5. FOREIGN EXCHANGE. Foreign exchange may best be described as the system by which payments are made between countries having different monetary systems. The terms °Exchange° and tForeign Exchange" are also used as meaning the drafts drawn by merchants and bankers resident in one country upon merchants and bankers resident in another.
9rigin.— Concerning the origin of the foreign exchange system as it exists at present there is a good deal of doubt. The best opinion is that the system as we now have it came into existence early in the Middle Ages as a result of the commercial dealings between the north ern Italian republics and the Levant. Venetian merchants, for instance, purchasing goods in Alexandria, found that on account of the prev alence of piracy in the Mediterranean payment for such goods in gold was extremely haz ardous. It being the case that the merchants of Alexandria were also purchasers of goods in Venice, a system was devised whereby, instead of actual gold being shipped back and forth, merchants in Venice having money owed to them from Alexandria were able to receive it from other merchants in Venice who had pay ments to make in Alexandria. Gradually it came about, as a result of these arrangements, that Alexandria kept balances in Venice and vice-versa. Payments instead of being made by means of actual gold shipments came gradually to be paid by drafts drawn on such balances.
The Pnnciple Stated.— A clear under standing of the basic principle underlying foreign exchange transactions may probably best be had from consideration of an actual international transaction. A merchant in Mem phis, Tenn., we will say, has sold a hundred bales of cotton to a spinner in Liverpool, England. For the merchant in Memphis the important thing is to realize upon his sale, at the earliest possible opportunity, United States currency or credit at bank. This payment he can receive in two ways. Either he can draw a draft upon the buyer of the goods in Liver pool in sterling (the currency of the buyer) and sell such draft in Memphis or New York at the current rate of exchange for American dollars, or (2) the buyer of the cotton in Liver pool can send to the merchant in Memphis a draft drawn on some point in the United States and payable in United States currency. Which
ever way the transaction is arranged, the de sired result will be obtained that the seller of the goods in Memphis immediately receives payment in bankable funds.
The banking machinery requisite for the conversion of sterling drafts drawn, for in stance, in Memphis, into United States dol lars, or for the furnishing of drafts drawn in sterling to American merchants who have pay ments to make abroad, is relatively simple. It consists simply of a number of banks and bankers with the necessary facilities for pur chasing the drafts drawn on foreign points in foreign currencies offered them, and for selling to their clients such drafts drawn on foreign points in foreign currencies as may be desired. It must, however, be clearly understood that the foreign exchange banker is not merely a broker in bills, buying bills from parties who have them to sell and selling the same bills to other parties who want to buy them. Having bought exchange drawn in a foreign currency on a foreign point, the foreign exchange banker does not resell those same bills, but instead sells a draft made by himself upon his correspondent bank abroad. The balance abroad out of which these bankers' drafts are paid is being continu ally replenished by remittances from this side, of foreign exchange which the banker buys in the regular course of business.
The foreign exchange banker, in other words, maintains a depositary abroad with whom he deposits the bills of exchange he buys and upon whom he draws the drafts which he sells his clients. Daily these balances are being drawn upon and replenished. At all times they are maintained at a certain point, that, of course, depending upon the standing of the banker and the extent of the foreign exchange business in which he is engaged. Some foreign exchange bankers carry balances at only one or two of the more important foreign money centres. Others carry balances at as many as 20 or 30 foreign points.