GENERAL ASPECTS OF FOREIGN EXCHANGE 1. Definition of foreign exchange.—Foreign ex change may be defined as the system by which two or more countries discharge their debts and adjust their financial and commercial transactions with each other. Payment is effected by inter-cancelation of indebt edness by means of bills of exchange and other credit instruments, the difference or "boot" only being ad justed from time to time by the shipment of gold or its equivalent. The foreign exchanges, therefore, operate as a clearing house between nations and, just as the banks offset their debts against one an other and settle the final difference in gold, so nations offset their debts against one another and in the final analysis settle the difference by shipping gold. It must not be overlooked, however, in studying inter national exchange that there are no definite settlement days for the adjusting of all transactions to date. The adjustment of international balances is a con tinuous process and, under normal conditions, hardly noticeable to the keenest observer, except at certain seasons of the year or when it serves as a corrective to some large and unexpected transaction.
2. How indebtedness between two countries arises.
—The mutual indebtedness of two -countries arises from a combination of the following: Exports of merchandise Investments abroad The purchase of foreign securities Payments of interest and dividends to foreign shareholders Charges for transportation, insurance and com mission paid to foreign corporations Tourists' expenditures, etc.
There are, of course, many other causes which affect the course of the exchanges, but the above are the principal factors in the fluctuations. Sometimes the balance of payment, as it is called, is with one country, sometimes with another, and the rate of exchange will accordingly rise and fall within certain well-defined limits, determined by the cost of shipping gold be tween the two countries. The rate of exchange may he defined as the price of the money of one country reckoned in the money of any other country.
The principal operations of foreign exchange in clude the issue of drafts and various forms of com mercial paper, money orders, letters of credit payable abroad, cable transactions and the purchase and ship ment of bullion and of foreign coin.
3. Similarity between inland and foreign exchange. —We endeavored in Chapter I to establish in the mind of the reader that the basic principles govern ing inland and foreign exchange are the same, the operation of both being based on the weight and fine ness of the gold contained in the monetary unit or units of the country or countries involved.
The same machinery is used in both foreign and in land exchange but in different degrees. In inland exchange, the transfer of funds is effected almost en tirely by checks, bank drafts and shipments of cur rency; very little gold is moved. Bills of exchange, tho extensively used, are comparatively small in amount and scattered in destination, and are, there fore, not an important factor in inland exchange. In foreign exchange the transfer of funds between two countries is effected chiefly thru the medium of bills of exchange and the shipment of gold. Few checks, aside from sight bills of exchange drawn by banks, are used. Currency, being redeemable in gold only in the country where it is used, is of course not ac ceptable for remittance abroad.
4. Expense of shipping important factor to consider in all exchange operations is the expense of transferring gold from one place to an other. This expense includes carriage, risk and in terest while the amount is in transit. The very gen eral use of checks and bills of exchange in transferring funds has caused this factor of expense to be more or less lost sight of, except when conditions call for the actual shipment of currency or gold. It is, how ever, latent in every exchange transaction, foreign and domestic.