions arise which necessitate or induce such shipments even at a loss. Whether or not shipment will take place depends usually upon the position of the exchange
rates. If the rate that is being charged for exchange on some foreign
country is so high that it will be cheaper to send gold than to buy
exchange, gold will be forwarded.

If, on the other hand, the price

that bankers are paying or charging for exchange makes it profitable
to import gold, gold will be shipped . The same general statement
applies likewise to silver shipments. In the case of gold standard
countries, the rates of exchange at which gold will flow into or out of a
country are known as the "gold points," or " specie points." These
points are fairly definitely fixed , but we shall see later that they are
slightly variable. The gold export point is the par of exchange plus
the cost of exporting gold, while the gold import point is the par of

ཚེསུ་

exchange minus the cost of importing gold . Thus while the par of
exchange does not change unless either or both of the countries con-

384

DOMESTIC AND FOREIGN EXCHANGE

cerned change the gold content of their standard monetary unit,
nevertheless the costs of actual shipment, or possibly the cost of the
gold itself, may vary from time to time, with corresponding changes
in the position of the gold points.
Let us consider first the details of gold exportation as they concern
the American banker in his relations with London. It is impossible
in any volume to deal with other than typical cases. A knowledge
of the fundamentals is sufficient for our purpose.
As has been stated above, gold may be shipped as gold bars or as
gold coins. We find both being resorted to at all times. When coins
are shipped, no matter how securely they may be packed, there is
bound to be a certain loss through abrasion. They are also much more
difficult to handle. There is less wear and tear on gold bars, so that,
if possible, bankers prefer to use them. The United States Treasury
stands ready at any time to supply the exporter with gold bars as long
as they last at a charge of 4¢ per $ 100 , which covers the cost of assaying, melting, etc. It usually takes at least a day to obtain the gold,
pack it, and place it on the outgoing steamer. If the sailing date is
two or three days hence, the interest lost in that connection must be
taken into consideration in calculating the costs. Also, if the bank
accumulates the gold bars or the gold coins over a period of time so
as to have them available for use when needed, and if such gold cannot
be used by the bank in any other connection for the time being, the
interest cost of this investment must likewise be counted as part of
the total costs .
The gold must be securely packed , usually in kegs holding $50,000no more and no less-and carted to the wharves under the protection
of guards. Wages and cost of material must be paid.¹ The shipment
has to be insured against loss. In normal times, the insurance rate is
approximately 1/20 of one per cent of the value of the shipment. At
the outbreak of the World War, it rose to one per cent because of the
extra risks experienced by all shipping. In February, 1917 , following
the establishment of a barred zone by Germany , a flat rate of 10 per
cent on all shipments to ports within that barred zone became effective ,
although in some instances an insurance rate of eight and nine per
cent was asked on shipments to the ports of the United Kingdom .
Mediterranean quotations ranged from ten to twelve per cent at that
time, but in December, 1916 , they had gone as high as fifteen per cent.
¹ Approximately $60 to $70 per $ 1,000,000 of shipment.

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GOLD AND GOLD MOVEMENTS
385

3
320

1

386

DOMESTIC AND FOREIGN EXCHANGE

As the danger passed, the rates gradually declined , ¹ until in May,
1921 , according to Mr. René Leon, Manager of the Bullion Department of the Guaranty Trust Company of New York, marine insurance was obtainable at 3/40 of one per cent. Ocean freight charges
also have to be paid. In May, 1921 , Mr. Leon estimated these
charges at approximately 3/4 of one per cent of the value of the shipment. Freight charges vary considerably and since 1914 have been
much higher than the figures given by writers before that date.
If the gold is forwarded to London and no draft covering the value
of the shipment is drawn and sold in New York, the exporter loses
interest on the gold while it is in transit. If, on the other hand, he
wishes to protect himself as much as possible against the loss of interest,
he draws a draft against his foreign account, which he is increasing by
the gold shipment, the draft usually being for the full amount of the
shipment, and sells the draft to some New York banker who desires to
obtain exchange on London. If the draft is sold on the day that the
gold is shipped, the draft, if it is a sight draft, will arrive in London
and be payable three days before the gold is ready to be deposited to
the London account of the exporter. If as a result the account of the
exporting banker is overdrawn, he will be put to the expense of an overdraft . The interest charged by the London bank will be at the Bank
of England's discount rate or at from ½ per cent to 1 per cent above
it. Cables are seldom, if ever, sold against gold exports, because a
cable would reach London and become payable from seven to ten days
before the arrival of the gold . If the banker in New York, to whom the
draft against the gold has been sold, pays the exporter in cash, the
bank would still lose interest for the one day that was required to obtain the gold, pack it, and place it on the steamer. And if payment
is made by draft or check, it will be collected through the clearing
house and another day's interest will be lost ; if a holiday or Sunday
intervenes, a third day's loss would be borne by the exporter. If, when
the gold reaches London, the correspondent is instructed by the exporter to sell it to another party,2 the London purchaser will pay out
1 Insurance rates per $ 100 on gold shipments in June, 1916, were as follows : From New
York to Japan, across the continent, 17½ ¢; to Argentina, 20¢; to European ports, 15¢
and to Spain, 37½ ¢. New York Journal of Commerce and Commercial Bulletin, June 16,
1919.
2 It matters not whether the gold after its arrival is sold to another party in London or
deposited to the account of the exporter; in either case, the London account of the exporter
will be ultimately increased by the amount of the gold shipment and thus be capable of meeting the draft when presented for payment.

GOLD AND GOLD MOVEMENTS

387

but 90 per cent of the value of the gold while its weight and fineness
are being determined, the remaining 10 per cent being paid at the end
of three days. This loss of interest on 10 per cent of the value of

me of the
14hare

the gold for the three intervening days must be counted in by the exporter. If the London correspondent is paid a commission for its part
in the transaction (which is by no means the custom) , it will normally
amount to 1/40 of one per cent of the value of the shipment. Finally,
the prevailing price for gold in the London market is a matter of importance. When the gold leaves New York, the price in London may
be 775. 10d. for bar gold and 76s. 4½d. for eagles. By the time the
shipment reaches London, the price may have declined to the Bank

daythes
vels

seof
eatthi

ercent
ts, beca

toters
towho

-in st

of England's minimum rates of 77s. 9d. and 76s. 3½d . respectively.
If the exporter's expected profit has been calculated on the basis of
the rates prevailing at the time of shipment (which in their turn are
based on the mint par of $4.8665) , he may find that the transaction
will yield him a much smaller profit, no profit at all, or even a slight
loss. The price of gold in the London market may fall at any time
to the Bank of England's minimum price, but it cannot go below it .
The exporting banker, therefore, must always keep that fact in mind
when figuring on the expected profits from a gold shipment. It is because of that fact that many banks construct what they call a "practical " par of exchange for use as the basis of their export calculations
in preference to the mint par. In the case of sterling exchange, they
figure that if an ounce (480 grains) of gold 11/12ths fine may possibly
bring only 77s. 9d. of English money, it is necessary to send a little
more than one ounce, i . e. , 480.7717 grains, in order to be sure that 77s.
10½d. of English money may be received .

the cem

ter. E
ed by the

If 480 grains of gold

11/12ths fine equal 775. 10½d. , the mint par of exchange between
England and the United States is $4.8665-but on the basis of the socalled " practical par " of 480.7717 grains of gold to 77s. 10½d., the
cost of £1 becomes $4.8744.¹
The cost of exporting gold varies in accordance with the items that
make up the total charge.2 If freight, insurance or interest rates de1 Samuel Montagu & Company, prominent English exchange and bullion dealers, construct their "practical " pars of exchange on all countries in this manner. Gold parity
between the pound sterling and the franc is thus set at 25.207 francs instead of 25,2215
francs; between the pound sterling and the mark at 20.418 marks instead of 20.428 marks,
etc. Cf. any number of the Weekly Review of Foreign Exchanges issued by Samuel Montagu
& Company of London.
2 As typical of the changed conditions wrought by the World War, the Annalist of Jan-

388

DOMESTIC AND FOREIGN EXCHANGE

cline, or if the charges for packing, carting, etc. , fall, the total costs
will be smaller, and vice versa. One must also remember that the
costs of the individual shipper will depend upon whether he is shipping
a large or a small amount, his facilities for packing, whether he is sending bars or coins, ¹ and whether or not the mint or banking authorities
in the country to which he is shipping the gold accord him certain
concessions, such as giving credit for interest on the gold before it
arrives, etc. , etc. The gold export point is therefore not only a variable
over a period of time for all shippers, but it is also a variable as between
different shippers.2 During the last twenty years of the 19th century,
text-books gave the gold export point as 4.89 or 4.90 because of the
higher costs of shipment . In the years immediately preceding the
World War it was commonly stated that the cost was about 1½¢ or
2¢ per pound sterling, so that the gold export point was quoted as being
4.8815 or 4.8865 , respectively. In May, 1921 , Mr. R. Leon, of the
Guaranty Trust Company, estimated the costs as then being approximately 1.1 per cent of the value of the shipment, apportioned as follows :
Freight, 34%..
Insurance, 34 %·
Interest, 15 days @ 6%.
Incidentals, 4%

.75
.075
.25
.025
I. 100

On this basis the cost of exporting a sovereign would be $.0535315,
and the gold export point would be 4.92 . Whether or not gold will
be exported depends normally on the position of the sight rate of exchange. If the sight rate is higher than the gold export point, gold
will, as a rule, flow out of the country ; sometimes , indeed, it flows
out before the exchange rate warrants its going. It will usually be
exported because it is cheaper or more profitable to ship gold than
to purchase exchange at a greater cost. The position of the cable
uary 24, 1916, gives the following table illustrative of the costs of shipping $10,000 in gold
to Amsterdam in that year, and also before the war.

Insurance
(7/8% ).
Freight
(3/4 %).
Miscellaneous (1 /8% ) .

Current Cost
$87.50
75.00
12.50
$175.00

(1/20 of 1%)
(1/4 of 1%)
(1/8 of 1 %)

Ante-Bellum Cost
$5.00
25.00
12.50
$45.50

1 Shipments of coin are the more costly.
2 For additional details regarding specie shipments, see Whitaker, op . cit. , Chapter XX;
Patterson, op. cit., Chapter 13 ; Johnson, J. F., "Money and Currency, " (1921 ed .) , pp. 9091; Margraff, op. cit., Chapter 27.

GOLD AND GOLD MOVEMENTS
The tota

mber t
herbese

389

rate of the long bill rate has nothing whatsoever to do with the gold
export point. This statement, as will be noted later, cannot be said
to be wholly true in the case of gold imports.
The following example of an instance of gold export is taken from
data supplied by Escher: 1

Suppose that an American banker desires to export 10,000 ounces
of bar gold, 993/1000 fine. He purchases that amount from the
United States Mint at its fixed price of $20.6718325 per ounce fine,

Decast 21

or for $205,271.29 . He must also pay the premium of 4/100 per cent
charged by the United States Assay Office for bar gold, or $82.08 for
the amount of bar gold purchased . Packing, cartage, etc. , of five

preced
about

kegs at $2.25 per keg, costs him $11.25 . Freight at 5/32 per cent costs
him $320.75 , and insurance at 1/20 per cent less 10 per cent, comes

actedas
Leat

to $92.34. The total cost of buying and shipping the gold is $205,777.71. When the gold reaches London, say that it is purchased at the

being

Bank's minimum rate of 77s. 9d . per ounce 11/12ths fine. The exporter receives the sum of £42,112 10s . In addition to the 1/40 per
cent commission to his correspondent , or £ 10 IOS. , he has to pay certain petty charges amounting to £1 18s. , both of which sums are deducted from the amount he receives for his gold in England. The net
proceeds credited to his account are £42,100 2s. In order not to lose
on the shipment, it will be necessary for him to sell sterling sight drafts
at 4.8878 . If he is able to sell sight drafts at a figure above that sum,
he obtains a profit on the shipment .
Gold imports usually , though not always, occur when it is profitable
to undertake them. If exchange rates in the United States fall so low

be $

that it is profitable for bankers to purchase exchange, send it abroad,
cash it in, and bring the gold back to the United States, gold imports
will normally take place. Or if a large importer has become very dis-

ofthe c

Che,CharterC

couraged with the prevailing low rate of exchange and prefers to send
his drafts to England to be paid and the returns forwarded to him in
gold, gold will flow into our country. This latter situation will seldom
occur, however, because it is only the big international bankers who
engage in gold shipments.
To pay for the gold which is to be imported, the banker may purchase long bills , say, on England, send them over for acceptance and
discount, and advise his correspondent to return the proceeds in gold.
Or he can purchase sight exchange or cables and forward them to Eng1 Escher and Jefferson, op. cit., p. 377.

390

DOMESTIC AND FOREIGN EXCHANGE

land with the order that the proceeds be returned to him in gold. Or
by cable or sight draft he can cash in on the account which he already
has in London, and ask that the gold be sent him. No matter which
method is followed, he must consider the rate charged for cables or for
The position of one or the other will necessarily affect
the position of his gold import point. If he uses cables with which to
purchase gold in England , his import point will be a little higher than
if he uses sight exchange. Sometimes the spread between the two
rates is so slight as to bring the import point of gold when based on
the cable rate very close to the import point when based on the sight
rate. The cable rate is therefore one of the essential elements that go
to determine whether or not gold will be imported.
sight drafts.

The costs of importing gold are greater than the costs of exporting
gold, for the reason that the loss of interest on the inward shipment
must be taken into consideration. If the New York importing banker
purchases a demand draft, say on England, and forwards it to his
English correspondent with directions that gold be returned to him,
he will have to bear the loss of interest on the amount of his investment until the draft reaches London, is cashed, and the gold returned
to him, approximately twenty days. On the other hand, if he purchases a cable (it takes but a few hours for the cable to reach London) ,
he will have to bear the loss of interest on the money invested only
for the length of time required to have the gold arrive from London,
which would be approximately ten days, but he will have to pay a
higher rate for the cable than for the sight draft. With gold exports
it is possible for the banker to draw a draft against the gold as soon as
shipped, thus enabling him to minimize or to obviate entirely the
loss of interest . But drafts cannot be drawn against gold imports,
and the only way by which loss of interest can be offset is by the central bank or the mint in the importer's country according credit or
paying interest for gold imports while in transit.

This will be more

fully discussed in a latter part of this chapter.
As in the case of gold exports, so with gold imports there are a large
number of variables that must be taken into account, so that it is not
possible to say that the gold import point is exactly or permanently
fixed, either for an individual shipper or for shippers as a whole. In
the first place, there is the rate that the importer will have to pay for
exchange on London , whether it be drafts or cables, with which he
pays for his gold, and these rates are continually fluctuating.

Next,

GOLD AND GOLD MOVEMENTS

391

there is the varying cost of gold itself in the London market. As noted
above, the price of gold is not fixed in London, and although it can
never fall below the minimum price of the Bank of England for gold
coins or gold bars, it may rise considerably above that figure even in
normal times. In the third place, there is the question as to the pos-

།

sibility of obtaining gold bars or of being compelled to take gold coins.
Interest charges , freight, insurance, and costs of packing and cartage,
are all variable items of expense. When the gold reaches the United
States it can be sold to the United States Mint at the fixed price of
$20.67183 for pure gold, or $ 18.60465 for gold 9/10ths fine. If gold
coins are imported, another variable, that of abrasion, must be taken
into consideration. There is, moreover, a slight delay at the mint,

ofeper
d

because the gold has to be assayed and weighed . The result of all
the varying costs is that authors and bankers give out differing statements as to the gold import point for the United States. Some claim
that as a rule costs approximate 2 cents, while others claim that they
run as high as 22 cents per pound sterling. The gold import point

of histe

would accordingly be respectively 4.8465 or 4.8415 . It is again well to
advise the student of the exchanges that the gold points are only approximations and vary with each separate transaction depending upon
the conditions existing in the market, the way the deal is handled, the
amount shipped, etc. , etc.

inm Las
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with this

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The data for the following example of an importation of gold from
London are based upon an instance cited by Patterson.¹ On September 1 , 1915 , 5,282.157 ounces of standard gold were purchased in London at the rate of 77s. 11d. per ounce, costing in all £20,578 8s. Id.
The gold was received in New York on September 10, 1915 , and immediately turned over to the United States Assay Office, which paid
90 per cent of its value on delivery, or $89,000 . Four days later it
paid the remaining 10 per cent ($11,097.18) , the importer receiving
a total of $ 100,097.18 for the shipment. From this sum he had to deduct certain charges. Freight and insurance cost him $ 1,389.94 ; assay
charges, $15.59 ; interest at 3½ per cent on 90 per cent of the shipment
during the nine days that it was in transit, $77; interest at 3½ per
cent on the remaining $11,097.18 for four additional days (13 days in
all), $13.81 ; making a total cost of $1,496.34 . The cable rate on London on September 1 was $4.56 per pound. In using cables to purchase
£20,578 8s. Id. in London, the importer had expended $93,837.62;
1Op. cit., p. 183.

392

DOMESTIC AND FOREIGN EXCHANGE

import costs had amounted to $ 1,496.34 ; leaving net profits of
$4,763.22 . The profits would have been greater or less depending
upon the fluctuations in the costs of shipment, the rate paid for the
cable or sight draft with which the gold was purchased, the cost of
the gold in England, whether coins or bars were shipped, etc.
For a number of years before the World War, the London Economist
quoted the gold points on the United States as follows :
Dollars 4.89 -5 per mille for us (meaning for England)
""
4.867-par.
66
4.827-8 per mille against us (meaning against England)
The 5 per mille (5/10 of one per cent or .005 per cent) covered
freight, packing, etc. , on gold sent to England from the United States,
while the 8 per mille (8/10 of one per cent) represented the costs when
gold was sent from England to the United States. The reason why it
cost the London bank more to export than to import gold was because
there was little or no demand for bills in London on New York, making
it necessary for the bank to wait for a return remittance from New
York, thereby sustaining a loss of interest. This lack of demand
in London for drafts on New York was due to our long prevailing
policy of remitting to London when we owed London, and of drawing
on London when London owed us, the result being that all bills went
to London and few, if any, bills came from London to the United
States.

As between the United States, England, France, and Germany,
the gold points are normally quoted as follows :

New York on London .
66
66 " Paris ..
((
66 " Berlin .
London on Paris ..
" Berlin .
66

Import
.$ 4.825
.19120
.23625
25.325 francs
20.52 marks

Export
$ 4.885
.19379
.240625
25.1225 francs
20.33 marks

It should be noted that gold points for London on Paris and for London on Berlin are quoted on the basis of movable or indirect exchange,
and that the points for New York are quoted on the basis of direct
exchange. Gonzales gives the following data relative to the highest
export and the lowest import gold points for the United States on
1
various foreign countries :
1Op. cit., p. 86.

GOLD AND GOLD MOVEMENTS

Country

pedz
the
etc.

Ex

IstedSea

e costs

Import
$4.82
.19
.19
.19
.19
.2350
.1850
Spain .
.1850
Canada .
.9950
Japan .
.4850
.26
Norway, Sweden and Denmark . .
Argentina .
.4150
Brazil ..
.3150
India .
.3180
Philippine Islands .
.49

London..
Paris .
Switzerland .
Antwerp .
Rome .
Berlin .
Athens .

393

Export

$4.9065
.1940
.1940
. 1940
. 1940
.2410
. 1960
.1950
1.0050
.5025
.2750
.4350
.3350
.3380
.51

was be

ef's

theTea

AM

ex

isd
the Ling

Gold shipments are at times sent from one country to another at
the request of a banker in a third country. It is not at all unusual for
American bankers to ship gold to South America or to the Orient at
the order of and for the account of English banking firms because it
may be more profitable or convenient to have the gold sent in that
manner. During the fall of 1914 , American bankers made payments
in London by shipping gold to Ottawa , Canada, for the account of the
Bank of England.¹

Gold is sometimes shipped to a financial center for the purpose of
using it there to purchase exchange on a third center. Suppose that
the exchange rate between Paris and London is low, between New
York and London high, and that a New York banker figures that a
profit can be made by sending gold to Paris and ordering his correspondent to purchase exchange on London, thus building up his London account against which to sell sterling sight drafts. The details of
2.
such a transaction based upon data furnished by Escher 2 are as follows : The exporter secures 48,500 ounces of bar gold .995 fine in New
York at $20.5684 per ounce, costing him $997,567. He is compelled
to add the assay charge of 4 cents per $100, or $400 ; freight of 1/8 per
cent of the value of the shipment , or $1,247 ; insurance at 4½ cents per
$100, or $450; cartage and packing, $60; a commission to his correspondent in Paris of $250, and interest at the prevailing call rate in

1 Cf. p. 531.

2 Escher and Jefferson, op. cit., p. 378.

394

DOMESTIC AND FOREIGN EXCHANGE

NewYork of 2 per cent for six days while the gold is in transit, amounting to $333. The cost of the gold plus the charges would amount to a
total of $1,000,307. When the gold reaches Paris the Bank of France
purchases it from the correspondent, say at the rate of 106.3705 francs
per ounce, netting 5,158,969 francs. If exchange on London is at
25.10 francs per pound sterling, 5,158,969 francs will buy £205,536.
The correspondent will forward this exchange to the New York
banker's designated London correspondent and the New York banker
will then be able to sell sight or cable exchange against the account
thus built up. It may be that he has drawn his draft against the shipment ofgold some days before the exchange from Paris reaches London,
in which event his draft would be presented for payment before he
has been credited with the amount in question, and he will have to pay
interest on the overdraft. But if he calculates his time correctly and
sells sterling exchange so that it reaches London after the remittance
from Paris has reached London, there will be no overdraft. If he sells
sight sterling at 4.8670, his shipment and exchange transactions will
yield £205,536 worth of drafts, for which he gets $ 1,000,342 . The
shipment cost him a total of $ 1,000,307 ; he receives from the transaction $1,000,342 or a profit of $35 on a shipment of 48,500 ounces
of bar gold. If the costs of shipping were lower, if the rate of exchange
in New York on London were higher , if the exchange rate in Paris on
London were more satisfactory, or if the money rate in New York were
lower than 2 per cent, the New York exporter would make a greater
profit on the transaction ; and of course the reverse would be true if the
costs were higher or the exchange rates less satisfactory.
Bankers export or import gold when there appears to be a reasonable
opportunity of making at least 1/32 of one per cent, but gold shipments
are frequently made at a loss. The best that can be said is that the
profits from gold shipments are usually small. If from $500 to $1,000
is cleared on an import or export of $1,000,000 the banker feels that
he has been fairly successful in the venture.
The student of the exchanges, however, should not conclude that
gold always flows into or out of a country when the exchange rates
are above or below the customarily accepted gold points . England has
frequently experienced the failure of the gold points to work as they
should in accordance with the principles laid down by the theory of
the exchanges . It is not at all unusual for her to lose gold long before
the exchange rates are sufficiently against her to justify its outward

GOLD AND GOLD MOVEMENTS

sit,am

ofF

395

shipment; she may even lose gold when the exchange rates are in her
favor. On the other hand, it has also been her experience that gold

Lordics.

does not necessarily flow toward her when exchange rates should induce it.¹ Our own experience also justifies the statement that the
customary gold points are not infallible indicators of a forthcoming

New Y

export or import of gold. The many reasons why this is true will be
pointed out in subsequent pages.

si

YorkFere
the a

nst thest

hesLo
te

During a panic or financial stringency when New York bankers are
greatly in need of funds, they get cash in hand by selling exchange on
their foreign accounts. This tends to lower the rate on those centers
and it may fall below the import point without the bankers engaging
gold for import. Their need is for immediate cash, and if gold is imported it will be from seven to ten days before it can possibly reach
New York and relieve the stringency. Banks that are unwilling to

Saction
the
500

in Pars

wait for that length of time sell exchange at a rate lower than the gold
import point. Gold may also be imported at times at an apparent―
and sometimes at a real- loss . Interests that desire to influence the
stock market favorably may import gold. Its importation affords the
bankers a larger amount of credit for loans in the stock market, and
tends to cause a falling off in the money rate. With the announcement
that gold has been engaged for import or that it is on its way, those
who are manipulating the market buy large blocks of securities on a
margin and hold them until the gold arrives and the money rates drop.

Ite

keagaz
etres

is the s

Dc to$
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This fall in the money rates induces freer buying, securities rise, and
the speculating gold importers unload their holdings at a profit.
Banks may import gold when exchange rates are still too high to
warrant its coming, and to the outsider it might appear that a loss
must be inevitably sustained. Investigation, however, may disclose
the fact that money rates at home are very high and appear likely to
remain so. The bankers may have felt that they can afford to take an
apparent loss for the purpose of being able to get the gold, build up
their credit, and expand their loans at the high rates of interest, thus
more than recouping their loss on the gold shipments. A dollar's worth
of gold may serve as the basis for three and a half or four times that
amount of loans. One must not overlook the fact, however, that the
importation of gold and the extension of credit may in their turn bring
1 "Not only do we [ England] always lose gold when the exchanges go against us, and
often get none when they go in our favor, but we often lose gold long before the exchanges
are sufficiently against us to justify its going, and sometimes even when they are strongly
in our favor." Withers, " Money Changing," p. 163 .

396

DOMESTIC AND FOREIGN EXCHANGE

about a lowering of the money rate in the market and turn the venture
into a real loss.
Bankers and investment houses sometimes import gold at a slight
loss for the advertising that it gives them. If the public learns that the
banking firm of X. Y. Z. & Co. has received $ 1,000,000 in gold from
abroad, it is apt to have a little more confidence in that house and
possibly shift some accounts to it. Sometimes it is necessary for a
bank to import gold even at a loss for the purpose of strengthening its
position. German banks before the World War were accustomed,
at certain periods of the year, to import gold even though exchange
rates did not justify it , so as to meet the great demand for money. In
October, 1916 , a large amount of gold was taken from New York by
the Canadian banks when exchange rates did not warrant it. The
only explanation offered was that the latter were preparing to make a
fine financial showing (" window-dressing ") preparatory to the publication of their November statement of condition .
In times of financial stringency it is not unheard of for the central
banks of European countries or for our Treasury Department to give
credit to the importer for gold that is in transit. Before the World
War the Reichsbank of Germany frequently gave the importer credit
for the gold as soon as it had left London or when it had reached the
border of the country. When such aid is given, the importer can engage gold for shipment long before the exchange rate falls to the gold
import point, his apparent loss being offset by the assistance given by
the central bank or the Treasury Department. At one time during
the panic of 1907-08 , the Reichsbank gave interest to the consignees
of gold while the shipment was in progress and also for three weeks
additional . Gold shipments to the United States have been assisted
at various times by the Secretary of the Treasury for the purpose of
relieving banks of serious financial strain.

In April and June, 1906,

the Secretary of the Treasury aided the importation of gold by depositing governmental funds with seven New York banks, thus giving
them the use of government money while the gold was in transit.
$50,870,000 worth of gold was imported at that time. Two of the
banks made a slight profit of $ 1,000, three broke even, and two sustained a loss.¹ Again on September 5 , 1906 , the Secretary of the
Treasury deposited government funds with banks that were importing
gold. As a consequence of the aid given , the drain of gold from Europe
1 Commercial and Financial Chronicle, July 14, 1906, p. 61 .

GOLD AND GOLD MOVEMENTS

397

to the United States reached large proportions and deranged the European money market. The Reichsbank of Germany was forced to
raise its discount rate on October 10, from five to six per cent while
on October 11 , the Bank of England raised its discount rate from four
to five per cent and on October 19 to six per cent. Finally, on October 23, the Secretary of the Treasury announced the termination of
the assistance. Approximately $54,000,000 worth of gold had been imported in that very short time ; during the year the gold import had
amounted to $ 103,000,000 .
In the early months of 1913 , both Germany and France were in the
American market for large amounts of gold. In January, 1913 , $ 10,000,000 of gold was shipped to France, although the exchange rates
did not warrant it. In February, another $ 10,000,000 was sent to
Argentina on Paris account, while Paris itself took $ 1,000,000 . At
this latter date, exchange rates began more nearly to approximate
the gold export point. In March, $ 17,000,000 went to Paris, Berlin,
Brussels , Venezuela , and Argentina , but all of the shipments to Europe
were considered to be transactions involving a loss to the importing
country. Shipments to France continued in May even though exchange rates had declined —about $12,000,000 being exported at that
time. Several reasons were advanced for these unexpected shipments.
The Balkan War had caused a renewal of the fear of war with Germany. French peasants had begun hoarding gold in large quantities
causing a drain on the gold reserve of the Bank of France, which resulted in a bad showing for several weeks in the latter's bank statement.

Gold had to be imported, even though not warranted by the

exchanges. Gold was also commanding a premium in France, and the
Bank of France could well afford to aid the importation by paying
interest while it was in transit . The May importations were made
partly because the Bank desired to be prepared to take care of the
expected demand for loans by the home government and the Balkan
States.
The existence of a premium on money (for ready cash) may likewise
cause gold to flow in spite of the position of the exchanges. An outstanding instance of this sort in our financial history occurred during
the panic of 1907-08. Because of the monetary stringency in the fall
of 1907 , banks throughout the country were paying a premium of about
3 per cent for gold, silver, or paper money in order to get funds with
which to meet their local needs. This premium (3 cents on the dollar)

398

TIC

DOMES

GN

AND FOREI

NGE

EXCHA

was equivalent to about 14 cents on the pound sterling ($4.8665) . On
October 26, sight sterling stood at 4.824 @ 4.825. During that week
$19,750,000 of gold was obtained in London for shipment to the
United States. The Bank of England on November 1 raised its discount rate to 52 per cent, on November 4 to 6 per cent, and on November 8 to 7 per cent, and raised its price on bar gold to 78s. 1/8d. The
Reichsbank of Germany raised its rate from 5½ per cent to 6½ per
cent on October 29, and to 72 per cent on November 8. The obstructions placed in the way of gold shipments through higher discount rates
and the premium on gold charged by the Bank of England did not prevent the shipment of the metal to the United States. In October, sight
sterling ranged from 4.8240 @ 4.8250 for low, to 4.8635 @ 4.8650 for
high; in November from 4.85 @ 4.8525 for low, to 4.8850 @ 4.8875
for high; and in December from 4.8410 @ 4.8415 for low, to 4.8660 @
4.8670 for high. It is evident that exchange rates played a minor
part in gold imports, since they were for the most part consistently
above the customary gold import point and at times approximated
the customary gold export point.¹ The controlling factor in the
situation was the high premium on ready cash dominating the New
York market. Gold importations were unusually profitable notwithstanding the loss of interest on imports resulting from the high rate
on money with which cables were purchased (call money rates on the
bulk of the business ranged from 20 to 50 per cent) and the premium
on gold charged by the Bank of England. Inasmuch as cables were
largely employed to pay for the gold, the banks followed the policy of
counting the gold in transit as part of their reserves, thus making
credit based on the gold available for loans in the New York market.
During the first week of November, the gold engaged for import from
the Bank of England reached approximately $44,000,000. The Bank
of France , fearing that if it did not come to the assistance of the Bank
of England the latter would be compelled to raise its discount rate
to 7 per cent and thus seriously interfere with the Paris market, decided in October to buy 58,870,726.77 francs of English bills and to
pay for them in gold. It subsequently purchased additional amounts
and on November 5 forwarded to the Bank of England 80,000,000
francs in American gold eagles, thereby relieving the pressure on the
English market. Our government had attempted to induce the Bank
of France to ship the gold directly to us, but we could not or would
1 On November 4, 1907, the sight sterling rate was 4.885 @ 4.8875.

GOLD AND GOLD MOVEMENTS

399

not give the guarantees demanded, so the gold went to England
and from there was forwarded to us. During October, November,
and December, over $ 112,000,000 gold actually arrived in the United
States, chiefly from London.
The price paid for gold by the Bank of England and the price
charged for gold in the United States may at times work to prevent
gold movements when exchange rates justify them. This is illustrated
by an instance that occurred in the spring of 1896. During the week
ending April 3 , 1896 , the sight rate on England stood at 4.89½ @
4.90, yet no gold was engaged for export . The price at which gold
was selling in England was 77s . 9d. , which, as we have seen, is the
minimum rate at which the Bank of England purchases the precious
metal.

On March 25, the United States Treasury, in order to protect

its gold holdings, had advanced its premium on gold bars from 1/16
to 3/16 of one per cent, so that with the low price of gold in England
and with the high premium being charged for gold bars in the United
States the sight rate of 4.89 % @ 4.90 was not sufficient to induce
us to send gold to England.¹
Difficulties in negotiating exchange transactions on outlying coun-

tries may also make it possible for the rates to remain for some time
either above or below the gold points without gold shipments taking
place. A supply of exchange on some outlying point may be available
for which there is no demand, or there may be a demand for exchange
on that point with no supply in sight. It is often difficult to negotiate
bills on certain South American countries. The bills may be taken
by the bank only as an investment, or the risk may be greater than in
the case of ordinary bills, with the result that the rate that the bank
will pay for the bills will be below the gold import point. Or it may be
that an unusual demand may arise for exchange on some out of the way
place, so that the exchange rate may rise and remain for some time
above the gold export point without any gold being shipped. We also
find that the rates charged or paid by small banks in dealing with their
local customers are frequently above or below the respective gold
points. Small banks charge or give " what the traffic will bear " without regard to gold points. In fact, many bankers who retail exchange
of various sorts would be nonplussed if asked to explain the meaning
and importance of " gold points."
While one might expect that, with the exception of war periods,
1 On May 29, 1896, the premium on gold bars was reduced to 1/8 of one per cent.

400

DOMESTIC AND FOREIGN EXCHANGE

the exportation of gold could be no more interfered with than the
exportation of any other commodity, nevertheless we do find obstacles
of various kinds being put in the way of its movement. Gold is the
one commodity of all commodities that a nation as a rule is hesitant
about exporting to too great an extent. Gold imports are much preferred and are anticipated with a great deal of optimism, although it
remained for the World War, that destroyer of many ideals, " laws,"
and theories , to give us the strange phenomenon of nations protesting
against receiving too much gold from their debtors and even taking
steps to prevent its importation. In times of war, gold movements
are usually under the complete regulation and control of the government, or are absolutely prohibited. But even in normal times it is considered advisable that some means be provided whereby the gold supply of a country, and incidentally the import and export of gold, can
be rather closely controlled , regardless of the exact position of the exchange rates. The central banks of Europe and the Federal Reserve
banks of the United States are the custodians of the gold reserves
of their respective countries. Up to the time of the enactment of the
Federal Reserve Law, there was no possibility of regulating our gold
flow in any manner whatsoever except through the action of the
Treasury in granting credit for gold in transit, or through the government's contracting with a syndicate to control gold exports, as was
done during the panic of 1893. Gold flowed into or out of our country
in untold millions, yet we had no more control over its coming or going
than over the waves of the ocean, and only in the most extraordinary
situations, when the interests of the government itself were at stake,
did we move to erect a dam to obstruct, or to dig a channel to guide,
its flow. During the panic of 1893 , Europeans dumped securities on
our markets in such quantities as to crush our stock exchanges and to
cause a tremendous outflow of gold,2 crippling our banks and bringing
our government to the verge of bankruptcy. Linked with these developments were the workings of the so-called "endless chain " 3
and the drain upon our gold resources caused by our very heavy adverse balance of trade, both of which were active factors in depleting
our gold holdings and in almost wrecking our financial system.

In

1 Cf. pp. 424-425.
2 During the first six months of 1893 we exported approximately $62,000,000 in gold.
Gold was drawn from the United States Treasury by the use of greenbacks and
Treasury notes, which, when paid out again by the government according to legal requirements, were gathered up and presented to the Treasury to be redeemed in gold.

GOLD AND GOLD MOVEMENTS

401

its necessity, the government finally made arrangements with the
"Morgan-Belmont " syndicate to protect its interests. The syndicate,
in order to bring exchange rates below the gold export point, pursued
the same tactics in pegging the rate that were adopted by England
during the war. It sold large amounts of securities to European investors and drew drafts against such sales, thus increasing the supply
of exchange and reducing the sight rate below the export point. In the
early part of May, 1895, the exchange market was flooded by large
offerings of such drafts. Sterling sight rates fell from 4.90 @ 4.90%
to 4.87 % @ 4.88 . The syndicate also sold large amounts of exchange
on the bank accounts of its members in European countries, and as
the rates eased off it was able to recoup itself and buy cover at rather
favorable rates. During June, 1895 , issues of Illinois Central bonds,
Alleghany Valley Railway bonds, and City of Chicago loans were
negotiated abroad, but they fell short of supplying the demand for exchange, rates again rose, and the syndicate was forced to enter the
market and supply the necessary exchange to take care of the situation.
A month later sight sterling rose to 4.90% with cables at 4.90 3/4, and
the syndicate once more found itself obliged to meet the heavy demand
for drafts. About $2,000,000 of gold was exported at this time. In
August, with cables at 4.91 , about $ 15,000,000 gold was exported .
Finally in September, a shipment of $14,150,000 gold succeeded in
breaking the market with the result that the rates eased off very satisfactorily. Also, at this time cotton future bills came forward and
helped to create an adequate supply of exchange. Developments
during the panics of 1907-08 and 1914 again revealed our absolute
lack of control over the movement of gold. It was partly to remedy
this condition of affairs that the Federal Reserve Law was passed in
1913, creating an open discount market and permitting the manipulation of the discount rate by the Federal Reserve banks for the purpose of controlling gold movements. As yet ( 1922) however, we have
had no occasion to try out the new machinery devised to meet
such emergencies. It is confidently expected, however, that it will
work successfully when called into play , for it is a replica of the method
followed by most of the central banks of Europe.
Until conditions in the financial world were upset by the declaration
of war in 1914, the Bank of England had stood for centuries as the
world's greatest warehouse of gold , ¹ receiving and giving out gold in
1 The following table shows the gold holdings of the Bank of France, the Reichsbank,

402

DOMESTIC AND FOREIGN EXCHANGE

a lavish manner according to the requirements of trade, finance, or the
foreign governments. It has not held the largest amount of the yellow
metal (the Bank of France and , before the Great War, the Reichsbank
and the Bank of Russia usually holding much larger sums) , but it has
really been the world's greatest warehouse because of the enormous
sums of gold that have continually flowed through its vaults. The
"Old Lady of Threadneedle Street," however, is wise enough, and
possesses adequate means, to safeguard her hoard if the occasion demands it. To do so she has recourse to any of a number of different
expedients. Usually her reserves against deposit liabilities range from
30 per cent to 50 per cent, averaging about 43 per cent. If as a result
of the gold drain the Bank's reserves get dangerously low, or if a heavy
gold export movement occurs which the Bank feels ought to be prevented or hindered , or if for some reason gold imports should be encouraged, the Bank may become the dominating and guiding factor
in the situation. It may go into the market and bid high in order to
obtain the needed supply of new gold ; or, to hinder gold being taken
for export, it may charge a higher price than customary for foreign
gold coins, or it may refuse absolutely to sell gold bars.¹
The Bank may find , however, that the gold is being drawn away
more rapidly than it can be accumulated , or that other parties in the
market are willing to bid higher for the new gold. The Bank can then
resort to a change in the minimum rate at which it will discount three
months' bills. Through its discount rate it may manipulate the gold
movement without entering the market as a higher bidder. Raising the
discount rate acts in several ways to influence the market and to assist
the Bank in controlling the flow of gold. In the first place, a rise in
the Bank's discount rate is usually followed by an increase in the money
rates of other banks and discount houses in London. If, in normal
times, the market money rates do not rise, the Bank may refuse to
loan money to bill brokers or to stock and bond dealers. This refusal
and the Bank of England at the time of their last weekly reports for December of 1913
and March, 1922. The data have been reduced to pounds sterling for comparison:
December, 1913
March, 1922
Last Weekly Report
France .
. £140,696,000
£221,033,997
77,793,000
49,819,250
Germany.
34,983,149
England .
128,779,763
On March 22, 1922, the Federal Reserve banks held $2,976,703,000 in gold and gold certificates. Converting the same at the rate of 4.86 per pound sterling for comparison with
the holdings of the European banks, gives the figure of £612,490,333.
1 As it did in 1890.

GOLD AND GOLD MOVEMENTS

403

compels them to go to the joint stock banks for their loans, and normally results in raising the market rates. When the Bank of England
decreases the amount of loanable funds in the market the joint stock
banks may have to call in their loans from brokers and others, compelling the latter to go to the Bank of England for funds. The Bank
may then charge what rates it deems necessary to force the money
rate in the open market to the desired level. When money rates are
high in England, owing to the increased discount rate of the Bank of
England, foreign bankers hasten to transfer their funds to England
so as to earn the higher interest rate. Prices of securities usually fluctuate inversely to money rates. As money rates rise, the London'
prices of securities fall, and it becomes more profitable for foreigners
to buy securities in London than at home. A demand is thus created
for sight and cable exchange on London, which in the end tends to
raise the sight rate in foreign countries to the gold export point and
soon gold begins to flow toward England.

Proceeding from another

angle, the same object is accomplished. High money rates prevailing
in England induce the English and foreign bankers to keep their funds
at home in preference to exporting them to other countries. London
bankers and others, who have funds invested abroad, recall them to
England. Raising the discount rate therefore not only induces gold
to flow toward England , but at the same time hinders its flow out
of England. It also makes it more difficult to finance home industry
because of the higher money rates. It causes goods, held for speculative purposes (mostly on borrowed money) , to be thrown onto the
market. Industry slows up; prices fall ; it becomes cheaper to buy in
England. This creates a demand for exchange on England with which
to pay for goods purchased , and sterling exchange tends to rise in
foreign centers to the gold export point.
The higher discount rate in England enables American bankers to
pay less for long time bills because more will be deducted from their
face value when they are discounted in England. Where ordinarily
the banker will purchase long bills with the idea of discounting them
in London in order thus to build up his account and make it possible
to sell sight exchange against that account, he will find it more profitable, when the discount rate is high, to purchase long bills for investment and to hold them until maturity.

This does not increase his

foreign account and consequently does not create a supply of exchange available for sight drafts. Thus, by raising the discount rate,

404

DOMESTIC AND FOREIGN EXCHANGE

the Bank of England creates a demand for sight exchange on the part
of those who wish to transfer funds to England wherewith to take advantage of the higher money rates, and at the same time it effectively
limits, for the time being at least, the amount of sight exchange in the
market. The result is an increase in the sterling sight rate in foreign
centers until it approximates or exceeds the gold export point.
If affairs in the financial world are running along smoothly and the
reserves of the Bank of England are at a satisfactory level, the Bank's
discount rate is of practically no significance. In normal times, very
little rediscounting is done at the Bank by the bill brokers or the joint
stock banks, because the Bank's rate is above that prevailing in the
open market. The Bank's rate never falls below 2 per cent while the
market, when carrying a large amount of surplus funds, may be willing
to discount for as low a rate as 3/4 per cent. Clare, as a result of his
study of the years 1881-1890 , states that during that period the market
rate averaged 77% per cent of the Bank rate.¹ The failure of the
market rate to move up and down in conformity with the Bank rate
is partly due to the fact that bankers do not pay interest on all of the
funds which they use, interest being paid only on interest-bearing
deposits ; banks therefore can afford to raise their rate of discount a
little less than the Bank does. If a financial stringency strikes the
London market and money becomes tight, the bill brokers and the
joint stock banks have recourse to the Bank of England for rediscounting purposes. The Bank of England , however, must rely upon its own
resources to stand the strain ; also , when, because of adverse exchange
rates, gold flows out of the country, it is the Bank of England's gold
reserves that are first affected . Under such circumstances, the Bank
of England will raise its discount rate for the purpose of tightening
the money market, conserving its own gold resources, or preventing
the outflow and encouraging the inflow of gold . If, when the Bank
raises its discount rate , the money rates in the open market do not
rise as the Bank hopes they will, the Bank proceeds to " make its rate
effective." It enters the market as a borrower of funds, thus curtailing
the available supply. During the early months of the World War, the
Bank could not make its rate effective owing to the lack of commercial
bills in the market and the great surplus of available funds. The open
market discount rate on three months bills was as low as 1 3/8 per
cent in February, 1915 , while the Bank's rate was 5 per cent. Το
1 "A Money Market Primer," p. 140.

GOLD AND GOLD MOVEMENTS

405

remedy the situation, the Bank began borrowing from the joint stock
banks in March. As a consequence of this action and also partly as a
result of the issuance by the Treasury of a large amount of Treasury
bills, which supplied a satisfactory form of investment for the surplus
funds, it was able to control the rates in the money market most
effectively. Another means sometimes used by the Bank to make its
rate effective, is through the sale of governmental bonds " on account,"
that is, to sell such bonds with the understanding that it may buy
them back at a later date. Such sales remove a portion of the free
capital from the market and thus tend to raise the open market money
rates.

If one were to plot two curves showing the fluctuations in the Bank
rate and the flow of gold, the results would clearly show that, as a rule,
when gold flows into England the Bank rate drops, and that when
gold flows out of England the Bank rate rises. Normally, gold flows
into England during the spring months because of payments made to
English merchants by foreign buyers . As the summer months pass
and autumn comes, England buys supplies of raw materials such as
cotton, grain, etc. , from foreign countries and as a result gold tends
to flow out of the country. Thus in the spring of the year the Bank
rate is low and gold imports are high ; in midsummer the two factors
more or less approach each other ; and as the year closes the Bank
rate rises and gold imports fall off. Clare, after making a careful
study of the situation , concludes that "Taking one year with another,
it may safely be said that a net gain to the Bank of a million from
foreign imports corresponds to a 1 per cent drop in the rate, and a loss
It may be taken for granted,
of that amount to a 1 per cent rise.
then, that the statistics of the Bank's gain or loss of strength from the
gold sent into or out of the country forms the best ground-work on
which to base a forecast of the future course of the market ; but at the
same time it must not be assumed that the connection is always so
close and clear as in the instance given. Due allowance must also be
made for other influences, such as the general conditions of the market,
the state of trade, the political outlook, etc. , all of which are considerations that the Directors, doubtless, take into account before deciding
on a change of rate.” 1
As may be inferred, the frequent changes in the Bank's rate exert
a most disconcerting effect upon the money market. Stability in the
1"A Money Market Primer," pp. 70-71.

406

DOMESTIC AND FOREIGN EXCHANGE

discount rate of a central bank is an ideal much desired by those engaged in financial circles. The Reichsbank and the Bank of France
likewise resort to a manipulation of the discount rate as a means of
controlling the gold flow, but not to the extent that the Bank of England does. Taking the ten-year period, 1898-1907, the Bank of France
changed its discount rate eight times, the Reichsbank forty-two
times, and the Bank of England forty-eight times. Both the Reichsbank and the Bank of France rely upon other methods than a change
in the discount rate to control the gold flow. Under abnormal conditions the discount rate of the Bank of England may fluctuate widely.
The following table shows its discount rate from 1914 to date :

January

July
August

39
66

5½

612

35 པ 335 པ

April
15
28
April
June
23
21
July
November 3
February 16
14
April

42%
4
3
4
8
ΙΟ

13

1922

13
18
5
6

Friday
Saturday
Thursday
Saturday
Thursday
66པ
66
10

1919
1920
1921

July
January
April
November

29
30
31
I
6
8

Thursday
"6
66
66

656

1916
1917

8
22

ཨཿ
༠
ས
ཙྪཱ

1914

66

5%
5
42
4

In commenting on these war-time fluctuations, the English Bankers
Magazine of February, 1921 ,¹ states that " Under the abnormal position created by the recent War, it has to be borne in mind that Bank
Rate changes during and since the War were not accurate indications
of current financial strain nor controllers of floating indebtedness
between London and foreign centers as in pre-war times," and it
wisely adds that " until the gold standard is restored, in the future
the Bank Rate must necessarily be largely considered as nominal. "

1 P. 198.

GOLD AND GOLD MOVEMENTS

those s
ofFran
means:

nk ofEx
ofFra

forty-t
he Res
a chara
malc

te wider
e:

407

As a means of protecting the gold holdings of the Bank of England,
it has been suggested that instead of manipulating its discount rate
the Bank should increase its price for gold. Gold responds very
readily to a slight change in price. Although the Bank would cut into
its profits if it paid a higher price for gold in times of need, nevertheless
it is claimed that the adoption of the proposal would obviate frequent
changes in the Bank rate, and thus remove a most disturbing influence
in the business and financial circles of England . As noted above, the
Bank of England pays about 76s. 4½d. per ounce for full weight gold
coins when 9/10 fine . But coins are seldom full weight, so that the sum
paid is generally 2d. less than that amount. At times the Bank has
actually raised its buying price with most satisfactory results, while attempting to maintain its Bank rate unchanged. In May, 1891 , for
example, when, because of the then existing Russian situation, the
Bank was compelled to prepare for the withdrawal of £3,000,000 or
more in gold, it found that it could not procure the needed quantity
of gold from Berlin or Paris and decided to attract gold from New
York. On May 6, the directors of the Bank of England agreed to pay
a premium of ½ cent over the customary price for American eagles.
The premium was gradually increased until in the middle of the month
the Bank's price stood at 76s. 6½d. In the market bar gold 11/12ths
fine was commanding 77s. 9 3/4d. The premium on American coin
had the desired effect and during the month of May approximately
$30,000,000 in gold was drawn from the United States. During this
efflux, an American banker shipped several bars of gold and was surprised to learn that they were less acceptable than coin, because, as
it was stated , when the fall movement of gold would set in toward the
United States, the Bank of England would prefer to return gold coin
than gold bars.¹ During the first week of June, the price was re-

Beste

he
Doming

duced to 76s. 5d. and shortly thereafter the premium was abandoned .
The plan had worked successfully.
The central banks of Europe encourage gold imports by giving
credit or making advances on gold while in transit. This was a rather
customary practice of the Reichsbank before the war in order to care
for the financial strain accompanying monthly or quarterly payments

in Germany. Both the Bank of England and the Bank of France, as
well as the Treasury of the United States, have at times resorted to the
same method. In times of urgent need the Bank of France has been
1 Commercial and Financial Chronicle, May 30, 1891 , p. 810.

408

DOMESTIC AND FOREIGN EXCHANGE

known to pay a premium on any gold deposited with it, as in November, 1921 , when a premium of 1 per cent was paid.
In addition to relying upon the discount rate as a means of checking
gold exports, the Bank of France at times falls back upon its right
to redeem its bank notes in silver five franc pieces instead of in gold
coin, thus preventing exporters from reducing the gold holdings of
the Bank. At the same time it may-and usually does- charge a
premium for bar gold or for foreign gold coins.1

In October and

November, 1907, when England, France, and Germany were being
called upon for large amounts of gold, which either directly or indirectly found their way to the United States to relieve our financial
stringency, the Bank of France charged a premium of 6/10 per cent
2
for gold. The premium charged by the Bank is often prohibitive
and compels the exporting firms to secure the necessary gold from the
internal circulation of the country. Coins are collected by money
changers from railway stations, hotels, etc. , and disposed of to the
exporting houses. This process entails time and expense, so that it is
not unusual for the demand for exchange on London in the meantime
to raise the rate considerably above the gold export point, although
the rate always declines when gold begins to flow out of Paris. This,
for example, was the case in December, 1899, when sight exchange
on London rose to 25.40 francs per pound sterling because of the delay
3
in securing gold for export.
When the Bank of France charges a
premium for bar gold or for foreign coins, the gold export point is
raised because the premium adds to the expense of exportation. The
possible loss on coins due to abrasion must also be considered . At a
premium of 4/10 of one per cent, exchange on London has to rise to
25.425 before it pays the exporter to get gold from the Bank of France
for export.

It is because of the methods followed by the Bank of

France in preventing gold from being freely obtained for export purposes that Paris has never been considered a free gold market. Some
claim that it is that fact alone which has prevented it from becoming
an important international financial center similar to London.
The Reichsbank of Germany, as noted above, resorts at times to
1 "The Bank of France always maintains a premium on gold for export purposes varying
from 2 % to 6 per mille (4 % to 6/10%)." H. V. Burrell, English Bankers' Magazine,
1916, p. 210.
2 In November, 1912 , a premium of nearly 34 per cent was charged on gold for export.
3 Gold usually flows from Paris to London in normal times if the sight rate rises to 25.32
francs per pound sterling.

GOLD AND GOLD MOVEMENTS

409

Gs

asi changing its discount rate so that it may control gold movements, but
it may also use two other means not availed of by either the Bank of
France or the Bank of England. If gold is demanded from the Reichs-

da

bank for export and the Bank feels that the yellow metal should be
retained in the country, it interposes objections of one sort or another
or delays payment or appeals to the patriotism of the exporter. The
Reichsbank is required at all times to redeem its notes in gold and,
except during and since the World War, it has always done so. But

གངས།2ས། །

banks and bankers of Germany do not draw upon the gold holdings
of the Reichsbank if it objects to such loss . Instead, gold will be taken
from the circulation of the country, which entails time and expense,
so that exchange rates may exceed the gold export point for some
time before the gold outflow becomes sufficiently large to affect the
situation. The Reichsbank, and the Bank of Belgium as well, also
follow the policy of keeping on hand a large supply of foreign bills of
exchange which may be used for protection when occasion demands.
The Reichsbank usually holds a large amount of sterling drafts together with some French drafts ; the Bank of Belgium invests more
heavily in French bills. These holdings are accumulated or replenished when exchange rates are low. If the rates of exchange rise so high
that gold exports are apt to occur, the bills are sold in the local market,
thereby creating a supply of exchange and lowering the rate below
the gold export point. Also, if it is advisable to encourage gold imports, the rate may be forced down until it is below the gold import
point, thereby causing gold to flow into the country.
Another method sometimes followed for the purpose of preventing

gold exports is to have the nation or the central bank obtain loans in
a country to which the gold should normally flow, and then sell exchange against the bank accounts thus created in that country, thereby
adding to the supply, weakening the rate, and thus preventing gold
exports. Or, again, such loans may be used for the same purpose but
as a means of decreasing the supply of exchange on the borrowing
country and so removing a most important weakening influence.
Thus during the World War the Allies obtained loans from the United
States, and the proceeds were deposited in New York banks. American
firms selling goods to the Allies drew dollar drafts against those accounts. The drafts, being on dollar accounts and paid in the United
States, did not add to the supply of exchange in the United States on
the allied countries, as would have been the case had the drafts been

410

DOMESTIC AND FOREIGN EXCHANGE

drawn on foreign accounts in sterling, francs, lire, etc. The exchanges
were thereby relieved from what would otherwise have been the crushing and overwhelming weight of an untold amount of drafts drawn
in foreign monies with no possibility of the Allies offsetting our claims
on them by their claims on us , as would normally have been the case.
We were selling to them but they were not selling to us.

Such loans,

however, merely postpone the evil day, because they must be paid
sometime, and at maturity become a powerful influence tending to
reduce exchange rates in the lending country to the gold import
point.
It is not unusual for arrangements to be made between bankers for
the "earmarking " of gold, thus making its shipment temporarily
or permanently unnecessary. During 1917 the American dollar was
at a discount in Argentina because of our adverse balance of trade
with that country. Gold was destined to leave the United States in
large amounts, even to the extent of possibly handicapping our participation in the European War. Not long after the outbreak of the
European War, Argentina passed a law enabling American importers
to make payments to the Argentine Ambassador in the United States,
who deposited the proceeds with the Federal Reserve Bank of New
York. Payments by Argentine importers were deposited with the
Banco de la Nacion in Buenos Aires. Claims of the merchants of one
country against those of the other were cleared through the two banks,
obviating, so far as possible, the shipment of gold . This law had
lapsed, but as a result of the dollar being so greatly at a discount in
Argentina, the Secretary of the Treasury of the United States asked
that the law be revived, which was done, and on January 7, 1918, he
announced that an agreement had been reached with Argentina
whereby the dollar rate on that country was to be stabilized at a little
higher than the gold export point. Payments were to be made to the
account of the Argentine Ambassador with the Federal Reserve Bank
of New York at the rate of three per cent above par to cover costs of
transportation, insurance, etc. , which would have had to be paid had
gold been shipped. The American importers were thereby saved a
premium of approximately seven per cent. We were also able to keep
our gold in the United States. Following the Armistice the Argentine
account was gradually withdrawn , the arrangement being terminated
in 1920 .
Another instance of the " earmarking " of gold occurred in 1919 when

GOLD AND GOLD MOVEMENTS

411

the Federal Reserve Bank of New York, acting on behalf of all of the
Federal Reserve banks, purchased from the United States Grain
Corporation about $173,000,000 worth of gold. This gold had been
sent to the Bank of England from Germany as gold marks and after
being reduced to bars had been " earmarked" by the former for the
account of the Federal Reserve Bank of New York. The latter, from
time to time, sold varying amounts of the gold to banks and bankers
in the United States who desired to export metal to various parts