The principle of domestic or local exchange is precisely the same as that described as underlying the foreign exchange business. In foreign exchange we have to do with a mixture of dollars with sovereigns or other foreign money. In domestic exchange we have dollars at both ends of the line.

Suppose A of New York owes B of Chicago $12,000. He buys a draft (check) on Chicago for this sum and mails it to B. Now this draft will cost him something in addition to its face, but it should not cost more than $12 exchange, for the reason that A can take his $12,000 in bills or gold and express it to Chicago for $12. If $12 were charged the rate of exchange would be 1/10 of one per cent.

But suppose that at the same time C of Chicago has $8,000 to send to D of New York and is trying to buy a draft in Chicago. If C keeps his money or turns it over to B, or to B's bank, or for that matter to any bank, A need not ship more than $4,000, for the balance can be turned over to D in New York, or to D's bank, or to any bank. Now $4,000 can be shipped for $4, so that the rate of exchange on a draft for $12,000, only $4,000 of which need be shipped, should not be more than one-thirtieth of one per cent.

Under normal conditions exchange should be based upon the cost of shipping the balances due rather than the gross amounts due. If Chicago is buying more through New York than New York is buying through Chicago, it will be necessary at regular intervals to ship gold or bills from Chicago to New York to meet the differences, and when this is the trade condition, drafts on New York if purchased in Chicago will be at a premium. Drafts bought in New York on Chicago should be at a discount, but as a matter of fact, they will be at par.

There are, of course, many other things which affect exchanges. Our banking system is such that the condition of the money market is uniform in each banking center, but these centers may differ very largely from each other, and while in Boston the banks might have more money than they could use, the banks of St. Louis or St. Paul might be unable to meet the demand upon them.