Foreign Exchanges - Encyclopedia

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"FOREIGN EXCHANGES io.50). - In no department of finance was there a greater upheaval as the result of the World War than in that of national currency-values as shown in the foreign exchanges. The theory of foreign exchange is sufficiently explained in the earlier article. It remains to deal here with the historical developments subsequent to 1910.

For some years immediately preceding the World War there had been a gradual movement on the part of all important countries towards the establishment of their currencies on a gold basis. It is true that only in England, the United States and India was there an absolutely free and unrestricted gold market, yet all the other leading countries, with the exception of China and Brazil, may be considered to have achieved this object, for although, as regards most of them, difficulties were placed in the way of those who desired to withdraw gold from their respective State banks for the purpose of export, yet it was generally understood that, in the last resource, these banks would part with gold rather than permit their exchanges to depreciate below their gold parity. The result was that exporters and importers in all these countries could trade with each other without troubling themselves about possible fluctuations in exchange. Rates moved within very narrow limits and merchants could ignore them.

Even in the case of such countries as Italy and Spain, which had not quite succeeded in stabilizing their exchanges (i.e.;bringing their currency-values up to the gold par), the risk of loss through sudden and violent fluctuations in exchange rates was very slight. It was only when trading with China, Brazil, Portugal, and a few small South American and Central American states, that merchants felt it necessary to take exchange risks into account, and the more prudent were in the habit of avoiding such risk by buying or selling exchange for forward delivery.

Most banks and banking houses in England and elsewhere bought and sold foreign exchange, but they did not do so primarily with the object of making large profits, for very little money could be made out of exchange operations when fluctuations were small and of rare occurrence. Their chief object was to meet the requirements of their customers. Indeed, foreign banks having branches in London regarded their foreign exchange trading departments as the least expensive form of advertising. In fact, when one looks back to those times, one realizes that the currencies of nine-tenths of the world were for all practical purposes identical. One felt just as certain of getting 25 francs or 20 marks for a pound sterling as of getting twelve pence for a shilling or ioo centimes for a franc.

In reviewing conditions that ruled during the early days of the war, one cannot but wonder at the remarkable adaptability of the London foreign exchange market, particularly when account is taken of the numerous obstacles and restrictions that the British Government considered necessary, for good reason, to put in the way of exchange transactions. When the British Treasury assumed complete control over the London exchange market at the outbreak of the war, they had three important objects in view: first, to prevent British capital from being sent abroad; secondly to close every avenue by which enemy nations might carry on their trade with direct or indirect assistance from England; and thirdly to enable every British or Allied trader to obtain or to dispose of all the " exchange " necessary to carry on his legitimate business.

The following are some of the difficulties that had to be contended with. All communication between England and enemy countries was strictly prohibited. All letters and telegrams to and from England were opened and read by official censors and were subject to indefinite delay, if indeed they ever reached their destination. No transactions of a " speculative " nature were permitted. No gold coin or bullion was allowed to be exported from Great Britain without a licence, which was almost always refused. Exchange dealers were not permitted to deal with neutral banks or firms unless they obtained from them their signatures to the following declaration: We undertake to the best of our ability that the account which you keep in our name on your books will not be utilized by us or by third parties for our account in any way which will, either directly or indirectly, assist, or be for the benefit of, any enemy of Great Britain, including any person, firm or company on any list published by His Britannic Majesty's Government and called the Statutory List; and, further, that any business whatsoever that we request you to undertake for our account will neither facilitate, nor compensate, nor clear transactions in any way or at any time connected with an enemy of Great Britain, including any person, firm or company on any list published by His Britannic Majesty's Government and called the Statutory List.

We understand this undertaking to apply to every kind of transaction for which we utilize our account with you, including (but not excluding any other transactions which might directly or indirectly benefit any enemy of Great Britain or her Allies as above stated): All sight or telegraphic payments to private individuals, firms, banks, etc., in Great Britain or other countries.

The transfer of pounds sterling and/or foreign moneys to or from neutral countries on behalf of ourselves or third parties.

The collection of remittances, coupons, drawn bonds, etc.

The opening of documentary credit for the import and/or export of goods to or from our country or other countries.

The collection and/or negotiation of cheques and bills on Great Britain and other countries.

All cheques and bills drawn by us to the order of third parties. All payments, telegraphic and mail, that we make in sterling through your intermediary.

All moneys that you receive in sterling from other parties for the credit of our account and/or moneys ordered to be held at the disposal of third parties.

Bills domiciled payable with you.

British banks and bankers, dealing with foreign countries, had to fill up once a week and send to the Ministry of Blockade, a printed form showing under four columns: (a). The approximate total of available cash sterling balances held for account of persons, firms and corporations domiciled in each country (less overdrafts); (b). The approximate total of British Treasury bills and other sterling bills, payable in Great Britain, held at their free disposal for persons, firms and corporations domiciled in each country; (c). The approximate sterling equivalent of foreign currency balances with banks in each country; (d). The approximate sterling equivalent of currency overdrafts " Nostro " abroad at banks in each country.

No British firm or institution was permitted to work in exchange in joint account with a neutral firm or institution. It was not permissible to execute an order for a neutral to buy or sell foreign exchange unless it was stated for whose account the order was given. It was not permissible for exchange dealers to keep in foreign countries more than the minimum cash balances necessary for keeping their accounts open. An official list was sent periodically to all exchange dealers from the finance section of the Ministry of Blockade containing the names of persons and firms whose transactions it was undesirable to facilitate or finance. The last of these lists (colloquially known as " Black Lists "), which was circulated in Dec. 1918, contained no less than io,000 names of persons or firms with whom it was not permitted to trade either directly or indirectly. It was not permissible to telegraph in cypher, though as a concession when ordering telegraphic transfers of money one private " check " word was permitted in each telegram, but this only to lessen the risk of fraud. (A few recognized codes in general use could, however, be employed, but the telegram had to commence with the name of the code and a small fee was charged by the censor.) Troublesome these restrictions undoubtedly were, but they were not unreasonable; and foreigners, both Allies and neutrals, recognized that they were necessary and were not intended in any way to hamper them in carrying out their own legitimate trade.

A large and increasing volume of orders to buy and sell foreign exchange came to the London market from the continent of Europe and also from America, with the result that London never lost its preeminent position as the world's centre for foreign exchange. Indeed, the great increase in the volume of exchange transactions that started very shortly after the declaration of peace, when exchanges were decontrolled and all restrictions were removed, found England better equipped than ever before for maintaining its leading position.

In this connexion the three subjoined tables, A, B and C, for London business done on various foreign centres, are of interest. The first (A) shows the highest and lowest exchange quotations during a normal pre-war year, the second (B) gives similar quotations for a post-war year, and the third (C) is a record of the rates at which actual transactions took place on one day in 1921: Table A.-Pre-war Rates-1912.

England was by no means the only country where foreign exchange transactions were subject to strict State control. In Germany, in fact, restrictions were far greater than in England. In that country dealings in foreign exchange were confined, officially, to certain firms and banks, numbering in all 28, who were granted licences by the German chancellor permitting them to do that kind of business. The offices where such transactions were authorized were known as Divisenstellen or " Foreign Exchange Offices." Official rates governing exchange transactions were fixed by the State Bank. These varied from time to time. Table D (on p. 42) gives the highest and lowest official Berlin rates for the years 1916, 1917 and 1918.

It will be noticed how very steady were the Austrian, Hungarian and Bulgarian exchanges, especially during 1917. Even that on Constantinople varied only about 5% during that year. If one compares these with the variations in the French, Italian and American rates of exchanges as quoted in London in 1917, one will find that the German control was, on the whole, rather more successful, for although the difference between the highest and lowest quotations for the " pegged " dollar was barely 4 of 1%, that for the French franc was about 24% and that for Italy was as much as 31 per cent.

Table B.-Post-war Rates-1920.

Among the other difficulties that the German trader had to. contend with were these :-No German current coins or banknotes were permitted to be sent abroad unless permission had been obtained previously from the State Bank. No German or foreign money could be sent abroad for the purpose of acquiring securities or merchandise of any description without the permission of the State Bank. This prohibition also extended to barter. No foreign credits of any description in German currency were permissible without the sanction of the State Bank. The Imperial chancellor had the power to authorize the State Bank to requisition from the possessor any foreign currencies, foreign balances or other " means of payment abroad," giving in exchange their full value in German marks at the official exchange then ruling. Persons or institutions acquiring or disposing of foreign exchange in any shape or form were obliged to give full information as to the nature of the business in question to the State Bank, and the Divisenstellen were empowered to make it a condition that this information should be given before doing business with them. Persons infringing any of these regulations or found to be giving false information, rendered themselves liable to fines varying from too to 50,000 marks and to imprisonment for periods not exceeding one year. In addition to this, the money or goods in question might be declared forfeit to the State.

Secrecy on the part of the Divisenstellen was ensured by an edict rendering anyone guilty of betraying any information obtained liable to a substantial fine or imprisonment.

The business of German money changers was very much hampered and restricted by emergency legislation. Money changers were certainly permitted to buy and sell foreign currencies against their equivalent in German marks, but the total amount so exchanged for one and the same person or firm by one or more money changers on one single day could not exceed I,000 marks, nor in one calendar month 3,000 marks, unless special permission had been granted by the State Bank. Certain exceptions were made. For instance, it was not necessary to obtain permission to send funds abroad for the purpose of providing for the necessary disbursement of ships, nor for the purchase abroad of German war bonds or exchequer bonds. That part of Belgium occupied by German troops was treated in an exceptional manner and its exchange could be purchased or sold to any extent. Still, even in Germany, a very large export and import business could be carried on with Holland, Switzerland and Scandinavia. That trade was practically impossible with more distant countries was due to the blockade and not to foreign exchange restrictions.

In order to appreciate the effect produced by the war on the mechanism of dealings in foreign exchange, it is necessary to bear in mind the position previously occupied by the sterling bill throughout the world. Owing to the fact that London had been, for a far longer period than any other country, an absolutely free market for gold, and that the Bank of England had been willing to cash its notes on presentation, in gold to any extent, both for internal use and for export, the " exchange " of the whole world centred round the sterling bill, which had come to be regarded as actual interest-bearing gold. Nearly every foreign state bank was in the habit of keeping a certain portion of its reserve in sterling bills, which were renewed from time to time, as they became due, and only " melted " when and as these banks desired to replenish their stocks of gold.

Another thing to be remembered is the facility with which the Government banks of England, France, Germany, Belgium, Holland and other countries, could, until the outbreak of war, control their exchanges by raising or lowering their official discount rates. If, for instance, the rate of exchange between London and Paris was such that gold was being sent in inconvenient quantities from England to France, the Bank of England would raise the bank rate (and thus the value of money) in London to a sufficient extent to make it profitable for French banks to leave their money in England, or English bankers would draw three-months bills on France, in order to meet the demand for remittances to that country. Such bills, being almost invariably of the highest quality, were eagerly sought for by French banks and readily discounted in Paris.

The immediate effect of the outbreak of hostilities at the opening of Aug. 1914 was to break down the whole fabric of foreign exchange throughout the world. Credit, as regards foreign exchange, for the time being ceased to exist, and in every country there was a rush on the part of bankers and merchants to bring home their credit balance from abroad and to " melt " all their foreign bills. The movement of exchanges at the beginning of Aug. 1914 was most interesting. In America, for a short time, it was quite impossible to obtain exchange to meet indebtedness. by remittances to London, and the value of the pound sterling in New York in consequence rose in one day as much as 30 per cent. On the other hand, in Paris the value of the pound depreciated 4 per cent. And this was in spite of the fact that, contrary to what prevailed in other countries, no prohibition was then put on the export of gold from the Bank of England.

In London, during the Aug. 1914 bank-holiday interval, which was prolonged by Royal Proclamation from Monday the 3rd until Friday the 6th, in order to avoid a panic, one of the most important problems before the British Treasury was the reestablishment of foreign exchange, since it was recognized that, until this was accomplished, it would be quite impossible to carry on the foreign trade of the country. It was necessary in the first instance to reestablish the position of the sterling bill. For this purpose two things were necessary: - (t) to induce English accepting houses to continue to grant legitimate trade credits, and (2) to induce banks and discount houses to discount these acceptances when created. The accepting houses realized that an unknown but probably a large proportion of their acceptances would not be provided for by the drawers at due date, while the discount houses believed that many of the bills bearing their endorsements or guaranteed by them might not be met by the acceptors. Neither acceptors nor endorsers therefore felt themselves justified in adding to their liabilities.

These two apparently insuperable difficulties were overcome by the Treasury, with the assistance of the Bank of England. The Government, by a series of proclamations, relieved the endorsers of all approved sterling bills of their liability as endorsers, and authorized the Bank of England to advance at interest to all approved English acceptors, who, for reasons connected either directly or indirectly with the war, should not receive the money necessary to meet their acceptances at maturity, loans to meet these bills, repayable on or before one year after the termination of the war. Almost immediately these measures had the desired effect, and so far as the import trade of the United Kingdom was concerned exchange very soon resumed more or less its normal position. All trustworthy export houses abroad were sure of being able to finance their exports to Great Britain, and could rely on finding a ready market in London for their sterling bills. Cash payments, owing to the irregularity of the post, were usually made by telegraphic transfers. Exchange operations resulting from British export trade were not found so easy to carry out, and it was in this connexion that the mechanism of exchange underwent most change. No belligerent country other than England had been able in the early days of the war to maintain a free discount market; and throughout Europe, in those countries where gold had hitherto been obtainable, its export was prohibited. The result was that, in continental rates of exchange on London, although there was a limit as to the extent of a fall, owing to there still being a free gold market in England, there was no limit as to a rise. As a result, no prudent bank or exchange dealer in London kept any substantial balance abroad, and portfolios of bills in foreign currency (formerly held to the value of tens of millions of pounds) were no longer maintained. Their place in the business was taken by Treasury bills.

Table D. - Official Rates of Exchange in Berlin.

The prohibition against selling stock-exchange securities owned by foreigners on the London market, and the difficulty in the way of selling securities held in England on any other market except that of New York, combined with the British Government having assumed practical control of all credit operations, resulted in the very early days of the war in foreign exchanges being swayed almost entirely by actual trade transactions. Thus, the American sterling exchange (London on New York) after the first month or so of the war remained at a rate then considered low, because Great Britain was importing vast quantities of food and munitions from the United States and a large adverse balance of trade was being created. On the other hand in countries like France and Italy, who made large purchases in England, the exchange rose (i.e. depreciated in value) to heights that had not hitherto been reached. The same thing occurred even to a greater extent with regard to the Russian exchange (rubles). Russia in prewar days had met its large indebtedness to England to a considerable extent by the export of food-stuffs, but owing to the closing of the Black Sea and the Baltic ports it was unable to carry on its export trade to anything like the normal extent. Heavy as was the depreciation in these rates of exchange, it would have been much heavier were it not for the fact that the British Government assisted its Allies to obtain large credits in London and in other markets.

In the case of countries like Brazil, Argentina and Chili, it had become almost impossible to obtain exchange on London. This was especially the case in Brazil where the export trade is seasonal. Before the war it had been the custom for South American banks to obtain financial credits in London during the periods when trade bills were not forthcoming, and by means of bills drawn against these credits their debts to Europe were tided over. These credits were eventually liquidated by means of trade bills created during the export season. In the early stages of the war European creditors either had to wait for their money or to accept very unfavourable rates.

Nevertheless, chiefly owing to the action taken by the British Government, the mechanism of foreign exchange was less seriously affected on the whole than might reasonably have been expected. Only for a very short period and between very few countries was trade held up altogether on account of exchange difficulties, but the fluctuations of rates of exchange between most countries became so great that the cost of exchange soon became a very important factor and had to be reckoned with, even in transactions on which the margin of profit was considerable.

During the first year of the war the pound sterling had maintained its value fairly well in all neutral countries and particularly so in the United States, which was neutral until April 1917.

At the end of 1915 the leading exchange rates with countries open to business on the London market were as follows: England however had been pouring money into America in ever-increasing amounts, to pay not only for those commodities for the supply of which England in normal times depends to a large extent on America, such as cereals, cotton, etc. - and these at very high prices - but also for the vast quantities of war material of all kinds which were being manufactured at high pressure and even higher cost both for England and for its Allies. Exchange to meet the payments for these articles as they became due was provided partly by the export of gold. Between Oct. r and Dec. 31 1915, gold to the value of over seventeen million pounds sterling was withdrawn from the Bank of England for export to New York alone - partly by the proceeds of the sale through ordinary channels of the bulk of what may be described as the floating stock of American securities held in England, and partly by the calling in as they became due of all the short-term loans that had been made by English investors to America. In deed, at the very beginning of the war, the city of New York was called upon to repay £13, 500,000 that happened to fall due at that time; and as this large sum had to be found very quickly on a panicky and depleted exchange market, as high an exchange as $6.75 had to be paid per British pound for prompt cable payment. It must have been evident at the time that, owing to the fact that England had just become involved in a life and death struggle with a desperate and powerful antagonist, whereas America could not but profit through its neutrality, the pound must depreciate and the dollar appreciate. But the demand in New York had to be met regardless of cost.

It is a curious and interesting fact that when the dollar was at its worst, i.e. $6.75 to the pound on Aug. 3 1914, the premium on the pound in New York was $1.79, whereas when the British pound was at its lowest value, about $3.19 in Feb. 1920, it was at a discount of only $1.642.

Very soon after the outbreak of the war, the principal foreign exchanges tended to group themselves into four divisions on the London market. These became known as the " Allied exchanges," the " Enemy exchanges," the " Neutral exchanges " and the " Eastern exchanges." Whether we take as a basis the pound sterling or the United States dollar (to which, in fact, the pound was steadily linked in value from the commencement of 1916 till four months after the Armistice was declared), we find, speaking generally, that the Allied exchanges were at a discount, the Enemy exchanges at a greater discount, and the Neutral and: Eastern exchanges at a premium.

The reason is not far to seek. Of the Allies, only England and France could be described as wealthy; and - partly because the war on the western front was waged mainly on French territory so that not only the most fertile part of France but also the chief centres of French industry were devastated, and also because the French were very inadequately taxed during the whole period of the war - French international credit was not maintained on the same level as that of England. The other Allies were lacking in accumulated wealth, and very soon became financially dependent, primarily on England and to a smaller extent on France. But the leading neutrals, who in Europe comprised Holland, Spain, Switzerland and the three Scandinavian kingdoms and in S. America the Argentine Republic, were in a very favourable financial position. The European neutrals could trade to their great pecuniary advantage with both groups of belligerents, and could take full advantage of the great demand that sprang up for their produce. Spain could supply France with textiles and metals, Norway and Sweden could meet the demand for timber and paper (which was much increased by the closing of the Baltic ports), and Denmark and Switzerland were able to supply both sides with dairy produce. In addition to these advantages the important mercantile fleets of Holland, Scandinavia and Spain were able to earn large profits because of the great rise that took place in freights. Indeed, throughout the war, preference was generally given by shippers to ships owned by neutrals, because the risk of their being sunk was considered somewhat less and the rates of insurance on their cargoes were therefore materially lower.

The eastern countries, China, India and Japan, were, it is true, belligerents, but their financial burdens were but slight compared with those of their European colleagues; and since China and India were large exporters of raw materials, while Japan assumed gradually the position of Germany as the chief supplier of the less costly manufactured articles, all three countries profited greatly by the war.

It may be asked why, although the United States was a free gold market and the pound was " pegged " (see below) to the dollar, both the sterling and dollar exchanges should have been for so long a period at a considerable discount in Spain and in Scandinavia. Indeed, on one day in Nov. 1917 the pound sterling was worth no more than Kr. 9.90 in Stockholm, and in April 1918 it was only saleable at Kr. 11.90 in Christiania and Copenhagen. The explanation is that, fearing the evils that might arise from " inflation," these four countries, one after another, announced that they would no longer purchase gold in any other form than that of their individual currencies, excepting on terms that would render such importation unprofitable. After the end of the war, when the demand for their produce slackened, these countries suffered from this somewhat original form of legislation by which gold was refused in payment. The exchanges of all of them fell to a substantial discount in New York, and three out of the four went to below their pre-war value as expressed in sterling.

Towards the end of 1915 the future outlook for sterling in New York began to assume a very serious aspect. The normal floating stock of American securities (as apart from regular investments) held in England was nearly exhausted, while the demands on America for war material were greater than ever. The British Government then decided that a supreme effort must be made to control foreign exchanges in general, and more particularly to ward off at all costs the threatened collapse in the gold (or in other words, the international) value of the pound sterling, as represented by its dollar exchange. Realizing, very wisely, that this task was too vast and too difficult to be dealt with in an adequate manner by any of the existing Government departments, they appointed a small committee which was known as the " London Exchange Committee " and gave them a free hand to deal with the situation as they thought best. The members of this Committee, which was under the chairmanship of the then governor of the Bank of England, Lord Cunliffe, included Sir Brien Cokayne (afterwards Lord Cullen), deputy-governor of the Bank of England; Sir Edward H. Holden; Sir Felix O. Schuster; Mr. Gaspard Farrer; Mr. Stanley Baldwin; the Hon. Sydney Peel. Later Mr. Baldwin retired and was replaced by Mr. H. G. Levick. The Committee were mainly men of international reputation, not only conversant with foreign exchange but also accustomed to deal with vast sums of money, and whose capacity had been proved by the success of the institutions they controlled. The activities of this Committee were not confined to American exchange, although that was considered to be its principal task, for the maintenance of the American exchange in itself was a support to the exchanges of the Allied nations and a great help to neutrals, for whose commercial transactions it was the only element of steadiness. It also watched carefully other exchanges, especially that of Holland, the wealthiest and most important of European neutral states.

Before starting their work the London Committee had to convince themselves that the means at their disposal were adequate for their task. What were these means? First came the stock of gold in the vaults of the Bank of England, over which they were given control, but this was none too large as a reserve against the Bank of England notes and the ever-increasing amount of Treasury notes that had taken the place of gold as the medium of circulation. Secondly, there was a considerable stock of gold held independently in the vaults of the London clearing banks, but this also was better left untouched if possible, as it formed a most valuable secret reserve that could be used to replenish the stock of gold held by the Bank of England should need arise, as indeed it did later on. Then there was the fresh gold coming in regularly from the gold-mines of the British Empire, averaging about £55,000,000 per annum or about 65% of the total world's production. This valuable " gold-income " was also placed at the disposal of the Committee to do with as they thought best. Finally, there was an unknown but certainly a very large quantity of foreign and colonial stocks and shares remaining in the hands of British investors and having an international market on realization: owners of these securities (see Dollar Securities Mobilization) were invited to sell them or to lend them to the British Government on favourable terms, and power was taken to commandeer them at market price should it become advisable to do so, but the amount forthcoming voluntarily was found to be ample.' ' The value of the foreign securities actually deposited in this way at the British Treasury reached the high figure of £438,311,- 000; this amount was considerably larger than had been expected. In addition to this, securities were sold to the Bank of England to the value of £46,000,000 and to the " Dollar Securities Committee " Having completed their exhaustive enquiries, the Committee decided that the means at their disposal were adequate and that the object in view was worth the cost. They embarked on their great task in Jan. 1916, and from that date until March 1919 the pound sterling was steadily maintained at a figure in New York equivalent to about par if allowance is made for the increased cost of freight and insurance for gold. It was not until March 1919 that it was decided that, the object having been achieved, control or " pegging " might be removed and the exchange allowed gradually to take its own course without interference.

It may be mentioned here that while financial authorities have been unanimously of opinion that this " pegging " of the American and English exchanges was the greatest, the most difficult, the most far-reaching in its effects, and the most successful of all the financial schemes embarked on during the war, there are some who think that the control was enforced for a longer period than was necessary, in view of the great expense entailed and the manifest fact that an exchange cannot be stabilized by artificial means for all time.

The Anglo-American exchange was the only one that was actually " pegged " or fixed, but the other exchanges were watched with equal care, and where ordinary means did not suffice gold shipments were made to Holland as well as to America. Important negotiations were entered into with such Governments as Argentina, Uruguay, and especially Japan, and proved very useful in maintaining some sort of stability for the pound, while other understandings were effected with various banks in Scandinavia, Spain and Switzerland.

The decontrol took place without any flourish of trumpets, and it was some little time before the world realized its full significance. It was not until July 1919 that the American sterling exchange fell below $4.50, nor till Dec. of that year that it, broke below the $4.00 mark. In Feb. 1920 it fell below $3.50, when it touched $3.19, the lowest point recorded. In April 1920 it temporarily rose once more to over $4.00, but subsequently declined again below that level. The fluctuations in exchange after decontrol gave rise to a vast amount of speculation.

One of the chief causes contributing to the success of the task of the London Exchange Committee was the confidence inspired in the minds of neutrals, for it stands to reason that, great as were the resources placed at their disposal, the amount of the indebtedness of England to America soon became much larger, increased as it was by England assuming responsibility of £170,044,000. The following table gives fuller details of these operations: - These figures are exclusive of a special creation of $40,000,000 Canadian Pacific Railway 4 per cent Dollar Debenture stock, deposited by the Canadian Pacific Railway Company. Of the total amount purchased, as given in the first column, i.e. £216,644,396, the Bank of England bought £48,600,000 and the Dollar Securities Committee £170,044,000. The deposits on loan on March 31 1919 amounted, therefore, to £405,951,000, which, with the deposits on loan sold to the Treasury, £24,360,000, and the £8,000,000 special deposit of the Canadian Pacific Railway Company, made the balance actually deposited £438,311,000. As will be seen from the above table, dollar securities constituted the major portion of those mobilized. Of the American securities, amounting to £250,543,000, which came into possession of the Treasury, £177,6r4,000 or more than 70% were bought for resale in New York, and £72,928,000 or 29% were still held in Great Britain at the time this report was made. A good deal was subsequently disposed of, bringing the total amount redeemed by the United States to about £200,000,000.

for debts contracted by its Allies for the purposes of the war. In fact, England may be said to have shouldered the entire burden until April 1917, when America joined the Allies. The neutrals believed in England's financial strength, and they also recognized that the pound sterling was interchangeable with the dollar on a basis which, with allowance for the increased cost of freight and insurance, was approximately equal to pre-war par value. In other words, since America remained on a real gold-basis, and the English and American exchanges were linked together, England was for practical purposes also on a gold basis. They therefore were equally content to leave their rapidly accumulating foreign credit balances either in England or America, in whichever country a better rate of interest was obtainable. In order to offer an inducement for them to select England, the British Government authorized the Bank of England on their behalf to pay to British banks and bankers a specially high rate of interest on deposits emanating from customers in neutral states (see Money Market). Thus neutrals were able to get in England a rate of interest for their balances substantially higher than they could have got with equal security in America. They therefore abstained to a great extent from converting their sterling into dollars, which would have added greatly to the difficulties and expenses of the London Exchange Committee.

Vast as this operation of " pegging " the sterling exchange in America was, it was only part of a still more ambitious scheme. The object in view was to stabilize at the same time the French, the Russian and the Italian exchanges. With France success might have been possible, although France lacked one of the great essentials for that purpose, i.e. a gold " income." None, or practically none, of the newly mined gold of the world was controlled by France. The Bank of France, however, possessed a very large stock of gold, amounting to £169,31,920 at the beginning of 1915, and the quantity of gold coin circulating in France was larger than in England. The French also had many investments abroad even apart from their holdings of Russian securities; but they were unwilling to make the great sacrifices that were necessary to ensure success. Their taxation was infinitely lighter than that of England. The logical mind of the Frenchman argued thus:-" If we lose the war we are ruined anyway. If we win, then we shall have power to force the defeated enemy to foot our bill down to the last franc. So why worry now?" They certainly did not over-estimate the power of the conqueror to dictate his own terms, but they omitted to take into their calculations the possibility that the defeated nations might be unable to pay what was demanded of them. At any rate they endeavoured to stabilize the French franc largely on money borrowed, first from the British Government and English investors and accepting houses, and later from America. Such an attempt was foredoomed to failure, and the wonder is that they were able to keep their rate of exchange as favourable (or as far from unfavourable) as they did for so long a period. The movements of the French exchange as well as those of other countries will be seen in the annexed tables.

With Italy it was still more difficult, and the various attempts that were made to prevent a breakdown in that exchange were not very successful; but then Italy was absolutely unable to rely on its own resources, much as it might wish to have done so, and it cannot justly be accused of backwardness in the imposition of taxes. As regards Russia, the attempt might well be described as farcical, since it resulted chiefly in enabling wealthy Russians to remove their money from their own country to places of safety abroad, at the expense of the British Government and the English accepting houses, who gave their unwilling assistance not with the object of making a profit, but because their patriotism was appealed to.

Table E gives the rates of exchange on New York ruling in London at the beginning and the middle. of each month from Jan. 1914 to Dec. 1920.

Indian Exchange.-In striking contrast to the success that crowned the efforts of the London Exchange Committee in dealing with the Anglo-American exchange, was the failure of the Indian Government to maintain the pre-war ratio between the Table E.

British pound and the Indian rupee that had existed without a break since 1898.

The Anglo-Indian exchange has always been a very difficult one to deal with, and it took five years' hard work (from 1893 to 1898) on the part of a particularly well-managed department of the Indian Government to establish the ratio of 15 rupees to the English sovereign, or is. 4d. per rupee. With great difficulty and at vast expense to the Indian taxpayer, this ratio was maintained during the war until Aug. 1917, when the Indian Council in London announced that they would no longer sell Indian exchange under is. 5d. per rupee. In April 1918 the rate was raised to is. 6d.; in May 1919 to is. 8d.; in Sept. of that year to 2S. od.; in Nov. to 2S. 2d. and in Dec. 1919 to 2S. 4d. In Jan. 1920 the rate was reduced to 2S. od., at which rate it was hoped that the exchange might be maintained, but by this time the Indian Government had been forced to come to the conclusion that the task of controlling the Anglo-Indian exchange was altogether beyond their power, and having spent on their attempts well over f 20,000,000 and having caused losses far exceeding this amount to the Anglo-Indian trading community, while achieving no adequate result, they abandoned the attempt to interfere with the natural movements of their exchange.

In the course of their operations they purchased from the United States practically the whole of their accumulated stock of silver, amounting to 200,000,000 ounces. They suspended their weekly offerings of rupee exchange in London, and for a considerable period offered sterling exchange on the Indian markets. But it was to no purpose. The phenomenal rise in prices of commodities up to the early days of 1920, and their subsequent rapid fall, made their task too heavy for them, and after having reached 2S. 94d. on Feb. 14 1920, the value of the rupee fell away till it touched is. 3d. on March 7 1921.

It must be borne in mind, however, that it is a far simpler task to " peg " an exchange to one which remains on a free gold basis-as was that of England before the war, and as that of America still remained-than to do so to that of a country whose currency is purely a fiduciary one and is subject to violent fluctuations in countries having a gold standard. In fact, during 1920 the average gold value of the pound note was only 14s. 6d. or 272% discount, equivalent to 42 pence on a is. 4d. rupee.

Chinese Exchange.-From time immemorial the Chinese exchange has been based on the price of bar silver, and the rate of exchange between Shanghai and England still rises and falls with the market price in London of that metal. It is true that the fluctuations in this exchange have been extraordinarily violent in recent years, but so have the movements in the price of silver. In this connexion it may be said that a large proportion of the supplies of silver that came to the London market during 1919 and 1920 was in the form of the melted silver currencies of France, Belgium, Germany and Austria, which were withdrawn from circulation and melted into bars. So much of this silver came into that market during this period that, notwithstanding the fact that the U.S. Treasury made an agreement with the American producers to purchase an amount of silver sufficient to replace what they had sold to the Indian Government at the fixed rate of a dollar an ounce, it was obtainable in large quantities at prices considerably below what it was costing to produce it in many of the most important mines. And yet the French, Belgian, German and Austrian Governments were making substantial profits in terms of their own depreciated currencies.

South African Exchange.-Up to the time of the outbreak of war, there was almost a stereotyped London rate of exchange on S. Africa, never varying beyond the cost of sending gold either way-usually, buying 0.5% discount, selling o 5% premium. Owing to the difficulty in getting the natives to take and circulate notes, gold was the S. African currency in common use. In normal times there is a considerable leakage of gold from S. Africa. This rose to considerable proportions after the war had commenced owing to the heavy premium on gold in other countries. Even after a law had been passed prohibiting the export of gold, a considerable amount of smuggling took place and continually reduced the amount of sovereigns held by the S. African banks. In order to replenish their stocks, the banks had to import sovereigns from England, resulting in the strange spectacle of the largest gold-producing country of the world importing gold. This was due to the fact that all the fresh gold produced by the mines was requisitioned by the British Government.

Owing to the shortage of sovereigns, and the shipping of gold being a considerable expense to the banks, exchange facilities to exporters from England were somewhat restricted, and in May 1920 a premium of 8% was charged for remittances to S. Africa. The scheme by which a Federal Reserve bank for S. Africa was authorized to issue inconvertible notes to take the place of the gold currency, caused the exchange to drop to par in Aug. 1920, and the swing of the pendulum, encouraged by a considerable increase in the import of goods, created a shortage of funds in London and sent the exchange in the other direction until 6% was charged for remittances on London in S. Africa in Nov. 1920. Hence the strange phenomenon of the currency of the greatest gold-producer in the world being at a discount as compared with the British Treasury note.

Rates of Exchange.-Table F gives the chief rates of exchange ruling in London on three typical days: the end of July 1914; the day on which the Armistice was declared (Nov. 11 1918); and the last working day of the year 1920. There are also given the pre-war parity rates; the highest and lowest rates touched during the war, and also the highest and lowest rates touched between Armistice day and Dec. 31 1920; and that of Aug. Io 1921. The Austrian and German rates of exchange current during the war are those obtained from neutral countries.

F.- Comparative Rates on London.

• Shanghai exchange being on a silver basis there was at no time a fixed parity between its currency and that of London. f To Jan. 7 1918.

G.-Value of pound sterling, Dec. 31 1920.

On Sept. I 192 the London rates were as follows:-New York, 3:73± Montreal, 4.14± Paris, 47.56; Belgium, 48.97; Italy, 84; Holland, 11.74; Spain, 28.61; Switzerland, 21.84; Stockholm, 17.16; Christiania, 27.55; Copenhagen, 21; Berlin, 319; Portugal, 6; Greece, 66± Bucharest, 317; Finland, 258; Vienna, 3,Ioo; Prague, 312; Warsaw, 10,650; India, is. 41d.; Yokohama, 2s. 7±d.; Buenos Aires, 431; Rio de Janeiro, 71; Serbia, 168; Bulgaria, 450; Budapest, 1,450.

Table G shows the changes that took place in the value of the pound sterling in different countries as between pre-war basis (1914) and Dec. 31 1920, the left section showing where the pound had risen to a premium and the right section where it had fallen to a discount.

In order to understand accurately the extent of the depreciation of the various exchanges since they ceased to have a gold standard, it is better to take as a basis for comparison the American gold dollar rather than the British paper pound.

Table H shows the rates of exchange ruling in New York (a) immediately before the declaration of war, (b) just after America joined the Allies, and (c) when the Armistice was declared. Table I gives the rates ruling on Dec. 31 1920, and includes those of several countries not previously quoted in America.

Speculation.-During the war speculation in foreign exchanges was almost entirely confined to the six neutral states of EuropeHolland, Denmark, Sweden, Norway, Spain and Switzerlandand to the United States, which was free to deal in all exchanges until it came into the war in 1917. These countries traded very extensively with both groups of belligerents, and quickly amassed very large profits through selling their produce and manufactures at high prices, and also through obtaining abnormally high freights with their steamers. Much of this money was paid in the currency of the purchasing countries and large foreign balances were thereby accumulated. The natural effect was to depreciate the value of the pound, the franc, the lira, the ruble, the mark and the Austrian crown, all considerably but in different degrees. Most of the neutral export merchants and shippers became large sellers of foreign credits, and had they not been able to do so they would have been obliged to cease exporting, but there are always people in every country willing to buy almost anything at a price, and it did not take long before the speculative habit which is the invariable result of sudden prosperity was turned in the direction of foreign exchange, and not only bankers and banks but also private individuals indulged in a perfect orgy of speculation.

Many of these speculators bought sterling exchange, others bought marks. They frankly backed the side they thought would win, and gained or lost accordingly, but there were others who thought it more prudent to " hedge "-that is, to divide their risks and turn part of their money into pounds and part into marks. These persons omitted one very important factor from their calculations, i.e. that the prospect of loss in the value of the currency of the losing side must of necessity be immeasurably greater than the prospect of gain in that of the winning side.

Table H.-New York Rates (in dollars) * I-Iong-Kong and Shanghai exchanges being on a silver basis, there was at no time a fixed parity between their currencies and that of New York.

TABLE I. -New York Rates, Dec. 31 1920.

For instance, a Dutch speculator might have bought £Io,000 for Ioo,000 guilders and at the same time 300,000 marks for another ioo,000 guilders: this was in the early part of 1916 when it was doubtful which side would win the war. On Jan. 1 1921, if he realized his holdings he would have gained about io,000 guilders on his sterling but lost 70,000 guilders on his marks. Should, however, this speculator have been tempted by the greater depreciation to have bought Austrian crowns and French francs, he would have lost half his money on the realization of his francs and practically the whole when he sold his crowns. It was, however, chiefly in their mark investments that neutral states lost a large proportion of their war profits.

Another very favourite speculation was the Russian ruble. Speculation in this currency started very early in the war and continued long after the establishment of the Soviet Government. To a great extent it took the form of buying actual ruble notes, and large masses of these came to Europe partly via Scandinavia and partly through Siberia. Many of them found a home in America, but large quantities remained in Sweden and in England. It was somewhat strange that this buying of ruble notes should have continued notwithstanding frequent announcements made by the Bolshevik leaders that it was their intention to issue fresh notes in sufficient quantities to destroy effectually their value as a purchasing instrument. It was only when it was realized that the Soviet Government were printing so-called " Imperial " notes in limitless quantities, using for that purpose the original plates and producing a spurious article quite undistinguishable from the original, that the speculators at last realized that their rubles were not only absolutely worthless at the moment but that there was but slight prospect of their having any value even in the distant future.

It was not however until the Anglo-American exchange was decontrolled, and restrictions as to dealing in certain exchanges were definitely removed in the belligerent countries, that speculation became general. Decontrolled exchange without a gold basis presented all the elements dear to the speculator - an unlimited supply of the article, violent and frequent fluctuations, ease in buying or in selling to any extent, no fear of being " cornered," and an international market. The volume of speculative business soon became much larger than that of transactions done for legitimate trade purposes. But foreign trade could still be carried on without the merchant running exchange risks unless he decided to do so. A system was elaborated by which for any bona-fide trade transaction a merchant enjoying good credit could purchase or sell his foreign exchange at a rate based on that of the day on which he did his transaction, for future delivery at dates that synchronized with his requirements. It was only when trading with countries whose exchange could not be sold in the ordinary way for immediate delivery, that he was unable to arrange for his future deliveries.

To avoid this difficulty, a scheme was drawn up in the autumn of 1920, known as the " Ter Meulen Scheme " (from the name of its originator, a partner in the firm of Messrs. Hope & Co. of Amsterdam). It was accepted by the League of Nations and was intended to assist impoverished nations which under existing circumstances were unable to attract funds for the financing of essential imports. Up to the end of 1921 this scheme was not in actual operation, but the plan proposed was recognized as one which would have an important bearing, if adopted, on the business of foreign exchange.

The Ter Meulen Scheme was as follows, the text of the League of Nations articles (Nov. 1920) being here slightly abbreviated: International Credits Scheme An International Commission shall be constituted under the auspices of the League of Nations.

The Commission shall be appointed by the Council of the League of Nationsand shall have discretion to appoint agents and subCommissions.

The Governments of countries desiring to participate shall notify to the Commission what specific assets they are prepared to assign as security for commercial credits to be granted by the nationals of exporting countries.

The Commission, after examination of the assets, shall determine the gold value of the credits which it would approve against the security of these assets.

The participating Governments shall then be authorized to issue bonds to the gold value approved by the Commission. The bonds shall be in such form, with such date of maturity and rate of interest, as the Commission may decide and shall, in particular, enumerate the assets pledged against the bonds. The denomination of each bond and the specific currency in which it is to be issued shall be determined by the participating Government in agreement with the Commission, in accordance with the conditions applicable to the particular transactions in respect of which they are issued.

The service of these bonds which will be obligations of the issuing Government shall be specifically secured out of the revenue of the assigned assets.

The assigned assets shall be administered by the participating Government or by the International Commission as a majority of the Council of the League of Nations may determine on the proposal of the International Commission.

Out of the revenues from the assigned assets there shall be purchased foreign currencies sufficient to provide (a) cover for the coupons falling due in the next year, (b) a sinking fund calculated to redeem at maturity Io% of the bonds outstanding, (c) a reserve in such foreign currency or currencies as the International Commission may determine for the redemption of any bonds sold as a consequence of failure by the importer to fulfil his contract. Any surplus remaining after the provision of these services shall be at the free disposal of the participating Government.

The participating Government will be free either to pledge its own bonds as collateral for credits for approved imports on its own account or to lend the bonds to its nationals as collateral for credits for approved imports on private account.

Each bond shall before issue be countersigned by the Commission in proof of registration.

The fundamental purposes of the scheme being to facilitate and expedite the import of such raw materials and primary necessaries as will enable the borrowing countries to reestablish production especially for export, bonds secured on the assigned assets shall not be utilized as collateral for credits for the import of other commodities.

For each borrowing country the Commission will draw up, in consultation with the participating Government, a schedule of approved imports which will be regarded as falling within the definition of raw materials and primary necessaries.

Particulars of each transaction must be registered with the Commission, which, before countersigning a registered bond will satisfy itself that the credit is for an approved import and that the period for which it is proposed to be granted is a reasonable one.

The same conditions as govern the pledge of the bonds as the collateral for credits for imports on private account shall apply in cases where the participating Government pledges its own bonds as collateral for imports on Government account.

After having received bonds duly countersigned the importer will pledge them with the exporter.

Pledged bonds shall be dealt with as follows: - (a) In the absence of any failure by the importer to fulfil his contract with the exporter, the coupons on their due date and the bonds as they are released shall be returned to the importer who shall return them to his Government forthwith. (b) In the event of the importer not fulfilling the terms of his contract, the exporter (or his assigns) may either hold the bonds until maturity, or if he prefers he may at any time sell them in accordance with the laws and customs of his country, providing that before the bonds are sold a reasonable opportunity shall be given to the issuing Government to repurchase them by paying to the exporter the amount of his claim. The proceeds of such sale shall be applied by the exporter towards covering his claims against the importer. Any surplus not required for this purpose shall be accounted for by the exporter to the participating Government. (c) Any coupons or bonds returned to the participating Government or purchased by such Government shall be forthwith cancelled in accordance with the regulations to be prescribed by the International Commission; cancelled bonds may subsequently with the approval of the Commission be replaced by other bonds either in the same or in a different currency in accordance with the conditions governing the original issue of bonds.

An unusual form of speculation sprang up during 1918-9. Orders were received in England, France and the United States from neutral countries for the purchase of English, French and American bank-notes at rates of exchange very much more favourable to the sellers than those current for ordinary bank credits. The French and the American Governments very soon forbade the export of their bank-notes but the British Government, after giving the matter mature consideration, decided that more advantages than disadvantages were to be gained by permitting the export of Bank of England notes, even if the ultimate destination of these notes were found to be the enemy countries. It was afterwards ascertained that these banknotes were actually bought for enemy account, and many of them are believed to have found their way to Turkey and Bulgaria. Subsequent events proved that the action of the purchasers, though perhaps not patriotic, was from a financial point of view a prudent one, as it was evident in 1918 that in the very probable event of the Allies winning the war, the value of the pound sterling in terms of their own currency was certain to increase to a far greater extent than the 10 or 15% beyond the then current rate of exchange on London that they were willing to pay to convert their currency into sterling in the only way they could do it, while at the same time circumventing the vigilance of the British Ministry of Blockade.

One interesting and important result of the enormous increase of the volume of foreign-exchange transactions carried out in London, which, after the Armistice, established itself more firmly that ever as the world's clearinghouse for that class of trade, has been a remarkable development in the business of the London foreign-exchange brokers.

Exchange brokers have existed in London for centuries, but their business was generally confined to buying and selling foreign exchange for merchants and for those bankers who had no direct relations with foreign countries. They were in the habit of meeting twice a week on the Royal Exchange, where the exchange dealers also attended, and foreign bills of exchange and cheques were then sold to the best buyers, and official rates of exchange were fixed. It is true that with the advent of the telephone it became more and more the custom to carry through the more important transactions, especially those between exchange dealers themselves, by means of telephonic communication, but such transactions were far from numerous, and, such as they were, they were generally done in a leisurely manner. Now all this is changed. The leading exchange brokers confine themselves entirely to working between the various exchange dealers. From ten in the morning until six in the evening their offices are a regular pandemonium. Some of them employ as many as 40 or 50 private telephones in addition to several general ones, and the largest of them carry through on an average about two-hundred transactions a day, mostly for very large sums. They make it their business to keep their clients posted in all the various and quick movements that occur almost from minute to minute in exchange rates, and carry out their transactions with the rapidity and accuracy without which business of that class would be impossible. They assume no financial liability, for when their contracts are passed their responsibility ceases. To succeed - and their business is a very lucrative one though their scale of. commission is infinitesimal - they need discretion, integrity and intelligence. They must never discuss one client's business with another client, nor divulge the name of a buyer to a seller or vice versa, until the transaction is completed. The service the broker renders to the dealer is an extremely valuable one, and the result is that there is practically no business done between dealers without the intermediary of a broker. An interesting fact in this connexion is that, at the end of 1920, the biweekly meetings that had been held between dealers for generations " on 'Change " were abolished.

Partly because this system of employing exchange brokers enables large and numerous transactions to be carried out with great rapidity, partly because the temperament of the chief London dealers in foreign exchange is such that they are easily able to resist the temptation to speculate to any great extent on their own account, partly because those who deal in foreign exchange in London are banks and bankers of the highest standing, but more particularly because the sterling bill has by no means lost its prestige throughout the world, London has established herself more firmly than ever as the central foreign exchange market of the world, and all day and every day there is a constant flow of cables and telegrams from all quarters bringing orders to buy and sell every possible kind of exchange in amounts that were never imagined possible in pre-war days.

Lessons of the War. - Many lessons have been taught by the new conditions brought about by the war, One of the most important of these is that State interference with the nature! movements of exchange, excepting for a limited period and with success practically assured, is a mistake and likely to lead to disastrous results. The " pegging " of the pound sterling to the American dollar - certainly so long as America was a neutral Power - proved nevertheless to be wise and legitimate. The attempts of other countries to stabilize their exchanges at that time were for the most part unsuccessful.

Another fact that has been brought to light is that, to a creditor country, especially one which depends for its prosperity to a large extent on its export trade, a favourable exchange is a distinct disadvantage, which can only be overcome if the nationals of that country are willing to invest a substantial proportion of the value of their exports in those foreign countries which buy their goods. An outstanding example of such a country is America, for up till the spring of 1921 Americans were only just beginning to acquire the habit of investing their money outside their own country; this rendered it extremely difficult for their export merchants to finance their business, as the majority of foreign importers were only able to pay for their goods by means of their own currencies.

It does not follow, however, that an American merchant would be absolutely precluded from selling goods (say) to Poland against payment in Polish marks merely because no one in America would be willing to invest his money in that country. So long as exchange dealers or speculators in another country whose own currency is in fair repute would be willing to purchase Polish marks either directly or indirectly against dollars - that is to say, either paying for the Polish marks in American dollars or in some currency that could be converted into dollars if the American exchange dealer so desired - so long could the American merchant continue to sell his goods to Poland against payment in that country's currency.

On the other hand, manufacturing countries whose exchanges have depreciated heavily and rapidly are in a very favourable position to compete in foreign markets. They can buy their raw materials abroad just as cheaply as any other country, while, as has been proved, the rise in the cost of manufacture - particularly as regards wages - lags far behind any rapid, rise that may take place in exchange rates. Such a country would be able to undersell its competitors to a considerable extent while still making very large paper profits. As an example: the first serious set-back in trade that occurred in Germany after the declaration of peace, was when the German rate of exchange fell temporarily from 365 to 120 marks to the pound, in the early part of 1920. Had the internal value of the mark, that is to say its purchasing power within the boundaries of Germany, depreciated to anything approaching its external value, it would not have been possible for German trade to revive as rapidly as it did.

It is safe to predict that in a highly civilized country, well organized for trade purposes, such as Germany, the internal and external value of its currency must equalize itself approximately sooner or later, but the process is slow and gradual, and during the years that intervene it may be possible for that country to build up an export trade on so firm a basis that it would be difficult for other countries to oust it from its position, even when it is no longer helped by favourable exchange conditions. In fact, it is a mistake to suppose that any country derives advantage from the greater depreciation of another country's currency. The latter cannot afford to import from the former anything beyond its merest necessaries, and on the other hand it is able to undersell it in all competitive markets. (E. L. F.)