The Organization of the Monetary System


A. Introduction


B. Sterling within the International Monetary System


C. Sterling within the Domestic Legal Order


D. Types of Currencies


Convertible and inconvertible currencies


E. Legal Tender


F. The Issue of the Currency in the United Kingdom


G. The Definition of the Unit of Account


H. Changes in the Monetary System


I. Revaluation and Devaluation


J. The Existence of Distinct Monetary Systems


The monetary system in France


The control of the monetary system


Monetary policy


Financial stability


Exchange rate policy


Management of official reserves


A. Introduction


Chiefly in the course of the nineteenth century, almost all States enacted legislation with a view to organizing their respective currencies. This led to the creation of national monetary systems as they are familiar to the modern world.


In relation to the monetary system as a concept, the relevant laws all define the unit of account by reference to its name and any applicable subdivisions of the unit.1 In relation to physical money, the applicable national law will lay down rules on legal tender,2 the technical specifications for notes and coins including, for example, their metallic content, standard of fineness, security features, and other matters.


At an institutional level, the monetary system usually comprises a central bank or similar monetary authority which enjoys the exclusive privilege of issuing national banknotes. That institution will usually also be responsible for the creation and holding of monetary reserves, including foreign currencies and—to a diminishing extent—gold. It was formerly possible to say that issues of this kind properly fell within the scope of constitutional (rather than monetary) law3 and that they should therefore be excluded from consideration in a work of this kind. Modern developments—including new theories of money4—mean that it is no longer appropriate to take this view, and questions touching central banks and their role within the monetary system will therefore have to be considered at a later stage.5


Against that very brief, introductory background, it is proposed to consider the role of sterling within the international and domestic legal orders, the relevance of the unit of account and legal tender legislation, and various other matters.6

B. Sterling within the International Monetary System


In a text which focuses upon English law, it is naturally of some importance to explain some of the history of the British monetary system and the manner in which it is organized. This must be so, even though sterling may now be regarded as a relatively minor player on the international currency markets. This survey will also help to explain, in a very general sense, the various means which have from time to time been adopted to ensure the credibility of a national currency.


The gold standard, in its historically older function of the regulator or stabilizer of the international value of money in general and of sterling in particular, originated in England in the eighteenth century. On the basis of the Proclamation of 1717 fixing the price of one guinea weighing 129.4 grammes at 21 schillings or at a mint price of £3 17s 10½d an ounce, it came to be recognized that gold had supplanted silver as the standard by reference to which money was to derive its value.7 By 1819, the figure of £3 17s 10½d an ounce had come ‘to be regarded as a magic price for gold from which we ought never to stray and to which, if we do, we must always return’.8 When Peel’s Act9 put an end to the Bank Restriction Period under which the country had laboured since 1797, this was achieved by providing that the Bank of England was to pay its notes at par, ie at £3 17s 10½d per ounce. This, then, was the gold specie standard in the classical sense of that term; it put the Bank of England under a statutory obligation to pay for all its notes in specie.10 These arrangements continued until 1914, when they ceased to exist de facto.11 When the Government attempted to deal with the disturbances of the First World War by returning to the gold standard,12 the legislation introduced the gold bullion standard by providing that only the Bank of England would be entitled to bring gold to the mint and to have it coined, and that the Bank should be required to sell gold bars of 400 ounces of fine gold to any purchaser who tendered £3 17s 10½d an ounce. Subsequently, the Bank was relieved of the obligation to sell gold in return for its own notes, and the gold standard was thus abandoned in the United Kingdom.13 For a period, the country lived under a monetary system which lacked any connecting link with gold for the purposes of valuing the pound. Its value was maintained and controlled by the operations of the Exchange Equalisation Fund.14


After the end of the Second World War, the British monetary system rested upon this country’s membership of the International Monetary Fund.15 Under Article IV, section 1 of the Articles of Agreement concluded at Bretton Woods, the ‘par value’ of the currency of each member country was to be expressed in terms of gold as a common denominator or in terms of the US dollar of the weight and fineness in effect on 1 July 1944.16 On 18 December 1946, the par value of sterling was fixed at 3.58134 grammes of fine gold or US$4.03 per pound sterling. Sterling was devalued twice within the framework of this system. On 18 September 1949, it was reduced to 2.48828 grammes of fine gold (US$2.80); on 18 November 1967, it was further reduced to 2.13281 grammes (or US$2.40). The par value determined the price of gold sold and bought by its members,17 and required them to ensure that foreign exchange dealings within their territories occurred only within narrow limits based on parity.18 Further, a member could not propose a change in the par value of its currency except to correct a ‘fundamental disequilibrium’; a change in excess of 10 per cent of the original par value required the Fund’s authority, but that authority could not be withheld if the proposed change arose from such a fundamental disequilibrium.19


These arrangements have been aptly described as a gold parity standard. Although banknotes were inconvertible, a large part of the Bank of England’s purchases and sales of gold was subject to the fixed pricing provisions of the Articles of Agreement. Accordingly, the value of sterling (or any other currency with a par value) was no less tied to gold than was the US dollar, the weight of which was fixed at 15 grains of gold fine or at US$35 per ounce.20 That the gold or par value could in certain circumstances be changed affected the firmness of the tie, rather than its existence as a matter of principle. It could certainly be less freely changed than in earlier times.21


What, then, was the legal significance of the fact that the pound had a par value of 2.13281 grammes of gold, which this country was not at liberty to vary in its sole discretion? The pound could not be said to mean 2.13281 grammes of gold. On the other hand, the Bretton Woods system involved far more than a mere programme or general policy. Rather, it defined the price which, subject to marginal variations, the Bank of England had to pay or receive if it agreed to deal in gold with other Fund members, and on which all foreign exchange transactions had to be based. It was the existence of a treaty obligation to maintain the par value that in law was the essential ingredient of the gold parity standard.22 The primary function of the gold standard was thus to support the system of parities established by the Bretton Woods Agreement.


The original Bretton Woods system broke down when, on 15 August 1971, President Nixon abolished the convertibility of dollars into gold.23 From that time, the par value system established by the Agreement was necessarily and universally disregarded. By the Smithsonian Agreement of 18 December 1971, the International Monetary Fund sought to establish a system of central rates and ‘practices that members may wish to follow in the present circumstances’.24 It is clear that these arrangements were irreconcilable with the specific terms of the Fund Agreement itself, and thus could not be regarded as having any binding force under international law.25 In any event, all currencies, including sterling, began to float, in the sense that dealings in gold and foreign currencies ceased to observe the system of fixed parities; the attempt to rescue a form of par value system by means of the Smithsonian Agreement thus proved to be wholly futile. The details of these developments are described by Kerr J in Lively & Co v City of Munich,26 where it was held that, regardless of the formal position, no par value system was ‘in force’ in any real sense in December 1973, when the bonds at issue in that case were due for repayment.


Eventually, as a result of the Second Amendment of the Articles of Agreement,27 which came into force on 1 April 1978, the International Monetary Fund became primarily a credit institution in that it retained the function to provide or procure international credit or liquidity for the benefit of member countries by transactions under Article V and the use of Special Drawing Rights (SDRs) under Articles XVI to XXV of the Article of Agreement. Article IV of the Articles Agreement now contains obligations on the part of member countries ‘to collaborate with the Fund and other members to assure orderly exchange arrangements and to promote a stable system of exchange rates’. Similar provisions require each member to ‘endeavour to direct its economic and financial policies towards the objective of fostering orderly economic growth’ and to ‘seek to promote stability by fostering orderly underlying economic and financial conditions’. It is only necessary to read these provisions in order to realize that they do not create any obligations of a character which are meaningful in law,28 although this is not in any sense to detract from their importance as practical guidelines for international monetary conduct. Nevertheless, Article IV provides a basis upon which the Fund consults with member countries on their exchange rate and other policies on a regular basis; reports on these consultation and surveillance procedures are published from time to time.


The Second Amendment also deprived gold of its former monetary status.29 The par value system has been abolished and can only be reintroduced by an 85 per cent majority of the Fund’s total voting power; further, the use of gold as a means of supporting exchange arrangements is now explicitly prohibited.30


It follows from this discussion that, from 1971 onwards, the Articles of Agreement of the Fund did not provide any fixed standard to which sterling was linked. As a result, the external value of sterling depended upon the market forces of supply and demand and on the confidence of investors holding sterling assets. Governmental intervention in the market was also possible where thought appropriate; for that purpose, an exchange equalization fund was established,31 the primary purpose of which is ‘checking undue fluctuations in the exchange value of sterling’.32 In spite of the comments made in the last paragraph, it is interesting to note that these funds may be invested not only in foreign currency assets and SDRs, but also in the purchase of gold.33


With effect from 8 October 1990, the United Kingdom joined the exchange rate mechanism of the European Monetary System. This involved an obligation to maintain the external value of sterling at levels which were based upon a central rate of DM2.95 to £1. The return to a fixed rate regime—albeit subject to margins—was, of course, a radical departure from the previous 20 years of floating rates. It proved, however, to be a short-lived experiment; sterling departed from the system as a result of the events of ‘Black Wednesday’ (16 September 1992), and since that time, the external value of the currency has, once again, depended on market forces.34

C. Sterling within the Domestic Legal Order


The second function of the gold standard was to regulate and limit the volume of money in circulation by the requirement that notes should be backed by a quantity of gold held in reserve as security. The gold standard in this sense has also disappeared and is therefore of historical interest only.


As a consequence, sterling—and indeed all other currencies—is now properly to be described as fiduciary or fiat money; ie it is accepted to have a certain value in terms of its purchasing power which is unrelated to the value of the material from which the physical money is made35 or the value of any cover which the bank may be required to hold. Thus, the Bank of England can now issue notes up to limits set by the Treasury;36 these notes are secured by the Bank’s duty to hold in the Issue Department securities of an amount sufficient to cover the issue.37


Where provisions for the tangible cover of a fiduciary issue exist, it is necessary to ask whether they afford any protection for the holder of the banknote. It is submitted that this question must be answered in the negative. It is true that, in the United Kingdom, notes must be backed by securities held within the Issue Department; equally, in the United States, the Gold Standard Act 190038 provided that the reserves ‘shall be used for the redemption of the notes and certificates for which they are respectively pledged and shall be used for no other purpose, the same being held as trust funds’. Yet these formulations are in the nature of administrative directions to the monetary authorities; they do not seek to confer any rights upon the holder of a banknote. That this is the true legal position was made clear by the remarkable case of Marshall v Grinbaum.39 The Russian currency reform of 1897 had included a decree requiring that notes must be secured by gold. Under Russian law, the notes were legal tender and were exchangeable at the State Bank for equivalent amounts of gold. A holder of notes claimed a charge upon gold which belonged to the State Bank but which was physically held by the defendant. Petersen J rejected the existence of a charge. In relation to the Russian decrees, he said40 that their objective:

was to maintain the value of the notes by making them exchangeable for gold and, in order to make this right of exchange effective, the Minister of Finance, as custodian of the State Bank was prohibited from issuing notes without keeping the gold reserve up to the prescribed amount. Where the ukase speaks of the notes being ‘secured by gold’ or of the issue of notes ‘against a gold security’ or of ‘the amount of gold securing the notes’, it does not contemplate the creation of a charge or mortgage in favour of the holders of credit notes, it is merely making regulations for the issue of notes with the object of insuring that any holder who brings a note to the State Bank may receive the nominal amount of the note in gold.


Thus, the government or the central bank retained full and unencumbered control over the issue of notes even when it was backed by gold; this must be even more so in the case of a fiduciary currency. Yet it would be easy to overstate the extent or value of the degree of control which the government enjoys in this area. In particular, it does not directly control the amount or growth of bank deposits.41 In the final analysis, a bank note is simply a liability of the issuing institution and its value, vis-à-vis other currencies may be influenced by a variety of factors. It is largely for these reasons that, in times of financial turbulence, gold tends to become an attractive investment and is viewed as a ‘safe haven’. It is a physical commodity with an intrinsic value unrelated to monetary or exchange rate policies, or similar matters.42


It follows that requirements as to ‘cover’ or ‘backing’ for the issue of banknotes have only a very limited impact on the overall supply of money within the economy. Furthermore, such requirements confer no legal rights upon the holder of physical money.43

D. Types of Currencies


Since sterling is no longer backed by physical assets such as gold, it is obvious that notes issued by the Bank of England are ‘inconvertible’; yet such banknotes are equally obviously legal tender. It is necessary briefly to examine these features.

Convertible and inconvertible currencies


Convertibility was a feature of those currency systems in which the standard currency consisted of gold, and in which any paper money in issue could always be exchanged for the standard money.44 The function of such convertibility was therefore to ensure that paper money maintained its nominal value; this objective would be achieved so long as paper money was genuinely redeemable in accordance with the procedure just described.


It has been shown that convertibility is very closely connected with the existence of a gold or other metallic standard. Convertibility in this sense had been an essential feature of the Bank of England Act 1833, but it was modified by the Gold Standard Act 1925, which exempted the Bank of England from liability to redeem its notes with gold coin and merely placed it under the obligation to sell gold bullion at a fixed price and, moreover, granted to the Bank of England the exclusive right of obtaining coined gold from the Mint. This limited convertibility was abolished by the Gold Standard (Amendment) Act 1931, and sterling has been an inconvertible currency since that time.


Inconvertibility exonerates the bank of issue from paying its own notes in gold and merely puts it under an obligation to pay them in currency, ie in its own notes.45 If legislation is passed which renders notes inconvertible, then this will apply (a) to all notes, whether issued before or after the inconvertibility rules were introduced;46 and (b) to all notes, even if held abroad.47 Therefore, in the case of inconvertible currencies the promise ‘to pay’ which banknotes express or imply is of limited significance. Nevertheless, inconvertibility does not deprive banknotes of their character as ‘money’ or as negotiable instruments, nor does it deprive them of their intrinsic monetary value.48

E. Legal Tender


One of the functions of the monetary system is to define those chattels or other assets which are to constitute legal tender within the State concerned.49 It thus becomes necessary to ascertain the meaning of legal tender and the consequences of this concept.


Legal tender is such money50 in the legal sense as the legislator has so defined in the statutes which organize the monetary system. Chattels which are legal tender therefore necessarily have the quality of money but the converse is not true—not all money is necessarily legal tender.51


In earlier times, the status of banknotes caused no small difficulty in this context. Section 11 of the Restriction Bill 1797 had merely provided that banknotes should be ‘deemed to be payments in cash, if made and accepted as such’52 and it was thus possible to decide that, in the absence of an agreement to that effect between the parties, banknotes were not legal tender.53 Subsequently, it was provided that Bank of England notes were legal tender for all sums above £5 ‘so long as the Bank of England shall continue to pay on demand their said notes in legal coin’.54 The present situation is derived from the Currency and Bank Notes Act 1954; all Bank of England notes are now legal tender in England and Wales for the payment of any amount.55 The legal tender quality of coins is defined by section 2 of the Coinage Act 1971, as amended by section 1(3) of the Currency Act 1983. Coins of denominations of more than 10 pence are legal tender for amounts not exceeding £10, coins of smaller denomination are legal tender for payment of amounts not exceeding £5 and bronze coins for amounts not exceeding 20 pence. Gold coins remain legal tender for any amount, provided that they remain of the required weight.56