HOW MONEY IS MADE IN FOREIGN EXCHANGE. THE OPERATIONS OF THE FOREIGN DEPARTMENT

As to what the foreign department of an American bank makes out of the business, it may be said that that depends very largely upon whether the bank here acts merely as a lending agent or whether the operation is for "joint account," both as to risk and commission. In the former case (and more and more this seems to be becoming the basis on which the business is done) both the American and the European bank stands to make a very fair return—‌always considering that neither is called upon to put up one real dollar or pound sterling. Take, for instance, the average sterling loan made on the basis of the borrower taking all the risk of exchange and paying a flat commission of three-eighths of one per cent. for each ninety days. That means that each bank makes three-sixteenths of one per cent. for every ninety days the loan runs—‌the American bank for simply drawing its ninety-day bills of exchange and the English bank for merely accepting them. Naturally, competition is keen, American banking houses vying with each other both for the privilege of acting as agents of the foreign banks having money to lend, and of going into joint-account loaning operations with them. Three-sixteenths or perhaps one-quarter of one per cent. for ninety days (three-quarters of one per cent. and one per cent. annually) may not seem much of an inducement, but considering the fact that no real cash is involved, this percentage is enough to make the biggest and best banking houses in the country go eagerly after the business.

5. The Drawing of Finance-Bills

Approaching the subject of finance-bills, the author is well aware that concerning this phase of the foreign exchange business there is wide difference of opinion. Finance bills make money, but they make trouble, too. Their existence is one of the chief points of contact between the foreign exchange and the other markets, and one of the principal reasons why a knowledge of foreign exchange is necessary to any well-rounded understanding of banking conditions.

Strictly speaking, a finance-bill is a long draft drawn by a banker of one country on a banker in another, sometimes secured by collateral, but more often not, and issued by the drawing banker for the purpose of raising money. Such bills are not always distinguishable from the bills a banker in New York may draw on a banker in London in the operation of lending money for him, but in nature they are essentially different. The drawing of finance-bills was recently described by the foreign exchange manager of one of the biggest houses in New York, during the course of a public address, as a "scheme to raise the wind." Whether or not any collateral is put up, the whole purpose of the drawing of finance-bills is to provide an easy way of raising money without the banker here having to go to some other bank to do it.

The origin of the ordinary finance-bill is about as follows: A bank here in New York carries a good balance in London and works a substantial foreign exchange business in connection with the London bank where this balance is carried. A time comes when the New York banking house could advantageously use more money. Arrangements are therefore made with the London bank whereby the London bank agrees to "accept" a certain amount of the American banker's long bills, for a commission. In the course of his regular business, then, the American banker simply draws that many more pounds sterling in long bills, sells them, and for the time being has the use of the money. In the great majority of cases no extra collateral is put up, nor is the London bank especially secured in any way. The American banker's credit is good enough to make the English banker willing, for a commission, to "accept" his drafts and obligate himself that the drafts will be paid at maturity. Naturally, a house has to be in good standing and enjoy high credit not only here but on the other side before any reputable London bank can be induced to "accept" its finance paper.

The ability to draw finance-bills of this kind often puts a house disposed to take chances with the movement of the exchange market into line for very considerable profit possibilities. Suppose, for instance, that the manager of a house here figures that there is going to be a sharp break in foreign exchange. He, therefore, sells a line of ninety-day bills, putting himself technically short of the exchange market and banking on the chance of being able to buy in his "cover" cheaply when it comes time for him to cover. In the meantime he has the use of the money he derived from the sale of the "nineties" to do with as he pleases, and if he has figured the market aright, it may not cost him any more per pound to buy his "cover" than he realized from the sale of the long bills. In which case he would have had the use of the money for the whole three months practically free of interest.

It is plain speculating in exchange—‌there is no getting away from it, and yet this practice of selling finance-bills gives such an opportunity to the exchange manager shrewd enough to read the situation aright to make money, that many of the big houses go in for it to a large extent. During the summer, for instance, if the outlook is for big crops, the situation is apt to commend itself to this kind of operation. Money in the summer months is apt to be low and exchange high, affording a good basis on which to sell exchange. Then, if the expected crops materialize, large amounts of exchange drawn against exports will come into the market, forcing down rates and giving the operator who has previously sold his long bills an excellent chance to cover them profitably as they come due.