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]

TABLE XLIX

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

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

[pg 234] does not stop to think how much currency it issues. The proportion of the issues and the reserve not being correlated the stability of the exchange standard, in so far as it depends upon the reserve, must always remain in the region of vagueness, far too problematical to inspire confidence of the system. Nay, the liability of redemption for foreign remittances, small as it appears, may become so indefinite as entirely to jeopardize the restoration of stability to the exchange standard.

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

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

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

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

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

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

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

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

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

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

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

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

TABLE L

Depreciation of the Notes of the Bank of England³⁷⁴

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

[pg 244] Which kind of depreciation is the greater evil we will discuss in the next chapter. Dealing for the present with this experience of the Bank of England, we have the fact that there can be a general depreciation without a specific depreciation. In view of this, the upholders of the exchange standard have no reason to be proud of the fact that the rupee has not shown signs of specific depreciation over periods of long duration. That a bank note absolutely inconvertible and unregulated as to issue should have maintained its par for very nearly thirteen years may speak far more in favour of the suspension system than the experience of the rupee can in favour of the exchange standard. There is a greater wonder in the former than there is in the latter, for the value of the rupee is sustained, apart from the fact that gold in terms of which it was measured was itself undergoing a depreciation, as is evident from the foregoing figures of general prices in England, and by a hope in some kind of convertibility, however slight or however remote but which had no place in the case of the Bank of England notes. Yet no one is known to have admired or justified the currency system of the suspension period, although it had not given rise to a specific depreciation for a long time.

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

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

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

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

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