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For Your Delectation . . .

‘The Stock Exchange is a voluntary society. It has upwards of 2,000 members.  It exists for the purpose of buying and selling, to which all its other functions are subordinate.  There is no reason to doubt that as between its own members it administers substantial justice.  The power that it wields extends to expulsion, that is the taking away from the person expelled his occupation in life.  Such a body can hardly be interfered with by Parliament without losing that freedom of self-government which is the very life and soul of the institution.’
 
(From a Commons Select Committee minute of March 1875)

A Defence of the Stock Exchange – published in Fraser’s Magazine, 1876

We, the Stock Exchange, never asked you to buy a bad security. If you thought fit to venture your money, and have lost it, so much the worse for you and for your advisers.’ Put another way: ‘The Stock Exchange is a channel, not a filter. It argues no fault in the construction of an aqueduct that the water it conveys is often dirty.’  And on this theme of what one might call a stringent passivity: ‘We afford you every facility for buying what you want, and for getting what you have bought, and for selling it again if you are tired of it…But our duties, responsibilities, and powers end there.’  ‘The trust confided to the members is but rarely abused’ ‘principals seldom suffer loss by the failure of brokers’

‘A Stock Exchange restricted to investment business [i.e. as opposed to speculation] would be as useful and as popular as a public-house licensed only for ginger-beer.’

‘The process of turning two shillings into half-a-crown, which is all that we profess to do, is not one calculated to arouse a moral, or even an intellectual, enthusiasm, like the work of a statesman, an artist or an author.  But it may nevertheless be necessary as to its purpose, honest as to its method, and satisfactory as to its results.  We cannot all live by writing articles in Fraser.  We cannot all join Ruskin’s Company of St. George.  There must be readers as well as writers, workers as well as thinkers.’

(From "The City of London. Volume 1: A World of Its Own, 1815-1890" by David Kynaston)

 
Some Quotations on Banking:-

From "The Daily Mail Article" by Frederick Straker, Fellow of the Institute

Lecture II  (delivered before the Institute on Wednesday November 25^th 1904).

"Now as to the Baring crisis….. Now let us turn to the figures given in our article and see what effect the Baring crisis had on the Returns of the Bank.  As with all crises, the Baring crisis had been preceded by a period of great inflation and speculation. In the autumn of the year 1890 much uneasiness began to be felt as to the financial position, but no specially weak spots could be pointed out as the cause of the trouble."

From "The Daily Mail Article" by Frederick Straker, Fellow of the Institute

Lecture II  (delivered before the Institute on Wednesday November 25^th 1904)

"Suppose that a man in London buys a motor car in Paris for 25,000 francs.  How will he pay for his car, and how much will it cost him? He will either have to send gold to Paris, or else to find somebody in London who has a draft for sale on Paris for 25,000 francs, which draft he can buy and remit to the motor car manufacturer; or else he must instruct the manufacturer to draw on him.

Supposing that he decides to send gold, how is he to ascertain how many sovereigns, shillings, and pence must be sent to settle his debt of 25,000 francs?  This brings us to the question of what are called Mint pars. In the ordinary course everybody looks at a sovereign as a sovereign – a coin of the realm it is good to have – but you can also look at it in another way, that a sovereign is a piece of metal which contains 7.988 grammes of gold, 11/12ths fine, that is 11/12^ths pure gold and 1/12^th alloy.  Twenty-franc pieces can also be looked at in this manner, as, by the French law, each kilogramme of gold, 9/10^ths fine, is coined into 155 twenty-franc pieces. Now, from these two sets of figures, by a simple calculation, we arrive at the fact that the pure gold in one sovereign is equal to the pure gold in 25.2215 francs.  This is called the Mint par between England and France, and it represents the fixed intrinsic value of the coin of one country expressed in terms of the coin of the other country.

If this man who had bought a motor car decides to send gold to Paris, he will have to send sufficient sovereigns that the gold in them would equal the gold in 25,000 francs; that is, at the Mint par of 25.22, about £991 5s 6d., he would also have to pay for the carriage and insurance of this parcel of coin, and this we can assume to amount to ten centimes per pound, which, on the transaction in question, would amount to £3 18s. 7d.  Altogether, if he sends gold, it will cost him £995 4s.1d., and this you will find is equal to an exchange at the rate of about 25.12 ½.  In other words, for each sovereign which he expends here, he will obtain 25.12 ½ francs in Paris.  The Paris Exchange, therefore, will not, under ordinary circumstances, fall lower than about 25,12, as at that figure gold can be sent to settle any liability, and is as cheap a form of remittance as bills.  This is called the Export Specie point to France, and when the Exchange falls to this rate, we may expect gold to leave us for that centre.

We will now see how the Import Specie point from France is arrived at.  Suppose that a Paris merchant has purchased a parcel of lace from Nottingham, and has to pay the sum of £1,000 for the same to some bank in London.  To pay this in gold, he will have to send a sufficient number of francs that the gold in them shall be equal to the gold in 1,000 sovereigns, that is, at the Mint par of 25.22, he will have to send 25,220 francs.  He will, of course, have to pay for carriage and insurance as well, at the average rate of about 10 centimes per pound, which will equal 100 francs; so that, to send gold from Paris to liquidate a debt of £1,000 in London, it will cost 25,320 francs altogether; and this is equal to a rate of exchange of 25.32.  This is the Import Specie point from France to England, and when the rate reaches this figure, gold should leave Paris for London, as gold is then as cheap a form of remittance as bills.  As a matter of fact gold does not always come to us when the exchange is at 25.32.  The Bank of France interposes difficulties in the way of the export of gold, which have the effect of preventing its coming to us in any large sums, unless the rate rises above this nominal figure.

We see, then, that the Mint par of London with Paris is 25.22, the Import Specie point (gold to us) 25.32 nominal, and the Export Specie point (gold from us) about 25.12.  In a similar way the Mint pars and gold points can be calculated with any foreign centre which has gold as a basis for its currency.

With silver-using countries these points cannot be fixed. Gold is with them a commodity only, and its value is measured in silver prices.  With us and other gold-using countries the reverse is the case as regards silver.  Hence, with silver-using countries, no common measure exists for determining the figures of Mint par etc.

We have not yet, however, explained the reason why rates fluctuate. Let us suppose that, as a result of the aggregate dealings between France and England, France, at one period, owes us more than we owe her.  Now, it will be apparent that in the settlement of these transactions, the merchants in France will find a difficulty in procuring sufficient drafts wherewith to settle their indebtedness, and, consequently, there appears to be a likelihood of some of the merchants there having to send gold to London, and bearing the cost of remittance.  Hence, there will be competition between the French merchants to obtain what bills are offered.  Demand will exceed supply, and, rather than be forced to send gold, buyers of drafts on London will be willing to pay more for them than the face value represented; that is, they will be willing to pay more than the Mint par.  So, supposing that our Paris merchant, who has bought £1,000 of lace in Nottingham, tries to buy a draft for the amount, and expects to pay only 25,220 francs for it, he will find that there are many buyers who are competing for the available drafts, and, to secure a remittance, he perhaps may offer 25,250 francs for his draft; that is, an exchange at the rate of 25.25.  He may obtain what he requires at this price, but if buyers are urgent, sellers will take advantage of the situation, and raise their prices still further; and, if the demand continues, the price will gradually rise to such a level, that it is as cheap to send gold as to buy and remit a bill.

Now, we will suppose the contrary of this first supposition; that is, that England owes more to France than France to us.  Under these circumstances, a buyer in London will find difficulty in procuring his draft on Paris, and if he expects to buy it at the rate of 25.22 francs for each pound, he will find others besides himself competing for the available drafts, and he will be forced to buy at a lower rate of exchange, say, 25.17.  If he cannot obtain his draft at this figure, he will agree to further reductions in the rate, until a point is reached when he will find it as cheap to send gold, and pay the costs of remittance, as to buy a bill.  Thus, although one sovereign is always equal to 25.22 francs, coin for coin, yet the price of bills expressed in these coins will fluctuate within certain limits, according to demand and supply.

Another point that may here be noticed is that the exchanges between various centres always keep nearly on a level, in other words, if the Paris on London rate increases from 25.22 to 25.25, London on Paris rate will move similarly, and so on.  The reason of this is capable of an easy explanation.  If there is any great divergence in the quotation between two centres, foreign bankers and arbitrage dealers will step in to snatch a quick profit, and the demand and supply which they create will tend at once to equalise the rates.  Suppose, as an extreme case, we quoted Paris at 25.20 and Paris quoted us at 25.30, the foreign arbitrage dealer in London, on seeing this quotation, would wire to his Paris correspondent to draw on him for £1,000 and sell the draft; which would realise, at the rate of 25.30, 25,300 francs.  At the same time the arbitrage dealer in London would draw on his Paris friend for 25,300 francs, and sell the draft in London, for which, at the rate of 25.20, he will receive £1,004 nearly.  By these operations, the Paris correspondent will be clear, as he has drawn a draft for £1,000 on London and sold if for 25,300 francs, and a draft has been drawn on him by London for the same number of francs.  The arbitrage dealer in London, however, has received £1,004 for his draft on Paris, and only has to provide £1,000 to meet the draft which has been drawn on him, thus showing a profit of £4. Competition among arbitrage dealers, however, would very promptly eliminate this profit, and bring the two quotations to a level.

There is often a slight difference in rates, however, and in settling any transactions of magnitude, advantage can be taken of this divergence by either drawing on the centre to which the money is owing, or, if it appears advantageous to do so, instructing the creditor in the foreign centre to draw on London.  In order to provide information on this point, the Money Article usually contains a little table of rates ruling in foreign centres, which rates are telegraphed to us daily, and of these we have an example in the second table in the article before you, on page 20.

If you would be good enough to turn to page 19 you will find the following words in the last paragraph: - "On ‘Change Bills on Germany were more offered, etc."  This paragraph refers to the conduct of Foreign Exchange business in London, and we will now briefly consider how such is conducted.  ‘Change is held in London twice a week, on Tuesdays and Fridays – which are called post days, this term being a relic of the past, when the foreign posts only went out twice a week.  The principals of the great foreign banking houses and a few brokers meet in the afternoons on the above-mentioned days at the Royal Exchange.  As a result of the business there effected, and the negotiations entered into, certain rates of exchange are arrived at, which are afterwards published by the brokers.  A table of these rates – called the Course of Exchange – appears in the Money Articles of the Press on Wednesdays and Fridays, together with a note of any alterations which may have occurred since the "last post" or ‘Change day.  Such a table and paragraph you have in the article before you.  Except when otherwise stated, the rates quoted in this table refer to bills having three months to run, that is the rates quoted are the rates for the long exchange.

I daresay that many of you know how the long exchange is calculated, but I will shortly explain it for the enlightenment of those unacquainted with this point.

Suppose our friend in London, who has to pay 25,000 francs for his motor car, instead of buying a sight draft or cheque on Paris, buys a three months’ bill, what should he pay for it?  Of course, if he buys a sight draft or cheque on Paris and remits it, that settles the transaction; but if he remits a three months’ bill, the transaction will not be settled, as the motor car manufacturer in Paris will not actually get his money for three months; therefore the question of interest comes in.  When the three months’ draft arrives in Paris, the receiver will discount it, and credit our friend with the proceeds only.  Therefore, for a three months’ draft, a buyer would only be willing to buy at a less price than for a sight draft; and less by such an amount that the difference would cover the discount of the bill at the foreign market rate ruling at the centre where it will be discounted. When I say that he will pay less for his bill, it is equivalent to saying that he will ask for more francs to be given to him for each sovereign, which means that the rate of exchange must be higher, and higher to such an extent that it will cover the discounting of the bill in Paris, plus expenses.

Thus, the long exchange is composed of the short exchange plus interest at the foreign rate, and also plus a small amount for stamps and contingencies. You must bear in mind that adding interest, etc., to the short rate to obtain the long rate, only holds good when you are referring to rates quoted in foreign currency, such as francs, marks, etc.  When rates are quoted in sterling, or the home currency, you must deduct the allowance for interest, etc.  The thing to bear in mind is that a bill due three months ahead is not worth so much as a bill due at once; consequently, its price will be less, which means that you receive rather more of the foreign currency for your unit – as more francs and centimes for a sovereign; or, that you give less of your money for one unit of the foreign currency – as fewer pence to a rouble.

From this you will notice that as Paris, or any other centre except London, quotes all rates in their particular home currency, at such centres long rates are less than sight rates.

If you will now look at the tables on page 20, you will notice that the Paris "cheque" is quoted as 25.11 ¼, and "three "months" at 25.31 ¼, and then, if you will refer to the third table on page 20, you will see that the market rate ruling in Paris is 2 5/8 per cent., which exactly accounts for the difference in the exchange rates, after allowing a small amount for stamps and contingencies.  So, incidentally, during the explanation of the long exchange, we have ascertained one of the uses of a table of rates for money current in foreign centres, being included in the Money Articles, and of this table you have a shortened example on page 20.

Returning now to the "course of exchange," you will notice that two prices are quoted against each centre.  These quotations are not like the quotations on the Stock Exchange, indicating at what price you can sell and at what price buy.  As regards the long rate, the two prices indicate the rates current for different classes of paper, banking paper or commercial paper.  Bank paper always discounts at a finer rate than commercial paper, and therefore the amount of interest to be added to the short rate to obtain the long rate on bank paper is less than that for commercial paper; and, consequently, the rates for bank paper are less than for commercial paper.  As regards two quotations being given for the short rate, the explanation is somewhat different.  Besides the question of the standing of the parties to a cheque, another element is taken into consideration, and that is that these short rates are taken to include all drafts having up to ten days to run, and a draft which is due in ten days is necessarily not of so much value as a draft due at once, owing to the question of interest.

All the rates quoted in the first table on page 20 indicate the number of foreign coins given for one sovereign with the exception of the rates of Spain, Portugal and Russia. In these cases, the quotation indicates the number of pence given for the Spanish peso, Portuguese milrei, and the Russian rouble respectively.

We quote all rates in London as we are quoted at foreign centres, with the exception of Spain, which quotes London at so many pesetas to a pound, while we quote pence to a peso; Russia which quotes so many roubles to £10, and we pence to a rouble; and New York which quotes London as dollars to a pound, while we quote pence to a dollar, although the latter exchange is as frequently quoted over here as dollars to a pound as pence to a dollar.

We can now follow the quotation in the last paragraph on page 19: - "On ‘Change bills on Germany were more offered," or, in other words, the sellers of bills on Germany were a little more anxious than the buyers, and therefore they were willing to increase the rate; that is, to give more marks and pfennigs for a sovereign than had been the case on the previous post day; and, on referring to the table on page 20, we see that the Berlin rate rose from 20.55 to 20.56. Again quoting from the article: "The rate on France moved further against this country," that is, not so much of the foreign currency was given for our sovereign.  The rate had fallen, and, from the table, we note that it receded from 25.12 ½ to 25.11 ¼. "Spanish and Portuguese "currencies depreciated."  These two rates, as already noted, are quoted in London as pence to the peso and milrei respectively, and as these rates are said to have depreciated, it means that they are cheaper to buy, and, from the table, we notice that they have fallen from 34 5/16 to 34 1/8 , and 42 5/16 to 34¼, respectively. In the Money Article you will often find it stated that the New York Exchange was weak – meaning that the exchange was tending to the export gold point; to the point at which we might lose gold.  When it is spoken of as being "strong," the contrary of this is meant.

You might note the fact that rates quoted by us in foreign currency are cheaper when they rise and dearer when they fall, while rates quoted in the home currency, as pence to a peso, are dearer when they rise and cheaper when they fall, as is the rule with ordinary purchases in this country.

I think we have now examined the question of the foreign exchanges sufficiently to enable anyone with a little thought to understand the various references made to the subject in any ordinary money article.  There is still one point to be considered, however, and that is the connection of the exchanges with our money market and Bank rate.

It is evident to all that if the market rate of discount for first-class paper is higher in London than in Paris, the French banker will earn more interest on his money if he buys London bills than if he buys Paris bills.  When dealing with foreign bills, however, another element besides interest comes into the question, one that is not present with the home article, and that is the question of exchange.  The question of exchange causes such transactions to contain an element of speculation.  For instance suppose the Paris market rate is 3 per cent and the London rate 4 per cent, the cheque exchange standing at 25.22, and the long rate in Paris of bills on London, consequently, standing at 24.97.  Suppose now that a banker in Paris buys a three months’ bill for £100 on London, he would pay for it 2,497 francs. If, when the bill is due, he sells it as a sight draft, and the short exchange remains as before, viz, 25.22, he will receive for it 2,522 francs, showing 25 francs as his interest for the three months on the sum invested; i.e. at the rate of 4 per cent., whereas with a French bill he would only have earned 3 per cent. But supposing that when the bill becomes due he finds the short exchange to be 25.12, when he sells the bill as a sight draft, he will only receive 2,512 francs, that is, his interest will only be 15 francs, or about 2 ½ per cent.  But now suppose, when the bill becomes due, he finds the short rate 25.32, he then obtains 2,532 francs, that is, 35 francs for interest, or a profit of 5½ per cent. Thus we see there is a wide fluctuation in the interest that may be earned on buying a foreign bill.

Consequent on this, when the French exchange is low, and the rate of interest ruling in London is above that ruling in Paris, there is great incentive for a French banker to invest in English bills.  Not only is the rate of interest which he will earn on his money greater than if he employed it at home, but the chances are in favour of a rise taking place in the rate of exchange before the maturity of the bills he buys, which will be to his advantage.  If the rate is low at which he buys, it cannot fall much, as it will not go below the export gold point, but it may rise considerably and yield him a handsome profit.  From this it follows that when our rates of interest are above those ruling in foreign centres, and the exchanges on us are low, a heavy investment demand sets in, on the part of Continental bankers, in order to take advantage, not only of the higher interest obtainable in London, but also of a possible profit on the rates of exchange.  This demand will not only have the effect of stopping a fall in exchange rates, but will even send them in the opposite direction.  If, through some cause or other, the exchanges remain low, in spite of this investment buying from the Continent, the Continental holders of our bills will keep them until they become due, and so earn the higher interest, but if the rates rise to any extent, certain holders will at once begin to sell, as they will have earned the interest for the time for which they have held the bills, and they see their way to secure a certain profit on the exchange.

We can now appreciate the value and importance of this investment business.  When our interest is high and the exchanges low, it indicates that we are having more or less of a money squeeze at home, and the low exchanges threaten gold exports, which will make matters worse.  The Continental banker then steps in for his own profit, and benefits us at the same time, as, by his action, he tends to support or raise the exchange, and thus to stop the outflow, or threatened outflow, of gold; and he also places some of his capital at our disposal.  As regards this latter point, Continental bankers, when investing in foreign paper, usually only buy first-class bills, and as there is only a limited amount of first-class London paper for sale on the Continent, they adopt the course of instructing their London representative to buy all they require, and they remit funds to cover the purchase.

When exchange rates are rising, and point to a possible inflow of fold to London, Continental bankers realise their holdings of bills, thus stopping the rise in exchange rates, and putting an end, for the time, to any possible inflow of gold.

Thus, investment business in bills really acts as a pendulum to the foreign exchanges, steadying the fluctuations and having a most important influence on the export and import of gold.  We can now understand how it is that a change in our Bank rate is so closely allied with the question of the foreign exchanges.  Supposing that the principal exchanges are unfavourable or low, and the rate for interest ruling in London is about the same as that ruling on the Continent, there is not much incentive to the Continental bankers to embark in this investment business.  If, then, we find that an export of gold threatens, which may reduce our Reserve below the figure at which it is desired to maintain it, the Bank of England will increase its official rate, and, if duly followed by the market, or if the market lags behind, steps be taken to compel it to follow suit, we hold out to the Continental bankers the advantage of an increased interest over that which they can earn at home, and a prospective profit from a possible rise in the exchange; and their purchases of London bills will then gradually have the effect of raising rates, and stopping the outflow of gold.

In the article before you, you will find three references to the question of gold. Nearly at the end of the first paragraph it is noted that Paris was a strong buyer of all the gold which came to our market, thus preventing it from passing into the hands of the Bank of England.  The French dealers offered more per ounce to the bullion dealers than was obtainable at the Bank of England, and, therefore, the gold was sold to them.  If the demand for gold falls off, dealers know what they can always obtain £3 17s 9d. per ounce for any quantity at the Bank of England, and, at such times, the Bank gets all the gold on offer.  We have already noted the second reference to gold, which is that £403,000 in German gold coin was sold for export, and this in spite of the Berlin rate not being down to the Export Specie point.

You will often see a notice in the money market articles that the Bank of England has "bought so much gold," and the question is frequently raised "How can the Bank of England "buy gold, and what do they give for it?  How are they better "off if they give gold for gold?"  The matter may appear a simple one to most of you, but I know that a difficulty ahs arisen in connection with this point in several minds.

The customary procedure of dealing with an import of gold is for the importer to hand the gold directly, or through an agent, to the Banking Department of the Bank of England.  The Banking Department credit the importer, or the agent, for the value of gold sent in, and pass the gold on to the Issue Department in exchange for notes.  Thus, after such an operation, the next weekly Return of the Banking Department should show an increase in "Other Deposits" – due to a customer having been credited for the gold; and, on the other side of the account, an increase in the notes held, i.e. an increase in the Reserve.  The figures of the Issue Department would also be increased on the debit side by further notes outstanding, and more gold in hand on the credit side.

The third reference to gold you will find on page 21, in which the output of New South Wales for the month of June is given.  The production of gold at the various mining centres of the world is always carefully noted in the Money Articles, as the fact of increase or decreased production of the metal is of great consequence to the international money markets.  Of this we have had a recent instance, owing to the stoppage and curtailment of supplies from South Africa, due to the late war, and to this stoppage the present position of stringency is, in part, assigned.

During the whole of the late summer and early autumn, you will doubtless have noticed that practically all the gold received in London from the productive centres was taken for abroad; and, in addition, various sums were drawn from the Bank of England for export; gradually depleting our Reserve, and threatening to deplete it still more.  Each export of gold was reflected in the Money Market by a hardening of discount rates; and when, in the early part of this month, gold began to be drawn from us for America, the market quite made up its mind that we were to have a 5 per cent Bank rate, and discount rates for three months’ bills were run up to 4¼ - although the existing official rate was only 4 per cent.  However, the Bank of England appear to have had early intimation that the demands for gold were not likely to be on a large scale, and, to the surprise of many people they maintained the rate at 4 per cent only.

If you will take the trouble to watch the movements and price of gold during a period of stringency, such as we have had this autumn, you will be surprised to see how these movements and prices are reflected in our rates of discount for first-class bills."