Money - Bill Of Exchange
( Originally Published 1909 )
HAVING reviewed the various forms of cash, or money here and now, for which goods and services are habitually exchanged, and for which the money market exchanges money some day or money somewhere else, we proceed to the bill of exchange, a versatile credit instrument which is often all these three forms of money in the course of its career. The complicated relations between the different kinds of money, and their habit of melting into another, are well exemplified when it is stated that the cheque, with which we are supposed to have already dealt, is actually nothing else but a bill of exchange, with which we now propose to deal.
But there is this difference. A cheque is a bill of exchange payable on demand. A bill of exchange, as we shall see, is an order from A to B to pay, a sum either to himself, A, or to a third party, C. When it is payable forthwith it is a cheque and bears a penny stamp ; when it is payable at a futures date it is a bill of exchange and bears a stamp 'ad valorem, varying with the amount of the sum named. It is characteristic of monetary nomenclature, which seems to try to confuse matters by applying illogical and confusing names, that the title "bill of exchange" should be given both to the genus and to one of the species into which it is divided.
Another distinction exists in the eye of the law, from the fact that a cheque, according to its legal definition, must be drawn on a bank, whereas a bill may be drawn on a bank but is more often drawn on a merchant or accepting house, or any debtor who gives his creditor the right to draw on him.
The practice of the marketplace, however, does not always follow the legal definition of the cheque, but applies the word to any bill payable on demand. The element of time is thus the real outstanding quality in the bill of exchange, which separates it from the cheque and justifies my reservation of it to a separate chapter apart from the forms of paper cash.
Logically, the reasons which included cheques under the category of cash would perhaps include the bill of exchange. Goods and services are constantly given in exchange for bills, and a good bill, drawn on an English bank or firm, is convertible into gold. But it has to go through two important processes before it can be so converted. It has to be accepted, and it has either to be discounted or to await maturity.
The bill of exchange is of immemorial antiquity.
" It is probable," says a great authority on its legal aspects, " that a bill of exchange was in its original nothing more than a letter of credit from a merchant in one country to his debtor, a merchant in another, requiring him to pay the debt to a third person, who carried the letter, and happened to be travelling to the place where the debtor resided... It was found that the original bearer might often with advantage transfer it to another, and the assignee was, perhaps, desirous to know, beforehand, whether the party to whom it was addressed, would pay it and sometimes showed it to him for that purpose; his promise to pay was the origin of acceptances."
It is obvious from this theoretical description of the early bill that it, like its modern descendant, was not immediately payable, since otherwise its bearer would most obviously and simply have tested the willingness to pay of the merchant on whom it was drawn, by presenting it for payment.
Acceptance is nothing else than the promise of the party on whom the bill is drawn that he will pay it at due date ; and this acceptance he signifies by writing his name across the face of it. A cheque, in its legal sense, drawn on a bank, does not require acceptance, because its payment constitutes and includes its acceptance ; but a cheque, in the sense of a bill payable on demand, drawn on a firm which is not a bank, is often accepted It is rather astonishing to find the authority just referred to stating that there is no evidence that bills of exchange were in use among the ancients, though he refers to a passage in Cicero's letters which appears, to a lay mind, to establish the fact beyond doubt. Writing to Atticus,
Cicero asks him to consider whether the monetary requirements of his son at Athens can be provided by exchange operations, and it is interesting to see that the Latin phrase is a literal counterpart of the English permutari. But although this passage is not sufficient evidence, from a legal point of view, that such a thing as a bill of exchange was used, it clearly proves the existence of some form of exchange machinery in Rome and Athens; and it is safe to assume that the acute and quick minded Greeks exchanged credits against the goods that they bought and sold between their busy cities.
The precise age of the bill of exchange, however, is a question of merely antiquarian interest. We are now concerned with its meaning and the function that it performs in the monetary machine.
It is legally defined as "an unconditional order in writing addressed by one person to another, signed by the person giving it, requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future time, a certain sum in money to, or to the order of, a specified person, or to bearer."
Thus says the law. But, as we have already seen, a bill of exchange becomes a cheque, in practice and in the eye of the tax-gatherer, when it is payable on demand ; and in the eye of the law likewise when it is payable on demand and drawn on a bank. So that the distinctive part of its actual definition consists in its being payable at a future date. Further, though it may be an order drawn by one party on another in the same street, nevertheless, since trade consists largely in the exchange of goods between persons separated by distance, it is usual to find that bills of exchange are drawn by the merchants or financiers of one centre on those of another. In other words, time is a constant element in the composition of a bill of exchange, and space is a very usual one. When Sancho Panza had his ass stolen by a ruffian whom his master's chivalry had set free from the grip of the law, Don Quixote consoled him with a promise of a bill of exchange (cédula di cambio) for three asses out of five in his stable. As they were then wandering in the Sierra Morena, the elements of time and space were both present. The bill was duly drawn on Don Quixote's niece, and ran as follows :---
Dear niece,—At sight of this, my first bill of ass-colts, give order that three out of the five I left at home' in your custody be delivered to Sancho Panza, my squire ; which three colts I order to be delivered and paid for the like number received of him here in tale ; and this, with his acquittance, shall be your discharge. Done in the heart of the Sierra Morena, the twenty-second of August, this present year--- "
"It is mighty well," said Sancho, "now you have only to sign it."
"It wants no signing," said Don Quixote; "I need only put my cipher to it, which is the same thing, and is sufficient, not only for three, but for three hundred asses."
The draft was thus in many respects irregular; apart from the fact, with which the priest consoled Sancho when he found that he had lost it, that one written in a pocket-book would not be accepted." Nevertheless, this bill drawn, in jest by Cervantes on posterity more than three centuries ago, is a very fair parody of its modern counterpart. Its verbiage, of course, has been left out, the bill of today being generally drawn with business-like brevity ; but it is a definite order to Don Quixote's niece, signed by his cipher, to pay a stated number of ass-colts, to Sancho, against value received from him at the place where the bill is drawn. The fact that this value received is wholly fictitious is not quite without parallel in modern practice. Modern practice, in its insatiable search for means of credit manufacture, has often found it convenient to create bills of exchange out of nothing, drawing them against aspirations or expectations or speculations.
And cases have been known in which an attempt was made to give the "kites," or accommodation paper, so produced, an air of demure respectability by some reference to goods passing, as imaginary as the three asses which Don Quixote states that he has received from Sancho. The original essence of a bill of exchange was that it was a claim for the payment of a debt, based on the moving of saleable produce to the place at which it is expected to find a market. The custom which made it payable at a date subsequent to its arrival, and the arrival of the goods, was presumably arranged in order to give the merchant who received them, and owed the money for them, time to dispose of them and garner the proceeds. But his acceptance of the bill, or acknowledgment that he has to pay the money at its date of maturity, makes it immediately negotiable, or convertible into cash, by the process of discount, which will be explained later. Let us take a concrete example, and simplify it by the elimination of many of the processes through which a modern bill actually passes.
Silas P. Watt, farmer, of Dakota, sells his wheat-crop for £2000 to John Smith, of London, corn-dealer; John Smith sees no reason why he should pay for the wheat before it has been shipped, knowing that a month or two must pass before it has reached him, and been marketed and turned into money in his pocket. Silas P. Watt, on the other hand, sees no reason why, during all this interval, he should have parted with his wheat and should have nothing to show for it; and his banker or trust-manager, who has probably made an advance against it, is even more strongly convinced of the impropriety of such a proceeding. Consequently, thanks to the compromise which commerce has devised to meet this difficulty, Watt in Dakota draws a bill on Smith in London for £2000 payable at sixty days' sight, and is able to give this bill to his bank or trust company to be realized in payment for the loan on his crop. The bank endorses the bill by signing its name on the back of it, and sends it to its agent in Landon, together with documents showing that the wheat has been actually shipped and insured against risks on the way, and on its arrival it is accepted by Smith, who writes his signature across the front of it to show that he acknowledges the indebtedness at the due date, and is given possession of the documents.
It is thereupon, supposing Smith's name to be good and in sound credit, a negotiable instrument which can be discounted, that is, turned into as much ready cash as a promise to pay at a distant date is worth according to the current rate of interest.
For example, if the £2000 bill has still a month to run and the current rate of interest is 6 per cent. per annum, its present value will be decided by simple arithmetic to be £1990.
This is a very simple example of the manner in which the bill of exchange facilitates trade by creating a piece of negotiable paper against a genuine trade transaction. Wheat was not wanted in Dakota, and is always wanted in London, and therefore its transfer from Dakota to London gives it value by putting it into the place in which it will fetch a price. The interval is bridged by the bill, which finances the transaction from its beginning to its end. When the bill falls due, if, as we may suppose for the sake of clearness, it has not been discounted, Watt or his bank (to whom we suppose him to have passed it on) applies through his London agent to Smith for the money, and Smith having in the meantime disposed of the wheat is in a position to give his cheque for the amount; the agent cashes the cheque and places the proceeds to the credit of the bank in London, to be used as it may direct. In actual practice, however, the bank's agent would probably have discounted the bill and so turned it into immediate cash on its arrival, and the bank in Dakota would already have sold drafts on London against it, to customers in America who had payments to make in England.
A bill, such as this one that we have imagined, drawn against the actual shipment of actual produce, and especially of produce of universal demand and immediate consumption, such as wheat, obviously possesses the great advantage of " paying itself," according to the common phrase in Lombard Street. The wheat comes to market and is sold, and cancels the debt created against it.
It thus begins to appear that the bill of exchange is not only' a beautifully simple and efficacious device for financing commerce, but is also an ideal form of investment for bankers and others who are obliged by the nature of their business to keep their resources liquid, that is, readily convertible into cash.
For a genuine bill of the kind described pays itself automatically, as we have seen, at maturity, owing to the necessities of the community, which must have wheat or perish, and a banker who invests his funds by discounting good bills has only to let some of his bills mature without replacing them, in order to replenish his store of cash. Bills drawn against wool, cotton, hides, and other raw materials of the principal industries which are turned into articles of universal consumption are, for practical purposes, equally good; for the goods behind the bill, being certain of a market, and likely, if anything, to rise in value in time of war or political scare, secure the acceptor against the chance of being "locked up," as it is called, with an asset which he cannot realize.
It is this quality, inherent in a genuine bill, which gave rise to the saying that banking is the easiest possible business to conduct, when once the banker has grasped the difference between a bill of exchange and a mortgage. We have seen that the genuine bill of exchange is easily negotiable before maturity, and on maturity is cash by the sale of the goods on which it is based. A mortgage or loan against real property, houses and land, is by no means readily negotiable, since the two expensive processes of survey and examination of title are involved before it can be transferred, and the security behind it is the most difficult of all to turn into cash, especially at times of political or other disturbance. "You may buy land now as cheap as stinking mackerel," says Falstaff, when he brings news of Hotspur's rebellion.
But, as a matter of practical fact, a very large number of the bills drawn are not of this genuine character, and the use of this admirable and efficient instrument of credit has been so extended, that the distinction between it and a mortgage on real property is nowadays sometimes in favour of the latter, which has at any rate something behind it.
We have seen that the original justification of a bill of exchange arose from its being drawn against produce in the course of being marketed, or being worked up into a state in which it would be more valuable, and that the bill bridged the intermediate period by providing the buyer and seller with an instrument that could be immediately realized. A very short step in advance of this arrangement led the dealers in exchange to create bills at a time of year when no crops were ready to be drawn against, in order to make profits out of the provision of a form of remittance at these periods, and to cover themselves later on when the genuine produce bills began to come forward. Let us once more take a concrete case. In July, Silas Watt may want to make a payment in London for farming machinery ; he has no crop to draw against as yet, but his banker will sell him a draft on London, having made arrangements with Smith, who is now grown from a merchant into an "accepting house," to accept bills drawn by it, for a consideration, against securities instead of produce. When Watt's crop is harvested, and a genuine bill on London is created by its sale, it will restore the American bank's credits in London, which were reduced by the draft that it had provided to pay for Watt's machinery.
When John Smith is described as having grown from a merchant into an accepting house, he is supposed to have passed through a process which has been a fairly common experience. Like many other merchant houses, he has given up the actual handling and selling of merchandise, though retaining the title of merchant, which is highly honoured in the City, and is confining his attention to the profits which he can more easily earn, if his name be good enough, by placing his acceptance at the disposal of borrowers who want to draw on him.
The arrangement that he has made with Watt's banker, and with many other dealers in bills of exchange in other parts of the world, enables them to draw on one another at any time, whether there be produce passing or no, and brings into being the instrument known as a finance bill. By this operation he and they create credit instruments which can be discounted and turned into cash, on the security of their names which are on the bills.
This system of creating bills of exchange, as long as they are created in anticipation of crop movements and other genuine processes by which products are given value by treatment and movement into the place where they are wanted, is quite legitimate, and tends, as will be explained in a later chapter, to steady the fluctuations in exchange, and to check unnecessary shipments of gold backwards and forwards across the hemispheres.
But having discovered that profitable business was to be done by creating bills in anticipation of movements of produce or manufactures, the enterprising spirits of the financial community were naturally impelled to go further, and create bills for the mere purpose of discounting them and so providing themselves with cash. As there was no moving produce in question, they were created against property that would be difficult of realization, such as landed estate, or against securities which might or might not be easy to sell, or merely against the credit of the creators, and all the varieties of bills so produced differ more or less essentially from the ideal form of bill of exchange, which, as we saw, paid itself on maturity by being drawn against actual movements of produce of general and rapid consumption. The dangers involved by the abuse of the ease with which bills can be created are increased by the great difficulty of detecting from the appearance of a bill whether there be real produce behind it, or some other form of security, or nothing but the credit of the parties.
Experts in credit, with a mass of collateral evidence at the back of their heads, may be able to hazard a shrewd guess from the appearance of a bill, as to what is behind it. But the phrase "Value received " covers a multitude of mystery, and the difference between a genuine produce bill and a piece of finance paper is often difficult to detect.
Finance bills being based on securities which are less readily realizable, especially in times of apprehension and uncertainty, than genuine produce of general demand, are obviously more likely to land their acceptors in difficulty if they have been accepting too many of them. And it is thus easy to understand why, when there is any strain on credit, Lombard Street sometimes begins to talk seriously about the number of finance bills that are passing.
Another class of bill that becomes unpopular when the market for credit is in a nervous state is the "house bill," that is, the bill drawn by a firm or company on itself., If, for example, John Smith establishes his brother Robert in Oporto to finance the port wine trade, and the Oporto Smith draws bills extensively on Smith in London, being merely an oversea branch of the same firm, the bills so drawn will not be as good as if they were drawn by one firm on another which is wholly distinct, and so carried behind them the credit and resources of two establishments. If this paper became too common, the watch-dogs of the credit organization would remark that there was too much Smith on Smith about, and would describe it, in its picturesque phrase, as mere " pig on pork." The classical example of pig on pork is the order on Mrs. Micawber which Mr. Micawber gave to David Copperfield in the King's Bench prison.
Mr. Micawber," so David tells the tale, "was waiting for me within the gate, and went up to his room (top story but one) and cried very much. He solemnly conjured me, I remember, to take warning by his fate ; and to observe that if a man had twenty pounds a year for his income, and spent nineteen pounds nineteen shillings and sixpence, he would be happy, but that if he spent twenty pounds one he would be miserable. After which he borrowed a shilling of me for porter, gave me a written order on Mrs. Micawber for the amount, and put away his pocket handkerchief and cheered up."
David would have found some difficulty in inducing anybody to discount that bill, though doubtless Mrs. Micawber would have accepted it with a fine flourish, and with perfect confidence that "something would turn up " before it was presented.
Nevertheless its complete worthlessness has been parallelled before now in the world of ommercial fact, when foreign firms have established branches, consisting of a clerk and an office boy, in England, and drawn bills on them, which have been accepted, of course, by the clerk, who had authority to sign for the firm by procuration, and have then actually been discounted and turned into cash.
Mr. Micawber has thus taken us a step further than Don Quixote. The Don drew a bill on his niece, whom he knew to be able and ready to meet it, in favour of Sancho, against a fictitious delivery by Sancho to him of three ass-colts. Micawber, in a debtors' prison, drew in favour of David on his wife, who was then in process of being sold up.
He doubtless believed, nay was certain, that his paper was as good as gold. So do many others who draw on a branch establishment which possesses nothing but an office table ; and this Micawberish optimism is at the back of a good deal of the exuberant energy which makes trade hum in times of activity. And consequently when trade slackens, and folk begin to consider sceptically concerning the basis of the credit that has been built up during the humming period, there are Sometimes some awkward moments of surprise and disillusionment.
The importance of the bill of exchange thus lies in a merit and a danger attached to it. The merit is the fact that in its genuine form it facilitates trade by creating credits and so supplying cash against, real produce not yet marketed, and is also an ideal form of investment for those whose investments must be liquid, or certain of easy realization. The danger is the ease with which it can be created against securities which may not be readily marketable, or by being drawn on firms by themselves, or by correspondents, in order to provide cash for speculative enterprise.