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Currency

The Present Problem with Indian Currency

World War I devalued the currency of many nations. Each country is now looking for ways to strengthen their currency. In this paper, Ambedkar explains how exchange rates are determined and gives prescriptions for India’s currency.

Most economists were vexed on whether a currency should be stabilized or pegged favorably to foreign currency. Many factors determine an exchange rate. The first and most important is the purchasing strength of currency in its home country. For example, if Indian prices drop allowing a consumer to buy more with his currency, then the currency value raises concerning other countries. That is if the other country experiences no change in price.

Exchange rates cause trade imbalances, not the other way around. When a country tries to peg their currency to foreign currency to improve trade is headed for disaster. If one ignores the actual purchasing power of the currency business at home will suffer.

For many years, the gold standard or pegging the currency to a fixed amount of gold was successful. Unfortunately, after the war, only the United States could keep their money pegged to an amount of gold. The gold standard reduces the ability of a country to change their money supply in times on need.

Economist split society into three classes. Investor class which lends money to the business class that hires the employer class. When a currency falls the business class benefits because the money they borrowed and the wage they agreed to pay their employees is discounted. When the currency increases it hurts the business class because the reverse will be true. So Ambedkar recommends India have a nimble currency that can move to accommodate changing conditions. He then presents a gold – rupee exchange rate that could work.

The full document can be read HERE

Evidence Before the Royal Commission

The paper is a court transcript in which Ambedkar advised the commission on how to improve the strength of the rupee. The transcript implies that rupees saturate the market.

To solve this problem, Ambedkar proposes what he calls the gold standard. India would use the following currencies.

1. The rupee which will no longer be manufactured

2. A paper currency fully backed by gold

3. Bank notes partially backed by gold

With these three currencies, there is always a possibility that one could be overvalued or undervalued in respect to the other two.

The gold back paper currency will have limited production each year. There will not be enough issued to affect the overall price of gold. The public can exchange the gold backed currency for gold. The ability to exchange will ensure the currency will not be undervalued in respect to gold. Because if it is the currency will be traded in for gold reducing the supply.

Another advantage to having gold-backed currency circulating in the economy is it helps to stabilize the price of gold. Ambedkar saw more and more countries stockpiling gold, yet there were many alternatives to gold in the form of currency. He estimated that the price of gold would continue to be devalued because as people substitute currency for gold. Keeping gold circulating would increase demand, and that would steady the price as gold production increases due to technology.

The market was over saturated with rupees, so Ambedkar recommended putting a halt on production. The price of the rupee would be pegged to gold, but rupees could not be exchanged for gold. So the value of the rupee would not go down because it had a limited issuance. The value would also not inflate because when it does people will use the gold back currency. Ambedkar did accept there could be some extreme conditions in which the government would be forced to trade rupees for gold.

Bank notes were only mentioned briefly. Bank notes will be issued by private banks, and the government will require that the notes are partially backed by gold. It can be assumed that Ambedkar didn’t think bank notes would be created in large numbers.

Ambedkar asserts that he is a member of the labor class. As a member of said class, it is in his best interest to create a currency scheme that keeps the price of goods low. Most economists want a currency that holds its value in respect to gold. By doing this, he gives a window into how he sees himself. He also asserts that keep prices low or steady is the best thing for the country because it helps most people.

The price of goods should be the primary factor in Indian currency policy. The reason is the Indian economy is chiefly driven by internal trade. Most large European countries are driven by foreign trade. Therefore European currency policies can’t be imported whole-cloth.

Many on the council wanted Indian currency to return to its pre World War I level. In response, Ambedkar reminds them that increasing the value of the rupee will only matter if the prices of goods return to the pre- World War I levels. Increasing the value of a currency will increase price hurting the poor. Increasing the value of currency will also reduce trade.

The opposing view of Ambedkar’s gold standard is the gold exchange standard. In a gold exchange standard, a gold back currency is circulating in the country, but it can’t be exchanged for gold within the country. However, the currency could be exchanged for gold outside the country. So the exchange value is only valuable to exporters. Ambedkar explains the limited exchange will not be enough to ensure that the money supply will not grow too large.

The full document can be read HERE

Review of Currencies and Exchanges

Ambedkar criticizes a book written by his colleague at Elphinstone College, H. Chablaini. He claims the work is too short to properly explain the topic. It lacks proper methodology and has conflicting ideas.

Chablani wrote his plan to stablize the Indian economy.

  1. Issue Rupees in conjunction with the increase in Indian production
  2. Allow large amounts of rupees to be converted into metals
  3. Have the Rupee backed by silver

If too many Rupees are issued their value would decrease in respect to gold and silver. The result would be investors trading in currency for metal reducing the amount of currency. The metal exchange would be a safety value for inflation.

Ambedkar rebuts this with a history of the gold exchange in the world market. In 1873, there was a sharp decline in gold production. Gold exchanges allowed for more money to circulate in the world economy keeping prices steady. After gold production increased in 1910, the major economies ended or restricted their gold exchanges. If they had not inflation would have reduced overall growth because too much money was circulating in the economy. So having a metal exchange would reduce the stability of currency.

Ambedkar also criticizes Chablani’s idea that the limited issuance of the Rupee did not lead to its rise in 1893. Ambedkar folds firm in his belief in fiat currency backed by gold without exchange value.

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