Through the assistance of the British Government, London was able to resume, toward the end of August, 1914, both the accepting and discounting of bills. But a few months later a new cause of difficulty presented itself. Sterling exchange, which throughout the world had ruled far above par for some time after the outbreak of the war, gradually began to decline, at first slowly, then more rapidly, until it was far below the gold export point from London. By August, 1915, sterling exchange in New York had dropped to $4.50, and fluctuated widely over short periods of time. In other words, the base rate from which rates on all time bills are calculated no longer fluctuated within narrow and definite limits between the export and import points. It consequently became an unsatisfactory medium in which to enter into contracts for payment at a future date. This unsatisfactory position of the sterling rate was due to the enormous importations of supplies to Great Britain on account of the war. Toward the end of 1915 arrangements were finally made for financing these purchases largely through the negotiation of loans in the United States; and thereafter the sterling rate was pegged at about $4.76. The establishment of a stationary base in this artificial manner could not, however, give that confidence in sterling which it enjoyed when subject only to slight changes due to normal trade and credit influences.

The European War, it will thus be seen, created conditions favorable to the development of the business of drawing bills of exchange on other markets than London, and in particular on New York, the most important financial center outside the zone of military activities. Fortunately the power to accept bills of exchange had been granted to the national banks by the Federal Reserve Act of 1913, and also to state banks and trust companies in a number of the States. Moreover, after the disturbance occasioned by the outbreak of the war had been overcome, discount rates in New York fell to a level distinctly below that in London. Under these favorable circumstances American bankers entered the foreign exchange field as acceptors and lenders, but whether this business will be retained and enlarged is uncertain. It is advantageous, both to importers and exporters, to have bills drawn on a single central world market, rather than on cities in each of the countries with which they are trading. There has been a broad market everywhere for sterling bills, because not only trade with England but with all countries has been handled by means of bills drawn on London. If a prolonged period of peace is to be anticipated at the close of the present war, the supremacy of the London foreign exchange market will probably continue. On the other hand if national enmities are to be continued and strife is merely transferred from the battlefield to the marketplace, the convenience of a central money market will presumably not be sufficient to warrant the risk in the event of further outbreaks. Moreover, if, unhappily, international trade is to be developed by national organizations, primarily for national objects, rather than for individual profit, it will be necessary for each important country to organize the financial machinery needed for handling its own trade.

A creditor position in the international loan market is of great advantage in periods of financial strain with the possible exception of those occasioned by the outbreak of great wars. The contraction of loans to borrowers entirely dependent on the local banks of a country cannot, as we have already seen, be carried very far without serious disturbances. In the case of foreign loans far more considerable contraction can be carried through without difficulty.A Loans of an international character can be placed elsewhere, both by foreign borrowers and those belonging to the country which is seeking to strengthen its position. Moreover, in the event that positive liquidation becomes necessary, since it is spread over a wide area, it will cause far less disturbance than a much smaller amount of liquidation confined to domestic borrowers.

In the preceding chapter it was noted that advances in the rate of discount were the chief reliance of central banks in safeguarding their reserves from depletion. It will now be evident that this device is by no means equally effective in all countries and circumstances. It is a certain safeguard affording immediate protection only for those money markets which occupy a creditor position in the international loan market. Such is the constant situation of London, Paris, and Amsterdam. Other markets, notably Berlin, occupy sometimes a creditor and at times a debtor position; still other markets, among which may be mentioned Vienna and New York, are normally debtors on balance to the rest of the world.

For London it has been absolutely certain, at all times during the last fifty years or more, that an advance in discount rates if pushed far enough would not only serve to check gold exports, but would also induce gold imports if the rest of the world met its obligations as they matured. Moreover, since the London market was regularly lending in all parts of the world, a large volume of indebtedness in the aggregate could be liquidated without occasioning such a considerable amount of contraction at any one point as to disorganize business and destroy ability to make payments. In these circumstances it has not been necessary for the Bank of England to hold a large reserve 9 of cash in order to give stability and strength to the English credit structure. It has also been a comparatively easy matter to maintain in London a free gold market, and without exciting apprehensions in the business community, even though at times there might be large quantities of gold taken for export.

The foreign short-time loans of the other creditor markets, such as Paris and Amsterdam, have been less widely distributed than those of London, and consequently the possibilities of contraction have been somewhat less. A somewhat larger gold reserve at the Bank of France than at the Bank of England would, therefore, seem to be necessary to give the same degree of strength to the credit structures of the two countries. In fact the reserve of the Bank of France has been many times greater than that of the Bank of England, and no effort has been made to establish a free gold market in Paris. French economic and financial activities would not have subjected the country to danger of depletion of its gold supplies, even if no restraint had been placed on gold movements, but the policy of the Bank of France in this matter has been determined by other considerations, to which attention will be given in a later chapter. It may, however, be observed that in France, and indeed in most other countries, undue importance has been attached to the outflow of gold with a consequent unwillingness to allow time and opportunity for underlying economic forces to bring back exchange rates from the gold export point to a normal position.

For markets in a debtor position in the international loan market it is necessary to possess a large gold reservein order to be able to meet all contingencies. Creditor markets can compel payment. Debtor markets must rely upon the much less certain resource of being able to retain foreign balances and perhaps attract additional funds from other markets. They must possess sufficient funds to meet foreign payments in case foreign balances are withdrawn. The smaller debtor markets are accustomed to rely, to a considerable extent, upon holdings of foreign bills, especially those drawn on London. Such a resource is, however, inadequate for large countries, such as Germany and the United States. The central banks, in such countries, particularly if free gold markets are to be maintained, must accumulate large reserves of gold in normal times and be prepared to supply from these reserves whatever amounts of gold may be needed for export or other purposes in periods of financial strain.