Principles of Political Economy

by Arthur Latham Perry

The par of Exchange, accordingly, between two countries, depends on the substantial equality of their commercial debts. In the above example, if the exchange as against London in favor of Paris continue long, and especially if the premium of 1% on bills drawn in London on Paris be sufficient to cover the expense of the transmission of specie from London to Paris, gold will begin to flow from London to Paris, because the debtors there may find it cheaper for themselves to buy and send gold than to pay the high premium on bills; and thus the equilibrium of payments and the commercial par may be restored. Also, this par tends to restore itself, without any sending of specie, in this other perfectly natural and effectual way: if bills on Paris are at a premium in London, for the same reason that they are so will bills on London be at a discount in Paris; therefore, there will be a direct encouragement to the extent of the premium for exportation of goods from England to France, because on every cargo thus sent bills can be drawn and sold in London for a premium; while the more bills on Paris thus offered in London, the more the premium disappears of course, and the par will be restored so soon as the bills on Paris substantially equal the bills on London offered in Paris; and at the same time, so long as the discount on London bills continues in Paris, there is a direct discouragement to further exportations from France to England, because the bills drawn in virtue of such cargoes can only be sold below par, and this too tends to restore the par in the commercial sense of the term.

Here is another instance of a magnificently comprehensive law, by which Nature vindicates her right to reign in the domain of Exchange. It is through this natural and beneficent law of automatic compensations, stimulating exportations on the one side and slackening them on the other, that most of the casual disturbances of the commercial par as between two countries are easily and perfectly rectified.

While this great law is in full possession of our minds, let us note in passing how artificial restrictions by one country on the importation of goods from another, commonly called "Protectionism," affects this commercial par as between those two countries. Besides stopping absolutely a mass of otherwise profitable exportations and importations for both countries, it makes less profitable to the country imposing the restrictions whatever foreign trade does take place between them in spite of the restrictions. Suppose England, as is the fact, opens her ports freely to the commodities of France, while France puts restrictions in the shape of heavy taxes upon importations from England; more French goods are likely under these circumstances to seek English ports than English goods to seek French ports, because they are more welcome; consequently, more bills of exchange drawn on London will naturally be offered in Paris than bills on Paris in London, and will so far forth be sold at a discount, while the London bills drawn on Paris will be sold at a premium; in other words, the comparatively few goods that do get out of a "protected" country, realize less to their owners than the natural value, because the bills drawn on them are extremely apt to be sold below par! With this course of things all known facts agree. Since the United States became conspicuously a "protected" country a quarter of a century ago, it has been at rare intervals and for short periods that bills drawn here on London have been at par. They have been usually much below par. The equivalent of £1 sterling in United States money is $4.8665; and when bills on London sell for less per pound sterling than $4.86, they are at a discount in New York or Boston; and exporters here are direct losers to the extent of the discount.

If, however, notwithstanding the beautiful action of this great law of commerce, the disturbance in the commercial par as between two countries continues obstinate, it indicates one of several things as true of the country, whose bills of exchange drawn on another persist in a considerable discount; (1) it has come to be a pretty steady debtor country as towards the other, by sending thither its national or State or corporation bonds, whose interest and ultimately principal also must sooner or later be remitted in exports extra to the exports needed to pay for the current imports of goods; (2) it has either naturally or by persistence in a bad public policy little or no shipping of its own, so that freights both ways have to be paid to foreigners in the form of exported goods extra to those exported to pay for those imported in transient trade, which of course increases the number and face of the bills drawn in the luckless country on the lucky country or countries; (3) it has made the vast and fatal mistake of excluding by legal barriers of taxes put on for that purpose the goods of foreigners, whose only motive in coming is to take off corresponding goods of the deluded country's own to the profit of both, and so these last-mentioned goods must seek a foreign market (if at all) at reduced rates, their natural market having been destroyed by national law; and (4) it may have made the national money in which the bills drawn on it are liable to be paid an inferior money, either transiently by mere abundance or permanently by worsened quality, which is well illustrated in the instance of Amsterdam as cited in a preceding chapter, and which can only be remedied by raising the standard of the money to the level of the best.

Very little, if anything, can be inferred as to the prosperity of a country or even as to the real condition of its "exchanges" in this technical sense of the term, by the transient movements of gold to and from the commercial countries, in their present complex relations as gold-producing and non-gold-producing countries and as debt-settling and non-debt-settling centres. Gold moves back and forth in obedience to several other impulses than to settle the balances in an international trade of Commodities. Gold-producing countries of course export gold just as they would any other native product. If for any reason gold becomes relatively more abundant in one country than in other commercial countries around it, general prices will rise in that country in consequence; which means, that gold is then and there the cheapest article that the people of that country can export to pay their commercial debts with. Also, the imports which a nation pays for in gold, or in bills of exchange bought above par, are often bought with a high profit. Creditor nations, nations that have managed to make themselves settling-places for the world's commercial debts, and nations that welcome imports without impediment from every quarter of the earth (and England may serve as a sample for all these three), will largely pay for imports in gold or in bills bearing a premium.

It is a thousand pities, that technical terms which are quite misleading unless one remembers their origin and exact significance, have come to be intrenched in commercial language too strongly to be dislodged at this late day, as the common terms to express the state of the "exchanges" as between two countries. These terms are "against" and "in favor of." The old Mercantile system, which has left other unsavory progeny behind it besides this, in order to keep and heap gold and silver in a country, encouraged exports in every way and discouraged imports, in order that the "balance of trade," as the phrase ran, that is, the difference in volume between exports and imports, might come back to the country in gold and silver; and this foolish and now thoroughly exploded notion gave rise to the terms in question; exchanges were then said to be "against" a country when the record seemed to show more imports than exports, as if that implied that the imports were too great for a "balance" in gold and silver; and were said to be "in favor of" a country when its export-line was greater than the line of imports, as implying a favorable balance to be met by a specie-import in future. The false "System" is gone forever, but the "terms" still abide in commercial language, and confuse the minds more or less (more rather than less) of everybody who tries to make these terms a vehicle of thought. We have now described the causes and courses of international bills of exchange without resorting to these technicalities, which imply movements of gold and silver which do not actually take place under the conditions supposed; for example, the exchanges were "in favor" of the United States in 1874-77, there being an apparent trade balance of $164,000,000 in 1877 and a still larger in 1876 and a larger one in the two years preceding, but the import of specie was small in all those years, averaging about $25,000,000 a year, and the rest of the excess of exports went to pay interest due to foreigners, freights on the cargoes both ways, and so on. It is difficult to use without abusing the terms "against" and "in favor of" in this connection, and the reader is cautioned not to employ them; although "discount" and "premium" on international bills of exchange are matters extremely important to observe and to know the grounds of. Were there no counterworking principle, bills of exchange drawn on capitalist and creditor countries, like Great Britain, whose imports are apt to be strongly in excess of the exports, and whose public policy is wise enough to put no obstacles in the way of the free receipt of imports, would be at a discount in countries sending exports thither.

This counterworking principle, already illustrated as to inland exchange in the case of New York, is best seen internationally in connection with London, which is the settling-place of the world's commerce. When the Romans dredged the Thames and made "the pool" just below London Bridge, they took the first steps towards making that town a commercial centre; since a market for products is products in market, the busy exchange of commodities there has quickened in every age the accumulation of capital and the increase of population; previous to the Dock Laborers' Strike in 1889, about 100 vessels entered the port of London every day, which received about one-half of the total customs revenue of the United Kingdom, and sent out about one-fourth of its exports; the business of out-of-the-way and semi-civilized countries has somehow (and it would not be hard to tell why) centered in London, as well as the business of originally British Colonies everywhere and of all other commercial countries; accordingly, debtors and creditors abound there, bills of exchange concentre there, and debts due from everywhere are payable there; and therefore, because bills on London are good all over the world, the Demand for them counterworks the natural cheapness of the bills drawn on exports thither as compared with the natural dearness of the bills drawn there on exports thence.

Another thing must be borne in mind in comparing the merchandise accounts of any country, namely, that whenever the "exchange" is sufficient to cover the cost and risk of the transmission of gold, gold itself is likely to go freely from the country, in which bills drawn on exports are at a premium, or to use for once the old hazardous phrase, "against" which the exchanges have turned, and bills will be drawn on that gold, as upon common merchandise, and sold of course for the sake of the premium; or, if a decidedly higher rate of discount prevail in a neighboring country, gold will naturally go thither from the lower-rate lands, because lenders in the latter will desire to realize the higher rate of current interest on money, and bills will be drawn on this gold as well, which will tend to lower the premium on bills there; unless, then, the premium and the difference in interest abroad will justify the speculation, the gold will not stir; although, if the difference in interest abroad were very considerable and promised to continue for some time, the bills on the gold might sell at a discount and still leave a profit to the senders; but the home bankers can always stop a drain of gold of this kind by raising their own rates of discount.

This casual mention of bankers leads on to the weighty point, that the whole business of foreign exchange is falling more and more into the hands of the bankers, because bills drawn by and upon well-known bankers naturally have a better credit than ordinary commercial bills, the names upon which are less widely and favorably known. Accordingly, persons sending cargoes of cotton, say, or of any other valuables, from New York to Liverpool, arrange with their bankers in New York to have the proceeds of the cargoes put to the bankers' credit in London, and then these bankers draw bills on the London bankers, which will bring a higher price in New York than a common commercial bill, because many remitters and most travellers prefer bankers' bills, which, though they cost more, pay better and buy better abroad. Commercial bills are still bought and sold in every commercial town, but bankers' bills are more and more taking their place; and the quotations usually give the current price of each.

London is so prominent as the settling-place of the world's transactions by means of bills drawn on and by London bankers, partly on account of the commercial predominance of England, partly from excellent banking customs there, and mainly because an immense mass of cheap loanable capital exists there, which even foreigners may borrow at London rates, provided only that they can get credit there, that is, leave to draw on a London banker, to whom of course remittances must be made as fast as he accepts their bills. Besides, the Bank of England, as the principal bank in Great Britain, and as closely connected with the Government, acts as a bank of support to the public and private Credit of that country. It does a regular business as a bank of deposits and discounts, but it means to keep its rate of discount somewhat above the rate demanded by the other bankers in London, so as not to come into competition with them much in their ordinary business, and be able to act as a bank of support to them and all others in times of pressure. All banks have about so much credit to sell, and no more; most banks sell in ordinary times about all the credit they have, because their profits depend on that; but if the Bank of England did this, it would become useless in periods of panic. In point of fact, that Bank just begins to sell its reserve credit, when the credit of the bankers below is exhausted. When they are at the end of their rope, there is generally an abundance of slack rope still in the great Institution above.