The balance of foreign exchanges is of essentially the same nature as the domestic cancelation of indebtedness. It is going on constantly between the two merchants in the same town, between two banks in the same town who represent groups of merchants, between men in neighboring towns, and between distant states like New York arid California .° The price of exchange to the individual is reduced by the special. izing of the business in the hands of a few dealers, permitting the cancelation of indebtedness or offsetting of exchange, and 6 See ch. 7, see. 8.
greatly reducing the amount of bullion to be transported in making the payments. The cost to the bank of providing this exchange for its customers varies as conditions change, but in any case is not great, so that in domestic business when any charge is made it is usually at a fixed rate, and is mainly for the service.
§ 10. Par of exchange. Foreign exchange from America to Europe is, however, in two features different from domestic exchange : (a) the cost of shipment of gold is greater ; (b) the monetary units of the two countries usually differ in name, weight, and fineness, and sometimes in materials. We may define foreign exchange as the purchase and sale of the right to receive a given kind and weight of metal or its mone tary equivalent in current funds at a specified time and place, or as the funds so purchased. Par of exchange between two countries using the same metal as a standard is the number of units of the standard coin of the one country that con tains the same amount of fine metal as the standard coin of the other country. There is no fixed par of exchange between gold-using and silver-using countries; par of ex change between them fluctuates with changes in the compara tive values of the two metals. The gold-shipping points for importing or exporting gold are respectively par of exchange plus or minus the cost of moving the actual metal. These points vary with means of transportation and communication. The par of exchange between New York and London being nearly $4.866 and the cost of expressing and insuring a gold pound between New York and London being approximately the shipping point for the export of gold from New York is $4.886 and for the import of gold to New York is $4.846. At these upper and lower limits, there is a motive for shipping gold as a commodity.
When large sales have been made to Europe and credits 7 This varies also with conditions: after the outbreak of the war in 1914 it was for a time as high ns $.05 because of high war rates of in.mrance.
are accumulating in New York and the importation of gold is imminent or already begun, the claims are bought by bank ers in New York at less than par. At such a time one need ing to remit a sum to London can buy exchange for less than par, for every such draft remitted reduces London's indebted ness and, by so much, the need of shipping gold to this coun try. As a rule, then, accumulating credits here mean a low Fig. 3, Chapter 15, shows the variation of New York rates of foreign exchange with four financial centers in the very abnormal period from 1914-1920. Exchange below par (0) indicates large purchases from
the United States, (the case of English and French exchange from the end of 1914). Exchange above par (Spain and Argentine, 1917-1919) indicates large purchases by the United States while the embargo pol icy was in effect (see Chapter 6).
rate of exchange, accumulating debits a high rate of ex change from this to the foreign country.
These are the merest rudiments of the subject. The many problems arising, such as the adjustment of foreign credits to changing needs, and such as arbitrage (the readjustment of the rates of exchange prevailing among different financial centers), make foreign exchange both a complex science and a difficult art.
The balance of all accounts for or against a country (includ ing new loans, current interest, and repayments) must thus eventually be settled in money. This cannot fail to effect the general level of prices in both countries, though this is brought about often only in indirect and gradual ways. The flow of money out of a country causes the loan market of a country to tighten (interest and discount rates to rise) in proportion as the reserves of the banks are reduced. Then "general prices" begin to fall' When prices fall, imports decline, as the country is not so good a place in which to sell: when prices rise, imports increase, as it is a better place in which to sell. The opposite effect is produced on exports, and thus in a short time the national credits and debits are again brought into equilibrium. A slight movement of money in either direction is enough to influence prices and set in motion to counteract a further flow of money. Decade after decade the circulating medium of leading coun tries changes very slightly in amount, and the fluctuations in its amounts during periods of so-called "favorable bal ance of trade" and of "unfavorable balance of trade" are only the smallest fraction of the value of goods passing through the ports of the country.
It is therefore absurd to imagine, as is sometimes done, that a country could continually import goods until it was drained of all its money, or that by any possible set of de vices it could forever have an excess of exports to be paid for by a continual inflow of gold. Long before either of such 8 The connection between a high rate of interest and falling prices is a dynamic phenomenon of a very temporary nature. In long-time static conditions the general level of prices and the prevailing rate of interest are dependent on entirely different sets of forces. See on the theory of interest, Vol. I, p. 308. In long-time movements of prices, in contrast with brief changes due to foreign trade such as are referred to above, high rates of interest are connected with rising prices, and vice versa. See above, ch. 6, 1 12, on fluctuating price levels and the interest rate.
movements could go far, the automatic readjustment of inter national prices would inevitably check it, and secure and re tain for each country its due portion of the money.