Foreign exchange, Drafts or checks play an indispensable role

The institution of foreign exchange has evolved over many centuries to enable people in one country to carry on financial relations with those in other countries. As old barriers to international trade disappear and as new ones develop, the foreign exchange market must adapt itself to the changed conditions. In this chapter we shall see what use the foreign trader makes of foreign exchange.

The domestic trader expects the money market to assist him in two ways: to provide the instruments and the clearing facilities by which money payments may be transferred from buyer to seller; and to provide credit if buyer or seller is unable or unwilling to "carry" the transaction until the goods are sold to the ultimate consumer. The foreign trader calls on the foreign exchange market to perform the same two services, transfer and credit.

The broad, ever-present difference between the functions of these two markets, of course, is to be found in the fact that every foreign exchange transaction involves not only a transfer of funds from one person to another and from one place to another but also from one currency to another. The similarity of the services rendered by the two markets emphasizes the fact that the foreign exchange market is simply a specialized section of the larger money market.

Drafts or checks play an indispensable role in both domestic and foreign trade. In domestic trade the seller may or may not draw a draft on the buyer; but in either case the buyer ultimately generally remits by bank draft or check. In foreign trade the exporter in the United States more usually--but, as we shall see, by no means invariably--draws a draft either in dollars or in foreign currency on the importer abroad, or, in contrast, with domestic practice, under a letter of credit opened by the importer's bank. Here another difference should be observed between domestic and foreign trade practice. In the former the buyer, in paying his bills, will usually draw a check on his own domestic bank account, although cashier's or treasurer's checks issued by a bank are sometimes used. The exporter in the United States, however, is rarely offered the buyer's own check on his local bank, and equally rarely do importers abroad maintain bank accounts in the United States on which drafts acceptable to exporters could be drawn.

In performing a credit function also there are similarities between the domestic money market and the foreign exchange market. The domestic seller will, if he needs cash at once, either sell for cash, give inducements which will encourage buyers to pay within a few days, or discount his customers' domestic trade acceptances. Furthermore, he may borrow against his notes receivable or in exceptional cases against his accounts receivable. In general, the American exporter has the same opportunity to demand cash or to borrow against his dollar or foreign-currency drafts on the buyer abroad. Any failure of the foreign exchange market to provide these facilities is an indication either of its immaturity or of its partial collapse.

Parallelism there is between domestic and foreign exchange and credit, but practices and instruments in foreign trade are sufficiently different to oblige us to give them detailed examination. The exporter and importer must solve certain problems in order to sell goods and receive payment across international boundaries. Since this book does not pretend to be a complete handbook of practical foreign trading some of these problems will be ignored; for example, export sales promotion, shipping procedure, customs formalities.