The problem of the rupee: its origin and its solution



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TABLE XLVII

Sale of Reverse Councils (figures in thousands of Pounds)

Date of sale.

Amount offered at each Sale.

Amount applied for at each Sale.

Amount sold at each Sale.

Progressive Total of Amount sold.

1920. January 2

1,000

770

770

770

„ 8

1,000

8,499

990

1,760

„ 15

2,000

300

300

2,060

„ 22

2,000

4,890

2,000

4,060

„ 29

2,000

1,334

5,000

5,394

February 5

2,000

32,390

2,000

7,394

„ 12

2,000

41,312

2,000

12,394

„ 19

2,000

122,335

2,000

14,394

26

2,000

78,417

2,000

16,394

March 3

2,000

64,931

2,000

18,394

„ 11

2,000

117,185

2,000

20,394

„ 18

2,000

153,559

2,000

22,394

„ 25

2,000

56,295

2,000

24,394

„ 31

2,000

35,050

1,988

26,382

April 1

 

 

 

 

„ 8

2,000

16,721

2,000

28,382

„ 15

2,000

48,270

2,000

30,382

„ 22

2,000

59,020

2,000

32,382

„ 29

1,000

53,210

1,000

33,382

May 6

1,000

89,514

1,000

34,382

„ 13

1,000

101,625

1,000

35,382

„ 20

1,000

122,279

1,000

36,382

„ 26

1,000

85,620

1,000

37,382

June 3

1,000

101,821

1,000

38,382

„ 10

1,000

109,245

1,000

39,382

„ 15

1,000

122,991

1,000

40,382

„ 24

1,000

73,391

1,000

41,382

July 1

1,000

106,751

1,000

42,382

„ 8

1,000

63,690

1,000

43,382

„ 15

1,000

101,830

1,000

44,382

„ 22

1,000

103,960

1,000

45,382

„ 29

1,000

75,486

1,000

46,382

August 5

1,000

101,260

1,000

47,382

„ 12

1,000

112,230

1,000

48,382

„ 19

1,000

114,767

1,000

49,382

„ 26

1,000

117,390

1,000

50,382

Sept. 2

1,000

126,425

1,000

51,382

„ 7

1,000

117,200

1,000

52,382

„ 13

1,000

115,095

1,000

53,382

„ 21

1,000

122,590

1,000

54,382

„ 28

1,000

120,050

1,000

55,382

 

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



 

Ill. Redemption in 1920



TABLE XLVIII

Sale of gold

No. of Sate

Date of Sale

Minimum Rate of accepted Tenders

Average Rate of accepted Tenders

Quantity sold (in Tolas)

Price of Country Bar Gold in the Bombay Bazaar

 

 

Rs. a. p.

Rs. a. p.

 

Rs. a. p.

1

1919. September 3

25 8 0

26 12 1

3,29,130

28 10 0

2

17

24 8 0

24 10 0

3,96,640

26 1 0

3

October 6

25 8 0

25 9 8

3,26,000

27 0 0

4

20

26 15 3

27 0 2

3,34,000

28 0 0

5

November 3

27 14 6

27 15 6

3,25,000

28 5 0

6

17

26 15 0

27 0 11

5,18,500

28 2 0

7

December 8

26 0 6

26 4 6

10,00,650

27 10 0

8

1920. January 5

26 4 3

26 7 9

7,63,300

27 3 0

9

19

26 13 3

26 14 7

8,00,000

27 5 0

10

February 5

25 2 3

25 9 7

7,56,450

25 6 0

11

19

16 2 3

21 9 1

9,60,590

23 4 0

12

March 3

18 8 0

18 12 4

12,96,125

21 7 0

13

„ 17

21 6 0

21 7 7

12,53,325

22 13 0

14

April 7

22 7 3

22 9 4

12,46,200

24 0 0

15

„ 21

23 7 4

23 8 6

10,68,175

24 4 0

16

May 5

20 13 3

21 3 2

11,96,750

21 8 0

17

.. 19

21 0 3

21 1 7

12,46,050

21 12 0

18

June 9

21 8 9

21 9 8

11,32,350

22 2 6

19

„ 23

20 14 10

21 0 5

12,25,250

21 8 0

20

July 7

21 1 4

22 2 2

12,81,500

21 6 0

21

„ 21

22 0 1

22 0 11

12,42,000

22 5 0

22

August 4

22 5 6

22 6 3

12,78,950

22 7 0

23

„ 19

23 9 4

23 10 2

5,54,500

23 7 0

24

September 1

22 8 3

22 10 8

8,27,700

23 1 6

25

14

23 9 4

23 12 11

2,30,500

23 8 0

 

Total

 

 

2,15,89,635

 

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

The success of this mechanism on the two previous occasions had strengthened the belief that it had the virtue of restoring the value of the rupee. But the failure of this mechanism in the crisis of 1920 compels one to adopt an attitude of reserve towards its general efficacy. It cannot be said that exchange gave way because this mechanism was not brought into operation. On the other hand, the view of the Government regarding the sale of reverse councils in 1920 had undergone a profound modification as compared with the view it held during the crisis of 1907-8. In that crisis the Government behaved like a miser, sitting tight on its gold reserve and refusing to use it for the very purpose which it was designed to serve. An Accountant-General had " to go on his knees " to persuade the Government of India to release its gold. [f8] It was probably because it was rebuked by the Chamberlain Commission for failing to make use of its gold reserve in 1907 that in the crisis of 1920 the policy of selling reverse councils was so boldly conceived. There was a great deal of ignorant criticism of that policy from the general public that it was an " organised loot." But the Finance Minister was undaunted, and argued[f9]:

"It is an essential feature of our exchange policy... that we should not only provide for remittances from London to India through council bills at approximately gold point, but from India to London in time of exchange weakness also at gold point, through the sale of sterling remittance known as reverse councils. It is simply an alternative to the export of gold. This is no new matter—we have been selling reverse councils for years...... and unless we do so the exchange policy does not become effective...... This is the reason, and the only reason, why we have sold reverse councils... It is an effort in fact to maintain exchange as near as possible to the gold point.... What would be the consequence if we yielded to the pressure placed on us and ceased to sell reverse councils at all ? I can understand a demand that reverse councils should be sold by some different method, or at rates different from those at present in force, but I must confess that I cannot understand the demand that the facilities for the exchange of rupees into external currency should be entirely withdrawn. I see that in Bombay it is urged that we should let exchange find its ' natural level.' That is a catchword which does not impress me. Used in the sense in which that phrase has been recently used, there is no such thing as a ' natural level ' in exchange, for, when one translates the internal currency into another currency, there must be some sort of common denominator to which both currencies can be brought; it may be gold, it may be silver, it may be sterling or it may be Spanish pesetas, which we take as our basis. The rupee must be linked on to something[f10] and if it is so linked, then it must be at some definite rate, and this necessarily involves that we must sometimes be prepared to sell reverse councils in order to maintain that rate. If reverse councils be withdrawn entirely, then we should have neither a gold standard, nor a gold-exchange standard, nor any kind of standard at all."

But that only raises the question: If the sale of reverse councils is efficacious in righting the exchange, why was its effect such a disastrous failure ? The Finance Minister answered the point tersely and cogently when he said:—

" If we have failed in narrowing the gap between the market price and the theoretical gold part of the rupee...... it is not because we have sold too many reverse councils; it is because we have sold too few. I put it to any member of the commercial community here, and I put it without fear of contradiction, that if our resources had enabled us...... to sell straight away 20, 30, or 40 millions of reverse councils, we should probably have had no gap between the market price of the rupee and the theoretical gold price of the rupee at all. One of our difficulties has been, not that we have sold too many reverse councils, but that we have been obliged to sell too few." [f11]

There would have been some force in this argument if the smount of reverse bills sold were " too few." Not 20, 30, or 40 millions, but 55 1/2 millions of reverse councils were sold, besides the large issue of gold internally, and the complete stoppage of council bills, and yet the rupee did not rise above 1s. 4d. sterling, let alone reaching 2s. gold. Why did not the sale of reverse councils suffice to rectify the exchange ? This leads us to examine the whole question of the efficacy of this redemption.



It is necessary to premise at the outset that redemption may result in mere substitution of one form of currency by another, or it may result in the retirement of currency. In so far as it results in substitution it is of no consequence at all, for substitution of currency is not a shrinkage of currency. [f12]To the restoration of the value of a currency what is essential is its shrinkage, i.e. its retirement, cancellation. The important question with regard to this mechanism is not to what extent the currency can be redeemed, but to what extent it can be retired. In the prevalent view of this question it seems to be accepted without question that this extent is determined by the magnitude of the gold resources of the Government of India and the Secretary of State. Let us first make it clear how these gold resources are located and distributed. It will be recalled that these gold resources are distributed between (1) the paper-currency reserve, (2) the gold-standard reserve, and (3) the cash balances of the Secretary of State. It has been the habit to speak of these resources as being three " lines of defence " on which the Government can safely rely when an exchange crisis takes place. But are they ? They can be, for the purposes of retirement, only if they were all " free " resources; in other words, if they were not appropriated resources. To what extent are they unappropriated ? Can the Secretary of State take gold from the paper-currency reserve ? He can, but then he must replace it by something else, or must cancel notes to that extent. Can the Secretary of State take gold out of his cash balances ? He can, but then he must either borrow to fill his Treasury or draw upon the Government of India if there is anyone to buy his bills, which is tantamount to issuing rupee currency. The gold in the paper-currency reserve and that in the cash balances is of no use at all, for it does not permit of the cancellation of the rupee currency, which is what is wanted in restoring its value when it suffers a fall. It is therefore sheer nonsense to speak of the effectiveness of redemption as being commensurate with the gold resources of the Secretary of State. The matter is important, and an illustration may not be out of place. Suppose A, a holder of rupees, wants to get gold for them. He can go to three counters; (1) that of the controller in charge of cash balances ; (2) that of the controller of currency in charge of the paper-currency reserve ; or (3) that of the custodian of the gold-standard reserve. If A goes to the first, what is the result ? The cash balance is pro tanto reduced. On the assumption that the cash balance is at its minimum, as it should be, the controller must reimburse himself immediately to maintain his solvency by drawing a bill on India and thereby releasing rupees received for gold again in circulation, so that in this case there is no shrinkage of currency. If A goes to the controller of currency, what happens ? The controller gives him gold, but on the assumption that the paper-currency account is a separate statutory account he must put the rupees received from A in place of the gold issued from his reserve, so that here again what happens is that the composition of the reserve undergoes a change, but the total paper currency remains the same. It must therefore be borne in mind that to the extent the gold in the paper-currency reserve and the cash balances are operated upon the result is not a retirement of currency. To speak of them as " lines of defences," as is so often done, is to overlook the fact that these two are not free resources but are appropriated resources.

What is, then, the resource left to the Government to retire the rupee currency ? Only the gold-standard reserve. That is the only reserve the amount of which is unappropriated for any particular use. It is free cash, and only to that extent is it possible for the Government to restore the rupee currency when a fall in its gold value eventuates. Of course it is important to bear in mind that this is the extent to which it can retire the currency. Not that it will, for it may not, and there is no want of cases in which it has not. Two instances will suffice. During the first period of the Mint closure, 1893-98, it will be recalled how a large number of rupees had accumulated in the hands of the Government, and in the interest of raising the value of the rupee they should have been locked away. Instead the Government of India released that money in circulation in extending railways and other public works, as though the spending of rupees by itself produced an effect different to what would have been produced had they been spent by the public. Similarly irresponsible conduct marked the sale of reverse councils in 1920. To meet these reverse councils the Secretary of State took the gold from the paper-currency reserve. But instead of cancelling notes to the extent of the gold that was taken out of the reserve, the Government took powers under an Act XXI of 1920 to fill the gap by manufacturing securities ad hoc, so that although there was redemption there was no retirement, and so much gold was merely wasted, for it produced no effect on prices or the exchange. This Act, passed in March, 1920, was of temporary duration, and would have obliged the Government to retire the currency by October, 1920, when it was to expire. Rather than do this the Government altered the paper-currency law, not temporarily but permanently (Act XLV of 1920), changing the provisions in such a manner as to require the Government to cancel the currency to the smallest degree possible by retiring their " created securities." Even this was not done, owing to deficits in the Government Budget.

But even if such indiscretions were not repeated the fact remains that Government cannot effect a greater retirement than is permitted by the gold-standard reserve. If that reserve fails Government has only two resources left: (1) to melt down the rupees and sell them as bullion for gold and to go on further contracting the currency, in this way till its value is restored: or (2) to borrow gold. Both these are evidently costly methods. To sell rupees as bullion is bound to result in loss unless the bullion in the rupee fetched more at the time of sale than what it cost when it was purchased for manufacturing it into bullion. The second process, that of borrowing, cannot be lightly resorted to for the purpose of creating a reserve fund to retire the currency. Indeed, so costly are such methods, and so complete would be the proof they would afford of the instability of the exchange standard if they were resorted to, that Government has never contemplated them as possible lines of defence in an exchange crisis. It seems certain, however, that Government does recognise that the gold-standard reserve by itself cannot suffice for the maintenance of exchange. For we find that from the year 1907-8 dates a complete change in the distribution of Government balances between London and India. Up to that period it was the policy of the Secretary of State to draw only as much as necessary to finance his Home Treasury. After that date the practice was originated of drawing as much as the Government of India could provide, and as the Government of India has been supreme in financial matters it provided large sums for council drawings by increased taxation and budgeting for surpluses. The effect of this was to swell the cash balances of the Secretary of State. [f13] No official explanation of a satisfactory character has ever been given for this novel way of financing the Home Treasury[f14]but we shall not be very far wrong if we say that the object in accumulating these balances is to provide a second gold reserve to supplement the true gold-standard reserve. Whatever strength the Government may derive for the time being from this adventitious resource, it is obvious that it cannot be permanent. Under a more popular control of Government finances the cash balances will have to be kept down to a minimum necessary to work the Treasury, and the gold-standard reserve will be the only reserve on which the Government will have to depend.

The gold-standard reserve is to the rupee what the paper-currency reserve is to the notes. The purport of both is to 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.[f15] 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. [f16] 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. [f17] Such differences apart, is the gold-standard 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 Table XLIX).

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 finds[f18]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.

 

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