OKONOMOS: FX sterilisation, 17th century style

A part of the bullion inflow was turned into ornaments

Each generation thinks its problems are unique. But only a few actually are. Certainly, although modern economists pretend to the contrary, globalisation and the consequences of the resulting capital flows are not.

No better proof of this can be found than in the latest volume of essays* by one of the doyens of Indian economic history, Professor Om Prakash of the Delhi School of Economics. The book, which should become a required reading for all trade and capital flow specialists before they start pronouncing judgment on current matters, is in two parts.

Of the 21 essays, the first 13 are about trade. The remaining eight are about capital flows, currency, mints, interest rates, prices, and banking. Almost each essay has something relevant to say about the modern-day policy dilemmas.

The one that interested me most was about capital flows, both in the Asian region in the 17th and 18th centuries and into India. The similarities to today are astounding.

Lack of space prevents a full discussion, so just one example will have to suffice. This is about the flow of bullion into India in the 17th century. If you substitute dollars for bullion, the similarity becomes obvious immediately.

The difference, however, is that the inflow then was because India, like China now (and indeed then as well) exported more than it imported, and was paid in gold and silver. Today, it attracts dollars for reasons other than a favourable balance of trade.

There is another similarity. From the early 16th century onwards, South American silver, too, had started to come to India. For the next 200 years, the supply of bullion increased worldwide as new mines were found.

The result, in economic terms, was exactly like the increase in the supply of dollars since 1971. This dollar supply has now turned into a flood because of the US budget deficit.

Om Prakash asks what impact this inflow would have had on the economy, especially on prices and the rate of exchange between gold and silver. Where prices are concerned, he says there is no evidence to suggest that they went up in any significant way.

He uses the quantity theory of money to explain why there was no surge in the price level: the level of transactions went up. This happened both because of increased European investment in the monetised part of the economy and an increase in the size of the monetised part itself.

As for the exchange rate, it was volatile but within a given range. The Mughal government had fixed the upper and lower bounds by determining the weights of the coins. You took your chances within that. It wasn't very sophisticated but it was effective nevertheless.

But all this is not surprising or even the whole story. The surprise, which some clever economists should investigate, lies in the other part of the story "" a part of the bullion was actually being sterilised. This was done not as a result of state policy but resulted from an aggregation of individual preferences.

What used to happen is well-known but has never been analysed as sterilisation. Sterilisation means taking out a part of the inflow of dollars (or bullion then) from circulation. This was done in the 17th century by people investing in ornaments and jewelry or even more simply, by hoarding gold and silver.

European scholars have complained that far too much was "sterilised" in this fashion. Om Prakash disagrees. The bullion that came in as payment for exports in one round was needed to procure the goods for export in the next. The bullion brought in by European traders (FDI, if you will) was also converted into coins for investing in the trade for which they came.

Therefore, there was indeed an increase in money supply. The reason it did not have much impact on prices has been given above "" increased European investment in the monetised part of the economy and an increase in the size of the monetised part itself.

The debate on how much was sterilised as ornaments will doubtless go on. I hope someone will address the issue of the incentives that persuaded people to convert a fairly large part of the bullion inflow into ornaments.

Hoarding can be explained by supply uncertainties. But why were people so keen on ornaments? Conspicuous consumption or precaution or both?

Bullion for Goods: European and Indian Merchants in the Indian Ocean Trade 1500-1800.