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BW Businessworld

Celebrating Good Luck

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some 150 countries have their own currency (some non-countries like Hong Kong have their own currency, some countries like the members of the European Union have no currency of their own, and some like East Timor use another country's currency). Between them, there must be 1502 or 22,500 exchange rates. Even a genius could not keep them in his head; and most foreign exchange dealers are not geniuses. How then do they manage?

They keep track of exchange rates with just three or four currencies; the rest can be worked out from those. That reduces the number of exchange rates to less than a thousand — a more manageable number, but still unmanageable. So most dealers specialise in a small number of currencies. Dealers in Rupees, for instance, need to keep track of only three or four rates — the Rupee rates against US dollar, Pound sterling, and the Euro, with the dirham of United Arab Emirates trailing behind.

It would be nice if those three or four could be reduced to one; and there was a time when life was simpler. Kings aspired to mint a currency of bullion — of gold or silver — embossed with their names and portraits. Not all could do so. For a king to have such a currency, people had to bring him bullion to emboss. They could do so only if they had the metals themselves. They could get them out of mines; but mines were few, and many got exhausted over the centuries. So most people could get bullion only if they traded; if a country's exports exceeded imports, its traders could take the difference in bullion, take it to their king and exchange it for gold or silver coins.

And if the price of the metals went over the price of the gold or silver in the coins, they could melt the coins and sell the metal. So every once in a while, coins would be melted off, and there would be a shortage of coins. A shortage of coins is the same thing as a surplus of everything else; when money goes short, prices of everything go down in terms of money. A pure gold or silver standard was susceptible to cycles of high and low prices.

So kings worked out an ingenious way of stabilising the supply of coins: they made coins out of metal that cost less than its value in coins. They adulterated gold and silver coins with cheaper metals like copper, and promised that if anyone brought enough coins, the kings would sell them pure gold or silver. The supply of even such base metals did not always match the needs of an economy; then people mixed metals into alloys — until the Chinese found an even cheaper substitute — paper. That is how countries reconciled limited supply of bullion to flexible requirements of currency.

Adulteration of currency was extremely tempting for kings since it offered enormous profits. While they might resist the temptation in normal times, patriotism overcame their inhibitions when they fought a war and had to spend as much as they could on the army. In times of war, therefore, they suspended their promise to convert their coins into bullion.

Not only wars; any event that increased the imports of a country far beyond its exports could lead it off gold or silver standard. One such event was the Vietnam war; it led to such deficit budgeting that the US went off gold standard in 1971. The oil crisis of 1973 hurled other countries into crises; by the late 1970s, bullion standards were largely dead.

That was 40 years ago; the world has changed since. Today, both Europe and the US have extremely high levels of unemployment; and their governments have to run enormous deficits just to sustain employment. Their currencies are engaged in a competition to the bottom. It is pure folly for the Reserve Bank to hold any of its reserves in either the US dollar or the euro.

The alternative is bullion. In March, the Reserve Bank was sitting on gold and foreign currency worth Rs 13 lakh crore. The total currency and notes with the public were less than Rs 9 lakh crore; even if the Reserve Bank took them all in and exchanged them for gold and silver, and if it imported all the needed bullion, it would be left with Rs 4 lakh crore of foreign currency assets. And people are not going to convert everything; they will continue to use notes or coins of small value. Notes of Rs 100 and less account for more than half of the value in circulation; they will stay in circulation. So at most, the Reserve Bank will have to issue gold and silver coins for Rs 4 lakh crore. For a start, it can issue 20-gram silver kodis worth Rs 1,000, 5-gram gold fanams worth Rs 10,000, and 50-gram gold mohurs worth Rs 1 lakh.

(This story was published in Businessworld Issue Dated 23-05-2011)