ALTHOUGH THE NUMBER is diminishing, various independent countries and colonial areas still have no monetary authority with discretionary power over currency circulation, but use either a foreign currency or a foreign exchange standard, i.e., a local currency with a mandatory 100 per cent foreign exchange cover. The characteristics and some of the possible advantages and disadvantages of these “automatic” currency systems are briefly described in this paper. However, the paper deals primarily with the economic cost of employing foreign assets as the circulating medium or as a mandatory cover for the currency. This cost is genuine, but in assessing its magnitude, account should be taken of the fact that countries having independent currency systems must also maintain foreign exchange reserves. The net cost of the automatic systems, therefore, relates only to the extra amount of foreign assets that is immobilized; in most instances, this net cost appears to be small.
Mr. Birnbaum, economist in the Finance Division, was educated at Ohio State University and the George Washington University. As a member of the Fund’s Statistics Division, he was formerly responsible for the statistics on government finance published in International Financial Statistics.
Of a total of 3.1 million balboas of coins minted up to the end of 1953, 1.4 million were held by banks (International Financial Statistics, Washington, April 1956, p.172).
For a discussion of the origins and evolution of the sterling exchange standard, and a synposis of U.K. colonial currencies, see H. A. Shannon, “Evolution of the Colonial Sterling Exchange Standard,” Staff Papers, Vol. I (1950–51), pp. 334–54, and “The Modern Colonial Sterling Exchange Standard,” Staff Papers, Vol. II (1951–52), pp. 318–62.
The Memorandum on the Sterling Assets of the British Colonies (Colonial No. 298, London, 1953, p. 3) indicates that the only exception to the rule of a mandatory 100 per cent foreign exchange cover for local currency was Southern Rhodesia, which could invest up to 10 per cent in Southern Rhodesian securities, 7 per cent in Northern Rhodesian securities, and 3 per cent in Nyasaland securities. Up to 1953, the currency authority had made use of this authorization only for the purchase of Southern Rhodesian securities. However, in December 1954 the U.K. Secretary of State for the Colonies stated that he had recently advised the colonial governments that “subject to a review of the individual circumstances of each territory, I would agree in principle to the investment of a small part of the cover for Colonial currencies in locally issued securities. The currencies would still be fully backed and automatically redeemable for sterling. It is not the intention to go beyond this.” (See House of Commons, Weekly Hansard, London, December 15, 1954, “Written Answers to Questions,” column 143.) At the time of writing this paper, no colonial government had been reported as having begun to implement this modification of policy by purchasing local securities. According to the Economist (London, August 11, 1956, p. 508), “there is no means of knowing how far there has yet been a shift from sterling to local currency assets. The movement has probably not gone far.”
This practice is described by Ida Greaves as an “anachronism” giving rise to frictions in the operation of the banking system (Ida Greaves, Colonial Monetary Conditions, Colonial Research Studies No. 10, London, 1953, pp. 59 and 86).
In general, the currency board authorities are required to accumulate the income from their investments until they amount to 110 per cent of the local currency circulation; net income beyond this point is paid to their governments as a component of the general revenue (Ida Greaves, The Colonial Sterling Balances, Princeton University, Essays in International Finance No. 20, September 1954, p. 11).
For an analysis of the West African currency board system, see United Africa Company Limited, Statistical and Economic Review (London), September 1955, pp. 1–21.
The effect of the absence of a central bank on the credit policies of local branches of foreign-owned banks would, of course, depend on the extent to which local branches have access to the cash resources of the head office. Also, the accessibility of the foreign loan market to locally owned commercial banks might be an important factor in some cases.
See, for example, J. Mars’ discussion of the “sacrifice of exported goods and services” to the extent that the currency circulation of Nigeria increases, in Mining, Commerce, and Finance in Nigeria (London, 1948), p. 190.
See, for example, Frank H.H. King, “Sterling Balances and the Colonial Monetary Systems,” The Economic Journal (London), Vol. LXV (1955), p. 720.
The communiqué issued by the Commonwealth Finance Ministers, after their meeting in Sydney in January 1954, stated that “Commonwealth Governments may now approach the London market after consultation with the U.K. Government.… In view of the many claims upon this market… access has to be limited.… It is also necessary in the general interest for the timing of any such borrowing to be carefully regulated.” Press reports during 1955 indicated difficulties in borrowing on the London market. In November, for example, the underwriters had to take up 86 per cent of their commitments on a £10 million loan floated in London by the Government of the Federation of Rhodesia and Nyasaland.
The fact that currency boards ordinarily accumulate foreign exchange until the holdings amount to 110 per cent of the currency is neglected in the subsequent discussion.
The marketing boards and other government agencies of certain British colonies, however, also hold relatively large foreign exchange reserves.
That is, including currency held by the banking system, since under an automatic system such holdings also immobilize foreign assets.
Theoretically, a comparison of foreign assets held under the automatic and discretionary systems should cover the total official holdings of foreign assets under both systems. However, official reserves held outside central banks (e.g., treasury holdings) have been neglected in the calculations. The amounts involved by the omission of other official holdings probably are relatively small.
Furthermore, beginning with 1952 the data on foreign assets used in the calculations refer to the Issue Department of the State Bank of Pakistan rather than to the total holdings of the Issue and Banking Departments, as in 1948–51. Information on holdings of the Banking Department has not been published for 1952 and later years.
The former Burmese Currency Board was permitted to cover some of its note circulation with Burmese Government securities (International Financial Statistics, Washington, January 1956, p. 217).
See “The Adequacy of Monetary Reserves,” Staff Papers, Vol. III (1953–54), pp. 181–227.
The critical relationships may be illustrated algebraically as follows: Let R = holdings of foreign reserves, M = imports, Y = national income (or some substitute such as gross national product), and C = (gross) currency circulation. This paper has examined statistically for 20 countries the ratios,
The algebraic relationship may also be examined in terms of the money supply (S) instead of gross currency (C), i.e.,
W.T. Newlyn and D.C. Rowan, Money and Banking in British Colonial Africa (Oxford, 1954), p. 259.
Ida Greaves, The Colonial Sterling Balances (Princeton University, Essays in International Finance No. 20, September 1954), p. 14.