A Decline in Money Rates Below the Level Prevailing at Other Important Foreign As money rates decline there is a strong tendency for capital to seek points at which a better rate is offered for its use. Trans fer of capital can be effected only through.re mittances of exchange to points where the capital is to be employed. A period of ex tremely low money rates at a point like New York, for example, with London offering a better rate for capital, is likely to be a time when there is a big demand for bills of ex change with which to make remittances to London.
The principal influences tending to cause a decline at any given point in exchange rates are as follows: Heavy Exports of Pay ment for merchandise exported from the United States is made largely by drafts' drawn in the currency of the country to which the goods are shipped, upon the buyer of the goods or upon some bank abroad designated by him. A time when merchandise is moving freely out of the country is a time when a large amount of such drafts are being offered to foreign exchange bankers. The result is, naturally, to cause a decline in the rate which bankers are willing to pay for such drafts.
Heavy Exports of Securities shipped out of the country, as is the case with merchandise, are generally paid for by means of a draft drawn by the seller upon the buyer. A time when, for any reason, large amounts of stocks or bonds are being shipped out is nat urally, a time when large amounts of exchange are being drawn and 'offered, with a consequent decline in the rate of exchange.
A Rise in the Rate for Money Above That Prevailing at Other Primary Points Abroad.— Just as banking capital tends to flow out of a market where the money rate is declining, so it tends to flow into a market where the money rate is rising. Let money rates at New York, for instance, rise considerably above those pre vailing in London or Paris, and immediately foreign capital begins to flow this way and American bankers begin to recall to this market for their own use a substantial part of the funds they have been carrying abroad. This recalling of balances is effected by drawing drafts on cor respondents abroad and by offering these drafts for sale in this market, the effect being to lower the rate of exchange.
There is, however, a limit beyond which, under normal circumstances, the rate of ex change between two countries having the gold standard cannot rise, and a limit beyond which it cannot fall.
The extent to which the exchange can rise is limited by the point at which it becomes cheaper for parties, having payments to make abroad, to send the actual gold than to send a banker's bill drawn in the currency of the place where the payment is to be made. If, for in stance, a merchant in the United States having a payment to make in Great Britain finds that each pound sterling of the draft he wants to buy will cost him $4.89, he can go to any United States sub-Treasury, purchase the exact amount of gold which when laid down abroad will yield one pound sterling, and send it to the other side at a total cost to him of considerably less than $4.89. The American merchant's idea being to discharge his obligation abroad with the least possible expenditure of American dol lars, he will elect to send the actual gold rather than to purchase and send a banker's draft.
The extent to which the exchange can fall at a point like New York, for instance, is lim ited by the point at which a new gold sovereign laid down in New York yields net a greater amount of dollars and cents than each pound sterling of a prime banker's draft drawn on London would yield. A New York bank, for example, has money on deposit in London which it wishes to withdraw to New York. It will sell its drafts only down to the point at which that process yields more dollars than if gold were imported. Below that point the rate of exchange cannot fall.
The above, however, applies only where there is a free interchange of gold between markets. If for any reason the natural flow of gold one way or the other is obstructed or restricted, exchange may rise far above or fall far below what would be the normal gold export or gold import point. By interfering with the natural outflow of gold from London through raising the discount rate and through buying up all available supplies of gold bullion in the market, the Bank of England, for instance, has on nu merous occasions brought about a condition where the rate of exchange in New York on London fell far below the gold import point without any gold being shipped to the United States. Similarly the rate of exchange both at Berlin and at Paris not infrequently rises far above the point at which gold can be profit ably exported for the simple reason that, through the interference of the governmental authorities, no gold for export can be obtained.