Indian Currency and Finance

by John Maynard Keynes

THE GOLD–EXCHANGE STANDARD

1. If we are to see the Indian system in its proper perspective, it is necessary to digress for a space to a discussion of currency evolution in general.

My purpose is, first, to show that the British system is peculiar and is not suited to other conditions; second, that the conventional idea of “sound” currency is chiefly derived from certain superficial aspects of the British system; third, that a somewhat different type of system has been developed in most other countries; and fourth, that in essentials the system which has been evolved in India conforms to this foreign type. I shall be concerned throughout this chapter with the general characteristics of currency systems, not with the details of their working.

2. The history of currency, so far as it is relevant to our present purpose, virtually begins with the nineteenth century. During the second quarter of this century England was alone in possessing an orthodox “sound” currency on a gold basis. Gold was the sole standard of value; it circulated freely from hand to hand; and it was freely available for export. Up to 1844 bank notes showed a tendency to become a formidable rival to gold as the actual medium of exchange. But the Bank Act of that year set itself to hamper this tendency and to encourage the use of gold as the medium of exchange as well as the standard of value. This Act was completely successful in stopping attempts to economise gold by the use of notes. But the Bank Act did nothing to hinder the use of cheques, and the very remarkable development of this medium of exchange during the next fifty years led in this country, without any important development in the use of notes or tokens, to a monetary organisation more perfectly adapted for the economy of gold than any which exists elsewhere. In this matter of the use of cheques Great Britain has been followed by the rest of the English–speaking world—Canada, Australia, South Africa, and the United States of America. But in other countries currency evolution has been, chiefly, along different lines.

3. In the early days of banking of the modern type in England, gold was not infrequently required to meet runs on banks by their depositors, who were always liable in difficult times to fall into a state of panic lest they should be unable to withdraw their deposits in case of real need. With the growth of the stability of banking, and especially with the growth of confidence in this stability amongst depositors, these occasions have become more and more infrequent, and many years have now passed since there has been any run of dangerous proportions on English banks. Gold reserves, therefore, in Great Britain are no longer held primarily with a view to emergencies of this kind. The uses of gold coin in Great Britain are now three—as the medium of exchange for certain kinds of out–of–pocket expenditure, such as that on railway travelling, for which custom requires cash payment; for the payment of wages; and to meet a drain of specie abroad.

Fluctuations in the demand for gold in the first two uses are of secondary importance, and can usually be predicted with a good deal of accuracy,—at holiday seasons, at the turn of the quarter, at the end of the week, at harvest. Fluctuations in the demand in the third use are of greater magnitude and, apart from the regular autumn drain, not so easily foreseen. Our gold reserve policy is mainly dictated, therefore, by considerations arising out of the possible demand for export.

To guard against a possible drain of gold abroad, a complicated mechanism has been developed which in the details of its working is peculiar to this country. A drain of gold can only come about if foreigners choose to turn into gold claims, which they have against us for immediate payment, and we have no counterbalancing claims against them for equally immediate payment. The drain can only be stopped if we can rapidly bring to bear our counterbalancing claims. When we come to consider how this can best be done, it is to be noticed that the position of a country which is preponderantly a creditor in the international short–loan market is quite different from that of a country which is preponderantly a debtor. In the former case, which is that of Great Britain, it is a question of reducing the amount lent; in the latter case it is a question of increasing the amount borrowed. A machinery which is adapted for action of the first kind may be ill suited for action of the second. Partly as a consequence of this, partly as a consequence of the peculiar organisation of the London Money Market, the “bank rate” policy for regulating the outflow of gold has been admirably successful in this country, and yet cannot stand elsewhere unaided by other devices. It is not necessary for the purposes of this survey to consider precisely how changes in the bank rate affect the balance of immediate indebtedness. It will be sufficient to say that it tends to hamper the brokers, who act as middlemen between the British short–loan fund and the foreign demand for accommodation (chiefly materialised in the offer of bills for discount), and to cause them to enter into a less volume of new business than that of the short loans formerly contracted and now falling due, thus bringing to bear the necessary counterbalancing claims against foreign countries.

4. The essential characteristics of the British monetary system are, therefore, the use of cheques as the principal medium of exchange, and the use of the bank rate for regulating the balance of immediate foreign indebtedness (and hence the flow, by import and export, of gold).

5. The development of foreign monetary systems into their present shapes began in the last quarter of the nineteenth century. At that time London was at the height of her financial supremacy, and her monetary arrangements had stood the test of time and experience. Foreign systems, therefore, were greatly influenced at their inception by what were regarded as the fundamental tenets of the British system. But foreign observers seem to have been more impressed by the fact that the Englishman had sovereigns in his pocket than by the fact that he had a cheque–book in his desk; and took more notice of the “efficacy” of the bank rate and of the deliberations of the Court of Directors on Thursdays, than of the peculiar organisation of the brokers and the London Money Market, and of Great Britain’s position as a creditor nation. They were thus led to imitate the form rather than the substance. When they introduced the gold standard, they set up gold currencies as well; and in several cases an official bank rate was established on the British model. Germany led the way in 1871–73. Even now apologists of the Reichsbank will sometimes speak as if its bank rate were efficacious by itself in the same manner as the Bank of England’s. But, in fact, the German system, though ostensibly modelled in part upon the British system, has become, by force of circumstances, essentially different.

It is not necessary for this survey to consider individual systems in any detail. But, confining ourselves to European countries, whether we consider, for example, France, Austria–Hungary, Russia, Italy, Sweden, or Holland, while most of these countries have a gold currency and an official Bank Rate, in none of them is gold the principal medium of exchange, and in none of them is the bank rate their only habitual support against an outward drain of gold.