BILLS OF EXCHANGE 1. Bills of exchange.—It has already been indicated that the fundamental purpose of a draft or bill of ex change is to settle debts and thus avoid the necessity of shipping gold. To satisfy a debt in one country by offsetting the amount against a debt due in another country, leaving only the difference, if any, to be re mitted in gold, is no less effective a means of payment as a double shipment of money, and is obviously far more economical. In this way, the difference or bal ance of payments as it is called, is settled by the debtor nation shipping gold or arranging a postponement of payment by means of finance bills or other corrective transactions.
A check is merely a demand bill of exchange drawn on a bank. Bills of exchange or drafts, as we shall DOW call them, assume a variety of forms and tenor, but, no matter what their currency or form, the un derlying principle is the same, namely, that of a cred itor drawing a draft upon an actual or constructive debtor.
Bills of exchange can be broadly divided into two classes according to their currency, known as short and long exchange.
Short exchange includes cable transfers, checks, bank drafts and sight or demand drafts. Travelers' checks, money orders and other forms of non-com mercial remittances come under this heading.
Long exchange includes all drafts with a currency of eight days or over, such as thirty and sixty-day commercial bills and bankers' long bills.
2. Sight and demand or sight drafts, whether drawn on a bank or a commercial house, have no days of grace for payment and must be paid on presentation, or protested. As a rule the sale of demand exchange is confined principally to banks, commercial drafts being usually drawn on time.
The rate or price of demand or sight exchange, un der modern conditions, may be considered as the basic rate on which all rates for time exchange are calcu lated. The old usance or sixty-days' rate, obtaining between London and New York, on which rates used to be calculated is a relic of the days of slow-going sailing vessels. In practice, of course, given the rate of interest, the rates of exchange are quickly con verted from one to the other. Under normal condi tions, a sight draft drawn in New York or London will be presented and paid six to eight days after nego tiation in New York, and is therefore, as regards time lost in transit, on a par with a shipment of gold.
The difference between the export gold point and the demand rate is represented by the freight, insurance charges, etc., on the shipment of gold. It is, of course, necessary for banks transacting a regular foreign ex change business to maintain balances with the various foreign correspondents against which they can draw demand drafts and sell cable transfers. Funds for these balances are provided. by remitting quantities of different kinds of exchange which have been purchased from customers and others. Demand and other short date items are credited immediately; acceptance is ob tained of the longer date items which are discounted and credited by the correspondent as occasion requires.
The selling of demand exchange and cables against remittances of the same is the most elementary form of foreign exchange. A banker, for instance, pur chases a demand draft on London for £10,000 at the current rate of exchange, say $4.86, and remits the bill to his London correspondent; at the same time he sells his own check or checks on London for the same amount at, say, the two transactions reach London by the same mail and offset each other. Apart from the expense of conducting his business, he clears 850 on the transaction and is not out of the use of his money for more than a few hours at the most. If the checks sold by the banker miss the mails by any chance, the banker has the use of the money in London until the mail is received ; hence the importance of watching the mail service closely in exchange transactions. This illustration is, of course, elementary and bankers do not often make money this way; but it shows the principle on which foreign exchange transactions are based. Banks are con stantly purchasing every kind of exchange and for warding it to their foreign correspondents by whom it is converted into an available balance. In any case there is constantly accuinulating to the credit of the New York banker a balance against which he is able to sell exchange and cables and meet his maturing obligations. Under normal conditions, owing to the reliability of the mail service, a banker is able to esti mate very closely the position of his London balance and as a rule receives a cable from his correspond ent at the end of each day.