Before taking up the mechanism of foreign exchange it may be well to examine briefly the sources of supply and demand which give rise to foreign bills. Basically the supply of and demand for foreign exchange is due to our trade with foreign countries. For the fiscal year ending June 30, 1913, the total exports of the United States to other countries amounted to $2,400,000,000 and our total imports for the same period amounted to $1,800,000,000. It is evident that a vast amount of foreign exchange must arise from the direct export and import of this enormous volume of merchandise. Without the service of the foreign exchange banker in effecting transfers of credit, much of this "balance of trade' between the United States and other countries would have to be settled by the shipment of gold.

In addition to the visible trade in merchandise, there is a large "invisible" foreign trade consisting of the exchange of evidences of debts, which has an important influence upon the movement and the price of foreign exchange. This invisible trade consists largely of international dealings in securities and in private and bankers' investments. European investors are large buyers of American stocks and bonds, payment for which gives rise to sterling exchange in precisely the same way as the export of cotton or grain. On the other hand, American investors have in recent years been buying extensively of foreign bonds. Then, again, there come times when European holders of American securities wish to dispose of them and we are required to buy back large amounts of our stocks and bonds. These transactions in securities give rise to a strong demand for exchange.

The making of international loans by bankers and of private investments in other countries are other classes of the invisible foreign trade that cause the drawing of large amounts of foreign exchange bills. Loans are constantly being made by bankers in one country to bankers and financial houses in another. If at a particular season the rates for money are higher in New York than in London, a London banker may cable his New York correspondent to draw upon him at 60 or 90 days' sight for 20.000 and to invest the proceeds realized from the sale of the draft in good commercial paper. In 1906 large sums of English and French capital were thus loaned in this country and in 1909 " American borrowings in London and Paris footed up to at least half a billion dollars."1 On the other hand, in 1897, when business was dull in the United States and active in Europe, American bankers attracted by the higher interest rates in Berlin and Paris allowed their European balances to increase, thus virtually lending to European centers. In this connection the use of the "finance bill" may be briefly noted. When money rates become decidedly higher in New York, for example, than in London or Paris, New York bankers arrange with bankers in those markets to allow them to draw bills at 60 or 90 days. These bills are sold and the proceeds loaned on the local market at the high rates. Before the drafts fall due some arrangement must be made, of course, to reimburse the foreign drawee. The arranging of these international loans creates large amounts of foreign exchange.

Many millions of dollars have been invested by foreigners in American mines, farms, timber lands, railroads and other enterprises, and Americans are beginning to invest capital in Mexico, South America, Canada and other countries. Exchange is affected not only by the drawing of exchange to meet these investments, but also by the necessity of remitting periodically the interest and dividends on the investments.

Other items which enter into the invisible trade causing a demand for foreign exchange are the disbursements of American travelers in Europe. It has been estimated that American tourists spend between $100,000,000 and $200,-000,000 a year in foreign lands. Then the expenditures of wealthy Americans living abroad for a part of the year, or permanently, call for many millions more. These expenditures must be met eventually by remittances of exchange from this side. This demand is offset in part by the supply of sterling exchange brought by foreign tourists to this country.

Still another important source of demand for foreign exchange is the freight paid to foreign ship-owners for carrying our enormous foreign trade, the greater part of our shipping being handled by foreign vessels. Our freight bill probably amounts to $150,000,000 a year, which must be remitted in exchange to foreign companies. So, too, the payment of insurance premiums to foreign concerns makes a steady demand for exchange.

1 Escher: Elements of Foreign Exchange, p. 12.

Summarizing the foregoing analysis, it may be stated that the principal sources of the supply of foreign exchange are exports of merchandise, sales of securities abroad, transfers of foreign banking capital to this side, and the sale of finance bills to European bankers; and that the principal sources of the demand are imports of merchandise, purchases of foreign securities, remittances of dividends and interest on foreign capital invested here, expenditures of tourists, and remittances for freight and insurance. As already noted, the direct export and import of merchandise is the largest factor in the demand for, and the supply of, foreign exchange. For many years the total exports of the United States have exceeded the total imports by many hundreds of millions of dollars, yet this excess does not lead to any marked excess of gold imports over exports of gold, though shipments of gold are made periodically to and from this country for reasons that will be explained later. Our excess of exports over imports is offset largely by such items in the invisible trade as securities owned abroad and the interest and dividend payments on them, freight payments to foreign ship-owners, and tourists' expenses in Europe.