1 see Spalding's Foreign Exchange and Bills (1915). This book is written from the English point of view, but it contains much useful practical information.

A money unit is employed as agreed by the traders

There are three possibilities in making foreign payments

Bullion may be shipped

A process of clearing may be relied upon

Commercial bills of exchange may be employed

Whatever the form of procedure, that is, irrespective of whether debtor or creditor takes the initiative, reliance must be placed upon the mediation of international bankers. They must either buy or sell the necessary bills. It is, of course, apparent that the purchase of commercial bills results in the building-up of balances abroad against which bankers' bills can be sold. The sale of bankers' bills manifestly reduces the balances. These balances can, therefore, be controlled through a proper regulation of bills bought and of bills sold. In so far as purchase and sale offset each other, there is involved simply the balancing of debits and credits implied in clearing.

The necessity of transforming or of translating the money claims arising in international transactions prevents the utilization in that field of the individual check. Were there a common money unit individual checks would not be impossible, but in such a case, as in domestic clearing, some form of international centralization of reserves or of voluntary exchange arrangements would be necessary. Assuming such conditions all that was said concerning these matters in the discussion of domestic clearing would be equally applicable here.

Money claims or orders bought and sold in international transactions are known as "foreign exchange" - sterling, mark, franc, etc., according to the money units in which they are ultimately payable.

In theory the reciprocal obligations between any two countries might be settled either with commercial bills or with bankers' bills, in the "exchange" of the debtor's country or in that of the creditor's. Practice, however, tends to establish a pretty definite procedure.

Or bankers' bills

International bankers are necessary

Individual checks are not serviceable in international transactions

"Foreign exchange"

In theory bankers' or commercial bills may be employed

Where the operations between two countries are direct, that is, where there are direct banking connections between them, but where one is largely a creditor country and the other is largely a debtor country, the initiative both in collecting amounts due and in remitting for debts payable tends to be taken in the debtor country, while the money unit employed tends to be that of the creditor country. The methods employed in the operations between England and the United States illustrate the point. If an American be the creditor he will in the great majority of cases sell a sterling bill. If he be the debtor he will buy a sterling bill. In both cases the initiative is taken in America.

The whys and the wherefores of this form of procedure are not difficult to understand. International loans, like domestic loans, are made in terms of money. The advances are made in the form of balances entered to the credit of bankers in the borrowing countries, and they are availed of through the sale of bills drawn against the credits. Of course the sale of these bills in the debtor country assumes that directly or indirectly payments are to be made for goods received or for services rendered.1 That is another way of saying that to be a creditor in international affairs a country must have a surplus of wealth for lending purposes. As the loans are, however, in terms of money, the individual creditors involved in the transaction and the ultimate sellers of goods on which the credits are based will in general desire to employ the money unit with which they are familiar. Since so large a part of the trade of borrowing nations depends upon credit obtained elsewhere, the preference of creditors and sellers in the lending country in this matter of payment becomes controlling.

In transactions between countries whose mutual dealings are not large, or which are not, on the average, evenly balanced, bills or remittances may be drawn in terms of the money of a third country. This presupposes in each of the two countries concerned a substantial market for the "exchange" involved. The debtor must feel fairly sure of a reasonable purchase price for such exchange, while the creditor must feel a similar assurance about the selling price. Such assurance can in both cases be felt only when the exchange employed is regularly dealt in in each country in sufficient volume to assure relative stability of the day-to-day rates.

Practice fixes the procedure

Explanation of practice

1 The "directly or indirectly" here employed takes into account the possibility of three-cornered exchange.

It is a matter of general knowledge that the English money unit, the pound sterling, has become by far the most commonly employed unit in international transactions. In the United States imports from South America, from Africa, and from the Orient were, until the outbreak of the Great War, paid for almost entirely by means of bills on London. And what was true of the United States was likewise true of other countries. Indeed it is usually stated that the sterling bill constituted the real medium of international exchange.

This widespread use of the sterling bill as an international medium of exchange was due mainly to three factors: (a) The tremendous scope of British commerce; (b) The lending power of England, and (c) The security in gold of the sterling bill. A word or two more concerning each of these factors will contribute to the general purpose of this chapter.

The British Empire grew out of the system of Mercantilism. One of the main objects of this system was the upbuilding and the maintenance of a "favorable balance of trade." England's leadership in the Industrial Revo-lution enabled her in the pursuit of this object to push her trade all over the world, and the control of colonies in both hemispheres made the task all the easier. There were few sections of the world where English commerce and shipping were unknown, and, consequently, there were few traders in the international markets who did not on one occasion or another find it necessary to make payments to England. Hence the universality of English trade coupled with the fact that it formed so large a proportion of all international trade, gave great vogue to the sterling bill as a means of remittance.