Besides the power of influencing gold movements which foreign bills possess, they afford a good investment to the banker, especially if the rate of interest rules higher in the centre upon which they are drawn than in the banker's own town. A banker can make a profit by buying "long" bills, keeping them till maturity, and then selling them at the "short" rate, or if the rate of interest in the foreign centre should fall in the meanwhile, he may make a quicker profit by selling them at once.

An illustration may make this somewhat clearer. As we saw previously, the difference between the long and the short rates is dependent upon the market rate of discount in the country upon which the bill is drawn. Supposing the sight rate of Paris on London is 25/25, and the rate of discount in London is 5 per cent., the three months' rate on London will be about 24.92. A Paris banker buys a three months' bill on London for 1,000, which will cost him 24,920 francs. If, at the end of the three months, the sight rate is unaltered, he can sell it for 25,250 francs, leaving 330 francs as his interest on capital invested. But, of course, it is very improbable that the sight rate will' be unaltered; it may be higher or lower, but its ultimate figure is altogether problematical. The interest which the banker will gain if he keeps the bill till maturity is therefore uncertain. But we will suppose that on the day after he buys the bill the market rate of discount in London drops to 4 per cent. The long rate, being dependent on the London discount rate, will rise, and the banker can make an immediate profit by selling the bill.

If the short rate remained the same, the long rate will rise to about 25 '00, but probably the sight rate will fall owing to the sale of bills by those wishing to take their profit. Suppose then sight rate falls to 25.22; this brings the long rate to about 24.97, and the Paris banker can sell his bill at once for 24,970 francs, leaving an immediate profit of 50 francs.

The issue of Circular Notes and Letters of Credit also influences the rate of Exchange. They are chiefly used by travellers, and at certain seasons of the year Englishmen migrate to the continent in crowds, mostly armed with these documents, which are in effect and usually in form, bills upon London. They consequently help to turn the exchanges against this country. The Englishman usually gets a fixed price for them, but to the foreign banker who cashes them the rate of exchange is important, as upon it depends the amount of his profit.

The third of the Banking influences is to be found in arbitrage operations. This is the name given to the transactions of certain bankers and mercantile houses who can draw upon, or be drawn upon, by a foreign house or agent. Profits can be made by buying bills in one centre and selling them in another, if there is sufficient difference in the rates ruling at these centres. It is a form of speculation in differences. There are arbitrage transactions in bills, in bullion, in stocks and shares, but in each case the operations are similar and the profits are made through the differences in price which may exist in various centres.

Take a very simple instance, one which from its very simplicity would never occur, but which will serve to illustrate the meaning of the term arbitrage.

A London merchant, Smith, has an agent in Paris, Duval, upon whom he can draw; possibly he has made arrangements with a Paris house to carry on an arbitrage business and share the profits. The London cheque rate on Paris is 25.25, while the Paris rate on London is 25.30. Smith draws at sight on Duval for 25,250 francs, and sells the draft on 'Change for £1,000. He then wires to Duval to draw upon him in London for £1,000; this Duval does, and sells the draft on the Paris bourse for 25,300 francs. Smith has £1,000 with which to meet the draft for £1,000 drawn upon him by Duval, and therefore the account balances on the London side. But Duval has 25,300 francs to meet a draft for 25,250 francs which Smith has drawn, and therefore makes a profit of 50 francs, less the expenses of stamps and telegrams. This is an extreme instance which would not occur in practice, because, owing to the influence of such transactions, the sight rates between two centres vary but little.

Paris quotes London for cheques at practically the same rate as London quotes Paris at the same time; any divergence is seized upon by the arbitrage operator and the difference quickly disappears. In long rates the reverse of this happens. The long rate quoted in Paris on London, or Berlin on London, is lower than the short rate, while the long rate of London on Paris or Berlin, or any other centre which London quotes in terms of the foreign coinage, is higher than the short rate.

Arbitrage operations become very complex in practice. The constantly varying market rates of discount in the gold centres add to the speculative nature of dealings in long bills, while very often operators in two centres will deal in bills drawn on a third or fourth centre; a Berlin banker, for instance, may find it worth his while to draw on Amsterdam, and remit to Paris in exchange for bills on St. Petersburg bought in Paris and remitted to Berlin.

So far we have discussed those influences which affect the rate of exchange through the demand and supply of bills, but exchange rates are subject to fluctuations which arise through no variations in the number of bills offered for sale or the demand for such bills, but simply from the condition of the currency in either or both of those countries.

A depreciated currency may be due to a debased or worn coinage, or to an over issue of paper; either of these will affect the nominal rate of exchange, because the rate is quoted in terms of the currency which can be legally tendered in payment of a debt, not in terms of the full weight coin, which is probably only a legal fiction and does not circulate. We have had examples of both in the history of our own country. Previous to the silver recoinage of William III.'s reign, when silver was the standard of value in England, the worn state of the silver coins resulted in an extremely adverse rate of exchange, which disappeared directly the new coinage was issued.

As we saw in Chapter IX., the depreciation of the Bank of England notes during the restriction of cash repayments had a similar effect in turning the rate of exchange against the country, There are several existing currencies which are depreciated by an over issue of paper; Spain, Portugal, Argentina and Brazil, among others. Russia's currency was at one time depreciated 50 per cent., and the difficulty was only overcome by legalising the depreciation and changing the rating of the gold Imperial from ten roubles to fifteen roubles. In countries where a depreciated paper currency exists, gold is not found in the ordinary channels of circulation, but can only be obtained by offering a premium in paper money. This is the meaning of the Buenos Ayres quotation in the table of Exchange Rates on London given on p. 188, in which the gold premium is given at 127 per cent.; in other words, 100 gold pesos or "dollars" are equal to 227 paper pesos.

Finally, between countries which use a different • metal as their standard, the rate is subject to the variations in the gold price of silver bullion. India and Japan have now adopted a gold standard, but most of the other Asiatic nations, notably China, still use silver as their standard metal, and the exchange between these countries and London depends not only upon the demand and supply of bills and telegraphic transfers, but also upon the price of silver in the London Market.