Section 11 of the Indian Coinage Act (iii of 1906) Ceased to Be

legal tender in payment or on account, but provision was made for their acceptance by Government at the ratio of Rs. 15 during a moratorium of twenty-one days. This Ordinance continued till September 9, 1920, when by Act XXXVI of 1920 the sovereign was again made legal tender. During this period gold had no legal status in India.

But that only raises the question: If the sale of reverse councils is efficacious in righting the exchange, why was its effect such a disastrous failure? The Finance Minister answered the point tersely and cogently when he said:—

“If we have failed in narrowing the gap between the market price and the theoretical gold par of the rupee … it is not because we have sold too many reverse councils; it is because we have sold too few. I put it to any member of the commercial community here, and I put it without fear of contradiction, that if our resources had enabled us … to sell straight away 20, 30, or 40 millions of reverse councils, we should probably have had no gap between the market price of the rupee and the theoretical gold price of the rupee at all. One of our difficulties has been, not that we have sold too many reverse councils, but that we have been obliged to sell too few.”³⁴⁶

³⁴⁶ Ibid., p. 1301.

There would have been some force in this argument if the amount of reverse bills sold were “too few.” Not 20, 30, or 40 millions, but 554 millions of reverse councils were sold, besides the large issue of gold internally, and the complete [pg 227] stoppage of council bills, and yet the rupee did not rise above 1s. 4d. sterling, let alone reaching 2s. gold. Why did not the sale of reverse councils suffice to rectify the exchange? This leads us to examine the whole question of the efficacy of this redemption. It is necessary to premise at the outset that redemption may result in mere substitution of one form of currency by another, or it may result in the retirement of currency. In so far as it results in substitution it is of no consequence at all, for substitution of currency is not a shrinkage of currency.³⁴⁷ To the restoration of the value of a currency what is essential is its shrinkage, i.e. its retirement, cancellation. The important question with regard to this mechanism is not to what extent the currency can be redeemed, but to what extent it can be retired. In the prevalent view of this question it seems to be accepted without question that this extent is determined by the magnitude of the gold resources of the Government of India and the Secretary of State. Let us first make it clear how these gold resources are located and distributed. It will be recalled that these gold resources are distributed between (1) the paper-currency reserve, (2) the gold-standard reserve, and (3) the cash balances of the Secretary of State. It has been the habit to speak of these resources as being three “lines of defence” on which the Government can safely rely when an exchange crisis takes place. But are they? They can be, for the purposes of retirement, only if they were all “free” resources; in other words, if they were not appropriated resources. To what extent are they unappropriated? Can the Secretary of State take gold from the paper-currency reserve? He can, but then he must replace it by something else, or must cancel notes to that extent. Can the Secretary of State take gold out of his cash balances? He can, but then he must either borrow to fill his Treasury or draw upon the Government of India [pg 228] if there is anyone to buy his bills, which is tantamount to issuing rupee currency. The gold in the paper-currency reserve and that in the cash balances is of no use at all, for it does not permit of the cancellation of the rupee currency, which is what is wanted in restoring its value when it suffers a fall. It is therefore sheer nonsense to speak of the effectiveness of redemption as being commensurate with the gold resources of the Secretary of State. The matter is important, and an illustration may not be out of place. Suppose A, a holder of rupees, wants to get gold for them. He can go to three counters: (1) that of the controller in charge of cash balances; (2) that of the controller of currency in charge of the paper-currency reserve; or (3) that of the custodian of the gold-standard reserve. If A goes to the first, what is the result? The cash balance is pro tanto reduced. On the assumption that the cash balance is at its minimum, as it should be, the controller must reimburse himself immediately to maintain his solvency by drawing a bill on India and thereby releasing rupees received for gold again in circulation, so that in this case there is no shrinkage of currency. If A goes to the controller of currency, what happens? The controller gives him gold, but on the assumption that the paper-currency account is a separate statutory account he must put the rupees received from A in place of the gold issued from his reserve, so that here again what happens is that the composition of the reserve undergoes a change, but the total paper currency remains the same. It must therefore be borne in mind that to the extent the gold in the paper-currency reserve and the cash balances are operated upon the result is not a retirement of currency. To speak of them as “lines of defences,” as is so often done, is to overlook the fact that these two are not free resources but are appropriated resources.

³⁴⁷ The most notable example is that of American greenbacks. Under the law of 1875 they were by 1879 retired in sufficient numbers to restore parity with gold. But by a counter-law of 1878, 347,000,000 of them have been kept in circulation. As soon as redeemed, they must be reissued; they cannot be retired.

What is, then, the resource left to the Government to retire the rupee currency? Only the gold-standard reserve. That is the only reserve the amount of which is unappropriated for any particular use. It is free cash, and only to that extent is it possible for the Government to restore the rupee currency when a fall in its gold value eventuates, Of course [pg 229] it is important to bear in mind that this is the extent to which it can retire the currency. Not that it will, for it may not, and there is no want of cases in which it has not. Two instances will suffice. During the first period of the Mint closure, 1893–98, it will be recalled how a large number of rupees had accumulated in the hands of the Government, and in the interest of raising the value of the rupee they should have been locked away. Instead the Government of India released that money in circulation in extending railways and other public works, as though the spending of rupees by itself produced an effect different to what would have been produced had they been spent by the public. Similarly irresponsible conduct marked the sale of reverse councils in 1920. To meet these reverse councils the Secretary of State took the gold from the paper-currency reserve. But instead of cancelling notes to the extent of the gold that was taken out of the reserve, the Government took powers under an Act XXI of 1920 to fill the gap by manufacturing securities ad hoc, so that though there was redemption there was no retirement, and so much gold was merely wasted, for it produced no effect on prices or the exchange. This Act, passed in March, 1920, was of temporary duration, and would have obliged the Government to retire the currency by October, 1920, when it was to expire. Rather than do this the Government altered the paper-currency law, not temporarily but permanently (Act XLV of 1920), changing the provisions in such a manner as to require the Government to cancel the currency to the smallest degree possible by retiring their “created securities.” Even this was not done, owing to deficits in the Government Budget.

But even if such indiscretions were not repeated the fact remains that Government cannot effect a greater retirement than is permitted by the gold-standard reserve. If that reserve fails Government has only two resources left: (1) to melt down the rupees and sell them as bullion or gold and to go on further contracting the currency, and so on till its value is restored; or (2) to borrow gold. Both these are evidently costly methods. To sell rupees as [pg 230] bullion is bound to result in loss unless the bullion in the rupee fetched more at the time of sale than what it cost when it was purchased for manufacturing it into bullion. The second process, that of borrowing, cannot be lightly resorted to for the purpose of creating a reserve fund to retire the currency. Indeed, so costly are such methods, and so complete would be the proof they would afford of the instability of the exchange standard if they were resorted to, that Government has never contemplated them as possible lines of defence in an exchange crisis. It seems certain, however, that Government does recognize that the gold-standard reserve by itself cannot suffice for the maintenance of exchange. For we find that from the year 1907–8 dates a complete change in the distribution of Government balances between London and India. Up to that period it was the policy of the Secretary of State to draw only as much as necessary to finance his Home Treasury. After that date the practice was originated of drawing as much as the Government of India could provide, and as the Government of India has been supreme in financial matters it provided large sums for council drawings by increased taxation and budgeting for surpluses. The effect of this was to swell the cash balances of the Secretary of State.³⁴⁸ No official explanation of a satisfactory character has ever been given for this novel way of financing the Home Treasury,³⁴⁹ but we shall not be very far wrong if we say that the object in accumulating these balances is to provide a second gold reserve to supplement the true gold-standard reserve. Whatever strength the Government may derive for the time being from this adventitious resource, it is obvious that it cannot be permanent. Under a more popular control of Government finances the cash balances will have to be kept down to a minimum necessary to work the Treasury, and the gold-standard reserve will be the only reserve on which the Government will have to depend.

³⁴⁸ For figures, see Chap. VII.

³⁴⁹ Cf. Memorandum on India Office Balances, Cd. 6619 of 1913.

The gold-standard reserve is to the rupee what the paper-currency reserve is to the notes. The purport of both is to [pg 231] prevent the respective currencies they support from falling or going to discount. But the treatment accorded by the Government to the rupee and the paper in respect of reserve shows a remarkable degree of contrast. In the case of the paper, as has been previously noted, the reserve is a statutory reserve, and even when the whole basis of Indian paper currency has been changed the provisions as to reserve are none the less strict and cannot be disregarded by the Government without infringing the law. Now, the rupee is nothing but a note printed on silver.³⁵⁰ As such, the provisions as to reserve should be analogous to those governing the paper currency. Strange as it may seem, any regulation is conspicuous by its absence in regard to the gold-standard reserve.³⁵¹ Not only is it not obligatory on the Government to redeem the rupee, but it does not seem that the Government is even bound to maintain the reserve, And that it has maintained such a reserve is no guarantee that it will replace it supposing that the reserve was dissipated.³⁵² Such differences apart, is the gold-standard [pg 232] reserve an adequate reserve? Figures of the magnitude of the gold-standard reserve, as usually given in official publications, are a meaningless array. What is the use of displaying assets without at the same time exhibiting the liabilities? To be able to judge of the adequacy of that reserve we must know what is the total circulation of rupees. When, however, we compare the circulation of the rupees with the reserve, the proportion between the two is not sufficiently large so as to inspire confidence in the stability of the system (see p. 233).

³⁵⁰ “We have virtually relegated our rupee currency to the position of a token currency, and we are now practically in the position of bankers who have issued a certain amount of fiduciary currency (whether paper or metal is immaterial), and to maintain the value of this fiduciary currency we are bound to be in a position to exchange it for gold when presented to meet legitimate trade requirements,” said the Financial Statement for 1903–4, p. 14.

³⁵¹ The Chamberlain Commission said: “There are disadvantages in restricting the freedom of the Government in a crisis, and it is undesirable that the disposition and amount of the reserve should be stereotyped. … We therefore do not regard that the gold-standard reserve should be regulated by statute.”—Report, Sec. 101.

³⁵² In the course of his speech on the Indian Paper Currency (Temporary Amendment) Bill, dated March 17, 1920, the Finance Minister observed: “… from a practical point of view, it is desirable to leave the gold-standard reserve until the paper-currency reserve has been re-transferred, in case … the Secretary of State finds it impossible to keep himself in funds by Councils for his heavy home liabilities. He will then be able to use the gold-standard reserve, and we can credit the gold-standard reserve out here. There is a third point, and I think a conclusive one. When you operate against the paper-currency reserve you have to operate within the paper-currency reserve; when you operate against the gold-standard reserve it disappears; it melts, and we are under no obligation to replace it; whereas we are under a statutory obligation to replace the paper-currency reserve.”—S.L.C.P., Vol. LVIII, p. 1416.

How can a reserve so small as this carry through the process of retirement to any sufficient extent? That it will not always do it the crisis of 1920 gives abundant proof. But the supporters of the exchange standard maintain that the smallness of the reserve is a matter of no consequence, for the reserve is kept only for the purpose of foreign remittances. That being the case, it is said the reserve need not be large. Granting that it is so, what must govern the magnitude of the reserve in order that it may prove adequate in any and every case? The only attempt made to enunciate a rule of guidance is that by Prof. Keynes. That rule he finds³⁵³ in the possible variations in the balance of trade of India. Now, does this make the problem of regulating the reserve more definite? As has been explained previously, the adverse balance of trade would be due to the depreciation of the currency, so that Mr. Keynes’s statement amounts to this, that the reserve should vary with the depth of the depreciation. But how is a Government to do this? Only by adverting to the movement of the price level. But in all its currency management the Government of India never pays any attention to the price problem. Indeed, as was pointed out above, its conception of the underlying causes of the fall of exchange is totally at variance with the only true conception, nothing but a firm grasp of which can enable it to avert a crisis. Being ignorant of the true conception it blindly goes on issuing currency until there occurs what is called an adverse balance of trade. All it aims at is to maintain a gold reserve, and so long as it has that reserve it [pg 233]

³⁵³ Op. cit., pp. 166–7.

TABLE XLIX

Distribution of the Gold-standard Reserve and its Proportion to Rupee Circulation (in Thousands of Pounds Sterling)

─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── In England. In India. Percentage ─────────────────────────────────────────────────────────────────────────────────────────────────────────────── of Purchase Cash Temporary Gold Total. Coined Outstanding Temporary Gold. Total. Volume Reserve March value at Loan deposited Rupees Debt Loan Total of to 31 of Short to at in from to Reserve, Rs. Rs. in Sterling Notice. the the India. Treasury Treasury England in in each Securities. Home Bank Balances. Balances. and Circulation Circulation Year. Treasury. of India. in (£ England. Crores. = Rs 15)³⁵⁴ ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14) ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1901 — — — — — — 1,831 — 1,200 3,031 3,031 143 3·1 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1902 3,454 — — — 3,454 — — — - — 3,454 138 3·7 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1903 3,810 — — — 3,810 — 1 — — 1 3,811 136 3·4 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1904 6,377 — — — 6,377 — 167 — — 167 6,544 144 6·8 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1905 8,377 — — — 8,377 — 152 — — 152 8,529 152 8·4 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1906 12,165 — — — 12,165 — 287 — — 287 12,452 164 10·7 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1907 12,519 — — — 12,519 4,000 301 — 22 4,323 16,842 178 10·6 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1908 13,187 — 1,131 — 14,318 4,000 — — — 4,000 18,318 191 11·2 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1909 7,414 — 470 — 7,884 10,587 — — — 10,587 18,471 187 7·1 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1910 13,219 3,011 — — 16,230 2,534 — — — 2,534 18,764 186 13·8 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1911 15,849 1,477 — — 17,326 1,934 — — — 1,934 19,260 184 14·8 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1912 16,748 1,074 — — 17,822 1,934 — — — 1,934 19,956 182 14·9 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1913 15,946 1,006 — 1,620 18,572 4,000 35 — — 4,035 22,607 191 14·8 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1914 17,165 25 — 4,320 21,510 4,000 22 — — 4,022 25,532 187 17·2 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1915 12,149 8 — 1,250 13,407 — 70 7,000 5,238 13,308 25,715 204 18·9 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1916 16,219 5,792 — — 22,011 — 1 4,000 239 4,240 26,251 212 15·7 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1917 25,406 6,001 — — 31,407 — — — 103 103 31,510 227 20·8 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1918 28,453 6,000 — — 34,453 — — — — — 34,453 219 23·5 ─────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────── 1919 29,729 6,016 — — 35,7245 — — — — — 35,745 228 23·5 ───────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────────

³⁵⁴ In striking the proportion the rupee portion of the reserve has been omitted.

But is a gold reserve such an important thing for the maintenance of the value of a currency? All supporters of the exchange standard must be said to be believers in that theory. But the view cannot stand a moment’s criticism. To look upon a gold reserve as an efficient cause why all kinds of money remain at par with gold is a gross fallacy.³⁵⁵ To take such a view is to invert the causal order. It is not the gold reserve which maintains the value of the circulating medium, but it is the limitation on its volume which not only suffices to maintain its own value, but also makes possible the accumulation and retention of whatever gold reserve there is in the country. Remove the limit on the volume of currency, and not only will it fail to maintain its value, but will prevent the accumulation of any gold reserve whatever. So little indeed is the importance of a gold reserve to the cause of the preservation of the value of currency that provided there is a rigid limit on its issue the gold reserve may be entirely done away with without impairing in the least the value of the currency. The Chamberlain Commission recommended that the Government of India should accumulate a reserve to maintain the value of the rupee because it was by means of their reserves that European banks maintained the value of their currencies. Nothing can be a greater perversion of the truth. What the European banks did was just the opposite of what the Commission recommended. Whenever their gold tended to disappear they reduced their currencies not only [pg 235] relatively but absolutely. It was by limitation of their currencies that they protected the value of the currencies and also their gold reserves.

³⁵⁵ Cf. in this connection the brilliant paper by F. A. Fetter, “The Gold Reserve: its Function and its Maintenance,” in the Political Science Quarterly, 1896, Vol. XI, No. 2.

The existence of a reserve, therefore, cannot lend any strength to the gold-exchange standard. On the other hand, if we inquire into the genesis of the reserve, its existence is an enormous source of weakness to that standard. For how does the Government obtain its gold-standard reserve? Does it increase its reserve in the same way as the banks do, by reducing their issues? Quite the contrary. So peculiar is the constitution of the Indian gold-standard reserve that in it the assets, i.e. the reserve, and the liabilities, i.e. the rupee, are dangerously concomitant. In other words, the reserve cannot increase without an increase in the rupee currency. This ominous situation arises from the fact that the reserve is built out of the profits of rupee coinage. That being its origin, it is obvious that the fund can grow only as a consequence of increased rupee coinage. What profit the rupee coinage yields depends upon how great is the difference between the cost price of the rupee and its exchange value. Barring the minting charges, which are more or less fixed, the most important factor in the situation is the price of silver. Whether there shall be any profit to be credited to the reserve depends upon the price paid for the silver to be manufactured into rupees.³⁵⁶

³⁵⁶ See footnote³⁵⁷, page 236.

Not only is the reserve an evil by the nature of its origin, but having regard to its documentary character the reserve cannot be said to be absolutely dependable in a time of crisis. There is no doubt that the intention of the Government in investing the reserve is to promote its increase by adding to it the interest accruing from the securities in which it is invested. The critics of the Government want a large and at the same time a metallic reserve. But they do not realize that having regard to the origin of the reserve the two demands are incompatible. If the reserve needs to be large then it must be invested. Indeed, if the reserve had not been invested it would have remained distressingly [pg 236] meagre.³⁵⁸ But is there no danger in a reserve of this kind? [pg 237]

³⁵⁷ In answer to Mr. M. L. Reddi Garu, the following statement was laid on the table:—

Statement showing the average cost of silver purchased by the—³⁵⁹

────────────────────────────────────────────────────────────────── Year. Royal Mint India Office Financial Average Cost for Average Cost for Year. Standard Ounce. Standard Ounce. d. d. ────────────────────────────────────────────────────────────────── 1893 36 5/16 No purchase 1893–94 1894 29¼ No purchase 1894–95 1895 30⅜ No purchase 1895–96 1896 30 5/16 No purchase 1896–97 1897 27⅞ No purchase 1897–98 1898 27¼ No purchase 1898–99 1899 27½ 28 1899–1900 1900 28¼ 29 1900–01 1901 27 15/16 No purchase 1901–02 1902 24 5/16 22·80 1902–03 1903 23 11/16 27·19 1903–04 1904 26½ 27·14 1904–05 1905 27 7/16 29·74 1905–06 1906 31 1/16 31·59 1906–07 1907 30 9/16 31·27 1907–08 1908 24 7/16 No purchase 1908–09 1909 23 11/16 No purchase 1909–10 1910 24⅞ No purchase 1910–11 1911 24 13/16 No purchase 1911–12 1912 27 15/16 28·71 1912–13 1913 28 1/16 28·71 1913–14 1914 24 15/16 No purchase 1914–15 1915 24¼ 33·96 1915–16 1916 30⅝ 33·96 1916–17 1917 39 15/16 42·78 1917–18 1918 47 15/16 48·20 1918–19 1919 49⅝ 52·04 1919–20 1920 50⅞ Silver purchased 1920–21 at special rates from the Baldwin mines and the Perth mint. ──────────────────────────────────────────────────────────────────

In the absence of information whether the price is F.O.B. or C.I.F. it is difficult to say that the Secretary of State has had to pay higher prices for silver than were paid by the Master of the Royal Mint.

³⁵⁸ From 1900–1 to 1920–21 the profits on coinage credited to the gold-standard reserve amounted to £28,573,606 only: while during the same period Interest and Discount gave £13,306,847 or nearly one-half the profits on coinage. Cf. East India: Accounts and Estimates, 1921–22, Cmd, 1517 of 1921, p. 20.

³⁵⁹ Legislative Assembly Debates, Vol. II, No. 3, September, 10 1921, p. 181.

The source of a danger in a reserve such as this was well pointed out by Jevons when he said:³⁶⁰

³⁶⁰ Money, p. 227.

“… good government funds and good bills can always be sold at some price so that a banking firm with a strong reserve of this kind might always maintain their solvency. But the remedy might be worse for the community than the disease, and the forced sale of the reserve might create such a disturbance in the money market as would do more harm than the suspension of payment. …”

In the same manner, who can say that all the increase of reserve from interest will not be wiped out by a slump in the value of the securities if put upon the market for conversion into gold at a time when there takes place an exchange crisis? Supposing, however, the full value of the securities is realized, the number of rupees the reserve will “sink” when occasion for redemption arrives depends upon what is the price at which the rupees are bought back. If the fall of the rupee is small, it may help to retire a large volume of currency and thus restore its value. On the other hand, if the fall is great, it will suffice to retire only a small part of the currency and may fail to restore its value as it did in 1920, so that what may appear to be a big reserve may turn out to be very inadequate. But, apart from considerations of the relative magnitude of the reserve that can be built up, the point that seems to have been entirely overlooked is that the process of building up the reserves directly involves the process of augmenting the currency. The Chamberlain Commission was cognizant of the fact that the gold-standard reserve could not be built up except by coining rupees. Indeed, it cautioned those desirous of a gold currency to remember that if gold took the place of “new rupees which it would be necessary otherwise to mint, the effect is to diminish the strength of the gold-standard reserve by the amount of the profit which would have been made from new coinage.”³⁶¹ Rather than recommend a policy which “would bring to an end the natural growth of the gold-standard reserve,” the Committee permitted the Government to coin rupees. But is there no [pg 238] danger involved in such a reserve? What is the use of a reserve which creates the very evil which it is supposed afterwards to mitigate? Indeed, those who have been agitating for an increase in the Indian gold-standard reserve cannot be said to have been alive to the dangers involved in the existence of such a reserve. The smaller the gold-standard reserve the better it would be, for there would be no inflation, no fall in the purchasing power of the rupee, and no necessity for its retirement.

³⁶¹ Report, par. 63.

Having regard to its origin, the gold-standard reserve, instead of acting as a brake upon reckless issue of rupee currency, is the direct cause of it and tends to aggravate the effects of an inconvertible currency rather than counteract them. Perversity cannot go further. If the fact that a mechanism like that of the gold-standard reserve, set up for the purpose of limiting the currency, cannot be made to function without adding to the currency, does not render the system an unsound currency, one begins to wonder what would. Great names have been invoked in support of the exchange standard. After trying hard to find authoritative precedents for his plan,³⁶² Mr. Lindsay [pg 239] claimed before the Fowler Committee that it was founded upon the Report of the Parliamentary Committee on Irish Exchange.³⁶³ There he was on firm ground. Among other things, the Committee did recommend that for stabilizing the exchange between England and Ireland the Bank of Ireland should open credit at the Bank of England and sell drafts on London at a fixed price. In so far as the exchange standard rests on gold reserve in London, Lindsay must be said to have faithfully copied the plan of the Irish Committee on exchange. But he totally neglected to give prominence to another and the most vital recommendation of the Committee, in which it is observed:³⁶⁴ “But all the benefits proposed by this Mode of Remedies would be of little Avail and very limited Duration if it [i.e. Bank of Ireland] did not promise at the same time to cure the Depreciation of Paper in Ireland by diminishing its over issue.” Indeed, so great, was the stress laid on the limitation of issue that when Parnell, in his resolution in the House of Commons on the reform of the Irish currency, regretted the non-adoption of the recommendations of the Committee,³⁶⁵ Thornton in his reply pointed out that nothing would help to stabilize Irish exchange so long as the vital condition laid down by the Committee was disregarded. The recent experience in pegging the exchanges well illustrates the importance of that vital condition. Pegging the exchange is primarily a device to prevent the external value of the currency falling along with its internal value. The way in which pegging effects this divorce is important to note.³⁶⁶ The primary effect of the peg is to permit the purchases of foreign goods by procuring foreign currency for home currency at a fixed price, which is higher than would be the case if it were determined by the general purchasing-power parity of the two currencies. By enabling people to buy [pg 240] foreign goods with foreign currency obtained at a cheaper price the peg virtually raises foreign prices more to the level of the home prices, so that if the exchange is stable it is not because there is a peg, but because the price-levels in the two countries have reached a new equilibrium. Essentially the exchange is stable because it is an artificial purchasing-power parity. Whether it will continue to be so depends upon the movements in the home prices. If the home prices rise more than the rise brought about by the peg in the foreign prices the mechanism must break. It is from this point of view that the condition laid down by the Irish Committee on exchange regarding the limitation on issue must be held as one of vital character. In omitting to advert to that condition the Indian currency contradicts what is best in that Report of the Irish Committee.

³⁶² In 1876, when Mr. Lindsay first set out his scheme in the pages of his Calcutta Review, he mentions no parallel at all. In 1892, in his Ricardo’s Exchange Remedy, he uttered the name of Ricardo as an authority for his plan, but in 1898 he shifted his ground, so much so that he blamed (Economic Journal, supra) Probyn for taking Ricardo’s gold-bar plan as a basis. The reason why he disavowed Ricardo as his authority most probably lies in the fact that Ricardo’s general views of currency were rather damaging to his position. In view of the fact that there are so many people who assert, no doubt, from the title of his Proposals for an Economical and Secure Currency, that Ricardo wrote against a metallic standard, it is worth while recording the following passage from his Proposals, in which he says: “During the late discussion on the bullion questions, it was almost justly contended that a currency, to be perfect, should be absolutely invariable in value. But it was said, too, that ours had become such a currency, by the Bank Restriction Bill; for by that bill we had wisely discarded gold and silver as the standard of our money … Those who supported this opinion did not see that such a currency, instead of being variable, was subject to the greatest variations—that the only use of a standard is to regulate the quantity, and by the quantity the value of the currency—and that without a standard it would be exposed to all the fluctuations to which the ignorance or the interests of the issuers might subject it.”

³⁶³ The Report, which is a masterly document, was eclipsed by the Bullion Report, though both contain the same doctrine, by reason of its not being printed till 1826. See Lords Paper 48 of 1826.

³⁶⁴ Report, p. 16. Italics not in the original.

³⁶⁵ See Hansard Parliamentary Debates, Vol. XIV, pp. 75–91.

³⁶⁶ Cf. the succinct statement by T. E. Gregory, Foreign Exchanges, p. 86.

The reason why Mr. Lindsay paid no attention to the question of limitation in setting up his exchange standard is largely that, notwithstanding the great reputation he has achieved as an author of a new system, he was profoundly ignorant of the true doctrine regarding the value of a currency. Neither he nor the hosts of currency-mongers who during the nineties exercised their ingenuity to devise plans for remedying Indian exchange troubles,³⁶⁷ understood that to stabilize the exchange was essentially a problem of stabilizing the purchasing power of currency by controlling its volume.³⁶⁸ The gold-exchange standard ignores the fact that in the long run it is the general purchasing power of a currency that will ultimately govern its exchange value. Its aim is to stabilize exchange and allow the problem of purchasing power to go hang. The true policy should be to stabilize the purchasing power of the currency and let exchange take care of itself. Had the Chamberlain Commission considered the exchange standard from this point of view it could not have called it a sound standard when in its fundamentals it was the very reverse of it. [pg 241]

³⁶⁷ See Chap. IV.

³⁶⁸ Cf. evidence of Mr. Lindsay before the Fowler Committee, Q. 4,190–95, where he asserted that exchange had nothing to do with the quantity of money in circulation.

Now some one who remains unconvinced of the weakness of the exchange standard may say that in examining its stability we have taken only those occasions on which the standard has broken down. Thinking such a treatment to be unfair, he might say: How about the years during which stability was maintained? Is there nothing to be said in favour of a system that maintained the gold value of the rupee from 1901 to 1907, or from 1909 to 1914? The question is a pertinent one, and the position that underlies it is supposed to be so strong that those who hold it have asked the opponents of the exchange standard either to admit that it is a stable standard or to show that under that standard the rupee has invariably failed to maintain its gold value.³⁶⁹

³⁶⁹ Dodwell, “A Gold Currency for India,” Economic Journal, 1911; Report on the Enquiry into the Rise of Prices in India, 1914, p. 94.

The validity of this position depends upon assumptions so plausible and so widespread that the argument urged so far against the exchange standard will not be of full effect until their futility is fully demonstrated. The first assumption is that there cannot be a depreciation of a currency unless it has depreciated in terms of gold. In other words, if the excess has not produced a fall in the value of a currency in terms of a particular commodity such as gold, then there has been no excess at all in terms of commodities in general. Now there was a time, particularly during the discussion on the Bullion Report, when the conception of a change in the value of the currency in relation to things in general was not quite clear even to the most informed minds,³⁷⁰ and was even pronounced invalid by high authorities.³⁷¹ In view of the absence of the system of index numbers, this simple [pg 242] faith in the summary method of ascertaining depreciation by some one typical article, gold for instance, as a measure of value, was excusable. But the same view is without any foundation to-day. No one now requires to be shown that the price of each commodity has varied to the same extent and in the same direction as prices of commodities in general before admitting that there has been a change in the value of a currency. Why assume a single commodity like gold as a measure of depreciation? It would be allowable, although it is short-sighted to do so, if the depreciation of gold was an accurate measure of the depreciation of a currency in terms of all other commodities. But such is not the case. Commenting upon the experience of the United States with the greenbacks during the Civil War, Prof. W. C. Mitchell observes³⁷²:—

³⁷⁰ Canning’s castigation of Lord Castlereagh’s definition of standard as “a sense of value” during the Bullion debates must be attributed to his ignorance on this matter.

³⁷¹ Ricardo, in his Proposals for an Economical and Secure Currency, says: “It has indeed been said that we might judge of the value of a currency by its relation not to one but to the mass of the commodities. … Such a test would be of no use whatever. … To determine the value of a currency by the test proposed … is evidently impossible.”

³⁷² Gold, Prices and Wages under the Greenback Standard, 1908, pp. 39–41.

“The fluctuations in the price of gold which attracted so much attention were much more moderate than the extreme fluctuations in the prices of commodities. The gold quotations lay all the time well within the outer limits of the field covered by the variations of commodity prices. … During the war gold moved up or down in price more quickly than the mass of commodities. … When gold was rising in price the majority of the commodities followed, but more slowly. … When gold was falling in price the majority of commodities stood still or followed more slowly. … This more sluggish movement of commodity prices appears still more clearly after the war. Rapid as was the fall of prices it was not so rapid as the falling gold. A more curious fact is that the price-level for commodities continued for ten years to be higher than the price-level for gold.”

This shows that the test sought to be applied by the adherents of the exchange standard is a false one and gives an inaccurate reading of the value of a currency. There can be no doubt that people who have urged its application to that standard would not have pressed for it so much as they have done if they had taken proper care to distinguish between specific depreciation of a currency and its general [pg 243] depreciation.³⁷³ The experience of the Bank of England during the suspension period is a capital instance of the phenomenon where a currency is generally depreciated, although it showed no sign of specific depreciation:—

³⁷³ Cf. Prof. Nicholson’s Principles of Political Economy (1897), Vol. II, Chap. XV, § 4; and Walker, F. A., Money, 1878, pp. 387–91.

TABLE L

Depreciation of the Notes of the Bank of England³⁷⁴

───────────────────────────────────────────────────────────────── Percentage Values of Bank Notes in Terms of ─────────────────────────────────────────────────────── (1) Gold. (2) Commodities. ───────────────────────────────────────────────────────────────── 1797 100·0 110 ───────────────────────────────────────────────────────────────── 1798 100·0 118 ───────────────────────────────────────────────────────────────── 1799 — 130 ───────────────────────────────────────────────────────────────── 1800 107·0 141 ───────────────────────────────────────────────────────────────── 1801 109·0 153 ───────────────────────────────────────────────────────────────── 1802 — 119 ───────────────────────────────────────────────────────────────── 1803 — 128 ───────────────────────────────────────────────────────────────── 1804 103·0 122 ───────────────────────────────────────────────────────────────── 1805 103·0 136 ───────────────────────────────────────────────────────────────── 1806 — 133 ───────────────────────────────────────────────────────────────── 1807 — 132 ───────────────────────────────────────────────────────────────── 1808 — 149 ───────────────────────────────────────────────────────────────── 1809 — 161 ───────────────────────────────────────────────────────────────── 1810 — 164 ───────────────────────────────────────────────────────────────── 1811 123·9 147 ───────────────────────────────────────────────────────────────── 1812 130·2 148 ───────────────────────────────────────────────────────────────── 1813 136·4 149 ───────────────────────────────────────────────────────────────── 1814 124·4 153 ───────────────────────────────────────────────────────────────── 1815 118·7 132 ───────────────────────────────────────────────────────────────── 1816 102·9 109 ───────────────────────────────────────────────────────────────── 1817 102·2 120 ───────────────────────────────────────────────────────────────── 1818 104·6 135 ─────────────────────────────────────────────────────────────────

³⁷⁴ From Hawtrey’s Credit and Currency, p. 269. On the values of the notes in terms of gold Prof. Foxwell says: “It is admitted by the severest critics of the bank that there is no substantial ground for complaint as to its conduct during the restriction until 1808–9. There does not seem, indeed, to have been any real depreciation of its paper until that date. The price of £4 per ounce, which figures monotonously for the years 1803–9, was really an arbitrary price, fixed by the bank itself as one at which it would purchase foreign gold.” Preface to Andréadès, p. xvi. Some people seem to doubt that there was no specific depreciation of the inconvertible notes of the Bank of England till 1810. Unfortunately data are not available to give direct evidence of the fact. But circumstantial evidence there is. It is to be remembered that the premium on gold was the only method then known of measuring depreciation and that Horner, Ricardo and others were open enemies of the Bank of England. That being the case, it does not seem probable that Horner would have waited to introduce his Resolution in the House of Commons till 1810 if the bank notes had shown signs of specific depreciation before that time.

This mode of measuring depreciation in terms of gold would be, relatively speaking, a harmless idea if it was not made the basis of another assumption on which the exchange standard is made to rest, that the general and specific depreciations of a currency are unrelated phenomena. As against this it is necessary to urge that the chief lesson to be drawn from this experience of the Bank of England for the benefit of the upholders of the exchange standard consists in demonstrating that although their movements are [pg 245] not perfectly harmonious, yet they are essentially interrelated. That lesson may be summed up in the statement that when the general depreciation of currency has taken place the occurrence of a specific depreciation, other things being equal, is only a matter of time, if the general depreciation proceeds beyond a certain limit. What will be the interval before specific depreciation will supervene upon general depreciation depends upon a variety of circumstances. Like the surface of a rising lake, general depreciation touches different commodities at different times according as they are located in the general scheme of things as determined by the relative strength of demand for them. If there is no demand for gold for currency purposes or for industrial purposes, the depreciation of the currency in terms of gold may be delayed. It is only to make foreign remittances that the demand for gold first makes itself felt, and it is there that specific depreciation primarily arises. But there again it need not, for everything depends upon whether other commodities equally good, which the foreigner would take as readily as gold, are forthcoming or not. Now, in the case of India all these three factors tending to postpone specific depreciation are more or less operative. The rupee is a full legal-tender currency and can effectively discharge debts without compelling resort to gold. The industrial demand for gold in a poor country like India cannot be very great.³⁷⁵ Consequently, the [pg 246] generally depreciated rupee does not show immediate signs of depreciation in the internal trade of the country. As for foreign payments, the position of India is equally strong, not because, as is absurdly supposed, she has a favourable balance of trade, but because she has certain essential commodities which a foreigner is obliged to accept³⁷⁷ in place of gold. Specific depreciation of the rupee will occur chiefly when the general depreciation has overtaken the commodities that enter into India’s foreign trade. That the depreciation should extend to them is inevitable, for, as is well said,

³⁷⁵ The following table regarding the consumption of gold in different countries is interesting:—

Consumption of Gold (millions of pounds sterling at 85s. per fine ounce)³⁷⁶

───────────────────────────────────────────────────────────────── 1915. 1916. 1917. 1918. 1919. 1920. ───────────────────────────────────────────────────────────────── Industrial Arts 17·0 18·0 16·0 17·0 22·0 22·0 (Europe and America) India (Year to 1·4 5·1 19·6 −3·3 27·7 5·1 March 31 following) China −1·7 2·6 2·6 0·4 11·5 −3·7 Egypt −0·8 −0·2 −0·1 −0·0 −0·0 ? Balance 80·5 68·0 48·2 64·9 13·8 46·6 available as money (difference) World 96·4 93·5 86·3 79·0 75·0 70·0 ─────────────────────────────────────────────────────────────────

³⁷⁶ The figures are those of Mr. Joseph Kitchin in The Review of Economic Statistics, Preliminary volume 3, No. 8 for August, 1921, p.257. If figures previous to 1914 are desired, see table ibid., p. 268.)

Omitting the abnormal years of 1917 and 1919 and reducing the figures to per capita basis the consumption of gold by India must be said to be remarkably small. Besides, it is to be noted that figures for India include industrial as well as monetary consumption. Further, in making comparison account must be taken of the difference in the period taken as unit in the case of India and other countries. Of course in these days when gold is so very greatly depreciated in terms of commodities in general, neither is there any necessity to shed tears if its production were to fall off, nor can it be anything but a welcome event if its use were to be extended. It would therefore be unwise to resent an increase, if it were to take place, in the importation and use of gold by India. The greater the use of gold and the less the production of it, the better for the world as it is circumstanced to-day. Cf. in this connection the remarks of Prof. Cannan on Mr. Shirras’s Paper in the J.R.S.S for July, 1920, pp. 623–24,

³⁷⁷ Evidence of Prof. Marshall, I.C.C., 1898, Q. 11,793.

“in a modern community the prices of different goods constitute a completely organized system, in which the various parts are continually being adjusted to each other by intricate business process. Any marked change in the price of important goods disturbs the equilibrium of this system, and business processes at once set going a series of readjustments in the prices of other goods to restore it.”³⁷⁸

³⁷⁸ Mitchell, ibid., p. 258.

It is true that in the case of India the interconnection between production for internal trade and production for external trade is not so closely knit as in the case of other countries. The only difference that this can make in the situation is to moderate the pace of general depreciation [pg 247] so that it does not affect foreign trade commodities too soon. But it cannot prevent its effect from ultimately raising their price. And once their price is risen the foreigner will not accept them, however essential. A demand for gold must arise, resulting in the specific depreciation of the currency.

This statement of the case agrees closely with the experience of the Bank of England and that of India as well. In the case of the Bank of England the “great evil,” i.e. the specific depreciation of the bank notes, of which Horner complained so much, made its appearance in 1809, some thirteen years after the suspension was declared. Similarly, we find in the case of India specific depreciation tends to appear at different intervals, thereby completely demonstrating that, even for the purpose of avoiding specific depreciation, it is necessary to pay attention to the general depreciation of a currency.

Having regard to these facts, supported as they are by theory as well as history, the incident that the rupee has maintained its gold value over periods of some duration need not frighten anyone into an admission that the exchange standard is therefore a stable standard. Indeed, a recognition of that fact cannot in the least discredit what has been said above. For our position is that in the long run general depreciation of a currency will bring about its specific depreciation in terms of gold. That being our position, even if we are confronted with the absence of specific depreciation of the rupee, we are not driven to retract from the opinion that the best currency system is one which provides a brake on the general depreciation of the unit of account. The exchange standard provides no such controlling influence; indeed, its gold reserve, the instrument which controls the depreciation, is the direct cause of such depreciation. The absence of specific depreciation for the time being is not more than a noteworthy and an interesting incident. To read into it an evidence of the security of the exchange standard is to expose oneself, sooner or later, to the consequences that befall all those who choose to live in a fool’s paradise. [pg 248]