Indian Currency and Finance: CHAPTER II - The Gold-Exchange Standard by@johnmaynardkeynes

Indian Currency and Finance: CHAPTER II - The Gold-Exchange Standard

1. If we are to see the Indian system in its proper perspective, it is necessary to digress for a space to a discussion of currency evolution in general. My purpose is, first, to show that the British system is peculiar and is not suited to other conditions; second, that the conventional idea of “sound” currency is chiefly derived from certain superficial aspects of the British system; third, that a somewhat different type of system has been developed in most other countries; and fourth, that in essentials the system which has been evolved in India conforms to this foreign type. I shall be concerned throughout this chapter with the general characteristics of currency systems, not with the details of their working.
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John Maynard Keynes

Indian Currency and Finance

Indian Currency and Finance by John Maynard Keynes is part of HackerNoon’s Book Blog Post series. You can jump to any chapter in this book here. Chapter I: The gold-exchange Standard


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

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

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

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

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

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

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

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

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

6. With the use of substitutes for gold I will deal in Chapter IV. in treating of the proper position of gold in the Indian system. But what props are commonly brought to the support of an “ineffective” Bank Rate in countries other than Great Britain? Roughly speaking, there are three. A very large gold reserve may be maintained, so that a substantial drain on it may be faced with equanimity; free payments in gold may be partially suspended; or foreign credits and bills may be kept which can be drawn upon when necessary. The Central Banks of most European countries depend (in varying degrees) upon all three.

The Bank of France uses the first two, and her holdings of foreign bills are not, at normal times, important. Her bank rate is not fixed primarily with a view to foreign conditions, and a change in it is usually intended to affect home affairs (though these may of course depend and react on foreign affairs).

Germany is in a state of transition, and her present position is avowedly unsatisfactory. The theory of her arrangements seems to be that she depends on her bank rate after the British model; but in practice her bank rate is not easily rendered effective, and must usually be reinforced by much unseen pressure by the Reichsbank on the other elements of the money market. Her gold reserve is not large enough for the first expedient to be used lightly. Free payment in gold is sometimes, in effect, partially suspended, though covertly and with shame. To an increasing extent the Reichsbank depends on variations in her holding of foreign bills and credits. A few years ago such holdings were of small importance. The table given below shows with what rapidity the part taken by foreign bills and credits in the finance of the Reichsbank has been growing. The authorities of the Reichsbank have now learnt that their position in the international short loan market is not one which permits them to fix the bank rate and then idly to await the course of events.

Reichsbank’s Holdings of Foreign Bills (excluding Credits).


(a): Since 1910 these figures have not been stated in the Reichsbank’s annual reports.

Reichsbank’s Holdings of Foreign Bills and Credits with Foreign Correspondents on last Day of each Year.


7. If we pass from France, whose position as a creditor country is not altogether unlike Great Britain’s, and from Germany, which is at any rate able to do a good deal towards righting the balance of immediate indebtedness by the sale of securities having an international market, to other countries of less financial strength, we find the dependence of their Central Banks on holdings of foreign bills and on foreign credits, their willingness to permit a premium on gold, and the inadequacy of their bank rates taken by themselves, to be increasingly marked. I will first mention very briefly one or two salient facts, and will then consider their underlying meaning, always with an ultimate view to their bearing on the affairs of India.

8. To illustrate how rare a thing in Europe a perfect and automatic gold standard is, let us take the most recent occasion of stringency—November 1912. The Balkan War was at this time at an acute stage, but the European situation was only moderately anxious. Compared with the crisis at the end of 1907, the financial position was one of comparative calm. Yet in the course of that month there was a premium on gold of about ¾ per cent in France, Germany, Russia, Austria–Hungary,and Belgium. So high a premium as this is as effective in retaining gold as a very considerable addition to the bank rate. If, for example, the premium did not last more than three months, it would add to the profits of a temporary deposit of funds for that period as much as an addition of 3 per cent to the discount rate; or, to put it the other way round, there would need to be an additional profit of 3 per cent elsewhere if it were to be worth while to send funds abroad.

9. The growing importance of foreign bills in the portfolios of the Reichsbank has been shown above. The importance of foreign bills and credits in the policy of the Austro–Hungarian Bank is of longer standing and is better known. They always form an important part of its reserves, and the part first utilised in times of stringency. It was supposed that in the third quarter of 1911 the Bank placed not less than £4,000,000 worth of gold bills at the disposal of the Austro–Hungarian market in order to support exchange. Amongst European countries, Russia now keeps the largest aggregate of funds in foreign bills and in balances abroad—amounting in November 1912 to £26,630,000. Account being taken of their total resources, however, the banks of the three Scandinavian countries, Sweden, Norway, and Denmark, hold the highest proportion in the form of balances abroad—amounting in November 1912, for the three countries in the aggregate, to about £7,000,000. These are enough examples for my purpose.

10. What is the underlying significance of this growing tendency on the part of European State Banks to hold a part of their reserves in foreign bills or foreign credits? We saw above that the bank–rate policy of the Bank of England is successful because by indirect means it causes the Money Market to reduce its short–period loans to foreign countries, and thus to turn the balance of immediate indebtedness in our favour. This indirect policy is less feasible in countries where the Money Market is already a borrower rather than a lender in the international market. In such countries a rise in the bank–rate cannot be relied on to produce the desired effect with due rapidity. A direct policy on the part of the Central Bank, therefore, must be employed. If the Money Market is not a lender in the international market, the Bank itself must be at pains to become to some extent one. The Bank of England lends to middlemen who, by holding bills or otherwise, lend abroad. A rise in the bank rate is equivalent to putting pressure on these middlemen to diminish their commitments. In countries where the Money Market is neither so highly developed nor, in relation to foreign countries, so self–supporting, the Central Bank, if it is to be secure, must take the matter in hand itself and, by itself entering the international money market as a lender at short notice, place itself in funds, at foreign centres, which can be rapidly withdrawn when they are required. The only alternative would be the holding of a much larger reserve of gold, the expense of which would be nearly intolerable. The new method combines safety with economy. Just as individuals have learnt that it is cheaper and not less safe to keep their ultimate reserves on deposit at their bankers than to keep them at home in cash, so the second stage of monetary evolution is now entered on, and nations are learning that some part of the cash reserves of their banks (we cannot go further than this at present) may be properly kept on deposit in the international money market. This is not the expedient of second–rate or impoverished countries; it is the expedient of all those who have not attained a high degree of financial supremacy—of all those, in fact, who are not themselves international bankers.

11. In the forty years, therefore, during which the world has been coming on to a gold standard (without, however, giving up for that reason its local currencies of notes or token silver), two devices—apart from the bullion reserve itself and the bank rate—have been evolved for protecting the local currencies. The first is to permit a small variation in the ratio of exchange between the local currency and gold, amounting perhaps to an occasional premium of ¾ per cent on the latter; this may help to tide over a stringency which is seasonal or of short duration without raising to a dangerous level the rate of discount on purely local transactions. The second is for the Government or Central Bank to hold resources available abroad, which can be used for maintaining the gold parity of the local currency, when there is the need for it.

12. We are now more nearly in a position to come back to the currency of India herself, and to see it in its proper relation to those of other countries. At one end of the scale we have Great Britain and France—creditor nations in the short–loan market. In an intermediate position comes Germany—a creditor in relation to many of her neighbours, but apt to be a debtor in relation to France, Great Britain, and the United States. Next come such countries as Russia and Austria–Hungary—rich and powerful, with immense reserves of gold, but debtor nations, dependent in the short–loan market on their neighbours. From the currencies of these it is an easy step to those of the great trading nations of Asia—India, Japan, and the Dutch East Indies.

13. I say that from the currencies of such countries as Russia and Austria–Hungary to those which have] explicitly and in name a Gold–Exchange Standard it is an easy step. The Gold–Exchange Standard is simply a more regularised form of the same system as theirs. In their essential characteristics and in the monetary logic which underlies them the currencies of India and Austria–Hungary (to take these as our examples) are not really different. In India we know the extreme limits of fluctuation in the exchange value of the rupee; we know the precise volume of reserves which the Government holds in gold and in credits abroad; and we know at what moment the Government will step in and utilise these resources for the support of the rupee. In Austria–Hungary the system is less automatic, and the Bank is allowed a wide discretion. In detail, of course, there are a number of differences. India keeps a somewhat higher proportion of her reserves in foreign credits, and keeps some part of these credits in a less liquid form. She also keeps a portion of her gold reserve in London—a practice made possible by the fact that for India London is not strictly a foreign centre. On the other hand, India is probably more willing than the Bank of Austria–Hungary to supply gold on demand. If we are to judge from the experience of recent years, India inclines to use her gold reserves, Austria–Hungary her foreign credits, first. But in the essentials of the Gold–Exchange Standard—the use of a local currency mainly not of gold, some degree of unwillingness to supply gold locally in exchange for the local currency, but a high degree of willingness to sell foreign exchange for payment in local currency at a certain maximum rate, and to use foreign credits in order to do this—the two countries agree.

14. To say that the Gold–Exchange Standard merely carries somewhat further the currency arrangements which several European countries have evolved during the last quarter of a century is not, of course, to justify it. But if we see that the Gold–Exchange Standard is not, in the currency world of to–day, anomalous, and that it is in the main stream of currency evolution, we shall have a wider experience, on which to draw, in criticising it, and may be in a better position to judge of its details wisely. Much nonsense is talked about a gold standard’s properly carrying a gold currency with it. If we mean by a gold currency a state of affairs in which gold is the principal or even, in the aggregate, a very important medium of exchange, no country in the world has such a thing. Gold is an international, but not a local currency. The currency problem of each country is to ensure that they shall run no risk of being unable to put their hands on international currency when they need it, and to waste as small a proportion of their resources on holdings of actual gold as is compatible with this. The proper solution for each country must be governed by the nature of its position in the international money market and of its relations to the chief financial centres, and by those national customs in matters of currency which it may be unwise to disturb. It is as an attempt to solve this problem that the Gold–Exchange Standard ought to be judged.

15. We have been concerned so far with transitional systems of currency. I will conclude this chapter with a brief history in outline of the Gold–Exchange Standard itself. It will then be time to pass from high generalities to the actual details of the Indian system.

The Gold–Exchange Standard arises out of the discovery that, so long as gold is available for payments of international indebtedness at an approximately constant rate in terms of the national currency, it is a matter of comparative indifference whether it actually forms the national currency.

The Gold–Exchange Standard may be said to exist when gold does not circulate in a country to an appreciable extent, when the local currency is not necessarily redeemable in gold, but when the Government or Central Bank makes arrangements for the provision of foreign remittances in gold at a fixed maximum rate in terms of the local currency, the reserves necessary to provide these remittances being kept to a considerable extent abroad.

A system closely resembling the Gold–Exchange Standard was actually employed during the second half of the eighteenth century for regulating the exchange between London and Edinburgh. Its theoretical advantages were first set forth by Ricardo at the time of the Bullionist Controversy. He laid it down that a currency is in its most perfect state when it consists of a cheap material, but having an equal value with the gold it professes to represent; and he suggested that convertibility for the purposes of the foreign exchanges should be ensured by the tendering on demand of gold bars (not coin) in exchange for notes,—so that gold might be available for purposes of export only, and would be prevented from entering into the internal circulation of the country. In an article contributed to the Contemporary Review of 1887, Dr. Marshall again brought these advantages to the notice of practical men.

16. The first crude attempt in recent times at establishing a standard of this type was made by Holland. The free coinage of silver was suspended in 1877. But the currency continued to consist mainly of silver and paper. It has been maintained since that date at a constant value in terms of gold by the Bank’s regularly providing gold when it is required for export and by its using its authority at the same time for restricting so far as possible the use of gold at home. To make this policy possible, the Bank of Holland has kept a reserve, of a moderate and economical amount, partly in gold, partly in foreign bills. During the long period for which this policy has been pursued, it has been severely tried more than once, but has stood the test successfully.

It must be noticed, however, that although Holland has kept gold and foreign bills as a means of obtaining a credit abroad at any moment, she has not kept a standing credit in any foreign financial centre. The method of keeping a token currency at a fixed par with gold by means of credit abroad was first adopted by Count Witte for Russia in the transitional period from inconvertible paper to a gold standard;—in the autumn of 1892 the Department of Finance offered to buy exchange on Berlin at 2·18 marks and to sell at 2·20. In the same year (1892) the Austro–Hungarian system, referred to above, was established. As in India their exchange policy was evolved gradually. The present arrangements, which date from 1896, were made possible by the strong preference of the public for notes over gold and by the provision of the law which permitted the holding of foreign bills as cover for the note issue. This exchange policy is the easier, because the Austro–Hungarian Bank is by far the largest dealer in exchange in Vienna;—just as the policy of the Government of India is facilitated by the commanding influence which the system of Council Bills gives it over the exchange market.

17. But although India was not the first country to lead the way to a Gold–Exchange Standard, she was the first to adopt it in a complete form. When in 1893, on the recommendation of the Herschell Committee, following upon the agitation of the Indian Currency Association, the Mints were closed to the free coinage of silver, it was believed that the cessation of coinage and the refusal of the Secretary of State to sell his bills below 1s. 4d. would suffice to establish this ratio of exchange. The Government had not then the experience which we have now; we now know that such measures are not by themselves sufficient, except under the influence of favouring circumstances. As a matter of fact the circumstances were, at first, unfavourable. Exchange fell considerably below 1s. 4d., and the Secretary of State had to sell his bills for what he could get. If there had been, at the existing level of prices, a rapidly expanding demand for currency at the time when the Mints were closed, the measures actually taken might very well have proved immediately successful. But the demand did not expand, and the very large issue of currency immediately before and just after the closure of the Mints proved sufficient to satisfy the demand for several years to come;—just as a demand for new currency on an abnormally high scale from 1903 to 1907, accompanied by high rates of discount, was followed in 1908 by a complete cessation of demand and a period of comparatively low rates of discount. Favourable circumstances, however, came at last, and by January 1898 exchange was stable at 1s. 4d. The Fowler Committee, then appointed, recommended a gold currency as the ultimate objective. It is since that time that the Government of India have adopted, or drifted into, their present system.

18. The Gold–Exchange Standard in the form in which it has been adopted in India is justly known as the Lindsay scheme. It was proposed and advocated from the earliest discussions, when the Indian currency problem first became prominent, by Mr. A. M. Lindsay, Deputy–Secretary of the Bank of Bengal, who always maintained that “they must adopt my scheme despite themselves.” His first proposals were made in 1876 and 1878. They were repeated in 1885 and again in 1892, when he published a pamphlet entitled Ricardo’s Exchange Remedy. Finally, he explained his views in detail to the Committee of 1898.

Lindsay’s scheme was severely criticised both by Government officials and leading financiers. Lord Farrer described it as “far too clever for the ordinary English mind with its ineradicable prejudice for an immediately tangible gold backing to all currencies.” Lord Rothschild, Sir John Lubbock (Lord Avebury), Sir Samuel Montagu (the late Lord Swaythling) all gave evidence before the Committee that any system without a visible gold currency would be looked on with distrust. Mr. Alfred de Rothschild went so far as to say that “in fact a gold standard without a gold currency seemed to him an utter impossibility.” Financiers of this type will not admit the feasibility of anything until it has been demonstrated to them by practical experience. It follows, therefore, that they will seldom give their support to what is new.

19. Since the Indian system has been perfected and its provisions generally known, it has been widely imitated both in Asia and elsewhere. In 1903 the Government of the United States introduced a system avowedly based on it into the Philippines. Since that time it has been established, under the influence of the same Government, in Mexico and Panama. The Government of Siam have adopted it. The French have introduced it in Indo–China. Our own Colonial Office have introduced it in the Straits Settlements and are about to introduce it into the West African Colonies. Something similar has existed in Java under Dutch influences for many years. The Japanese system is virtually the same in practice. In China, as is well known, currency reform has not yet been carried through. The Gold–Exchange Standard is the only possible means of bringing China on to a gold basis, and the alternative policy (the policy of our own Foreign Office) is to be content at first with a standard, as well as a currency, of silver. A powerful body of opinion, led by the United States, favours the immediate introduction of a gold standard on the Indian model.

It may fairly be said, therefore, that in the ten years the Gold–Exchange Standard has become the prevailing monetary system of Asia. I have tried to show that it is also closely related to the prevailing tendencies in Europe. Speaking as a theorist, I believe that it contains one essential element—the use of a cheap local currency artificially maintained at par with the international currency or standard of value (whatever that may ultimately turn out to be)—in the ideal currency of the future. But it is now time to turn to details.

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Keynes, John Maynard, 2015. Indian Currency and Finance. Urbana, Illinois: Project Gutenberg. Retrieved May 2022 from

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