Exchange, in Political Economy, is based on the elementary fact that we are ready to give what we do not want for what we do want, or what we want less for what we desire more. Even in very old communities we find a considerable exchange. As soon as the primitive division of labour into agriculturist, weaver, smith, and carpenter was established, there must have followed a mutual exchange of the produce of these callings. But the early exchange was practicable only under very restricted local conditions, for the means of transport and communication were for long not suffi- ciently developed to convey the staple commodities of industry over very great distances. Indeed, until the means of transport and communication were revolutionised by steam and electricity, all articles that have a considerable weight and bulk in proportion to their value were in general consumed at the place where they were produced. The grain was ground at the village mill, and consumed by those who had produced it; the village smith attended to the iron-work, the village carpenter did the same for the carpentry-work. In the village the wool was spun and woven into cloth, which in general was worn by the people of the locality. The village, parish, or district was an economic unit, within which the business of exchange was for the most part confined.
On the other hand, there had existed from very early times an exchange on a wider scale of commodities which possess a high value in proportion to their bulk and weight, and which are not readily perishable. Gold and silver, precious stones, spices, silk, &c. were the objects of a commerce which was carried on between the Mediterranean countries and the distant East. As civilisation with the corresponding industrial development advanced along the Mediterranean, a more varied and active exchange grew up among the peoples near that great highway of early commerce. Later on it found further scope on the seas and rivers of western and north-western Europe, and along various land routes, especially on those between Italy and Germany. The discovery of America and of the sea-way to India opened up an exchange which has now become universal.
The growth of exchange has simply followed the general social and industrial development. Exchange is based on differences of soil and climate, on differences of social development, on the distinction between town and country, on the growth of the division of labour—in fact, on the wide organic development of the great human society over the different areas of the world. It has particularly depended on the improvement of the means of transport and communication, on the construction of roads and canals, on the development of navigation, and, above all, on the development of steam and electricity. The means of transport are now so perfect that heavy and bulky commodities, such as grain and coal, can be profitably carried half-way round the globe. Exchange has become a dominating principle in economics. Production is only to a very slight degree carried on by the producers for the direct supply of their own needs. Under the large system of industry now prevalent, the outlet for the consumption of any article offered by the producers of it themselves is ridiculously inadequate. Production is carried on for exchange, for a market which may be co-extensive with the world; and through the vast and intricate mechanism of that world-market the consumer obtains the supply for his needs.
The growth of a world-wide exchange has naturally led to a corresponding development of what may be called the instruments and institutions of exchange. First of these is the medium of exchange. In primitive communities we find barter, the simplest method of exchange, still extant; even in the English colonies in North America it was common during the 18th century. The exchange of the civilised world is conducted through the medium of a very elaborate currency. The business of exchange in all the miscellaneous articles known to the civilised world is most largely concentrated in the great markets and exchanges, notably those of London, New York, Paris, Berlin, and Vienna.
Exchange, which up to the end of last century at least was hampered by innumerable restrictions and regulations, may now be generally described as free; it is managed by the free competition of buyers and sellers. But there are very important exceptions and modifications which have been indicated in the article COMPETITION.
In exchange the agreement between buyer and seller is reached by a process of bargaining, which has been called the higgling of the market. It is an adjustment of supply and demand, and ultimately of the interests of producers and consumers. The proportion in which things exchange for each other is their Value (q.v.), but this value is generally expressed in money, the medium of exchange, which is their price. But, while the value is expressed in money, exchange itself is always one of commodities against commodities.
It is an evidence of the prominence attained by exchange in the economy of the civilised world that so high an authority as Whately recommended that the science of political economy should be called Catalectics (from Gr. katalassō, 'I exchange'). The effect of such a name would be to confound the fundamentals of a science with one of its salient characteristics. Production is a more important department of economics than exchange, while distribution and consumption are fundamental. The chief end of economics is the satisfaction of human needs, production and exchange being alike subsidiary and subordinate to this.
Such is the general doctrine of political economy regarding exchange; but there are some special applications of the word that require notice. Thus, exchange is specially applied to the conversion of the money of one country into its equivalent in the money of another—as by stating the relation which French francs or German marks bear to pounds sterling. It also refers to the difference between the actual value of money, taken by the standard of bullion, in any two places with relation to each other. If in London it costs more than £100 to pay £100 in St Petersburg, the rate of exchange is against the former town, and in favour of the latter; an inhabitant of which will be able to pay a debt of £100 in London with less than £100 worth of bullion in St Petersburg. The process will be best explained by analysing it through means of simple examples. If Thomson & Co. of London buy £100 worth of wine from De la Rue of Paris, and De la Rue, on the other hand, buys £100 worth of cotton goods from Thomson & Co. of London, the two debts, were there no others between the merchants of the same towns, would extinguish each other, and there would be no necessity either for transmitting money or drawing bills of exchange. Suppose, however, that it is not De la Rue, but his neighbour Bouchamp who has bought the £100 worth of cotton goods from Thomson & Co., then the debts of all will be settled by Bouchamp paying £100 to De la Rue on Thomson & Co.'s account. Suppose, next, the case of De la Rue being due nothing to Thomson and Co., and Bouchamp being due them only £50, a like sum has to be otherwise found. Van Pradt of Amsterdam is due precisely this sum to Thomson & Co., while either De la Rue or Bouchamp is due the same amount to Van Pradt for a purchase of Gouda cheeses; then it is clear that the several debts can be adjusted among them without the transmission of bullion. It will cost some trouble to adjust the payments, however, and this trouble will have to be paid for. As in paying Thomson and Co. their debt of £100 De la Rue will have to pay for this trouble, the rate of exchange will be against him. If the debt, or any part of it, cannot be met by such an adjustment out of cross debts and credits, it will be necessary for the debtor to send bullion to his creditor; and, this being an expensive process, it throws the rate of exchange against the debtor who so pays. For instance, if the sum due by the Frenchmen to Van Pradt was only £25 instead of £50, then De la Rue would have had to be at the expense of sending £25 to London in bullion.
No such actual transactions take place in the existing mercantile world, because the accounts in debtor and creditor connected with the three towns above referred to are to be counted in thousands, and ramify into other towns; but the above examples may be held to represent the groups of debtors and creditors, as algebraic signs represent quantities. The individual merchants in one trading town have no idea how the surplus of debit or credit may lie between them, far less can they tell how it may be adjusted by debits and credits in other towns; but, through the agency of bankers, bill-discounters, and other persons who deal in money, the relations of all trading-places towards each other are in a constant state of shifting and adjustment; and any one who has to pay a debt in any trading-place can find out how much he has to give to get that debt paid, and can pay it accordingly. When, through the operation of these complicated transactions, you require to give more than £100 in London to get that amount paid in Paris, then the rate of exchange is against London, and is in favour of Paris, where less than £100 in cash will pay a debt of £100 in London. The difference will generally depend on the difficulty of adjusting questions of debt and credit throughout the field of European commerce in such a manner as to get the debt paid. If it cannot be paid by adjustment, then bullion must be sent; and thus it is generally said that the rate of exchange against any place is limited by the charge of transmitting bullion to it. The rate of exchange is liable to be brought to a level also by commercial exportation and importation, since, whenever it is expensive to get money sent to a country, goods may be sent to that country to compensate the debt. In the general circle of transactions of this kind, the state or town which has the largest amount of transactions will have the largest number of debtors and of creditors, and will thus afford the chief facility for each compensating the other. For this and other reasons London is the centre of the money-market, where all the debts and credits in the world may be said to meet and extinguish each other (see BILL OF EXCHANGE). While the old notions about the Balance of Trade (q.v.) existed, it was supposed that the nation which the exchange was against was going to ruin, while that which it was in favour of was prospering through the other's loss. Such general statements must be tested by a comprehensive analysis of all the relevant facts. Gold-producing countries find bullion their most advantageous export, and the same is the case with countries into which gold has flowed in excess.