If a loan when taken up acts as an export from the borrowing country, the interest due thereon will, when payable, be equal to an import into the country which contracted the liability. These permanent debts do not, it is quite true, affect the relative indebtedness of countries, except when they are to be repaid, but the interest thereon will, of necessity, be a permanent feature and must materially affect the trading capacity of a country borrowing to a large extent abroad, as she must either export so much more or import so much less.

From the above it will be clear that the large totals which appear as representing the imports and exports of mere merchandise between two countries are no index of its indebtedness, of which they only form one item. It is therefore erroneous to imagine that the prices of bills - the rates of exchange - depend upon the imports and exports of merchandise, for they depend upon the balance of indebtedness.

Of late years the operations in what are termed international stocks have played a prominent part in influencing the foreign exchanges. On several occasions certain stocks have been largely bought by a country which would thereby of course increase its indebtedness just as much as if it had imported corn or cotton.

Another item which we must mention as at least temporarily influencing the balance of indebtedness is that class of bills called ' financial paper' These are bills which are not drawn against shipments of goods, but against open credits to be provided for at maturity. The effect of such bills will in the end be nought, for the buying of the ' cover' at maturity will counteract the effect of the sale of the bills; but while such bills are floating about unprovided for the effect will be the same as an export from the drawing and an import to the accepting country.

There are other things, such as spending money in foreign lands, which will influence the rates of exchanges; but we will not follow them any further in detail. We have enumerated the important items and conclude by repeating that all liabilities incurred, whether large or small, have an influence upon the exchanges, and that the course of exchanges depends in the end on the balance of indebtedness. Our example of the triangular trade will have shown our readers that, by ' balance of indebtedness ' we do not mean that existing between two countries only, but that existing between one country and the rest of the world. England, for instance, takes more from America than she exports to America, yet the exchange is almost continually in favour of England, because the balance of America's total indebtedness is rather against her.* The rates of exchanges between two countries, therefore, do not depend so much upon the state of trade between those identical two countries as upon the indebtedness of each of those countries to the whole world. This is a consequence of what is called ' arbitration of exchanges' which is continually at work to bring all exchanges to the same level. If, for instance, bills on Paris are at a premium in London, and bills on Antwerp at a discount, whilst bills on Paris are also at a discount in Antwerp, a London merchant may liquidate his debt at a cheaper rate by purchasing a bill on Antwerp and buying there a bill on Paris, than by buying in London a bill on Paris direct. When three places are used in these operations, they are called 'simple arbitration,' when more than three are used, 'compound arbitration.3

The influences which bear upon the exchanges which we have hitherto explained are those occasioned by the requirements of trade and commercial intercourse, and we have seen that, however manifold and complete they are, all they can bring about is a fluctuation of the exchanges between the two ' specie points,' - a comparatively small difference, and which through the increased facilities of transportation and the greater security of shipments of specie is daily growing still smaller. Much larger and more important are the fluctuations in the rates of exchanges which are brought about not by a commercial but by a political disturbance, by the issue of inconvertible paper money. The Italian, the Austrian, the Russian, and above all the American exchanges during the civil war, have thus undergone most violent fluctuations. But there is a difference between an unfavorable rate brought about through a depreciated paper money and one resulting from an unfavorable balance of indebtedness, and the former may be called nominal, the latter real.

* Of late the American exchange has exhibited a tendency to be more farourable to the United States.

We have already stated that we can calculate the real exchange in such an instance by allowing for the depreciation of the currency as indicated by the rise of the market price of bullion above the Mint price, and when we apply this test we may sometimes find the real exchange in favour of a country while the nominal exchange is largely against it. Thus the nominal exchange between London and Amsterdam fell more than 20 per cent. against England in 1694 on account of the depreciation of her currency, at the same time the real exchange was in her favour.

From the foregoing it will be seen that the further the balance of indebtedness is against a country, in such proportions will the exchanges become unfavorable, until that point is reached at which it is cheaper to purchase and remit bullion. To bullion-producing countries like America and Australia this will be the normal state of the exchanges, but for countries which are not in this position it is clear that the state of things must have become abnormal, when the precious metals are remitted in payment for any length of time.

The fluctuations in foreign exchanges, which we have hitherto been investigating concern more particularly the 'short exchanges,' which are directly influenced by the balance of indebtedness. But it is not always easy to trace the effect of this cause because the exchanges are generally quoted for ' long sight,' and in order to be able to make the necessary allowances we shall now examine the forces which come here into play.