Personal finance advice in 87 words: Lessons on investing from Scott Adams

 scott adams[1]Vivek Kaul
One of my bigger mistakes in life was to spend two years doing an MBA. ‘Herd mentality’ usually leads to disastrous decisions. After completing my MBA, I discovered Scott Adams and his cartoon character ‘Dilbert’. Dilbert(and effectively Adams) taught me more about management and how companies ‘really’ work, than two years I spent at a business school.
Interestingly, in the recent past, I have also picked up some basic personal finance lessons from reading a few books written by Adams. In his latest book 
How to Fail at Almost Everything and Still Win Big, Adams shares some of his experiences and draws a few personal finance lessons from them.
When the dotcom boom was on, Adams invested in this start-up called Webvan. “You could order grocery-store items over the Internet and one of Webvan’s trucks would load your order at the company’s modern distribution hub and set out to service all the customers in your area,” writes Adams.
He thought that Webvan would do for grocery what Amazon had done for books and bought the shares of the company. As the dotcom bubble lost steam and the stock price of Webvan fell, Adams bought more stock (probably following the strategy of dollar cost averaging). As the price of the stock fell, he repeated this process several times.
As Adams writes “When management announced they had achieved positive cash flow at one of their several hubs, I knew I was onto something. If it worked in one hub, the model was proven, and it would surely work at others. I bought more stock.”
A few weeks later, Webvan went out of business. “Investing in Webvan wasn’t the dumbest thing I’ve ever done, but it’s a contender…What I learned from the experience is that there is no such thing as useful information that comes from a company’s management.”
Adams also talks about this phenomenon in the context of professional stock analysts in his book 
Dilbert and the Way of the Weasel. As he points out “Professional stock analysts can do something that you can’t do on your own, and that is to talk directly to senior management of the company. That’s how a stock analyst gets all the important inside scoop not available to the general public, including important CEO quotes like this: “The future looks good!””
After his disastrous experience with Webvan, Adams decided to that get some professional help in investing all the money that he was making once the royalties of Dilbert started to pour in. As he writes in 
How to Fail at Almost Everything and Still Win Big “I didn’t have the time to do my own research. Nor did I trust my financial skills…My bank, Wells Fargo, pitched me on its investment services, and I decided to trust it with half of my investible funds. Trust is probably the wrong term because I only let Wells Fargo have half; I half trusted it. I did my own investing with the other half of the money.”
The results of the half trust weren’t any good either. “The experts at Wells Fargo helpfully invested my money in Enron, WorldCom, and some other names that have become synonymous with losing money. Clearly investment professionals did not have access to better information than I had. I withdrew my money from their management and have done my own thing since then,” writes Adams. He has been investing in index mutual funds since then.
Adams discusses the problem of listening to so called experts in 
Dilbert and the Way of the Weasel. As he writes “My problem is that I listen to financial experts, who give valuable advice for moving my money from me to them. My first clue that experts are less than omnipotent might have been that they all recommended different and conflicting things. The one thing that all their recommendations have in common is that is that if you follow their advice, they will get richer.”
Adams also talks about the importance of investors concentrating on systems and not goals. “Warren Buffett’s system for investing involves buying undervalued companies and holding them forever, or at least until something major changes. That system (which I have grossly oversimplified) has been a winner for decades. Compare that with individual investors who buy a stock because they expect it to go up 20 percent in the coming year; that’s a goal, not a system. And not surprisingly, individual investors generally experience worse returns than the market average,” writes Adams in 
How to Fail at Almost Everything and Still Win Big. This is a simple but a very important point to understand for every investor.
In fact, Adams once even tried to write a book about personal investing. As he writes in 
Dilbert and the Way of the Weasel “It was supposed to be geared toward younger people who were investing for the first time. After extensive research on all topics related to personal investing I realized I had a problem. I could describe everything that a young first-time investor needs to know on one page. No one wants to buy a one-page book even if that page is well written…People would look at it and say, “That’s all well and good, but I’m paying mostly for the cover.””
In fact, the plan was not even one page. It was just 87 words and here it is:
Make a will. Pay off your credit cards. Get term life insurance if you have a family to support. Fund your 401k to the maximum. Fund your IRA(individual retirement account) to the maximum. Buy a house if you want to live in a house and can afford it. Put six months worth of expenses in a money-market account. Take whatever money is left over and invest 70% in a stock index fund and 30% in a bond fund through any discount broker and never touch it until retirement. (as described in 
Dilbert and the Way of the Weasel) (401k and IRA are essentially what we call provident funds in India).
These 87 words summarise all that is there to know about personal finance.

The article originally appeared on on February 15, 2014
 (Vivek Kaul is a writer. He tweets @kaul_vivek)  

Why author/banker Ravi Subramanian is wrong in supporting Penguin pulping Doniger's book

Vivek Kaul 
Ravi Subramanian, the author of best-sellers like BankeruptIf God was a BankerTheBankster,The Incredible Bankers and so on, has written a blog justifying the decision of Penguin India to pulp Wendy Doniger’s book The Hindus – An Alternative History.
In this blog titled 
Stop the Hypocrisy, Penguin did the right thing Subramanian defends Penguin’s decision by saying that “am not sure how many copies of Wendy Donigers book was Penguin selling in any case. Market feedback tells me that in four odd years since launch Penguin would  not have sold more than 5000 copies of the book. Many of them as gifts (which would not have been read for sure). Retailers / Distributors would have had heaps of stock gathering dust.”
And given this Subramanian feels that Penguin has made a “smart call” to pulp Doniger’s book. As he writes “By the time the instruction to pull out books reaches the last retailer, most of the books would have in any case got sold. People are in fact rushing to buy her book before it gets taken off book shelves (Even her more recent book with Aleph Publishers has shown a huge sales traction over the last two days).”
This would mean that Penguin would exhaust all stocks of Doniger’s book in India, writes Subramanian. “In the process they[i.e. Penguin] have managed to get more people (in India and overseas) to read Wendy’s book, than even Wendy would have imagined. Probably a lot more than the number of people who have read her in the last five years. I see it as a win-win for everyone. So why are the hypocrites complaining.”
First and foremost, it is surprising that a writer is defending a publisher’s decision to withdraw a book. But that in the words of Subramanian would be a “hypocritical” argument to make. So let’s move on from that. Second, if this is an excellent win-win situation for everyone including Penguin, why doesn’t the publisher practice it more often? Given the number of groups in this country, who are opposed to almost everything and anything, how difficult is it to get any group going against any book? Since Subramanian seems to be advocating this “win-win” strategy, would he have implemented it on his book 
Bankerupt, which has been published by Penguin and thus, sold a few more copies in the process? Subramanian is a passout of IIM Bangalore, and he surely understands what the phrase “win-win” means.
Subramanian also writes that “every publisher exists in this business for profits. Lets not glamorize this basic reason for existence with lofty words, like upholding of freedom of speech, bowing down before religious fundamentalists etc etc. If after defending Wendy’s book for four years, Penguin felt that they were on a weak wicket, what’s wrong in pulling the plug?”
That seems like a fair point, especially for someone like Subramanian who has worked for banks like Citibank, HSBC and ANZ Grindlays, most of his life. (You can read his detailed Wikipedia entry here). As we all know, bankers in their greed for more and more profit, brought the world to a standstill in 2008. The world is still suffering from the aftermath of the financial crisis that started in 2008. Many big banks (including Citi where Subramanian worked) had to be rescued by governments. Hence, for a banker, most things revolve around profit and more money, and that is not surprising.
But the question is should anything and everything seen from the profit lens? As Philosopher Michael Sandel writes in 
What Money Can’t Buy – The Moral Limits of Markets “Today, the logic of buying and selling no longer applies to material goods alone. It increasingly governs the whole of life.” Sandel also wrote something similar in a piece in The Atlantic “We live in a time when almost everything can be bought and sold. Over the past three decades, markets—and market values—have come to govern our lives as never before. We did not arrive at this condition through any deliberate choice. It is almost as if it came upon us.”
Given this, it is not surprising that Subramanian has defended Penguin’s decision to pulp Wendy Doniger’s book in the way that he has. Its all about money. Who cares about old world phrases like the freedom of expression, any more?
Subramanian also asks “w
here were the hypocrites when other books were being pulped?” As he writes “In life, the sure shot way of getting into the media glare is to take potshots at leading luminaries, big organisations etc. I guess people doing this to Penguin, surely have this also at the back of their minds. Hit out to get noticed. Make a controversial statement and be featured. If this is not true, and you were serious custodians of free speech, torch bearers for freedom of expression, where were you when Jitendra Bhargava’s book “The Descent of Air India” (Bloomsbury) was scuttled by Ex-Union Minister, Praful Patel. Or when Sahara Group scuttled Tamal Bandhopadhyay’s book “Sahara – The Untold Story”, published by Jaico.”
This is a very lame argument to make. Since when did two wrongs start to make a right? Just because the level of protests on Bloomsbury scuttling Jitendra Bhargava’s book on Air India and Sahara scuttling Tamal Bandopadhyay’s book, were not very high, that does not mean that Penguin’s decision to pulp Doniger’s book is correct.
Also, protests against the pulping of Doniger’s book have been made by a range of people (from Arundhati Roy to a lot of my Facebook friends who do not agree with what Doniger says, but don’t want her book being pulped either). Painting everyone with the same brush and accusing them to be seeking publicity, is a rather far fetched argument to make, even for a banker.
Subramanian also talks about the peace of mind of the families of people who work for Penguin. As he writes “Over a hundred people work at Penguin’s office in Panchsheel Park in New Delhi. Penguin, like any other organisation, is accountable for their safety and security. The peace of mind of a hundred families would be shattered if Hindu Fundamentalists were to attack that office.”
By that logic no form of creative expression should be allowed any more because it might hurt the sensibilities of someone and that in turn might put other people in danger. The only form of creative expression that we can allow are probably the films of Salman Khan (given that they are so mindless that they can’t hurt anyone). Even a Karan Johar does not make this cut, given that his movie 
My Name is Khan managed to create a lot of controversy.
As far as books go only the Chetan Bhagats and the Ravinder Kumars of the world will make the cut. Even Subramanian’s books will not pass through, given that they show bankers in negative light, at times. And hence, some banker somewhere, who is not right in the head, may want to hurt the employees of Penguin (the publisher of Subramanian’s latest book) and Rupa (the publisher of Subramanian’s previous books). Given this, why should publishers take the risk of publishing Subramanian?
Guess its time, Subramanian read the German anti Nazi theologian Martin Niemöller. As he wrote: “
First they came for the Socialists, and I did not speak out–
Because I was not a Socialist.
Then they came for the Trade Unionists, and I did not speak out–
Because I was not a Trade Unionist.
Then they came for the Jews, and I did not speak out–
Because I was not a Jew.
Then they came for me–and there was no one left to speak for me.”

Subramanian will probably understand what the issue is all about, if and when, they come after his books.
The article originally appeared on on February 15, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

What the latest WPI number tells us about the Indian economic story

InflationVivek Kaul

Inflation as measured by the wholesale price index(WPI) fell to a eight month low of 5.05% in January 2014. On the face of it, it might seem like a reason to rejoice, but the devil as they say always lies in the detail.
Around 65% of the wholesale price index is made up of manufactured products. The rate of inflation for manufactured products stood at 2.76%. In comparison, this had stood at 4.96% in January 2013.
On the other hand the price of food articles which constitute around of the index rose by around 8.9%. In comparison, the rise had been at 12.4% in January 2013.
Vegetable prices went up by 16.60% (in comparison to over 30% during the same period last year). The price of rice was up by 13.4% (in comparison to 17.8% during the same period last year). The price of Egg, Meat and Fish went up by 10.9% (in comparison to 11.2% during the same period last year).
If India has to get economic growth going again, the manufacturing inflation needs to rise from its current level and the food inflation needs to fall further.
For more than five years, food inflation has been very high. High inflation has eaten into the incomes of people and led to a scenario where their expenditure has gone up faster than their income. This has led to people cutting down on expenditure which is not immediately necessary.
When people cut down on expenditure, the demand for manufactured products falls as well. This is reflected in the rate of inflation for manufactured products which stood at 2.76% in January 2014. Interestingly, this is also reflected in the consumer durable number( a part of the index industrial production from a use based point of view), which fell by 16.2% in December 2013.
At a more practical level it is reflected in the falling car sales numbers. The domestic car sales number stood at 1,60,289 units in January 2014, falling from 173,449 units in January 2013. The two wheeler sales went up by just 5% to 179,576 units in January 2014 over January 2013.
With high inflation eating into the incomes of people it is not surprising that they are cutting down on their expenditure. Also, high inflation has prevailed for close to five years now. Given this, a fall in overall inflation, as it has over the last couple of months, will not immediately lead to increased consumption. People need a little more evidence of falling inflation before they decide to open up their purses. This means, that overall inflation (as measured through the wholesale price index or the consumer price index for that matter) needs to continue to fall over the next few months, for consumer demand to return. Whether that happens remains to be seen.
While food inflation has been falling, the inflation at the retail level still continues to be strong. If one looks at core retail inflation (i.e. non food non fuel inflation which forms around 40% of the consumer price inflation index) it continues remains to be high at 8%
The core inflation contains measures of housing, medical care, education, recreation, transport, personal care etc, basically, everything that is required for a reasonably comfortable living.
If consumer demand has to return, the core retail inflation needs to come down from a level of 8% to close to 5-6%.
What makes a fall in core retail inflation even more important is the fact that the items that constitute it (i.e. housing, medical care, education, recreation, transport, personal care etc) are the ones that consumers deal with on an almost daily basis. And they will not feel inflation has come down, unless the price rise of these items starts to slow down.
This number is closely tracked by the Reserve Bank of India(RBI) as well. The RBI governor Raghuram Rajan had said on January 29, 2014, “that he would have liked to see a greater reduction in core inflation.”
Also, f
ood inflation needs to continue to fall. Its the high price of food that feeds into wages and thus leads to high levels of core retail inflation. Once that is brought under control, consumer demand will return, and will start to reflect in higher manufactured products inflation and a better index of industrial production number (which stood at -0.6% in December 2013).
And that, in turn, is likely to show up in higher economic growth.

The article originally appeared on on February 14, 2014

(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Food inflation is down but the figure Raghuram Rajan is watching hasn’t even budged

ARTS RAJANVivek Kaul  

As soon as some new economic data is declared by the government, the business lobbies demand that the Reserve Bank of India(RBI) should cut interest rates. The response is almost Pavlovian. Something similar happened yesterday as well. The index of industrial production(IIP) shrunk by 0.6% for the month of December 2013.
The manufacturing sector which constitutes close to three fourths of the index declined by 1.6% during the month. In comparison, it had declined by 0.8% during December 2012. The IIP is a measure of the industrial activity within the country and given that the number is in negative territory, what it tells us is that all is not well with the Indian businesses.
No sooner had the number been declared, the Confederation of Indian Industry I(CII), a leading business lobby in the country demanded that interest rates be cut. “We are especially concerned about the performance of the manufacturing sector, which continues to be in the red,” 
CII Director General Chandrajit Banerjee said. “We look forward for an accommodative monetary policy to spur demand and revive investment activity especially as inflation has started receding,” he added. Accommodative monetary policy essentially refers to the RBI cutting the repo rate, the rate at which it lends to banks.
The logic is that if the RBI cuts the repo rate, the banks will cut the interest rates at which they lend. This will ensure that people will borrow and spend more, which will translate into greater revenue and profit for businesses. Once businesses start making more money, they are likely to invest more as well. All this will lead to a higher economic growth, which for this financial year is likely to be at or around 5%. Or so goes the argument.
Another reason why business lobbies feel that the RBI should be cutting interest rates is the fact that the consumer price index(CPI) inflation in January 2014 fell to a two year low of 8.79%. This was on the back of food inflation falling to a 22 month low of 9.9%. Food products constitute nearly half of the consumer price index. Food inflation was at 12.2% in December 2013.
Food inflation came down because of the vegetable prices falling by 13.2% between December and January. This was primarily on account of greater supply of vegetables hitting the market. During the period August-September 2013, farmers made significantly better returns on their produce. This led to them planting more vegetables, leading to an oversupply in the recent months.
So with the consumer price inflation falling to a two year low, the business lobbies want the RBI to start cutting interest rates in order to revive consumer demand, which has been stagnating for a while. The IIP data when looked from a use based point of view, indicates towards the same. The consumer durables measure fell by 16.2% during December 2013.
But the question is will a cut in interest rates revive consumer demand? While in theory the link appears to be fairly straightforward, that is really not the case. Let’s consider a case where an individual takes a three year two wheeler loan of Rs 40,000 from the State Bank of India to be repaid over a period of 36 months at an interest of 18.25%. The EMI for this comes to around Rs 1451.
Now lets assume that interest rates crash dramatically by one third from their current levels and the rate of interest on a two wheeler loan from the State Bank of India falls to 12.25%. In this case, the EMI falls to Rs 1333 or around Rs 118 lower. Hence, even if interest rates come down by a third, the EMI falls only by around Rs 118 or a little over 8%.
Someone who wants to buy a two-wheeler will definitely not be influenced by it. As John Kenneth Galbraith writes in 
The Affluent Society, first published in the 1950s, “The customer, in contemplating the purchase, is less aware of the interest rate than of the monthly charge…There is, in fact, considerable agreement that monetary policy does not make any effective contact with consumer borrowing and spending. During periods of active monetary policy, increased finance charges have regularly been followed by large increases in consumer loans.”
Given this, the customer who wants to purchase a consumer good by taking on a loan should be comfortable with the idea of paying an ‘x’ amount of money every month as an EMI, irrespective of what the interest rate is.
In this scenario, what becomes very important is the rate of inflation. For more than five years, inflation as measured by the consumer price index has been very high. This has largely been on account of food prices having gone up at a very fast rate. High inflation has eaten into the incomes of people and led to a scenario where their expenditure has gone up faster than their income. This has led to people cutting down on expenditure which is not immediately necessary. This is reflected in the consumer durable number which fell by 16.2% in December 2013.
Food prices have now started to come down and that is some good news for the Indian consumer. But if one looks at what economists call core inflation (i.e. non food non fuel inflation which forms around 40% of the consumer price inflation index) that remains to be high at 8%, as it has over the last few months. The core inflation contains measures of housing, medical care, education, recreation, transport, personal care etc, basically, everything that is required for a reasonably comfortable living.
Interestingly, this number is closely tracked by the RBI governor Raghuram Rajan. 
He had said on January 29, 2014, “that he would have liked to see a greater reduction in core inflation.” A day earlier in an interaction with the media he had said that “. Core (inflation) tells us something about the second round effects. Even within core, there are some which we need to pay attention to like some aspects of services like education, which have been going up quite strongly.” Given this, it is unlikely that the RBI will cut the repo rate anytime soon.
If the consumer demand story is to be revived again, the core inflation needs to be brought down, so that consumers feel comfortable in spending money. The ironical part here is that despite the economic growth falling from more than 10% to less than 5%, over the last few years, core inflation continues to remain high. The explanation for this lies in the fact that the high price of food, leads to a demand for higher wages and that leads a higher core inflation. When businesses have to pay higher wages, they, in turn, demand a higher price from consumers. And this in turn impacts consumer demand.
The government can definitely play a role here by cracking down on hoarders of food and at the same ensure that there is no shortage of wheat and rice in the market, of which it has enormous stocks.
As far as businesses lobbies are concerned it is worth looking at what Galbraith said in that context. “To restrict consumer borrowing by increasing the interest cost on instalment and other loans collides abruptly with the process of consumer-demand creation…Any step to discourage borrowing and buying will be automatically opposed by the machinery for consumer-demand creation.”

 The article originally appeared on on February 13, 2014
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

The Complications of Easy Money

vivekAn Indian writer dives deep into the history of money and concludes that government interventions rarely end well

Although he is not by formal training an economist – and perhaps because he is not – Vivek Kaul has established a reputation as a provocative, clear-voiced economic commentator for Firstpost and other publications in India. One article about Kaul’s recently published history, “Easy Money: Evolution of Money from Robinson Crusoe to the First World War,” paid Kaul the compliment of being “readable.” In response, Kaul explained that he devotes considerable study to “break things down. If a child cannot understand what I am writing, it is pointless.”
Though perhaps understandable to the younger population, Kaul’s extensively researched, 300-page volume speaks to a very different, highly educated audience. He delves into the origins and evolution of monetary systems and finds in them pointed, cautionary lessons for the central bankers who manage the modern-day money supply and for policymakers concerned about the risks and stability of financial systems.
“One of the lessons from history is that money printing has never really ended well,” Kaul says in this recent interview conducted by Dr. Nupur Pavan Bang of the Insurance Information Bureau of India. “It has inevitably led to disaster. We don’t seem to have learned that lesson at all.”

Why is “Easy Money” your title?
I use the term ‘Easy Money’ in the context of money being created out of thin air by kings, queens, rulers, dictators, general secretaries and politicians. The practice was regularly resorted to by kings of Rome and has been abused ever since. As the Roman Empire spread, it needed more and more money to keep its huge army all over the world going. But gold and silver could not be created out of thin air. Also, as Romans grew richer, luxury and showing off became an important part of their lives. This also increased the demand for precious metals. This meant more plunder of the territories Rome had captured in battle. But plunder could not generate gold and silver beyond a point. Hence, the Roman kings resorted to debasement.
How did debasement work?
A metal like copper was mixed with the gold or silver in coins, while keeping their face value the same. So let’s say a coin which had a face value of 100 cents had silver worth 100 cents in it. After it was debased, it only had 80 cents worth of silver in it. The remaining 20 cents was pocketed by the ruler debasing the currency. Once the Romans started this, the rulers who followed also debased various forms of money regularly. And that is a practice that has continued to this day. These days, governments print paper money and pump it into the financial system by buying government bonds. Actually, most of this money is created digitally and resides in bank accounts, but “printing paper money” is a simple way to explain this.
How and where has that history repeated?
Governments at various points in history have worked toward destroying money and the financial system. The Romans under Nero were the first to do it systematically by lowering the silver content in the Denarius coin. The Mongols, Chinese, Spaniards, French, Americans and Germans followed, at various points of time. When gold and silver were money, the governments destroyed money by debasing it, i.e., lowering the content of precious metals in the coins they issued. When paper currency replaced precious metals as money, the governments destroyed it simply by printing more and more of it.
Today, in the U.K., for example, the government does not print money on its own. It sells securities to the central bank, which prints money to buy them. This started with the Bank of England being tricked into lending endless money to the government in the late 1790s by Prime Minister William Pitt. This allowed the government to borrow as much money from the Bank of England as it wanted to, without having to get clearance from the Parliament. Governments all over the world continue with this practice of borrowing unlimited amounts from their respective central banks. The practice has only increased over the last few years, since the advent of the financial crisis.
The first volume of your planned trilogy covers “from Robinson Crusoe to the First World War”. Do you think some earlier practices like barter were actually better?
Not at all. In fact, if barter was better, we would have probably stayed with it, and money and the financial system wouldn’t have evolved. Barter had two fundamental problems. The first was the mutual coincidence of wants. I have some eggs and I want to exchange them for salt. So, I need to find someone who has salt and, at the same time, wants to exchange it for eggs. What if the person who has the salt does not want eggs, and wants sugar instead? To complete the transaction, I need to find someone who has sugar and is ready to exchange it for eggs. A simple, straightforward transaction could become fairly complicated.
In a barter system that has four goods to be exchanged, there are six ratios of exchange. But imagine a situation where there are 1,000 goods to be exchanged under a barter system. There will be 499,500 exchange rates.
And the second problem with barter?
Indivisibility. Let us say I have a potter’s wheel and want to exchange it for some basic necessities like eggs, salt and wheat. One way would be to find someone who has these three things and is ready to do an exchange. If I am unable to find such a person, then barter does not work for me. That demonstrates the utility of money.
The evolution of the concept of money, where a standardized commodity could be used as a medium of exchange, did away with the problems of barter. Also, money allowed people to specialize in things they were good at. People can work in areas they feel they are most suited to without having to worry about how to go about getting the other things that they might require to live a decent life. This specialization, in turn, leads to discovery and invention. The concept of money is at the heart of human progress.
You write that gold, which historically backed the value of coins or currency, “is valuable, because it is useless”. Can you explain this oxymoron?
That may sound oxymoronic, but it is not. Gold is highly malleable (it can be beaten into sheets), ductile (can be easily drawn into wires), and the best conductor of electricity. Despite these qualities, gold does not have many industrial uses like other metals have. This is primarily because there is very little of it around. Also, pure gold is as soft as putty, making it practically useless for all purposes that need metal.
Now, why am I making this point? It is important to understand that when commodities are used as money, they are taken away from their primary use. If rice or wheat is used as money for daily transactions and to preserve wealth, then there are lesser amounts of rice and wheat in the market for people to buy and eat. This, in turn, would mean higher prices of grains, which are staple food in large portions of the world. If a metal like iron is used as money, it is not available for its primary use.
Why is gold different?
Given the fact that it is extremely expensive, and that it does not have many industrial uses, the mere act of hoarding gold does not hurt anyone or infringe their rights. That “uselessness” also helps it to retain value.
Silver has lots of industrial uses. If one owns silver during a recession, chances are that the price of silver, and thus its purchasing power, would fall, because there would be less demand for silver for its industrial uses. The same would be true for metals like platinum and palladium which are also used for industrial purposes. Gold would not be impacted. As analyst Dylan Grice wrote in “A Minskian Roadmap to the Next Gold Mania“ (2009), “The price of gold will be unaffected by any decline in industrial demand because there is no industrial demand!” Hence, gold is useful because it is useless. This is paradoxical, but true.
What determines currency values now, and what causes them to crash, as was the case in the South East Asian crisis of 1997?
Paper currencies inherently do not have any value. What makes them money is the backing by the government that has issued them. Hence their designation as fiat currencies. One paper currency’s value vis-à-vis another to a very large extent depends on the economic strength of the issuing country. Before the South East Asian crisis, the Thai baht was pegged against the U.S. dollar: one dollar was worth 25 baht. Thailand’s central bank ensured that this rate did not vary. Hence, it sold dollars and bought baht when there was a surfeit of baht in the market and vice versa.
Once economic trouble broke out in Thailand’s and other regional currencies, investors exited them en masse. They exchanged baht for dollars to repatriate their money. In the normal scheme of things, with a surfeit of baht in the market, the value of the baht would have fallen. But the baht was pegged to the dollar. The Thai central bank kept intervening by selling dollars and buying baht. But it could not create dollars out of thin air. It ran out of dollars, and the peg snapped.
The baht was a piece of paper before the crisis. And it continued to be a piece of paper after the crisis. What changed was the economic perception people had of Thailand. As a result, the baht rapidly depreciated in value against the dollar.
What is the relevance today?
Central banks around the world have been on a money-printing spree since the late 2008. Between then and early February 2013, the U.S. Federal Reserve System expanded its balance sheet by 220%. The Bank of England did even better, at 350%. The European Central Bank came to the money-printing party a little late and expanded its balance sheet by around 98%. The Bank of Japan has been relatively subdued, increasing its balance sheet by 30% over the four-year period. But it is now printing a lot of money, planning to inject nearly $1.5 trillion into the Japanese money market by April 2015. This is huge, given that the size of the Japanese economy is $5 trillion.
One of the lessons from history is that money printing has never really ended well. It has inevitably led to disaster. But we don’t seem to have learned that lesson at all.
In a past interview, Dr. Ishrat Husain, former governor of the Central Bank of Pakistan, pointed out that if shareholders’ equity in a bank amounts to 8% of deposits, then 92% belongs to depositors, ang although excessive risks are taken with the depositors’ money, the upside gains are captured by the shareholders and managers. But, if they lose money, taxpayers have to bail them out. This “asymmetric relationship in incurring risk and appropriation of reward makes the financial sector more vulnerable to exogenous shocks.”
I totally agree with Dr Husain. I talk about this in some detail in “Easy Money.” Walter Bagehot, the great editor of The Economist, wrote in Lombard Street,“The main source of profitableness of established banking is the smallness of requisite capital.” This book was published in 1873. So things haven’t changed for more than a century. The low shareholders’ equity of banks makes the entire financial system very risky.
What would it take to mitigate that riskiness?
Anant Admati and Martin Hellwig explain this point beautifully in “The Bankers’ New Clothes” (2013).Let us say a bank has shareholders’ equity of 2%, as some had between 2007 and 2009. If the value of the assets falls by 1%, half of its equity is wiped out. The bank cannot issue any new equity. So what does the bank need to do, if it wants to move its shareholders’ equity back to 2%? If the bank has assets worth $100, its shareholders’ equity earlier stood at $2. If the value of these assets fell by 1%, the bank’s assets are now worth $99. Its equity is also down to $1. To increase shareholders’ equity back to 2%, assets must fall to $50 – meaning $49 worth of assets must be sold.
In times of trouble, a lot of banks need to do this, leading to a rapid fall in the value of their assets. This tells us that if banks have a little more equity, then they will need to sell a smaller amount of assets, which will make for a more stable financial system during times of trouble.
Therefore, shareholders’ equity in banks needs to go up. This is a no-brainer, the influence of Wall Street notwithstanding. 

 The interview was first published by the Global Association for Risk Professionals on February 06th 2014