Chapter VI

CHAPTER VI

STABILITY OF THE EXCHANGE STANDARD

It will be recalled that at the time the Indian Mints were closed to the free coinage of silver there were two parties in the country, one in favour of and the other opposed to the closure. Being placed in an embarrassing position by the fall of the rupee, the Government of the day was anxious to close the Mints and raise its value with a view to obtaining relief from the burden of its gold payments. On the other hand it was urged, on behalf of the producing interest of the country, that a rise in the exchange value of the rupee would cause a disaster to Indian trade and industry. One of the reasons, it was argued, why Indian industry had advanced by such leaps and bounds as it did during the period of 1873–1893 was to be found in the bounty given to the Indian export trade by the falling exchange. If the fall of the rupee was arrested by the Mint closure, it was feared that such an event was bound to cut Indian trade both ways. It would give the silver-using countries a bounty as over against India, and would deprive India of the bounty which it obtained from the falling exchange as over against gold-using countries.

Theory had already scoffed at these fears. It is therefore interesting to see that later history has also confirmed the verdict of theory. Indian trade with a gold-standard country like England or a silver-standard country like China did not suffer a setback, notwithstanding an arrest in the fall of the rupee. The following figures furnish sufficient evidence to support the contrary:— [pg 182]

TABLE XXV

Trade of India with United Kingdom (before and after the Mint Closure)

Annual Average. Exports to U.K. Imports from U.K.

Merchandise. Bullion and Specie. Total. Merchandise. Bullion and Specie. Total.

£ £ £ £ £ £

I 1889–93 31,569,891 1,180,646 32,750,537 31,837,482 7,694,149 39,531,631

II 1894–98 26,329,764 2,215,049 24,544,813 28,963,180 6,750,736 35,713,916

III 1899–1903 28,709,819 2,089,656 30,799,475 33,498,480 7,301,172 40,799,652

IV 1903–8 36,784,628 2,232,857 39,017,485 47,294,311 9,586,706 56,881,017

— — — — — —

Percentage of Increase (+) or Decrease (−) in —

Period II in comparison with Period I −16·598 +87·613 −25·055 −9·028 −12·261 −9·657

Period III in comparison with Period II +9·039 −5·661 +25·483 +15·659 +8·154 +14·240

Period IV in comparison with Period III +28·126 +6·853 +26·682 +41·183 +31·304 +39·415

Period IV in comparison with Period I +16·518 +89·122 +19·135 +48·549 +24·597 +43·887

[pg 183]

TABLE XXVI

Trade of India with China

Annual Average. Exports to China. Imports from China.

Merchandise. Treasure. Total. Merchandise. Treasure. Total.

£ £ £ £ £ £

I 1889–93 9,454,014 20,223 9,474,238 1,666,840 1,992,914 3,659,754

II 1894–98 8,509,284 112,105 8,621,389 1,713,529 503,357 2,216,886

III 1899–1903 9,679,830 183,647 9,863,477 1,309,975 798,053 2,108,028

IV 1903–8 12,461,535 160,879 12,622,414 1,248,822 919,402 2,168,224

— — — — — —

Percentage of Increase (+) or Decrease (−) in —

Period II in comparison with Period I −9·993 +454·333 −9·002 +2·801 −74·743 −39·425

Period III in comparison with Period II +13·756 +63·817 +14·407 −23·551 +58·546 −4·910

Period IV in comparison with Period III +28·737 −12·398 +27·971 −4·668 +15·206 +2·856

Period IV in comparison with Period I +31·812 +695·508 +33·229 −25·078 −53·866 −40·755

[pg 184] That the arrest in the fall of the rupee should have lifted the burden from Indian finances was just as was expected to follow from the closure of the Mints. Notwithstanding important reductions in taxation and large expenditure of social utility, the annual budgets since the Mint closure have shown few deficits (see p. 185).

Now there is a tendency among some writers to interpret these facts as unmistakable proofs of the soundness of the currency system. It is argued that if the trade of the country has not received a setback,³⁰¹ and if the finances of the country have improved,³⁰² then the implication is that the currency of which such results can be predicated must be good. It is not necessary to warn students of currency that such easy views on the soundness of the currency system, however plausible, are devoid of the logic necessary to carry conviction. Trade no doubt is dependent on good money, but the growth of trade is not a conclusive proof that the money is good. It should be noted that during the periods of debased coinages so common at one time the social misery and nuisance arising there from were intolerable, yet during the same periods it was possible for countries to make great advance in trade. Speaking of seventeenth-century England, when that country was afflicted with debased and constantly changing coinage and when there was, besides, a long period of civil war and confusion, Lord Liverpool, who was above all statesmen of his day most alive to the evils of a bad currency, remarks:—

“It is certain, however, that during the whole of this period, when our coins were in so great a state of confusion, the commerce of the kingdom was progressively improving, and the balance of trade almost always in favour of this country.”³⁰³

That commerce can increase even when currency is bad is easily supported from the experience of India herself. In no period did Indian trade make such strides as it did [pg 185]

TABLE XXVII

Finances of the Government

Years. Surplus + Deficit − Years. Surplus + Deficit − Years. Surplus + Deficit − Years. Surplus + Deficit − Years. Surplus + Deficit −

Rs. £ £ £ £

1893–94 −1,546,998 1898–9 +2,640,873 1903–4 +2,996,400 1908–9 −3,737,710 1913–14 +2,312,423

1894–95 +693,110 1899–1900 +2,774,623 1904–5 +3,456,066 1909–10 +?,606,641 1914–15 −1,785,270

1895–96 +1,533,998 1900–1 +1,670,204 1905–6 +2,091,854 1910–11 +3,936,287 1915–16 −1,188,661

1896–97 −1,705,022 1901–2 +4,950,243 1906–7 +1,589,340 1911–12 +3,940,334 1916–17 +7,478,170

1897–98 −5,359,211 1902–3 +3,069,549 1907–8 +300,615 1912–13 +3,107,634 — —

[pg 186] between 1873 and 1893. Was the Indian currency of that period good? On the other hand, it is possible to hold that if trade is good it may be because the currency is bad. The trade of India between 1873 and 1893 flourished because it received a bounty. But the bounty was a mulcting of the Indian labourer, whose wages did not rise as fast as prices, so that the Indian prosperity of that period was founded not upon production, but upon depredation made possible by the inflation of currency.

Similarly, it cannot be granted without reserve that the new currency system must be good because it has obviated the burden of the gold payments and given relief to the Indian taxpayer. Such a view involves a misconception of the precise source of the burden of India's gold payments during the period of falling exchange. It has been widely held that the burden of gold payments was caused by the fall in the gold value of silver, a view which carried with it the necessary implication that if India had been a gold-standard country she would have escaped that heavy burden. That it is an erroneous view hardly needs demonstration.³⁰⁴ It is not to be denied that India bore an extra burden arising from the increased value of the gold payments. But what is not sufficiently realized is that it was a burden which weighed on all gold debtors irrespective of the question whether their standard was gold or silver. In this respect the position of a gold-standard country like Australia was not different from a silver-standard country like India. In so far as they were gold debtors they suffered each in the same way from the same cause, namely the appreciation of the standard in which their debts were measured. The fact that one discharged her debts in gold and the other in silver made no difference in their condition, except that the use of silver by India to discharge her debts served as a refractory medium through which it was possible to see the magnitude of the burden she bore. The fall of silver measured and not caused the burden of India's gold payments. The arrest in the fall of the rupee cannot be accepted as a prima facie [pg 187] proof of a relief to the taxpayer and therefore an evidence of the soundness of the currency system. It is possible that the benefit may have been too dearly paid for.

Although favourably impressed by the increase of trade and the buoyancy of Government finances under the exchange standard, the Chamberlain Commission did not care to found its case for it on the basis of such arguments. The chief ground on which it rested was that the currency system was capable of maintaining the exchange value of the rupee at a fixed par with gold.³⁰⁵ We must therefore proceed to examine this claim made by the Commission on behalf of the exchange standard. The table on p. 188 presents the requisite data for an elucidation of the question.

Assuming, for the moment, the criterion laid down by the Commission to be correct, can it be said from the data given above that the rupee has maintained its gold value? It would be over-confident if not rash to say that the system, even from the narrow point of view of the Commission, has been an unquestioned success.

Between June, 1893, and January, 1917, the rupee was rated to gold at the rate of 1 rupee equal to 7·53344 troy grs. of fine gold. At that rate the sovereign should be equal to 15 rupees, the mint price of gold should be Rs. 23–14–4 per tola (i.e. 180 grs.) of bar gold 100 touch, and the exchange on London should be 1s. 4d., and should have varied within 1s, 4·125d., the import point, and 1s. 3·906d., the export point, for gold. [pg 188]

TABLE XXVIII

Gold Value of the Rupee

As expressed in Terms of Foreign Exchange Rates on London. Par R. = 1s. 4d. As expressed in Terms of Gold.

Years. (1) Rupee Prices of Sovereigns. Par Rs. 15 = 1 Sovereign. (2) Rupee Price of Bar Gold. Par Tola = Rs. 23–14–4

Years. Highest. Lowest. Highest. Lowest. Highest. Lowest.

s. d. s. d. Rs. A. P. Rs. A. P. Rs. A. P. Rs. A. P.

1892–93 1 3·969 1 2·625 1893 16 10 6 15 6 0 26 11 0 24 14 0

1893–94 1 4·031 1 1·500 1894 19 0 0 16 1 0 32 4 0 25 9 0

1894–95 1 1·906 1 1·000 1895 19 5 0 18 2 6 30 8 0 27 6 0

1895–96 1 2·875 1 1·100 1896 17 7 0 16 1 0 27 13 6 27 2 0

1896–97 1 3·842 1 1·781 1897 16 10 0 15 3 0 26 12 6 25 4 0

1897–98 1 4·125 1 2·250 1898 15 7 0 15 1 0 24 10 0 24 0 0

1898–99 1 4·156 1 3·094 1899 15 4 0 15 0 0 24 2 0 23 4 0

1899–1900 1 4·375 1 3·875 1900 15 1 3 15 0 0 24 2 0 23 15 6

1900–1901 1 4·156 1 3·875 1901 15 0 0 15 0 0 24 2 0 24 0 0

1901–1902 1 4·125 1 3·875 1902 15 4 6 15 2 6 24 2 6 24 0 0

1902–1903 1 4·156 1 3·875 1903 15 3 0 15 1 6 24 3 0 24 0 0

1903–1904 1 4·156 1 3·875 1904 15 5 0 15 1 3 24 2 0 24 0 3

1904–1905 1 4·156 1 3·970 1905 15 4 0 15 1 6 24 2 0 24 0 0

1905–1906 1 4·156 1 3·937 1906 15 1 0 15 2 0 24 4 6 24 0 0

1906–1907 1 4·187 1 3·937 1907 15 4 0 15 0 0 24 4 0 23 15 6

1907–1908 1 4·187 1 3·875 1908 15 1 0 15 0 0 24 10 0 24 2 0

1908–1909 1 4 1 3·875 1909 Premium between 12 and 3% 24 3 6 23 15 0

1909–1910 1 4·156 1 3·875 1910 15 5 0 15 0 0 24 4 0 23 15 0

1910–1911 1 4·156 1 3·875 1911 15 0 0 15 0 0 24 0 6 23 14 0

1911–1912 1 4·156 1 3·937 1912 15 0 0 15 0 0 24 0 0 23 14 0

1912–1913 1 4·156 1 3·970 1913 15 0 0 15 0 0 24 0 3 —

1913–1914 1 4·156 1 3·937 1914 15 14 0 15 2 0 26 10 0 23 15 6

1914–1915 1 4·094 1 3·937 1915 15 13 6 15 5 0 25 14 0 24 8 0

Taking a general survey of the stability of the rupee with regard to its value in terms of gold, it will be noticed that from the date of the Mint closure up to 1898 the rupee was far below par. The depreciation of the rupee, measured in terms of exchange or price of gold or sovereign, ranged somewhere between 25 to 30 per cent. So great was the depreciation that it redoubled the difficulties confronting the Government when the rupee was not fixed to gold. The financing the Home Treasury by the usual means of selling Council Bills became well-nigh impossible.³⁰⁶ The [pg 189] Secretary of State found himself in an embarrassing position. Offering to sell below par involved the obloquy of having led the way to the defeat of the policy of stabilizing exchange. Refusing to sell at market rates involved the danger of a dry Treasury. The Government of India suggested that the Secretary should lay down a minimum rate for or a maximum amount of the bills that he put upon the market. The Secretary of State agreed to neither, but consented to reduce his drawings so as not to unduly depress the exchange rate. The drawings of the Secretary of State during the first fiscal year since the Mint closure have been the smallest on record:—

TABLE XXIX

Council Drawings

Date of Drawing. Amount of Drawings. £, 000 omitted. Rate at which drawn (Pence per Rupee).

1893. June 2,478 15·039

July 25 15·974

August 78 15·243

September 7 15·350

October 5 15·334

November 617 15·251

December 14 15·242

1894. January 98 14·408

February 1,023 13·787

March 1,915 13·870

April 1,368 13·626

The curtailment of drawings to save the rate of exchange from being lowered was not an unmitigated good, for it imposed the necessity of a resort to the by no means inexpensive method of sterling borrowings to finance the Home Treasury.³⁰⁷ The remittances by drawings fell short of the net disbursements of the Home Treasury in 1893–94 by £6,588,000, which deficit was met by permanent sterling [pg 190] borrowings to the extent of £7,430,000, the interest on which added to the already over-heavy burden of the gold payments. Rather than incur such a penalty the Secretary of State gave up the attempt to dominate the market and preferred to follow it. But this let-go policy was not without its cost. The drop in the exchange below 1s. 4d. added to the burden of remittances to the Home Treasury, and also compelled the Government to grant exchange compensation allowance to its European officers, civil and military—an aid which it had so far withheld. The cost to the Government involved by the fall of the rupee below par was quite a considerable sum.³⁰⁸

TABLE XXX

Cost of the Fall of the Rupee

Years. Loss on Council Bills being sold below par. Loss by Exchange Compensation Allowance. Loss by Increase of pay of British Troops. Total on each Account in each Year. Total on all Counts for three Years.

In Rupees. In Sterling at 1s. 4d.

Rs. £.

1894–95 3,74,15,000 78,02,000 37,84,000 4,90,01,000 11,91,86,000 7,945,733

1895–96 3,05,91,000 87,18,000 49,38,000 4,42,47,000

1896–97 1,66,48,000 48,95,000 44,25,000 2,59,38,000

In the midst of such a situation it is no wonder if the faith of the Government in the ultimate stability of the rupee had given way, for we find that in October, 1896, the Financial Member of the Council had personally come to the conclusion that it would be better in the interest of stability to substitute 15d. for 16d. as the par of exchange between the rupee and gold.³⁰⁹ But the suggestion was dropped as the rupee showed signs of reaching the gold par, which it did in January, 1898, after a period of full five years of depreciation from the established par.

Between January, 1898, and January, 1917, twice did the rupee fall below its gold par. The year 1907–8 records the second occasion when the parity of the rupee under [pg 191] the exchange standard broke down. The actual rates of exchange prevailing in the market were as follows:—

TABLE XXXI

Rates of Exchange, London on India (From “The Times”)

Par R. = 1s. 4d.

Date On Calcutta. On Bombay.

Highest. Lowest. Highest. Lowest.

1907. September 1 4 1/32 1 3 31/32 1 4 1/32 1 3 31/32

October 1 4 1/32 1 3 31/32 1 4 1/32 1 3 31/32

November 1 4 1 3 23/32 1 3 31/32 1 3 23/32

December 1 3 15/16 1 3 27/32 1 3 15/16 1 3 23/32

1908. January 1 3 15/16 1 3 29/32 1 3 15/16 1 3⅞

February 1 3 31/32 1 3⅞ 1 3 31/32 1 3⅞

March 1 3 29/32 1 3 27/32 1 3 29/32 1 3 27/32

April 1 3⅞ 1 3 27/32 1 3 27/32 1 3 27/32

May 1 3⅞ 1 3 27/32 1 3 15/16 1 3 27/32

June 1 3 29/32 1 3 27/32 1 3⅞ 1 3 27/32

July 1 3⅞ 1 3 27/32 1 3⅞ 1 3 27/32

August 1 3 29/32 1 3 27/32 1 3 29/32 1 3 27/32

September 1 3 31/32 1 3 29/32 1 3 31/32 1 3⅞

October 1 3 15/16 1 3⅞ 1 3 29/32 1 3 13/16

November 1 3 29/32 1 3⅞ 1 3⅞ 1 3⅞

December 1 3 15/16 1 3 29/32 1 3 31/32 1 3⅞

After a crisis lasting over a year the rupee recovered to its old gold par and remained fixed at it, though by no means firmly, for another seven years, only to suffer another fall from its parity during the year 1914–15 (see table, p. 192).

After 1916 the stability of the exchange standard was threatened by a danger arising from quite unsuspected quarters. The Indian exchange standard was based upon the view that the gold value of silver was bound to fall or at least not likely to rise to a level at which the intrinsic value of the rupee became higher than its nominal value. The price of silver at which the intrinsic value of the rupee equalled its nominal value was 43d. per ounce. So long as [pg 192]

TABLE XXXII

Rates of Exchange London on Calcutta (from the National Bank of India)

Months. 1914. 1915.

Highest. Lowest. Highest. Lowest.

January — — 1 3 15/16 1 3 15/16

February — — 1 4 1/32 1 3 29/32

March — — 1 4 1 3 15/16

April — — 1 3 15/16 1 3 29/32

May 1 4¼ 1 3 15/16 1 3 15/16 1 3 29/32

June 1 3 31/32 1 3 15/16 1 3⅞ 1 3 27/32

July 1 3 31/32 1 3 13/16 1 3 22/32 1 3 22/32

August 1 3⅞ 1 3 13/16 1 3 15/16 1 3 27/32

September 1 3 15/16 1 3 13/16 1 4 1 3 15/16

October 1 3 15/16 1 3 15/16 — —

November 1 3 15/16 1 3 15/16 — —

December 1 3 15/16 1 3 15/16 — —

the intrinsic value of the rupee remained below its nominal value, i.e. the price of silver did not rise above 43d., there was no danger of the rupee circulating as currency. Once the price of silver rose above that point the danger of the rupee passing from currency to the melting-pot was imminent. Now, with the exception of a brief period from September, 1904, to December, 1907, the gold price of silver had since 1872 showed a marked tendency to fall. The decline in its price was so continuous and so steady as to create the general impression that the low price had come to stay. Indeed, so firm was the impression that the framers of the exchange standard had never taken into account the contingency of a rise in the price of silver above 43d. So little was it anticipated, that the system was not criticized on this ground by any of the witnesses who deposed before the successive Committees and Commission on Indian currency. But the unexpected may happen, and unfortunately did happen after 1916, and happened suddenly. On February 10, 1914, the cash price in London of silver [pg 193] per ounce of standard fineness was 26⅝d. It fell to 22(11)/(16)d. on February 10, 1915, and though it jumped to 27d. on the same date in 1916, yet it was below the rupee melting-point. After the last-mentioned date its rise was meteoric. On February 9, 1917, it rose to 37⅝d.; on February 8, 1918, to 43d.; and on the same date in 1919 to 48(7)/(16)d., thereby quite overshooting the rupee melting-point. But the price of silver broke all record when on February 11, 1920, it reached the colossal figure of 89½d. per standard ounce.

The rise in the intrinsic value of the rupee above the nominal value at once raised a problem as to how the rupee could be preserved in circulation. Two ways seemed open for the solution of the problem. One was to scale down the fineness of the rupee, and the other to raise its gold parity. All other countries which had been confronted by a similar problem adopted the former method of dealing with their silver coinages—a method which was successfully tried in the Philippines and the Straits Settlements and Mexico in 1904–7, when a rise in those years in the price of silver had created a similar problem in those countries.³¹⁰ The Secretary of State for India adopted the second course of action and kept on altering the rupee par with every rise in the price of silver. The alterations of the rupee par following upon the variations in the price of silver are given below:—

TABLE XXXIII

Date of Alteration of the Rupee Par. Pitch of the Par.

s. d.

January 3, 1917 1 4¼

August 28, 1917 1 5

April 12, 1918 1 6

May 13, 1919 1 8

August 12, 1919 1 10

September 15, 1919 2 0

November 22, 1919 2 2

December 12, 1919 2 4

[pg 194] After having played with the rupee par, for two years, in this manner, as though such alterations involved no social consequences, the Secretary of State, on May 30, 1919, appointed a new Currency Committee under the chairmanship of Babington Smith, to recommend measures “to ensure a stable gold exchange standard.” The majority of the Committee, after half a year of cogitation, reported to the effect³¹¹ that

“(i) The object should be to restore stability to the rupee, and to re-establish the automatic working of the currency system at as early a date as practicable.

“(ii) The stable relation to be established should be with gold and not with sterling.

“(iii) The gold equivalent of the rupee should be sufficiently high to give assurance, so far as is practicable, that the rupee, while retaining its present weight and fineness, will remain a token coin, or in other words, that the bullion value of the silver it contains will not exceed its exchange value.

“After most careful consideration” (the Committee said) “we are unanimous (with the exception of one of our members who signs a separate report) in recommending that the stable relation to be established between the rupee and gold should be at the rate of one rupee to 11·30016 grs. of fine gold both for foreign exchange and internal circulation.”

i.e. the rupee to be equal to 2s. (gold).

The minority report, which harped on the old cry of a stimulus of low exchange and penalty of high exchange, stood out for the maintenance of the old rate of 15 rupees to the gold sovereign or 113·0016 grs. troy of pure gold, and recommended the issue of a two-rupee silver coin of reduced fineness compared with the old rupee, so long as the price of silver in New York was over 92 cents.³¹² By the announcements of February 2, 1920, the recommendations of the majority of the Committee were accepted [pg 195] by the Secretary of State and also by the Government of India, which abandoned the old parity of 7·53344 grs. per rupee for the new parity of 11·30016 grs. troy. Now, has the rupee maintained its new parity with gold?

In the matter of ascertaining this fact the exchange quotation on London is no guide, for the value of the rupee was 2s. gold and not 2s. sterling. Had gold and sterling been identical the case would have been otherwise. But during the war, owing to the issue of virtually inconvertible money, the pound sterling had depreciated in terms of gold. We must therefore take as our standard a currency which had kept its par with gold. Such a currency was the American dollar, and the exchange quotation on New York is therefore more directly helpful in measuring the gold value of the rupee than is the sterling quotation on London. We can also employ the actual rupee-sterling quotation as a measure by comparing it with the amount of sterling the rupee should have purchased, as an equivalent of 11·30016 grs. of fine gold, when corrected by the prevailing cross-rate between New York and London.³¹³

Compared with the par of exchange, the actual exchange, either on New York or on London, indicates a fall of the rupee which is simply staggering (see table, p. 196).

Consider, along with the external gold value of the rupee, its internal value in terms of sovereigns and bar gold (see table, p. 197). [pg 196]

TABLE XXXIV

Actual Gold Value of the Rupee and the new Parity in Terms of Foreign Exchanges

As in the Middle of the Month of— New York on Bombay in cents. Bombay on London in s. d.

1920. 1921. 1922. 1920. 1921. 1922.

Par Rate. Actual Rate. Par Rate. Actual Rate. Par Rate. Actual Rate. Par Rate. Actual Rate. Par Rate. Actual Rate. Par Rate. Actual Rate.

January 0·4866 0·4400 0·4866 0·2925 0·4866 0·2800 2 7½ 2 3⅝ 2 7 5/16 1 5⅝ 2 3⅝ 1 3 13/16

February 0·4866 0·4850 0·4866 0·2800 0·4866 0·2845 2 10 11/32 2 9⅛ 2 5 13/16 1 4⅛ 2 2 7/32 1 3 9/16

March 0·4866 0·4850 0·4866 0·2625 0·4866 0·2787 2 7 29/32 2 5¾ 2 5 31/32 1 3¼ 2 2 29/32 1 3 5/16

April 0·4866 0·4775 0·4866 0·2625 0·4866 0·2785 2 5 7/16 2 3¾ 2 5 13/16 1 3⅝ 2 2½ 1 3⅛

May 0·4866 0·4325 0·4866 0·2675 0·4866 0·2930 2 6 19/32 2 2⅛ 2 5 7/32 1 3½ 2 2¼ 1 3 9/16

June 0·4866 0·4125 0·4866 0·2525 0·4866 0·2900 2 5 31/32 1 10 13/16 2 6 29/32 1 3⅜ 2 2⅛ 1 3 19/32

July 0·4866 0·3900 0·4866 0·2400 0·4866 0·2900 2 5 31/32 1 8 1/16 2 8 9/32 1 3¼ 2 2⅝ 1 3⅝

August 0·4866 0·3650 0·4866 0·2475 0·4866 0·2916 2 8 9/32 1 10 1/16 2 7 29/32 1 4¾ 2 2 3/16 1 3 19/32

September 0·4866 0·3325 0·4866 0·2675 0·4866 0·2875 2 9 9/16 1 10 1/16 2 7 15/32 1 5 1/16 2 2 6/16 1 3 9/16

October 0·4866 0·3025 0·4866 0·2825 0·4866 — 2 9 21/32 1 7¾ 2 6 1/32 1 5 7/16 — —

November 0·4866 0·3025 0·4866 0·2695 0·4866 — 2 10 9/16 1 7⅛ 2 5 16/32 1 4⅛ — —

December 0·4866 0·2650 0·4866 0·2775 0·4866 — 2 9 9/16 1 5¼ 2 4 1 3⅞ — —

[pg 197]

TABLE XXXV

Gold Value of the Rupee and the new Parity in Terms of the Price of Sovereigns and Gold

Months. 1920. 1921. 1922.

Price of British Sovereigns Price of Bar Gold per Tola 100 touch. Price of British Sovereigns. Price of Bar Gold per Tola 100 touch Price of British Sovereigns. Price of Bar Gold per Tola 100 touch

Par 10 Rs = 1 Sov. Par Rs 15–14–10 = 1 Tola Par 10 Rs = 1 Sov. Par Rs 15–14–10 = 1 Tola Par 10 Rs = 1 Sov. Par Rs 15–14–10 = 1 Tola

Rs. A. P. Rs. A. P. Rs. A. P. Rs. A. P. Rs. A. P.

January Nominal 28 0 0 Nominal Official figures not yet published. 17 14 0 Official figures not yet published.

February Nominal 22 0 0 Nominal 17 14 0

March Nominal 24 0 0 Nominal 17 14 0

April Nominal 24 8 0 18 12 0 —

May Nominal 22 12 0 19 0 0 —

June Nominal 22 4 0 19 12 0 —

July Nominal 23 0 0 20 9 0 —

August Nominal 21 8 0 20 9 0 —

September Nominal 25 4 0 19 2 0 —

October Nominal 27 6 0 18 14 0 —

November Nominal 28 10 0 18 8 0 —

December Nominal 27 12 0 18 6 0 —

The tables need no comment. The rupee is not only far away from 2s. (gold), but is not even 1s. 4d. (sterling).

Do not the facts furnish an incontrovertible proof of the futility of the exchange standard? How can a system which fails to maintain its value in terms of gold, which it is supposed to do, be regarded as a sound system of currency? There must be somewhere some weakness in the mechanism of a system which is liable to such occasional breakdowns. The rupee fell or rather was below par in 1893, and did not reach its parity to any real degree of firmness until 1900. After an interval of seven years the rupee again falls below par in 1907. The year 1914 witnesses another fall of the rupee. A meteoric rise since 1917, and again a fall after 1920. This curious phenomenon naturally raises the question: Why did the rupee fail to maintain its gold parity on these occasions? A proper reply to this question will reveal wherein lies the weakness of the exchange standard. [pg 198]

The only scientific explanation sufficient to account for the fall of the rupee would be to say that the rupee had lost its general purchasing power. It is an established proposition that a currency or unit of account will be valued in terms of another currency or unit of account for what it is worth, i.e. for the goods which it will buy. To take a concrete example, Englishmen and others value Indian rupees inasmuch and in so far as those rupees will buy Indian goods. On the other hand, Indians value English pounds (and other units of account, for that matter) inasmuch and in so far as those pounds will buy English goods. If rupees in India rise in purchasing power (i.e. if the Indian price-level falls) while pounds fall in purchasing power or remain stationary or rise less rapidly (i.e. if the English price-level rises relative to the Indian price-level), fewer rupees would be worth as much as a pound, i.e. the exchange value of the rupee in terms of the pound will rise. On the other hand, if rupees in India fall in purchasing power (i.e. if the Indian price-level rises) while pounds rise in purchasing power or remain stationary or fall less rapidly (i.e. if the English price-level falls relative to the Indian price-level), it will take more rupees to be worth as much as a pound, i.e. the exchange value of the rupee in terms of the pound will fall.

On the basis of this theory the real explanation for a fall in the Indian exchange should be sought for in the movement of the Indian price-level. Lest there be any doubt regarding the validity of the proposition let us take each of the occasions of the fall and find out whether or not the fall was coincident with the fall in the purchasing power of the rupee.³¹⁴ [pg 199]

TABLE XXXVI

Period I, 1893–98

Years. Currency in Circulation, Rupees + Notes. Index Number of Prices in India 1890–94 = 100. Index Number of Prices in England 1890–94 = 100.

Amount in Crores of Rs. Index Number 1890–94 = 100

(1) (2) (3) (4) (5)

1890 120 92 113 104

1891 131 100 106 105

1892 141 108 100 99

1893 132 101 96 99

1894 129 99 85 93

1895 132 101 89 90

1896 127 97 99 89

1897 125 96 120 90

1898 122 93 109 91

1899 131 100 108 94

TABLE XXXVII

Period II, 1900–1908

Years. Currency in Circulation, Rupees + Notes. Index Number of Prices in India 1890–94 = 100. Index Number of Prices in England 1890–94 = 100.

Amount in Crores of Rs. Index Number 1890–94 = 100

(1) (2) (3) (4) (5)

1900 134 103 126 103

1901 150 115 120 98

1902 143 109 115 96

1903 147 113 111 97

1904 152 116 110 100

1905 164 126 120 100

1906 185 142 134 107

1907 190 145 138 113

1908 181 139 147 104

[pg 200]

TABLE XXXVIII

Period III, 1909–14

315

Years. Currency in Circulation, Rupees + Notes. Index Number of Prices in India 1890–94 = 100. Index Number of Prices in England 1890–94 = 100.

Amount in Crores of Rs. Index Number 1890–94 = 100

(1) (2) (3) (4) (5)

1909 194 152 138 105

1910 199 152 137 110

1911 209 160 139 114

1912 214 164 147 117

1913 238 182 152 124

1914 237 182 156 124

TABLE XXXIX

Period IV, 1915–21

316

Years. Currency in Circulation, Rupees + Notes. Index Number of Prices in India 1913 = 100. Index Number of Prices in England 1913 = 100.

Amount in Crores of Rs. Index Number 1913 = 100.

(1) (2) (3) (4) (5)

1915 266 104 112 127·1

1916 297 116 125 159·5

1917 338 132 142 206·1

1918 407 155 178 226·5

1919 463 180 200 241·9

1920 411 160 209 295·3

1921 393 114 183 182·4

[pg 201] Now do these tables confirm, or do they not, the argument that the fall in the gold value of the rupee is coincident with a fall in the general purchasing power of the rupee? What was the general purchasing power of the rupee when a fall in its gold value occurred? If we scrutinize the facts given in the above tables in the light of this query there can be no doubt as to the validity of this argument. From the tables it will be seen that the gold value of the rupee improved between 1893–1898 because there was a steady if not unbroken improvement in its general purchasing power. Again, on the subsequent occasions when the exchange fell, as it did in 1908, 1914, and 1920, it will be observed that those were the years which marked the peaks in the rising price-level in India; in other words, those were the years in which there was the greatest depreciation in the general purchasing power of the rupee. A further proof, if it be needed, of the argument that the exchange value of the rupee must ultimately be governed by its general purchasing power is afforded by the movements of the rupee-sterling exchange since 1920 (see p. 202).

But, although such is the theoretical view confirmed by statistical evidence of the causes which bring about these periodic falls in the gold value of the rupee (otherwise spoken of as the fall of exchange), it is not shared by the Government of India. The official explanation is that a fall in the gold value of the rupee is due to an adverse balance of trade. Such is also the view of eminent supporters of the exchange standard like Mr. Keynes³¹⁷ and Mr. Shirras.³¹⁸

No doubt some such line of reasoning is responsible for the currency fiasco of 1920. How is it possible otherwise to explain the policy of raising the exchange value of the rupee? Both the Smith Committee on Indian Currency³¹⁹ and the Government of India³²⁰ were aware of the fact that the rupee was heavily depreciated, as evidenced by the rise of prices in India. [pg 202]

TABLE XL

Date. Rupee Prices in India. 1913 = 100. Sterling Prices in England (Statist). 1913 = 100. Average Rate of Exchange London on Calcutta. Rupee-sterling Purchasing Power Parity. 16d. × (Col. 3)/(Col. 2)

(1) (2) (3) (4) d. (5) d.

1920. January 202 289 27·81 22·89

February 203 306 32·05 24·12

March 194 301 29·66 25·40

April 193 300 27·88 26·95

May 190 298 25·91 25·77

June 192 293 23·63 25·08

July 196 282 22·63 24·49

August 193 263 22·75 24·70

September 188 244 22·31 24·94

October 188 232 19·88 24·00

November 186 215 19·69 22·62

December 179 209 17·44 21·81

1921. January 169 200 17·66 21·96

February 164 191 16·31 20·98

March 162 183 15·53 20·40

April 163 186 15·75 19·63

May 170 182 15·44 17·98

June 172 176 15·53 17·14

July 171 163 15·38 17·40

August 178 161 16·25 16·36

September 178 157 17·22 15·82

October 178 156 17·02 14·65

November 173 161 16·25 14·89

December 169 157 15·94 14·86

1922. January 162 156 15·88 15·41

February 159 156 15·59 16·70

March 160 157 15·34 15·70

April 160 159 15·19 15·90

May 162 159 15·59 15·70

June 169 160 15·63 15·14

July 170 158 15·69 14·87

August 166 153 15·66 14·74

Given this fact, any question of raising the gold value of the rupee to 28. gold when the rupee had scarcely the [pg 203] power to purchase 1s. 4d. sterling was out of the question. The Committee indulged in loose talk about stabilizing the Indian exchange. But even from this standpoint the Committee's insistence on linking the rupee to gold must be regarded as a little grotesque. Stable exchange, to use Prof. Marshall's language, is something like bringing the railway gauges of the world in unison with the main line. If that is what is expected from a stable exchange, then what was the use of linking the rupee to gold which had ceased to be the “main line”? What people wanted was a stable exchange in terms of the standard in which prices were measured. Linking to gold involved unlinking to sterling, and it is sterling which mattered and not gold. Given this importance of sterling over gold, was any policy of exchange stabilization called for? First of all it should have been grasped that such a policy could succeed only if it was possible to make sterling and rupee prices move in unison, for then alone could the ratio of interchange between them be the same. What control had the Government of India over the sterling? They might have so controlled the rupee as to produce the effect desired, but all that might have been frustrated by an adverse move in the sterling. The success of the policy of linking to sterling would have been highly problematical although highly desirable. But was it called for? Now the problem of stabilization is primarily a problem of controlling abnormal deviations from the purchasing-power parity between two currencies. In the case of India there were no abnormal deviations from the rupee-sterling purchasing power parity. On the other hand, the Indian exchange was moving in a more or less close correspondence with it. There was therefore no ground for originating any policy of exchange stabilization. But, supposing there were abnormal deviations and that, owing to some reasons known to it, the Committee believed that the exchange value of the rupee was not likely to return to the point justified by its general purchasing power, in that case the Committee should have fixed the exchange value well within the range of the purchasing power of the rupee. As it was, the value fixed [pg 204] by the Committee the rupee never had. In giving a value to the rupee so much above its purchasing-power parity, it is obvious the Committee originated a solution for the simple problem of stabilizing the rupee which involved the much bigger and quite a different problem of deflation or raising the absolute value of the rupee. How was the object to be attained? The Committee never considered that problem. And why? Was it because the price of silver had gone up? Maybe. But it is doubtful whether the Committee could have believed firmly that the value of silver was going to be permanently so high as to require a modification of the gold par. Anyone who cared to scrutinize the rise in the price of silver could have found that the rise was largely speculative and could not have been permanent.

TABLE XLI

Price of Silver in Sterling (Pence)

321

Year Highest. Lowest. Average. Range of Variation.

1913 29⅜ 25 15/16 27 9/16 3 7/16

1914 27¾ 22⅛ 25 5/16 5 5/8

1915 27¼ 22 5/16 23 11/16 4 15/16

1916 37⅛ 26 11/16 31 5/16 10 7/16

1917 55 35 11/16 40 7/8 19 11/16

1918 49½ 42½ 47 9/16 7

1919 79⅛ 47¾ 57 1/16 31⅜

1920 89½ 38⅞ 61 7/16 50⅝

1921 43⅜ 30⅝ 37 12¾

But supposing that the rise in the price of silver was not speculative, did it follow that the rupee was appreciated? The diagnosis of the Committee was an egregious blunder. With the facts laid before the Committee it is difficult to understand how anyone with a mere smattering of the knowledge of price movements could have concluded that because silver had appreciated the rupee had therefore appreciated. On the other hand, what had happened was [pg 205] that the rupee had depreciated in terms of general commodities, including gold and silver. Indeed, the appreciation of silver was a depreciation of the rupee. The following is conclusive evidence of that fact:—

TABLE XLII

Depreciation of the Rupee

Date. Price of Bar Gold in India (Bombay) per Tola of 180 grs. Price of Silver in India (Bombay) per 100 Tolas. Index Number for Prices in India

Rs. A. Rs. A. 1913 = 100.

1914 24 10 65 11 —

1915 24 14 61 2 112

1916 27 2 78 10 125

1917 27 11 94 10 142

1918 (July) 34 0 (May 16) 117 2 178

1918 (Nov. 28) 82 10 —

1918 August 30 0 — —

1918 Sept. 32 4 — —

1919, March 32 0 113 0 200

Thus the rise in the price of silver was a part of the general rise of prices or the depreciation of the rupee. The Committee desired to raise the gold value of the rupee to 10 rupees per sovereign when it cost twice that number of rupees to purchase a sovereign in the market. So marked was the depreciation of the rupee in terms of gold that a few months before the Committee submitted its report the Statesman (a Calcutta paper) wrote:—

“If you land in the country with a sovereign the Government will take it away from you and give you eleven rupees three annas in return. If you are in the country and happen to have a sovereign and take it to the currency office you will get fifteen rupees for it. On the other hand, if you take it to the bazar you will find purchasers at twenty-one rupees.”

These facts were admitted by the Finance Department of [pg 206] the Government of India to be substantially correct,³²² and yet in the face of them the Committee recommended the 2s. gold parity for the rupee. The Committee confused the rupee with the silver, and thus failed to distinguish the problem of retaining the rupee in circulation and raising its exchange value in terms of gold. The latter solution was applicable only if the rupee had appreciated. But as it was silver that had appreciated in terms of the rupee, the only feasible solution was to have proposed the reduction of the fineness of the rupee. Had the Committee regarded silver as a commodity distinct from the rupee like any other commodity to be measured in terms of the rupee as a unit of account, probably it might have avoided committing the blunder which it did. But what is more than probable is that the Committee did not think that the general purchasing power of the rupee was a factor of any moment in the consideration of the matter it was asked to report upon. What was of prime importance in its eyes for the maintenance of the exchange value of the rupee was a favourable balance of trade, and that India had at the time the Committee drafted its Report. For the Committee, in the course of its general observations on the exchange standard, remarked:

“that the system had proved effectual in preventing the fall in the value of the rupee below 1s. 4d., and unless there should have been profound modifications in India's position as an exporting country with a favourable trade balance, there was no reason to apprehend any breakdown in this respect.”³²³

Proceeding on this view of the question it was quite natural for the Committee to have argued that if a favourable balance of trade sustained 1s. 4d. gold exchange, why should a similar balance of trade not sustain 2s. gold exchange?

Again, it is only on some such hypothesis that one can explain why the recommendations of the Committee were adopted at all when the necessity for their adoption had [pg 207] passed away. Even if the intrinsic value of the rupee exceeded its nominal value, there was no danger of a wholesale disappearance of the rupee from circulation in view of the enormous volume of rupees in India.³²⁴ What would have taken place was not a wholesale melting of rupees, but a constant dribble of an irregular and illegal character leading to the contravention of the orders then issued by the Government of India against the melting or exportation of the rupee coin. At the time when the Committee reported (December, 1919) the price of silver was no doubt high, but it was certainly falling during 1920 when the Government took action on the Report. Indeed, on August 31, 1920, when the Bill to alter the gold value of the rupee was introduced into the Council, gold was selling at 23¼ rupees to the tola, while if the sovereign was to be equal to 10 rupees, the market price of gold should have been Rs. 15–14–0 per tola, so that there was a difference of Rs. 7½ or 33 per cent. between the market ratio of gold to the rupee and the new mint ratio. Moreover, the price of silver had also gone down in the neighbourhood of 44d., so that there was no danger of the rupee being melted out of circulation.³²⁵ But, notwithstanding such a disparity, the Government rushed to fix a higher gold parity for the rupee. The financial reason for this rash act was, of course, obvious. The impending constitutional changes were to bring about a complete separation between provincial and imperial finance in British India. Under the old system of finance it was open for the central Government to levy “benevolences” in the form of contributions on the Provincial Governments to meet such of its imperious wants as remained unsatisfied with the help of its own resources, apart from the lion's share it used to take at every settlement of the provincial finance. Under the new constitution it was to be deprived of this power. The Central Government was therefore in search of some resource to obtain relief without [pg 208] appearing to tax anybody in particular. A high exchange seemed to be just the happy means of doing it, for it was calculated to effect a great saving on the “home charges.” But how was this high exchange to be maintained, supposing it was desirable to have a high exchange from the financial point of view?³²⁶ Not only had the price of silver gone down and the rupee shown evident marks of depreciation in terms of gold, but the balance of trade had also become adverse to India at the time when the Government proceeded to take action on the Report of the Committee. But this enactment, so singular in its rashness, was none the less founded upon the hope that the balance of trade would become favourable in time and thus help to maintain the 2s. gold value of the rupee. That this is a correct interpretation of the Governments calculations is borne out by the following extract from the letter which it addressed to the Bengal Chamber of Commerce in explanation of the currency fiasco.³²⁷ After speaking of the necessity for granting international credits to revive commerce, the letter goes on to say:—

“But for the rest they [i.e. the Government of India] can now only rely on the natural course of events and the return of favourable export conditions, combined with the reduction of imports … to strengthen the exchange. Experience has demonstrated that in the present condition of the world trade stability is at present unattainable, but the Government of India see no reason why the operation of natural conditions … should not allow of the eventual fixation of exchange at the level advocated in the report of the Currency Committee.”

Which of the two views is correct? Is it the low purchasing power of the rupee which is responsible for its fall, [pg 209] or is it due to an adverse balance of trade? Now, it must at once be pointed out that an adverse balance of trade, as an explanation of the fall of exchange, is something new in Indian official literature. A fall of exchange was a common occurrence between 1873 and 1893, but no official ever offered the adverse balance of trade as an explanation. Again, can the doctrine of the adverse balance of trade furnish an ultimate explanation for the fall that occurred in 1907, 1914, and 1920? First of all, taking into consideration all the items visible and invisible, the balance-sheet of the trade of a country must balance. Indeed, the disquisitions attached to the Indian Paper Currency Reports, wherein this doctrine of adverse balance as a cause of fall in exchange is usually to be found, never fail to insist that there is no such thing as a “drain” from India by showing item by item how the exports of India are paid for by the imports, even in those years in which the exchange has fallen. The queer thing is, the same Reports persist in speaking of an adverse balance of trade. Given the admission that all Indian exports are paid for, it is difficult to see what remains to speak of as a balance. Why should that part of trade liquidated by money be spoken of as a “balance”? One might as well speak of a balance of trade in terms of cutlery or any other commodity that enters into the trading operations of the country. The extent to which money enters into the trading transactions of two countries is governed by the same law of relative values as is the case with any other commodity. If more money goes out of a country than did previously, it simply means that relatively to other commodities it has become cheaper. But if there is such a thing as an adverse balance in the sense that commodity imports exceed commodity exports, then there arises the further question: Why do exports fall off and imports mount up? In other words, given a normal equilibrium of trade, what causes an adverse balance of trade? For this there is no official explanation. Indeed, the possibility of such a query is not even anticipated in the official literature. But the question is a fundamental one. An adverse balance of trade in the above sense is only another way of stating [pg 210] that the country has become a market which is good to sell in and bad to buy from. Now a market is good to sell in and bad to buy from when the level of prices ruling in that market is higher than the level of prices ruling outside. Therefore, if an adverse balance of trade is the cause of the fall of exchange, and if the adverse balance of trade is caused by internal prices being higher than external prices, then it follows that the fall of exchange is nothing but the currency's fall in purchasing power, which is the same thing as the rise of prices. The adverse balance of trade is an explanation a step short of the final explanation. Try to circumvent the issue as one may, it is impossible to escape the conclusion that the fall in the exchange value of the rupee is a resultant of the fall in the purchasing power of the rupee.

Now what is the cause of the fall in the purchasing power of the rupee? In that confused if not absurd document, the Report of the Price Inquiry Committee,³²⁸ one cause of the rise of prices in India was assigned, among others,³²⁹ to the decline in supplies relatively to population. In view of the more or less generally accepted theory of quantity of a currency as the chief determinant of its value, the line of reasoning adopted by the Committee is somewhat surprising. But there is enough reason to imagine why the Committee preferred this particular explanation of the rise of prices. The position of the Government with regard to the management of the Indian currency is somewhat delicate. Already the issue of paper currency was in the hands of the Government. By the Mint closure it took over the management of the rupee currency as well. Having the entire control over the issue of currency, rupee and paper, the Government becomes directly responsible for whatever consequences the currency might be said to produce. It must [pg 211] not, also, be forgotten that the Government is constantly under fire from an Opposition by no means over-scrupulous in the selection of its counts. As a result of this situation the Government walks very warily, and is careful as to what it admits. Lord Castlereagh, in the debate on Horner's resolution of 1811 stating that bank notes were depreciated by over-issue, asked the House of Commons to consider what Napoleon would do if he found the House admitting the depreciation even if it was a fact. The Government of India is in the same position, and had to think what the Opposition would do if it admitted this or that principle. The reason why the Government of India adheres to the adverse balance of trade as an explanation of the fall of exchange is the same which led the Committee to ascribe the rise of prices to the shortage of goods. Both the doctrines have the virtue of placing the events beyond the control of the Government and thus materially absolving the Government from any blame that might be otherwise cast upon it. What can the Government do if the balance of trade goes wrong? Again, is it a fault of the Government if the supply of commodities declines? The Government can move safely under the cover of such a heavy armour!³³⁰ But does the explanation offered by the Committee invalidate the excess of currency as an explanation of the rise of prices in India? The value of money is a resultant of an equation of exchange between money and goods. To that equation there are obviously two sides, the money side and the commodity side. It is an age-worn dispute among economists as to which of the two is the decisive factor when the result of the equation of exchange undergoes a change, i.e. when [pg 212] the general price-level changes. There are economists who when discussing the value or the general purchasing power of money emphasize the commodity side in preference to the money side of the equation as the chief determinant of it. To them if prices in general fall it may not be due to scarcity of money; on the other hand, it may be due to an increase in the volume of commodities. Again, if prices in general rise they prefer to ascribe it to a decrease in the volume of commodities rather than to an increase in the quantity of money. It is possible to take this position, as some economists choose to do, but to imagine that the quantity theory of money is thereby overthrown is a mistake. As a matter of fact, in taking that position they are not damaging the quantity theory in the least. They are merely stating it differently. The weakness of the position consists in failing to take note of what the effect on the general price-level would be if in speaking of increase or decrease of commodities they included a corresponding increase or decrease of currency. If the volume of commodities increases, including the volume of currency, then there is no reason why general prices should fall. Similarly if the volume of commodities decreases, including the volume of currency, then there is no reason why general prices should rise. The commodity explanation is but the reverse side of the quantity explanation of the value of money. Recasting the argument of the Committee in the light of what is said above, we can say without departing from its language that the rise of prices in India was due to the supply of currency not having diminished along with the diminution in the supply of goods. In short, the rupee fell in purchasing power because of currency being issued in excess, and there is scarcely any doubt that there has been a profuse issue of money in India since the closing of the Mints in 1893.

The first period, from 1893–98, was comparatively speaking the only period marked by a rather halting and cautious policy in respect of currency expansion. The reason no doubt was the well-known fact that at the time the Mints were closed the currency was already redundant. Yet the [pg 213] period was not immune from currency expansion.³³¹ At the time the Mints were closed the silver bullion then in the hands of the people was depreciated as a result of the fall in its value due to the closure. An agitation was set up by interested parties to compel the Government to make good the loss. Ultimately, the Government was prevailed upon by Sir James Mackay (now Lord Inchcape), the very man who forced Government to close the Mints, to take the silver from the banks. The Government proposed to the Secretary of State that they be allowed to sell the silver even at a loss rather than coin and add to the already redundant volume of currency. The Secretary of State having refused, the silver was coined and added to the currency. The stoppage of Council Bills in 1893–94 had temporarily accumulated a large number of rupees in their Treasuries, a transaction which practically amounted to a contraction of currency. But the Government later decided to spend them on railway construction—a policy tantamount to an addition to currency. The resumption of Council Bills after 1894 had also the same effect, for a sale of bills involves an addition to currency. In view of the heavy cost of financing the Home Treasury by gold borrowings, the resumption of sale was a pardonable act. But what was absolutely unpardonable was the increase in the fiduciary portion of the paper-currency reserve from 8 to 10 crores,³³² thereby putting 2 crores of coined rupees into circulation, particularly so because the Finance Minister refused to pay any heed to its incidence on the currency policy, arguing:—

“I am a little doubtful whether, in discussing the question of the investment of the currency reserve, we are at liberty to look at outside considerations of that kind.”³³³

All told, the additions to the currency during the first period were negligible as compared to what took place in the second period, 1900–1908. This period was characterized [pg 214] by a phenomenal increase in the volume of currency poured by the Government into circulation. Speaking of the coinage of rupees during this period, Mr. Keynes, anything but an unfriendly critic of the Government's policy, observed³³⁴:—

“The coinage of rupees recommenced on a significant scale in 1900 a steady annual demand for fresh coinage (low in 1901–2, high in 1903–4, but at no time abnormal), and the Mints were able to meet it with time to spare, though there was some slight difficulty in 1903–4. In 1905–6 the demand quickened, and from July 1905 it quite outstripped the new supplies arising from the mintage of the uncoined silver. … This slight scare, however, was more than sufficient to make the Government lose their heads. Having once started on a career of furious coinage, they continued to do so with little regard to considerations of ordinary prudence … without waiting to see how the busy seasons of 1906–7 would turn out, they coined heavily throughout the summer months. … During the summer of 1907, as in the summer of 1906, they continued to coin without waiting until the prosperity of the season 1907–8 was assured.”

Evidently in this period the Government framed their policy “as though a community consumed currency with the same steady appetite with which some communities consume beer.” The period also witnessed a material expansion of the paper currency. Up to 1903 the use of the currency notes was limited by reason of the fact that they were not only not legal tender outside their circle of issue, but also because their encashability was restricted to the offices of the circles of their issue. This was a serious limitation on the extension of paper currency in India. By Act VI of 1903 the Rs. 5 was made universal in British India excepting Burma, i.e. was made legal tender in all circles, and also encashable at all offices of issue. Along with this the fiduciary portion of the paper-currency reserve was increased to Rs. 12 crores by Act III of 1905. The first event was only calculated to enlarge the circulation of the [pg 215] notes, but the second event had the direct effect of lowering the value of the rupee currency.

The third period (1909–14) was comparatively a moderate but by no means a slack period from the standpoint of currency expansion in India. The first three years of the period were, so to say, years of subdued emotion with regard to the rupee coinage. With the exception of the year 1910, when there was no net addition to rupee coinage, and 1911, when the addition was a small one, the coinage in the years 1909 and 1912 ranged from 24 to 30 lakhs. But during the last two years of this period there was a sudden burst of rupee coinage, when the total reached 264 crores. The expansion of paper currency took place also on a great scale during this period. In 1909 the Rs. 5 were universalized in Burma as they had previously been in other parts of India. This process of universalization was carried further during this period, when, under the authority granted by the Paper Currency Act (II of 1910), the Government universalized notes of Rs. 5 and Rs. 50 in 1910, of Rs. 100 in 1911. Along with the stimulus thus given to the increase of paper currency, the Government actually expanded the fiduciary portion of the issue from 12 to 14 crores by Act VII of 1911, thereby throwing into circulation 2 crores of additional rupees.

During the fourth period (1915–1920) all prudential restraints were thrown overboard.³³⁵ The period coincided with the Great War, which created a great demand for Indian produce and also imposed upon the Government the necessity for meeting large expenditure on behalf of H.M. Government. Both these events necessitated a great increase in the current means of purchase. There were three sources open to the Government to provide for the need: (1) Importation of gold; (2) increase of rupee coinage; and (3) increase of paper currency. It must not be supposed that the Government of India had no adequate means to provide the necessary currency. Whatever [pg 216] expenditure the Government of India incurred in India, the Secretary of State was reimbursed in London. So the means were ample. The difficulty was that of converting them to proper account. Ordinarily the Secretary of State purchases silver out of the gold at his command to be coined in India into rupees, This usual mode was followed for the first two years of the period, and the currency was augmented by that means. But the rise in the price of silver made that resource less available. The Secretary of State had therefore to choose between sending out gold or issuing paper. Of the two, the former was deemed to be too unpatriotic. Indeed, the Secretary of State believed that from an Imperial point of view it was entirely ungracious even to “earmark” the gold he received in London as belonging to India. But how was demand for additional currency in India to be met? As a result of deliberation it was agreed that to provide currency in India without employing gold the best plan was for the Secretary of State to invest at one end the gold he received on India's behalf in the purchase of British Treasury bills, and the Indian Government to issue currency notes at the other end on the security of these bills. Such a procedure, it will be observed, involved a profound modification in the basic theory of Indian paper currency. That theory was to increase the fiduciary issue by investing a portion of the metallic reserves only when the proportion of the latter to the total of the notes in active circulation had shown, over a considerable period, a position sufficiently strong to warrant an extension of the invested reserves and a corresponding diminution of the metallic reserves. The main effect of the principle was that the extent of the paper currency was strictly governed by the habits of the people, for whatever the amount of fiduciary issue at any given moment it represented metallic reserves which were once in existence. Under the new scheme the old principle was abandoned and paper currency was issued without any metallic backing, and what is more important is that its magnitude, instead of being determined by the habits of the people, was determined by the necessity of the Government and the amount of security it possessed. [pg 217]

This fatal and facile procedure was adopted by the Government of India with such avidity that within four years it passed one after another eight Acts, increasing the volume of notes issuable against securities. The following table gives the changes in the limits fixed by the Act. and the total issues actually made under them:—

TABLE XLIII

Issue of Currency Notes

Acts prescribing the Fiduciary Issue of Currency Notes.

I. Limits to fiduciary issues Act V of 1915 Act IX of 1916 Act XI of 1917 Act XIX of 1917 Act VI of 1918 Act II of 1919 Act XXVI if 1919

In Lakhs of Rupees.

(a) Permanent 14,00 14,00 14,00 14,00 14,00 14,00 14,00

(b) Temporary 6,00 12,00 36,00 48,00 72,00 86,00 106,00

Total limit 20,00 26,00 50,00 62,00 86,00 100,00 120,00

II. Total issues of currency notes 61,63 67,73 86,38 99,79 153,46 179,67³³⁶

III. Reserve Silver 32,34 23,57 19,22 10,79 37,39 47,44

Gold 15,29 24,16 18,67 27,52 17,49 32,70

Securities 14,00 20,00 48,49 61,48 98,58 99,53

But this facile procedure could not be carried on ad infinitum except by jeopardizing the convertibility of the notes. Consequently the very increase of paper money, added to the increased demand for currency, compelled the Government to go in for the provision of metallic money for providing current means of purchase and also give a backing to the watered paper issues. The rising price of silver naturally made the Government go in for gold. An Ordinance was issued on June 29, 1917, requiring all gold imported into India to be sold to Government at a price based on the sterling exchange, and opened a gold Mint at [pg 218] Bombay for the coinage of it into mohurs.³³⁷ Frantic efforts were made to acquire gold from various quarters. The removal of the embargo on the export of gold by the U.S.A. on June 9, 1917, and the freeing of the market for South African and Australian gold, enabled the Government to obtain some supply of that metal. From July 18, 1919, immediate telegraphic transfers on India were offered against deposit at the Ottawa Mint in Canada of gold coin or bullion at a rate corresponding to the prevailing exchange rate, and at New York at competitive tenders from August 22, 1919. Arrangements were also made for the direct purchase of gold in London and U.S.A. Finally, to encourage the private import of gold, the acquisition rate was altered from September 15, 1919, so as to make allowance for the depreciation of the sterling. But the gold thus obtained was a negligible quantity. Besides, the issue of gold did not serve the purpose the Government had in mind—namely its retention in circulation. In the nature of things it was impossible. The rupee was depreciated in terms of gold to an enormous extent, and consequently at the rate of exchange gold passed out of circulation as quickly as it was issued by the Government. What the Government could do was to make the use of gold and silver coins illegal for other than currency purposes and to prevent their exportation, which it did by the Notifications of June 29 and September 3, 1917. Realizing that it could not rely upon gold, the Government renewed its efforts to enlarge the rupee coinage. To facilitate the purchase of that metal the import of silver on private account into India was prohibited on September 3, 1917. This measure, however, removed only a few of the smaller competitors for the world's diminished supply of silver, and the world-demand remained so heavy that the Secretary of State was unable to obtain sufficient supply notwithstanding the great conservation effected in the use of silver by substituting nickel coinage for silver coins of subsidiary order,³³⁸ and by the issue of notes of denominations [pg 219] as low as that of R.1³³⁹ and of R.2–8.³⁴⁰ The Government of the United States was therefore approached on the subject of releasing a portion of the silver dollars held in their reserve. The American Government consented and passed the Pittman Act, under which the Government of India acquired a substantial volume at 101½ cents per fine ounce. The total silver purchased during this period was as follows:

TABLE XLIV

Rupee Coinage, 1915–20

Year. Silver purchased in Open Market, Standard Ounces. Silver purchased from U.S.A., Standard Ounces. Total Standard Ounces.

1915–16 8,636,000 — —

1916–17 124,535,000 — —

1917–18 70,923,000 — —

1918–19 106,410,000 152,518,000 —

1919–20 14,108,000 60,875,000 —

— — —

Total 324,612,000 213,393,000 538,005,000

Now, recalling the fact that from 1900 to 1914 the Government had coined about 532 million standard ounces of silver,³⁴¹ it means that the coinage of silver by Government during these five years exceeded the amount coined in the fourteen preceding years by five million ounces.

Thus the fall in the gold value of the rupee is an inevitable consequence of the exercise of the power to issue inconvertible currency in unlimited quantities. This is the fate of all inconvertible currencies known to history. But it is said that an exception must be made in the case of the rupee [pg 220] currency, for if the Government has the liberty of issuing it in unlimited quantities it has also resources to counteract the effects of a fall when it does occur. We must therefore turn to an examination of these resources.

The basis of the reasoning is that the rupee is a token currency, and that if the value of a token currency is maintained at par with gold by applying to it the principle of redemption into gold³⁴² it should be possible to maintain the value of the rupee at par with gold by adopting a similar mechanism. What is wanted is an adequate gold fund, and so long as the Government has it, we are assured that we need have no anxiety on the score of a possible fall in the value of the rupee. Such a fund the Government of India has, and on all the three occasions when the gold value of the rupee fell below par that fund was operated upon, The process of redemption is carried on chiefly in three ways: (1) The sale of what are called reverse councils, by which the Government receives rupees in India in return for gold in London; (2) the release of gold internally in receipt for rupees in India; and (3) the stoppage of the Secretary of State's council bills to prevent further rupees from going into circulation. The cumulative effect of these, it is said, is to contract the currency and raise its value to par. Although all the three may be employed, the first is by far the most important means adopted by the Government in carrying through this process of redemption. The extent of the redemption effected on the three occasions when it was employed may be seen from the three following tables:— [pg 221]

I. Redemption of Currency, 1907–8.

TABLE XLV

Date. By the Sale of Reverse Councils. By Release of Gold. Diminution of Govt. Stock of Gold during the Month. Private Exports of Gold Coin during the Month. Drawings of the Secretary of State.

Amount offered. Amount sold.

£ £ £ £ £

1907—

Sept. — — 152,000 14 858,896

Oct. — — 254,000 9,109 921,678

Nov. — — 532,000 3 427,344

Dec. — — 338,000 2,501 571,905

1908—

March 26 500,000 70,000 226,000 — 172,699 (for the whole month)

April 2 500,000 449,000 461,000 — 66,834

April 9 500,00 340,000

April 16 500,000 441,000

April 23 500,000 329,000

April 30 500,000 205,000

May 7 500,000 81,000 645,000 — 62,764

May 14 500,000 145,000

May 21 820,000 793,000

May 28 500,000 500,000

June 4 1,000,000 755,000 334,000 — 169,810

June 11 1,000,000 70,000

June 18 500,000 Nil

June 25 500,000 50,000

July 2 500,000 470,000 16,000 — 186,847

July 9 500,000 304,000

July 16 500,000 500,000

July 23 1,000,000 968,000

July 30 1,000,000 860,000

Aug. 6 1,000,000 418,000 354,000 — 262,217

Aug. 13 500,000 310,000

Aug. 20 500,000 Nil

Aug. 27 500,000 Nil

Sept. 3 500,000 Nil 502,000 — 1,431,012

Sept. 10 500,000 Nil

Total 15,320,000 8,058,000 4,394,000 249,912

[pg 222]

II. Redemption in 1914–16

TABLE XLVI

Date. Reverse Councils (in £, 000). Drawings of the S. of S. (in Lakhs of Rs.).

1914. April Nil 270

May Nil 61

June Nil 68

July Nil 66

August 2,778 72

September 1,515 25

October 1,895 41

November 1,044 32

December 1,250 30

1915. January 225 29

February Nil 181

March Nil 287

Total 8,707 1,162

1915. April Nil 1,53

May Nil 1,03

June 651 17

July 3,377 8

August 815 23

September 50 2,17

October Nil 2,25

November Nil 2,02

December Nil 3,28

January Nil 5,26

February Nil 6,02

March Nil 6,33

Total 4,893 30,37

[pg 223]

III. Redemption in 1920

TABLE XLVII

Sale of Reverse Councils (Figures in Thousands of Pounds)

Date of Sale. Amount offered at each Sale. Amount applied for at each Sale. Amount sold at each Sale. Progressive Total of Amount sold.

1920. January 2 1,000 770 770 770

January 8 1,000 8,499 990 1,760

January 15 2,000 300 300 2,060

January 22 2,000 4,890 2,000 4,060

January 29 2,000 1,334 5,000 5,394

February 5 2,000 32,390 2,000 7,394

February 12 2,000 41,312 2,000 12,394

February 19 2,000 122,335 2,000 14,394

February 26 2,000 78,417 2,00 16,394

March 3 2,000 64,931 2,000 18,394

March 11 2,000 117,185 2,000 20,394

March 18 2,000 153,559 2,000 22,394

March 25 2,000 56,295 2,000 24,394

March 31 2,000 35,050 1,988 26,382

April 1

April 8 2,000 16,721 1,000 28,382

April 15 2,000 48,270 2,000 30,382

April 22 2,000 59,020 2,000 32,382

April 29 1,000 53,210 1,000 33,382

May 6 1,000 89,514 1,000 34,382

May 13 1,000 101,625 1,000 35,382

May 20 1,000 122,279 1,000 36,382

May 26 1,000 85,620 1,000 37,382

June 3 1,000 101,821 1,000 38,382

June 10 1,000 109,245 1,000 39,382

June 15 1,000 122,991 1,000 40,382

June 24 1,000 73,391 1,000 41,382

July 1 1,000 106,751 1,00 42,382

July 8 1,000 63,690 1,000 43,382

July 15 1,000 101,830 1,000 44,382

July 22 1,000 103,960 1,000 45,382

July 29 1,000 75,486 1,000 46,382

August 5 1,000 101,260 1,000 47,382

August 12 1,00 112,230 1,000 48,382

August 19 1,000 114,767 1,000 49,382

August 26 1,000 117,390 1,000 50,382

Sept. 2 1,000 126,425 1,000 51,382

Sept. 7 1,000 117,200 1,000 52,382

Sept. 13 1,000 115,095 1,000 53,382

Sept. 21 1,000 112,590 1,000 54,382

Sept. 28 1,000 120,050 1,000 55,382

[pg 224] Not only did the Government sell reverse councils on a large scale, but it also sold gold for rupees for internal circulation, a thing which it seldom did before.

III. Redemption in 1920

TABLE XLVIII

Sale of Gold

No. of Sale. Date of Sale. Minimum Rate of accepted Tenders. Average Rate of accepted Tenders. Quantity sold (in Tolas). Price of Country Bar Gold in the Bombay Bazaar.

Rs. A. P. Rs. A. P. Rs. A. P.

1 1919, September 3 25 8 0 26 12 1 3,29,130 28 10 0

2 September 17 24 8 0 24 10 0 3,96,640 26 1 0

3 October 6 25 8 0 25 9 8 3,26,000 27 0 0

4 October 20 26 15 3 27 0 2 3,34,000 28 0 0

5 November 3 27 14 6 27 15 6 3,25,000 28 5 0

6 November 17 26 15 0 27 0 11 5,18,500 28 2 0

7 December 8 26 0 6 26 4 6 10,00,650 27 10 0

8 1920. January 5 26 4 3 26 7 9 7,63,300 27 3 0

9 January 19 26 13 3 26 14 7 8,00,000 27 5 0

10 February 5 25 2 3 25 9 7 7,56,450 25 6 0

11 February 19 16 2 3 21 9 1 9,60,590 23 4 0

12 March 3 18 8 0 18 12 4 12,96,125 21 7 0

13 March 17 21 6 0 21 7 7 12,53,325 22 13 0

14 April 7 22 7 3 22 9 4 12,46,200 24 0 0

15 April 21 23 7 4 23 8 6 10,68,175 24 4 0

16 May 5 20 13 3 21 3 2 11,96,750 21 8 0

17 May 19 21 0 3 21 1 7 12,46,050 21 12 0

18 June 9 21 8 9 21 9 8 11,32,350 22 2 6

19 June 23 20 14 10 21 0 5 12,25,250 21 8 0

20 July 7 21 1 4 22 2 2 12,81,500 21 6 0

21 July 21 22 0 1 22 0 11 12,42,000 22 5 0

22 August 4 22 5 6 23 6 3 12,78,950 22 7 0

23 August 19 23 9 4 23 10 2 5,54,500 23 7 0

24 September 1 22 8 3 22 10 8 8,27,700 23 1 6

25 September 14 23 9 4 23 12 11 2,30,500 23 8 0

Total 2,15,89,635

During 1920 no council bills were drawn by the Secretary of State on the Government of India.

The success of this mechanism on the two previous occasions had strengthened the belief that it had the virtue of restoring the value of the rupee. But the failure of this mechanism in the crisis of 1920 compels one to adopt an attitude of reserve towards its general efficacy. It cannot be said that exchange gave way because this mechanism [pg 225] was not brought into operation. On the other hand, the view of the Government regarding the sale of reverse councils in 1920 had undergone a profound modification as compared with the view it held during the crisis of 1907–8. In that crisis the Government behaved like a miser, sitting tight on its gold reserve and refusing to use it for the very purpose which it was designed to serve. An Accountant-General had “to go on his knees” to persuade the Government of India, to release its gold.³⁴³ It was probably because it was rebuked by the Chamberlain Commission for failing to make use of its gold reserve in 1907 that in the crisis of 1920 the policy of selling reverse councils was so boldly conceived. There was a great deal of ignorant criticism of that policy from the general public that it was an “organized loot.” But the Finance Minister was undaunted, and argued³⁴⁴:—

“It is an essential feature of our exchange policy … that we should not only provide for remittances from London to India through council bills at approximately gold point, but from India to London in time of exchange weakness also at gold point, through the sale of sterling remittance known as reverse councils. It is simply an alternative to the export of gold. This is no new matter—we have been selling reverse councils for years … and unless we do so the exchange policy does not become effective. … This is the reason, and the only reason, why we have sold reverse councils. … It is an effort in fact to maintain exchange as near as possible to the gold point. … What would be the consequence if we yielded to the pressure placed on us and ceased to sell reverse councils at all? I can understand a demand that reverse councils should be sold by some different method, or at rates different from those at present in force, but I must confess that I cannot understand the demand that the facilities for the exchange of rupees into external currency should be entirely withdrawn. I see that in Bombay it is urged that we should let exchange find its ‘natural level.’ That is a catchword which does not impress me. Used in the sense in which that phrase has been recently [pg 226] used, there is no such thing as a ‘natural level’ in exchange, for, when one translates the internal currency into another currency, there must be some sort of common denominator to which both currencies can be brought; it may be gold, it may be silver, it may be sterling or it may be Spanish pesetas, which we take as our basis. The rupee must be linked on to something,³⁴⁵ and if it is so linked, then it must be at some definite rate, and this necessarily involves that we must sometimes be prepared to sell reverse councils in order to maintain that rate. If reverse councils be withdrawn entirely, then we should have neither a gold standard, nor a gold-exchange standard, nor any kind of standard at all.”

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

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.

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.

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).

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]