Differences in discount rates indicate differences in value of money funds

Any change in the discount rate that is intended really to influence the foreign exchange rates must be "effective." That is to say, the rate proposed must be controlling in the market. If anywhere in the market present money-funds are available at rates below the proposed rate, purchasers or borrowers of funds will go to the seller asking the lower price. But when an enlargement of the supply of the domestic funds is possible only on the basis of the higher rate, then it may be said that the value of such funds has been effectively enhanced.

Instead of thinly veiled interference with gold exports, and of the burdensome enhancement of the value of domestic funds, it is possible to employ a serviceable substitute. A supply of foreign credits may be kept on hand against which bills can be sold whenever the exchange rate advances to the gold export point.

Such a supply of foreign credits is for international exchange purposes quite as effective as gold at home available for export. As already indicated, gold shipments are made by international bankers for one purpose only -the establishment of credits in terms of the money of the country to which the gold is sent. Hence, if the agency in ultimate control of the gold reserves is enabled to maintain balances in foreign countries, bills drawn against such balances may be thrown on the market to increase the supply of exchange when the rate reaches the gold export point. With a proper management of the reserves at home there is no objection to counting such foreign balances as a part of the domestic reserves, since redemption at home in normal times is incidental to the need of gold for export purposes. If this need can be met in some other way the home reserve demand is correspondingly diminished. Moreover, such foreign credits may in times of emergency be augmented by special loans, and changing necessities may be taken care of through arbitrage operations. The administration of such credits involves some delicate questions, but they have no bearing upon the fundamental principle and may be waived here. Assuming such difficulties to be properly handled, the fact remains, as demonstrated by the experience of some of the central banks of the continent, that foreign credits are at times very effective substitutes for gold reserves at home.

Change in discount rate must be effective

Foreign credits may be serviceable

Foreign credits as good as gold for exchange purposes

1 "It is the foreign exchanges that regulate the outflow or influx of gold, and foreign exchanges can only be regulated by the value of money." - Sir Felix Schuster, the Governor of the Union of London, and Smith's Bank, in Publications of National Monetary Commission, Vol. 1, p. 51. "The whole essence of it is to increase the cost to the man who wants to take the gold up to the point when he has to say: 'I must do something else.'" - Mr. Charles Gow of the London Joint Stock Bank in Publications of National Monetary Commission, Vol. 1, p. 90.

There are times, however, when power to restrict gold exports is not of itself adequate. Under certain exigencies, as for example when more gold is needed to sustain confidence at home, it becomes necessary actually to import gold. Experience has demonstrated that gold imports may be stimulated in several ways.

The simplest way of getting gold is of course to go in the world market and buy it outright at whatever price in domestic funds may be necessary to obtain it. Assuming, as before, the gold standard in a country, the mint price of gold cannot of course be changed, but in view of the disproportionate strengthening of bank reserves by the positive addition of gold - just as there is a disproportionate weakening through the actual withdrawal of gold - it is possible and may be profitable to offer a price in bank funds beyond the price that is fixed by the coinage law, or at least beyond the price which, all things considered, is held to represent the par in the money market. In normal times gold is regularly auctioned each Monday in London. The mint price for gold is £3 17s. 101/2d. per ounce. The Bank of England is required to give its notes, however, at the rate of £3 17s. 9d. per ounce. The difference is supposed to be an offset for the waiting that would be necessary if the owner of gold desired to have his bullion converted into coin on his own account at the mint. Representatives of foreign banks oftentimes bid higher than the accepted legal rate, and, if the Bank of England wishes to retain the gold, it must outbid the competitors in the market. It will be seen that this method involves, to the extent of the premium, the sacrifice of domestic funds for the benefit of the foreigner, but the strengthening of reserves and the buttressing of confidence at home would, of course, be cheaply bought with such a sacrifice.

Gold imports sometimes needed

Gold may be purchased

Furthermore, some of the means that are normally employed in checking gold exports may be applied with sufficient rigor to stimulate an actual inflow of gold. There may be, for example, a direct loan of gold instead merely of a loan of foreign credits against which bills of exchange may be sold. Or if there be substantial foreign credits these may be directly drawn down in gold, or bills drawn against them may be offered in such volume that the market rate for foreign exchange drops below the gold import point. In like manner the value of domestic funds in the world market may be enhanced to such a degree that those with available resources will desire to profit thereby and will lend such sums as they can command. Such an enhancement might be brought about, as already explained, through the effective increase of the discount rate. Of course, the relative enhancement of the value of domestic funds is involved in the sacrifice of foreign credits on the domestic market, but the consequences are not the same in both instances. Raising the value of funds at home does not imply the same sacrifice that is inevitable in the wholesale dumping of foreign funds. Where the reserve and the credit system are not adequately managed and controlled it "is the dumping" expedient that must be mainly relied upon. In New York, during the panic of 1907, the bottom dropped out of the foreign exchange market. So great was the demand for funds at home that foreign bills were almost unsalable at any price.