Fluctuations in the Bates of Exchanges are the result of two sets of causes: (1) Those dependent upon the demand and supply of bills; (2) those dependent upon the condition of the currency of the countries.

The following diagram is intended to show the nature of these sets of causes:

It must be borne in mind that the rate of exchange is not dependent upon the indebtedness of the countries concerned. It is the debts which are in the process of being paid which affect the exchanges, but the total indebtedness of either country may not affect the exchanges in any way. Most nations are indebted to England owing to the investment of English capital abroad, and though, as we shall see, the payment of the interest on such investments has an important bearing on the rate of exchange, yet the capital sums do not affect the rates except at the time they are borrowed or repaid.

Turning to the trade conditions upon which depend the demand and supply of foreign bills, abnormal imports tend to turn the exchanges against a country, and abnormal exports tend the reverse way. Take the New York Exchange, for instance. In the autumn of each year we import enormous amounts of wheat and other food-stuffs and cotton from the United States, and therefore the price of bills on London falls in New York, and the rate of exchange is usually unfavourable to this country.

It is not, however, safe to expect that the trade conditions between this country and another will always act upon the rate of exchange with that particular country; it may affect exchange rates in quite a different quarter. Suppose, for instance, we have imported food-stuffs in great quantities from Denmark, and that Denmark has drawn upon London to pay herself for them. Germany may have heavy payments to make to London and may find it convenient to buy these bills from Denmark in order to remit them to London. In this way the effect of such imports from Denmark may be, so far as this country is concerned, simply to steady the rates between London and Berlin, which would otherwise have been in our favour.

Bills on London find such a ready market in most financial centres that it must not be expected that they will be remitted direct from the country which draws them.

Under the second head of trade conditions affecting the rate of exchange we have what are called "invisible exports and imports." This is an expression used to include services rendered by one nation to another which have to be paid for, and which, therefore, exert just the same influence on the exchanges of the country which renders the service as would an export of goods by that country. The freight earned by our carrying fleet is an important item in our exports which does not appear in the Board of Trade Returns, and the amount of which cannot be easily estimated, though, as we own roughly half the mercantile marine of the world, it is by no means inconsiderable.

Brokerage and commission earned in London on business transacted for foreigners is also another important item, and we can perhaps best include under this head the earnings of British capital invested abroad.

Stock Exchange influences on the rates of exchange are divided into two heads: investments and speculations in international stocks, and the issue of foreign loans.

Paragraphs such as the following may often be observed in the daily money article: "Turkish Unified opened weak, but the receipt of heavy buying orders from Paris resulted in the price closing 1/2 up."

The prices of certain "international" stocks which find a ready market on all the chief European "bourses' are telegraphed continually from one financial centre to another, and variations in the prices quoted result in orders to buy or sell being sent from one centre to another. There is always an international account running between the chief investing centres. Parcels of bonds are sent from London to be sold at Wall Street and vice versa, and the payment of the cheques drawn to settle the accounts turn the exchanges one way or the other.

A similar effect results from loans floated in a foreign centre. Most nations who wish to float a loan open a subscription list in London, and the money so borrowed has to be remitted in some shape. Sometimes the proceeds are exported from England in the shape of goods, and so influence the exchanges indirectly through trade channels. War indemnities have a similar effect upon the exchanges. For instance, at the end of the Chino-Japanese war, China paid a large part of the indemnity through London, where it remained a considerable time, part of the amount being remitted by us to Japan in the shape of ships and other manufactured articles, and part remitted by bills upon London.

Money is also borrowed in London for commercial undertakings abroad, and English capital is invested all over the world. Of late years, the reverse of this is happening with respect to the United States, who are acquiring an increasing financial interest in English undertakings, while it is said that the holdings of Englishmen in American railways and other commercial concerns is on the decline. In some quarters fears are expressed that the heavy excess of imports from the United States over our exports to that country is being paid for by a decline in our capital invested there, and that the Americans are buying back their securities which we hold by this export of goods to us. This is nothing more than a surmise, however, and is not a necessary corollary from the facts before us. An import of goods from one country may be, and usually is, paid for by an export of goods or services rendered to some other country with, may be, no apparent trade relations with the first-named.

The third factor in determining the price of bills on the market is classified under the head of banking influences. Chief among these are the bankers' investments in bills as a means of influencing gold movements. Certain financial centres, London, Paris, New York, and Berlin, are known as "gold centres," because a more or less free market for gold exists there, as opposed to those other centres where gold cannot always be obtained for export. In each of these centres great interest is felt in the gold reserves, and every effort is made to attract gold when the state of these reserves is unsatisfactory. London bankers hold very few foreign bills, but Paris and Berlin habitually hold bills on other centres, which can, if necessary, be discounted in the centre where payable, and the proceeds remitted in gold.