Rupee debacle: UPA should stop blaming gold for screw up

goldVivek Kaul

How do I define history?” asked Alan Bennett in the play The History Boys, It’s just one f@#$%n’ thing after another”.
But this one thing after another has great lessons to offer in the days, weeks, months, years and centuries that follow, if one chooses to learn from it.
Finance minister P Chidambaram and other fire fighters who have been trying to save the Indian economy from sinking, can draw some lessons from the experience of the Mongols in the thirteenth and the fourteenth century.
The Mongol Empire at its peak, in the late 13th and early 14th century, had nearly 25 percent of the world’s population. The British Empire at its peak in the early 20th century covered a greater landmass of the world, but had only around 20 percent of its population. The primary reason for the same was the fact that the Mongols came to rule all of China, which Britain never did.
In 1260 AD, when Kublai Khan became King, there were a number of paper currencies in circulation in China. All these cur­rencies were called in and a new national currency was issued in 1262.
Initially, the Mongols went easy on printing money and the supply was limited. Also, as the use of money spread across a large country like China, there was significant demand for this new money. But from 1275 onwards, the money supply increased dramatically. Between 1275 and 1300, the money supply went up by 32 times.By 1330, the amount of money in supply was 140 times the money supply in 1275.
When money supply increases at a fast pace, the value of money falls and prices go up, as more money chases the same amount of goods. As the value of money falls, the government needs to print more money just to keep meeting its expenditure. This leads to the money supply going up even more, which leads to prices going up further and which, in turn, means more money printing. So the cycle works. That is what seems to have happened in case of Mongol-ruled China.
Gold and silver were prohibited to be used as money and paper money was of very little value as the various Mongol Kings printed more and more of it. Finally, the situation reached such a stage that people started using bamboo and wooden money. This was also prohibited in 1294.
What this tells us is that beyond a certain point the government cannot force its citizens to use something that is losing value as money, just because it deems it to be so. By the middle of the 14th century, the Mongols were compelled to abandon China, a country, they had totally ruined by running the printing press big time.
There is a huge lesson here for Chidambaram and others who have been trying to put a part of the blame on the fall of the rupee against the dollar because of our love for gold. The logic is that Indians are obsessed with buying gold. Since we produce almost no gold of our own, we have to import almost all of it. And every time we import gold we need dollars. This sends up the demand for dollars and drives down the value of the rupee.
This logic has been used to jack up the import duty on gold to 10%. 
But as Jim Rogers told the Mint in an interview “Indian politicians…suddenly blamed their problems on gold. The three largest imports to India are crude oil, gold and cooking oil. Since they can’t do anything about crude and vegetable oil, the politicians said India’s problems were because of gold, which, in my view, is totally outrageous. But like all politicians across the world, the Indians too needed a scapegoat.”
The question that no politician seems to be answering is, why have Indians really been buying gold, over the last few years? And the answer is ‘high’ inflation. As we saw in Mongol ruled China, it is very difficult to force people to use something that is losing value as money. And rupee has constantly been losing value because of high inflation.
High inflation has led to a situation where the purchasing power of the rupee has fallen dramatically over the last few years. And given that people have been moving their money into gold. As Dylan Grice writes in a newsletter titled 
On The Intrinsic Value Of Gold, And How Not To Be A Turkey “Now consider gold. In ten years’ time, gold bars will still be gold bars. In fifty years too. And in one hundred. In fact, gold bars held today will still be gold bars in a thousand years from now, and will have roughly the same purchasing power. Therefore, for the purpose of preserving real capital in the long run, gold has a property which is unique in comparison with everything else of which we know: the risk of a loss of purchasing power approaches zero as one goes further into the future. In other words, the risk of a permanent loss of purchasing power is negligible.”
And this is why people are buying gold in India. Gold is the symptom of the problem. Take inflation out of the equation and gold will stop being a problem, though Indians might still continue to buy gold as jewellery. But creating ‘inflation’ is central to the politics of the Congress led UPA. Now that does not mean that people need to suffer because of that? Especially the middle class. As M J Akbar 
put it in a column in The Times of India “Gold is the minor luxury that a confident economy purchases for its middle class. The cost of gold imports has become a problem only because the economy has imploded.”
Nevertheless people need to protect themselves against the inflationary policies of the government. “Historically, people have understood money’s intrinsic value when they have been forced to, when alternative monies have been rendered unfit for purpose by persistent debasement,” writes Grice.
In ancient times Kings used to mix a base metal like copper with gold or silver coins and keep the gold or silver for themselves. This was referred to as debasement. In modern day terminology, debasement is loss of purchasing power of money due to inflation.
Given this, people will continue to buy gold. The buying may not show up in the official numbers because a lot of gold will simply be smuggled in. 
A recent Bloomberg report quoted Haresh Soni, New Delhi-based chairman of the All India Gems & Jewellery Trade Federation as saying “Smuggling of gold will increase and the organized industry will be in disarray.”
And other than leading to a loss of revenue for the government, it might have other social consequences as well. As Akbar wrote in his column “If we are not careful we might be staring at 1963, when finance minister Morarji Desai imposed gold control to save foreign exchange. Desai, and a much-weakened prime minister, Jawaharlal Nehru, could issue orders and change laws but they could not thwart the Indian’s appetite for gold, even when he was in a much more abstemious mood half a century ago. All that happened in the 1960s was that the consumer turned to smugglers. From this emerged underworld icons like Haji Mastan, Kareem Lala and their heir, Dawood Ibrahim. India has paid a heavy price, including the whiplash of terrorism.”
Maybe the new Dawood Ibrahims and Haji Mastaans are just about starting up somewhere.
The piece originally appeared on on August 20, 2013

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

Why the new bear market theory in gold is all wrong

goldVivek Kaul
An old theory about bull markets is that every bull market has a theory behind it. This was true about the bull market in gold which started in 2002 and ran for almost ten years till late 2011. The price of gold during this period went up from around $280 per ounce (one troy ounce equals 31.1 grams) in January 2002 to around $1895 per ounce in September 2011.
The gold bull market had essentially two theories driving it, at different points of time. Between 2002 and September 2008, gold rallied because there was the fear of the American financial system collapsing, as the American citizens went piling on debt to buy new homes, only to sell them after a short period of time.
The American financial system came close to collapse. And some time later it was revealed that Europe was heading towards a similar and a bigger mess. Central banks around the world tried to stem the rot by printing truck loads of money. This money was first used to save the various financial institutions and banks which were on the verge of collapse.
After the governments had managed to save the financial institutions from collapsing, the next lot of money printing was carried out to revive their respective economies. The hope was that by pumping more and more money into the economy, the governments would be able to ensure that there was ample money supply in the economy.
This would ensure low interest rates, leading to people borrowing and spending more, and banks lending more. This spending would lead to people buying more homes, automobiles, consumer goods and so on, helping businesses make more money and thus help revive the overall economy. Low interest rates would also help people to re-finance their homes loans, leading to lower equated monthly instalments(EMIs). The money thus saved would be spend on other things and thus add to economic growth.
The danger here was that all this excess money floating around could chase the same number of goods and services, and lead to very high inflation, as had happened in the past. To hedge against this risk, investors started moving their money into gold.
The investment in gold comes with the belief that gold retains its purchasing power over long periods of time. As Nick Barisheff President and CEO of 
Bullion Management Group Inc and the author of$10,000 Gold: Why Gold’s Inevitable Rise Is the Investor’s Safe Haventold Firstpost in a recent interview “It took 66 ounces of gold to buy a compact car in 1971. Today it would take about 10 ounces. We can see the same ratio with houses…Today you can buy 3 average size houses for the same amount of gold you would have needed to buy 1 house in 1971 even though the prices of houses have risen significantly in dollar terms since then. That’s how gold serves as a hedge against inflation and maintains its purchasing power.”
With investors buying gold to hedge the risk of high inflation, the price of the yellow metal went up from $780 per ounce in mid September 2008 to around $1895 per ounce in early September 2011, which meant an absolute return of 143% over a three year period.
The price of gold has fallen since September 2011, and as I write this it quotes at around $1410 per ounce. With this fall, we now have a new theory being bandied around. And its now being said that gold rallied 
all these years on a misunderstanding.
As per this new theory, those investing in gold have got it all wrong. The fundamental argument about investing in gold is that excess money printing leads to high inflation and to hedge against that inflation investors buy god. But this time around the argument doesn’t really hold, we are now being told. This is because the world is in the midst of a balance sheet recession.
The term balance sheet recession has been coined by the Japanese economist Richard Koo. He feels the situation in the United States and almost all of Europe is very similar to as it was in Japan when the stock market bubble as well as the real estate bubble burst in 1990.
In a balance sheet recession a large portion of the individuals who had taken on loans to be a part of a bubble (real estate in case of America as well as Europe and real estate as well stock market in case of Japan), start saving more to repay their loans. When this happens they are not spending as much as they were in the past. This means incomes of businesses come down, which slows down economic growth as well.
Governments try to revive this economic growth by printing and pumping more money into the economy. This is done in the hope that interest rates will remain low, and encourage people to borrow and spend more. This spending will in turn create economic growth. The trouble is that people are in the saving mode and no mood to borrow and spend.
This also means that all this money that has been printed continues to remain in the vaults of banks. And when that happens, the situation where more and more money chases the same amount of goods and services, leading to higher prices and inflation, doesn’t really come around.
And when there is no high inflation there is no point in buying an asset as useless as gold is.
Hence, there is a fundamental flaw in the reason why people have been buying gold. This is one of the new bear market theories in gold, being bandied around.
There are multiple problems with this approach. First and foremost, the theory has come around only after the price of gold has fallen. Over and above that governments all around the world have been printing money in the hope of maintaining low interest rates and people borrowing and spending more. They have also been printing money in the hope of creating some inflation. When prices are rising or are expected to rise, there is a greater chance of people getting out in the market and buying stuff, so that they don’t have to pay more in the days and months to come.
But this hasn’t really worked because there is a balance sheet recession on. Central banks and governments have tried to solve this by printing even more money. But inflation hasn’t shown up in the official numbers as yet.
As Jeff Nielson, Editor of puts it “The premise is that you can print infinite quantities of paper; but as long as you hive-off that money-printing from the “broader economy” there (supposedly) will be no inflationary impact.”
So governments can print all the money that they want but there will be no inflation, as long as the money is lying in bank vaults. The question is that if money is to lie in banks vaults only and not lent out, then why print it in the first place?
Also, just because people are not borrowing doesn’t mean all the money being printed is not being put to use. As Nielson explains “What is meant by hiving-off this money-printing? Giving every penny to bankers, and letting them gamble with it in their (private, unregulated) derivatives casino, or hold government bonds for the interest arbitrage.”
So bankers and financial institutions are borrowing this money at close to 0% interest rates and speculating in different kinds of investments and markets around the world. This also explains to a large extent why stock markets around the world have been doing stupendously well, even though the global economy has been stagnating. It has also led to bankers and financial institutions buying government bonds, and thus helping governments borrow money at close to 0% interest rate. All this obviously isn’t reflected in the official inflation numbers.
The other trouble is the way in which official inflation numbers are calculated. The consumer price index which measures inflation is looked at as a definitive measure by economists. But there are problems with the way it is constructed. As a recent report titled 
Gold Investor: Risk Management and Capital Preservation released by the World Gold Council points out “The weights that different goods and services have in the aforementioned indices do not always correspond to what a household may experience. For example, tuition has been one of the fastest growing expenses for US households but represents only 3% of CPI (consumer price index). In practice, tuition costs correspond to more than 10% of the annual income even for upper-middle American households – and a higher percentage of their consumption.”
An August 2012 World Bank report said between June 2012 to July 2012, corn and wheat prices had risen by 25%. While soybean prices had increased by 17%. During this period inflation in the United States was close to 0%. This led Nielson to quip that “total inflation was supposedly at absolute-zero among the obese U.S. population. Did nobody eat that month…?”
Famed investor Jim Rogers 
summarised this best in an interview when he said “if you shop in the U.S., you know that there is inflation – whether it’s taxis or tolls or insurance or education or entertainment or food. I mean, the price of everything is going up. It’s only the U.S. Government that says prices aren’t going up…Go and try to buy something. Go see that there is inflation in the U.S. just as there is everywhere else.”
Then there are also methodological changes that have been made to the consumer price index and the way it measures inflation over the years, which in practice do not always reflect the full erosion of the purchasing power of money. If inflation in the United States was still measured as it was in the 1980s, it would be now close to 10% instead of the official 2%.
So yes there is a lot of inflation, it is just that it is not showing up in the government numbers (
This link gives a detailed argument). Nielson makes another fundamental point. He says “For me the perversity of the mainstream media acknowledging all the money-printing but refusing to acknowledge currency-dilution is even more fundamental. All of these people are reporting on markets. If a company dilutes its share structure through excessive printing of shares; all of these same analysts would immediately recommend fleeing that company because of “dilution.””
But the same analysts don’t do that when governments print money. “Fiat currencies(i.e. Paper money) are literally nothing but the equivalent of “shares” in our overall economy. Yet when our currencies are 
diluted (through exponentially increasing money-printing) the concept of “dilution” is — supposedly — impossible for any of these analysts to comprehend,” says Nielson.
As economist Milton Friedman (who was no gold bug) wrote in 
Money Mischief – Episodes in Monetary History: “Inflation occurs when the quantity of money rises appreciably more rapidly than output, and the more rapid the rise in the quantity of money per unit of output, the greater the rate of inflation. There is probably no other proposition in economics that is as well established as this one.”
To conclude, its worth remembering that just because money printing by government hasn’t produced official inflation till date, doesn’t mean that there will be no high inflation in the time to come. We simply don’t know. And that is something worth remembering.
(The article originally appeared on on June 4, 2013)

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