215. Arbitrage Profits

Straight arbitrage between two stock exchanges is a more or less exact operation, much more so than the great amount of arbitraging in bonds which is going on all the time. More difficult to put through, these deals are far more profitable than the shaving off of fractions in stocks. And realizing how big the outside market for American bonds in London has become, many prominent houses have men whose sole business it is to keep in touch with the market for international securities in New York and London and to put through trades between the two markets.

In theory the idea is the same as when bonds come into the Philadelphia market and a Philadelphia house offers them by wire in New York, half a point or a point higher. In actual practice, however, the case is very different, for the number of private wires into most of our big cities is such that there is not much chance for profit. But between New York and London there are comparatively few competitors in the field and cabling is too expensive a luxury to be indulged in freely.

Where the New York house has the right London connections this arbitrage business in bonds is exceedingly profitable. Even on fairly active bonds it is not at all unusual to make over a point net, while on bonds in which there is not a continually quoted market there is the opportunity to take much more. The element of risk, too, can be completely eliminated if the operator wishes, for firm bids and offers for cable reply are to be had in both markets. What is absolutely essential, of course, in business of this kind, is to have a man in charge of it who knows not only the market here but who knows exactly where the right bids and offers are to be found on the other side.

216. Market Influences

These are the three great classes of international security trading. Concerning their effect upon gold movement it is apparent that as foreign speculative stock operations are usually of a temporary nature, and as arbitrage transactions in stocks and bonds are evened up the same day, the first class of dealings is the only one which can exert any permanent influence on foreign exchange and the international money market. There are times, in fact, when the foreign exchange market is governed exclusively by international investment sales or purchases of securities. The trade balance, heavy exports of commodities, and such factors, seem to be completely ignored. What seems to be all-important is the fact that a selling movement is under way. Stocks are being sold and exchange to pay for them must be bad. So the price of exchange goes up.

Such a rise in exchange is by no means necessarily due to stocks or bonds actually sold. Very frequently it is predicated upon what foreign exchange managers and dealers think of the chances of a continuation of the selling movement. Europe may sell 50,000 shares of investment stock here to-day and exchange will have to be found to pay for it. But what really regulates the price of that exchange is what the dealers think of the probability of the selling movement's going on. If they think that Europe's sales of to-day will be followed by continuing sales to-morrow and next week, they figure that exchange will have to be bought all along, and they will be loathe to draw on their balances. It not infrequently happens that bankers have good round balances abroad drawing but very moderate interest, but that it is impossible to buy drafts from them except at continually advancing rates. They figure exchange as rising, and simply decline to draw.

217. International Gold Movements

When the rise has gone to the gold point and gold begins to go out, what the extent of any movement will be, depends very largely upon the extent of bankers' accumulated foreign balances. When the gold export point has once been established during any particular phase of the market, there is no use in bankers holding on to their balances abroad, because the price of exchange cannot rise measurably above the gold point. So that if there is any volume of accumulated exchange, at this stage it begins to come on the market and if there is enough of it, puts an end to the outflow of gold.

What influences great movements of gold perhaps more than anything else is a steady selling or buying of securities by one international market in another. Movements of this kind sometimes go on for weeks and months, are interrupted, and are resumed. It is when stocks and bonds are being bought by us on the foreign markets in quantity that foreign exchange is consistently strong, and when we are selling on a large scale that it is consistently weak. Other influences can be at work, but an actual movement in securities, either way, will always give the exchange market its real trend. And it is for that reason, more and more as the financial relationship between our own and the foreign markets is being developed, that the exchange market is coming to be looked upon as far and away the best tangible indication of what the international movement of securities actually is.