Gold

Why Subbarao can’t cut rates; only Chidambaram can

 

P-CHIDAMBARAM
Vivek Kaul

If politicians and corporates are to be believed then India’s much beleaguered economy can be put back on track only if the Reserve Bank of India(RBI) brought down interest rates. The finance minister P Chidambaram did not mince words when he said in an interview to The Economic Times that “reduction in interest rates will certainly help get us to 6.5% (economic growth).” In another article in the Business Standard several CEOs (including those of real estate firms) have come on record to say that the RBI should cut interest rates in order to revive the economy. 
The RBI meets next on March 19. And both CEOs and politicians seem to be clamouring for a repo rate cut. Repo rate is the interest rate at which RBI lends to banks. So the logic is that once the RBI cuts the repo rate (as it did when the last time it met in late January) the banks will get around to passing that cut by bringing down the interest rates they charge on their loans. Given this people will borrow and spend more. They will buy more houses. They will buy more cars. They will buy more two wheelers. They will buy more consumer durables. Companies will also borrow and expand. All this borrowing and spending will revive the economic growth and the economy will grow at 6.5% instead of the 4.5% it grew at between October and December, 2012. And we will all live happily ever after. 
Now only if life was as simple as that. 
Repo rate at best is a signal from the RBI to banks. When it cuts the repo rate it is sending out a signal to the banks that it expects interest rates to come down in the time to come. Now it is up to the banks whether they want to take that signal or not. And turns out they are not. 
Several banks have recently been raising interest rates on their fixed deposits. Of course, if banks are raising interest rates on their deposits, they can’t be cutting them on their loans, given money raised from deposits is used to fund loans. And hence interest rates on loans has to be higher than those on deposits. Banks have raised interest rates despite the fact that the RBI cut the repo rate by 25 basis points (one basis point is equal to one hundreth of a percentage) when it last met on January 29, 2013. 
So why are banks raising interest rates when the RBI has given the opposite signal? The answer for that lies in the Economic Survey released on February 27, 2013. The gross domestic savings of the country were at 36.8% of the Gross Domestic Product (GDP) during the course of 2007-2008 (i.e. the period between April 1, 2007 and March 31, 2008). They had fallen to 30.8% of the GDP during the course of 2011-2012 (i.e. the period between April 1, 2011 and March 31, 2012). I wouldn’t be surprised if they have fallen further once figures for the current financial year become available. 
The household savings (i.e. the money saved by the citizens of India) have also been falling over the last few years. In the year 2009-2010 (i.e. the period between April 1, 2009 and March 31, 2010) the household savings stood at 25.2% of the GDP. In the year 2011-2012, the household savings had fallen to 22.3% of the GDP. 
What this means is that the country as a whole is saving lesser money than it was before. A straightforward explanation for this is the high inflation that has prevailed over the last few years. People are possibly spending greater proportions of their income to meet the rising expenses and that has lead to a lower savings rate. 
Interestingly the financial savings have been falling at an even faster rate than overall savings. As the Economic Survey points out “Within households, the share of financial savings vis-à-vis physical savings has been declining in recent years. Financial savings take the form of bank deposits, life insurance funds, pension and provident funds, shares and debentures, etc. Financial savings accounted for around 55 per cent of total household savings during the 1990s. Their share declined to 47 per cent in the 2000-10 decade and it was 36 per cent in 2011-12. In fact, household financial savings were lower by nearly Rs 90,000 crore in 2011-12 vis-à-vis 2010-11.”
One reason for this (explained in the Economic Survey) is that a lot of savings have been going into gold. And why have the savings been going to gold? The government would like us to believe that it is our fascination for gold that is driving our savings into gold. But then our fascination for gold is not a recent phenomenon. Indians have always liked gold. 
People buy gold as a hedge against inflation. When inflation is high the real returns on fixed income instruments are low. Real return is the difference between the rate of interest offered on let us say a fixed deposit, minus the prevailing rate of inflation.
As the Economic Survey puts it “High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising(gold) imports and falling real rates.” (As can be seen from the following table).
What this means is that when inflation is high, the real return on fixed income investments like fixed deposits is low. Consumer Price Inflation has been close to 10% in India over the last few years. And this has meant that investment avenues like fixed deposits have been made unattractive, leading people to divert their savings into gold. “The overarching motive underlying the gold rush is high inflation…High inflation may be causing anxious investors to shun fixed income investments such as deposits and even turn to gold as an inflation hedge,” the Economic Survey points out. 
What does this mean in the context of b
anks? It means that banks have had a lower pool of savings to borrow from. One because the overall savings have come down. And two because within overall savings the financial savings have come down at a much faster rate due to lower real rates of interest, after adjusting for inflation. This means that banks need to offer high rates of interest on their fixed deposits to make it attractive for people to deposit their money into banks. It is a simple case of demand and supply. 
And who is the cause for all the inflation that the country has seen over the last few years and continues to see? Not you and me. 
High inflation has been caused by the burgeoning subsidies provided by the government. The total subsidy in 2006-2007(i.e. The period between April 1, 2006 and March 31, 2007) stood at Rs 53,462.60 crore. This has gone up by nearly five times to Rs 2,57,654.43 crore for the year 2012-2013 (i.e. the period between April 1, 2012 and March 31, 2013).
All this expenditure of the government has landed up in the hands of people and created inflation. The Economic Survey admits to the same when it states “With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation.” So the Economic Survey equated the high government spending to inflation. 
The subsidy bill for the year 2013-2014 (i.e. the period between April 1, 2013 and March 31, 2014) is expected to be at Rs 2,31,083.52 crore. This is number seems to be underestimated as this writer has explained before. And so the inflationary scenario is likely to continue. 
Given that people will want to deploy their savings to other modes of investment rather than fixed deposits. And hence banks will have to continue offering higher interest rates to get people interested in fixed deposits. 
As the Economic Survey points out “The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance.” 
To conclude, there is very little that the D Subbarao led RBI can do to push down interest rates. In fact interest rates are totally in the hands of the government. If the government can somehow control inflation, interest rates will start to come down automatically. For that to happen subsidies in particular and the high government expenditure in general, will have to be controlled. And that is not going to happen anytime soon.

The article originally appeared on www.firstpost.com on March 4, 2013

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

Subsidies = Inflation = Gold problem

ES gold
The government has a certain theory on gold as per which buying gold is harmful for the Indian economy. Allow me to elaborate starting with something that P Chidambaram, the union finance minister, recently said “I…appeal to the people to moderate the demand for gold.”
India produces very little of the gold it consumes and hence imports almost all of it. Gold is bought and sold internationally in dollars. When someone from India buys gold internationally, Indian rupees are sold and dollars are bought. These dollars are then used to buy gold.
So buying gold pushes up demand for dollars. This leads to the dollar appreciating or the rupee depreciating. A depreciating rupee makes India’s other imports, including our biggest import i.e. oil, more expensive.
This pushes up the trade deficit (the difference between exports and imports) as well as our fiscal deficit (the difference between what the government earns and what it spends).
The fiscal deficit goes up because as the rupee depreciates the oil marketing companies(OMCs) pay more for the oil that they buy internationally. This increase is not totally passed onto the Indian consumer. The government in turn compensates the OMCs for selling kerosene, cooking gas and diesel, at a loss. Hence, the expenditure of the government goes up and so does the fiscal deficit. A higher fiscal deficit means greater borrowing by the government, which crowds out private sector borrowing and pushes up interest rates. Higher interest rates in turn slow down the economy.
This is the government’s theory on gold and has been used to in the recent past to hike the import duty on gold to 6%. But what the theory doesn’t tells us is why do Indians buy gold in the first place? The most common answer is that Indians buy gold because we are fascinated by it. But that is really insulting our native wisdom.
World over gold is bought as a hedge against inflation. This is something that the latest economic survey authored under aegis of Raghuram Rajan, the Chief Economic Advisor to the government, recognises. So when inflation is high, the real returns on fixed income investments like fixed deposits and banks is low. As the Economic Survey puts it “High inflation reduces the return on other financial instruments. This is reflected in the negative correlation between rising(gold) imports and falling real rates.”(as can be seen from the accompanying table at the start)
In simple English, people buy gold when inflation is high and the real return from fixed income investments is low. That has precisely what has happened in India over the last few years. “The overarching motive underlying the gold rush is high inflation…High inflation may be causing anxious investors to shun fixed income investments such as deposits and even turn to gold as an inflation hedge,” the Survey points out.
High inflation in India has been the creation of all the subsidies that have been doled out by the UPA government. As the Economic Survey puts it “With the subsidies bill, particularly that of petroleum products, increasing, the danger that fiscal targets would be breached substantially became very real in the current year. The situation warranted urgent steps to reduce government spending so as to contain inflation.”
Inflation thus is a creation of all the subsidies being doled out, says the Economic Survey. And to stop Indians from buying gold, inflation needs to be controlled. “The rising demand for gold is only a “symptom” of more fundamental problems in the economy. Curbing inflation, expanding financial inclusion, offering new products such as inflation indexed bonds, and improving saver access to financial products are all of paramount importance,” the Survey points out. So if Indians are buying gold despite its high price and imposition of import duty, they are not be blamed.
A shorter version of this piece appeared in the Daily News and Analysis on February 28, 2013
(Vivek Kaul is a writer. He tweets @kaul_vivek) 

Gold price falling? Why it’s still okay to buy the metal

goldVivek Kaul
Gold prices fell below Rs 30,000 per ten grams for the first time in seven months on February 21, 2013. Data from www.goldprice.org shows that the yellow metal has fallen by around 6.5% in dollar terms over the last 30 days. In rupee terms the fall has been a little lower at 5.7%.
This fall has meant that everyone who has been recommending gold (including this writer) have ended up with eggs on their face. But every forecast cannot be right all the time. There are situations when a forecast is wrong till it is proved right.
Allow me to explain. Every bull market has a theory. So why has the price of gold gone up over the last few years? The answer is very simple. Central banks around the world have printed a lot of money. This money has been pumped into the financial system with the hope that banks will lend it to people and businesses, who will then spend this money and thus help in reviving the economy.
The fear was that with all this extra money chasing the same number of goods and services, there would be a great rise in prices. To protect themselves from this rise in price and loss of purchasing power, investors around the world had been buying gold. This pushed up its price. Unlike paper money gold cannot be created out of thin air by the government and thus is looked upon as a hedge against inflation.
But the inflation is still to come. And so this theory which drove up the price of gold doesn’t seem to be working. As a result the price of gold has taken a beating. With no inflation there is really no reason for people to buy the yellow metal and protect themselves against loss of purchasing power.
As Gary Dorsch, Editor, Global Money Trends points out in a recent column “So far, five central banks, – the Federal Reserve, the European Central Bank, Bank of England, the Bank of Japan and the Swiss National Bank have effectively created more than $6-trillion of new currency over the past four years, and have flooded the world money markets with excess liquidity. The size of their balance sheets has now reached a combined $9.5-trillion, compared with $3.5-trillion six years ago.”
But even with so much money being printed there has been very little inflation. So money is being diverted to other asset classes rather than buying up what John Maynard Keynes referred to as the barbarous relic.
Also this lack of inflation has made central bank governors and politicians around the world victims of what Nassim Nicholas Taleb calls the great turkey problem. As he writes in his latest book Anti Fragile “A turkey is fed for a thousand days by a butcher; every day confirms to its staff of analysts that butchers love turkeys “with increased statistical confidence.””
With the butcher feeding it on a regular basis, the turkey starts to expect that the good times will continue forever and the butcher will continue feeding it. That is what seems to be happening with central bank governors and politicians around the world. The fact that all the money printing has not produced rapid inflation till now has led to the assumption that it will never produce any inflation. Ben Bernanke, the Chairman of the Federal Reserve of United States, the American central bank, has even gone to the extent of saying that he was 100% sure he could control inflation.
And using this conclusion central banks are printing even more money. This is like the lines from La Haine, a French film released in 1995 “Heard about the guy who fell off a skyscraper? On his way down past each floor, he kept saying to reassure himself: So far so good… so far so good… so far so good.”
But the person falling from a skyscraper has to hit the ground at some point of time. The good days of every turkey being reared by a butcher also comes to an end. As Taleb writes “The butcher will keep feeding the turkey until a few days before Thanksgiving. Then comes that day when it is really not a very good idea to be a turkey. So with the butcher surprising it, the turkey will have a revision of belief – right when its confidence in the statement that the butcher loves turkeys is maximal and “it is very quiet” and soothingly predictable in the life of the turkey.”
Or as the line from La Haine goes “How you fall doesn’t matter. It’s how you land!”
Similarly all the money printing has to end up somewhere. As Taleb puts it “central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.”
Or as James Rickards author Currency Wars: The Making of the Next Global Crises puts it “They can’t just keep printing…All major central banks are easing…Eventually so much money will be printed that this will lead to inflation.”
There is a reason to why the inflation is taking time even with governments around the world printing money rapidly. Henry Hazlitt has an explanation for it in his brilliant book, The Inflation Crisis and How to Resolve it.
In the initial stages of inflation, the man on the street does not know that the government is printing money and hence he has confidence in the paper money he is using. He does not think that the paper money is going to lose value anytime soon, and does not rush out to spend it. Gradually news starts to get around the government is printing money and this is when there is some rush to spend money before it loses its value. This is when prices start to go up at the rate at which money is being printed. In the final stage, as the central bank backed by the government of the day, continues to print money, people start to feel that this will continue indefinitely. And hence they try to get rid of paper money, as soon as they get it. This in turn leads to prices rising at a rate even faster than the rate at which money is being printed.
This is how most inflations evolve whenever governments print money at a very rapid rate.
Once the market starts discounting the idea of inflation, the price of gold will rise at a very rapid rate. But till that happens, people like me, who have and continue to recommend investing in gold, will look stupid. Also it is important to remember that every bull market has its bear runs. In the middle of the bull run in gold prices in the seventies gold prices fell by nearly 44%. The price of gold as of end of December 1974 was at $186.5 per ounce (one ounce equals 31.1 grams). By end of August 1976, it had fallen to $104 per ounce, or nearly 44.2% lower. But prices rallied again from there and peaked very briefly at $850 per ounce on January 21, 1980.
So as I said at the beginning forecasts can be wrong for a long time, till they are proven right. And when they are proved right, even for a brief period, its then when the ‘real money’ gets made.
Taleb talks about people who had been predicting a financial crisis in the developed world. There predictions were wrong for a very long till they were proven right. As he writes “You were wrong for years, right for a moment, losing small, winning big, so vastly more successful than the other way.”
Hence, I would still recommend buying gold, limiting it to around 10% of the overall portfolio or even lower, depending on how much money you are willing to back what is a particularly risky trade. Investment in gold has to be looked upon as a speculation on the continued printing of money and the eventual arrival of rapid inflation. This strategy can prove to be tremendously beneficial. As Taleb writes “If you put 90 percent of your funds in boring cash…and 10 percent in very risky, maximally risky, securities, you cannot possibly lose more than 10 percent, while you are exposed to massive upside.” Gold has to be played like that. 
The article originally appeared on www.firstpost.com on February 22, 2013
(Vivek Kaul is a writer. He can be reached at [email protected]. Nearly 14% of his investment portfolio is in gold through the mutual fund route. He continues to buy gold through the SIP route) 

Why Chidu and Subbu do not have much control over the fiscal deficit

P-CHIDAMBARAM
Vivek Kaul
In the past few pieces I have written about the huge amount of money being printed by central banks and governments all across the developed world. 
The Federal Reserve of United States, the American central bank, has expanded its balance sheet by 220% since early 2008. The Bank of England has done even better at 350%. The European Central Bank came to the party a little late and has expanded its balance sheet by around 98%. The Bank of Japan has been rather subdued in its money printing efforts and has expanded its balance sheet only by 30% over the last four years. But is now joining the money printing party and is looking to print as many yen as required to get an inflation of 2% going. 
The idea as I have mentioned in a couple of earlier pieces is to create some consumer price inflation to get consumption going again. As a greater amount of money chases the same amount of goods and services, the hope is to create some inflation. When people see prices going up or expect prices to go up, they generally tend to start purchasing things. This helps businesses as well as the overall economy. So by trying to create some inflation or at least create some inflationary expectations, the idea is to get consumption going again. 
But this trick practiced by central banks hasn’t worked. Inflation has continued to elude the developed world.
Central bank governors and governments when they decide to print money are essentially following the Chicago university economist Milton Friedman. Friedman had even jocularly suggested that a recessionary situation could be fought by printing and dropping money out of a helicopter, if the need be, to create inflation.
The idea behind this assumption is that just by dropping money out of a helicopter there will be in an increase in money supply and the inflation will be created. So in that sense it did not really matter who is standing under the helicopter when the money is dropped. But French economist Richard Cantillon who lived during the early eighteenth century showed that money wasn’t really neutral and it mattered where it was injected into the economy. In the modern sense of the term, it matters who is standing under the helicopter when printed money is dropped from it.
Before we get back to Cantillon, let me deviate a little.
Christopher Columbus wanted to discover the sea route to India. He went on his first journey to find India on the evening of August 3, 1492. Before that he had managed to negotiate a contract with King Ferdinand and Queen Isabella of Spain, which entitled him to 10% of all the profit
But he ended up somewhere else instead of India. An island he named San Salvador, which the locals called Guanahani. The question though is why did he want to go to India? It seems he had read the published accounts of Marco Polo and was very impressed by the wealth that lay in store in India.
Columbus made three more journeys in search of a sea route to India, but never found it. In the end, it didn’t really matter, because the Spaniards found what they were looking for: gold and silver, in ample amounts. Though not in India, as was the original plan, but in what came to be known as the “New World” immediately and South America a little later. Within half a century of Columbus’ first expedition, the Spaniards had found most of the treasure that was to be found in the New World.
With all this silver/gold coming into Spain from the New World there was a sudden increase in money supply and that led to inflation in Spain. Richard Cantillon studied this phenomenon and made some interesting observations.
What he said was that when money supply increased in the form of gold and silver it would first benefit the people associated with the process of money creation, the mining industry in general and the owners of the mines, the adventurers who went looking for gold and silver, the smelters, the refiners and the workers at the gold and silver mines, in particular.
These individuals would end up with a greater amount of gold and silver i.e. money, before anyone else. This money they would spent and thus drive up the prices of meat, wine, wool, wheat etc. This new money would be chasing the same amount of goods and thus drive up prices.
This rise in prices would impact people not associated with the mining industry as well, even though there incomes hadn’t risen like the incomes of people associated with the mining industry had. As Dylan Grice an analyst formerly with Societe Generale told me a few months back “The problems arise for other groups. Anyone not involved in the production of money or of the goods the newly produced money purchased, but who nevertheless consumed them – a journalist or a nurse, for example – would find that the prices of those goods had risen while their incomes hadn’t.”
This is referred to as the Cantillon effect. “Cantillon, writing before the days of Adam Smith, was the first to articulate it. I find it very puzzling that this insight has been ignored by the economics profession. Economists generally assume that money is neutral. And Milton Friedman’s allegory about the helicopter drop of money raising the general price level completely ignores the question of who is standing under the helicopter,” said Grice.
The money printing that has happened in recent years has unable to meet its goal of trying to create consumer price inflation. But it has benefited those who are closest to the money creation like it had in Spain. In the present context, this basically means the financial sector and anyone who has access to cheap credit (i.e. loans).
Institutional investors in the developed world have been able to raise money at close to zero percent interest rates and invest that money in financial assets all over the world, and thus driven up their prices. As Ruchir Sharma writes in Breakout Nations – In Pursuit of the Next Economic Miracles:
What is apparent that central banks can print all the money they want, they can’t dictate where it goes. This time around, much of that money has flown into speculative oil futures, luxury real estate in major financial capitals, and other non productive investments…The hype has created a new industry that turns commodities into financial products that can be traded like stocks. Oil, wheat, and platinum used to be sold primarily as raw materials, and now they are sold largely as speculative investments. Copper is piling up in bonded warehouses not because the owners plan to use it to make wire, but because speculators are sitting on it…figuring that they can sell it one day for a huge profit.
Other than this all the money printing has also led to stock markets across the world reaching levels they were at before the financial crisis started. Investment banks and hedge funds have borrowed money at very low interest rates and invested it all over the world.
This has led to an increase in price of oil as well, something that impacts India majorly. Currently one basket of Indian crude costs around $108 per barrel. The Indian government hasn’t passed on this increase in oil prices to the Indian consumer and sells products like diesel, petrol, kerosene as well cooking gas at a loss.
The losses thus faced by the oil marketing companies on selling diesel, kerosene and cooking gas are compensated for by the government.
This means increased expenditure for the Indian government and thus a higher fiscal deficit. Fiscal deficit is the difference between what the government earns and what the government spends.The other impact because all this money printing has been an increase in price of gold. Investors all over the world have been buying gold as more and more money is being printed. The Indian investors are no exception to this rule. India produces very little gold of its own. Hence, most of the gold being bought in India needs to be imported. When these imports are made India needs to pay in dollars, because gold is bought and sold in dollars internationally.
In order to pay in dollars, India needs to sell rupees and buy dollars. This means that there is an increase in the supply of rupees in the market, and the rupee loses value against the American dollar.
A little over a year back one American dollar was worth Rs 49. It touched around Rs 57 by the middle of 2012. Currently one dollar is worth around Rs 53.5.
When the rupee loses value against the dollar it means that India has to pay more in rupees for the imports it makes. India’s number one import is oil. Hence, with the rupee losing value against the dollar over the course of the last one year, India has been paying more for the oil being imported in rupee terms.
This has in turn has led to increasing government expenditure and therefore a higher fiscal deficit. A higher fiscal deficit means that the government has had to borrow more and that in turn has meant higher interest rates as well. This explains to a large extent why the government has in recent times tried to control the import of gold by increasing the duty on it and thus control the value of the rupee against the dollar.
What this entire story tells us is that the likes of P Chidambaram and D Subbarao have far lesser control over the Indian economy and the fiscal deficit of the government, there attempts to prove otherwise notwithstanding. So as long as the Western world continues to print money prices of oil and gold will continue to remain high. Hence, that Indians will continue to buy gold and the oil bill will continue to remain high.
The article originally appeared on www.firstpost.com on February 12, 2013
(Vivek Kaul is a writer and he can be reached at [email protected])
 

Chidambaram should realise that gold is useful because it is useless

P-CHIDAMBARAM
 Vivek Kaul
Gold bashing seems to have become the favourite pastime of finance minister P Chidambaram these days. He has repeatedly warned Indians to get over their fascination for gold.
But Mr Chidambaram does not know his history well enough. If he did he wouldn’t be saying the things that he has been.
Gold over the centuries became universal money and there were several reasons for the same. It is not fragile and is durable. It does not rot. It is chemically inert unlike copper, silver and iron, which means its radiance is timeless.
Given its chemically inert nature most of the gold mined since eternity is still around. Estimates suggest that the world has 1,65,000 tonnes of gold. The supply of gold rarely goes up suddenly.
A report released by Standard Chartered in 2011, expected the supply of gold to go up at the rate of 3.6% per year between 2011 and 2015, suggesting the stable supply of the yellow metal. In a bear case scenario the report said that the supply would grow at an even slower rate of 1.2% per year. The price of gold has rallied over the last 2 decades even then there has hardly been any significant growth in supply of gold, with production going up at the rate of minuscule 0.7% per year. During the period 1900 to 1990 the production of gold grew at the rate of 1.9% per year.
This has historically held good as well. Since 1492, the supply of gold has never gone up by more than 5% in any given year. In fact, during the normal course of things gold supplies have grown between 1 to 2% every year. The exception to this is when new gold discoveries happen and lead to a gold rush. These are the only occasions, as was the case with California and Australia in the 1850s or South Africa in the 1890s, when gold supplies went up faster than 4% per year. With the supply of gold being limited, what it means is that it has held its value much better than other forms of saving money over the centuries.
Gold is 20 times as dense as water and twice as dense as lead, which means a lot of it can be packed into a very small size. One cubic metre of gold would weigh around 19.3 metric tonnes (i.e. 19,300 kilograms). What this means is that very high value of money can be easily moved around if it’s in the form of gold.
When it came to rarity something like a diamond or a ruby was a better bet. But figuring out the quality of a diamond and other stones was difficult. Experts could easily haggle on it, with different experts having a different opinion. When it came to gold such problems did not exist.
As Aristotle, the Greek philosopher and teacher of Alexander the Great put it “It became necessary to think of certain commodities, easily manageable, safely transportable, and of which the uses are so general and so numerous, that they insured the certainty of always obtaining for them the articles wanted in exchange.” Gold had all these qualities.
And that’s how over the centuries gold emerged as money that everyone preferred to use. What also helped was the “uselessness” of gold. Despite the fact that it is highly malleable (can be beaten into sheets easily) and ductile(can be easily drawn into wires) and the best conductor of electricity, gold does not have many industrial uses like other metals like silver have primarily because there is very little of it going around.
Also when commodities are used as money they are taken away from their primary use. So if rice or wheat is used as money for daily transactions and to preserve wealth, it means a lesser amount of rice and wheat in the market. This in turn would mean higher prices of grains which are staple food in large parts of the world. Gold doesn’t have many practical uses. So if people hoard gold, it doesn’t hurt anyone.
As the blogger FOFOA put it, “Gold’s utility is that for thousands of years it has held its value relatively well. And because it is not used for many things other than mere hoarding, the act of hoarding gold is not an infringement on the natural rights of others to enjoy the utility value of “real world” things like BMW’s and oil and wheat… If one were to corner, say, the copper market or the chocolate market, there would likely be repercussions as those industries fought back through the power of the collective that likes to consume chocolate and copper. But with gold there is no such worry.”
Gold started giving away to simple paper money at the start of the First World War in 1914. While it did make a few comebacks as money over the years, the world moved onto a complete paper money system in the early 1970s.
What this did was that it allowed governments around the world to print as much money as they wanted to. And this has led to paper money rapidly losing its purchasing power over the years. Things have become particularly worse since the start of the financial crisis in September 2008. The government of Western nations have been printing more and more paper money and pumping it into their financial systems. This was been done in the hope that their citizens will spend that money, which will help revive their economies.
Given that the global money supply has increased dramatically over the last few years, there is a grave danger that paper money will lose value rapidly in the years to come. And this has led to people buying gold all over the world which is seen as the ultimate store of value.
People in India have bought gold because of this reason as well. The other reason has been our high rate of inflation which has led to the purchasing power of the rupee going down dramatically, motivating people to buy gold which is seen as a commodity which holds its value relatively well.
And the good part is that people in India have been buying ‘hoarding’ gold to ensure that the value of their accumulated wealth does not fall.
Imagine if they had tried to hold wealth in the form of rice or wheat. In a world where nearly 79 million people are being added to the dinner table every year (and a lot of them in India), hoarding rice and wheat could have caused food riots. Imagine if all the Indians would have actively speculated on metals used across industries. There prices would have gone through the roof. (in fact with huge demand for industrial metals from China these metals had been rallying for the last few years. Imagine what would have happened to the price if Indians had started actively speculating in them?)
So its good that people are buying gold to hoard their wealth and not something which is actually useful. As FOFOA puts it “Thankfully we have a commodity that is mostly used for hoarding, and little else. Like Warren Buffet said, we dig it up and then bury it again in a vault. And all it does is one little thing: it maintains its value over thousands of years. That’s gold’s utility.”
And Mr Chidambaram should thank his stars for that.
References: 
Chen,Y and others. 2011. In Gold We Trust. Standard Chartered
Bernstein, P. 2000. The Power of Gold – The History of an Obsession. John Wiley and Sons.
FOFOA. 2010. The Value of Gold. Available at www.fofoa.blogspot.com
Skousen, M. 2010. Economics of a Pure Gold Standard. Foundation for Economic Education
The article originally appeared on www.firstpost.com on January 10, 2013.
(Vivek Kaul is a writer. He can be reached at [email protected])