THE PROBLEM OF THE RUPEE:
ITS
ORIGIN AND ITS SOLUTION
(HISTORY OF INDIAN CURRENCY & BANKING)
__________________________________________________________________________________________________
CHAPTER II
THE SILVER STANDARD AND THE DISLOCATION OF ITS PARITY
The metallic part of it was
regulated by Act XXIII of 1870. The coins authorised and legalised thereunder were as
shown on p. 379. (Table VIII)
The Act made no innovations
either in regard to the number of coins issued by the Mints or their legal-tender powers.
Identical though it was with the earlier enactment’s in the matter of coins,[f1] its juridical provisions were designed to
perfect the monetary law of the country as had never been done before. The former Acts
which it repealed were very sparing in their recognition of the principle of mint " remedy " or " toleration," as it is called. The point has been
largely deemed to be one of mere mint technique. That is so ;
but it is not without its monetary significance. When the precious metals were current by weight the question of a mint toleration
could not possibly have arisen, for it was open to every one to ascertain the same by
weighing the value of his return. But since the invention of coinage, when currency came
to be by tale, every one has trusted that the coins contained the value they were
certified to contain.
TABLE VIII
Denomination
of Coins issued by the Mint. |
Remedy
in Weight. |
Fineness.
Troy Grs. |
Remedy
in Fineness. |
Legal-tender
Power. |
|
|
|
|
|
|
|
180 |
2/1000
ths |
165 |
2/1000
ths |
|
|
(ii)
Third of a Mohur . (iii) Two-thirds of a Mohur |
60
120 |
,, ,, |
65
110 |
,, ,, |
Not
Legal Tender at all. |
(iv)
Double Mohur |
360 |
,, |
330 |
,, |
|
|
|
|
|
|
|
(i)
Rupee
(ii)
Half-rupee |
180
90 |
5/1000
ths |
165
82.5 |
2/1000
ths |
Unlimited
Legal Tender. |
(iii)
Quarter-rupee |
45 |
7/1000
ths |
41.25 |
3/1000ths
. |
Legal
Tender for Fractions of |
(iv)
Eighth of a Rupee |
22.5 |
10/1000
ths |
20.625 |
|
a
Rupee only. |
III.
Copper Coins (c) |
|
|
|
|
|
(i)
Pice |
100 |
1/40
th |
— |
— |
Legal
Tender for 1/64th part of a Rupee |
(ii)
Double Pice |
200 |
,, |
— |
— |
Legal
Tender for 1/32nd part of a Rupee |
(iii)
Half-pice |
50 |
,, |
— |
— |
Legal
Tender for 1/128th part of a Rupee |
(iv)
Pie |
33.3 |
,, |
— |
— |
Legal
Tender for 1/192nd part of a Rupee |
The actual value of the coin
cannot, however, always be in exact agreement with its certified value. Such differences
are bound to exist, and even with all the improvements in the art of coinage it would be
difficult to avoid them. What matters is the extent of the deviation from the true mint
standard. The mint laws of all countries, therefore contain provisions which declare that
coins shall not be legal tender at their certified value if they err from their legal
standard beyond a certain margin. Indeed to make coins legal
tender without prescribing a limit to their toleration is to open a way to fraud. In so
far as the Act laid down a limit of toleration to the coins it authorised to be issued
from the Mint, it was a salutary measure. It is to be regretted, however, that the Act
instituted no machinery with which to ascertain that the coinage conformed to the law.[f2] Another important improvement made by the Act
was the recognition of the principle of free coinage. The principle, though it has not
received the attention it deserves, is the very basis of a sound currency in that it has
an important bearing on the cardinal question of the quantity of currency necessary for
the transactions of the community. Two ways may be said to be open by which this quantity
can be regulated. One way is to close the Mint and to leave it to the discretion of the
Government to manipulate the currency to suit the needs. The other is to keep the Mint
open and to leave it to the self-interest of individuals to determine the amount of
currency they require. In the absence of unfailing tests to guide the exercise of
discretion necessary in the case of closed Mints, the principle of open Mints has been
agreed upon as the superior of the two plans. When every individual can obtain coin for
bullion and convert coin into bullion, as would be the case under open Mints, the quantity
is automatically regulated. If the increasing demands of commerce require a large amount
of circulating medium, it is for the interest of the community to divert a larger quantity
of its capital for this purpose; if, on the contrary, the
state of trade is such as to require less, a portion of the coin is withdrawn, and applied
as any other commodity for purposes other than those of currency. Because the Act of 1870
expressly recognised the principle of open Mint, it is not to be supposed that the Mints
were closed before that date. As a matter of fact they were open to the free coinage of
both gold and silver, although the latter alone was legal tender. But, strange as it may
seem, none of the earlier Acts contained a word as to the obligation of the Mint Master to
coin all the metal presented to him—a
condition which is of the essence of the open mint system. The provisions of the Act on
this point are unmistakable. It required:—
"Section 19. Subject to
the Mint-rules for the time being in force, the Mint Master shall receive all gold and
silver bullion and coin brought to the Mint: "
Provided that such bullion and coin be fit for coinage: "
Provided also that the quantity so bought at one time by one person is not less, in case
of gold, than fifty tolas, and, in the case of silver, than one thousand tolas.
"
Section 20. A duty shall be levied at the rate of one rupee per cent. at the Mint on the
produce of all gold bullion and on all gold coin brought for coinage to the mint in
accordance with the said Mint-rules.
"Section 21. All silver
bullion or coin brought for coinage to the Mint, in accordance with the said Mint-rules,
shall be subject to a duty at the rate of 2 per cent. on the produce of such from the
return to be made to the proprietor.
"Section 22. A charge of one-fourth per mile on
gold bullion and coin, and of one per mile on silver bullion and coin, shall also be
levied for melting or cutting such bullion and coin so as to render the same fit for
receipt into the Mint.
Section 23. All gold and
silver bullion and coin brought to the Mint for coinage, and which is inferior to the
standard fineness prescribed by this Act, or which, from brittleness or other cause, is
unfit for coinage, shall, in case it is refined, be subject, in addition to the duty and
charge aforesaid, to such charge on account of the loss and
expense of refining as the Governor-General in Council prescribes in this behalf.
"
Section 24. The Mint Master, on the delivery of gold or silver bullion or coin into the
Mint for coinage, shall grant to the proprietor a receipt which shall entitle him to a
certificate from the Assay Master for the net produce of such bullion or coin payable at
the General Treasury.
"Section 25. For all
gold bullion and coin, in respect of which the Assay Master has granted a certificate,
payment shall be made, as nearly as may be, in gold coins coined under this Act or Act No.
XVII of 1835; and the balance (if any) due to the
proprietor shall be paid in silver, or in silver and copper, coins, in British
India."
In the matter of paper
currency the Government, it is to be noted, did not proceed upon the principle of freedom
of issue, which then obtained in the country. There prevails the erroneous view that
before the introduction of the Government paper currency the right of note issue was
confined to the three Presidency banks of India. As a matter of fact there existed in
India what is called the free banking system, in which every bank was at liberty to issue
its notes. It is true that notes of the Presidency banks enjoyed a status slightly
superior to that enjoyed by the notes of other banks in that they were received by the
Government to some extent in payment of revenue[f3]— a privilege for which the Presidency
banks had to submit to a stringent legislative control on their business#, from which
other banks whose issues were not so privileged were immune.
#The
reasons for such control are to be found in the peculiar relationship that subsisted
between the Government and the Presidency banks. Prior to 1862, as a safeguard against
their insolvency, " the Presidency Bank Charters restricted the kind of business in
which they wore to engage themselves. Put very briefly the principal restrictions imposed
prohibited the banks from conducting foreign-exchange business, from borrowing or
receiving deposits payable out of India, and from lending for a longer period than six
months, or upon mortgage, or on the security of immovable property, or upon promissory
notes bearing less than two independent names, or upon goods unless the goods or title to
them wore deposited with the banks as security. The Government held shares in the banks
and appointed a part of the Directorate. In 1862, when the right of note issue was
withdrawn, these statutory limitations on the business of the banks were greatly relaxed,
though the Government power of control remained unchanged. But, the banks having in some
cases abused their liberty, nearly all the old restrictions of the earlier period were
reimposed in 1876 by the Presidency Banks Act, Government, however, abandoning direct
interference in the management, ceasing to appoint official directors, and disposing of
its shares in the banks. Some of these limitations have been incorporated in Act XLVII of
1920, which amalgamated the three Presidency banks into the Imperial Bank of India. Banks
other than Presidency banks have been entirely immune from any legislative control
whatsoever, except in so far as they are made amenable to the provisions of the Indian
Companies Act. Cf. in this connection Minutes by Sir Henry Maine, No. 47, and the
accompanying note by W. Stokes. The control of these banks is one of the important
problems of banking legislation in India.
But this disadvantage was
not sufficient to discourage other banks from indulging in the right of issue which was
left open to them by law. However, this freedom of issue does not seem to have been
exercised by any of the banks on any very large scale, not even by the Presidency Banks**, and was taken away from ail in 1861, [f4]when there was established a national issue for the whole of
India entrusted to the management of a Government Department called the Department of
Paper Currency.
**It
should however, be noted that in 1860 the circulation of notes of the three Presidency
banks was larger than their current accounts, as is evident from the following :—
|
|
|
Name of the
Bank
|
Accounts
current |
Notes in circulation |
Bank
of Bengal
|
£
1,254,875 |
£ 1,283,946 |
Bank
of Bombay
|
438,459 |
765,234
|
Bank
of Madras
|
161,959 |
192,291 |
(Bankers'
Magazine, April, 1893, p. 547)
But if private interest was
not allowed to play the same part in determining the quantity of paper currency as was the
case with regard to metallic currency, neither was any discretion left to the Government
Department in the regulation of the paper currency. The Department of Paper Currency had
no more discretion in the matter of paper currency than the Mint Master had in the matter
of metallic currency.
The Department's duty was
confined by law[f5] to the issue of notes in exchange for the
amount thereof : (1) in current silver coin of the
Government of India; (2) in standard silver bullion or
foreign silver coin computed according to standard at the
rate of 979 rupees per 1,000 tolas of standard silver fit for coinage ; (3) in other notes of the Government of India, payable to
bearer on demand of other amounts issued within the same circle ;
and (4) in gold coin of the Government of India, or for foreign gold coin or bullion,
computed at such ratio and according to such rules and conditions as may be fixed by the
Governor-General, provided that the notes issued against gold did not exceed one-fourth of
the total amount of issues represented by coin and bullion.
The whole of this amount was required by law to be retained as reserve for the payment of
notes issued with the exception of a fixed amount which was invested in Government
securities, the interest thereon being the only source of profit to the Government. The
limit to the sum to be so invested was governed " by
the lowest amount to be estimated to which according to all reasonable experience, the
paper currency might be expected to fall."[f6] Estimating on this basis, the limit to the
investment portion was fixed at 4 crores in 1861,[f7] at 6 crores in
1871[f8] and at 8 crores in 1890.[f9] But notwithstanding the growing increase in
the investment portion, never was the fiduciary issue based thereon so great as to abrogate the essential principle of the Indian
Paper Currency Law, the object of which was to so regulate the volume of paper currency
that it should always preserve its value by contracting and
expanding in the same manner and to the same extent as its metallic counterpart.
|
Note |
Composition
of the Reserve |
Percentage
of each Component of the Reserve to the Total |
|||||
Period |
Circulation |
|
Circulation |
|||||
|
|
Silver |
Gold |
Securities |
Total |
Silver |
Gold |
Securities |
|
|
|
|
|
|
|
|
|
1862-1871 |
7.63 |
4.80 |
0.03 |
2.80 |
7.63 |
63 |
|
37 |
1872-1881 |
11.82 |
5.98 |
|
5.84 |
11.82 |
51 |
|
49 |
1882-1891 |
15.74 |
9.64 |
|
6.10 |
15.74 |
61 |
|
39 |
Such was the organisation of
the mixed currency that existed in India before it underwent a profound change during the
closing years of the nineteenth century. Though of a mixed character, the paper portion
formed a comparatively small part of the total. The principal reasons why the paper
currency did not assume a large proportion are to be found in the organisation of the
paper currency itself.[f10] One such reason was that the lowest
denomination of the notes was too large to displace the metallic currency. By the law of
1861 the denomination of notes ranged upwards from Rs. 10
as the lowest to Rs. 20, 50, 100, 500, and 1,000. In a
country where the average range of transactions did not exceed R.
1 and were as low as 1 anna or even lower, it is impossible to expect that paper currency
could, to any great extent, figure in the dealings of the people. Even Rs. 5 notes, the issue of which was first sanctioned in the
year 1871,[f11] were not low enough to penetrate into the
economic life of the people. The other impediment to the increase of paper currency was
the difficulty of encashing notes. One of the infelicitous incidents of the paper currency
in India consisted in the fact that they were made legal tender everywhere within a
circle, but encashable only at the office of issue. For
such a peculiar organisation of the paper currency in India, what was largely responsible
was the prevalence of internal exchange** in the country.
**It
may be pointed out that although the Presidency banks had ceased to issue notes, yet under
the agreements made with the Government in virtue of Act XXIV of 1861 the banks were
employed by the Government " for superintending, managing and becoming agents for the
issue, payment and exchange of promissory notes of the Government of India, and for
carrying on the business of an agency of issue " on a renumeration of 3/4, per cent.
per annum "on the daily average amount of Government currency notes outstanding and
in circulation through the agency of the bank." In the conflict that ensued between
the Government of India and the Secretary of State because it believed that it would help
the extension and popularization of the notes as to the propriety of thus employing the
banks, the former was in favour of the plan, while the latter disliked the arrangement
because it seemed to him to compromise the principle of complete separation between the
business of issue and the business of banking. Neither of the two, however, grasped the
fact that the profit on remittances on different centres owing to the prevalence of
internal exchange was so great that the commission allowed to the banks was an
insufficient inducement to cause them to promote the circulation of notes by providing
facilities at their branches for the free encashment of them. So high was the internal
exchange, and so reluctant seemed the banks to popularise the notes, that Government
finally discharged them from being their agents for paper currency from January 2, 1866. See House of Commons Return, East Indian (Paper
Money) 215 of 1862.
It raised a serious problem
for the Government to cope with. If notes were to be made universally encashable it was
feared that merchants, instead of using notes as currency, might use them as remittance on
different centres to avoid internal exchange, and the Government be obliged to move funds
between different centres to and fro, lest it should have to suspend cash payments. To
undertake resource operations on such a vast scale between such distant centres when
facilities for quick transport were so few, was obviously impossible,[f12] and the Government therefore decided to
curtail the encashment facilities of notes it issued. For the purposes of the paper
currency, the Government divided the country into a number of circles of issue, and each
currency circle was further subdivided into sub-circles,§[f13] and the notes issued bore on their face the name of the
circle or sub-circle from which they originated. Notes issued from any agency of issue
situated in the territory comprised within a circle of issue were not legal tender in the
territory of any other currency circle, nor were they encashable
outside their own circle. Nay more, the notes issued from sub-circles subject to the same
chief circle were legal tender in one another's territory, but were not encashable except
at their office of issue or at the issue office of their chief circle. The sub-circle
notes could thus be cashed at two places, but the notes of the issue office of the chief
circle, though legal tender in the entire territory covered by it, were encashable nowhere
except at its own counter, not even at any of its own sub-circles.[f14] This want of universal encashability, though it saved the Government from the
possibility of embarrassment, proved so great a hindrance to the popularity of the notes
that it may be doubted whether the paper currency could have made a progress greater than
it did even if the lowest denomination of the notes had been lower than it actually was.
It must, however, be borne
in mind that it was not the intention of the Indian Legislature to make the Indian
currency as economical[f15] as was desired by the Executive Government.
The Legislature was no doubt appealed to by the original author of the paper currency to
turn India into a new Peru, where as much currency could be
had with as little cost,[f16] but the Legislature showed a rather prudent
reserve on the matter of aiding the consummation of such a policy. As the centres of
encashment were so few, and the area included within each so large as to separate the
furthest point in a circle by a distance of about 700 miles from the centre of encashment
of the circle, it viewed with dread the authorising of notes of smaller denomination which
the poor could not refuse and yet could not cash.[f17] Besides the hardship involved in the want of encashability in the notes, the Legislature feared they would
prove a " fugitive treasure "
in the hands of the Indian peasant. Not being able to preserve them from rain and
ants, he might have had to pay a heavy discount to be rid of the notes he could have been
forced to accept.[f18] So opposed was the Legislature to the
economising clauses of the Paper Currency Bill as contrived
to drive out metallic currency that it gave the Government an option to choose between
legal-tender notes but of higher denomination and lower-denomination notes but of no
legal-tender power.[f19] And as the Government chose to have
legal-tender notes, the Legislature in its turn insisted on their being of higher
denomination. At first it adhered to notes of Rs. 20 as the
lowest denomination, though it later on yielded to bring it down to 10, which was the
lowest limit it could tolerate in 1861. Not till ten years after that, did the legislature
consent to the issue of Rs. 5 notes, and that, too, only when the Government had promised
to give extra legal facilities for their encashment. [f20] On the whole, the desire of the Indian
Legislature was to make the Indian currency safer, rather than economical, and such it
undoubtedly was.
How did the currency system
thus constituted work ? Stability of value is one of the
prime requisites of a good currency system. But if we judge the Indian currency from this
point of view, we find that there existed such variations in its value that it is
difficult to escape the conclusion that the system was a failure.
Taking the rate of discount
as an evidence of the adequacy of currency for internal commerce, it was the opinion of
such a high financial authority as Mr. Van Den Berg that the unexpected contortions and
sudden transitions in the Indian money market were unparalleled in the annals of any other
money market in any other part of the world.[f21] India is pre-eminently a country subject to
seasonal swings**.
**It should be
noted that the slack and the busy seasons are not uniformly distributed over the whole
surface of the country. The distribution is roughly as follows :—-
|
Eastern
India |
Western |
Northern
India |
|
|||
Months |
|
India |
|
Southern |
|||
|
Rangoon |
Calcutta |
Bombay
and |
Cawnpore |
Lahore |
India
Madras |
|
|
|
|
Karachi |
|
|
|
|
Busy |
3
Months |
4
Months |
6
Months |
6
Months |
9Months |
6
Months |
|
Slack |
9
Months |
8
Months |
6
Months |
6
Months |
3
Months |
3
Months |
|
January |
Busy |
Slack |
Busy |
Slack |
Busy |
Slack |
|
February |
,, |
,, |
,, |
Busy |
,, |
Busy |
|
March |
|
|
|
|
|
|
|
April |
Slack |
,, |
,, |
,, |
,, |
,, |
|
May |
, |
|
,, |
Slack |
Slack |
,, |
,, |
June |
|
|
|
|
|
|
|
July |
|
|
|
,, |
,, |
Slack |
,, |
August |
, |
, |
Busy |
,, |
,, |
,, |
Slack |
September |
, |
, |
,, |
,, |
Busy |
,, |
,, |
October |
, |
, |
,, |
,, |
,, |
Busy |
,, |
November |
, |
, |
,, |
Busy |
,, |
,, |
,, |
December |
• |
' |
Slack |
- |
Slack |
- |
- |
Busy |
Jan.
to |
Aug.
to |
Nov.
to |
Feb.
to |
April
to |
Feb.
to |
|
|
March |
Nov. |
April |
April |
June |
July |
|
Slack |
April
to |
Dec.
to |
May
to |
May
to |
July
to |
April
to |
|
|
Dec. |
July |
Oct. |
Aug. |
Sept. |
Dec. |
|
Busy |
|
|
|
Sept.
to |
Oct.
to |
|
|
|
|
|
|
Nov. |
March |
|
|
Slack |
|
|
|
Dec.
to |
|
|
|
|
|
|
|
Jan. |
|
|
|
Midsummer is naturally a period of diminished activity, while autumn brings renewed vigour in all activities of social and economic life. Not production alone is affected by seasons. On the side of consumption, Indian social life is also subject to seasonal variations. There are marriage season, holiday seasons and holy seasons. Even distribution has assumed in India quite a seasonal character. The practice of paying rents, wages, dividends, and settling accounts at stated intervals has been gaining ground as a result of contact with Western economic organisation. All these generate a kind of rhythm in the social demand for money, rising at certain periods of the year and falling at others. Having regard to the seasonal character of the economic and social life, the fluctuations caused by the discount rate soaring high during busy months when it should have been low enough to liquidate the transactions, and falling low during slack months when it should have been high enough to prevent the market from being demoralised, are unavoidable. But what made the contortions of the Indian money market so obnoxious was the circumstance that the seasonal fluctuations in the discount rate were so abnormal.
##The
rate of discount of the Bank of Bengal for private paper running thirty days and after was
altered—
In
1876 16 times, with 6 1/2 percent, as minimum and 13 1/2, percent, as
maximum. |
In
1877 21 times, with 7 1/2 percent, as
minimum and 14 ½ percent, as maximum |
In
1878 10 times, with 5 1/2 percent, as
minimum and 11 ½ percent, as maximum |
In
1879 15 times, with 6 1/ percent, as minimum and 11 ½ percent, as maximum |
In 1880
8 times, with 5 1/ percent, as minimum and 9
½ percent, as maximum |
In 1881 9
times, with 5 1/ percent, as minimum and 10 ½ percent, as maximum |
In 1882 9 times, with 6 1/2 percent, as minimum and 12 ½ percent, as maximum |
In 1883 times, with 7 1/2 percent, as minimum and
10 ½ percent, as maximum |
(
Van Den Berg, loc. cit.)
The explanation for such a
market phenomenon is to be sought in the irregularity of the money supply of the country.
In order that money may be had at a uniform price, its supply should be regulated
according to the variations in the demand for it. It is well to recognise that the demand
for money is never fixed. But it will avail nothing until it is realised that the changes
in the demand for money which take place from year to year with the growth of population,
trade, etc., belong essentially to a different category from the fluctuations in the
demand for money which occur within the course of a year owing to seasonal influences. In
any well-regulated currency it is necessary to distinguish these two categories of changes
in monetary demand, the one requiring steadiness and expandability and the other
elasticity. On a comparative view it seems more than plausible that a metallic money is as
especially adapted to furnish this element of steadiness and stability as paper money is
to furnish that of elasticity. Indeed, so appropriate seem to be their respective
functions that it has been insisted[f22] that in an ideal system, these two forms of
money cannot interchange their functions without making the currency burdensome or
dangerous. The proof of the soundness of this view, it may be said, is found in the fact
that, excluding the small transactions which take place by direct barter, the purchasing
medium of any commercially advanced country is always a compound of money and credit.
On the face of it, the
Indian currency is also a compound of money and credit, and as such it may be supposed
that it contained provisions for expandability as well as elasticity. But when we come to
analyse it we find that it makes no provision whatever for elasticity. Far from allowing
the credit part of it to expand and contract with the seasonal demands, the Paper Currency
Act placed a rigid limit upon the volume of its issue regardless of any changes in the
volume of the demand. Here, then, is to be found one of the causes for the " convulsions " in
the discount rates prevalent in the Indian money market. As was pointed out by Mr. Van Den
Berg —
"The paper currency
established by the Indian legislator fully answers the purpose, so far as business
requires an easier means of exchange than gold or silver coin ;
but no connection whatever exists between the issue of the fiduciary currency and the
wants of the public to have their bills or other commodities converted into a current
medium of exchange...... and this is the sole cause of the
unexpected convulsions and sudden transitions in the money market so utterly detrimental
to business to which the British Indian trade is constantly exposed.[f23]
It may, however, be objected
that such a view is only superficial. The Indian Paper Currency Act is a replica of the
English Bank Act of 1844 in all its essentials. Like the English Bank Act, it ?et a definite limit to the fiduciary issue of notes. Like it,
it separated the Issue Business from the Banking Business,[f24] and if it made the banks in India mere banks
of discount, it is because it copied the Bank Charter Act, which deprived banks in
England, including the Bank of England, from being banks of issue. And yet, it cannot be
said that the English money market is affected by such "convulsions
and sudden transitions " as has been the case with the
Indian money market. On the other hand, it was the considered opinion of Jevons[f25] that "the Bank of England and
bankers generally have just the same latitude in increasing or diminishing their advances
now (i.e. under the Act of 1884) as they would have under a [nun] restricted system ";
for, as he elsewhere argued, if the limitation on fiduciary issue is arbitrary, and if
people want more money, " it is always open to them to
use metallic money instead. The limitation is imposed not upon money itself, but upon the
representative part.''[f26] What, then, is the reason that the Indian
Paper Currency Act should produce the evils which its English prototype did not ? A priori there
need be no such convulsions in a money market subject to such law. The Act, by limiting
the issue of notes, did seem to leave no choice but to use metallic money even for
seasonal demand. This would be true if notes were the only form in which credit could be
used. As a matter of fact, this is not so. Credit could take the form of a promise to pay,
issued by a bank, as well as it could take the form of an order on the bank to pay,
without making any difference to the social economy of the people who used them.
Consequently, if under the provisions of the Act banks are restricted from issuing
promises to pay, it does not follow that the only way open
to them is a resort "to use metallic money instead," for they are equally free
to consent to honour as many orders to pay as they like. Indeed, the success or failure of
the Act depends upon which of the two alternatives the banks adopt. It is obvious that
those who will submit to the ruling of the Act and resort to metallic money will have to
bear the " convulsions," and those who will
circumvent the Act by utilising other forms of credit will escape them. The chief reason,
then, why the Act has worked so well in England and so badly in India, is due to the fact
that, whereas English banks have succeeded in implanting the order or cheque system of
using credit in place of the note system, Indian banks have unfortunately failed. That
they should have failed was however, inevitable. A cheque system presupposes a literate
population, and a banking system which conducts its business in the vernacular of the
people. Neither of these two conditions obtains in India. The population is mostly
illiterate, and even were it otherwise it could not have availed itself of the cheque
system, because Indian banks refuse to conduct their business in any other medium but
English. Besides, the growth of the cheque system presupposes a widespread network of
banks, a condition which is far from being fulfilled in India. In the absence of banking,
a cheque is the worst instrument that could be handled. If not presented within a certain
time, a cheque may become stale and valueless, and is therefore inferior to a note as a
store of wealth. In such circumstances as these, it is no wonder that in India cheques did
not come into being on a sufficiently large scale to amend the inelasticity of the notes.
But even if Indian banks had
succeeded in making use of credit in a form other than that of notes, they could not have
eased the money market to the same extent as the English banks have been able to do. One
of the incidents of banking consists in the liability of banks to pay cash on demand. If
all their deposits were received in cash this liability would involve no risk. As a matter
of fact, a larger part of their deposits consists of bills which they make it their
business to undertake to pay in cash. One of the first things, therefore, that a banker
has to look to is the proportion which his cash deposits bear to his credit deposits. Now,
this proportion may be adversely affected either by an increase in his credit deposits or
by diminution in his cash deposits. In either case his ability to pay cash is pro tanto weakened
by lowering the ratio of his total cash to his total liabilities. Against an undue
expansion of credit a banker may effectually guard himself.
But, notwithstanding the development of the cheque system, there is always lurking the
possibility of withdrawal of some cash at some time or other. A banker must, therefore,
provide by keeping on hand a certain minimum reserve. How large should be the reserve
depends upon what the possibilities for the withdrawal of cash are. The point is that to
the extent of the reserve the power of the bank to grant credit is curtailed. If the
reserve of the bank is already at the minimum it must stop discounting or must strengthen
its position by recovering the cash withdrawn from its coffers. Now, it is obvious that if
the amount of money withdrawn is kept in the current of business where the banks can get
at it, they of course can strengthen their position again immediately, and not only always
keep themselves well away from the danger line of minimum reserve, but be always prepared
to meet the needs of the money market. What was the position of the Indian banks from this
point of view ? Owing to the absence of a cheque system the
possibilities for the withdrawal of cash are great, and the reserve was required to be
large in consequence thereof. A large part of their funds being thus held for a reserve,
their resources for discounting were small. But there was a further weakening of their
position as lenders by reason of the fact that the cash withdrawn did not speedily return
to them. The result was that the Indian banks were obliged to curtail their discounts to a
far greater extent than were the English banks, in order to preserve a due proportion
between their cash and their credits. The absence of branch
banking was an important desideratum in this regard. But, even if there were branch banks,
the money withdrawn could not have returned, for it was not left in the current channels
of business. It was locked up in Government treasuries, whose operations were independent
of the banking transactions of the country. Of course, there could be nothing inherently
wrong in the maintenance by a Government of an Independent Treasury, and if its operations
were to have a resultant connection with the operations of the business community no harm
need arise. But the operations of the Indian Treasury ran counter to the needs of
business. It locked up when it should have released its hoards, and released its hoards
when it should have locked them up.
The causes that " convulsed " the
Indian money market had therefore been the inelasticity of the credit media and the
working of the Independent Treasury System in so far as they were the prime factors
affecting the money supply of the country (see
Chart 1). The evil effects of such convulsions of the discount rate can hardly be
exaggerated.[f27] In an economy in which almost every business
man must rely, at certain seasons, if not all the year round, on borrowed capital, the
margin of profit may be wiped out by a sudden rise or augmented by a sudden fall in the
rate of discount leading to under-trading or over-trading. Such fluctuations increase
business risks, lead to higher business expenses and a greater cost to the consumer. They
bring about swings in prices, promote speculation, and prepare for panics.
CHART I
DISCOUNT RATE IN INDIA
Evils such as these would
have in any other country compelled the authorities to take proper steps to deal with
them. But it is a curious fact that in India no serious attempts were made to alleviate
the sufferings they inflicted upon the trading community. A reform of the paper currency
or the abolition of the Independent Treasury System would have eased the situation, though
a reform of both would have been better. The general community, however, was not desirous
for a change of the paper currency[f28] but was anxious for the abolition of the Independent
Treasury. The Government, on the other hand, refused to do away with its Independent
Treasury System *** and repudiated even its moral obligation to help the business
community on the somewhat pedantic plea that in locking up currency it did not lock up
capital ###.
*** It should, however, be noted that between 1862 and 1876, at some centres comprising the head offices and branch offices of the Presidency banks, the Independent Treasury System was suspended. By way of compensation for the loss of their right of note issue, the Presidency banks were given certain concession by the Government under agreements entered into in accordance with Act XXIV of 1861. Among the concessions one was the use by the banks of Government balances. The first agreement, that of 1862, conceded to the banks the following privileges in regard to the Government balances : (1) The unrestricted use for banking purposes " of all moneys and balances which but for the agreement would have been received or held at the General Treasury " up to the limit of 70 lakhs in the case of the Bank of Bengal, 40 lakhs in the case of the Bank of Bombay, and 15 lakhs in the case of the Bank of Madras. (2) The option of setting aside the excess over these sums in a separate strong room for production when demanded, or of investing it in Government paper or other authorised securities, the power of investment being subject to the condition that the banks should be " at all times answerable and accountable to Government for the surplus cash balance for the time being." (3) The right to interest from Government on the difference between the actual balance and 50 lakhs in the case of the Bank of Bengal, 30 lakhs in the case of the Bank of Bombay, and 10 lakhs in the case of the Bank of Madras, whenever the balances at these banks fell below these minima. (4) Permission to the banks to use the Government balances at their branches on similar terms, suitable limits being fixed in each case, as in the head office agreements.
A
year after the agreements were executed, difficulties arose with the Bank of Bengal, which
had locked up the funds to such an extent that it was unable to meet the demands of the
Government on the public balances it held. Negotiations were therefore opened in 1863 for
the revision of the agreements, and the revised agreements came into force on January 2,
1866. They contained the following provisions regarding the public balances : (1)
Undertaking by Government to maintain in the hands of the banks at their head offices an
" average cash balance " of 70 lakhs at the Bank of Bengal, 40 lakhs at the Bank
of Bombay, and 25 lakhs at the Bank of Madras, " so far as the same may conveniently
be done." (2) Permission to the banks to use the whole balances for the time being
deposited with them for banking purposes. (3) The right to interest from Government when
the Government balance at the head offices of the Bank of Bengal, Bank of Bombay, and Bank
of Madras fell below the minima of 45 lakhs, 25 lakhs, and 20 lakhs respectively. (4)
Permission to employ " the whole of the balances (at branches) however large for the
time being " for banking purposes, subject to the condition that each branch should
" at all times be ready to meet the drafts of the Government " to the extent of
the Government balances at the
branch.
These
revised agreements were to remain in force till March, 1, 1874. In 1874 the question of
the revision of the charters of the Presidency banks was under consideration, and it was
the aim of the Government to continue to the banks the right to use the whole Government
balances. Just at this time (1874) difficulties occurred with the Bank of bombay and the
government could not draw upon their balances. This led to a reconsideration of the policy
of merging the Government balances with the bank balances and leaving them in the custody
of the banks. After a somewhat lengthy discussion the Government of India reverted to the
system of Independent Treasury by instituting what were called Reserve Treasuries at the
headquarters of the Presidencies which held the Government balances previously held by the
Presidency banks. For a history of this episode see
House of Commons Returns 109 and 505 of 1864 ; also J. B. Brunyate, An Account of the Presidency Banks, Chap. VII.
###
In the dispatch of May 6, 1875, sanctioning the re-establishment of the Independent
Treasury System, the banks were admonished by the Secretary of State thus : " Capital
supplied by Government, and not representing the savings of the community, is a resource
on whose permanence no reliance can be placed, and which therefore tends to lead traders
into dangerous commitments. It gives ease for a time, and produces prosperity which is at
the mercy of an accident. A political exigency suddenly withdraws the adventitious
resources, and the commerce which trusted to it finds itself pledged beyond what its own
resources can make good." Under the arrangements of 1876 leading to the establishment
of the Reserve Treasuries, the Government agreed as before to pay interest to the banks
when their balances at the banks fell below certain minima. The Government entered into no
formal undertaking as regards maxima, and gave the banks to understand " that the
Government will ordinarily not leave with the headquarters of the banks, otherwise than
temporarily, more than the following sums : Bank of Bengal 100 lakhs, Bank of Madras 30
lakhs, and Bank of Bombay 50 lakhs. But this condition will not be inserted in the
contract, which will impose no obligation upon the Government to leave any balances
whatever with the banks...... The Government will not undertake to give to the banks the
exclusive custody of all the public balances where the Government banks with the
banks." The question of the amount of balances which the Government would have with
the banks in the ordinary course being thus settled, the only way left open to give help
to the banks to meet seasonal demands was to grant loans to the Presidency banks for its
balances held in the Reserve Treasuries. After 1900 it agreed to make such loans of a
limited amount at the bank rate. Up to 1913 only six loans were made, which shows that the
terms of such loans were rather onerous. The Chamberlain Commission of 1913 recommended
loans rather than the abolition of the Independent Treasury system. The war, however,
hastened the course of events. It proved the necessity of co-operation between the
Presidency banks and the Government, and also the need of a large and powerful Banking
Institution. This was accomplished by the amalgamation of the Presidency banks into an
Imperial Bank of India (Act XLVI I of 1920), with the inauguration of which the
Independent Treasury system is again in the process of abolition. For a history of
episodes of the Independent Treasury after 1876, see Appendices to the Interim Report of the Chamberlain Commission, Vol.
I, Cd. 7070 of 1913, Nos. I and II.
Nor is it possible to say,
since it was not called upon to enunciate a policy, how far it would have gone to modify
the Paper Currency Act so as to relieve the situation. Before, however, this controversy
could end in a satisfactory solution for imparting to the currency system that element of
elasticity which it needed, there developed another and a greater evil, which affected its
metallic counterpart in a degree sufficient to destroy its most vital element of
steadiness and stability of value, which it was its virtue to furnish. So enormous did the
evil grow, and so pervasive were its effects, that it absorbed all attention to the
exclusion of everything else.
What fixity of value between
the different units of its currency is to the internal transactions of a country, a par of
exchange is to its internal transactions. A par of exchange between any two countries
expresses the relative exchange values of their respective currencies in terms of each
other. It is obvious from this that the par of exchange between any two countries will be
stable if they employ the same metal functioning as their standard money, freely
convertible into and exportable as bullion, for in that case they would have as a measure
of value a common medium, the value of which could not differ, given freedom of commerce,
in the two countries by more than the cost of its
transhipment, i.e., within specie points. On the other hand, there can be no fixed par of
exchange between two countries, having different metals as their currency standards of
value. In that case, their exchange is governed by the relative values of gold and silver,
and must necessarily fluctuate with changes in their value relation. The limit to the
exchange fluctuations between them will be as wide or as narrow as the limit to
fluctuations in the relative values of the two metals may happen to be. When, therefore,
two countries such as England and India are separated by differences in their metallic
standards, theoretically there could be no possibility for a stable par of exchange
between them. But, as a matter of fact, notwithstanding the difference in their metallic
standards, the rate of exchange between England and India seldom
deviated[f29] from the normal[f30]rate of 1 s. l0 1/2 d. for R. 1. So
steady was the rate up to 1873 that few people were conscious of the fact that the two
countries had different currency standards. After 1873, however, the rupee-sterling
exchange suddenly broke loose from this normal parity, and the dislocation it caused was
so great and so disorderly (Chart II) that no one knew where it would stop.
|
CHART II : FALL OF THE RUPEE-STERLING EXCHANGE
The ball once set rolling,
the work of demonetising silver began to grow apace. First in the field was Germany.
Having vanquished France in the war of 1870, she utilised the war indemnity in the reform
of her chaotic currency[f38] by hastening to adopt a gold currency for the
United Empire of Germany. The law of December 4, 1871, authorised the change, with the
mark as the unit of currency. Silver was demonetised by this enactment; but the existing silver coins continued to be legal tender
though their further coinage was stopped, along with the new gold coins at the legal ratio
of 15 to 1/2 to 1. This full legal-tender power of the silver coins was taken away from
them by the law of June, 9, 1873, which reduced them to the position of a subsidiary
currency.[f39] This policy was immediately copied by other countries of
Germanic culture. [f40]In 1872 Norway, Sweden, and Denmark formed a Scandinavian
Monetary Union, analogous to the Latin Monetary Union, by which they agreed to demonetise
silver as was done by Germany. This treaty, which established a gold standard and reduced
the existing silver currency to a subsidiary status, was ratified by Sweden and Denmark in
1873 and by Norway in 1875. Holland also followed the same course. Till 1872 she had a
pure silver standard. In that year she closed her Mint to the free coinage of silver,
although the old silver money continued to be legal tender to any amount. In 1875 she went
a step further and opened her Mints to the free coinage of gold. Her policy differed from
that of the Germanic countries in that she only suspended the free coinage of silver,
while the latter had demonetised it. Even the Latin Union was unable to resist this tide
against silver. As a consequence of this exclusion of silver, the Latin Union, enlarged as
it was by additional members, naturally desired to take precautionary measures against
being flooded by the influx of this depreciated silver. Nor was this fear unfounded, for
the silver tendered for coinage at the Belgian Mint in 1873 was three times greater than
what was tendered in 1871. Rather than be embarrassed, Belgium, by the law of December 8,
1873, suspended the free coinage of her silver five-franc pieces. This action of Belgium
forced the hands of the other members of the Union to adopt similar measures. The
delegates of the Union met in Paris in January, 1874, and
"
agreed to a treaty supplementary to that originally framed in 1865, and determined on
withdrawing from individuals the full power of free coinage by limiting to a moderate sum
the silver five-franc pieces which should be coined by each State of the Union during the
year 1874. [f41]
The respective quotas fixed
for 1874 were slightly increased in 1875, but were reduced in 1876@@.
@@The
quotas fixed at the conferences for the several members of the Union were-
|
1874 |
1875 |
1876 |
France |
60 |
75 |
54 |
Belgium |
12 |
50 |
36 |
Italy |
40 |
15 |
10 |
Switzerland |
8 |
10 |
7 |
Greece |
... |
.... |
...... |
Total |
120 |
150 |
110 |
In
1874 Italy was allotted an extra 20 million francs. Ibid.,
p. 155.
But the actual coinage did
not even reach these small quotas. So greatly was the Union
perturbed by the silver situation that during 1877 the coinage of silver five-franc pieces
was, with the exception of Italy, [f42]entirely suspended. This action was, however, only a
preliminary to the treaty of November 5, 1878, by which the Latin Union agreed to close
its Mints to the free coinage of silver till further action. Though at first sine die, the closure proved in the end perpetual. [f43]Simultaneously with the precautionary measures of the Latin
Union, Russia suspended, in 1876, the free coinage of silver except to such an amount as
was necessary for the purposes of her trade with China, [f44]and the Imperial Decree of November 22, 1878, directed that
all customs duties above 5 roubles and 15 copecks should be payble
in gold.[f45] Austria in like manner suspended the free
coinage of silver in 1879.[f46]
On the other side of the
Atlantic, an important event had taken place in the United States. In 1870 that Government
resolved to consolidate the Mint laws, which had not been revised since 1837, in a
comprehensive statute. Since the legislation of 1853, the silver dollar was the only coin
which the United States Mints coined freely. But in the new consolidated Mint Statute of
1873, the silver dollar was deleted from the list of coins to be issued from the Mint, so
that it virtually amounted to suspension of the free coinage of silver in the United
States.[f47] The silver dollars previously coined continued
to circulate as full legal tender, but that power was taken away by the law of June, 1874,
which declared that " the silver coins of the United
States shall be a legal tender at their nominal value for
any amount not exceeding five dollars in any one payment."
The other factor appealed to in explanation of the dislocation of the relative
values of gold and silver was the great increase in the production of silver as compared
to gold.
TABLE IX
RELATIVE PRODUCTION OF GOLD AND SILVER (OUNCES)
|
Total Production |
Annual Average |
Index Number |
|||
Period |
|
Production |
for Average |
|||
|
|
|
Annual |
|||
|
|
|
Production |
|||
|
Gold |
Silver |
Gold |
Silver |
Gold |
Silver |
1493-1600 |
24,266,620 |
734,125,960 |
224,693 |
6,797,463 |
100 |
100 |
1601-1700 |
29.330.445 |
1,197,073,100 |
293,304 |
11,970,731 |
130.5 |
176.1 |
1701-1800 |
61,066,215 |
1,633,672,035 |
610,662 |
16,336,720 |
271.6 |
269.7 |
1801-1840 |
20,466,552 |
601,155,495 |
512,217 |
20,026,667 |
227.9 |
293.1 |
1641-1870 |
143,166,224 |
931,091,326 |
4,772,676 |
31,036,376 |
2,124.1 |
456.6 |
1671-1690 |
106,950,602 |
1.715,039,955 |
5,347,545 |
65,751,996 |
2,375.4 |
1,261.5 |
The
history of the production of the precious metals in modern times begins from the year
1493, a date which marks the discovery of the American continent. Reviewing the results of
the production from 1493 to 1893, a period in all of 400 years, we find that during the
first hundred years the production of gold and silver rises at a uniform rate of
progression. Assuming the annual average production of each during the first century
(1493-1600) in the modern history of their production to be 100, it will be seen that in
the next century (1601-1700) the index number for the production of gold rises to 130 and
that of silver to 176. This rate of progression is also kept up in the succeeding century
(1700-1800), during which the figure for both gold and silver approximates to 270, and
continues without much disturbance up to 1840, when the respective index numbers stood at
228 for gold and 293 for silver. From this point onwards, the relative production of the
two metals underwent a complete revolution. During the next thirty years (1841-70) the
production of gold reached unprecedented heights, while that of silver lagged behind,
relatively speaking. The index number for silver production advanced only to 450, but that
for gold went up to 2,124. This revolution was followed by a counter-revolution, as a
result of which the position as it stood at the end of 1870 was well-nigh reversed. The
production of gold received a sudden check, and though it had increased enormously between
1840-70 it remained stationary between 1870-93. On the other hand, the production of
silver, which was steady between 1841-70, increased threefold between 1870-93, so that the
index number for its average annual production during the latter period stood at 1,260.
In the controversy which
arose over the reasons, which brought about this dislocation and decline in the value of
silver in terms of gold, there were parties to whom one of these two factors was a
sufficient cause. One side argued that had suspension or demonetisation of silver not
taken place, its value could never have fallen. This position was vehemently challenged by the other side, which believed in the
over-supply of silver as the primary cause of its depreciation. Now, was the argument from
relative over-supply sufficient to account for the fall in the gold value of silver ? On the face of it, the explanation has the plausibility of a
simple proposition. It is one of the elementary theorems of political economy that the
value of a thing varies inversely with its supply, and if the supply of silver had largely
increased, what could be more natural than that its value in terms of gold should fall ? The following were the relevant facts which formed the basis
of the argument:—
TABLE X
gold
and silver[f48]
RELATIVE PRODUCTION AND RELATIVE VALUE
Period |
Ratio
of Production (by Weight) of Gold to Silver As 1 Grain to: |
Ratio
of value of Gold to Silver As 1 Grain to |
Index
Number for the Ratio of Production |
Index
Number for the Ratio of Value |
||
|
|
|
|
|
Relative
Production of Silver Falls— Rises+ |
Relative
Value of Silver Falls— Rises+ |
1681-1700 |
31.8 |
14.95 |
100 |
100 |
|
|
1701-1720 |
27.7 |
15.21 |
87 |
101.7 |
-13 |
-1.7 |
1721-1740 |
22.6 |
15.10 |
71 |
101 |
-
29 |
-
1.0 |
1741-1760 |
21.7 |
14.70 |
67 |
98.3 |
-33 |
+1.7 |
1761-1780 |
31.5 |
14.40 |
99 |
96.3 |
-1 |
+3.7 |
1781-1800 1801-1810 |
49.4
50.3 |
15.08
15.67 |
155.6
158.0 |
100.8
104.8 |
+55.6
+58.0 |
- .8
- 4.8 |
1811-1820 |
47.2 |
15.68 |
148.0 |
104.9 |
+48.0 |
-4.9 |
1821-1830 |
32.4 |
15.82 |
101.9 |
105.8 |
+
1.9 |
-5.8 |
1831-1840 |
29.4 |
15.77 |
92.4 |
105.4 |
-7.6 |
-5.4 |
1841-1850 |
14.2 |
15.81 |
44.6 |
105.8 |
-55.4 |
-5.8 |
1851-1855 |
4.4 |
15.45 |
13.8 |
103.3 |
-86.2 |
-3.3 |
1856-1860 |
4.5 |
15.28 |
14.0 |
102.2 |
-86.0 |
-2.2 |
1861-1865 |
5.9 |
15.42 |
18.55 |
103.1 |
-81.5 |
-3.1 |
1866-1870 |
6.9 |
15.52 |
21.7 |
103.8 |
-78.3 |
-3.8 |
1871-1875 |
11.3 |
16.10 |
35.5 |
107.6 |
-64.5 |
-7.6 |
1876-1880 |
13.2 |
17.79 |
41.5 |
119.0 |
-58.5 |
-19.0 |
1881-1886 |
17.3 |
18.81 |
54.4 |
125.8 |
-45.6 |
-
25.8 |
1886-1890 |
19.9 |
20.98 |
62.6 |
140.3 |
-37.4 |
-40.3 |
1891-1895 |
20.0 |
26.75 |
62.9 |
178.9 |
-37.1 |
-78.9 |
CHART III
RELATIVE
VALUES AND RELATIVE PRODUCTION OF GOLD AND SILVER
The facts thus presented led
to two conclusions. The first is that the supposed enormous increase in the relative
production of silver was an assumption which had no foundation in reality. On the
contrary, a glance at the figures for relative production discloses the curious fact that
since the beginning of the eighteenth century silver, instead of rising, has been falling
in proportion. With the exception of the first quarter of the nineteenth century, silver
had formed, throughout the two centuries covered by the table, a diminishing proportion as
compared with gold.
[f49]Indeed, never was the proportion of silver so low as it was
in the latter half of the nineteenth century, and even when after 1873 it began to grow it
did not reach half the magnitude it had reached in the beginning of the eighteenth
century. The second conclusion which these facts were claimed to sustain was that the
value of silver in terms of gold did not move in sympathy with its supply relative to that
of gold. According to theory, the value of silver should have been rising because the
relative volume of its production had been diminishing. On the other hand, a closer
examination of the figures of relative values and relative productions, as given in the
foregoing table, instead of showing any close correlation (see Chart III) between them, pointed to the
contrary. Instead of supply and value being inverse in proportion, it showed that as its
supply was falling there was also a fall in its value. Such being the facts of history, it
was contended that they gave no support to those who rested their case on over-supply
rather than on demagnetisation as a sufficient explanation for the depreciation of silver.
Apart from such minor
points, the issue was considerably narrowed by the peculiarity of the events of the twenty
years preceding and following the year 1873[f50] Compare, it was said, the period commencing
with 1848 and ending with the year 1870 with the period following 1870, and there emerges
the arresting fact that these two periods, though they have been the opposite of each
other with reference to the relative values of the two metals, were alike with reference
to the changes in their relative supply. The period between 1870 and 1893 on the side of
relative production was marked by the preponderance of silver. The period between 1848 and
1870 is an exact parallel to the above period with respect to changes in the relative
supply of the two precious metals, only in this case it was gold that had increased in
volume. Now, if it is over-supply that governed the value relations of the two metals in
the second period (1870-93) the same should be true of their value relations in the first
period (1848-70). Was there, then, a disturbance in the relative values of the two metals
in the first period anything like what took place in the second period ? It was insisted that the disturbance in the ratios of
production of the two metals in the first period was enormously greater than that which
occurred in the second period. Indeed, comparatively speaking, the disturbance in the
second period was nothing to speak of. And yet their relative value during the first
period was well-nigh constant at the ratio of 1 to 15 1/2,
while in the second it fluctuated between 16.10 and 26.75. Those, who argued that the
value of silver fell after 1873 because of its over-supply, were thus faced with the problem as to why the value of gold did not fall when its
supply had become so abundant before 1873. The whole controversy was therefore centred
into the question as to what could have made this difference in the two situations ? If the colossal increase in the production of gold in the
first period did not raise the value of silver by more than 2 per cent., how was it that a comparatively insignificant rise in the
relative production of silver in the second period led to such an enormous rise in the
price of gold ? What was the controlling influence present
in the one case which was absent in the other ? Those who
held that it was demonetisation of silver that was responsible for its depreciation argued
that, though alike in every way, the two periods differed in one important particular. What distinguished them was the fact that in the
former it was a common practice to define the standard money of a country as a certain
quantity of gold or a certain quantity of
silver. Prior to 1803 the two metals were rated differently in different countries,[f51] but since that date the rating of 1 to 15 1/2 became more
uniform, with the result that the monetary standard throughout that period was either 1 gr. of gold or 15
1/2 grs. of saver. On the
other hand, during the second period, the "or"
which characterised the first period was. deleted by the silver-demonetising and
suspending decrees. In other words, the first period was characterised by the prevalence
of bimetallism under which the two metals could be used inter-changeably
at a fixed given ratio. In the second period they could not be so used owing to the fact
that the fixed ratio necessary for interchange had been abrogated. Now, could the
existence or non-existence of a fixed ratio be said to be such a powerful influence as to
make the whole difference that set the two periods in such marked contrast ? That this was the factor which made the whole difference was
the view of the bimetallists. It was said that, by virtue
of the monetary system prevalent during the first period, gold and silver were rendered
substitutes and were regarded as " one commodity of
two different strengths." So related, the conditions of supply had no effect upon
their ratio of exchange, as would have been the case in respect of a commodity without a
substitute. In the case of commodities which are substitutes, the relative scarcity of one
can give it no greater value in terms of the other than that defined by their ratio of
exchange, because by reason of the freedom of substitution the scarcity can be made good
by the abundance of the other. On the other hand, the relative abundance of one cannot
depreciate its value in terms of the other below the ratio of exchange, because its
superfluity can be absorbed by the void created in consequence of a paucity of the other.
So long as they remain substitutes with a fixed ratio of substitution, nothing originating
in demand or supply could disturb their ratio. The two being one commodity, whatever
changes take place in the demand or supply of either system beyond the needs of commerce
express themselves in the price level exactly as though one of them alone was the money
medium; but their ratio of exchange will be preserved
intact in any case
In support of this was cited
the authority of Jevons, who said[f52]:—
"
Whenever different commodities are thus applicable to the same purposes their conditions
of demand and exchange are not independent. Their mutual ratio of exchange cannot vary
much for it will be closely defined by the ratio of their utilities. Beef and mutton
differ so slightly that people eat them almost indifferently. But the wholesale price of
mutton, on an average, exceeds that of beef in the ratio of 9 to 8, and we must therefore
conclude that people generally esteem mutton more than beef in this proportion, otherwise
they would not buy the dear meat...... So long as the
equation of utility holds true, the ratio of exchange between mutton and beef will not
diverge from that of 8 to 9. If the supply of beef falls off people will not pay a higher
price for it, but will eat more mutton; and if the supply
of mutton falls off, they will eat more beef...... We must,
in fact, treat beef and mutton as one commodity of two different strengths—just as
gold at 18 carats and gold at 20 carats are hardly considered as two but rather as one
commodity, of which twenty parts of one are equivalent to eighteen of the other.
"
It is upon this principle that we must explain, in harmony with Cairnes'
views, the extraordinary permanence of the ratio of exchange of gold and silver, which
from the commencement of the eighteenth century up to recent years never diverged much
from 15 to 1. That this fixedness of ratio did not depend
entirely upon the amount or cost of production is proved by the very slight effect of the
Australian and Californian
gold discoveries, which never raised the gold price of silver more than about 4 2/3 per
cent., and failed to have more than a permanent effect of 1
1/2 per cent. This permanence of relative values may have been partially due to the fact
that gold and silver can be employed for exactly the same purposes, but that the superior
brilliancy of gold occasions it to be preferred, unless it be about 15 or 15 1/2 times as
costly as silver. Much more probably, however, the explanation of the fact is to be found
in the fixed ratio of 15 1/2 to 1, according to which these metals are exchanged in the
currency Of France and some other continental countries. The French Currency Law of the
year XI established an artificial## equation—
Utility of gold = 15 1/2 X utility of silver
and it is probably not
without some reason that Wolowski and other recent French
economists attributed to this law of replacement an important effect in preventing
disturbance in the relations of gold and silver."
##It
is this artificiality of the bimetallic system which unfortunately befogs the minds of
some people and prejudices those of others. Some do not understand why the price
determination of two commodities used as money should be so different from the price
determination of any other two commodities as to be governed by a ratio fixed by law.
Others are puzzled as to why, if gold and silver are a pair of substitutes, should they
require a legal ratio while other pairs of substitutes circulate without a legal ratio,
merely on the basis of the ratio of their utility. These difficulties are well explained
away by Prof. Fisher thus:
"
.... ..two forms of money differ from a random pair of commodities in being substitutes.
Two substitutes proper are regarded by the consumer as a single commodity. Thus lumping
together of the two commodities reduces the number of demand conditions, but does not
introduce any indeterminateness into the problem because the missing conditions are at
once supplied by a fixed ratio of substitution.
Thus if ten pounds of cane sugar serve the same purpose as eleven pounds of beet-root
sugar, their fixed ratio of substitution is ten to eleven......... In these cases the
fixed ratio is based on the relative capacities of the two commodities to fill a common
need, and is quite antecedent to their prices...... The substitution ratio is fixed by
nature, and in turn fixes the price ratio.
"
In the single case of money, however, there is no fixed ratio of substitution...... We
have here to deal not with relative sweetening power, nor relative nourishing power, nor
with any other capacity to satisfy wants—no capacity inherent in the metals and
independent of their prices. We have instead to deal only with relative purchasing power. We do not reckon a utility in the
metal itself, but in the commodities it will buy. We assign their respective
desirabilities or utilities to the sugars...... before we know their prices, but we must
inquire the relative circulating value of gold and silver before we can know at what ratio
we ourselves prise them. To us the ratio of substitution is incidentally the price ratio.
The case of the two forms of money is unique. They are substitutes, but have no natural
ratio of substitution, dependent on consumers' preferences.
"
The foregoing considerations...... are overlooked by those who imagine that a fixed legal
ratio is merely superimposed upon a system of supply and demand already determinate, and
who seek to prove thereby that such a ratio is foredoomed to failure...... the ......
analogy ...... is unsound...... Gold and silver ...... are not completely analogous even
to two substitutes because for two forms of money there is no consumers' natural ratio of
substitution. There seems, therefore, room for an artificial ratio......"—Purchasing Power of Money, 1911, pp. 376-77
[f52] Elementary
principles of Economics, 1912, pp. 228-29.
In the illustrations given by Prof. Fisher he appears, although he does not mean it, to
make the success or failure of bimetallism hang upon the question whether or not the two
metals are maintained in circulation. For in the illustration which he gives to show the
failure of bimetallism—Fig. 14 (b)—his film /shows gold to be entirely thrown
out of circulation ; while in the illustration he gives to show the success of
bimetallism—Fig. 15 (b)—his film shows
gold to be only partially thrown out of circulation. But there seems to be no reason to
suppose that there cannot be a third possibility, namely, that while the position of the
film is is as in Fig. 14 (b)—a possibility in which bimetallism succeeds although one
of the two metals is entirely pushed out of circulation. For the success of bimetallism it
is not necessary that both the metals should remain in circulation. Its success depends
upon whether or not the compensatory action succeeds in restoring the relative values of
the two bullions to that legally established between the two coins. If it succeeds in
achieving that, the ratio would be preserved even if the compensatory action drives one
metal entirely out of circulation.
But granting that before
1873 the ratio was preserved owing to the compensatory action of the bimetallic law, can
it be said that it would have been maintained after 1873 if the law had not been suspended
? To give an uncompromising affirmative as the bimetallists did is to suppose that bimetallism can work under
all conditions. As a matter of fact, though it is workable under certain conditions it is
not workable under other conditions. These conditions are well described by Prof. Fisher.[f53] The question under bimetallism is
whether the market ratio between gold and silver bullion will always be the same as the
legal ratio between gold and silver coins freely minted and possessing unlimited
legal-tender power. Now supposing the supply of silver bullion has increased relatively to
that of gold bullion, the result will obviously be a divergence in the mint and the market
ratio. Will the compensatory action of the bimetallic law restore the equilibrium ? It may succeed in doing it or it may not. If the increase in
the supply of silver bullion and the decrease in that of gold bullion are such that a
decrease in that of silver caused by its inflow into the currency and an increase in that
of gold caused by its outflow from currency can restore them to their old levels as
bullion, bimetallism would succeed ; in other words, the
market ratio of the two bullion’s would tend to return to the mint ratio. But if the
increase in the supply of silver bullion and the decrease in that of gold is such that the
outflow of silver bullion into currency reduces the level of the silver bullion to the old
level, but the outflow of gold bullion from currency does not suffice to raise the level
of the gold bullion to the old level, or if the outflow of gold from currency raises the
level of the gold bullion to the old level, but the inflow of silver into currency does
not result in the reduction of the level of silver bullion to its old level, bimetallism
must fail; in other words, the market ratio of the two
bullion’s will remain diverted from the mint ratio legally established between their
coins.
Under which of these two
possibilities could the circumstances arising after 1873 have fallen ? That is a question about which no one can say anything
definitely. Even Jevons, who admitted the success of the
bimetallic law in the earlier period, was not very sanguine about its success in the
latter period. It was he who observed[f54]
"that the question of
bimetallism is one which does not admit of any precise and simple answer. It is
essentially an indeterminate problem. It involves several variable quantities and many
constant quantities, the latter being either inaccurately known or, in many cases,
altogether unknown......"
Nonetheless, it is certain
that the divergence between the mint ratio and the market ratio under a bimetallic system
must be smaller than may be the case where there is no bimetallic system. Whenever the market ratio diverges from the mint ratio
the compensatory action under the bimetallic law tends to restore the equilibrium, and
even where it fails in restoring it, it does succeed in abridging the gulf between the two
ratios. That being the case, it is safe to argue that had there been no demonetisation of
silver after 1873 the ratio between gold and silver would have probably been preserved as
it was during the monetary disturbances of the earlier period. At any rate, this much is
certain, that the market ratio between the two metals could not have diverged from the
mint ratio to the extent it actually did.[f55]
It is therefore a sad commentary on the monetary legislation of the seventies that if it did not actually help to create, for no purpose, a problem unknown before, it certainly helped to make worse a bad situation. Prior to 1870, not all countries had a common currency. There were India and countries of Western Europe which were exclusively on a silver basis, and others, like England and Portugal, which were exclusively on a gold basis, and yet none of them felt the want of a common standard of value in their mutual dealings. So long as there existed the fixed-ratio system in France and the Latin Union the problem was really provided for, for under it the two metals behaved as one and thereby furnished a common standard, although all countries did not use the same metal as their standard money. It was therefore a matter of comparative indifference to most countries which metal they used so long as there was some one country which used either at a certain defined ratio. With the destruction of this fixed ratio what was thus a matter of comparative indifference became a matter of supreme concern. Every country which had before enjoyed the benefits of a common international standard without having a common currency was faced with a crisis in which the choice lay between sacrificing its currency to securing a common standard or hugging its currency and foregoing the benefits of a common standard. That exigencies of a common standard ultimately led to its accomplishment was as it should have been, but it was not a fact before a great deal of harm and some heavy burdens had brought home to people what the want of it really meant to them.