Colonial Currency Boards: The Seigniorage Issue

Compared with using a foreign currency as the medium of exchange, a currency board enables a country to capture seigniorage that would otherwise have accrued abroad. The seigniorage takes the form of income on the foreign reserves that provide a 100 per cent backing for the currency board’s issue of domestic currency. But, given circumstances where a fixed exchange rate is optimal, can convertibility be sustained with a lower reserve percentage and, if so, is there a further national gain to be had from putting the released resources to some other use? This paper explores the attempts made to address these questions in the late 1940s and 1950s within the context of a debate about the colonial currency board system. At that time, most critics of the system saw it as handicapping development because it locked up excess foreign reserves that could be used to finance domestic investment. Some saw the system as also handicapping income stabilisation because lack of access to excess reserves hindered sterilisation of the monetary effects of external imbalances. Estimates of excess reserves that could be gainfully used for these purposes while preserving convertibility varied considerably, with some recognition that in principle very open economies might have none at all. Rough calculations in the present paper suggest that this was possibly the case for at least one currency board economy, and that for another with apparently large excess reserves, the gain from using them for domestic investment would have been very small.