RATES OF EXCHANGE 1. Bills of exchange and their relation to gold.— The strength and usefulness of credit rest entirely on the fact that the holder of a bill of exchange or other evidence of indebtedness has every confidence that the instrument will be absolutely and unquestionably redeemed in gold or its equivalent at maturity.
The payment of a debt, therefore, in another part of the same country, or to a foreign country by means of a check or bill of exchange, theoretically involves the payment of so many grammes or grains of gold. If Brown in Toronto owes Smith in Winnipeg he pays $100.25 to his bank in Toronto in order that Smith may receive $100 in gold or its equivalent in Winni peg. As a matter of interest, we will work out the transaction in terms of gold (the dollar contains 23.22 grains of fine gold) . For the bank draft of $100 Brown pays his bank 2,327.805 grains of fine gold (2,322 grains + grains commission) in order that Smith may receive 2,322 grains of fine gold in Winnipeg. Now, if we divide 2,322 grains and 2,327.805 grains by 23.22 (the amount of fine gold in the dollar), we get our original $100 and $100.25. Brown could have sent the amount to Smith himself in cash in the form of either gold or currency (govern ment and bank notes redeemable in gold on demand) but he would have had to pay as much or more than the 25 cents commission for express charges.
2. Cost of sterling exchange.—Similarly in sterling exchange, if a draft on London costs, for instance, one cent per pound over the par of $4.86%, Brown would pay $4.87% per pound sterling for a draft on London, or worked out in grains of gold, add one cent's worth of gold or .2322 grain to 113.0016 grains (the weight of fine gold in the sovereign) and we get 113.2338 grains, which divided by 23.22 gives $4.876656 per sovereign or one cent over par.
If sterling exchange is low, say, $4.85 per sovereign or about 1.656 cents lower than par, a draft on Lon don for £1,000 would cost Brown $4.850; in other words, in order that Brown's creditor may receive 113,001.605 grains of fine gold in London he has to pay only 112,617.08 grains to his banker for the draft,
the difference 384.523 grains or .38452 grain per pound sterling is the equivalent in grains of 1.656 cent (.2322 X 1.656 = .38452 grain).
With sterling as low as $4.85, Brown would not think of shipping the gold himself, but, if he were asked $4.88% per pound, it would pay him to do it as the shipping charges would be less than two cents per pound. What form would the shipment take? It can only be fine gold 113,001.605 grains in weight in the form of bullion, or sovereigns (1,000 of them ), or eagles to the value of $4,866.56 weighing 123,274.47 grains (113,001.605 grains of fine gold). Brown could not send currency, as he could in t le case of Winnipeg, as bank and government notes, tho re deemable in gold in Canada, are not so in foreign countries. It is an important difference between foreign and inland exchange that apart from checks and bills of exchange, gold is the only medium of settlement between two countries, whereas within a country itself any form of currency that circulates freely may be remitted.
3. Bates of of exchange are a commodity and as such are bought and sold, and like other commodities are subject to the law of supply and demand. The reader should, for the present, dismiss from his mind the thought that he is dealing in the money of foreign countries and should regard bills of exchange and other credit instruments, used in transferring funds, as representing a definite kind of commodity—evidences of indebtedness.
The rate of exchange is the price per foreign unit at which the right to collect these debts is sold and does not refer, except indirectly, to the value of the gold monetary unit. A sovereign is always worth par in New York and the gold eagle always worth par in London. When sterling is quoted at, say, $4.85 in New York it does not mean that the sovereign has depreciated 1% cents below par ; it means that the "right" to obtain a sovereign in London is worth only $4.85 in New York. In this case the supply of these "rights" is ample and the demand small, hence the price falls.