Our Banking Messiah II

Our Banking Messiah II ¹

BY PROF. B. RAMACHANDRA RAU, M.A.

While accepting some of the salient conclusions of Sir Daniel Hamilton, viz.,

(a) that the paper-rupee is the most suitable monetary unit of the proposed system;
(b) that it should not be based on gold and silver;
(c) that the co-operative credit societies should be the machinery through which the money instruments are issued indirectly to the people;
(d) that paper created should be covered by goods or work in actual existence;
(e) that credit is the ‘elan vital,’ the energising influence and integrating force of the modern State, political and economic;

I believe that the organisation of the new monetary system should be on the following lines and pay heed to the lessons of our past experience.

As it is deemed advisable to provide for a better organisation of the monetary system, it has to be declared that the paper-rupee issued by the National Board of Currency Commissioners or a Central Bank shall by law be current as money within the Indian Empire. It shall also be declared lawful tender in all payments whatsoever. The present outward appearance of the paper-rupee note has given entire satisfaction and should continue to be so in the future, except that the minimum denominations of the paper-note would be one-rupee. Bills of exchange representing actual work, which are already used to a certain extent in the import and export business of our country, should be drawn on specific goods and all paper-rupees in future issued against such first-class trade bills alone. The co-operative banks should discount first-class trade bills and create this money which would be issued to them on

the strength of such bills by the Central Bank or the National Board. This new authority will be issuing such paper currency from its office to the co-operative banks, which in turn place it in the hands of the real users of money. The quantity of money issued would not only be elastic but the automatic liquidation of bills at the end of the period would ensure the return of paper-rupees. The only business of the Central Bank would be to create the paper money against such bills arising out of purchase and sale of articles alone, and place it in the hands of the co-operative banks who endorse it before discounting the same at the hands of the National Board. The co-operative banks must also see that paper money is issued against such bills alone located definitely in its hands. If the market rate of interest is adjusted carefully to suit the demands of trade, agriculture and industry, the output of paper-money would be possessing the steady purchasing power of money. The price-stabilisation policy, mainly with the object of realising economic stability, has to be pursued by the National Board acting in co-operation with the co-operative banks and the existing banks, which would have to perform the same discounting of trade bills or agricultural bills or industrial bills. The rediscounting rate might be lower than the market rate so as to induce them to offer the highest class of bills for rediscounting.

Comprehensive publicity of the National Board's or the Central Bank's operations and efficient supervision by the Government would enable the new machinery to work smoothly. The profits arising out of this business should go to the Government who might spend it for securing the wider interests of the country. This is the kernel of the new scheme and so long as no single plank of the outlined reform is broken, sound money would result out of this suggestion.

MAIN POINTS OF DEPARTURE

The chief point of departure from Sir Daniel's outlined scheme is the adoption of the Government-guaranteed bank currency or national money. Mere Government currency is in no way superior to a Government-guaranteed bank note. The example of Government currency in the early days of the U.S.A. warns us against placing too much faith in the creation of value. The public had no faith in the ‘continentals.’ Even the legal tender laws could not make them circulate. "Fine, imprisonment, forfeiture of claim, outlawry and death" were the penalties decided upon to be meted out to those who refused to take the notes at their face value. But they were of no use. ‘Not worth a continental’ has become a famous English proverb.

Starting with the fundamental assumption that money is not capital but a ticket to make easy the transfer of capital for the main purpose of creating further wealth, it is absolutely essential to see that these tickets are not increased in any way without specific increase of goods, for, in the event of over issuing these tickets, the holder can get only a proportional dividend out of the stock of goods. A Government issuing money is apt to over issue it and bring about such a deplorable situation. Hence the Central Bank or a disinterested national machinery such as the National Board to issue the Government-guaranteed bank note or national money. The quantity of this money would be the natural outcome of economic conditions throughout the country. The interplay of these conditions i.e. the economic demand for currency and the totality of bank-note currency created would automatically fix the bank rate.

PERFECTING THE CO-OPERATIVE MACHINERY

Before the actual commencement of this permanent system for providing the national paper-money can be taken up in right earnest, the perfecting of the machinery of the co-operative banks has to be achieved. The present defects of the co-operative movement should be analysed by Provincial Committees set apart for the work of reconstruction. As I have pointed out elsewhere², the three arms of the co-operative credit triangle need much strengthening. The co-operative financial arm, the non-official training, propaganda and supervision arm; and the Government arm of inspection and audit; has each its own defects which require early attention. Each arm consists of three parts. The co-operative credit arm is composed of the co-operative credit society, the co-operative Central Bank and the Provincial Apex Bank. The non-official arm consists of the supervising unit, the district federation, and the Apex Provincial Co-operative organisation society. These need immediate strengthening. Finally, inspection, auditing and liquidation, are the duties of the Governmental arm. If the different arms or limbs of the co-operative body do not harmoniously combine with each other, it is quite possible that there would be complete paralysis as in the case of the old parable–the man and the limbs.

DFFICULTIES IN CHANGING THE CURRENCY SYSTEM

Even granted that the monetary instruments are perfected and the needed co-operative banking machinery is created, it must be remembered that the existing money system cannot be scrapped light-heartedly. The gold and silver hoards would lose value. As it is impossible to have a clean slate in the matter of monetary reform, the claims of these people must be considered. The position of the silver-rupee is in the present system illogical. It is a stumbling block even to the peaceful and steady return of the gold bullion standard. These difficulties would be aggravated thousand fold if neither silver nor gold is used as currency. The only possible thing is to think of their sale abroad, but the mere announcement of the Hilton-Young Commission's recommendations, though no actual ‘dethronement of the rupee’ was contemplated, pulled down the value of silver. Hence the sale of unwanted silver on a large scale without actually paring its value to a very great extent is impossible. Nor can the new Central Bank or the National Board immediately take up the task of supplying at a fixed rate these new units as compensation for the present holders and as a means of averting possible loss to the stored-up energy in the form of precious metals. Even if it is attempted and even if it were possible to sell it gradually on the world markets in small quantities by means of the tender system, the value would still fall. There is no source that can be indicated as a desirable fund to withstand this loss. The gain to the Corporation of the National Board or the Central Bank would not be very great in the beginning. It would not be sufficient to act as a reservoir to bear this loss.

Most of the present day contracts and monetary claims are payable in gold or legal tender currency. Their value would be affected to a certain extent by the introduction of this reform. When doubts arise in people’s minds as regards the soundness of the newly introduced paper, difficulties are sure to arise.

India should after all have a domestic gold bullion market. With the least sign of over-issue of inconvertible paper currency, a premium on gold would ensue. This would bring further discredit on the paper money in use.

If other countries do not adopt this self-same policy, as they are not likely to do, there would be danger to our society by rising prices or falling prices elsewhere. Tempted by falling prices, they may be led to sell stocks of goods in our country. If our price-level is kept steady, as it naturally would be if money is created only in due response to business needs, our exports might falloff. There would be increasing competition which our manufacturers would have to bear. Secondly, the foreign producers, though paid in paper, would go to the Central Bank or the National Board and get it converted into foreign exchange which would be useful for their own domestic uses. Thus a drain on the foreign exchange resources of the currency authority would ensue.

Taking the converse case of rising prices elsewhere, there would be irresistible temptation to sell our goods in foreign countries, and gold or foreign exchange resources would have to be liberated. Our price-level would again be leveled up to the one prevailing in the outer world.

It is inevitable that with managed and stabilised currency for domestic purposes, the foreign exchanges must be made to fluctuate when world prices are unstable. When all countries of the world are now attempting to achieve relative stabilisation of the price-level by a return to the better managed gold standard and obtain exchange stability, our above-foreshadowed plan would be running contrary to their plan of action. Lack of a fixed unit par of exchange or exchange stability at such times has its own evil effects. It would be extremely disturbing to trade, government finance, and free flow of capital for investment purposes.

MANAGED GOLD STANDARD

Thus this monetary reform would be futile except for a brief period, and disturbances would be created as a result of extraneous circumstances over which we have no control. We would have to dance up to the tune sung by other peoples. All over the world, there has been the return to the gold standard and the problems confronting the present day gold standard are to be solved.

India's contribution towards the gold problem can indeed be a magnificent one for which the whole world might be held in fee. Were the future gold stocks to be smaller than the actual demand, the disgorging of her hoards which would indeed be a slow process and dependent on the development of the banking system, can be counted upon. The idea of the gold coin accompaniment, which a gold bullion standard can hope to possess, would have to be sacrificed. With the creation of a Central Bank of Issue co-operating with the other Central Banks, the perfection of the domestic banking system and the popularising of the credit currency can be achieved. It can mobilise gold and issue notes during times of scarcity of gold stocks. With the advent of sound banks, ‘the store of value’ function which hoards are now doing can be safely entrusted to them. The industrial or the arts demand for gold can be lessened to a certain extent. But much progress cannot be achieved in this direction until the legal status of women is improved.³

India's contribution can be equally weighty even if there were to be an actual increase of gold stocks with reference to world demand. Her use in the arts can be stimulated. The gold bullion demand for hoarding might now be acting as a god-sent gift or measure. The Central Bank of Issue need not hope to immobilize or impound gold in its reserve as was done in the U.S.A. banking system in 1923 or send it to the treasury and get gold certificates issued against gold. The above two remedies would be very efficacious in this respect.

The upshot of the above discussion would be that India can safely join the ranks of the gold standard countries. By creating a Central Bank of Issue and by perfecting the needed statistical service, that would be required for presenting a true state of the exact economic conditions of society, the management of the gold standard can be efficiently done by this enlightened body. India need not worry herself about the gold problem confronting her as well as the other nations. But she can be a tower of strength to the other nations of the world and can hope to render substantial service in either direction, of gold shortage or gold inflation, that might occur in the near future. Her services in this direction would be in no degree less than the supposed and doubtful benefits that she will confer by pointing out the path to achieve a new monetary era–the regime of free-paper standard.

Under such circumstances, the wisest course is to co-operate with the rest of the world. An effective and sound monetary system can be secured thereby very easily. Gold fiat money introduced and managed by the Central Banks of the different countries of the world as a result of mutual understanding, would be immensely superior to the Government paper currency or the free-paper standard managed by the Central Bank or the National Board. Monetary isolation from the rest of the world would be introducing far more serious consequences than cultural or economic isolation. Monetary non-co-operation is unthinkable at this stage of our economic development.

Recognising the full stabilising influence of international gold fiat money, India must join the ranks of other nations rather than isolate herself. It is by doing so alone that India can possess a stable monetary unit for internal as well as external purposes, than by tying herself up to a free-paper standard scheme which may not after all be nicely and intelligently regulated. Secondly, by removing risks attached to unstable currency, interest rates would be stable and low at the same time. Thirdly, stability of exchange with all the gold standard countries can be easily obtained and India's exports can easily find a sale for them in the Gold standard countries. Fourthly, greater confidence abroad in India would encourage the free flow of capital for productive purposes. "Without currency stability, conservative capital would shrink from the country" says the Kemmerer-Vissering Report⁴ and that has been our very experience during 1870 to 1892, years of unstable exchange. Fifthly, gold money or silver money which is so Convenient for the people can ultimately be used under the gold standard. This is far more sanitary than bank notes or the Government paper currency of Sir Daniel. Sixthly, the credit-standing which India now possesses abroad would not be destroyed under some form of the gold standard or other. It is risky policy then to adopt the managed free-paper standard.

Even if we accept a reformed and much improved scheme of Sir Daniel, India would become one of the money wrenches that would be left sticking in the world's monetary machine. It all looks very grand to inaugurate a new monetary era, but it may perhaps bring in its train insuperable difficulties. That the "whirligig of time brings in its own revenges" should not be forgotten. To remedy them all, the world should be brought over to India's new monetary standard. This international concerted action in using managed paper currency is apparently an impossible task. If the mountain does not come to Mahomed, Mahomed must go to the mountain. It is folly to sever ourselves from the world standard and money.

CONCLUSION

Taking all things into consideration, the interests of the people who have the small hoards of silver or gold, the inherent difficulties involved in the transition to the new monetary era, the possible consequences that would befall us by monetary isolation from the rest of the world, the grip and fascination which gold exercises over the Indian people, the lack of the truly reliable co-operative societies, and the dearth of the financial statesmanship that would be needed by the members of the Central Bank or the National Board, I reject the free-paper standard, no matter however perfect the scheme might be made by ingenious safeguards against inflation and its possible consequences. India can confer a permanent and lasting benefit to the world by joining the ranks of the gold standard countries and perfecting the Central Bank of Issue in the light of international requirements and co-operation that would be forthcoming. A fairly intelligent regulation of credit currency is infinitely superior to Government fiat money. Gold price fluctuations can and should be eliminated by credit currency operating under an enlightened regime and nexus of international Central Bank solidarity. Of both the systems, the gold fiat and the Government fiat systems, the gold fiat system is ‘a new and experimental one’ but it is gradually improving its technique. If it succeeds in removing the tidal action on prices without attempting to establish complete surface tranquility, with the help of a uniform system of index-number agreed upon internationally, the quest for a sound monetary system need not be carried further.

1 This is the second and final article on Sir Daniel Hamilton's Free-paper Standard Scheme. The first was published in ‘Triveni’ for March-April,1929.

2 See my third edition of ‘Present Day Banking in India’ –Calcutta University.

3 See my article on Hoarding –in the Indian Finance –1928.

4 Report on the Resumption of Gold Payments by the Union of South Africa.