THE ELEMENTS OF FOREIGN EXCHANGE Foreign Trade Balance Foreign trade like domestic trade is, in the long run, barter— the exchange of goods against goods. If more merchandise is sent by the people of the United States to the people of France than is imported from France, the balance of trade with regard to the United States is said to be favorable. Although under mer cantilism " favorable" had a fallacious connotation, now when properly used it means simply that, if no other contemporary foreign transactions be considered, after balancing the money value of exports and imports and canceling the debts to that de gree, a net indebtedness is owing to the Americans and there is a tendency for gold or other goods to flow to this country. Even though the debt stands for years, the only way America can be satisfactorily compensated is by the French sending an excess of goods directly or indirectly to America. To the degree that gold can be used in America in the arts or to meet the needs of a grow ing country for a larger stock of money media to handle its trade at the prevailing price level, the gold will be a satisfactory form of goods; but if gold cannot be so used and simply inflates the price level, no advantage accrues to America. The rising price level will soon stop, if it does not reverse, the direction of trade between America and France, for America becomes a poor place for France to buy in and France becomes a poor place for Amer ica to sell in. These elementary principles of trade apply equally well to the trade between different parts of the same country.
When between two countries a credit system develops, the debts of importers in one country may be balanced against the credits of the exporters of that country and only the net balance be paid in gold. The debt may be left, of course, to run perma nently or until such time as the balance of indebtedness is re versed. Since gold is exported with such reluctance and at some expense, foreign trade is conducted almost wholly by the cancella tion of contemporary or serial debts, and the economy of gold is most marked. These debts are bought and sold; an importer, for instance, makes settlement by buying directly or indirectly a credit from an exporter and remitting it to the foreign creditor. The common instrument of debt in foreign trade is the bill of exchange. The term "foreign exchange" means the operations connected with international payments by bills of exchange. These documents are many, complex, and various, and have for centuries been regarded as the mystery of commerce.
The Demand for Bills of Exchange A bill of exchange is an order by one party on a second to pay to a third. To illustrate the fundamental nature of inter national payments let us adopt for convenience the following abbreviations: A, the United States of America E, England B, Brazil Ea, the American exporter Ia, the American importer Ba, the American banker Da, an American firm, person, bank, or discount house which buys and sells bills of exchange in the New York open discount market Ee, Ie, Be, and De, the corresponding English parties at London Eb, Ib, and Bb, the corresponding Brazilian parties at Rio Janeiro Be and Ba may be assumed to be mutual correspondents having accounts with each other, and Bb may have a corre spondent in London and New York.
Suppose Ia buys £I,000 value of merchandise from Ee and wishes to make payment. He has the alternative of shipping ST ,000 gold or buying a bill of exchange to remit; the former will cost him £I,000 plus expenses; but the American money unit is dollars, the pure gold equivalent of Si,000 being $4,866.50, and the shipping expenses may aggregate, say, $29.5o. If he can buy a bill of £1,000 for less than $4,896 it is plainly to his advan tage to do so. On the other hand, if a £1,000 bill costs more than $4,896 it is cheaper to ship specie. The price $4,896 is called the "gold export point." The American importer might by chance find an exporter who has a £I,000 bill for sale, but in all probability he would buy the bill from his bank. The elements of such a bill would be, that Ba orders Be to pay £1,000 to Ee at sight, on demand or after a certain time, depending upon when Ia's debt to Ee is due, and to charge it to Ba's account. Ia would pay Ba, say, $4,893 for the bill, and send it to Ee, who, if it were a sight or demand bill, would collect at once from Be; Be would then write off Ba's account ET ,000 and send the voucher to Ba. If, however, it were a time bill, Ee would present it to Be for acceptance; that is, Be writes "accepted," "good," or some other such expression, across its face, and thus obligates himself to pay it at maturity; Be is then the acceptor as well as the drawee and payer, and the bill is known thereafter as an "acceptance." Ee may retain the acceptance until maturity and present it to Be for payment, and Be then writes off Ba's account and sends the voucher to Ba.