CHAPTER V. ON THE PRINCIPLES OF EXCHANGE.

BILLS of exchange are those commercial instruments by which a merchant in one country or place directs money which is subject to his control in another country or place to be paid over to a third party. In the commercial transactions of every nation, some of the merchants become indebted to other merchants in foreign countries for commodities purchased there upon credit, whilst some others have funds in those foreign countries arising from the sale of cargoes disposed of there. If bills of exchange did not exist, the debtor class of these merchants would be obliged to incur the expense and risk of transporting coin or bullion to foreign countries in discharge of their debts, and the creditor class would also be obliged to incur the same expense and risk in importing coin or bullion in payment of their cargoes sold abroad. By this double transmission, the merchants, and consequently the nations to which they belonged, would be losers to an amount equal to all the expenses and risks so incurred, together with interest on their capitals for the time they were out of their reach. Nor could this be avoided unless the importers and exporters were always the same identical individuals, in which case the merchandise purchased abroad would be paid for by the proceeds of the merchandise sold. By the operation, then, of bills of exchange, the necessity of this double transmission is entirely avoided, and the funds abroad, instead of being sent home, are transferred to those who have debts to pay abroad, and who are thus exempted from the expense and risk of sending coin or bullion in payment of their debts.

But this benefit, in which the whole nation participates, is not limited to the mere application of funds in any given place to the payment of a debt due in that place. It matters not whether the fund and debt both stand on the books of merchants at the same place, or whether the debt be due at Manchester and the fund be at Paris. The magic power of bills of exchange transfers the payer and receiver both to London, the great seat and centre of British and indeed of European commercial operations.

But the merchants who make remittances of bills of exchange to foreign countries, to pay for merchandise purchased there, do not, it is manifest, procure those bills of exchange for nothing. They must purchase them from those who have funds abroad to draw for, and in doing this they will endeavor to procure them at as cheap a rate as they can. It is, on the other hand, the interest of those who have bills for sale, to secure the highest price for them they can, and it is this competition between buyer and seller that determines the market price, which, like the market price of commodities, must always depend upon the proportion which the supply bears to the demand. If bills of exchange are scarce, their price will be high. If they are plenty, their price will be low. There is, however, one peculiarity belonging to a bill of exchange, which is not common to any commodity, and which ought always to be kept in mind in discussing this subject. It is, that if it cannot be sold at a price that will suit its owner, he has it in his power to avoid the necessity of a sale at great loss by importing his funds in coin; and if it cannot be purchased at a price that will suit a purchaser, the latter can avoid the necessity of a disadvantageous purchase by exporting coin in payment of his debt. The existence of this peculiarity places a limit upon the fluctuations in the rate of exchange, which cannot for any long period together fall and remain below par, or rise and remain above par, to a greater extent than to an amount equivalent to the expense of transporting the precious metals from the debtor country to the creditor country. For, if a merchant owes a debt abroad, and cannot procure a bill of exchange at an advance above par equal to the freight, insurance, commission, and brokerage, and to the value which he attaches to that certainty of punctuality in the fulfilment of his engagement abroad, which a set of bills of undoubted credit, sent by two or three different vessels affords, but which a shipment of coin cannot always furnish, how solvent and prompt soever might be the underwriters in settling in case of loss, he will unquestionably transmit coin as being the most economical mode of making a remittance.* And so, on the other hand, the drawer of a bill, if he cannot sell at a price which will yield him as much money as the importation of coin would do, taking into the account, besides the charges of importation, the interest for the time he must wait before his money can arrive, and if money be scarce, the inconvenience or loss he would sustain by the delay, he will undoubtedly order his funds to be shipped to him in coin, as the most advantageous mode of getting them into his possession.

Of the correctness of these positions there cannot be a doubt, and whenever the market price of exchange differs from these rates, it must have its cause in one of the following circumstances.

If the exchange be above, it must either be that the merchants who have remittances to make are ignorant of their business, and therefore pay more for a bill than it is worth, or that small profits are not worth their attention, or that there is a penalty or a degree of odium attached to the exportation of coin which they are not prepared to encounter, or that the punctuality which is expected of them by their correspondents abroad is of a character that would not justify the hazard of a miscarriage by a single ship.

If the exchange be below, it must be because the owner of the funds abroad cannot afford to wait the time requisite for the transmission of the coin, or because in the actual state of the money market, money is worth to him more than the ordinary interest, or because there exists a penalty or a degree of odium attached to the exportation of coin in the country from which his fund is to be drawn.

It must, however, be remarked, that it sometimes happens that bills are sold below the limits here designated in the following cases, viz:

1. Where the commanders of ships of war on foreign stations have occasion to draw bills upon their government, at ports of limited trade, or at which the course of trade does not call for such bills. I have known a bill on the navy department drawn at a port in South America to be sold at twelve per cent, below the true par.

2. Where masters of vessels and supercargoes, at such ports, have not merchandise enough to fill up their vessels, and on that account find it for their interest to sell bills at a great discount, for the purpose of buying bulky commodities to bring home, and thereby earn a freight more than equivalent to the loss sustained on the bills.

3. Where masters of vessels enter such ports in distress, and are obliged to draw bills upon their owners for necessary repairs.

In wealthy countries, however, where bankers are prepared with large capitals devoted to speculations in bills of exchange, great fluctuations from the par are not likely to take place, inasmuch as bills can always be bought from or sold to them, by allowing a small profit beyond the expenses of exporting or importing coin. The trade of a banker in Europe is to study the exchanges not only between the place at which he resides and all other places, but also between all those places and each other, by which means he is generally enabled, by a combination of operations, by selling bills on one place and by buying them on another, not only to raise the fund with which he deals, but to realise a profit. Thus, for instance, if he reside at London, and can sell a bill on Hamburgh at half per cent, premium, and buy one on Paris at half per cent, discount, and with the latter buy one through his correspondent at Paris on Hamburgh at par, he will have realised one per cent, by the transaction, without the employment of any capital; the bill remitted from Paris to Hamburgh arriving in time to meet the bill drawn upon his correspondent at the latter place.

Having in the foregoing remarks spoken of the par of exchange, it is proper that the meaning of that term should be explained.

Exchange is an operation, which, strictly speaking, has relation only to the precious metals, and every bill of exchange is in reality a mere order for the delivery, on a certain day, of a given quantity of gold or silver. Exchange is at par or equality, when a merchant in one country can purchase with an ounce of pure gold, or an ounce of pure silver, a bill at sight upon a foreign country, which will there put him in possession of an ounce of pure gold or an ounce of pure silver, and the coins of full weight of the two countries which are the respective equivalents of an ounce of pure gold or an ounce of pure silver, will express that par. This is an axiom in political economy, and should never be lost sight of, whatever appearances to the contrary may at times be presented. Exchange is above par when a greater quantity is required for the purchase of a bill that will command an ounce of pure gold or pure silver; and it is below par when a less quantity is required. Now, if all the trading nations of the world were to use only one of those metals as their currency, and if their coins were of the same standard as to purity, and of the full mint weight, the science of exchange would be as simple as the plainest calculations in arithmetic. But this not being the case, each nation having its own standard of fineness, and its own particular coins, some having one metal and some the other, and some both, to constitute their currencies; and the coins of some countries being worn by wear and tear more than those of others, without being prohibited from passing by tale, and there being in some countries a seignorage charged on the coins, whilst in others there is none, the subject is involved in an obscurity which very few persons are disposed to take the trouble to penetrate, and indeed which very few persons have the means of penetrating. This has been particularly the case in reference to the exchange between the United States and England, which, being for many years past, up to the present day, quoted in all the newspapers, prices current, and correspondence, upon false principles, has occasioned a wide-spread error, the origin of which will now be explained.

By an act of congress, passed on the 31st of July, 1789, it was declared, that the British pound sterling (which, although not at that time a coin, was the equivalent of the quantity of gold contained in a guinea, less the one and twentieth part, the guinea being twenty-one shillings) should be taken as of the value of four Spanish silver dollars and fourty-four hundredth parts of a dollar in estimating ad valorem duties upon British merchandise at our custom houses. This estimate was founded upon the circumstance, that at that period, the Spanish dollar, the only coin of that denomination in circulation in the United States, was the well known equivalent in the British market, of four shillings and sixpence sterling, and very nearly such equivalent at the British mint.*

By another act of congress of 2d April, 1792, establishing the mint, and authorising a coinage for the United States, it was provided, that there should be silver dollars coined, “each to be of the value of a Spanish milled dollar,” to contain 17dwt. 8 grains of standard silver; and that the proportion which the gold and silver coins should bear to each other, should be that of 1 to 15, that is, that one ounce of pure gold should be the equivalent of fifteen ounces of pure silver.†

But there is no natural proportion between gold and silver, as has been observed on a former occasion, any more than there is between lead and iron, and it is therefore very manifest that no law can permanently fix a par of exchange between them. When any change in their relative value takes place in the market of the trading world, whether it be by an increased or diminished supply, of one or the other metal, or, by an increased or diminished demand for one or the other, the par becomes changed. This event did in reality take place, and in process of time, an ounce of gold, as has been already stated, became gradually worth more than fifteen ounces of silver, and finally reached the proportion of one to sixteen. With this gradual change in the relative value of gold and silver, the silver dollar ceased to be the equivalent of four shillings and sixpence sterling, and consequently the pound sterling became the equivalent of more than four dollars and fourty-four hundredth parts of a dollar, for the simple reason, that any person who possessed the quantity of gold represented by the pound sterling before the coinage of the sovereign, and now actually contained in that coin, could obtain for it more than four dollars and forty-four hundredth parts of a dollar in silver. But the mercantile usage did not conform to this change. The merchants adhered to the old par, as if a pound sterling was the equivalent of four dollars and forty-four cents by some unchangeable law of nature, and for many years continued to ascribe the nominal premium on sterling bills of exchange, which was the mere exponent of this change in the relative value of gold and silver, to the influence of the balance of trade. The delusion was partly removed by the act of congress of 14th July, 1832, which raised the value of the pound sterling for the calculation of ad valorem duties at the custom house to $4.80, and by two subsequent acts, one of 28th June, 1834, by which the British sovereign was made the equivalent in American gold coins of $4. 87.075+, and one of 18th January, 1837, by which it was made the equivalent of $4.86.65+, which is now the true par on London, corresponding within a very small fraction to 9½ per cent. premium on the old computed par.* I say “partly removed,” because, strange as it may appear, there are thousands of persons at this very day, who have no other belief on this subject, than that the nominal premium quoted on exchange, is a real advance which takes so much money out of their pockets. To remove, however, the vestiges of this deep rooted error, the Chamber of Commerce of New York, early in the year 1839, recommended to the merchants of that city, to quote the exchange on England in dollars and cents for the pound sterling, instead of designating the per centage above or below par; a recommendation which was soon after followed up by the Chambers of Commerce of Philadelphia and other places, and will perhaps in time be generally adopted.*

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