# The Theory of the Foreign Exchanges/Chapter II

CHAPTER II
analysis of international indebtedness considered as the basis of the foreign exchanges
The first element which we have to consider in discussing the Foreign Exchanges is to be found, as has been already stated, in international indebtedness; the exchanges in question are exchanges of claims or debts, and an inquiry into the origin and nature of these debts will throw considerable light upon the subject.
It is an error often committed to imagine these debts to be incurred simply by the importation of foreign commodities, and to look on the balance of trade as a mere question of import and export, and being the excess of the one over the other. It is necessary to look closer into the transactions between two countries before an idea can be formed of the position of their mutual indebtedness.
It will be discovered to result not so much from the exchange of their respective produce as from the relative totals of all the amounts expended by each upon the other, whether in payment of produce and manufactures, or for the purchase of shares and public securities, or for the settlement of profits, commissions, or tribute of any kind, or for the discharge of the expenses incurred in foreign residence or travel; in fact, from the entire payments (or promises to pay) which pass between the respective countries. The idea of actual borrowing must be lost sight of; it is the liability incurred with which we are now concerned; and this liability is identical in its effect, whatever its origin may be.
Payments which have to be made by one country to another for any purpose whatsoever, have the same effect as payments for direct importations. Thus it is possible that the general indebtedness of two countries to each other may be almost balanced, though the one imports far more commodities from the other than those which is supplies in return. For instance, the excess may amount to three millions sterling; but the nation which, through this class of transactions, has thus become a creditor for the excess of three millions, may spend one million thereof in remittances to such of its body as have taken up their residence in the other country, or have been traveling and spending money abroad: and another million may be sent to the country which has imported the excess, in order to buy up public securities; and supposing this latter country to be a great shipping nation, another million may be due to it for freights. Thus the equilibrium between the two countries would be restored, and there would be no adverse balance on either side; the indebtedness would be equal.
It may not be superfluous to examine some of these international transactions more in detail. As an instance, we may examine the force of foreign loans. Treating the subject, as is at present the case, with a view to the Foreign Exchanges, a foreign loan will tell against the balance, not of the country which receives the loan, but of that which supplies it.
The loan will certainly have ultimately to be repaid; but, at the time when it is contracted, it acts with the same force as an export upon the country which receives it, and with that of an import to the country which gives it. In fact, the borrowing country exports its securities, which are imported by the capitalists who lend. The force of the axiom that, with regard to the balance of trade, to contract a foreign loan is equivalent to an increase of exportation, will subsequently be more fully felt when the correctives of an unfavorable exchange come to be discussed. It will be seen that when the indebtedness of a country becomes excessive and the liability cannot be liquidated either by shipments of bullion or by an increase of exportation, recourse is sometimes had to a loan in order to readjust the balance; the country exports public securities made for the purpose, when it has no other available resources left with which to satisfy its foreign creditors. Russia will furnish an illustration of this position.
Or, again, there may be a nation, rich in capital and very self-dependent, importing little, because it contains within its own limits most of its requirements, but exporting very largely. The tendency of such a country would be to become the creditor of all her neigghbours. How is the balance to be restored? This case is the converse of the one just now considered; the indebtedness under the present hypothesis is not excessive, but under the mark; such a country often restores the equilibrium by becoming the speculative purchaser and importer of loans and stocks and securities of all kinds; her manufactures are repaid by railway debentures, and the sums which other countries expend on the commodities with which she supplies them, she in her turn expends on the Stock Exchanges of foreign capitals. There is no doubt but what the balance of trade is immensely affected at such times, when any great speculative mania for foreign securities springs up. In the same way as the monetary position of a country may be endangered when it imports more foreign produce than the amount of its exportation, so may it be endangered by the undue purchase of foreign stocks, with the sole exception that the latter are often far more adapted for re-exportation than manufactured goods or produce, on which the charges of shipment or re-shipment are infinitely heavier.
It will appear from the foregoing observations that, when the relative indebtedness or the balance of trade between two countries is spoken of, the permanent debts of country to another do not enter into consideration, -at least, not until the term of payment has arrived; the balance of trade depends upon the transactions which have to be settled, not upon those which by common consent are held in abeyance for a long term of years. For instance, there is no doubt that the United States owe an enormous amount to England in the shape of American securities in the hands of English holders; but with the exception of the interest on these securities, this indebtedness, being one which does not require settlement, exercises hardly any influence on that other indebtedness which has been regulating (or rather disarranging) the exchanges between the two countries since the commencement of the year.
These securities are articles of commerce, previously imported by England, and when they were imported, they no doubt acted upon the exchanges equally with the cotton which came from the same quarter; and if they are re-exported to America (which is possible enough), they would again affect the exchanges in the contrary direction, with the same force as is exercised by cotton when it is re-exported to America is the shape of Manchester goods.
Otherwise, involving no immediate claim, they cannot be regarded as a set-off to the debts which we incur to the Americans for cotton and corn. The balance of trade may be entirely against England, though the amount of American securities in English hands should immensely exceed that balance.
The case of the coupons attached to such stock is very different. The interest which they bear is a constant and important feature in national indebtedness. It constitutes an immediate liability incurred by the borrowing country; it is expenditure in favour of a foreign creditor. A country which has large sums of interest pay annually abroad, must import so much less or export so much more. Conversely, a rich country with a tendency to import too much, both of foreign produce and of foreign securities, receives some compensation in the annual collection of interest. It sets off these receipts against its excessive expenditure. It may look upon them as capital coming in against capital going out.
The large sums which England every year in payment of interest from foreign countries, reduces considerably the balance which, notwithstanding our enormous exportation, is almost always against us; the foreign loans negotiated in England increase her indebtedness at the time when they are contracted; but, by the annual revenue subsequently derived from them, her indebtedness is afterwards reduced.
The effect of profits and commissions on the mutual liabilities of nations is much the same as that which we have just described as exercised by interest. Among such profits, we may class the freights earned by the ships of different countries; the country which becomes the carrier for others thereby establishes claims against them with which it can pays its importations from them. The charge for freight acts with the same force as a charge for a commodity actually produced and exported. An exclusively maritime country could discharge its obligations to other countries which supply it with necessaries, simply by becoming their carrier without exporting any produce or manufactures to them in return.
Or, again, a peculiarly favorable position may enable one nation to make others its debtors for various tributes and commissions, and thus to obtain a revenue equivalent to one consisting of interest, of freights, or of the proceeds of exported commodities. A country which, like England, mediates the transactions of many others, and, being the banking and mercantile centre of the world, is able to secure some slight commission or profit upon all the operations which it assists in conducting, derives no inconsiderable revenue from this source. Formerly, when London was the great emporium of goods for foreign markets, and accordingly supplied the greater part of the Continent (which was itself in no direct trade with India or America) with cotton, coffee, sugar, tea, -in fact, with all the produce of the East and West Indies, -the commissions and profits on this mediation must have been very considerable, and have been an important element in the income secured to the nation from foreign sources. However, the tendency of the age, which is constantly bringing the producer and consumer into closer and more direction connexion by eliminating middle men and intermediate profits, is likewise exhibited in the fact that the Transatlantic or Indian producer is brought more and more into immediate connexion with the continental consumer. At present the continental shipowners and merchants make their importations from the producing countries direct, thus emancipating themselves from the London market, though not entirely from the London banking facilities. The interest and commissions which are still paid by almost every country to English capitalist, certainly form a noticeable element in the revenue by which England is enable to discharge her enormous foreign liabilities.
An allusion was cursorily made to the expenditure in traveling or residence abroad. Russia supplies the best illustration of the force of this expenditure. Several millions sterling are annually spent by the rich Russian nobility in traveling or in foreign residence, and the capital which is thus taken from Russia is lost precisely in the same manner as if it had been spent in Russia in importing commodities from abroad. The bills drawn by the traveling princes on their St. Petersburg bankers affect the exchanges precisely with the same force as bills drawn on St. Petersburg for the champagne sent thither from France. The liabilities incurred by foreign travel are peculiarly felt by Russia, in the first instance, because they are of themselves excessive; in the second, because independently of this expenditure, Russia consumes more than she produces.
There are many other international transactions which, in a complete summary of the items from which the so-called balance of trade is formed, might well deserve enumeration: for instance, import duties, or transit dues, and the whole range of Government imposts. But the consideration of the force of these charges belongs to a different field of inquiry to that on which we are now employed. The expense of armaments to distant regions, especially the regular expenditure of ships of war at foreign stations, also form an item in international indebtedness which should not be overlooked.
The preceding analysis of some of the more important elements may suffice to convey a general and intelligible notion of the different points to which attention should be directed, when a judgement as to the relative transactions between two nations, and the balance which they may ultimately present, is to be formed. The first and principle element no doubt is to be found in the comparative imports and exports in the literal sense of the term; but the operation of these transactions is so self-evident and generally understood that it has not been necessary to dilate much upon this portion of the subject. In addition to the consideration of the exports and imports, it has been show to be requisite to measure the further expenditure of nations upon each other - including therein all national extravagance exhibited in the granting of foreign subsidies or loans and in keeping up costly armaments abroad, as well as all individual extravagance, as displayed in excessive foreign travel or residence, or in the speculations on foreign Stock Exchanges. On the other hand, it will be necessary to measure the force of national acquisitiveness in securing tributes, voluntary or involuntary, from other countries: and of individual enterprise in securing to itself, by superiority of position, capital, or activity, the larger share of the advantages of international commerce. To form a correct notion of the relative indebtedness of two given countries is, from the complexity of the facts, a most difficult task; but it is hoped that the principles on which the balance should be struck, and the class of facts which should be especially search for an examined, have become sufficiently plain the general reader in the course of the foregoing observations.