CHAPTER XVII INTERNATIONAL TRADE THE supply of gold, the development of trade, money, banking and credit, in short all the economic forces and institutions discussed in the chapters immediately preceding, take on special complexity when they become international in scope. The fundamental principles underlying international trade and credit are the same as those underlying domestic trade and credit truth too frequently forgotten - but trade between two countries in which language, banking institutions, monetary units, and monetary legislation are different presents special problems which call for separate treatment. a Foreign Exchange. In the beginning a brief description must be given of the mechanism of foreign exchange. In international as in domestic trade, only a small amount of money is used, compared to the enormous money values of the goods exchanged. Purchase is set against sale, debt canceled by credit, and money is employed only for the occasional settlement of balances. This cancellation of offsetting claims is effected by the banks and bankers who engage in foreign exchange. Their work is indispensable in the development of foreign trade. The European War, for instance, by interrupting traffic between Europe and South America opened up large export possibilities to American manufacturers; but it was found impossible to take large or immediate advantage of this opportunity, partly because the necessary banking and credit connections had not been established between South America and this country. As illustrative of the processes of foreign exchange, let us take our trade with England. Ordinarily, an American exporter who has sold goods to England draws an order a bill of exchange on the English debtor, directing him to pay the claim at some specified time and place in London. American importers, on the other hand, commonly pay their foreign balances by buying bills of exchange or drafts on London, and sending them to their English creditors. In this way American debts and credits are balanced in London without transferring any money at all, except occasionally to settle the balance of indebtedness. Bills of exchange drawn on a commercial debtor are usually accompanied by bills of lading, insurance receipts, certificates of weight and origin, and all the documents necessary to give the purchaser of the bill full title to the goods until the bill is accepted or paid. They are accordingly referred to as "documentary bills" or "commercial bills," to distinguish them from "bankers' bills" and other instruments of international credit described hereafter. Documentary bills are freely negotiable, passing from hand to hand by indorsement, and gathering strength with each new indorsement. It is important, also, to note the difference between " sight bills" and "long bills," the former calling for payment upon presentation, the latter usually for immediate "acceptance" by the drawee1 and payment after thirty, sixty, or ninety days. The price of long bills is fixed by the price of sight bills and the discount rate in London. We may now enlarge our simplified illustration to something like life size. Documentary bills drawn by exporters or creditors all over the country are sold by the drawers to bankers, usually New York bankers, who may be called the "wholesalers of exchange." The sale may be either direct or through exchange brokers," the jobbers of exchange." These documentary bills are sent by the New York banks to their foreign correspondents 1 "Acceptance" of a bill definitely obligates the acceptor to pay it. Many importers arrange to have bills drawn upon them accepted by some bank, protecting the accepting bank by a deposit of collateral and paying it a commission for its services. Bills accepted by banks ("bankers' acceptances") command a very low rate of discount, and are for many reasons very desirable elements in an "open discount market." The federal reserve banks are seeking to develop the use of bankers' acceptances in the United States. National banks are now empowered to accept bills of exchange originating in foreign trade. for collection (in the case of sight bills) or acceptance (in the case of long bills). The balances thus built up abroad by the New York banks constitute the fund against which they draw their own bills. These are sold directly or through smaller banks the "retailers of exchange". located in all parts of the country. Foreign exchange is sold in a great variety of forms bankers' drafts, travelers' checks, travelers' letters of credit, commercial letters of credit, cable transfers, and the like descriptions of which may be found in the references given at the end of the chapter. The illustrations used above, while typical of a large part of the foreign exchange of this country, fail to represent adequately the complexity which marks some of the interactions of international credit. An illustration of the more complex class is found in the three-cornered or "triangular exchange." We import from, very much more than we export to, South America. A part of the debit balance though possibly not the larger part at the present time is settled by the transmission of London drafts to our South American creditors, who can use them advantageously in the settlement of their debts in Europe. Our rate of exchange with any particular foreign country is therefore controlled not by our trade with that country, but by our dealings or general balance with the rest of the world; and London "clears" for the world as New York "clears" for America and Paris for France. Just as the net balance of our domestic trade is struck in New York, so final international balances are cleared or settled in London, although London's preeminence in international exchange is not now so striking as it has been in the past. The European war transferred, for the time being at least, a considerable amount of this business to New York. The question next arises how the price or rate of exchange is determined. The factors controlling the price or rate of exchange are as numerous and as difficult to trace as the influences which affect the price of any economic good of world-wide purchase and sale. However, to facilitate discussion, we may classify them as: (1) the amount of pure gold in the monetary units which are to be exchanged, (2) the cost of shipping gold, and (3) "general credit conditions." An English pound sterling contains as much fine gold as 4.866 American dollars, and when exactly this amount must be paid in New York for a draft or order for one pound payable in London, exchange is said to be at par. Sterling exchange and German exchange are usually quoted in dollars and cents, i.e. the amount of American money required to buy one pound or four marks respectively. Consequently, they rise or become dear when exchange mounts above par. French exchange, on the contrary, is usually quoted in francs, the number of francs purchasable with one dollar; and it is consequently cheap when above par and dear when below par. Exchange between the United States and countries with silver or paper standards lacks the steadying influence of a par determined by the actual mass of fine gold in the respective units of value, and hence fluctuates much more than exchange between countries on a gold basis. In order to be as brief and clear as possible, the following discussion will be confined to exchange between countries on a gold basis. Fluctuations in the rate of exchange depend chiefly upon the "general credit conditions" mentioned above, but it is plain. that upper and lower limits to these variations are established by the actual cost of shipping gold. Suppose, for a moment, that it costs two cents to transport $4.866 worth of gold bullion between New York and London. Except under unusual circumstances, then, sterling exchange could not rise above $4.886, nor fall below $4.846. Such limits are frequently spoken of as the "gold points," "specie points," "shipping points," or "export and import points"; and it is necessary to mention them because of their frequent employment in discussions of foreign exchange. But they are usually defined in much too definite terms. The cost of shipping gold varies with the size of the shipment, with freight, insurance, and interest rates, and in some degree with the steamer and the season of the year. Furthermore, gold is so important as the basis of bank credit in all parts of the world that it is frequently imported regardless of the rate of exchange. During the war between Russia and Japan, for instance, the Bank of France imported large quantities of American gold in this semiarbitrary way in order to protect reserves. The "gold points," then, while in one sense very real, represent extreme limits and are in themselves variable. Within these extreme limits set by the cost of shipping gold, the rate of exchange varies according to general credit conditions, i.e. with the supply of and demand for bills of exchange, with discount rates here and abroad, and the innumerable forces which influence discount rates. Suppose, for instance, that our imports of merchandise in a given season greatly exceed our exports of merchandise. The demand for bills on London would greatly exceed the supply of bills on London, and the price of sterling exchange would rise very high if no other factors were involved. But it may happen at the same time that interest rates in New York are higher than in London, and under these circumstances our foreign creditors may prefer to lend their balances in New York in order to earn the high rate of interest obtaining there. The placing of these loans in New York will in turn reduce the demand for foreign exchange, and thus moderate both the interest rate and the rate of exchange. After the beginning of the European War, conditions became exactly the reverse of those assumed in the preceding illustration. Europe bought enormous quantities of goods in this country, there was an unprecedented excess of exports over imports and a corresponding drop in the rate of exchange. We loaned large sums to Europe, extending credits to foreign purchasers and buying government securities. We also bought back a very considerable quantity of American securities. All this is indicative of the dependence of international trade upon international credit and banking, of the fact that if we sell to foreigners we must buy from them or give them credit, of the interdependence of foreign exchange, interest rates, and the territorial distribution or placing of credit. But it is more indicative, perhaps, of the facts that the stock of gold is a world stock, that the credits resting upon it tend to flow to the point where they command the highest price, that the foreign exchanges evince normally a strong aversion to the actual move |