FOOTNOTES:

FOOTNOTES:[43]The Purchasing Power of Money, pp. 14-71. The Macmillan Company. New York. 1911.[44]This theory, though often crudely formulated, has been accepted by Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, Kemmerer and most writers on the subject. The Roman Julius Paulus, about 200a. d., stated his belief that the value of money depends on its quantity. See Zuckerkandl,Theorie des Preises: Kemmerer,Money and Credit Instruments in their Relation to General Prices, New York (Holt), 1909. It is true that many writers still oppose the quantity theory. See especially, Laughlin,Principles of Money, New York (Scribner). 1903.[45]See Scott, "It has been a most fruitful source of false doctrines regarding monetary matters, and is constantly and successfully employed in defense of harmful legislation and as a means of preventing needed monetary reforms."Money and Banking.New York, 1903, p. 68.[46][For a method of determining the velocity of the circulation of money, see Appendix A.][47]It is important to bear in mind that whereverPis used in this chapter it represents the index number, or scale of prices, at which the trade,T, is conducted.—Editor.[48]An almost opposite view is that of Laughlin that normal credit cannot affect prices because it is not an offer of standard money and cannot affect the value of the standard which alone determines general prices. See thePrinciples of Money, New York (Scribner), 1903, p. 97. Both views are inconsistent with that upheld ... [here].[49]This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the assumption of an absolute scarcity of specie reserves." SeePrinciples of Money, p. 127.[50]Interesting changes in the magnitudes of the equation of exchange between 1896 and 1914 are given in the appended diagram, which is taken from a reprint of Professor Fisher's article,The Equation of Exchange for 1914, and the War, theAmerican Economic Review, Vol. V, No. 2, June, 1915.—Editor.[51]Adapted from Irving Fisher.Recent Changes in Price Levels and Their Causes, Bulletin of the American Economic Association. Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 43-44.[52]Irving Fisher,The Purchasing Power of Money, pp. 74-88.[53]Ibid., pp. 149, 150.[54]Causes of the Changes in Prices since 1896.Bulletin of the American Economic Association, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 27-36.[55]There is a possible error here of perhaps $500,000,000.[56]The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director of Mint, 1909, p. 80.[57]Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.[58]Ibid., pp. 52-61.[59]Money and Credit Instruments in their Relation to General Prices, 2d edition, 1909. New York: Henry Holt & Company.[60]The passages referred to are omitted.—Editor.[61]Kemmerer,Money and Credit Instruments, pp. 9-18, 74-82.[62]Ibid., pp. 82-8, 121-6, 145-8.[63]Ibid., p. 9. [See Fisher:Purchasing Power of Money, pp. 175-180.][64]The value of gold bullion deposited at the United States mints and assay offices increased from $87,924,000 for 1897 to $205,036,000 for 1907. Figures furnished by the Director of the Mint.[65]It is noteworthy that the reserves of the New York associated banks for example are usually kept very close to the legal reserve requirements. Cf. Sprague,Crises under the National Banking System, p. 222.[66]Gold produced before 1492 represents an insignificant part of the existing supply.[67]Useful tables summarizing all of these index numbers, except those of Canada, are given by Achille Necco, in his article onLa curva dei prezzi delle merci in Italia negli anni 1881-1909, inLa Riforma Sociale, Sept.-Oct., 1910.[68]Comparison is for 1897 and 1906, figures for 1907 not being available.[69]De Launay thinks that the industrial consumption averages somewhere between 40 and 50 per cent. of the annual output, but believes that for several years past the industrial uses have been absorbing a decreasing proportion, though an increasing amount. (The World's Gold, pp. 176-7.)[70]Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.[71]Ibid., pp. 61-63.[72]Ibid., p. 64.[73]The quotation here referred to is omitted.—Editor.[74]Ibid., pp. 64-65.[75]Ibid., pp. 65-67.[76]Ibid., pp. 67-69.[77]Adapted fromThe Purchasing Power of Money, pp. 150-157; and Bulletin of the American Economic Association, Fourth Series, No. 2. Papers and Discussions of the Twenty-third Annual Meeting, December, 1910. p. 70.[78]David Ricardo,Reply to Mr. Bosanquet's Practical Observations on the Report of the Bullion Committee, Works, pp. 326-328. John Murray. London. 1888.[79]The Bank could not on their own principles, then urge that most erroneous opinion, that the rate of interest would be affected in the money market if their issues were excessive, and would therefore cause their notes to return to them, because, in the case here supposed, the actual amount of the money of the world being greatly diminished, they must contend that the rate of interest would generally rise, and they might therefore increase their issues. If, after the able exposition of Dr. Smith, any further argument were necessary to prove that the rate of interest is governed wholly by the relation of the amount of capital with the means of employing it, and is entirely independent of the abundance or scarcity of the circulating medium, this illustration would I think afford it.

[43]The Purchasing Power of Money, pp. 14-71. The Macmillan Company. New York. 1911.

[44]This theory, though often crudely formulated, has been accepted by Locke, Hume, Adam Smith, Ricardo Mill, Walker, Marshall, Hadley, Fetter, Kemmerer and most writers on the subject. The Roman Julius Paulus, about 200a. d., stated his belief that the value of money depends on its quantity. See Zuckerkandl,Theorie des Preises: Kemmerer,Money and Credit Instruments in their Relation to General Prices, New York (Holt), 1909. It is true that many writers still oppose the quantity theory. See especially, Laughlin,Principles of Money, New York (Scribner). 1903.

[45]See Scott, "It has been a most fruitful source of false doctrines regarding monetary matters, and is constantly and successfully employed in defense of harmful legislation and as a means of preventing needed monetary reforms."Money and Banking.New York, 1903, p. 68.

[46][For a method of determining the velocity of the circulation of money, see Appendix A.]

[47]It is important to bear in mind that whereverPis used in this chapter it represents the index number, or scale of prices, at which the trade,T, is conducted.—Editor.

[48]An almost opposite view is that of Laughlin that normal credit cannot affect prices because it is not an offer of standard money and cannot affect the value of the standard which alone determines general prices. See thePrinciples of Money, New York (Scribner), 1903, p. 97. Both views are inconsistent with that upheld ... [here].

[49]This fact is apparently overlooked by Laughlin when he argues that there is not "any reason for limiting the amount of the deposit currency, or the assumption of an absolute scarcity of specie reserves." SeePrinciples of Money, p. 127.

[50]Interesting changes in the magnitudes of the equation of exchange between 1896 and 1914 are given in the appended diagram, which is taken from a reprint of Professor Fisher's article,The Equation of Exchange for 1914, and the War, theAmerican Economic Review, Vol. V, No. 2, June, 1915.—Editor.

[51]Adapted from Irving Fisher.Recent Changes in Price Levels and Their Causes, Bulletin of the American Economic Association. Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 43-44.

[52]Irving Fisher,The Purchasing Power of Money, pp. 74-88.

[53]Ibid., pp. 149, 150.

[54]Causes of the Changes in Prices since 1896.Bulletin of the American Economic Association, Fourth Series, No. 2, Papers and Discussions of the Twenty-third Annual Meeting, December, 1910, pp. 27-36.

[55]There is a possible error here of perhaps $500,000,000.

[56]The estimate for 1908 is $113,996,000. Cf. U. S. Report of Director of Mint, 1909, p. 80.

[57]Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 46-52.

[58]Ibid., pp. 52-61.

[59]Money and Credit Instruments in their Relation to General Prices, 2d edition, 1909. New York: Henry Holt & Company.

[60]The passages referred to are omitted.—Editor.

[61]Kemmerer,Money and Credit Instruments, pp. 9-18, 74-82.

[62]Ibid., pp. 82-8, 121-6, 145-8.

[63]Ibid., p. 9. [See Fisher:Purchasing Power of Money, pp. 175-180.]

[64]The value of gold bullion deposited at the United States mints and assay offices increased from $87,924,000 for 1897 to $205,036,000 for 1907. Figures furnished by the Director of the Mint.

[65]It is noteworthy that the reserves of the New York associated banks for example are usually kept very close to the legal reserve requirements. Cf. Sprague,Crises under the National Banking System, p. 222.

[66]Gold produced before 1492 represents an insignificant part of the existing supply.

[67]Useful tables summarizing all of these index numbers, except those of Canada, are given by Achille Necco, in his article onLa curva dei prezzi delle merci in Italia negli anni 1881-1909, inLa Riforma Sociale, Sept.-Oct., 1910.

[68]Comparison is for 1897 and 1906, figures for 1907 not being available.

[69]De Launay thinks that the industrial consumption averages somewhere between 40 and 50 per cent. of the annual output, but believes that for several years past the industrial uses have been absorbing a decreasing proportion, though an increasing amount. (The World's Gold, pp. 176-7.)

[70]Bulletin, Am. Econ. Assoc., Fourth Series, No. 2, 1910, pp. 59-61.

[71]Ibid., pp. 61-63.

[72]Ibid., p. 64.

[73]The quotation here referred to is omitted.—Editor.

[74]Ibid., pp. 64-65.

[75]Ibid., pp. 65-67.

[76]Ibid., pp. 67-69.

[77]Adapted fromThe Purchasing Power of Money, pp. 150-157; and Bulletin of the American Economic Association, Fourth Series, No. 2. Papers and Discussions of the Twenty-third Annual Meeting, December, 1910. p. 70.

[78]David Ricardo,Reply to Mr. Bosanquet's Practical Observations on the Report of the Bullion Committee, Works, pp. 326-328. John Murray. London. 1888.

[79]The Bank could not on their own principles, then urge that most erroneous opinion, that the rate of interest would be affected in the money market if their issues were excessive, and would therefore cause their notes to return to them, because, in the case here supposed, the actual amount of the money of the world being greatly diminished, they must contend that the rate of interest would generally rise, and they might therefore increase their issues. If, after the able exposition of Dr. Smith, any further argument were necessary to prove that the rate of interest is governed wholly by the relation of the amount of capital with the means of employing it, and is entirely independent of the abundance or scarcity of the circulating medium, this illustration would I think afford it.

It is an essential feature of the gold exchange standard as it exists in the Philippines, for example, that premiums charged by the Government in Manila for exchange on New York, and in New York for exchange on Manila are fixed at a point somewhat below the gold export points in each case. Thus the would-be exporter of gold in the Philippines never finds it profitable to ship gold to New York. On the other hand, international bankers in New York never find it profitable to ship gold or currency to the Philippines, because the authorised agent of the Philippine government in New York always stands ready to sell in exchange for United States currency, drafts drawn upon Manila at a premium less than the cost of shipping gold or currency. Through a regulation of the supply of silver pesos in actual circulation in the Philippines they are maintained at a definite ratio to—not gold in the Philippines, but—gold, or its equivalent, in New York. The way in which the supply of local currency in the gold-exchange country is regulated will be made clear in what follows.The gold exchange standard has not entirely escaped criticism. Professor J. Shield Nicholson has recently attacked this standard in India. (Economic Journal, June, 1914.) It is his contention that inflation may occur in India, if it has not already occurred, on account of the "impeded convertibility of rupees into gold." After a certain point is reached in the inflation the decline in the general purchasing power of the rupee must be followed, he affirms, by a specific depreciation as regards gold; and then the main object of the plan would be defeated. He offers no evidence, however, that prices have risen faster in India than in gold standard countries. With the exception of Mexico, where currency conditions have become extremely chaotic, the historical material here reprinted is in accord with the recent monetary history of the countries under discussion.

The gold exchange standard has not entirely escaped criticism. Professor J. Shield Nicholson has recently attacked this standard in India. (Economic Journal, June, 1914.) It is his contention that inflation may occur in India, if it has not already occurred, on account of the "impeded convertibility of rupees into gold." After a certain point is reached in the inflation the decline in the general purchasing power of the rupee must be followed, he affirms, by a specific depreciation as regards gold; and then the main object of the plan would be defeated. He offers no evidence, however, that prices have risen faster in India than in gold standard countries. With the exception of Mexico, where currency conditions have become extremely chaotic, the historical material here reprinted is in accord with the recent monetary history of the countries under discussion.

[80]When the Government of British India sought, in 1893, to give a fixed gold value to about £120,000,000 in rupee silver, it undertook an experiment of great importance to the financial world, and one which was naturally viewed in many quarters with grave misgivings. The experience of fifteen years which have followed that experiment has taught many lessons in monetary science. It may, indeed, be said to have blazed a new path in the principles of money—at least, in their practical application. The effort to raise the coins to a fixed gold value by scarcity alone was not successful, but it led to otherdevices, which, imitated or improved upon in Mexico, the Philippines, and the Straits Settlements, as well as in India, have created a new type of monetary system which has come to bear the title of the gold exchange standard.

The gold exchange standard differs in several respects from the limping standard. It has been the product of definite purpose and plan in the Philippines and in Mexico and to a certain extent in India. While in British India it has been, like the limping standard, a compromise with existing conditions, it has there, as elsewhere, received a definite form and substance which separated it from the limping standard as evolved in France and in other countries which found themselves with a large amount of legal-tender silver on their hands when the metal had fallen below the official parity. There are two other essential differences between the limping standard and the gold exchange standard. One is that the gold exchange standard contemplates a circulation of token coins of silver without any necessary concurrent circulation of gold or paper. The other is that the gold exchange standard contemplates definite and comprehensive measures to maintain the value of token coins at par with gold instead of relying purely upon custom and scarcity to give them value.

The essential principle upon which the exchange standard has been established is that the value of money is governed by the law of supply and demand. So long as supply was indefinite and excessive, as under the system of the free coinage of silver, there was no way of preventing safely and effectively the decline in the gold value of the coins to the bullion value of their silver contents. The moment, however, that Government undertook to limit the supply of coins to the demand for them, it took an important step to separate their value from that of their bullion contents and to give them a value based upon the demand for them as money signs required for carrying on exchanges. Strangely enough, while this principle had been in operation for many years in the case of subsidiary coins, its bearing upon the use of silver in countries where the standard had been depreciating was not clearly comprehended until within recent years. Those who understood the principle doubted its sufficiency to give a fixed value to silver coins asthe sole medium of exchange, or they distrusted the ability of any government to judge accurately the number of coins required.

Upon the latter point they would have been correct if dependence had been placed upon guesswork or any empirical method of determining the amount needed. It remained to find the true solution of the problem by so regulating the quantity of the coins that it would respond automatically to the demands of trade. The correct method of doing this is through the system of exchange funds. As this system is operated in the Philippines, it is not possible to obtain gold coin for silver certificates in small quantities; but it is possible always to obtain drafts upon New York at par, plus the usual charges for exchange between gold standard countries. These drafts have to be purchased with actual silver coin or coin certificates. In either case the coins and certificates are, by the requirements of the coinage law, held in the Philippine Treasury. The law does not permit their deposit by the Treasury in current account at a bank, which would turn them back into the general circulation.

For practical purposes the volume of currency in circulation is contracted to the same extent as if a corresponding amount of gold were taken from the circulation for export. When the current turns and rates for money become high in the Philippines, Philippine currency can be released for local circulation by the purchase in New York from the gold standard fund of bills upon the Philippine Treasury. This rule of locking up the proceeds of the sale of bills is not rigidly applied to the funds in New York, because the influence of the Philippine purchases upon the local circulation there would be insignificant. On the contrary, the Government obtains a generous interest rate, which has at times been as high as 4 per cent., upon the deposit of Philippine funds with New York bankers. During the stress of the autumn of 1907 considerable transfers of capital were made from Manila to New York by means of the purchase of New York drafts from the Philippine Treasury. The process, often repeated even under less serious pressure, clearly shows that the monetary system of the Philippines is linked to gold, and that capital can be freely transferredupon a gold basis between Manila and other markets.

The experience of fifteen years since the free coinage of rupees was first suspended in British India, of five years since the new system was established in the Philippines, and of nearly four years since it was in operation in Mexico, have settled most of the doubts which were felt when the experiment was undertaken in India. In the first place, it has been made clear that the value of the coins in exchange, as fixed by law, has not been influenced by variations in the price of silver bullion. This statement, of course, applies only to one side of the problem—the fall of the gold value of the silver in the coin below its face value. It would not be possible under any system yet discovered, except such uneconomic devices as prohibiting exportation, to prevent the disappearance of silver coins when the [bullion] value of their contents rises above the legal value in exchange. Both the Philippines and Mexico have faced this menace to their monetary circulation since their systems were inaugurated, but both have succeeded in removing it. In the Philippines the contents of the silver unit—the peso—was reduced in 1906 from about 371 grains to 247 grains in pure silver. The amount fixed by the law of 1903 was practically the same as the contents of the old Mexican dollar. The adoption of a coin of this weight was caused partly by the desire to avoid the distrust which some feared might arise from reducing the weight. At the time of the passage of the law, moreover, the price of silver was nearly at the lowest point in its history, having touched the minimum of 21-11/16 pence in January, 1903, and being at an average price of 22-1/2 pence in March. The adoption of so heavy a coin, however, was not in accordance with the original recommendation made by the present writer to the War Department in November, 1901. The weight then recommended was 385 grains, nine-tenths fine, or about 347 grains of pure silver.

In Mexico the rise of the silver coins above the legal gold value proved a blessing in disguise. It enabled Mexico to go almost to an absolute gold standard by selling her silver at a premium. From May 1st, 1905, to October 22nd, 1907, the old silver piasters were exported to the amount of $85,956,202,while gold coinage was executed to the amount of $71,646,500 (about £7,200,000).[81]The gold has gone chiefly into the reserves of the banks, which have in circulation about $95,000,000 in notes. Gold holdings of the banks, which were only $15,832,840 in January, 1906, were $54,165,483 in October, 1907, while silver holdings declined over the same period from $49,781,155 to $14,399,924.[82]This influx of gold came about because silver at 33 pence was above the Mexican coinage ratio of about 32 to 1, and much of it was sold by the Commission on Money and Exchange at a direct profit to the Mexican Treasury. In view of the subsequent fall in silver below 23 pence, at which rate Mexico is in a position to replenish her supply of subsidiary coinage, her statesmen may claim the credit of following the great rule of profit in the commercial world as well as on the stock exchange—to sell when things are dear and to buy when things are cheap.

The coincidence in the rise of silver and the adoption of the Mexican monetary reform in 1905 was in some degree accidental. It facilitated the reform, not only by introducing gold, but by removing the objections which would otherwise have been heard from the miners of silver to the rise in gold wages which would have accompanied a fixing of the exchange at a point above the value of silver bullion. It was the intention of the Mexican Government, however, to proceed resolutely, though deliberately, to a fixed exchange, and they would undoubtedly have accomplished this result, even if they had not been aided by the rise in the value of silver. Its subsequent fall has in no wise impaired the stability of the gold standard.

Some fears were expressed in the Philippines as to the willingness of the natives and of Chinese traders to accept a silver coin at a gold value fixed by law which was obviously above its value as bullion. This difficulty has proved almost negligible. Silver within less than three years has been above 33 pence per ounce and below 23 pence. It is doubtful if the Government officials in India or the Philippines have so much as taken note of the daily fluctuations since the price droppedbelow the legal parity of the coins, and it is certain that the exchange value of the coins has been in no wise impaired by their fall in bullion value. When the last reduction was made in the weight and fineness of the Philippine coins, lowering by almost 30 per cent. their silver contents, the precaution was taken of advising the public by means of an official circular, translated into the various languages and dialects of the Islands, why the change had been made, and that it would not affect the exchange value of the coins. Provincial and municipal treasurers were also directed to carry on a campaign of education among the people by way of explaining the character and effect of the change. The greatest menace to the value of the new coins lay with the Chinese, for in China for many hundreds of years local bankers and merchants have adhered to the rule that a coin derived no value from the stamp, but was worth just what it would fetch on the scales. The Chinese traders at first undertook to discriminate in this manner against the new coins of the Philippines. In some cases they refused to receive them except at a discount varying from 20 to 40 per cent. They also offered 105 in the new coins for 100 in the old, evidently in the hope of exporting the old at a profit while they continued to be worth as bullion more than their legal gold value. The success of this discrimination was local and extremely short-lived. The first consignment of the new coins reached Manila on May 4, 1907, and when the Treasurer of the Islands prepared his annual report on October 15th, 1907, he was able to make the following statement of conditions:

At this time, October 15, the new coin is accepted without question in every part of the Islands, and no reports or complaints have been received for the past two months as to discounting it, and, so far as can be ascertained, no premium is now paid for the old coin. In fact, the demand for the new coin for exchange purposes has so far exceeded the supply that it became necessary to withdraw nearly half a million of the new pesos from the banks to meet the requisitions therefor from the provinces.

The hesitation which prevailed, therefore, in many quarters in regard to the ability of a government to overcome the conservatism of the East in its preference for coins of full bullion value has not been warranted by events. This demonstrationis of importance if the exchange standard is to be considered for China. At present the Government of China is not perhaps strong enough and sufficiently centralised to assure its subjects that it can give a definite gold value to a token coin and maintain it honestly and efficiently. The trial of the system, however, in the Philippines, in British India, and in the Straits Settlements, in all of which there are many Chinese, has probably so far cleared the air upon this point that the Chinese Imperial Government would be able to establish the gold exchange system if it did so under sufficient guarantees to the financial world that it would be honestly and intelligently maintained.

Next in importance to the settlement of this question of native willingness to accept the new system may be considered the degree of difficulty in maintaining it. It is not surprising, perhaps, that when it was proposed in an incomplete form for British India, it should have been denounced as a "fair weather" device—"a leap in the dark," which would not stand the test of business depression, deficient crops, and an unfavourable balance of trade.[83]

The most serious difficulty which has been foreseen by critics of the gold exchange system relates to the sufficiency of the exchange funds. Up to the period of the general panic of 1907 and the crop failure in India in the spring of 1908, it might fairly be said, perhaps, that the system had not been subjected to any but "fair weather" conditions. The experience of India, however, has thrown striking light upon the possibilities and limitations of the system in time of stress. The test in India has been of such magnitude, moreover, that its results are much more conclusive than any test which might have been afforded in a smaller country dealing with a less enormous mass of token coins. If the test had come before the exchange funds had acquired a respectable size, the system might have been allowed to break down, through timidity and delay in taking proper measures of protection, and discredit have thus been cast upon it before it had been fairly tried.

What happened in India was that the failure of the cropsdeprived the country of the usual means of compensating by exports the heavy imports of foreign goods which had been contracted for. It became necessary, under the settled principles of exchange, to find gold to fill the gap. Usually the exchange account substantially balanced itself by the sale in London of Council drafts upon the Indian Government to obtain gold to pay the interest on the debt held in England. These drafts were purchased by importers in London, and used to pay for the Indian crops; but all through the spring of 1908 purchasers for drafts failed to appear, because there had been no considerable exports of Indian crops to be paid for. Hence Council drafts were without a market, and for a moment it seemed that the link which bound the Indian monetary system to the gold market of London had been severed, and that the silver rupee might drop as disastrously as the Mexican dollar before its free coinage was suspended. This would have added the influence of an appalling disaster to the burden already imposed upon Indian finance by the failure of the crops, for it would have compelled the Indian importer of English goods to find a greatly increased number of rupees to meet his gold obligations in London. Obviously, it was a disaster which, if it had occurred, would have invited the bankruptcy of the country, reflected lasting disgrace upon English financial foresight, and perhaps even have led to organised revolt.

The Indian Government had available for meeting the crisis about £18,500,000, principally invested in securities in London. This fund, known as the gold standard reserve, was distinct from the currency reserve, consisting of gold received for currency notes, which amounted in the spring of 1908 to about £12,000,000. It was against the former fund that the Indian Government felt compelled to offer to sell exchange in India. Such offers were made for a time in limited amounts of £500,000 each, but they proved substantially adequate for meeting the demand, and by early summer the demand fell below the supply. The offer of exchange in this form for rupees maintained the value of the rupee coinage, contracted the amount of rupees in circulation in India, and enabled the Indian merchants to meet their obligations without the loss which they must have suffered if the currency had been allowed to depreciatein gold value. The actual sales of bills upon the exchange funds in London reached, between March 26th and August 13th, 1908, the considerable total of £8,058,000. Of this amount about £2,000,000 was taken from the currency reserve in gold, which was "earmarked" at the Bank of England, incidentally affording relief to the London money market which was keenly appreciated. Most of the remainder was obtained by the sale of securities to an amount which reduced such holdings from £14,019,676 on March 31st to £9,415,708 on July 31st.

The test to which the Indian system, as the most important example of the gold exchange standard, was thus subjected was perhaps of a higher importance than was realised by those in the thick of the conflict. It was plainly intimated, however, in the annual report on financial conditions for 1908 that, if necessary, the Indian Government would have issued short-dated securities in order to still further replenish the exchange funds in London. This would have been the true means of meeting the situation if the existing fund had been unduly impaired. The argument against it would have been that the demand was indefinite, and might become so large as to be unmanageable. The fact that the demand for exchange was met without the issue of new securities and without trenching upon the reserve funds beyond the amount of £8,000,000 out of £18,500,000 affords pretty strong evidence that there is a natural limit to such demands.

It is in this principle, that there is a natural limit to the possible drain upon the exchange funds, that the security of the new system lies.... It is only the supply of local currency on the margin of possible export demands which needs to be safeguarded. The substratum, which can never leave the country unless under the influence of an almost inconceivable economic cataclysm, is analogous in some respects to the "authorised" circulation of the Bank of England. It represents the irreducible minimum below which the local need for currency can never fall. If the supply on the margin of the international exchange movement is adequately guarded, then the whole system is secure. If it were conceivable that the demand for exchange would equal the whole amount of the local currency,or even the half of it, then it would be necessary to maintain exchange funds equal to the whole amount of token coins or the half of them in order to insure safety. But obviously this could never be the case.

This argument against the exchange standard is only a repetition of the dilemma sometimes presented by untrained minds in regard to bank-notes: what would happen if all the notes should be presented at one time for redemption? That question has been answered by banking experience; the question in regard to the gold exchange system has been and must be answered by experience in substantially the same manner. No country can be subjected to such stress as to consent to part with its entire monetary circulation, or even the half of it. On the contrary, every influence which tends to contract the circulation tends to create a condition which makes further contraction more difficult. Rates for the loan of money are affected, prices of imported goods are influenced, imports fall off and exports increase, and inevitably in the modern money market local equilibrium is restored, often with considerable strain, but none the less without pulling down the pillars of the financial temple.

The experience of last spring in India proves the adequacy of a reserve of 15 or 20 per cent. of the circulation to maintain the steady parity of a token coinage. There is apparently no evidence that serious distrust of the rupee arose, even when the Government was hesitating as to just what steps should be taken to meet the demand for exchange. Even if such distrust had arisen, however, it could have expressed itself through financial channels only by the demand for drafts on London. These would not have been very valuable to the average local tradesman except as he was able to sell them back again to the banks for the very rupees which had aroused his distrust. In this respect the gold exchange standard may be said to put a brake upon the disposition to export currency from fear alone, when the exportation is not demanded by the balance of trade.

If any mistake was made in the management of the Indian currency, it was in the investment of too large a proportion of the gold standard reserve in securities. While investment insecurities is naturally attractive because of the income earned, and while it is not subject to just criticism while kept within certain limits, the possession of actual gold to a considerable amount is highly desirable. It would not be necessary, perhaps, that such gold should be "earmarked." If the Indian Government had a large deposit account in such an institution as the Union of London and Smith's Bank, or the London City and Midland, it would possess for the purposes of the Indian Government the character of gold. Drafts against such a deposit could be sold without the discount or delay which might be required in disposing of securities. It seems highly desirable, therefore, in spite of the prudence with which the recent pressure was met, that at least 30 or 40 per cent. of the gold standard reserve should in the future be kept either in "earmarked" gold or in the form of demand deposits.

In the case of the Philippine Islands the reserve is not "earmarked," but is at present entirely in the form of deposits with New York bankers. The problem in the Philippines is really child's play compared to that in British India. The entire circulation of the Philippine Islands is about 40,000,000 pesos (£4,000,000), against which a large reserve has accumulated as the result of the recoinage at a reduced rate as well as by the profits on the original coinage. It is hardly conceivable that an emergency would arise which would impair this reserve; but if this should occur, the scratch of a pen in Washington would remedy the situation. This would be accomplished by depositing gold or its equivalent in the exchange fund in New York to the credit of the war and navy, and placing an equivalent amount of local currency at the command of the military forces in the Philippines. Such a deposit would operate to increase the resources at the command of military disbursing officers in the Islands without increasing the amount actually in circulation until the occasion arose to disburse it. The Panama currency has been steadily maintained at par by friendly interchanges of this sort, even with a very insignificant official exchange fund. No Governor of the Philippines, therefore, need have any fear of his ability to maintain the parity of the Philippine coinage.

Whether the exchange standard would stand the strain of agreat war is yet to be subjected to practical test.[84]It may be said, however, that its capacity to meet such a test would run upon all fours with the capacity of any monetary system which does not consist exclusively of gold coin. The experience of France in the war with Prussia seemed to justify the suspension of specie payments for the purpose of husbanding the national stock of gold. The history of the Spanish exchange, where the coins have followed the value of the bank-notes instead of that of silver bullion, is another case in point. Both Russia and Japan, however, in the war of 1904-5, succeeded in maintaining complete convertibility of their bank-notes. There is no reason why the gold exchange standard should not be successfully maintained so long as the country where it was established retained its national independence and pursued a sound financial policy. The issue of large amounts of debt would not in itself impair the stability of the standard, unless the Government, in order to obtain gold, ravished the exchange funds in financial centres. The questions involved would be substantially the same as those involved in maintaining the parity of bank-notes or paper money: first, the disposition of the Government to maintain its credit; secondly, the resources which the Government was able to command. Without either good intentions or monetary resources, the monetary system, along with the fiscal system, would break down. It is not apparent, however, that a country operating upon the gold exchange system would find any greater difficulty in maintaining the system than the Bank of Japan had in maintaining the convertibility of its notes during the war with Russia.

If there were a disposition in time of war to transfer capital abroad by excessive demands upon the exchange funds, it could be counteracted in three ways. One would be the automatic influence of the deficiency of currency which would arise at home. Another would be the issue of loans abroad, from which exchange demands could be met. A third would be the deliberate elevation by a small percentage of the charge for exchange. This would amount to a slight depreciation in thecurrency, but if kept within prudent bounds, it would probably permit the maintenance of an adequate circulation without disturbance to local prices and without even a theoretical depression below the 2 or 2-1/2 per cent. which affected the notes of the Bank of France in the war of 1870.

The gold exchange system may indeed be said to be an extension of the bank-note system to token coins. The token coin is, in effect, a metallic bank-note, whose maintenance at gold par is subject to the rules of sound banking. Its advantages over the bank-note in undeveloped countries are that it conforms to a strong prejudice in favour of "hard money," not subject to the vicissitudes of tropical climes, and that the output can be more safely regulated, where new coins are issued only for gold, than where a bank may increase its note issues to take over assets of speculative or doubtful character. In the advanced countries, with a highly organised credit system, gold, and gold alone, is the proper form of full legal-tender coin; but in the less advanced countries of the Orient silver token coins have the advantage that they conform in size and denominations to the small scale of local transactions, that they are not so rapidly absorbed by hoarding, and that their very non-exportability enables the Government to keep in circulation a quantity of currency which might under a different system be drained away to richer countries, and leave the community denuded of an adequate medium for carrying on exchanges.

[85]... the establishment of the gold standard in the Straits Settlements ... in the spring of 1903 ... provided for the recoinage of the British and Mexican dollars then circulating in the Malay Peninsula into new Straits Settlements dollars ... of the same weight and fineness as the British dollar, and for the subsequent raising of the value of these new dollars to an unannounced gold par by means of limiting the supply,in accordance with the principle by which India raised the gold value of the rupee....

The objections urged to the adoption of the gold-exchange standard are [were]: (1) That it would unduly interfere with the [foreign exchange] business of the banks. (2) That it would encourage banks to work on dangerously low cash balances, knowing as they would that they could obtain dollars of the Government on a moment's notice by the purchase of cable transfers on Singapore from the crown agents for the colonies in London. (3) That there would be danger of the Government's notes [a part of the circulating medium] depreciating unless they were redeemable in gold in the country itself. (4) That the monetary circulation of the Straits Settlements was too small to make the plan feasible there. (5) That the plan would require a larger reserve fund than would otherwise be necessary, because the Government would be compelled to keep a reserve both in London and Singapore; and that in each place the reserve would have to be large, because drafts on the fund through the sale of telegraphic transfers would not give the Government any such warning in advance of the demands liable to be made as would enable it to replenish the reserve.

The above arguments, all of which were urged upon the writer either by officials or business men in the Straits Settlements, do not appear to be conclusive for the following reasons, which may conveniently be stated in the same order as the objections.[86](1) If the rates for the sale of government drafts were fixed at the "gold points," as they presumably would be under the gold-exchange standard, and if only drafts of large amounts were to be sold by the Government, redemption by the sale of drafts would not interfere appreciably more with the business of the banks than would redemption in coin. Under these circumstances the banks themselves would be the principal purchasers of government drafts, and such drafts would be purchased and forwarded merely in lieu of the shipment of sovereigns. (2) The sale of telegraphic transfers,while desirable in the interest of currency elasticity, is by no means a necessary feature of the gold-exchange standard. If the Government were opposed to making a minimum legal reserve requirement of banks, it could limit its sales of drafts to demand drafts or even, if need be, to short-time drafts. (3) If government notes were redeemable in silver dollars on demand, and if the silver dollars were redeemable in gold exchange on demand, depreciation would be impossible in a country where the people have the confidence in the Government which they have in the Straits Settlements. (4) The system of the gold-exchange standard is better suited to a country with a small circulation than to one with a large circulation. It is evidently easier to maintain a small reserve abroad than a large one and the operations with a small reserve are less disturbing to the money market of the financial center in which the reserve is located. (5) It is not probable that the Straits Settlements would require so large a reserve under the gold-exchange standard as it will under the system to be adopted. Under either system it would need a sovereign reserve and a dollar reserve. Under the system to be adopted both reserves will be located in Singapore; under the gold-exchange standard the dollar reserve would be located in Singapore and the sovereign reserve in London. The sale of cable transfers is not a necessary part of the system, as above pointed out; and, even if it were, the movement of market rates of exchange would ordinarily give ample warning of a demand for dollar drafts or sovereign drafts. Emergency cases, if such should arise, could be met through the temporary transfer of funds to the gold reserve from the security portion of the note guarantee fund, or through the transfer of dollars to the credit of the home government in Singapore in exchange for an equivalent amount of sovereigns placed to the credit of the Straits government in London.... A prolonged and severe drain upon the reserve fund, which in a country like the Straits Settlements would be an extremely improbable contingency if the Government withdrew from circulation dollars presented in the purchase of government drafts, could of course always be met by the forward sale on the London silver market of the redundant dollars piling up in the Government's dollar reserve in Singapore.The gold-exchange standard would probably enable the country to get along with a smaller gold reserve than will the system to be adopted, inasmuch as it would keep gold coins out of circulation and the demands upon it would be limited to the requirements of meeting foreign trade balances—the only monetary use to which the dollars could not be applied. The Straits Settlements, inasmuch as it is a country for whose trade requirements silver coins are better adapted than gold, and a country which is anxious to maintain its reserve at as small an expense as possible, would in fact seem to be a place peculiarly adapted to the gold-exchange standard. The premiums which the Government would realize on its sale of exchange, together with the interest it would obtain on that part of its reserve deposited abroad, would doubtless yield sufficient profit, as in the Philippines, to pay the expenses of administering the currency system and to provide in addition a substantial annual increment to the gold reserve.

Back to Index Next