Section XVI. Money Transactions between Nations—Bills of Exchange

The moneys of different countries are different; that is to say, they consist of different portions of the precious metals, and go by different names. The pound sterling, for example, is the money of England, the dollar is the money of certain other countries; the pound sterling contains one quantity of the precious metal, the dollar contains a less quantity; and so of other varieties.

The purchases which are made by one country in another country, are, like other purchases, made by money. If the Dutch merchant, for example, purchase goods in England, he buys them at so many pounds sterling. If the English merchant buys goods in Holland, he buys them at so many guilders. To pay the pound sterling, the Dutch merchant must either send the English money, or an equivalent. The direct equivalent is a quantity of the precious metal equal to what is contained in the pounds sterling due. If the Dutch merchant has no other medium but guilders, he must send as many guilders as contain an equal quantity of the precious metals.

When the language now used by the merchants of Europe was established, a computation was made of the quantity of one currency which contained the same quantity of the precious metal, as a certain given quantity of another. This was called the par of exchange. The guilder contained not quite so much of the metal as two shillings English; but to simplify our language, let us suppose that it contained just as much. The par of exchange was then, 10 guilders to 1l.; or, in the abridged language of the merchants, 10.

The business of exchange, however, between country and country, is carried on, not by transmitting currency, or the metals, but, in a much greater degree, by the instrumentality of bills. The language, which the merchants have adopted for carrying on the traffic of bills, is very elliptical and abridged; and being, in several respects, not well chosen, is a source of obscurity and misapprehension.

The simple transaction is this. The merchant in London, to whom a merchant in Amsterdam owes a sum of money, writes a line to the merchant in Amsterdam, directing him to pay the money. The writing of this line is called drawing; the line itself is called a bill; and the person whom the line is written to, is said to be drawn upon. If the merchant in London, at the same time that he has money to receive from Amsterdam, has money to pay in Amsterdam, he draws his bill upon his debtor in Amsterdam, to the order of his creditor; or, in other words, his line written to the person who owes him money in Amsterdam, is a line directing him to pay the amount to that other person to whom he is indebted. If the sum to be received is equal to the sum to be paid, the bill discharges the debt; if it is less, it pays as far as it goes, and the difference constitutes a balance.

It so happens, in the course of business, that the individuals who import goods from Holland, for example, are not the same individuals who export goods to Holland. The merchants who import corn, or butter, or tallow, from Holland, are one set of merchants; the merchants who export cottons and hardware to Holland, are merchants of another description; the individuals, therefore, who have money to receive from Holland, have nothing to do with any payments in Holland; they make a demand for their money, and expect it shall be paid. There are other individuals, however, who have money to pay in Holland, and who, to save themselves the expense of sending money, are desirous of obtaining from the individuals, who have money to receive from Holland, orders upon their debtors, that is, bills drawn upon them for the sum. The English exporters, who have money to receive from Holland, therefore, draw bills, upon their correspondents in Holland, and, without needing to wait for the return from Holland, receive the money in England from the English importers.

There are thus two sets of persons in England: one, who have money to receive from Holland; another, who have money to send to Holland. They who have money to send, are desirous of meeting with the persons who have money to receive, and bills to draw; the persons, again, who have bills to draw, and money to receive, are desirous of meeting with the persons who have money to pay, and who would give it them immediately, and save them the delay of waiting the return from Holland. But these two sets of men do not always know how to find one another. This gives rise to a set of middle men, who, under the name of bill-brokers and exchange-brokers, perform the function of bringing them together, or rather act as the medium between them.

When it so happens that the amount, for which bills are drawn, is the same with that, for which bills are wanted; in other words, when those, who have money to receive abroad are equal to those who have money to pay; the amount of bills to be bought, and the amount to be sold, will be exactly the same. For each man desirous to purchase a bill on Holland, there will be another man, equally desirous to sell one. There will be neither premium, therefore, on the one side, nor discount on the other; the bills, or in the language of the merchants, the exchange, will be at par.

When it happens, however, that the debts and credits are not equal; that England, for example, has more money to pay, than she has to receive; in other words, has imported to a greater amount than she has exported, there are more persons who want to purchase bills on Holland, than there are persons to sell them. Those who cannot obtain bills to discharge their debts in Holland must send the metals. That, however, is an operation, attended with a considerable cost. There is, therefore, a competition for bills; and the merchants give for them rather more than they are worth. A bill, for example, drawn on Holland, for 10,000 guilders, (the 10,000 guilders being, by supposition, equal to 1,000l.) will be willingly purchased for something more than 1,000l. In this case, the exchange is said to be in favour of Holland, and against England. It is against England, because in Holland, when bills are drawn upon England, there are more people who have bills to sell, than people who have any occasion to buy. There is a competition, therefore, among the people who wish to sell, and the price falls. A bill on England for 1000l., instead of selling for 10,000 guilders, will sell for something less. This, it is evident, is a discouragement to the Dutch merchant who exports goods to England. It is also a discouragement to the English merchant who imports goods from Holland, and who, in addition to the 10,000 guilders, which his goods have cost, must pay something more than 1000l., or 10,000 guilders, for a bill to pay them. On the other hand, there is an encouragement to the English merchant, who exports goods to Holland, inasmuch as he receives for his bill of 10,000 guilders on Holland, rather more than 1,000l., which is the value of his goods; he is, therefore, stimulated, by this increase of profit, to increase the quantity of his trade.

It is very easy to see, what is the limit to this variation in the price of bills, called in the language of merchants, the exchange. The motive to the purchase of a bill is the obligation of paying a debt. The merchant, however, on whom it is incumbent to pay a debt in Holland, can pay it without a bill, by sending the metal. To send the metal is attended with a certain cost. If he can obtain the bill without paying beyond this cost, he will purchase the bill. This cost, therefore, is the utmost amount of the premium which he will pay for a bill, and the limit to the rise of its price. As the cost of sending the metal, which is a great value in a small bulk, is never considerable, the exchange can never vary from par to a considerable amount.

It is well known in commerce, how a balance is transferred from one country to another, by means of bills of exchange.

If a balance is due by England to Holland, and by Hamburgh to England, the holder of a bill at Amsterdam for 1,000l. upon England, will not send his bill to England, where it will fetch him only 1,000l.; if by sending it to Hamburgh, it will fetch him something more; (i.e.) if he has a debt to pay at Hamburgh, when bills upon England are there at a premium, or if the premium will exceed the cost of transporting the gold from Hamburgh to Amsterdam. A debt, which England owed to Holland, is thus paid by a credit which it had at Hamburgh. In England, the merchants who have imported from Holland, pay for the goods which they have imported, by paying the merchants, who have exported to Hamburgh, for the goods which they have exported.

Such are the transactions between country and country, by means of bills of exchange; and such is the language in which they are expressed. There are two states of things, in which these operations take place: The First, when the currency of both countries remains the same as at the time when the par of exchange was originally computed; when 10 guilders of Holland, for example, contained as much of the precious metal as 1l. sterling; and the par of exchange, of course, was said to be 10: The Second, when the relative value of the two currencies does not remain the same; as, for example, when 1l., instead of being equal to 10 guilders, becomes equal to 12, or to no more than 8.

If we suppose the quantity of the precious metal in the pound sterling to be diminished in such a degree, that it contains no greater quantity than that which is contained in 8 guilders, the par of exchange, in this case, would really be 8, instead of 10. The merchants, however, from the time at which the par of exchange appears to have been originally computed, never altered their language. If the par of exchange between the guilder and the pound sterling was 10, it continued to be called 10, though the relative value of the currencies might be changed; though the pound sterling, for example, might become equal to 8 guilders only, instead of 10. Notwithstanding this the value of the bills was regulated according to the real value of the currencies; a bill for so many pounds sterling was not when such a change took place equal to a bill for as many times 10 guilders, but for as many times 8. As the par of exchange, however, still was called 10, though really 8, the exchange was said to be against England, in the proportion of 10 to 8, or 20 per cent. This 20 per cent. of unfavourable exchange was altogether nominal; for when there was this 20 per cent. of discount on the English bill, the exchange was really at par. The language, therefore, was improper and deceptious but if, in such case, it is borne in mind, that 20 per cent. against England means the same as par, it will then be easy to see that every thing which we demonstrated, in the preceding pages, as true with respect to the par, will, in this case, be true with respect to the 20 per cent. Every thing which raises the exchange above par, according to the proper language, makes it as much less than 20, according to the improper; every thing which reduces it below par, according to the proper, makes it as much more than 20, according to the improper. All the effects which follow from what is called the rise above, or fall below par, in the one case, follow from the same things, but called by different names, in the other. On this, therefore, I have no occasion to enlarge.

When the currencies of two countries are metallic, a change in their relative value beyond the fluctuations which are limited by the expense of transmiting the metals, and continually corrected by their transmission, can only happen by a change in the relative quantity of the metal they contain; there being checks, as we have already seen, which prevent any considerable difference between the value of a metallic currency and that of the metal which it contains. There is, however, another case, namely, that of a paper money, not convertible into the metallic. This requires to be considered by itself.

Let us resume the former supposition, that the pound sterling contains as much of the precious metal as 10 guilders; and let us suppose that a paper money, not payable in the metals, is issued in England, in such quantity, that a pound in that money is reduced 20 per cent. below the value of the metal contained in a pound sterling; it is easy to see that a bill for 100l. sterling, in this case, is of the same value exactly as a bill for 100l. sterling when the currency was degraded by losing 20 per cent. of its metal. A bill for 100l. in both cases, is equal not to 100 times 10 guilders, but 100 times 8 guilders. The reason is, that the bill will in England buy only as much of the metal as is contained in 100 times 8 guilders. It will exchange, therefore, of course, only for a bill of 800 guilders.

The facts may be expressed in the form of a general rule. The value of a bill drawn upon any country is equal, when it arrives, to all the precious metal which the money for which it is drawn can purchase in the market: a bill for 100l., for example, is equal to all the metal which it can purchase, whether it is the same quantity which would be purchased by 100l. sterling, or less. To whatever amount the portion which it can purchase is less than what could be purchased by 100l. of the coins, the paper money is degraded below what would be the value of the coins, if they circulated in its stead. The exchange, therefore, against any country, can never exceed the amount of two sums; First, the difference between the value of the degraded and the undegraded currency or that between the nominal amount of the currency, and the quantity of the precious metal which it can purchase; secondly, the expense of sending the metal, when purchased. It thus appears, how perfectly unfounded is the opinion of those (and some political economists of great eminence are included in the number) who conceive that the real, not merely the nominal, exchange, may exceed the expense of transmitting the precious metals. They say, that when, by some particular cause, a great absorption of the precious metals has taken place, creating a scarcity in consequence of which goods must be sent from the country where it is scarce, to bring it back from the countries where it abounds, bills, drawn by the country in which it is scarce, upon the countries where it abounds, may bear a premium, equal to the cost of sending goods which may fetch in the foreign market the value of the bill; and this, in certain cases, may greatly exceed the cost of sending the precious metals.

If the facts are traced, the answer will be seen to be conclusive.

When the exchange between two countries (call them A and B) is at par, it is implied, that the exports and imports of both are equal: that each receives from the other as much as it sends. In this case the goods which A sends to B must be so much cheaper in A than they can be made in B, that they can there be sold with all the addition required on account of the cost of carriage: in like manner the goods which B sends to A must be so much cheaper in B, that the cost of carriage is covered by the price which they fetch in A. This cost of carriage, it is obvious, does not affect the exchange, any more than an item in the cost of production.

Next, let us observe what happens, when the state of the exchange is disturbed. Let us suppose that a demand is suddenly created in A, for the means of making payments in B, greatly beyond the value of the former exportations. The demand for bills on B is consequently increased beyond the supply, and the price rises. The question is, what is the limit to that rise in the price of bills? At first it is evident the rise of price is limited to the cost of sending the precious metal. As the metal, however, departs, the value of it rises. If the currency is paper, and its value stationary, the gold will rise, and rise equally, both in currency and commodities. The final question, then, is, what is the limit to the rise in the value of gold?

Before the premium on the bills commenced, goods in A were so cheap, that a portion of them could be sent to B, and sold, with all the addition of the cost of carriage, and of course with the ordinary profits of stock. The whole of the premium on the bills, therefore, is an addition to the ordinary profits of stock.

If A be taken for England, and B for the continent of Europe, the case will be, that English goods, when the interchange is at par, go abroad, and are sold at a price which includes both profits and cost of carriage; when the premium on bills rises only so high as to equal the cost of sending bullion, it is to that extent an additional profit on the sending of goods.

It is evident that, in proportion as this premium should rise, it would not only enhance the motive to increase the exportation of the goods which could be exported with a profit before the rise of the bills, but that it would render many other kinds of goods exportable, which before could not be exported. Thus, when the exchange was at par, there were certain kinds of goods in England, which, after paying cost of carriage, could be sold abroad with a profit; there were certain other kinds which, on account of their high price in England, could not be thus exported; some might thus be 1 per cent. too high to be exported, others 2 per cent. too high, others 3 per cent., and so on. It is obvious that a premium of 1 per cent. on bills would enable the first kind to be exported; a premium of 2 per cent. would enable the second; and a premium of 10 per cent. would enable two or three kinds to be exported, which could not have been exported before. As the counter operation would be of the same kind and the same power, viz. to prevent the importation of foreign goods into England, exportation would be exceedingly increased, importation nearly prevented. The two operations together would be so powerful, that any great deviation from the real par of exchange could never be of long duration. A deviation equal to the cost of sending the precious metal, permanent circumstances might render permanent. If England, for example, sent every year a large amount of the precious metal to India, and received it from Hamburgh, the exchange would be to the extent of the cost of sending the metals, permanently favourable with Hamburgh, unfavourable with India.

If bills of exchange were always drawn for so much weight of gold, the case would be simple. Suppose a bill in London drawn upon Paris for 100 ounces of gold, no man would pay for that bill more gold beyond the 100 ounces than the cost of sending the 100 ounces. He might purchase the 100 ounces at one time with 390l. of currency, at another with 410l. of currency, but that would be entirely owing to changes in the relative value of the currency and the gold. These changes, it is said, may in certain circumstances, take place from a rise in the value of the gold, the currency remaining of the same value. This implies that gold can become more valuable in one country than in the neighbouring countries; in England, for example, than on the Continent. But this it cannot do without increasing the exports in England, and diminishing, almost to nothing, the imports. Suppose the rise in the value of gold to be 1 per cent., 2 per cent., or to amount to 10 per cent.; at this last rate the goods which could be sent abroad with the ordinary profit, could be now sent abroad with 10 per cent. more than the ordinary profit, while all the other kinds of goods, those 1 per cent., those 2 per cent., those 3 per cent., 4 per cent. 5 per cent., and so on, too dear to have been sent before, would now all be sent; at the same time that the counter operation would be equally strong to prevent foreign goods from being imported. These are the necessary effects of a high value of gold in one country as compared with other countries; and they are evidently such as to render it impossible that a high value of the precious metal in one country, compared with the neighbouring countries, can ever in a state of freedom be of long duration.