Chap. I: Of the first Principles of Exchange

Having ended what I had to say of banks, in which most of the principles of private credit and domestic circulation, have been sufficiently deduced, I now proceed to the doctrine of exchange, which is the principal operation of mercantile credit, for the carrying on of foreign circulation.

The security which merchants commonly take from one another when they circulate their business, is a bill of exchange, or a note of hand: these are looked upon as payment. When they give credit to one another in account, or otherwise, the cause of confidence is of a mixed nature; established partly upon the security of their effects, partly on the capacity, integrity, and good fortune, of the person to whom the credit is given.

No man but a merchant has any idea of the extent and nature of this kind of credit. It is a thing to be felt, but cannot be reduced to principles; and merchants themselves can lay down no certain rules concerning it. It is an operation which totally depends upon their own sagacity.

But when they deal by bills of exchange, the case is very different. The punctuality of acquitting these obligations is essential to commerce; and no sooner is a merchant's accepted bill protested, than he is considered to be a bankrupt. For this reason, the laws of most nations have given very extraordinary privileges to bills of exchange. The security of trade is essential to every society; and were the claims of merchants to linger under the formalities of courts of law, when liquidated by bills of exchange, faith, confidence, and punctuality, would quickly disappear; and the great engine of commerce would be totally destroyed.

A regular bill of exchange is a mercantile contract, in which four persons are concerned, viz. First, The drawer, who receives the value: Secondly, His debtor in a distant place, upon whom the bill is drawn, and who must accept and pay it: Thirdly, The person who gives value for the bill, to whose order it is to be paid: and, Fourthly, The person to whom it is ordered to be paid, creditor to the third.

By this operation, reciprocal debts, due in two distant parts, are paid by a sort of transfer, or permutation of debtors and creditors.

(A) in London, is creditor to (B) in Paris, value 1OO l. (C) again in London, is debtor to (D) in Paris for a like sum. By the operation of the bill of exchange, the London creditor is paid by the London debtor, and the Paris creditor is paid by the Paris debtor; consequently, the two debts are paid, and no money is sent from London to Paris, nor from Paris to London.

In this example, (A) is the drawer, (B) is the acceptor, (C) is the purchaser of the bill, and (D) receives the money. Two persons here receive the money, (A) and (D), and two pay the money, (B) and (C); which is just what must be done when two debtors and two creditors clear accounts.

This is the plain principle of a bill of exchange. From which it appears, that reciprocal and equal debts only can be acquitted by them.

When it therefore happens, that the reciprocal debts of London and Paris (to use the same example) are not equal, there arises a balance on one side. Suppose London to owe Paris a balance, value 100 l. How can this be paid? I answer, that it may either be done with or without the intervention of a hill.

With a bill, if an exchanger, finding a demand for a bill upon Paris, for the value of 100 l. when Paris owes no more to London, shall send 100 l. to his correspondent at Paris in coin, at the expence, I suppose, of 1 l. and then, having become creditor on Paris, he can give a bill for the value of 100 l. upon his being repaid his expence, and paid for his risk and trouble.

Or it may be paid without a bill, if the London debtor shall send the coin himself to his Paris creditor, without employing an exchanger.

This last example shews of what little use bills are in the payment of balances. As far as the debts are equal, nothing can be more useful than bills of exchange, but the more they are useful in this easy way of business, the less profit there is to any person to make a trade of exchange, when he is not himself concerned, either as debtor or creditor.

When merchants have occasion to draw and remit bills for the liquidation of their own debts, active and passive, in distant parts, they meet upon Change; where, to pursue the former example, the creditors upon Paris, when they want money for bills, look out for those who are debtors to it. The debtors to Paris again, when they want bills for money, seek for those who are creditors upon it. This is a representation of what we have frequently called the money market, in which the demand is for money, or for bills.

This market is constantly attended by brokers, who relieve the merchant of the trouble of searching for those he wants. To the broker every one communicates his wants, as far as he finds it prudent; and by going about among all the merchants, the broker discovers the side upon which the greater demand lies, for money, or for bills.

We have often observed, that he who is the demander in any bargain, has constantly the disadvantage in dealing with him of whom he demands. This is no where so much the case as in exchange, and renders secrecy very essential to individuals among the merchants. If the London merchants want to pay their debts to Paris, when there is a balance against London, it is their interest to conceal their debts, and especially the necessity they may be under to pay them; from the fear lest those who are creditors upon Paris should demand too high a price for the exchange over and above par.

On the other hand, those who are creditors upon Paris, when Paris owes a balance to London, are as careful in concealing what is owing to them by Paris, from the fear lest those who are debtors to Paris should avail themselves of the competition among the Paris creditors, in order to obtain bills for their money, below the value of them, when at par. A creditor upon Paris, who is greatly pressed for money at London, will willingly abate something of his debt, in order to get one who will give him money for it.

It is not my intention to dip into the intricacies of exchange: all intricacies must here be banished; and instead of technical terms, which are very well adapted for expressing them, recourse must be had to plain language, for pointing out the simple operations of this trade. It is by this method that principles must be deduced, and from principles we shall draw the consequences which may be derived from them.

From the operation carried on among merchants upon Change, which we have been describing, we may discover the consequence of their separate and jarring interests. They are constantly interested in the state of the balance. Those who are creditors on Paris, fear a balance due to London; those who are debtors to Paris, dread a balance due to Paris. The interest of the first is to dissemble what they fear; that of the last, to exaggerate what they wish. The brokers are those who determine the course of the day: and the most intelligent merchants are those who dispatch their business before the fact be known.

Now I ask, how trade, in general, can be interested in the question, who shall outwit, and who shall be outwitted, in this complicated operation of exchange among merchants?

The interest of trade and of the nation is principally concerned in the proper method of paying and receiving the balances. It is also concerned in preserving a just equality of profit and loss among all the merchants, relatively to the real state of the balance. Unequal competition among men engaged in the same pursuit, constantly draws along with it bad consequences to the general undertaking, as has been often observed; and secrecy in trade will be found, upon examination, to be much more useful to merchants in their private capacity, than to the trade they are carrying on.

Merchants, we have said, in speaking of the bank of England, endeavour to simplify their business as much as possible; and commit to brokers many operations which require no peculiar talents to execute. This of exchange is of such a nature that it is hardly possible for a merchant to carry on the business of his bills, without their assistance, upon many occasions. When merchants come upon Change, they are so full of fears and jealousies, that they will not open themselves to one another, lest they should discover what they want to conceal. The broker is a confidential man, in some degree, between parties, and brings them together.

Besides the merchants, who circulate among themselves their reciprocal debts and credits, arising from their importation and exportation of goods, there is another set of merchants who deal in exchange; which is the importation and exportation of money and bills.

Were there never any balance on the trade of nations, exchangers and brokers would find little employment: reciprocal and equal debts would easily be transacted openly between the parties themselves. No man feigns or dissembles, except when he thinks he has an interest in so doing.

But when balances come to be paid, exchange becomes intricate; and merchants are so much employed in particular branches of business, that they are obliged to leave the liquidation of their debts to a particular set of men, who make it turn out to the best advantage for themselves.

Whenever a balance comes to be paid, that payment costs, as we have seen, an additional expence to those of the place who owe it, over and above the value of the debt.

If, therefore, this expence be a loss to the trading man, he must either be repaid this loss by those whom he serves, that is, by the nation; or the trade he carries on will become less profitable to him.

Every one will agree, I believe, that the expence of high exchange upon paying a balance, is a loss to a people, no way to be compensated by the advantages they reap from enriching the few individuals among them, who gain by contriving methods to pay it off: and if an argument be necessary to prove this proposition, it may be drawn from this principle, to wit, whatever renders the profit upon trade precarious or uncertain, is a loss to trade in general: this loss is a consequence of high exchange; and although a profit do result from it upon one branch of trade, namely, the exchange business, yet this profit cannot compensate the loss upon every other.

We may, therefore, here repeat what we have said above, that the more difficulty, there be found in paying a balance, the greater will be the loss to the nation.

This being admitted, I shall here enumerate all the difficulties which occur in the paying of balances. Most of them have been already mentioned from their relation to subjects already discussed; and could it be supposed, that every reader had retained the whole chain of reasoning already gone through, a repetition in this place would be superfluous: but as this cannot be expected, I shall, in as short and distinct a manner as possible, recapitulate, under four articles, what I hope will be sufficient to refresh the memory upon each of them.

The first difficulty which occurs in paying a balance, is to determine exactly the true and intrinsic value of the metals or coin in which it is to be paid; that is to say, the real par.

The second, How to remove the domestic inconveniences which occur in paying with the metals or coin.

The third, How to prevent the price of exchange from operating upon the whole mass of reciprocal payments, instead of affecting the balance only.

The remedies and palliatives for these three inconveniences once discovered, comes the last question, viz. How, when other expedients prove ineffectual for the payment of a balance, the same may be paid by the means of credit, without the intervention of coin; and who are those who should conduct this operation.