In commerce the term exchange is generally used to designate that species of mercantile transactions by which the debts of individuals residing at a distance from their creditors are canceled without the transmission of money. Among cities or countries having any considerable intercourse together, the debts mutually due by each other approach,for the most part, near to an equality.

There are at all times, for example, a number of persons in New York indebted to London, and perhaps, as many persons in London indebted to New York. Hence when A of New York wishes to make a payment to B of London, he does not send the actual money, but he goes into the market and buys a bill of exchange on London; that is, he goes to a New York bank, doing a foreign business, such as Brown Bros,or J.Pierpont Morgan & Co. and buys a draft, called a bill of exchange, which is in reality the New York banker's order on his London correspondent,asking the latter to pay the money to the person named.

It may be that about the same time some London merchant who owes money in New York goes to the very same London banker and buys a draft on the New York bank. In this way the one draft cancels the other, and when there is a difference at the end of a week or month the actual gold is sent across to balance the account.

Inland or domestic bills are commonly called drafts. Foreign bills, that is bills on foreign countries, are called exchange.

The par of the currency of any two countries means, among merchants, the equivalency of a certain amount of the currency of the one in the currency of the other, supposing the currencies of both to be of the precise weight and purity fixed by their respective mints. Thus, according to the mint regulations of Great Britain and France, £l sterling is equal to 25.2 francs, which is said to be the par between London and Paris. And the exchange between the two countries is said to be at par when bills are bought and sold at this rate; that, is for example, when a bill for £100 drawn in London is worth 2520 francs in Paris, and conversely. When £l in London buys more than 25.2 fr.,exchange is said to be in favor of London.

The par of exchange between Great Britain and the United States is 4.86 2-3, that is, £l sterling is worth $4.86 2-3.

Exchange is quoted daily in New York and other city papers at 4.87, or 4.871/2,etc.,for sight bills and at a slightly lower rate for sixty-day bills. These are the two common kinds of bills usually bought. The sixty-day bills bought in New York are as good as cash when they reach London, but they are cashed at a discount from their face value, unless they are held until the date of maturity.

The foregoing statements explain in a general way the meaning of the par of exchange,but its exact determination,or the ascertaining of the precise equivalency of a certain amount of the currency of one country in the currency of another, is exceedingly difficult. If the standard of one be gold and that of another silver, the par must necessarily vary with every variation in the relative values of these metals. The value of the precious metals even in contiguous countries, is always exposed to fluctuations from the over-issue or withdrawal of paper,from circumstances affecting the balance of payments. Gold is usually high when there is a demand for gold or a scarcity of it, just as it is in the case of potatoes or wheat. It is obvious, therefore, that it is all but impossible to say, by merely looking at the mint regulations of any two or more countries, and the prices of bullion in each, what is the par of exchange between them.

The imports and exports of bullion are the real test of exchange. If bullion is stationary, neither flowing into nor out of a country, its exchanges may be truly said to be at par;and, on the other hand, if the bullion is being exported from a country, it is proof that the exchange is against it, and conversely if there be large importations.

Variations in the actual course of exchange, or in the price of bills, arising from circumstances affecting the currency of two countries trading together, are nominal only: such as are real grow out of circumstances affecting their trade. When each buys of the other commodities of precisely the same value, their debits and credits will be equal, and the real exchange will be at par. This condition of affairs very rarely happens.

The cost of conveying bullion from one country to another forms the limit within which the rise and fall of the real exchange between them must be confined. If a New York merchant owes a debt in London and exchange costs him, say 2 per cent, and the cost of shipping the gold is only 1 per cent, it will be to his advantage to pay the debt by sending the actual coin across, so that the limit within which trade fluctuations may range corresponds to the actual cost of making remittances in cash.

Fluctuations in the nominal exchange, that is, in the value of currencies of countries trading together, have no real effect on foreign trade. When the currency is depreciated, the premium which the exporter of commodities derives from the sale of the bill drawn on his correspondent abroad is only equivalent to the increase in the price of the goods exported, occasioned by this depreciation.

A favorable real exchange operates as a duty on exportation, and as a bounty on importation. It is to the interest of merchants or bankers who deal in foreign bills to buy them where they can get them the cheapest, and to sell them where they are the dearest. For this reason it might often be an advantage for a New York merchant to buy a bill on London to pay a debt in Paris, or to buy a bill on Paris to pay a debt in Berlin. For instance, in the trade between England and Italy the bills drawn on England amount almost invariably to a greater sum than those drawn on Italy. The bill-merchants, however, by buying up the excess of the Italian bills on London, and selling them in France and other countries indebted to England, prevent the real exchange from ever becoming very much depressed.

Changes in Exchange Rates. Exchange is not affected so much by the balance of trade as by the balance of indebtedness. Europe can contract debts in America by the purchase of stocks, bonds, or other securities as readily as by the purchase of wheat, cotton, or oil, the rate of foreign exchange being similarly affected no matter what is bought. European owners of American securities when sending them to America obtain the right to draw against the American receivers of those securities.

One hundred shares of stock sent by a London firm to a New York firm will make as much exchange against New York as the same value in wheat shipped by a New York firm to a Liverpool account;so that the balance of trade, so far as imports and exports are concerned, may appear favorable and yet no balance of indebtedness appear. The movement of merchandise is recorded while the movement of securities is not recorded. The sum total of our securities in European hands is unknown, but it probably exceeds our national debt.

The rate of foreign exchange, affected by trade movements and by the movements of securities, is also affected by interest and dividend payments and by remittances for freight on importations of merchandise, the owners of vessels usually being foreigners. Our large cities send annually to Europe drafts for hundreds of thousands of dollars to cover interest on city bonds.

Foreign exchange is affected too, by the difference which exists at any time between the American and European market rate of interest. If money can be loaned at 10 per cent in New York while only 3 per cent can be obtained in London, there is an advantage in keeping or sending money there, the difference in interest being greater than the cost of transportation. The fact of the United States being a gold producing country is also important, for it indicates that a small annual export of gold is to be expected.

There is another factor which has a noticeable effect, namely that of travel. Thousands of wealthy Americans travel abroad every summer and the letters of credit which they carry, if not counterbalanced by some other cause, require gold shipments to meet them. Ordinarily when the market rate of demand exceeds 4.867 it is evident that foreign goods have been imported too freely, or American goods are not wanted abroad, or American securities find a better market here than in Europe, or rates of interest here are too low to attract or keep foreign money, or foreigners are short of money, or there are a great number of Americans abroad, or we have produced a surplus of gold, or freight remittances are large, or interest payments on securities owned abroad are heavy. And when the market rate is below 4.867, the reverse is true.

Of course there are other causes, and important ones too, but those named are the principal causes of changes in rates under normal trade conditions. Eastern capital is extensively used in the West, because the people of the West can make a profit by its use in excess of the interest and dividends sent to its owners. For the very same reason, European capital is extensively used in the United States.