great rush on the part of European holders of American securities to sell them back to us as a means of securing funds required for war purposes. At the same time the usual fall movement of our cotton and other products was checked both by a temporary decline in European demands and by the fear of German raiders. Insurance rates also tremendously increased, so that the gold-exporting point no longer remained at 4.885. So great was the demand for sterling bills as compared with the supply that sterling exchange rose at one time as high as $7.00, though it soon declined to $5.00, a figure still substantially above the previous maximum.

In the autumn of 1915, however, when Great Britain began to buy great quantities of war supplies in the United States the situation was sharply reversed: the supply of bills of exchange outran the demand, and exchange quickly fell to the gold-importing point. For a time Great Britain attempted to maintain the normal method of correcting adverse exchanges by allowing an export of gold, but this had to be checked before long because of the disastrous consequences to the British monetary system.

The balance of payments continued to run so heavily in favor of the United States that sterling declined to 4.48, at which point the British government intervened, checked further depreciation, and restored the rate to about 4.761, where it remained "pegged" until March, 1919. This pegging of the exchanges was accomplished chiefly through sales by the British government of American securities which were taken over from British owners, and by government loans from the United States.

VI. THE POST-WAR DEPRECIATION OF THE

EUROPEAN EXCHANGES

With a view to effecting a gradual restoration of the normal functioning of the international exchanges, the British government, four months after the conclusion of the armistice, abandoned control of exchange rates; and similar action was shortly taken by France, Italy, and other countries. For

reasons to be discussed elsewhere (see p. 270 below), European embargoes on gold shipments were, however, still retained; hence the normal corrective of depreciated exchanges remained inoperative. The results of the international economic maladjustments occasioned by the war were quickly shown in a sharp fall in exchange rates on all these countries.

One reason for the decline may be easily seen by a brief consideration of some of the changes that have occurred in the financial and trade transactions enumerated on page 108 above. As between the United States and England, for instance, interest on British investments has largely ceased because of the return of American securities. On the other hand, we have lent huge sums to Great Britain, so that heavy interest payments were due us instead. British shipping has been reduced by submarine destruction; but American shipbuilding has increased, with the result that the American debt to Great Britain on account of freight charges is now much less than formerly. Tourist travel in England is for the present almost negligible; and finally, the balance of trade is temporarily tremendously in our favor, owing to the necessity for England to import large quantities of raw materials, as well as food-stuffs, until such time as her own industries can be rehabilitated for the purposes of peace. These same general factors hold in exaggerated fashion as between the United States and the Continental belligerents.

An idea of the magnitude of the changes that have occurred may be gained from a consideration of the following figures: Before the war we owed foreign nations about $6,500,000,000, on which the annual interest charges amounted roughly to $300,000,000. During the war we bought back nearly five billions of these securities, and loaned to the Allies about $10,000,000,000 on government account and about $2,000,000,ooo on private account, the interest charges on which amount to about $600,000,000 annually.'

'Another important factor in the post-war depreciation of European exchanges is the irredeemable paper currency of all of the belligerent countries. See pp. 270-73 below.

For a discussion of the economic consequences of the depreciation of the exchanges wrought by the maladjustments of the war, and the remedy that has been suggested, the reader is referred to chapter xxvii below.

QUESTIONS FOR DISCUSSION

1. Enumerate as many sources of international obligations as possible, in addition to those listed on page 108.

2. Why is it that specie alone is acceptable in settling the balance of international obligations?

3. Define parity of exchange; gold points; premium; discount. 4. What data would you require in order to ascertain the parity of exchange between United States and Japanese money?

5. What is the service performed by the banks in connection with settling trading obligations by means of bills of exchange? 6. Show by a concrete illustration how bankers may find it profitable to draw finance bills when exchange is below par. What is the effect of such purchases upon the volume of currency shipments? 7. Describe the process by which each nation is required to settle with actual currency only its net balance with all the rest of the world.

8. What is meant by finance bills? Do they affect exchange rates in the same way as trade bills?

9. What will determine whether the United States has an inflow or outflow of gold in a given week or month?

10. Describe the process by which the international financial equilibrium is maintained.

II. In the light of the exchange mechanism is there any reason to fear an inundation of American markets by cheap foreign goods? 12. In the light of foreign-exchange analysis do you accept the doctrine that an excess of exports gives a "favorable" balance of trade?

13. Under what circumstances would an inflow of gold into a country be particularly advantageous? Under what circumstances would an outflow be disadvantageous? Give concrete illustrations, if possible.

14. One of the leading bankers of this country stated in 1916 that the United States had received a great inflow of gold and that means must be devised to prevent its outflow in the future. Since this banker was engaged in international financial operations, do you

imagine the activities of his bank were, in fact, directed toward impounding this gold supply for the permanent use of America? 15. How does a nation which does not produce gold secure a gold supply?

16. What is the par of exchange between Berlin and Cologne ? Paris and Berne? London and Montreal?

17. Enumerate the chief sources of obligations as between New York and Chicago.

18. What caused sterling, exchange to rise to $7 shortly after the outbreak of the European war? Do you think it was necessary for the European nations to suspend, as a war measure, the normal operation of the exchanges?

19. Indicate the changes that occurred during the war in the international financial relations between the United States and France, and show the effect of each upon French exchange.

20. By what means were the exchanges "pegged" by the European governments?

21. During the war we loaned in the neighborhood of $9,000,000,000 to the Allies. Of what did such loans consist? What was their relation to exchange rates?

22. Why should this war-time control of the foreign exchanges have

been abandoned in March, 1919? What would have been involved in a continuance of the policy of pegging the exchanges? 23. Draw up in parallel columns a statement of the sources of international obligations that now obtain between the United States and Great Britain, and compare them with the statement in the text showing the situation before the war.

24. Look up in the financial pages of the press the present exchange rates between the United States and the principal European countries.

REFERENCES FOR FURTHER READING

Escher, Franklin: Elements of Foreign Exchange, chaps. i, ii, iii, and v.

Johnson, Joseph French: Money and Currency, chap. v.

Phillips, Chester A.: Readings in Money and Banking, chaps. xvii and xviii.

Scott, William A.: Money and Banking, chap. viii, pp. 121–31. Whitaker, Albert C.: Foreign Exchange, chap. v.

Withers, Hartley: Money Changing, chaps. ii, viii, and ix.

CHAPTER IX

THE NATURE AND FUNCTIONS OF CREDIT

With this chapter we pass from a study of the nature and functions of money to a consideration of the part that credit plays in the general economic organization. The great importance of the institution which we loosely call "credit" finds emphasis in such common expressions as: "modern industrial society is a credit society"; "credit is the heart and core of the industrial system"; and "credit is the life-blood of commerce and industry." What is the nature of this striking phenomenon? In what does its great service consist; and why, precisely, does it occupy so prominent a position in the economic system of today? It is the purpose of the present chapter to consider the nature of credit operations, to study the numerous types or classes of credit that exist today, and to indicate in a general way the significance of the institution of credit from the point of view of economic organization. It will be the task of the remainder of the volume to disclose in greater detail the economic functions of credit and to indicate the services that are rendered by the numerous types of financial instruments and institutions which have been developed in order to facilitate credit operations.

I. THE NATURE OF CREDIT

In simple business parlance, credit involves merely getting something now and paying for it later. It is synonymous with borrowing, the essential element in credit operations always being the postponement of payment for something that has been received. It is important to bear in mind that the thing loaned (on credit) may be either commodities or funds. Goods sold on time involve credit; indeed, we usually say that such goods are sold "on credit." a return of goods in kind;

Such goods may be paid for by though under modern conditions