In Search of Stability

Economics of Money, History of the Rupee

Sashi Sivramkrishna

• Publisher: Routledge
• Year: 2016
• Print ISBN: 9781138234819
• eBook ISBN: 9781351997485
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

In Search of Stability seeks to understand the economics of money through a narrative on the history of the rupee. The period delineated for study is from the time of introduction of the rupee by Sher Shah Suri in 1542 up to 1971, the year which marked the beginning of the end of the Bretton Woods era and a fixed exchange rate regime.

The underlying thread that runs through the narrative is the positive economics of money and history of the rupee. This is a book that explains what happened rather than raising normative questions on what ought to have happened or what could have been a more appropriate monetary system for India.

The economics of money also draws us into understanding the evolution of monetary instruments through history and their impact on the economy. These instruments cannot be separated from the institutions that develop and are developed by them. A digression into a study of the origins, nature and development of some of the most important monetary institutions in India has therefore been included in this study.

While standards of living have risen enormously, money has struggled to maintain its value across place and time, without definitive success. This has brought with it crises and severe hardship to entire societies; a lesson which the history of the Indian rupee unequivocally reveals.

Part I
Development of Monetary Instruments and Their Stability 1542–c. 1860

CHAPTER 1
Currency Money

The study of money, above all other fields in economics, is one in which complexity is used to disguise truth or to evade truth, not to reveal it.

JOHN KENNETH GALBRAITH

Money plays the largest part in determining the course of history

KARL MARX

Metallic coins, shells or cowries are currency, i.e. media of exchange that are generally and readily accepted in the immediate settlement or discharge of debt. Currency is the most commonly used form of money in day-to-day transactions. Convertible or inconvertible paper money is also currency, but I defer its independent study to later. After outlining the economics of currency money, I present the evolution of India’s currency money, the silver rupee coin, from its introduction in 1542 until 1853, the year in which Lord Dalhousie declared it to be the sole legal tender (apart from copper coins for fractional transactions) in territories under the rule of the English East India Company.

1.1: The Economics of Currency Money

So you think that money is the root of all evil. Have you ever asked what is the root of all money?

AYN RAND

What is money? While you try answering the question let me mention the importance of this chapter; it is the backbone of the book, providing readers a conceptual framework to approach monetary history. Throughout the book I will return to concepts outlined here. Coming back to our question; while most of us have an intuitive idea of what money is, only a few may be able to articulate a precise definition. Money can broadly be defined as a medium or an instrument that is used in settlement of claims or debts that arise from purchase of goods and services. The notion of money is, however, better captured by its functions as a unit of account, a medium of exchange and a store of value. Simple as these may seem, the difficulty of monetary instruments to fulfil all three functions simultaneously, effectively and efficiently, across space (domestically and internationally) and time (intertemporally), has been and continues to be the root cause of many contemporary national and global financial crises. Take, for instance, the cries of a currency war that echoed over the economic landscape soon after the Great Recession of 2008, threatening to disrupt foreign trade and investment, or the need for a new international currency in the context of an emerging multi-polar global economic world; these and many other issues, as we will see, are ultimately linked to the search for a stable money that accomplishes its three functions fully and satisfactorily. This search for stability not only connects several cataclysmic episodes through monetary history but is also the thread that strings our narrative on the Indian rupee together.

The functions of money are best understood when we go back into the distant past to a world before money when exchange took place through barter or the direct exchange of one commodity for another. But barters inconvenient in more ways than one. Imagine a village where five sheep trade for twelve blankets, seventeen blankets trade for one cow, seven cows for one ton of iron nails and one kilogram of iron nails for a kilogram of peanuts. How many kilograms of peanuts are required to buy a blanket? Without recourse to conversion calculators, a solution to the above problem would have kept the ablest arithmeticians of those days busy and may well have been a lucrative profession with one hour of his services fetching 50 kg of peanuts.¹ To make life simpler the price of all goods and services could be expressed in terms of any one of the goods ora unit of account, say, sheep. Trading ratios in this village are shown in Table 1.1.

TABLE 1.1: EXCHANGE RATIOS WITH SHEEP AS THE STANDARD OF VALUE

1 sheep	2.4 blankets
1 sheep	0.14 cow
1 sheep	20 kg nails
1 sheep	20 kg peanuts
1 sheep	2½ hours of arithmetician's time

From this, cross price ratios between goods other than sheep become easier to compute; if 2.4 blankets exchange for 20 kg of peanuts then a blanket would command 8.33 kg of peanuts. Life becomes a little simpler with this common unit of account. In a barter economy, the convenience, if not the necessity of a common unit of account would most probably have sown the seeds for the emergence of money.

Sheep as a unit of account is not yet money for there are other functions that have to be satisfied. Our village, therefore, continues to operate in a barter economy and with it, constraints on exchange. For one, the problem of double coincidence of wants remains. The peanut farmer if he were looking for a blanket would have to find a weaver looking for peanuts, at that very point of time and for quantities he wants to trade. Now this may have been a feasible proposition in a simple economy which included a few small villages with a limited set of occupations and where consumption patterns were well established and predictable. In such communities, exchange was organized on the basis of social, tradition and cultural norms rather than purely economic terms. However, as the number of commodities produced grew and trade became geographically more widespread and impersonal, the double coincidence of wants would have had a debilitating effect on trade and commerce. To overcome the constraint imposed by barter on exchange, it is possible that the unit of account would have evolved into a common medium of exchange. Things, however, may actually have happened the other way around; the evolution of a medium of exchange may have overcome the constraints of barter.

The villagers call a meeting. The chief announces, ‘We have been using sheep as the unit of account for all our transactions. Henceforth, let us make it a common medium of exchange for all transactions’. What would owning a sheep now mean in this village? The owner of sheep has a claim over goods and services produced by the other villagers, quantities being in accordance with Table 1.1 Sheep, as a medium of exchange, is nothing but a receipt, a certificate or a bookkeeping entry, which establishes claims over goods and services produced by all others in this society who agreed to the village chief’s announcement. In other words, owning a sheep establishes the fact that a person has given society (a member of it) something equal in value to one sheep and, therefore, society (any member of it) must give her back at anytime goods and services, the value of which must be equal to that of one sheep. If sheep indeed were to become readily and generally acceptable money by one and all in this village, it can be called currency.² A Rs. 100 currency note serves exactly the same purpose. It is a receipt that you have given someone in India, goods or services worth this amount and therefore have a claim over anyone else, in India at least, for goods and services amounting to Rs. 100 in return. This decree or fiat, and the agreement or compulsion of members in a society to honour it, does away with the problem of double coincidence of wants. Going back to our village economy, the ironsmith can accept a sheep in exchange for nails which the cowherd bought, and then look for a farmer to buy peanuts with sheep in exchange. The cowherd, therefore, need not waste time and resources looking for an ironsmith who wants a cow.

Unfortunately, with sheep as their unit of account and medium of exchange this village will soon face serious problems. What if I wanted just one blanket? At the risk of sounding offensive, I would have to ‘divide’ my sheep into several parts. Not only would each part be of different value (for that matter even two sheep may not be of equal value) but the sum of all parts would not add up to the whole. Even if I were to divide the sheep into equal parts successfully, it would not retain value for even a few hours as it begins to decompose. I would therefore be forced to settle claims immediately before my money (sheep) turns worthless. This brings us to the third important property that money must possess if it must be useful; it should be a good store of value. Unlike sheep, shells or metals are a better store of value over an extended period of time. But it is not just the perishable nature of sheep which makes it unsuitable as a store of value; a change in the price of sheep could also affect its purchasing power over time.

There is yet another problem with sheep (and other commodities) as money. To rear sheep requires the diversion of the community’s resources for this purpose, including cultivable land, shepherds, veterinarians, medicine, and so on. Currency as it changes hands is also subject to wear and tear. Replacing currency which is not resilient to such damage imposes a cost on society. As the economy develops and more currency is required to support trade, the monetary system will become expensive, diverting scarce resources of a society towards physical production of the monetary instrument. Given these disadvantages of sheep, the villagers would rethink their choice of money and look for cheaper and more convenient alternatives.

With all these problems in using sheep as money, the village may soon decide to switch over to iron nails. Not only is it more homogeneous, more easily divisible and of smaller units but it can also retain value over a longer period of time. Unfortunately, nails have their own limitations. Carrying a handful of nails in your pocket would not be comfortable; nails are neither convenient nor a handy medium of exchange. Given the possibility to produce them easily, nails may also be too cheap to be a suitable medium of exchange so that common transactions would entail large amounts of nails to be exchanged. A farmer wanting to sell a ton of peanuts would have to carry back a ton of nails. Moreover, nails can be easily produced. To prevent a fall in its price, the village would have to control its supply. As nails represent a claim over other commodities a serious crisis would develop if people began making nails instead of engaging themselves in other pursuits. If iron ore and charcoal were easily available in this village, the weaver and farmer may decide to produce nails rather than make blankets or cultivate peanuts. Soon all the villagers will do the same. With nothing else but nails produced its price falls relative to all other goods, rendering it worthless.

Assume that access to iron ore is restricted and the village decides that instead of nails, small iron flats are to be considered as currency. Everyone agrees not to make such iron flats illegally so that only a certain fixed quantity will circulate. But can you trust the iron flats that the shepherd gives you in exchange for your blankets? Is it not possible that he cheated by adding some slag and re-melted the iron flat into two pieces? Will the cowherd or the baker accept this iron flat? This concern will only grow as trade and exchange expands beyond the domain of a small village, becoming increasingly impersonal. Certification of authenticity of the iron money becomes necessary if it must perform its task of making exchange smooth and simple. Minting of coins arose from this concern and evolved over centuries from crude symbols stamped on a single side of a flat piece of metal to intricate designs that we see on coins today. Stamping of coins, however, came at a cost and the mint entrusted with this job levied a fee to issue currency called brassage.

From our discussion so far, we can summarize the properties a commodity must possess if it is to pass as money. It must be homogeneous and divisible, it must be available in sufficient quantity to enable exchange but at the same time not too easily available, it must not degenerate physically, it must not be easily duplicated, it must be easily identifiable as the commodity it is supposed to be, it must be universally accepted by members of society that it is a receipt or certificate of a member’s contribution to society and therefore a legitimate claim over goods and services produced by others in that society and finally the most difficult, it must retain its purchasing power (or value) over a period of time. From beads to fur to cowrie shells to metals to precious metals to paper, societies continuously struggled to find commodities that could serve as money, in particular, as currency. And to a great extent they ultimately did in two precious metals: gold and silver.

What made gold and silver so ideally, though not perfectly suited as currency? Let’s begin with gold. Given its imperishable nature and the care people take of it, existing stocks of gold above the earth’s surface do not diminish by attrition, loss in manufacture, or accident. Its durability allows the same coin to be used many times over. The accumulations made by previous generations are thus maintained, with little lost in amount. It is also not easily lost to wear and tear like (say) leather. Gold can, therefore, be expected to...

Table of contents

• Cover
• Half Title
• Title
• Copyright
• Dedication
• Contents
• List of Boxes, Figures and Tables
• Preface
• Introduction
• PART I: DEVELOPMENT OF MONETARY INSTRUMENTS AND THEIR STABILITY, 1942-c. 1860
• PART II: EXTERNAL AND INTERNAL STABILITY IN THE VALUE OF THE RUPEE, c. 1860-1971
• PART III: EPILOGUE, POST-1971