INTERNATIONAL PAYMENTS. The observer who learns that, during a given year, England imported 1100,000,00o worth of raw cotton from the United States, and sold 150,000,000 worth of coal to the Continent, and that simultaneously Austria, Hungary, Finland and other countries raised loans totalling $200,000,000 in New York, can be excused for wondering exactly how these huge sums of money are remitted. Even if he is con versant with the theory of the balance of trade (q.v.), or has learnt that "imports pay for exports," and even if he knows some thing of the principles of Foreign Exchange (q.v.), he may still be excused for a failure to realize how it works out in actual practice.
In reality the process of remittance from country to country is extremely simple, and the chief stumbling blocks are the exist ence of different currencies, the huge sums involved and the use of technical terms by those engaged in the business. The easiest way to approach the question is by the examination of the normal financial relations between individual and individual.
Take the case of : (I) Brown, a butcher, who banks at bank A ; (2) Jones, a farmer, who banks at bank B; (3) Smith, a needy relative of Jones, who banks at bank C.
Brown buys cattle from Jones and in due course owes him 150. Smith buys meat from Brown, also to the tune of 150. Finally Smith goes to Jones and borrows 150. In each case, to settle the amounts outstanding, the payer, whether he be debtor or lender, draws a cheque for 150 in favour of the payee, whether he be creditor or borrower. The cheque is drawn on the drawer's bank, and paid by the payee into his own bank.
The result is that bank B holds a cheque for 150 drawn by Brown on bank A and relating to his purchase of cattle. Bank C holds a cheque for 150 drawn by Jones on bank B and relating to his loan to Smith. Bank A holds a cheque for 150 drawn by Smith on bank C, and relating to his butcher's bill. To clear these three cheques, three operations are necessary in the case of each one. The first of these is the crediting of the payee's bank account with 15o, and the third is the debiting of the drawer's bank account with 150. These are effected simply by entries in the banks' ledgers. The second, which in theory appears more com plex, is the transfer of funds from bank to bank, for bank A owes bank B 150 on Brown's cheque, bank B owes bank C 150 on Jones's cheque, and bank C owes bank A 15o on Smith's cheque. In practice, to effect these settlements, representatives of each bank meet together in a local place of refreshment, present their cheques to each other and proceed to cancel them out. It remains to add, in case this last sentence seems very picturesque, that the London Clearing House is said to have originated in a coffee-house.
Now it makes no difference whether or not these cheques were for 150 or 15,000,000, or whether Brown turns into the Mammoth Meat Packing Syndicate, Jones into the Incorporated Graziers' Society and Smith into a civic corporation or even into an im portant national government. In theory the banks can cancel out the cheques and in practice they have devised means of doing so. The obstacle of the huge amounts involved has clearly been overcome, and the only necessary condition is that the drawers and banks are together good for the amount, however large it may be.
Now here the currency question must be dealt with. Brown wants to be paid in dollars, and Jones can only pay in sterling.
Jones, in his turn, wants sterling from Schmidt, who can only ,pay in marks; and while the Bremen corporation raise a dollar loan, and so undertake to pay principal and interest in dollars, they want their money in marks.
The key obviously lies in bankers' foreign balances.
(a) Brown draws a bill for $10,000 on Jones, and sells it to his American bank for $10,000, less discount. So Brown gets his dollars. The American bank sends the bill to its London agent, who presents it to Jones, who pays it with 12,000. This sum of £2,000 is placed by the London bank to the credit of the American bank's balance with it. This settles Brown and Jones.
(b) Jones, when he sold his yarn, told Schmidt to have a con firmed (or irrevocable) credit of 12,000 opened in his (Jones's) favour at a London bank. Schmidt arranged for his Bremen bank
to do this with their London agents, where they (the Bremen bank) kept their balance. Once this credit is opened, Jones goes straight to the London bank, identifies himself, hands over the documents relating to the shipment of cotton yarn to Schmidt, and gets his 12,000. The London bank debit the Bremen bank's balance with them to the tune of 12,000, and the Bremen bank debit Schmidt's account Mks. 40,000, plus their own charges. This settles Jones and Schmidt.
Now for the Bremen corporation and their loan. The investors in New York who bought the loan paid $10,000 in dollars over to the New York issuing house, and the issuing house lodged them to the credit of its account with its New York bankers. It next instructs its bankers to remit Mks. 40,00o, which is the mark equivalent, to the Bremen corporation. The New York bank de cides to do this through London, so it instructs its London agents to transfer 12,000, the sterling equivalent, from their balance to the Bremen corporation bank's balance, which may be with them or with another London bank. This is done, and the Bremen bank's London agents advise them of the receipt of £2,000, on account of the Bremen corporation's New York loan. Whereupon the Bremen bank credit the Bremen corporation with the mark equivalent of £2,000; i.e., with Mks. 40,000. This settles the loan.
Now just as, in the first instance, no money passed between banks A, B and C, so, in this instance, the total of sterling held in London on either American or German account, remains un changed. In the first of the last three transactions, the American bank's London balance was increased by 12,000; in the second, the Bremen bank's London balance was decreased by 12,000; in the third, the American balance lost 12,000 to the Bremen balance. The result is a complete "cancel out." Other Methods.—In the first instance, the debt was paid by means of a bill of exchange; in the second through the medium of a banker's credit (see BILL OF EXCHANGE, FOREIGN EXCHANGE) ; in the third by direct instructions to the bank im mediately concerned. In either case the debtor could have bought a banker's draft, mail transfer, cheque or telegraphic transfer drawn in the creditor's currency. The banker's foreign balance would have lost or gained in the same way.
(I). American Liberty bonds can be tendered at par in pay ment of debts due to the American Government. On one oc casion the British Government, in anticipation of a coming in stalment due on the American debt, paid sterling over to an inter national finance house's office in London, and arranged for the house to credit the British Government with the equivalent in dollars in New York. It next instructed the finance house to use those dollars to buy Liberty bonds at the current Wall street price, which was then 90. These bonds were tendered in settle ment of the instalment to the American Government, who, by its own law, was bound to accept them at par.
(2). When the franc collapsed in the spring of 1924, the French Government arranged for credits to be opened in its favour by banks in London and New York. In other words, these banks engaged to lend the French Government pounds and dollars on demand up to the limits of the credits. The French Govern ment broker then went on the Paris Bourse and sold pounds and dollars to the market, so arresting the fall in the franc. Long before the credits were exhausted, the worst of the crisis was over. The essential point was that the French Government had previously arranged for an adequate supply of pounds and dollars.
(3). When the pound and, later, the lira were stabilized, the British and Italian Governments arranged credits in New York. If speculators had tried to break the stabilization by selling pounds or lire for dollars, the Governments concerned would have drawn on their New York credits, and so put up all the dollars needed to buy up the pounds or lire the speculators were selling.
In short, the system of banker's foreign balances, even if only held in one common foreign centre such as London, provides a ready means of transferring funds from one centre to another right across the world. For the maintenance of these foreign balances by the banks themselves, and for the reasons why the banks add to them and deplete them on their own account, the reader is referred to the article on EXCHANGE, FOREIGN. (See also BALANCE OF TRADE; BANKING AND CREDIT; BILL OF Ex