Monetary System Chapter 2 PDF

Monetary System- Monetary Standards
Introduction: Monetary Standard refers to the overall set of laws and practices which control the quality
and quantity of money in a country. The term monetary standard refers to the type of standard money used
in any money economy. Thus, if in any country gold or silver is used as the main commodity for money
unit then the country has either the gold or silver standard. When both metals are simultaneously used as
standard money the country is said to be on a bimetallic standard. When the standard currency consists of
paper money, the situation is one of paper or fiat money standard. Although there are numerous monetary
standards, the choice basically rest between the commodity money standard and the paper standard. When
the monetary authority of a country decides in favor of a metallic standard it has also to decide whether it
should adopt a monometallic or bimetallic standard that is either gold or silver or both. If countries
standard money is stabilized in terms of gold, it is said to be on gold standard; if it is stabilized on silver, it
is said to be on a silver standard. If it is said to be in gold and silver both, it is said to be on a bimetallic
standard; and if it is not stabilized in terms of any metal, it is said to be an inconvertible standard. Some
authors defined monetary in a broader sense to include within its scope not only the selection of a unit of
account, but also the laws and practices affecting a country‘s money. According to Shapiro: ―The
monetary standard of a nation involves the overall sets of laws and practices which control the quality and
quantity of money in the system‖
Monetary standard has two aspects national and international. Basically monetary standard is national in
character because it is intended to meet the internal requirements of an economy. But the monetary
standard also assumes international character, since it has to facilitate international payments. Thus a
sound monetary standard also assumes international character, since it has to facilitate international
payments. Thus, a sound monetary system should fulfill 2 Objectives: -
- To maintain stability in the currency‘s internal value or the price level.
- To maintain stability in the currency‘s external value, i.e. value in terms of foreign currencies.
History of Modern Monetary Standards: The United States adopted bimetallism beginning with the
Coinage Act of 1792, which defined the "dollar" as 371.25 grains of pure silver or 24.75 grains (roughly
1/20th a troy ounce) of pure gold. (The American government had determined that the average Spanish
dollar in circulation weighed 371.25 grains rather than the official weight of 377 grains claimed by Spain.)
(A grain, originally defined as the weight of a plump grain of wheat, is slightly more than a 16th of a
gram.)
This 371.25/24.75 exchange rate for silver/gold was the market ratio in 1792, but increased silver
production soon made the legal fixed ratio deviate from the market ratio. Gresham's Law states that when
two or more media of exchange are being used, one that is legally or otherwise overvalued will drive the
others off the market. In this case, gold coins were driven-off the market until gold discoveries, several
decades later, reversed the process and drove silver coins off the market. Most national governments
began demonetizing silver in 1873 — which led to a sharp decline in the price of silver (indicating the
extent to which exchange-value augmented the value of the metal above commodity-value). In 1844
Britain adopted a gold national standard, with Bank of England notes fully backed by gold. In the 1870s
virtually every country in Western Europe went onto a gold standard. A gold standard international
monetary system was most complete from the mid-1890s until 1914. This was a period of intense
economic activity and international trade. The value of the use of gold as a universal currency of
Swaminath S, Dept. of Commerce, BUB Page 1

international trade has been compared to an idealized universal language in which "translation costs" have
been eliminated, just as "transaction costs" would be eliminated in the economic sphere.
Balance of payments problems, according to an analysis originating from David Hume, are self-
correcting. If one country imported more than it exported, gold would flow out of the country. With less
gold competing for the same number of goods and services, price levels in the deficit country would drop,
causing a higher foreign demand for exports and a lower domestic demand for imports, thereby causing
gold to flow back into the country. If the deficit were due to excessive national borrowing or overspending
reserves, however, the deficit country is no different from an individual who has created a "balance of
payments crisis" by "living far beyond his/her currently earned means".
With the development of international trade in the 17th and 18th century, many countries developed the
view that exports increased national wealth, whereas imports disrupted the national economy. This view,
known as mercantilism, induced many countries to adopt protectionism and other policies designed to
produce a "favorable balance of trade", meaning exports in excess of imports. Adam Smith wrote
WEALTH OF NATIONS to denounce mercantilism. Smith cautioned against equating wealth with
money, saying "the real wealth or poverty of a country... would depend altogether upon the abundance or
scarcity of these consumable goods". The import of cheap, useful goods for consumption and productive
capital assets may increase the wealth of a nation more than monetary metals. "A country that has
wherewithal to buy wine will always get the wine which it has occasion for; and a country that has
wherewithal to buy gold and silver will never be in want of these metals". It is possible to regard exports
as a cost, draining domestically produced goods from the country, while the gain of trade stems from
imports — but this view is just the converse fallacy to mercantilism.
During World War I, most belligerents went off the gold standard because of the desire to use money-
creation to help finance the war effort. Although most countries were able to curtail continuing monetary
expansion after the war, Germany could not — resulting in perhaps the greatest hyperinflation in history.
Germany had been fined 132 billion gold Marks in war reparations by the Allies.
In January 1923, France, Belgium and Italy occupied the Ruhr river valley (Germany's industrial core) to
enforce compliance with reparations payments — and imposed an economic blockade. German bitterness
to the Treaty of Versailles and the actions of the Allies was widespread — leading to work stoppages
throughout the country, most notably in the Ruhr. Massive printing of money by the German government
to meet urgent financial demands (including paying salaries to the Ruhr workers who were striking in
protest) caused the value of the German Mark to drop 600-million fold in 1923 — to an exchange rate of
4.2 trillion Marks to the Dollar. Those working were paid twice daily and given a half-hour break after
each paycheck so that the money could be spent before it lost too much value. Barter became widespread
in Germany.
In the 1920s there was worldwide concern that there was not enough gold to meet liquidity needs. But
gold was still being held at the statutory price of $20.67 per ounce. Allowing the price of gold to rise
would have been equivalent to increasing its "quantity". Nonetheless, in the interest of "economizing",
most Western nations in the 1920s adopted a "gold-exchange standard" based on a fractional reserve of
gold for their currency. The self-correcting mechanisms of the Human analysis were either removed or
amplified to crisis proportions. A nation with a 10% gold reserve behind its currency is understandably
concerned if it must redeem 5% of its currency abroad by shipping gold. It has lost half of its reserves!
Most Western countries maintained their reserves in British pounds, while Britain purported to redeem
pounds for gold. Britain printed pound notes with little restraint while other countries inflated their own
currencies backed by their inflated pound note reserves. Developing countries which had mainly remained
on a silver standard experienced "inflation" due to reduced demand for silver. Western powers set to work
using political pressure to force the "gold-exchange standard" as a replacement for silver or bimetallism
throughout the world. By the 1930s there was a widespread belief that the "gold standard" was not
working. Many countries suspended gold convertibility and made gold ownership (other than some
jewelry and collector's gold) illegal for their citizens. President Roosevelt made gold ownership
punishable by imprisonment and he gave American citizens 3 weeks to sell their gold to the government at
$20.67 per ounce — before devaluing the dollar to $35 per ounce. Governments pursued highly
nationalistic policies to deal with problems of the depression, particularly unemployment. Devaluations
and fixed exchange rates were the most commonly used tools. Fixed exchange rates led to shortages and
surpluses of currencies, as commonly happens when prices are fixed above or below their market level.
"Competitive devaluations ―between countries became known as "beggar my neighbor policies",

construed as attempts to "export one's unemployment". Just as inflation causes real wages to fall
(temporarily) and thereby increases demand for labor at the new lower price, reducing the gold value of
one's currency reduces the price (in gold) of labor and many goods in the devaluing country, relative to its
"neighbors", thus increasing the demand for exports. But the neighbor is "beggared" in a more direct way
insofar as the money of the devaluing country, held as exchange reserve abroad, immediately loses value.
Economic nationalism (protectionism) stifled international trade and worsened the depression.
In an attempt to replace predatory nationalist monetary policies with deliberate international monetary
cooperation, 44 nations meeting in Bretton Woods, New Hampshire in July 1944 established the
International Monetary Fund (IMF). The theoretician behind the design of the Bretton Woods
agreement was English economist John Maynard Keynes, who called gold a "barbarous relic" based on a
superstitious "worshipping the Calf" (a Biblical reference to the story of the ten commandments). World
War II had left the United States with 75% of the world's gold, and the American economy had been
relatively undamaged by the war. The Bretton Woods agreement provided for the US Dollar, convertible
to gold at $35 per ounce, to be the basis of international payments. All other currencies were to have fixed
exchange rates against the Dollar within a 1% range, supported by loans from the IMF. IMF member
contributions to the Fund were 75% in their own currencies and 25% in gold. The US stood a chance to
gain from its role, just as someone who writes checks that others adopt as a medium-of-exchange is in the
enviable position of being able to buy additional goods without losing a position of wealth. But from the
1950s to the 1970s, American gold reserves steadily dwindled. By 1972, US gold reserves were 25% of
the world's monetary stock. A gold market had been established in London, but the major financial powers
pooled their resources to sell gold on the London market so as to keep the price at $35 per ounce.
Speculators bought gold on the London market in anticipation of eventual devaluation.
American President Lyndon Johnson's spending programs and war in Vietnam put great pressure on the
US economy. The budget deficit increased from $8 billion in 1967 to $26 billion in 1968. Johnson had
refused to raise taxes to finance his spending. The Federal Reserve raised interest rates to prevent
inflation, contributing to recession in 1970.
In August 1971 US President Richard Nixon imposed wage & price controls while suspending gold
convertibility so as "to defend the dollar against speculators". Legalization of gold ownership for
American citizens was probably less motivated by a libertarian spirit, than by a desire to see the market
increase the value of government gold reserves. Many Keynesians believed that the demonetization of
gold had finally been completed. US Federal Reserve Notes replaced the words "Payable to the Bearer on
Demand" with "In God We Trust". The collapse of the Bretton Woods system left the world on a pure
"dollar standard" which was undermined within two years following two devaluations of the dollar. Fixed
exchange rates were abandoned as most nations chose to "float" their currencies. Nonetheless, these often
proved to be managed floats ("dirty floats") in which central banks attempted to intervene in the foreign
exchange market to influence their rates. In the 20 years following 1971 the German Mark lost 52% of its
value, the US Dollar lost 70% and the British Pound lost 84%. Although Keynes was instrumental in the
design of Bretton Woods‘s system, Keynesians believe a flexible exchange rate increases the effectiveness
of domestic monetary policy because the central bank has a freer hand to inflate national currency at will.
When the Special Drawing Right (SDR) was created in 1970 by the IMF, it was defined as the gold-
equivalent of a US dollar. In 1981 it was redefined as a weighted average of the value of the five major
currencies in international trade (currencies of Japan, Britain, France, West Germany and the US). SDRs
were simply IMF bookkeeping entries added to the quotas of its members and deriving value from the
obligation of its members to accept SDRs and provide national currency in exchange.
For SDRs to be a medium of exchange, they would have to be accepted in private markets, but they were
only balances in central banks. If the IMF had the power to be a world central bank, it would undermine
the ability of national central banks to create their own seignior age and conduct their own monetary
policy. Political pressures from those in the United States who fear that the SDR could displace the dollar
as an international reserve limited SDR interest rates to 1.5%. The central banks of many countries
respond, as a matter of policy, to demands for foreign exchange (demand for exports, usually) by simply
creating more money. Japan, by doing this only in moderation, was forced to deal with the consequences
of an "expensive" yen: reduced demand for its exports and cheaper imports available for Japanese
consumers. In a flexible economy, deflation would correct the effects of a currency grown relatively
strong in world trade, but contracts for wages, materials, etc. in fixed numbers of yen makes deflation
slow. The short-term consequences are unemployment and economic recession in response to the
decreased foreign demand for the overpriced goods.
The inflationary practices of many governments have led to the adoption of American dollars as a de facto
monetary standard in many countries. Russia has more dollars in circulation than any country outside the
US. Seventy percent of the currency actually used in commerce in Peru & Bolivia is in dollars. Panama &
Liberia have used dollars as the official currency for many years, and Ecuador was forced to substitute
dollars for its own currency, the sucre, in early year 2000. Widespread use of the dollar as a global
currency both expands the power of the Fed and allows the US government to export paper (dollars) in
exchange for real goods and services from abroad. Although the IMF failed to become the world central
bank as intended by Bretton Woods, it has become a sugar daddy for foreign governments that mismanage

their economies — thereby encouraging such practices. One-fifth of IMF funds used for bailout loans
comes from the United States. Rather than allowing the natural discipline of economic failure to provoke
reform, the IMF effectively underwrites these failures while creating indebtedness to the IMF.
As an example, in the 1990s, Thailand, Indonesia, South Korea and a number of other Asian countries
rapidly expanded their money supplies while their central banks lowered interest rates. Local stock
markets soared in this illusory prosperity, but in 1998 the US Dollar rose over 100% against the Thai Baht
and 500% against the Indonesian ruppiah. To prevent currency collapse the local central banks tightened
interest rates — precipitating the "Asian crisis", blamed on currency speculators (a favorite scapegoat of
governments). Indonesia accepted money from the IMF, signing agreements which it violated, and
continued its policies of crony capitalism while the IMF continued to demonstrate "considerable
flexibility". Even where IMF requirements have been observed the effect is often detrimental, since the
IMF so often demands tax increases. In the case of Argentina, increased taxes have actually accompanied
reduced tax revenues, and have probably stifled economic growth.
In exchange for bailout funds, the IMF generally demands local central banks that can be "harmonized"
with the US Fed. Cynics might argue that the IMF is acting so as to expand the global dollar-reserve
system. This is not simply an issue of power-politics, however, because most people sincerely believe that
government regulated money & banking is superior to a free market system — and that the US Fed
"knows best".
Qualities of Good Monetary Standard:
1. Simplicity: The monetary system should be simple and easily understandable. A simple monetary
system inspires public confidence.
2. Elasticity: A good monetary system should be elastic. It should be capable of changing the money
supply according to the requirements of the economy.
3. Economical: The monetary system should be economical. It should not require heavy expenditure
on its operation. An expensive monetary system is a burden on the country. In this regard, paper
money is better than the metallic money.
4. Stability: A good monetary system should ensure internal price stability and external exchange
rate stability. Stable internal price level is necessary for the economic growth of the country and
stability in the foreign exchange rates is essential for the development of foreign trade.
5. Convertibility: A sound monetary system must possess the quality of convertibility of the
currency into some expensive metal Convertible currency system serves to inspire public
confidence and facilitate interna-tional payments.
6. Automatic Working: A good monetary system should have built- in-flexibility. It should be
capable of operating automatically without the government intervention. According to Prof.
Caiman, gold standard was, "a fool-proof and knave-proof standard". There was no scope for
artificial change in gold standard.
7. Legality: A good monetary system must possess legal sanction; it must be backed by the force of
law. Legal tender money increases public confidence and ensures general acceptability.
8. Economic Development: An ideal monetary system must be helpful for a country to achieve the
objectives of economic development and maximization of employment.

9. Other Qualities: A monetary standard should also possess some other qualities like
transferability, portability, cognizability (capable of being known), uniformity, divisibility, etc.
Qualities / Characteristics of Good Money:
1. General Acceptability: Good money is accepted by all because it serves as a medium of

exchange. Metallic money is acceptable due to its utility and value. Gold and silver coins had
general acceptability. The holder can use it as money or as metal. He does not lose value in both
cases.
2. Malleable: A good money material must be malleable. A metal is melted and then coins are
minted. The proper designs are made on it. The money material, which can be melted, is fit for
making coins. The malleable materials have impression on its face and back for recognition.
3. Elastic: The good material has the quality of elasticity. The business needs from season to season.
Paper money possesses the quality of expansion and contraction of money supply.
4. Recognizable: Good money is recognized either by sight or touch. The printing of notes is secret.
The imitation is not possible, because the process of coloring and the quality of paper are always in
the hands of central bank. The general public is familiar with the various kinds of notes.
5. Durable: Money should be durable. The money must not lose its value with the passage of time.
Metals are most durable as compared to other forms of money. The gold and silver do not wear out
quickly but it can be treated as durable due to replacement by the bank.
6. Portable: Good money must be portable easily. It should have more value in small quantity. The
passenger must feel easy while taking money with them.
7. Storable: A good money material is storable for for meeting the future demand. The minimum
space and lowest storing expenses are necessary for keeping the money material. The rupee notes
and coins have this quality.
8. Standardized: The good money material is of standardized nature and quality of its material does
not undergo great change.
9. Stable: Money must have stable value because it serve as a standard for measuring the value of
other things. A change in its value brings change in the prices of goods and services. The public
confidence is developed if value of money is stable. The money having ever-changing value is not
liked by the people.
10. Divisible: The money is always divisible without losing its value. The small units of money are
needed for making the smallest payments. The metallic money is to make nominal payments in
paisa. Public confidence develops due to this quality of money.
11. Difficult to duplicate: Good money is one which is difficult to duplicate. There should be no
danger of fake issuance of money.
12. Scarce: The scarcity is the quality of good money material. Good money is always scarce. Money
must be limited in supply as compare to demand for it. This quality induces the people to have
more and more money for meeting their basic necessities of life.
13. Homogenous: Good money must be of the same quality and quantity. The unit of money must be
of the respects otherwise there will be confusion in buying and selling of goods and services. The
color and size of money material help the people to deal in the market.

14. Economical: The good money material has economical quality. The cost of printing currency
notes and minting coins must be lower. The money system cannot last for a longer period if it is
too much costly.
15. High Value: The money material should possess high value in small bulk, so that it can be
conveniently carried and handled.
16. Effective Supervision: The good money is one that can be effectively supervised by a central
monetary authority. It is of such a nature that central authority is able to keep records of the
amount of money in circulation and the pattern of its distribution.
17. Government Support: The good money material must be supported by the government. The
people accept even fiat money (money issued without keeping any metallic reserves) due to the
government support. The government's backing to money creates a sense of confidence.
Types of Monetary Standard:
The term ―monetary standard‖ refers to the monetary system of a country. Prof. Halm defines monetary
standard as the ―principal method of regulating the quantity and the exchange value of standard money.‖
When the standard money of a country is chosen in the form of some metal, then the country is said to
have metallic standard. Broadly there are two major types of monetary standards. Metallic standard and
paper standard, these are two types; however can be further classified into many other types as shown in
the chart given below: -
A. Monometalism – Gold / Silver Standard

1. Gold Coin Standard
2. Gold Bullion Standard
3. Gold Exchange Standard
4. Gold Reserve Standard
5. Gold Parity Standard
B. Bimetalism – Gold and Silver both
6. Silver Standard
7. Gold Standard
C. Paper Standard
8. Free
9. Managed
Metallic Standard: Under metallic standard, the monetary unit is determined in terms of some metal like
gold, solver etc. standard coins are made out of the metal. Standard coins are full-bodied legal tender and
their value is equal to their intrinsic metallic worth. Metallic standard may be of two types:
A. Mono Metallism: Mono metallism refers to the money in which the monetary unit is made up of
convertible only one metal. Under Monometallism standard, only one metal is used as standard
money whose market value is fixed in terms of a given quantity and quality of the metal.
Features:
 Standard coins are defined in terms of only one metal.
 These coins are accepted as unlimited legal tender in the discharge of day to day obligations.

 Paper money also circulates, but it is convertible into standard metallic coins.
 There are no restrictions on the export and import of metal to be used as money.
 There nominal values as legal tender are fixed.
Types of Monometallism:
1. Silver Standard: Under silver standard the monetary unit is defined in terms of silver. The
standard coins are made of silver and are of a fixed weight and fitness in terms of silver. They are
unlimited tender. There is no restriction on the import and export of silver. Silver as a monetary
standard cannot boast of a rich career like its counterpart, the gold. Silver coins were first officially
struck in Rome in the year 268 B.C, silver remain predominant in Rome up to the end of the
Republic. Although a silver standard like the gold standard can be adopted in the form of either a
silver coin; silver bullion; or silver exchange standard on the same pattern as that adopted in the
case of gold standard. The reasons why silver has not enjoyed a coveted position like the gold are
not difficult to understand. Gold has two advantages over silver as money. Firstly, gold is more
valuable in proportion to weight and bulk and thus less expensive to transport in making
international payments as compared to silver. Secondly gold is more stable in value. Silver was
used as money by most of countries up to 1873. In that year Germany and England adopted gold
standard and free coinage if silver was stopped by most countries of Europe during the next
decade. There was a rapid decline in the price of silver. In the decade 1921-30, France, Belgium
and Finland discontinued the free coinage of silver. India abandoned silver by 1893 and China by
1935. When India was on the silver standard (between 1885 and 1893) silver rupee of 180 grains
of 11/12 purity silver was the standard coin. In 1893 on the recommendations of Herschel
Committee the silver standard was abandoned and its place was taken by the gold standard.
2. Gold Standard: Gold standard is the most popular form of Monometallism standard, the monetary
unit is expressed in terms of gold. The standard coins possess a fixed weight and fineness of gold.
Gold standard has been defined differently by different monetary economists. According to ―D. H.
Robertson‖ Gold standard is a state of affairs in which a country keeps the value of its monetary
unit and the value of a defined weight of gold at equality with one another. According to
―Coulborn‖ Gold standard is an arrangement whereby the chief price of money of a country is
exchangeable with a fixed quantity of gold of a specific quality. The gold standard remained
widely accepted in most of the countries of the world during the last quarter of the 19th century and
the 1st quarter of the 20th century. Gradually gold standard disappeared from different countries
and finally it was completely abandoned by the world by 1936.
Merits of Monometallism:
 Avoid Gresham’s law or Non-operation of Gresham’s Law: Monometallic avoids the

operation of Gresham‘s law. According to this law, both good as well as bad money exists in
the economy, bad money tends t drive out of circulation of good money.

 Simplicity: Since only one metal is used as a standard of value, monometallic is simple to
operate and easy to understand.
 Public confidence: Since the standard money is made of a precious metal and it inspires public
confidence.
 Promotes foreign trade: Monometallic facilitates and promotes foreign trade. Gold or silver
standard is easily acceptable as an international means of payment.
De-merits of Monometallism:
 Costly standard: It is a costly standard and all countries particularly the poor countries can‘t
afford to adopt it.
 Lacks elasticity: Monometallic money lacks elasticity, money and supply depends upon the
metallic reserves, thus, money supply can‘t be changed in accordance with the requirements of
the economy.
 Lacks price stability: Since the price of the metal cannot remain perfectly stable, the value of
money under Monometallism lacks stability.
 It retards or slows down the economic growth.
B. Bimetallism: According to ―Chandler‖: - A bimetallism or double standard is one in which the

monetary unit and all types of nation‘s money are kept as constant value in terms of gold and also
in terms of silver. Under bimetallism two metallic standards operate simultaneously. Two types of
standard coins from different metals are minted.
In a bimetallic standard, the value of the standard money and all other monies in the country is
pegged in terms of gold and silver. Bimetallism is in fact the simultaneous adoption of the gold
and silver standards by the government of a country. Gold and silver coins or warehouse receipts
(representative paper money) command unlimited legal tender powers. A debt calling for the
payment of a given sum of money could be discharged by tendering either silver or gold coins or
both. Both metals are given the right of free and unlimited coinage into standard money units. The
government sets the price at which it buys and sells gold and silver. Thus, a bimetallic standard or
bimetallism is a monetary arrangement in which the unit of account is expressed in terms of value
of the certain quantity of gold and silver of given purity.
The mint ratio expresses the relationship between the two metals used as money. For example: if a
standard gold rupee contains one gram of fine gold and a standard silver rupee contains ten grams
of fine silver, the mint ratio between the silver and gold coins would be 1:10, which would mean
that one gram of gold is equal to ten grams of silver. The theory basic to bimetallism is simple.
It assumes that both the metals ought to be used simultaneously as the standard of value since it is
improbable that the value of the two metals would change in the same direction and to the same
degree. For example, while the mint ratio between the silver and gold coins were 15:1, if the price
of silver in the market fell from the silver-gold ratio of 15:1 to 16:1, then the holders of solver

would bring silver to the mint for coinage because the mint price of silver was higher than its
market price.
People would buy silver in the market at lower price of to resell it to the mint at a higher price.
Thus, the demand for silver in the market would increase and the market price of silver would rise.
Meanwhile the supply of gold in the market would increase as people sold it to buy silver.
Consequently, the price of gold in the market would fall. The rise in the gold price of silver and the
fall in the silver price of gold in the market would, therefore, approximate the mint-ratio of 15:1.
The reverse effects would operate if the market ratio between silver and gold was 14:1 while the
mint ratio remained pegged at 15:1.
Features:
 A bi-metallism standard is based on two metals: - it is the simultaneous maintenance of both gold
and silver standards.
 There nominal values as legal tender are fixed.
 Gold and Silver coins circulate side-by-side and are interchangeable.
 There is free and unlimited coinage of both metals at the fixed mint ratio.
 There is free import and export of both the metals.
 The coins of both the metals must be in circulation as standard and unlimited legal tender money.
Merits of Bi-metallism:
C. Convenient full-bodied currency: Bi-metallion provides convenient full-bodied coins for both
large and small transactions. It provides portable gold money for large transactions and convenient
silver money for smaller payments. The argument however, lost it force now when the exchange
money has developed.
D. Price stability: The flexibility of money supply assured price stability. If the output of silver rise,
that of gold will fell and vice versa.
E. Encouragement to production: The total money supply was greater than its demand as a result
the rate of interest declined which encouraged investment and production.
F. Adequate supply of currency: As both gold and silver coins rise in circulation and freely minted,
there was no likelihood of both becoming short in supply simultaneously.
G. Stable purchasing power: it is argued that the value of money unit under bimetallism is
determined by the supply of and demand for the two metals. Bimetallism will minimize
fluctuations because any change in the market value of one metal is promptly checked by inertia of
other metal. This is known as equilibrating action of bimetallism. William Stanley states that
―Imagine two reservoirs of any connecting pipe, the level of water in each will be subject to its
own fluctuations only. But if we open a connection the water in both will assume a certain mean
level and the effects of an excessive supply or demand will be distributed over the whole area of
both reservoirs‖.
H. Maintenance of bank reserves: Under Bi-metallism the maintenance of bank reserves becomes
easy and economical. Under this system, both gold and silver coins are standards coins and
unlimited tender. Therefore it is easy for the banks to keep their cash reserves either in gold coins
or in silver coins or in both.
I. Stimulates foreign trade by stabilizing foreign exchange rate: Bi-metallism stimulates
international trade in two ways: - a) a country on bi metallism can have trade relations with both

gold standard and silver standard countries. b) There are no restrictions on imports and exports due
to the free flow of both types of coins. It stabilizes the currencies between bimetallic countries.
J. Bimetallism can be adopted by those countries which do not possess enough quantity of gold to
adopt the gold-coin standard. In short, it can be adopted both by the gold producing and by the
silver producing countries. Since both the gold and silver are accepted in the settlement of
transactions, the expansion of international trade under bimetallism is easier than is under gold std.
De-merits of Bi-metallism:
 Costly monetary standard: Bi-metallism is a costly monetary standard and all nations,
particularly the poor nations can‘t afford to adopt it.
 Inequality in market rates: Bi-metallism can operate successfully only if the equality between
the market rate and the mint rate can be maintained. But in practice, it is difficult to maintain
equality between the two rates. The relative values of gold and silver in the market are likely to
vary from those established at the mint so that the metal undervalued at the mint will forsake its
monetary use. Particularly when one metal is oversupplied than the other.
 Impossible to fix permanent ratio (mint): it is impossible to fix for all times a ratio between the
values of two metals, each of which is subject to entirely different demand and supply conditions.
The fixed mint-ratio is bound at any time to overvalue and undervalue the other. If one country
alone adopts bimetallism, while others have no fixed price for silver, then silver in India at its fixed
price will always be cheaper or dearer than in the rest of the world. If it is cheaper, then rest of the
countries will sell gold in exchange of silver and India will lose all its silver. If it is dearer in India
then rest of the world will sell all its silver to India in exchange of gold so that India will lose its
gold. The conclusion is that bimetallism is adopted by whole world, is has a greater chance of
success than when only one country is adopted. So it is not possible to keep gold and silver coins
simultaneously in circulation over a longer period of time.
 No stimulus to foreign trade: International trade is stimulated, if all countries adopt bi-metallism,
but this is a rare possibility in the present circumstances.
Bimetallism in Practice: Bimetallism played an important role in world‘s monetary history in 19th
century. Till the 70s of 19th century, bimetallism was prevalent in almost all European countries except
England. Efforts are made in US towards reintroduction bimetallism in 19th century. In the 30s of 20th
century too, attempts were made in the USA and other countries to increase the importance of silver as a
money metal. France was on the bimetallic standard from 1803 to 1875 at the silver-gold mint-ratio of
15.5:1. After 1875 several international conferences were held in Paris (1878) and Brussels (1893) with a
view to securing the adoption of international bimetallic standard, but in the face of national jealousies and
apathetic attitude of England who already in force of gold standard from 1816, nothing was accomplished
by these conferences and bimetallism as a monetary standard became a matter of history. In the 30s the
agitators for silver actually succeeded in the USA. The silver purchase act of 1934 was passes in that
country with the object of increasing the proportion of silver to gold in the country‘s monetary reserves by
purchasing silver at home or abroad. When the act was passes in 1934 it was estimated that 1.3 billion fine
ounces of additional silver would have to be purchased to fulfill the stated aim. In 1949, after 15 years
during which about 2 ¾ billion ounces of silver was purchased, the treasury was still over 2.2 billion

ounces short of its goal of one dollar in silver for each three dollars of gold. The enormous gold imports
during this period had been responsible for this situation.
Gresham’s Law: When two kinds of money are in circulation, the problem before the government is to
keep them concurrently in circulation. When the two currencies having same legal value have different
intrinsic value or real value in the domestic or foreign market then the money having higher market value
is said to be undervalued currency while the other is said to be overvalued currency; in such a situation,
the overvalued currency will tend to drive out the undervalued currency from circulation. The undervalued
currency is withdrawn from monetary use, melted and diverted to the non-monetary uses. Gresham‘s law
is based on this observation. Gresham was by no means the first to make statement on the issue of the
overvalued money driving away the undervalued money. Gresham‘s law loosely stated through the
expression ―bad money drives out good money from circulation‖. Gresham‘s law has been widely cited
and often misunderstood. A correct statement of this law is found in the following passage.
―Where two or more forms of money of the same nominal or face value are concurrent in circulation and
if one is relatively overvalued for monetary purposes, the self-interest of the public will lead them to
discriminate between the two forms. The undervalued form will be retained, and the overvalued form will
be passed along to others. In time the form of money which is undervalued for monetary purposes will
disappear from circulation. If the community is in a position to refuse to accept the bad money; the good
money will not disappear but will continue to circulate at a premium‖.
Gresham’s law is based on the following assumptions:

 The different monies in circulation are full legal tender and the public is not indifferent towards
any of them.
 The total quantity of money exceeds the total monetary requirements of the public that is a part of
the total money supply is redundant.
 The supply of the overvalued money is sufficient to meet the monetary demand of the community.
If this was not so the undervalued money will not altogether disappear from circulation at a
premium.
The operation of Gresham‘s law is not restricted to a bimetallic standard. In fact, it will operate under
bimetallism, monometallic or paper standard provided overvalued and undervalued coins circulate
concurrently. A basic principle of Gresham‘s law is that the undervalued money can remain in circulation
at home only if it will circulate at premium. This conclusion follows from the fact that people will not
spend the undervalued money at home on the same basis as the overvalued money when they can get
relatively more for the undervalued money in foreign countries.
Reform Monetary Standards:
 Symmetallism: The reform monetary standard was suggested by Alfred Marshal in 1887.
Stimulated by the controversy regarding the operation of Gresham‘s Law under bimetallism
Marshall gave the suggestion of adopting a symmetallic standard under which gold and silver
would be fused in specific proportions in the form of a coin or bar. In 1886 in his reply to the
commissioners on Trade Depression, Marshall suggested paper currency for circulation based on
gold and silver symmetallism as the standard. My alternative scheme is got from his Ricardo‘s

simply by wedding a bar of silver of, say, 2000 grammes to a bar of gold of, say, 1000 grammes;
the government undertaking to be always ready to buy or sell a wedded pair of bars for a fixed
amount of currency.
 Parallel Bimetallism: The suggestion was given to remove the defects arising from disparity
between the fixed mint ratio and fluctuating market ratio between the two metals under a simple
bimetallic standard. Under a parallel bimetallic standard it is suggested that the mint-ratio should
be flexible enough to adjust itself to the changes which may occur in the market ratio between the
two metals.
 Tabular Standard: The standard is not the price of a single commodity but it is based upon the
price of a representative list of commodities. In this crude form this standard was adopted in
Massachusetts twice in the 18th century. Alfred Marshall in 1885 also made a proposal for usage in
case of longer period contracts. Under this standard, money‘s demand over the goods and services
would be kept constant by causing shifts in the quantity of money repaid from time to time. If price
rose, larger number of units would be repaid and vice versa. If, for instance, price raised by 10% a
debtor owing Rs. 1000 to his creditor would pay Rs. 1,100 as principal amount plus interest. The
fundamental idea of the tabular standard was employed by several American was boards and
business firms during world war 2 to adjust wages to changing cost of living index to determine
wages of government employees during the period of currency demoralization. Although this
standard has the merits of simplicity and of guaranteeing justice to both the debtors and the
creditors, it is doubtful whether perfectly correct index numbers could be constructed. The
standard, unless adopted universally, would also disrupt international economic relations.
 Compensated Standard: Professor Irving Fisher was the main proponent of this plan. Under this
standard the metallic contents of the currency unit would vary according to the changes in the level
of prices in such a way that the purchasing power of the money unit remains stable. If prices rise, if
the value of money unit fell, the quantity of metal in the money unit would be increased
proportionately so as to raise its value to the original level and vice versa. Under this plan the
quantity of metal in the money unit would be changed periodically to offset changes in its value.
The scheme of the compensated standard merely enables the banks and government to issue more
currency and credit but does not ensure that the amount of currency in circulation will be increased
and prices increased. For this reason, it is said that the scheme cannot offset cyclical changes in
prices, even though it might succeed in affecting long-run price trends.
 Multimetallism: Under this monetary system more than two metals act as the standard unit of
money. The management of this standard is far more difficult than the management of bimetallism.
 Fiat Standard: Under this the intrinsic value of the money is substantially less than its face value.
Fiat money, although generally associated with an inconvertible paper money may also be of metal
or other material. There are three main tests of a standard fiat money. Firstly, the legal value of the
money unit must be substantially higher than its commodity value. That is, it has little or no
intrinsic value within itself as a commodity. Secondly the money unit must not be redeemable in
gold or silver or in any other commodity whose value is substantially equal to its own stated value.
Fiat money circulated not on its worth but on account of the command of the government. Thirdly,
its purchasing power is not kept at par with any commodity, gold or silver, into which it might
have formerly been convertible.

Gold Standard:
The gold standard is the value of monetary unit is fixed in terms of a specified weight and purity. The gold
standard was the policy objective of all monetary systems in the pre-war period. The rich nations of the
world had adopted the gold-coin standard while poorer countries also enjoyed the prestige of a gold
standard nation by adopting a cheaper variant of gold standard – the gold exchange standard. World war
one disrupted the currencies of many gold standard countries inducing them to adopt the inconvertible
paper money standard. The attempts towards the restoration of the gold standard in the post war period
lacked uniformity resulting ultimately in the breakdown of the gold standard. According to Dennis Holme
Robertson ―gold standard is a state of affairs in which a country keeps the value of its monetary unit and
the value of a defined weight of gold at equality with one another‖. It is clear that under the gold standard
gold serves as the standard of value such that the money unit is either made of gold or its value is
unequivocally defined in terms of certain stated weight of gold of given fineness. Besides, gold is freely
imported and exported and the monetary authority of the gold standard country undertakes to buy and sell
gold in unlimited amount at the officially fixed price.
Features of Gold Standard:
 Definition of standard money in terms of gold (the value, weight and fineness of the principal
monetary unit are defined in terms of gold).
 Gold money is unlimited legal tender
 Sale-purchase of gold by the monetary authority
 Free coinage of gold
 Convertibility of other types of money into gold
 No restriction on import-export of gold.
Functions of Gold Standard:
 To regulate the volume of currency: Internally gold standard forms the basis of the currency and
acts as a regulator of the volume of currency in the country. This function is called the domestic
aspect of the gold standard since it is concerned with stabilizing the internal value of the currency
under gold standard. Currency notes are exchangeable on demand for gold of equivalent value.
thus note issue is fully backed by gold reserves and the growth of fiduciary note issue is checked,
moreover since the amount of cash in the country is limited by the gold reserve held by the central
bank and there must be a cash basis for credit creation, the capacity of the banks to create credit is
also limited by the gold reserve. Thus under gold standard, total currency of the country is
regulated by its gold reserves.
 To maintain the stability of exchange rate: Externally gold standard aims at regulating and
stabilizing the exchange rate between the gold standard countries. This function is called the
international aspects of the gold standard because it is concerned with stabilizing the external value
of currency. Under gold standard, every member country fixes the value of its currency in terms of
certain weight of gold given parity. Moreover, there is an undertaking given by each country‘s
money authority to purchase or sell gold in unlimited quantity at the officially fixed price.
Merits of Gold Standard:

 Simplicity: Gold standard is considered to be a very simple monetary standard. It avoids the
complications of other standards and can be easily understood by the general public.
 Check on inflation: For every increase in amount of currency gold reserve were also required to
be increase to a given extent. There was thus an alternative check on the issuing of paper currency
by a country. There was also no fear of inflation, because the country could not increase the
quantity of money in an unlimited manner.
 Expansion of International trade: These were made possible to stable exchange rate and stable
value of gold in countries. These led to the expansion of international trade and capital movement.
 Public confidence: Gold standard promotes public confidence because a) gold is universally
desired because of its intrinsic value; b) all kinds of non-gold money are convertible into gold; c)
total volume of currency in the country is directly related to the volume of gold and there is no
danger of over-issue of currency.
 Automatic working (No outside interference): under gold standard, the monetary system
functions automatically and requires no interference of the government for relationship between
gold and quantity of money. Changes in gold reserves automatically lead to corresponding changes
in the supply of money.
 Exchange stability: Gold standard ensures stability in the rate of exchange between countries.
Stability of exchange rate is necessary for the development of international trade and the smooth
flow of capital among countries. Fluctuation in the exchange rate adversely affects the foreign
trade.
 Price stability: gold standard ensures internal price stability under this monetary system, gold
forms the currency base and the price of gold do not fluctuate much because of the stability in the
monetary gold stock of the world and also because the annual production of gold and existing
stock of the gold in world reserves.
De-merits of Gold Standard:

 Not always simple: gold standard in all its forms is not simple. The gold coin standard and to
some extent gold bullion standard may be regarded as simple to understand but the gold exchange
standard which relates the currency unit of a country to that of the other is by no means simple to
be comprehended by a common man.
 Lack of elasticity: under the gold standard the monetary system lacks elasticity, under this
standard, money supply depends upon the government reserves and the gold reserves cannot be
easily increased. So money supply is not flexible enough to be changes to meet the changing
requirement of the country.
 Costly and wasteful: Gold standard is costly because the medium of exchange consists of
expensive metal. It is also a wasteful standard because there is a great wear and tear of the precious
metal when gold coins are actually in circulation.
 Fair-weather standard: The gold standard has been regarded as a fair-weather standard because
its works properly in normal or peaceful time, but during the period of war or economic crisis, it
invariably fails, during abnormal periods. Those who have gold try to hoard it and those who have
paper currency cry for its conversion into gold. In order to protect the falling gold reserves the
monetary authority prefers to suspend the gold standard.

 Economic dependence: under gold standard the problems of one country are passed on to the
other countries and it is difficult for an individual country to follow independent economic policy.
 Unsuitable for developing countries: gold standard is particularly not suitable to the developing
economies which have adopted a policy of planned economic development with an objective to
secure self sufficiency.
 Not automatic: The automatic working of the gold standard requires the mutual co operation of
the participating countries. but during the world war, because of lack of international co-operation
all types of countries, those receiving gold as well as those losing gold, found it necessary to
abandon the gold standard to prevent disastrous inflation on the one hand and when more
disastrous deflation and unemployment on the other.
 Anarchy in world credit control: The gold standard was laissez fair standard and operated only
under normal times. It failed miserably in condition of severe inflation or deflation. When in 1929
it become worldwide phenomenon.
 Rigid Standard: because it was based on gold every country had to circulate gold coins or keep
gold reserves.
 Adverse effects of Interest rate exchange: When there was an inflow of gold, the bank rate was
lowered, while it was raised with the outflow of gold. Such changes in interest rate were forced
upon trade and industry simply to expand or reduce money income within country.
 Deflationary Bias: It was in the interest of the gold losing country to deflate prices, when
deflation started become very difficult to bring revival even with the beats efforts of the bank.
Advantages of the Domestic Gold Standard: In the first place, it commands confidence of the public in
the monetary system of the country since the volume of the currency notes in the country is directly
related to the volume of gold reserves. Consequently, it guarantees against an over issue of currency and
the dangers of cheap money. Secondly, it is automatic in its working, given the relationship between the
gold and the quantity of money, under the domestic gold standard the inflows and outflows of gold will
lead to corresponding expansion and contraction in the quantity of money such that the ideal
predetermined relationship between gold and the quantity of money remains stable. Thirdly, it is argues
that under the domestic gold standard with gold serving as the currency base the price level is more stable
than would be in the absence of such a standard. Variation in production of gold cannot cause any
perceptible instability in the volume of gold and so in the volume of currency based upon the total gold
reserves. Consequently, the price system based upon a relatively stable gold reserves foundation would be
more stable if it was based upon the less stable foundations under some other monetary standard.
Disadvantages of the Domestic Gold Standard: In the first place, the currency system of the country
under the domestic gold standard becomes inelastic. In emergencies like war, economic crisis or when a
country‘s government wishes to embark upon ambitious schemes of economic development with a view to
ensuring full employment and higher standard to its people involving large outlays, the domestic gold
standard, which restricts the monetary freedom of country‘s government, proves a serious hurdle in the
national efforts of ensuring economic progress of the country. The domestic gold standard allows no scope
for national monetary management. It is a standard meant for normal times. It breaks down in times of war
and economic crises. Consequently, it has been called a ―fair weather standard‖. Secondly, the automatic
working of the domestic gold standard is dangerous for the economic prosperity of the country. A
discovery of new gold mine or improvement in the methods of extracting gold from the mines may result

in the increased gold supply which by increasing the supply of money may (unless the demand for money
also increases) cause an increase in prices and cause inflation in the country. Thirdly, the domestic gold
standard causes price instability in the economy. By linking the value of country‘s currency unit to gold,
the price level may fluctuate in the volume of gold reserves that result from the discovery of new gold
mines, closure of the old mines, changes in the techniques of mining the gold, changes in the distribution
of world‘s total monetary gold stock between different countries, etc.
Advantages of International Gold Standard: Firstly, it provides the gold standard countries with an
international medium of exchange and standard of value. Secondly, the most important advantage of the
international gold standard is stability of the rate of foreign exchange. Stable foreign exchange rates are
necessary for the smooth flow of international trade and capital movements. An overriding objective of
the monetary policy of the gold standard countries in the pre-1914 period was the maintenance of fixed
foreign exchange rates between their currencies. Thirdly, under the international gold standard prices
between different countries are closely related. If at any time prices are low in one country and high in
other, this price discrepancy is corrected through the mechanism of gold movements. Fourthly, gold
standard protects the country against the abuses of impecunious governments. The gold might allow mild
doses of expansion and contraction but it rejects outright violent deflations and inflations. The golden
rules of the gold standard game enjoin the governments of the gold standard countries not to inflate the
quantity of money beyond the proportions justified by their gold reserves.
Defects of International Gold Standard: In the first place, it has an ―inherent bias toward deflation‖.
While gold losing country has to contract money and credit and suffer deflation, the gold-receiving
country is not under compulsion of expanding currency and credit and experiencing inflation. This is
supported by the monetary lessons of the inter-war period. For instance, the massive gold outflows from
England caused income deflation and unemployment in that country while gold inflows caused no
corresponding currency expansion and inflation in America.
Secondly, under the international gold standard deflation or inflation caused in one country is soon
transmitted to the other gold standard countries. This means that the countries have to bear the share of the
troubles of the country even though they may not be prepared to face them. Thirdly, too much stress has
been laid on the automatic character of the gold standard. The fact is that the much publicized automatic
character of the gold standard is subject to many ‗buts‘ and ‗ifs‘. Increases and decreases in the quantity of
money, even if they follow the automatic working of the gold-flow mechanism, are dangerous for the
economic stability of the gold standard countries. Furthermore, even assuming that the central banks in the
gold standard countries are willing, yet they may prove incompetent to adjust the cost and price downward
in the case of credit-squeeze or to create sufficient demand for new loans in the case of credit expansion.
Fourthly, the gold standard forces the country to surrender the domestic price stability for the poor sake of
exchange rate stability. Price stability and exchange rate stability are contradictions under the gold
standard. The gold standard limits the freedom of the national economic policies. A gold standard country
has to give up the privilege of following whatever appropriate monetary policy it wishes to follow in order
to stabilize the domestic price level. It leaves the domestic economy of the gold standard country on the
mercy of the vagaries of the yellow metal.
Fifthly, gold standard is an anachronism in the modern world where every country considers full
employment and growth important for its economic prosperity. It is considered to be an outmoded
instrument of monetary policy. Sixthly, the gold standard involves the avoidable waste of costly specie
which is blocked as the ―gold reserves‖. These gold reserves are essential for automatic working of the
gold standard. By adopting a well-managed paper standard the same results could be achieved without the
need of having any gold reserves which amounts to locking a large part of the precious metal denying the
community to use for more important industrial purpose. Seventhly, the gold standard has been
responsible for causing disorders. Misdistribution of gold has let loose deflationary and inflationary
tendencies which do uncalculated harm to the economic prosperity of the countries.
Lastly, the gold standard is unsuitable for a growing economy. A country committed to a policy of
economic development will have to expand their currency to finance their development projects. A policy
of deficit financing through the creation of credit money without the backing of gold reserves becomes
essential to adopt. Under this gold standard this cannot be done without violating the rules of the gold
standard.
Types or Kinds of Gold standard:

1. Gold Coin Standard
2. Gold Bullion Standard
3. Gold Exchange Standard
4. Gold Reserve Standard
5. Gold Parity Standard
1. Gold Coin or Gold Currency Standard: Gold coin standard or gold currency standard or gold
species standard is the oldest form of gold standard. It is also known as orthodox gold standard or
traditional gold standard, this standard was prevailed in UK, France, Germany and USA before 1st
world war. Gold coin standard is also regarded as full gold standard because under this standard,
full-bodied standard coins are made of gold were circulated, other forms of money are redeemable
into gold. In short, under gold coin standard legal tender money consists of coined gold of
specified weight and fitness. Gold bullion is supplied in exchange for the gold coins which is the
standard of value. When the coinage and melting of gold is free, the price of gold would be fixed.
According to Crowther: ―A currency system in which gold coins either form the whole circulation or
else circulate equally with notes is known as the full-gold standard.
Features:
 Monetary unit is defined in terms of gold. Ex: before world war, sovereign was the
standard coin in the UK, its weight was 123.17441 grains with 11/12 parity. Other forms of
money are also in circulation but they are easily convertible into gold.
 Gold coin was full and unlimited legal tender.
 There is free coinage of gold.
 Purchase and sale of gold by government.
 Gold is a measure of value.
 Gold coins could be freely minted for other purposes.
 Non-gold metallic coins and paper currency notes also circulated side by side and
convertible into gold coins at fixed rates.
 Export and Import of gold is free.

 All credit money and all legal tender money other than gold coins in redeemable at par in
gold on demand.
Merits:
 Public confidence: Since the standard coin is made of gold. It is universally acceptable.
Thus, gold coin standard enjoys fill confidence of the public.
 Simplicity: Gold coin standard is considered to be a very simple monetary standard. It
avoids the complications of other standards and can be easily understood by the general
public.
 Automatic working: It is automatic in working and needs no government interference,
money supply depends upon the volume of gold reserves and money supply can be
changed in accordance with the changes in the volume of gold reserves.
 Price stability: Since there are no frequent changes in the supply of gold, this system
ensures reasonable degree of internal price stability.
 It ensures the foreign exchange rate stability and protects people from the dangers of over-
issue of currency resulting in inflation at the hands of the impecunious government.
De-merits
 Fair weather standard: It is fair-weather standard it operates smoothly during peace times but
fails to work properly and inspire public confidence at the time of economic crisis.
 Wastage of gold: There is great deal of wastage of gold under this standard. Circulation of
gold coins suffer depreciation, moreover, since paper currency is fully backed by gold, gold
remains idle while in reserves.
 Without international co-operation, its automatic working is not possible
 Stability of internal price under this standard is more imaginary than real
 Gold currency is not essential to maintain price and exchange stability
 Gold currency standard is deflation-oriented
2. Gold Bullion Standard: World War I imposed such heavy financial burdens that nation after
nation freed itself of the inhibiting restrictions imposed by the gold standard. Gold hoarding, free
coinage of gold and free convertibility of currencies into gold were forbidden. Currencies
depreciated and gold standard ceased to exists. After 1st world war, gold standard was received in
some countries of Europe, not on gold currency basis but on gold bullion basis. It was adopted by
Great Britain in 1925. Gold bullion standard is a modified version of gold coin standard in which
there was no gold coinage and the currency is convertible into gold bullion. Free coinage of gold
was free prohibited although gold still was preserved as a standard and as currency into gold in
demand. It could only be converted into gold bars of certain specified weight after paying the
necessary amount in the local currency. All forms of money – paper, copper, silver and gold – had
the same purchasing power since all the non – standard money was exchangeable for the standard
money at any time. The value of money defined and redeemed in terms of the fixed quantity of
gold money was stable. (Hilton Young commission for India in 1926; France given up 1936)
Features:

 Gold coins are not in circulation, but the standard currency unit is expressed in terms of a definite
quantity of gold of a given fineness. Thus, gold does not act as a medium of exchange. But it
remains a measure of value.
 There are no restrictions on export and import of gold.
 Coinage of gold is not allowed and currency in circulation is convertible not in gold coins but in
the form of gold bars of specified gold weight.
 Other forms of money are not fully backed by gold reserves or Paper money was not backed up
fully by gold-can be converted into gold.
 No free gold coinage and Sale-purchase of gold at fixed price – 1056 Tholas.
 Gold kept by the treasury or central bank in the reserves for convertibility of the currency
constitutes only a fraction of the total currency in circulation. In other words the currency is issued
on the fractional reserves basis.
Merits:
 Economy in the use of gold: The gold bullion standard economizes the use of gold, gold coins are
not in circulation and there is no wastage of the precious metal. Moreover, there is no hundred
percent gold backing of note issue. It imparts elasticity to the monetary system of the country.
 Use of gold in public interest: Since, under gold bullion standard, all gold is not kept idle in
reserves. It can be properly utilized for public purposes.
 It imparts elasticity to the monetary system of the country. It can be adopted even by less favorably
placed nations with regard to gold reserves.
 Stability in foreign exchange rates, Simplicity, Greater public confidence
 Both these gold standard: Gold coin as well as gold bar standard were designed as “automatic”
because it was believed that there was no need for the government supervision or control to
operate these standards. Automatic working ensures equilibrium of supply and demand for money.
De-merits:
 Fair-weather standard: Like gold coin standard, gold bullion standard also fails to work at the
time of economic crisis. It losses public confidence during war periods when the demand for gold
increases and the government reserves are not sufficient to meet this demand.
 Uneconomical: Under this system, enough gold reserves are kept. They remain idle and can‘t be
put to productive uses.
 Government Intervention: Government bullion standard can‘t function properly without
government intervention. In a way, it is a managed currency system because under this system the
government manages the token money, paper money and gold reserves.
 The gold bullion standard, however, is inferior to the gold coin standard because although in
theory the redeemability of money is there but in practice it is not possible to get the gold in
exchange for each money unit. Since there is a minimum quantity of gold which is required to be
redeemed, a common man cannot afford to realize his/her dreams. In France the people dubbed the
gold bullion standard adopted in June 1928 as ―the rich man‘s standard‖.
3. Gold Reserve Standards: After the breakdown of gold standard a new money system called gold
reserve standard was developed in 1936 mainly to ensure stability in exchange rates. In 1936 Great

Britain, USA and France a Tripartite monetary agreement, according to which the free flow of gold
or foreign currency was allowed to stabilize exchange rates and promote foreign trade without
affecting the internal value of the domestic currency. For this purpose, exchange equalization
funds were created. To carry out the provisions of the agreement, the exchange equalization fund
of one country was to sell or purchase gold and foreign currency at a fixed rate to its counterpart in
the other countries which were signatories to the tripartite agreement. The gold reserve standard
functioned successfully for 3 years and came to an end with the outbreak of World War 2.
(Objective is to establish ex stability among these countries)
Features:
 There were no gold coins within the country.
 The currency consisted of paper notes & inconvertible into bullion.
 Establishment of ex-equalization fund to maintain stability in exchange rates. For this purpose,
the fund keeps besides local currency, foreign exchange and gold. If the demand for a foreign
currency rises, its value will also raise in term so other currencies. In that case, be selling that
foreign currency in the open market, the EEF will prevent any rise in the value of that
currency.
 There was no free export and import of gold except by fund authority for maintaining stability
in the exchange.
 No link with gold & Secrecy of reserves, Exchange stability secured without intervention in the
internal economy of the member country.
Merits:
 No link with gold: Under this standard gold is used neither as a medium of exchange nor a
measure of value. The domestic currency is made of paper money and taken coins. The
convertibility of domestic currency into gold is not ensured.
 Strict secrecy: The composition and movement of reserves of the exchange equalization fund
are kept strictly confidential from the public.
 Exchange stability: Under this standard, exchange rate stability is achieved without disturbing
the internal economy of the member country.
 No free movement of gold: Under this system, the private individuals are not allowed to
import and export gold. The government monopolies the country‘s import and export of gold.
Gold is imported and exported only for monetary purpose.
 International Trade: Under this standard, exchange rate stability paves the way for growth in
international trade and expansion of international trade.
De-merits:
 Complex: This standard is complex in its working and is not easily understandable by the
common people.
 Inflation oriented: under this system money supply can be increased easily but it is very difficult
to reduce money supply, hence it is prove to inflation.
 Not automotive: This standard does not work automatically and needs active government
intervention. It may be more appropriately called a managed standard.

4. Gold Exchange Standard: It is a cheaper variant of the gold standard whereby a country adopts
the gold standard without either issuing the gold coins or maintaining the costly gold reserves
against the currency simply by determining the value of the domestic currency in terms of the
another country‘s currency unit which itself is either on the gold coin or gold bullion standard. The
Geneva Conference unit held in April 1922 proposed that those countries which were not
immediately able to restore full gold standard should adopt the gold exchange standard. The gold
exchange standard will enables those poor countries which cannot afford the luxury either of the
costly gold coin or gold bullion standard; to reap the advantages of the gold standard without
having to issue the gold coins or keep the gold reserves as backing against the currency. In this
regard, gold coins are not in circulation. There is paper currency and the base metal coins in
circulation in the country. The monetary authority in under no obligation to convert the coins and
paper notes into gold; under this standard there is no direct relationship between domestic currency
and the quantity of the gold reserves. The monetary authority will converts the domestic currency
only for the purposes of obtaining foreign exchange by converting it in some other foreign
currency which is convertible in gold.
Features:
 Gold coins did not circulate within the country.
 Payments from abroad are accepted in gold or currencies based on gold.
 The prices of goods and services are determined in an indirect manner by the price of gold
 Circulation of token money and inconvertible paper currency.
 The currency consisted of paper notes and token coins of silver and other metals.
 These were not convertible into gold coins and bullion.
 The local currency was linked with some foreign currency which was gold currency system.
 It was convertible into such foreign currency at fixed rate.
 Indirect link with gold-convertible at a fixed rate into the currency of another country which is
on the gold standard.
 Gold availability only for making foreign payments & absence of a free gold market
Merits:
 It is economical to adopt since it can be adopted by a country without possessing the costly
gold reserve, even poor countries can adopt it without difficulty.
 It Imparts elasticity to the monetary system of the gold exchange country.
 Practically all the advantages of the costly gold coin standard are available in this standard.
 The government earns profit by making foreign gold investments.
 International payments are effected with ease.
De-merits:
 Complexity, Inflexibility, Expensiveness, Loss on monetary freedom, Fear of loss to member
countries.
 This standard lacks the confidence of the public as there are no gold reserves to back it.
 It cannot be called automatic and the essential feature of a true gold standard is absent.
 In this standard the domestic currency depends upon the mercy of the foreign currency.

 There are many reserves – gold reserves, foreign exchange reserves, etc. in this standard which
are difficult to manage.
5. Gold Parity Standard: This system has emerged with the establishment of IMF in 1946; it
doesn‘t possess any feature of the various gold standards explained above, under this ―every
country has to declare the par value of its monetary unit in terms of a fixed quantity of gold‖. It
aims at keeping the exchange rate of the currency stable in terms of gold. According to Crowther
―The domestic gold standard is mainly concerned with the volume of money and with its influence
on the domestic price level‖.
Essential Characteristics:
 Local currency has no link with gold
 Definition of money in terms of gold
 Every member country follows an independent monetary policy
 Flexibility in exchange rates
 Provision of loans by the IMF
Rules of the Gold Standard: The gold standard functioned smoothly before the First World War; these
conditions have come to known as the ―rules of the games‖. The Macmillan committee pointed out in this
connection ―it is difficult to define in precise terms what is implied by the rules of game‖. Following are
the general principles for the successful working of the International Gold Standard.
 It should involve a Common agreement among nations as to the objectives for which it existed.
 It should bring stability of prices and guarantee stability of exchange.
Following are the main conditions for its smooth working:
 There should be free and unrestricted export and import of gold between countries.
 The country receiving gold should expand the credit and the gold exporting country should
contract the credit.
 There should be high degree of price wages, income and cash flexibility in countries on the gold
standard so that these change with the gold movement.
 It means gold standard presupposed the existence of the free trade among the nations.
 The country on gold standard should strictly adhere to the policy of maintaining exchange stability.
 Gold standard depends on the movement of short term funds could be influenced by exchange of
the bank rates.
 Gold value of the domestic currency was kept stable not over and undervalued.
 Last but not the least the success of gold standard required normal time.
 According to Crowther ―The gold standard is a jealous god it will work provided it is given
exclusive devotion‖.
Working of the Gold Standard: The answer to this question is related to the functioning of the gold
standard before 1914. All countries which were on the gold standard in the late 19 th and early 20th century
were interrelated and interdependent. A country having a favorable balance of payment trade received
gold from the other countries, because it had excess of exports over imports. On contrary, a country

having an unfavorable trade suffered from the loss of gold on account of the excess of imports over
exports. This movement affected both countries. Increase in money supply of goods and services lead to
rise in price, wages, income and costs. The outflow of gold would lead to a decline in its monetary
reserve. This will increase the internal money supply of the country. This made domestically produced
goods relatively cheaper than foreign goods.
First World War, powerful central banks like the Bank of England, one of the principal objectives of the
central bank policy was to maintain stable exchange rates for a country on the gold standard. The total
currency in a country was connected to gold standard reserves which increase or decreases with the rise or
fall in the latter. The central bank raised the bank rate; higher interest rates induced the indigenous
capitalist to invest funds internally and also attracted foreign investment to the country. The increase in the
monetary reserves of the country was welcomed.
―The Deflationary Bias‖ Robertson pointed out that the gold standard ―Inherent bias towards deflation.‖
Whenever a country lost gold, it experienced falling price, it was in the interest of the gold losing country
to deflate prices. If it done in the short period of time the deflating pressure along with the rise in the bank
rate would bring a financial crisis. There is 2 or more reason for D. B‘s: - a) some country BOP was more
important relatively to their internal economy; b) Trade took place between countries of unequal size.
Decline and fall of the Gold Standard: Causes of the breakdown of the gold standard.
 Crowther ―Gold standard is jealous god, it will work provided it is give exclusive devotion‖ the
primary objective of the gold standard was exchange stability.
 The technical task of maintaining exchange stability maintained by making adjustment; it is
difficult because of the domestic currency are over or undervalued, there was downward rigidity in
the wage cost structure, the short term were not influenced by changes in the rate of interest
affected by speculation.
 The imposition of reparation (compensation) and the insistence on the payment of war debt from,
Germany made it difficult for the foreign market to be controlled by the weapon of the gold
standard.
 Almost every country imposed high tariff, imposition of high tariffs especially by the creditor
countries restricted imports from the debtors.
 The non observance of the rule of gold standard, the central bank failed to observe gold standard.
Downfall:
 Violation of rules, Abandonment of policy of free trade
 Unbalanced distribution of gold stocks, Payment of war reparations
 Rise of economic nationalism, World depression of 1929
 Havoc caused by short—term of refugee capital, Political instability
 Inelasticity in internal prices in the post-war period.
 Lack of co-operation among countries of the world
Paper Money or Currency Standard: The paper or fiat money standard, also known as the managed
standard, refers to the monetary system in which the inconvertible paper money circulates as standard
money or unlimited legal tender. The distinguishing feature of the paper standard does not consist so much
in the use and circulation of paper currency because paper money may also be found in circulation in the

gold standard as warehouse receipt, as in the fact that paper money cannot be converted into gold or silver.
Although adopted on a worldwide scale only recently – until 1931 the gold standard was in vogue in one
form or the other with the exception of four years of war (1914-18) – paper money was not known in past.
In France, inconvertible paper currency was issued in 1788 before the revolution. In this connection
Edwin Walter Kemmerer tells us that ―the first serious threat of paper money was an edict of the kind
dated august 16, 1788 creating a form of short term interest-bearing paper, intended to circulate as money.
It met with such a storm of public protest, however, that it was revoked within a month. In America the
Colonial government issued paper money as early as 1690.
In England bank notes were printed about 1729. Under paper standard although the standard money is
made of paper, there may also be in circulation metallic coins concurrently with the paper currency. Both
paper and metallic money are standard and unlimited legal tender money for purposes of payments. No
gold reserves are required either to back domestic paper currency is to facilitate foreign payments. There
is no direct relation between the money and the gold reserves; the paper money is inconvertible in specie –
gold or silver. The quantity of money in circulation is controlled by the monetary authority in the country
with a view to bring about stability in prices and incomes.
The supply of money adjusts to the economy‘s demand for it. For purposes of foreign trade the rate of
exchange is determined on the basis of parity between the purchasing powers of the currencies of the
respective countries. At present the rate of exchange between different currencies is determined through
the relationship of par values of the currencies determined in terms of SDR according to the procedure laid
down by the International Monetary Fund established in 1944. Since the intrinsic value of paper money is
substantially less than its legal value and furthermore as it is not convertible into gold, paper money is also
referred as the fiat money and the monetary standard as the fiat standard. Features of paper money
standard are: -
 Paper money circulates as standard money and accepted as unlimited legal tender.
 The unit of money is not defined in terms of commodity.
 Paper money is not convertible in any commodity or gold.
 The purchasing power of the monetary unit is not kept at par with any commodity.
 The foreign rate of exchange is determined on the basis of the parity of purchasing powers of the
currencies of different countries.
Advantages / Merits:
 Ensures full employment and economic growth: Under paper standard, the monetary authority
or government is enabled to pursue a policy of price stabilization designed to promote full
employment of the productive resources, business stability and promotes economic growth.
 Avoids deflation: Under paper standard, a country avoids deflationary fall in prices and incomes
which is the direct consequences of gold export. Such type of situation arises under gold standard
when a participating country experience adverse balance of payments. This results in outflow of
gold and contraction of money supply.

 Economical: Since under paper standard no gold coins are in circulation and no gold reserves are
required to back paper notes. It is the most economical form of monetary standard; even the poor
countries can adopt it without any difficulty.
 Proper use of gold: Wastage of gold is avoided and this precious metal becomes available for
industrial art and ornamental purpose.
 Convenience: Any metallic standard was bound to be ‗a fair weather friend‘ and a country
realized its disadvantages in times of war or national commodity. Paper standard comes to the
rescue of the government in difficult times of war by allowing the government to finance its
programmes. Fiat paper money standard provides the government with one of the most convenient
means of commanding resources not available through conventional forms of taxation.
 Rate of exchange: It allows far more effective and automatic regulation of the rate of exchange in
comparison to the gold standard.
 Elastic money supply: Since paper money is not linked with any metal, the goal or the monetary
authority can easily change the money supply to meet the industrial and trade requirements of the
economy.
 Easy to count: It is easier to count paper money than metallic money.
 Cognizable: It is easy to recognize paper notes of different denominations.
 Replaceable: Denominations replaced by printing notes of different types of the same
denominations.
 Stability in internal price level: Under this system, the monetary authority of a country can
establish stability in the domestic price level by regulating money supply in accordance with the
changing requirements of the economy.
Disadvantages / Demerits:
 Exchange instability: Since the currency has no link with any metal under paper currency, there
are wide fluctuations in the foreign exchange rates. This adversely affects the country‘s
international trade. Exchanging instability arises whenever external prices move more than
domestic prices and it is a serious problem for modern economies particularly for those which
depend for their economic prosperity on international trade.
 Dangers of inflation: Paper standard has a definite bias towards inflation because there is always
a possibility of over issue of currency. The government under paper standard generally has a
tendency to use managed currency to cover up its budget deficit. It is so easy to get from a
printing press any extra resources that are wanted urgently. As more inconvertible paper money is
put out beyond a certain amount it depreciates and as it depreciates public confidence in the
currency is shaken and it depreciates more. This results in inflationary rise in prices with all its
evil effects.
 Absence of automatic working: The paper standard does not function automatically, to make it
work properly; the government has to interfere from time to time.
 Lacks confidence: Paper money lacks confidence as it is not backed by government reserves.
 Lack of durability: Paper money has less durability than metallic coins. It is easily destroyed by
fire and insects.
 Token Money: In the event of dematerialization of notes, they have n intrinsic value and are
simply like waste papers.

 Not automatic: Paper money does not operate automatically it requires much care and caution on
currency by monetary authority.
 Limited freedom: In the present world of great economic interdependence between nations it is
very difficult for any particular country to insulate her domestic economy against the impact of
international economic fluctuations simply by adopting the fiat paper currency standard.
 Finally under the fiat paper money standard the price level has fluctuated violently and social
classes have been wiped off by hyperinflations and severe deflations. Fluctuating changes have
not restored the nations bop to equilibrium and thereby removed the necessity for throttling
restrictions on foreign trade.
Characteristics of Note Issue: A sound monetary system has the qualities of economy, confidence,
simplicity, security, automaticity, elasticity etc. A currency system should command the confidence of the
people. For this it is desirable that the currency should be backed by adequate gold or silver reserves. The
elasticity, which may be defined as the responsiveness of the supply of money to changes in the demand
for it, is another quality of sound monetary system. The amount of notes issued should vary in accordance
with the needs of the economy. In order to command the quality of automaticity the note-issue system
should be free from manipulations on the part of the monetary authority. In order to be economical, the
metallic reserves should be reduced to the minimum possible limit consistent with the confidence of the
public in the currency system.
Principles of Note-Issue:
1. Currency Principle: The currency principle is advocated by the ‗currency school‘ comprising Robert
Torrens, Lord Overtone, G W Norman and William ward. Currency principle is based on the assumption
that sound system of note issue should command the greater public confidence. This requires that the note
issue should be backed by 100% gold or silver reserves. The currency school believed that the object of
issuing and regulating the paper notes was to save metal from waste resulting from wear and tear when the
coins were in circulation and thus to make the monetary system economical. Under this system the amount
of notes issued varies directly with the variations in the quantity of gold or other metallic reserves held by
the monetary authorities.
There is no danger of inflation resulting from an over-issue of paper money. It renders the country‘s
currency secure and confidence-worthy. But it also renders the currency system of the country inelastic
and thus is subject to similar criticisms which were advanced against the gold standard. It attaches too
much importance to the maintenance of proper metallic reserves as barometers of safety and confidence
and cannot be practiced by underdeveloped countries as they have no gold reserves with them. Since large
hoards of precious metal are locked in the form of currency reserves, this principle of note-issue is not
economical. The conditions of the currency principle are indeed so rigid that no country adheres to these.
If a country were in a position to keep 100% specie as reserves behind its currency, it could then adopt the
gold standard and enjoy the prestige of a rich nation and command great confidence of the people in her
currency system.
2. Banking principle: The banking principle is advocated by the banking school, the important members
of which are Thomas, John Fullerton and James Wilson & J W Gilbert. The banking principle based on

the assumption that the common man is not much interested in getting his currency notes converted into
gold or silver. It is referred to as elastic principle and entrusted to central bank.
According to this principle, only a certain percentage of the total paper currency should be kept in the
form of gold reserves and it is of no use to maintain 100% gold reserves against the currency. The
principle is also economical to adopt since it dispenses with the need to have large gold reserves. It also
gives some degree of autonomy to the monetary authority to adjust supply of money to the needs of the
economy. In modern times banking rather than currency principle has met with general approval of the
nations and consequently the present paper currency system is based upon the banking principle of note-
issue.
Right of Note Issue:
The problem of note issue concerns itself basically with two questions: i) should note-issuing authority be
vested in the government or in the banks? ii) If it is vested in the banks should a single bank or several
banks be given the right to issue currency notes?
Those who favor the idea of the government vesting itself with the necessary authority to issue notes,
argue that the currency issued by the Treasury would enjoy greater prestige and confidence of the public
than it is were issued by some bank, it can also be control currency system more efficiently since it has the
necessary sanction to enact and enforce necessary laws. It is argued by the supporters of government
monopoly of note-issue that it is very risky to entrust the control and management of money to private
institutions. The government is seldom able to give that minute attention to the delicate problems
connected with monetary management which an organization specializing in money and banking can give
at a moment‘s asking. Government options are provably slow and in important matters like monetary
management a country cannot afford slackness on the part of monetary administration. ―A government
whose primary duty is to look to the security of the currency system is naturally forced to study the
problem that arises, time elapses before any action is taken and the emergency demand may go
unsatisfied. It may, therefore, happen that at times the supply of currency may be less than its demand.
There may be stringency of money or that the supply may exceed the demand, viz., there may be over
issue of money.
Civil servants, who can competently run the government and tackle political issues, cannot effectively
tackle financial problems which lie within the sphere of businessmen who have developed pecuniary
habit. The bank which is directly in contact with trade and industry is more favorably placed to know the
monetary needs of the economy. Moreover if government issues currency notes there is no authority to
exercise effective control over the irregularities and frauds committed by it since there is no superior
executive authority over it. If the duty of note-issue is entrusted to the bank, the government can exercise
proper check over the irregularities committed by the former. The latter can act as a check on the
malpractice committed by the former. Thus, in modern times the tendency is to entrust the job of note-
issue to the central bank subject to the overall control exercised by the government.
So far as second question is concerned, the work of note-issue should be carried only by a single bank in
the system. When more than one bank is allowed the privilege of note-issue, it becomes very difficult to
locate the responsibility for the over-issue of notes. Since banks are guided more by considerations of

profit than by considerations of soundness of the system, in their temptation to earn more profit they
overshoot the ideal mark by indulging in over-issue of paper bank notes. One bank may adopt policies
contradictory to those of other. Consequently there is created the problem of co-ordination, checks and
counter-checks between different note-issuing banks. All these difficulties are removes if a single bank is
granted the monopoly of note-issue. The central bank have at present the monopoly of note-issue based
upon the principle of single note-issue system in almost all countries of the world.
System / Methods of Note Issue:
1. Fixed Fiduciary System: Under the fixed fiduciary system, the central bank is authorized to issue
only a fixed amount of currency note against government securities of a prescribed amount fixed
by all and all issue in excess of this limit should be fully backed by gold and silver reserves.
Fiduciary issue means the issue of currency note without the backing of gold and silver. This
system was first introduced in England under the bank charter act of 1844 and still prevails there.
India followed this system in 1862-1920. The object of fixed fiduciary system was to ensure
absolute convertibility of note-issue and to regulate the paper currency so as to avoid inflation and
equate the internal and external values of the currency. Since the only method increasing the
currency fixed is through the acquisition of gold or silver, there could be no unnecessary expansion
of note-issue under this system. The criticism against the fixed fiduciary note-issue system is that it
makes the note-issue inelastic since notes could be issued only when metallic a reserve is
increased.
Merits:
 It ensures convertibility of currency notes.
 This system not only provides value stability but also provides economic stability, which is
helpful for regulating internal prices and exchange rate.
 It inspires public confidence since the government guarantees the convertibility of notes.
 There is no danger of over issue of paper notes because the entire note issue is backed by gold
standard.
 This method of note issue provides safety to notes issued and acts as brake, which also
provides safety to currency value.
Demerits:
 It is a costly system which requires sufficient gold reserves; poor countries cannot afford to adopt
it, it is uneconomical and unresponsive to the requirements of trade.
 In the modem age of ever changing world, the government needs a capital to finance its projects.
But this system is unsuitable for a Modern economy in which money needs are often changed.
 Under this system an internal and external drain of gold or silver cause to decrease in supply of
notes even though economic conditions require increase in it.
 This system is relatively inelastic because under this, notes other than "fiduciary limit can be
issued only by increasing gold or silver reserves of the same value. Government can change the
fiduciary limit but change in the limit shows weakness of the government.
 This system locks up a fixed quantity of gold, which could otherwise be used for productive
purposes.
 If fiduciary limit is high or it has been increased with the passage of time then people will loose
confidence in the currency.
2. Fixed Maximum Fiduciary System: Under this system of note-issue the government fixes the
maximum limit up to which the monetary authority can issue paper notes with or without backing
of metallic reserves. The limit is determined after a careful study of the monetary needs of the
economy. According to Keynes this system is perhaps the best of all systems of note-issue where
the amount of note-issue us regulated by law.
Merits:
 Under this method it is not required to keep gold in the reserve for issuing notes. Thus, Gold
and Silver etc. do not lie idle in the reserves.
 After a certain limit, there is no risk of over-issue of notes, even if bullion is available,
 It can be applicable to all the countries.
 This system enjoys a measure of elasticity in so far as the maximum fiduciary limit is fixed by
the government by taking into account the trade requirements of the country concerned. If the
trade increases, the maximum fiduciary limit is also raised by the government.
Demerits:
 This system is altogether too rigid and incapable of sufficient adjustments to the requirements
of the present day money market.
 This method does not provide any guarantee against inflation. In France, where it was adopted,
maximum was always raised and excessive issue of notes was resorted too.
3. Proportional Reserves System: Under the proportional reserves system, certain proportion of
currency notes (40%) are backed by gold and silver reserves and the remaining part of the note
issue by approved securities. In certain emergencies central bank is authorized to issue notes by
reducing the gold reserves below the statutory minimum amount. India adopted this method on the
recommendation of Wilton Young Committee. According to the RBI Act 1933, not less than 40%
of the total assets of the issue, department should consists of gold bullion, gold coins and foreign
securities, with the additional provision that gold coins and gold bullion were not at any time to be
less than Rs.40 crores.
Merits:
 It guarantees convertibility of paper money currency.
 Due to the simplicity of this method a fixed percentage of bullion, money supply could be
increased.
 Under this method, for every additional issue of currency, some additional bullion being
necessary, thus, there is no risk of excessive issue of currency.
 It is economical and can be easily adopted by the poor countries.
 This system possesses the advantage of elasticity in so far as the extraordinary demands can be
met without difficulty or delay by increasing the fiduciary issue in the legally authorized
manner.

De-merits:
 Under this system, it is easy to expand currency but very difficult to reduce it. The reduction of
currency has deflationary effects in the economy.
 There is wastage of gold because large amount of gold lies in the reserves and cannot be put to
productive use.
 Under this method percentage of notes issue is held in bullion, it is uneconomical to that
extent.
 Under this system the convertibility of paper notes is imaginary, not real.
4. Minimum Fiduciary System: Under this minimum fiduciary system that minimum reserves of
gold against note issue that the authority is required to maintain are fixed by law against their
minimum reserves, the monetary authority can issue as much paper currency as it considered
necessary for the economy. Beyond this limit notes may be issued without increasing the reserves.
The minimum fiduciary system can prove very useful for developing countries. In India this
system is in force at present and the RBI is required to hold the minimum reserves of Rs. 200
crores in which not less than Rs. 115 crore must be held in the form of gold holdings.
Merits:
 The system is economical because the entire note issues need not be backed by metallic reserves.
Only a minimum reserve is to be maintained. It is economical.
 It renders elasticity to the monetary system. After maintaining the minimum reserves, the monetary
authority can issue any amount of currency that it feels necessary.
De-merits:
 Since, under this system no additional reserves are required for increasing the supply of currency;
there is always a tendency towards the over-issue of currency, and hence an inherent danger of
inflationary pressures.
 Since the system provides no convertibility of currency notes into gold, it lacks public confidence.
5. Percentage Deposit System: under this system of note-issue a certain % of the total notes issued
is kept as reserves in the form of gold although a certain % of reserves may also be kept in the
form of foreign exchange. (1960) RBI held 40% in the form of gold and 60% in the form foreign
exchange reserves. This system of note-issue is economical and can be easily adopted by even
poor countries.
Merits:
 This system results in saving of gold, in other words, it is not essential to cover the entire note-
issue with gold. The gold thus, saved can be put to other profitable uses.
 Further, this system reaps all those advantages (such as elasticity, economy and convertibility)
which are associated with the proportional reserve system.
De-merits:
 This system also suffers from all those disadvantages which are to be found in the proportional
reserve system.

6. Bonus Deposit System: This system of note-issue provides for the reserves to be kept in the form
of government treasury bills which are short-term IOU‘s of the government. The system was
adopted in India in 1902 although it was subsequently given up. Before 1913, the national bank
notes in America were issued according to this system of note-issue.
7. Simple Deposit System: According to this system the Central Bank is required to keep a Metallic
reserve equal to the amount of notes issued. The papers issued under this system thus, become
representative money, the reason being that there is 100% cover behind such paper currency. It
was followed in USA for the issue of currency by member banks of the Federal Reserve board.
Merits:
 Under this method, expansion of currency is made possible by simple increasing deposits.
 Under this system deposits are maintained equal to the amount of note-issued which inspires
confidence amongst general public.
 Under this system there is a no fear of over-issue of paper currency, since every note issued has to
be fully covered by metallic reserves.
De-merits:
 This system is not economical, because gold and silver lies idle in the reserves.
 This system also lacks elasticity altogether because any expansion of paper currency has to be
proceeded by 100% metallic cover.
 Under this system foreign reserves not being maintained, so there arises difficulty in making
foreign payments.
Broadly speaking, A Sound Currency System must fulfill the following conditions:
 It must maintain a reasonable stability of prices in the country. This means that its internal value
(or purchasing power in terms of goods and services in the country concerned) must not fluctuate
too violently. This involves regulation of the amount of money in circulation to suit the
requirements of trade and industry in the country.
 A sound currency system must maintain stability of the external value of the currency. This means
that its purchasing power over goods and services in foreign countries, through its command over a
definite amount of foreign currency, should remain constant.
 The system must be economical. A costly medium of exchange is a national waste. It is
unnecessary. That is why all countries use mostly paper money.
 The currency must be elastic and automatic so that it expands or contracts in response to the
requirements of trade and industry.
 The currency system must be simple so that an average man can understand it. A complicated
system cannot inspire public confidence.
Paper Gold or SDR:
A measure of a country's reserve assets in the international monetary system; also called Special Drawing
Rights (SDR). The term paper gold means you have a piece of paper acting as a substitute for the physical
gold. With paper gold, you don't own the gold; you own a promise to receive physical gold. In plain
English, it means you are a creditor of the corporation issuing the paper gold certificate, thus subject to
counter party risks. Owning the physical gold has no counterparty risk and is fully under your control.
Examples of paper gold are gold certificates issued by banks and mints, pool accounts, futures accounts

and the NYSE listed exchange-traded fund. With these products you own a piece of paper rather than
physical gold. These paper products give you exposure to the gold price; you can make a profit by selling
them to someone wishing to own paper gold, however when the music stops and nobody wants to
purchase paper anymore, it becomes worthless since you may not able to redeem your metal.
System of Note Issue in India:
In India, the paper currency was first issued during British East India Company rule. The first paper notes
were issued by the private banks such as Bank of Hindustan and the presidency banks during late 18th
century. Via the Paper Currency Act of 1861, the British Government of India was conferred the
monopoly to issue paper notes in India. After this act, the government of India entered into agreements
with the Presidency Banks to work as authorized agents to promote circulations of the paper notes across
length and breadth of British India. But since India is a vast country, redemption of these notes became a
issue soon. Consequently, some ―Currency Circles‖ came up in various parts of country where the paper
notes of Indian government were legal tenders. In 1867, the agreements with the presidency banks were
terminated. The job of promoting, circulating and redemption of the currency notes was entrusted to Mint
Masters, Accountant General and the Controller of Currency. This practice continued till RBI came into
existence in 1935. Section 22 of the RBI Act 1934 makes provided that RBI has the sole right to issue
Bank notes of all denominations. Thus, Reserve Bank is responsible for the design, production and overall
management of the nation‘s currency, with the goal of ensuring an adequate supply of clean and genuine
notes. In consultation with the Government, the Reserve Bank routinely addresses security issues and
targets ways to enhance security features to reduce the risk of counterfeiting or forgery of currency notes.
Key Landmarks:
 1935 : Currency Function moved from Controller of currency to RBI
 1957 : Decimalization of coinage
 1995 : RBI sets up printing Press
 2000 : RBI mechanizes the currency processing
 2005 : RBI introduces Machine-readable security features
Paper Currency Notes - At present, paper currency notes in India are issued in the denomination of Rs.
5, Rs.10, Rs.20, Rs.50, Rs.100, Rs.500 and Rs.1,000. The printing of Rs. 1 and Rs. 2 denominations has
been discontinued, though the notes in circulation are valid. Reserve Bank of India has been authorized to
issue notes of Rs. 5000 and Rs. 10000 also. In fact, as per RBI act, RBI can issue any note of any
denomination but NOT exceeding Rs. 10,000. The notes denomination is notified by Government and RBI
acts accordingly.
Issue Department and Currency Department RBI has a separate department called issue department
whose assets and liabilities are kept separate from the Banking Department. Currency Management
function of Reserve Bank is carried out at the ―Department of Currency Management‖ located at Central
Office Mumbai. There are 19 Issue offices. RBI authorizes selected branches of Banks to establish
Currency Chests and Coin Deposits. At present there is a network of 4281 Currency Chests and 4044
Small Coin Deposits.

Issue of Coins the distribution of Coins is undertaken by RBI as an agent of the Government, (coins are
minted by the Government and not by RBI). Coins up to 50 paisa are called ―small coins‖ and coins of
Rupee one and above are called ―Rupee coins‖.
Proportional Reserve System v/s Minimum Reserve System Originally, the assets of the Issue
department were to consist of not less than 2/5th of the Gold or sterling securities, provided Gold was not
less than Rs. 40 Crores in value. Remaining 3/5th of the assets might be rupee coins. This was called
―Proportional Reserve System‖. In 1956, this system was changed. Now, RBI is required to maintain a
Gold and Foreign Exchange Reserves of Rs. 200 Crore of which at least Rs. 115 Crore should be in Gold.
This is called Minimum Reserve System. This system continues till date.
Currency Chests Currency chests are storehouses where bank notes and rupee coins are stocked on
behalf of the Reserve Bank. The currency chests have been established with State Bank of India, six
associate banks, nationalized banks, private sector banks, a foreign bank, a state cooperative bank and a
regional rural bank. Deposits into the currency chest are treated as reserves with the Reserve Bank and are
included in the Cash Reserve Ratio.
Locations of Note Printing Presses: The Security Printing and Minting Corporation of India Limited
(SPMCIL) print the notes. It is a wholly owned company of the Government of India. Its printing presses
are located at Nasik (Maharashtra) and Dewas (Madhya Pradesh). Apart from that, the Bharatiya Reserve
Bank Note Mudran Pvt. Ltd. (BRBNMPL), a wholly owned subsidiary of the Reserve Bank, also has set
up printing presses. The presses of BRBNMPL are located at Mysore in Karnataka and Salboni in West
Bengal. Security Printing and Minting Corporation of India Limited (SPMCIL) has 4 mints for coin
production located at Mumbai, Noida, Kolkata and Hyderabad.
Coins and notes as Legal Tenders: One Rupee Note and One Rupee coins are legal tenders for unlimited
amounts. 50 Paisa coins are legal tender for any sum not above Rs. 10. The coins of smaller than 50 paisa
value are legal tenders of a sum below Re. 1.
Star Series Notes - The Star series notes are currently issued in Rs. 10, 20, 50 and Rs. 100. These notes
are issued to replace the defected printed notes at the printing press. They have an additional character of a
star and the bundles are NOT in series. Rest all the features are same.
Languages on Currency Notes - The amount of a banknote is written on it in 17 languages out of 22

official languages of India. The languages are Assamese, Bengali, Gujarati, Kannada, Kashmiri, Konkani,
Malayalam, Marathi, Nepali, Oriya, Punjabi, Sanskrit, Tamil, Telugu and Urdu.
Monetary Policy:
RBI works as the monetary authority of India and there by operates the monetary policy. Reserve Bank of
India announces Monetary Policy every year in the Month of April. This is followed by three quarterly
Reviews in July, October and January. But, RBI at its discretion can announce the measures at any point

of time. The Annual Monetary Policy is made up of two parts viz. Part A: macroeconomic and monetary
developments; Part B: Actions taken and fresh policy measures. Monetary policy of the RBI deals with
almost all other vital topics such as financial stability, financial markets, interest rates, credit delivery,
regulatory norms, financial inclusion and institutional developments etc.
Monetary policy refers to an umbrella of operations used for the control of money supply in the economy
with broad objective to maintain economic and financial stability; and ensure adequate financial resources
for the purpose of development. These objectives of the monetary policy in India have gone through a
process of gradual evolution and can be further expanded to maintaining price stability, adequate flow of
credit to productive sectors, promotion of productive investments & trade, promotion of exports and
economic growth.
Objectives of Monetary Policy:
1. Full Employment: Full employment has been ranked among the foremost objectives of monetary
policy. It is an important goal not only because unemployment leads to wastage of potential output, but
also because of the loss of social standing and self-respect.
2. Price Stability: One of the policy objectives of monetary policy is to stabilize the price level. Both
economists and laymen favour this policy because fluctuations in prices bring uncertainty and instability
to the economy.
3. Economic Growth: One of the most important objectives of monetary policy in recent years has been
the rapid economic growth of an economy. Economic growth is defined as ―the process whereby the real
per capita income of a country increases over a long period of time.‖
4. Balance of Payments: Another objective of monetary policy since the 1950s has been to maintain
equilibrium in the balance of payments
5. Adequate flow of credit to productive sectors: RBI makes efforts for the controlled expansion of
bank credit and helps commercial banks in credit creation. It also makes decisions regarding credit
allocation to priority and marginal sector. The overall objective is to allow equitable distribution of credits
to all sectors of economy and all segments of people.
6. Promotion of productive investments & trade: RBI tries to increase the productive investments in the
country by retraining non-essential investments and creating an enabling environment for productive
investments. These efforts lead to a boost in the efficiency of the financial system of the country.
Monetary Policy Stance: India had entered into the era of economic planning in 1951. At that time, the
monetary and Fiscal Policies had to be adjusted to the requirements of the planned development in the
country and accordingly, the economic policy of the Reserve Bank was emphasized on the following two
major objectives.
1. To speed up the economic development of the nation and raise the national income and
standard of living of the people.
2. Control and reduce the ―Inflationary‖ pressure on the economy.

The requirement was an adequate financing of the economic growth programmes, and at the same time
containing the inflationary pressure and maintenance of price stability. Thus this was a period of
―Controlled Expansion―. Since 1972, there is a rapid increase in the money supply with the public and
banking system. The expansion of the Bank credit to trade and industry also increased.
The early 1970s marked an era of serious inflationary situations. The frequent fluctuations in the
agricultural productions, defective government policies and global inflationary pressures arising out of the
oil prices etc. led the RBI to abandon the ―controlled expansion‖ and adopt a policy that is most suitable
for retraining the credits. This is called ―tight monetary‖ policy and RBI has been successful with varying
degree of success. In summary, monetary policy stance is based upon the assessment of the
macroeconomic and financial conditions and monetary measures.
Instruments of Monetary Policy: Various instruments of monetary policy of RBI can be divided into
quantitative and qualitative instruments. They have been discussed below.
Quantitative Instruments of Monetary Policy Various measures of monetary policy can be divided into
quantitative measures and qualitative measures. The quantitative measures are Open Market Operations,
Liquidity Adjustment Facility (Repo and Reverse Repo), Marginal Standing Facility, SLR, Bank Rate,
Credit Ceiling etc.
a. Open Market Operations In the case of excess liquidity, RBI resorts to sale of G-Securities to
suck out rupee from system. Similarly, when there is a liquidity crunch in the economy, RBI buys
securities from the market, thereby releasing liquidity.
b. Liquidity Adjustment Facility RBI uses the weapons of Repo Rate and Reverse Repo Rate for
injection or absorption of liquidity that is consistent with the prevailing monetary policy stance.
The repo rate (at which liquidity is injected) and reverse repo rate (at which liquidity is absorbed)
under the Liquidity Adjustment Facility (LAF) have emerged as the main instruments for the
Reserve Bank‘s interest rate signaling in the Indian economy.
c. Marginal Standing Facility To curb the problem of volatility in inter-bank interest rates in the
overnight rate, banks are allowed to borrow more funds against G-secs as collateral from the RBI
at a rate 100 basis points above the Repo Rate. This is known as Marginal Standing Facility.
d. Statutory Liquidity Ratio The banks and other financial institutions in India have to keep a
fraction of their total net time and demand liabilities in the form of liquid assets such as G-secs,
precious metals, approved securities etc. This fraction is called Statutory Liquidity Ratio (SLR).
e. Bank Rate Bank Rate refers to the official interest rate at which RBI will provide loans to the
banking system which includes commercial / cooperative banks, development banks etc.
f. Credit Ceiling Under the credit ceiling, RBI informs the banks to what extent / limit they would
be getting credit. When RBI imposes a credit limit, the banks will get tight in advancing loans to
public. Further, RBI may also direct the banks to provide certain fractions of their loans to certain
sectors such as farm sector or priority sector.
Qualitative Measures of Monetary Policy There are some qualitative measures also such as margin
requirements, consumer credit regulation, guidelines, Moral suasion and direct action.

1. Margin requirements: This refers to difference between the securities offered and amount
borrowed by the banks.
2. Consumer Credit Regulation: This refers to issuing rules regarding down payments and
maximum maturities of installment credit for purchase of goods.
3. RBI Guidelines: RBI issues oral, written statements, appeals, guidelines, and warnings etc. to the
banks.
4. Rationing of Credit: The RBI controls the Credit granted / allocated by commercial banks. Moral
Suasion
5. Moral Suasion refers to a request by the RBI to the commercial banks to take certain measures as
per the trend of the economy. For example, RBI may ask banks to not to give out certain loans. It
includes psychological means and informal means of selective credit control.
6. Direct Action This step is taken by the RBI against banks that don‘t fulfill conditions and
requirements. RBI may refuse to rediscount their papers or may give excess credits or charge a
penal rate of interest over and above the Bank rate, for credit demanded beyond a limit.
Conclusion: For an effective anti-cyclical monetary policy, bank rate, open market operations, reserve
ratio and selective control measures are required to be adopted simultaneously. But it has been accepted
by all monetary theorists that (i) the success of monetary policy is nil in a depression when business
confidence is at its lowest ebb; and (ii) it is successful against inflation. The monetarists contend that as
against fiscal policy, monetary policy possesses greater flexibility and it can be implemented rapidly.
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Monetary System- Monetary Standards

Swaminath S, Dept. of Commerce, BUB Page 1

"Competitive devaluations ―between countries became known as "beggar my neighbor policies",

Swaminath S, Dept. of Commerce, BUB Page 4

Qualities of Good Monetary Standard:

Swaminath S, Dept. of Commerce, BUB Page 5

Qualities / Characteristics of Good Money:

1. General Acceptability: Good money is accepted by all because it serves as a medium of

Swaminath S, Dept. of Commerce, BUB Page 6

Types of Monetary Standard:

A. Monometalism – Gold / Silver Standard

Swaminath S, Dept. of Commerce, BUB Page 7

 Avoid Gresham’s law or Non-operation of Gresham’s Law: Monometallic avoids the

Swaminath S, Dept. of Commerce, BUB Page 8

B. Bimetallism: According to ―Chandler‖: - A bimetallism or double standard is one in which the

Swaminath S, Dept. of Commerce, BUB Page 9

Swaminath S, Dept. of Commerce, BUB Page 10

Swaminath S, Dept. of Commerce, BUB Page 11

Gresham’s law is based on the following assumptions:

Reform Monetary Standards:

Swaminath S, Dept. of Commerce, BUB Page 12

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Features of Gold Standard:

Functions of Gold Standard:

Merits of Gold Standard:

Swaminath S, Dept. of Commerce, BUB Page 14

De-merits of Gold Standard:

Swaminath S, Dept. of Commerce, BUB Page 15

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Types or Kinds of Gold standard:

Swaminath S, Dept. of Commerce, BUB Page 18

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Following are the main conditions for its smooth working:

Swaminath S, Dept. of Commerce, BUB Page 23

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Right of Note Issue:

Swaminath S, Dept. of Commerce, BUB Page 28

System / Methods of Note Issue:

Swaminath S, Dept. of Commerce, BUB Page 30

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Paper Gold or SDR:

Swaminath S, Dept. of Commerce, BUB Page 32

System of Note Issue in India:

Swaminath S, Dept. of Commerce, BUB Page 33

Languages on Currency Notes - The amount of a banknote is written on it in 17 languages out of 22

Swaminath S, Dept. of Commerce, BUB Page 34

Objectives of Monetary Policy:

Swaminath S, Dept. of Commerce, BUB Page 35

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Swaminath S, Dept. of Commerce, BUB Page 37

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