The Bankers' Costs of Foreign Exchange

The Bankers' Costs of Foreign Exchange

Banks, by their nature, seek the greatest profit under a given set of circumstances. Expenses of a transaction bear an inverse relationship to profits. If all other variables remain the same, a reduction of expenses will increase a bank's profits.

Interest on money is always a consideration.

Interest Cost, and the Sequence of Title

... "In actual business there is usually from one to three days loss of interest [on an export of gold]. For example, if a steamer sails Saturday at 10 a.m., the gold must be taken out and paid for on a Friday, while the bill of exchange is sold under contract for Saturday's steamer and paid for on that day. Now if this latter transaction is settled for in gold [original emphasis], there would be a loss in interest of one day; but according to custom the bill of exchange is paid for by a draft on some Clearing House institution, which must be presented for payment through the Clearing House on Monday; so actually you would get payment for the bill of exchange in gold three days after you made payment for the shipment. On the other hand, should the steamer sail at 4 o'clock in the afternoon and dock on the other side before 10 a.m. there would be time to clear the transaction during banking hours, both here and abroad, which would cause no loss of interest. We always take into consideration the actual conditions at the time shipment is made." ...

Foreign Exchange, Albert C. Whitaker 
D. Appleton and Co., New York and London, 1919, Pg. 527 
quoting a letter by Mr. G. E. Gregory, National City Bank.

Gold export [original italics] against a sale of demand drafts involves no interest cost [to the exporting banker] if incidental circumstances are the most favorable possible, because the return from the sale of drafts may be had on the same day with the outlay for gold. But, as already explained, more frequently from one to three days elapse between the payment for the gold and the receipt of money for the drafts. The true interest charge depends simply on the actual loss of time experienced.

Ibid., Pg 536.

The above quotation and following discussion provides additional detail regarding the actual financial mechanics of an export engagement.

[Discussing the transaction from a London banker's perspective] In New York, when a consignment of gold is sent out, the American shipper can at once recoup himself by selling his bill [in New York, drawn] on London [Emphasis supplied.], but with shipments from London to New York, the banker is unable to do this, since bills in sufficient quantity drawn on America cannot be obtained on the London market; consequently, we have to wait for the return remittance from America before we are in funds again, hence the extra charge of 3 per mille for loss of interest.

Foreign Exchange and Foreign Bills, 3rd Ed. 
William F. Spalding 
Sir Isaac Pitman & Sons, Ltd., Bath, 1919, Page 35.

To minimize its interest expense, the exporting bank would withdraw gold from the Assay Office (or Sub Treasury, in the case of coin) at the last possible moment at which time it makes payment to the US Government and begins to accrue interest expense on its cash outlay. Rather than buying gold, the bank's cash could have been earning interest elsewhere and it is this loss of interest that becomes an expense of the exporting banker's gold transaction. The exporting bank then delivers its purchased gold to the steamship pier for transport. Once delivery is made to the steamship company, the exporting bank sells its foreign currency denominated drafts (demand drafts) locally for dollars, thereby receiving payment for its gold, recouping at that time the funds that it had expended for the gold, with profit; its interest expense, then, ceases. The drafts are sold, for example, to local businesses such as importers who have to make payment to foreign companies in a foreign currency. The importing banker creates the foreign currency account in its city and funds this account with the agreed amount of foreign currency for its purchase of and payment for the gold. This is the account against which the exporting bank's drafts are drawn. Often, the drafts sold by the exporting bank actually accompany the gold shipment. As a result, the terms of the transaction appear to be FOB alongside ship, and the exporting bank has concluded its transaction with the foreign purchasing bank upon delivery of the gold to the steamship company. Title to the gold, then, upon delivery to the pier and acceptance, would presumably pass to the purchaser. See also: What happened to the Cecilie's gold?

Other Costs

How to Figure a Gold Export Transaction. - The way, then, [for the banker] to figure the gold export point at any given time is (1) to find the cost of the gold (plus the Assay Office charge), (2) to add thereto the charges for packing, carting, freight and insurance, and loss of interest, (3) to figure how many pounds sterling in London that amount of bar gold will produce at the current rate, (4) to find the rate of exchange at which the new balance must be sold to produce as many dollars (plus the desired profit) as were originally expended in New York. 
Where gold coin instead of gold bars is being exported, the procedure is the same except that the cost of the gold in New York will not be figured at so-and-so-much per ounce but at $10 per eagle or $20 per double eagle. Here is where the item of "abrasion" comes in. If new coin can be secured, it is very nearly as satisfactory to ship as bars. But in the case of gold which has been in circulation and is not full weight, a higher rate will have to be secured for the drafts drawn against the shipment than in the case of bars. Coin, it must be remembered, whether it is new or old, is bought on this side at face value, and credited on the other side according to weight. Consequently, if the coins have been in circulation for some time and have lost something of their weight, the shipper on this side is paying for something he doesn't get. The only way he can get it back is by obtaining a higher rate of exchange on the drafts he sells against the gold.¹

Certain expenses have to be calculated in any gold shipment, and although some may be small, the sum total has to be considered in arriving at a specie point between London and New York. Freights, Insurance, Interest, Packing and Commission are the chief items to be considered. … Insurance depends on the amount of gold to be shipped. If the shipment is considered to be already sufficient for one boat, the insurance rates will be higher pro rata for any additional amount.²

If a shipment of gold becomes necessary, the banker usually engineers it. He may consider that he cannot safely deplete any further the balance of his foreign account, but this will not prevent him from selling more of his drafts to the importers who want them. He has special facilities for the shipment of gold and charges the importers at about or slightly higher than the export specie point for the drafts. The expense of shipping gold is, as already indicated, one which varies from time to time, but the nature of the expense will remain fairly constant. Freight and Insurance are two obvious expenses in connexion [sic] with the shipment; packing charges and an allowance for loss in weight below the Mint standard in the case of shipment of coin, are also invariable parts of the cost. If any interest is lost it will be charged for, and this will depend on the time which clapses [sic] between the banker making payment for the gold and receiving payment for the drafts he sells against it; as both transactions take place in the same country, the delay can only be a very short one.³

The costs [for gold shipments] include first the amount that must be paid for the gold itself. At the United States sub-treasuries [assay offices?] gold can be purchased at $1 for each 1.67182 grammes .900 fine, plus a charge of 4 cents per $100 to cover refining, etc. The costs include next packing charges, insurance and freight. The later items are subject to constant change. Reference is usually made in this connection also to loss of interest on the gold while in transit. Such a loss may or may not directly appear. It does not directly appear when, as soon as the bullion is engaged for export, bills are sold against the credits to be established by the bullion when it arrives. Oftentimes bills based on bullion shipments move on the same steamers which carry the metal itself. The banker who thus immediately gets his money back does not himself lose any interest. But obviously somebody loses interest on gold in the hold of a ship, and as a matter of fact it tends to be shifted to the general market through the competitive determination of the different classes of rates. In calculating the profitableness of exporting gold the banker must finally take into account the "buying price" for gold "to arrive" in the market to which it is consigned. The mint price is fixed in gold standard countries but it takes time to assay gold and to coin it. Ordinarily immediate credit is wanted for gold sent, and the price that can be obtained for gold in immediately available funds tends thus to fluctuate slightly below the fixed mint price. The difference between the buying price and the mint price is small, but on large shipments the total sum involved may be considerable. Thus the mint price of gold at the English mint is £3, sh. 17, d. 10 ½ per ounce. The Bank of England is required, however, to exchange its notes, and in practice will also give deposit credits, for gold at the rate of £3, sh. 17, d. 9 per ounce. The actual buying price in the English market normally fluctuates between these two levels. In the end, therefore, what the banker has to figure out, is whether at a given buying price for gold in the foreign country, the rate that can be obtained for exchange on such country is high enough to make it profitable for him to go to the trouble and expense of obtaining and sending the gold required.

Bankers Alone Interested In Gold Shipments - Gold shipments are practically never undertaken by private individuals. Long before it would pay the layman to arrange gold shipments of his own the international banker, doing business on a large scale, finds it profitable to arrange gold shipments and to buy or sell exchange against them as circumstances dictate. In other words the gold points for the banker are well within what they would be for private business men. Indeed, the business is conducted on such a small margin of profit that in the New York market not more than nine or ten of the big foreign exchange bankers themselves ever undertake to handle gold shipments.⁴