Indian Currency and Finance

by John Maynard Keynes

8. To illustrate how rare a thing in Europe a perfect and automatic gold standard is, let us take the most recent occasion of stringency—November 1912. The Balkan War was at this time at an acute stage, but the European situation was only moderately anxious. Compared with the crisis at the end of 1907, the financial position was one of comparative calm. Yet in the course of that month there was a premium on gold of about ¾ per cent in France, Germany, Russia, Austria–Hungary,[9] and Belgium. So high a premium as this is as effective in retaining gold as a very considerable addition to the bank rate. If, for example, the premium did not last more than three months, it would add to the profits of a temporary deposit of funds for that period as much as an addition of 3 per cent to the discount rate; or, to put it the other way round, there would need to be an additional profit of 3 per cent elsewhere if it were to be worth while to send funds abroad.

9. The growing importance of foreign bills in the portfolios of the Reichsbank has been shown above. The importance of foreign bills and credits in the policy of the Austro–Hungarian Bank is of longer standing and is better known. They always form an important part of its reserves, and the part first utilised in times of stringency.[10] It was supposed that in the third quarter of 1911 the Bank placed not less than £4,000,000 worth of gold bills at the disposal of the Austro–Hungarian market in order to support exchange. Amongst European countries, Russia now keeps the largest aggregate of funds in foreign bills and in balances abroad—amounting in November 1912 to £26,630,000.[11] Account being taken of their total resources, however, the banks of the three Scandinavian countries, Sweden, Norway, and Denmark, hold the highest proportion in the form of balances abroad—amounting in November 1912, for the three countries in the aggregate, to about £7,000,000. These are enough examples for my purpose.

10. What is the underlying significance of this growing tendency on the part of European State Banks to hold a part of their reserves in foreign bills or foreign credits? We saw above that the bank–rate policy of the Bank of England is successful because by indirect means it causes the Money Market to reduce its short–period loans to foreign countries, and thus to turn the balance of immediate indebtedness in our favour. This indirect policy is less feasible in countries where the Money Market is already a borrower rather than a lender in the international market. In such countries a rise in the bank–rate cannot be relied on to produce the desired effect with due rapidity. A direct policy on the part of the Central Bank, therefore, must be employed. If the Money Market is not a lender in the international market, the Bank itself must be at pains to become to some extent one. The Bank of England lends to middlemen who, by holding bills or otherwise, lend abroad. A rise in the bank rate is equivalent to putting pressure on these middlemen to diminish their commitments. In countries where the Money Market is neither so highly developed nor, in relation to foreign countries, so self–supporting, the Central Bank, if it is to be secure, must take the matter in hand itself and, by itself entering the international money market as a lender at short notice, place itself in funds, at foreign centres, which can be rapidly withdrawn when they are required. The only alternative would be the holding of a much larger reserve of gold, the expense of which would be nearly intolerable. The new method combines safety with economy. Just as individuals have learnt that it is cheaper and not less safe to keep their ultimate reserves on deposit at their bankers than to keep them at home in cash, so the second stage of monetary evolution is now entered on, and nations are learning that some part of the cash reserves of their banks (we cannot go further than this at present) may be properly kept on deposit in the international money market. This is not the expedient of second–rate or impoverished countries; it is the expedient of all those who have not attained a high degree of financial supremacy—of all those, in fact, who are not themselves international bankers.

11. In the forty years, therefore, during which the world has been coming on to a gold standard (without, however, giving up for that reason its local currencies of notes or token silver), two devices—apart from the bullion reserve itself and the bank rate—have been evolved for protecting the local currencies. The first is to permit a small variation in the ratio of exchange between the local currency and gold, amounting perhaps to an occasional premium of ¾ per cent on the latter; this may help to tide over a stringency which is seasonal or of short duration without raising to a dangerous level the rate of discount on purely local transactions. The second is for the Government or Central Bank to hold resources available abroad, which can be used for maintaining the gold parity of the local currency, when there is the need for it.

12. We are now more nearly in a position to come back to the currency of India herself, and to see it in its proper relation to those of other countries. At one end of the scale we have Great Britain and France—creditor nations in the short–loan market.[12] In an intermediate position comes Germany—a creditor in relation to many of her neighbours, but apt to be a debtor in relation to France, Great Britain, and the United States. Next come such countries as Russia and Austria–Hungary—rich and powerful, with immense reserves of gold, but debtor nations, dependent in the short–loan market on their neighbours. From the currencies of these it is an easy step to those of the great trading nations of Asia—India, Japan, and the Dutch East Indies.

13. I say that from the currencies of such countries as Russia and Austria–Hungary to those which have explicitly and in name a Gold–Exchange Standard[13] it is an easy step. The Gold–Exchange Standard is simply a more regularised form of the same system as theirs. In their essential characteristics and in the monetary logic which underlies them the currencies of India and Austria–Hungary (to take these as our examples) are not really different. In India we know the extreme limits of fluctuation in the exchange value of the rupee; we know the precise volume of reserves which the Government holds in gold and in credits abroad; and we know at what moment the Government will step in and utilise these resources for the support of the rupee. In Austria–Hungary the system is less automatic, and the Bank is allowed a wide discretion. In detail, of course, there are a number of differences. India keeps a somewhat higher proportion of her reserves in foreign credits, and keeps some part of these credits in a less liquid form. She also keeps a portion of her gold reserve in London—a practice made possible by the fact that for India London is not strictly a foreign centre. On the other hand, India is probably more willing than the Bank of Austria–Hungary to supply gold on demand. If we are to judge from the experience of recent years, India inclines to use her gold reserves, Austria–Hungary her foreign credits, first. But in the essentials of the Gold–Exchange Standard—the use of a local currency mainly not of gold, some degree of unwillingness to supply gold locally in exchange for the local currency, but a high degree of willingness to sell foreign exchange for payment in local currency at a certain maximum rate, and to use foreign credits in order to do this—the two countries agree.

14. To say that the Gold–Exchange Standard merely carries somewhat further the currency arrangements which several European countries have evolved during the last quarter of a century is not, of course, to justify it. But if we see that the Gold–Exchange Standard is not, in the currency world of to–day, anomalous, and that it is in the main stream of currency evolution, we shall have a wider experience, on which to draw, in criticising it, and may be in a better position to judge of its details wisely. Much nonsense is talked about a gold standard’s properly carrying a gold currency with it. If we mean by a gold currency a state of affairs in which gold is the principal or even, in the aggregate, a very important medium of exchange, no country in the world has such a thing.[14] Gold is an international, but not a local currency. The currency problem of each country is to ensure that they shall run no risk of being unable to put their hands on international currency when they need it, and to waste as small a proportion of their resources on holdings of actual gold as is compatible with this. The proper solution for each country must be governed by the nature of its position in the international money market and of its relations to the chief financial centres, and by those national customs in matters of currency which it may be unwise to disturb. It is as an attempt to solve this problem that the Gold–Exchange Standard ought to be judged.

15. We have been concerned so far with transitional systems of currency. I will conclude this chapter with a brief history in outline of the Gold–Exchange Standard itself. It will then be time to pass from high generalities to the actual details of the Indian system.

The Gold–Exchange Standard arises out of the discovery that, so long as gold is available for payments of international indebtedness at an approximately constant rate in terms of the national currency, it is a matter of comparative indifference whether it actually forms the national currency.

The Gold–Exchange Standard may be said to exist when gold does not circulate in a country to an appreciable extent, when the local currency is not necessarily redeemable in gold, but when the Government or Central Bank makes arrangements for the provision of foreign remittances in gold at a fixed maximum rate in terms of the local currency, the reserves necessary to provide these remittances being kept to a considerable extent abroad.