Exchange rate

“ The international money markets are a most decidedly complex proposition, and there is literally never a time when several influences tending to put exchange rates up are not conflicting with several influences tending to put rates down. The actual movement of the rate represents the relative strength of the two sets of influences. ”

“ For the rate on commercial bills is purely a matter of the drawer's credit. The best documentary commercial exchange, drawn at sight on banks abroad or houses of the highest standing will command a rate of exchange in the open market only a little less than the banker's own draft. From which point the rate realizable on commercial bills tapers off with the credit of the house in question, some bills regularly selling a cent or a cent and a half per pound sterling below the best bills of their class. ”

“ Many economists prefer this measure when gauging the economic power an economy maintains vis-à-vis its neighbors, judging that an exchange rate captures the purchasing power a nation enjoys in the international marketplace. Official exchange rates, however, can be artificially fixed and/or subject to manipulation - resulting in claims of the country having an under- or over-valued currency - and are not necessarily the equivalent of a market-determined exchange rate. ”

“ There exists, and always has existed, an actual exchange rate between the money units118 of all countries, or between the claims expressed therein, no matter what the money was based on; although there cannot be a par of exchange except between moneys based on the same metal. These actual rates are continually varying, even between countries like England and Australia, which not only use the same standard, but a common unit, and there is, therefore, no difference in the practical working of exchange between countries having the same standard and those having different ones. ”

“ Under the first, the country which wants more imports than its exports will pay for, must offer its exports at a cheaper rate, as the sole means of creating a demand for them sufficient to re-establish the equilibrium. When money is used, the country seems to do a thing totally different. She takes the additional imports at the same price as before, and as she exports no equivalent, the balance of payments turns against her; the exchange becomes unfavourable, and the difference has to be paid in money. ”

“ The formula finally selected is dependent on the actual value of the foreign currency in our own money. The rate for the foreign exchange with whioh the imported goods are purchased is recognized as the measure of value of the foreign currency; the use of that rate reflects values in United States currency which are deemed sufficiently accurate to serve as the measure of the valuation of the goods for purposes of the ad valorem tax. ”

“ Particular attention will be given later on to the way in which the Bank of England and the other great foreign banks manipulate the money market and so control the course of foreign exchange upon themselves, but in passing it is well to note just why it is that when the interest rate at any given point begins to go up, foreign exchange drawn upon that point begins to go up, too. Remittances to the point where the better bid for money is being made, are the very simple explanation. Bankers want to send money there, and to do it they need bills of exchange. ”

“ An unexpected rise in the bank rate in London, the announcement of a big loan or any one of many different happenings, are apt to cause a reduction in the exchange market and a bewildering movement of rates up and down. At such times a rise or fall of fifty points in sterling within half an hour is not at all out of the ordinary, while in times of panic, or when great crises impend, the fluctuations will be three or four times as great. ”

“ The purchasing power of an inconvertible currency in a foreign country, i.e. the currency’s external purchasing power, must be the rate of exchange between the home-currency and the foreign-currency, multiplied by the foreign-currency’s purchasing power in its own country. (3) In conditions of equilibrium the internal and external purchasing powers of a currency must be the same, allowance being made for transport charges and import and export taxes; for otherwise a movement of trade would occur in order to take advantage of the inequality. ”

“ How the exchange market fluctuates in the meantime—‌what rate may have to be paid at the end of ninety days for the necessary demand draft—‌concerns the borrower not at all. He received dollars in the first place, and when the loan comes due he pays back dollars, plus four, five or six per cent., as the case may be. What rate has to be paid for the demand exchange affects the banker only, not the borrower. ”

“ When we come to bill our goods in sterling, however, it is at once seen that our exporters are obliged to take a risk of exchange, which is a serious handicap when competing with British exporters. Our exporters who are to receive payment for their goods in sterling must previously decide on what rate of exchange will make the transaction profitable. ”

“ Such checks are always to be had in great volume in the exchange market, the banker's business being to draw and sell exchange, and his degree of willingness being merely a matter of rate. There come times, of course, when bankers have every reason to leave their foreign balances undisturbed, but even at such times the bid of a high enough rate will usually bring about the drawing of bills. ”

“ They have no bank or post-office where you have a legal right to get a dollar for ten 10-cent pieces, and the result therefore of recklessly coining the base 10-cent pieces has been not only to depreciate it with regard to the dollar, but to make it an uncertain value, so that you must go to the money exchangers almost every morning and ask for the rate of exchange between the dollar and the small silver pieces. ”

“ As an exchange transaction it only pays to ship gold to America when bills on London can only be sold in New York at a lower price than gold would fetch if brought from London and exchanged into dollars in New York. If bills on London are selling at 4.83-3/4, and gold can be bought and shipped and turned into dollars at the rate of 4.83-7/8, after allowing for all charges and commissions and the loss of interest during transit, then the operation pays as an exchange transaction. ”

“ The cost to the bank of providing this exchange for its customers varies as conditions change, but in any case is not great, so that in domestic business when any charge is made it is usually at a fixed rate, and is mainly for the service.
§ 9. #Par of exchange.# Foreign exchange from America to Europe is, however, in two features different from domestic exchange: (a) the cost of shipment of gold is greater; (b) the monetary units of the two countries usually differ in name, weight, and fineness, and sometimes in materials. ”

“ It thus appears, that a depreciation of the currency does not affect the foreign trade of the country: this is carried on precisely as if the currency maintained its value. But though the trade is not affected, the exchanges are. When the imports and exports are in equilibrium, the exchange, in a metallic currency, would be at par; a bill on France for the equivalent of five sovereigns, would be worth five sovereigns. But five sovereigns, or the quantity of gold contained in them, having come to be worth in England 6l., it follows that a bill on France for 5l. ”

“ When, therefore, the real exchange is at par, there will be a nominal exchange against the country, of as much per cent as the amount of the depreciation. If the currency is depreciated 10, 15, or 20 per cent, then in whatever way the real exchange, arising from the variations of international debts and credits, may vary, the quoted exchange will always differ 10, 15, or 20 per cent from it. ”

“ Just as unusually large imports of commodities mean a sharp demand for exchange with which to pay for them, unusually large exports mean a big supply of bills. In a previous chapter it has been explained how, when merchandise is shipped out of the country, the shipper draws his draft upon the buyer, in the currency of the country to which the merchandise goes. When exports are heavy, therefore, a great volume of bills of exchange drawn in various kinds of currency comes on the market for sale, naturally depressing rates. ”

“ A great country like the United States will have no trouble in buying the money of any other country at equitable rates—at rates regulated by the purchasing powers of the moneys of the two countries, respectively.
No country in the history of the world, having a money local to itself, has ever found the slightest difficulty in buying, upon ratios determined by the relative purchasing powers of the two kinds of money, a sufficient amount of foreign exchange (which simply means the money of another country) to meet all adverse balances of trade. ”

“ Approaching the subject as tenderly and in as elementary a manner as possible, I will at once simplify matters by saying that, with a few exceptions (such as regard India, Russia, China, &c.) , the foreign rates of exchange represent the amount of money in its own currency (be it paper or gold) that the specified financial centre of each country is willing to give for a pound sterling on London. ”

“ Which goes to show that the mint par is not what governs the price at which drafts in pounds sterling can be bought, but that demand and supply are the controlling factors. There are exporters who have been shipping merchandise and selling foreign exchange against the shipments all their lives [Pg 310] who have never even heard of a mint par of exchange. All they know is, that when exports are running large and bills in great quantity are being offered, bankers are willing to pay them only low rates—$4.83 or $4.84, perhaps, for the commercial bills they want to sell for dollars. ”

“ In the first place, the rise of prices at home, unless it should happen by an extraordinary coincidence to be accompanied by a corresponding rise of prices in all the foreign countries with which we trade, must necessarily have the two-fold effect of putting a check to the export of our own commodities to the foreign markets, and of encouraging an increased importation from those foreign markets to our own. And in the second place, the decline in the rate of interest produces a proportionate rise in the price of public securities ”

“ By enabling people to buy [pg 240] foreign goods with foreign currency obtained at a cheaper price the peg virtually raises foreign prices more to the level of the home prices, so that if the exchange is stable it is not because there is a peg, but because the price-levels in the two countries have reached a new equilibrium. Essentially the exchange is stable because it is an artificial purchasing-power parity. ”

“ This kind of variation is sure to correct itself, since the country which receives the larger proportion of money will return it for other commodities when it becomes a superfluity; and the country which receives the smaller proportion of money will gladly import more as it becomes deficient.
The real variation from par can never therefore exceed a certain limit.
This limit is determined by the cost of substituting for each other metal money and one of its representatives,--viz., that species of paper currency which is called Bills of Exchange. ”

“ If the market rates of exchange fall further than the country’s existing or impending currency policy justifies by its effect on the internal purchasing power of the country’s money, then sooner or later the exchange value is bound to recover. ”

“ Now, as the prices of foreign commodities in the home market, which could not have been supplied in the usual abundance during the operation of the subsidy when we had a large balance to pay, would fall, and would be in greater demand from the moment that our commodities would be received in exchange, the exportation of our goods would be balanced by the importation of foreign goods, and the sellers of bills would neither exceed nor fall short of the purchasers. ”

“ Evidently the increase of money of credit is not to meet increased demand, but to increase trade independently of demand; and its decrease is not to meet decreased demand, but because trade, having been increased beyond the demand, under the stimulus of credit, must be returned to its proper support or perish. The rate of the currency is not an element of political economy. Those elements are population, demand, industry, supply, consumption, and savings or wealth, which, being mutually dependent, are not properly subject to great or sudden variations of relations. ”

“ Supposing the amount of trade and mode of circulation to remain stationary, if the quantity of money be increased, its value will fall, and the price of other commodities will proportionally rise, as the latter will then exchange against a greater amount of money; if, on the other hand, the quantity of money be reduced, its value will be raised, and prices in a corresponding degree diminished, as commodities will then have to be exchanged for a less amount of money. ”

“ It may be urged that the relative state of high prices at home occasioned by an augmentation of currency is the natural effect of such a cause, but that this is not the case in a subsidy; that the exportation of commodities in payment of a subsidy is forced, and that it will produce a glut in the foreign market, but that after the subsidy is paid and the necessity for exportation shall cease prices will rise in the foreign market to their former rate. ”