This section is from the "Practical Banking" book, by Albert S. Bolles.
A bill of exchange is a familiar instrument, for it is one of the oldest used in commerce. It may be defined as an order by a person on another living in a different place, directing him to pay a sum of money to a third person. Worcester's definition of exchange is: " the method of adjusting accounts or paying debts, when the debtor and creditor are distant from each other, by means of an order or draft called a bill of exchange, so as to avoid the transmission of either money or goods." The person who writes the bill is called the drawer, the person to whom it is addressed is called the drawee, and the person who is to receive the money is called the payee. When the drawee has accepted the bill he is called the acceptor. This is done by writing his name and the word "accepted "across the face of the bill, and also the date if the bill is payable after sight. In accepting a bill, the acceptor cannot vary the terms of it; for example, if it be drawn on a person living in New York, and payable there, he cannot accept it payable in Boston. He must follow the direction in the bill.
The phrase "bill of exchange" is often abbreviated and called simply exchange. In newspaper quotations the one word is generally used. Thus "exchange on New Orleans," or "exchange on London," is quoted at a certain figure. The term is somewhat ambiguous, however, sometimes meaning the rate of exchange and sometimes the instrument. But the term is employed in such relations to other words that persons have no difficulty in understanding what is meant.
What is the use of these instruments, and what purpose do they serve? Suppose that Jones, who lives in New York, owes Williams, of St. Louis, $ 10,000. Exchange on New York being almost always at a premium, Jones will either send his certified check on his New York bank for the amount he owes in St. Louis, or he will deposit the money in his New York bank, and take the bank's certificate of deposit for the amount, payable to the order of his debtor, Williams, in St. Louis. Williams will have no difficulty in negotiating this certified check, or the certificate of the New York bank, because, as already stated, New York exchange is almost everywhere acceptable. But if, on the other hand, Williams, of St. Louis, desires to pay $10,000 to Jones, of New York, he will either draw a draft on some party in New York who is indebted to him, and send the draft to Jones, or he will go to his bank in St. Louis and buy, at the current rate, exchange on New York, i. e., the bank's draft on its New York correspondent, payable to the order of Jones. If bills of exchange did not exist, Williams would be obliged to ship the money from St. Louis to New York. This would cost expressage, besides the danger of loss by robbery or other accident, and the loss of interest during the period of transmission.
Many bills are drawn payable at sight, and in certain States these must be paid when presented. In other States, however, the drawees are entitled on sight drafts to three days' grace. To render bills payable at once when presented the words "at sight" are omitted, and the drafts are then payable on demand.
The business of buying and selling exchange is a very large one, especially that of foreign exchange. The buying of exchange comes about in this way. Suppose Williams, of St. Louis, having sold a bill of goods to Jones, of New York, has drawn a bill of exchange on Jones for the amount payable to his (Williams') own order. Williams wants the money at once, perhaps to pay for purchases. He goes to a bank and asks the cashier if he will buy the bill. The cashier looks at it; he knows that the drawee is perfectly good, and that in the event of his failure to pay he can hold the drawer responsible. He buys the bill and pays Williams the money therefor. Transactions of this kind are occurring daily among the banks. Enormous quantities of cotton, wool, breadstuffs, provisions of all kinds and other commodities are bought and paid for by means of bills of exchange. The bank charges the agreed rate of exchange and interest to reimburse itself for the use of the money until the draft or bill can be collected. The bill is then forwarded for collection to the correspondent of the bank in the place where the draft is payable.
It is a very common thing for the western merchant to make advances to the farmer or planter to enable him to grow his crops. He may advance him cash or furnish him with the necessaries of life, usually in either case taking as security a chattel mortgage on his stock and a lien upon the growing crops. Suppose the product to be cotton. When gathered the cotton is shipped to the merchant, who proceeds to sell it for account of the planter, and to reimburse himself for the advances made. When sold the cotton is shipped East, and the transportation company's bill of lading for so many bales is attached to the merchant's draft on the consignee for the value of the cotton; or the merchant may forward the goods to a commission merchant East for sale. He then attaches his draft for the approximate value of the goods, and goes to his local banker and sells his bill of exchange with documents, the latter being endorsed so as to convey the title to the cotton to the owner of the draft.
Merchants in St. Louis, Chicago and the other Western and Southern points are constantly buying merchandise, groceries, dry goods, etc., from merchants in New York and the East. For this merchandise the West and South is indebted to New York and the East. On the other hand, the products of the West and South, cotton, grain, beef, pork, etc., are constantly being shipped North and East.