Precious Metal and Rate of Exchange Chap. 3.35.2
                                    II. THE RATE OF EXCHANGE

      [The rate of exchange is known to be the barometer for the international movement of money metals. If England has more payments to make to Germany than Germany to England, the price of marks, expressed in sterling, rises in London, and the price of sterling, expressed in marks, falls in Hamburg and Berlin. If this preponderance of England's payment obligations towards Germany is not balanced again, for instance, by a preponderance of purchases by Germany in England, the sterling price of bills of exchange in marks on Germany must rise to the point where it will pay to send metal (gold coin or bullion) from England to Germany in payment of obligations, instead of sending bills of exchange. This is the typical course of events.

     If this export of precious metal assumes a larger scope and lasts for a longer period, then the English bank reserve is affected, and the English money-market, particularly the Bank of England, must take protective measures. These consist mainly, as we have already seen, in raising the interest rate. When the drain on gold is considerable, the money-market as a rule becomes tight, that is, the demand for loan capital in the form of money significantly exceeds the supply and the higher interest rate follows quite naturally from this; the discount rate fixed by the Bank of England corresponds to this situation and asserts itself on the market. However there are cases when the drain on bullion is due to other than ordinary combinations of business transactions (for instance, loans to foreign states, investment of capital in foreign countries, etc.), and the London money-market as such does not justify an effective rise in the interest rate; the Bank of England must then first "make money scarce," as the phrase goes, through heavy loans in the "open market" and thus artificially create a situation which justifies, or renders necessary, a rise in the interest rate; such a manoeuvre becomes more difficult from year to year. — F.E.]

     How this raising of the interest rate affects the rates of exchange is shown by the following testimony before the Committee of the Lower House concerning bank legislation in 1857 (quoted as B. A. or B. C. 1857).

      John Stuart Mill: "2176. When there is a state of
      commercial difficulty there is always ... a considerable
      fall in the price of securities ... foreigners send
      over to buy railway shares in this country, or English
      holders of foreign railway shares sell their foreign
      railway shares abroad ... there is so much transfer of
      bullion prevented." — "2182. A large and rich class
      of bankers and dealers in securities, through
      whom the equalisation of the rate of interest and the
      equalisation of commercial pressure between
      different countries usually takes place ... are always
      on the look out to buy securities which are likely to
      rise.... The place for them to buy securities will be
      the country which is sending bullion away." — "2184.
      These investments of capital took place to a very
      considerable extent in 1847, to a sufficient extent to
      have relieved the drain considerably."
     J. G. Hubbard, ex-Governor, and a Director of the Bank of England since 1838:

      "2545. There are great quantities of European securities
      ... which have a European currency in all the different
      money-markets, and those bonds, as soon as their value
      is reduced by 1 or 2 per cent in one market, are
      immediately purchased for transmission to those
      markets where their value is still unimpaired." — "2565.
      Are not foreign countries considerably in debt
      to the merchants of this country? — Very largely." —
      "2566. Therefore, the cashment of those debts might be
      sufficient to account for a very large accumulation of
      capital in this country? — In 1847, the ultimate
      restoration of our position was effected by our
      striking off so many millions previously due by
      America, and so many millions due by Russia to this country."

[At the same time, England owed these same countries "so and so many millions" for grain and also did not fail to "draw a line" through the greater portion of these millions via the bankruptcy of the English debtors. See the report on Bank Acts, 1857, Chapter XXX above. — F.E.]

      "2572. In 1847, the exchange between this country
      and St. Petersburg was very high. When the Government
      Letter came out authorising the Bank to issue
      irrespectively of the limitation of £14,000,000
      [above and beyond the gold reserve — F.E.], the
      stipulation was that the rate of discount should be
      8%. At that moment, with the then rate of discount,
      it was a profitable operation to order gold to be
      shipped from St. Petersburg to London and on its
      arrival to lend it at 8% up to the maturity of the three
      months' bills drawn against the purchase of gold." —
      "2573. In all bullion operations there are many points
      to be taken into consideration; there is the rate of
      exchange and the rate of interest, which is available
      for the investment during the period of the maturity
      of the bill [drawn against it — F.E.]."