Kemmerer: The A B C of the Federal Reserve System, Ch. VIII. Kniffen: Practical Work of a Bank, Ch. XI. Laughlin (Ed.): Banking Reform. White: Money and Banking, Bk. III, Ch. III. CHAPTER XV DOMESTIC AND FOREIGN EXCHANGE 109. Domestic exchange.-One of the most important functions of banks is to facilitate domestic and international trade transactions through dealing in domestic and foreign exchange. Just as banks in the same city settle their claims against each other through the clearing house, thus reducing to a small balance the amount to be settled in cash, so balances between different cities are settled by the operations of domestic exchange, and balances between countries by foreign exchange. Reference has been made elsewhere to the work of the banks in facilitating payments and in collecting for their customers, checks, drafts and other instruments of credit in daily use. These transactions involve two sets of settlements: first, those between the buyer and the seller with the bank as intermediary; and second, settlement between the banks involved. It will be recalled that the personal draft. or bill of exchange differs from a check in that it is drawn by one person upon another and not upon a bank. It may be drawn in favor of the drawer himself or of a third person, and it may be made payable at sight or at a certain number of days after sight or after date. If it is a time draft it will be presented to the drawee as promptly as possible for his acceptance. An accepted time draft becomes to all intents and purposes the promissory note of the acceptor. The use of these drafts in connection with bills of lading is described in the chapter on loans and discounts. They are used extensively in the financing of the grain and cotton crops and many other lines of business. For example, a New Orleans cotton buyer when he sends a shipment of cotton to New York draws on the New York firm for the amount, attaches the draft to the bill of lading, and takes it to his local banker to realize on it. The banker buys the draft and the proceeds are placed to the shipper's credit at once or as soon as advice is received from New York that the draft has been paid or accepted. The banks render an important service in presenting, collecting and discounting these commercial drafts or bills of exchange. While merchants and traders in different parts of the country are enabled through the agency of banks to make settlements with each other by offsetting the claims of one section against those of another, these claims never exactly balance. It becomes necessary, therefore, either to ship currency or to provide some form of credit that will have undoubted acceptability. This need is met by the use of the bank draft. A bank draft is an order drawn by one bank on another bank or banker. Practically every large bank in the country has funds on deposit with banks in other cities, and so is able to sell to its customers drafts calling for the payment of money in those cities. Owing to the fact that New York is the commercial and financial center of the country and that business men all over the country have financial dealings with New York, most banks find it advisable to keep deposits with banks in that city. Drafts on New York, commonly known as "New York exchange," are generally as acceptable as cash anywhere in the United States, and are widely used in making remittances from one part of the country to another. Even remote country banks can usually sell New York drafts, for though they may not have deposit accounts in New York, they have an arrangement with some bank in a nearby city which maintains a New York deposit by which they, too, are permitted to draw upon it. Drafts upon other large financial centers, like Chicago or St. Louis, are generally acceptable through the West and some local use is made of bank drafts on smaller places, but New York exchange is constantly being used all over the United. States. 110. Currency movements.1-The varying balances between credit and debit accounts due to the payments and collections of the country, and the offsetting of these accounts through the agency of the banks, give rise to the transfer of funds and to what is known as "rates of exchange." "Thus, exchange on New York in Nashville or in Seattle may be at par to-day, but a month hence it may be at a discount, and in three months the merchant who wishes to remit to New York or some other city may have to pay a premium for it. The variation in the rates of exchange and the seasonal movements of currency to and from "the interior" can best be understood by noting exchange operations during the crop-moving season. In the late summer and autumn when the great grain crops of the West and the cotton of the South are being gathered and shipped those sections must have large supplies of funds. Harvest hands and farmers must be paid and as consignments of grain and cotton are made to dealers in New York and other Eastern points heavy drafts are made on New York. New York exchange may become so plentiful that it will fall to a discount. The Western or Southern banker sends the drafts bought from shippers to New York and after a while he finds that he has a big credit balance there while his actual cash on hand is being exhausted, and he will be less and less inclined to buy more New York exchange. If he continues to buy it he must have sent to him some of the money which has been piling up to his credit in New York. It will be understood that the accumulation of credits in New York during the crop-moving season is offset to some extent by debit obligations incurred in the West and 1 The phenomena here described will be changed considerably when the Federal reserve system becomes well established. South through the purchase of manufactured goods and all kinds of merchandise from Eastern dealers. In the winter and spring months the agricultural districts are buying largely from Eastern cities and selling little. As a result the demand in the interior for drafts on New York becomes so heavy that the country banks will charge a premium for New York exchange and generally will have to send back to New York some of the funds they received a few months before to cover their drafts. There is another reason, aside from the normal operations of exchange, for this seasonal movement of money between New York and the country districts. In the harvesting and crop-moving months the West and South must have large amounts of actual cash with which to pay harvest hands and farmers, cotton pickers and planters. To meet this demand the country banks must have the cash shipped to them from New York and other reserve centers. Then in the winter and spring cash flows back into the country banks, and as there is comparatively little local demand for it during those months, they ship it back again to build up their balances in New York. They get a low rate of interest on these balances, but frequently they instruct their New York correspondents to lend a part of their balance on call or otherwise when the money market is favorable. In the past this alternating ebb and flow of money with its resulting scarcity of funds at one season and abundance at another, due to defects in our banking system, caused great disturbance in the money market, notably in the Eastern centers. When the banks of the interior began to draw down their New York balances in the autumn, the New York banks were compelled to curtail their loans. This affected not only stock exchange operations but also commercial loans to business houses, which at that season require not less but more loan accommodations. On the other hand, the flow of money back to New York at the beginning of the year caused large surplus reserves, low rates for money, and an expansion of loans for speculative |